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

[HershOstropoler]

Sten:

"Q4 GDP should beat estimates by 100bp or so, even with the deflator accelerating."

That doesn't sound the bond trader I know and like.

DrSpike:

Colon is right in that you're as evasive as a trial lawyer on steroids, though I'm not sure you are that on purpose. But let's see, maybe you can answer those questions to further my understanding from what corner of economics you're actually coming....

1. You advocated "if you have reason to think it (NAIRU) may have changed, due to, say, a hypothetical permanent upward shift in potential productivity growth then you can use the (albeit not perfect) model you have built to see what that implies for possible policy."

IMO that is what the greenspan fed did, based on assumptions about NAIRU originally being at 5-6 % and supposedly accelerated poductivity growth pushing it lower. Agree ? The result was an artificial easy money boom and the current hangover. Agree ?

2. You mentioned an "unhealthy obsession with monetary aggregates is undesirable."

What do you consider proper consideration of monetary aggregates in light of Fed policy from 1996-2000 ?

Do you really think the Fed's leniancy to tolerate 10 or 12 % M3 growth was a good idea while
- the household savings rates approaches zero
- the private sector financing deficit reaches 7 % of GDP
- the foreign account deficit reaches 4-5 % of GDP
- asset price inflation stands at ~7 % in real estate and 10-20 % in the stock markets as opposed to output or consumer price inflation somewhere in the 2-4 % range

Or would you agree that those taken combined clearly showed a monetary policy that was too easy ?

3. Do you assume NAIRU for germany to be maybe 7 % ? 8 %?
What changed that from the 1960s/early 70s where I suppose the NAIRU estimate would be 2 % unemployment or so ?

[DrSpike]

Originally posted by HershOstropoler
DrSpike:

Colon is right in that you're as evasive as a trial lawyer on steroids, though I'm not sure you are that on purpose. But let's see, maybe you can answer those questions to further my understanding from what corner of economics you're actually coming....

My apologies if I didn't get to every last post at the end of yesterday's discussion.....they were coming thick and fast and I had already spent most of the afternoon discussing the issues. Today I am busy, but I will try to answer your questions this evening.

[DanS]

"Q4 GDP should beat estimates by 100bp or so, even with the deflator accelerating."

Interestingly, this would put the annuals roughly in line with White House/Treasury year ago estimates of 3%. O'Neill was derided as "cheerleading" for these estimates.

Spike: If their economy is anything like their porn, we're in for quite a ride.

[DanS]

Cleaning up from the last of the other thread...

"Is that an argument pro or contra NAIRU?"

Not an argument either way. I was just describing what filtered down through the press and what I observed about the "talk" over time. Even though The Post never said "NAIRU" (since they were written for a non-technical audience), that's clearly what they described. In fact, I'd never heard of NAIRU until Spike mentioned it.

The articles made clear that this was something that policy makers were looking at, and that they were surprised about not seeing any increasing inflation at such low unemployment levels. This is extemely important to official Washington (and hence The Washington Post), because sustained low unemployment makes our social problems a heck of a lot easier to solve. For instance, the politicians took the opportunity to reform welfare (i.e., to throw people off the dole).

Edit: Thought you might be interested in a Taylor speech given earlier this month about the history of monetary policy...

http://www.treas.gov/press/releases/docs/fried.pdf

Don't know if he's too widely published to be the next Fed chairman, but he's interesting to watch...

[Adam Smith]

DanS:

Here is a quick and dirty derivation of NAIRU which may help illustrate why this is both a useful concept for organizing thinking and at the same time very difficult to apply in practice. (This is my recollection from Robert J. Gordon’s graduate macro class 20+ years ago, so please don’t hold me to the details. )

Start with a production function, which relates the inputs used by the economy to the total output produced
(1) Q = ZL^aK^bE^c
where
Q = real GDP
Z = productivity factor
L = labor
K = capital
E = energy
a, b, c = known shares of labor, capital, and energy in GDP. ^ is an exponent.
Assume a + b + c = 1 (constant returns to scale) for simplicity.

Converting (1) to annual growth rates,
(2) q = z +al + bk + ce
where lower case letters represent the annual growth rates of their upper case counterparts.

