Wednesday, January 30, 2008

The News Today, Oh Boy

A big day for macroeconomic news:

The BEA released its advance estimate of US output for 2007, reporting that real GDP grew by 2.2%, which is slower than the postwar average of 3.3%. The effect of the housing market implosion is evident in the 16.9% decrease in "residential fixed investment" which contributed -0.97% to overall GDP growth. With the aid of a declining dollar, exports increased by 7.9%, contributing 0.89% to the total (imports also rose, by a smaller amount, making for a total contribution of 0.55% from net exports).

The last quarter of the year was sluggish indeed, with an 0.6% annual growth rate. At that pace, growth is too slow to keep unemployment from rising, but as long as output growth is positive, we're not - technically - in a recession.

Inflation, as measured by the GDP deflator, came in at 2.7%, and the currently fashionable deflator for personal consumption expenditures excluding food and energy (i.e. "core PCE") increased 2.1% (and at a 2.7% pace in the 4th quarter.... is that a whiff of stagflation in the air?).

An important caveat - today's release was the "advance estimate," which will be followed by the "preliminary estimate" at the end of February and the final figure a month after that. (See also Krugman's observations, and James Hamilton's).

Later the same day...

The Federal Reserve announced announced a 50 bps (0.5%) cut in the target for the Federal Funds Rate, to 3.0%. This is only eight days after the surprise 0.75% cut last Tuesday (today was the regularly scheduled meeting for the FOMC). The Fed said:
Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

The Fed's short term concern is growth and employment, but it also has a mandate to keep inflation low (and, as ever, tension between those two goals). Even as the Fed pushes short-term rates down, the yield on 30-year US Treasury bonds has risen from 4.28% on Jan. 18 (before the 0.75% cut) to 4.44% today. Many things can influence rates, but this increase in the term component may be a sign that the Fed's apparent eagerness to keep growth growing with loose monetary policy has caused inflation expectations to tick upwards. Willem Buiter is not pleased:

By now, the neglect by the Fed of the price stability leg of its mandate no longer comes as a surprise. But even fully anticipated mistakes hurt. The US and the world economy will pay the price when, in due course, the Fed has to clean up the mess it is creating by its reckless pursuit of the maximum employment objective.
Also, Dean Baker makes an interesting point about the steepening of the yield curve.

Update (2/2): The Journal's Real Time Economics reports on the rise in inflation expectations, as measured by the yield on TIPS (Treasury Inflation Protected Securities) which are Treasury bonds whose value is indexed to inflation (see also Mankiw's comment).

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