January 31, 2010

China’s strident tone raises concerns among Western governments, analysts

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An example would be events that unfolded in December when 22 Chinese Muslims showed up in Cambodia and requested political asylum. China wanted to hold seven of them on suspicion of participating in anti-Chinese riots in the Xinjiang region in July.

Under intense pressure from Beijing, Cambodia sent the group home, despite protests from the United States. Two days after the group was repatriated, China signed 14 deals with Cambodia worth about $1 billion.

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China threatens US arms companies

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By Kathrin Hille in Beijing and Patti Waldmeir in Shanghai

Published: January 30 2010 12:45 | Last updated: January 31 2010 06:00

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// ]]>China threatened to impose sanctions on US arms firms and cut cooperation with Washington unless it cancels a $6.4bn arms sale to Taiwan, in an unprecedented move signalling Beijing’s growing global power.

Although Beijing ritually protests US weapons sales to the island, it has not previously targeted the companies involved in the trade. Although the US restricts arms sales to China, a number of the companies that would supply systems involved in the new Taiwan package, which include Boeing, United Technologies, Lockheed Martin and Raytheon, could face pressure in other business areas.

Boeing, in particular, has been counting on China sales of commercial aircraft in its battle with Airbus. Boeing, which warned on Friday that it expects revenue to fall this year, declined to comment on the Chinese threat. Beijing centrally manages aircraft purchasing and political factors have played a role in the past.

Books pulled from in pricing dispute

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NEW YORK (AP) — New copies of Hilary Mantel’s “Wolf Hall,” Andrew Young’s “The Politician” and other books published by Macmillan were unavailable Saturday on, a drastic step in the ongoing dispute over e-book prices.

Macmillan CEO John Sargent said he was told Friday that its books would be removed from, as would e-books for Amazon’s Kindle e-reader. Books will be available on through private sellers and other third parties, Sargent said.

Sargent met with Amazon officials Thursday to discuss the publisher’s new pricing model for e-books. He wrote in a letter to Macmillan authors and literary agents Saturday that the plan would allow Amazon to make more money selling Macmillan books and that Macmillan would make less. He characterized the dispute as a disagreement over “the long-term viability and stability of the digital book market.”

Macmillan and other publishers have criticized Amazon for charging just $9.99 for best-selling e-books on its Kindle e-reader, a price publishers say is too low and could hurt hardcover sales, which generally carry a list price of more than $24.

Macmillan is one of the world’s largest English-language publishers. Its divisions include St. Martin’s Press, itself one of the largest publishers in the U.S.; Henry Holt & Co., one of the oldest publishers in America; Farrar, Straus & Giroux; and Tor, the leading science-fiction publisher.

Sargent credited Amazon in his letter, calling the company a “valuable customer” and a “great innovator in our industry.”

But, he wrote, the digital book industry needs to create a business model that provides equal opportunities for retailers. Under Macmillan’s model, to be put in place in March, e-books will be priced from $12.99 to $14.99 when first released and prices will change over time.

For its part, Amazon wants to keep a lid on prices as competitors line up to challenge its dominant position in a rapidly expanding market. The company did not immediately return messages seeking comment Saturday.

Barnes & Noble’s Nook and Sony Corp.’s e-book readers are already on sale. But the latest and most talked about challenger is Apple Inc., which just introduced the long-awaited iPad tablet computer and a new online book store modeled on iTunes. Apple CEO Steve Jobs, in an interview with The Wall Street Journal, suggested publishers may offer some e-titles to Apple before they are allowed to go on sale at

The e-book market is an increasingly important one for Amazon. The company hasn’t given specific sales figures on the Kindle, but CEO Jeff Bezos said Thursday that “millions” own the device. The company now sells six digital copies to every 10 physical ones of books available in either format.

To preserve the more lucrative hardcover business, publishers including Simon & Schuster and HarperCollins Hachette Book Group USA have said they will impose delays on the release of digital copies.

It’s not the first time that books have disappeared from Amazon’s virtual shelves. Last summer, Kindle users were surprised and unsettled to receive notice that George Orwell works they had purchased, including “1984” and “Animal Farm,” had been removed and their money refunded. It was a deletion of pirated copies that had been posted to the Kindle store, but the ordeal highlighted a concern — that a book already paid for and acquired can be revoked by an e-tailer. The Kindle operates on a wireless connection that Amazon ultimately controls.

Bezos later apologized, and Amazon offered affected customers free books or $30.

Late Friday, author Cory Doctorow, who is published by Tor, the Macmillan division, called readers and writers “the civilian casualties” of the dispute in a post on his popular Web site, It’s a “case of two corporate giants illustrating neatly exactly why market concentration is bad for the arts,” he wrote.

Another Tor writer, John Scalzi, speculated that Amazon’s move would have “a long-term effect on Amazon’s relationship with publishers, and not the one Amazon is likely to want,” he wrote on his Web site.

AP Business Writer Andrew Vanacore in New York contributed to this report.

Why We Should Fear Deflation- J. Bradford DeLong

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University of California at Berkeley, and

National Bureau of Economic Research

April, 1998

For the Brookings Panel on Economic Activity, March 25-26, 1999

Post-meeting draft


After more than sixty years, deflation has reappeared as something to worry about. In the past six months major newspapers printed 438 articles classified under the keyword “deflation”–compared to 36 such in the first half of 1997 and 10 such in the first half of 1990. For sixty years, ever since the middle years of the Great Depression, next to no one had worried about deflation. Next to no one had seen actual falls in the price level as even a remote possibility. Now people do.

