Thursday, May 31, 2018

India sets a price floor for sugar and gets a surplus

See India, Buried in Sugar, Tries to Dig Out: Government price controls have created an unsustainable glut, with 13 million tons stockpiled by Vibhuti Agarwal of The WSJ.

This is what we teach in ECON 101. If the government says the price has to be above where supply and demand intersect. then the quantity supplied rises and the quantity demanded falls and you have a surplus.

Excerpt from the article:
"The Indian government’s price controls have created an unsustainable sugar glut, and now New Delhi wants to dump it on the already struggling world market for the commodity.

India is the world’s second-largest producer and biggest consumer of sugar. Thanks to strict controls of imports, exports and prices, the country generally produces all it needs.

In a holdout from an era of central planning, New Delhi sets the minimum price for cane, and to keep sugar-cane farmers sweet with the government, it keeps raising that price. But end-user sugar prices are free to fluctuate and currently are so low that refiners say they lose money on every teaspoon they sell.

“Stocks get added every year, but there are not as many takers,” said refiner Amit Agarwal, who runs sales operations in a sugar mill in the northern state of Uttar Pradesh. Pointing to a warehouse packed with 77,500 metric tons of sugar he can’t sell, Mr. Agarwal said his mill is under pressure to pay farmers on time. “But where is the money to pay them?” he said.

Refiners are required to buy everything the cane farmers bring them at a government-set price. But because they only have to pay the farmers after they sell it, they are hoarding the sugar and waiting for a better price—or better incentives."

The result: piles and piles of sugar, in warehouses all over India. Mr. Agarwal’s five warehouses all have sugar bags piled 34 feet high. At last count, in late May, Indian refiners had a stockpile of 13 million tons of sugar—more than all the sugar consumed in the U.S. last year."

Tuesday, May 29, 2018

Higher U.S. interest rates recently helped fuel a surprise rally in the dollar

See U.S. Government Bonds Pay More Than Debt From Other Developed Nations: Higher yields reflect investors’ struggle to reconcile expectations for faster U.S. growth with concerns about impact of deficits and inflation by Daniel Kruger of The WSJ.

This is one of the factors that affects the value of the dollar that I talk about when I cover exchange rates. If the interest rate on U.S. government bonds rise relative to those in other countries, the demand for the dollar will increase because investors need dollars to buy more U.S. bonds. So then the value of the dollar also rises. That is, it will take more of other currencies to buy one U.S. dollar.

See Trade Weighted U.S. Dollar Index: Major Currencies (DTWEXM) from the St. Louis Federal Reserve Bank (a timeline chart of this is at the end of the post.

Now an excerpt from The WSJ article:
"U.S. government bonds are paying more than debt from other developed countries for the first time in almost two decades, a new sign of investors’ struggle to reconcile expectations for faster U.S. growth with concerns about the impact of deficits and inflation.

The yield on the benchmark 10-year Treasury note, a key barometer for borrowing costs for consumers and companies, last week topped 3.1%, its highest close in almost seven years. It’s a climb that’s rippling through markets, buffeting stocks and helping fuel a surprise rally in the dollar as higher rates attract yield-seeking investors to the currency.

Analysts said the rise in yields in part reflects optimism about the U.S. economy and expectations for a pickup in inflation, which threatens the value of government bonds by eroding the purchasing power of their fixed payments.  A market-based measure of expectations for annual inflation over the next 10 years, known as the break-even rate, recently reached its highest levels since 2014.

“The U.S. has the highest rates of everyone in the G-10 and it looks like the rate differential will continue to widen,” said Chris Gaffney, president of EverBank World Markets. “The U.S. seems to be going it alone in this rising interest-rate path.”

The 10-year yield’s surge this year has pushed it above yields on bonds from seven major developed countries for the first time since June 2000, according to an analysis by Bianco Research. It recently exceeded the yield on 10-year debt from a record number of countries, according to Deutsche Bank Research, and surpassed the 10-year German bund yield by the most in almost three decades."
Related posts:

Why Is The Dollar Down 5.6% This Year?

Why Did The Value Of The Dollar Rise More Than 20% From July 2014 To March 2015?

The weakening dollar is having rippling effects around the world.

