Inflation Evaluation

.. single exponential smoothing model for its’ forecast which produced a Durbin Watsin statistic of 1.85, and standard error statistic of 1.211. This model eventually proved to be the superior model because of its lower than others error statistics. The combination model produced lower MAD, MSE, RMSE statistics than did the automatic method, but smoothing model was more accurate in that it produced a significantly lower MAPE. The summary of method errors, as well as forecasting models, are contained in appendix 6a. Therefore, using these crude methods I have been able to determine that Smart’s single exponential smoothing model provides the most accurate forecasting tool for considering this type of numerical data.

Based on this model, the forecasted values of inflation for the third and fourth quarters of 1999 are as follows: Q3 = -3.166*.258*3.682 Q4 = -3.216*.258*3.732 Smart software estimates these value ranges with 95% confidence and an average forecast error of 1.689. By considering some current events that are taking place in the domestic and global economy one might be able to more reasonably estimate this range, and thus assert some greater probabilities upon it. As of August 24, 1999 the Federal Reserve Board took a stance to reduce the leverage of some contributive inflationary aggregates. These actions included a .25% increase in the federal funds rate, bringing the total to about 5.25%. As discussed in Money and Banking, this will have a direct impact on the reserve positions and actions for lending institutions. The FOMC helped to accommodate this position stance by selling treasury securities in the secondary market.

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This is but one of the FOMC directives that can produce this effect. By doing so it detracts funds from the banks, thus further tightening their positions. On November 3, 1999, the Federal Reserve Bank of Minneapolis released a document prepared with information accumulated before October 25, 1999. These findings were summarized and placed in the Beige Book. Within this report there is data pertaining to the latest statistics on consumer spending, manufacturing, labor markets, wages and prices, real estate and construction, and banking and finance.

The article points out that the majority of districts are reporting increases in consumer outlays, and only a handful show signs of slowing. Some of these districts report that consumer expenditures might be down only due to the effects of hurricane Floyd. Most reported positive outlooks as the economy continues its’ wild ride and the Holiday seasons are soon approaching. Virtually all districts reported increases in manufacturing across a wide variety of economic sector and industries. This includes massive increases in biotech’s to strong growth in paper processing. The November 3 Beige Book for Minneapolis also points out that labor markets are saturated and the demand for workers exceeds that of the supply in many areas.

This may be taken as good news from a college student’s perspective, but at the same time it might also add to cost-push inflationary pressures. Given the increases in wages and disposable income, it is no doubt that mortgage markets continue to prosper. The east coast has seen 5 to 6 % increases in property value, but the volume of loans is growing at much smaller rate. (1 to 2%) On December 1, 1999 the Bureau of Economic Analysis (BEA) released their information pertaining to the third quarter of 1999. This article contained much information, including some of the most recent economic estimates and reports. Among them was news concerning the trade deficit. Because net exports is a component of GDP, it is important to recognize the nature of this sector when considering the future magnitude of GDP, potential inflation, and future monetary and fiscal policies determined by the Fed. It is plain to see that the recent currency crisis, increasing energy costs, and tariff problems with China have had a profound effect on the trade deficit.

(As demonstrated graphically in appendix 7a) The rate of increase related to the trade deficit, and imports exceeded that of any other in two decades. It is also noteworthy that export growth during this time had slowed considerably and even decreased. The BEA noted that for the first time in many months, foreign markets were beginning to show signs of real recovery. Having noted this the article went on to mention that import growth had showed only a slight increase above last quarters, and exports showed a 7% increase over last quarter. If these trends continue it could mean additional growth to gross domestic product. The increases have predominantly from Japan and other industrial countries, while the Asian tigers and Latin America are still in turmoil.

To what extent this news is relevant to the domestic economy in terms of growth and inflationary pressures has yet to be seen. However it does seem logical that we can expect the trade deficit to at least flatten out in the coming months, or even experience some decline depending on the resiliency of the other foreign markets. The BEA also estimated that GDP had increased by approximately 5.5% in the third quarter up from an increase of 1.9% in the second. This number was slightly higher than the upper range of an earlier estimate. Related to this increase the bureau noted that corporate profits related to current production were up, although the profits per unit of real production have decreased. These tendencies might be correlated to the factors earlier discussed relating to wage increases relative to productivity.

