KnowNOW!

Global Economic Watch

Syndication

Recent Posts

Tags

View more

Other Useful Blogs

Archives

  • SF Fed Economic Letter: 'Crises Before and After the Creation of the Fed'

    With the Federal Reserve turning 100, San Francisco Fed economists Early Elias and Òscar Jordà take a moment to look at the impact of their parent institution on crisis mitigation. They point to fewer crises over the last 100 years than in the previous century, and the less severe results of the Great Recession compared to the Panic of 1907 as evidence of the Fed's relative success. Here is an excerpt from their Economic Letter: Recessions originating from a financial event were common in the late 19th and early 20th centuries. Many stemmed from banking panics. Figure 1 provides a global historical perspective. We calculate by decade the number of countries that experienced financial crises among a sample of 17 industrialized economies representing more than half of global GDP during the past 140 years (for details, see Jordà, Schularick, and Taylor 2012). Figure 1 shows a notable downward global trend in the incidence of these highly disruptive events, with the conspicuous exceptions of the Great Depression and the Great Recession of 2007–09. In the United States, the rate of banking crises declined markedly after the 1913 creation of the Federal Reserve System. Other than the Great Depression and Great Recession, the only significant banking crisis of the past century was the savings and loan crisis. By contrast, ten significant banking crises occurred in the 19th century. The panic of 1907 and the resulting recession are generally credited with providing the catalyst for the creation of the Federal Reserve System. When the Federal Reserve was chartered, the United States had been without a central bank for about 70 years. Congress chartered The First Bank of the United States in 1791 during the Washington presidency, under the guiding hand of Secretary of Treasury Alexander Hamilton. However, its 20-year charter was allowed to expire in 1811. Then, under President Madison, the Second Bank of the United States was created in 1817 for another 20-year period. Once again, the charter was allowed to expire amid President Jackson’s strong opposition to the central bank. Read the full letter here .

  • SF Fed President: "An aggregate demand shortfall is exactly the kind of problem monetary policy can address"

    San Francisco Fed President John C. Williams visited the Forecasters Club in New York last Thursday and gave his assessment of the economy. He named four key factors behind the slow, or "tepid" recovery: 1) the effects of the housing bubble and crash; 2) austerity measures reducing aggregate demand; 3) eroding demand for exports with a weakened global economy; and 4) unusually high levels of uncertainty. He then addressed the question of whether these factors affect supply and demand: So, is the problem today inadequate supply, or demand, or both? A useful way to think about this question is to compare the unemployment rate with the natural rate of unemployment. By the natural rate, I mean the unemployment rate that minimizes labor market imbalances and pressures—either upward or downward—on inflation. The unemployment gap—the difference between the unemployment rate and its natural rate—measures the degree to which labor demand is unequal to supply. Movements in the natural rate itself reflect changes in supply. Of course, we can’t directly measure the natural rate of unemployment. Rather, we must estimate it. This topic has appropriately garnered a great deal of attention among economists at the Federal Reserve and elsewhere in recent years. Extensive analysis of the labor market comes to a clear conclusion: Supply-side considerations explain only some of the rise in unemployment. Most of that rise is explained by a lack of labor demand. Let’s look at this more closely. Prior to the recession, a typical estimate of the natural rate of unemployment was between 4¾ and 5% (see Williams 2013). The empirical evidence suggests that the recession and policy responses to it, such as extended unemployment insurance benefits, contributed to dislocations in the labor market. These have pushed the natural rate above its pre-recession level by about 1 percentage point (see Congressional Budget Office 2013 and Daly et al. 2012b). Consistent with these findings, my estimate of the current natural rate of unemployment is about 6%, roughly 2 percentage points below the current unemployment rate. This 6% figure is consistent with many other estimates, including the most recent median estimate of the Survey of Professional Forecasters (Federal Reserve Bank of Philadelphia 2012). Fortunately, many of the influences that have elevated the natural rate of unemployment since the crisis and recession should fade over time. In fact, this process is already under way. The extended unemployment insurance programs have been scaled back and are affecting fewer and fewer people. Eventually these programs will be phased out. In addition, measures of mismatch between workers and available jobs are receding (Lazear and Spletzer 2012 and Șahin et al. 2012). And, at least so far, we are not seeing permanent scarring effects of long-term unemployment (Valletta 2013). I expect that, in coming years, the natural rate will return to a more historically typical level of about 5½%. I should note that the fact that economists are busily studying, debating, and revising their assessments of the supply side of the economy is encouraging. It makes a repetition of the mistakes of the late 1960s and 1970s much less likely. In our research, Orphanides and I found that, if economists and policymakers had similarly reevaluated their views back in the 1960s and 1970s, the stagflation of that period could have been avoided (Orphanides and Williams 2013). The conclusion that the economy is suffering primarily from weak demand rather than a shortage of supply receives additional support when the factors weighing on recovery are analyzed. The finding of the research that I mentioned on the economic effects of uncertainty—that heightened uncertainty raises unemployment and depresses inflation—is evidence that uncertainty primarily acts as a barrier to demand, not supply. Other research supports that view. In recent work published by the San Francisco Fed, Mian and Sufi (2013) compare state-level employment performance during the recession and recovery with state-level survey data from the National Federation of Independent Business. The NFIB survey asks small business owners to identify the single most important problem they face. Answers include taxes, poor sales, labor costs, government regulation, insurance costs, et cetera. Mian and Sufi find that declines in state employment were highly correlated with the percentage of respondents in each state citing lack of demand as their most important business problem. Read the full speech here .