Monday, May 28, 2018

Comparative Advantage

Yesterday I posted a link to the new PBS series "First Civilizations" which had an interesting episode on trade. Last year was the 200th anniversary of David Ricardo's important idea called "comparative advantage." It explains how two nations can benefit from trade even if one country seems to be better at making all products than the other.

The Washington Post even had an article about it last year. It's the 200th anniversary of the most counterintuitive idea in the social sciences by Daniel W. Drezner, a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.

Trade can benefit both sides. Otherwise, why make the trade? For example, if you have bread and no water and I have water and no bread, if I trade some water to you for some of your bread, we both gain or are better off.

It might seem like if one country is "better" at producing all goods than another, they have no room for trade. But even then, the seemingly more advanced country will still gain from trade.

Here is an example that comes from  David Ricardo himself. Comparative advantage is when you can produce a good at a lower opportunity cost than others face (in a two good example, it is impossible to have the comparative advantage in both goods).

Suppose it takes 40 labor hours to make a barrel of wine in England and 2 hours to make a yard of cloth. In Portugal, those numbers are 10 and 1, respectively. So it looks like Portugal is "better" at producing both goods since it takes them less time to make wine and less time to make cloth.

The labor hours numbers means that if England wants a barrel of wine, it would have to give up 20 yards of cloth (since 40/2 = 20-if you don't produce a barrel of wine, you save 40 hours of labor and you can make 20 yards of cloth in that time).

In Portugal, if you want to trade a barrel of wine, you can get 10 yards of cloth. Not spending 10 hours making wine allows them to make 10 yards of cloth.

So Portugal has the comparative advantage in wine since less cloth is given up there (10 yards) than in England (20 yards) for every one barrel of wine produced. That is a lower opportunity cost.

England would only give 1/20 a barrel of wine to make cloth while Portugal gives up 1/10 a barrel. England has the  comparative advantage in cloth.

How can the two countries gain from trade? What if England trades 15 yards of cloth to Portugal for 1 barrel of wine?

Both countries gain. England is better off since they only give up 15 yards of cloth to get that barrel of wine when normally they have to give up 20.

Portugal gets more cloth (15 yards instead of 10) for that 1 barrel of wine they trade. They are better off, too (even though it takes them less time to make each product than in England).

Sunday, May 27, 2018

New PBS Series "First Civilizations" Has Interesting Episode On Trade

Here is a summary of the episode.
"Examine an ancient civilization unlike any other, that of the Indus Valley. Rather than imposing order through war or religion, it relied on the free flow of trade. The exchange of goods promoted wealth, co-operation and trust."
Click here to go to the list of episodes. There should be a link that will allow you to watch it. Highly recommended.

Saturday, May 26, 2018

Is The Phillips Curve Dead In Japan? Maybe not

See In Booming Japan, the Phillips Curve Is Dead: Unemployment is down but inflation isn’t budging. Why companies resist raising prices by Greg Ip of The WSJ. Excerpt:
"By several measures, the economy is overheating. Total activity is now 1.5% above normal capacity, the Bank of Japan estimates. Unemployment, at 2.5%, and businesses’ spare capacity are both the lowest since 1993, when the 1980s property and stock bubbles were still deflating. There is more than one job opening for every active job seeker in all 47 prefectures. “This clearly means there is much more demand than supply,” says Masatsugu Asakawa, vice-minister of finance. “Almost every indicator has been great. The only mystery is the weak performance of prices.”

In defiance of the Phillips curve, these intensifying bottlenecks have had only limited impact on wages, and none on prices. Inflation in the year through April was just 0.4% when fresh food and energy are excluded. That’s better than the outright deflation that generally prevailed from 1998 to 2012, but not by much, and it’s a far cry from the Bank of Japan’s 2% target. This is a problem, because if inflation gets stuck at or below zero, interest rates also get stuck at zero, robbing the central bank of its ability to stimulate the economy by cutting rates."

But that is only recently. Below is one of the graphs from the article and since the late 1990s, there have been periods in Japan when the unemployment rate fell while the inflation rate rose.

Look at the two green lines. It looks like from 1998-2002, unemployment and inflation go in the opposite direction (the unemployment rate rose while the inflation rate became lower). That is what the Phillips curve predicts.

Then it looks like they moved in the opposite direction for the next 2-3 years (the yellow lines), although unemployment fell while inflation rose.

Then starting in 2009, they moved in the opposite direction again for a couple of years. Red lines.

And from 2010-2015, they moved in the opposite direction. Black lines.

