Friday, December 23, 2016

Macro Musings Podcast: Xmas Economics

My latest Macro Musings podcast is a special holiday edition on the economics of Christmas.Two special guests joined me all the way from Germany to discuss this topic. My first guest was Anna Goeddeke, a professor of economics at ESB Business School in Reutlingen, Germany. My second guest was Laura Birg, a postdoctoral researcher at the Center for European, Governance, and Economic Development Research, University of Göttingen 

Together they coauthored an article in Economic Inquiry titled “Christmas Economics—a Sleigh Ride” that surveys and summarizes the economics literature on Christmas. It is a great read for this time of the year and was the basis of our conversation. We touched on a number of interesting topics like the seasonal business cycle, the deadweight loss of Christmas, and charitable giving during the holidays.

The seasonal business cycle discussion was particularly fascinating for me. There is a literature that starts with Barksy and Miron (1989) (ungated version) that shows most of the variation in aggregate economic measures like GDP comes from seasonal fluctuations. Yet most macroeconomists, myself included, typically start our analysis with seasonally-adjusted data. Here is a Barky and Miron summarizing their findings on GDP for 1948:Q2-1985:Q5:
The standard deviation of the deterministic seasonal component in the log growth rate of real GNP is estimated to he 5.06%, while that of the deviations from trend is estimated to be 2.87%. Deterministic seasonal fluctuations account for more than 85% of the fluctuations in the rate of growth of real output and more than 55% of the (percentage) deviations from trend. Business cycle fluctuations and/or stochastic seasonal fluctuations represent a relatively small percentage of the fluctuations in real output. Plots of the log level of real output (Figure 1) and the log growth rate of real output (Figure 2) make this point even more clearly. The seasonal fluctuations in output are so large and regular that the timing of the peak or trough quarter for any year is rarely affected by the phase of the business cycle in which that year happens to fall. 
Unfortunately, the BEA no longer makes available non-seasonally adjusted GDP data. However, we can look at other times series to see how large seasonal swings can be relative to recessions. For example, below is retail sales:

What makes this really interesting is that these wide swings in economic activity are not matched by similarly-sized swings in the price level. Most of the seasonal boom is in real activity. Put differently, there is an exogenous demand shock every fourth quarter where prices remain relatively sticky so real activity surges. This is a microcosm of demand-side theories of the business cycle. It seems, then, that more could be learned about broader business cycle theory from studying GDP and other time series in their raw non-seasonally adjusted form. That will have to wait, however, until the BEA starts releasing the data.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Monday, December 19, 2016

The Trump Shock and Global Interest Rates

One more quick note on the Trump shock and interest rates. For some time I have been following the global safe asset shortage problem and how it has created a downward march of safe assets interest rates. This can be seen in the figure below:

The latest development in this story is that the safe asset interest rates have all started heading up, as seen in the above figure. Even Japan's which is supposed to be targeted at 0 percent but has climbed to 0.8 percent. Now these yields have a long ways to go before reaching normal levels and they started rising before Trump's election. But since the election the ascension of these interest rates has accelerated in many cases. This is a bit puzzling. It is one thing to think the Trump shock has changed the growth and inflation outlook in the United States so that treasury yields are now going up, but why the other advanced economies?

As you may recall, the safe asset shortage story says there has been a price floor (ceiling) on safe asset interest rates (bond prices) that has kept the market for safe assets from properly clearing. (See this pre-2008 figure and post-2008 figure for a graphical representation of this story.) The shortage was a big deal because these securities functioned as transaction assets for institutional investors. The shortage, therefore, amounted to an effective shortage of money that was evident in the below trend growth of broad monetary aggregates that measure both retail and institutional money assets. 

There were there three solution paths that could solve this problem: increase the supply of safe assets, decrease the demand for safe assets by improving the economic outlook, or do negative interest rates. These three paths are depicted below:

The Trump shock seems to be working through the first two options for U.S. treasuries. First, the Trump infrastructure plans and tax cuts imply larger budget deficits. Second, the spending and supply-side reforms suggest an improved economic outlook that is decreasing demand for treasury securities. This story, though, only explains the U.S. situation. 

What is puzzling is why the Trump shock seems to be causing foreign safe assets yields to rise. Maybe it is the reverse of the Caballero, Fahri, Gourinchas (2016) story that says shortage of safe assets problem will spread from one country to another. That is, the easing of safe asset pressures in the United States is causing an easing of safe asset pressures elsewhere. But that story runs up agains the potential global economic downside from a stronger dollar that will result from a stronger U.S. economy. So I am left a bit puzzled. 

