Monday, July 21, 2014

Notable pictures: How Americans die

Quite a few things to note and ponder in this chartbook on the causes of death, from the always-appealing Bloomberg Visual Data. "How Americans die":

1. The mortality rate for men has converged to that for women.

2. Mortality rates have declined almost monotonically for almost all age groups.

3. Something happened in the 25-44 group, as Bloomberg points out: mortality rates rose from the early 1980s through the mid 1990s....

4. ...which is explained, Bloomberg says, by AIDS.

5. If you're between 45 and 54, your odds of dying haven't changed much since 1998--while everyone else's have fallen.

6. DRUGS and suicide explain much of that.

7. Drugs and suicide now end the lives of a lot more people than before, and have overtaken car accidents as the leading causes of violent death, across all ages.

8. As one would expect, a higher life expectancy comes with a rise of Alzheimer, senility, and dementia as causes of death.

9. What surprised me, though, is that the share of healthcare spending that goes towards nursing and retirement facilities has not increased.

Monday, July 14, 2014

Forever low? A discussion of the outlook for long-term interest rates*

Are low interest rates the new norm?

In a 2012 TV commercial for a U.S. bank, a stage curtain goes up to reveal Tom Sargent, Nobel laureate in economics. A voice asks: “Professor Sargent, can you tell me what CD rates will be in two years?” Sargent replies with a confident “No.” The curtain goes down.