The post-Korean War 1950s and the early 1960s saw measured rates of inflation as low as those of today. Yet then people worried not about deflation but about inflation. Only in the late 1990s, not in the 1950s or 1960s, have inflation rates of two percent per year or less called forth fears of deflation.

Source: Bureau of Labor Statistics.

In the past, low inflation did not induce forth fears of deflation because observers believed that the institutions created by the Keynesian revolution had a bias toward inflation. Yet today this belief is gone, or at least greatly attenuated. What happened to the built-in bias toward inflation that past economists believed was inherent in post-WWII institutions? I suspect that the institutional bias toward inflation was never as large as many economists believed, and that it has recently been reduced or eliminated by the growth of countervailing forces.

Given that deflation is back on the agenda, should it be feared? Perhaps we should not worry about deflation because the probability that it will come to pass is infinitesimal. Perhaps we should not worry about deflation because it is not especially damaging. If costs of inflation and deflation are roughly equal–if our social loss function is symmetric around zero as a function of the deviation from price stability–then there is more to fear from renewed inflation than from deflation, for the price level is still rising.

I tentatively conclude that there is reason to fear deflation. The probability of serious deflation or of events that do the same kind of damage to the economy that deflation does is low, but it is not zero. There is good reason to fear that our social loss function is asymmetric: that deflation does more macroeconomic damage than an equal and opposite amount of inflation.

The root reason to fear deflation is that the nominal interest rate is bounded below at zero. Significant deflation–even completely anticipated deflation–thus generates high real interest rates and large transfers of wealth from debtors to creditors. By contrast, significant anticipated inflation does not generate abnormally low real interest rates (although significant unanticipated inflation is associated with large transfers of wealth from creditors to debtors).

Deflation’s high real interest rates depress investment, lower demand, and raise unemployment. Deflation’s transfers of wealth from debtors to creditors diminish the economy’s ability to keep the web of credit and financial intermediation functioning. Such disruption of the financial system puts additional downward pressure on investment, demand, and unemployment.

Thus it seems to me to be hard to argue that our social loss function is symmetric, and that deflation is not to be especially feared. It is easier to argue that the chances of deflation coming to pass are very low. Yet I suspect that they are not as low as we would like to believe, for the Federal Reserve’s power to offset surprise downward shocks to the price level is low.

Inflationary Bias

From its beginning the Keynesian Revolution brought fears of inflation. Before the ink was dry on the copies of Keynes’s General Theory, Jacob Viner already warned that:

    …[i]n a world organized in accordance with Keynes’ specifications there would be a constant race between the printing press and the business agents of the trade unions, with the problem of unemployment solved if the printing press could maintain a constant lead…

A quarter century later in his AEA presidential address Arthur Burns argued that Viner’s fears had come true: that the post-World War II world was one of constant wage-push inflation.

Viner’s and Burns’s fears have been developed and sharpened by Finn Kydland and Edward Prescott, who pointed out that a benevolent central bank possessing discretion and the ability to induce unanticipated shifts in aggregate demand will be under great temptation to try to take advantage of any short-run Phillips curve boost employment and production. The rational expectations equilibrium will be dissipative: workers and managers will expect such actions from the central bank, and in equilibrium production and unemployment will be unaffected but inflation will be higher than desirable.

This Kydland-Prescott framework suggests two ways to counter this institutional bias towards inflation created by central bank possession of discretion and concern over high unemployment. First– Kydland and Prescott’s preference–make sure central banks are bound by rules and do not possess discretion. Second–a line of thought associated with Ken Rogoff–appoint central bankers who are unconcerned high unemployment.

The pattern of economic policymaking in the 1990s suggests that both of these ways of modifying institutions to diminish inflationary bias have been adopted. The U.S.’s central bank today appears to follow the rule (in the sense of Blinder (1998) although perhaps not in the sense of Kydland and Prescott (1977)) of giving first and highest priority to attaining near price stability. The past decade has seen the flowering of a common culture of central banking in which control of inflation comes first, and always taking the long view is applauded. And some central bankers at least appear to have been appointed with an eye toward their relative lack of concern with–or disbelief in their power to affect–the level of unemployment. The result is a situation in which long-time inflation hawks criticize the European Central Bank for pursuing overly-tight monetary policy, and in which the ECB president announces–with euro-zone inflation approaching one percent per year and euro-zone unemployment approaching ten percent per year– that the ECB “will act, should the need arise, to prevent either inflationary or deflationary pressures…”

Thus it appears that attempts to reform institutions to eliminate inflationary bias have been successful, or perhaps that the bias toward inflation seen in the 1960s and 1970s was not so much the result (as Kydland and Prescott theorized) of the game-theoretic structure of the interaction between central bankers and the economy or (as Burns theorized) of the absence of fear of high cyclical unemployment, but instead the result of painful misjudgments about the structure of the economy and the slope of long-run Phillips curves that were corrected after the 1970s.

Why We Should Fear Deflation: Economic History

In the early 1920s most economists treated “inflation” and “deflation” as symmetric

    …evils to be shunned. The individualistic capitalism of today, precisely because it entrusts savings to the individual investor and production to the individual employer, presumes a stable measuring rod of value, and cannot be efficient–perhaps cannot survive–without one.

Deflation was dangerous because entrepreneurs were necessarily long real and short nominal assets:

    …the business world as a whole must always be in a position where it stands to gain by a rise… and to lose by a fall in prices…. [The] regime of money-contract forces the world always to carry a big speculative position [long real assets], and if it is reluctant to carry this position the productive process must be slackened…. The fact of falling prices injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations; yet it is upon the aggregate of their individual estimations of the risk, and their willingness to run the risk, that the activity of production and of employment mainly depends…

The fact of falling prices bankrupted entrepreneurs. The fear of falling prices led them to unwind their positions, close down productive operations, and reduce output and employment.

