In Memory of Milton Friedman
Here I compiled a list of comments and interviews of Milton Friedman, as a special tribute to the greatest economist of the 20th century, and my most admired one.
For some of us who came to the States from those non-free regimes (former and now), his half-century fight for economic&political freedoms is especially inspiring. He will certainly be missed.
In memory of him, PBS will broadcast a special TV program called "The Power of Choice: the life and idea of Milton Friedman", on January 29, 2007. To get a preview clip of the program, please go to: http://freetochoosemedia.org/production/POC/press.php
Now here is the list...
From Friends and Foes:
Gary Becker: written in 2002, on the influence of Friedman's ideas
http://home.uchicago.edu/~gbecker/Businessweek/BW/2002/07_01_2002.pdf
Thomas Sowell: his former student, now at Hoover Institution, previously at UCLA
http://www.opinionjournal.com/forms/printThis.html?id=110009268
Greg Mankiw:
http://gregmankiw.blogspot.com/2006/11/milton-friedman.html
Brad Delong (kindof foe, but still admires him):
http://www.salon.com/news/feature/2006/11/17/milton_friedman/
On Uncle Milton
http://www.j-bradford-delong.net/movable_type/2003_archives/001309.html
some excerpt: "Friedman... how great an influence on my thought? Let me think who has had more... Smith, Keynes, Summers, Shleifer... I would put Friedman fifth: only four other economist have had a greater influence on how I think... I'm not atypical at Berkeley in finding myself moving under the influence of the intellectual field generated by Milton Friedman--at least, I don't think I am... "
Paul Krugman (real foe):
I wish he had written one. Maybe he will, as he did for James Tobin.
In-Depth Interviews:
PBS: Charlie Rose on Friedman, Nov. 17, 2006, about 1 hour
http://video.google.com/videoplay?docid=-921891628093252478&q=milton+friedman
PBS: Charlie Rose interview with Friedman, Dec. 2005, about 1 hour
http://video.google.com/videoplay?docid=-2963837673813979186&q=milton+friedman
Friedman on PBS, many years ago:
http://video.google.com/videoplay?docid=6813529239937418232&q=milton+friedman
From professional papers:
WSJ:
http://online.wsj.com/article/SB116369744597625238.html?mod=hps_us_at_glance_most_pop
if you don't have access to wsj, read it from here: http://www.pauldeng.com/pdf/in%20memory%20of%20milton%20friedman.pdf
Economist Magazine:
http://www.economist.com/daily/news/displaystory.cfm?story_id=8190872&top_story=1
BusinessWeek:
http://www.businessweek.com/print/bwdaily/dnflash/content/nov2006/db20061117_169299.htm
From major newspapers:
New York Times:
http://www.nytimes.com/2006/11/17/business/17milton.html?ex=1321419600&en=a0db578046e72e19&ei=5088&partner=rssnyt&emc=rss
Washington Post:
http://www.washingtonpost.com/wp-dyn/content/article/2006/11/16/AR2006111601779_pf.html
For more info about Friedman, please go to: http://www.freetochoose.net/
-Paul
SUBSCRIBE: 
Saturday, November 18, 2006
Thursday, September 07, 2006
Congestion Pricing
Yesterday the Journal had an interesting article (attached below) on traffic pricing: a dynamic-pricing system in which drivers where charged different amounts depending on the time of the day. It's William Vickery's theory of "'congestion pricing" in practice.
Relating to this, another Nobel Laureates R. Selten recently presented a paper on his experiment on day-to-day driving route choice behavior. People who are interested in experiment, behavior and dynamic game might be interested in reading this paper:
http://www.wior.uni-karlsruhe.de/LS_Puppe/Personal/Papers-Kube/route.pdf
Stockholm's Syndrome
Hostages to Traffic, SwedesWill Vote on High-Tech Plan To Untangle Snarls With Tolls
By LEILA ABBOUD and JENNY CLEVSTROM August 29, 2006; Page B1
Soren Astrom, a 40-year-old advertising executive in Stockholm, spent the first half of this year working later than usual, beginning his drive home after 6:30 p.m. each night. But it wasn't his boss keeping him chained to his desk. He was avoiding the extra tolls charged to drivers using city streets during peak hours.
