Deflation Update

Friday, September 29, 2006

Is The Deflation Alert About To Sound Again?

Time to dust the rust off this blog I think.

Using a footballing analogy, all the economic defences seem to be 'ballwatching' at the moment, and looking at the inflation issue. But the recent fall in oilprices, and the developing slowdown seems to be resurrecting a danger that many felt was long dead: deflation.

Look at this from Singapore:

Singapore's inflation rate fell to an 11-month low in August as a stronger currency made fuel and other imports less expensive.

The consumer price index rose 0.7 percent from a year earlier after gaining 1.1 percent in July, the Department of Statistics said in a statement today. That was less than the median 0.9 percent forecast in a Bloomberg News survey of 13 economists. From July, consumer prices were unchanged.

The Singapore dollar's 5 percent gain against its U.S. counterpart this year, the fifth-best performing of 15 Asia- Pacific currencies tracked by Bloomberg, is helping cut the cost of oil and other imports. That may prompt the city-state's central bank next month to extend its 2 1/2-year policy of allowing a ``gradual and modest'' appreciation in the currency.

``We are seeing less upside in fuel and utility costs,'' said Song Seng Wun, an economist at CIMB-GK Research in Singapore. ``The currency policy effectively keeps imported inflation minimal.''

and while the most recent EU data is still not out, Inflation in Germany does seem to be falling fast:

German inflation is expected to fall sharply in September as a result of declining petrol prices and base effects related to last years increase in energy prices after Hurricane Katrina, said Ken Wattret of BNP Paribas.

"Be prepared for a striking drop in inflation in September" Credit Suisse economists said.

Consumer prices data from key German states are due in the early part of the week and economists said they are likely to show a month-on-month fall of 0.2 pct in both the CPI and HICP measures. This will cut the CPI year-on-year inflation rate to 1.2 pct from 1.7 pct and the HICP rate to 1.3 pct from 1.8 pct.

Of course this is why the emphasis on 'core inflation' is so important, but still, more 'sudden drops' in German inflation will certainly not be good news.

Friday, April 14, 2006

Richard Fisher and the Output Gap

I've been posting about this topic from time to time on Bonobo Land ), and about how our idea of a national output gap may be somewhat quaint and outdated in a globalised world. "The global output gap" idea of Borrio and Filardo is an interesting one. To a great extent I go along with Dallas Fed President Richard Fisher's argument that in a globalised world the idea of a national output gap is less and less relevant, but globally the idea makes much more sense. This also fits in with Andy Xie's methodological proposal that in macro terms we stop thinking about the global economy as an agglomeration of individual partially-open economies, and instead consider it one single 'developing economy' with a lot of regional market imperfections (home bias etc). Personally I find this idea makes a lot more sense.

You can find a good example of Fisher's speeches here:

The literature on globalization is large. The literature on monetary policy is vast. But literature examining the combination of the two is surprisingly small.

I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold.

There are many convoluted definitions of globalization. Mine is simple: Globalization means economic potential is no longer constrained by political and geographic boundaries. A globalized world is one where goods, services, capital, money, workers and ideas migrate to wherever they are most valued and can work together most efficiently, flexibly and securely.

Where does monetary policy come into play in this world? Well, consider the task of the central banker, seeking to conduct monetary policy to achieve maximum sustainable non-inflationary growth.

Former Federal Reserve Governor Larry Meyer gave an insider’s view of the process in his excellent little book A Term at the Fed. It was one of the first things I read as I prepared for my new job. In it, you get a good sense of the lexicon of monetary policy deliberations. The language of Fedspeak is full of sacrosanct terms, such as “output gap” and “capacity constraints.” There is the “natural rate of unemployment,” which morphed into “the non-accelerating inflation rate of unemployment,” or “NAIRU.” Central bankers want GDP to run at no more than its theoretical limit, for growing too fast for too long might stoke the fires of inflation. They do not wish to strain the economy’s capacity to produce.

One key capacity factor is the labor pool. A shibboleth known as the Phillips curve posits that unemployment falling beneath a certain level ignites demand for greater pay, with inflationary consequences for the entire economy.

Until recently, the econometric calculations of the various capacity constraints and gaps of the U.S. economy were based on assumptions of a world that exists no more. Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC members as the U.S. economy entered a new economic environment in the second half of the 1990s. At the time, economic growth was strong and accelerating. The unemployment rate was low, approaching levels unseen since the 1960s. In these circumstances, inflation was supposed to rise—if you believed in the Phillips curve and the prevailing views of potential output growth, capacity constraints and the NAIRU. That is what the models used by the Federal Reserve staff were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents gathered around the FOMC table. Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable. They were frustrated by Chairman Greenspan’s insistence they postpone the rate hikes.

