Net Foreign Purchases for March increased to $55.8 billion in March, up by $33.8 billion from $22 billion in February.  Net foreign purchases of long-term U.S. securities were $56.4 billion, $30.0 billion of which were from private foreign investors purchasing more U.S equities, and $26.4 billion purchased by foreign official institutions which have purchased larger volumes of Treasury Bonds and Notes.  U.S. residents purchased a net $0.6 billion of long-term foreign securities.

Industrial Production fell by 0.5% in April to an index value of 97.1 (2002=100), the lowest level since December of 1998 following a 1.7% decline in March, revised downward by 0.2%, and was expected to fall by 0.6% this month.  Having fallen for 6 consecutive months, the index is down 12.5% from April 200 and has fallen by 16% since the start of the current U.S. recession dated at December 2007. Production in the Mining Sector fell by 3.2% in March, production in Manufacturing fell by 0.3%, and production in Utilities increased by 0.4%. Capacity Utilization was reported at 69.1%, the lowest level since the series was instated in 1967, estimated by analysts at 68.8%, following a 69.4% level in March, revised from 69.3% originally reported. In April 2008, capacity utilization was as high as 79.2%.

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Retail Sales Fall An Annual 8%

Retail sales, excluding cars and fuel, fell by an annual 8 percent in August, the largest such decline registered since at least 2001. This follows a 6 percent in August. The year on year chart (see below) couldn't be clearer.



Sales were also down month on month (ie with respect to August), this time by a non seasonally adjusted 7%. In fact, on a seasonally adjusted basis retail sales peaked in February 2008, and have been trending down since. We still don't have the seasonally corrected data from Eurostat for September, but looking at the uncorrected data we do have from the Estonian statistics office, it does seem that retail sales were down again in Q3 over Q2.




Thus retail sales turned negative in March and the trend simply continues. The decrease in the retail sales of goods was most influenced by the stores selling manufactured goods where sales decreased by 12% compared to September 2007. Sales in non-specialized stores selling manufactured products and shops selling household goods and appliances, hardware and building materials were the worst hit.

Sales in grocery stores have, as might be expected, been rather more stable, with sales only down 3% . As had been the case in previous months, the decrease in food sales was largely influenced by the rise in food prices and the resulting decline in consumption.



Industrial Output Down 3.8%

Output adjusted for working days decreased an annual 3.8 percent, compared with a revised fall of 3.7 percent in August.

If we look at the seasonally and working day adjusted output index, then we can see that the level of output is now meandering downwards, and we now are way off the highs reached during last October and November. With this in mind we should expect the year-on-year percentage drops to start to decline after December, but it will then become much more interesting to follow the evolution of the absolute levels indicated by the general output index.

The main reason for the decline in output is evidently the lack of demand. The fall in manufacturing output was greatest in food, wood and building materials production. Food output was especially hit by the decrease in consumption resulting from this years large price increases. Although the rate of price increase has decelerated in recent months, food product prices are still up by 12% compared to September 2007.

The other area with big output drops is the manufacturing of wood and wood products, where the drop in sales in both domestic and external markets continues. The Estonian market is influenced by the construction slump, while in the external market Estonian manufactures are having a hard time due to the competitive environment and their own weaknesses in price competitiveness. Compared to September 2007, 22% less sawn timber and 9% less glue-laminated timber were produced. The largest drop (32%) was in the production of building materials which is directly connected with the decline in the construction market.

Some export-oriented industries have been continuing to expand - even in this difficult environment - especially enterprises involved in the manufacture of metal products, chemical products, and electrical machinery. Output was also up in the manufacture of machinery, radio and communication equipment, precision instruments and motor vehicles, since again a lot of the output is for export. The export share is 97% in the manufacture of radio and communication equipment and 91% in the manufacture of precision instruments.

Both Wages and Unemployment Still On The Rise


Wages continued to rise rapidly in the second quarter, up by 15.2%, even if this was the slowest pace of increse in more than two years, while the unemployment rate rose - to 3.1 percent in September - the highest level in more than three years.

Estonia's jobless rate, based on the number of unemployed registered with labor offices, rose to 3.1 percent, the highest since July 2005, from 2.9 percent in August, according to data from the Estonian Labor Market Board. The number of people signed on as seeking a job rose 6.6 percent from the previous month to 20,015. This number is of course, incredibly low by any comparable international standard, and is hard to square with a country in the midst of a very deep rcession (even after all the ritual genuflections towards the labour marekt being a lagged indicator). In order to understand how this situation is possible it is important to take into consideration Estonia's special demography and migration history.



