Inflation, Here and There (Wonkish)/April 16, 2011, 8:51 am

Inflation, Here and There (Wonkish) インフレ、あちらでもこちらでも(オタク風)

A few notes about recent inflation developments.

Inflation is now a big and growing problem in emerging economies. Why? It’s the combination of the liquidity trap in advanced economies and the unwillingness of emerging nations to let their currencies rise.
インフレは現在途上国において、大きい問題に膨らみつつある。どうしてだろうか? それは、先進国における流動性の罠と新興国が通貨の上昇を放置しようとしないこととの組み合わせによるものだ。

The story runs like this: in advanced economies, the collapse of housing bubbles and the overhang of debt run up during the Great Moderation is leading to persistently depressed demand, even with very low policy interest rates. The result is low returns to investment; not much point in adding to capacity when you’re not using the capacity you have.

Meanwhile, emerging economies have plenty of demand, in part because they’re emerging, in part because they didn’t share in the big debt runup. So what the world economy “wants” to do is have large capital flows from North to South, and, correspondingly, large current account deficits in the emerging world — which would, of course, help the advanced economies recover.

But since the doctrine of immaculate transfer is false, the transmission mechanism by which capital flows get translated into trade balances has to involve a rise in the relative prices of goods and services produced in the emerging nations. The natural and easy way to get that would be via currency appreciation; but governments don’t want to see that happen. So the invisible hand is in effect getting the same result — gradually — by pushing up nominal prices in these countries.

It’s worth noting that when these governments try to control inflation by squeezing demand rather than by letting their currencies rise, they’re not just engaged in an eventually doomed effort; they’re also helping to perpetuate the slump in advanced countries. Good work all around.

Meanwhile, back in the North …

March core inflation came in lower than expected, and there’s been a lot of talk about that. But really, when it comes to high-frequency data, stuff happens. People who got all worked up over a bump in prices, seeing it as the harbinger of a big inflationary takeoff, were ignoring the lessons of history, which is that short-run spikes in inflation generally reverse themselves.

I’ve taken to looking at the Billion Price Index, which looks a lot like the goods-only, but with much higher frequencies. And right now the BPP index is clearly indicating that the big price bump of early 2011 is fading away:


And taking the longer perspective, you can’t have a wage-price spiral if wages refuse to spiral; and all indications are that wages are being held down by high unemployment, never mind gas and food prices:


Wage growth hasn’t fallen as much as I expected a couple of years ago; it’s now clear to me that I failed to put enough weight on the downward wage rigidity literature. But there’s nothing here to suggest any reason to consider inflation a problem.

Why People Say “Eeh!” When They Learn About the ECB/April 8, 2011, 9:35 am

Why People Say “Eeh!” When They Learn About the ECB なぜ人はECBについて知ると“Eeh!” と言うのか

With all the craziness at home, I didn’t have time to comment on the European Central Bank’s decision to raise rates despite continuing very high unemployment.

The first thing to say is that overall eurozone numbers look very much like US numbers: a blip in headline inflation due to commodity prices, but low core inflation, and no sign of a wage-price spiral. So the same arguments for continuing easy money at the Fed apply to the ECB. And the ECB is not making sense: it’s raising rates even as its official acknowledge that the rise in headline inflation is likely to be temporary.

But there’s another, euro-specific aspect to this story. I was spared the need for chart-making by this very good post by Paul Mason, who gives us this:


During the eurobubble years, there were huge capital flows to peripheral economies, leading to a sharp rise in their costs relative to Germany. Now the bubble has burst, and one way or another those relative costs need to be brought back in line. But should that take place via German inflation or Spanish deflation?

From a pan-European view, the answer is surely some of both — and given that deflation is always and everywhere very costly, the bulk of the adjustment should in fact take the form of rising wages in Germany rather than falling wages in Spain.

But what the ECB is in effect signaling is that no inflation in Germany will be tolerated, placing all of the burden of adjustment on deflation in the periphery. From the beginning, euroskeptics worried about one-size-fits-all monetary policy; but what we’re getting is worse: one-size-fits-one, Germany first and only.

That’s a recipe for a prolonged, painful slump in the periphery; large defaults, almost surely; a great deal of bitterness; and a significantly increased probability of a euro crackup.