We now recognize with 20/20 hindsight that Greenspan was the first to grasp changes in the traditional relationships among economic variables. The former chairman understood the data and the Fed staff’s modeling techniques, but he was also constantly talking—and listening—to business leaders. And they were telling him they were simply doing their job of seeking any and all means of earning a return for shareholders. At the time, they were being enabled by new technologies that enhanced productivity. The Information Age had begun rewriting their operations manuals. Earnings were being leveraged by technological advances. Productivity was surging. Inflation wasn’t rising. Indeed, it just kept on falling.

Globalisation and inflation: New cross-country evidence

The header refers to the title of a paper by two economists at the BIS (and this paper was the reason I was rumaging around the BIS site and came up with my last post. Basically New Economist has the details in his post How has globalisation affected inflation?. Basically NE suggests that "this chapter (in the latest IMF WEO), How Has Globalization Affected Inflation? (PDF), provides "robust support for the global competition hypothesis", with greater trade integration and foreign competition seeing falling import prices. There have also been greater restraints on domestic price and wage growth in sectors more exposed to international competition, such as textiles and electronics. However "the direct effect of globalization on inflation through import prices has in general been small in the industrial economies". The IMF however do go on to qualify this:

That said, when global spare capacity increases—such as during the 1997–98 Asian financial crises and the 2001–02 global slowdown—import price declines have had sizable effects on inflation over one- to two-year periods, shaving more than 1 percentage point off actual inflation in some advanced economies.

Stephen Roach also has a post about the Claudio Borio and Andrew Filardo paper:

BIS researchers have recently extended this analysis, arguing that a “globe-centric” framework now does a much better job in explaining inflation than does the traditional “country-centric” approach (see Claudio Borio and Andrew Filardo, “Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation,” March 2006). Their major contribution is a careful construction of several alternative versions of a “global output gap” -- in effect, a measure of the difference between aggregate supply and demand for the overall global economy. In looking at a sample of 15 major industrialized countries, Borio and Filardo find that the global output gap does a much better job in explaining fluctuations in inflation of individual economies than does the domestic output gap. In other words, to the extent that there is slack in the global economy, inflationary pressures could well remain in check -- even for those nations that have run out of spare capacity in labor and product markets at home.

Putting it more formally, Borio and Filardo’s broadest measure of the global output gap -- a GDP weighted construct -- paints a picture of good balance between worldwide supply and demand in 2005. That stands in sharp contrast with earlier periods of cyclical excess when the global output gap tipped into the danger zone, with aggregate demand exceeding supply by anywhere from 1.25% (2000) to nearly 3% (1973). That’s not to say that that the global output gap will stay constructive in the years ahead -- especially if there comes a point when the growth dynamic in the supply-driven non-US world draws increasing support from internal demand. In my view, however, that day is still very much in the future. Consequently, with the global price rule still flashing an all-clear sign, the bond market may have a very difficult time pushing nominal long-term interest rates much above current levels.

Research on Deflation

Well, I'm back, after nearly two and a half years of absence, starting to limber up on the whole question of deflation again. Toady I thought about doing this after looking at this paper from two economists at the Bank of International Settlements: Claudio Borio and Andrew J Filardo, Back to the future? Assessing the deflation record. Here's the abstract:

The rhetoric of deflation has become more prevalent in policy circles and in the press despite the fact that deflation has been a rare phenomenon in modern fiat currency economies. To better understand the nature of deflation, this paper looks back to a period when deflation was a regular feature of the economic environment, across both time and a wide set of countries. One feature of the deflation record stands clear. During the 19th century and early 20th century, deflation was not generally associated with persistent and deep economic malaise. Most periods of deflation also appear to have been largely unanticipated, with interest rates rarely approaching their zero lower bound. One notable exception to this typical pattern was the Great Depression of the early 1930s, the event that nowadays colours current general perceptions of what deflationary episodes might look like. At the risk of oversimplification, one way to think about this broad sweep of history is that deflations come in three basic types: the good, the bad and the ugly. The paper then jumps forward in time, seeking to draw lessons from the past about the possibility of future episodes of deflation and their characteristics. In doing so, it pays particular attention to the similarities and differences in the monetary and financial regimes prevailing now and in the past. While great care should be taken in any such exercise, the paper concludes that certain features of the past can help to shed some light on the policy challenges that policymakers might face in the future.

