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

The Fed’s moving target: NAIRU

by Rebecca

Neal Soss and Henry Mo at Credit Suisse published a very interesting article, “Where is full employment in a more volatile macroeconomy?”, where they argue that the natural (long run) rate of unemployment may be shifting (they do this by showing that the Beveridge curve, which plots the the job vacancy rate against the unemployment rate, is shifting upward). I cannot provide a link, but here are their conclusions pertaining to monetary policy:

In the case of rising NAIRU [RW: this is the rate of unemployment that does not grow inflation, often called the long-run rate] and higher economic volatility, the monetary policy implication is complicated.

On the one hand, a higher NAIRU suggests that it would require a strong and prolonged recovery for the unemployment rate to return to the level attained in the past two decades. This scenario argues for a long period of low interest rates, because the economy’s structure will make it harder to get unemployment back to the low levels of recent business expansions.

On the other hand, a higher NAIRU suggests higher inflation pressure, as the output gap is smaller than otherwise would be the case. In other words, the Fed would have to normalize its policy stance sooner than would have been the case warranted by a stable NAIRU.

The burden of this is likely to be several years of quite low short-term interest rates by any modern standard other than the zero-ish levels of today. Even if the NAIRU is deteriorating, it is likely to be several years before the economy generates enough of a drop in unemployment to get to the new NAIRU, presumably above the levels of the last 20 years but surely below the current 9.7% unemployment rate. Between now and then, high unemployment is likely to remain the focus of policy attention. Labor market policies, such as job retraining for the unemployed, to improve the inflation unemployment trade-off, would make the central bank’s job a lot easier as that longer-run unfolds.

Basically, if the long-run level of unemployment, which the Fed targets implicitly under their dual mandate (maximum sustainable employment and stable prices), is changing then the Fed’s job becomes that much more difficult. Policy is only as good as the model’s calibration: they need to confidently estimate and target a level of employment that may be very much in flux. A simple Taylor Rule estimation illustrates this point.

Note: The Taylor Rule is a policy rule that relates the federal funds target to inflation and the output gap: roughly speaking, as inflation rises relative to the output gap, the Fed should tighten (raise its target); and as the output gap rises relative to inflation, then Fed should ease (lower its target). I estimate the relationship, and you can view my data here, and Wells Fargo’s forecast here.

On one hand, the CBO projects that NAIRU is 4.8%. In this case, the Taylor Rule policy drops the fed funds target to -4.6% by the end of the year. Put it this way: the output gap is so big that policy is very, very aggressive but bound by zero.

On the other hand, if NAIRU has shifted to something more like 6% – this is roughly its level in the 1980’s – then the policy prescription is less aggressive. The output gap remains wide, but the implied target rises to -3% rather than almost -5% – still negative, but suggestive of a more benign policy strategy. Inflation pressures would start to build earlier than under the 4.8% case.

This complexity has been documented by the Fed in the minutes of their August 2009 meeting:

Though recent data indicated that the pace at which employment was declining had slowed appreciably, job losses remained sizable. Moreover, long-term unemployment and permanent separations continued to rise, suggesting possible problems of skill loss and a need for labor reallocation that could slow recovery in employment as the economy begins to expand.

Note: this not the same thing as a jobless recovery – the unemployment rate may very well fall with economic growth (no jobless recovery), but then settle at a structurally higher level.

Rebecca Wilder

P.S. I will not be able to respond to comments until tomorrow.

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Brad’s Draft Lecture

Robert Waldmann

Brad DeLong just posted a very interesting Draft Henry George lecture. It contains ideas which I haven’t found written down before by Brad or by Krugman. I strongly recommend reading it (for one thing I don’t know how to cut and paste from it). People who have read the draft lecture are invited to read my thoughts after the jump (I can’t keep people who haven’t read it out, but comments which reveal ignorance of the lecture will be mocked ruthlessly).

update: I hereby ruthlessly mock myself for failing to provide the link.
What an idiot. That’s the problem with it enables people incapable of handling html to post on the web.

