1. On January 1, unless preventive legislation is enacted beforehand, the U.S. economy will be gripped by a fiscal contraction equal to 41/4% of GDP. Some fiscal drag is inevitable in 2013, and a little more than ⅓ of the potential fiscal contraction already is reflected in MA’s forecast that GDP will grow at a modest 2.3% rate during the first half of next year. However, unless averted by a budget deal, the U.S. faces a spending “sequester”, the “sunset” of the “Bush tax cuts”, and a sharp widening in the reach of the Alternative Minimum Tax (AMT), none of which are assumed in our forecast. 

    Failure in Washington to reach an accord that avoids these additional elements of the “fiscal cliff” would compel us to mark down sharply our forecast for GDP growth in 2013. Absent an accord, and despite offsetting declines in interest rates and commodity prices, GDP would contract in the first half of 2013 and grow just 1.1% over the four quarters of the year. The unemployment rate, rather than trending down towards 7.5% by the end of 2013, would rise to 8.5%. 

    Following a fall off the cliff, GDP would, as early as 2014, grow faster than under a “grand bargain” and with less debt. That, however, doesn’t make the cliff a bargain. Our simulations suggest that under a “cliff” scenario, the federal primary budget would move into surplus by 2018, and the ratio of debt to GDP could fall below 60% by 2021.  However, GDP would be lower and unemployment higher for a decade. This is partly the result of the extra fiscal drag and partly the result of higher marginal tax rates. The lost output would amount to 10% of this year’s GDP, a high price to pay for the inability to manage fiscal policy effectively. The distributional outcome would be different — and likely less desirable — than that associated with a negotiated, balanced approach to deficit reduction.

    Parsing the Effects of the Fiscal Cliff

    We’re often asked how much of a drag on growth is associated with each of the provisions of current law that usually are described as comprising the fiscal cliff. The table below presents such results for the four quarters of 2013 and the year as a whole in descending order of importance. These simulations were generated with MA/US, our recently updated macro model, assuming the model’s endogenous monetary offset but holding oil prices along the baseline path and making no judgmental adjustments in the model to other financial conditions. Each provision was simulated separately, so the total reported in the table excludes interaction effects between the provisions. The largest two items are — not surprisingly — the expiration of the Bush tax cuts (-1.15 percentage points of GDP growth over the year) and the spending sequester (-0.76 percentage point of GDP growth). At the bottom of the list, the new taxes enacted as part of the Affordable Care Act will subtract less than one-tenth of a percentage point from growth over 2013. In total, the maximum potential hit to growth from the fiscal contraction is 3.4 percentage points over the entire year, but more than 5 percentage points in the first half of the year. Our baseline forecast includes roughly 11/4 percentage points of the total possible hit to growth.


    Click here to download the complete report.
    Posted by Unknown
    Labels: fiscal cliff fiscal policy Joel Prakken

  2. The size of the Fed's balance sheet hardly changed between mid-September-when QE3 started-and the end of October. What happened to QE3?

    Rest assured, the Fed has been implementing QE3 as advertised. There are two reasons why the balance sheet was little changed last month.

    This is from a commentary that was published on November 20, 2012.

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    Posted by Unknown

  3. As we approach the fiscal cliff, attention is focused on what the FOMC will do and say on the way to and possibly over the cliff.

    The macro effects of the cliff would be far too large for the FOMC to offset over any reasonable period. The Chairman has said so repeatedly.

    This is from a commentary that was published on November 16, 2012.

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    Posted by Unknown


  4. General Points

    We expect that  some economic activity will be delayed several days or even weeks, but this is an intra-quarter story with no impact on Q4 GDP growth.

    The value of property destruction itself is not a negative in GDP. For example, if a factory with a market value of $1 billion is destroyed, GDP does not go down by $1 billion – although insurance company profits could!

    The destruction of that factory does reduce GDP by the value of the goods that otherwise would be produced in that factory (per year), but this is usually much smaller than the property loss itself.

    The rebuilding of the destroyed property is a positive in GDP, probably /spread over a year or two, but starting almost immediately.

    Historical Comparison

    Katrina is the grand-daddy of all US storms.
    • BEA: losses were about $110 billion ($90 bil private, $20 bil govt) in private and public capital; Insured losses of around $80 billion. 
    • CBO: Reduced GDP growth by about half a point in 3rd and 4th qtrs of 2005.
    • Rebuilding was spread over several years.
    • But the initial disruption was centered in the gulf energy industry and there were upwards of ½ million laborers displaced for a considerable period of time. 
    For Sandy, we're seeing initial estimates of $5-10 bil in damages.

