Thursday, April 7, 2011

FT Tidbits

In the Financial Times today, a couple of things caught my eyes. I can't link to the article due to the paywall, but hopefully, the statements will be clear.
- There was talk of a "two-track" economy in Ireland: the export-sector tens to do well while the domestic economy is facing credit constraints. The part that I found interesting was the introduction:
Garlester has a big order book, but local banks will not stump up the finance. 
Garlester is a "Small or Medium Enterprise"(SME). So this is an example for one firm, and the FT is not really expanding on the "order book" part. We can just read that the SME are credit constrained. You can have a look at the report from the Irish Small and Medium Enterprise Association(ISME), where we see that
  • 25% of respondents had requested a change in their banking facilities, similar to the previous quarter but significantly down on the corresponding period last year. 
  • 48% of companies who applied for funding in the last three months were refused credit by their banks, compared to 33% in the previous quarter.
  •  79% of firms outlined that the banks are making it more difficult for SMEs to access finance, a deterioration on the 68% in the previous quarter.

 The first bullet point seems to contradict the "full order book" story, in the sense that the number of firms asking for credit is low. The credit story is picked up in the second and third point. Still, I am not clear on the first bullet point, in the sense that I am not sure it is explicitly linked to a low demand from firms. What is sure is that the US, the access to credit is fine, but demand is still quite low, though consumption has picked up. I am trying to find more things on this. I'll come back to that later.
- The second issue was about the different central bank behavior on both sides of the Atlantic. A short comment mentions that the Fed and the Bank of England consider that prices are soaring because of temporary shocks on which monetary policy can have no impact, while the ECB and the People's Bank of China consider that loose monetary policy is responsible for the spike in food prices. The journalist says, rather vaguely, that
much of the world still operates as a US dollar block, so emerging economies are indeed affected by monetary decisions in Washington
The conclusion is that "oil is the new interest rate": because the Fed and the BoE are not changing their interest rates, the cyclicality is transfered to commodity prices.

There are a couple of things here, that I'll write quickly, and I'll try to see if I can find data later(so for now, do not take this as my definitive point.). First, unemployment is still high in Europe(though it is at a low point in Germany), and wage growth has not picked up. So a "loose monetary policy" from the ECB would have no large impact on inflation. Second, the article seems to consider import prices for Europe, since he mentions oil and dollarization. However, there is no link to the domestic prices, and given that Europe intra-trade account for 2/3 of the overall European trade, I don't see how the Fed policy could impact European inflation by a lot.
Also, I REALLY don't understand how the ECB and the PoBC can be put in the same basket. It's not like the two are facing the same economy, the same housing market or the same inflation or the same growth

I've always felt that the increase in food prices was driven by the drought in China and Russia, and that the rise in oil prices was due to a rise in demand from developing countries. So I am a bit reluctant to accept the argument made by the FT vaguely above, but I should look into this.
For now, I'll refer to Krugman. First, core inflation is not rising, but headline inflation is. Core inflation is the focus of the Fed, headline inflation is the focus of the ECB. However, there is no clear link between headline inflation and core inflation if the drivers of headline inflation are temporary. For instance:
 other things we buy, even if they seem to have a large commodity component, are actually made mainly out of labor and other sources of value-added.
Krugman follows by showing that wheat accounts for around 12% of the cost of bread.

Second, core inflation is stable:

Data only goes to 2010M12, but I'll try to get data on 2011Q1. Third, I think, wages are not growing. I'll post data on this if i find them. So the sticky prices and wages are not moving. Krugman:
 it's [this] category that is subject to inflation inertia, and therefore where you have to worry that inflation or deflation can get baked into the economy, and become hard to undo.
More precisely

The key thing about these less flexible prices — the insight that got Ned Phelps his Nobel — is that because they aren’t revised very often, they’re set with future inflation in mind. Suppose that I’m setting my price for the next year, and that I expect the overall level of prices — including things like the average price of competing goods — to rise 10 percent over the course of the year. Then I’m probably going to set my price about 5 percent higher than I would if I were only taking current conditions into account.
And that’s not the whole story: because temporarily fixed prices are only revised at intervals, their resets often involve catchup. Again, suppose that I set my prices once a year, and there’s an overall inflation rate of 10 percent. Then at the time I reset my prices, they’ll probably be about 5 percent lower than they “should” be; add that effect to the anticipation of future inflation, and I’ll probably mark up my price by 10 percent — even if supply and demand are more or less balanced right now.
Now imagine an economy in which everyone is doing this. What this tells us is that inflation tends to be self-perpetuating, unless there’s a big excess of either supply or demand. In particular, once expectations of, say, persistent 10 percent inflation have become “embedded” in the economy, it will take a major period of slack — years of high unemployment — to get that rate down. Case in point: the extremely expensive disinflation of the early 1980s.

The bottom line is: I don't buy the impact of the US monetary policy on European inflation

- Finally, there is a nice summary of what's going on in Russia, related to what I talked about yesterday.
In it, Neil Buckley writes
It is clear the starting gun has been fired for presidential elections just under a year from now. (...) Opinion polls show support for both men, still high by western standards, has fallen to its lowest for several years
The journalist sees two possible reasons for the recent skirmishes between the top Russian couple: it is either positioning for the next election(which sounds intuitive), but it could also be "an attempt to stimulate interest among Russians who are wearying of tightly controlled politics(...) The ostling may be an attempt to prevent either figure becoming a lame duck"

Anyway, as I said, it's something to follow, I think.

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