How to avoid the horrors of ‘stag-deflation’

Nouriel Roubini writes in FT an Op-ed, "How to avoid the horrors of ‘stag-deflation’"

The U.S. and the global economy are at risk of a severe stag-deflation, a deadly combination of economic stagnation/recession and deflation. A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labor markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 percent level leading to concerns about deflation. The worst is not behind us: 2009 will be a painful year of a global recession, deflation and bankruptcies. Only very aggressive and coordinated policy actions will ensure the global economy recovers in 2010 rather than facing protracted stagnation and deflation.

For more click on this link.

More Bad News on Employment

Today's employment news is driving stocks down.
Nonfarm payroll employment fell sharply (-533,000) in November, and the unemployment rate rose from 6.5 to 6.7 percent. Job losses were large and widespread across the major industry sectors.
Here is the entry from the Financial Times.


US job losses steepest since 1974
By Joanna Chung in New York
Published: December 5 2008 14:05 Last updated: December 5 2008 17:05
The US economy lost a stunning 533,000 jobs in November – the largest monthly drop in more than three decades – as the unemployment rate jumped to 6.7 per cent, the labour department said on Friday.
Non-farm payroll data were far worse than expected by many economists, whose median forecast was that employers would shed about 340,000 positions in November.
The news sparked a fall in US stocks, with the S&P 500 down 1.6 per cent in early trade, the Dow Jones Industrial Average 1.5 per cent lower and the Nasdaq off 1.4 per cent. European stocks were also sharply lower.
The report marked the 11th consecutive month of job losses in the US economy, underscoring the severe impact the downturn is having on the labour market.
“Today’s figures seem awful, but we would stress that they are merely in line with what a number of indicators have been pointing to for months, and there could be an even bigger negative lurking out there in the months ahead,” said Rob Carnell, analyst at ING Financial Markets.
The National Bureau of Economic Research declared this week that the US economy has been in recession since December last year, but Friday’s figures, the latest in a string of grim economic data, suggest conditions are getting worse.
With upward revisions to both September and October showing sharper job cuts than previously reported, the economy has lost more than 1.2m jobs in the last three month alone, bringing the tally for the year to about 1.9m, the data showed.
October’s job losses were revised to show a fall to 320,000 compared with a previously reported loss of 240,000, while September’s losses were revised up to 403,000 from 284,000.
November’s job losses are the highest since December 1974. The month’s employment rate, which rose to 6.7 per cent from 6.5 per cent in October, was slightly lower than expected but still the highest reading since 1993, having risen 1.7 percentage points since December last year.
Service sector employment fell 370,000 in November while retail cut 91,000 jobs – further underlining the slowdown in consumer spending. But the job losses cut across a broad range of sectors, from manufacturing to construction to services.
However, in contrast to most industries, healthcare added jobs in November, with jobs rising 34,000, an increase of 341,000 so far this year.
The job losses were coupled with disheartening data for the broader market. The number of people who worked part-time for economic reasons – including those who would like to work full-time – continued to increase and reached 7.3m, having risen by 2.8m in the past 12 months. Though the average hourly earnings rose by 7 cents, or 0.4 per cent, the average work week fell by 0.1 hour to 33.5 hours.
President-elect Barack Obama said the job losses were ”more than a dramatic reflection of the growing economic crisis we face”, adding that a recovery plan was needed to ”save or create at least 2.5m more jobs over two years while we act decisively to maintain the flows of credit on which so many American families and American businesses depend.”
Grim news on the health of the US economy has emerged throughout the week. On Wednesday, other data showed that US service industries contracted by the biggest margin on record in November, while the private sector shed the most jobs in six years.
The situation reinforces widespread expectations that the Federal Reserve will cut the federal funds target rate, currently 1 per cent, even further when it meets later this month.
“Policymakers were given a new mandate to act decisively to address the economic and financial crisis today, with job losses moving to levels rarely seen,” said Tony Crescenzi, analyst at Miller Tabak.
“For its part, the Federal Reserve will make further forays into the realm of quantitative easing, and is now more likely to expand its programme of purchasing mortgage-backed securities and of targeting long-term interest rates.”
Copyright The Financial Times Limited 2008

Inflation is --- A Letter to a 10 year old.

