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Topic of the week: Federal Reserve Actions

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1/13/2015 8:43:26 PM
Posted: 2 years ago
Mod note: If you have an idea for a topic of the week, please submit it to me via PM.


The Federal Reserve, in the wake of the worst financial calamity since the Great Depression of the 1930s, has pursued an unprecedented expansionary policy, decreasing its policy rate to the zero lower bound in December 2008 and engaging in a series of large-scale asset purchases predicated on reducing long-term interest rates and spurring consumption and business investment. It has also provided accommodative forward guidance pledging to maintain the current federal funds rate until the economy improves, in accordance with the Krugmonian-Svensson-Woodfordian argument that promising policy accommodation in the future produces more accommodation now by impacting market expectations. But, in the wake of improving economic data, the Fed has been signaling that it may begin raising short-term interest rates around the middle of this year. They cited, as justification for this, falling unemployment, rising G.D.P. growth, and the fact that the disinflationary impact of falling commodity prices is only transitory"in fact, they contend, falling oil prices generate a net a positive for the U.S. economy, and will accelerate growth in the near term.

More hawkish FOMC participants, like Charles Plosser and Richard Fisher, would argue that maintaining unprecedented accommodation invites the potential for an inflationary buildup and financial imbalances, and may un-anchor inflation expectations, which would effectively undue 30 years of disciplined central banking. They may cite improving G.D.P. growth, gauges of unemployment falling faster than projections, that 2014 was the fastest year of job growth since 1999, and structural impediments"such as hysteresis amongst the long-term unemployed"which have increased the NAIRU, or the non-accelerating inflation rate of unemployment. Because monetary policy operates with "long and variable lags," and the elasticity of the Fed's interest on reserves tool, which will be its primary tool in raising short-term interest rates in light of elevated levels of excess reserves, is unknown"meaning that lack of due diligence or imprecise economic models may invite excess inflation risk upon beginning liftoff--the Fed may risk falling behind the curve if it fails to act quickly and decisively. More moderate participants, such as James Bullard, argue that current economic data may warrant an accommodative stance, but not a crisis-era fed funds range of near-zero nominal interest rates. In other words, liftoff would not be ipso facto contractionary to the extent that some of the more dovish participants would argue.

More dovish FOMC participants, like Narayana Kocherlakota, Eric Rosengren, William Dudley, and Charles Evans, are virulently opposed to this form of contractionary policy, and believe there is merit in being patient. They would contend, first, that falling commodity prices provide the Fed more room to be accommodative by holding down inflation in the near term. In fact, they may cite the Paradox of Toil, whereby a rightward shift in aggregate supply"as falling oil prices constitute a de-facto tax cut"would entice people to supply more of their labor, applying downward pressure on nominal wages and inflation, thus raising real interest rates at the zero lower bound and reducing consumption and investment, which would be self-reinforcing. They may cite declining global growth in China, Japan, Europe, and emerging market economies and the resulting rapid appreciation of the dollar, all of which negatively bears on exports. Finally, they may argue that the unemployment rate vastly understates the amount of slack in the labor market due to the vast amounts of people long-term unemployed, part-time for economic reasons, discouraged, and marginally attached, and encourage us to look at broader measures of unemployment, such as the U6, which remains elevated relative to historic levels. For this reason, estimates of the NAIRU may be misleading, they may contend, and a flattening Phillips curve-or a reduced trade-off between unemployment and inflation due to increasing nominal rigidities, globalization, and anchored expectations-has produced a reduced trade-off between policy accommodation and inflation risk. In light of this, and the fact that Europe and Japan have suffered from the deleterious impact of tightening policy too early, the risks and costs are weighted to the downside, not the upside, especially with falling inflation expectations.

In its upcoming meeting this month, the Fed is expected to remove its pledge from its policy statement to maintain short-term interest rates at their effective lower bound for a "considerable time" following the completion of its asset purchasing program, known as quantitative easing. Instead, it may focus on its pledge to be "patient" in raising interest rates, which Chair Yellen has clarified, during her recent press conference, refers to maintaining the current federal funds range for at least the next two FOMC meetings. Unquestionably, there remains open questions as to the degree of labor market slack, countervailing and conflicting data, and a complex balance of risks and rewards.

In light of this, what do you believe the Fed will do over the next few months?

Will it increase interest rates as planned, hold off until 2016, or increase rates more rapidly?

Furthermore, what do you believe the Fed should be doing?