From January through July, Stockholm tested one of the world's most sophisticated traffic-management systems as part of a plan to reduce gridlock, lower smog levels and improve quality of life in the city. Unlike most other traffic-control plans in place in cities such as London and Rome, Stockholm used a dynamic-pricing system in which drivers were charged different amounts depending on the time of day. If Mr. Astrom, for example, left the city center at the busiest time of the afternoon rush, from 4 to 5:29, he would have paid the equivalent of $2.76. But by waiting until 6:30 (image placeholder)p.m., he traveled toll-free. "People changed their habits," he said.
The project is essentially a giant behavior-control experiment designed to distribute traffic more efficiently throughout the day and to spur more people to take public transportation. The approach, known as "congestion pricing," first gained attention in the 1950s through work by Nobel-prize winning economist William Vickery. He theorized that billing drivers for driving at peak hours would give them an incentive to modify their routines. Because even small declines in the volume of cars on the road can have a huge impact on the flow of traffic, some economists believe pricing could eliminate some of the worst snarls.
The Stockholm system, implemented by International Business Machines Corp. in a contract with the Swedish national government, used small transponder boxes, laser detectors and a network of cameras to track the path of every car in the city.
Each time a car passed through one of 23 tolling points, the system identified the car either from its transponder or by reading its license plate. It then checked it against vehicle-registration information and calculated the appropriate fee depending on the time of day and location.
Drivers using a windshield-mounted transponder, similar to the E-ZPass in the U.S., had the tolls deducted automatically from their bank accounts.
The Stockholm plan is an experiment in democracy as well as technology. One of its key elements, say urban planners, is how the city government is getting drivers to back the program. Now that the trial period has ended, the city has scheduled a referendum next month to let residents decide whether to continue the system. If the referendum fails, city officials promise to scrap the $525 million project. But they hope it will pass, and will lead to reduced congestion and smog. A poll done in June found that 52% of voters favor the plan.
Urban planners and city officials from as far away as Bangkok and New York traveled to Stockholm during the trial to review how it might be adapted to their own cities. Dublin and San Francisco are planning similar projects, and Prague and Copenhagen have the plan under consideration.
Preventing traffic tie-ups is one of the great urban puzzles of physics and economics. Solving it is more than an academic question; the time people spend stuck in traffic is essentially wasted economic productivity. "We'd love to see a Stockholm-style demonstration project in the U.S.," said Tyler Duvall, the assistant secretary for policy at the U.S. Department of Transportation.
Mr. Duvall said the referendum approach might help implement an effort in the U.S., where higher tolls are seen as politically unpalatable. "I think people would be willing to pay more if they could see that congestion was meaningfully reduced and that their quality of life improved," he said.
During the Stockholm trial, the city collected data on how the system affected air quality, parking and bus ridership. The results showed that traffic passing over the cordon decreased 22%, while traffic accidents involving injuries fell by 5% to 10%. Exhaust emissions, including carbon dioxide and particles, decreased by 14% in the inner city and by 2% to 3% in Stockholm County.
Greater Stockholm has fewer than two million people. It is made up of an archipelago of islands connected by several bridges, with a single road encircling the center. That makes the central area prone to traffic jams, despite an extensive public-transportation system. (image placeholder)
Before the trial, a drive into the city during morning rush hour used to take almost triple the time of a nonpeak trip. By the end of trial, the morning rush was just over double the time of an off-peak ride.
The Stockholm trial produced another insight into a vexing traffic-reduction programs: getting people to use public transportation. Before the trial began, Stockholm spent about $180 million on improvements to public transportation. It bought about 200 new buses, and added rush-hour trains, express bus routes and more park-and-ride lots. But the changes had little impact on the number of people who left their private cars at home. In spring 2006, however, during the trial, use of all forms of public transportation jumped 6% and ridership on inner-city bus routes rose 9%, compared with a year earlier.
In the trial, about half of the drivers opted for the transponders; cameras checked the others' license plates. People without transponders also could pay at convenience stores, which were connected to the network. Anyone trying to evade payment had their bill sent to the Swedish tax authorities for collection. Taxis, cars licensed in foreign countries and environment-friendly cars were exempt.
Putting the system in place took four months. Construction teams fanned out at night to build 23 metal archways over the roads at each charging point. The cameras and lasers had to be perfectly calibrated to identify cars as they sped by. "You have a few milliseconds to identify each car," said Johan Westman, a technical architect at IBM who worked on the project.
