GDP, M&A, EBITDA, P/E, NASDAQ, Econo-thread Part 12

[HershOstropoler]

Krugman is one of the few people stateside who realise what's going on. The rest is happily dreaming in their little fantasy world.

Now for the controversy... Sten: What output gap ? US is still a couple percent above trend...

[Colon™]

Originally posted by DrSpike
Dan's fault

*loose monetary policy*

....

Ok.

Now about forecasting, I'm quoting Baum here: (I’m you dislike her as much as you like Krugman)

”for gross domestic product, Englund found the Fed's average forecast error was 0.8 percentage point for the current year and 1.2 percentage points for the following year.

MMS's own forecasts for the same 1985-to-the-present period yielded a miss of 0.7 percentage point and 1.2 percentage point, respectively, for the current and following year.

``The interesting thing is that if the Fed had just forecast 2.6 percent every year for real GDP, its forecast error would have been the same: 1.2 percentage points,'' Englund says.”

Being on average 1.2% wrong for the following year seems pretty significant to me, considering rate changes only kick in after a year. (give or take a couple of months, depending on the estimate of course)

*To clarify the dominant paradigm post*

I feel you would benefit from reading what you can find about monetary policy in the 80s, where monetary aggregates were king. You see the question of whether to target monetary aggregates or have an explicit inflation target may seem like no big deal to the casual observer. It turns out to make a huge difference.......due to where in relative terms most of the uncertainty lies, in the real sector or the monetary sector. Hehe, this is back to Gordon again, IIRC he did some of the key work in the 80s on this very topic. It turns out that velocity (in AS's quantity theory of money equation earlier) changes make monetary aggregates too slippery, even when you can control them, which you only can to a limited extent.

Velocity fluctuates within a given period, but in the long run money supply equals nominal GDP. (read Gordon)

I don't know the finer aspects of the Fed's attempt to monetarism (you’re free to lecture on that) but they didn’t seem able to do what I have in mind with targeting money supply.

I took a look at M3 on the Januaries of each year from 79 till 89 (IIRC the fed adopted monetarism in 79), and calculated the growth from the previous January:

79-80: 10%
80-81: 10.8%
81-82: 12.5%
82-83: 9.4%
83-84: 9.1%
84-85: 11.2%
85-86: 7.1%
86-87: 9.1%
87-88: 5.1%
88-89: 6%

So, did they have a M3 growth target, and if yes, what was it?

[el freako]

Originally posted by DrSpike
I am prepared to match my 2003-2005 forecasts against any that wish to participate.

Later though, I have to go pompously teach some future clueless people material written by the present day clueless.

Ok I'll rise to that

My forecasts are output-gap based.


GROWTH:

USA:
2001: 0.3%
2002: 2.5%
2003: 2.7%
2004: 3.7%
2005: 3.5%
2006-10: 3.7%
2001-10: 3.1%

EU15:
2001: 1.6%
2002: 0.8%
2003: 1.7%
2004: 2.7%
2005: 2.5%
2006-10: 2.8%
2001-10: 2.3% (2.8% adjusted)

Japan:
2001: -0.3%
2002: -0.2%
2003: 1%
2004: 1.3%
2005: 1.3%
2006-10: 1.7%
2001-10: 1.2% (1.5% adjusted)


UNEMPLOYMENT

USA:
2001: 4.8%
2002: 5.7%
2003: 6.0%
2004: 5.8%
2005: 5.5%
2010: 4.2%

EU15:
2001: 7.3%
2002: 7.6%
2003: 8.0%
2004: 8.2%
2005: 8.2%
2010: 7.0%

Japan:
2001: 5.0%
2002: 5.4%
2003: 5.7%
2004: 5.5%
2005: 5.3%
2010: 3.5%

(edited with new OECD estimates of the output gap)

Please note that when comparing US growth the the EU15 and Japan that there is a discrepancy between reported growth rates and the share of US GDP at current prices and PPPs - this amounted to 0.46% a year for the EU in the period 1970-2001 and 0.39% a year for Japan - the 'adjusted' figure corrects for this.

On a side note has anyone noticed the sharp closing of the gap between US and EU population growth? - It has halved in the last 5 years to 0.5%

Year, USA, EU
1997: 1.2% 0.2%
1998: 1.2% 0.3%
1999: 1.2% 0.4%
2000: 1.1% 0.4%
2001: 1.0% 0.4%
2002: 0.9% 0.4%

[DrSpike]

Colon:

Your post confused me.......not sure about the purpose of my first quote in your post (*edit* unless you were agreeing with my earlier points - I didn't consider that on first reading ). Did I say something about forecasting, or is it just a general query?

But anyway I read the article. It doesn't say anything controversial.......sometimes forecasting is hard, but on average central banks do at least as good a job as the private sector, and probably a better job, depending on whose study you place most weight on. Romer's study (the one that says the fed beats the private sector on average) is required reading.......very informative and thorough. I haven't seen the other one so I can't comment. The time horizon looks a little short though.

