Category Archive for: Fed Speeches [Return to Main]

Thursday, January 11, 2007

NY Fed's Geithner on Risks to the U.S. Economy

New York Fed president Tim Geithner expresses concern over risks from the budget deficit, fixed exchange rates, and growing inequality:

N.Y. Fed’s Geithner Issues Clearer Warnings, by Greg Ip, WSJ Washington Wire: New York Fed President Timothy Geithner delivered one of his strongest warnings yet on threats facing the U.S. economy, citing the budget deficit, fixed exchange rates and growing inequality. ...

He said some countries, to keep their currencies fixed to the dollar, are accumulating big reserves of dollar-denominated securities, thereby holding down long-term interest rates, which might be distorting U.S. growth and investment. He did not name the offenders, but China and some Persian Gulf oil exporters are probable candidates.

He also ventured into politically charged terrain that Fed Chairman Ben Bernanke has tried to avoid. ... Geithner warned that current year deficits are too high while Bernanke has generally limited his concerns to the threat of higher entitlement spending in later years. Geithner said, “Even … before the increase in number of retirees starts to have a major impact on Social Security and Medicare expenditures, we are running an unsustainably large fiscal deficit.” ...

Geithner explicitly endorsed the new Democratic majority’s move to restore “pay-go” rules that require new tax cuts or spending programs to be funded with offsetting revenues or spending cuts. But “they need to be complemented by a consensus on policy changes that will produce smaller future deficits.”

He also echoed San Francisco Fed President Janet Yellen on the threat of growing inequality. And paraphrasing his former boss, former Treasury Secretary Lawrence Summers, he said it’s “not enough” to say globalization is inevitable and protectionism will only hurt. Nor, he suggested, is it enough to call for more education and a better safety net: they “have a long fuse and they may not yield the hoped-for increase in support.” He did not, however, say what steps should be taken.

After the speech he said he took little comfort in the lack of broader fallout from the demise of the hedge fund Amaranth. “It was very interesting but very special” episode that may not have broader lessons on the impact of hedge funds, he said. ...

[Update: See also Wage gap ‘undermines’ free trade support (open) from the Financial Times.] Here's the entire speech:

Developments in the Global Economy and Implications for the United States, by Timothy F. Geithner, President NY Fed: It is a pleasure to be here at the Council on Foreign Relations, and to be here with Jerry Corrigan. A few brief remarks about the global economy, both the real and financial dimensions, to provide a basis for our discussion.

Continue reading "NY Fed's Geithner on Risks to the U.S. Economy" »

Tuesday, November 28, 2006

Bernanke: Inflation Risks Remain Elevated

Ben Bernanke says he remains concerned about the elevated risk of inflation. From Greg Ip at the the Wall Street Journal:

Bernanke Warns of Inflation Risks, Suggesting No Rate Cut Coming Soon, by Greg Ip, Wall Street Journal: Federal Reserve Chairman Ben Bernanke said he is still worried about inflation as tight labor markets fuel wage gains, and economic growth outside of housing remains solid.

Mr. Bernanke's hawkish remarks on inflation and upbeat view of the economy contrast with the emerging view on Wall Street that the economy is weakening and inflation risks have faded. Those views, in recent weeks, had led to rising expectations the Fed will cut rates in the next six months. ...

But Mr. Bernanke said the choice facing the Fed at present is whether to raise rates, not cut them. "Whether further policy action against inflation will be required depends on the incoming data," Mr. Bernanke said...

Mr. Bernanke said that both the economy and inflation had behaved much as expected when he testified on the economy in July. "Outside of the housing and motor-vehicle sectors, economic activity has, on balance, been expanding at a solid pace," he said. While trends in core inflation, which excludes food and energy, are less worrisome than in the spring, at 2.7% in October it "remains uncomfortably high," he said.

While much of the speech reiterated themes of other Fed commentary and his own testimony in July, Mr. Bernanke broke new ground by dwelling on the tight labor market and its potential to push up wages and prices. ... Furthermore, in another break from recent commentary, he said the fact the economy is operating with less spare capacity has "likely played some role in the rise in core inflation."

The primary reason for his new emphasis on these factors likely relates to the steady decline in the unemployment rate, hitting 4.4% in October. Back in July, Fed officials projected a year-end jobless rate of 4.75% to 5%. At the same time, hourly earnings growth and employment costs has accelerated. Job growth has also been solid, and with it, personal income growth -- the most important determinant of consumer spending. ... Mr. Bernanke said that outside housing, consumer spending has been growing at about the same rate through the current quarter that it has since late 2001.

He acknowledged the housing market remains a risk to the economic outlook. "The rate of home-price appreciation has slowed significantly," he noted, and the overhang of unsold homes is likely even larger than the sizable official figures. But he added that home sales seem to be "stabilizing," though construction could continue to decline for a while to bring the supply of unsold homes back in line with demand.

He acknowledged "the correction in the housing market could turn out to be more severe and widespread" than expected. But he also said the economy could rebound from the housing-induced slowdown more briskly than expected. On inflation, "the risks to the forecast seem primarily to the upside. Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome."

Here is the entire Speech by Chairman Ben S. Bernanke on the economic outlook.

Update: See Calculated Risk for a different perception of Bernanke's speech.

Thursday, November 16, 2006

The Role of the Fed in Financial Crises

William Poole on what the Fed should do when financial instability strikes: "In most cases, nothing":

Responding to Financial Crises: What Role for the Fed?, by William Poole, St Louis Fed President: I am delighted to return to Cato, an organization with which I feel a natural affinity, especially through Bill Niskanen with whom I served as a member of the Council of Economic Advisers a quarter century ago. ... The key issue then, as today, is time inconsistency. It seems to make sense in the middle of a financial crisis for someone to bail out a failing firm or firms. However, the inconsistency is that, however sensible a bailout seems in the heat of crisis, bailouts rarely make sense as a standard element of policy. The reason is simple: Firms, expecting aid if they end up in trouble, hold too little capital and take too many risks. As every economist understands, a policy of bailing out failing firms will increase the number of financial crises and the number of bailouts. Along the way, the policy also encourages inefficient risk-management decisions by firms. ...

Federal disaster relief policy is exhibit A, but every company, financial or otherwise, knows that if it gets into trouble it is at least worth a major effort to attempt to secure a bailout because there is always a significant probability of success. ...

Now for the topic of the panel. What should the Fed do when financial instability strikes?

In most cases, nothing. The important principle here is support for the market mechanism rather than support for individual firms. The Fed has, appropriately, permitted many highly visible firms to fail without any attempt to provide support, or even any particular comment except to say that it does not intend to intervene.

