Tag Archives: inflation

Is Europe On The Verge Of Another Great Depression – Or A Great Inflation?

By Simon Johnson

The news from Europe, particularly from within the eurozone, seems all bad.  Interest rates on Italian government debt continue to rise.  Attempts to put together a “rescue package” at the pan-European level repeatedly fall behind events.  And the lack of leadership from Germany and France is palpable – where is the vision or the clarity of thought we would have had from Charles de Gaulle or Konrad Adenauer?

In addition, the pessimists argue, because the troubled countries are locked into the euro, there are no good options.  Gentle or even dramatic depreciation of the exchange rate for Greece or Portugal or Italy is not in the cards.  As a result, it is hard to lower real wages so as to restore competitiveness and boost trade.  This means that the debt burdens for these countries are likely to seem insurmountable for a long time.  Hence there will likely be default and resulting global financial chaos.

According to the September 2011 edition of the IMF’s Fiscal Monitor, 44.4 percent of Italian general government debt is held by nonresidents, i.e., presumably foreigners (Statistical Table 9).  The equivalent number for Greece is 57.4 percent, while for Portugal it is 60.5 percent.  And if you want to get really negative and think the problems could spread from Italy to France, keep in mind that 62.5 percent of French government debt is held by nonresidents.  If Europe has a serious meltdown of sovereign debt values, there is no way that the problems will be confined just to that continent.

All of this is a serious possibility – and the lack of understanding at top European levels is a serious concern.  No one has listened to the warnings of the past three years.  Almost all the time since the collapse of Lehman Brothers has been wasted, in the sense that nothing was done to put government finances on a more sustainable footing.

But perhaps the pendulum of sentiment has swung too far, for one simple and perhaps not very comfortable reason. Continue reading

Ben Bernanke Doesn’t Get the Message

By James Kwak

I was on vacation last week (far from Jackson Hole) when Ben Bernanke gave his widely anticipated speech. The media (see the Times, for example) seemed to focus mainly on his criticisms of the political branches and economic policymaking, which were accurate enough. But in my opinion, Bernanke drew the wrong lessons from those observations.

He was very clear that the problem today is unemployment, not inflation:

“Recent data have indicated that economic growth during the first half of this year was considerably slower than the Federal Open Market Committee had been expecting, and that temporary factors can account for only a portion of the economic weakness that we have observed. Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters. With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate.”

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Paul Ryan Criticizes Bernanke for Failing to Contain Tooth Fairy

By James Kwak

In a Congressional hearing today, Representative Paul Ryan (R-WI), chair of the House Budget Committee, strongly criticized Federal Reserve Chair Ben Bernanke for failing to contain the severe inflation threat posed by the Tooth Fairy.

Ryan pointed to numerous studies showing that, despite ongoing economic sluggishness, the Tooth Fairy is paying much more for children’s baby teeth than in past years. In neighborhoods such as Winnetka, Cleveland Park, the Upper East Side, and Palo Alto, children can receive more than $20 per tooth — a dramatic increase from the 25-50 cents that the Tooth Fairy paid only a decade or two ago. In the Hamptons, summertime prices for teeth can easily exceed $100, according to a survey commissioned by the American Enterprise Institute.* Because the Tooth Fairy is able to create money magically, her purchases of unused teeth (with no apparent economic value**) increase the money supply, fueling inflation. Without explicitly accusing Bernanke of participation in the Tooth Fairy’s scheme, Ryan implied that the Tooth Fairy’s higher payouts may be part of the Federal Reserve’s quantitative easing scheme.

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Fed Chest-Thumping for Beginners

I generally avoid writing about monetary policy, since every economics course I’ve taken since college has been a micro course, and besides Simon is a macroeconomist, among other things. But since just about everyone in my RSS feed has been linking to Tim Duy’s recent article on the Fed, I thought I would try to put in context for all of us who don’t understand Fed-speak.

Duy takes as his starting point a series of statements by Fed governors and bank presidents indicating “hawkishness,” which in central banker jargon means caring primarily about inflation, not economic growth. (“Doves” are those who care more about economic growth and jobs, although, just like in the national security context, no one likes to be known as a dove. This itself is a disturbing use of language, since it implicitly justifies beating up on poor people, but let’s leave that for another day.)

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Where Are We Now? Five Point Summary

1. Financial markets have stabilized – largely because people believe that the government will not allow Citigroup to fail.  We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside.  How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view).  For more on how we got here, see the Frontline documentary that airs on Tuesday and Paul Solman’s explainer wrap up.

2. The real economy begins to bottom out, although unemployment will not peak for a while and could stay high for several years.  Longer term growth prospects remain uncertain – has consumer behavior really changed; if finance doesn’t drive growth, what will; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)? Continue reading

Brazen Tunneling and Inflation

In most societies it is traditional to be somewhat sneaky in squeezing your shareholders or the government.  You might set up a complicated transfer pricing scheme or perhaps you arrange for a family-owned firm to acquire assets on the cheap from the publicly traded corporation that you control.  Or you could always arrange for the Kremlin to provide foreign exchange at a “special” price.

