Markets still react to Bernanke

Okay, I'm going to briefly weigh in again where I probably shouldn't---the macro situation.

Apparently in response to Bernanke's speech in Jackson Hole today, the stock market and treasury bills rallied modestly, and the 10-year T-bill rate fell over 6 basis points.  I suppose one could argue this was due to something else, but I don't see anything other explanation in the news.

Paul Krugman summarized Bernake's speech as:

1. Things are really, really bad.

2. The damage is cumulative; the longer this goes on, the worse the prospects for the future.

3. The Fed has the power to do a lot to help the economy.

4. While you can argue that there are costs to action, the case for major costs is quite weak, and in particular much weaker than the case for major benefits.

5. Therefore, what we at the Fed will do is, um, sit on our hands some more, and think very seriously about maybe, someday, doing something.

While Krugman greatly supports the Fed trying to do more, he has also expressed skepticism that they can help much when the economy is at the zero lower bound.

But I'd just like to point out that the market still seems to respond to Bernanke's most demure suggestions.  I mean, how much news was there in his Jackson Hole speech?  We all more-or-less knew that the Fed was looking to do more imminently anyway, and now he's nudged another inch in that direction.

If we extrapolate from this, I think it suggests the Fed can do a lot more.  It could do this by changing market expectations, by replacing point 5 in Krugman's summary with a clear and firm commitment for the next X years.  That commitment could be to hold rates where they are for a longer period of time, to target a higher long-run inflation rate,  a commitment to hold rates low until unemployment falls to 6 percent, or a commitment to achieve trend nominal GDP.

I don't think it matters much which commitment they choose.  But I believe that if the Fed were to make a bold commitment of continued easing the economy would recover quickly. It's a shame they probably won't do that.

Update: Slight clarification: I expect the Fed will do something, but whatever they do will be relatively modest.  Perhaps there will be more asset purchases or something.  But I rather doubt we'll see a strong commitment to longer term policy.

Brad Plumber writes what I think about the drought

Brad Plumber over at Ezra Klein's Wonkblog writes my thoughts better than I do :-)

While my comments about CAFO's in my post the other day are sure to offend many, I did try to choose my words carefully.  There are many ethical and environmental issues that surround CAFOs, and I'm not dismissing those issues. 

But we should be aware of indirect consequences of CAFOs.  Some of those indirect consequences can be good for feeding the world and even good for the environment.  It's only responsible to spell out all of those tradeoffs, and I see that as my job. There are good arguments to be made that modern industrial agriculture is good for the environment in much the same way as high-density urban living is good for the environment: by concentrating these activities we leave less of a footprint on the planet as a whole.

Incidentally, unlike the other guy in the news these days, I think "wonk" suits Wonkblog very well.

Sea Ice Extent

Sea ice extent is one of the more interesting barometers of climate change.

This year has been a record low, beating the previous record from 2007.  Extent is a little more than half the 1979-2000 median, or about 6 standard deviations below it.

From Justin Gillis's article today in the NYT:

“It’s hard even for people like me to believe, to see that climate change is actually doing what our worst fears dictated,” said Jennifer A. Francis, a Rutgers University scientist who studies the effect of sea ice on weather patterns. “It’s starting to give me chills, to tell you the truth.”....

....“It’s an example of how uncertainty is not our friend when it comes to climate-change risk,” said Michael E. Mann, a climate scientist at Pennsylvania State University. “In this case, the models were almost certainly too conservative in the changes they were projecting, probably because of important missing physics.”

What's the price of corn in your meat? Less than you think.

In my OpEd last week I had a lot of back and fourth with the editor.  I probably had too many statistics and my first draft was just too long.  I also should have provided background information up front for the statistics I wanted to present.

One thing that got dropped in the process was an explanation for why retail food prices will rise so little even though corn prices have increased 60 percent.  So much of our food is ultimately derived from corn, or from other commodities like wheat and soybeans whose prices track corn prices fairly closely.  But it still makes little difference.

Take meat, for example.  There are only 3-5 pounds of corn used to make an additional pound of beef, and between 2 and 3 pounds of corn for a pound of chicken or pork.   The calculation isn't particularly straightforward, but these numbers are probably about right ``on the margin," as economists like to say. This can vary a bit from operation to operation or how it's measured, but feed use efficiency has risen a lot over the last couple decades with the growth of confined animal feeding operations, or CAFOs.

Let's says 5 pounds of corn per pound of meat.  There are 56 pounds of corn in a bushel and since June prices have increased from about $5 to about $8 per bushel.  This means the amount corn in your quarter-pound burger have increased from about 11 cents to about 18 cents.  If there is market power by processing companies or retailers, retail prices would go up by less than this amount (this is basic microeconomics, but I'll save the details for another time).  So, you'll have to squint to see the effect of this year's drought on prices at grocery stores and restaurants.

