There were four posts yesterday. The first was “PPP and Japanese Inflation Expectations (Extremely Wonkish):”
I’m doing a bit of work on Abenomics, which will surface in a week or so. One thing I discovered along the way is that nobody much likes any of the existing measures of inflation expectations, as this New York Fed post by Mandel and Barnes explains. In particular, the Japanese market in inflation-protected securities is considered too thin to rely on.
Mandel and Barnes, building off work by Goldman Sachs, suggest an ingenious workaround: they use inflation expectations inferred from US TIPS, then adjust by the forward exchange rate. The idea is that relative purchasing power parity more or less holds in the long run, so you can assume that Japanese inflation equals US inflation plus change in the exchange rate. And since the forward premium is basically equal to the interest-rate differential, this in turn means inferring Japanese inflation expectations as equal to the US TIPS spread minus the difference between US and Japanese rates.
It’s a clever idea, but I think incomplete. There is strong evidence that real exchange rates are mean-reverting (pdf), and you should take that into account too. Estimating the rate of mean-reversion is tricky, but we can more or less sidestep this by looking at long-term expectations: after a decade, we can expect the bulk of any deviation from the norm to be eliminated.
You may ask, what is the long-run equilibrium real exchange rate? Interesting question, but not one we need to answer if we’re just trying to assess the impact of Abenomics, where what matters is the change in inflation expectations on Abe’s watch.
So here’s what I did: I took the implied 10-year breakeven inflation rate from US TIPS, minus the 10-year interest rate differential, plus the real appreciation Japan would experience if the real exchange rate against the dollar 10 years from now were to return to its level in January 2010. You can adjust this as you like with whatever your estimate of the difference between the 1-2010 rate and the equilibrium rate is; it will just shift the line up or down. Here’s the result:
I have my doubts about the apparent decline in recent months. It’s being driven not by events in Japan but by the taper scare, which drove up US rates. There is a question about why that rise in US rates didn’t produce a lot more yen depreciation, but something seems off here.
The main point, however, is that this measure does suggest a substantial rise in expected inflation since Abenomics began, which is good news.
The second post yesterday was “The Economics of Rip Van Winkle:”
Binyamin Applebaum’s piece on the growing acknowledgment that moderate inflation can help, especially under current circumstances. But I can’t help thinking, only now they notice? I mean, this was all worked out and carefully explained fifteen years ago.
Oh, and the hard thing now is how you get inflation when we’re already at the zero lower bound. You really want this tied to expansionary fiscal policy, not austerity.
Still, any intellectual forward motion is welcome.
Yesterday’s third post was “Currency Regimes, Capital Flows, and Crises (Wonkish):”
Update: Link fixed
What I’ve been working on, in draft, here. For afficionados of modeling, the hard part was section 3, the miniature New Keynesian model — it took me a long time to find assumptions that made complicated dynamics boil away, and let me concentrate all the action in period 1 (which is what I wanted for my purposes.)
I’m not sure whether everyone will find this persuasive — but if you disagree, show me the model! Much as I respect Antonio Fatas, he still hasn’t done that; Brad DeLong is left trying to do his modeling for him.
Anyway, these times we live in make for interesting economics; too bad the actual policies have been so disastrous.
The last post yesterday was “Sheiks and Princelings and Beeznessmen, Oh My:”
Joe Weisenthal tells us who’s buying all those incredibly expensive London residences. It’s not the locals:
New York is experiencing a similar transformation into a global rentier city, although my sense is that it hasn’t gone nearly as far down that road.
It’s going to present an interesting conundrum for Bill de Blasio: He seems set to win the mayor’s race by a huge margin of New Yorkers, but he’s be governing a city where a lot of the wealth was generated somewhere else and resides in NYC for the amenities (which include the ability to rub shoulders with other rentiers.) So he needs to milk these people, but not too hard.
I guess it’s better than being Detroit.