The coming of the Great Depression, however, shifted economists’ focus away from balanced fears of inflation and deflation and to the conclusion that deflation was deeply dangerous, and to be avoided at all costs. Economists’ analyses of the root causes of the Great Depression were (and continue to be) widely divergent. Nevertheless, alomost every analyst of the Great Depression placed general deflation–and the chain of financial and real bankruptcies that it caused–at or near the heart of the worst macroeconomic disaster the world has ever seen.

Each analysis focused on a different channel. Irving Fisher stressed that past deflation meant bankruptcy or near-bankruptcy for leveraged operating companies and nearly all financial institutions. Friedman and Schwartz stressed the harm inflicted by deflation on banks’ balance sheets by reducing the nominal value of collateral and diminishing debtors’ ability to service loans: resulting financial-sector bankruptcies led to sharp rises in reserves-to-deposits and currency-to-deposits ratios, lowering the money stock and aggregate demand in the absence of adequate Federal Reserve response. Peter Temin focused on rising risk premia on corporate debt over 1929-1933: deflation-driven corporate balance sheet deterioration increased risk and drove a wedge between low short-term interest rates on safe assets like government bonds and high long-term interest rates on corporate debt.

Barry Eichengreen wrote of the fear that countries would depreciate their currencies, and how this fear forced country after country to adopt deflationary policies to reduce the price level and shrink the money supply. Charles Kindleberger wrote of how currency depreciation exerted deflationary pressures: a small country that reduced the value of its currency discovered that its businesses and banks had borrowed abroad in gold, and could no longer service their debts. Christina Romer argued that even those who were not heavily long equities found it advisable to cut back on spending and increase liquidity margins in the aftermath of the 1929 stock market crash.

All of these channels share common features. First is that nominal interest rates cannot fall below zero. Hence banks could not respond to anticipated deflation by paying negative interest on deposits: if they could, then the key banking-crisis channel that Friedman and Schwartz see as the principal cause of the Great Depression would have been much weaker. Businesses could not rewrite their debt contracts ex post to diminish the effect of falling demand and prices on their balance sheets: if they could, then the wedge between Treasury and corporate interest rates that Peter Temin focuses on would have been much smaller. Exchange rate depreciation did not, in 1931 any more than in 1997, carry with it a writing-down of the hard money or hard currency debts that domestic firms owed to foreign nationals: if it had, then the channel that Kindleberger notes would have been much weaker. The increases in uncertainty and falls in consumer wealth that Romer focuses on would have had only trivial effects on purchases of durable commodities had not consumers feared that in the future they might want to have very liquid balance sheets of their own.

Second is a common focus on financial fragility: the belief that the interruption of the chain of financial intermediation has disastrous consequences for production and employment, whether the disruption occurs at the level of bank creditors (as in Friedman and Schwartz, in which it is increases in currency-to-deposits and reserves-to-deposits ratios that does the work), of operating companies (as in Keynes’s or Fisher’s stories of entrepreneurs unhedged against price level declines), of banks themselves (as in Temin, in which the deterioration of bank debtors’ balance sheets does the work), of companies with foreign liabilities (as in Kindleberger), or of consumers who no longer dare to be short in nominal terms to finance their purchases of durable assets (as in Romer).

In all of these channels sharp deterioration in debtor balance sheets leads to desires on the part of both debtors and creditors to unwind their positions and boost their liquidity, and to sharp reductions in business investment and consumer spending.

Economists do not have satisfactory theories of why borrowers choose to borrow and lenders choose to lend in unstable units of account, or of why demand is so sensitive to credit-market disruptions. Economic theory tells us that debt contracts are good ways to reduce the principal-agent problems that arise when investors confront entrepreneurs and managers who have vastly greater knowledge of a firm’s circumstances and opportunities. Economic theory tells us that when borrowers’ balance sheets are impaired such debt contracts no longer work. But there is no theoretical reason why such contracts should be written in potentially unstable units of account, or why they should not condition on observed macroeconomic variables.

Nevertheless, debtors borrow and creditors lend in nominal terms–whether consumers financing purchases of durables, banks taking deposits from households, real estate developers pledging land and property as collateral, or companies borrowing from banks. Such debt contracts interpret nominal deflation and the consequent difficulty in servicing or repaying the loan as a signal that the debtor has failed to properly manage their enterprises, and hence that the enterprise needs to be restructured or liquidated.

This confusion of nominal deflation with entrepreneurial failure is what makes a deflation such a dangerous exercise.

How dangerous? We do not know. We do not know how financially-fragile the U.S. economy is today, either in the sense of how vulnerable financial-sector and non-financial-sector entrepreneurial net worth is to deflation or how much reduction in aggregate demand would be caused by impaired financial-sector and non-financial-sector balance sheets. The U.S. economy has not experienced deflation since World War II. We know that economic historians blame debt-deflation and financial-fragility channels for the greatness of the Great Depression. We have no reliable evidence on the strength of these channels today.

The (relatively poor) data on aggregate movements in production and prices before World War II can be used to support the claim that the association of price changes and output changes is non-linear, with larger falls in prices associated with proportionately greater falls in output. A simple regression of peacetime annual changes in industrial production on the change and the squared change in the wholesale price index is certainly not inconsistent with the existence of a powerful non-linear deflation channel–as long as the World War I years are excluded, and as long as 1920-1921 is excluded as well.

Source: NBER Macro History database.

