by Calculated Risk on 8/02/2010 08:15:00 PM

A few excerpts from Professor Krugman: Why Is Deflation Bad?

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. ....

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts. Now, you might think this is a zero-sum affair, since creditors experience a corresponding gain. But as Irving Fisher pointed out long ago (pdf), debtors are likely to be forced to cut their spending when their debt burden rises, while creditors aren’t likely to increase their spending by the same amount. ...

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. ...

Now, alert readers will have noticed that none of these arguments abruptly kicks in when the inflation rate goes from +0.1% to -0.1%. Even with low but positive inflation the zero lower bound may be binding; inflation that comes in lower than borrowers expected leaves them with a worse debt burden than they were counting on, even if the inflation is positive; and since relative wages are shifting around all the time, some nominal wages will have to fall even if the overall rate of inflation is a bit above zero.

There are more details at Krugman's post.

The third point on sticky wages (and prices) is very important. Relative wages are being adjusted all the time in the economy. With some inflation, real wages can be cut (if needed) by keeping wage increases below the inflation rate. However, if inflation is near zero - or there is deflation - many companies that need to cut wages a little will have difficulty competing since it is difficult to cut nominal wages. This is a key reason why a little inflation is better than no inflation. Of course too much inflation is really bad too, but that isn't the problem right now.

by Calculated Risk on 8/02/2010 05:04:00 PM

1) July Auto Sales. Light vehicle sales will be reported tomorrow by the automakers. In the weekly schedule, I noted that "expectations are for about a 11.6 million SAAR for light vehicles in July – up from the 11.1 million sales rate in June." There is a pretty wide range in forecasts:

From Bloomberg: Auto Sales May Rise to Highest of Year on U.S. Closeout Deals

Industrywide deliveries ... may reach an annualized rate of 11.9 million vehicles in July, the average of eight analysts’ estimates compiled by Bloomberg. That would be 5.3 percent higher than last year’s 11.3 million pace and the best month since August 2009 ...

And from Reuters: Auto Sales in US Expected to Rise Slightly in July

Analysts surveyed by Reuters expected an average annualized sales rate of 11.4 million vehicles in July, up slightly from 11.1 million in June and 11.2 million a year earlier. Forecasts for July range from 11.1 million to 12.1 million vehicles.

2) Pending Home Sales: The consensus is for a slight decline in the pending homes sales index for June, after the 30% drop decline in May. Lawler expects about a 3% decline (based on limited data).

3) FOMC meeting on August 10th: There has been some speculation that the FOMC would ease monetary policy next week. As an example from CNBC: Fed Will Ease Monetary Policy on Aug. 10: Economist

Japan's Nomura has become the first investment bank to predict the Federal Reserve will begin to ease monetary policy following the recent slowdown in growth in the world's biggest economy.

The deterioration in expectations for growth and inflation argues for an easing of monetary policy, Paul Sheard, the global chief economist at Nomura, wrote in his latest report.

Given Chairman Bernanke's comments this morning, this seems very unlikely. Bernanke's speech was fairly positive, and I think the FOMC statement might note that growth has slowed, but the "extended period" wording will probably remain the same - and there will probably be no mention of further easing. The following was the key sentence in Bernanke's speech:

"In particular, in the household sector, growth in real consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions."

Unless there is a huge downside surprise this week, I think the FOMC statement will basically remain the same.

by Calculated Risk on 8/02/2010 02:54:00 PM

Usually when auction buyers lose money it is because they either overvalue the home, or the home was seriously damaged. However this is an unusual story from Carolyn Said at the San Francisco Chronicle: Winning bid on mortgage buys family heartache (ht Jesse)

Roberta and Randall Strand took $97,606 out of their paid-off house to buy a foreclosed home at a courthouse auction. Five months later, they found out they actually bought the second mortgage, and that the bank planned to foreclose on the first mortgage, leaving them out in the cold.

This is pretty easy to check. In this case the lender (Wachovia, now Wells Fargo) held both the 1st and 2nd and foreclosed on both. Because of timing issues, the 2nd went to the court house steps first - and the buyers are now out around $100,000. Well, probably less ...