However, it is also true to say that unemployment does normally follow changes in economic output with a time lag, se we should expected it to rise considerably in the coming months and quarters. Indeed the unemployment rate as measured by the Estonian statistics office in quarterly labor surveys is nearer to 4 percent in the second quarter (and the EU harmonised rate which is based on the survey shows 4.2% for September in the Eurostat database), and may rise as high as 10% according to recent estimates from Erkki Raasuke, head of Baltic research for Swedbank AB (not that they have been getting too much right of late, but still).


Despite the fact that unemployment will undoubtedly rise further as the recession deepens, it is the very tighness of the labour market (which is, as I say, in part a product of Estonia's demography) which prevents wage increases slowing down more rapidly, and thus the entire Estonian price system adapting to the slowdown (this phenomenon is often called "sticky wages and prices", and as we can see, the degree of viscosity here is almost treacle like). So Estonia's low earlier fertility fuelled the initial wage craze which along with the credit boom got us to the present point, and now the same lack of strength in depth in the labour market blocks the downward adjustment. In both cases the net by-product is massive pressure on the Kroon-Euro peg as Estonia struggles to find export competitiveness.


Consumer Confidence Falls Again


Unsurprisingly Estonian consumer confidence fell again in October, hitting its lowest level in more than 9 years, a sure sign the that the economy is about to shrink again, as domestic demand continues to search for a bottom. The Tallinn-based Konjunktuuriinstituut consumer confidence index declined to minus 27, its lowest reading since June 1999, and down from minus 22 in September. The institute cited worsening expectations for personal and state finances as the key drivers behind the drop.

“We expect the EU and the IMF to announce additional rescue packages for other Central and Eastern European economies in the coming days and weeks. Top of the list are the most imbalanced countries in the region - the Baltic States, Romania and Bulgaria."
Lars Christensen, Danske Bank, Copenhagen

Both Standard & Poor's and Fitch Ratings have responded over the last month to mounting risks from the global credit crunch by downgrading or revising credit rating outlooks to negative for a number of CEE economies including the Baltic states, the Balkans, Hungary and Ukraine. Moody's Investors Service has also revised its outlook to negative for Latvia and downgraded Ukraine.

S&P and Fitch both downgraded long-term sovereign ratings to Latvia and Lithuania on Oct. 27, citing recession risks and the growing need for external financing, while Estonia, had its rating cut by Fitch and outlook revised to negative by S&P. Basically, the crunch is biting in terms of both the cost and the availability of credit. This tightening in credit conditions is not, of course, new in Estonia, and in many ways we could say that the credit conditions should never have been allowed to get so "loose" in the first place. As can be seen from the chart below, the year on year rate of increase in peaked at the end of 2006, and since then the slowdown in Estonian domestic demand has been driven by the slowdown in the availability of credit (strictness off the terms, documentational requirements etc). Evidently, if such criteria had been applied much earlier, and the rate of annual increase never approached 80% all this may well have been a much less dramatic process.







The Estonian central bank said last week revised it's forecast for the economy, which has already made the turn around from being the second-fastest growing one in the EU in 2006, to being one of the most rapidly contracting ones in 2008. According to the bank the Estonian economy may shrink 1.8 percent in whole-year 2008 and 2.2 percent in 2009. As we have noted above the economy sank by 0.8% q-o-q in Q2 and by 1% year on year.



The decrease in GDP in Q2 was mainly a result of weak domestic demand, but the drop in both imports and the rate of increase in the export of goods and services meant that the contribution from external trade was negative. About the only item which maintained some momentum was government spending - buoyed by the tax income from an earier and better epoch. Compared to Q2 2007, total domestic demand was down by 2.8% , largely as a result of adecrease in private consumption and capital investments ( down by 2.0% and 2.5%, respectively).



Private consumption decreased mainly due to the decrease in expenditures on transport and clothing and footwear. The growth of expenditures on food and non-alcoholic beverages decelerated. Capital investments decreased in both the financial and the household sector. Investments in manufacturing industry were almost stationary year on year. At the same time public sector construction investments accelerated.