Mr. Westman worried that the system wouldn't be able to identify cars in the harsh Stockholm winters because of all the salt, snow and dirt on the roads and vehicles. But the trial period went smoothly and the cameras functioned well in the winter months. IBM's customer-service center, which anticipated 30,000 calls a day, fielded just 2,000 a day; and few appeals of charges were filed to the tax authorities. (image placeholder)
Some Stockholmers argue that the whole plan to reduce emissions can backfire. Lars-Inge Svensson changed the route he drove to his job at the postal service to avoid two tolling points. His new way to work was three miles longer, but he avoided about $8.40 in tolls. "I let out the same amount of exhaust fumes, or more, but at different locations," said Mr. Svensson.
Some of the biggest beneficiaries, however, weren't drivers, but cyclists and bus riders. Astrid Ericsson, a 32-year-old who lives in the city center, said her 35-minute bicycle ride to work in the morning was much less stressful during the trial. She found fewer cars and more bikes on her route. On rainy days, she took the bus, which got to the office 15 minutes faster than usual. "I will vote for it," she said of the referendum.
If Stockholm residents vote against the referendum, it could set back efforts to try congestion pricing elsewhere. "Sweden is a pretty environmentally oriented place and it has good public transport," said Hani Mahmassani, professor of transportation engineering at the University of Maryland. "If congestion pricing isn't accepted by people there, many other places will balk."
-Paul
Relating to this, another Nobel Laureates R. Selten recently presented a paper on his experiment on day-to-day driving route choice behavior. People who are interested in experiment, behavior and dynamic game might be interested in reading this paper:
http://www.wior.uni-karlsruhe.de/LS_Puppe/Personal/Papers-Kube/route.pdf
Stockholm's Syndrome
Hostages to Traffic, SwedesWill Vote on High-Tech Plan To Untangle Snarls With Tolls
By LEILA ABBOUD and JENNY CLEVSTROM August 29, 2006; Page B1
Soren Astrom, a 40-year-old advertising executive in Stockholm, spent the first half of this year working later than usual, beginning his drive home after 6:30 p.m. each night. But it wasn't his boss keeping him chained to his desk. He was avoiding the extra tolls charged to drivers using city streets during peak hours.
From January through July, Stockholm tested one of the world's most sophisticated traffic-management systems as part of a plan to reduce gridlock, lower smog levels and improve quality of life in the city. Unlike most other traffic-control plans in place in cities such as London and Rome, Stockholm used a dynamic-pricing system in which drivers were charged different amounts depending on the time of day. If Mr. Astrom, for example, left the city center at the busiest time of the afternoon rush, from 4 to 5:29, he would have paid the equivalent of $2.76. But by waiting until 6:30 (image placeholder)p.m., he traveled toll-free. "People changed their habits," he said.
The project is essentially a giant behavior-control experiment designed to distribute traffic more efficiently throughout the day and to spur more people to take public transportation. The approach, known as "congestion pricing," first gained attention in the 1950s through work by Nobel-prize winning economist William Vickery. He theorized that billing drivers for driving at peak hours would give them an incentive to modify their routines. Because even small declines in the volume of cars on the road can have a huge impact on the flow of traffic, some economists believe pricing could eliminate some of the worst snarls.
The Stockholm system, implemented by International Business Machines Corp. in a contract with the Swedish national government, used small transponder boxes, laser detectors and a network of cameras to track the path of every car in the city.
Each time a car passed through one of 23 tolling points, the system identified the car either from its transponder or by reading its license plate. It then checked it against vehicle-registration information and calculated the appropriate fee depending on the time of day and location.
Drivers using a windshield-mounted transponder, similar to the E-ZPass in the U.S., had the tolls deducted automatically from their bank accounts.
The Stockholm plan is an experiment in democracy as well as technology. One of its key elements, say urban planners, is how the city government is getting drivers to back the program. Now that the trial period has ended, the city has scheduled a referendum next month to let residents decide whether to continue the system. If the referendum fails, city officials promise to scrap the $525 million project. But they hope it will pass, and will lead to reduced congestion and smog. A poll done in June found that 52% of voters favor the plan.
Urban planners and city officials from as far away as Bangkok and New York traveled to Stockholm during the trial to review how it might be adapted to their own cities. Dublin and San Francisco are planning similar projects, and Prague and Copenhagen have the plan under consideration.
Preventing traffic tie-ups is one of the great urban puzzles of physics and economics. Solving it is more than an academic question; the time people spend stuck in traffic is essentially wasted economic productivity. "We'd love to see a Stockholm-style demonstration project in the U.S.," said Tyler Duvall, the assistant secretary for policy at the U.S. Department of Transportation.
Mr. Duvall said the referendum approach might help implement an effort in the U.S., where higher tolls are seen as politically unpalatable. "I think people would be willing to pay more if they could see that congestion was meaningfully reduced and that their quality of life improved," he said.