So maybe for 13-14 of the last 19 years, things have gone the way the Phillips curve would have predicted. And certainly since 2009 except for the last 2 years.

AD and SRAS help explain what is going on. As AD increases or shifts to the right, prices rise. But the increases get bigger. Q or GDP increases, which lowers unemployment, but less each time. That tells the same story as the Phillips curve. But, what if supply shifts to the right? (which I don't show). If SRAS shifts more to the right than AD, then the rise in prices might be slight (and inflation could be less than what it was in the past) while the increases in Q can be large and the unemployment rate falls. That is the opposite of the Phillips Curve. So the Phillips Curve has to assume a fixed SRAS.

Thursday, May 24, 2018

Is The Phillips Curve Not Holding Up Well Beacuse The Service And Goods Sectors Are Behaving Differently?

Split in Goods and Services Inflation Underscores Fed’s Challenge: Conventional theory on the link between unemployment and prices holds up for one category, but not in the other by Paul Kiernan of The WSJ. Excerpts:

"On one hand is the goods economy, where products like computers, gasoline and hair dryers are made and purchased, and where Americans spend roughly one-third of their money. On the other hand is the services economy, where cable guys, nurses and bus drivers jostle for the bulk of consumer spending.
The goods economy has been transformed by trade and technological innovation over several decades, giving consumers access to inexpensive products made in foreign countries or automated factories. The services economy has been more sheltered from international competition and technological change. You can’t hire cheap Chinese labor to serve you pizza or a robot to teach your ninth-grader English.

Because of those differences, inflation behaves differently in the two economies."

"Economic theory holds that as unemployment falls and labor becomes scarcer, wages and inflation should rise. But the theory—known as the Phillips curve, after 20th century economist William Phillips—hasn’t held up very well in the past decade. Since 2009, the unemployment rate has fallen from a peak of 10% to an 18-year low of 3.9% in April, yet overall inflation has remained stubbornly low, running under the Fed’s 2% target for most of the expansion."

"So far in this expansion, services inflation as measured in the consumer-price index has moved up from near 0.5% to near 3%, a trend that theory suggests should happen as unemployment falls. Something different is happening in the goods economy, where prices have been falling for much of the past five years as if disconnected from the overall unemployment rate."

"Prices for services tend to be “sticky,” meaning they’re slow to respond to changes in monetary policy or the broader economy. That means turning them around, should inflation exceed the Fed’s target, could become a challenge."

See also yesterday's post Has the Fed Flattened the Phillips Curve?

Wednesday, May 23, 2018

Has the Fed Flattened the Phillips Curve?

See How the Unfettered Fed Flattened the Phillips Curve: Insulating the central bank from politics made it possible to keep inflation and unemployment low by Neel Kashkari. He is president of the Federal Reserve Bank of Minneapolis.

I have had some recent posts on inflation, unemployment and their tradeoff (The Phillips Curve). After some excerpts, I show a Phillips curve and how, if it is flattened, that reducing the unemployment rate will result in a smaller percentage point increase in the inflation rate.

"Until the early 1980s the Phillips curve predicted price and wage growth with reasonable accuracy, but since then the economy has wandered far from the traditional relationship. Wages and inflation haven’t grown nearly as much as it would predict, given the sinking jobless rate."

"This curve is flatter than it used to be, simply because the Fed has gotten better at managing inflation. When unemployment shot up from 4.6% in 2007 to 10% in 2009, the normal curve predicted deep deflation. But the Fed’s aggressive interventions stabilized core inflation, which never fell below 0.9%."

"On the other hand, the “underlying” Phillips curve represents the intrinsic relationship between inflation and the fundamental supply and demand for labor. Even when the Fed keeps actual inflation in check, inflationary pressures can build, and the underlying Phillips curve might remain steep."

"The underlying Phillips curve began to flatten, or lose its power to forecast inflation, in the mid-1980s, and the trend has continued."

"As market participants have gained confidence that the Fed will make decisions based on economic data rather than short-term political considerations, inflation has become more predictable, and wages and prices have become less subject to short-term changes in employment."

In the graph below, on the steep Phillips curve, if the unemployment rate is 8%, and the inflation rate is 3% (point A), to get the unemployment rate to 4%, the inflation rate would have to rise to 7% (point B). That is a three percentage point increase.

