Semi-Daily Journal

I would wager that the Economist hasn't been looking at a map recently, as they might otherwise have noticed that there are other countries in the euro area besides Germany.

Also note that "large devaluations" is not exactly an option for curing a global deflation, and that the Economist is inventing an econoic theory of its own when it claims that "as in Japan, there is then a risk that money is channelled into politically favoured projects with low returns" is a serious objection to the *cyclical* effectiveness of public spending.

Finally, we get a paragraph that effectively says: "Japan is in deflation, the USA is on the brink of deflation and the Euro zone is some way away from deflation but might be dragged into it by Japan and the USA. Aren't the ECB fools?".

Why do you keep reading the Economist, Brad? It knocks about ten points off your economic intelligence.

"large devaluations followed by pegged exchange rates, inflation targeting, or the two-handed approach of large government deficits financed by printing money: either the fiscal side or the monetary side should be effective...."

The problem with large deflations, as we're seeing with the dollar now, is that one man's meat is another's poison. Solving the US problem by sending Germany to a dark and horrible place is no solution, and this needs to be said clearly.

In this sense this weekend's G7 finance meeting is critically important. It's here that the whole Bush strategic vision needs to be reversed, in a global world there is no go-it-alone solution available. But here also is the danger: my fear is that the very shock which Stephen Roach so fears could come from a realisation that money has no safe haven, that a frantic chase from dollar to euro to yen and back again serves no known purpose. In a world swimming in money, this could be very grave indeed.

Inflation targeting: this is all about 'expectations', and convincing people you can do it, I mean, I'm not convinced and I fear there may be others. Looking at Japan, what we may well be in is a 'credibility trap'.

On the deficit, this is back to Gauti Eggerston, and 'commiting to being irresponsible'. Isn't that just what the Bush set are doing. Is this convincing people? Not if I read this column aright it isn't. Pumping up the deficit as Japan and Europe already know, and the US is discovering, only pushes you closer up against the hard rock of the underlying demographic reality.

We need to have a view which looks beyond short run business cycle dynamics on this.

Hi Daniel,

Our stars for once are in harmony since we were both posting together.

I see we agree for once about devaluations being a non-starter (oh, goddam, we just lost the 'foolproof path').

Now if you have a map of Europe handy, I suggest you get a crayon and start colouring in. Immediate danger: Germany AND Italy (I'm non-commital on Belgium, but they need to be borne in mind). Knock-on victims: Portugal, Greece and Spain. Next wave group: Portugal, Hungary, Czech Republic, Latvia, Estonia, Lithuania........

How do I 'know': just check out the population numbers.

The UK: how long can the housing 'thing' keep running?

Is the US really on the brink of deflation? As reported in the Wall Street Journal, we seem to have inflation in many of the things people commonly buy such as medical care, college tuition, insurance, utilities and automobiles. My personal experience certainly bears that out. Note that the Bureau of Labor Statistics does not include sales, income or property taxes in its market basket of goods and services. Increases in the price of residential real estate are not included either. Evidently, BLS thinks rents are a surrogate for home prices. That’s certainly not true in San Francisco or Berkeley where rents are controlled. So I would think the SF Bay Area CPI really under estimates the cost of living here. There has also been an increasing gap between rents and home prices nationwide as people buy real estate for investment purposes. Then there are the quality adjustments BLS makes, a fertile area for BLS statisticians to do a little fiddling. No doubt, there is some economic theory as to why tax increases are not part of the CPI. The federal government has every incentive to keep the CPI down as many items are indexed to it, like TIP bonds.

"The problem with large deflations..."

I meant, of course, large DEVALUATIONS.......

The type of deflation we might expect, far from being large, is more likely to be Japan stlye "slow drip".

>>On the deficit, this is back to Gauti Eggerston, and 'commiting to being irresponsible'. Isn't that just what the Bush set are doing. Is this convincing people?

But committing to irresponsibility only works if you can convince people that the debt will eventually be monetised. And that's not going to happen while Greenspan is in place. For this strategy to work, Bush ought to have replaced AG with a political placeman or something. The current situation is likely to have a perverse effect, as every jump up in the deficit makes people more sure that AG will eventually have to raise rates hard.

"I would wager that the Economist hasn't been looking at a map recently, as they might otherwise have noticed that there are other countries in the euro area besides Germany."