Regarding the targetting of monetary aggregates you said it all. If I had had those numbers handy I would have posted them along with the post that you quote.

Quick overview of the issues for any interested:

It is important to realise the aim of the dominant paradigm which I outlined and the aim of targeting monetary aggregates is the same: macroeconomic stabilisation. The key model for understanding these issues in the short run is IS-LM (check it out in Gordon, it is a relatively simple yet very powerful model), in which the interest rate and equilibrium output are determined by the interaction of the real side of the economy and the monetary side.

Now the monetary side in the simplest exposition has a vertical money supply curve (ie it is whatever level the CB decides) and a money demand equation that shows that more money is demanded for transaction purposes as interest rates fall, and the opportunity cost of holding cash decreases.

If the CB can indeed control money supply, and money demand is known with certainty then it doesn't matter if you use open market operations to hit money supply (and hence interest rate) targets consistent with output stabilisation, or you use interest rates directly to target inflation directly. But of course (as Colon's figures indicate) the money supply is hard to target effectively, and, what is more, velocity changes mean money demand is very uncertain, so that even if you could hit the money supply target there are troubles with attaining the desired goal.

So what is the solution?

Well the solution we use is to set interest rates directly (in practice to hit an inflation target), and allow the money supply to adjust to whatever level of demand is consistent at that rate. The LM curve in the model hence becomes horizontal at whatever rate the CB sets. This procedure can be shown under conditions of uncertainty to be the best procedure for macroeconomic stabilisation.

Now it *is* important to keep an eye on monetary aggregates, but it is more important not to retain the unhealthy obsession with them that is the legacy of the 80s. You cannot argue with the logic of the quantity equation material in the long run.........but in the long run, as Keynes famously said, we are all dead.

Long live the dominant paradigm. Hope that helps.

[pchang]

Micro to Macro and Vice Versa

In physics, statistical mechanics is used to bridge the gap between quantum/atomic/molecular properties and macro properties such as temperature and the like. Is there any corresponding concept that ties together micro and macro economics?

[DrSpike]

Yes and no.

There are microfoundations to much modern macroeconomics, but to examine macro issues rigorously in this way is very technical, and requires compromise elsewhere in the models to make them useable.

Much practical macro is more touchy-feely than micro......with the focus on building models of aggregate behaviour that help explain macro fluctuations, and reflect micro considerations without explicitly being derived from them.

The macro wars of the last 20 years have been between the new classicals, who believe strongly in microfoundations, and build intertemporal utility maximisation models with rational expectations, and the new keynesians, who believe in the logic of IS-LM and AS-AD, and try and provide some micro justification for the nominal rigidites that are necessary for these models to accurately reflect the path of key variables over the economic cycle.

I am strongly in the 2nd camp........I get into trouble for writing how silly some of the intertemporal maximisation models (like real business cycle models) are........but hey, it's the pursuit of truth that matters above all else, right?

[HershOstropoler]

Spike:

"Now it *is* important to keep an eye on monetary aggregates..."

Fine. But you think velocity changes a lot, do you not ? If you look at M3 vs nominal GDP from 1996 to now, you get, I repeat myself, "Velocity changes affecting the aggregates by 3-5 % a year, over several years".

Explanation without including asset-related transactions and net imports ?

When I'm at digging up earlier questions:

Are you denying that the Fed's real mandate is to sustain the viability of the financial sector at all cost ?

[DrSpike]

Originally posted by HershOstropoler

Fine. But you think velocity changes a lot, do you not ? If you look at M3 vs nominal GDP from 1996 to now, you get, I repeat myself, "Velocity changes affecting the aggregates by 3-5 % a year, over several years".

So you see now the point about which instrument to use to hit what target, and how uncertainty affects the best choice? Don't quite see the point here.

And of course the mandate of the fed is not to sustain the financial sector.........that is ludicrous........I do not know why you would say this; it is legally wrong, theoretically wrong, and inconsistent with the evidence.

[HershOstropoler]

"So you see now the point about which instrument to use to hit what target, and how uncertainty affects the best choice?"

I have no idea to what you refer there.

"Don't quite see the point here."

Explain the velocity changes. Or are you just taking them as force majeure, like death, taxes and the salzburg weather ?

"And of course the mandate of the fed is not to sustain the financial sector.........that is ludicrous........I do not know why you would say this"

The Fed has, in part as a consequence of the great depression, in part as a consequence of the regional reserve banks being quasi-owned by the commercial banks, a policy to sustain the viability of the financial sector at all cost.

The Fed sees it as its its responsibility to ensure financial stability in the economy. Disagree ? The Fed does use its regulatory and supervisory powers to ensure that the financial system will remain resilient. Disagree ? And the Federal Reserve is ready to use the discount window and other tools to protect the financial system. Disagree ?