There is sound reason for the exclusion of the 1920-21 data point as an outlier. Coming immediately after the World War I inflation, the 1920-21 deflation came before businesses and financial institutions had had sufficient opportunity to rebalance their portfolios and readjust their degrees of leverage. Thus financial and non-financial balance sheets were unusually strong, and financial and non-financial net worth were unusually high in 1920-1921. The economy was thus less vulnerable to the channels through which deflation reduces production: the fact that 1920-1921 does not fit the correlations found in the rest of the data can be read as evidence for, not evidence against, the importance of debt-deflation channels back before World War II.

But an economist willing to try hard enough can always find sound reason for excluding an influential and inconvenient observation.

Moreover, these (relatively poor) pre-World War II data on industrial production and wholesale price index changes are of doutbful relevance for the U.S. economy today. And we lack data and convincing theory needed to identify how much of the correlation between changes in prices and changes in industrial production back before World War II reflects movements along an aggregate supply curve and not any destructive consequences of deflation.

Why We Should Fear Deflation: Present Vulnerability

Alternative Channels that Impair Balance Sheets

If the danger of deflation springs from its effect on net worth and depends on the degree of financial fragility in the economy, then economies may well have more to fear than declines in broad goods-and-services price indices alone. If securities and real estate holdings have been pledged as collateral for debt contracts, then large-scale asset price declines also trigger the confusion of macroeconomic events with entrepreneurial failure that makes deflation feared.

Is the United States today potentially vulnerable to large-scale asset price declines in this way? In real estate no. In the stock market yes. Perhaps fundamental patterns of equity valuation have truly changed, as investors have recognized that the equity premium over the past century was much too large–in which case stock prices have reached a permanent and high plateau. But it seems more likely that there are substantial risks of stock market declines on the order of fifty percent back to Campbell-Shiller fundamentals.

Source: Robert Shiller (1987), Market Volatility.

A second source of potential deflation-like pressure–seen during Sweden’s exchange rate crisis of 1992, during Mexico’s exchange rate crisis of 1994-5, during the East Asian crises of 1997, as well as in Great Depression-era events like the Austrian financial crises of 1931–arises out of large-scale foreign-currency borrowing by banks, companies, and governments in countries whose exchange rates then sharply depreciate.

Exchange rate depreciation is a standard reaction to a sudden fall in foreign demand for a country’s goods and services exports (on the current account) or property (on the capital account). When demand for a private business’s products falls, the business cuts its prices. When demand for a country’s products falls, a natural reaction is for the country to cut its prices, and the most way to accomplish this is through exchange rate depreciation.

But if governments, banks, and non-financial corporations have borrowed abroad in hard currencies, depreciation writes up the home-currency value of their debts and impairs their balance sheets in the same fashion as conventional goods-and-services price index deflation.

We know that other countries certainly have been vulnerable to this form of financial market disruption. Is the U.S. vulnerable? Not today. U.S. gross external obligations of $7 trillion or so are overwhelmingly equity or dollar-denominated investments. But will they still be dollar-denominated come the end of the year 2000, when they will amount to perhaps $9 trillion, and when these gross obligations are part of a net investment position of more than -$2 trillion?

The Limits of Monetary Policy

Moreover, even a pure commodity price deflation may not be as unlikely as we hope.

How adept is monetary policy at controlling the price level? The answer has always been–or at least since Milton Friedman stated that monetary policy works with “long and variable lags”–“not very.” Power and precision are two different things.

Modern estimates of the impact of monetary policy shocks on production, employment, and the price level continue bear out this assessment. Authors like Christiano, Eichenbaum, and Evans are very pleased that they find substantial agreement on the qualitative impact of changes in monetary policy (as measured by the short-term interest rates that the Federal Reserve actually controls) “in the sense that inference is robust across a large subset of the identification schemes that have been considered in the literature.” But the confidence intervals surrounding their point estimates are large. Moreover the time delay in the effect of a change in monetary policy is large as well: not until some eight quarters after the initial interest rate shock has the impact of a change in interest rates had anything near its long-run effect on the rate of inflation (or deflation). According to Christiano, Eichenbaum, and Evans, a one percentage point upward shift in the federal funds rate is associated with a less than one tenth of one percent decrease in the annual rate of inflation even ten quarters out.

Monetary policy remains the tool of choice for stabilization policy. The lags associated with Presidential and Congressional changes in spending plans and tax rates are even longer and more variable than the lags associated with monetary policy. But in the UnitedStates today monetary policy has no appreciable effect on the rate of price change for a year and a half after its implementation, and has nothing close to its full long-run effect on the rate of price change until two and a half years have passed. Moreover, there are important policy recognition and policy formulation lags as well in the making of monetary policy. The FOMC’s reliable information flow is at least one quarter in the past. The FOMC is a committee that moves by consensus guided by its chair, and committees that move by consensus rarely act quickly.

How Large Are Price Level Shocks?

If we today could reliably and precisely forecast what the price level would be two and a half years hence, the long and variable lags associated with monetary policy would not be worrisome. But we cannot do so. In the years since 1950 the standard deviation of the price level two and a half years hence is 6.6%. A little of this variation can be attributed to systematic policy. Conditioning on the level of CPI inflation today accounts for less than a third of the two and a half-year-ahead variance in the price level, and reduces the standard error of the price level two and a half years out to only 5.5%. Conditioning on both inflation and unemployment reduces the standard error of the price to only 5.4%. And conditioning on inflation, unemployment, and current nominal interest rates reduces the standard error only to 4.8%.