Saturday, November 08, 2003

This was my Day-to-Day Weblog on Deflation during the US deflation alert of 2002-2003. Since I am by no means convinced that this issue is compltely over the blog remains here in suspended animation, pending developments which might make its resussitation worthwhile. More Detailed in-depth commentary, analysis and links on the deflation phenomenon can be found on the Deflation Page on My Website

Staggering Rise in US Labour Productivity

US labour productivity may have risen at an astounding 8.5% in the third quater, at least that's what Bloomberg are telling us. Following close on the heals of a 7.2% growth in GDP for the same quarter these numbers clearly are incredible: frighteningly so. It is clear that something pretty important is happening, but I fear we may need to wait for the dust to settle before we can see what that 'something' actually is.

U.S. worker productivity may have grown in the third quarter at the fastest pace in more than a year as economic growth surged, economists said they expect a government report to show today. The Labor Department's gauge of how much an employee produces for every hour worked may have risen at an 8.5 percent annual rate from July through September, the most since the first quarter of 2002, when the economy was emerging from recession, according to the median of 64 estimates in a Bloomberg News survey. In the second quarter, productivity rose at a 6.8 percent rate.

Last quarter saw the economy expand at a 7.2 percent annual pace, the most in 19 years. During those three months, companies cut 41,000 workers from payrolls, suggesting remaining employees were more efficient. The resulting boost to corporate profits may soon lead to more investment and renewed hiring. "While it will be difficult to grow at quite that pace in coming quarters, it seems clear we have entered a new phase of economic expansion,'' Treasury Secretary John Snow said a speech to the Economic Club of Washington. Private economists agree. "As corporations continue to register higher profits, you will ultimately see new hiring programs kick in,'' said Bill Sullivan, a senior economist at Morgan Stanley in New York. "Ultimately these productivity gains slow and businesses must begin to raise payroll levels.''

The Labor Department issues the report at 8:30 a.m. Washington time along with statistics that may show a decline in claims for unemployment benefits. New applications may have dropped by 6,000 in the week ended Saturday to 380,000, based on the median of forecasts. Last week would be the fifth in a row for claims to hold below 400,000, the longest such stretch since six weeks in January and February.

The ability to produce more with fewer workers reflects past investments in computers and other equipment that are still making employees more efficient. From 1996 through 2000, productivity gains averaged 2.5 percent a year, more than a percentage point higher than the 1976-1995 average of 1.4 percent. "Much of the strength we saw in the third quarter is likely to continue,'' Snow said in his speech. ``This is not a fleeting glimmer -- there is real muscle behind the growth trend.'' The surge in productivity "probably is a lagged tribute to the 1990s boom in capital investment,'' said Bill Sharp, a senior economist at J.P. Morgan Securities Inc. in New York.

Greater efficiency may have damped unit labor costs, or the amount paid for each unit of production, according to the survey. Costs may have dropped 5 percent last quarter, the most since the first quarter of 2002, following a 2.8 percent decrease in the previous three months, according to the survey median. Falling costs together with rising sales are providing a lift to corporate balance sheets. Third-quarter profits are increasing at the fastest pace in more than three years. Earnings have risen 21.7 percent, based on results from 80 percent of the Standard & Poor's 500 companies reporting so far, according to Thomson Financial. Almost two-thirds of the companies that reported profits topped the average estimate.

Productivity historically slows in the quarter following a surge. It has grown at a 7 percent annual pace or more 26 times since the end of World War II. In the subsequent three-month periods, it dipped to an average of 1.6 percent while companies hired an average of 481,000 workers. "These productivity numbers aren't sustainable,'' said Russell Sheldon, a senior economist at BMO Nesbitt Burns Inc. in Toronto. If business leaders ``remain cautious at this point in the recovery, other companies are going to get the lion's share of growth, and most aren't going to let that happen.''

Companies may have added 65,000 workers to payrolls last month, following a gain of 57,000 in September, the Labor Department may report Friday, according to the median of 68 estimates in a separate survey. September's gain was the first since January. The unemployment rate may have held at 6.1 percent for a third month, the survey found.

