Today in "Economists Are NOT Totally Clueless" (Interlude; Part 2 of 3 or 4)
Tyler Cowen can count:
In sum, maybe three percent expected inflation conflicts with the desire to rapidly recapitalize banks through maintaining a wide interest rate spread. Maybe we need that zero nominal short rate or at least the Fed thinks we do….
I also regard this as a somewhat gruesome hypothesis. It means that “Main Street” is paying for “Wall Street” (forgive me the use of those awful terms) in at least two ways: high unemployment and inability to earn much on one’s savings….
The term structure also implies that the market is expecting rising short rates, so if the bank mess isn’t cleaned up soon, heaven forbid. The spread, as a means of restoring bank profitability, won’t last forever.
And Ryan Avent (via Brad DeLong) points out the next piece of that puzzle:
[T]he Fed’s commitment to undo its interventions is already having an effect. In expectation of more of these moves to come (as well as, perhaps, increases in interest rates) markets have been bidding up the dollar, which has busily appreciated during the month of December. That, in turn, will deprive the American economy of a potential source of demand—growth in consumption of American exports thanks to the effect of a weak dollar.
More bluntly, we’re seeing a move toward contractionary monetary policy at a time when unemployment is at 10%. Funny that.
I can’t think of a scarier way to end the year. Sorry about that. Best wishes for 2010—we’re all going to need them.
The logic is sort of OK. Only problem is that I can not recall Tyler Cowen being right about anything … ever. Not that he’s a nut case. But IMO he is usually wrong. In this case, if the market is expecting higher short term rates — and I personally do not think that to be true — then the market must be expecting a solid recovery very soon. Not very likely IMHO.
The expectation that the rise of the dollar will harm US exports is sound economics. But I very much doubt it is true. In point of fact, imports are dominated by petroleum which actually gets cheaper when the dollar is strong. US exports are not terribly price sensitive because they consist mostly of stuff that is either unavailable elsewhere (weapons systems) or commodities that are anamolously cheap here. Sound economics will rule again someday when the disparity in production costs between the developed and developing world has flattened out, but I don’t think it is a strong predictor in this decade of this century.
Avent says: “T]he Fed’s commitment to undo its interventions is already having an effect. In expectation of more of these moves to come (as well as, perhaps, increases in interest rates) markets have been bidding up the dollar, which has busily appreciated during the month of December.”
I always love it when someone attaches one phenomenon to an F/X move in December (of all months). There was a clear flight to safety in the last two months, as money managers swept up their annual gains and held them through the end of the year. Remember when the money market curve was inverted? Furthermore, there was a very strong employment report that occurred (not coincidentally) at the onset of the dollar’s trend – Greece?
My point is: this dollar trend is NOT going to hold. And its recent trend, in my view, does not stem from the Fed’s decision to exit. In fact, it is more clear to me that the fed will be the one following suit in rates next year, rather than leading the pack.
Rebecca