Two Policy Prescriptions for the Global Crisis

Date: 24-04-2013
Source: Project Syndicate

WASHINGTON, DC – One thing that experts know, and that non-experts do not, is that they know less than non-experts think they do. This much was evident at the just-completed Spring Meetings of the International Monetary Fund and the World Bank Group – three intense days of talks that brought together finance ministers, central bankers, and other policymakers.

Our economic expertise is limited in fundamental ways. Consider monetary and fiscal policies. Despite decades of careful data collection and mathematical and statistical research, on many large questions we have little more than rules of thumb. For example, we know that we should lower interest rates and inject liquidity to fight stagnation, and that we should raise policy rates and banks’ cash-reserve ratios to stifle inflation. Sometimes we rely on our judgment in combining interest-rate action with open-market operations. But the fact remains that our understanding of these policies’ mechanics is rudimentary.

These rules of thumb work (at least tolerably so) as a result of evolution. Over time, the wrong moves are penalized, and their users either learn by watching others or disappear. We get our monetary and fiscal policies right the same way that birds build their nests right.

Central Banks’ Outdated Independence

Date: 17-04-2013
Source: Project Syndicate

BUENOS AIRES – The global financial crisis has raised fundamental questions regarding central banks’ mandates. Over the past few decades, most central banks have focused on price stability as their single and overriding objective. This focus supported the ascendancy of “inflation-targeting” as the favored monetary policy framework and, in turn, led to operational independence for central banks. The policy was a success: the discipline imposed by strict and rigorous concentration on a sole objective enabled policymakers to control – and then conquer – inflation.

But, as a consequence of this narrow approach, policymakers disregarded the formation of asset- and commodity-price bubbles, and overlooked the resulting banking-sector instability. This, by itself, calls for a review of the overall efficacy of inflation-targeting. Moreover, after the financial crisis erupted, central banks were increasingly compelled to depart from inflation targeting, and to implement myriad unconventional monetary policies in order to ameliorate the consequences of the crash and facilitate economic recovery.

The Price of Gold Is Crashing. Here’s Why

Date: 16-04-2013
Source: Businessweek

A chart of the crashing price of gold looks like a wedding ring rolling off a table. Gold futures for June delivery closed at $1,361 an ounce on the Comex in New York today, a drop of more than $200 in two sessions. Gold’s fall of 13 percent since April 11 was the biggest two-session decline since 1980.

Why is gold plunging? The most important factor is that global inflation is falling, reducing gold’s value as a hedge against rising prices. Gold bugs who were betting on an outburst of inflation are scrambling to reverse their bets and exit their gold positions at any price.

For consumers struggling to make ends meet, it may seem hard to believe that inflation is falling. But the evidence is clear from JPMorgan Chase’s (JPM) global consumer price index, which covers more than 30 countries that collectively represent more than 90 percent of world economic output.

According to the JPMorgan index, global inflation peaked at 4 percent in 2011 and has fallen steadily since. Global prices in February were up only about 2.5 percent from a year earlier, the bank’s index says.

JPMorgan has two scenarios for what happens next. Its main one is based on a “bottom-up” collection of analysts’ forecasted price trends sector by sector around the world. That shows inflation rising very slightly from its current level for the rest of 2013. In contrast, JPMorgan’s “top-down” analysis, which is prepared by the banks’ economists and takes into account prices of commodity futures contracts, among other factors, shows inflation moving down closer to 2 percent in the second half of 2013.

The headline on JPMorgan’s report: “The slide in global inflation may not be over.”

Is inflation targeting dead? Central banking after the Crisis

Lucrezia Reichlin, Richard Baldwin, 14 April 2013, voxeu

Inflation targeting did not prevent financial instability before the Crisis nor did it provide sufficient stimulus after the Crisis. In a new Vox eBook, 14 world-renowned scholars, practitioners and market participants analyse inflation targeting and its future. They argue that inflation targeting should be refined not replaced. Indeed, it is needed now more than ever to keep expectations anchored while the advanced economies work their way through today’s slow growth, rickety banks, and over-indebted public sectors.

Before the Crisis, inflation targeting had become the de facto standard framework for monetary policy. Even non-inflation targeters like the ECB and the Federal Reserve built their monetary policy around the idea of commitment to a quantitative objective for medium-term inflation.

