Brad DeLong's Semi-Daily Journal (2004)

http://www.cbpp.org/1-28-04bud.htm

The new CBO ten-year projections understate the likely size of future deficits because they do not reflect the costs of continuing various policies currently in effect; for example, the CBO baseline assumes that all of the tax cuts enacted since 2001 will expire. The baseline also assumes that relief from the Alternative Minimum Tax will end, and the number of tax filers subject to the AMT will rise from three million today to 29 million by 2010.

The new CBO report projects deficits totaling $1.9 trillion over the ten-year period from 2005 through 2014. A more realistic assessment — one that uses CBO estimates but incorporates likely or inevitable costs, following the same methodology that was used in the September 2003 report by the Committee on Economic Development, Concord Coalition, and the Center on Budget and Policy Priorities — shows a ten-year deficit of $5.2 trillion.

Under these assumptions, the national debt climbs from $4.0 trillion today to $9.7 trillion by the end of 2014 (reflecting the $5.2 trillion in deficits for the 2005 – 2014 period, plus the nearly $500 billion deficit in 2004). Debt rises from 33 percent of Gross Domestic Product in 2001 to 54 percent of GDP by 2014.

Under the more realistic assessment, the deficit exceeds $400 billion in every year and stands at about $477 billion in 2009, the year in which the President has said that the deficit would be cut in half. The $477 billion figure is essentially identical to the projected 2004 deficit, indicating little progress toward the Administration’s goal of halving the deficit. Furthermore, by 2014, under these more realistic assumptions, the deficit reaches $708 billion.

The data show that the large deficits projected for the coming decade are more a reflection of a historically low level of revenues, measured as a share of the economy, than of an unusually high level of federal spending. In 2004, revenues will total only 15.8 percent of GDP under current law, the lowest level since 1950. Although revenues will rise as the economy recovers from the recession, they still will average only 17.1 percent of GDP over the coming decade (2005 through 2014), assuming the recent tax cuts are extended and AMT relief is continued. That is below the average levels for every decade in the second half of the 20th century.

Where were all the fine federal reserve economists when we set about squandering a wonderful surplus? Remember when Alan Greenspan was fretting about the possibility that the federal debt might actually be paid off this decade? Fret no longer.

Speaking of communication (as Mr. Ferguson did at this week's meeting - let's hope it helped), is the Fed communicating that Bernanke was wrong? Bernanke said that inflation was too low and on a trend lower. The FOMC found that the inflation risk was nearing balance. Bernanke said the labor market is weaker than the jobless rate suggests. The FOMC said the labor market may be stronger than the jobs tally suggests. Changes to the statement were the most substantial since May, when the two-part risk statement was adopted. This after an extended period of Fed officials sounding pretty happy with the assumption that rates were on hold all year (the Fed funds strip is now pricing in good odds of a June hike).

Is the Fed communicating that the NYT is wrong? The Times argued today (quoting Meyer along the way) that the Fed is unlikely to hike rates in a presidential election year. If growth risks are balanced, inflation risks nearly balanced and the funds rate far from neutral, and the labor market maybe not in such bad shape, shouldn't the Fed be thinking about hiking rates pretty soon?

Anne,
I've always enjoyed your insight on the issues here. I hope this isn't off topic, but I'd like to hear your thoughts on the following:

I work in the commercial construction industry supplying products and labor that rely primarily on steel. Since the tarrifs on steel have been lifted, our company has been notified by virtually all of our suppliers that pricing will be increasing by 4 to 8% in the next month. Some suppliers have indicated that we should expect 4% increases monthly, for the next 3 to 6 months.
Not one of these suppliers have cited increased demand for product as a reason for the price increases. The most prevelant reason cited is that the weak dollar is the culprit. If true, will other sectors of the domestic economy start seeing upward pressure on the cost of finished goods, and what will the inflationary impications be for the "recovery"?

I was wondering why the dollar rose $0.015 against the Euro in a few hours.