  • SF Fed President Explains Fed's Use of 'Unconventional' Monetary Policies

    In its efforts to hold ground against the recession, the Federal Reserve has tried some policies that John Williams , president of the San Francisco Fed , refers to as "unconventional." Williams spoke last week at the University of California, Irvine and addressed the two primary unconventional policies the Fed has used: forward policy guidance and large-scale asset purchases (which we have come to know as quantitative easing). Here is an excerpt from that speech. A great deal of research has analyzed the effects of forward policy guidance and large-scale asset purchases on financial conditions and the economy. As I mentioned before, forward policy guidance has proven to be effective at lowering expectations of future interest rates (see Swanson and Williams 2012 and Woodford 2012). Similarly, the evidence shows that LSAPs have been effective at improving financial conditions as well. To be precise, the estimated impact of a $600 billion LSAP program, such as QE2, is to lower the 10-year Treasury yield by between 0.15 and 0.20 percentage point (see, for example, Williams 2011, Krishnamurthy and Vissing-Jorgensen 2011, Hamilton and Wu 2012, Swanson 2011, Gagnon et al. 2011, and Chen, Curdia, and Ferrero 2012). It is around the same magnitude as the effects of forward policy guidance, and about how much the yield on 10-year Treasury securities typically responds to a cut in the fed funds rate of three-quarters to one percentage point (see Chung et al. 2012 and Gürkaynak, Sack, and Swanson 2005). So, by that metric, LSAPs have big effects on longer-term Treasury yields. By pushing down longer-term Treasury yields, forward guidance and LSAPs have rippled through to other interest rates and boosted other asset prices, lifting spending and the economy. For example, mortgage rates have fallen below 3½%, apparently the lowest level since at least the 1930s. Thanks in part to those rock-bottom rates, we’re at long last seeing signs of life in the housing market. Likewise, cheap auto financing rates have spurred car sales. And historically low corporate bond rates encourage businesses to start new projects and hire more workers. In addition, low interest rates help to support asset prices, such as the value of people’s homes and their retirement funds. All else equal, households are more likely to consume if their wealth is growing rather than falling. Stronger asset prices support consumption because they make people feel wealthier and more confident. And that in turn helps boost the economy. Finally, although it’s not our main intention, these unconventional policies have also had an effect on the dollar versus foreign currencies. When interest rates in the United States fall relative to rates in other countries, the dollar tends to decline as money flows to foreign markets with higher returns. One estimate is that a $600 billion program like QE2 causes the dollar to fall by roughly 3 or 4% (see Neely 2011). That helps stimulate the U.S. economy by making American goods more competitive at home and abroad. The full speech is available here .