Of course, the Fed has intervened from time to time. One important case was the provision of additional liquidity and moral support to the markets when the stock market crashed in 1987. The Fed also provided support to the market at the time of the near failure of Long Term Capital Management in 1998. In both cases the Fed cut the federal funds rate, which provided evidence to the markets that the Fed was on the job and prepared to provide extra liquidity as needed. I realize that the Fed’s presence in the negotiations for additional financial support for LTCM from other firms is controversial; I would simply emphasize that the Fed itself did not provide any financial support and, in my opinion, would not have done so if the effort to encourage support from other firms had failed.

Some observers have viewed the large expansion of hedge funds as a rising danger to financial stability, requiring additional regulation and Fed readiness to intervene. I myself believe the dangers of systemic problems from hedge fund failures are vastly overrated. The hedge fund industry is indeed large but it is also highly diverse and competitive. Many and perhaps most of the large positions taken by individual firms have other hedge funds on the opposite side of the transactions. I trust normal market mechanisms to handle any problems that might arise. ...

A very interesting case arose with the terrorist attacks on 9/11. Thinking back to my academic years before coming to St. Louis, I recall no discussion or journal articles analyzing the possibility that the payments system might crash because of physical destruction. But that is what nearly happened, because the Bank of New York, a major clearing bank, was disabled when the twin towers came down. Moreover, trading closed in the U.S. Treasury and equity markets, and banks were unable to transfer funds because the Bank of New York was not functioning. With normal sources of liquidity shut down, many banks faced the prospect of being unable to meet their obligations. The Fed’s provision of funds through the discount window and in other ways prevented a cascading of defaults around the world. No private entity would have been able to provide liquidity on such a massive scale.

I do not know what a totally unanticipated future systemic shock might be but am sure that the Fed needs to be ready to respond, and to some extent, invent the appropriate response on the fly to a currently unimaginable shock. That is surely what a central bank is for, among other things. At the same time, a great reluctance to intervene will serve the economy well in the long run.

I can summarize my position very succinctly. The Fed has a responsibility above all to maintain price stability and general macroeconomic stability to reduce the likelihood of economic conditions that would be conducive to financial instability. Included in this responsibility is provision of advice to Congress on needed legislative action to deal with possible risks. The largest of these risks on my radar screen arises from the thin capital positions maintained by government-sponsored enterprises and the ambiguity of whether Congress would or would not act to bail out a troubled firm. The time to deal with potential financial instability caused by structural weaknesses of the GSEs and their regulatory regime is before instability strikes. ...

Although prevention is the most important of the Fed’s responsibilities, without question the Fed needs to be prepared to provide liquidity support should markets be in danger of ceasing to function. We know a lot about this subject and have in place deep contingency arrangements to assure that the Fed itself will remain operational at all times. I do not see any way that these functions could be privatized; I believe the markets do have confidence that the Fed has necessary legal authority and the internal strength to act as necessary. That said, the Fed’s reluctance to act is also an important element of strength.

Friday, October 13, 2006

Mishkin: Globalization: A Force for Good?

The newest Fed Governor, Frederic Mishkin, gives his first speech. The topic, the globalization of financial markets, has been covered here recently in an commentary by Mishkin from the Financial Times, and an interview from Crooked Timber about his book on the same topic. Here's one small section of the speech:

Globalization: A Force for Good?, by Frederic S. Mishkin, Board of Governors: ...Can more globalization--in particular, financial globalization--be a force for good?

The globalization of trade and information over the past half century has lifted vast numbers of the world's people out of extreme poverty. Despite the doom and gloom that you often hear, world economic growth since the Second World War has been at the highest pace ever recorded. What we are seeing in countries that are export oriented, and thus able to take advantage of the present age of globalization, is a reduction in poverty and a convergence of income per capita toward industrial-country levels. In India and China, for example, globalization in recent years has lifted the incomes of more than 1 billion people above the levels of extreme poverty. ...

The benefits of globalization of trade in goods and services are not controversial among economists. Polls of economists indicate that one of few things on which they agree is that the globalization of international trade, in which markets are opened to flows of foreign goods and services, is desirable. But financial globalization, the opening up to flows of foreign capital, is highly controversial, even among economists...

For example, in his best-selling book Globalization and its Discontents, Nobel laureate Joseph Stiglitz is very critical of globalization because he sees the opening up of financial markets in emerging-market economies to foreign capital as leading to economic collapse. Even Jagdish Bhagwati, one of the leading economists defending globalization of trade (after all, his book is titled In Defense of Globalization), is highly skeptical of financial globalization, stating that "the claims of enormous benefits from free capital mobility are not persuasive." George Soros, the prominent financier, opens his book On Globalization with a chapter entitled "The Deficiencies of Global Capitalism."

One reason for the controversy is that opening up the financial system to foreign capital flows has led to some disastrous financial crises causing great pain, suffering, and even violence. These crises can arise when bad policies encourage excessive risk taking by financial institutions, policies that rich elites in the developing countries often advance for their own profit. There are those (including Stiglitz and Bhagwati) who put the primary blame for the failures of financial globalization in emerging-market economies on outsiders, specifically on the International Monetary Fund, or what they refer to as the Wall Street-Treasury complex. The evidence has brought me to the conclusion that institutions like the IMF or the U.S. Treasury are not primarily to blame, although neither are they blameless--public and private financial institutions active in the international capital markets have often aided and abetted poorly designed financial globalization, although that was not their intention. ...

We have seen that the repression of the financial system is a great obstacle to economic growth and the reduction of poverty in poorer countries. Yet, if financial development offers such tremendous benefits, why doesn't every country jump on the path to growth and prosperity by imitating the institutions of the advanced economies? Part of the answer is that good institutions need to be home-grown; institutional frameworks that have been developed in the rich countries frequently do not translate well to poorer countries. This is a lesson that many in the advanced economies of the world have yet to learn. The development of good institutions in the advanced countries took hundreds of years; as they grew, they adapted to local conditions. Poor countries must develop their own institutions, and the citizens of these nations must feel they have ownership of the institutions or the institutions will be ineffective and short lived. ...

I will conclude by saying that those who oppose any and all globalization have it completely backward: Protectionism, not globalization, is the enemy. It is true that, by itself, globalization in both finance and trade is not enough to ensure economic development and that economies must position themselves to handle foreign capital flows. But as I said, to be against globalization as such is most assuredly to be against poor people, and this is presumably not the position antiglobalizers want to take. Developing countries cannot get rich unless they globalize in both trade and finance. Making financial flows truly worldwide and creating robust, efficient financial markets in developing countries is not optional: It needs to be the focus of the next great globalization. In sum, I want to challenge those who oppose globalization to rethink their objections. As Kofi Annan, the Secretary General of the United Nations, has put it, "The main losers in today's very unequal world are not those who are too much exposed to globalization. They are those who have been left out." Rather than opposing or limiting globalization, we in the rich countries and those in the developing countries must, as a moral imperative, work together to make globalization work for the general good of people all over the world.

Wednesday, October 04, 2006

Bernanke: Will We Treat Future Generations Fairly?

