Take this masterpiece song from the fifties musicalMy Fair Lady. Notice the explicit introduction of “enchantment” into the lyrics:
“On the Street Where You Live”
I have often walked Down the street before, But the pavement always stayed Beneath my feet before All at once am I Several stories high, Knowing I’m on the street where you live
Are there lilac trees In the heart of town? Can you hear a lark in any other part of town? Does enchantment pour Out of every door? No, it’s just on the street where you live
And oh, the towering feeling Just to know somehow you are near The overpowering feeling That any second you may suddenly appear
People stop and stare They don’t bother me, For there’s no where else on earth That I would rather be
Let the time go by, I won’t care if I Can be here on the street where you live
People stop and stare They don’t bother me, For there’s no where else on earth That I would rather be Let the time go by I won’t care if I Can be here on the street where you live, Can be here on the street where you live, Can be here on the street where you live
Life So they say Is but a game and they’d let it slip away Love Like the autumn sun Should be dyin’ But it’s only just begun
Like the twilight in the road up ahead They don’t see just where we’re goin’ And all the secrets in the universe Whisper in our ears All the years will come and go Take us up Always up
We may never pass this way again We may never pass this way again We may never pass this way again
Dreams So they say Are for the fools and they let ’em drift away Peace Like the silent dove Should be flyin’ But it’s only just begun
Like Columbus in the olden days We must gather all our courage Sail our ships out on the open seas Cast away our fears And all the years will come and go Take us up Always up
We may never pass this way again We may never pass this way again We may never pass this way again
So I wanna laugh while the laughin’ is easy I wanna cry if makes it worthwhile I may never pass this way again That’s why I want it with you
’Cause You make me feel like I’m more than a friend Like I’m the journey and you’re the journey’s end I may never pass this way again That’s why I want it with you Baby
We may never pass this way again We may never pass this way again We may never pass this way again We may never pass this way again
After deeply drinking in this and other songs, you could become more “attuned” to academic philosophy which would become less of an abstract and insipid blur. Pre-awareness and pre-understanding give you the receptivity you need and you get these from movies and songs and private life. The trick is to use meta-intelligence to straddle the campus and the off-campus worlds.
Conflict, supply disruption, rising prices, and shortages are all impacting food supplies globally. Just as we are nearing some form of recovery from the pandemic, we are now facing another global challenge in the form of a food crisis – and it’s likely to get worse.
This is a regional problem that cannot be solved by individual economies acting on their own. It must be looked at with a wider lens, such as through bodies, like APEC, that promote regional economic cooperation. APEC members acknowledge that all areas of the agri-food value chain are interdependent and that there is a need for a whole-system approach.
In my capacity as the Chair of APEC’s Small and Medium Enterprises Working Group, I’d like to stress the importance of the latter: inclusivity and small business. MSMEs account for over 97 percent of all business in APECeconomies and employ over half of the workforce. Any strategy for reducing food wastage will have to involve the wholesale participation of the region’s smaller businesses.
This is easier written than done. For one thing, fit-for-purpose data is scarce. No APECeconomy has food waste data that is specific to MSMEs. And while all have policies and measures to address the problem of food waste, there are no large-scale direct MSME–food waste reduction targets, policies or plans. Few have tried to reduce MSMEfood waste in the retail food and food service industries. Supermarkets, food storage facilities or warehouses in many APECeconomies aren’t required to donate excesses.
Most entrepreneurs aren’t even aware of the problem, or underestimate its true cost. Those who do understand have limited options or capital, and are unable to find cost-effective solutions to create value out of food waste, and face problems with logistics and transportation. On top of this, there are few to no regulatory frameworks to guide them. From a technology perspective, a majority of APECeconomies utilize modern technologies, including mobile applications, to reduce or manage MSMEfood waste/surplus food, but these modern technologies are used only by large companies in big cities.
Amid these challenges are an abundance of opportunities to help MSMEs reduce food waste. Training, policies and guidelines can aid them in improving profits by reducing costs and increasing the value added of food. They can reduce their carbon footprint, which enhances consumerdemand, and divert waste to new products or bioenergy.
A November study by the APEC Small and Medium Enterprises Working Group presents case studies, identifies the best available data on food waste for MSMEs, and identifies several best practices for economies in dealing with food waste through MSME policy.
In one section, the study’s authors analyze a case study of a successful MSME, and identify four key factors contributing to its successful reduction of food waste: 1) creating a network of people — e.g., a community surrounding a farm; 2) using innovation and technology to facilitate farming and save time; 3) producing knowledge and providing it through several channels — e.g., a learning and training center, friendly guide books; and 4) considering the environment at every step of the process.