But if the Phillips curve becomes flatter, then getting the unemployment rate to 4% means the inflation rate only has to rise to about 3.5% (point C). That is only a 1.5 percentage point increase.

Related posts

Nobody knows what the natural rate of unemployment is today

More on the natural rate of unemployment

How Central Banks Differ In Their Methods Of Calculating Inflation

Tuesday, May 22, 2018

Supply Means Producing A Good And Customers Being Able To Purchase It

When I teach the shift factors for supply and demand, one is expectation of future price. If buyers expect a significant increase in price in the near future, demand today will rise since consumers will want to beat the higher price.

But firms will reduce supply today, since they would rather wait just a bit and sell at a higher price. That is, the amount they offer for sale today will fall. One textbook, which I think was wrong, said that supply would increase since firms will want to have more to sell when the higher price comes.

But supply means that customers have to be able to buy the product. If a firm produces more, but keeps the goods locked in a warehouse until the price rises, supply has not increased today.

Something like this is happening with oil right now. See Trans-Atlantic Oil-Price Spread Soars as Supply Glut Disappears: Divergence is a sign of how stretched global supplies have become even as U.S. output has marched higher by Alison Sider of The WSJ.

World oil prices are rising and it seems like that would cause U.S. prices to rise. But U.S. prices are lagging behind. Here is an excerpt from the article:

"U.S. oil prices are lagging behind global oil prices climbing toward $80 a barrel, the latest sign of a market that has gone from glutted to exceptionally tight in the past year.

U.S. oil futures are trailing Brent, the global benchmark, by nearly $7 a barrel, settling at $72.24 a barrel on Monday. Last week, the difference was even wider, approaching $8 a barrel, based on closing prices. The two benchmarks haven’t been that far apart since 2015, before U.S. crude could be freely exported.

The divergence is a sign of how stretched global oil supplies have become even as U.S. output has marched higher, overtaking Saudi Arabia and rivaling Russia. That has contributed to soaring U.S. exports, which have hit a record of nearly 2.6 million barrels a day as users clamor for it."


"Lately, Brent has been pulling ahead of West Texas Intermediate, the U.S. benchmark. Tensions in the Middle East and anticipation that renewed sanctions will crimp Iran’s oil exports are having an outsize impact on global prices."


"U.S. oil producers that can get their oil to the Gulf Coast to be loaded onto tankers are reaping the benefits. Pioneer Natural Resources Co. , for example, told investors recently that 95% of its West Texas production flows toward refineries and export facilities at the Gulf, where it fetches prices linked to Brent. That added $16 million to its cash flow in the first quarter.

But others aren’t so lucky: A lot of oil is backing up in West Texas, where there aren’t enough pipelines to get all of the oil to market."

Not all the oil can get to a place where the customers can buy. So it is being produced but not supplied to the market. If it were supplied to the market outside the U.S., that would reduce the world price and there would be less of a gap between the Brent price and the West Texas Intermediate price.

Again, production does not necessarily mean supply. The goods have to be where the customers can buy them.

Sunday, May 20, 2018

A number of women who put off having babies after the 2007-09 recession are forgoing them altogether; more educated women and student debt also contribute to decline in birth rates

See U.S. Births Hit Lowest Number Since 1987: Last year’s fertility-rate drop was the largest one-year decline since 2010 by Janet Adamy of The WSJ.
"American women are having children at the lowest rate on record, with the number of babies born in the U.S. last year dropping to a 30-year low, federal figures released Thursday showed.

Some 3.85 million babies were born last year, down 2% from 2016 and the lowest number since 1987, according to the Centers for Disease Control and Prevention’s National Center for Health Statistics. The general fertility rate for women age 15 to 44 was 60.2 births per 1,000 women—the lowest rate since the government began tracking it more than a century ago, said Brady Hamilton, a statistician at the center.

The figures suggest that a number of women who put off having babies after the 2007-09 recession are forgoing them altogether. Kenneth M. Johnson, senior demographer at the University of New Hampshire, estimates 4.8 million fewer babies were born after the recession than would have been born had fertility rates stayed at prerecession levels."

"The postrecession baby lull appeared to be ending when births ticked up in 2014. But they’ve now fallen for three straight years, and last year’s fertility-rate drop was the largest one-year decline since 2010."