We want to use this relationship to tie together the two macroeconomic concepts which we care about: unemployment and inflation.

For unemployment,
(3) l = w - u
where
w = annual growth rate in the labor force, which is given by demographics
u = unemployment rate

For inflation, start with the standard monetarist equation of value
(4) PQ = MV
where
P = price level
Q = real GDP
M = quantity of money
V = velocity of money
Converting to annual rates of growth,
(5) p + q = m + v

Substituting (3) and (5) into (2) results in
(6) m + v – p = q = z +a(w-u) + bk + ce

The left side of (6) is the monetary side of the economy, and the right side of (6) is the real side. If we take all the other rates of growth as given, then there is some u (unemployment rate) such that p (inflation rate) is zero. This is the NAIRU.

The good news: we pulled all the factors in the economy into one equation, which is very valuable in organizing one’s thinking.
The bad news: NAIRU depends on a whole bunch of factors which don’t necessarily stay constant.
The worse news: we can only measure these factors imperfectly (e.g., productivity) or with a lag, which makes policy decisions imprecise.

[DrSpike]

Nice one AS.....I'd expect anyone who learnt macro from R J Gordon to exhibit a similar level of sense.

Hersh: Good questions.......addressing a very wide range of topics, so forgive me if this gets lengthy.

1) I agree there was a belief (and a reasonable one at that) that a productivity improvement had raised the rate of growth that could be sustained without generating inflation.

Now if the economy can grow faster without inflation is there a good reason to keep monetary policy tighter and not realise the potential gain? No, there isn't. And what is more the costs to overly tight monetary policy are huge. The fed does what it is legally bound to do, use monetary policy to hit an inflation target.

I cannot agree that monetary policy was ever too loose. Now there are 2 wrong arguments I see regularly from laypeople here: firstly, and most annoying, is the view that post dotcom crash rates were slashed too aggressively, leading to a present bubble in the property market. The alternative, of course, when investment plummeted, would have been a full blown recession without doubt. Should one criticise the fed? Hell no, you should applaud them.

The second misconception I can empathise with, because it contains an (albeit small) element of truth. This is the view that the initial stock market bubble was the fed's fault. The thing here is, you can hit but one target with one instrument, and it is not the fed's responsibility to use monetary policy to affect the stock market. You can choose to believe that would be a better target than an inflation target, but of course you would be wrong.

2) A lot of what I said in 1) applies. In addition 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.

3) Question 3 is a very different kettle of fish than the first 2......and opens up a whole new area for debate. There have been many attempts to explain the worldwide rise in unemployment since the 60s......ultimately a lot of the change is due to 'inflation illusion', because how expectations are formed is critical......but there are other factors. I'll mention another key one - productivity growth fell post 1970 all across the world, this undoubtedly played a role as well.

Ultimately it is easy to criticise the fed, because you can't see the alternative realities and there is always something in the actual reality to ***** about. Do central banks make mistakes? Hell yes.......but the ONLY question that is relevant here is does discretionary monetary policy perform better than simple rules? History/theory/empirics all suggest OVERWHELMINGLY that it does. And monetary authorities make far fewer mistakes because they use models and concepts like output gaps and NAIRU to make their guesstimates. This is why I objected to the claim that such concepts were useless, and I stand by that.

[Colon™]

Originally posted by DrSpike
Nice one AS.....I'd expect anyone who learnt macro from R J Gordon to exhibit a similar level of sense.

RJ Gordon's handbook into macro economics happens to be the first one I ever bought.

[DrSpike]

Then read it.

[Colon™]

No silly, I use it as toiletpaper.

[DrSpike]

That explains a lot.

Check out Gordon's views on the things we disagree about..........funnily enough he agrees with me.

[Colon™]

What do we disagree about? I don't even know your opinion besides "you should shut up because you don't know the basics and I'm the all-knowing being as I parrot that other economist".

[DrSpike]

Well what are the main 2 topics we discussed in the last 40 or so posts?

1) Are NAIRU/output gaps and such concepts near useless.

You: yes
Me: No, with lengthy explanations, despite your attempts to paint me as someone who merely repeats textbooks.

