Another Look at the Depressed Michigan Economy

In a previous posting I mentioned how the depressed economy in Michigan was making it difficult to sell my home. I posted a graph that showed how the Michigan housing market never benefited from the U.S. housing boom of 2003-2005, yet it is now feeling the pain of the U.S. housing bust. Poor, poor Michigan.

Over the past few days there has been added attention given to the depressed Michigan economy because of the Republican debate that was held there last night. For example, the New York Times reports on "Michigan's economic Woes" and the Arizona Republic reports "Michigan's plight backdrop of GOP debate on economy." Here is an excerpt from the latter article:

"We're an economic basket case, and it's dominating everything here," said Bill Ballenger, editor and publisher of the influential nonpartisan newsletter Inside Michigan Politics. "Our unemployment rate is 7.4 percent, the highest in the country. We've lost 400,000 manufacturing jobs, which is the heart of our economy here in Michigan. We've just never really recovered from the 2001 recession, and that has affected state revenues and has led to a budget crisis here that has been largely averted now, but there are still a lot of problems. Michigan is the worst, probably, in the entire country."

I find it interesting that Bill Ballenger says the Michigan economy never really recovered from the 2001 recession. This lack of recovery is evident in the my housing graph from this previous posting. Following its report on the debate last night, NPR also chimed in on the depressed Michigan economy with this discussion. By far, however, the most interesting piece I saw on the Michigan economy is the video clip below from CNBC. Among other things, it discusses how the foreclosure rate in Michigan is one of the highest in the nation and how home prices in Detroit have fallen 32% over the past year. (Thanks to Brian Arner for helping me make the video clip work.)

CNBC's Diana Olick reports on the Michigan housing market.

Update:

Paul asks about the housing market in Ann Arbor in the comments sections. I turned to the OFHEO housing price index for insight. Here is a figure constructed from the OFHEO index that shows the year-on-year housing price growth rate in current dollar terms.

The Probability of a Recessin for 2008 Falls Below 50%

Friday we learned that nonfarm payrolls showed 110,000 jobs were created in the month of September. This report does not sound like a recession to me. However, the best news from Friday was that the supposed 4000 lost jobs in August were actually 89,000 new jobs. These job numbers led to headlines such as : '"Nevermind--US job growth firm after revisions", "Job Growth Looks Rosier, Easing Recession Fears", or "Jobs: A September Shocker." These numbers certainly are encouraging and, as noted in the above stories, have some observers reevaluating their economic forecasts. I went to intrade and looked at the contract for there being a recession next year. Here is the graph:

The wisdom of the markets now say there is now less than a 50 probability of a recession next year. I really hope these jobs numbers are a turning point for the US economy, but for reasons discussed in this blog before I will not surprised if this good news is fleeting.

And from the Big Picture, Barry Ritholtz keeps us sober by reminding that "[a]ny report under approximately ~150k month (subject to revisions) is weak. It means that job creation is failing to keep up with population growth."

Update

Below is a graph from the Cleveland Fed showing the market's expectation for the outcome of the October FOMC meeting. This graph is based on options on federal fund futures. Note that as of Friday it shows a greater than 50% of the federal funds rate staying at 4.75%.

Lawrence White on the Right Type of Inflation Target

Lawrence White has a interesting article in the most recent CATO journal titled "What Type of Inflation Target?" One point from his article is that an inflation targeting rule that only targets output prices is not sufficient to prevent the boom-bust cycles in asset prices we have seen over the past few decades. An excerpt:

"The remedy for central-bank-generated-asset-bubble problems isn’t continued discretion, but rather a better “price rule”... In other words: the problem isn’t in having a target, it’s in having a target limited to the CPI. A better target would incorporate asset prices, directly or indirectly, rather than only consumer prices. Examples of direct incorporation include a gold standard, a rule targeting an Alchian-Klein-type index that incorporates asset prices, or a rule targeting an index of input prices (wages and/or raw material prices). An example of indirect incorporation would be a rule targeting a broad measure of per capita nominal expenditure (Py), as proposed by George Selgin (1990), rather than only the CPI price index (P)."

Similar arguments have been made by others observers. Here is the Economist magazine in a 2005 article titled "Steering by a Faulty Compass." Some excerpts:

"When inflation targets were first introduced (in New Zealand in 1989), the exact measure of inflation did not matter much. The main objective then was to reduce high rates of inflation by anchoring expectations. Today, however, consumer-price indices are arguably too narrow. Charles Goodhart, a former member of the Bank of England's Monetary Policy Committee, has long argued that central banks should instead track a broader price index which includes the prices of assets, such as houses and equities...