Aside from that, it’s prudent, reasonable policy.

Exchange Rates and Price Stickiness (Wonkish)/February 5, 2011, 10:13 am

Exchange Rates and Price Stickiness (Wonkish) 為替と物価の粘着性(オタク風)

I mentioned recently that the correlation between nominal and real exchange rates is one key piece of evidence that we live in a Keynes-Friedman world of sticky prices, not the classical, perfect flexibility world of real business cycle theorists. Now that I have a few moments, let me elaborate on that.

In international macro we talk a lot about real exchange rates, which are price-level adjusted rates. The nominal dollar-euro rate is the number of dollars per euro; the real dollar-euro rate is dollars/euro * European price level / US price level. So suppose that there were a doubling of prices in America while inflation remained at zero in Europe, but that the dollar lost half its value against the euro. The real exchange rate, which measures the relative price of US goods, would not change.

If you have a classical view of the world, you would argue that nominal shocks should affect the nominal, not the real exchange rate: the real exchange rate is a real phenomenon, and money is a veil. Specifically, you’d expect any nominal shock to move the price level by the same amount that they move the exchange rate. In reality, however, what we normally see is that nominal and real exchange rates are very closely correlated. Here are changes in the US-German nominal and real exchange rate (computed using consumer prices, and with Deutsche marks before 2000, euros thereafter) since 1951:


Now, a classical economist could (and some did) try to explain away this observation by arguing that what’s going on here is that there are real shocks, and that monetary policy was used to stabilize each country’s price level. But then you run into another problem, highlighted in a classic paper by Mike Mussa (haven’t found the original online, but he summarized the argument here (pdf)). Mussa pointed out that the behavior of both nominal and real exchange rates changed dramatically when the exchange rate regime changed, becoming vastly more volatile with the end of Bretton Woods. You can see that in the figure above; here’s one of Mussa’s figures, which highlights it even better because it covers a shorter period of floating rates:


You can, if you’re desperate, try to explain this away by saying that there was some fundamental structural change in the early 1970s, but at that point you’re deep into epicycle territory. And there’s more — for example, Ireland went abruptly from having a stable real exchange rate against the UK to having a stable rate against Germany when it joined the European exchange rate mechanism, etc..

Incidentally, I suspect that this evidence is one reason why international macro people have tended to stay more Keynesian than domestic macro people — why those of us who read Obstfeld and Rogoff knew that Ricardian equivalence didn’t imply ineffectual fiscal policy, while even Nobel laureates on the domestic macro side were getting it wrong. If you work with international data, the evidence for price stickiness is so overwhelming that it’s hard to stay in denial.

Oh, and to anticipate some comments: saying that wage and price stickiness is clearly there, and that it plays a key role in how we should understand the slump we’re in, does not say that increased wage flexibility is the answer; see this post.

1921 and All That/April 1, 2011, 5:25 pm

1921 and All That 1921年のこと

Every once in a while I get comments and correspondence indicating that the right has found an unlikely economic hero: Warren Harding. The recovery from the 1920-21 recession supposedly demonstrates that deflation and hands-off monetary policy is the way to go.

But have the people making these arguments really looked at what happened back then? Or are they relying on vague impressions about a distant episode, with bad data, that has been spun as a confirmation of their beliefs?
だが、こういう議論をしている人たちはその時本当に何が起こったか見たのだろうか? あるいは遠い過去のエピソードについて、酷いデータを使った曖昧な印象を信念の確信にまで捻じ曲げたんではないのか?

OK, I’m not going to invest a lot in this. But even a cursory examination of the available data suggests that 1921 has few useful lessons for the kind of slump we’re facing now.

Brad DeLong has recently written up a clearer version of a story I’ve been telling for a while (actually since before the 2008 crisis) — namely, that there’s a big difference between inflation-fighting recessions, in which the Fed squeezes to bring inflation down, then relaxes — and recessions brought on by overstretch in debt and investment. The former tend to be V-shaped, with a rapid recovery once the Fed relents; the latter tend to be slow, because it’s much harder to push private spending higher than to stop holding it down.