"One bright spot in Thursday’s figures, which are preliminary, is a continued sharp decline in teen births, which fell 7% last year. Since 2007, the teen birthrate has declined by 55%, and is down 70% since its peak in 1991. Children born to adolescents are more likely to have poorer educational, behavioral and health outcomes throughout their life."

"lower teen fertility accounts for about one-third of the overall decline in births among U.S. women.

The increase in women attending college is another force behind the birth decline, researchers say. Those with more skills face a greater trade-off if they interrupt their careers to have children.

“People are coming out with a lot of debt,” said Jennie Brand, professor of sociology and statistics at UCLA who has studied the impact of education on fertility. That gives them an incentive to keep working. “It’s another thing they have to grapple with before they might think about starting a family.”"

Related posts:

The Economy Affects The Birth Rate (2010)

Did The Recession Help Lower The Birth Rate? (2011)

U.S. Fertility Rate Hits Lowest Level on Record (2012)

Thursday, May 17, 2018

Has An Increase In Supply Reduced The Economic Value Of Recycling?

See Recycling, Once Embraced by Businesses and Environmentalists, Now Under Siege: Local officials raise fees and send recyclables to landfills as economics erode by Bob Tita of The WSJ. It seems like there is so much of it that the price has fallen and it is not worth the cost of sorting, etc. The article has a graph that shows that just in the last two years the price of cardboard has fallen by 50% while it has fallen even more for mixed paper. Excerpts:
"The U.S. recycling industry is breaking down.

Prices for scrap paper and plastic have collapsed, leading local officials across the country to charge residents more to collect recyclables and send some to landfills. Used newspapers, cardboard boxes and plastic bottles are piling up at plants that can’t make a profit processing them for export or domestic markets.

“Recycling as we know it isn’t working,” said James Warner, chief executive of the Solid Waste Management Authority in Lancaster County, Pa. “There’s always been ups and downs in the market, but this is the biggest disruption that I can recall.”"

"As cities aggressively expanded recycling programs to keep more discarded household items out of landfills, the purity of U.S. scrap deteriorated as more trash infiltrated the recyclables. Discarded food, liquid-soaked paper and other contaminants recently accounted for as much as 20% of the material shipped to China, according to Waste Management Inc.’s estimates, double from five years ago.

The tedious and sometimes dangerous work of separating out that detritus at processing plants in China prompted officials there to slash the contaminants limit this year to 0.5%. China early this month suspended all imports of U.S. recycled materials until June 4, regardless of the quality. The recycling industry interpreted the move as part of the growing rift between the U.S. and China over trade policies and tariffs.

The changes have effectively cut off exports from the U.S., the world’s largest generator of scrap paper and plastic. Collectors, processors and the municipal governments that hire them are reconsidering what they will accept to recycle and how much homeowners will pay for that service. Many trash haulers and city agencies that paid for curbside collection by selling scrap said they are now losing money on almost every ton they handle."

"The waste-management authority in Lancaster County this spring more than doubled the charge per ton that residential trash collectors must pay to deposit recyclables at its transfer station, starting June 1. The higher cost is expected to be passed on to residents though a 3% increase in the fees that haulers charge households for trash collection and disposal."

"Mr. Warner may limit the recyclable items collected from Lancaster County’s 500,000 residents to those that have retained some value, such as cans and corrugated cardboard. He said mixed plastic isn’t worth processing."

"the more intensive sorting process takes too long to process scrap profitably."
Interesting that the article mentions that few items still have value, including cans and  corrugated cardboard. It reminds me of a 2015 New York Times article by John Tierney called The Reign of Recycling. Excerpt:
"According to the E.P.A.’s estimates, virtually all the greenhouse benefits — more than 90 percent — come from just a few materials: paper, cardboard and metals like the aluminum in soda cans. That’s because recycling one ton of metal or paper saves about three tons of carbon dioxide, a much bigger payoff than the other materials analyzed by the E.P.A. Recycling one ton of plastic saves only slightly more than one ton of carbon dioxide. A ton of food saves a little less than a ton. For glass, you have to recycle three tons in order to get about one ton of greenhouse benefits. Worst of all is yard waste: it takes 20 tons of it to save a single ton of carbon dioxide.
Once you exclude paper products and metals, the total annual savings in the United States from recycling everything else in municipal trash — plastics, glass, food, yard trimmings, textiles, rubber, leather — is only two-tenths of 1 percent of America’s carbon footprint.
As a business, recycling is on the wrong side of two long-term global economic trends. For centuries, the real cost of labor has been increasing while the real cost of raw materials has been declining. That’s why we can afford to buy so much more stuff than our ancestors could. As a labor-intensive activity, recycling is an increasingly expensive way to produce materials that are less and less valuable.

