I’ve been highly skeptical of Christina Romer’s thinking since she came out with that egregiously poorly-reasoned paper (PDF) that got so much play a couple of years ago. But her NYT “Economic View” piece today seems cogent, lucid, and well-supported to me.
Basically: the emperors of theory-driven, sky-is-falling inflation hysteria are not wearing any clothing.
Although the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, shows virtually no change in long-run inflation expectations since the start of the program, the theorists hold fast to their concerns.
And she doesn’t even pull out the big guns to prove her point — the TIPS spread, which should be telling us the market’s best guess for inflation ten years out. (Click to build your own graph.)
Terrifying, huh? And who knows better than the market?
I do have one small problem with the piece, though it’s somewhat peripheral to the main thrust.
Reductions in American interest rates make domestic assets less attractive, reducing the demand for dollars and lowering the currency’s value in foreign exchange markets. This tends to decrease our imports and increase our exports, raising domestic production and employment.
This cuts straight to the core of my current hobby horse: she’s saying that lower interest rates make American financial assets less attractive. But by lowering the dollar’s value, they make real assets — like American factories and businesses — more attractive. It drives me crazy that even top economists use the term “assets” so sloppily.
The Inflation Debate That’s Muting the Fed’s Response – NYTimes.com. HT: Ramster
Comments
4 responses to “Christina Romer Gets It Right. Mostly.”
When I see a chart like this one, I like to look for trend lines by connecting either peaks or valleys. The down slope is easy to spot. I just eye-balled the peaks by holding the edge of a piece of paper against the computer screen. They fall on a straight line with something close to perfection. That sort of thing always amazes me, but I’m never surprised by it any more.
You don’t get a change in direction without a really convincing break of the trend line.
Cheers!
JzB
RE: “they make real assets — like American factories and businesses — more attractive.”
Agreed that she might have said “financial” assets, but her point is valid. She’s talking about the demand for US assets from foreigners. US investment flows from abroad are overwhelmingly into financial, not real assets (or so I believe — can you find data on this?). Thus the point: foreign demand for dollars is largely a function of the rate on US treasurys.
Or so I believe.
Thinking more about this, I realize that what she really means is:
Lower interest rates make it less attractive for foreigners to lend us money.
The only “assets” this statement really applies to is newly issued credit instruments. (i.e. Treasuries)
@Asymptosis
Not just newly issued treasurys [Weirdly, I’m told this is the correct spelling!]. All kinds of bonds. Most credit rates are tied to treasury yields. Think credit cards, commercial paper, short-term corporates and munis, mortgages, etc. So all types of credits become more attractive to investors when treasury yields rise. In addition, “used” bonds on the secondary market become more attractive as well, since their price drops as yields rise.