2) Are rules preferable to discretion?

You: yes.
Me: No, with further lengthy explanations.

Sounds like disagreements to me. If I have misrepresented your opinions I'm sure you'll respond and say so.......but you made them pretty clear I think.

I am a little bemused at your repeated attempts to portray me as saying things like "you should shut up because you don't know the basics and I'm the all-knowing being as I parrot that other economist" and having no substantial arguments. Anyone that can read can see that neither is the case......and _my_ opinions stem from years of considering the problems at hand and contributing to my science......alas it seems you reach for such dishonourable debating tools becuase it is in fact your position that lacks intellectual coherence.

[Saras]

DrSpike, you have to admit you have been, to say the least, condescending. You might be right, but you might try to maintain a normal dialogue. Seems like you're on right track now, though.

[Colon™]

Originally posted by DrSpike
Well what are the main 2 topics we discussed in the last 40 or so posts?

1) Are NAIRU/output gaps and such concepts near useless.

You: yes
Me: No, with lengthy explanations, despite your attempts to paint me as someone who merely repeats textbooks.

Let’s see.

These was my last post:

Think so? The history of economic forecasts and policies based on that is pretty bad. How often hasn't it been that a CB kept increasing the rate while the economy was already entering a downturn? Or that govt passed tax cuts that only had their effect when the economy was already blossoming again?

And these were your last posts:

I have to say in all seriousness I really do do my best in trying to answer any questions that are asked of me, and to answer them without resorting to technical models, which is very hard at times. I do not know why you imply that this is not the case, since I have spent much time doing what I can to help people understand various concepts, and I have to say it is my belief that for the most part I have succeeded in this.

You are, of course, free to disagree with this, just as you are free to disagree with anything you choose. I have never called you or anyone else an inferior being for disagreeing with me..........though I admit freely your seeming belief that a professional economist possesses no more insight than an intelligent but ultimately unskilled layperson is frustrating at times.

Don't be silly. The point is that we have tried lots of things, and what we do now works better than all those things.

Anyway, enough. I have to do some work this afternoon.

I hope I have succeeded in convincing you all of the worth of imperfect tools like output gaps and NAIRU, and I hope there is none among you that seriously believes in ditching discretionary policy.

There is no lumping together.........each economy estimates its own NAIRU and uses that to help guide policy. And yes, in my opinion (and thankfully, in the opinion of everyone who counts in the world of economics), policy based on good guesstimates is better than policy based on flipping a coin.

I see levels of hot air that could cause global warming, but no counterarguments.

The ultimate irony is that AS said pretty much the same thing as I did, just stuffing it with formulas, and you commend him for it. Is it that you don’t like brevity?

2) Are rules preferable to discretion?

You: yes.
Me: No, with further lengthy explanations.

Me:

Why not, set a money supply target and ban discretionary spending based on output fluctuations. Discretionary spending is usually a pork barrel fest anyway.

(ok, don’t take that too literally but it seems a better starting point)

You:

The importance of knowing recent economic history raises its oversized head once more. We didn't reach the dominant paradigm of an independent central bank using an inflation target and floating exchange rates overnight.......it is the culmination of years of painstaking research and trial and error. The targeting of various monetary aggregates......targeting of exchange rates......mechanistic non-discretionary rules, these are all possible. Ultimately they are all inferior to the dominant paradigm.

I’ll freely admit that my post of a money supply target combined with no discretionary spending is a bit outrageous, but there’s no reason why we can’t discuss what the practical problems would be. Instead you just dismiss it because I supposedly wouldn't know the basics and then blow off some high-pitched rhetoric.

[DrSpike]

Originally posted by Saras
DrSpike, you have to admit you have been, to say the least, condescending. You might be right, but you might try to maintain a normal dialogue. Seems like you're on right track now, though.

I get defensive when attacked, as everyone does.......Colon posted for the first time in a while yesterday, and I responded to his posts (which I disagreed with) with complete civility, as you can check.

Alas I must confess my style could be seen as abrasive at times......I hate muddled thinking and inconsistent analysis and rail against it wherever I find it. Just a flaw I guess, but one I can live with.