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Transcript
CPI Inflation Gauge
(Measure of price inflation in retail goods and services)
Web address: www.bls.gov/cpi/
No monthly revision, annual revision in February.
CPI:
Inflation affects the following activities
Costs of doing business
Investment decisions
Retirees quality of life
Labor contracts & rental contracts
Government macroeconomic policy
Social security benefits, food stamps, alimony, child support payments
CPI is an index number which leads to a historical perspective of inflation.
(1982-84 =100)
Inflation Explanations:
Monetarist View – excessive money supply growth. Too many dollars, chasing to few goods. If DM/M > DY/Y
then DP/P > 0
Keynesian View – AD > AS => shortage =>  Prices
inflation is a function of the state of the business cycle and level of production slack/idle capacity/resource scarcity
Core-CPI - best measure of underlying inflation
2 Population Groups:
CPI-W (wage earners & clerical workers) 32% of population
benchmark for pay increases in collective bargaining agreements and for yearly cost-of-living adjustments on social
security checks.
CPI-U (all urban workers)
CPI Inflation Gauge
(Measure of price inflation in retail goods and services)
Deflationary Spiral:

prices =>  corporate profits => job layoffs =>  household income =>  consumption spending =>  inventories => 
prices
Forecasting Tool:
Business can anticipate future technology and medical costs
Investors can reassess investment strategies
Union leaders use inflation forecasts in pay negotiations
CPI is a lagging economic indicator
6 Other Price Gauges:
PCE, Producer Prices, Import Prices, Employment Cost Index, Unit Labor Costs,
GDP deflator.
---------------------------------------------------------------------------------------------------------
Unexpected increase in inflation
Bond Market:
 bond demand =>  bond price =>  nominal interest rates
Stock Market:
 nominal interest rates => borrowing costs =>  profits=>  stock prices
Federal Reserve  nominal interest rates =>  borrowing costs =>  profits =>  stock prices
Firms prefer an increase in output rather than an increase in prices to boost revenues
FX Market:
AD > AS => unexpected inflation
 Y =>  r =>  exchange rate (good investment environment)
 DP/P =>  i =>  exchange rate (erodes dollar-based investments held by foreigners)
Inflation (CPI)
(year over year % growth)
6%
Hoarding money => deflation
Austerity => stagnation/deflation
Deflation => rising purchase power of dollar
Deflation => lower wages => rising debt burden
5%
4%
3%
2%
1%
0%
95
-1%
-2%
96
97
98
99
00
01
Deflation leads to:
•Households postpone spending
•Rising real interest rates
•Rising debt burdens
-3%
Headline
Core (excludes food and energy)
02
03
04
05
06
07
Deflation can lead to:
Falling goods & services prices
Falling home prices
Falling stock prices
Falling wages
08
09
10
11
12
13
Phillips Curve:
•
Shows short-run inverse relationship between the
DP/P and U.R.
Not a structural economic relationship
•
•
•
Not a permanent long-run tradeoff
•
•
Basic behavioral relationship that remains unchanged over
long periods
Long-run Phillips Curve is vertical
Not a reliable menu of DP/P and U.R. combinations
in the long run.
Quantitative Easing 2
(Fed creating money to purchase assets)
QE1 2009-2010: Fed bought $1.75 Trillion MBS and Treasury Securities
QE-2 Cost/Benefit Analysis
What are the tradeoffs?
Quantitative Easing 2
QE-2
(11/3/10)
Fed’s statutory mandate – foster maximum employment and
price stability
1. Fed will purchase a further $600 billion of longer-term
Treasury securities for the System Open Market Account
(SOMA) by June 2011.
2. The open market trading desk will continue to reinvest
principle payments from agency debt and agency MBS
($300 billion over next 8 months)
QE2 Benefits
QE2 Financial Effects:
1.
Lower nominal interest rates (Treasury, corporate, mortgage) if the fall in real
interest rates exceeds the rise in inflation expectations.
Nominal interest rates = real interest rates + inflation expectations.
2.
3.
4.
5.
Lower real interest rates
Lower dollar exchange rate
Higher stock prices
Higher inflation expectations
QE2 Benefits
QE2 Real Economy Effects
1.
Additional 2011 economic growth of 0.6%
2.
Additional 2011 job growth of 500,000
3.
Lower 2011 unemployment rate by 0.4 percentage points
4.