    This is far less than Katrina and with no real hit on energy industry or longer-term displacement of workers.

    Bottom Line

    Sandy might reduce GDP growth by 0.1 - 0.2 percentage points, with a lot of that reduction being made up starting as early as within Q4 of 2012 and Q1 of 2013.

    The storm is terrible news for individuals directly affected, but not a big macroeconomic story.

    Our thoughts and prayers are with everyone in the storm's path.


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    Posted by Unknown

  5. The outcome of this election will almost certainly affect the conduct of monetary policy.
    • We assume that, if President Obama is re-elected and Ben Bernanke does not seek or is not offered another term, Janet Yellen will be nominated to be Chair of the Federal Reserve Board (and thus also of the FOMC).
    • If Governor Romney is elected, he will most likely nominate one of his two principal economic advisers: Glenn Hubbard or Greg Mankiw. John Taylor, another adviser, would surely also be on the short list.

    In three of the four cases, the prospective Chairs have written down a simple policy rule that would inform their policy decisions.
    • We have previously distinguished between dovish and hawkish rules.  
    • Dovish rules portray recent and current policy as restrictive, notwithstanding the prevailing near-zero funds rate. Hawkish rules portray policy today as too stimulative.
    • Dovish rules embed a much more aggressive response to departures from full employment than do hawkish rules.
    • Dovish rules prescribe a later first rate hike than do hawkish rules.

    Using these rules as proxies for policy preferences, we can place three of the prospective Chairs along the dove-hawk continuum.
    • Taylor is unquestionably the most hawkish. His rule embeds a modest response to departures from full employment. The FOMC would already have raised rates under his rule.
    • Yellen is the most dovish. Based on her rule, policy should respond aggressively to departures from full employment, and the first rate hike would still be two years away.
    • Mankiw is somewhere in between. While his rule, like Taylor's, allows for only a modest response to departures from full employment, it nevertheless prescribes a later first rate hike that is still one year away.
    • While Glenn Hubbard has not written down a rule, his recent comments reveal that he is not as hawkish as Taylor, not as dovish as Yellen, but likely somewhat more hawkish than Mankiw.
    This is from a commentary that was published on October 10, 2012.

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    Posted by Unknown
    Labels: Antulio Bomfim Ben Bernanke FOMC FOMC Chatter Janet Yellen Laurence Meyer Mitt Romney monetary policy MPI Policy Focus QE

  6. Contact Macroeconomic Advisers
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    Labels: ADP Employment Report Joel Prakken TV