Assume a Perfect World

By John Mauldin | Apr 12, 2013

Assume a Perfect World
Objects in the Rear-View Mirror Are Larger
An Imaginary Recession
Peace in Our Time?
Government Spending Per Household Exceeds Median Household Income
What Do You Want It to Be?
Las Vegas, Singapore, San Francisco, and Carlsbad

An engineer, a chemist, and an economist are stranded on a deserted island. They are starving, when miraculously they find a box filled with canned food. What to do? They consider the problem, bringing their collective lifetimes of study and discipline to the task.

Being the practical, straightforward sort, the engineer suggests that they simply find a rock and hit the cans until they break open. “No, no!” cry the chemist and economist, “we would spill too much food and the birds would get it!”

After a bit of thought, the chemist recommends that they start a fire and heat the cans. The pressure in the cans will force them open and the food will conveniently already be heated. But the engineer and economist object, pointing out correctly that the cans would likely explode and splatter the food all over the beach.

The economist, after carefully studying the cans and reading the labels, starts scrawling a series of equations in the sand, which eventually cover the entire beach. After much pondering, he excitedly announces, “I’ve got it! I’ve got it!” as he points to the final equation. They ask him to explain, with their visions of finally getting a meal causing them to regard the economist with a new sense of respect.

The economist clears his throat and begins, “First, assume a can opener …”

I am not sure how old that joke is, but it dates to about the time when economists discovered mathematics and models, which is to say, about the time when economists developed physics envy and decided they would like to be regarded as scientists rather than philosophers. This week we continue to look at the data and models developed by economists, with a view to understanding both their usefulness and their limitations. The specific data we will examine this week is inspired by the release of the President’s FY 2014 US budget proposal this week. While it and the House and Senate budget proposals may appear to be widely divergent, there are some underlying and quite disturbing similarities among them.

Specifically, all three proposals assume away the real world. It does not matter which version you prefer; they all lack the basic precautions and hedges that those of us involved with preparing family and business budgets make sure to include in our own forecasts. While whole books could be written about the underlying assumptions in these latest budget proposals, we will examine (hopefully briefly) just a few of the more glaringly problematic ones.

 

Assume a Perfect World

The death of inflation

Date: 11-04-2013
Source: The Economist

Central banks in the rich world may have been too successful in subduing price pressures

IT TOOK an iron will (and a handbag) to beat the inflation of the 1970s. Under Margaret Thatcher the British government squeezed the economy with high interest rates until the beast submitted. The Federal Reserve, then led by Paul Volcker, followed suit. Such displays of fortitude convinced markets that governments were serious about keeping inflation low. Expectations of future price increases converged around central-bank targets, touching off an era of long expansions and mild recessions. Yet relative price stability may now be adding to the rich world’s economic woes.

Deep recessions like the recent global contraction would normally be expected to send inflation tumbling. Workless labourers ought to reduce wage demands to find employment; firms with unsold goods should slash prices to clear inventories. There was every reason to expect that inflation would go to zero or even enter negative territory in recent years. In April 2009 the International Monetary Fund forecast that inflation in that year would be -0.2% for advanced economies. Instead it has barely budged across the latest business cycle (see left-hand chart).

The euro crisis: Has anyone seen the ECB?

Date: 04-04-2013
Source: The Economist

LET’S just review the brutal facts:

• The economy of the euro area has been in recession since the third quarter of 2011.
• The euro-area unemployment rate is at a record-high 12%, up more than two percentage points from 2011.
• Year-on-year inflation is falling and is now down to 1.7%. Monthly inflation rates are flat to falling across most of the euro area.
• The latest data indicate that recession continued through the first quarter and may have been deepening as of March.

The European Central Bank has a price stability mandate, and so, superficially, it doesn’t have to care about a terrible performance on output or employment. In reality, of course, terrible performances on output and employment feed into falling inflation. One would think that the ECB would be worried about the possibility that inflation may soon slip well below its target.

When Interest Rates Rise

31-03-2013
Source: Project Synndicate

CAMBRIDGE – Long-term interest rates are now unsustainably low, implying bubbles in the prices of bonds and other securities. When interest rates rise, as they surely will, the bubbles will burst, the prices of those securities will fall, and anyone holding them will be hurt. To the extent that banks and other highly leveraged financial institutions hold them, the bursting bubbles could cause bankruptcies and financial-market breakdown.

The very low interest rate on long-term United States Treasury bonds is a clear example of the current mispricing of financial assets. A ten-year Treasury has a nominal interest rate of less than 2%. Because the inflation rate is also about 2%, this implies a negative real interest rate, which is confirmed by the interest rate of -0.6% on ten-year Treasury Inflation Protected Securities (TIPS), which adjust interest and principal payments for inflation.

