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Friday, December 3, 2021

Labour Market Tightness

The interesting part of the inflation debate is the question of labour market tightness. If we are looking at the CPI, what we see is that many components hit high rates of inflation. This means that we need similar gains in 2022 to keep the CPI from dropping back towards 2% or whatever. The more interesting issue is whether strong wage gains will continue, as that increased purchasing power would give a lift to demand and increase purchasing power across all sectors.

The latest U.S. labour market data dump was consistent with continued improvement in the labour market, with the broad employment-to-population ratio rising to 59.2% (figure above). That is well above the lows, and returned to the values seen in middle of the last cycle.

My not very useful observation is that hourly earnings is perkier than would be justified by historical rules of thumb based on macro data. Potential explanations appear to be as follows.

  • One explanation I have seen is that wage growth may be more sensitive to the rate of job creation, rather than levels, as is conventionally assumed. (I saw the analysis on the EmployAmerica website, but I cannot remember which blog/report contained it.) Since a good portion of job gains are firms getting back to work after shutdowns, employment growth rates will presumably burn out relatively soon.

  • Policies that paid people not to work obviously help tilt bargaining power towards workers. I am unsure as to how much of this effect remains.

  • Have workers dropped out of the workforce due to health concerns? This is the story being pushed by the hawks. It is unclear to me how sustainable such a strategy is for workers.

  • On a related point, day care employment has not fully recovered, and so workers are effectively locked out of the job market.

  • The changing consumption patterns of consumers has invalidated certain modes of operation for firms. So firms could theoretically have the same number of employees, yet need a different mix of workers. This would cause “skills bottlenecks,” even in the absence of net employment growth.

  • Certain firms and industries feasted on unsustainable labour practices — being able to call in workers effectively on demand, for example. Even a slight amount of labour market tightening would squeeze out such practices. Meanwhile, there are industries reliant upon pushing capital expenditures to “contractors”: trucking and ride sharing. Sooner or later, the supply of suckers who don’t understand depreciation would dry up.

Projecting high wage growth on a multi-year horizon appears to be reliant on the premise that firms and workers cannot adapt to the realities of a world with COVID-19.

Peak Oil

One of the other issues with the inflation outlook is the question of oil prices. At the moment, wholesale energy prices have undergone a correction, which will blow a hole in the rate-of-change of the energy component of the CPI. On a longer horizon, we might need to be cautious.

As seen in the chart above, “liquid” production has peaked in the United States (right about when one of the more reliable contrary indicators on Twitter was laughing about Peak Oil). This was somewhat predictable: fracking generates output quickly, but the depletion rate is also rapid. The industry was unable to keep up the frenetic pace of drilling since it was not economic.

Admittedly, high oil prices could generate another burst of fracking activity. However, the reality is that the fracking needs to move towards more marginal sites, and depletion gets worse as conventional oil production continues its secular decline.

There are of course other sources of hydrocarbons. However, the United States was the epicentre of fracking triumphalism, and the most that oil production bulls can hope for is that the same script plays out elsewhere (horrifying anyone worried about climate change).

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(c) Brian Romanchuk 2021

Monday, November 29, 2021

Preliminary Agent-Based Model In Place

I have made some progress on my agent-based modelling project (in between CFL playoff games). It is now possible to interact with the simulation, making this the minimum viable space trading game. My objective was to get the economy running in a somewhat sensible fashion, so that it is possible to examine how any particular agent reacts to a coherent economy state, and thus I am free to refine behaviour.

(I have a Patreon to support my open source projects, of which this is the one that is currently getting the most development time. I also have my stock-flow consistent modelling module, as well as my research platform that I use to generate the charts for my blog. All use Python, although I do my plots in R.)

Friday, November 26, 2021

Pondering The Economic Significance Of Aggregated Price Indices

Blair Fix wrote an interesting article “The Truth About Inflation.” There is a lot of material in there, which overlaps some of my thinking that would go into a section of my inflation primer. One key observation is that variance in price changes for individual items swamps the change in the aggregate CPI. I ran into a comment that “everybody knows” about variance in CPI components, but this points to the problem that conventional approaches to macro have a theoretical blind spot — what if aggregate CPI is not economically meaningful because we are literally and figuratively adding up apples and oranges?

Monday, November 22, 2021

Interest Rate Policy Versus Alternatives

One of the ongoing arguments about Modern Monetary Theory (MMT) that I run across is the general disdain for monetary policy among MMT proponents. (At one extreme, Warren Mosler argues that interest rate policy works in a way that is backwards versus the consensus.)

Thursday, November 18, 2021

Doing Agent-Based Modelling...

I am currently working on adding functionality to my Python agent-based model framework, so no other article from me this week.

I set up a Patreon to support my Python projects, and the agent-based model is the current focus. I wrote a few small pieces this week discussing recent work: here and here.

Monday, November 15, 2021

The Great Inflation Scare Of 2021 (Or Not...)

Chart: 5-/5-Year TIPS Breakeven Inflation Rate

We had a blowout CPI print in the United States last week, which I probably should have discussed. Unfortunately for my writing productivity, I had some consulting work going as well as visiting family, so I did not have time to dig.

Since then, large numbers of electrons were spilled online discussing the inflation outlook. As I doubt that I will add any details that are novel at this point, I have decided to bow out of that discussion. Instead, I will just offer a few generic observations.

The first thing to note is that forward breakeven inflation rates (as calculated by the Federal Reserve) have risen since the pandemic lows — but are still not above the levels seen in the early 2010s. (As a technical note, one might be able to fine tune breakeven inflation calculations with access to security-level data. But the Fed H.15 data is perfectly adequate for a big picture chart like the one above.)

We need to use forward inflation since everybody accepts that there will be a run of punchy inflation data over the coming months. How long the “punchiness” lasts is the topic of heated debate. As a non-forecaster, I am staying out of that debate. That said, the TIPS market indicates that the punchiness subsides within 5 years. Say what you want, that is not exactly a secular shift in inflation pricing.

Could technicals influence the forward? Sure. The problem is that the most important technical is the demand for inflation protection by the private sector, which is really only counter-balanced by TIPS supply. If people were really worried about inflation, they would be bidding up protection versus fair value — the breakeven ought to be biased higher versus “true” expectations. If that were the case, then the “true” expectations are not elevated relative to “target” (which is vaguely defined at this point).

So unless we are convinced the market is wrong — and it could be (you pays your money, you takes your chances) — the inflation story is just about the timing of “transitory.” Even without digging into data, it seems clear to me that we need to get the flurry of holiday spending out of the way before we can see what the underlying supply chain status looks like.

The other angle is wage inflation. I think we have seen some unsustainable business models based on the availability of desperate workers, and/or hoodwinking people who were unable to account for depreciation into being “contractors” have finally hit the end of their sustainability. Such business are going to face higher wage costs. It remains to be seen whether this is a one-off shift, or sustains itself.

In any event, I hope to return to my inflation manuscript later this week. My feeling is that it will make sense to hold off finishing the book until after we see the backside of this inflation wave (or not), so if I get the bulk of the text sketched out, I will then let the text rest for some months.

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(c) Brian Romanchuk 2021

Tuesday, November 9, 2021

Understanding Long End Inversion

I have seen a certain amount of chatter about inversions of the long end (or ultra-long end) of the Treasury curve. I do not have enough information to offer definitive conclusions on recent market action, but in the article I explain why I view a 20-/30-year inversion is not comparable to a 2-/10-year inversion.