There are lots of complaints about CAFOs being inhumane for animals.  That may be, but they are also extremely efficient at using resources.  Without CAFOs, you would see bigger prices in all kinds of food, and this year's heat and drought would have caused a larger price spike.  We would also be using more land in crop production globally, and be using more fertilizers that pollute water and all manner of other environmental problems that follow from crop production.  Many environmentalists don't like CAFO's but they may well be doing more good for the environment than eating grass-fed beef, unless the high price of grass fed beef causes you to eat less.  (Granted, grass-fed beef is probably healthier.)

Anyhow, the main point is that commodities are a tiny share of retail prices in developed economies.  Prices of most everything, including food, is made up primarily of labor and capital costs, plus rents to producers and retailers with market power.  The big concern for high commodity prices in the developed world where the commodity share of food expenditures is much, much greater and people spend a much larger share of their income on food.

(cross posted at G-FEED)

Are we coping with extreme heat better than the past?

I'm live at CNN.  This is the biggest splash I've ever had....

Extreme heat and droughts -- a recipe for world food woes

With extreme heat and the worst drought in half a century continuing to plague the farm states, there are important lessons to be learned for all of us -- farmers, consumers and the world's poorest populations alike -- about the effect of climate change.

The Agriculture Department announced this season's first major crop yield forecasts, and they weren't pretty: a nationwide average of 123.4 bushels of corn per acre, the lowest level since 1995. Soybean yield is expected to be low too, though not as bad as corn.

The United States, which is the world's largest producer and exporter of staple grains, is grappling with the biggest surprise in production shortfalls since the Dust Bowl of the 1930s. Certainly, this July surpassed July 1936 as the hottest month on record. 

So, how will the devastation affect U.S. crop farmers? .....

Forecasting Corn Yields

My colleague Wolfram Schlenker has developed forecasts for this year's corn yield based on weather through August 6.  We've been considered pessimists by some, since this model predicts really big declines in crop yields under projected climate change.  But this year we're the optimists: our model predicts a US yield only a 14 percent below trend. That's bad, but it's not nearly as bad as USDA's forecast last Friday of 25 percent below trend.

I'm replicating his post so you don't have to click through:

USDA today announced its forecast for corn yields. It might be fun to compare those forecast to one using a statistical model of corn yields that my colleague Michael Roberts and I have developed. It uses only four temperature variables (two temperature and two precipitation variables - if you want to read more, here's a link to the paper). The temperature variables in 2012 are shown here.

All weather variables in the model are season totals for March 1st - August 31st. The following graph combines actual weather observations for March 1st-August 6, 2012 with historic averages for August 7th-August 31st in each county.  Once the actual weather for the rest of August is realized, the predictions will obviously change dependent on whether it warmer or cooler than usual.

Should the Ethanol Mandate be Temporarily Suspended?

There seems to be a big push to roll back the ethanol mandate, at least temporarily, due to the crop losses and high prices for corn, soybeans and wheat we're experiencing this year.  See, for example, Colin Carter and Henry Miller's Op Ed in the New York Times.

How much would a temporary suspension of the mandate affect prices?

As I write, the future price for corn delivered in December 2012 is $7.95/bu.  The price for delivery in December 2013 is just $6.30.  So, there is no incentive to store commodities, and inventories are very low.  So, any reprieve on the demand side will push directly on this year's price. With regard to prices, it would be equivalent to reducing the size of crop losses.  If we lose 1/3 of the crop from heat and drought, and we reduce demand by 1/3 by temporarily halting ethanol production, we'd probably go back to early-Spring prices of around $4-5/bu.

One problem with this back-of-the-envelope calculation is that ethanol production is unlikely to stop completely just due to a temporary suspension of the mandate.  There are shutdown and startup costs, and a 10% ethanol blend is firmly in place.  So prices probably wouldn't fall back that far, but they would fall a lot.

In fact, I wouldn't be surprised if speculation about a temporary suspension of the mandate is already  folded into futures prices, at least partly.  It's hard to know what the odds of a repeal might be, but the market knows it's not zero.  And the worse are crop losses, the greater the odds of a temporary  suspension.

What's more subtle and potentially more interesting is that temporarily repealing the mandate would set a precedent that would affect futures prices and inventory demand going forward.  It would be interesting to evaluate an ethanol policy with a "safety valve" that would relax the mandate in the event prices exceeded some threshold.  This kind of analysis is more difficult. Nam Tran, a grad student at NCSU, is working on it.  I'll post his results here if and when he has them.

(Cross-posted on G-FEED)