Wells and the family negotiated a confidential settlement and were finalizing details late last week.

by Calculated Risk on 8/02/2010 12:06:00 PM

Overall construction spending increased slightly in June, and private construction spending, both residential and non-residential, decreased in June.

Click on graph for larger image in new window.

This graph shows private residential and nonresidential construction spending since 1993. Note: nominal dollars, not inflation adjusted.

Residential spending is now 62% below the peak of early 2006.

Private non-residential construction was revised down for both April and May, and spending is now 35% below the peak of late 2008.

From the Census Bureau: June 2010 Construction at $836.0 Billion Annual Rate

The U.S. Census Bureau of the Department of Commerce announced today that construction spending during June 2010 was estimated at a seasonally adjusted annual rate of $836.0 billion, 0.1 percent (±1.6%)* above the revised May estimate of $834.8 billion.
...
Spending on private construction was at a seasonally adjusted annual rate of $527.6 billion, 0.6 percent (±1.3%)* below the revised May estimate of $530.9 billion. Residential construction was at a seasonally adjusted annual rate of $258.3 billion in June, 0.8 percent (±1.3%)* below the revised May estimate of $260.3 billion. Nonresidential construction was at a seasonally adjusted annual rate of $269.3 billion in June, 0.5 percent (±1.3%)* below the revised May estimate of $270.6 billion.

I expect:

Private residential construction spending will decline sharply in July since builders rushed to complete homes in June (because of the tax credit).

Private non-residential investment in structures will be revised down in the Q2 GDP report. The advance GDP report showed an increase in non-residential investment in structures of 5.2% (SAAR) and a positive contribution to GDP of 0.14 percentage points. This will probably be revised away.

Based on the Architecture Billings Index, non-residential spending will decline further in 2010 - and into 2011.

Residential spending will probably exceed non-residential later this year (or early 2011), but that will be mostly because of weakness in non-residential construction, as opposed to any significant increases in residential spending.

by Calculated Risk on 8/02/2010 10:18:00 AM

From Fed Chairman Ben Bernanke: Challenges for the Economy and State Governments

On the economy:

While the support to economic activity from stimulative fiscal policies and firms' restocking of their inventories will diminish over time, rising demand from households and businesses should help sustain growth. In particular, in the household sector, growth in real consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions. In the business sector, investment in equipment and software has been increasing rapidly, in part as a result of the deferral of capital outlays during the downturn and the need of many businesses to replace aging equipment. At the same time, rising U.S. exports, reflecting the expansion of the global economy and the recovery of world trade, have helped foster growth in the U.S. manufacturing sector.

To be sure, notable restraints on the recovery persist. The housing market has remained weak, with the overhang of vacant or foreclosed houses weighing on home prices and new construction. Similarly, poor economic fundamentals and tight credit are holding back investment in nonresidential structures, such as office buildings, hotels, and shopping malls.

Importantly, the slow recovery in the labor market and the attendant uncertainty about job prospects are weighing on household confidence and spending. After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, an improvement but still a pace insufficient to reduce the unemployment rate materially. In all likelihood, significant time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than six months.

On state and local governments:

Cuts in state and local programs and employment are also weighing on economic activity. These cuts principally reflect the historically large decreases in state tax revenues during the recession. Sales tax revenues have declined with household and business spending, and income tax revenues have been hit by drops in wages and salaries, capital gains, and corporate profits. In contrast, property tax revenues collected by local governments generally held up well through the beginning of this year, although reappraisals of the values of homes and commercial properties may affect those collections in the future.
...
With revenues down and Medicaid spending up, other categories of spending by state governments have been tightly squeezed. Over the past year, numerous state governments have laid off or furloughed employees, decreased capital spending, and reduced aid to local governments. Indeed, state and local payrolls have fallen by more than 200,000 jobs from their peak near the end of 2008. Some states have also raised taxes, but the weak economy has made it difficult to find significant new revenues.

Assistance from the federal government, especially through the fiscal stimulus package, has eased, but certainly not eliminated, the budget difficulties faced by states. Although states and localities will continue to receive significant aid this year, that source of help will be winding down next year.

On a more positive note, state and local tax revenues seem set to increase as economic activity expands.

This is a fairly positive outlook for the overall economy, but less so for local governments.