Meta Intelligence is a heterodox view of education where formal education (courses, diplomas, universities, fields) are incomplete and limited without adding informal education which is part of your life such as movies, songs, conversations and images (paintings, posters, etc). Your “lifeworld” (Edmund Husserl’s apt coinage) fuses all the kinds of education where the word education means thought-provoking and illuminating. Even personal experience counts such as illnesses or bad marriages! Only via this Meta Intelligence will you achieve a glimpsed “holism.” (Meta Intelligence is that meta-field outside fields, borders and boundaries.)
“Riders on the storm Riders on the storm Into this house, we’re born Into this world, we’re thrown Like a dog without a bone An actor out on loan Riders on the storm”
“Some enchanted evening, you may see a stranger, You may see a stranger across a crowded room, And somehow you know, you know even then, That somehow you’ll see here again and again. Some enchanted evening, someone may be laughing, You may hear her laughing across a crowded room, And night after night, as strange as it seems, The sound of her laughter will sing in your dreams.
“Who can explain it, who can tell you why? Fools give you reasons, wise men never try.
“Some enchanted evening, when you find your true love, When you hear her call you across a crowded room, Then fly to her side and make her your own, Or all through your life you may dream all alone.
“Once you have found her, never let her go, Once you have found her, never let her go.”
Notice that “chant” is a component of enchantment.
One could say that conventional enchantment has been transferred to the world of science and mathematics where a deep beauty is intuited. Professor Frank Wilczek of MIT (Nobel Prize) wrote several books on this intersection of science and the quest for beauty whereas Sabine Hossenfelder of Germany has argued, per contra, that this will be a “bum steer.”
You should sense that like movies, songs give you a “side window” or back door into thinking and knowledge, which should be center stage and not depreciated.
“If you raise [the development of the BRI] to the strategic level, there are countries where … you will have to lose money and there are countries where you will be free to make money.”
How to respond to the growing political divide between China and the West marked by partial decoupling, security alliances, and the risk of sanctions, amongst other things, continues to be a major topic of discussion among China’s intellectual elite. As already evidenced in previous editions of this newsletter, opinions vary considerably. Those presented here so far have ranged from Da Wei (达巍) stressing the importance of preserving if not strengthening ties with the West and Shen Wei (沈伟) arguing in favor of reforming the WTO and building up a network of free trade agreements to Ye Hailin (叶海林) emphasizing the need for China to demonstrate its military might to demobilize U.S. allies and Lu Feng (路风) calling for self-reliance and greater assertiveness in the field of tech. A certain amount of overlap certainly exists among these perspectives but the differences are nonetheless striking.
Today’s edition of Sinification looks at a speech made last month by Yang Ping (杨平), head and editor-in-chief of the highly regarded Beijing Cultural Review (文化纵横, hereafter BCR). Yang is also director of the Longway Foundation (修远基金会) which publishes BCR. The foundation describes its publication as “the most influential magazine of intellectual thought and commentary in China” and sees itself as having a key role in helping shape the direction of intellectual debates in China (“议题的设置就是意识形态斗争成功的一半”). Indeed, BCR often republishes old articles at key junctures as so often highlighted by David Ownby’s wonderful Reading the China Dream.
The following are excerpts from an edited transcript of a speech by Yang made at an event hosted by Renmin University’s Chongyang Institute for Financial Studies, which was attended by China’s Vice-minister of foreign affairs Xie Feng (谢锋). In his speech, Yang advocates building a new international system led by countries in the Global South (which, of course, includes China) rather than the West. His ideas are not particularly novel but are nevertheless noteworthy in that they represent yet another viewpoint in the ongoing debate over how China should respond to the increasing tensions that characterize its relations with the U.S. and other Western countries. Next week, I will be sharing a somewhat longer piece that proposes a way of protecting China from the growing threat of Westernsanctions.
China must respond to this growing trend by building a “new type of international system” with other countries in the Global South.
BRI projects should be increasingly focused on achieving this goal and thus allow more room for loss-making endeavors.
Capitalist politics ≠ Capitalist economics
“Since 2022 and the Russo-Ukrainian conflict, our main focus and topic of discussion has been China’s construction of a new type of international system.