Debt refinancings will lower debt burdens and repair households and firms balance sheets
5.
Rising exports
6.
Chase investors into riskier assets
7.
Higher stock prices will encourage additional business capital expenditures and hirings
8.
Higher stock prices will boost household net worth, reducing savings rates and boosting consumption spending
9.
Lower corporate risk premium => increase capital formation => job creation
10. Rising inflation => rising nominal returns on investment
11. Rising inflation expectations => boost consumption spending today at the expense of future consumption
12. Rising inflation expectations => falling real interest rates => rising consumer spending and business investment
QE2 Costs/Risks
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
May send signal to investors the Fed is panicking
The Fed is “pushing on a string” as demonstrated by the large holdings of excess reserves
Fed is monetizing the additional Treasury debt through June 2011
Low U.S. yields will chase capital abroad, appreciate foreign currencies, create global
economic distortions. For example, asset price bubbles and excess accumulation of reserves.
QE2 will not significantly lower nominal interest rates: lower real interest rates will be offset by
higher inflation expectations.
Falling dollar will decrease the Chinese Yuan because of its peg.
Low interest rates are suppose to mobilize resources, but it could misallocate resources.
Low interest rates may boost the economy today, only to collapse it tomorrow.
Low interest rates subsidize borrowers at the expense of savers.
Competitive Quantitative Easing – Countries competing by printing more money to reduce
exchange rates. This is inherently unstable. Someone must lose share of world trade at expense
of others who gain share.
Trade Wars – Boosting export strategy can turn into blocking imports policy
Gold bubble
QE-2 won’t work because households and firms are repairing and deleveraging their balance
sheets.
Firm’s cash stock piles are at record levels
Fed’s determination to avoid deflation could actually cause deflation: ELEP is a sign the Fed
expects underemployed resources for an “extended period” => private sector pessimism =>
business expect investments to fail and households expect falling prices => cash hoarding =>
weak economy => deflation.
Monetary policy options to prevent deflation and increase inflation expectations
1. Quantitative easing: print money to buy long-term government debt
2. Buy private-sector debt
3. Change expectations by announcing it will keep short-term rates low
for a long time
4. Raise its long-run inflation target
(encourage borrowing, discourage cash hoarding)
5. Reduce the interest rate paid on excess reserves.
6. Move from inflation targeting (rate of change) to price level targeting
Anticipated inflation is expected and built into planning
Unanticipated inflation is unexpected and disrupts planning
•Alters expected outcome of long-term projects
•Reduces long-term investment
•Distorts the information in prices – reduces the effectiveness of markets
•Results in actions based on price anticipation, instead of production
Consumer Confidence/Sentiment Index
(Real Time Measures of Consumers Attitudes on Economy, Personal Finance, and Future Spending)
Web: http://www.conference-board.org/economics/consumerConfidence.cfm
Web: http://www.sca.isr.umich.edu/main.php
Minor revisions
Happy consumers are good for business so index is useful for predicting consumer spending. Unfortunately, the
relationship between confidence index and spending is not a close one.
Difficult to predict how humans will behave. Sales are the best method of measuring consumer confidence.
A six month moving average of confidence is a better indicator of future household outlays.
Index is important during economic turning points. Better at forecasting recessions than recoveries.
Consumer confidence Index polls 5,000 new households, the survey has 5 questions with emphasis on labor
market conditions - which can lag the economy
Consumer Sentiment Index polls 500 new and continuing households (the rotating interview strategy is 60%
new and 40% second time interviews => less erratic index), 50 questions with emphasis on financial and
personal income expectations which is a driving force behind consumer spending => better leading indicator.
------------------------------------------------------------------------------------------------------------------------------------------------
Market Analysis:
Bonds:  Confidence =>  borrowing/spending =>  DP/P =>  DBonds =>  iBonds
Stocks:  Confidence =>  borrowing/spending =>  DY/Y =>  profits =>  PStocks
Dollar:  Confidence =>  borrowing/spending =>  DY/Y =>  iBonds =>  dollar
150
Consumer Confidence &
Sentiment Index
150
140
140
130
130
120
120
110
110
100
100
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
Recession
Confidence
10
Sentiment
0
95
96
97
98
99
00
01
02
Source: Conf erence Board & University of Michigan
0
03
04
05
06
07
08
09
10
11
12
13