Real, long-term interest rates have been slipping for 30 years. Look no further than the yields on U.S., U.K., and Japan inflation-linked bonds to see the persistent decline. For other countries, which lack liquid markets in inflation-protected bonds, economists adjust market yields for expected inflation to estimate real interest rates. Those estimates tell the same story: ever-lower real rates. Global composites, such as the IMF’s (2014), and King and Low’s (2014), show real rates declined from 4% or 5% in 1985 to about zero in 2012.
Students of the real interest rate have chalked up its decline to various factors. In this essay I will discuss which ones I find most plausible, and then ponder what might reverse the trend.
Why interest rates fell
The most cited reason why real interest rates have tumbled is the “global savings glut.” Bernanke gets credit for the term. Faster income growth in emerging markets—according to the IMF (2014) report— lifted savings, which the West wasn’t able to absorb quickly. A persistent abundance of capital reduced its price.
Saving alone, however, tells us nothing about the equilibrium interest rate. In the aggregate, saving must equal investment. Excess desired saving –or the shortfall of desired investment— is what depresses the real interest rate.
For interest rates to fall, then, investment needed to fall as well, or at least rise less than desired saving. That’s presumptively what has happened since the 1970s in mature economies. The McKinsey Global Institute (2010) estimates that capital spending from 1980 through 2008 was $20 trillion less than if the investment rate had remained stable. Granted, investment in emerging countries soared, especially in China. But saving rates rose even more, so developing nations became net exporters of capital.
The lower demand for investment can be traced, in turn, to two other factors. Summers (2014) has recently argued that the entrepreneurial ventures of the 20th century (think Ford, British Petroleum, Airbus) required millions of dollars, whereas today’s startups need just a few thousands in seed capital. Also, investment demand has gone down because the relative price of capital goods has declined.  A truckload of widgets buys more computers than ever before.
Another explanation is that the income distribution changed. The capital share of income has risen, and so has wage inequality among workers. For corporations, a bigger piece of the income pie has implied more saving, because businesses’ demand for capital has grown less than profits. Among households, the saving rate is much higher at the upper end of the income distribution. When the financial crisis hit borrowing-constrained households, the gap between desired saving and borrowing grew wider.
A declining labor force implies a falling natural interest rate as well. This point was famously made by Alvin Hansen (1939) in a speech where he laid out his secular stagnation hypothesis. He guessed the decline in population growth and “the failure of any really important innovations” would hold back growth and depress interest rates. The next 30 years proved Hansen spectacularly wrong—clearly on the innovation count—but the demographic concern seems relevant in the 21st century.
Man-made barriers can contain investment too. That’s an explanation favored by the “supply siders” in this debate, such as John B. Taylor and John Cochrane. Policy uncertainty, bad regulation, and distortions, they say, has discouraged investment.
Finally, besides a mismatch between intended saving and investment, a portfolio shift took place. The relative demand for safe assets increased, primarily by central banks and sovereign wealth funds in emerging countries. This shift further pushed down yields on liquid, “safe” assets, as the IMF (2014) has argued. On this count, then, declining interest rates reflect scarcity of “safe,” liquid assets. (Bernanke has mentioned this also.) Quantitative easing may have compressed term premiums as well since 2008, although it’s unclear how much.
Back to historical “normal”? Don’t take it for granted
What might undo this decline of interest rates? A big player is China. Between 2001 and 2013 the Asian mammoth exported more capital than all other emerging countries combined, as measured by current account balances. China, then, probably did more to depress interest rates than any other country, due to policies that curb consumption. Going forward, this will change, but it’s not obvious what that means for global interest rates.
If China hits a debt wall –as I think they will— investment will fall, perhaps even in absolute terms. Reducing private saving shouldn’t be difficult, as the government policies that repress consumption seem to be binding. This may or may not reduce China’s excess saving, depending on the size of the investment and consumption shifts. If done the “right way,” as Michael Pettis (2013) calls it, saving would decline more than investment, and the current account balance would shrink. This has been happening already: China’s current account balance may have peaked in 2012.
Things could go differently tomorrow, though. The IMF projects that China’s excess saving will creep up through 2019. Pettis explains Beijing is finding it hard to raise consumption. If saving is sticky, and China heeds recommendations to lower investment, net saving could easily rise. Besides, policymakers in surplus countries like China and Germany see net saving as a virtue, and routinely resist calls to reduce their current account balances.
How about other countries? In the future developing countries may not grow as fast as they used to. A new study by the IMF (2014b) shows the potential growth rate in emerging markets is now 1.25% lower than in the 2000s. Lower growth can sap saving, pushing interest rates up.
The McKinsey Global Institute (2010) also thinks we should say goodbye to cheap capital—but for the opposite reason. The McKinsey paper posits that an investment boom is imminent in developing economies. Rapid urbanization is lifting the demand for roads, ports, power grids, schools, hospitals, and housing. That, plus a decline in saving, will reverse the secular decline in real long-term interest rates.
Three things bother me about this hypothesis. One, it may underestimate the likely slowdown of investment in China, by far the largest of emerging markets. Two, those projections are tied to the fact that, in emerging markets, the capital stock per capita is low. Yes, poor countries grow faster. But Korea and Taiwan remained capital-poor for centuries. The investment-led race to riches is open to others, like India or Indonesia, but we don’t know whether the gates will open in 2014, 2020, or 30 years from now. Three, the investment surge will be smaller if we use today’s GDP growth forecasts than the ones from 2010, when the paper was written.
Age-related spending will too weigh on saving, public and private, in mature economies. The population older than 60 will peak by 2030, and pension and healthcare spending will balloon with it. Households will begin dissaving. It doesn’t help that productivity increases more slowly in healthcare and domestic help services than in other sectors. This additional consumption will put upward pressure on interest rates.
Other factors, however, indicate interest rates will stay low. Aging, for instance, operates through the portfolio channel to decrease the interest rate. As baby boomers retire I would expect a rebalancing towards income portfolios, which would hold interest rates down.
Oil exporters made up at least 30% of the world’s combined current account surpluses in 2001-13, and a big fall in their saving is unlikely unless the price of oil collapses.
Another reason interest rates may stay low is that policymakers want it that way. Interest payments in Western Europe, U.S., and Japan, whose governments are deeply in hock, may become unsustainable if rates go up. To ensure the cost of debt stays low they may engage in “financial repression.” The term describes a host of fiscal and regulatory measures that work to hold interest rates down. One example is stuffing public pension funds and government-owned entities with sovereign debt; another one is capital requirements that nudge banks and insurers to hold Treasury securities.
Higher soon, uncertain later
So can we predict which way rates will go? I’m positive Tom Sargent’s discussion would be better than mine. But I bet his bottom line would be “No.”
If I must produce an outlook, I think real interest rates will go up through the next recession. In the short term monetary policy will steer market interest rates higher, especially at the Fed and the Bank of England. The European Central Bank and the Bank of Japan lag behind, but will eventually follow.
Beyond cyclical ups and downs, however, real interest rates are subject to multiple, moving forces. I began this essay with one question, and I end up with many more: Can India become the new locomotive of global investment? Will wage inequality keep rising? Will the return to capital exceed the rate of economic growth, thus widening income inequality? Will the renminbi become a convertible currency, thus expanding the potential supply of liquid, “safe” assets? Will internet-based technologies spur productivity growth, overcoming stagnation? Any one of these questions may shape the path of real interest rates.

