Fed Puts Macho Bada$$ery At Risk

Rational nerdiness vs macho bada$$ery in monetary policy by Cardiff Garcia @ FT Alphaville

The US economy has had several false starts since 2009, and it’s likely that several tangled factors were responsible for their not lasting longer. It’s reasonable to think that one of these factors was that the initial reflationary effects of these unconventional measures faded, because of doubts about the Fed’s commitment to maintaining accomodative policy during a period of catch-up growth. If such growth threatened to generate above-target inflation, then monetary conditions could be expected to tighten.

The rational-nerdy thing to do was to soften the macho commitment to inflation and commit to a temporary period of inflation-tolerance, thereby balancing the two sides of the mandate — but to do so while retaining credibility on both. But as Harless notes, ceding a little ground on one side could be interpreted as ceding all ground. Being a “macho badass” central banker means credibly committing to never cede ground.

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All of which has been a long windup to saying that the appeal of the Evans Rule, and if we ever get it, some variation of NGDP level targeting, is this: they institutionalise the macho badassery, which in a dual-mandate framework can only be applied to one of the two mandates.

Woj’s Thoughts - This post is reminiscent of a thread from last year involving Steve Roth and Ryan Avent on The Asymmetric Nature of Monetary Policy. In that post I made the following claim:

Whereas Roth suggests that asymmetric credibility stems from the Fed’s actions, I believe it is actually an inherent condition in our current monetary system. The Fed sets the base price for money and credit, but with private banks free to create credit, it holds relatively little control over the total amount outstanding at any time. As growth in the US has exceeded inflation for much of the past three decades, the conditions were ripe for borrowing and credit outstanding now greatly surpasses the sum of base money.

Even if the Fed promised indefinite QE, it’s hard to see the mechanism, aside from adjusting inflation expectations (wealth effects are minimal), by which this would spur real growth. Given the Fed’s skewed abilities and determination to maintain its credibility, it seems more obvious why inflation targeting remains prominent. Further, this may help explain why the Fed downplays its employment mandate (which should be removed anyways). Facing the endgame, the Fed knows it can reduce inflation (and growth) but remains unsure how successful it could be at achieving other targets.

Sucumbing to pressure, the Fed has finally decided to cede ground on its commitment to inflation. Unfortunately for the Fed, both inflation expectations and unemployment are not cooperating:


At this point I doubt whether even altering inflation expectations would provide any boost to actual inflation or employment. If fiscal policy continues to contract the budget deficit, these numbers will continue moving in the wrong direction. The Fed has taken a big risk with its established credibility. I fear the results will be very disappointing.

(Late) 2013 Predictions

Last year I took a chance and threw my own projections into the ring. Similar to Byron Wien and Edward Harrison, I mostly selected events that were widely seen as having a low probability (less than 33%) but which I believed held a greater than 50% chance of occurring. The final results were a bit disappointing, but that won’t stop me from trying again this year. Since these predictions already represent a late release, without further adieu, here are the 2013 predictions:

1) Spain requests access to ECB’s OMT - Since ECB President Mario Draghi announced the OMT program, yields on Spanish debt have fallen rather dramatically. Although this eases financing pressure, it has done little to alter the actual economy’s downward spiral. During 2012 Spain’s GDP growth became increasingly negative, falling by 1.8% year-on-year in the fourth quarter. Meanwhile unemployment continues its meteoric rise to over 26% for the general population and nearly 60% for youth. With the large banks still severely undercapitalized and households over-indebted, private sector lending continues to decline:

Seeing no recovery and potentially a worsening decline, “bond vigilantes” will eventually test Draghi’s threat. At that point Spain will be forced to accept a Memorandum of Understanding (MoU) in return for ECB bond-buying through the OMT program.

2) The Euro finishes the year above $1.30 - After falling nearly 10% during the first half of 2012, the euro has more than recouped its losses on the back of optimism and deflationary policies.

At points during 2013 the optimism is likely to fade, but I expect politicians and central bankers will take the necessary steps to quell fears for the time being. Unfortunately those steps will involve further deflationary policies that push the euro higher. These competing forces will largely cancel out, leaving the euro close to or above where it began the year.