In the New United States, life is much simpler and bank tunneling considerably more brazen. Continue reading

GDP Growth Rates for Beginners

For a complete list of Beginners articles, see Financial Crisis for Beginners.

My post about French sociology got a wide range of comments, ranging from “Without a doubt, your best post yet” to “Reading this post made me think, for the first time, of ignoring Baseline Scenario from now on,” which I guess indicates we have a wide range of readers. In any case, for today I’m returning to something much more mundane: GDP growth rates. Like many Beginners articles, this one starts out with some basics, and then gets (a little) more interesting, but its main goal is to help you decipher the news that you already read.

To a casual reader, yesterday’s GDP announcement was that Gross Domestic Product (an aggregate measure of economic activity) fell by 6.1% or, more precisely, at an annual rate of 6.1%. What does this mean?

For those of you who have never visited the BEA website, this is what the raw numbers look like. (They give you  columns B and E, I calculated the rest.) Note that this is all in 2000 dollars, so inflation has been taken out.

gdp1

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Inflation Expectations for Beginners

For a complete list of Beginners articles, see Financial Crisis for Beginners.

Only a few years ago, the accepted remedy for a recession was for the Federal Reserve to lower interest rates – namely, the Federal funds rate. Now, however, the economy has been stuck in recession for over fifteen months and the Federal funds rate has spent the last several months at zero. (The Fed funds rate cannot ordinarily be negative, because one bank won’t lend $100 to another bank and accept less than $100 in return; it always has the option of just holding onto its $100.) As a result, the Fed has resorted to other policy tools, most notably large-scale purchases of agency and Treasury securities, funded by creating money. (Here’s James Hamilton’s analysis.)

As the Fed’s monetary policy plays a more prominent role in the response to the economic crisis, there will be more talk of inflation or, more accurately, inflation expectations. While inflation is what affects the purchasing power of the money in your wallet, inflation expectations are what affect people’s behavior in ways that have a long-term economic impact. Take the case of wage negotiations, for example: a union that believes inflation will average 5% over the life of a contract will demand higher wage increases than a union that believes inflation will average only 1%. Once those higher wages are built into the contract, the employer is forced to raise prices in order to cover those wage increases, and inflation begins to ripple through the economy.

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Causes Of A Great Inflation: Tunneling For Resurrection

Here is Ben Bernanke’s problem.

1. The financial sector is busy setting up arrangements in which employees are guaranteed high levels of compensation if they stay on through the difficult days ahead.  These retention-type payments allow firms to survive in their existing form, pursue business-as-usual, and gamble for resurrection, i.e., make further risky investments.

2. But these same payment schemes, e.g., Goldman Sachs’ loans-for-employees deal, are a form of poison pill with regard to further bailouts – the Administration may want to help these firms down the road, but this kind of tunneling means Congress will put its foot down.  Do you think that President Obama’s $750bn for bailouts (scored as $250bn) will survive the budget process?  No New Bailout Money is a slogan reaching from here to the midterm congressional elections. 

3. And the financial system is in big trouble.  Unless the economy turns around, somewhat miraculously, we are in for a big slump.  Or even for a Great Depression – watch closely the words and body language in Bernanke’s interview on 60 Minutes

The big banks are essentially making themselves Too Politically Toxic To Rescue, and this has potentially bad macroeconomic consequences.  So what will Bernanke do? Continue reading

The Long Bond Yield Also Rises

The spread between Greek government 10-year bonds and the equivalent German government securities rose sharply this week – Greek debt at this maturity now yields 6.0% vs. German debt at 3.1%.  Other weaker eurozone countries appear to be on a similar trajectory (e.g., Irish 10 year government debt is yielding 5.8%) and if you don’t know who the PIIGS are, and why they are in trouble, you should find out.

We also know East-Central Europe (including Turkey) has major debt rollover problems and most of that region is in transit to the IMF, with exact arrival times determined by precise funding needs relative to the usual political desire to keep the party going through at least one more local election.  Put the IMF down for another $100bn in loans over the next six months, and keep the G20 talking about providing the Fund with more resources.

But the big news of the week, with first-order implications for the US and the world, was from the UK where the prospect of further bank nationalization now looms.  Continue reading

Who’s Afraid of Deflation?

According to the Federal Open Market Committee’s (FOMC) minutes, released on Tuesday, some members think inflation targetting would be a useful way to persuade people that prices will not fall, i.e., forestall deflationary expectations.  WSJ.com seems to have the interpretation about right,

“The added clarity in that regard might help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low and support aggregate demand,” according to the minutes.