  • SF Fed: 'Credit Access Following a Mortgage Default'

    In a new Economic Letter for the San Francisco Fed , William Hedberg and John Krainer take a look at the impact defaulting on a mortgage has on borrowers returning to the mortgage market. Not surprisingly, it takes defaulters a long time to get back into the home-owning game. For the vast majority (90%), that means not getting another mortgage for at least a decade. So the idea that defaulting represents an easy way out of a bad investment, and therefore something of a clean slate, does not seem to hold up. From the article: We treat access to credit as a decision more or less made by lenders. In other words, at what point are they willing to lend again to a borrower with a tarnished history? In reality, borrowers may not want credit. The data only show the quantity of credit outstanding. They do not directly indicate credit demand or supply, although some inferences regarding credit supply can be made. In addition, important institutional restrictions affect credit following mortgage default or foreclosure, especially mortgage borrowing. People with a major derogatory event on their credit history, such as foreclosure or bankruptcy, typically can’t qualify for a conventional loan securitized through government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac until four to seven years have elapsed, depending on circumstances surrounding the event. This restriction does not completely preclude lending to borrowers who have recently defaulted. A lender has the option of making the loan and keeping it on its own balance sheet instead of selling it to one of the GSEs. However, the GSEs own or guarantee the vast majority of new mortgages, which makes the restriction a powerful barrier keeping defaulters from returning to the market. The Equifax data confirm that a prior mortgage default has a large effect on future access to mortgage credit. Figure 1 shows the rate at which borrowers with different credit histories return to the mortgage market following a termination or exit. Termination is defined as having a zero mortgage balance after having a positive mortgage balance. The blue line in Figure 1 plots the rate for returning to the mortgage market for borrowers with no prior defaults or foreclosures. We do not know why these borrowers terminated their mortgages. They could have moved, or adjusted their housing expenditures by trading up or downsizing. Or they could have paid down their mortgages and now own their houses outright. We might expect that most borrowers who have paid off their mortgages will never return to the market. Indeed, 12 years after a termination, just above 35% of borrowers with no prior defaults have taken out new mortgages. This number may seem low. But, as the red line in Figure 1 shows, it is much higher than the average rate at which borrowers with prior defaults return to the mortgage market over the same time horizon. Read Credit Access Following a Mortgage Default here .

  • Impact of Uncertainty on Unemployment

    In a new Economic Letter , San Francisco Fed researchers Sylvain Leduc and Zheng Liu , look at the impact of uncertainty on economic activity. As they display in the following figure, uncertainty is countercyclical (this figure shows perceived uncertainty and "VIX index, a measure of the volatility of the Standard & Poor’s 500 Index." Leduc and Liu conclude that uncertainty has had a significant effect in at least one area: unemployment. Our statistical model suggests that uncertainty has pushed the unemployment rate up at least one percentage point in the past three years. By contrast, uncertainty was not an important factor in the unemployment surge during the deep downturn of 1981–82. One possible reason why uncertainty has weighed more heavily on the economy in the recent recession and recovery is that monetary policy has been limited by the zero lower bound on nominal interest rates. Because nominal rates cannot go significantly lower than their current near-zero level, policy is less able to counteract uncertainty’s negative economic effects. Read Uncertainty, Unemployment, and Inflation here .

  • SF Fed: Euro Debt Crisis and the US Bond Market

    One of the ways in which the European debt crisis is likely having an impact on the U.S. economy is via the corporate bond market. San Francisco Fed economists Galina Hale , Elliot Marks , and Fernanda Nechio look into the extent of that impact. In a new Economic Letter , Hale, Marks, and Nechio share some of their findings: Corporate bond spreads vary by industry and credit rating. Thus, we also measure contagion on a disaggregated basis, separating borrowers by industry sector and credit rating. Using Bank of America/Merrill Lynch data from Bloomberg, we constructed spreads by subtracting 10-year generic government yields for the U.S. and Germany from the U.S. and euro-area corporate bond yield-to-maturity series, respectively. The indexes are available for several industry groups and credit ratings. We selected nonfinancial and financial borrowers, and ratings of AAA, AA, A, BBB. We computed weekly changes in spreads using end-of-trading-week values. Figure 2 shows contagion coefficient estimates for these subgroups. The left panel presents results for nonfinancial issuers and the right panel for financial issuers. Both panels show contagion coefficients for the four different rating categories. The results indicate that the relationship between credit rating and vulnerability to European shocks is very different for financial and nonfinancial companies. For the nonfinancial sector, contagion coefficients are higher for lower-rated bond issuers. In particular, bonds of AAA-rated nonfinancial U.S. issuers are significantly insulated from bond market funding shocks originating in Europe. The opposite is true for financial borrowers. The highest rated appear to be more susceptible to contagion from the European bond market. This may be because higher-rated financial institutions tend to be larger and more involved in global capital markets, which makes them more vulnerable to foreign financial market shocks. In fact, some of the AAA-rated banks are multinational institutions that issue bonds in both Europe and the United States, and are components of U.S. and euro-area AAA bond indexes. By contrast, highly rated nonfinancial companies tend not to rely much on foreign financing. Therefore, they are more likely to be insulated from financial shocks, especially those originating in foreign countries. Read Are U.S. Corporate Bonds Exposed to Europe? here .