Friday, December 16, 2016

The Trump Shock and Interest Rates

I have a new piece in The Hill where I argue markets are increasingly seeing the Trump shock as an inflection point for the U.S. economy:
It seems the U.S. economy is finally poised for robust economic growth, something that has been missing for the past eight years. Such strong economic growth is expected to cause the demand for credit to increase and the supply of savings to decline 
Together, these forces are naturally pushing interest rates higher. The Fed’s interest rate hike today is simply piggybacking on this new reality. 
Here are some charts that document this upbeat economic outlook as seen from the treasury market. The first one shows the treasury market's implicit inflation forecast (or "breakeven inflation") and real interest rate at the 10-year horizon. These come from TIPs and have their flaws, but they provide a good first approximation to knowing what the bond market is thinking. In this case, both the real interest rate and expected inflation rate are rising. This implies the market expects both higher real economic growth and higher inflation. The two may be related--the higher expected inflation may be a reflection of higher expected nominal demand growth causing real growth. The higher real growth expectations are also probably being fueled by Trump's supply-side reforms.

The next figure shows the New York Fed's decomposition of the 10-year treasury into the term premium and a 'risk-neutral' nominal interest rate. Both have gone up since Trump's election. The term premium going up can be seen as investors being less risk averse and therefore demanding higher compensation for holding longer-term safe asset-bonds. The risk-neutral part can be seen as a product of the real interest rate and the expected inflation. And, as we saw in the first figure above, they are both growing:  

These figures, as well as the surge in the stock market, indicate the markets see more robust growth ahead. Given the timing of these surges, the figures seem to attribute the improved economic outlook largely to the Trump shock. 

Now markets may be getting ahead of themselves, but if these expectations come to fruition there is another big lesson to be learned from the Trump shock:
One of the big lessons from this rate decision is that the Fed cannot sustainably push up interest rates through the brute force of monetary policy. Rather, interest rates have to be pulled up by robust economic growth with the Fed following suit.  
This understanding also means the Fed did not push interest rates to zero percent in late 2008. Rather, it followed the collapsing market forces that were pulling interest rates down at the time. 
To the extent the Fed wants a stable economy, it is limited in how much it can adjust interest rates. Its interest rate adjustments have to follow the health of the economy.  
Luckily for the Fed, the health of the U.S. economy seems to have turned the corner and begun a robust recovery. This has allowed the Fed to finally break free from the chains of low interest rates.
This is a point I have repeatedly made over the past eight years. For example, see this older National Review article with Ramesh Ponnuru or this more recent piece from the Mercatus Center's Interest Rate Colloquium.[Update: See also this post to which Paul Krugman replied] My hope is that the lesson sinks in to the many Fed watchers claiming the Fed created 'artificial interest rates'.

Update: Just to make it clear, here is a figure showing both the stock market and treasury market response since Trump's election.

Macro Musings Podcasts: The Macroeconomics of Star Wars and Star Trek

My latest  Macro Musings podcast is special one where we look at the macroeconomics of Star Wars and Star Trek. We do so with the help of two guests who are experts on the economics of these two scifi franchises. [Update: sound quality starts out poor, but gets better a few minutes into the show.]

Our first guest is Zachary Feinstein. Zach is an assistant professor at Washington University in St. Louis and  the author of a study titled "It's a Trap: Emperor Palpatine's Poison Pill" where he provides a fascinating look at the financial consequences of the destruction of the second death star. This article received a lot of media coverage last year when Star Wars: the Force Awakens came out. For example, below is a screen shot from a Bloomberg interview discussing the financial burden of building the two death stars. Now with the release of Star Wars: Rogue One upon us it was only fitting to have him join the show and share with us his knowledge of the economics of Star Wars.

Our second guest is Manu Saadia. Manu is a writer based in Los Angeles and a lifelong Trekkie. He published this year titled Trekonomics: the Economics of Star Trek which is a must read for any serious Trekkie. The book was hailed by Nobel Laureate Paul Krugman as "the book on the topic". This book too has received a lot of media attention. One reason for its popular reception is that book wrestles with many of the issues now facing advanced economies as they become increasingly automated and run by smart networked machines. Below is the cover of the book.

This was super fun conversation. We started out discussing the basic economic institutions--money, interplanetary trade, trade, labor specialization, taxes, banking systems, etc-- of Star Wars and Star Trek. We next turned to business cycle issues--the destruction of the second death start created the mother of all depression--and then to the long-run economic growth in both scifi universes. We concluded by considering the implications from these franchises for us today.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Monday, December 5, 2016

Macro Musings Podcast: Peter Conti-Brown

My latest Macro Musings podcast is with Peter Conti-Brown. Peter is a financial historian and legal scholar at the University of Pennsylvania. He is also the author of a new book The Power and Independence of the Federal Reserve and joined me on the show to discuss it.