The idea that central banks should track asset prices is hardly new. In 1911 Irving Fisher, an American economist, argued in a book, “The Purchasing Power of Money”, that policymakers should stabilise a broad price index which included shares, bonds and property as well as goods and services. Central banks already take account of asset prices by estimating their effect on wealth and hence on demand and future inflation, but the idea behind a broad price index goes much further, acknowledging that asset-price inflation can be harmful in its own right.

The most obvious way is through a giddying rise and subsequent crash of markets for shares or property. Big swings in asset prices can also lead to a misallocation of resources and so slower economic growth, just as high rates of general price inflation distort economies by blurring relative price signals. For instance, soaring property prices can encourage households to borrow too much and save too little, and can pull excessive resources into property at the expense of other forms of investment.

More fundamentally, if inflation is defined as “changes in the value of money”, then the consumer-price index is flawed because it only measures the prices of current consumption of goods and services. A classic paper written in 1973 by two American economists, Armen Alchian and Benjamin Klein, argued that people care about changes in the prices not only of the goods and services they consume today, but also of what they use tomorrow. Because assets are claims on future goods and services, their prices are proxies for the prices of future consumption. If I buy a house—i.e., a claim on future housing services—and its price is higher than a year ago, then surely that should be included in inflation since it reduces the purchasing power of my money. Many consumer durables, such as cars, which also provide services over several years, are already included in the CPI.

If the prices of goods and services and those of assets move in step, then excluding the latter does not matter. But if the two types of inflation diverge, as now, a narrow price index could send central bankers astray. Granted, asset prices are hard to measure: a rise in house prices may partly reflect an increase in the average quality of homes; and economists disagree over what weight house prices should have in a broad index. Yet buying a home is an enormous expense, so it is absurd to use such a rough approximation as rent, as does America's CPI, or to exclude the costs of owner-occupier housing altogether, as does the European Union's harmonised index of consumer prices."

Too bad the Fed did not incorporate these ideas into policy making over the past decade.

The Housing Recession Hits Home

Readers of my blog know I have taken a hard line against Fed interventions during the past few months. For example, in "Sound Policy or Liquidity Addicts" I took the Jim Cramer's of the world to task for their calls for a Fed bailout of financial markets. Some readers may read postings like that and conclude that I am just another out-of-touch academic spouting painful policy prescriptions from the comfort and safety of my ivory tower. If this thought has crossed your mind then this posting is especially for you.

Yes, I have been prescribing painful economic medicine, but this advice has not been in my own self-interest. This past summer I moved from Southwestern Michigan to Central Texas. As part of this move, I put my home on the worst national housing market in the past 40 years. What made my life even more interesting is that my house was placed on one of the worst state housing markets as well. Consequently, my home has been getting few bites and I have been making two home payments. Two home payments for our one-income family have been painful. Questions about this arrangement persisting for some time--some observers are predicting the housing recession will continue through 2009--has also been troubling. To add some perspective to this discussion consider the two figures below. These figures show the growth rates of the OFHEO housing price index for the nation, the state of Michigan, and South Bend, Indiana. The latter one is included because my home was not too far from South Bend, Indiana. The first figure shows the growth rates of housing prices unadjusted for inflation:

This figure shows the Michigan housing has had some big swings in the past and currently is declining in current dollar terms. Moreover, the figure indicates that Michigan and South Bend housing markets never really were part of the housing boom during the 2003-2005 period. The bottom line from this figure is that I bought a home in a particularly weak housing market... not very promising. But wait, there is more to this story. The above figure does not adjust for inflation. What has been the real return for houses in Michigan over this time? The next figure, which takes the OFHEO index and deflates it with the PCE deflator, answers this question:

This figure is striking: the growth rate of real home prices in Michigan has been declining since 2001 and turned negative in 2005. The South Bend, Indiana housing market is slightly better than the Michigan housing market, but still is relatively flat compared to the national average. Some caution should be taken in evaluating this figure: the regional housing price indices were deflated with a national price index. I am not sure, though, that the outcome would be much different if a regional price index were used.

Now back to my world. This week my wife and I finally received an offer on our home. We gave a counter offer and the prospective buyers accepted. Our counter offer requires us to bring money to table. We are glad to be paying this amount just to unload our home. So, we too have been hit by this housing recession. I would like to think that makes me an academic who has not lost touch with the real world

Update
I redid the second figure with the PCE deflator. The results seem more reasonable than what they were using the CPI as the deflator.

The Forex Market

Menzie Chinn at Econbrowser points us to the BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity. Among other things, this report shows the amount of forex transactions as well as the currency distribution of forex transactions. The table below shows on average $3.2 trillion of forex traded per day!




This next table shows the currency distribution of forex transactions. The dollar makes up 86.3% in 2007.




Very interesting reading...