So that was a nice lecture wasn’t it ? Much of it was new to me.

1) Brad confesses the reason for his lapsed Greenspanism.

I hadn’t seen the explanation that he opposed tight regulation of finance, because he thought the purpose of structured finance was to trick people into bearing more risk that they want to bear and that this is a good thing, since people are irrationally unwilling to bear risk.

Oh my not just Greenspanian but a Straussian believer in noble welfare enhancing lies. I might have found the argument convincing in 2006, so I’m glad I didn’t read it.

2) Brad claims that fresh water economists have traction, are getting attention etc. I didn’t know that. I’d guess a lot of it is due to Paul Krugman who is arguing with them in public. Also, I mean, Nobel memorial laureates tend to get all the attention they want. However, Brad has an interesting theory. Republicans in power listen to economists who don’t sound crazy to them (and all non economists). Republicans in opposition use any rhetorical weapon to hand so any criticism of Obama however crazy it sounds to non economists is amplified by the vast right wing conspiracy. An interesting idea. Are fresh water economists really getting a hearing from non economists ? That’s a scary thought.

3) Brad notes the similarities between Herbert Hoover, Alan Greenspan and Job. Hoover and Greenspan have been very loyal to the pro market ideology. yet when trouble comes, people who should be their friends accuse them of being pinkos.
Now that is an excellent rhetorical weapon to hand.

Brad’s been writing about how Prescott has decided that the Great Depression was caused by the anti market policies of Herbert Hoover. He notes that for Prescott’s latest theory to make sense, one would have to argue that Hoover was more anti market than Roosevelt, Truman or Johnson (or any post WWII European socialist ever in power). Now to me, this is no more absurd than the average assertion by Prescott. But it seems to me much more striking to non economists. Usually Prescott uses mathematical terminology and so most people either have no clue as to what he is saying or assume that the clue they have must be misleading, because he couldn’t be claiming that (as he is). I’d say some documentation that Hoover was not a pinko is in order.

The similar claim that fresh water economists are saying that Greenspan over regulated is also interesting. I think documentation of that claim is in order. Then I’d go to Greenspan’s personal history as a disciple of Ayn Rand. I just found out that he was not just a fan from a distance but part of her tiny group. Rand was a very extreme ideologue and a very unpleasant person. Many on the right will not accept criticism of her. In a no holds barred rhetorical struggle, writing about Rand and Greenspan is likely to be an effective strategy.

Of course, I am not interested in rhetoric and think we should all seek the truth together assuming that all are sincere and well meaning, so I will have nothing to do with that. But someone less high minded and scrupulous than I would talk about Ayn Rand’s sex life as often as possible.

update: I am not suggesting that Brad is interested in using any rhetorical arm at hand. I’m sure he argues in good faith and presumes that others do as well until they prove otherwise.

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Policy and housing: someone’s gotta give!

by Rebecca

Housing demand is being propped up by government subsidies and low mortgage rates, and the level of supply is held back by low prices. Right now, the housing market is a complicated hodgepodge of policy, foreclosures, and very weary potential home-buyers.

Home sales are stabilizing; home building is stabilizing; and home prices (might be) stabilizing – the chart to the left illustrates a positive trend in sales away from distressed and first-time home-buyers, the targets of policy, according to the NAR. But what would the housing market look like if the massive policy expired this year? Not good, and it will.

Some points on the housing market:

  1. Subsidies are set to expire. If the Fed continues to buy its average of $105 billion in GSE-backed MBS per month (see the NY Fed’s website for weekly updates), it will max out the announced $1.25 trillion in four months. The $8,000 tax credit for first-time home-buyers expires at the end of this year. The Fed’s Treasury buyback program will run its course by October.
  2. There are several home price indices out there, each painting a slightly different picture of the level and trend in aggregate home values (see AB post).
  3. The foreclosure modifications program is holding off some foreclosures; but the program is no match for market forces.
  4. There is a large shadow inventory out there – potential sellers that are reluctant or unwilling (TIME calls some of these sellers “accidental landlords”) to relinquish home ownership at current prices. However, if home values continue to take baby steps forward, shadow sellers (new supply) will emerge.
  5. There is a bimodal distribution of sales across the high-end and low-end housing markets. Low-end sales are hot, while the upper end is not.