  • Liquidity, Traditional Deposits, and Risk Mitigation at U.S. Banks

    Philip Strahan --professor of finance at Boston College's Carroll School of Management , and a visiting scholar at the Federal Reserve Bank of San Francisco --has an Economic Letter on liquidity risks at banks during and following the 2007-2008 financial crisis. Strahan highlights the importance of traditional deposits to mitigating risk: Banks finance their balance sheets with more than just deposits and equity capital. Other liabilities include uninsured wholesale deposits, repurchase agreements, and other short-term unsecured debt instruments. These sources became scarce during the crisis. For example, repurchase agreements, known as repos, were often used to finance risky assets such as private-label mortgage-backed securities. Gorton and Metrick (2011) show that, in the middle of 2007, mortgage-backed securities could be almost completely financed with short-term borrowed funds in the repo market. However, by the fourth quarter of 2008, only about 55% of each dollar invested in such securities could be financed this way. Banks that used repos to finance purchases of mortgage-backed securities faced an unpleasant choice. They could sell their securities holdings into a falling market and take a big loss. Or they could find new, and presumably expensive, sources of credit. In the case of nonbank brokerage firms, the collapse of the repo market was a calamity. However, it was less of a disaster for commercial banks because they could use increases in deposits to bridge the financing gap. Figure 1 shows how these sources of liquidity risk affected overall bank credit during the crisis. Off-balance-sheet loan commitments rose steadily from 1990 to 2007. Overall bank credit production, including both on- and off-balance-sheet credit commitments, started to fall in the middle of 2007. The decline accelerated sharply in the last quarter of 2008. By contrast, loans held on bank balance sheets continued to rise until the end of 2008. That rise in on-balance-sheet loans during the crisis was due to borrowers drawing down preexisting credit lines. Banks began cutting back new lending in the middle of 2007. This illustrates how bank obligations to existing borrowers crowded out new borrowers. Read Liquidity Risk and Credit in the Financial Crisis here .

  • Economic Letter: Impact of QE2 on Financial Markets

    The long term impact of the Federal Reserve's two round of quantitative easing may not be clear for some time, but two researchers at the San Francisco Fed say that the financial markets have already seen benefits. In a new Economic Letter , Jens Christensen and James Gillan argue that the Fed's purchase of Treasury inflation-protected securities (TIPS) in particular improved market liquidity. The second LSAP program, frequently referred to as quantitative easing 2, or QE2, was announced on November 3, 2010. The program increased the Fed’s balance sheet by $600 billion through purchases of Treasury securities over approximately an eight-month period. In addition, the Fed reinvested maturing principal on its holdings of Treasury and mortgage-backed securities purchased during the first LSAP program from January 2009 to March 2010 by buying Treasury securities. The Fed’s purchases of Treasury securities from November 3, 2010, through June 29, 2011, totaled nearly $750 billion, of which TIPS purchases represented about $26 billion. The program was implemented on a regular schedule. Once a month, the Fed publicly released a list of operation dates for the following 30-day period, indicating the relevant maturity range as well as the expected purchase amount for each operation. The Fed carried out TIPS purchases on 15 separate dates, fairly evenly distributed over time, with a stated goal of purchasing between $1–2 billion each time. TIPS were the only asset purchased on the specified dates and the Fed did not acquire TIPS outside of those dates. Finally, all outstanding TIPS with at least two years remaining to maturity were eligible for purchase, so there should not be any security-specific price movements on purchase dates based on the Fed’s announcements. Figure 1 (below) shows the weekly average and eight-week moving average of daily trading volume in the secondary TIPS market. Daily TIPS trading volume was averaging about $7–8 billion when the second LSAP program began. Some effect would be expected from the Fed’s injecting an additional $1–2 billion into this market approximately every two weeks. TIPS trading volume increased notably during the program. However, we are looking for the flow effects of the TIPS purchases rather than changes in trading volume. That is, we want to know what effects the purchases had on TIPS liquidity premiums, as well as liquidity premiums in the related market for inflation swap contracts, on the dates of TIPS purchases. Read Do Fed TIPS Purchases Affect Market Liquidity? here .

