What They’re Saying: 14 Feb 2013

The following are some quotes I found interesting over the past week or so.

Janet Yellen, in this speech, outlines the central question facing the Federal Reserve:

The greater amount of permanent job loss seen in the recent recession also suggests that there might have been an increase in the degree of mismatch between the skills possessed by the unemployed and those demanded by employers. This possibility and the unprecedented level and persistence of long-term unemployment in this recovery have prompted some to ask whether a significant share of unemployment since the recession is due to structural problems in labor markets and not simply a cyclicalshortfall in aggregate demand. This question is important for anyone committed to the goal of maximum employment, because it implicitly asks whether the best we can hope for, even in a healthy economy, is an unemployment rate significantly higher than what has been achieved in the past.

For the Federal Reserve, the answer to this question has important implications for monetary policy. If the current, elevated rate of unemployment is largely cyclical, then the straightforward solution is to take action to raise aggregate demand. If unemployment is instead substantially structural, some worry that attempts to raise aggregate demand will have little effect on unemployment and serve only to stoke inflation.

She then gives her answer later in the speech:

This and related research suggests to me, first, that a broad-based cyclical shortage of demand is the main cause of today’s elevated unemployment rate, and, second, that whatever problems there may be today with labor market functioning are likely to be substantially resolved as the broader economy improves and bolsters the demand for labor.

In other words, according to Yellen, Fed policy should remain at the very least this easy as long as economic conditions remain at least this depressed.

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Caroline Baum asks a very good question about the ‘risk taking’ the Federal Reserve is trying to get investors to do via its policy (emphasis mine):

Whenever I hear the bit about risk-taking, I wonder what the dividing line is between encouraging higher asset prices and creating froth in asset markets. How does the Fed know when asset prices have gotten out of whack?

Good question. The Fed can’t control how its money creation gets allocated. It hopes the money flows from asset prices into the real economy, but that isn’t always the case. For example, an individual’s decision of what to buy — goods and services versus stocks and bonds — depends on the expected return, said David Beckworth, an assistant professor of economics at Western Kentucky University in Bowling Green. “I might put off buying a new car if I could get a great return on buying a new home,” he said.

That’s exactly what happened in the last decade, when home prices became untethered from their anchors.

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From the Telegraph, describing the effects of inflation in Britain over the last number of years:

Three years of inflation outstripping wage growth has seen real wages fall back to 2003 levels, the ONS announced this morning. Over the long term, we are back to square one with men earning slightly less in real terms than in 2002, and women slightly more.

Given that they depend on relatively fixed incomes without the bonus culture and income control of the top decile, and without the recent inflationary benefits rises of the bottom decile, the working and middle classes will bear the brunt, as the Resolution Foundation argued yesterday. Annual spending power across the country is declining by £280 a year, 55pc of the “squeezed middle” have no savings, 69pc have no pension, a low to middle income household could have saved a deposit in three years in 1983, it would take 22 today thanks to our determination to prop up asset prices, despite 83pc of men and 75pc of women in that group working. There is a large and growing class of person in this country for whom this crisis is not a parlour game jumble of bond yields and pointless railways, but a one-way ticket to an economic life as indentured, miserable and joyless as any generation’s since the Great War.

Definitely one for the ‘inflation is not a problem’ contingent who continue to wonder why recovery (if you can call it that) is so sluggish despite some of the surface metrics rebounding.

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Also from the Telegraph, this time Jeremy Warner. Although it’s a piece I have many issues with, this particular passage is the most puzzling:

In any case, in today’s world, with its interconnected supply chains, devaluation is pretty much a zero sum game, as we are discovering to our cost here in Britain. Notionally, it helps exporters, but by raising the cost of imports, it adds to input inflation, which, in turn, damages living standards, crimping domestic demand and ultimately hitting the cost competitiveness of exporters.

All the complaint about currency wars is therefore basically just a lot of political hot air. If countries are to be allowed to stimulate growth – and after more than two decades of going nowhere, it seems entirely reasonable that Japan should at least be allowed to try – they are bound to take monetary action that will have consequences for the currency.

Politicians who complain about it are doing the equivalent of what business losers do when they are out-traded by rivals – they go running off to the regulator screaming unfair competition. Why look to the mote in your own eye when there is always Johnny Foreigner to blame?

He first correctly describes the fact that devaluation is not an answer and usually does more harm than good. Then in the very next paragraph he implies that it is, in fact, the answer for Japan and the rest of the world shouldn’t moan about it. Why should something that is a ‘zero sum game,’ which ‘damages living standards’ be allowed to flourish? Perhaps he is really angling for a stronger pound, and disappointed in the fact that the Bank of England won’t oblige, maybe the Bank of Japan can force the pound higher in relative terms. Who knows. Warner describes the issues the BoE faces below.

If we accept that countries are indeed trying to gain competitive advantage through devaluation, then of course Britain is one of the worst offenders. At Wednesday’s Inflation Report press conference, Sir Mervyn King, Governor of the Bank of England, aired some apparently shocking numbers. Since the financial crisis began, not only had interest rates been reduced to close to zero, but the Bank of England’s balance sheet had been expanded by a factor of five.

Expressed as a share of GDP, the increase has been greater than that of the US, greater than that of the European Central Bank, and greater than that of Japan. This is way beyond being an unprecedented degree of stimulus. These are completely uncharted waters we are in, and even Sir Mervyn seems to be getting worried by them.

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The Swiss are trying to nip a property bubble in the bud:

Switzerland’s central bank has a message for lenders: act now to stem surging credit growth or face further restrictions.

The government, at the urging of the Swiss National Bank, yesterday ordered banks to hold additional capital as a buffer against risks posed by the country’s biggest property boom in two decades. The amount, set at 1 percent of banks’ risk- weighted assets tied to domestic residential mortgages, can be increased to as high as 2.5 percent.

This is a problem of their own making:

Property prices have surged in Switzerland as investors funnel money into one of Europe’s most stable economies amid the sovereign debt crisis and record-low interest rates. The SNB has kept borrowing costs at zero after introducing a franc ceiling of 1.20 versus the euro in September 2011 to stop investors from piling into a currency perceived as a haven.

In keeping with the absurd ‘strong currencies are bad’ myth that pervades mainstream economics, the SNB acted in 2011 to peg the Swiss Franc to the Euro. In printing the mountains of CHF to make this peg work, the Swiss economy has just imported more and more inflation, which seems to be manifesting itself in a housing bubble. It is true that even without the peg, the inflows relating to the Euro crisis may have driven asset prices up, but the limited number of CHF available to the market would have limited the extent of the rise, or it would have seen a decline in prices in other areas. The fact that the SNB has made new CHF available thanks to the peg has fostered the conditions for a bubble to form. At least it is attempting to be proactive, but anything short of pricking the bubble (if there indeed is one) won’t be enough.

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