The most significant improvement in forecasting comes from conditioning on the identity of the Federal Reserve Chair, which reduces the standard error to 3.8%. But fitting a step function to any process will improve the fit. I see little in the views and characters of Arthur Burns and Alan Greenspan that would lead the replacement of the first by the second to generate an immediate nine percent fall in one’s estimate of the price level two and a half years out. It strains credulity to believe in a +26 percent effect on the price level from any chair, even G. William Miller.


Standard Deviation and Conditioning Variables

6.6%: –None–

5.5%: 12-mo inflation rate

5.4%: 12-mo inflation rate, capacity utilization rate

5.3%: 12-mo inflation rate, unemployment rate

4.8%: 12-mo inflation rate, unemployment rate, federal funds rate

4.8%: 12-mo inflation rate, unemployment rate, federal funds rate, 10-yr Treasury rate

3.8%: 12-mo inflation rate, unemployment rate, identity of Federal Reserve chair

Nevertheless, even a 3.8% standard deviation tells us that–if the normal distribution applies appropriate–that there is once chance in twenty that the price level two and a half years hence will be more than seven and a half percent higher or lower than we forecast. At current rates of inflation, an unanticipated fall in the price level of more than five percent before the Federal Reserve can react seems to be an event that would happen once every forty years. Is this a high risk of a serious deflation? No, but it is large enough to be worrisome.

Reasons for Confidence

Is such instability enough to make a debt-deflation spiral set in motion by unanctipated commodity price declines a serious threat? Probably not.

First, it may well be that it takes a bigger economic shock to induce a certain amount of deflation than it takes to induce the same amount of accelerating inflation or of disinflation. If so, calculations of price-level variability from an era of accelerating inflation and disinflation are unreliable guides to the potential for deflation. It takes a much greater contractionary impulse to cause deflation than to cause disinflation.

Second, a large chunk of the post-1960 variance in changes in the rate of inflation comes from the relatively narrow period of the turbulent 1970s. The years between 1971 and 1983 inclusive–one third of the sample–account for ninety percent of the squared deviations of CPI inflation around its mean. Since 1984 the standard deviation of two-and-a-half year ahead changes in CPI inflation is only a third the full-sample standard deviation. Perhaps episodes of variability like the 1970s oil shocks and the breakdown of confidence in the Federal Reserve’s commitment to price stability will not happen again because of increasing levels of knowledge about how to make monetary policy.

It is easy to make such arguments in the United States, where monetary policy makers have been skillful and astonishingly lucky over the past decade. It is, however, harder to make this argument from policy making competence elsewhere in the world. In Japan producer prices are 5% lower than they were a year ago, and over the past three months have fallen at a rate of 10% per year. Estimates of the output gap relative to potential in Japan today range between 8 and 25 percent of current GDP. In the euro zone inflation is less than one percent per year, and unemployment approaches ten percent. These macroeconomic problems are different from those of the 1970s. They are not less serious. And they do not appear to be consistent with greatly increased skill in the making of monetary policy.


Our ability to forecast and control the price level at a time horizon that corresponds to the effective range of monetary policy is low. Our policy instruments are powerful, but they are imprecise and are subject to long and variable lags. Moreover, other sets of circumstances than general goods-and-services price declines alone could set in motion the economic processes that we fear from deflation.

Thus there seems to be reason to fear deflation.

But there is no reason-at least not yet–to be very afraid. The institutional structures of our labor market provide us with insurance against debt-deflation as in the argument of Akerlof, Dickens, and Perry (1996)–although note that this insurance comes at a substantial price: in their model the natural rate of unemployment rises substantially as the inflation rate hits zero. The relatively high price level variability of the 1970s may truly be a thing of the past, not a thing to fear in the future.

But if the volatility of the 1970s does come again, and if deflation is not much harder to cause than disinflation, and given that monetary policy is an imprecise instrument that works with long and variable lags, what then? If your loss function is asymmetric–if moderate deflation is much more damaging than moderate inflation–and if the variance of outcomes around targets is large, then the conclusion is obvious: good monetary policy should aim for a rate of price level change consistently on the high side of zero.

After all, in a still-impoverished world, it is worse to provoke unemployment than to disappoint the rentier.


George Akerlof, William Dickens, and George Perry, “The Macroeconomics of Low Inflation,” Brookings Papers on Economic Activity Vol. 1996, No. 1 (Spring 1996), pp. 1-59.

Ben Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review Vol. 73, No. 2 (June 1983), pp. 257-76.

Ben Bernanke and Mark Gertler, “Agency Costs, Net Worth, and Business Fluctuations,” American Economic Review Vo. 79, No. 1 (March 1989), pp. 14-31.

Ben Bernanke and Mark Gertler, “Financial Fragility and Economic Performance,” Quarterly Journal of Economics Vol. 105, No. 1 (February, 1990), pp. 87-114.

Mauro Boianovsky, “Wicksell on Deflation in the Early 1920s,” History of Political Economy Vol. 30, No. 2 (Spring 1998).

Ricardo Caballero and Mohamad Hammour, “The Cleansing Effect of Recessions ,” American Economic Review Vol. 84, No. 5 (December 1994), pp. 1350-68.

Lawrence Christiano, Martin Eichenbaum, and Charles Evans, “The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds,” Review of Economics and Statistics, Vol 78, No. 1 (February 1996), pages 16-34.

Lawrence Christiano, Martin Eichenbaum, and Charles Evans, “Monetary Policy Shocks: What Have We Learned and to What End?” NBER Working Paper No. 6400 (February 1998).

J. Bradford DeLong, “American Fiscal Policy in the Shadow of the Great Depression”, in Michael Bordo, Claudia Goldin, and Eugene White, eds., The Defining Moment: The Great Depression and the American Economy in the Twentieth Century (Chicago: University of Chicago Press, 1997).