I think that this was not an "inflation" thing, but a "prop up the dollar" thing.

What part of the Fed's message isn't getting through? They will have to begin tightening at some point, and the stronger economic performance becomes, the sooner that day will arrive. I don't see what the Fed can possibly do to smooth the transition; banks that are heavily invested in bonds as a way of profiting from the yield curve will dump them the minute the short end starts going up. The only way to be first out the door is to anticipate that moment, and that means that every changed nuance in the Fed's pronouncements will trigger this kind of reaction.

I think the Fed saw the markets (bond, stock, currency) becoming complacent on the assumption that rate increases were so far away that they didn't need to worry about them now. It might yet turn out to be a long time before a rate increase, but now we can get away fom the silliness that the Fed can guarantee what it will be thinking half a year from now.

Points to both Dave L and snsterling. Curve trades that haven't been undone when rate hikes start are a Greenspan nightmare. He once provoked a 75 bp one-day rise in bond rates with a 25 bp hike in the funds rate - and then things just kept getting worse in days after. This all happened after Greenspan did what he reportedly described as "everything short of jumping up and down on the table" to signal that rates had to go up. The notion that the Fed can predict much beyond 6 weeks troubles some Fed members - they do have meetings very 6 weeks, after all.

At least some of the ambiguity has to be deliberate -- the last thing the Fed wants, even when sending what it hopes will be unambiguous signals, is to strip the Delphic cloak away entirely. They have to reckon that they get enough recrimination from not doing what people want, much less from not doing what they say they're going to do...

I think some folks are overreacting to Fed Press Release.

Even before the language was changed, it was pretty widely understood that the Fed was very uncomfortable with its impicit commitment to maintain a certain funds rate for any period of TIME, even if that period was vaguely defined. It was also widely understood that the Fed would eventually drop that commitment and perhaps replace it with a clearer statement of the economic conditions under which it might begin to renormalize rates. The ambiguity around the second part reflected that not everyone on the FOMC was (or is) in favor of such clarity. For example, Bernanke favors clarity while Greenspan does not (although the latter won't admit it).

Accordingly, the question around "considerable period" was, when would the Fed be willing to pay the price (measured in higher term interest rates) that accompany adopting more sensible language? Almost everyone in the markets thought that they would not be willing to pay that price quite yet because inflation is still falling and the labor market has been far weaker than the Fed desires (minor measurement controversies aside). Therefore, the Fed's replacement of "considerable period" with "patience" communicates that they are now more confident in the economic outlook and/or in their ability to manage the back-up of term interest rates triggered by the language change.

But does it tell us that the Fed is getting ready to raise interest rates, say, within the next six months? I don't think so. The conditions for a Fed rate hike are not currently in place. Nor are they likely to be in place within the next 6 months. Obviously, we can debate about whether my speculation about the conditions is correct. But there is nothing in the Press Release to suggest that the Fed's own assessment of this issue has changed. After all, the risks around growth are even, which means that they do not see the output gap closing (quickly). And the inflation tilt is still marginally downward, even though the core deflator is currently running at 0.5 or 0.6%, which is far below the Fed's comfort zone.

The difference between "patience" and "considerable period" is not semantics. Considerable period clearly refers to time, whereas one may "patient" with some sort of CONDITION or PROCESS. For example, I think the Fed will patiently await much stronger labor market conditions and an upturn of measured inflation. Otherwise, there is some -- admittedly small -- risk that members of the FOMC go down in history.

Tony -- I would like to respond to your comments.

The key point about the dollar is that it is a two
step process. A drop in the dollar by itself has no impact on trade. The second, and necessary step before the trade flows can change is a change in relative prices. US products can not start replacing foreign products until relative prices change. At the old price US producers are unable to profitably supply the goods. What you are now seeing is the price hike needed before US producers can displace foreign goods. Before the
weak dollar can lead to weaker imports we have to see a significant rise in domestic prices. If you look at the PPI this is happening. AT every stage of production -- crude, intermediate, and finished -- the core PPI is starting to show significant price increases across the board just like what you are seeing in your industry.