Ben Bernanke describes the challenges ahead due to an aging population and steps that might be taken now to prepare for the changes and minimize the transition costs. Much of the discussion is in terms of generational equity and the tradeoff between making hard choices now and shifting the burden of an aging population to future generations:

The Coming Demographic Transition: Will We Treat Future Generations Fairly?, by Ben Bernanke, Chair of Federal Reserve System: In coming decades, many forces will shape our economy and our society, but in all likelihood no single factor will have as pervasive an effect as the aging of our population. ...

This coming demographic transition is the result both of the reduction in fertility that followed the post-World War II baby boom and of ongoing increases in life expectancy. Although demographers expect U.S. fertility rates to remain close to current levels for the foreseeable future, life expectancy is projected to continue rising. ...

[It's] difficult to describe increasing life expectancy as bad news. Longer, healthier lives will provide many benefits for individuals, families, and society as a whole. However, an aging population also creates some important economic challenges. For example, many observers have noted the difficult choices that aging will create for fiscal policy makers in the years to come, and I will briefly note some of those budgetary issues today. But the implications of demographic change can also be viewed from a broader economic perspective. As I will discuss, the broader perspective shows clearly that adequate preparation for the coming demographic transition may well involve significant adjustments in our patterns of consumption, work effort, and saving. Ultimately, the extent of these adjustments depends on how we choose--either explicitly or implicitly--to distribute the economic burdens of the aging of our population across generations. Inherent in that choice are questions of intergenerational equity and economic efficiency, questions that are difficult to answer definitively but are nevertheless among the most critical that we face as a nation.

Continue reading "Bernanke: Will We Treat Future Generations Fairly?" »

Monday, September 25, 2006

"Wagner’s Music is Better Than it Sounds"

The title expresses Dallas Fed President Richard Fisher's assessment of the U.S. economy -- it's better than it sounds -- except for inflation, which he believes may be a problem. His bottom line?:

While I am well aware of the risks to economic growth, the history of inverted yield curves, and the ever present possibility of exogenous shocks in a politically hazardous world, the “balance of risk,” in my book, is still tilted to the inflation side of the equation. ... While the inflation risk ... is very much on my mind, it is my considered judgment that the recent tempering of U.S. economic growth to a more sustainable rate, combined with the lagged effects of our 17 prior quarter-point rate increases, should act to lower the inflation rate over time. However, if this proves not to be the case, appropriate action will have to be taken.

Fisher's speech is below, but first here's the national outlook from the Dallas Fed:

Continue reading ""Wagner’s Music is Better Than it Sounds"" »

Friday, September 15, 2006

Hedge Fund Worries

New York Fed president Tim Geithner is worried that market failures such as "lack of information, incentive conflicts and moral hazard" are causing risk levels in hedge fund markets to grow and, if the growth of risk continues, increased regulation of the markets may be required. He's cautious because, "With too much government intervention, innovation is constrained and the system is stifled." However, "With too little, the probability of systemic crisis may rise to levels that are unacceptably high":

NY Fed chief warns on hedge funds, by David Wighton and Peter Thal Larsen, Financial Times: Hedge funds may need to be regulated because of the increasing risk they could pose to the financial system, according to the head of the New York Federal Reserve... Geithner ... said supervision of core banks and investment banks had encouraged the transfer of risk to unregulated institutions such as hedge funds.

Their growth was now increasing the risk that if they ran into problems, it could damage the regulated core. ... Mr Geithner said that, for the moment, regulators should continue to focus on encouraging the banks and brokers that lend to hedge funds to improve their “counterparty discipline” of the funds.

But, over time, the growth in hedge funds “will force us to consider how to adapt the design and scope of the supervisory framework to achieve the protection against systemic risk that is so important to economic growth and stability.” ...

Mr Geithner ... [said] ... the ... effectiveness of this market discipline may be compromised by “market failures” such as lack of information, incentive conflicts and moral hazard. “Supervision and regulation have the potential to help mitigate these sources of market failure,” he said.

We don't know enough about these markets, particularly their vulnerability to large shocks. [Update: The WSJ's Greg Ip has more].

Thursday, September 07, 2006

Are We There Yet?

San Francisco Fed President Janet Yellen indicates that, as of now, she sees no reason to raise rates further:

Support for Fed Pause Was Broad Among the 12 Regional Banks, by Greg Ip, WSJ: Just two of the Federal Reserve's 12 regional banks [Richmond and Philadelphia] wanted to raise interest rates ahead of the central bank's policy meeting last month, suggesting support for the Fed's rate "pause" is relatively broad...

The Fed discount-rate minutes add to the evidence that the Fed is willing to leave rates alone for the time being to see how growth and inflation evolve. ... Janet Yellen added to that sentiment Thursday, telling an audience ... that "it appears that the current stance of policy will move inflation gradually back to the comfort zone while giving due consideration to the risks to economic activity." Markets put just a 11% probability on a rate increase at the Fed's Sept. 20 meeting. ...

Continue reading "Are We There Yet?" »

Friday, August 25, 2006

Bernanke: A Short History of Global Economic Integration

Ben Bernanke opens the Fed conference at Jackson Hole with a discussion about economic integration. The talk has two sections, the history of economic integration, and the current episode of economic integration. Once conclusion from the history section is that, while economic integration is beneficial overall, the costs are not shared equally:

A third observation is that social dislocation, and consequently often social resistance, may result when economies become more open. An important source of dislocation is that--as the principle of comparative advantage suggests--the expansion of trade opportunities tends to change the mix of goods that each country produces and the relative returns to capital and labor. The resulting shifts in the structure of production impose costs on workers and business owners in some industries and thus create a constituency that opposes the process of economic integration. More broadly, increased economic interdependence may also engender opposition by stimulating social or cultural change, or by being perceived as benefiting some groups much more than others.

His quote of Martin Luther from 1524 is one illustration of this:

Continue reading "Bernanke: A Short History of Global Economic Integration" »

Wednesday, July 19, 2006

When to Hit the Pause Button?

The Wall Street Journal has a summary of Ben Bernanke's written remarks from his testimony before the Senate Banking Committee. The message is the same, growth is moderating but inflation remains a concern:

Link to video of hearing (CSPAN - expires in 15 days).

Bernanke Sees Inflation Pressures Declining as Growth Moderates, by Brian Blackstone and Campion Walsh, WSJ: Federal Reserve Chairman Ben Bernanke said Wednesday a moderation in U.S. growth "now seems to be under way," which "should help to limit inflation pressures over time."

While noting that some of the recent rise in underlying inflation is due to technical factors and that inflation expectations "remain contained," inflation remains "of concern" to policy makers, Mr. Bernanke said in semiannual monetary policy testimony prepared for delivery to the Senate Banking Committee. ...