During the Stockholm trial, the city collected data on how the system affected air quality, parking and bus ridership. The results showed that traffic passing over the cordon decreased 22%, while traffic accidents involving injuries fell by 5% to 10%. Exhaust emissions, including carbon dioxide and particles, decreased by 14% in the inner city and by 2% to 3% in Stockholm County.
Greater Stockholm has fewer than two million people. It is made up of an archipelago of islands connected by several bridges, with a single road encircling the center. That makes the central area prone to traffic jams, despite an extensive public-transportation system. (image placeholder)
Before the trial, a drive into the city during morning rush hour used to take almost triple the time of a nonpeak trip. By the end of trial, the morning rush was just over double the time of an off-peak ride.
The Stockholm trial produced another insight into a vexing traffic-reduction programs: getting people to use public transportation. Before the trial began, Stockholm spent about $180 million on improvements to public transportation. It bought about 200 new buses, and added rush-hour trains, express bus routes and more park-and-ride lots. But the changes had little impact on the number of people who left their private cars at home. In spring 2006, however, during the trial, use of all forms of public transportation jumped 6% and ridership on inner-city bus routes rose 9%, compared with a year earlier.
In the trial, about half of the drivers opted for the transponders; cameras checked the others' license plates. People without transponders also could pay at convenience stores, which were connected to the network. Anyone trying to evade payment had their bill sent to the Swedish tax authorities for collection. Taxis, cars licensed in foreign countries and environment-friendly cars were exempt.
Putting the system in place took four months. Construction teams fanned out at night to build 23 metal archways over the roads at each charging point. The cameras and lasers had to be perfectly calibrated to identify cars as they sped by. "You have a few milliseconds to identify each car," said Johan Westman, a technical architect at IBM who worked on the project.
Mr. Westman worried that the system wouldn't be able to identify cars in the harsh Stockholm winters because of all the salt, snow and dirt on the roads and vehicles. But the trial period went smoothly and the cameras functioned well in the winter months. IBM's customer-service center, which anticipated 30,000 calls a day, fielded just 2,000 a day; and few appeals of charges were filed to the tax authorities. (image placeholder)
Some Stockholmers argue that the whole plan to reduce emissions can backfire. Lars-Inge Svensson changed the route he drove to his job at the postal service to avoid two tolling points. His new way to work was three miles longer, but he avoided about $8.40 in tolls. "I let out the same amount of exhaust fumes, or more, but at different locations," said Mr. Svensson.
Some of the biggest beneficiaries, however, weren't drivers, but cyclists and bus riders. Astrid Ericsson, a 32-year-old who lives in the city center, said her 35-minute bicycle ride to work in the morning was much less stressful during the trial. She found fewer cars and more bikes on her route. On rainy days, she took the bus, which got to the office 15 minutes faster than usual. "I will vote for it," she said of the referendum.
If Stockholm residents vote against the referendum, it could set back efforts to try congestion pricing elsewhere. "Sweden is a pretty environmentally oriented place and it has good public transport," said Hani Mahmassani, professor of transportation engineering at the University of Maryland. "If congestion pricing isn't accepted by people there, many other places will balk."
-Paul
Monday, August 07, 2006
Feldstein on current state of the economy
Tomorrow Fed's interest rate decision will be one of the
most important ones in recent years. Will Bernanke pause
as the market expected (80% bet so in futures market)?
Or will he surprise the market again (partly damage his own
reputation) by tilting the delicate balance between
inflation and growth?
The latter was suggested by Feldstein as should-be-done
(see his article below), who was the No. 1 competitor to
Bernanke's job before he was nominated.
Steve believes the rate should be at least 6% in order to
get current inflation under control, but do it gradually
(see his recent inflation update).
The Fed's Difficult Task
By MARTIN FELDSTEIN
August 7, 2006; Page A13, WSJ
A soft landing is a natural aspiration for any central bank confronting an unacceptably high rate of inflation. For today's Federal Reserve, that means bringing inflation down to less than 2% without the fall in output and employment that would constitute a recession.
The Fed governors and Reserve Bank presidents appear to believe this will happen. Their "central tendency" economic projections, summarized in the July Monetary Policy Report, state that the Fed's favored measure of inflation, the PCE price index excluding food and energy, will decline from the 2.9% rate in the most recent quarter to between 2% and 2.25% in 2007, presumably on its way to Ben Bernanke's "comfort zone" of 1% to 2% in 2008. They project this to occur with real GDP growing above 3% and the unemployment rate remaining under 5%. Indeed, not a single one of the 19 FOMC members projected growth of less than 2.5% in 2007 or an unemployment rate above 5.25%.