Hansen, Alvin, 1939, “Economic progress and declining population growth,” American Economic Review, vol. 29, no. 1, pp.1-15.
International Monetary Fund, 2014, “Perspectives on global real interest rates,” World Economic Outlook, April 2014.
International Monetary Fund, 2014b, “Emerging markets in transition: Growth prospects and challenges,” Staff Discussion Note 14/06.
King, Mervyn, and David Low, 2014, “Measuring the ‘world’ real interest rate,” NBER working paper 19887.
Pettis, Michael, 2013, “Avoiding the fall: China’s economic restructuring,” Carnegie Endowment for International Peace.
Summers, Lawrence H., 2014, “U.S. economic prospects: secular stagnation, hysteresis, and the zero lower bound,” Business Economics, vol. 49, no. 2, pp. 65-73.

*This is an edited version of an article that will appear in the August issue of Morningstar Magazine. Morningstar Inc. is my employer.

Monday, July 7, 2014

Keynesian Yellen vs. Wicksellian BIS

Gavyn Davies writes an excellent summary of the debate between the"mainstream-central bank-Keynesian" view of the economy and the "alternative-BIS-Wicksellian" view. (It's on the blog section of the Financial Times, but I'm not sure if it's gated.)

Davies juxtaposes a recent speech by Yellen to the BIS annual report, both of which, I'm sure, are excellent readings.

Similarities between the two views:

There is agreement that financial crashes that trigger “balance sheet recessions” lead to deeper and longer recessions than occur in a normal business cycle. There is also agreement that inflation is not likely to re-appear any time soon, and that the current recovery should be used to strengthen the balance sheets of the financial sector through regulatory and macro-prudential policy.
Wicksellians and Keynesians have radically opposed views, however, on what caused the great financial crisis:
The BIS views the crash as the culmination of successive economic cycles during which the central banks adopted an asymmetric policy stance, easing monetary policy substantially during downturns, while tightening only modestly during recoveries[...]On this view, monetary policy has been too easy on average, leading to a long term upward trend in debt and risky financial investments. The financial cycle, which extends over much longer periods than the usual business cycle in output and inflation, eventually peaked in 2008[...]In contrast, the mainstream central bank view denies that monetary policy has been biased towards accommodation over the long term. Ms Yellen’s speech claims that higher interest rates in the mid 2000s would have done little to prevent the housing and financial bubble from developing. She certainly admits that mistakes were made, but they were in the regulatory sphere, where there was insufficient understanding of the new financial instruments that would eventually exacerbate the effects of the housing crash. Higher interest rates, she says, would have led to much worse unemployment, without doing much to reduce leverage and dangerous financial innovation.
Because central banks are using the "wrong model," their policies are inadequate, and even exacerbating some problems:
[...]even now, the BIS says that the central banks are attempting to validate the long term rise in debt and leverage, instead of allowing it to correct itself. Excessive debt, it contends, is preventing the rise in capital investment needed for a healthy recovery. Financial and household balance sheets need to be repaired (ie debt needs to be reduced) before this can take place.[...]The BIS argues that zero interest rates and quantitative easing are becoming increasingly ineffective in boosting GDP growth. Instead, they are artificially inflating asset prices, and blocking a necessary correction in excessive debt. Macro-prudential and regulatory policy might be helpful here, but will not be sufficient. The main risk is that the exit from these accommodative monetary policies may come too late.
The Yellen view is in sharp contrast to this. There is no admission that quantitative easing is becoming ineffective, or that excessive debt should be reversed [3]. There is an outright rejection of the view that interest rates have been too low throughout previous cycles. If anything, the “secular stagnation” argument is adopted, suggesting that real interest rates have been and remain too high, because the zero lower bound prevents them from falling as far as would be required to reach the equilibrium real rate. On this view, the danger is that the exit from accommodative monetary policies will come too early, not too late.
One massive difference between the two views of the economy is that the BIS would prefer to see a tightening of both monetary and fiscal policies, whereas Keynesians think that neither should be tightened "too soon." On fiscal policy:
This divergence of views on economic capacity leads in turn to a major difference on appropriate fiscal policy. The BIS implies that cyclically-adjusted fiscal policy is looser than it seems, because GDP can never return to its earlier trends. The Keynesian/Yellen view is that fiscal policy should not be tightened too soon, and perhaps not at all until output has fully recovered.