Also, CPI figures were released today and core inflation was up a bit more than anticipated adding to inflation worries:

Earlier Wednesday, the Labor Department reported that the June consumer price index increased 0.2%. Excluding food and energy, consumer prices advanced 0.3%, the fourth-straight rise of that size. Fed chairmen receive major economic reports, including consumer prices, the evening before they're released to the public. ...

The Wall Street Journal also reports market reactions:

Markets reacted immediately to the numbers. Stock futures gave up early gains, on the expectation the Fed will be more likely to raise interest rates again in August. The federal-funds futures contract at the Chicago Board of Trade, where traders bet on future Fed policy, priced in a 90% chance of a quarter-point August increase, compared with 68% before the consumer-price release....

Those of us who would like to see the Fed take a breather in its rate hike campaign to avoid overshooting aren't getting a lot of help from the inflation reports.

Update: The markets have changed their mind after hearing Bernanke's comments:

After struggling amid concerns about the Mideast conflict and rising oil prices, stocks surged Wednesday after Federal Reserve Chairman Ben Bernanke indicated in Congressional testimony that the central bank may stop raising interest rates soon.

The comments, delivered before the Senate Banking Committee, reversed earlier concerns about further rate increases inspired by a report that showed a measure of retail price inflation is rising at a faster pace than expected.

I'll update this later when summaries of Bernanke's remarks in response to questions are available.

Note: If you don't have a WSJ subscription, here are links to Bloomberg reports:

Update: Tim Duy is working an a new Fed Watch for tomorrow, so I will let him put the remarks into perspective. For now, here's Greg Ip and Mark Whitehouse of the WSJ with a summary of Bernanke's remarks:

Bernanke Sees Inflation Pressures Declining as Growth Moderates, by Greg Ip and Mark Whitehouse: Federal Reserve Chairman Ben Bernanke called rising inflation a "concern" but predicted an economic slowdown would reverse that rise. Markets took those words to mean that, for now, the Fed will worry more about slowing growth and stop raising interest rates soon. Bond yields fell and the Dow Jones Industrial Average soared Wednesday.

Mr. Bernanke spoke the same day as the government reported inflation rose and home construction fell last month, underlining the opposing risks confronting the central bank.

"The recent rise in inflation is of concern," Mr. Bernanke told the Senate Banking Committee. "Possible increases in [energy] and other commodity prices remain a risk to the inflation outlook."

But Fed policy makers "project that growth … should moderate" to its long-term potential rate "both this year and next. Should that moderation occur as anticipated, it should help to limit inflation pressures over time."

Part of Mr. Bernanke's job Wednesday was to blunt accusations of sending inconsistent messages since taking the post on Feb. 1. ... Wednesday, he appeared to seek ... balance by acknowledging that inflation was too high but laying out a forecast of slowing growth and stable energy prices that would allow inflation to fall back. And, in an important break from the past few years, he gave no explicit signal about how the Fed would move interest rates to achieve that forecast, forcing markets to decide for themselves...

Update: See David Altig at macroblog for an analysis of today's price report.

Thursday, April 27, 2006

Bernanke Testimony on the Economic Outlook

First, here's a video and link to a text version of his prepared testimony:


Download RealPlayer if the video is not playing above.

The Fed is continuing to communicate the meaning of a pause in rate hikes should it occur, indicating that the Fed is looking to pause once incoming data on expected growth and inflation support such a move. Repeating what Tim Duy said
in a recent Fed Watch:

Continue reading "Bernanke Testimony on the Economic Outlook" »

Tuesday, April 18, 2006

Fed Minutes Say the End is Near

The FOMC meeting minutes for Bernanke's first meeting as chair were released. If you are looking for evidence the Fed will move to 5% and then pause, it's there. But if you feel there is a chance rates will go higher, statements about being vigilant toward inflation expectations and about risks being tilted slightly toward worry about inflation give support for that position as well. Putting the two together, the Fed wants us to get their message, repeated frequently lately with Janet Yellen as the latest messenger, that further rate moves beyond the move to 5% at the next meeting are data (and I would add forecast) dependent:

Fed Members Saw End of Rate Rises Likely 'Near' in March, Minutes Show, Bloomberg: Most Federal Reserve policy makers considered the end of their interest rate increases ''was likely to be near,'' while also citing the need for vigilance against inflation, minutes of their March meeting showed.

Continue reading "Fed Minutes Say the End is Near" »

Thursday, April 06, 2006

'Da Bears' or 'Da Bulls' at the Fed?

Chicago Fed president Michael Moskow gave a speech today echoing previous optimistic outlooks for the economy by other Fed officials:

Moskow Calls Recent U.S. Economic Data `Positive', Bloomberg: Chicago Federal Reserve Bank President Michael Moskow said the outlook for U.S. economic growth is encouraging and inflation is under control, making him the fourth Fed member this week to offer such an optimistic view. "The latest economic data have been quite positive," Moskow said ... "At the same time, core inflation remains contained."

Continue reading "'Da Bears' or 'Da Bulls' at the Fed?" »

Tuesday, April 04, 2006

Richmond Fed's Lacker: No Fundamental Worries about Housing

Richmond Fed president Jeffrey Lacker gave a speech today and his outlook for both growth and inflation are optimistic. For output, he says:

It looks like we’re on track for continued expansion, with real GDP growing at about a 3 ½ percent annual rate this year. Consumer spending should grow in line with GDP and will be supported by job growth and real wage gains. Residential investment will flatten or slow, but business capital spending should remain robust. And that capital spending will support productivity growth going forward, which in turn will support the future income growth that keeps household spending healthy. And while there are risks to this forecast, as there are with any forecast, I do not see any single scenario that is compelling enough to alter the central tendency of this outlook.

And for inflation:

Let’s turn now to the inflation picture, where again things are looking better now than many had expected six months ago. ... longer-term expectations of inflation have remained moderate even as energy prices have moved up over the last couple of years. Looking ahead, short-term movements in the inflation rate can be hard to predict. But what is important is to stabilize inflation over medium- and longer-term horizons. And here the indicators about what the public expects look fairly good. Both survey data and the market prices of inflation-protected Treasury securities tell us that the public expects inflation to continue to be contained. ...

As for housing, he is not worried at all about the housing bubble popping because he doesn't believe there is a bubble. It's all fundamentals:

Looking ahead, to assess the outlook for consumers’ spending, you begin with their income prospects. Expectations are that the overall labor market will continue to be strong ... and further real wage gains should lead to healthy advances in incomes and, thus, overall consumer spending.

Before turning away from households, I’d like to touch on residential housing activity. As I’m sure you know, the housing market has had an amazing run in recent years. ... You won’t hear me use the B-word to describe this remarkable activity. Instead, I believe fundamental factors can fully explain the expansion we’ve seen in the demand for housing, particularly rising incomes, rising population, favorable tax treatment, and very low interest rates. At the present time, mortgage interest rates are not as favorable as they were a few years ago, and so it is not surprising that we are seeing some signs of a tapering off of residential activity in many markets. ... I see this not as a precipitous decline, but rather as a return to more normal conditions in many markets. ... Looking ahead, it seems reasonable to expect the housing market to remain strong, even as some further tapering off in sales and production takes place.