3) The Eurozone remains in recession the entire year - Forecasters now expect euro-zone economic activity to be flat this year, down from a previous prediction of 0.3% growth made just three months ago. Last year saw practically continuous downgrades to GDP growth forecasts and I expect this year to be no different. Austerity measures are momentarily easing, but more will likely be enacted based on the outcomes of several elections. The recent appreciation of the euro against several major currencies will also dampen growth by putting pressure on net exports. With banks across Europe trying to build up capital and persistently high unemployment, the private sector will remain especially weak. Though Germany may experience a temporary rebound, the Eurozone as a whole will not register GDP growth this year.

4) The Japanese yen rises above 90 per $ - Since the election of PM Shinzo Abe, the yen has fallen fast and is down more than 20% from recent highs.

During this time the Nikkei has risen more than 20%, yet yields on Japanese sovereign debt are little changed. This suggests many foreigners may be speculating on the supposedly forthcoming monetary and fiscal stimulus. As previously stated, the fiscal stimulus will probably be small and short-term. On the monetary front, short of actually entering the foreign exchange market, the Bank of Japan (BOJ) has essentially no mechanism to spur inflation and thereby cause a sustained depreciation of the yen. When market participants recognize the inability of Japan to avoid continued deflation, the yen will return to appreciating against the dollar.

5) Gas prices will peak above $4.20 per gallon and set a new yearly record-high average above $3.75 per gallon - Gasoline prices have been on the rise for the past 31 days, currently averaging approximately $3.75 per gallon. Though this current streak will probably end soon, prices are unlikely to give back much of the gains before beginning the typical rise into summer. The ongoing potential for flare ups in the Middle East will keep prices elevated throughout the year. Higher gas prices, which already account for 4% of before-tax household income (chart below), will be a drag on consumer spending in 2013.


6) U.S. Yearly GDP growth falls below 1.5% - Forecasts of ~3% annual GDP growth over the past couple years have been overly optimistic as real growth in 2011 and 2012 was merely 1.6% and 1.9%, respectively. Apparently forecasters are being a bit tamer in their estimates this year, now expecting only 2% annual growth. Unfortunately I suspect these estimates will once again prove too optimistic. Various tax hikes and the upcoming sequester (which will go through in some respect) will reduce the budget deficit by a few percent this year. Housing is likely to remain a bright spot, but further declines in interest rates will not lead to similar magnitudes of the wealth effect. Credit remains tight for many households and small business, which should also limit private sector activity. All of these factors combined will probably not be enough to bring about a new recession but will lead to the lowest annual growth rate during this upswing.


7) U.S. Unemployment rises above 8% - Currently sitting at 7.9%, the unemployment rate is forecast to decline during 2013. Due to weaker GDP growth, corporate revenues will barely rise again this year. As companies face increasing pressure to maintain profit margins at record levels, a new wave of layoffs may occur. Separately, continuing economic growth will encourage previously discouraged workers to re-enter the job market. Both of these factors will lead to slightly higher measured unemployment.

8) Federal Reserve forecasts shift first rate hike to 2016 - After extending their forecast for the first rate hike to 2015, the Federal Reserve changed its tactics to a more rule-based monetary policy. The Fed has, in effect, promised to keep rates low until we've hit either 6.5 percent unemployment or 2.5 percent inflation. Based on the above outlook for unemployment and a continuing decline in inflation expectations (chart below), FOMC members will revise their own forecasts and push back expectations for the first rate hike.


9) U.S. Corporate Earnings (ex-Federal Reserve) finish year below 2012 peak - Meager revenue growth was not enough to prevent U.S. Corporate Profits after tax from reaching record highs in the fourth quarter of 2012 on the back of record profit margins.

US Corporate Profits After Tax data by YCharts

As global growth slows in 2013, revenues will come under further pressure. At this point the ability of firms to continue cutting costs without sacrificing output seems limited, which means margins may begin to compress. As margins revert to previous norms, earnings will register a yearly decline.

10) Bonds outperform stocks - During the first seven weeks of this year the stock market has been on fire, even though earnings estimates continue to fall.