Recyclers have tried to improve the economics by automating the sorting process, but they’ve been frustrated by politicians eager to increase recycling rates by adding new materials of little value. The more types of trash that are recycled, the more difficult it becomes to sort the valuable from the worthless.
In New York City, the net cost of recycling a ton of trash is now $300 more than it would cost to bury the trash instead. That adds up to millions of extra dollars per year — about half the budget of the parks department — that New Yorkers are spending for the privilege of recycling. That money could buy far more valuable benefits, including more significant reductions in greenhouse emissions."
See also his 1996 article Recycling Is Garbage.

Wednesday, May 16, 2018

Have Performers Found A Way To Beat Ticket Scalpers?

It seems like it has been going on for a long time. Pop stars put tickets on sale and a concert is sold out quickly. But many of the the tickets are bought by scalpers who turn around and sell them for a higher price.

Why wouldn't the performers just raise the price to what fans end up paying anyway? Then there is no margin for the scalpers. The pop stars have long wanted the publicity of the instant sell out and also might not have wanted to alienate their fans with high prices.

But now, it seems like there are ways to verify who the "real" fans are online who buy early. They get discounts and it prevents the scalpers from buying up large blocks of tickets early on.

See Why Empty Seats at Taylor Swift’s Concerts Are Good for Business: Pricier tickets aimed at squeezing out scalpers and delivering higher returns to promoters are producing fewer instant sellouts by Anne Steele of The WSJ. The new policy seems to be working because Swift has already made 15% more than her last tour. Excerpts:
"The strategy, which could reset how tickets to high-profile tours are sold, is to use aggressive pricing to limit the ability of scalpers to purchase tickets and later sell them at higher prices. In addition, a program from Ticketmaster is aimed at giving passionate fans earlier access to tickets at discounted prices."

"For the current Taylor Swift tour, would-be concertgoers were encouraged to register for Ticketmaster’s Verified Fan program months before tickets went on sale. They could boost their standing in the ticket queue by watching music videos and purchasing the “Reputation” album or merchandise. Users then received codes that allowed them the chance to purchase discounted tickets over a six-day presale period."

"Half of Ms. Swift’s tickets were allocated to the Verified Fan presale. Ticketmaster said soon after the presale that only 3% of those tickets had made their way to secondary websites such as StubHub, compared with an average of 30% to 50% of tickets for high-demand artists. It is unclear whether that statistic has held up; several of the dates now have upward of 3,000 tickets listed on StubHub."

"many artists have been hesitant to raise prices for fear of appearing greedy.

With tickets priced closer to their market value, scalpers—who not only profit but also absorb the risk on tickets that go unsold—have less incentive to try to flip them."

"with artists pricing closer to market value, he said, the fan experience is little changed compared with what it might have been buying tickets on the secondary market."
See a post from 2009 Miley Cyrus vs. The Ticket Scalpers.

Tuesday, May 15, 2018

How Central Banks Differ In Their Methods Of Calculating Inflation

My last two posts covered the uncertainty about the natural rate of unemployment. That is the lowest rate of unemployment compatible with price stability or a low level of inflation. That implies that, if the policy makers try to get the unemployment rate too low, the inflation rate will go over some target, like 2% (the Fed's target).

But it also appears that there is no "right" way to calculate inflation. See Lies, Damn Lies and Inflation: CPI figures have different meanings in the U.S. and Europe, thanks to different treatment of housing and health care by James Mackintosh of The WSJ. Excerpt:
"It is less well understood that the inflation figures have quite different meanings, thanks to different treatment of housing and, to a lesser extent, health care. The most dramatic difference is housing: In the U.S., shelter makes up a third of the consumer-price index, because it includes an imputed rent for homeowners. In Europe only actual rents are measured, at a weight of just 6% of the basket of goods and services underlying the price index.