The key point I would like to emphasize is that the housing phenomenon was not a mysterious, independent boost to the economy, driven by some sort of animal spirits, but instead was a rational response by households to the economic fundamentals, especially very low real interest rates. Thus, going forward, the adjustment of the housing market ... will continue to fit comfortably within the standard economic framework. My assessment is that plausible rates of moderation in housing activity will not pose a problem for overall activity this year or next. Moreover, I don’t see diminished housing price appreciation as a major problem for consumer spending, since again, the primary determinant of spending is income, and we see solid and improving prospects for real incomes for the nation as a whole.

Update: Bloomberg report.

Update: From Calculated Risk:

DCalculated Risk: Dr. Leamer says: Expect Slow, Gradual, Painful House Price Declines: In this Mercury News article, UCLA's Dr. Leamer makes some interesting comments:

If history is any guide ... home prices won't peak for a while... When the end of the Cold War caused consolidation of the defense industry, the number of home sales in the Los Angeles area peaked in November 1988 -- but home prices didn't top out for nearly 2 1/2 years. "Then the prices began this gradual, painful, slow deterioration" of about 5 percent a year, Leamer said. "Don't watch the prices," he said. "Watch the volume."

In Santa Clara County, sales of new and existing houses and condos dropped 14 percent from the record mark set the previous February. It was the slowest February since 2001... If sales have peaked, Leamer predicts homeowners are likely to endure a test of their patience and financial mettle.

"It's really slow, not enough to drive you totally crazy," Leamer said. "It's a little bit of pain every year. If you try to sell, you can't find anybody to buy, and the price is eating into your equity little by little. That's the kind of adjustment we expect to see."

Update: William Polley covers a speech by Dalls Fed president Fisher. Fisher repeats a common theme in his recent speeches about the difficulties of measuring productive capacity and labor tightness in the presence of globalization.

Tuesday, March 21, 2006

Fed Watch: The Perils of Calling the Top

Tim Duy with a Fed Watch:

Policymakers are gearing up for another 25bp rate hike at the end of the month – essentially a given at this point. Market participants are also pricing in another 25bp hike in May, although the odds have backed off a bit. Last week I said the mood on the FOMC appeared to be shifting to favor a pause at 5% on the Fed Funds rate. Soon thereafter, John Berry at Bloomberg argued that 5% was a more likely stopping point than 5.25% or higher. Sounded good to me. But then, while cleaning my office, I stumbled upon this piece that I wrote on May 14, 2001. This part caught my eye:

Continue reading "Fed Watch: The Perils of Calling the Top" »

Monday, March 20, 2006

Bernanke: The Yield Curve and Monetary Policy

Ben Bernanke discusses why long-term interest rates have remained low throughout the Fed's current tightening cycle and the implications of this for monetary policy. He notes two main explanations for low long-term rates, and he discusses why the monetary policy implications differ according to which explanation is adopted. If low long-term rates are due to a decline in the term premium, the effect is  stimulative and policy would need to be tightened. But if low long-rates are due to current or anticipated economic conditions, e.g. an anticipated slowdown in growth in the future, the implications for policy are the opposite. Tim Duy will have a Fed Watch later, so for now here's a shortened version of Bernanke's remarks:

Reflections on the Yield Curve and Monetary Policy, by Chairman Ben S. Bernanke, March 20, 2006: ...I intend to ... address an intriguing financial phenomenon: the fact that, over the past seven quarters or so, tightening monetary policy has been accompanied by long-term yields that have moved only a little on net. Why have long-term interest rates not risen more...? And what implications does this ... have for monetary policy and the economic outlook? As you will see, in my remarks I will do a better job of raising questions than of answering them. ... I will conclude that the implications for monetary policy ... are not at all clear-cut. ...

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Thursday, March 16, 2006

Monetary Policy and Asset Prices

Donald Kohn gave a speech on asset prices and monetary policy as part of a conference in honor of the ECB's chief economist, Otmar Issing who is retiring soon. The speech discusses a disagreement between Kohn and Issing on the role of central banks in managing asset prices:

Monetary policy and asset prices, by Donald Kohn, Fed Reserve Governor: I am honored to participate in this tribute to Otmar Issing. ... I can think of no better way to celebrate the signal contributions of this leading force in the world of monetary policymaking than to address an issue of great importance to central banks, ... the proper role of asset prices in the determination of monetary policy. Otmar and I have debated this issue on many occasions...

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Monday, March 13, 2006

San Francisco Fed President Yellen on Explicit Inflation Targets

Federal Reserve Bank of San Francisco president Janet Yellen  promotes explicit inflation targets:

Enhancing Fed Credibility, by Janet Yellen, San Francisco Fed President: ...There has been a great deal of discussion of whether the Federal Reserve should [announce] a specific, numerical inflation objective. I will spend the remainder of my remarks addressing this question, looking first to the results from theoretical and empirical research on the effects of such communication.

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Thursday, March 09, 2006

Geithner: Monetary Policy in the Global Financial Environment

As noted in this Bloomberg report, NY Fed president Tim Geithner gives considerable weight to fixed exchange rate regimes as the cause of the current pattern of global imbalances. As these countries pursue fixed-exchange rate regimes, it puts upward pressure on aggregate demand and inflation in the U.S., and the Fed may be forced to implement policy to offset the potential inflationary consequences:

Geithner Says Global Capital Flows May Require Fed to Raise Rates More, Bloomberg: Foreign purchases of U.S. bonds are keeping long-term interest rates low and may require the Federal Reserve to counter the effects with higher short-term interest rates, New York Fed President Timothy Geithner said.

''To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions,'' Geithner said... U.S. interest-rate policy ''would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation.''...

Geithner discussed Fed Chairman Ben S. Bernanke's view that the U.S. is absorbing a global "savings glut" and suggested instead that money is flowing to the U.S. because Asian economies are buying bonds to sustain inflexible currencies. ... "Sustaining that objective in the past several years has required large accumulation of dollar assets. The scale of this activity has been particularly dramatic in parts of Asia."... Oil exporting nations are also accumulating large amounts of dollar reserves, Geithner said...

Geithner didn't speak directly about the near-term path of monetary policy or the state of the U.S. economy. ...

Here's the speech:

U.S. Monetary Policy in the Global Financial Environment, by New York Fed President Timothy F. Geithner: We are in the midst of another wave of global economic and financial integration. ... Many of these implications are positive... In important ways, economic integration may have made the principal job of central banks easier, by contributing to productivity growth and reducing some sources of inflation pressure, at least during the transition when a large share of the working age population of the world is being brought into the market.