The decrease in exports and imports since the second half of 2007 which had been noted in Q1 went even further in the 2nd quarter. Compared to the 2nd quarter of the previous year, exports of goods and services decreased by 4.9% and imports by 8.2% (at constant chain-linked prices).




Goods exports were down by 3.2% primarily due to the decrease in exports of refined petroleum products. At the same time, exports of basic metals and electrical machinery (electrical motors and appliances), which significantly influence export movements, increased. Exports of services decreased by 8.9% primarily due to the decrease in exports of services for railway cargo, airway passengers and cargo transport and trade related exports services. The decrease in imports of goods was influenced mainly by the decrease in imports of refined petroleum products and motor vehicles. While imports decreased faster than exports, the deficit of net exports in GDP has increased since the second half of 2007 and amounted to -4.6% of GDP in the 2nd quarter. In the 1st quarter the impact of net exports was -7.1% (so the negative impact slowed vis a vis Q1).

Fiscal Crunch Coming

Basically, as the economy slows, and government income increases even while counter cyclical spending policies add to expenses, the government is moving into tricky fiscal deficit territory. Mindful of this the Estonian government approved on September 25 a draft 2009 budget which attempted to balances overall finances, including local government and the social insurance funds. The budget, which is still to be finally approved by the Estonian parliament, will fall into a deficit and need to be covered from government reserves, according to former Prime Minister Vaehi in a recent interview with the Maaleht newspaper Maaleht.

A deficit of 10 billion krooni would equal 3.5 percent of the expected gross domestic product of 283 billion krooni forecast by finance ministry in August. SEB have forecast a deficit of 1 percent of GDP in Estonia's overall finances next year.

Falling tax revenue has forced the Estonian governemnt of Prime Minister Andrus Ansip to cut spending and seek out new financing in an attempt to maintain a balanced budget, formerly a linchpin of the country's fiscal policies. The Finance Ministry have already forecast the budget will fall into a deficit of 3.1 billion krooni, or 1.2 percent of gross domestic product this year, after running surpluses in each of the last 6 years.



Two Questions In Conclusion

Basically then, it is hard to call the exact impact of trade on Q3 data without having the September trade data in front of us, since although the July and August export numbers are well below the April and May ones, we also need to take into account the accompanying drop in imports (which helps net trade, and thus is GDP positive). On the other hand the general impression you should get from all the data is that we are in for another shocker in Q3. Which leaves us with two questions:

1/ Where do we go from here?
2/ Just how long will it be before we hit generalised price deflation?

Let's take the second one first. Possibly for many people the question will appear to be a ridiculous one, but it isn't. If you look at the CPI index itself (this now becomes much more important than the year on year inflation rates, since what we need to watch for are the price movements from month to month. Now in the rate of increase from one month to another has been slowing, and in September the index was barely up over August (less than 0.5%, following a virtually stationary reading in August over July) so we should not be surprised to see the index hit a ceiling at some point, and then start to come down. Basic economic theory leads us to expect this (on the back of falling commodity and food prices and in a situation where internal capacity is way above the sum of internal and external demand available to the Estonian economy at current prices). Thus there is only one way for prices and wages to go: down. Although people may struggle with all this yet awhile before they accept the inevitable.



So what about the future of the economy in general? Well, let's take two quotes from the most recent Eesti Pank growth forecast. First, a recognition that they got it wrong in the past:

According to the base scenario of Eesti Pank's 2008 autumn forecast, Estonia's gross domestic product will decline by 1.8% in 2008 and by 2.1% in 2009. So far the economic correction has been more abrupt than expected primarily due to decreasing domestic demand. In addition to the cessation of the rapid real estate market expansion, also private consumption dropped in spring more than forecasted.

According to Eesti Pank's estimate, the economy should pick up again either at the end of 2009 or at the beginning of 2010. The average economic growth rate of 2010 will be 3%. Private consumption growth should recover in 2010 along with the revival of household confidence, whereas 2009 will be characterised by slowing wage growth and increasing unemployment.

Of that 5.6% year-over-year price increase, 1.9% came within the last two months alone. And there's no question that the big story driving that 2-month increase has been energy prices. NewJerseyGasPrices.com reports that the average retail price of gasoline sold in the United States rose from about $3.78/gallon in the middle of May to $4.12 in mid July, a 9% increase. That's in line with the 10.6% 2-month increase that BLS reported in their seasonally adjusted consumer energy price index between May and July. Energy prices have a weight near 10% in the total CPI. That means that if energy prices had held constant between May and July but all other price increases had been the same, the year-over-year CPI number would have been more like 4-1/2% rather than 5-1/2%.