Tuesday, July 1, 2014

What caught my eye

1. Benjamin Friedman describes the perils of downsizing the central bank's balance sheet. It wasn't my first guess, though. Friedman argues that, by holding an assortment of assets, central banks have acquired a new tool to fine-tune monetary policy.

2. A three-part essay on alternative measures of inflation, on the website of the Atlanta Fed, by Mike Bryan, the father of the trimmed CPI and the median CPI.

3. Australia proposes to raise the retirement age to... 70! (on Bloomberg)

4. Excellent review of the consensus view why the "natural" interest rate has tumbled, by Larry Summers (via John Cochrane).

5. The TIOBE index: the most popular programming languages.

6. A comparison of programming languages in economics, by Aruoba and Fernández-Villaverde, from this week's batch of NBER working papers.

7. Can productivity rise forever? A partial discussion of the main issues, by Robin Harding at the FT.

8. Repeat after me: banks do not "lend out" reserves, by Paul Sheard at S&P, via David Andolfatto. David commented on Sheard's note, and was quickly corrected by Nick Rowe. David has now written a simple model to think through the issue of excess reserves and inflation risk. Don't you love economics blogs??

Friday, June 27, 2014

Chart of the week

Admit it: you keep an eye on the World Cup while at work. So do stock traders, apparently.

Bloomberg Businessweek relays the results of a paper by researchers at the European Central Bank, showing that stock market trading volume plunged, at least in some countries, during matches of the 2010 World Cup.

Here's the abstract of the paper, by Michael Ehrmann and David Jan-Jansen (the chart above is from Table 3b, page 28):
At  the 2010 FIFA World Cup in South Africa, many soccer matches were played during stock market  trading  hours,  providing  us with  a  natural  experiment  to analyze  fluctuations in  investor  attention.  Using  minute‐by‐minute  trading  data for  fifteen  international  stock exchanges, we present three key findings. First, when the national team was playing, the number of  trades  dropped  by  45%, while volumes  were  55%  lower.  Second,  market activity  was influenced by match events. For instance, a goal caused an additional drop in trading activity by 5%. The magnitude of this reduction resembles what is observed during lunchtime, and as such might not be indicative for shifts in attention. However, our third finding is that the comovement between  national  and  global  stock  market  returns decreased  by over  20%  during World  Cup matches, whereas no comparable decoupling can be  found during lunchtime. We conclude that stock markets were following developments on  the soccer pitch rather  than in  the  trading pit, leading to a changed price formation  process.
Aside from these findings, I found something else noteworthy. On pages 18-19, Ehrmann and Jan-Jansen report that the standard deviation of minute-by-minute stock returns across individual stocks declined significantly during matches. They interpret this result as that limited attention makes traders process less firm-specific information, relative to market- and sector-wide information.

If you don't believe in market efficiency, World Cup games might be a good time to trade.

Thursday, June 19, 2014

Four stories of quantitative easing

I strongly recommend this paper (no math, some jargon) to those of you interested in monetary policy. Brett Fawley and Christopher Neely walk the reader through the "quantitative easing" programs of the Big Four central banks (Fed, BoE, BoJ, ECB), from 2008 through 2012. Aside from the month-by-month, bank-by-bank chronicle, this paper provides great charts, tables, and links to the sources.

For a wider cross-section of central banks that have doubled the monetary base, dating back to the early 1990s, see Anderson, Gascon, and Liu (2010).