[DrSpike]

There is no way I know of to accurately model velocity changes.....the practical problem is to pick the best target given conditions of uncertainty and pick the best instrument to hit that target. This is what lies behind the dominant paradigm stuff I posted earlier, and clarifies why I told you before not to have an unhealthy obsession with monetary aggregates. But anyway I think that is clear now, so onward.

Originally posted by HershOstropoler

"And of course the mandate of the fed is not to sustain the financial sector.........that is ludicrous........I do not know why you would say this"

The Fed has, in part as a consequence of the great depression, in part as a consequence of the regional reserve banks being quasi-owned by the commercial banks, a policy to sustain the viability of the financial sector at all cost.

The Fed sees it as its its responsibility to ensure financial stability in the economy. Disagree ? The Fed does use its regulatory and supervisory powers to ensure that the financial system will remain resilient. Disagree ? And the Federal Reserve is ready to use the discount window and other tools to protect the financial system. Disagree ?

Right, the fed (or any CB) is responsible for financial stability, and it does a lot in this regard so I agree with the first 2 statements. It absolutely does *not* use monetary policy with the aim of 'sustaining' financial markets; rather it tries to hit the inflation target to which it is legally bound. You're trying (it seems), to make a case for monetary policy being too loose in your opinion because the fed's real aim is to protect stockmarkets. Now there are things you can credibly criticise the fed for. This is not one of them.

[HershOstropoler]

"There is no way I know of to accurately model velocity changes...."

Right. However do asset markets have an effect on velocity as measured by money supply v output ?

"....I agree with the first 2 statements. It absolutely does *not* use monetary policy with the aim of 'sustaining' financial markets..."

Point 1-3 are all from here:

http://www.federalreserve.gov/BoardDocs/speeches/2002/20021121/default.htm

And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system…

Or:

http://www.federalreserve.gov/faq.htm#frsq2

the Federal Reserve's duties include conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices; promoting the stability of the financial system...

And this is the official sugarcoated version, always tied into and justified by economic needs. Anyway, the stability of the financial system is the key task of the Fed - everything else is icing on the cake.

The Fed has prepared markets for a while for unconventional operations, Bernanke's speech is going quite far. Of course it is all theoretical, he says... of course.

[DrSpike]

The second quote is fine........the CB plays all sorts of roles in financial regulation and as lender of last resort......these are key roles in financial stability.

The phrasing in Bernanke's article does surprise me..........I suspect if pressed he would state as I did that the main aim of *monetary* policy is the inflation (and hence output/growth) target. He is not suggesting that the fed would emphasise, say, stock market valuations over the aforementioned targets, which I what I thought you were driving at as part of your quest to paint the fed as negligent.

I just wanted to make the point that the fed doesn't subordinate monetary policy to stock market issues over the targets discussed. You may not have been angling for that, but that was my impression from past posts.

[HershOstropoler]

I said financial system/sector whatever. Includes banks, other lenders, general liquidity concerns, about anything credit-related. "systemic risk" scare. The stock market is a side issue for the Fed, unless a crash poses the risk of doing damage to the financial system. Hence it did not bail out worldcom, but LTCM (yes, I know, it was an indirect bailout).

"The phrasing in Bernanke's article does surprise me..."

Doesn't surprise me at all. Talk like that has been gradually building up.

I wonder how Sten likes the idea of the Fed going for the full yield curve, and including corporate bonds.

[DrSpike]

Ok, fine. It may be my imagination but I think we are really getting somewhere with the recent exchanges. So tell me what ideas I have managed to sell, and which ones I haven't.

Do you still believe the fed was wrong to slash interest rates after the dot com crash? Do you think the behaviour of monetary aggregates is indicative of negligence on the part of the fed in this regard? Do you believe any present imbalances are the 'fault' of the fed? Do you still believe 50/50 on the US becoming Japan, because of your beliefs regarding the other 3?

As an aside, Bernanke's article is quite lucid, and may help bolster my stated position on the last question, as well as reinforcing many of the points I made in the deflationary spiral debate.

[HershOstropoler]

"Do you still believe the fed was wrong to slash interest rates after the dot com crash?"

Wrong question. We have not only had a dotcom crash, there's much more going on. Also this is not a simple yes/no question, there are 525 bps for a differentiated answer.

Cuts yes. Whether it has gone too far is another question; in the current environment I think it has.

"Do you think the behaviour of monetary aggregates is indicative of negligence on the part of the fed in this regard?"

The behaviour of monetary aggregates is indicative of the Fed negligence mostly from 1997-2000.

"Do you believe any present imbalances are the 'fault' of the fed?"

Yes.

"Do you still believe 50/50 on the US becoming Japan"

Yes. I see two main scenarios for 2003-5: One is a real recession, one is sluggish growth that maintains the imbalances and lowers the trend growth rate. The third one is a liquidation of imbalances along sluggish growth, but that is a quite optimistic view IMO.