Relevant and even prescient commentary on news, politics and the economy.

Photographing Phantom Invisible Bond Vigilantes

Robert Waldmann

A specter is haunting Paul Krugman — it is the specter of apparently sophisticated forecasters who predict a huge spike in US long term bond rates in the near future. He notes that most investors can’t believe this or rates would already be high. He also notes that some of those who are predicting a spike seem to be top advisors somewhere in the Obama administration.

He is puzzled by this phenomenon. I just note that it is not new at all. Basically such apparently sophisticated people predicting a spike in long term US interest rates are (almost) always with us. So far they have always been wrong. This issue is extensively researched by Nazaria Solferino et al in an article forthcoming in the journal of forecasting.

The phantom invisible bond vigilantes are not a new phenomenon. Consider Blue Chip Forecasts TM an organization which aggregates forecasts of, among other things, rates on Treasury bonds.

Usually there are some forecasters who predict that long term US interest rates will spike in the near future. There isn’t one such chicken little in the blue chip TM sample every month, but there is most months.

The interesting thing is that, so far, they have always been wrong. In an article forthcoming in The Journal of Forecasting Nazaria Solferino and I show that is it is possible to use a very simple formula to identify 1082 forecasts of US 30 year interest rates which are too high without one single solitary error so far. That’s a record of 1082 to zero (so far). The vast majority of the forecasters in the sample made such an incorrect prediction of a long term interest rate spike at least once. See

There is no such fat tail of always wrong bond doves and almost no such 100% (so far) identifiable errors in forecasts of short and medium term interest rates.

Basically, phantom bond vigilantes are always with us. Almost always someone is convinced that the US is heading to high sustained inflation and that everyone else will agree a few months from now. It is an astounding feature of forecast data.

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How Do We Predict Inflation?

Ken Houghton notes that playing with data is dangerous.

Predicting the future tends to be easy. There are several ways to do it. First, you can predict that everything will grow as it did this year—or last year, or the mean of the past x years. Or you can predict that it will be great if a Republican is in office, but horrible if a Democrat is. (Call this The Kudlow Effect.)

Or, you can just predict that everything next year will be the same as it is this year.

This appears to be fairly close to what consumers do, judging by this scatterplot of annual inflation (i.e., inflation over the previous twelvemonth) against the University of Michigan’s median expectation from consumer surveys.

So the “Rational Agent” believes that nothing will change. Comments?

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Comment woes.

Js-kit has some comments embedded in the post, at the bottom of each post after clicking on the title of the post you want to read. There is a disconnect with the blue comment link at the top of the post (blogger comment format). Very inconvenient. Sorry.

Update: Blogger and js-kit are synchronized in ‘below the post comment form’. I believe all comments have been included. Yeah me. I can synchronize in pop up window as well, but it lacks any versatility.
Any preferences for a day or two?

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The Phantom Menace

Robert Waldmann

The one by Paul Krugman is a must read.

what I hear is that officials don’t trust the demand for long-term government debt, because they see it as driven by a “carry trade”: financial players borrowing cheap money short-term, and using it to buy long-term bonds.


the remedy should be financial, not fiscal. Have the Fed buy more long-term debt; or let the government issue more short-term debt.

That does sound rather obvious doesn’t it ? Why aren’t they doing that ?
My guesses after the jump.

I assume you have read Krugman’s post. The very brief recap is that someone in the Obama administration does not want to count on carry traders to short short term bonds and hold long term bonds, yet they are not arguing that the Fed or the Treasury should do that directly.

I can only guess that the Treasury has strict taboos against this sort of thing and I further guess that the origin of the taboo is that fiscal honesty requires the Treasury to act like a private firm.

A private firm that issued a huge amount of short term debt to finance medium and long term liabilities is vulnerable to bankruptcy. The firm has to roll over it’s short term debt. A prophecy that it will fail to do so will be self fulfilling. For a private firm, issuing a huge amount of short term debt and counting on being able to roll it over is reckless.

I guess that some permanent employees at Treasury have a very strong rule that the correctly stated Federal deficit is the deficit it would have if it followed similar rules to a private firm. Counting the cost of carrying debt long term at the short term interest rate is cheating. The Treasury has to constantly fight politicians who want to cheat and understate the deficit. This temptation can only be resisted by strong taboos and bogus arguments based on wildly overstating the risk the Treasury will go bankrupt.