For their part, company leaders are hesitant to jump the gun on hiring. "With all the gains that have been made in productivity, employment is going to come back very gradually,'' said Michael Jackson, chief executive officer of AutoNation Inc., the largest U.S. retailer of new and used cars, in a television interview with Bloomberg News last week. "And I see a gradual recovery from the consumer perspective, not roaring back.'' The economy may grow at a 4 percent annual rate this quarter as consumer spending rises at a slower rate, according to the median estimate of 56 economists surveyed by Bloomberg News this month. Household spending, which accounts for about 70 percent of the economy, may grow at a 2.8 percent rate compared with a 6.6 percent increase last quarter that was the biggest since the third quarter of 1997.
Source: Bloomberg

The 'Lump of Structural Reform' Fallacy

I must have had a hard week, since I find myself leaning more and more on Joerg for inspiration. But I really do think he has a good point. Structural reforms are being converted into something quasi-physical, that need to be handed round and round...........and round. Apart from making ourselves all extremely dizzy, isn't there something rather self-defeating in all this. Stephen Roach sums the problem up rather nicely:

To the extent that the road to a renewal of economic growth rests on a foundation of sustained productivity enhancement, market-based reforms become an essential ingredient of the global growth equation. Primary focus on the rhetoric of currency policies deflects attention from this critical objective.

It’s not hard to understand why politicians and policy officials would rather turn their attention elsewhere. The structural reforms required to sustain productivity-led growth are often the toughest medicine for any economy to take. That’s because they usually entail a reworking of social contracts between governments, businesses, and workers. As such, structural reforms can threaten deeply entrenched conventions of job and income security -- threats that have enormous social and political implications. In light of these severe consequences, there is a natural inclination to avoid reforms. Yet in the end there is no other choice. It takes courage and vision to look through the short-term pain and see the long-term gain. In my view, it also takes pressure -- pressure that leaves an economy and its leadership with no option other than reform. To the extent that a strong currency achieves such an outcome, that is a good thing.
Source: Morgan Stanley GEF

Now one of the problems I think many of us (even those of us who consider ourselves 'admirers') have with Roach are those little 'slight of hand' arguments he wheels out from time to time. One of these is the 'world GDP' argument (for new readers, I think 'world GDP' is a nonsense concept: ie it doesn't mean anything). Another is the idea that protectionism caused the great depression (which as Eddie keeps pointing out is just plain false). Now we have another one: that the road to sustained economic growth rests almost exclusively on a foundation of sustained productivity enhancement driven by structural reforms.

Right and wrong. Right, in that productivity is a good thing, and if you can increase productivity by moving your economy out of agriculture and into, say, industry (think France and Japan in the 70's and 80's) then you can obviously live better, or if you can move out of industry into high-end services then ditto. But, and here is the big point, if you move into what are intrinsically low-value labour-intensive services, but gain the productivity by everybody running faster, then what exactly have you gained? Roach is also passing the white rabbit quickly from one hand to the other when he insinuates that recent growth has come mainly from increased productivity: in fact recent growth has come mainly from two sources, increasing the level of 'participation' in the economy (whether through more women working, or because we have a higher proportion of people in the 16 - 60 age group) or from increasing the quantity of capital in play (ie either using more labour or using more capital). So in one sense economic growth depends on imagination and creativity: using our inventive capacities to find ever newer ways of creating wealth and well-being. My real problem comes when Roach starts to talk about 'severe consequences' and 'threats' to income and security. 'Good' productivity doesn't necessarily have to be tough medicine: whilst trying to defend unproductive jobs is. I have just spent the week (virtually speaking) way down south of the Rio Grande. I have set up what I consider to be an extremely interesting working goup (of which you'll hear more later), and all without moving outside the office, except, that is, in search of coffee and light relief. None of this is 'painful'. It isn't painful because we're doing more for less. But too many of the structural reforms involve doing the same for more (effort): I personally don't see what this has got to do with growth. We are going into a difficult adjustment period there is no doubt about that. In view of the sacrifices we may all be called upon to make, maybe it would be better if we were all a little clearer about why we are doing it.

Monday, October 27, 2003

Only Known Export Jobs: Part I

This, it seems, is going to be the title of a new series here. The title is plagiarised: former US Treasury Secretary Paul O'Neill (or was it GWB himself, help, someone?) once said of Argentina that it was a country with no known export industry, and it didn't seem to care. This was before the crash. Well I'm now throwing the jibe back: the only unambiguously successful US export industry right now is the jobs one (if you don't count the dollar bill one that is). Of course the US has enormously successful companies. Of course the US can generate products that are world beaters. But how do you do this at prices that the rest of the world can afford? This is the problem. If you look at the US current account deficit the situation is clear.