Historically, the real interest rate on ten-year Treasuries has been above 2%; thus, today’s rate is about two percentage points below its historical average. But those historical rates prevailed at times when fiscal deficits and federal government debt were much lower than they are today. With budget deficits that are projected to be 5% of GDP by the end of the coming decade, and a debt/GDP ratio that has roughly doubled in the past five years and is continuing to grow, the real interest rate on Treasuries should be significantly higher than it was in the past.

Zypern und das geldpolitische Trilemma

25.03.2013 | 13:39 | Von Georg Erber (Ökonomenstimme)

Die Einführung von Kapitalverkehrskontrollen wird womöglich zum Präzedenzfall für weitere Krisenländer.

Zypern ist gerettet? Wirklich? Das Ergebnis weckt mehr Zweifel am Fortbestand der Währungsunion als es Vertrauen in deren Fortführung liefert. Zypern wird 10 Mrd. Euro Finanzhilfen aus dem ESM erhalten, aber dies hat seinen Preis. Man hat wegen der massiven Kapitalflucht, die das Land bedroht, Kapitalverkehrskontrollen eingeführt. Das steht in klarem Widerspruch zu den vier großen Freiheiten der Wirtschafts- und Währungsunion. Hierzu zählen der freie Warenverkehr, die Personenfreizügigkeit, die Dienstleistungsfreiheit und der freie Kapital- und Zahlungsverkehr. Berührt sind bei letzterem das Kapitel 4 – Der Kapital- und Zahlungsverkehr (Art. 63 – 66) des Vertrags über die Arbeitsweise der Europäischen Union.

Offenbar konnte einvernehmlich mit dem Europäischen-Rat, dem Quasi-Direktorium der Eurozone, das zypriotische Parlament, den freien Kapital- und Zahlungsverkehr innerhalb der Eurozone zwischen Zypern und den übrigen Mitgliedsstaaten außer Kraft setzen. Es gilt offenbar: Not kennt kein Gebot, d.h. Verträge sind dazu da, um gegebenenfalls gebrochen zu werden. Seltsamerweise ist dieser Tabubruch nicht Gegenstand der allgemeinen Presseberichterstattung. Wie lange diese Notmaßnahme in Kraft bleiben wird, ist derzeit offen. Letztendlich ist jedoch ein Präzedenzfall geschaffen worden, der bei einer weiteren Verschärfung der Eurokrise in anderen Ländern, insbesondere Italien und Spanien sowie möglichweise auch Frankreich, Modellcharakter haben könnte. Da ja ein Bail-In bzw. Bail-Out dieser Länder durch den Rest der übrigen noch finanziell stabilen Länder wie insbesondere Deutschland nicht tragfähig ist, wird man in diesen Fällen um Kapitalverkehrskontrollen ebenso wenig herumkommen wie im Falle Zyperns.

Is The Government Lying To Us About Inflation? Yes!

are we really so dumb to accept that? (hfk)

The official rate of inflation may be two to four times lower than the actual rate

John Mauldin’s Outside the Box, 23/3

In today’s Outside the Box, Gary D. Halbert (my old and very dear friend and former business partner of many years) reminds us about a few significant facts concerning the Consumer Price Index (CPI) that mainstream economists and the media tend to ignore. The central question is whether the CPI is really indicative of the actual inflation rate. Not likely, says Gary, since the US Bureau of Labor Statistics (BLS), which compiles the CPI, has engaged in methodological shenanigans over the past couple decades (as has been well documented by John Williams of ShadowStats, among others). The upshot of all their monkeying with the numbers is that the official rate of inflation may be two to four times lower than the actual rate (which is rather convenient if you’re a government bureaucrat trying to hold down interest costs and Social Security payments).

These changes are hotly debated in academic circles. There are many economists who agree with the changes and can show with their models that inflation is low. That is the currently accepted wisdom, or what passes for it. The problem is that inflation only shows up, as one person put it, in the things we actually buy. If your main costs are food, energy, education, and healthcare (ring any bells?), then inflation is a great deal higher than 2%. Other items are actually falling in price. It comes down to the mix of items in the calculations and whether you buy into the concepts of substitution (if beef gets too expensive we buy hamburger rather than steak) and “hedonics,” which says that prices of products drop over time as quality and manufacturing efficiency improve, so the calculation of inflation should take this into account.

Which means you can have official inflation at a low level (or even falling for certain items), while the amount you actually spend out of your very real pocket is rising! And thus the debate.