Although this optimistic outlook is possible, experience suggests that it is unlikely. A mild slowing of economic growth is generally not sufficient to reverse rising inflation. That generally requires a sustained period of excess capacity in product and labor markets, with GDP growth falling significantly or even turning negative.
The Fed's projected combination of strong growth and declining inflation requires either a rise in the rate of productivity growth that slows the rise in unit labor costs, or some favorable spontaneous decline of the external drivers of inflation that is unrelated to unit labor costs. Neither seems likely. Productivity growth appears to be slowing, and external drivers are pointing to a continuation of high or rising inflation.
The official estimates of productivity growth showed a gradual decline of productivity growth in the nonfarm business sector from 3.9% in 2003 to 3.4% in 2004 and 2.7% in 2005. The result of the slower productivity growth and rising compensation per hour (from a 4% rate in 2003 to 5.1% in 2005) caused the increase in unit labor costs to accelerate from 1.3% in 2003 to 2.1% in 2004 and 2.8% in 2005. Taking the new GDP estimates into account is likely to lower the calculated productivity growth rates and cause estimated unit labor costs to have risen faster than 3% in the most recent quarter. There is no reason to anticipate a favorable productivity surprise of the type that contained inflation in the 1990s.
The rapid rise in the overall cost of living creates wage pressures that make it harder to limit the rise in unit labor costs. The CPI in June was 4.3% higher than a year ago. Since wages and salaries have not kept pace, real wages were actually declining over the past year. That came to an abrupt end in June when they jumped at a 5.7% rate.
The external drivers of inflation imply that actual inflation is likely to rise even more rapidly than the unit labor cost numbers would otherwise imply. The doubling of the price of oil is being reflected in transportation costs and in the costs of goods that use petrochemical inputs. The gap between the sharp rise in real-estate prices over the past few years and the much smaller rise in rents is now causing a catch-up in rents, and in the implicit rental prices that the government statisticians impute to owner-occupied housing. The decline of the dollar in the past year, and its likely further decline in the year ahead, will boost the prices of imports and of domestic goods that compete in global markets. The expected rate of inflation implied by comparing the yields on Treasury Inflation Protected Securities and ordinary Treasury bonds has increased during the year to 2.6%.
But while a decline in the core inflation rate may not be compatible with the FOMC's "central tendency" growth projections, the interest rate hikes of the past two years could soon cause a significant and sustained economic slowdown, bringing down future inflation without the need for further rate hikes. Although it is too soon to tell, some FOMC members may oppose a rise in the interest rate at tomorrow's meeting because of this possibility, and because of their fear that another rate increase could lead to an unnecessarily deep economic decline.
The published forecasts of the FOMC members do not capture the full range of each individual's views. While stating that the most likely growth is 2.5%, an FOMC member may also believe that there is a risk that the growth and employment picture could be substantially worse than his or her forecast. As Alan Greenspan emphasized, monetary policy is a balancing of risks and cannot be made on the basis of the most likely projections alone.
The consequences of the past interest rate hikes are difficult to predict. The fall in the real level of house prices has caused residential construction to plummet, with housing starts off 14% from 12 months ago. The combination of lower housing wealth and a sharp fall in mortgage refinancing may cause the household saving rate to return to a positive level, bringing down consumer spending. Business expenditures on equipment and software slowed sharply in the most recent quarter. So a much sharper slowdown than the central tendency forecasts is certainly possible.
While this risk provides a rationale for a pause at tomorrow's meeting, it would be wrong to focus just on this downside risk. The probability that inflation will rise above the FOMC forecast is at least as great. The unemployment rate of 4.8% still represents a tight labor market. Waiting for more data before deciding to raise rates is not costless. If the Fed does not act and core inflation continues to rise, expected inflation may rise further. Higher expected inflation would cause faster increases in wages and prices. If the core PCE inflation rate rises above 3% in 2007, it would take a very substantial slowdown and a large loss of GDP and employment to bring it back under 2%.
In assessing the current interest rate decision, the FOMC members should recall that during the Volcker and Greenspan years the Fed pushed the fed funds rate to 8% above the concurrent rate of CPI inflation in the early 1980s, to 4% in 1989 and to almost 3% in 2000. That measure of the real fed funds rate is now less than 1%.
