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This edition was written by Elijah Asdourian, Georgia Nabors, Lorae Stojanovic, and Louise Sheiner.
The difference between the interest rate on a 10-year and 3-month government security—the yield spread—is often used to predict the future behavior of the economy. (When the long-term yield is below the short-term yield that is seen as predicting an economic downturn.) Using data from 1995 to 2023, Menzie D. Chinn of the University of Wisconsin and Laurent Ferrara of SKEMA Business School find that the yield spread is useful in predicting recessions and industrial production growth in the U.S. and Canada but has varied success in other advanced economies. Incorporating yield spreads abroad and the ratio of income to debt service payments for non-financial firms, in addition to the yield spread, improves the economic models’ ability to predict recessions in the U.S. and other high-income countries. In emerging economies, however, the yield spread and other financial variables have limited success in predicting recessions and growth.
The Trump administration imposed substantial new tariffs on China. China responded by imposing retaliatory tariffs on the United States. Though the “trade war” was billed as a way to increase agricultural and manufacturing employment in the U.S., David Autor of MIT and co-authors find that U.S. tariffs on China did not have a substantial impact on U.S. employment in tariff-protected sectors, while Chinese tariffs on the U.S. decreased agricultural employment. As one possible explanation, the authors point to research which found that other countries increased their exports to the U.S. after tariffs were imposed on Chinese goods, while U.S. industries were unable to expand their exports to new markets in the face of Chinese tariffs. Using congressional district-level data on political affiliations, the authors find that, despite negative employment effects, regions with higher tariff exposure swung further to the Republican Party in the 2020 election than regions with low tariff exposure.
Catherine Hausman of the University of Michigan finds that a small number of American electricity producers have strong incentives to block investment in U.S. electricity transmission capacity that would ease congestion. Transmission networks convey energy over a distance, enabling consumer demand to be matched with the lowest-cost energy producers within a network’s geographic footprint. Hausman finds that congestion within two electricity markets covering the Great Plains, Great Lakes, and Gulf Coast regions of the United States increased the total cost of electricity generation by $2 billion in 2022. Additional transmission lines would benefit solar and wind power generators, whose plants tend to lie farther from urban centers but would disadvantage fossil fuel powered incumbents. Had there been no congestion in 2022, the four most advantaged firms would have earned an additional $1.0 billion in profits while the four most disadvantaged firms would have lost $1.6 billion in profits. Hausman highlights decades of accusations against two of the four most adversely affected firms, alleging they employed various tactics to obstruct the construction of new transmission lines.
“Uncertainties remain and central banks now face two-sided risks. They must avoid premature easing that would undo many hard-earned credibility gains and lead to a rebound in inflation. But signs of strain are growing in interest rate-sensitive sectors, such as construction, and loan activity has declined markedly. It will be equally important to pivot toward monetary normalization in time, as several emerging markets where inflation is well on the way down have started doing already. Not doing so would jeopardize growth and risk inflation falling below target," says Pierre-Olivier Gourinchas, Chief Economist of the International Monetary Fund.
"My sense is that the United States, where inflation appears more demand-driven, needs to focus on risks in the first category, while the euro area, where the surge in energy prices has played a disproportionate role, needs to manage more the second risk. In both cases, staying on the path toward a soft landing may not be easy. The biggest challenge ahead of us is to tackle elevated fiscal risks. Most countries came out of the pandemic and energy crisis with higher public debt levels and borrowing costs. Bringing down public debt and deficits will give space to deal with future shocks.”
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