Greg Ip

Articles by The Economist’s U.S. Economics Editor

Archive for June 2012

The Federal Reserve’s inflation target: Shiny, new, unopened & unused

leave a comment »

Jun 18th 2012, 16:35 by G.I. | WASHINGTON

When Federal Reserve officials meet this week, they will despondently confront an economy yet again falling short. Employment growth has flagged. GDP probably grew less than 2% (annualized) in the first half of this year; clouds from Europe, Asia and America’s own “fiscal cliff” darken the second half. The Federal Open Market Committee’s full year forecast of 2.4% to 2.9% looks out of reach.

So what will they do? Much of the street expects some kind of action, a view I share. It would probably come as an extension of “Operation Twist,” the purchase of longer-term bonds in exchange for short or medium bonds already in the Fed’s portfolio. It could stretch this out over a few months or a full year.

This, however, will be fiddling at the edges. What critics say the Fed needs is a wholesale makeover of its goals and methods. Some want the Fed to raise its inflation target. Others would have it adopt a nominal GDP target. Both approaches are intended to induce easier monetary policy that would foster faster growth in employment.  At the opposite end of the spectrum, more conservative economists and Republican legislators want to take away the Fed’s responsibility for full employment and have it focus solely on inflation.

Lost in this blizzard of outside advice is the fact that the Fed actually has a new framework of its own. In January it declared that henceforth its long-run target for inflation was 2%. Previously Fed members only stated their long-run preference, which ranged from 1.5% to 2%. It also said it considered its two statutory goals, low inflation and full employment, equally important. Previously, employment was, de facto, subordinate to inflation.

If you haven’t heard more about this, it’s because the Fed has treated the target like an unwanted Christmas gift, still unopened months after the tree has been taken down. The initial announcement was devoid of any hint of radicalism; it didn’t even use the word “target” or spell out the implications of its “balanced” approach to inflation and employment. It felt like the FOMC couldn’t agree on whether it was, or ought to be, a genuine departure. Indeed, the Fed acts as if nothing has changed. Its “appropriate” monetary policy in April yielded  forecast inflation of 2% or lower over the next few years. This vindicates critics who say the Fed acts as if 2% is a ceiling, not a target.

If the Fed were conducting policy based on this new framework, inflation would be centered around 2%. Indeed, if the Fed treated employment and inflation equally, it would likely tolerate inflation above 2% given that it is missing its full employment mandate more than its low inflation mandate.  Read the rest of this entry »


Written by gregip

June 18, 2012 at 6:51 am

America’s budget woes: Shift this cliff

leave a comment »

Politicians love postponing problems. America’s budget is a rare case where it makes sense to do so, briefly

Jun 16th 2012 | from the print edition

WHEN quarrelling politicians got into a deadlock in 2010 and again last year over how to close America’s gaping budget deficit, they picked the easy way out. They applied temporary patches that would expire after this November’s presidential and congressional elections.

For the political parties, this made sense. Then as now, they seemed incapable of compromise. Democrats were hostile to spending cuts; Republicans as fond of tax increases as they were of flag-burning. Rather than moderate their views, both sides preferred to fight it out during an election campaign.

For the country, however, the strategy has been costly. The temporary patches postponed a premature fiscal tightening, but created a fiscal “cliff” at the end of this year. It included the reimposition of the taxes that George W. Bush cut, an increase (in effect) in payroll taxes and a string of across-the-board spending cuts (“sequesters”). You do not have to be Sherlock Holmes to see that wrestling on a cliff-edge is dangerous.

Altogether America is set to see a fiscal tightening equivalent to some 5% of GDP. That is easily enough to tip the economy, which is expected to grow by 2.2% this year, back into recession. Around the same time, the Treasury’s legal authority to keep borrowing more will run out. The last time Congress squabbled over raising this “debt ceiling”, one credit-rating agency stripped America of its precious AAA rating, spooking the markets. With the euro wobbling and emerging markets slowing, businesses are fearful. The cliff adds another huge uncertainty, discouraging companies from investing or hiring until they can see the future more clearly (see article).

Numerous Republicans, Democrats and this newspaper have repeatedly argued that the solution is a grand bargain that raises taxes, preferably through base-broadening reform, and curbs the growth of entitlements (ie, public spending on health care and pensions). This is also the formula that Barack Obama and John Boehner, the leading Republican in the House of Representatives, toyed with last year, before the deal fell apart.

Time to buy time

The best solution by far would be to agree on some version of this grand bargain sooner rather than later. Read the rest of this entry »

Written by gregip

June 14, 2012 at 6:58 am

The cloud of uncertainty: Dithering in the dark

leave a comment »

Quantifying the effect of political uncertainty on the global economy

Jun 16th 2012 | WASHINGTON, DC | from the print edition

[Greg Ip] EUROPE teeters at the edge of an economic abyss, its fate in the hands of political leaders at odds over how to solve the continent’s twin debt and bank crises. America may be pushed over a “fiscal cliff” at the end of the year by political dysfunction. And even China, although unlikely to take a deep dive, is hostage to the will and ability of its government to stimulate growth. More than at any point in recent history, the global economy’s fate is tied to the capriciousness of policymakers. How much does such uncertainty cost?

Anecdotal evidence suggests that it costs a lot. Customers of Cisco Systems, the world’s biggest maker of internet gear, are taking longer to make decisions, according to John Chambers, the company’s boss. Their orders tend to be smaller than before, and to require more in-house approvals. They say they are planning to buy more stuff later this year, reported Mr Chambers recently, but “then in the very next breath they say it depends on what happens on a global and macro scale.”

In Europe firms must reckon not only with recession but also with the risk that their investments may be redenominated in a different currency or locked in by capital controls. Robert Bergqvist of SEB, a Swedish bank, says that several Swedish corporate customers have put investment projects on hold because they don’t know how the euro crisis will unfold.

If America falls over the “fiscal cliff”, it would suffer a fiscal squeeze of 5% of GDP, easily enough to push the economy into recession. Last summer, as America’s government came perilously close to exhausting its legal authority to borrow, Barack Obama and Republicans in Congress could not resolve their fiscal differences. Instead, they kicked the can down the road, agreeing on huge automatic spending cuts that would start on January 2nd, just as all of George Bush’s tax cuts are due to expire, along with a separate temporary payroll tax cut. Read the rest of this entry »

Written by gregip

June 14, 2012 at 6:55 am

A big hairball of risk

leave a comment »

Jun 4th 2012, 3:09 by G.I. | WASHINGTON

PERHAPS the most disconcerting aspect of the world’s current flight to safety is the lack of a single overriding threat to justify it. China is slowing, but hardly in recession. Europe is in crisis—but when has it not been in the last three years? And America—well, there’s that fiscal cliff later this year but it’s hard to find any investor thinking that far ahead.

The puzzle was underlined by May’s weak jobless report in America. What fundamental factors could explain it? Consider the usual suspects: Read the rest of this entry »

Written by gregip

June 3, 2012 at 7:40 pm

Posted in Blog posts