In other words, a commitment to an inflation target, say annual growth of 1.5% to 2%, would help keep prices from falling outright and prevent the kind of economic chaos that plagued Japan in the 1990s and the U.S. during the Great Depression.

The Congressional Budget Office thinks there is still time to prevent deflation (or perhaps it is the new measures already in the works that will keep inflation positive).  Their forecast for 2009 (see Table 1 in today’s testimony) predicts low inflation, e.g., the PCE price index is expected to be 0.6 percent for 2009 – but note that the CPI is seen as barely positive, at 0.1 percent, over the same period.

Meanwhile, the financial markets (e.g., inflation swaps) predict minus 4 percent inflation in 2009 (part of which is likely due to lower commodity prices) and then a small degree of deflation over the next few years.  According to this view, we should next see today’s price level again in about 5 or 6 years.

Of course, the financial markets could well be wrong.  It may be that the markets haven’t fully digested or understood the size of the fiscal stimulus, and it may be that further news about other parts of the Obama approach (including the directly on housing and banking) will significantly change inflation expectations.

But it is striking that financial market inflation expectations – e.g., over a five year horizon – have barely moved from their low/near deflation level since it became clear that Mr Obama would win the election or since we first realized that a massive fiscal stimulus would soon arrive (see slide 2 in my presentation from Sunday; the scale is hard to read, but the decline is from around 2% through the summer to around 0% currently).  At least for now, whether or not we are heading for deflation remains the key open question.

Overweight Fiscal? (The Obama Economic Plan)

Most of the current discussion regarding the Obama Economic Plan focuses on whether the fiscal stimulus should be somewhat larger or smaller ($650-800bn seems the current range) and the composition between spending and tax cuts.  President Obama stressed on Tuesday that trillion dollar deficits are here to stay for several years, and it looks like part of the arguing in the Senate will be about whether this is a good idea.

There is at least one key question currently missing from this debate.  Is this Plan too much about a fiscal stimulus and too little about the other pieces that would help – and might even be essential – for a sustained recovery?  The fiscal stimulus may be roughly the right size (and $100bn more or less is unlikely to make a critical difference), but perhaps we should also be looking for more detail on the following:

1. Recapitalizing banks.  Their losses to date have not been replaced by new capital and it is currently not possible to issue new equity in the private markets.  If you think we can get back to growth without fixing banks, check Japan’s record in the 1990s.

2. Directly addressing housing problems, including moving to limit foreclosures and reduce the forced sales that follow foreclosures.  There is apparently some form of the Hubbard-Mayer proposal waiting in the wings, but we don’t know exactly what – and this matters, among other things, for thinking about the debt sustainability implications of the overall Plan.

3.  Finding ways to push up inflation, presumably by being more aggressive with monetary policy.  Deflation is looming – according to the financial markets, despite all of the Fed’s moves and recent statements, prices will fall or be flat over the next 3 to 5 years.  This fall in inflation, from its previous expected level around 2 percent per year, constitutes a big transfer from borrowers/spenders to net lenders/savers.  The contractionary effect is likely to outweigh any fiscal stimulus that is politically feasible or economically sound.  (We have more detail on this point on WSJ.com today, linked here.)

So perhaps the issue is not the absolute size or composition of the fiscal stimulus, but rather the role of the fiscal stimulus relative to other parts of the Plan.  Hopefully, it’s a more evenly weighted package, and just we haven’t yet seen the details.  Still, it’s odd that the presence and general contours of these other important elements have not yet been clearly flagged.

Exit Strategy: Inflation

We know there is going to be a large fiscal surge in the US (the latest estimate is a stimulus of $675-775bn, which is a bit lower than numbers previously floated).  This will likely arrive as the US recession deepens and fears of deflation take hold. 

The precise outcomes for 2009 are, of course, hard to know yet – this depends primarily on the resilience of US consumer spending and whether large international shocks materialize.  But we can have a sense of what happens after the fiscal stimulus has played out (or its precise consequences become clear).   There are two main potential scenarios. Continue reading

Expansionary Monetary Policy is Infectious

The Federal Reserve’s announcement yesterday makes it clear that we should see its leadership as radical incrementalists.  They will move in distinct incremental steps, some small and some larger, but they will do whatever it takes to prevent deflation.  And that means they will do what it takes to make sure that inflation remains (or goes back to being?) positive.  If they need to err on the side of slightly higher inflation, then so be it.  This is pretty radical (and a good idea, in my opinion.)

What effect does this have on the rest of the world?  Continue reading

Kenneth Rogoff Embraces Inflation

Right here. I wouldn’t ordinarily just pass along a link you can find elsewhere, but I can’t help remarking that that makes two former chief economists of the IMF to take this position. That was Simon’s old job; his article on the topic is here. Of course, you are free to keep whatever opinion you may have about the IMF and its chief economists.

(Thanks to Mark Thoma for flagging this.)