But does it make any sense to ask, What if energy prices hadn't gone up between May and July? There are certainly good reasons why the Fed should not be taking as much comfort in "core inflation" as it has in recent years. But in this case, there is a clear need to net out the May-to-July energy price increase-- it's already been reversed. The US national average gas price is back to $3.78/gallon, right where it was in mid-May. Thus, even without any further drop in the price of gasoline-- and personally, I do expect further drops-- the 4-1/2% number is a better summary of where we stand right at the moment than 5-1/2%.

So no, I don't think that yesterday's CPI numbers will cause the Fed to panic. Because yesterday's news is already way of out of date.

Technorati Tags: CPI, inflation, core inflation, macroeconomics, economics

Defining a true cost of living index must begin on the household level, and then move to the social level. The Konuis (1939) true cost of living index for a single household is defined as the ratio of the minimum costs of achieving a certain reference utility level in a base period, given the prices prevailing at that time, and at a later "current" period, given whatever changes in prices had occurred in the interval. An appropriate generalization of the Konuis cost of living concept to the case of many households is Pollak's (1981, p. 328) social cost of living index, which is the ratio of the total minimum cost or expenditure required to enable each of the households present in the two periods to attain their reference utility levels in both time periods.

As economists have long known, a Laspeyres index, which finds the cost of purchasing a fixed basket of goods representing the base period and then the cost of buying the same basket in the present, tends to overstate the rise in the cost of living by not allowing any substitution between goods to occur. Conversely, a Paasche index, which finds the cost of purchasing a fixed basket of goods representing the present and then the cost of buying that same basket in the past, tends to understate the rise in the cost of living. Diewert (1983, p. 191) showed that the (unobservable) Pollak-Konuis true cost of living index was between the (observable) Paasche and Laspeyres price indexes. An implication of this result is that some average of the Paasche and Laspeyres aggregate price indexes should provide a reasonably close approximation to the underlying true cost of living. Note that this argument does not rely on any particular assumption about the form of the house- hold preferences; in particular, it does not assume that indifference curves are homothetic (that is, shaped so that the slope of the indifference curves will be the same along the path of a ray extending out from the origin).

One strong candidate for an average of the Laspeyres and Paasche indexes is the Fisher (1922) ideal price index, which is the geometric average of the Laspeyres and Paasche indexes (that is, the square root of their product). This choice can be defended from at least four different perspectives. First, it is evident that the base period basket used in the Laspeyres index is just as valid as the current period basket used in the Paasche index. Hence it makes sense to take an even-handed average of the two. The geometric mean is more desirable than other simple averages, like the arithmetic mean, because it has a time reversibility property: using the Fisher formula, price change going from the current period to the base period is the reciprocal of the original price change (Diewert, 1997). Note that the Paasche and Laspeyres indexes also do not satisfy this time reversal test. This leads to a second justification for the Fisher formula: it satisfies more reasonable "tests" or "axioms" than any of its competitors (Diewert, 1992). The test approach to index number theory, initiated by Walsh (1901) and Fisher (1922), looks at an index number formula from the viewpoint of its mathematical properties. For example, if current period prices increase, does the price index increase? Does the price index lie between the Paasche and Laspeyres indexes? If current period prices increase by a common factor of proportionality, does the price index increase by that same factor of proportionality? These reasonable tests are all satisfied by the Fisher formula.' A third justification for the use of the Fisher formula is the fact that it is exact for (that is, consistent with) a homothetic preference function that can approximate arbitrary homothetic preferences. Diewert (1976) calls index number formulae that have this property "superlative". The Toernqvist index which is discussed by the Boskin Commission is an example of another superlative formula. A final justification for the use of the Fisher formula rests on its consistency with revealed preference theory (Diewert, 1976, p. 137).

Of course, in this article directed toward generalists, the specific rationales and arguments and proofs are omitted, so one might feel that one is taking too much on faith. Fortunately, Diewert has written a comprehensive review recently published in the New Palgrave Dictionary of Economics (co-edited by UW professor Steven Durlauf). This article is available in its pre-publication form as UBC Discussion Paper 07-02. In this review, Diewert lays out the criteria by which one might prefer one index over another, and what is true is that the Laspeyres (fixed base period weight) approach is not one of the preferred methods.