Our conversation begins with what Peter calls the three foundings of the Fed: 1913, 1935, and 1951. These were the pivotal dates where major changes were made in the legal structure of the Fed. These changes, however, only changed the legal infrastructure to the Fed. Important personalities continued to transform the institution. Peter points specifically to three Fed chairs for making the Fed what it is today: William McChesney Martin, Paul Volker, and Allan Greenspan.

We also cover the important role the staff plays at the Fed. In particular, the discuss the inordinate influence the head of the international finance division and the general counsel play in shaping international and domestic policy. That they have so much power, but are not appointed creates legal issues according to Peter. Similarly, regional bank presidents are FOMC members who set national policy but not appointed by the President. Peter believes a reexamination of how they are appointed is warranted too.

We then discuss some more recent issues such as the debate over whether the Fed was really constrained by law when it came to bailing out  Lehman. Peter, a lawyer, provides a discussion of this legal claim made by Fed officials and does not find it convincing. 

Finally, we talk about the future of the Fed under President Trump. One question we consider is whether the President can fire a Fed chair. President Truman fired Thomas McCabe and there enough legal ambiguity that it could be done again. But it would be politically costly. We also discuss who would be on the shortlist for the board of governor positions for Donald Trump.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more shows are coming.

Related Links
Peter Conti-Brown's home page
Peter Conti-Brown's twitter account

Friday, December 2, 2016

Can the Global Economy Survive a Stronger Dollar?

One of the big questions going into 2017 is how resilient the global economy will be to a further strengthening of the dollar. The Trump shock and the Fed's desire to raise interest rates almost guarantee a strengthening of the dollar next year. Unfortunately, this is not the best time for a surging dollar since the global economy is ripe with dollar-denominated debt and anemic growth. 

The dollar's initial surge took place between mid-2014 and late 2015 when it grew over 20 percent. This sharp rise was tied to the Fed talking up interest rate hikes while the ECB signaled lower future interest rates. The figure above shows this by reporting the spread between the U.S. and Eurozone 6-month interest rate, 6 months ahead along with the trade-weighted dollar. The figure shows that after plateauing for much of 2016--with some bumps along the way--the dollar has recently started strengthening again as the spread has started to widen. My concern is that this will continue into 2017.

It is instructive to look closer at the dollar surge in 2014-2015 to get  sense of what could happen in 2017. For this initial dollar growth explains a lot of developments in the global economy over the past couple of years. 

First, it explains the timing of the financial stress of late 2015 and early 2016. By that period the value of the dollar had reached a point where it caused the financial imbalances in China to start cracking. Those financial stresses temporarily spread to stock markets around the globe. 

Second, it also explains why China allowed its currency to devalue, as I suscepted would happen. China was violating the macroeconomic trilemma and could only do so for so long. The stronger dollar forced the hand of the Chinese monetary authorities who have been allowing a moderate devaluation of their currency this year. Now that the dollar is strengthening even more, the capital outflows are increasing in anticipation of further devaluation of the renminbi. And no, I do not think capital controls will solve the problem.

Third, it explains why the Fed has been stuck in a seemingly endless rate-hike-talk-loop-cycle in 2016. The cycle goes something like this: the Fed talks up interest rate hikes → dollar begins to strengthen → bad economic news emerges → the Fed dials down its rate hike talk → dollar pressures ease → good economic news emerges → repeat cycle. This cycle occurs because one, there is approximately $10 trillion in dollar-denominated debt outside the United States per the BIS and two, because many countries still peg to the dollar. A strengthening dollar is a problem for the former since implies a higher debt burden while for the latter it means pegging countries have to import the Fed's tightening of monetary policy. Most Fed officials, other than Governor Lael Brainard, fail to fully appreciate this loop. 

Fourth, it explains a sizable part of oil's decline since 2014. Both Ben Bernanke and Jim Hamilton estimated that about 40-45 percent of oil's decline this time is because of weakened global demand. Following similar methods, I estimated it to be about 50 percent. Of course, this begs the question as to what caused global demand to weaken. The obvious candidate was the strengthening dollar putting a chokehold on global economic growth.

Going into 2017 these same dynamics are likely to intensify if market forecasts are correct. Both the stock market and bond market see improved economic growth ahead from the Trump shock. Along with this growth, however, will come higher interest rates and a stronger dollar. So while the U.S. economy seems geared to take off in 2017, the global economy seems positioned to sputter as it faces a stronger dollar. If that sputtering turns into an outright stall then all bets are off for the Fed tightening next year. 

Related Links
Edna Curran and Craig Torres--'Trump Tower Accord' Mooted to ease Dollar Pains