And the 1920-21 recession was basically an inflation-fighting recession — although the Fed was trying to bring the level of prices, rather than the rate of change, down. What you had was a postwar bulge in prices, which was then reversed:


Money was tightened, then loosened again:


Discount rates are a problematic indicator, but here’s what happened to commercial paper rates:


And so there was a V-shaped recovery:


The deflation may have helped by increasing the real money supply — at least Meltzer thinks so (pdf) — but if so, the key point was that the economy was nowhere near the zero lower bound, so there was plenty of room for the conventional monetary channel to work.

All of this has zero relevance to an economy in our current situation, in which the recession was brought on by private overstretch, not tight money, and in which the zero lower bound is all too binding.

So do we have anything to learn from the macroeconomics of Warren Harding? No.
そこで我々がウォーレン・ハーディングのマクロ経済学から学べることはあるだろうか? 何もない。

The Transmission Mechanism for Quantitative Easing (Wonkish)/April 4, 2011, 9:06 am

The Transmission Mechanism for Quantitative Easing (Wonkish) 量的緩和の伝達メカニズム(オタク風

It’s now widely claimed that QE2 has been a success — and for sure, the US economy, which seemed to be sliding into a deflationary morass last summer, has perked up since then. But why? A few thoughts.
現在量的緩和が成功していると広く喧伝されている―確かに、昨年デフレの泥沼に滑り落ちていくと思われたアメリカ経済はその時以来活気付いている。しかしどうやって? ちょっと考えてみよう。

Back in the old days, when dinosaurs roamed the earth and students still learned Keynesian economics, we used to hear a lot about the monetary “transmission mechanism” — how the Fed actually got traction on the real economy. Both the phrase and the subject have gone out of fashion — but it’s still an important issue, and arguably now more than ever.

Now, what you learned back then was that the transmission mechanism worked largely through housing. Why? Because long-lived investments are very sensitive to interest rates, short-lived investments not so much. If a company is thinking about equipping its employees with smartphones that will be antiques in three years, the interest rate isn’t going to have much bearing on its decision; and a lot of business investment is like that, if not quite that extreme. But houses last a long time and don’t become obsolete (the same is true to some extent for business structures, but in a more limited form). So Fed policy, by moving interest rates, normally exerts its effect mainly through housing.
その時教えられていたのは、伝達メカニズムは主に住宅産業を通して働くということだ。どうしてだろうか? なぜなら長期の投資は利子率にとても敏感だが、短期の場合にはそれほどではないからだ。もし企業が従業員にスマートフォンを配布することを考える時、それは3年後には骨董品になってるだろうから、利子率はその決定に大きな影響を与えないだろう。そして多くのビジネス投資は、その率が極端なものでないならそういうものだ。だが住宅は長期間存続するものであり、時代遅れになることもない(もっと限定された形でだが、同じことはビジネス用の建造物にもある程度当てはまる)。そういうわけでFRBの政策は、利子率を動かすことにより、一般的に主に住宅産業を通してその効果を発揮する。

Not this time, however, since housing is deeply depressed and there’s a huge overhang of excess capacity.

So if QE2 did work, how did it work?

Well, if you look at the sources of fourth-quarter growth it looks like this:


It’s basically consumption and net exports. Now, that net export number is a bit funny: there was a huge drop in imports, which probably came largely from a rundown in inventories, and isn’t sustainable. Still, trade does seem to be making a positive contribution. Nonresidential investment has been rising rapidly, but it was doing that even before QE2 was announced.

And what might be driving consumption and net exports? How about this?
何が消費と純輸出を押し上げたんだろうか? こんなグラフはどうかな:


For what it’s worth, casual observation suggests that a lot of the growth in consumer spending has been at the high end, which suggests in turn that a higher stock market might be driving it. And the lower dollar has clearly helped US exporters and import-competing firms.

If QE really is working through stocks and the dollar, are there further implications? I’m not sure — in a highly indebted society, you might hesitate at policies that would increase private debt further, but if stocks are driving the story, the consumers now spending more aren’t the same people who are in debt trouble — so that’s actually OK. And as for the weaker dollar, if the Chinese and the Brazilians don’t like it, they are free to let their currencies appreciate.

Anyway, that’s my casual take on what has happened. I would say that if it’s right, it’s far from clear that the recovery will prove self-sustaining.