Wednesday, March 1, 2017

Signs of contraction

Real estate and commercial and industrial loans have both flatlined since October.
Source

But, we need to raise rates, because if inflation reaches the target rate, Phillips Curve something something.

Looks like we might be operating in Strong Form IMH.  Defensiveness certainly seems prudent.

18 comments:

  1. Because 30yr expected inflation is at target levels and we most certainly do not want to get stuck in a 2007-style situation where inflation went from 2% to 5% in 6 months.

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    1. Energy inflation went to 20% while core inflation remained at 2-2.5%. I don't think that is generally identified as a context that calls for monetary tightening, even in hindsight, but certainly not prophylactically. Why would we do that?

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    2. I cut the 2008 Fed an ounce (but only an ounce) of slack because they probably were spooked by inflation numbers. One lesson we learned though from that incident is inflation expectations beyond 5 years are extremely firmly anchored regardless of how poorly the Fed is performing. Even in 2009 when inflation had turned negative, the 5 year inflation, 5 years forward moved very little from the 2% anchor.

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    3. I disagree. Inflation will usually (always?) look like a supply-problem. By definition inflation is going to occur where the market it tight and supply response is slow. Rent inflation will look like a zoning problem. Health inflation will look like a regulatory problem. Energy inflation will look like a geopolitical problem.

      When monetary policy is done properly that inflation is offset elsewhere. Oil goes up so you spend less on food and food inflation goes down...and you stay roughly at your inflation target.

      Further these supply side arguments are always asymmetric, in the direction of easier money. Where is the argument that 2% inflation is actually too high because we've had amazing supply growth in xyz? I've never heard that.

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    4. Normally, that would be the case. One reason I say that this is different is that most rent inflation is imputed. There is no cash transaction. So, in this case, there would not be an offset. Homeowners don't have $100 less in the bank because their imputed rent payment went up $100. This is why inflation excluding rent is a better indicator of monetary stance.

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    5. Even if i might agree with you in a strictly economic sense, this is terrible policy from a social perspective. Roughly 40% of the population does not own a home, and i'm sure lower income people are heavily represented in that group. To ignore rent inflation among the people who can least afford it is short-sighted.

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    6. That's the point of this. Rent inflation is a supply problem, and can only be solved by building homes. Exactly how is it helping low income households to create supply-side inflation in the category that takes up an especially large portion of their budgets, then to suck cash out of the economy in general? The only way to solve the problem you are talking about is to build homes. Surely it is not controversial at this point to point out that a decade of tight mortgage markets and low inflation don't fix that problem.

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    7. Ok, so let's say the current return on real estate development is 10%. After a bout of rent inflation (which somehow leaves land/building costs unaffected), that return becomes 12%. So we build homes until the return is back the prior equilibrium of 10%. At that point the math is exactly the same as it is today leaving similar supply growth but now higher rents.

      OK, you might argue that the rent inflation will cause overbuilding and therefore rents to fall below their prior level. But we know that central banks will respond to any significant drop in asset values with aggressive monetary stimulus. So that doesn't seem realistic (not to mention the negative knock-on effects of such a boom-bust).

      There is already ample financial incentive to build. There are a variety of other variables limiting supply. And in theory a few of those could be addressed without either punishing the renting population or encouraging boom-bust behavior.

      How has the renter gained in your scenario?

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    8. Over the past two years, this blog evolved into a project that amounted to empirically and conceptually discovering and explaining why everything in your comment is wrong.

      The only way rent could rise without a rise in building costs is if mortgage markets are obstructed so that middle and lower-middle income households are forced back into the renters' market. Places with structural rent inflation have politically imposed cost inflation. There is little supply response in those places to rising rents.

      Rent inflation is not related to overbuilding anywhere. Rent inflation comes from obstacles to building. The Fed didn't respond to dropping asset values with aggressive monetary stimulus. They caused the dropping asset values with monetary contraction.

      Housing starts were in sharp decline, and rent inflation was rising, for 18 months before prices collapsed. Prices didn't collapse because of too much supply or falling rent. Prices collapsed because monetary contraction caused financial markets to seize up.

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  2. I regret to say this is excellent post.

    Also note that due to IOER banks will be getting 1% for doing nothing....

    And the Fed will be loath to reverse course...

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  3. Ben, you would have "loved" the interview yesterday on MSNBC between Barney Frank and Becky Quick. They couldn't agree on why the banks are carrying $2 trillion in excess reserves, though both dismissed very quickly (less than one second) the idea that IOER was playing any role. "It's just 50 bps" was the quote. I was ripping my hair out.

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    1. Of course, if they did lend out $2 trillion where there is a gaping need for it - in mortgages - the Fed would contract the money supply because of macroprudential concerns, and Elizabeth Warren would be asking why they aren't in jail.

      Deposits have pretty much moved in an exponential line throughout this whole mess. Starting in 2008, some of those deposits basically were diverted from mortgage funding to excess reserves. Since the bottom of the contraction, C&I lending has been pretty much at expansion terminal velocity (until recently). But they can't make mortgages.

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    2. There is no such thing as excess reserves. The Fed chooses the level of reserves plain and simple. If a bank loans me $100 and I buy a shirt, the recipient of that sale puts $100 in their account and reserves are identical (albeit at different banks potentially).

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    3. Not all of that money comes back to the bank. Some remains in circulation as cash. I agree, though, that in the current context, the level of excess reserves is fairly arbitrary.

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    4. So, would you say it only matters in what direction the quantity of excess reserves are going (increasing or decreasing)?

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    5. Well, normally the amount of money created would be directly related to the interest rate target. But, it seems to me that now the Fed could keep IOR where it is, but they could change the amount of reserves outstanding by buying or selling treasuries, even while the rate remains the same. It just seems like there are more moving parts now, and especially with the repo program they are running that is taking some of those reserves, the level of excess reserves is not a dependable gauge of monetary posture. It seems like they could lower the rate while simultaneously selling treasuries.

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  4. https://www.greenstreetadvisors.com/insights/CPPI

    For Kexin, see above. Nice graph, and commercial property values have flatlined since August

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    1. Great news, Benjamin! Asset prices can only be too high, so we have to assume this is a long-awaited correction. Good to see the Fed get on top of this, FINALLY. :-P

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