William White on Benign Deflation

I have discussed in this blog the difference between malign and benign deflation and why it matters to macroeconomic stability. I have also posted some of Andy Xie's (formerly of Morgan Stanley) work who makes this same argument. Here is an excerpt from another voice making this same point:

Is Price Stability Enough?
William White , Bank for International Settlements

"One implication of positive supply side shocks is that they call into question whether monetary policy should continue to pursue the near-term [monetary policy] target of a low positive inflation rate... Failure to adjust the [monetary policy] target downward (whether explicitly or implicitly) in the face of positive supply shocks would result in lower policy rates than would otherwise be the case... Paradoxically, taking out insurance against a benign deflation might over an extended period increase the probability of the process eventually culminating in a “bad” or even “ugly” one. "

Yes, I have provided a link to this article before, but I after looking at it again today I thought it was worth another plug on my blog. Read the entire article.

Daniel Gross is Scratching His Head...

Mark Thoma and David Altig do a good job explaining why it is appropriate for the Fed to look at core measures of inflation when conducting monetary policy. Their argument is essentially that core inflation (or trimmed-mean PCE) does a better job predicting future overall inflation. Many observers are critical of this approach and say that it runs against reality. Here is one such observer:

Gross: There's No Inflation (If You Ignore Facts)
By Daniel Gross
Newsweek

Oct. 8, 2007 issue - Imagine that a cardiologist told you that aside from the irregular heartbeat, the stratospheric cholesterol count and a little blockage in your aorta, your core heart functions are just fine. That's precisely what the government's cardiologist—Ben Bernanke, chairman of the Federal Reserve—has just done. The central bank is supposed to make sure the economy grows fast enough to create jobs and make everybody richer, but not so fast that it produces inflation, which makes everybody poorer. "Readings on core inflation have improved modestly this year," the Federal Open Market Committee said in justifying its 50-basis-point interest-rate cut last month, while conceding that "some inflation risks remain."

Catch that bit about "core inflation"? That's Fedspeak for: inflation is under control, unless you look at the costs of things that are going up. The core rate excludes the prices of food and energy, which can be volatile from month to month. Factor them in, and inflation is about as moderate as Newt Gingrich. In the first eight months of 2007, the consumer price index—the main gauge of inflation—rose at a 3.7 percent annual rate. That's more than 50 percent higher than the mild 2.3 percent core rate. The prices of energy and food are soaring, at 12.7 percent and 5.6 percent annual rates, respectively, and have been doing so for years. As a result, the CPI—including food and energy—has risen 12.6 percent since July 2003, for a compound rate of about 3 percent.

Signs of inflation are evident throughout the economy. When investors fear a rising inflationary tide, they latch onto the driftwood of gold. The day Bernanke cut rates, the price of the precious metal soared to heights not seen since 1980, when inflation ran at nearly 12 percent! I read about this in The Wall Street Journal (whose newsstand price rose 50 percent in July), which I picked up in the lobby of a New York hotel (where the average nightly rate soared 12.5 percent in the first seven months of 2007 from 2006, according to PKF Consulting) while sipping on a Starbucks Frappuccino (whose price has risen twice since last October).

There are sound macro-economic reasons to believe higher inflation may be a fact of economic life, according to former Federal Reserve chairman Alan Greenspan, who discusses the topic in his new memoir, "The Age of Turbulence." (Apparently, the editors killed the original title: "The Dotcom Bubble Wasn't My Fault. Nor Was the Housing Bubble.") Greenspan notes that vast anti-inflationary forces in the 1990s—especially China's emergence as a low-cost producer of goods—helped tamp down prices. But China's rampant growth and rising living standards could encourage inflation. "China's wage-rate growth should mount, as should its rate of inflation," he writes.

In a recent paper, Albert Keidel of the Carnegie Endowment for International Peace warns of China's "gathering inflation storm," powered in part by "explosive price increases in key consumer categories" like noodles and pork... China is bound to export its inflation—it exports everything else, after all—either in the form of higher prices for toys, or in the form of higher global prices for the commodities it consumes in increasingly huge gulps.

In the United States, companies are passing along high-er commodity and fuel costs by boosting prices, slashing portions and tacking fuel surcharges onto things ranging from deliveries to lawn service. And because food and energy prices are so visible—the prices are posted in public, and consumers buy these goods frequently—price increases have a disproportionate impact on perceptions of inflation.

China's government is trying to deal with its inflation in predictably Orwellian fashion. "Beijing has instructed local provincial and urban statistical bureaus in a subtle form of denial—they are not to use the word 'inflation' to describe what is happening," notes Keidel. It's easy to mock Beijing's clumsy bureaucrats. But by focusing on core inflation, the Federal Reserve—along with the legions of investors who reacted ecstatically to the interest-rate cut—is practicing its own subtle form of denial.