“We have witnessed two typical manifestations of the separation of politics and the economy and the impact of politics on the economy:
The first is the conflict between Russia and Ukraine. The sanctions imposed on Russia by the United States and the West have reached unthinkable, abominable [令人发指] and unimaginable proportions. Under established international rules, it was understood that such sanctions could not possibly occur, but now they have. These include the fracturing of the financial system, the expropriation and seizure of Russian private assets and the freezing of Russianforeign exchange reserves. These are all abominable and unimaginable forms of confrontation. At the same time, the Russo-Ukrainian conflict has led to serious disruptions in global food and energy systems and supply chains, with massive food ‘shortages’ and soaring food prices, particularly in developing countries. Sanctions and political repression [政治打压] have severely disrupted the [world’s] economic order.
The second is the conflict between the U.S. and China. Since the Trump era, the U.S. has been engaged in a trade war against China, mainly by raising tariffs. Basically, this was simply about balancing trade [with China] and used mainly economic means. But under Biden, it [has become] a war that mixes politics with economics. Biden’s strategy towards China can basically be summed up in just a few words: one, friend-shoring, [i.e.] only allowing friendly countries into [parts of] its supply chains; two, alliancepolitics, [i.e.] continuously forging an alliance system involving NATO, the European Union, Japan, AUKUS and the four Asia-Pacific countries [I assume he is referring to South Korea, Japan, New Zealand and Australia taking part for the first time in a NATO summit last year] and constantly opposing China [不断应对中国]; three, its so-called ‘precision strikes’, [i.e.] its radical crackdown on China’s high tech [industry], especially our chip industry.”
China is being pushed out of the U.S.-led international system
“The information I have seen so far is that the number of Chinese companies included in the U.S.’s ‘entity list’ has risen from 132 under Trump to over 530 now. The scope of such point-to-point [点对点] precision strikes is constantly expanding. With such a political impact on the economy, we can feel the [world’s] economic order being disrupted across the board. The world is moving inexorably in the direction of decoupling. The phenomenon of politics affecting the economy and the capitalistpolitical order no longer upholding the capitalisteconomic order are extremely striking.
“In such a context, the challenges now facing China are extremely serious and varied. We have the pressures of dealing both with containment in the Indo-Pacific and with the U.S.-led politics of alliances across the world. More importantly and fundamentally China faces the strategic task of building a new type of international system [新型国际体系] … The existing Western-dominated international system used to be one in which we tried hard to blend [so as] to become one with it. During this process, we [sought to] absorb the West’s advanced technologies and management [practices] and thus complete our mission of industrialisation and modernization.
“But once you enter the existing international system, he [who is already inside] does not want to play with you, and even wants to drive you back out. He wants to divide both supply chains and the economic system into two parts [搞成两套] and desperately wants to contain and suppress you. This is not something that can be determined by your own subjective preferences. He has made up his mind: you have already become his ‘fated opponent’ [命定的对手]. He has to suppress you and drive you out of the existing system.”
Building a new international system with the Global South
“It is at this point that China is faced with the task of constructing a new type of international system that is not dominated by the West. In today’s so-called strategic quadrangle consisting of the U.S., Europe, Russia and China, how to construct such an international system appears particularly difficult [逼庂 literally means ‘narrow’ or ‘cramped’ rather than ‘difficult’].
“But if we look a little further south, we will find a vast number of developing countries, the Third World and the countries of the global South. They should be our strategy’s depth [我们的战略纵深]. That is to say, [we should] build a new type of international relations and a new type of international system that has strategic depth and in which China and the countries of the global South are jointly integrated. [This] is, in my view, an important strategic task for China’s international relations in the coming decades.”
BRI projects: Strategy trumps profitability
“For China today, especially for businesses and governments at all levels [within China] that are currently working hard to develop BRI trade, there is a very important point to which they should be alerted or reminded about: the development of the BRI has to go beyond mere business, beyond the general export of [China’s excess] production capacity, beyond the partial thinking of industry and the partial thinking at the regional level, or the simple economic way of thinking of business. The development of the BRI should be considered at the strategic level. That is, it should be included into China’s strategy when thinking about Africa, South America, Southeast Asia and Central Asia.
“If you raise [the development of the BRI] to the strategic level, there are countries where you won’t be able to make money and will have to lose money, and there are countries where you will be free to make money. You have to unite the two within your organic strategy.
“The strategic task of building a new type of international system is, in my view, a strategic proposition that Chinesethink tanks and research institutes should pay very close attention to with regards to international relations.
“Time is limited today. I just wanted to make a start here. I hope to receive your corrections and criticisms. Thank you!”
The recessive importance of the Global South was previously explored by Richard and his partner Larry, with input from Supratik Bose, many decades ago as shown here.