Multiple expansion is currently being driven by the Federal Reserve’s actions despite their ineffectiveness at generating actual NGDP growth. When investors eventually turn their attention to continuing troubles in Europe, ongoing deflation in Japan, and/or weakening growth in China, U.S. earnings may once again enter the picture. Recognition that S&P 500 earnings growth has slowed substantially may cause the market to give up much of this year’s gain. These concerns combined with declining inflation expectations will result in many investors returning to the safety of U.S. Treasuries. The subsequent rise in prices (decline in rates) will generate another year of positive returns for the Treasury market.


Will my predictions prove too pessimistic once again? Only time will tell...

European Markets and GDP Move in Opposite Directions during 4th quarter

With data now confirming Europe’s awful fourth quarter on the GDP and unemployment front, it may be time to reconsider whether recent optimism is truly warranted...

Europe's A Fragile Bubble', Citi's Buiter Warns Of Unrealistic Complacency courtesy of Zero Hedge

We recognise that, in a decentralised market economy where expectations of the future, moods, hopes and fears drive private (and sometimes also government) behaviour directly and through their effect on the prices of real and financial assets, today’s subjective expectations and other psychological characteristics in part determine what tomorrow’s fundamentals will be.

Irreversible or costly-to-reverse decisions like capital expenditure, human capital formation, resource extraction etc, are driven by subjective expectations and moods, making the distinction between a fundamentally warranted asset boom and a bubble slightly fuzzy at the edges.

But this indeterminacy, bootstrapping, self-validating characteristic of complex dynamic economic systems inhabited by partially forward-looking households, firms and policy makers – called reflexivity by George Soros – can be taken too far.

Mere optimism and confidence will not permit the authors of this note to bootstrap themselves into winning the men’s doubles at Wimbledon 2013. The fact that financial markets have radically reduced their implied estimates of the likelihood of sovereign default in the periphery of the EA (other than in Greece) and of senior unsecured bank debt restructuring throughout the EA, core as well as periphery, should not stop us from continuing to analyse carefully the fundamental drivers of both sovereign credit risk and senior unsecured bank debt credit risk. When we do this, the conclusion that the markets materially underestimate these risks is, in our view, unavoidable.

Woj’s Thoughts - Actions by central bankers and politicians in the Euro Area, U.S., and Japan are increasingly betting on the fact that optimism and confidence alone will solve the problems underlying the presently weak economic growth. On this matter I side with Buiter in thinking markets have gotten well ahead of economic realities, especially in the Euro Area periphery. Recent flare-ups highlight the ongoing undercapitalization of banks and the inability of fiscal policy to either reduce unemployment or meet given targets. Political fallout from recent scandals and a strengthening euro may reignite the EU crisis.

Bubbling Up...1/15/13

1) The State We’re In by David Glasner @ Uneasy Money (emphasis added)

it’s interesting to note that, despite his Marshallian (anti-Walrasian) proclivities, it was Friedman himself who started modern macroeconomics down the fruitless path it has been following for the last 40 years when he introduced the concept of the natural rate of unemployment in his famous 1968 AEA Presidential lecture on the role of monetary policy. Friedman defined the natural rate of unemployment as:

"the level [of unemployment] that would be ground out by the Walrasian system of general equilibrium equations, provided there is embedded in them the actual structural characteristics of the labor and commodity markets, including market imperfections, stochastic variability in demands and supplies, the costs of gathering information about job vacancies, and labor availabilities, the costs of mobility, and so on."

Aside from the peculiar verb choice in describing the solution of an unknown variable contained in a system of equations, what is noteworthy about his definition is that Friedman was explicitly adopting a conception of an intertemporal general equilibrium as the unique and stable solution of that system of equations, and, whether he intended to or not, appeared to be suggesting that such a concept was operationally useful as a policy benchmark. Thus, despite Friedman’s own deep skepticism about the usefulness and relevance of general-equilibrium analysis, Friedman, for whatever reasons, chose to present his natural-rate argument in the language (however stilted on his part) of the Walrasian general-equilibrium theory for which he had little use and even less sympathy.