Another issue is the perpetual war between the political staff which wants high spending and low taxes and economic advisors and the Treasury and which wants a low deficit. Polls are showing strong public concern about the deficit and a desire for lower deficits causing the political staff to switch sides. Economists who have been warning of the dangers of deficits are reluctant to reverse field. In particular, people are reluctant to admit that arguments which they made in support of low deficits are and were bogus. Economists are reluctant to admit that their predictions were dead wrong. They are tempted to argue “It hasn’t happened yet, but it will soon.” A well known Obama administration economist has been predicting a sharp rise in interest rates on Treasury bonds for a while now.

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Quantitative Easing

Robert Waldmann

Can the Fed do any more to stimulate the economy ? The question is back. The answer is only by making credible promises about the fairly distant future. My view is that this means no. I review the issue after the jump.

Long ago Paul Krugman proposed that the Bank of Japan target inflation. In the new millennium this is called quantitative easing. The idea is that when an economy is stuck in a liquidity trap, the real interest rate can only be cut by causing expected inflation. The monetary authority can achieve this by promising to cause inflation when it can. It can only after the economy is out of the liquidity trap. So only if the monetary authority can pre-commit to high inflation when things are back to normal and it will want low inflation, can it stimulate investment in an economy in a liquidity trap.

The argument (due to Krugman of course) is that right now the monetary authority can only push on a string. Private agents are willing to hold unlimited amounts of money given the current short term safe interest rate of almost exactly zero. Only when agents want to do something else with their wealth will it be possible to cause inflation by pouring in more money than people are willing to hold at current prices.

The proposal is that the Fed pump huge gigantic amounts of money into the economy (oops it has already) *and* promise not to buy that money back when prices finally start rising. I quote Brad DeLong

Quantitative easing–pouring a whole bunch of cash in the system with the idea of never reversing the money stock expansion could boost spending and employment considerably by creating expectations of inflation and so reducing the spread–but the Federal Reserve is not going there, and regards the idea with horror, shock, and shame.

I note that the first step, pouring a whole bunch of cash, has been done already and that it isn’t needed for the scheme to work. The Fed doing nothing with the idea of pumping a whole bunch of cash in the system when unemployment is back to normal would work just as well.

Brad also has another approach

I do wonder how much good would be done if the FOMC were simply to stand up and announce that they were raising their long-term GDP-deflator inflation target from 2% to 3%. It might do a lot of good. And it is certainly something the Fed could do without cracking its credibility as committed to low inflation.

It might, but it might not. The Fed can’t keep inflation as high as 2%. The announcement is an announcement about policy in the distant future.

OK assume that the Fed has a precommitment technology so it can set future policy now. Should it commit to higher inflation ?

This is a purely academic deeply hypothetical question. I love those. I have two arguments for no.

1) First a major effect of promising inflation in the future is to drive down the dollar. This would help the US economy at the expense of other countries. One of those countries is called China which is investing huge amounts of Yuan in an effort to keep up the dollar. A Fed vs People’s bank of China war over the exchange rate is a terrifying prospect. Basically the Fed might win, the PBC decide to cut it’s losses by shifting to Euros and suddenly US nominal interest rates are very very far from zero.

Recall what Ben Bernanke used to do. He studied the depression. One lesson is that competitive devaluations were a very bad policy for everyone. He must be thinking of that lesson. I’m sure he is trying to maintain exchange rate peace in our time with the PRC.

2) Aside from that, the policy only works if managers and/or shareholders are smart and managers care about the long term interests of shareholders. That is it works if pigs fly.

The policy is to have inflation low to negative until the unemployment rate returns to normal (because there is no way to avoid this) then have high inflation once it returns to normal (by making unemployment lower than the NAIRU). This means that long term bonds will be cheap (have high yield) and that the return from holding them will be lower than the stated yield (their market price won’t rise steadily as maturity approaches but rather will stay the same until the economy exits the liquidity trap).

The assumption is that firms decide how much to invest based on demand and long term real interest rates. This simple formula fits the post wwII data. However, for that period current inflation is a reasonable forecast of future inflation. The proposal is to make a rapidly changing path of expected inflation. The effect of such expectations on investment can’t be determined from available data.

The argument for investing is that the firm can issue say a 10 year bond and invest in real capital and in 10 years, much of the real value of the bond will be inflated away. For this to work, managers have to believe what the Fed says about monetary policy 3 to 10 years from now *and* they have to care. That is not the way in which managers manage (and they admit it). Larry Summers did a survey once. Many CEOs actually responded. The average response was something like

” to decide whether to make an investment we construct an estimate of the effect of the investment on accounting profits equal to sales plus net inventory investment minus spending on labor, materials and excise taxes, then we discount that flow at an annual rate of 30% and see if the number is positive. If the result is positive we invest”. 30% ! They said they had an extreme short term bias. They also care about accounting.