J. Bradford DeLong and Lawrence H. Summers, “The Changing Cyclical Variability of Economic Activity in the United States,” in Robert Gordon, ed., The American Business Cycle: Continuity and Change (Chicago: University of Chicago Press for the NBER, 1986).

Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression (New York: Oxford University Press, ).

Irving Fisher, “The Debt-Deflation Theory of Great Depressions,” Econometrica Vol. 1, No. 4 (October, 1933), pp. 337-57.

Douglas Gale and Martin Hellwig, “Incentive-Compatible Debt Contracts I: The One-period Problem,” Review of Economic Studies Vo. 52, No. 5 (Octobert, 1985), pp. 647-63.

Friedrich Hayek, “The System of Intertemporal Price Equilibrium and Movements in the ‘Value of Money’,” in Israel Kirzner, ed., Classics in Austrian Economics: A Sampling in the History of a Tradition. Volume 3. The Age of Mises and Hayek. (London: Pickering and Chatto, 1994 [orig. pub. 1928), pp. 160-98.

Friedrich Hayek, The Road to Serfdom (London, 1944).

Walter Heller, New Dimensions of Political Economy (Cambridge: Harvard University Press, 1965).

John Maynard Keynes, A Tract on Monetary Reform (London: Macmillan, 1924).

John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936).

Charles Kindleberger, The World in Depression

Finn Kydland and Edward Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy Vol. 87, No. 3 (June, 1977), pp. 473-492.

George Perry (1998), “Is Deflation the Worry?” (Washington D.C.: Brookings Institution, Policy Brief #41).

Christina Romer, “Is the U.S. Economy More Stable?” Journal of Economic Perspectives (forthcoming).

Christina Romer, “The Great Crash and the Onset of the Great Depression,” Quarterly Journal of Economics Vol 105, No. 3 (August 1990), pp. 597-624.

Robert Shiller (1987), Market Volatility (Cambridge: MIT Press).

John Taylor, “Is There a Role for Fiscal Policy in Macroeconomic Stabilization?” Journal of Economic Perspectives (forthcoming).

Robert Townsend, “Optimal Contracts and Competitive Markets with Costly State Verification,” Journal of Economic Theory Vol. 21, No. 5 (October, 1979), pp. 265-93.

Jacob Viner, “Mr. Keynes on the Causes of Unemployment,” The Quarterly Journal of Economics, Vol. 51, No. 1. (Nov., 1936), pp. 147-167.

The ABCs Of Risk-Free I Bonds

Filed under: Uncategorized — ktetaichinh @ 2:29 am

Mel Lindauer, 01.29.10, 02:00 PM EST

How to buy, redeem and get the highest return from U.S. Treasury inflation protected bonds.

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Mel Lindauer

In my previous column I provided an introduction to I Bonds and discussed some of their many benefits, including:

1. They’re risk free.
2. They’re tax deferred.
3. They’re very flexible.
4. They’re free from state and local taxation.
5. They offer inflation protection.
6. They offer a “put option.”
7. You can’t lose money.
8. Even in deflationary periods, you never lose the interest you’ve previously earned.

Now let’s explore the mechanics of purchasing and redeeming I Bonds and talk a bit about how they work.

Purchasing paper I Bonds.

You can purchase paper I Bonds simply by filling out the proper form (available at most banks) and providing the bank with the paperwork and the funds, which are expected to be on deposit at the bank. The bank will provide you with a dated receipt copy and you’ll receive the I Bonds in the mail from the Federal Reserve in about two to four weeks. Regardless of how long it takes the Federal Reserve to process your paperwork and get the I Bonds out to you, as long as your bank is an agent for the Federal Reserve (most commercial banks are, but you’ll want to make sure before buying) your issue date will be the month you purchased them at the bank. (I Bonds only carry a month and year for the issue date.)

Purchasing electronic I Bonds.

You must first open an individual account at and link it to your bank account. Once your account is open, you can then make your purchase online and the Treasury will deduct the purchase price from your linked bank account.

Purchase limits.

There is an annual purchase limit of $10,000 in I Bonds per Social Security number. To reach that limit you must buy both paper and electronic I Bonds, since each has a separate $5,000 limit. A married couple could, therefore, purchase a total of $20,000 per year in I Bonds, provided they buy both paper and electronic bonds.

Avoiding probate.

I Bonds don’t qualify for a step-up in cost basis at one’s death as many other investments, such as stocks and real estate, do. (I Bonds are like bank-CDs in that regard.). That means there is no tax advantage to titling I Bonds only in one name. But you can title them in such a way so as to avoid having them included in your estate subject to probate—by having either a second co-owner or a beneficiary listed on your I Bonds.

How I Bonds work.

When I Bonds are issued, they contain an “Issue Date” which is the month and year of purchase. In my previous column I explained that there are two components (a fixed interest rate and an inflation adjustment) that make up the total yield, or composite rate, for each I Bond issue date. The fixed interest rate of an I Bond remains the same for the 30-year life of the bond, but the inflation-adjustment figure and the fixed rate for newly purchased I Bonds are announced twice each year, on May 1 and Nov. 1. Each I Bond goes through six-month cycles based on its issue date, and on the six- and 12-month anniversaries of its issue, the rate is adjusted based on the original fixed interest rate and the latest announced inflation adjustment. Adding these two figures together determines the new composite rate the previously issued I Bonds earn for the next six months. This cycle repeats for the life of the I Bond.

Redeeming paper I Bonds.

Simply take your paper I Bonds to your bank, sign the back and the bank will credit your account just as if you had deposited cash. The funds will normally be available to you the following day. You could also receive cash.