Inspired by the powerful policy conclusions that followed from the natural-rate hypothesis, Friedman’s direct and indirect followers, most notably Robert Lucas, used that analysis to transform macroeconomics, reducing macroeconomics to the manipulation of a simplified intertemporal general-equilibrium system. Under the assumption that all economic agents could correctly forecast all future prices (aka rational expectations), all agents could be viewed as intertemporal optimizers, any observed unemployment reflecting the optimizing choices of individuals to consume leisure or to engage in non-market production.

Woj’s Thoughts - I had to read this section of Glasner’s fantastic post twice because its conclusion is so striking given the particular economist involved. Although I was aware Friedman’s work played a large role in the neoclassical synthesis, it remains strange to think that someone so opposed to government intervention would set forth a policy benchmark by which future economists would determine intervention is necessary.

2) Buchanan: Seeing With New Eyes, by Garett Jones @ EconLog

Buchanan saw Arrow's Theorem as a solution to a problem raised by America's founders: how can democracies avoid the tyranny of the majority? Well here's one way, Buchanan said: Just let democracy behave normally. As long as people are diverse enough in their views for Arrow's assumptions to hold, then the factions holding power will change relatively often. His words:

"Would not a guaranteed rotation of outcomes be preferable, enabling the members of the minority in one round of voting to come back in subsequent rounds and ascend to majority membership?"

Where other economists--including myself--had seen Arrow's Theorem as an indictment of democracy, as a reducing the scope for democratic utopianism, Buchanan saw an argument that democracy might not be quite so dangerous after all.

Woj’s Thoughts - Although I did not have the opportunity to meet James Buchanan, as a student of economics and member of the George Mason community, I’m saddened by his recent passing. This past semester I became more formally introduced to his work through his book Cost and Choice. The many remembrances, including the one above, have shed even more light on the multitude and magnitude of his achievements throughout his life. I look forward to learning far more about the ways in which Buchanan separated himself from average economists in the years ahead.

3) Burn This Into Your Brain…. by Cullen Roche @ Pragmatic Capitalism

I really like this quote from the NY Fed:

“Most commonly used measures of the broad money supply include both currency and certain types of bank deposits, which in effect represent money created by banks when they make loans, but not reserves. These broad money measures tend to be more directly relevant for economic activity and inflation.” (emphasis added)

Woj’s Thoughts - The NY Fed recognizes that “inside” money is relevant for economic activity and inflation. How come mainstream economics doesn't?

Bubbling Up...12/1/2012

1) China after the Global Minotaur by Yanis Varoufakis

In the book’s penultimate chapter, I discussed the Soaring Dragon which, as everyone tells us, is waiting in the wings, purportedly to take over from the Global Minotaur (click here for a pdf copy of that chapter). In my concluding remarks, written back in January 2011, I wrote: “To buy time, the Chinese government is stimulating its growing economy and keeps it shielded from currency revaluations, in the hope that vibrant growth can continue. But they see the omens. And they are not good. On the one hand, China’s consumption-to-GDP ratio is falling; a sure sign that the domestic market cannot generate enough demand for China’s gigantic factories. On the other hand, their fiscal injections are causing real estate bubbles. If these are unchecked, they may burst and thus cause a catastrophic domestic unwinding. But how do you deflate a bubble without choking off growth? That was the multi-trillion dollar question that Alan Greenspan failed to answer. It is not clear that the Chinese authorities can.”

In the eighteen months that followed since those lines were written, events have confirmed the projected pattern. The table below reveals that the falling rate of Chinese consumption is continuing unabated. In 2011 of every one dollar of income produced, only 29 cents entered China’s markets. With net exports making a small annual contribution to domestic demand (even though they contribute greatly to the country’s capacity to invest and, thus, boost productivity), the onus falls increasingly on investment to meet the demand shortfall. However, as suggested in the avove paragraph, this emphasis on investment is a double edged sword, as it threatens to let the Giny out of the bottle in real estate markets, where bubbles have been looming threateningly for a while now.