  7. In what must be one of the most dramatic shifts in policy positions in the history of the FOMC, President Kocherlakota changed teams today, moving from virtual “captain” of the “hawk team” to perhaps the new captain of the “dove team.”
    • President Kocherlakota said in a speech in May 2011 that, under his baseline forecast, “it would be desirable for the FOMC to raise the fed funds target by a modest amount toward the end of 2011."
    • He used the Taylor rule to defend his earlier view, noting that the unemployment rate had fallen and inflation had risen over the previous year. Nothing that has happened since contradicts this logic, however faulty it may be.
    • In contrast, today, President Kocherlakota offered a “liftoff plan” that calls for the Committee to indicate that, provided longer-term inflation expectations remain stable, it “will not raise the fed funds rate unless the medium-term outlook for the inflation rate exceeds a threshold value of 2-1/4 percent or the unemployment rate falls below a threshold value of 5.5 percent.” He said that the first rate hike “may not take place for four or more years.”
    • The forecast of FOMC members (midpoint of the central tendency range) is that the inflation rate should remain stable at or just below 2% through 2015. Our own forecast is that inflation will not surpass 21⁄4% even as the unemployment rate falls toward 51⁄2%, which might not happen until 2016 or 2017!
    • So President Kocherlakota’s proposal is very dovish. It could actually work, if longer- term inflation expectations remained stable. But that’s a very big if.
    President Kocherlakota’s liftoff plan reflects a remarkable transformation because he had been one of the most aggressive members of the Committee in arguing that the economy might already be at or near capacity.
    • His earlier view was based on the prospect that structural factors had raised the NAIRU, perhaps to the point where there was no unemployment or output gap.
    • Indeed, he said in August 2010 that much of the current unemployment rate is due to “mismatch that is not readily amenable to monetary policy.” In that case, further monetary stimulus could only raise inflation.
    President Kocherlakota’s transformation apparently reflects the  gravitational pull of President Evans, next to whom he sits around the FOMC table, or so Kocherlakota quipped.
    • Larry is surprised by this comment since sitting next to Bob McTeer at the FOMC table for several years never made Larry any funnier!
    • In any case, President Kocherlakota says he has moved toward the spirit of the Evans 7/3 proposal. Both the Evans and Kocherlakota proposals set a numerical trigger for the unemployment rate and a tolerance zone for short-run departures of inflation from its medium-term target.
    • Both the Evans and Kocherlakota proposals are forms of “outcome-based” forward rate guidance, as distinguished from “calendar-based” rate guidance. That is, the timing of the first rate hike is determined not by a publicly announced calendar date but by well defined economic outcomes.
    • Kocherlakota says the unemployment rate is a threshold, not a trigger, because the Committee always retains the option of keeping rates exceptionally low or raising the funds rate. Threshold, trigger, pick your poison. Trust us, it is a trigger!
    President Kocherlakota advanced the ball with his talk today, even if his proposal is (deservedly) dead on arrival, deader than a doornail!
    • He has come out firmly for outcome-based guidance. We expect this is a direction that the Committee more generally is moving toward.
    • However, President Williams said it best: “That's harder to do than to say.” The Evans and Kocherlakota proposals are examples that prove that point!
    Both have a “no-tolerance” policy with respect to the stability of longer-term inflation expectations. Or do they?
    • Measuring longer-term inflation expectations is very difficult. There are many measures—survey-based and market-based—each with its own problems.
    • So there is a gray area here, and neither has actually said whether or not there is a tolerance zone with respect to measures of longer-term inflation expectations. If there is one, we suspect that it is narrower than the one for medium-term projected inflation.
    The two proposals have different numerical triggers for the unemployment rate.
    • The numerical trigger in the Evans proposal is 7%. That seems to us a very reasonable judgment, given that the FOMC’s consensus on the NAIRU is about 51⁄2%.
    • The Kocherlakota trigger is 51⁄2%, the same as FOMC participants’ median forecast of the unemployment rate over the long run. Even assuming he believes that the NAIRU is 51⁄2% (rather than, say, 4%), his choice of an unemployment rate trigger seems odd: Stay exceptionally accommodative until the economy reaches full employment?!
    The two proposals also differ in the width of the tolerance zone.
    • Evans would be willing to tolerate inflation as high as 3%; that’s a lot! Kocherlakota would be willing to tolerate inflation as high as 21⁄4%; that’s not much!
    • President Kocherlakota’s narrow tolerance zone is a protection, to some degree, relative to the very low numerical trigger for the unemployment rate.
    • But this protection makes his proposal hard to fathom. One should pick a tolerance zone that one believes is wide enough to be consistent with the numerical unemployment rate trigger.
    • The Kocherlakota proposal would make market participants scratch their heads, perhaps to the point of baldness!
    We would like to be matchmakers and marry the Evans and Kocherlakota proposals.
    • Given the current state of the economy, substantial uncertainty about the macro outlook, and the risks to the stability of longer-term inflation expectations, we find the Evans tolerance zone for inflation too wide.
    • We believe that most FOMC members agree with our assessment of the Evans proposal and, we suspect, that’s why President Evans has not gotten much traction, even though his basic idea is appealing, if not compelling.
    • In contrast, President Kocherlakota’s numerical trigger for the unemployment rate is too low. This would be even more unacceptable to Committee members than the Evans threshold for inflation tolerance.
    • Here is our proposal: a 7/21⁄2% plan: Keep the funds rate where it is today for as long as the unemployment rate remains higher than 7%, provided inflation remains below 21⁄2%, and, of course, longer-term inflation expectations remain stable.
    We are big fans of outcome-based guidance, but it may be hard to change communication horses so soon.
    • While one can translate a calendar-based guidance into an implicit outcome-based guidance for the unemployment rate, there is no information about the tolerance zone for inflation.
    • A calendar-based guidance has to be regularly changed as the forecast changes. Outcome-based guidance remains in place until the triggers are breached.
    • Outcome-based guidance allows the market to learn about the FOMC’s reaction function.
    • Nonetheless, the FOMC moved to a calendar-based guidance only about one year ago, and the Committee might have a hard time agreeing on the relevant numerical thresholds. (Perhaps, members should take turns sitting next to President Evans!)