What I got from this reading:

1) There's a difference, at least in appearance, between "quantitative easing" and "credit easing." QE has as explicit target to expand, in a pronounced and persistent way, the liabilities of the central bank (i.e. the monetary base, or M0). QE can take the form of asset purchases or lending programs. Credit easing, on the other hand, intends to improve liquidity or the cost of credit, perhaps in specific credit markets. Credit easing may lead to an enlarged balance sheet, and that's often the case, but credit easing does not target an expansion of the monetary base.

2) Only some of the BoJ's and the BoE's programs can be properly described as QE policies, because they explicitly stated the goal to enlarge the central bank's liabilities. The Fed and the ECB have not formally engaged in QE. In practice, however, just looking at balance sheets, it's difficult to tell un-sterilized credit easing from QE. Fawley and Neely seem to lean towards considering that any policy that increases the monetary base substantially and for a long period is QE, whether as a stated goal or de facto.

3) An exhaustive list of references to the QE and credit easing programs implemented by those four banks through 2012.

Tuesday, June 17, 2014

What caught my eye

1. The Bank of Japan's balance sheet is about to get much, much bigger, by Sober Look, via the excellent MacroDigest.

Here is why. Credit Suisse for example projects that Japan's inflation rate has peaked and is about to begin declining. In fact CS researchers see a complete divergence between the BoJ's own projection of inflation and reality. A number of other researchers (for example Scotiabank) agree.
2. Big Ideas in Macroeconomics, by Kartik Athreya. Noah Smith's excellent, three-part review makes me want to read it.

3. Is this an example of financial repression?
Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10tn corporate bond market.
The article is somewhat ambiguous on whether the exit fees would apply only to corporate-bond funds or to government-bond funds as well.
4. An organization I didn't know about: OMFIF, or Official Monetary and Financial Institutions Forum. They put together commentary, analysis, surveys, conferences, etc. around central banking. This week they were in the news because they published a report showing that "public-sector institutions" (including central banks, public pension funds, and sovereign funds) are buying more and more equities. The report is not available online.

5. Speaking about central banks, I just signed up for the "Grand Central" newsletter, the WSJ's blogging service about, well, central banking.

6. Blog recommendation. A mysterious Jesse Livermore writes (mostly) about the stock market on Philosophical Economics. I particularly enjoyed this post, but I would say everything he writes is worth reading.

7. The macroeconomic effects of asset purchases, by Martin Weale and Tomasz Wieladek on VOX EU. I am skeptical of the VARs (how are shocks identified?), but here it is anyways.
Our results suggest that an asset-purchase shock that results in an announcement worth 1% of nominal GDP leads to a rise in real GDP of about 0.36% in the US and 0.18% in the UK; and to a rise in the CPI of 0.38% in the US and 0.3% in the UK. These findings are encouraging, because they suggest that asset purchases can be effective in stabilising output and prices. The implied UK Phillips curve is steeper than in the US, meaning that the same change in output would have a relatively greater impact on UK inflation. Quantitatively, monetary easing leading to a 1% rise in output results in a 1% rise in the US CPI, whereas in the UK the CPI rises by 1.5%. These estimates of the inflation–output trade-off are similar to those that previous studies reported for conventional (interest rate-based) monetary policy. Table 1 compares the implied effect on output and prices with that reported in previous studies of unconventional monetary policy. For real GDP, our reported figures are very similar to those reported in previous studies. For the US, we also find a similar effect on the CPI, but for the UK, our results suggest that the impact on the CPI is almost three times as large as the effect reported in Baumeister and Benati (2013) and Kapetanios et al. (2012).
8. A note on Piketty and diminishing returns to capital. Highly recommended by Tyler Cowen.

Friday, May 23, 2014

Chart of the week

The core PCE inflation rate has slowed down from 2% to 1% in two years. The chart above, from Bloomberg, shows the contribution to that decline of the inflation rate of different categories of personal consumption expenditures (vertical axis).

Health care services make the largest contribution to disinflation, about one third, in part because they have a large weight in the price index. This disinflation in medical services is thought to be a one-off, the result of lower Medicare reimbursements as part of the 2013 budget sequestration, and the expiration of patents on some drugs, which opened the floodgates to generic alternatives.

The category with the sharpest deceleration, however, in inflation (horizontal axis) was clothing. That seems to be the continuation of a decades-long trend of declining prices of apparel, as the share of imported clothing increases and prices of those imports decline.