“We’ve had a time of red-hot housing market all over the country… Shelter inflation is going to remain high for some time. We’re looking for it to come down, but it’s not exactly clear when that will happen. Hope for the best, plan for the worst.”
The rapid run-up of shelter costs—both house prices and rents—during the recovery from the pandemic has raised questions about how inflation pressures might affect housing affordability. Since March 2022, the Federal Reserve has rapidly lifted its federal funds rate target from near zero to over 4%, and policymakers have signaled that they are open to keeping the monetary policy stance sufficiently restrictive to return inflation to the longer-run goal of 2% on average. The tightened financial conditions following those policy changes, especially the surge in mortgageinterest rates, have helped cool house price growth. However, rentinflation remains elevated.
This Economic Letter examines the effectiveness of monetary policy tightening for reducing rentinflation. We estimate that, during the period from 1988 to 2019, a policy tightening equivalent to a 1 percentage point increase in the federal funds rate can reduce rentinflation—measured by 12-month percentage changes in the personal consumption expenditures (PCE)housing price index—by about 3.2 percentage points, but the full impact takes about 2½ years to materialize. Based on housing costs’ share in total PCE, this translates to a reduction in headline PCEinflation of about 0.5 percentage point over the same time horizon.
Rentinflation also accelerated during the pandemic period. Figure 1 shows that rentinflation—measured using 12-month changes in the PCEhousing price index and including rents for tenant-occupied housing and imputed rents for owner-occupied housing—rose from a low point of about 2% in early 2021 to 7.7% by December 2022, the highest level since 1986. During the same period, rentinflation measured by 12-month changes in the shelter component of the consumer price index (CPI) experienced a similar increase. Thus, following the tightening of monetary policy, house price growth has slowed but rentinflation continues to rise.
Economic theory suggests that some common forces such as changes in housing demand can drive both rents and house prices. For example, the expansion of remote work since the COVID-19 pandemic has increased demand for housing, raising both house prices and rents (Kmetz, Mondragon, and Wieland 2022). To the extent that the stream of current and future rents reflects the fundamental value of a house, house prices can be a leading indicator of future rentinflation (Lansing, Oliveira, and Shapiro 2022). Thus, monetary policy can affect both house prices and rents by cooling housing demand.
Housing demand responds to changes in financial conditions, such as increases in mortgageinterest rates. However, theory suggests that house prices are more sensitive than rental prices to changes in financial conditions, because home purchases typically require longer-term mortgage financing. In addition, unlike rents, house prices can be partly driven by investor sentiments or beliefs, which explains the observed larger swings in house prices than in rents over business cycles (Dong et al. 2022). Long-term rental contracts can also contribute to slow adjustments in rentinflation.
Rentinflation is an important contributor to overall inflation because housing costs are an important component of total consumption expenditures. On average, housing expenditures represent about 15% of total PCE and 25% of the services component of PCE. In CPI, shelter costs represent an even larger share, accounting for about 30% of total consumption of all urban consumers and about 40% of core consumption expenditures excluding volatile food and energy components.
The contribution of rentinflation to overall PCEinflation has increased since early 2021. As Figure 2 shows, in the first quarter of 2021, rentinflation accounted for about 22% of the four-quarter change in the PCE services price index, excluding energy: 0.5 of the 2.3 percentage points increase in service prices was attributable to rentinflation. By the third quarter of 2022, the contribution of rentinflation had climbed to about one-third, or 1.5 of the 4.7 percentage point increase in service prices.
Figure 2: Rising contribution of rent inflation to services inflation
For our analysis, we use a measure of monetary policy surprises constructed by Bauer and Swanson (2022). Their measure focuses on high-frequency changes in financial marketindicators within a short period surrounding the Federal Open Market Committee (FOMC) policy announcements. If the public fully anticipates a policy change, then the financial market would not react to new policy announcements. However, if the market does react to an announcement, then the policy change must contain a surprise element. Thus, changes in financial marketindicators, such as the price of Eurodollar futures, in a narrow window around an FOMC announcement can capture policy surprises. In practice, however, the data constructed this way are not complete surprises because they can be predicted by some macro and financial variables shortly before FOMC announcements. We follow the approach of Bauer and Swanson (2022) to purge the influences of those macro and financial variables from the measure of policy surprises. We use the resulting quarterly time series to measure monetary policy shocks, with a sample period from 1988 to 2019.