  • SF Fed's 'Economic In Person' Series: The Great Recession and Unemployment

    One key legacy of the Great Recession will be the damage it caused to the labor market, says Mary Daly . That damage is deep and wide. And it only just begins to show up in the stats discussed in the media. In the first installment of a new series from the Federal Reserve Bank of San Francisco , Daly--Associate Director of Research and Group Vice President at the bank--discusses four distinguishing characteristics of the recession and its impact on unemployment. frbsf on livestream.com. Broadcast Live Free

  • Potential Advantages of a Global Trade Pact

    In a new Economic Letter for the Federal Reserve Bank of San Francisco , Carolyn Evans shares this diagram representing a series of trade agreements among various countries: This "spaghetti bowl" shows the complexity in managing global trade policy through a series of partner-to-partner agreements--or Preferential Trade Agreements (PTAs). Evans: This type of proliferation of agreements has been termed a “spaghetti bowl” because there are so many overlapping bilateral arrangements among nations. Such a complex mesh of relationships could have the unintended effects of raising the cost of trade and distorting production patterns across countries. These consequences may emerge from two aspects of a plethora of trade agreements: rules of origin and tariff rates. Rules of origin set out standards determining where a particular product originates. They specify that, in order for a product to be deemed to originate from a certain country, a meaningful portion of that product’s value must come from that country. Rules of origin are put in place to eliminate cheating, whereby one country imports a product from a non-partner country and then re-exports it to the free-trade partner. Satisfying rules-of-origin requirements has become increasingly complex, since production processes now stretch across multiple countries. When an assembling country sources inputs from a number of other countries and then exports the finished product to another final market, it becomes difficult to determine exactly where the product originates. Since each PTA has its own rules of origin for particular parties to the agreement, meeting those requirements may become quite complicated. While global, multi-lateral trade agreements are very difficult to work out, they may be a more efficient way to work out more effective, and efficient global trade. They also, Evans argues, offer "unique economic opportunities over and above what is available via more limited agreements." Read Bilateralism, Multilateralism, and Trade Rules here .

  • SF Fed: Rising Asset Prices, Rising Debt

    In a new Economic Letter for the Federal Reserve Bank of San Francisco , University of California, Davis professor Paul Bergin takes a look at the relationship between rising housing values and increased debt. And he sees a fairly strong one: To what degree were households able to cash in on rising asset values by selling or borrowing off of those assets? Figure 3 (below) shows the components of the U.S. financial account, which tracks the sale of assets used to finance the current account deficit. The dramatic rise in total financial inflows in the mid-2000s was tracked almost fully by a rise in international net sales of debt securities, including government and private-issue securities. The other two main categories, direct foreign investment and international net sales of stock, did not rise in similar fashion to finance the rising current account deficit. In fact, net trade in those two categories was negative for most of those years. That indicates there was a net outflow of capital in those two categories. Thus, foreign direct investment and international sale of U.S. equities were not part of the capital inflow that financed the current account deficit. This pattern reflects the tendency of U.S. investors to purchase higher-risk, higher-yield foreign assets, such as international stocks, while selling lower-risk, lower-yield assets such as debt securities to foreigners. The lower volume of net trade in stock and direct investment suggests that consumers were not able to cash in on rising asset values by directly selling assets in those categories abroad. Rather, it appears that households used their higher-value assets as collateral to gain access to the U.S. financial market and take out loans. Some of those loans made their way overseas in the form of net sales of debt securities. It appears that the rise in U.S. stock and housing prices was in part to blame for the fall in national saving and the rise in the current account deficit. This may help explain why the collapse of the prices of those assets was so potent in reducing the U.S. current account deficit. It may be that the sharp fall of the housing and stock markets was the mechanism needed to reduce large current account imbalances not only in the United States, but in other countries that had taken advantage of rising asset prices to finance consumption. In this way, falling asset prices have brought current account deficits back to more sustainable levels and helped restore a better global financial balance. Read Asset Price Booms and Current Account Deficits here .