	1990	1995	2000	2005	2009	2011
Private Consumption	49	44	45	40	34	29
Investment	35	42	36	42	48	58
Government Consumption	12	13	17	12	11	10
Net Exports	4	1	2	6	7	3

Composition of Chinese Aggregate Demand (Percentages of Gross Domestic Product). Source: National Bureau of Statistics of China

Woj’s Thoughts - Most economists agree that China needs to re-balance its economy away from investment and towards private consumption. China has made very little progress, if any, in this regard. As for the potential housing bubble, opinions are far more divergent. After a recent trip to China, my wonderful professor, Garrett Jones, remarked that families were using second homes as a savings vehicle but faced difficulty in abruptly moving their larger, extended families living under the same roof. While I respect that view, the growth of private debt to purchase homes leads me to side with Yanis.

2) When the Credit Transmission Mechanism Breaks… by Cullen Roche @ Pragmatic Capitalism

If you look at the 30 year mortgage rate closely you’ll notice a relatively steady inverse correlation between rates and new home sales.  That is, all the way up until about 2007.  Then, rates remain low and new home sales stay depressed.  The low rate transmission mechanism breaks.

Why does it matter?  This is exactly what we’d expect to see given the state of the balance sheet recession.  You see, demand for credit is very low because households are still recovering from the implosion in their balance sheets.  Instead of taking on more debt, households are paring back debt.  This is clear from yesterday’s NY Fed report on household credit trends.  And this is why monetary policy has been so broken in recent years.  The Fed can’t gain traction because their primary transmission mechanism is busted.  And the economy won’t feel quite right until this part of the monetary system starts working normally again….

3) Death of a Prediction Market by Rajiv Sethi

A couple of days ago Intrade announced that it was closing its doors to US residents in response to "legal and regulatory pressures." American traders are required to close out their positions by December 23rd, and withdraw all remaining funds by the 31st. Liquidity has dried up and spreads have widened considerably since the announcement. There have even been sharp price movements in some markets with no significant news, reflecting a skewed geographic distribution of beliefs regarding the likelihood of certain events.

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It seems to me that the energies of regulators would be better directed elsewhere, at real and significant threats to financial stability, instead of being targeted at a small scale exchange which has become culturally significant and serves an educational purpose. The CFTC action just reinforces the perception that financial sector enforcement in the United States is a random, arbitrary process and that regulators keep on missing the wood for the trees.

4) The Different Paths of Greece and Spain to High Unemployment by Thomas Klitgaard and Ayşegül Şahin @ Liberty Street Economics 

The high unemployment rate in Greece is not surprising given the depths of its recession, but what explains Spain’s 25.8 percent unemployment rate given its much more modest downturn? One contributing factor is the fact that the composition of Spanish jobs made the economy vulnerable to dramatic job losses during a recession. In 2007, almost 13 percent of jobs in Spain were in construction, compared with roughly 8 percent in Greece and the euro area. Such a heavy weight on this sector made employment more vulnerable to a downturn given the fact that construction is the sector that typically experiences the steepest decline in a recession. Indeed, construction, as measured in the GDP accounts, fell 35 percent from 2007 to 2011, and the sector accounted for almost 60 percent of the decline in total employment over this period.

   Another contributing factor is the very high percentage of employees tied to temporary work contracts in Spain. Data from the Organisation for Economic Co-operation and Development show that 32 percent of employees in Spain worked under temporary contracts and 68 percent under permanent contracts in 2007. In Greece, 10 percent were on temporary contracts; the figure for Europe as a whole was 15 percent.

Woj’s Thoughts - Both countries suffer from excessive private debt that is being transferred to the public sector as the private sector attempts to deleverage. Considering the size of the housing bubble in Spain (the bust continues), the relatively large portion of jobs in construction before the crisis and decline in employment within that sector afterwards are no surprise. However, the percentage of temporary workers in Spain is striking (Does anyone know if this is tied to cultural or policy reasons?). As both countries attempt to move towards balance budgets, the downward trend in unemployment and GDP is likely to continue.

ECB's Changing Philosophy is Good for Bond Holders but Bad for the Economy

Last week, a report from Jon Hilsenrath at the WSJ and comments from ECB President Mario Draghi sent markets screaming higher in expectations of an onslaught of monetary stimulus being announced this week. Following the conclusion of meetings by the FOMC and ECB, those expectations are now delayed. Bernanke was the first to disappoint, announcing no new monetary stimulus and merely repeating the obvious pledge to do more, if necessary. Today, Draghi proved that European policy makers will continue to talk a big game while offering little in terms of details or even a plan of action.