We then use a local projections model—a statistical tool proposed by Jordà (2005)—to project how rentinflation responds over time to a tightening of monetary policy equivalent to a 1 percentage point unanticipated increase in the federal funds rate in a given quarter. The model takes into account how monetary policy shocks interact with other macroeconomic variables, including lags of rentinflation, real GDP growth, and core PCEinflation.
In the final step, we compute the responses of rentinflation relative to its preshock level over a period up to 20 quarters after the initial increase in the federal funds rate.
Gradual impact of policy tightening on rent inflation
Figure 3 shows the response of rentinflation during the first 20 quarters after an unanticipated tightening of monetary policy (solid blue line). The shaded area shows the confidence band, indicating the statistical uncertainty in estimating the responses. Under the assumption that the model is correct, the shaded area contains the actual value of the rentinflation responses to the monetary policy shock roughly two-thirds of the time. The policy shock is normalized such that it is equivalent to a 1 percentage point unanticipated increase in the federal funds rate.
Figure 3: Response of rent inflation to monetary policy tightening
Source: Bureau of Economic Analysis, Bauer and Swanson (2022), and authors’ calculations. Note: Response of rentinflation to a monetary policy shock equivalent to a 1 percentage point surprise increase in the federal funds rate. Shaded region shows 68% confidence band around the estimate.
The figure shows that monetary policy tightening has significant and gradual effects on rentinflation. On impact, a 1 percentage point increase in the federal funds rate reduces rentinflation about 0.6 percentage point relative to its preshock level. Over time, rentinflation declines gradually, falling about 3.2 percentage points in the 10 quarters following the impact. The slow adjustment in rentinflation partly reflects the stickiness in nominal rents due to long-term rental contracts. Since housing expenditures account for about 15% of total PCE, this estimate translates to a reduction in headline PCEinflation of about 0.5 percentage point, stemming from the decline in rentinflation over a period of 2½ years.
The rent component of PCE is measured based on average rents, including those locked in long-term rental contracts, which are slow to adjust to changes in economic and financial conditions. Rents on new leases, however, are more flexible. For example, the 12-month growth in Zillow’s observed rent index, which measures changes in asking rents on new leases, has slowed significantly since March 2022 (see Figure 4). Asking rents are typically a leading indicator of future average rents. Thus, the slowdown in asking rent growth could portend lower future rentinflation.
Figure 4: Year-over-year observed rent growth starting to slow
Source: Zillow and Haver Analytics. Note: Twelve-month percentage changes in Zillow’s observed rent index. Gray shading indicates NBER recession dates.
Conclusion
Rents are an important component of consumer expenditures. Recent surges in rentinflation have led to concerns that overall inflation might stay persistently high despite tightening of monetary policy. We present evidence that monetary policy tightening is effective for reducing rentinflation, although the full impact takes time to materialize. A policy tightening equivalent to a 1 percentage point increase in the federal funds rate can reduce rentinflation up to 3.2 percentage points over the course of 2½ years. This translates to a maximum reduction in headline PCEinflation of about 0.5 percentage point over the same time horizon. Although average rents are slow to respond to policy changes, growth of asking rents on new leases has started to slow following recent monetary policy tightening. Our finding suggests that this tightening will gradually bring rentinflation down over time, thereby helping to reduce overall inflation.
It means that many more qubits, the basic calculating unit, can be joined together than is possible on a single microchip. This will make a more powerful quantum computer possible.
The scaling of qubit numbers from the current level of around 100 qubits to nearer 1 million is central to creating a quantum processor that can make useful calculations.
The significant achievement is based on a technical blueprint for creating a large-scale quantum computer, which was first published in 2017 with funding from EPSRC.
Their development may help solve pressing challenges from drug discovery to energy-efficient fertilizer production. But their impact is expected to sweep across the economy, transforming most sectors and all our lives.
Potential to scale up
Winfried Hensinger, Professor of Quantum Technologies at the University of Sussex and Chief Scientist and co-founder at Universal Quantum said:
The researchers were successful in transporting the qubits using electrical fields with a 99.999993% success rate and a connection rate of 2424 transfers per second. Both numbers are world records.
Dr. Kedar Pandya, Director of Cross-Council Programmes at EPSRC, said:
This significant milestone is evidence of how EPSRC funded science is seeding the commercial future for quantum computing in the UK.
The potential for complex technologies, like quantum, to transform our lives and create economic value widely relies on visionary early-stage investment in academic research.
We deliver that crucial building block and are delighted that the University of Sussex and its spin-out company, Universal Quantum, are demonstrating the strength it supports.