Measure both using the European approach, and overall prices have risen the same amount since 2011. It is true that using this measure—known as the harmonized index of consumer prices, or HICP—U.S. prices have risen faster since last summer. But that appears to be in large part due to energy, where the weak dollar has pushed oil prices up faster than in Europe. There aren’t any detailed breakdowns available for U.S. HICP, which is still an experimental statistic, but the CPI excluding shelter, food and energy is the best equivalent to core eurozone inflation, and exactly the same at 1.2%.

Another indication of the importance of housing comes from the Cleveland Fed’s median CPI, which takes the middle price rise from a ranking of the CPI components. It drops from 2.6% to 1.7% when imputed rents are excluded, although in recent months it, too, has accelerated.

The Fed’s preferred inflation gauge, the PCE price index, takes a sixth of its weight from rent and imputed rent. The gap from CPI weights is made up mostly by including employers’ health-care costs to get a health-care weight of a fifth. In Europe the equivalent health-care costs, mostly borne by government, are ignored in HICP, and booze and smokes are almost as important as health-care in determining inflation.

Statisticians have argued for years about how to include housing costs, and they keep changing their minds. The Swedish central bank switched its target last year to a different measure of inflation in order to exclude mortgage rates, while the British statistical agency last year started promoting a measure of inflation including imputed rents, with mixed success."

Monday, May 14, 2018

More on the natural rate of unemployment

The WSJ printed a letter about the article I linked in the previous post and then had a related article. See Was the Phillips Curve Ever a Reliable Tool?

Here is the letter:
"Prof. Blinder suggests nobody knows what the nonaccelerating rate of unemployment (Nairu), the neutral (natural) rate of interest (aka r-star or r*) and the Phillips curve are today. This is hardly new. Estimates of Nairu and the Phillips curve have changed constantly over the last 50 years. Alan Greenspan noted this fact at the December 1995 Federal Open Market Committee meeting: “saying that the Nairu has fallen, which is what we tend to do, is not very helpful. That’s because whenever we miss the inflation forecast, we say the Nairu fell.” Other FOMC participants made similar comments at other meetings, e.g., at the February 1999 meeting William Poole, president of the St. Louis Fed, said, “the Phillips curve is an unreliable policy guide”; Edward Boehne, president of the Philadelphia Fed, said “Nairu . . . has about zero value in terms of making policy.” The natural rate of interest is also essentially impossible to measure and, hence, a useless guide for policy.

The truth is making monetary policy is no more difficult or easier today than it ever was. The problem is Mr. Blinder and others have deluded themselves into believing that measures of these concepts have been useful for making policy, even though he notes that the correlation between the unemployment rate and changes in inflation has been essentially zero for nearly 30 years. Inexplicably, he and others choose to ignore the fact that these concepts have had to be re-estimated continuously when their forecasts proved to be wrong.

Dan Thornton, Ph.D.
Valley Park, Mo.
Mr. Thornton is a retired vice president of the Federal Reserve Bank of St. Louis."
See also Unemployment Plunge Raises Stakes in Fed’s Goldilocks Conundrum: Danger of an overheating economy looms ever closer—or not, as theories increasingly come up short by Harriet Torry of The WSJ. Excerpts:
"Ryan Sweet, an economist at Moody’s Analytics, says Nairu is the economics profession’s Loch Ness monster: You might think you’ve seen it, but it’s always hard to know.

Over the past seven decades, Nairu has ranged from about 4.6% to just over 6%, according to the Congressional Budget Office’s economic projections.

Complicating matters, Nairu estimates rely on a contentious theory that falling unemployment pushes up prices and wages. That relationship appears to have broken down in recent years, when inflation remained below the Federal Reserve’s 2% target even as the jobless rate steadily declined.
There are several explanations for why. Nairu itself might not be a useful guide. Or the U.S. might not be at full employment yet. The White House’s chief economist, Kevin Hassett, said last month that full employment “could be in the threes now.”

A broader measure of unemployment that includes workers stuck in part-time jobs or too discouraged to search for work remains high, suggesting slack remains in the labor market. The measure fell to 7.8% in April from 8% in March, whereas in December 2000 it stood at 6.9%.

Former Fed Vice Chairman Alan Blinder points to his “traumatized worker” theory. “Workers still remember the bad old days and they’re more interested in job security than they are in seeking out a raise,” he said.

The Fed’s rough estimate for Nairu is now around 4.5%. Officials project the actual jobless rate will drop to 3.8% by end of this year and reach 3.6% in 2019 and 2020."