Redeeming electronic I Bonds.

You can redeem your I Bonds (or any portion of your bond holdings, so long as you leave at least $25 in your account) using your online account. The money is then transferred into your linked bank account.

Timing your trades.

It’s important to know how and when I Bond interest is credited to your account in order to maximize your return. Interest is earned on the last day of each month and is posted to your account on the first day of the following month. So, if you own your I Bonds on the last day of any month, you’ll earn that full month’s interest. Therefore, it’s best to buy your I Bonds near the end of the month, since you can earn a full month’s interest while only owning the I Bonds for perhaps a day or two. On the other hand, when redeeming I Bonds, you’ll want to do so on or near the first business day of the month, since redeeming them later in the month won’t earn you any additional interest.

Understanding how I Bonds work is important since it can mean more money in your pocket. In the next column, I’ll talk about using I Bonds tax-free for qualifying educational expenses and about free software that can help you track the value of your I Bonds.

Mel Lindauer, CFS, WMS is one of the founders of the Bogleheads community and co-author of The Bogleheads’ Guide to Investing, along with Taylor Larimore and Michael LeBoeuf. He is also co-author of The Bogleheads’ Guide to Retirement Planning, along with Taylor Larimore, Richard Ferri, and Laura Dogu.

Axis Of Wheat

Filed under: Uncategorized — ktetaichinh @ 1:53 am
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Russia wants to include India in its strategic reserve plan for wheat. India will need to handle its foreign relations and grain storage much better to take advantage of that.

The second was a bit trickier. The last thing any farmer wanted was a collapse in prices. That is where the largest wheat consuming countries–India, China and Turkey–had to be roped in as partners. If this could be done, Russia could not only become the biggest grain producer in the world but could also blunt the U.S.’ constant use of wheat diplomacy with developing nations (Indians are still upset about the PL-480 deals that the U.S. forced on India in the 1960s and ’70s).

India is at a crossroads now. Should it join hands with Russia or should it partner with the U.S.? “Logically, India should opt for the best deal, without being tied down to any one player,” says a former ministry of external affairs diplomat who prefers anonymity on this issue. Russia is making an offer that the U.S. hasn’t. If the terms are right and the long-term price commitments attractive, India should tie up with both countries thus preventing a situation where India would have to import wheat at astronomical prices.

Unfortunately, when India or China–large consuming markets–decides to purchase anything from spot markets, prices tend to zoom by 25% to 50%. In case both decide to purchase anything–be it oil, oilseed, cement, fertilizers or food grain–at the same time, prices may shoot up by even 100%. That is why long-term contracts and buffer stocks are critical to the country’s food situation.

Sadly, the government does not pay attention to this, says an executive from the Central Warehousing Corp. (CWC), which stores much of the grain that the government procures either from domestic markets or from overseas. In July 2009 a leading publication (India Today) secretly filmed how 300,000 tonnes of pulses that “were imported from the international market using taxpayers’ money … are lying [to rot for several months] at Tuticorin port … and in the warehouses of CWC.”

“In fact, there is a general destruction of value in all our food grain and vegetables, at multiple levels, and the government isn’t even bothered about it,” says an industrialist engaged in providing refrigeration services to agro-producers.

First there is a destruction of value in perishables not being stored or being destroyed on the way to the markets. Then comes the procurement process. When support prices are announced for wheat or rice, the procurement is actually done by the state government and stored in state warehouses. which are neither temperature- or humidity-controlled nor protected from insects and rodents. This grain lies with state governments for a few years before being transferred to the central government at a loss because of the destruction (or theft) of the food grain. That is one reason why losses running into thousands of crores of rupees (a crore is equal to 10 million rupees) can be seen on the books of almost every state government that procures food grains. The central government, too, puts this grain in CWC warehouses, which are similar to state government warehouses, exposed to rodents, humidity and pests.

That is why in 2000 the Ministry of Agriculture and Food floated a global tender for scientifically designed silos and warehouses. Adani Logistics Ltd. (ALL) won the global tender to build as a pilot project silo storage units with a total capacity of 600,000 tonnes at seven centers in India. “We think this is critically important if India has to manage its food security and are waiting for the pilot project to be converted into a bigger, full-fledged storage plan,” adds Pranav Adani, director of ALL.

“The urgent need, of course, is to find countries where India can grow its pulses and its grain, because India’s farms may just not be enough,” adds Adani.

This article appears in the Feb. 5 issue of Forbes India, a Forbes Media licensee.

Steve Jobs and the Economics of Elitism

Filed under: Uncategorized — ktetaichinh @ 1:30 am
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“Real innovation in technology involves a leap ahead, anticipating needs that no one really knew they had and then delivering capabilities that redefine product categories,” said David B. Yoffie, a professor at the Harvard Business School. “That’s what Steve Jobs has done.”

Timing is essential to make such big steps ahead. Carver Mead, a leading computer scientist at the California Institute of Technology, once said, “Listen to the technology; find out what it’s telling you.”

Mr. Jobs is undeniably a gifted marketer and showman, but he is also a skilled listener to the technology. He calls this “tracking vectors in technology over time,” to judge when an intriguing innovation is ready for the marketplace. Technical progress, affordable pricing and consumer demand all must jell to produce a blockbuster product.

Indeed, Apple designers and engineers have been working on the iPad for years, presenting Mr. Jobs with prototypes periodically. None passed muster, until recently.

The iPad bet could prove a loser for Apple. Some skeptics see it occupying an uncertain ground between an iPod and a notebook computer, and a pricey gadget as well, at $499 to $829. Do recall, though, that when the iPod was introduced in 2001, critics joked that the name was an acronym for “idiots price our devices.” And we know who had the last laugh that time.

