Kee Points with Jim Kee, Ph.D.

Fourth Quarter Real GDP increased at an annual rate of 2.8%. That was a little below most consensus estimates (there are multiple surveys that industry insiders point to as the consensus–WSJ, Bloomberg, etc), but inline with continued “modest” growth (to quote the Fed). In fact, 2011 was a year of continuously accelerating growth, starting with the first quarter’s abysmal .4 and continuing with 1.3% (Q2), 1.8% (Q3), and 2.8% (Q4). We expected the second half to be stronger than the first, but 2011’s overall real GDP growth rate of 1.7% was pretty weak. Modest gains in consumer spending and business investment were offset somewhat by weakness in government spending (that’s to be expected). Inventory rebuilding accounted for a good chunk (1.9%) of 4th quarter growth. By the way, this “inventory investment,” as it is called, can be a good omen or a bad omen. For example, inventories can grow because demand is slowing, which is bad, or they can grow because firms anticipate higher future sales, which is good. Anyway, looking to 2012, the Federal Reserve lowered its forecast slightly, from the 2.5%-2.9% range down to the 2.2%-2.7% range. I think that kind of spurious precision is silly. Call it “expected GDP growth somewhere between 2% and 3% for 2012.” That’s what we at STMM expect.


Europe continues its (hopefully) two steps forward, one step back routine. The consensus among global leaders last week at “Davos,” the Swiss World Economic Forum which holds its annual meeting in Davos, Switzerland, seemed to be that the most dangerous phase of the eurozone crisis could be over, largely due to European Central Bank President Mario Draghi’s efforts over the past few months to provide liquidity and funding to European banks. Let’s hope so. Tentative evidence for this is the fact that ongoing, if not increasing, concerns regarding Greek and Portuguese indebtedness have not lead to contagion fears as they would have a year ago. (Financial Times). Germany has warned Greece that it must “implement reforms, not just announce them.” It’s a little surreal to hear German Finance Minister Wolfgang Schauble cite U.S. research (Rogoff and Reinhart) suggesting that high public debt is a drag on economic growth. “I don’t know how it’s best done in America,” said Schauble, “but in Germany it works like this: If you want more private demand, you have to take people’s angst away” (referring to credible commitments to fiscal discipline–WSJ). I think that’s how it works in America too.


Another big story from last week’s headlines was the Federal Reserve’s FOMC (Federal Open Market Committee) statement. The Fed did two noteworthy – so bound to be misinterpreted – things. First, it specified projections for interest rates through 2014 and published the individual projections of the 17 officials who participate in the policy meetings. “Vintage Bernanke” is how this has been described, and rightly so. This is part of Fed Chairman Bernanke’s ongoing efforts to increase Fed transparency and to minimize the need for the private sector to be constantly guessing at what the Fed might do next. The second thing Bernanke did was more explicitly spell out inflation and unemployment goals. While other central banks like the European Central bank have explicit inflation goals, the Federal Reserve’s goals have had to be inferred. Here again, Bernanke is just trying to eliminate conjecture as to the Fed’s intentions, which should facilitate private sector decision making.


A little discussion on this point might help. The Fed has a so-called dual mandate to address inflation and unemployment. This was the outcome of the Humphrey Hawkins Act of 1978, which was written when both inflation and unemployment were rising. There seems to be a layman’s consensus that these two goals are conflicting, i.e. that controlling inflation is bad for unemployment, the so-called Phillips Curve trade-off. But many economists, and I’d count Bernanke among them, assert that the maximum (or optimal) impact that monetary policy can have on growth and employment is through price stability, which best facilitates production and exchange (which is how wealth is really created). So controlling inflation is also the most effective way to minimize unemployment. That’s what Bernanke meant last week when he stated that the goals of controlling inflation and maximizing employment are complimentary. The idea is that the Fed can’t create output and employment by playing with the money supply, or not permanently anyway. It can facilitate wealth creation, however, by ensuring the value and stability of the medium of exchange (money). That’s largely what Bernanke was alluding to last week when he said, “The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market.” It’s a point he’s been making softly for about two years now, namely, that slow growth and high unemployment is a fiscal policy problem.


The most interesting thing I saw last week: The Conference Board has changed the way it calculates its Leading Economic Index by, among other things, removing the M2 measure of the money supply and replacing it with a “Leading Credit Index.” It’s about time! Money supply figures are horrible indicators by themselves, as they can be demand driven or supply driven, with components that can be both endogenous (created within the economy) and exogenous (central bank). That’s all I’ll say on it for now, but if I start hearing bad reporting on this in the press (e.g. “a conspiracy to secretly cover up inflation!”, etc.), then I’ll surely address it in future Kee Points.