But the process of change in how economies and financial markets interact also complicates the task of central banks. ... In my remarks today, I will talk about some of the implications of these challenges for the conduct of monetary policy. I will focus on two features ... first, the behavior of forward interest rates in financial markets, and, second, the pattern of external imbalances. ...

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Wednesday, March 08, 2006

Bernanke Discusses Changes in Risks Faced by Community Banks

Traditional community banks have an advantage over large banks when information on borrowers is costly or difficult to obtain, a situation encountered most often with smaller local businesses. By developing a relationship with a local bank, information flows between the bank and business develop over time and allow these businesses to take out loans that would not otherwise be available. Thus, community banks play an important intermediation role.

However, advances in information technology are eroding this advantage for community banks creating new competitive pressures from larger banks. Ben Bernanke reviews changes in the structure of the community banking industry and discusses how the change impacts the Fed's role in bank regulation.

Because the traditional business for community banks is becoming increasingly competitive, smaller community banks have turned more and more to commercial real estate lending to fill the void. This change in the type of loans made by commercial banks, along with an apparent decline in underwriting standards, is the focus of the Fed's concerns. The Fed is particularly focused on risks to community banks that are heightened when output falls as in an economic slowdown or when interest rates rise:

Community Banking and Community Bank Supervision in the Twenty-First Century, by Ben Bernanke, March 8, 2006: ...Today, I will begin by making some observations, based in part on research done at the Federal Reserve and elsewhere, about the health of community banks and their evolving role in our economy. Community banks are generally doing quite well... But community banks also face a changing business environment that presents a number of important long-run challenges. ... I will speak a bit about how the Federal Reserve, as the supervisor of many community banks, is also adjusting to a changing environment, and ... some of the key financial risks facing community banks.

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Fed Speak Says Watch Inflation Expectations

Chicago Fed president Michael Moskow says to keep an eye on inflation expectations in a speech given today on the U.S. economic outlook:

Moskow Says Faster Inflation Outlook Would Boost Rate, Bloomberg: A rise in expected inflation ... would require further increases in the Federal Reserve's main interest rate, said Michael Moskow, president of the Chicago Fed. "The next policy decision is much less certain now than it was" ... If measures of inflation expectations "were to rise persistently, then policy would clearly have to be tightened further." ...

St. Louis Fed President William Poole also warned of inflation risks today should the economy grow too rapidly, according to a report by Reuters. ...

Here's the Reuters report on Poole's remarks:

Interview-Stronger data may mean more rate hikes-Fed's Poole, Reuters: The U.S. economy has a "great deal of momentum" and the Federal Reserve may have to raise interest rates further. ... St. Louis Federal Reserve President William Poole ... said he thought the Fed was already close to neutral. But he favored overstepping this mark and making monetary policy restrictive, if there was any doubt, rather than risk letting inflation get out of hand. "If the inflation rate rises in a sustained fashion and particularly if inflationary expectations start to develop, that is a harder process to reverse. ... "I think that if it turns out that policy-tightening has overshot the mark, then we ease off." ...

William Polley has more.

Wednesday, March 01, 2006

Fed Speak

  • New York Fed president Tim Geithner discusses concerns about systemic risk exposure in financial markets due to recent financial innovation and suggests steps to reduce the risk exposure. He says, "The frontier of challenges in the risk management process lies principally in the discipline of stress testing and scenario analysis to capture potential losses in adverse conditions in the "tail" of the distribution. This has been and will continue to be a principal focus of our supervisory efforts."
  • Chicago Fed president Michael Moskow talks the structure of state and local pensions and the magnitude of the growing funding gap which threatens to undermine the ability to fund public programs in other areas.
  • As noted here after the January 31 FOMC meeting, only eleven of the twelve regional banks asked for an increase in the discount rate with the Minneapolis Fed the one exception. Since the discount rate is currently set at 1% above the federal funds rate, a bank's proposed change in the discount rate can be interpreted as its proposed change in the federal funds rate. Today, the minutes of Board discount rate meeting were released, and, as Blooomberg notes, they indicate that "the Minneapolis Fed, voted on Jan. 19 to keep the discount rate unchanged at 5.25 percent because it did not see a "compelling" case for an increase, the minutes said, "although they noted that it was a close call.""

Tuesday, February 28, 2006

The Fed's Communication Strategy

St. Louis Federal Reserve president William Poole doesn't think the typical consumer of Fed speak has enough training in economics and monetary policy to understand unfiltered policy deliberations properly, so the statements need to be cleaned of potentially misleading technical language. I'm not sure I agree on this point. Here's a brief part of a much longer speech on Fed communication:

Fed Communications, by William Poole, St. louis fed President, Feb. 24, 2006: ...Fed communications issues are often discussed under the general term “transparency.” What, literally, does transparency mean? ... Transparency must mean disclosing as much as possible without damaging the integrity of policy deliberations. That integrity is essential both to be sure that all issues are fully debated and to ensure that information ... remains confidential. But there is [an] aspect to transparency that is incompletely understood. ... Much of the FOMC deliberation consists of fairly technical discussions. Without an advanced degree in economics, or extensive policy experience, much of this material is simply incomprehensible. Thus, although policy experts can understand undigested material, the message that they would convey to the general public would likely not be timely and might not closely match, in emphasis and tone, the consensus message the FOMC would want to convey. ...Instead, the Fed needs a conscious communications strategy rather than a strategy of simply “opening up.” The purpose of a conscious strategy is not to hide anything but rather to have a clear transmission of information. ... FOMC transcripts ... require a substantial background in economics and the history of monetary policy to interpret correctly. ...

What about members of the FOMC who do not have this background (see "Kevin Who?")? Should we be worried they might misinterpret technical material presented at meetings?

Friday, February 24, 2006

Bernanke: The Benefits of Price Stability

Ben Bernanke's delivered his first speech outside of Washington since becoming Federal Reserve Chair. This was given at at a symposium for the 75th anniversary of Princeton's Woodrow Wilson School of Public and International Affairs and marks his return to Princeton. [See Bloomberg for coverage of remarks made after the speech in response to questions]:

The Federal Reserve Board eagle logo links to home page


Remarks by Chairman Ben S. Bernanke, February 24, 2006

The Benefits of Price Stability

It is a great pleasure for me to return to Princeton today, to see so many friends and former colleagues, and to help celebrate the seventy-fifth anniversary of the founding of the Woodrow Wilson School of Public and International Affairs. I taught at Princeton for seventeen years--more often than not in Bowl 1, in the deep, dark basement of Robertson Hall--and my wife Anna and I raised our two children here. Like all good New Jerseyans, we will always think of our home address in terms of a Turnpike exit--in our case, Exit 9.