Tax Tricks For Kids

Filed under: Uncategorized — ktetaichinh @ 1:01 am

Having your first child means more chores–more laundry, more shopping, more food preparation and yep, more tax planning and paperwork too.

So you’d think the politicians would want to simplify life for time-pressed parents. Instead, in an effort to show they’re family friendly, they’ve created numerous, sometimes overlapping tax breaks for children, for child care and for education. Then, to hold down the tax cost of all those tax goodies, they’ve added various phaseouts and gotchas, which interfere with some families’ ability to claim them. Still, at the right income level and with a little planning, your bundle of joy could turn into a bundle of tax savings.

First consideration: timing. If you had your baby after Jan. 1, you can’t claim a penny of the two basic child breaks–the dependent exemption, which knocks $3,650 off your taxable income per child or the child credit, which cuts your tax bill by $1,000 per child–on your 2009 return due April 15. If your child was born Dec. 31, congratulations; you can get the full year break for 2009. “Having a baby in December, that’s what I call good tax planning,” quips Robert Meighan, a CPA and vice president of Turbo Tax, Intuit‘s ( INTU news people ) tax preparation software unit.

(If you’re not expecting until later in 2010, there might still be a way to cut your 2009 bill: High medical expenses associated with conceiving or with an ongoing pregnancy could be deductible for 2009. For more on medical deductions, click here. Also, if you’re in the process of adopting, save those 2009 receipts. They can be used to claim an adoption credit of up to $12,150 in the year your adoption is final.)

The dependent exemption is available for children who are 18 or under (or 23 and under, if they’re full-time students) for at least part of the year. The child credit is available for children who are 16 or younger for the full calendar year. You can get them both if your kids are the right age. Sound simple? For many middle-class families these breaks are in fact simple to claim–or simple compared with those for child care. Standard tax software such as TurboTax or H&R Block‘s ( HRB news people ) At Home will calculate them for you.We say for “many” families, because both low-income and upper-middle-class families face special complications. Congress has made the $1,000 child credit partially “refundable”–meaning lower-income families who don’t actually owe any income taxes can get a government check for part of the credit. Couples with income as high as $40,000 (with one child) or $48,000 (with three children) may also qualify for an Earned Income Tax Credit. For more on the EITC, click here.)

Note that taxpayers with AGI below $57,000 may be able to complete their federal returns and file online for free through the IRS’s FreeFile program.

Still, the complexity of all these credits, for even lower income folks, helps explain why 60% of taxpayers use preparers and Jackson Hewitt Tax Service ( JTX news people ) is this tax season setting up shop in 1800 Wal-Mart ( WMT news people ) stores.

What about those higher-income folks? Couples begin to lose the child credit when their modified adjusted gross income hits $110,000; single parents when it hits $75,000. In 2009, exemptions begin to phase out at $250,200 for couples filing jointly and $208,500 for single parents, but some families making far less lose the exemptions too because they’re stuck in the alternative minimum tax, which doesn’t allow personal exemptions at all. (For more on phaseouts, click here.)

If you’re near the child credit phaseout range, start thinking about ways to reduce your AGI, such as increasing your pre-tax contributions to a 401(k) and diverting pre-tax money into a dependent care account, rather than claiming the dependent care credit.

Now here’s where it gets really confusing. You can divert up to $5,000 per year from your pretax salary to pay for child care costs, including nursery school tuition, after-school programs, summer day camp and a nanny’s wages. To use a dependent care account (or to claim the dependent care credit) you must need child care to earn an income. So if you’re married, both spouses must be employed, unless one is disabled, a full-time student or looking for work. If both spouses work for employers who offer these accounts, the combined set aside can’t exceed $5,000.

Normally, you must make decisions about how much to put into a dependent care account before the start of the year, but you can change your election within 30 days of a change in your family status, such as the birth of a child.

Warning: You can’t recover unspent money from your pretax account or carry it over to the next year. So if you’re unsure how high your childcare bills will be–maybe you don’t know whether you’re both going back to work–put less in the dependent care account and make greater use of the dependent care credit. In fact, coordinating these two breaks is one of the biggest areas of tax confusion new parents confront.

You can claim the credit against a maximum of $6,000 of expenses, or $3,000 if you have only one child. The dependent care credit equals 35% of costs for the lowest-income families, but those with $43,000 of AGI or more get a 20% credit, saving at most $1,200. President Obama, as part of his new middle-class families initiative, wants to extend the 35% rate to families making up to $85,000, for a maximum tax credit of $2,100 for two or more children, and $1,050 for one. The 35% rate would be phased out as income climbed, and those earning more than $115,000 would be back to the old 20% rate.

Bottom line: Even if Congress adopts Obama’s proposal, if you’re high income, and particularly if you have only one child, you will still save more with the $5,000 dependent care account, provided you don’t set aside money you never use. Note that if you have two or more eligible children you can put $5,000 in the pretax account and then claim a 20% credit for an additional $1,000 in childcare bills–but not for the same expenses.

If you’re setting money aside for the first time in a pretax dependent care account, there’s one more gotcha, warns Susan Nash, an employee benefits lawyer at McDermott, Will & Emery. Your employer typically might cut off funding below $5,000 because of an IRS rule designed to make sure that low-income as well as high-income employees at a company use pre-tax accounts. Nash has had clients stuck with extra income on their W-2 that they didn’t count on at year-end because they thought they could shelter the full $5,000, and then found they couldn’t. “That tends to make highly paid people angry at year-end,” she says. For even more detail on child care breaks and the nanny tax, click here.

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