The key question is when does this start showing up in the CPI or PCE deflator. Part of the problem is about 60% of the CPI reflects things that are not in the PPI like medical care, tutition, other services.

Historically, one of the most reliable leading indicators of fed policy is the core intermediate PPI and it along with many other indicators implies that the Fed should already be raising rates. A Taylor type rule implies that fed funds should never have fallen below 3%. What we seem to be seeing is a policy argument among fed officials. Bernauke represents one side of the argument. He believes the economy has massive excess capacity and the danger of deflation is still very real. he would oppose rate increases. Other, probably including Greenspan think we are seeing a more normal economic cycle and would tend to agree that fed funds are now lower than they should be. They cut rates to 1% because they believed the "risk" of deflation justified
an extremely aggressive easing that cut rates about 200 points below where they should have been. They now see the risk of deflation as much lower and are concerned now that they were too agressive last year because of the risk of deflation. They are thinking that they may have to take back the extra 200 basis point cut in rates they implemented last year. If we continue to see the change in relative prices that Tony is seeing in his business the Fed could raise rates much sooner than wall street expects. I have no particular insight as to when the fed will start raising rates. But, I suspect that when they do the street will go back to talking about only one increase. However, I suspect that once the fed starts to act they will implement a series of increases much faster and much bigger than expected.

Maybe the new language referencing "patience" is aimed partly at curbing "irrational exuberance" in the equity markets. Why not?

But at any rate, the Fed has a lot of rate reductions to take back, and this is a pretty gentle way to start the job. Probably about time.

Gerard,

OK, not to pick nits or anything, but what you've described is a semantic difference. Semantics is about meaning. Expressions like "oh, that's just semantics" stands the meaning of semantic on its head.

Beyond that, there were more changes to the FOMC statement than just the "considerable period" phrase that the press with which the press has been so obsessed. The discription of labor market conditions also turned more optimistic, and in a way not well advertised in Fed comments ahead of the meeting. The "other indicators suggest improvement in the labor market" bit suggests that a majority on the Board are willing to entertain the possibilty that the establishments survey is wrong, that the labor market is stronger than the establishments job tally suggests. This is just the opposite reading than that given by Fed Governor Bernanke on January 4, when he told us the labor market may be weaker than the jobless rate suggests. Bernanke's comments were taken to heart in the debt market. Beginning on January 5, there was a two-week rally in the Treasury market, fostered in part by the rotten establishments survey reading on job growth in December, which seemed to confirm Bernanke's view. Bernanke also highlighted the labor market as important to medium term monetary policy - as have other Fed officials. If Fed policy will be based more on the jobless rate and jobless claims (the "other indicators" and less on the establishments tally of job growth, then the labor market is less of an impediment to rate hikes than we thought. As to your 6-month window, yes, we can argue about that. I tend to agree with that timetable, but it is the unwillingness of Fed officials to commit to anything much past 6 weeks which led some of them to object to the "considerable period" phrase. If they aren't sure, we shouldn't be either. More immportantly, for the coupon curve and stocks, it is not an issue of a rate hike within 6 months or not. It is an issue of sooner than expected or not. Holding a 5-year note or discounting a stream of earnings over a period or years requires assessing financing costs over longer than 6 months.

"Complex verbal strategies"? Hmmn

Tony Daniel:

Since the tarrifs on steel have been lifted, our company has been notified by virtually all of our suppliers that pricing will be increasing by 4 to 8% in the next month.... Not one of these suppliers have cited increased demand for product as a reason for the price increases. The most prevelant reason cited is that the weak dollar is the culprit. If true, will other sectors of the domestic economy start seeing upward pressure on the cost of finished goods, and what will the inflationary impications be for the "recovery"?

Important example and question. Today, I will look at numbers and think about the issue.

Anne

My personal homepage.

Chris Smith o