The inflation targeting proposal is that one should invest, even if one only cares about the short term, as one will gain as the value of debt rises less quickly than the calculated yield on debt. That one can write down the debt marking it to market. This does not work. Investors do not want shares of a firm which claims profits because its own debt has lost market value. The firm’s debt loses market value as the risk of bankruptcy increases. In this case, it is losing value (compared to a silly forecast) because of increasing expected inflation. However, the approach to accounting is one to avoid like the plague.

The firms will gain overt the life of the bond, but they won’t be able to tell investors this in the medium future. The policy should cause increased investment but, in the real world, I think it won’t.

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I Blame This on the NHL

With all the talk of “Detroit,” you would think that Michigan would have lost the most employees, as a percentage of same, on the year. After all, the scariest graph of the U.S. MSAs isn’t scary for nothing.

But the Regional and State Employment data is out for October (h/t CR), and there’s a different leader.

Apparently, the bursting of the Sunbelt Bubble (building expensive houses in the absence of a water table; what could go wrong?) compares well with destroying unionized automobile production. (Note to Senator Shelby: destroying Detroit didn’t keep your state from being #10 on the list.)

Also note that #4 on the list is my favorite state for bank failures. (The three states with 20 or more bank failures since Bear Stearns failed are 4th, 9th, and 11th on the list. The only other state in double-digits right now, Florida, is 16th.) I’ll wait patiently for Brad DeLong to explain again how “support of the banking system by the Fed and the Treasury [has] significantly helped the economy.”

The third and biggest point is that many of those are large states that have leaned Democratic in the past several years. Anyone betting that they—and the next two states, North Carolina and Wisconsin, which both went for Obama in 2008—will be hard-pressed to support Democratic policies twelve months from now without a significant change in the trend.

New Jersey showed you what happens when you run a former Goldman Sachs CEO for Governor right now. Virginia showed what happens when the base isn’t motivated. Paul Krugman makes the point directly:

The longer high unemployment drags on, the greater the odds that crazy people will win big in the midterm elections — dooming us to economic policy failure on a truly grand scale.

What are the odds of crazy people winning big? I’m not certain, but I make them much better than 20:1 based on the current data.

UPDATE: Via Mark Thoma, Free Exchange, of all places, also sees the danger:

[W]hat is clear is that it does no good for prominent, respected economists to continue heaping praise on a Fed that failed in its mission before the crisis and which [sic] is failing in its mission now.

Because as unpleasant as the prospect of Congressional intervention in monetary policy is, two more years of high unemployment might well lead to far worse.

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Agribusiness, Food, Vegetarianism—-and Taxes

[cross-posted on ataxingmatter–see posting there for additional comments]

As some of you may know, I am one of the many people who eat a vegetarian diet. I don’t eat cows, pigs, fish, whales, sharks, chicken, turkey, sheep, wild game, tame game… As I sometimes say when people ask me about my diet, I eat everything you eat, except for a very short list of items–the critters that can move themselves from one place to another (or move their appendages) under their own propulsion.

(Note that we often have two words for animals that we eat–their live-form word –e.g., cow, sheep, pig– and their edible-corpse form word –e.g., beef, mutton, pork. That evolved when we borrowed the Romance language word for what we ate but kept the Germanic language word for the animals.)

It started when I was a child–I was one of those who would cut the meat into tiny pieces and then spread it all over my plate so it looked like I’d eaten it. The idea of eating a cow, with those beautiful liquid brown eyes, was repulsive. (My father came from a family with thirteen kids in the hills of Tennessee, so I’d seen cows up close.) I even took a whole piece of veal once and hid it behind the dining room cabinet (taking it out to the wastebasket after it dried)! I refused to eat the squirrel and venison that my dad brought home from hunting trips (mostly, if not always, somebody else’s kill). I even refused to let my cocker spaniel share in that dead stock.

But now that I’m an adult, why do I maintain that diet? I get asked that a lot.

Funny, nobody says (with shocked exression)–“Gee, you eat meat? Why would anyone ever want to eat a toxins-laden dead corpse of an animal that lived a horrendous life and suffered an agonizing death? ” But they do often ask–usually treating it as a good-natured tease about a wacky alternative diet–why I’d want to avoid eating corpses.

James McWilliams got me thinking about this again this morning, when I read his “Bellying up to environmentalism” in the Washington Post for Nov. 16, 2009, where he noted that we should be asking questions in the reverse, that make meateaters feel uncomfortable at defending their own meateating. After all, there’s really no good reason for eating meat other than that someone is so addicted to its taste that he or she can’t exert the willpower to do without it.