    Interested in reading more of Larry Meyer's analysis of the FOMC?
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    Posted by Unknown
    Labels: doves Evans FOMC hawks Kocherlakota





  8. Monthly GDP rose 0.7% in July following a 0.2% increase in June that was revised up by two-tenths.  The sharp increase in July was more than accounted for by a large increase in nonfarm inventory investment.  Outside of nonfarm inventories, declines in net exports and capital goods were partially offset by an increase in PCE.  Monthly GDP in July was 3.4% above the second-quarter average at an annual rate.  Our latest tracking forecast of 1.7% GDP growth in the third quarter includes a 0.7% decline in GDP in August--reflecting an assumed sharp decline in nonfarm inventory investment--and a 0.2% increase in September.






    This is based on a commentary that was published on September 18, 2012.

    Macroeconomic Advisers’ index of Monthly GDP (MGDP) is a monthly indicator of real aggregate output that is conceptually consistent with real Gross Domestic Product (GDP) in the NIPA’s. The consistency is derived from two sources. First, MGDP is calculated using much of the same underlying monthly source data that is used in the calculation of GDP. Second, the method of aggregation to arrive at MGDP is similar to that for official GDP. Growth of MGDP at the monthly frequency is determined primarily by movements in the underlying monthly source data, and growth of MGDP at the quarterly frequency is nearly identical to growth of real GDP.


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  9. The U.S. is experiencing one of the worst droughts in recent history.  While the farm sector directly accounts for only about 1% of the U.S. economy, the hit to farm output is likely to be large enough to have a noticeable impact on U.S. GDP.  We estimate that a sharp drop in farm inventories as a direct result of the drought will shave just over ½ percentage point from GDP growth in the second half of this year.  This effect will be quickly reversed early next year.  Furthermore, a rise in the price of food late this year and into next year will lower real income and wealth enough to shave an additional one-tenth from GDP growth in the fourth quarter of this year and the first quarter of next year, with this effect gradually reversing as prices return to baseline.  In this Macro Musing, we discuss how we arrived at these estimates.

    Project 2012 NIPA farm value added using USDA projections    .  The U.S. Department of Agriculture (USDA) prepares detailed projections of several measures related to farm income.  Included in the details are receipts from sales of crops and livestock, purchases of inputs, interest expenses, spending on contract and hired labor, etc.  BEA uses these data to estimate value added in the farm sector.  While it’s not possible to reproduce BEA figures with precision — some of the data are unpublished, and BEA makes some adjustments — we can arrive at reasonable estimates. USDA’s August 28 detailed projection of 2012 farm income and related measures suggests nominal value added in the farm sector of $133.5 billion for 2012, down 3.7% from 2011.


    Fill in Q3 and Q4 2012 farm value added given 2012 projection and published values for Q1 and Q2    .  Using BEA’s published estimate of nominal farm value added for the first half of this year, we judgmentally filled in values for the third and fourth quarters to hit the 2012 annual total.  This resulted in a 17% annualized decline in nominal farm value added from the first half of 2012 to the second half.

    Project farm prices using USDA reports.  Implicit in USDA’s projection for 2012 receipts from farm sales are projected prices for crops and livestock.  From various USDA reports, we compiled forecasts for prices of corn, soybeans, wheat, cattle, hogs, and milk.  Historically, variation in these prices has accounted for the majority of variation in overall farm prices.  We used these projections to generate a forecast of the price index for NIPA farm value added.  From the first to the second half of this year, we project a 26% annualized increase in the price index for farm value added.
    Deflate Q3 and Q4 2012 nominal farm value added with the projected NIPA price index to arrive at real farm value added in Q3 and Q4 of 2012.  The quarterly profiles we assume for nominal farm value added and the price index in the third and fourth quarters imply that (annualized) real farm value added will decline $14 billion (46% annual rate) in the third quarter and $12 billion (46% annual rate) in the fourth quarter.

    Project real farm value added over 2013 and 2014    .  Over the last 35 years, real farm value added has trended higher at roughly a 3% annual rate.  Chart 1 shows the log of real farm value added along with this trend over history and in our forecast.  Notice that farm output dropped sharply from 2010 to 2011, reflecting drought conditions last year.  Our projection for real farm value added shows recovery over 2012 and 2013 that reverses not only the effects of this year’s drought, but last year’s drought, too.

    A quick aside on GDP, value added, and spending.  Nominal GDP is the sum of value added across all producing sectors of the economy. It is also the sum of final sales and inventory investment across all goods and services, regardless of the producing sector.  Any change on the value-added side, therefore, must be matched in magnitude by a change on the spending side.  A drop in nominal farm value added, in particular, holding constant value added in other sectors, must be matched by a drop in nominal spending on final goods and services or inventories (or some combination of the two).  In real terms, though, this is only approximately true, because real GDP is not additive across components of real value added or across components of real final sales and inventory investment.  A change in real value added in one producing sector, holding constant real value added in the other producing sectors, need not be matched exactly by a drop in real final sales or inventories.  But the correspondence usually will be close.