Here is something interesting from the Foundation of Economic Education. It is response to a query from a 10 year old.

Inflation is ...

U.S. recession began in December 2007, NBER says

MarketWatch is reporting that it is official, the US economy entered into a recession in December 2007.
The U.S. economy entered a recession in December 2007, a committee of economists at the private National Bureau of Economic Research said Monday. The economy reached a peak in December and has been declining since, according to the business cycle dating committee of the NBER. The committee does not judge a recession as two consecutive quarterly declines in gross domestic product; rather, it looks at four key monthly economic indicators, including employment, industrial output and sales. Employment peaked in December.

Is the US too big to fail?

Why are investors rushing to purchase US government securities when the US is the epicentre of the financial crisis? Carmen and Vincent Reinhart, in "Is the US too big to fail?" attribute the paradox to key emerging market economies’ exchange practices, which require reserves most often invested in US government securities. America’s exorbitant privilege comes with a cost and a responsibility that US policy makers should bear in mind as they handle the crisis.This column attributes the paradox to key emerging market economies’ exchange practices, which require reserves most often invested in US government securities. America’s exorbitant privilege comes with a cost and a responsibility that US policy makers should bear in mind as they handle the crisis.

Bankers' strike

A responder to Krugman's post "Corporate cost of borrowing"writes:

Sigh. Yes, things are getting uglier. And, Paul, with all due respect and admiration, you have been missing the point by failing to analyze where we are in the crash-contraction-depression dynamic. You are running ahead to policy from, say, 1934.
We currently have a bankers’ strike (perhaps a tragic “I can’t help myself” strike, but still a management strike), which is acting exactly like a huge set of bank runs. The depression comes later; this is the contraction. Policy for the depression is not yet relevant; nor is a Keynes-Friedman debate.
Again, the FDR-era RFC physically replaced recalcitrant bank managers with Federal officers. Why is this not on the table? Couldn’t we cushion the contraction to some important degree by not choking off viable businesses access to capital? Remember, just-in-time finance was not in vogue in 1930. Our contraction is different. The bank strike kills good businesses; the demand recoil fully ices the deadly cake.
These bank managers–or their Federal agent replacements–simply have to write the “Yes We Can” lending memos or this is going to get much, much worse. Will some (some, a few, not “all” as some hysterics think) of the loans go bad? Of course, but so what? Compared to a further cascade of catastrophic failures it is simply not a big deal.
Economists fighting an irrelevant civil war while ignoring live policy options from history: Tell me how this is helping anything.
No offense I hope. And best of luck to all in these times.
–Jim in MN

Price-level targeting

Real rates are not declining inspite of the Fed's best effort. The high real rate is troubling to many, including Krugman and Mankiw. Mankiw proposes a way for the Fed to manage expectations, in the hope this will lower the real rate.

Here is one idea. Suppose the Fed cuts the federal funds rate once again to, say, 25 basis points. More important, at the same time, the Fed announces a target path for the price level as measured by the core CPI. The price path might be, say, an increase of 2 or 3 percent per year. The Fed promises not to raise the fed funds rate over the next 12 months and, after that, will keep the funds rate at that low level as long as the price level is significantly below its target path.The credibility of the promise is paramount. To get long-term real interest rates down, the Fed needs to convince markets that it will vigorously combat deflation, and that if deflation happens in the short run, the Fed will reverse it by subsequently producing extra inflation. A credible promise of subsequent price reversal after any deflation ensures that long-term expected inflation stays close to the inflation rate implied by the Fed's target price path. Monetary economists will recognize that this policy is price-level targeting rather than inflation targeting.