Is it already behind the inflation curve, or is money still far too tight, in spite of its actions thus far? Moderator
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1/14/2015 2:15:20 PM
Posted: 2 years ago
While we're not technically in a recession, and most likely won't be. Instead, we're in a situation that is worse and can drag out for months if not years. The ISM reports, manufacturing and non-manufacturing alike, showed flat business with a decline in employment, and yet higher rises in the prices of materials. The unemployment rate remained at 5.5%, still at full employment, but the wages being paid workers are not rising fast enough to pay for increased costs of everyday goods.
Remember, stagflation is high inflation with slow growth. That growth is so slow it's painful. Watching grass grow is more exciting. Fixing stagflation requires Volcker-like determination, which is unlikely to come from the present Fed leadership. Look for a still weaker US dollar, and start working $200 and $250 oil into your planning scenarios. If you have not already. Last week, the European Central Bank raised rates: they have the right idea. In the meantime, we're importing more inflation every day, unnecessarily.
One would think that the economy would be booming with the stimulus of easy money. What's happened instead is that fixed income investments now pay a below-inflation yield, meaning that saving money ensures that one loses money. If you have a healthy business with a legitimate rock-solid positive outlook, now is a good time to borrow money and pay it back with cheaper dollars, sticking the banks with the inflation risk. Not many businesses, or consumers, are in that kind of situation, but it is a scenario worth considering if all of the aspects are aligned correctly. As for me, I hate debt and have never really used it, so it's easy for me to offer borrowing advice to others.
While everyone is focused on oil prices, these are still not record highs, as we have discussed at various times. It's the adjustment to the most recent prices that is a real problem. When energy was less expensive, other goods and services filled in that spending; now that other spending is being nudged or forced out. Starbucks is the latest "victim," but it could be that the fad of Starbucks was just waiting to a reason to end. People have to go to work, so they will spend on energy, and high-end Starbucks products become a treat instead of a necessity. While Starbucks is closing 600 poor-performing outlets, it's still important to note that they are opening 200 new ones.
As an aside, the IRS finally raised its deduction for business mileage after July 1 from $0.505 to $0.585. That's only a 15% increase; maybe their accountants need to get out from behind their desks and pump some gas a little more often.
There is one thing that I still find rather amusing, and that's the oft-heard comment that "oil is important because energy costs are in everything." Of course energy costs are in everything. But so are labor, taxes, real estate/space, finance, legal compliance, and numerous other categories. Just like there is nothing, not even intellectual property, that cannot be created without energy, nor can any product be created without labor, space, equipment, and numerous other categories. Just think of what is required to produce intellectual property today: computers, communications, office or other space, labor, and other categories.
This chart, for example, shows that in 2008, the average American family worked 64 days to pay for food and transportation, while it worked 113 days to pay its federal and state taxes. I suspect that the taxes on energy were not even included in the transportation calculation. Housing and household operations was 60 days. Taxes, of course, are in every product that we buy. In terms of GDP, energy is about 7%, health spending is 14%, and taxes are about 19% on the Federal level. Taxes and health spending are in every price that we pay for goods, and energy is still a smaller component than they are. It is impossible to find a general category of economic production that is not in any product's price. Energy is in everything, but so is everything else. Most of the energy cost in economic history has been as a replacement of labor cost, such as use of equipment rather than muscle and sweat. Better to use a jackhammer than a sledgehammer. Using a sledgehammer would save energy, but the worker's productivity and the worker's wage would decrease significantly. What higher energy costs do is eliminate the tasks where there is no economic return to their use or where a better return can be had elsewhere.
During periods of stagflation, when one sector such as energy is rising in price significantly, the common approach is to look at other areas for efficiency to counterbalance them. In a stagflation situation, those other areas are generally rising in prices as well, so it requires a significant step back and reorganization to permanently adjust. That is, rapid energy cost increases outweigh the benefits of simple alternatives. The printing industry still has untapped benefits of non-production information systems implementation to achieve, and these benefits are hard to create without investment and retructuring of jobs. Generally, the backroom processes and management information systems are still inefficient in printing companies in relation to the attention the shop floor gets.
Those efficiencies will be sorely needed if we have more months like May. As our monthly report details, commercial printing shipments were down -3.5% compared to May 2007. That's in current dollars, not even adjusting for inflation. I instant messaged with an industry publisher that the numbers were gruesome enough without adjusting for inflation. He suggested I just leave them the way they are and not make them worse. I couldn't help myself: it was -7.4% adjusting for inflation. We're watching the employment of the creative sectors carefully for signs of what this Fall's printing shipments will be like. We'll know more this week. Employment in advertising and design looked like it was starting to break down last month, which is not a good sign. This month's report audio commentary reviewed all of our forecasts. We also updated our GDP model of print volume: the statistical relationship is relatively weak, and it's still negative: as GDP rises, print declines.
I've often written how the media report about the economy in terms of what happens in their business. Basically, we're in a depression because the newspaper and big publishing businesses are doing rather poorly. The same folks were "new economy" cheerleaders in the late 1990s as their ad pages swelled with internet start-up advertising. This opinion piece sums it up quite well. When my neighbor loses a job it's a recession; when I lose my job, it's a depression.

so, to answer the questions, yes, yes and no.
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1/23/2015 8:51:02 PM
Posted: 1 year ago
I have a very simple way of measuring the economic outlook and it is 100% accurate. If you can't quite your job right now and go find another one that pays the same or more within a week. The economic outlook is abysmal and a depression is on the way. I could not even think of quitting my job and expect to make half what I make doing the same thing somewhere else. They don't have to pay. There are 30 people competing for every available job that pays over $15 hr. That's a hell of alot less than what I make now. And if I lost my job god forbid that would be the starting rate. And I am an extremely skilled person in many fields.
I am not what you think I am. You ARE what you think I am