The whys for not eating meat, on the other hand, are legion. Let me just list a few here, from the mundane to the truly significant:

1. cooking is easier–throw veggies in a pot and steam them; throw veggies in a pot and make soup, throw veggies in a fry pan and fry them, throw beggies in a pot and bake them; and variants thereon

2. clean-up is a lot easier–none of that icky clinging greasy layer of animal fat on every pan

3. refrigerated leftover use is easier–throw the leftovers in a pot and steam them (etc. from one above) and there’s none of that congealed lard on top of the leftovers in the fridge

4. rotten vegetables in the fridge are less disgusting than rotten corpses in the fridge

5. a decent diet is generally considerably cheaper

6. the more people who adopt a vegetarian diet, the more people who are currently going hungry could be fed

  • one of the many articles I’ve read said something that stuck with me (sorry, don’t have the cite)–that it takes the same resources to feed one meat-eater that it takes to feed about 80 vegetarians.
  • That’s because of the huge waste as you use up primary foodstuffs to feed the animals that will be slaughtered, then use up primary energy stuffs to slaughter, process, ship and deliver the meat to the meat eater, compared to even transported vegetables (localvore, with vegetables, is even more saving of resources)

7. without meat-eating, there are no feedlots where animals literally eat and sleep out the remainder of their short lives in their own shit

8. you can have a small flock of hens who live out their natural lives with nice living conditions (indoor/outdoor)

  • disclosure: I had one hen who lived to be 22; she was still laying eggs up until the week or so before her death from natural causes

9. Hens lay bigger and bigger eggs each year that they live past the first year w(hen most are slaughtered) and they still lay fairly regularly

  • disclosure: 6 eggs every 7 days was typical in my experience

10. Even hens have personalities

  • disclosure: when I lived in upstate New York, I had one named Gumption who loved to fly up to the top of a two-story house and survey her domain, and another named “kiss me” who would follow me around all day like a pet dog

11. Animals that we eat are as smart as–or smarter than–animals that we keep for pets (pigs compared to dogs, for example)

12. Animals care for their young and suffer when their young are taken from them (think dairy cattle and the young that are bred so that the mothers will give milk)

13. Some eating of animals is even more obnoxious than the norm (think “veal calves” that are taken and put in tiny sheds to they can fatten without any musculature development or “foie gras” where geese are fattened by having food stuffed down their throats with a tube)

14. Life is precious: there is no reason to sacrifice animal lives to lead a decent human life, so why do it?

15. Agribusiness–the main way that animals are raised and sold for meat–is an environmental nightmare

  • use of fertilizers to grow the grain that is fed to the cattle that are fed to the humans results in polluted land, water and air and uses up petroleum and other resources
  • consolidation results in long transportation (inhumane to animals; wasteful of oil and gas resources)
  • the subsidies (including some tax expenditures) for agriculture have gotten out of control–costly, misdirected, ill-conceived, and essentially now a form of corporate welfare for huge agribusiness enterprises

16. A meatless diet is healthier for humans than a meat-based diet, so we could cut health-care costs by simply cutting out meat

17. The process of butchering animals is a cruel leftover from the dark ages–people who work in slaughterhouses are inured to suffering, and that may well spill over into their “normal” lives outside work

18. The process of butchering animals is itself a source of harm–

  • sick animals are slaughtered, making it possible that eaters of that dead flesh will be sickened as well (mad cow disease);
  • animals are slaughtered in the midst of their own excrement, and some of that excrement gets into the food chain (making people sick as well);
  • the leftovers from the animal slaughter have to be gotten rid of somehow, leading to even more water, land and air pollution
  • workers are exposed to awful conditions–not just the process of mercilessly killing animals day in and day out, but also the risk of infection and injury on the line

19. The use of antibiotics in animal feed (given to healthy and unhealthy animals alike) ensures that resistant strains will develop even more rapidly, while leaving excess antibiotics not absorbed by the animals to pass out in their urine and excrement and into the land and water to act as toxins to others (including fish and birds and humans) leading to additional environmental nightmares…

20. Agribusiness pig farms and cattle feedlots are a blight on any humans within their vicinity (as well as a disaster for the natural world, noted above under environmental problems) from the stench of the manure (that can pollute the countryside for miles around) to the ugliness of the barren, treeless manure-laden fields.

So what to do? Maybe we should enact an excise tax on all meat products, like a”sin” tax for sodas and sweets and cigarettes. Comments, anyone?

PS Arthur C. Clarke has a great sci fi short story, taking place some time in the future, when a more advanced civilization than ours is aghast at the purported discovery that their ancestors used to–cover the young ones’ ears–eat dead corpses of animals…..Clarke’s ideas were way ahead of his time in lots of ways.

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