The Federal Reserve has a difficult task ahead. It is understandable that it would like to achieve the soft landing of low inflation with continued solid growth. But that may not be possible. And if the Fed wants to convince the markets that inflation will be contained in the future, it must show that it is willing to take the risk of tightening too much.
Mr. FELDSTEIN, professor of economics at Harvard, was chairman of the Council of Economic Advisers under Reagan.
-Paul
ps: you can bet on interest rate on hedgestreet.com.
Tomorrow Fed's interest rate decision will be one of the
most important ones in recent years. Will Bernanke pause
as the market expected (80% bet so in futures market)?
Or will he surprise the market again (partly damage his own
reputation) by tilting the delicate balance between
inflation and growth?
The latter was suggested by Feldstein as should-be-done
(see his article below), who was the No. 1 competitor to
Bernanke's job before he was nominated.
Steve believes the rate should be at least 6% in order to
get current inflation under control, but do it gradually
(see his recent inflation update).
The Fed's Difficult Task
By MARTIN FELDSTEIN
August 7, 2006; Page A13, WSJ
A soft landing is a natural aspiration for any central bank confronting an unacceptably high rate of inflation. For today's Federal Reserve, that means bringing inflation down to less than 2% without the fall in output and employment that would constitute a recession.
The Fed governors and Reserve Bank presidents appear to believe this will happen. Their "central tendency" economic projections, summarized in the July Monetary Policy Report, state that the Fed's favored measure of inflation, the PCE price index excluding food and energy, will decline from the 2.9% rate in the most recent quarter to between 2% and 2.25% in 2007, presumably on its way to Ben Bernanke's "comfort zone" of 1% to 2% in 2008. They project this to occur with real GDP growing above 3% and the unemployment rate remaining under 5%. Indeed, not a single one of the 19 FOMC members projected growth of less than 2.5% in 2007 or an unemployment rate above 5.25%.
Although this optimistic outlook is possible, experience suggests that it is unlikely. A mild slowing of economic growth is generally not sufficient to reverse rising inflation. That generally requires a sustained period of excess capacity in product and labor markets, with GDP growth falling significantly or even turning negative.
The Fed's projected combination of strong growth and declining inflation requires either a rise in the rate of productivity growth that slows the rise in unit labor costs, or some favorable spontaneous decline of the external drivers of inflation that is unrelated to unit labor costs. Neither seems likely. Productivity growth appears to be slowing, and external drivers are pointing to a continuation of high or rising inflation.
The official estimates of productivity growth showed a gradual decline of productivity growth in the nonfarm business sector from 3.9% in 2003 to 3.4% in 2004 and 2.7% in 2005. The result of the slower productivity growth and rising compensation per hour (from a 4% rate in 2003 to 5.1% in 2005) caused the increase in unit labor costs to accelerate from 1.3% in 2003 to 2.1% in 2004 and 2.8% in 2005. Taking the new GDP estimates into account is likely to lower the calculated productivity growth rates and cause estimated unit labor costs to have risen faster than 3% in the most recent quarter. There is no reason to anticipate a favorable productivity surprise of the type that contained inflation in the 1990s.
The rapid rise in the overall cost of living creates wage pressures that make it harder to limit the rise in unit labor costs. The CPI in June was 4.3% higher than a year ago. Since wages and salaries have not kept pace, real wages were actually declining over the past year. That came to an abrupt end in June when they jumped at a 5.7% rate.
The external drivers of inflation imply that actual inflation is likely to rise even more rapidly than the unit labor cost numbers would otherwise imply. The doubling of the price of oil is being reflected in transportation costs and in the costs of goods that use petrochemical inputs. The gap between the sharp rise in real-estate prices over the past few years and the much smaller rise in rents is now causing a catch-up in rents, and in the implicit rental prices that the government statisticians impute to owner-occupied housing. The decline of the dollar in the past year, and its likely further decline in the year ahead, will boost the prices of imports and of domestic goods that compete in global markets. The expected rate of inflation implied by comparing the yields on Treasury Inflation Protected Securities and ordinary Treasury bonds has increased during the year to 2.6%.
But while a decline in the core inflation rate may not be compatible with the FOMC's "central tendency" growth projections, the interest rate hikes of the past two years could soon cause a significant and sustained economic slowdown, bringing down future inflation without the need for further rate hikes. Although it is too soon to tell, some FOMC members may oppose a rise in the interest rate at tomorrow's meeting because of this possibility, and because of their fear that another rate increase could lead to an unnecessarily deep economic decline.