    Estimate the response of farm inventories to the decline in real farm value added    .  We assume that the direct hit to real farm value added is reflected on the spending side in farm inventory investment only.3  Furthermore, rather than assuming that the hit to real farm value added is absorbed exactly by farm inventory investment, we estimate the response of farm inventory investment using our error-correction model that links real farm inventories to real farm value added.  This allows for the possibility of an effect on the spending side (in real farm inventory investment) that is different from the direct effect on real farm value added.4  Finally, we judgmentally adjusted down the prediction of our model for farm inventory investment over the second half of this year by an average amount equal to 1½ standard errors of the model.  We did this to move the estimated hit to real farm inventory investment close to our estimate of the hit to real farm value added.

    In our forecast, real farm inventories decline at an annual rate of $14 billion in the third quarter and $30 billion in the fourth quarter.  (See the section of Table 1 titled “Forecast Including Direct Impact of Drought.”)  This would follow declines in the first and second quarters averaging about $2½ billion per quarter.  Were it not for the drought, our model of farm inventories would have predicted a $2 billion annualized increase in farm inventories in the third quarter and a $4 billion increase in the fourth quarter.  (See the section of Table 1 titled “No 2012 Drought Baseline.”)  The difference between the drought and no-drought projection for the level of farm inventory investment in the third and fourth quarters is $16 billion and $34 billion, respectively (Table 1, “Direct Impact of Drought”).  The difference between the drought and no-drought projection for the change in farm inventory investment in the third and fourth quarters is $16 billion and $17 billion, respectively, implying subtractions from GDP growth in the third and fourth quarters of 0.6 percentage point per quarter (relative to the no-drought baseline).  This is our estimate of the direct hit to GDP growth from the drought.

    Early next year, as conditions are assumed to return to normal, real farm value added rises quickly (see Chart 1) and real farm inventory investment rises rapidly.  The contribution to GDP growth in the first quarter of next year is nine-tenths, and the contribution in the second quarter is five-tenths.  The level of real farm inventory investment rises above baseline to begin rebuilding depleted farm inventories.

    Estimate the indirect effect of higher food prices    .  While prices received by farmers are expected to rise substantially from the first to the second half of this year, retail prices for food are expected to rise considerably less.  This is because raw materials (grain and livestock) account for only a small share of the cost of finished foods.  Other costs include processing, packaging, transportation, advertising, retail margins, and so on.  In late August, the USDA projected that the CPI-U for food at home, on a year-over-year basis, would rise from 2.5% to 3.5% in 2012 and 3.0% to 4.0% in 2013.  We filled in a reasonable monthly profile for the CPI-U for food at home that hits the middle points of these ranges to generate Chart 2, which shows the 12-month percent change in the CPI-U for food at home as projected by USDA (including the effects of the drought) and, for reference, the 12-month change that would result were the CPI-U for food at home to rise from August forward at the rate it has risen on average over the last 20 years (0.22% per month).


    Using a relative importance of 0.07, which is roughly the nominal share of food and beverages purchased for off premises consumption in total PCE, we estimated the boost to annualized quarterly growth of the PCE price index implicit in the difference between growth of the CPI-U for food at home in USDA’s forecast and the no-drought alternative.  That boost is about 0.1 percentage point in the third quarter of this year, 0.4 percentage point in the fourth quarter, and 0.2 percentage point in the first quarter of next year.  (See the section of Table 1 titled “Indirect Impact of Drought from Higher Food Prices.”)  After that, the boost turns into a subtraction of one- to two-tenths over several quarters (as prices return to baseline).  We simulated the effects of this boost to the PCE price index using our macroeconometric model and found that GDP growth was reduced by one-tenth in the fourth quarter of this year and by one-tenth in the first quarter of next year.  The contribution to GDP growth rounds to zero over the balance of next year.  Combining this with the direct impact of the drought, we estimate that annualized GDP growth will be reduced by six-tenths in the third quarter and by seven tenths in the fourth quarter (Table 1, section “Total Impact of Drought”).  During the first half of next year, assuming conditions return to normal, GDP growth will be boosted by an average of seven-tenths per quarter.



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    Posted by Unknown
    Labels: agriculture drought GDP Macro Musing

  10. Contact Macroeconomic Advisers
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    Labels: Ben Herzon GDP inflation
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