  • SF Fed Economic Letter: A Potential Decline in the Decline of Small Business Lending

    While the number and overall value of loans to small businesses continues to decline, the rate of decline may be leveling off, according to San Francisco Fed economists Liz Laderman and James Gillan . In an Economic Letter , Laderman and Gillan chart lending to small businesses from large and small banks. Here's the trend for large banks: Laderman and Gillan write: The small business loan trend at large banks is similar to the trend for all banks. Aggregate small business loans at large banks shrank between June 30, 2008, and June, 30, 2009, at a steeper rate from then until June 30, 2010, and more slowly over the four quarters to June 30, 2011 (Figure 1). At those large banks, the rate of contraction moderated for small CRE loans and especially for small C&I loans. The moderation in C&I contraction since mid-2010 is consistent with the results of the Federal Reserve’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices, which gathers data from approximately 60 large domestic banks plus some U.S. branches and agencies of foreign banks. The July 2010 survey was the first to show an easing of standards on C&I loans to smaller businesses since late 2006 (Federal Reserve Board 2010). But, whether positive growth in small C&I loans at large banks will soon occur and be sustained may depend on small business loan demand. The National Federation of Independent Business reports that about 25% of the small businesses it surveys cite poor sales as their main business problem. In contrast, only 3% cite financing as their main business problem, although 8% report that not all of their credit needs are satisfied (Dunkelberg and Wade 2011). It appears that a key variable for banks, small banks in particular, is whether small business loans are backed by commercial real estate or not. Those loans not backed by real estate are looking more promising. Read Recent Trends in Small Business Lending here .

  • SF Fed Economic Letter: Boomer Retirement and the Equity Markets

    The oldest members of the baby boomer generation are turning 65 this year--the official retirement age. Not exactly the best time for a lot of new retirees to start selling off equities. In a new Economic Letter , Zheng Liu and Mark Spiegel of the San Francisco Fed 's Economic Research Department point out that "U.S. equity values have been closely related to demographic trends in the past half century." And that is cause for a little worry: Since an individual’s financial needs and attitudes toward risk change over the life cycle, the aging of the baby boomers and the broader shift of age distribution in the population should have implications for capital markets (Abel 2001, 2003; Brooks 2002). Indeed, some studies attribute the sustained asset market booms in the 1980s and 1990s to the fact that baby boomers were entering their middle ages, the prime period for accumulating financial assets (Bakshi and Chen 1994). However, several factors may mitigate the effects of this demographic shift. First, demographic trends are predictable and rational agents should anticipate the impact of these changes on asset demand. Consequently, current asset prices should reflect the anticipated effects of demographic changes. In addition, retired individuals may continue to hold equities to leave to their heirs and as a source of wealth to finance consumption in case they live longer than expected (e.g., Poterba 2001). Foreign demand for U.S. equities might also reduce the downward pressure on asset prices. However, the effect is probably limited for two reasons. First, other developed nations have populations that are aging even more rapidly than the U.S. population (Krueger and Ludwig, 2007). Second, there is substantial evidence of home bias in equity holdings. Individual investors typically hold disproportionate shares of domestic assets in their portfolios. For example, in 2009, the foreign equity holdings of U.S. investors were only 27.2% of the share of foreign equities in global market capitalization. While the low level of international equity diversification is still not well understood (Obstfeld and Rogoff 2001), it suggests that foreign demand for U.S. equities is unlikely to offset price declines resulting from a sell-off by U.S. nationals. Read Boomer Retirement: Headwinds for U.S. Equity Markets? here .