The Atlanta Fed’s Wage Growth Tracker was 6.1 percent in January, the same as in December. For people who changed jobs, the Tracker in January was 7.3 percent, compared to 7.7 percent in December. For those not changing jobs, the Tracker was 5.4 percent, compared to the 5.3 percent reading in December.
Theodicy is the inquiry into the paradox that a loving God would witness and allow such endless evil as exists in the world.
Movies can be very informative as a parallel university which gives you a visual and story-based entry into such a problem or puzzle or conundrum or dilemma.
Consider the following exchange between Prospero (Vincent Price plays a kind of “evil machine”) from the film:
Prospero: Somewhere in the human mind, my dear Francesca, lies the key to our existence. My ancestors tried to find it. And to open the door that separates us from our Creator.
Francesca: But you need no doors to find God. If you believe…
Prospero: Believe? If you believe, my dear Francesca, you are… gullible. Can you look around this world and believe in the goodness of a god who rules it?
Famine, Pestilence, War, Disease and Death! They rule this world.
Basic Story:
The evil Prince Prospero is riding through the Catania village when he sees that the peasants are dying of the Red Death. Prospero asks to burn down the village and he is offended by the villagers, Gino and his father-in-law Ludovico. He decides to kill them, but Gino’s wife, the young and beautiful Francesca, begs for the lives of her husband and her father and Prospero brings them alive to his castle expecting to corrupt Francesca. Prospero worships Satan and invites his noble friends to stay in his castle which is a shelter of depravity against the plague. When Prospero invites his guests to attend a masked ball, he sees a red-hooded stranger and he believes that Satan himself has attended his party. But soon he learns who his mysterious guest is.
Theodicy and the Explanation of God’s Coexistence with Evil:
Wikipedia informs us:
Theodicy means the vindication of God. It is to answer the question of why a good God permits the manifestation of evil, thus resolving the issue of the problem of evil. Some theodicies also address the problem of evil “to make the existence of an all-knowing, all-powerful and all-good or omnibenevolent God consistent with the existence of evil or suffering in the world.” Unlike a defense, which tries to demonstrate that God’s existence is logically possible in the light of evil, a theodicy provides a framework wherein God’s existence is also plausible.
One of life’s educational tricks (a pillar of Meta Intelligence) is to let the off-campus “university” of movies give you an on-ramp, if you know how to take it, into formal academe on the campus.
In this Economic Letter, we assess whether recent higher inflation is leading businesses and households in Mexico to expect inflation to remain high over the long run. Specifically, we focus on what rising market-based measures of inflation compensation may imply about bondinvestors’ outlook for inflation. The rise in inflation compensation since spring 2021 could reflect three factors: an increase in investors’ inflation expectations, an uptick in the premium investors demand for assuming inflation risk, or changes in other risk and liquidity premiums. We explore the relative importance of each of these factors using a novel dynamic term structure model of nominal and inflation-adjusted yields described in Beauregard et al. (2021, henceforth BCFZ). Overall, our results for five-year inflation expectations five years from now suggest Mexicanbondinvestors’ long-term inflation expectations have been little affected by the recent rise in inflation. Instead, the rise in inflation compensation reflects a notable uptick in the inflation risk premium to the high end of its historical range. This suggests that, despite inflation expectations being little changed on average, some investors are particularly concerned about the risk that inflation will remain above expected levels.
The recent rise in Mexican inflation
Figure 1 shows the year-over-year change in the Mexicanconsumer price index (CPI) measured both by the headline CPI (green line) and the more stable core CPI (blue line) that strips out volatile food and energy prices. Also shown with a horizontal gray line is the 3% inflation target of the nation’s central bank, the Bank of Mexico.
Figure 1: Mexican consumer price index inflation
Source: Instituto Nacional de Estadística y Geografía.
We note that MexicanCPIinflation has averaged somewhat above the Bank of Mexico’s target since its adoption in 2002. More importantly, CPIinflation in Mexico appears to have become more volatile and somewhat higher over the past five years. Although previous research by De Pooter et al. (2014) found inflation expectations in Mexico to be well anchored, the significant global economic dislocations caused by the coronavirus pandemic and related inflationary pressures could impact inflation expectations of businesses and households.
The difference between nominal and real yields for bonds of the same maturity is known as breakeven inflation (BEI). This represents a market-based measure of inflation compensation used to assess financial market participants’ inflation expectations. Figure 2 shows BEI rates at different maturities, meaning annual average rates of inflation compensation between now and maturity, from 1 to 10 years at the end of March 2021 (green line) and at the end of November 2022 (blue line). The slightly upward-sloping BEI curve of close to 3% in 2021 contrasts with the higher downward-sloping BEI curve in 2022.