The published forecasts of the FOMC members do not capture the full range of each individual's views. While stating that the most likely growth is 2.5%, an FOMC member may also believe that there is a risk that the growth and employment picture could be substantially worse than his or her forecast. As Alan Greenspan emphasized, monetary policy is a balancing of risks and cannot be made on the basis of the most likely projections alone.
The consequences of the past interest rate hikes are difficult to predict. The fall in the real level of house prices has caused residential construction to plummet, with housing starts off 14% from 12 months ago. The combination of lower housing wealth and a sharp fall in mortgage refinancing may cause the household saving rate to return to a positive level, bringing down consumer spending. Business expenditures on equipment and software slowed sharply in the most recent quarter. So a much sharper slowdown than the central tendency forecasts is certainly possible.
While this risk provides a rationale for a pause at tomorrow's meeting, it would be wrong to focus just on this downside risk. The probability that inflation will rise above the FOMC forecast is at least as great. The unemployment rate of 4.8% still represents a tight labor market. Waiting for more data before deciding to raise rates is not costless. If the Fed does not act and core inflation continues to rise, expected inflation may rise further. Higher expected inflation would cause faster increases in wages and prices. If the core PCE inflation rate rises above 3% in 2007, it would take a very substantial slowdown and a large loss of GDP and employment to bring it back under 2%.
In assessing the current interest rate decision, the FOMC members should recall that during the Volcker and Greenspan years the Fed pushed the fed funds rate to 8% above the concurrent rate of CPI inflation in the early 1980s, to 4% in 1989 and to almost 3% in 2000. That measure of the real fed funds rate is now less than 1%.
The Federal Reserve has a difficult task ahead. It is understandable that it would like to achieve the soft landing of low inflation with continued solid growth. But that may not be possible. And if the Fed wants to convince the markets that inflation will be contained in the future, it must show that it is willing to take the risk of tightening too much.
Mr. FELDSTEIN, professor of economics at Harvard, was chairman of the Council of Economic Advisers under Reagan.
-Paul
ps: you can bet on interest rate on hedgestreet.com.
Tuesday, July 25, 2006
Some opposite view in contrast to market's reaction last week on Bernake's comments. Also attached is a link to Cecchetti's view on current state of inflation. I happened to believe also the Fed raised the interest rate too slow back in 2003-05.
The Fed's Logic
appeared on wsj
Every investor likes to believe that the bad news is behind him, so stocks understandably soared yesterday on Fed Chairman Ben Bernanke's allegedly dovish testimony to Congress on the future course of interest rates. For our money, however, yesterday's bigger and less reassuring news was the Commerce Department's June inflation report.
The June consumer price index proved, if more proof were needed, just how big a monetary policy mistake the Fed made from late 2003 through 2005. The government's price indices operate on a lag, often as long as 24 months, and they are now showing a marked inflation revival that too many economists and pundits, including more than a few Fed Governors, have been reluctant to acknowledge.
Overall prices rose in June by 0.2%, a deceptively low number since it included a big decline in energy prices for the month; the real signal is that inflation has set in across the breadth of the U.S. economy. For the last 12 months prices have climbed at an annual rate of 4.3%, and for the last three months by 5.1%. So-called "core" inflation -- sans food and energy -- rose 0.3% in June and is now well above the 2% annual rate that the Fed says is at the top of its tolerable range. For the last three months, "core" inflation is up a scary 3.6%.
So when Mr. Bernanke declared in his testimony yesterday that "Inflation has been higher than we had anticipated in February," he was understating things by a good measure. The Fed has been wrong for a lot longer than February; it has merely taken the conventional price indices this long to make some people believe it.
One striking, and perhaps worrying, part of Mr. Bernanke's testimony yesterday was his implicit logic that real economic growth will soon slow down, therefore we don't have to worry about inflation as much, ergo interest rates may not have to keep rising. Mr. Bernanke is too good an economist to actually believe this . Real GDP growth (defined as growth less inflation) can decline even as prices are rising fast and nominal growth continues to roar. What the Fed should be watching is less real GDP than real prices, and this is where the Fed took its eye off the ball by staying too loose for too long.
Mr. Bernanke is still scrambling to catch up, and the danger looking ahead is that the Fed will have to raise rates more than if it had tightened money faster and earlier in the final years of the Alan Greenspan era. Investors in stocks were betting yesterday that the interest-rate increases are almost over, though we wouldn't bet our own mortgage on it. Stocks were also perhaps oversold last week due to Middle East worries. More price increases are baked in the cake in coming months, and those will surely test whether the Fed can make its much-ballyhooed "pause" in raising rates at its August meeting -- and for how long.