The German economy is about a third of the Eurozone economy so it is apt to affect activity levels elsewhere in the zone which, overall, is only a little more open to the rest of the world than the US economy is. Besides:

"Figures released yesterday by Eurostat, Europe’s official statistics agency, showed that GDP in the eurozone failed to grow at all in this year’s first three months. Germany’s economy contracted by 0.2 per cent and the Italian economy by 0.1 per cent. The Netherlands fell into outright recession as activity shrank by 0.3 per cent." - from: http://www.timesonline.co.uk/article/0,,5-681984,00.html

"The German, Dutch and Italian economies - accounting for more than half of eurozone economic activity - all shuddered to a halt in the first quarter, official figures showed today." - from: http://www.guardian.co.uk/germany/article/0,2763,956579,00.html

Hourly labour compensation costs of production workers in manufacturing in Germany at prevailing exchange rates were out of sync with those of its main trading partners even before appreciation of the Euro against the US Dollar and the UK Pound - see Chart 2 in: http://www.bls.gov/fls/flsichcc.pdf

I am a bit … what is it? … mystified, confused … The Economist worries that public investments may be politically motivated, so have low returns. Is return on investment really the first priority when crafting a stimulus policy? As a secondary concern, yes, I can see it. If you can have cake and ice cream too, that’s nice. Point is, the Economist already more or less came down on the side of higher government spending, as more likely to be unambiguously stimulative (no risk the fiscal stimulus will be saved, so prove non-stimulative). With that firmly in mind, let’s worry about return on investment as an afterthought.

Speaking of returns on public investment, don’t we have a notoriously undermaintained bunch of bridges in our state and federal highway systems?

Bernanke’s view that monetary policy, correctly crafted, will always be enough is dandy, except that picking his view over coordinated fiscal and monetary policy carries the risk he could be wrong. A short-term fiscal stimulus has a cost, but does that cost really outweigh the risk that monetary policy alone might fail?

Not to defend the Economist too vigorously, but I had the impression that mentioning devaluation and pegging was mostly just to have a complete catalog of current policy prescriptions. I didn't have the impression the Economist was actually advocating the "foolproof" path.

Bob: You know the difference between recession and deflation, I know the difference between recession and deflation, so let's try not to confuse anybody else, shall we now?

K Harris: On stimulus programs, you are quite right. On devaluation, the Economist is not worth defending; it's not even mathematically possible for all the major economies of the world to devalue relative to each other.

Dsquared: "The current situation is likely to have a perverse effect, as every jump up in the deficit makes people more sure that AG will eventually have to raise rates hard."

That doesn't seem to be happening, as long-term corporate and treasury rates in fact declined sharply after the most recent Fed meeting. What's your read on this market reaction? Is the market making a mistake?

Just a correction: Deflation makes it impossible for real interst rates to fall below the rate of deflation (and, a fortiori, below zero). It's not just negative real interest rates -- as the Economist claims -- that deflation rules out, but any real interst rate less than the rate of deflation.

>>That doesn't seem to be happening, as long-term corporate and treasury rates in fact declined sharply after the most recent Fed meeting. What's your read on this market reaction? Is the market making a mistake?

It's a recursive I-think-you-think game; the fact that nobody believes that the Bush deficits will be allowed to lead to inflation means that they expect deflation, which means that long rates fall. The idea is that over the next ten years, any incipient inflation will be choked off by immediate sharp rate rises, which throw the economy into recession meaning that rates come down again. So the average level of rates over the next ten years will be lower.

Naïve question: in what sense are negative interest rates impossible? I see that it's politically impossible, but what prevents the banks from saying "OK, we'll keep your money safe for a year and charge you 2% for the privilege."?

Ankh-Morpork would.

And, continuing naïve, wouldn't that increase the urge of many people to find something useful to invest in directly? (I realize I may be misusing 'direct investment' here.)

Clew,

I believe that negative interest would be money that is paid to the borrower by the lender. Your case is a particular option, and it exists.

DSW

Clew is on to a point here, but it rather begs the broader question as to whether deflation is simply a monetary phenomenon.

Technologically there could be some practical solution to the 'no-negative-interest' trap, like issuing notes which are bar coded and lose value according to an leapsed-time-between-transactions function. Electronic money can be similarly punished for standing still.

The problem is that this can cause a flight into alterantive assets like property or gold, which may produce bubbles with equally undesireable consequences.

The problem is to address the consumption-expectations-investment dynamic, and why the process may have sprung the 'leak' which produces the now-famous liquidity ('viscosity') trap. The root-of-all-evil here may not, in fact, be money.

"Naïve question: in what sense are negative interest rates impossible?"

Negative rates have in fact appeared in Japan, though only on a small scale and for brief periods as of yet. IIRC negative rates also appeared briefly in the US during the deflationary period of the Depression.