While many reports are focusing on the lack of follow through by Draghi, a strong countervailing opinion is presented at Mosler Economics.

Karim writes:Draghi announced significant philosophical changes today. The key announcements were:

• The ECB was ready to renounce seniority on its bond purchases.

• The size of future purchases was open-ended: ‘size adequate to reach its objectives’.

• Future purchases may not be sterilized, as they have been with the SMP so far.

• Purchases would be front-end focused as that ‘falls squarely in line with monetary policy instruments’. A key instrument is obviously the LTROs. So would imagine purchases would be 3yrs and in on the curve.

The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions [for some action on the ECB side]. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed.Other news was that:

• As in the excerpt above, purchases would be subject to strict conditionality via the EFSF (i.e., Spain has to accept a Memorandum of Understanding). Fiscal consolidation and structural reform were listed as the key conditions.

• He threw cold water on the ESM getting a banking license, saying he was ‘surprised by the attention this has received’.

• Logistics and objectives on bond purchases were TBD by a committee.

• Further non-standard measures were forthcoming.

• Rate cuts were discussed but unanimously voted down; as for a negative depo rate he said ‘we are in unchartered waters’, implying the hurdle may be high.

Relative to levels before Draghi’s London speech last week, Spanish 2y yields are 200bps lower, and 10yr yields are 50bps lower.

Whether or not these “philosophical changes” ever become reality remains an open question, but the ideas of renouncing seniority and leaving QE open-ended are clearly a step in the right direction. That being said, Draghi maintains the ECB’s position that further action is conditional on fiscal consolidation and structural reform. In this more important sense, the ECB’s philosophy has not really shifted at all. Describing that philosophy recently (ECB's Means (Lost Decade With High Unemployment) To An End (Structural Reform)), I concluded:

By working to prevent an all out collapse of the EMU, Draghi is merely taking the necessary actions to maintain his position. If Spain or other European countries must “suffer from a decade of recessions with unemployment over 20%” in order to implement the desired structural reforms than so be it.

As long as this philosophy remains in play, the most likely outcome in Europe will be a sustained period of high unemployment with declining or stagnating growth. Operationally this scenario can go on indefinitely but politically the time may be running out.

Two weeks off...little has changed

I’m back! After ten much needed days of vacation (largely without internet) and a couple days feeling under the weather, Bubbles and Busts is back.

Catching up on the news feed was a bit tedious as it appears a lot has happened, yet made very little difference. The Euro Summit, as predicted, offered the impression that progress was being made and momentarily provided an all-clear for risk-on betting. However, similar to the other 20-something summits, once the details began to leak out it became widely recognized that minimal real progress had been made. The timetable and size of the Spanish bank bailout are both unrealistic. Meanwhile, the negative effects of further attempts at austerity (tax hikes and spending cuts) are only slightly offset by the upward revisions in allowable public deficits for this year and next (which Spain will still not meet).

Separately, data out of China continues to suggest that growth is slowing much quicker than many expected. Falling inflation allowed the Chinese central bank to cut rates, but that action will do little to spur consumer spending (or boost growth). The Chinese government is increasingly facing the tough decision of whether to promote structural rebalancing and allow growth to slow or to put of rebalancing and jump start growth with fiscal stimulus. This decision will likely have a large impact on markets in the short-run and it appears most US investors are betting on the latter outcome.

Lastly, US economic data has also been weakening, topped off by the poor employment report last Friday. Yes the warm winter pulled economic activity forward, but I’m also convinced that the timing of the 2008-2009 crisis has altered the seasonal adjustments in a manner that overstates fall/winter months and understates spring/summer months. Regardless, 2Q GDP growth is likely to be below the already meager 1.9% growth during the 1Q. Corporate profits are now feeling the effects and have already turned negative (q/q). Both full-year GDP and S&P earnings expectations remain overly optimistic and will likely be trimmed over the coming weeks.