Saturday, May 12, 2018

Nobody knows what the natural rate of unemployment is today

See Is the Phillips Curve Dead? And Other Questions for the Fed: Before adjusting interest rates again this year, the central bank should focus on the fundamentals by Alan Blinder. I provide a graphical explanation at the end. Excerpts:
"Most economists determine whether the economy needs stimulus by comparing current and projected unemployment rates with a measure called the Nairu—the nonaccelerating inflation rate of unemployment (sometimes called the natural rate of unemployment). That number is supposed to mark the dividing line between unemployment so high that it pulls inflation down and unemployment so low that is pushes inflation up

Trouble is, nobody knows where the Nairu is today. The FOMC is acting under the assumption that today’s 4.1% unemployment rate is below Nairu, which it currently pegs at 4.5%. That could be right. But a year ago the committee thought Nairu was 4.7%, and three years ago it pegged it at 5.1%. The estimate kept falling because inflation stubbornly refused to rise despite low unemployment.

Here’s my own view, but it’s no more than an educated guess: The unemployment rate has settled at 4.1% for six months now, and inflation is creeping up very slightly. That suggests a Nairu in the 4% to 4.5% range, just a pinch lower than what the Fed now believes. But remember, the Fed keeps lowering its estimate.

Now to the second question: With the federal funds rate in the 1.5% to 1.75% range today, is monetary policy stimulating the economy or restraining it? To answer that question in the past, economists have compared the real interest rate—the funds rate minus inflation—to another key dividing line: the neutral (or natural) real interest rate, which Wall Street calls r* (pronounced “r-star”). Here’s the idea: When the real federal funds rate is above r*, that means money is “tight,” the Fed is holding back demand and inflation should fall. When the real federal funds rate is below r*, money is “loose,” the Fed is pushing demand up, and inflation should rise.

But where is that dividing line today? That’s a complicated question, because r* depends on many factors beyond the Fed’s control. If any of those other factors change, so will r*. The most prominent example today is fiscal policy, which has recently changed quite a lot due to large tax cuts and a bipartisan spending spree. These developments have presumably pushed the neutral interest rate above the Fed’s semiofficial estimate made last fall, which was 0.4%.

Where are we today? The federal funds rate is at 1.7%, while inflation is at 2% and inching up. This means the real federal funds rate—the difference between those two metrics—is slightly negative and thus almost certainly below the neutral rate, though perhaps not by a huge amount. The Fed’s current monetary policy is therefore still slightly stimulative"

"When I was the Fed’s vice chairman in the 1990s, we felt we had a reasonable handle on the Phillips curve: If unemployment rose by 1 percentage point for a year, that would knock about half a percentage point off the inflation rate, plus or minus. That rule of thumb worked pretty well back then. But not lately.

Since 2000, the correlation between unemployment and changes in inflation is nearly zero."
Now my graphical explanation.

The more money in the economy, or the lower the interest rate, the more demand for all goods and services, holding all other factors constant (this total demand is called aggregate demand or AD). The price level in the economy and the total output or quantity produced in the economy is determined by the interaction of AD and aggregate supply (in this case I am interested in something called short-run AS or SRAS-so yes there is a long-run AS but that is not the important issue here although in the long run we will come back to QF with even more inflation if we go past it in the short run). 

The full-employment GDP (QF in the graph below) is the level of GDP that gives us the natural rate of unemployment. If we move from AD1 to AD2, we will still have very small price increases while having a big increase in GDP which will help lower the unemployment rate. But if we go past AD2 (if interest rates get too low), then we get much bigger price increases than for AD increases to the left of QF. So we want the Fed to set interest rates so that we are at AD2. But no one knows for sure if we are at AD2 or not.

The SRAS also keeps getting steeper since inefficiency increases as we get closer to (and beyond)  QF. As inefficiency increases, costs increase faster and faster. This gets passed on to the consumer in the form of ever faster increases in prices. The slope has to get steeper to reflect this. The inefficiencies come in partly because we keep bringing less efficient resources into production the more we try to produce.

If a company has 4 idle factories and demand picks up, it brings the most efficient of the four back online, then the next one, and so on. The demand for resources might be increasing at an increasing rate.
Related posts

Fed Officials Disagree On Threat Of Inflation (from 2009)

Fed Chair Janet Yellen: "there remains considerable slack in the economy" (from 2014)