The housing market still has a long, long way to go before unsubsidized demand equals supply at a price that doesn’t exacerbate foreclosures – strategic or otherwise. With virtually all of the subsidies expiring within four months, it’s hard to believe that policymakers won’t give.

So who’s gonna cry uncle? My bet’s on the Fed, as it lacks does not require Congressional approval. Some Fed officials even tout that the MBS program should be scaled back; that’s ridiculous, given points 1. through 5. above. I agree with Daniel Indiviglio at the Atlantic: the Fed is more likely to increase its MBS purchase program, rather than to curtail or even adhere to the current limit.

By the way, the Fed and the Treasury have successfully dropped mortgage spreads to 2006 levels, even lower on the 30-yr; but it took an accumulation of $1 trillion in MBS to date to do that.

Rebecca Wilder

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Central bankers: slow to acknowledge the start; quick to declare the end

by Rebecca Wilder

There is always an agenda when a central banker declares the recession is over – and Bernanke is no different. The following facts remain: US GDP contracted at a 1% annualized pace in the second quarter of 2009 (its fourth consecutive drop), industrial output grew just two consecutive months after declining every month (except one) since January 2008, employment is still falling, retail sales are improving somewhat, and real personal income has formed no discernible upward trend.

In that light, the most accurate description of Bernanke’s declaration is that he “thinks” the recession is over, rather than it “is” over. His strategic announcement plays on market expectations to the upside, just as announcing that the recession is underway would play on expectations to the downside.

Are central bankers generally more apt to declare the end of a recession sooner that the beginning? I bet that they are. Will an AB reader do a little investigative reporting to find the first time that Bernanke acknowledged the onset of the 07-09 recession? My money’s on 12/08, the date when the NBER declared it as such and a year after it began.

To his credit, much of Bernanke’s Brookings address was spent highlighting the weak recovery that is expected. Bernanke is brilliant and surrounds himself with likewise brilliant economists – but data is data; and he sees what I see, which is a murky bottom and expected positive growth.

The charts below illustrate the key monthly macroeconomic variables used by the National Bureau of Economic Research to date the recession peak and trough by month: real income (I use personal income through July), employment (through August), industrial production (through August), and wholesale-retail sales (through August).

George Cooper is on to something in his book “The Origin of Financial Crises” (highly recommended). He criticizes central banking for adhering to efficient markets thinking, which leads to lax policy on the upside of the business cycle, i.e., allowing aggregate demand to outpace underlying fundamentals, and overly aggressive policy on the way down.

In this light, central bankers might be quicker to face the end of the recession and slower to conclude the onset of one. It is akin to policy mistakes being made on the way up and a triumph on the way down.

Rebecca Wilder

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G-20 to talk about ‘exit strategies’…

Rebecca Wilder

With the developed and developing economies printing money like it’s going out of style, the exit strategy – i.e., taking back the hundred percent increase in the monetary base (at least in the US) – is rumored to be the topic du jour at the G-20 summit later this month.

According to Reuters, the “G20 countries have agreed it is too soon to withdraw measures to end the global economic crisis and will discuss coordinating policy to wind up the trillions of dollars in support at talks in London this week.”

The article focuses on fiscal policy, but only a delinquent discussion of exit strategy leaves out the record monetary easing of late. However, I would most certainly agree that it is too soon.

The global labor market is plummeting.

And global sticky wages are consequently growing at snail-speed rates.

I’ve always been a big believer in the output-gap story. And until that unemployment rate starts to fall, I just don’t see how global inflation is going to be much of a problem.

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This May Make Robert Shiller and SocSec recipients happy…

but it doesn’t do that much for the rest of us. Via The Ambrosini Critique, Scott Sumner discovers there was no housing crash:

The BLS claims that housing prices are up 2.1% in the last 12 months….According to the BLS, housing makes up nearly 40% of the core basket of goods and services.

