Some Bad News for Good News — Optimistic Forecasts Create Recessions

Positive forecasts lead the public and private sector to ‘celebrate’ by borrowing more, says IMF paper

By Georgi Kantchev of The WSJ. Excerpts:

"over-optimistic economic growth forecasts—including the IMF’s own—could help cause recessions and fiscal problems. The IMF argues that positive forecasts lead the public and private sector to “celebrate” by borrowing more, which encourages the sort of debt accumulation that builds frailties in the economic system, harming growth.

“Over-optimism brings economic damage in later years,” the authors write. “An overestimation of the future rate of economic growth could provide a short-run boost to the economy, but it also increases the subsequent probability of a recession and other economic difficulties,” they say."

"forecasts for next year’s gross domestic product growth have been 0.58 percentage points higher than the actual number. Research shows that such an upward bias is also present in forecasts made by private sector economists"

"The IMF has also missed most recessions in its forecasts, predicting only 24% of recessions one year ahead of the event."

What's the Difference Between Bills, Notes and Bonds?

By Nickolas Lioudis of Investopedia.

"Treasury bills (T-Bills), notes and bonds are marketable securities that the U.S. government sells in order to pay off maturing debt and to raise the cash needed to run the federal government. When you buy one of these securities, you are lending your money to the government of the U.S.

Understanding T-bills

T-bills are short-term obligations issued with a term of one year or less, and because they are sold at a discount from face value, they do not pay interest before maturity. The interest is the difference between the purchase price and the price paid either at maturity (face value) or the price of the bill if sold prior to maturity.

For example, an investor who purchases a T-bill at a discount price of $97 will receive the $100 face value at maturity. The $3 difference represents the interest return on the security.

Treasury Notes and Bonds

Treasury notes and bonds, on the other hand, are securities that have stated interest rates that are paid semi-annually until maturity. What makes notes and bonds different are the terms to maturity. Notes are issued in one-, three-, five-, seven- and 10-year terms. Conversely, bonds are long-term investments with terms of more than 10 years.

To learn more about T-bills and other money market instruments, read An Introduction to Treasury Securities, The Basics of the T-Bill, and our Money Market Tutorial. For further reading on bonds, see our Bonds Basics Tutorial.

Read more: What's the Difference Between Bills, Notes and Bonds? | Investopedia https://www.investopedia.com/ask/answers/difference-between-bills-notes-and-bonds/#ixzz5HZsE3uSo"

Vanilla Is In The News Again

See Vanilla is worth more than silver by Tyler Cowen. I had a post on this last year (link below). 

The price of vanilla has hit a record high of $600 (£445) per kilogram for the second time since 2017 when a cyclone damaged many of the plantations in Madagascar, where three quarters of the world’s vanilla is grown. Silver by comparison currently costs $538/kg.

Demand for vanilla has kept the prices high, leading some ice cream manufacturers to cut back and even halt production of the flavour, sparking fears of shortages over the summer.

Here is the full story, and note this:

Replacement printer ink cartridges can cost between $8 and $27, depending on the type of printer you have. A single black ink jet cartridge from one major manufacturer can cost $23 for just 4ml of ink – enough to print around 200 pages.

Manufacturers argue they need to charge this to cover the loss they are selling the printer hardware at, together with the research and development they do on ink technology. But cut open an ink cartridge and you will see that most of the space inside is taken up with sponge, designed to help preserve and deliver the ink.

And when you are paying what works out to be around $1,733/kg of ink, you might be better off printing with pure silver instead."

See also Vanilla is so valuable now that it needs to be guarded. There are actually "Vanilla bandits."

Is There A Neutral Interest Rate? If So, How Much Is it?

See Fed Minutes Signal Rate Increase in June: May meeting minutes say ‘it would likely soon be appropriate’ for another rate rise by Nick Timiraos of The WSJ. Excerpts:

"The Fed held its benchmark federal-funds rate steady at the May meeting in a range between 1.5% and 1.75%, but it looked ahead to future increases that might leave policy at a neutral level that neither spurs nor slows growth."

"The Fed’s postmeeting statement at the May meeting caught some attention because officials added a second reference to their “symmetric” 2% inflation target, meaning they won’t necessarily accelerate interest rate increases once inflation runs at or slightly above 2%."

Some officials at the May meeting said a temporary period in which inflation rises modestly above 2% “would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

At the time of the May meeting, the unemployment rate had held steady since October at 4.1%. A report released after the meeting showed the rate fell to 3.9% in April.

Most officials still believe in a framework that sees an inverse relationship between unemployment and inflation (the is is the Phillips Curve). If the unemployment rate drops faster, officials likely will be more attuned to the potential for acceleration in inflation.

The minutes show officials are still unsure over the degree to which lower unemployment will fuel faster wage increases or firmer price pressures"

"San Francisco Fed President John Williams said last week he still estimates the current neutral fed-funds rate to be 2.5%. Officials’ March projections show a median expectation that the fed-funds rate would settle over the long-run at around 2.9%—an approximation of neutral.

Estimates of the neutral rate matter because a consensus appears to be forming among Fed officials that they should stay on their current “gradual” path of raising rates by a quarter percentage point at roughly every other meeting until they reach neutral. The bigger debate is likely to be over what to do after they get there."

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. Maybe a neutral interest rate keeps AD right at QF, the level of GDP that gives us the lowest rate of unemployment with inflation no higher than a set target. This is full-employment.




Related posts:

Is The Phillips Curve Dead In Japan? Maybe not

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

Has the Fed Flattened the Phillips Curve?

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.

Fed Officials Disagree On Threat Of Inflation (from 2009)

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

The percentage of 25-54 year-olds employed was unchanged in May

One weakness of the unemployment rate is that if people drop out of the labor force they cannot be counted as an unemployed person and the unemployment rate goes down. They are no longer actively seeking work and it might be because they are discouraged workers. The lower unemployment rate can be misleading in this case. People dropping out of the labor force might indicate a weak labor market.

We could look at the employment to population ratio instead, since that includes those not in the labor force. But that includes everyone over 16 and that means that senior citizens are in the group but many of them have retired. The more that retire, the lower this ratio would be and that might be misleading. It would not necessarily mean the labor market is weak.

But we have this ratio for people age 25-54 (which also eliminates college age people who might not be looking for work)

The percentage of 25-54 year olds employed is 79.2% for May. It was 79.2% in April. It is still below the 79.7% in December 2007 when the recession started (it was 80.3% in January 2007).  Click here to see the BLS data. The unemployment rate was 3.8% in May . Click here to go to that data. The % of those 16 and older employed went from 60.318% in April to 60.389% in May.

Here is a good graph from the St. Louis Fed. It shows that there are 126,295,000 people in the 25-54 year old group. So since we are 0.5 percentage points below the 79.7% of December 2007, that is still 631,475 fewer jobs (Hat tip: Vance Ginn of the Texas Public Policy Foundation).

Here is the timeline graph of the percentage of 25-54 year olds employed since 2007.


Here it is going all the way back to 1948


The annual numbers are important, too. It rose to 78.63% for all of 2017 from 77.925% in 2016. We have had 4 or more straight years of a 0.5 or more gain. The last time that happened was 1984-89. But we are still below the 79.9% for all of 2007 (the recession started in Dec. 2007).

Again, there were about 125 million people in the 25-54 year old group in 2017. So since we were 1.26 percentage points below the 79.9% of 2007, that is still 1.58 million fewer jobs. 

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."

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.

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).

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.

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.