  • SF Fed Economic Letter: Impact of Energy Costs on Consumers' Inflation Expectations

    The latest Thomson Reuters/University of Michigan consumer survey shows that American households are becoming more wary of inflation. While the survey showed consumers' anticipating 3% inflation back in December, now they are expecting inflation to average 4.5%. Bharat Trehan , a research advisor at the Federal Reserve Bank of San Francisco , warns us not to put too much stock in this forecast (largely because of how energy prices affect inflation expectations). He shares the following graph in an Economic Letter for the San Francisco Fed: Trehan explains: Figure 2 shows the results of a regression, a statistical exercise that allows us to estimate how much attention consumers pay to recent core and noncore inflation in setting their inflation expectations for the year ahead. Importantly, the statistical procedure allows for the possibility that the amount of attention consumers pay to either measure of inflation can vary over time. The black line in the top panel of Figure 2 plots the estimated response of household inflation expectations to recent core inflation. To take one example, the estimate for the fourth quarter of 2000 shows that, if recent core inflation had been one percentage point higher than it was, households would have expected 0.4 percentage point more inflation over 2001. As the figure indicates, the estimated response of consumer expectations to core inflation was unchanged for much of the subsequent decade, though it did rise a bit in 2007 and 2008. Perhaps more noticeable is the decline since 2008, which brought the black line to about 0.1 by the first quarter of 2011, the end of our sample. The two blue lines are error bands that provide a measure of the uncertainty around the estimated response. Two-thirds of the time, the true response should lie between the blue lines. The lower blue line fell below zero beginning in 2010. Once the lower blue line falls below zero, statistically speaking we can no longer distinguish the estimated response from zero. In other words, we can no longer be sure that households are paying attention to the core inflation rate when forming inflation expectations. The bottom panel of Figure 2 presents the relationship between household inflation expectations and noncore inflation. Household response to noncore inflation seems more variable than household response to core inflation. It is high at the beginning of the sample and falls toward the middle. In the past few years, household expectations seem to have become more sensitive to noncore inflation-at about the same time that household sensitivity to core inflation has gone down. Read Household Inflation Expectations and the Price of Oil:
It's Déjà Vu All Over Again here .

  • SF Fed President: Inflation Will Peak in Middle of 2011

    Commodity prices have been rising, and this has raised some concern about rising inflation across the board. Speaking last week in Los Angeles, John C. Williams , CEO of the Federal Reserve Bank of San Francisco , gave his prognosis on inflation. In short, he expects inflation to peak in the coming months, and then "return to an annual level of about 1¼ to 1½%." Williams: There are several reasons for thinking the inflation bulge will be short-lived. First, commodity prices are not likely to keep increasing indefinitely at a rapid rate. Indeed, in recent weeks, prices for a number of commodities, including sugar and cotton, have fallen sharply. In addition, the prices of contracts for certain key commodities in the futures markets, such as crude oil, indicate that traders believe these prices won’t keep rising at double-digit rates. For example, the numerous supply disruptions that have pushed up prices of some foodstuffs, such as poor harvests in Russia and China, are not likely to be repeated. So even if commodity prices remain elevated, they won’t keep pushing up inflation. A second reason for believing that inflation will peak and then trend down is that higher commodity prices generally represent only a small proportion of the cost of the finished goods American consumers buy. For example, corn and sugar make up only a fraction of the cost of a box of Frosted Flakes. Most of the cost comes from the labor involved in manufacturing, distributing, and selling the breakfast cereal, including paying for air time for Tony the Tiger. This means that large percentage increases in commodity prices typically translate into relatively small percentage increases in consumer prices. Of course, some goods, such as gasoline, have very high commodity input shares. But, in today’s economy, these are more the exception than the rule. The stability of longer-term inflation expectations is a third factor that leads me to expect that inflation will start to ease later this year. It’s true that surveys show that consumers expect moderately high inflation over the next year. Households see gasoline prices going up and up and up, and, not surprisingly, they get worried about near-term inflation prospects. But medium-term measures of inflation expectations have barely budged. In other words, ordinary Americans agree that we are seeing a transitory rise in inflation. Those survey results reflect the fact that inflation has remained low and relatively steady for several decades and that the public believes the Fed is committed to keeping inflation under control. As long as household, business, and investor inflation expectations remain stable, then it’s unlikely that an inflationary dynamic will become established or that underlying inflation will jump sharply. Read the full speech here .
1 2 Next >