The Real Deflategate

The Fed has intensely debated
When interest-rate hikes should be slated.
Like a team I won't name,
They're playing the game
With balls that are underinflated.

With a mandate to find the right measure
Of balancing jobs versus treasure,
They're Patriots all,
But the Hawks want the ball
To be at the usual pressure.

The rate of the jobholding share
Is less than appears to be there,
As if it were tested
And then one suggested
To secretly let out some air.

In spite of the fear of inflation,
Wages display moderation,
Since it's hard to inflate
With a tumbling rate
Of labor force participation.

Says Yellen: "It starts to annoy,
In discussing the rate of employ,
The analogy calls
For playing with balls;
Is it something the fellows enjoy?"

"It seems to me, based on my role,
The economy's just like the Bowl:
The material might
Be flaccid or tight,
But the point is to get to the goal."

En (La)Garde Against Deflation

Said Lagarde, of a threat that dismayed 'er:
"There's a danger that prices may crater. 
We're conditioned to fear
That things become dear
But deflation's the risk that is greater."

"With deflation, the instinct is human
To save and cut back on consumin',
But though disciplined ways
Are worthy of praise,
They prevent the economy's boomin'."

"To all of those countries who plan
To avoid the malaise of Japan:
Forget all the rules
Of conventional tools,
And stimulate now, while you can!"

Doves & Hawks Together

Thoughts diverge in the FOMC
On how long to hold on to QE,
But in case of deflation,
Without hesitation,
They'll ease up unanimously.

Season of Easin'

S&P GSCI GLOBAL COMMODITY INDEX 
VS. U.S. 5-YEAR INFLATION EXPECTATION

The Fed has a great flexibility
To promote economic stability;
They may finish QE
If it's growth they foresee,
Or extend if they sense more fragility.

In the weakening outlook of Spring,
It appears to QE they must cling,
While back in the Winter,
We thought they'd begin ter
Discreetly unwind the whole thing.

High? What High?

Said a really curmudgeonly guy
On the Dow Jones Industrial high:
"It's still quite a ways
From the Internet craze,
When adjusted for core CPI."

Bernanke's Records

Said Bernanke, in argumentation
To the makers of Fed legislation:
"You may think me a dove,
But take notice of
My record-low rate of inflation."

Those Congressmen failed to point out
That, for all of his monet'ry clout,
He couldn't deflate
The very high rate
Of laborers laying about.

Along came an eminence grise
Saying: "High or low rates such as these
Are attributed less
To your skill or success,
And more to the global unease."

Turning Japanese

Said Krugman: "It boggles me how
Any long-term concerns may allow
Our political corps
To mostly ignore
The depression we're living in now."

Ev'ryone calls for a plan
On inflation, which isn't at han'.
If we tighten too soon,
We won't be immune
To a Lost Decade à la Japan."

Good As Gold?

Said a fellow who looked into gold
For the hedging effects it may hold:
"After testing with rigor,
I really can't figgur
The typical tales that are told."

"It's hard to explain how this thing got
The following no other bling got,
But immunization
From rampant inflation
Is more than you get from an ingot."

State of the Union Econ Highlights

"The state of the union is iffy,
As I stand here tonight looking spiffy.
The economy's slow
To get up and go,
And Congress is fiscally cliffy."

"The minimum wage in the nation
Should be tied to the rate of inflation,
So that all may enjoy,
While in private employ,
Relief from the grip of privation."

"America, please hear my sermon:
The Yank should be more like the German,
With apprenticeship skills
That fix our job ills,
As numerous studies determine."

"The number-one US priority
Is the growth of the fact'ry sorority,
So we can bring back
The fam'ly of Mac,
If not all, then at least a minority."

"Of course, I must certainly preface it
As a President these days professes it:
These are policies which,
By taxing the rich,
Will not add a dime to the deficit."