In some ways there is analogy here with the energy situation. Energy resources may or may not become depleted before alternatives are available, everything is a question of timing. The jobs market and economic development have been tied to a progressive evolution from agriculture to bottom-end manufacturing, to hi-tech manufacturing to services, to services/information. Now it is these high-end services and intellectual property producing activities that are starting to be outsourced, and the OECD world needs to move to the next-generation activity (whatever that may be, and we are talking structurally here). The question is again one of timing. And just as with the energy tech-fix there is no guarantee, so with the labour market evolution there is none either. This is the point I am making. I could tie all this in to the laxity of attitudes in the present US administration, since I think that with another administration in the White House all of this would be being treated five times more seriously as a problem.

A couple of interesting inks. One I picked up from Fons Tuinstra which, incredibly, describes the outsourcing situation over at Palm, the other a link that Macromouse LLoyd sent me from 'Last Remaining Radical' Ed Strong . Now apart from understanding why he is concerned, and recognising his right to say what he says, I dont go down Ed's road at all. I have already commented at length on Ed's post (comment reproduced below). Nonetheless one detail is worthy of note, and it relates to the notorious Singapore issues. One 'hot topic' among these issues was opening government procurement (transparency I think it is called) to free competition. Well, if you look at what is happening in the US (and I'm sorry this is NOT a US-only issue, it is an OECD issue) you will see that 'procurement' is becoming an 'issue du jour'. Take Shirley Turner, eg:

"After Shirley Turner, a Democratic state senator from New Jersey discovered that a program from her state, Families First, which provides welfare recipients with grocery debit cards had been outsourced to Mumbai, India, she proposed bill No. 1349.Her bill, which was approved unanimously by the New Jersey Senate in December 2002, would require all state contracts to be performed by either US citizens or foreign citizens who work legally in the United States. Following her lead, Connecticut, Maryland, Missouri, and Wisconsin all have similar bills under consideration."

Now for my comments on Ed's post:

Hi Ed.
Interesting post. I'm both for you, and I'm against you I'm afraid. I'm for you since I am convinced you are right to be pre-occupied by what is happening. This is, and is going to be, an enormous issue for the US.

The key to the problem: the value of your currency and the trade deficit. The key to the value of your currency: the reserve role of the dollar. So it seems somewhere deep-down, behind all this we may need to address questions of financial architecture.

You see moving from manufacturing into services isn't (in principle) a problem. It's when you start moving out of high value services and into relatively lower value ones (as you indicate) like the low-tech 'human' end of health, looking after gardens and old people etc, construction attached to all the deficit spending which will be seen as the solution etc etc: it's in this move downstream that the problem starts. This then becomes a historic first, and the 'usual arguments' seem to have less validity.

One intersting side issue is that of procurement and the Singapore issues. Normally the accusation of using restrictive practices to avoid competition is a jibe that is thrown at the third world but here we have your very own Shirley Turner demonstrating just how rife this practice probably is even in the 'good ol' US of A.

I see the US today as very much in the same situation as the UK post WWI (in fact NY university historian Niall Ferguson made just this point in a very perceptive article 'To the Debtor the Spoils' in the NYT just after the Iraq war).

Why this isn't really being picked up inside the US I don't know. The Bushies obviously aren't interested, and the 'opponents' lead by 'road runner' Krugman (who was last seen painting an entrance in the wall to lead the pack down a dimly-lit cul-de-sac) seem obsessed with demonstrating that everything is a consequence of the 'dreaded tax cut'. This leads him (in his recent 'lump of labour' piece) to the absurd extreme of suggesting that those who are pointing to the structural problem are trying to defend Bush!

Another area where I'm not exactly with you is over the accent on the telephone. I got over this as a child in Liverpool trying to make long distance contact via an operator in Scotland! I don't think it matters what accent someone has - or what colour their skin is - if they are doing a good job. And since the American ideal of competition is that who does the best job cheapest wins, looking at you from the outside, I think it's kinda hard to cry 'foul'.

My proposal. Accept the new reality. Asia is on the rise. We in Britain had, eventually to accept the rise of the US. In the end it was good for us, you helped us out in 1939. So accept the reality and learn to live with it. We in Britain may not have the world influence we once had, but we're hardly poor. We are also more mature about money. Despite Ms Thatchers best attempts we still don't value money as much as you do. Come on over, it's not as bad as it looks. And, anyway, at the end of the day I really can't believe that reducing poverty in other parts of the world isn't something important to you as a person.

In case you're interested, here is a recent link to , Monbiot in the Guardian to show how the British seem to be looking at this.