Figure 2: BEI curves for 1-year to 10-year Mexican bond maturities
Source: Authors’ calculations using bond prices from Bloomberg.
The increase for shorter maturities, the left end of the 2022 BEI curve, is closely tied to the current high level of inflation and suggests inflation may remain elevated for some time. In contrast, the increase at longer maturities, the right end of the 2022 BEI curve, suggests that investors’ longer-term inflation expectations may be drifting above the Bank of Mexico’s inflation target. To better understand the shape and sources of variation of the BEI curve we use a yield curve model.
A yield curve model of nominal and real yields
Market-based measures of inflation compensation such as BEI rates contain three components. First, they include the average CPIinflation rate expected by bondinvestors, which is the focus here. Second is an inflation risk premium to compensate investors for the uncertainty of future inflation. This premium is embedded in nominal yields that provide no inflation protection. Third is the difference in relative market liquidity between standard fixed-coupon and inflation-indexed bonds. As discussed in BCFZ, both of these types of Mexicanbonds are less liquid than U.S. Treasuries, and their prices therefore contain a discount to compensate investors for their liquidity risk. Neither the inflation risk premium nor the liquidity premiums are directly observable and must therefore be estimated.
To adjust for these challenges, we first use the nominal and real yields model developed in BCFZ to identify liquidity premiums in standard fixed-coupon and inflation-indexed bond prices as a function of the time since issuance and the remaining time to maturity. The time since issuance serves as a proxy for declining liquidity as, over time, a larger fraction of bonds gets locked into buy-and-hold strategies. We refer to the observed BEI net of estimated liquidity premiums as the adjusted BEI. In a second step, we then separate adjusted BEI into components representing investors’ inflation expectations using a formula based on the absence of bond market arbitrage opportunities and the residual inflation risk premium.
Results
To assess whether investors’ inflation outlook has fundamentally changed, we follow De Pooter et al. (2014) and examine the five-year forward BEI rate that starts five years ahead, denoted 5yr5yr BEI. This is a horizon sufficiently long into the future that most transitory shocks to the economy can be expected to have vanished. Hence, the embedded inflation expectations are presumably less affected by current high inflation and pandemic-related transitory conditions and can therefore speak to the question about the anchoring of inflation expectations in Mexico.
Figure 3 shows the breakdown of 5yr5yr BEI into its various components according to our model. The dark blue line is the observed BEI, and the red line is the estimated adjusted BEI without liquidity risk premiums or other residual disturbances. The difference between these two measures of BEI—the yellow shaded area—represents the model’s estimate of the net liquidity premium or distortion of the observed BEI series due to risk premiums in both nominal and inflation-indexed bond prices. The adjusted BEI is entirely above the observed BEI, suggesting the liquidity risk distortions are systematically larger in the inflation-indexed bond prices, consistent with similar evidence from the U.S. Treasury market (Andreasen and Christensen 2016). Note that the net BEI liquidity premium widened around the financial turmoil in spring 2020 at the start of the pandemic and remains elevated.
Figure 3: Components of 5yr5yr breakeven inflation for Mexico
Source: Survey forecasts from Consensus Economics and authors’ calculations using bond prices from Bloomberg.
The model also allows us to break down the adjusted BEI into an expected inflation component (light blue line) and the residual inflation risk premium (green line). Also shown is the Bank of Mexico’s 3% inflation target (gray horizontal line). For comparison, the figure also shows the 5yr5yr expected CPIinflation in Mexico reported semiannually in the Consensus Forecasts surveys (dark blue squares). We note that both observed and adjusted BEI have trended higher since the start of the pandemic in early 2020. Importantly, the breakdown indicates that long-term expected inflation in Mexico has remained stable, slightly above the 3% inflation target. As a result, the increase in BEI can be attributed to the inflation risk premium, which is at the high end of its historical range towards the end of our sample. Given the elevated levels of current inflation, this suggests some investors are concerned that inflation could remain elevated for longer than currently anticipated.
This raises the question of whether long-term inflation expectations in Mexico are likely to remain anchored near their current level going forward. To assess this risk, we simulate 10,000-factor paths over a three-year horizon using the estimated factors and factor dynamics as of November 2022—that is, the simulations are conditioned on the shapes of the nominal and real yield curves and investors’ embedded forward-looking expectations as of November 2022. These simulated factor paths are then converted into forecasts of 5yr5yr expected inflation. Figure 4 shows the median projection (solid green line) and the 5th and 95th percentile values (dashed green lines) for the simulated 5yr5yr expected inflation over a three-year horizon.