President Barack Obama's latest State of the Union address, the first of his second term, was mostly prosaic, at least in its economic prescriptions.  The poetry came at the end, when the President invoked the victims of gun violence in the House chamber, repeatedly intoning: "They deserve a vote!"  Also, the sight of 102-year-old Desiline Victor, who Mr. Obama cited for her waiting six hours to vote (presumably for him), was enough to make one verklemmt.

Here is the full prepared text of the speech.

Inflated Expectations

The specter of higher inflation
Makes investors want more compensation,
Thus driving up yields,
While prices of deals
Will fall, in an inverse relation.

The longer the stated maturity
Of a given fixed-income security,
Then all the more great
The effect of the rate,
As the market may show us with surety.

Bond prices tend to be countercyclical with stock prices and the economy as a whole.  In good times, or when inflation is elevated (or when both happen at once), bond prices tend to fall because rates are rising.  In bad times, or when investors show aversion to risk, there is a "flight to safety" that pushes them into bonds, driving up the price - and thus lowering the yield.  As The Wall Street Journal never fails to remind us: "Bond yields fall when prices rise." These dynamics were prominently on display in January, when 10-year bond prices fell 2.6% while the S&P 500 gained 5%.  In part, the bond selloff reflected more economic optimism and relief over the (partial) resolution of the fiscal cliff.  The higher yields also responded to awakening inflation anxiety, as the Fed's long-term inflation projection crossed over 3% for the first time in many moons.  Going forward, there is plenty for bond investors to feel anxious about - from the US debt ceiling to the eurozone - and little prospect for rapid economic growth, so inflation fears may not be driving rates any higher (and prices lower).

Tale of the Taylor Rule

There's a model of rate calculation,
First advanced in the Great Moderation,
That would have the Fed set
The cost of our debt
Based on output as well as inflation.

Then one of those Keynsian guys
Came and asked: "Do you think it is wise
To posit, post-crisis,
The worst is that prices
May lag, as the model implies?"

"A recession of untold ferocity
And slow monetary velocity
Demand a new means
To grease the machines,
And yours lacks the needed viscosity."

The Taylor Rule is one of those economic concepts of which I often hear mention, but on which I rarely focus. Created by Stanford professor John Taylor and others in the early '90s, the Rule would have the Federal Reserve raise (or lower) the base interest rate by about 1.5 percentage points for every one-percentage-point change in inflation. A 1% point change in GDP would call for a 0.5% point change in rates. (For those who appreciate the beauty of algebra, the Taylor equation below is explained in the link above.) Depending on which economist you talk to, Prof. Taylor has given us either a useful rule of thumb, or an article of faith.

This weekend, I was absorbed by a blog post from University of Oregon professor Mark Thoma, which questions adherence to the Taylor Rule orthodoxy in these days of deleveraging-driven Great Recession. In the Economist's View, Prof. Thoma and others argue that it's silly to hold the Fed to a rule that assumes no economic frictions except for "mild price stickiness." Evidently, the Taylor Rule would have the Fed setting rates much higher than zero, but even future Nobel Prize winners should know that unquestioning adherence to a model may have adverse real-world consequences.

Flip-Flopper?

An economist known to propound
A theory he thought to be sound
Ignored a taboo
By changing his view
When facts that disproved it were found.

"You have to learn from the data," says Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis (pictured at right). This, he says in an interview with The Wall Street Journal, is why he set aside his concerns regarding "structural unemployment" and came to support the Fed's easing efforts more strongly. Structural unemployment results when the jobless lack the skills or mobility to fill open positions, while cyclical unemployment merely reflects a temporary economic downturn. Mr. Kocherlakota has been studying the problem of structural unemployment and concluded that it is less important than he previously espoused. In fact, he now believes that the Fed's most effective course is to keep interest rates low until the jobless rate falls to 5.5%.