Our own belief is that the Fed has substantially increased the chances of a recession in the next year or two by failing to blunt inflationary expectations early enough. Let's hope the economy's current supply-side momentum, led by very strong business investment, and stronger global growth will offset the impact of higher rates and $75 oil. Monday's Fed report of a big 0.8% jump in June industrial production was an encouraging sign that business spending and manufacturing remain strong.
One question for the Fed, and especially for its staff, is whether its inflation mistake will lead to any policy introspection. Mr. Bernanke is surely right, as he said yesterday, that "monetary policy makers operate in an environment of uncertainty." But those policy makers also continue to downplay, or even dismiss, the relevance of such real-time inflation signals as a weak dollar and the soaring price of commodities including gold. Those prices have been warning the Fed about future inflation for a long time. Some policy reflection can be good for the soul, and even better for the economy.
Link to Steve's most recent inflation update: http://people.brandeis.edu/~cecchett/pdf/inf_current.htm
-Paul
The Fed's Logic
appeared on wsj
Every investor likes to believe that the bad news is behind him, so stocks understandably soared yesterday on Fed Chairman Ben Bernanke's allegedly dovish testimony to Congress on the future course of interest rates. For our money, however, yesterday's bigger and less reassuring news was the Commerce Department's June inflation report.
The June consumer price index proved, if more proof were needed, just how big a monetary policy mistake the Fed made from late 2003 through 2005. The government's price indices operate on a lag, often as long as 24 months, and they are now showing a marked inflation revival that too many economists and pundits, including more than a few Fed Governors, have been reluctant to acknowledge.
Overall prices rose in June by 0.2%, a deceptively low number since it included a big decline in energy prices for the month; the real signal is that inflation has set in across the breadth of the U.S. economy. For the last 12 months prices have climbed at an annual rate of 4.3%, and for the last three months by 5.1%. So-called "core" inflation -- sans food and energy -- rose 0.3% in June and is now well above the 2% annual rate that the Fed says is at the top of its tolerable range. For the last three months, "core" inflation is up a scary 3.6%.
So when Mr. Bernanke declared in his testimony yesterday that "Inflation has been higher than we had anticipated in February," he was understating things by a good measure. The Fed has been wrong for a lot longer than February; it has merely taken the conventional price indices this long to make some people believe it.
One striking, and perhaps worrying, part of Mr. Bernanke's testimony yesterday was his implicit logic that real economic growth will soon slow down, therefore we don't have to worry about inflation as much, ergo interest rates may not have to keep rising. Mr. Bernanke is too good an economist to actually believe this . Real GDP growth (defined as growth less inflation) can decline even as prices are rising fast and nominal growth continues to roar. What the Fed should be watching is less real GDP than real prices, and this is where the Fed took its eye off the ball by staying too loose for too long.
Mr. Bernanke is still scrambling to catch up, and the danger looking ahead is that the Fed will have to raise rates more than if it had tightened money faster and earlier in the final years of the Alan Greenspan era. Investors in stocks were betting yesterday that the interest-rate increases are almost over, though we wouldn't bet our own mortgage on it. Stocks were also perhaps oversold last week due to Middle East worries. More price increases are baked in the cake in coming months, and those will surely test whether the Fed can make its much-ballyhooed "pause" in raising rates at its August meeting -- and for how long.
Our own belief is that the Fed has substantially increased the chances of a recession in the next year or two by failing to blunt inflationary expectations early enough. Let's hope the economy's current supply-side momentum, led by very strong business investment, and stronger global growth will offset the impact of higher rates and $75 oil. Monday's Fed report of a big 0.8% jump in June industrial production was an encouraging sign that business spending and manufacturing remain strong.
One question for the Fed, and especially for its staff, is whether its inflation mistake will lead to any policy introspection. Mr. Bernanke is surely right, as he said yesterday, that "monetary policy makers operate in an environment of uncertainty." But those policy makers also continue to downplay, or even dismiss, the relevance of such real-time inflation signals as a weak dollar and the soaring price of commodities including gold. Those prices have been warning the Fed about future inflation for a long time. Some policy reflection can be good for the soul, and even better for the economy.
Link to Steve's most recent inflation update: http://people.brandeis.edu/~cecchett/pdf/inf_current.htm
-Paul
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