Figure 4: Three-year projections of 5yr5yr expected inflation, Mexico
Source: Authors’ calculations.
Our model projections indicate that long-term inflation expectations are likely to deviate only modestly from their current level, consistent with the variation of the historical estimates back to 2009. Overall, our findings represent tangible evidence that long-term inflation expectations remain well-anchored in Mexico despite the recent rise in inflation.
Conclusion
Global inflation pressures in the aftermath of the pandemic have raised fears about a sustained increase in the level of inflation around the world, which could be particularly challenging for developing economies with monetary policy guided by an inflation target. In this Letter, to assess this risk for a major emerging economy with an established inflation target, we examine the variation in Mexico’s nominal and inflation-indexed bond prices, while accounting for their respective liquidity risk premiums. This allows us to estimate Mexicanbond investors’ inflation expectations and associated risk premiums. The results reveal that the inflation risk premium has pushed up Mexican BEI rates in recent years, while investors’ long-term inflation expectations have remained stable near the Bank of Mexico’s inflation target despite the rise in inflation.
The policy path needed to keep inflation expectations anchored in a situation with highly elevated inflation may involve tradeoffs. The Bank of Mexico responded early and forcefully to inflation pressures starting in June 2021 and has indicated further tightening of the policy rate would likely be appropriate to bring inflation back down to target over the medium term. This could lower economic growth in Mexico in both 2022 and 2023. On the other hand, history shows that it may be difficult and costly to reverse extended departures from announced inflation targets. Thus, it will be important for central banks with inflation-targeting frameworks to monitor measures of long-term inflation expectations in the current situation.
While continuing to cool over the last several months, 12-month inflation remains at historically high levels. The headline personal consumption expenditures (PCE) price index rose 5.5% in November 2022 from a year earlier. This marks a decline in inflation to a level last observed in October 2021, but still well above the Fed’s longer-run goal of 2%. A portion of the inflation moderation is attributable to recent declines in energy prices. Core PCE inflation, which removes food and energy prices, has shown less easing.
Owing to fiscal relief efforts and lower household spending over the course of the pandemic, consumers accumulated over $2 trillion dollars in excess savings, based on pre-pandemic trends. Since then, consumers have drawn down over half of this excess savings which has helped support recent growth in personal consumption expenditures. A considerable amount of accumulated savings remains for some consumers to support spending in 2023.
In the wake of the pandemic, consumer spending patterns shifted away from services towards goods. While there appears to be some normalization of spending behavior, this shift has generally persisted. Real goods spending remains significantly above its pre-pandemic trend, driven by strong demand for durables such as furniture, electronics, and recreational goods. Spending on services has shown a resurgence but remains below its pre-pandemic trend.
Supply chainbottlenecks for materials and labor remain a constraint on production, although there are some recent signs of easing. The fraction of manufacturers who reported operating below capacity due to insufficient materials peaked in late 2021 and has moderately declined over the past year. However, the fraction of manufacturers reporting insufficient labor has persisted at high levels.
The labor market remains tight, despite some signs of cooling. The number of available jobs remains well above the number of available workers, although vacancy postings have been trending down in recent months. The tight labor market has put continued upward pressure on wages and labor market turnover.
A decomposition of headline PCE inflation into supply– and demand-driven components shows that both supply and demand factors are responsible for the recent rise in inflation. The surge in inflation in early 2021 was mainly due to an increase in demand-driven factors. Subsequently, supply factors became more prevalent for the remainder of 2021. Supply-driven inflation has moderated significantly over recent months, while demand-driven inflation remains elevated.
Although the labor market is currently very strong, financial markets are pointing to some downside risks. Namely, the difference between longer- and shorter-term interest rates has turned negative, which historically tends to occur immediately preceding recessions. It remains unclear whether lower longer-term yields are indicative of anticipated slower growth or lower inflation.
Short-term inflation expectations remain elevated relative to their pre-pandemic levels in December 2019. Consumers are expecting prices to rise 5% this year, while professional forecasters are expecting prices to rise 3.5%. Longer-term inflation expectations remain more subdued, indicating that both consumers and professionals believe inflation pressures will eventually dissipate.
Rentinflation is expected to remain high over the next year. The prices for asking rents have grown quite substantially over the last two years. As new leases begin and existing leases are renewed, these higher asking rents will flow into the stock of rental units, putting upward pressure on rentinflation.