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Fed Speeches: Santomero, Fisher, and Ferguson

There were several Federal Reserve speeches today. Philadelphia Fed president Santomero in his last speech before stepping down as president discusses The U.S. Economy: How Fast Can We Grow?. After the speech he indicated that the target rate is near the neutral range and that the Fed must begin to take seriously lags in the effects of policy at its next meeting:

"Actions take time to work through the system ... We have to be cautious. As we go about raising rates, it will take some time to be fully felt in the system," Santomero said ... "That is part of the logic that has to go into the next decision" on interest rates, he said.

Dallas Fed president Fisher also spoke today on Trade Deficits and the Health of the U.S. Economy. Finally, Roger Ferguson gave a speech on Globalization, Insurers, and Regulators and expresses worry that puzzlingly low long-term rates might suddenly increase.

Friday, February 17, 2006

William Poole on Inflation Targeting

William Poole discusses inflation targeting. It's fairly long and is here. The key point is that he strongly supports an explicit inflation target. He also states his hawkish stance on inflation and says that properly measured, he favors zero inflation as a target, a statement that translates into a .5 to 1.5 range for measured long-term inflation. If you are interested in this topic, this is a fairly thorough treatment of the subject.

Wednesday, February 15, 2006

Why Greenspan Retired

From the WSJ's Washington Wire reporting on Bernanke's testimony, news of why Greenspan retired even though legislation by Rep. Brad Sherman (D., Calif.) to extend his term was in the works. A sole but influential opponent stopped the legislation. In other notes, Bernanke opposes Wal-Mart's entry into banking services, wants tougher legislation for Sallie Mae and Freddie Mac, and refuses to comment on the propriety of Greenspan's dinner with clients of Lehman Brothers:

The Chairman Speaks Regularly, Washington Wire, WSJ: Bernanke endorses a bill ... to close a loophole that lets commercial companies own FDIC-insured "industrial loan corporations," like the one Wal-Mart Stores Inc. wants to operate in Utah. ... The bill, Bernanke said, would "relieve our anxieties considerably." But he didn't endorse a House bill that would tighten regulation of Fannie Mae and Freddie Mac. The measure ... "doesn't provide sufficient guidance" to regulators to limit their portfolios. "...these large portfolios represent a risk to financial stability,'' he warned.

Asked about former Fed Chairman Alan Greenspan's reported remarks to select audiences since leaving the Fed..., Bernanke said: "My only comment ... is that, according to government ethics rules and to FOMC rules, it's permissible for a retired governor to speak in public about the economy, so long as he or she does not divulge confidential information. And I have no indication that he has violated that rule. And I have no further comment on that."

Rep. Brad Sherman (D., Calif.) told Bernanke he was the only member of the House Financial Services Committee to work actively to thwart his appointment as chairman of the Federal Reserve Board. "Ben, it's nothing personal," the congressman said. "I simply authored legislation to extend your predecessor's term limits. You owe your office to that bill's sole and very powerful opponent: Andrea Mitchell."

Economist's react, me included, to Bernanke's testimony. There were also two Fed speeches over the last two days:

Jeff lacker, Richmond Fed President on Transition and Continuity at the Federal Reserve in 2006.

Richard Fisher, Dallas Fed President on Trade Deficits and the Health of the U.S. Economy.

Tuesday, February 14, 2006

Economic Forecasts and Monetary Policy

Cleveland Fed president Sandra Pianalto on the use of economic forecasts in monetary policy and the importance of structural interpretations of the numbers used to assess current and future economic conditions:

Economic Forecasts and Monetary Policy, by Sandra Pianalto, Cleveland Fed President: Today I would like to share with you some of my thoughts about economic forecasts and monetary policy. I will begin with some comments about the economy's recent performance and the outlook for 2006. Next, I will explain why making sound policy decisions requires me to think about both the demand and supply sides of the economy. Finally, I will describe how the stories behind the forecasts directly relate to the way I think about the appropriate course for monetary policy. ...

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Friday, February 10, 2006

Moskow: Inflation Pressures May Force Further Increases in the Target Interest Rate

Chicago Fed president Michael Moskow says rates may need to go up further to reduce inflationary pressures. Here's the Bloomberg report (full speech):

Moskow Says Rates May Need to Rise to Stem Inflation, Bloomberg: The Federal Reserve may need to keep raising the benchmark U.S. interest rate to prevent inflation from accelerating, Chicago Fed Bank President Michael Moskow said. "There are risks to the inflation outlook -- namely, the potential for energy cost pass-through, pressures from increases in resource utilization, or rising inflationary expectations,'' Moskow said in a speech... "If inflation or inflation expectations were to rise persistently, then policy clearly would have to be tightened further.'' ... "The economy is operating close to potential,'' he said. "We need to carefully monitor for the emergence of any economy-wide resource pressures.'' ... Decisions about future changes will depend on incoming information on the economy, Moskow said. If economic growth stalls as the housing market slows, the Fed may even have to reduce rates...

Monday, February 06, 2006

Dallas Fed President Fisher Dons the Foam Finger: We're #1!!!

Dallas Fed president Richard Fisher speaking in London, though at the end it might be better described as lecturing, says economic conditions look strong strong in the growth rim, the megastate, and the uberstate. Although growth looks to be a bit more chilly up north, there is every reason to believe the U.S. will continue to fuel the world economy, a situation that will persist so long as foreign leaders fail to achieve open and flexible markets:

The United States: Still the Growth Engine for the World Economy?, by Richard W. Fisher, Dallas Fed President:  ...My kind hosts, who had no idea that this event would follow ... the meager growth estimate reported for last year’s fourth quarter, have asked me to address the question: Is the United States still the growth engine for the world? The answer is yes. ... The American economy has been on an upswing for more than four years. ... I would not be surprised if GDP were revised upward when we take a more definitive look at the fourth quarter. ... We have weathered hurricanes’ fury and record-high energy prices while continuing to grow and keep inflation under control. ...

This is especially true in what I call the “growth rim”—an arc of population centers with favorable demographics that begins in Virginia, runs down the southeastern seaboard through Georgia to Florida, then through the megastate of Texas and on to the uberstate of California and up to Seattle. I use “mega” and “uber” to describe the two largest states for a reason: to illustrate the depth and breadth of our economy. In dollar terms, Texas produces 20 percent more than India, and California produces roughly the same output as China. To the extent there is weakness in the U.S. economy, it is in the Northeast and North Central states.

Netting all this out, the consensus of most economic forecasters is that growth in the first quarter will rebound to a rate well above 4 percent. To understand what this kind of growth means, we need ... to “do the math.” The United States produces $12.6 trillion a year in goods and services. Be conservative ... and assume that in 2006 we grow at last year’s preliminary rate of 3.5 percent. The math tells us we would add $440 billion in incremental activity—in a single year.

That is a big number. What we add in new economic activity in a given year exceeds the entire output of all but 15 other countries. Every year, we create the economic equivalent of a Sweden—or two Irelands or three Argentinas. ... Of course, our growth is driven by consumption, a significant portion of which is fed by imports, which totaled $2 trillion last year. Again, do the math: Our annual import volume ... exceeds the GDP of all but four other countries—Japan, Germany, Britain and France.