Further reading gets us to the base of the claim: Owner-Equivalent Rents went up 2.7% in the past year. CR was all over this in April and May. Take a gander at this chart–from the CR posting in May:
Price-to-Rent Ratio

So while the ratio has gone from 1.4 to 1.1 (which would be more than a 21% decline), almost a whole 10% of that change has been because the base (rent) has gone up. The other 19% of decline doesn’t matter for BLS in(de)flation calculation purposes.

No one better tell David Malpass or his investors at Encima Global (motto: “Failing Up is Always an Option”; see the Forbes article link at the left side of the Encima page).

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Those Who Think the "Left of Center" is Too Tough on N. Gregory Mankiw

should read Sensible Centrist J. Bradford DeLong on the difference in forecasting between the current Administration and the CEA under N. Gregory Mankiw.

Romer/Bernstein/Kreuger et al., 2008-9 edition:

As I understand matters, last December the median private-sector forecast had the unemployment rate topping out at 9% in the second half of 2009. The incoming Obama administration simply adopted that forecast. At the time I thought that was a mistake: (I thought that was a mistake: I thought they should have made a bifurcated forecast with a “good case” 80th-percentile scenario and a “bad case” 20th-percentile scenario; they should then have stressed that in the bad case we would need a large stimulus indeed to prevent high unemployment, and that in the good case we could restrain inflation via monetary policy.)

Mankiw et al., 2003 edition:

it would make it extremely difficult for things to happen like what happened to the Mankiw CEA over the winter of 2003-2004, when high politics appears to have reached down into the forecast, changed the table for payroll employment (and only payroll employment: the rest of the forecast is not out of line with contemporary professional forecasts), and produced an estimate for December 2004 (a) inconsistent with the rest of the forecast, and (b) high by 2.3 million in its estimate of payroll employment–all because Karl Rove and company thought it important to avoid headlines like “Bush administration forecasts 2004 payroll employment to be less than when Bush took office.” (link from original)

The positive-spin version is that Mankiw plays politics better than the Obama Team.

UPDATE: Kauffman Foundation invitee Mark Thoma adds to the fun.

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Silliness from Time Magazine

Via Brad DeLong, I see Time magazine has identified the “25 people to ‘blame’ for the financial crisis.” [my sarcastic quotes on blame; Time appears to be serious]

Amazingly, none of TWX’s (mostly former) top management—who pushed LBOs in the 1980s and Internet bubbles in the 1990s—makes on the list.

More amazingly, Lew Ranieri is on the list, while David Malpass is not.

Also making the list: Wen Jiabao, because the Chinese government “supplied the U.S. with an unprecedented amount of credit over the past eight years.” Let’s leave aside whether that credit wasn’t primarily to support Chinese exports (see, e.g., Brad Setser) and ask the obvious question:

Given that an external economy is providing you with (realtively) “easy” credit, what does that imply your Monetary Policy should be?

UPDATE: DeLong takes M2 to the next step, with predictable results.

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Cactus and gold

by cactus

Tax cuts aren’t the only thing that work great in every situation. Hoarding gold works too:

Gold is now regarded as a hedge against both inflation and deflation, says Alan Ruskin, the chief international strategist at Greenwich, Connecticut-based RBS Greenwich Capital Markets Inc. The first is reflected in the high dollar price of bullion, the second by the surge in gold’s price in euros.

Having been in the presence of gold at different times, I can attest that it also flies, improves mental health, and eliminates odors from cat poop boxes at twenty paces. But seriously, what the heck does that second sentence even mean?

FYI, the “RBS” in “RBS Greenwich Capital Markets Inc.” stands for Royal Bank of Scotland. Yes, that Royal Bank of Scotland. Now I didn’t know anything about Alan Ruskin, so I googled him. It turns out he penned this piece [link fixed- klh] on moral hazard in the Financial Times back in 2007.

Anyway, there are a lot of places this post could go, and most of ’em all but write themselves. Have a go at it in comments.
by cactus

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