The Minneapolis Fed president's comments, first conveyed in a speech on Thursday, appeared to move him from hawkish to the dovish side of the Federal Reserve board. However, Mr. Kocherlakota's public change of mind also serves as a reminder of the silliness and artificiality of "sides" in questions as complex as growth, inflation and employment.

QE3

It's expected the FOMC
Will finally enact QE3,
Prodigiously trying
By means of bond-buying
In some way to boost GDP.

If 500 billion is loosed,
There's a zero-point-one percent boost
In the rate of employed,
Which may leave one annoyed
With the gain this investment produced.

"Economists are skeptical about the benefits of another round of bond-buying by the Federal Reserve," writes Phil Izzo in the Wall Street Journal, but nearly all of them expect it, anyway. QE3, the third round of quantitative easing, will comprise more buying of Treasury and mortgage bonds, in a further attempt to reduce long-term interest rates and boost economic activity. Within the economic community, however, expectations for QE3's effectiveness could hardly be lower. 47 forecasters surveyed by the Journal estimate on average that, for every $500 billion in bond purchases, we can expect a 0.1 percentage point drop in the unemployment rate and a 0.2 percentage point increase in GDP. At least there will be no harm done: the group expects inflation to tick up by only 0.2 percentage points.

Back to School

An earnest young lady named Esther
Was beginning her freshman semester,
And her greatest concern,
In preparing to learn,
Was that school would financially test 'er.

Everybody complains about the high cost of a college education, but nobody does anything about it. Now, at least, one man has put forward a microeconomic explanation. Kenneth Gould lays out an intriguing price discrimination argument in the American Enterprise Institute's online magazine.*

Gould's point is that the financial aid system allows the providers (colleges) to learn how much the consumers (students) are willing and able to pay, and thus practice first-degree price discrimination using financial aid to set different prices for the same service (education).

First degree price discrimination occurs when normal markets are interfered with and producers are allowed to learn exactly what each consumer is willing and able to pay for the good or service. Using this data, all the producers set individual prices for each consumer, eliminating competition and forcing the consumers that are willing and able to pay a higher price to pay it. In this pricing scheme, those who are willing and able to pay only a lower price get a break. ... As it turns out, this seemingly humane aim has a fundamental flaw — the same flaw that afflicts all non-market based systems: When producers no longer need to compete, production costs always rise faster than they otherwise would.

*Note to reader: the word "intriguing", when used in this space, refers to an argument with which the writer potentially agrees but must regard skeptically on political grounds.

Waning Middle Class

A big social sciences trust
Researched and concluded, nonplussed:
"Our suburbanite set,
Adjusted for debt
And inflation, is actually bust."

Aaron Task and Henry Blodget of Yahoo! Finance alert us to a study conducted by the Pew Research Center. Pew looked at the data related to income and wealth inequality in the US and determined: the US economy sucks because the middle class is broke. Task and Blodget agree, in their discussion below, that US employers must hire more workers and pay them more, for the good of the economy as a whole. As Henry Ford realized a century ago, well-paid workers can afford to buy things, and their liquidity feeds a rising tide that lifts all boats. Can the private economy, which is sitting on mountains of idle cash, do this on its own without the intervention of our dysfunctional government? I ask you.

Less Than Zero

The economy's got so abominable
That constraints on the Fed are phenomenal,
But the will to inflate
Makes a negative rate
Seem potentially real, if not nominal.

Thanks to Marketplace radio, it has come to my attention that members of the general public are still concerned about the Fed's inability to drop interest rates below zero. Because of the so-called "zero lower bound" problem, it may seem that the Fed has run out of monetary tools to stimulate the economy. In terms of nominal interest rates, this is correct. That's why, according to Marketplace Money economics editor Chris Farrell, it may be time for the Fed to "get real":

The Fed can create a negative "real rate" under certain conditions. Two quick definitions: "Real" means adjusted for inflation and "nominal" means the stated rate. So if the fed funds rate is at zero (nominal) and inflation is running at 2.5 percent, the real rate (inflation-adjusted) is below zero. In other words, if the Fed's nominal rate is at 0 percent and the inflation rate is 2.5 percent, then the real rate of interest is -2.5 percent. The Fed could lower the real rate of interest by pushing for a higher rate of inflation -- say, 3 percent (for a -3 percent real rate). Among others, it's an approach that New York Times columnist and Nobel laureate Paul Krugman has written about favorably.