On the whole, global growth is clearly slowing and politicians in all of the major regions appear to be merely reacting, belatedly, to problems that surface. US stock markets have now given back most of the initial gains from the EU summit and Treasury yields are holding at or near all-time lows across the curve. Peripheral sovereign yields in the Eurozone have received a bit of a bid the past couple days (from the ECB?) but remain at unsustainable levels. Given the recent actions, my bias remains pessimistic for the next 1-2 years. Now it’s time to get back to more in-depth blogging...  

Talking About Demand Leakages

Demand leakages are unspent income. And if any agent doesn’t spend his income, some other agent has to spend more than his income or that much output doesn’t get sold.

And if the non govt sectors collectively don’t spend all of their income, it’s up to the govt to make sure its income is less than its spending, or that much output does’t get sold, which translates into what’s commonly called the ‘output gap’. Which is largely a sanitized way of saying unemployment.

And with the private sector necessarily pro cyclical, the (whopping) private sector spending gap in this economy can only be filled with by govt via either a (whopping) tax cut and/or spending increase, depending on your politics.

Read it  at The Center of the Universe
Demand leakages- the 800lb economist in the room
By Warren Mosler

For many years the desire of some individuals to save was countered by a growing number of other households/corporations willing/able to spend more than their income. As rising interest costs on outstanding debt began outpacing meager income growth, debt levels became unsustainable without infinitely rising asset prices. During this period government was acting equally pro-cyclical, encouraging the massive expansion of credit.

As Warren correctly notes, the government can make up for lack of private sector demand through larger deficits. However, this is not the only possible solution and holds untold costs of its own. Another possibility is to force major writedowns of outstanding private debt, my preferred solution. There are many ways to attack this problem, if so desired, but the first key is to make this issue a widespread topic of conversation.

Odd Consistency in Unemployment Claims Data

(Source: Zero Hedge - Same Trick Different Week: "Initial Claims Decline Following Revision"; Deficit Surge Pushes Q1 GDP To 1.5%)

This data is for the weekly initial and continuing unemployment claims provided by the BLS (Bureau of Labor Statistics). If recollection serves me correctly, the revisions data for 2011 would show a similar, nearly 100%, occurrence of upward revisions. Further, the size of revisions has been relatively stable. Anyone care to explain how an initial estimate for a given statistic, in this case unemployment claims, could consistently miss in the same direction?

Points of Public Interest

Ugly day in DC after a beautiful week, but more good NCAA basketball on TV. Good luck to those whose brackets still have a chance of winning!

1. “The Current Models Have Nothing to Say”

Should we be surprised? Policy makers continue to employ models of an economy with no financial system.

2. Economics without a blind-spot on debt

The aggregate level of debt, especially private, matters in

forecasting economic growth.

3. Consumer Credit Growing at Highest Rate in Past Decade: Unhealthy and Unsustainable?

Stopping addictive habits is not easy, but extending those actions will only make the eventual adjustment more difficult and painful.

4. The Japan debt disaster and China’s (non)rebalancing

Chinese consumers continue to increase savings in lieu of domestic consumption. Japan is attempting to rebuild its trade surplus, but which countries will allow their surplus to decline or deficit to increase? Global (and domestic) imbalances not addressed remain significant risks to the global economic outlook.

5. A step in the right direction

Scientific exploration incorporating complex systems and networks continues to move our understanding of reality forward.

6. It's not structural unemployment, it's the corporate saving glut

Businesses save instead of investing in labor when consumer demand is weak. Until policy focuses on improving the consumer balance sheet (e.g. debt write-downs), unemployment will remain high.

7. Wrong vs Early – Contrarians Bet on Natural Gas

The best investors are often early and patient.

8. The Real Problem with Microfoundations

Microeconomics is not especially sound in predicting all outcomes

either.

9. Principal writedowns of the day, mortgage edition

Positive for households but will Bank of America (and others) really accept the associated losses?

10. Why Using P/E Ratios Can Be Misleading

In early 2009, at the market bottom, the P/E jumped to over 100 as profits plummeted. Using E/P corrects for this issue and shows the market is slightly overvalued currently.