The Fed’s new thresholds: The mandate is willing but the tools are weak

Dec 13th 2012, 2:00 by G.I. | WASHINGTON, D.C.

[Greg Ip] Low inflation and full employment have been statutory goals of the Federal Reserve since 1977, but its officials always felt more comfortable with the first than the second. After all, in theory monetary policy can’t alter unemployment in the long run.

But the stubbornly weak economy of recent years prompted some at the Fed to question their historical neglect of the second half of their mandate. “The Fed’s dual mandate … has the force of law behind it,” Charlie Evans, president of the Federal Reserve Bank of Chicago, said in September, 2011.  “So, if 5% inflation would have our hair on fire, so should 9% unemployment.”

Advertisement

America’s jobs numbers: A steady pulse

Dec 7th 2012, 16:57 by G.I. | WASHINGTON, DC

AMERICA’S jobs numbers are less freighted with political significance now that the election is over, but they’re still an important measure of the economy’s pulse. The numbers released on November 7th show that the pulse is steady: employment growth remains moderate and unemployment continues to fall faster than the economy’s strength can explain.

Non-farm payrolls rose last month by 146,000. Wall Street had expected only half that number because of the impact of Hurricane Sandy, which struck at the end of October, just before the Bureau of Labor Statistics surveyed employers and households. But the BLS said, “Our analysis suggests that Hurricane Sandy did not substantively impact the national employment and unemployment estimates.” Nevertheless, payrolls in both September and October were revised down, by a combined 49,000.

Monetary policy, the unintended consequences: QE through the looking glass

Nov 29th 2012, 21:37 by G.I. | WASHINGTON, D.C.

Even if you follow central banking, you may not have heard much about Jeremy Stein. He’s a highly regarded finance economist from Harvard University who became a governor this year, and since then he has given only one speech. But judging by the contents of that speech, Mr Stein’s profile seems bound to grow.

The subject of the speech was the Fed’s large scale asset purchases (LSAPs), colloquially known as quantitative easing (QE). It had none of the tantalizing hints about coming Fed actions that attract headlines. Rather, it mucked about in dark, abstruse corners of corporate finance, devoting three of its 19 pages to academic references.

How to solve the fiscal cliff: The Obamney tax plan

Nov 8th 2012, 23:33 by G.I. | WASHINGTON, D.C.

This post has been updated.

PRESIDENTS choose their words carefully. So when Barack Obama talked of  “tax reform” but not “tax rates” in his acceptance speech early Wednesday, he was presumably sending a signal. And it was similarly significant that later that day John Boehner repeatedly stated his opposition to higher tax “rates” rather than tax revenue.

Within those two statements lies the nucleus of a deal: raising tax revenue through some means other than higher tax rates.

Understanding economics: Priceless

Oct 18th 2012, 19:49 by G.I. | WASHINGTON

[Greg Ip] WHAT is economics concerned with? A layman taking in the raging debates over financial stability, inflation, economic growth, and budget deficits, would say it’s about money. That, of course, is not right. Money matters only insofar as it is a proxy for welfare. Money is a handy way of denominating prices and economists love prices because they are so efficient at allocating supply and demand so as to maximise welfare. Yet markets do not have to have money or prices to serve that welfare-maximising function. That distinction lies at the heart of the work that won this year’s Nobel Prize in economics, the subject of this week’s Free Exchange column.

Lloyd Shapley of UCLA and Alvin Roth of Stanford University got the prize for studying the barriers to welfare maximisation in markets without prices: examples including matching college applicants to colleges, kidney donors to recipients, and even husbands to wives.  Mr Shapley and David Gale (now deceased) devised an algorithm 50 years ago that would maximise the satisfaction of such multi-sided matching games. Read the column to learn more about  how the theory works and its applications. I want to focus here on a more philosophical implication of their work.

The fiscal cliff and the economy: Pointless, painful uncertainty

Jul 18th 2012, 20:59 by G.I. | WASHINGTON

[Greg Ip]

Everyone agrees uncertainty is bad for the economy. But doing something with this observation is seriously hampered by the fact that uncertainty is almost impossible to define and measure. 

Many academics count things that proxy for uncertainty, such as mentions of the word in news articles. That’s one of the components in the uncertainty index developed by Scott R. Baker, Nicholas Bloom, and Steven J. Davis whose work we wrote about it here; it links heightened policy uncertainty to weaker growth. It’s also used by Jonathan Brogaard and Andrew Detzel here; they find increased policy uncertainty leads to lower stock prices and private investment.

Establishing causality is tricky. A weak economy or a traumatic event like a financial crisis or terrorist attacks will both raise uncertainty and provoke a policy response, but it’s the economic event, not the policy, that raises uncertainty and hurts growth.

I have my own back-of-the-envelope exercise. I count mentions of the word “uncertainty” in the Federal Reserve’s “beige book.” As my nearby chart shows, uncertainty has shot up in the last month. (Some months are blank because no beige book was released then.)

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

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. 

A big hairball of risk

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:

America’s labour force and the economy: The missing five million

May 4th 2012, 20:55 by G.I. | WASHINGTON, D.C.

THERE’S a short term and a long-term story in today’s job numbers. The stock market did not like the short-term story, and fell sharply as a result. But the short-term news is not as bad as it looks, while the long-term news is actually quite disturbing.

Let me explain. The sharp deceleration in employment growth in the last two months probably does not point to a sudden slowing in economic growth but rather tells us that the more brisk pace of growth earlier this year was unsustainable because much of it was due to warm weather. A useful gauge is the number of people not working because of weather. Morgan Stanley says this tally was unusually low during the winter, but in April it returned to normal levels. This suggests the weather payback effect is largely over.

Taking from the 19%, giving to the 1%: Mitt’s maths

Apr 20th 2012, 18:16 by G.I. | WASHINGTON, D.C.

My tax plan actually does cut the marginal rates across the economy by 20 percent. I’m going to reduce and restrict deductions and exemptions at the same time. [That] and creating more growth will mean that the policy is revenue neutral.  

—Mitt Romney, March 19, 2012

As Mitt Romney tightens his lock on the nomination, his economic proposals are getting more scrutiny. This week’s print edition analyzes his economic platform and how his fiscal positions have converged with Paul Ryan’s; an accompanying editorial urges him to flipflop away from his current positions on China and taxes.

Mr Romney himself drew more attention to his platform this week when he was overheard telling a group of wealthy donors that he might eliminate the tax deduction on mortgage interest for second homes, and on state and local taxes. This was notable because he had studiously avoided saying what tax expenditures (as deductions, exemptions and credits are known) he would eliminate to pay for his rate cuts. Matt O’Brien at The Atlantic and Deborah Solomon at Bloomberg View leapt on him for the pathetically small amount of money this would yield relative to the humungous cost of Mr Romney’s corporate and personal tax cuts.

I think this is a bit of a sideshow. Mr Romney has repeatedly said his tax plan would be revenue neutral, and knows he will have to cut more than just those two items. It’s cowardly of him not to say what those other things are now, but no more cowardly than the typical candidate for office. The odds of eliminating any tax break go down the more a candidate has to discuss it before an election.

The real question is, can Mr Romney plausibly produce a revenue neutral tax plan that cuts rates as much as he does?