Bernanke - Assimilated by the Borg?

"My fellow Princetonian, Ben,"
Said Krugman, "A man of great ken,
Said to signal, in crisis,
Inflation of prices,
Would get people spending again."

"But his Fed, in my own objectivity,
Has shown unexpected passivity
To use every tool
That he spoke of in school
To boost economic activity."

"To fight unemployment so brutal,
One should use the whole kit and caboodle,
But the Fed, in its thrall,
Assimilates all,
Against which, resistance is futile."

In a scathing critique entitled "Earth to Ben Bernanke", New York Times columnist and Princeton professor Paul Krugman took the Fed chairman to task for seemingly forsaking the advice that he gave to Japan's central bankers twelve years ago. Then-Professor Bernanke lectured the Japanese on their "Self-Induced Paralysis"; were they to face the "liquidity trap" of a stagnating economy and zero interest rates with sufficient boldness, wrote Bernanke, the Bank of Japan would signal a higher inflation target of, say, 4%. This would likely induce folks to take their yen out of their futons and spend them. A similar lesson would apply to today's Fed, says Krugman, but Chairman Bernanke has not followed the advice of Professor Bernanke. Has Bernanke been cowed by anti-inflation political bullying, he asks, or "assimilated by the Fed Borg and turned into a conventional central banker?"

Fed's Moving Interest Rate Target

Said the FOMC gals and guys,
In words reassuring and wise:
"Our keeping rates low
Is quite apropos,
But we forecast that interest will rise."

The Fed Open Market Committee ended its latest two-day meeting on Wednesday with no change in policy, as expected. However, Federal Reserve Chairman Ben Bernanke sowed confusion and frustration in the press conference that followed. While he maintained the Fed's intention of holding rates near zero until 2014, Mr. Bernanke found it difficult to square this with the forecasts of seven of his committee members, which call for rate increases up to 2% by that time. These divergent outlooks highlight the difficulty of projecting employment and inflation trends over the next two years.

Bernanke's Just Right

Said Mankiw: "The public should soften
Its critique of our central bank boffin;
Were I in his stead,
I would not have the Fed
Giving stimulus more or less often."

Harvard economics professor (and Romney economic advisor) Greg Mankiw writes in The New York Times:

Mr. Bernanke has worked tirelessly to shepherd the economy through the worst financial crisis since the Great Depression, and yet, for all his efforts, seems vastly underappreciated.

While left-leaning critics find the Fed's stimulus measures wanting, those on the right obsess over inflation, expecting it to pop out at any moment. Cool it, says the professor to both camps. After all, left-wingers, the Fed has used up all the stimulating weapons in its arsenal, and could not do more without risking a dangerous rise in inflation over the target rate of 2%, where, right-wingers, it has consistently averaged throughout Bernanke's five years at the helm. In other word's Papa Bernanke's porridge is neither too hot, nor too cold, but just right.

Pungent Predicament

The high price of onions in Mumbai
Means for many, they're harder to come by,
So the Bombayite lunch
Loses some of its punch,
Unless they can really find some buy.

With millions of poor farmers and even more millions of poor consumers, India tries to strike a balance between supporting farm prices and moderating food prices.  Now however, Bloomberg Business Week and others report that the cost of farm production is going up by 20% due to fuel and fertilizer price hikes.  This means that the government will have to re-calibrate the minimum guaranteed price of crops that farmers receive, as well as the subsidies that are extended to such staples as grains and oils.  In a pinch, however, things may have to get blander at the dinner table.