Though not mentioned by the BEA the rate of unemployment continues to slide toward all time lows. Day in and day out, reports of local, state, and federal record low unemployment is being reported. Thus the amount of cyclical unemployment in the economy is virtually zero, and the economy is operating at near full capacity. The unemployment rate is graphically illustrated in appendix 7b. This economics student is not ready to say how long the economy can sustain these r.p.m.’s, but does know that eventually the engine must be cooled or the economic expansion and bull market may come to an abrupt end.

At the time of the August 24 meeting the Federal Reserve Board and Dr. Greenspan did not anticipate the need for any further tightening of the reserve markets in the near future. Given the fact that the economy has continued to outperform economists expectations over the inter-meeting period, it will be interesting to see what courses of action and concerns the Fed discusses at the next meeting. (Scheduled sometime near the end of November) What do these rapid and consistent increases mean for the domestic economy. From my perspective, this economy is all I have known.

Many of the problems that used to face Americans seem to have been deleted. Leaving us today with the new challenges and fronts to conquer. One of these challenges is keeping this economy heading in a positive and stable direction. A looming threat to the stock markets and domestic economy is inflation. While doing research for this paper I stumbled across the unofficial fan club for Alan Greenspan.

I had never heard of a fan club for an economist, but after seeing how stable the growth rates of GDP and inflation have been, my interest and admiration are growing quickly. Earlier this year Fred Vogelstein wrote an article quoting Mr. Greenspan as saying, “Do worry. Be unhappy.” This from an economist with his own fan club; sounds like trouble. The article summarized some of Greenspan’s remarks in which he speculated about the increasing probability of an “inflation spike” and increased interest rates. He also pointed the possibility of a stock market correction, and the possible onset of a bear market.

Given the above remarks from Mr. Vogelstein’s article it seems likely that the inflation forecast previously presented will likely be in the upper portion of the range. That is, it is likely to be between .25 and 3.7% for the remainder of 1999. Though it is important to note that this analysis is based strictly on numerical data, and does not consider the realities of global economics. Inflation to investors generally means that their actual returns are going down.

As a result the prices are usually bid down in order to better reflect the required yield on equity. Based on my further analysis of this article it seems that investors concerns about inflation were and are indeed genuine, and the onset of inflation in the future could mean further plateaus in equity prices and increases in interest rates. However, I believe that this course of events might also present diversified and risk adverse investors with several opportunities to strengthen their positions, and add some securities that might be presently overvalued. (Increasing energy prices also increase the attractiveness for companies such as bldp and ucr.) Bibliography (1) Baye/Jansen. “Money and Banking.” Houghton Mifflin Publishing Company.

(1995) Pages 61-88. (2) Economagic, (1999) “Economic Time Series Page.” < http://www.economagic.com/> (3) “Employment Cost Trends.” BLS, (1999) < http://stats.bls.gov/ecthome.htm> (4) Freidma. “PPT Slide Show.” http://www.ecom.unimelb.edu.au/ecowww/rdixon/101/n otes/msi/tsld001.htm (5) The Hutchinson Encyclopedia. “Inflation” Helicon Publishing (1999) http://ukdb.web.aol.com/hutchinson/encyclopedia/30 /M0006130.htm (6) Manering, Virginia. “BEA News Release.” Bureau of Economic Analysis (11/24/99) (7) “Minutes of the Federal Open Market Committee” The Federal Reserve Board. (8/24/99) < http://www.bog.frb.fed.us/fomc/MINUTES/19990824.HT M> (8) “The Beige Book” The Federal Reserve Board.

Summary (11/3/99). (9) Vogelstein, Fred. “Do Worry. Be Unhappy.” Us News Online (3/8/99).

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