So, yes, the United States is the growth engine for the world economy. And it is important that it remain so because no other country appears poised to pick up the torch if the U.S. economy stumbles or tires. Are there reasons to worry it might do so? In fashionable circles and at various “chat shows” like Davos, you certainly hear many.

Of immediate concern is the potential bursting of the so-called housing bubble. ... Again, it is important to do the math. Currently, 80 percent of U.S. homeowners have fixed-rate mortgages. Just one in five has a variable-rate mortgage. ... It is true that homeowners with variable-rate loans borrow larger amounts. It is also true that they have higher incomes. ...

In recent years, the analytically nettlesome Interest-Only—or IO—mortgages have become a significant percentage of housing loans in some markets. ...  Many of these mortgages, however, have long periods during which the interest rate and IO period are locked up. ... many houses will be sold or refinanced before the amortization period ever kicks in. Given this, I will let you draw your own conclusions about whether the housing market’s financial dynamics will strain the U.S. economy as interest rates rise in response to Federal Reserve tightening. ...

The other preoccupation is the U.S. current account deficit, a subject second only in popularity to the ongoing saga of Brad Pitt and Angelina Jolie. America’s large trade deficits have been discussed for so long by so many eminent analysts that I have little to add—except to remind you that it takes two to tango. Those urging the United States to rein in its spending should be equally full-throated in prodding countries with excess savings and trade surpluses to create conditions for growing their domestic demand.

If they fail to do so, and the U.S. suddenly becomes virtuous on its own, the global economy would sink into a deep funk. So if there is a ready substitute for the United States as the consumer of first and last resort for many developing economies, I would like someone to tell me which country, or group of countries, might fill the bill. ...

The key to the American economy’s success in recent years ... has been a unique combining of money and brains to enhance productivity ... New technology fed the productivity surge. The microprocessor led to a host of productivity-enhancing tools ... The Information Age technologies were available in nearly all countries, but few reaped the same productivity gains as the United States. ... The key to wringing more from the new technologies lies in the American economy’s adaptability. ... We have not saddled the private sector with regulations that interfere with hiring and firing or dictate outmoded methods of production. ...

I would like to think that America’s greatest asset is the wisdom and steady hand of its central bank. But truth be told, wise and temperate monetary policy is a necessary but insufficient condition for America’s success. Our greatest asset is our inherent flexibility ... As long as the Federal Reserve does its job of holding inflation at bay, and as long as our political leaders resist protectionism and other forms of interference..., we will remain a productive economic machine. ...

It is up to the continent’s political leaders to create conditions that liberate the private sector to reignite the combined mass of Europe’s economies as an engine of growth while the ECB ensures that business remains undistracted by inflation. Until then, the task of being the world’s economic engine falls to the United States.

Monday, January 23, 2006

Global Imbalances and Monetary Policy

NY Fed president Tim Geithner gave a speech today on the implications of global imbalances for the conduct of monetary policy. Here's the speech. Brad Setser comments here. I'll update this post later today.

Update: Here's a follow up from the Financial Times. President Geithner believes the trajectory for the current account deficit is unsustainable, and it's not necessarily self-correcting in a smooth, non-disruptive fashion, but we just don't know for sure how rocky the road might be. In his view, the longer the trade gap builds, the larger the risks. Because of this, policies such as reductions in the federal budget deficit are needed to mitigate the risk:

US current account deficit ‘unsustainable’ – NY Fed chief, by Christopher Swann, Financial Times: Timothy Geithner, president of the New York Federal Reserve, on Monday dismissed the view that the US current account deficit was sustainable, suggesting the risk of a sudden fall in the dollar would grow the longer the trade gap widened. ... Mr Geithner said the problem could not necessarily be expected to solve itself. “Time does not necessarily help. The longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany that process,” he said.

“The plausible outcomes range from the gradual and benign to the more precipitous and damaging,” he said. “The size and duration of these [global] imbalances, perhaps the most visible of which is the US current account deficit, present challenges – and risks – for the world economy.” His warning came as Raghuram Rajan, chief economist at the International Monetary Fund, repeated his concern over the risk of a run on the dollar. “You cannot discount a run on the dollar. But you cannot fully quantify that risk at the moment,” he said ...

Mr Geithner ... does not see a role for monetary policy in responding to the current account by raising interest rates to slow domestic demand growth and so the demand for imports. Rather, he believes the risks on the external side make it more important for the Fed to keep inflation under control, to avoid adding to the problems and to preserve the Fed’s flexibility in a crisis.

Many economists have argued that the risks to the dollar from the bloated current account deficit are mitigated by support for the currency from Asian central banks... However, Mr Geithner said this should provide little comfort over the long term. “A prolonged continuation of the exchange rate arrangements that have given rise to the large increase in foreign official investments in US financial assets is unlikely to be consistent with the domestic requirements of those economies and for this reason many are already in the process of change,” he said.

“Even if we could be confident that the world would be comfortable financing the US on these terms for some time, that fact alone does not mean that it is prudent for the US to continue borrowing on this scale.” Mr Geithner repeated his call for US politicians to reduce the budget deficit. The fact that the US is using much of the money borrowed from abroad to finance public spending, he said, increased the dangers. If it was being invested in the productive capacity of the US tradeable goods industries, this would at least help the US to pay back its foreign obligations.

Friday, January 20, 2006

FedSpeak Links

There have been four speeches over the last two days by Fed officials, two yesterday by Fed Governor Susan Bies, Productivity and Economic Outlook, and Richmond Fed President Jeffrey M. Lacker, The Economic Outlook for 2006. Both were discussed very briefly here.

Today, there were two more speeches (Bloomberg reports Atlanta Fed president Guynn also spoke today, but I haven't found his remarks posted yet):

San Francisco Fed President Yellen: 2006: A Year of Transition at the Federal Reserve

Bottom line: As in the two speeches yesterday, she is comfortable with current economic conditions, but expresses concern that inflation risks are weighted towards the upside. She also says about inflation targets:

I'm sympathetic to the idea of a quantitative objective for price stability, as I agree that it enhances both Fed transparency and accountability. ... I see an inflation rate between 1 and 2 percent, as measured by the core personal consumption expenditures price index, as an appropriate price stability objective for the Fed. However, I also think it is critically important that a numerical inflation objective not weaken our commitment to a dual mandate that includes full employment. Therefore, I would see the numerical objective as a long-run goal, and would want the Committee to have a flexible timeframe within which to maintain it.

Dallas Fed President Fisher also spoke today:

Dallas Fed President Fisher: Excerpts from Remarks on the Process of Creative Destruction

Bottom line: He discusses economic transition, but does not mention U.S. policy in his posted remarks.

Here's the Bloomberg report on Yellen's speech:

Fed's Yellen Says Inflation Risks 'Skewed Slightly' to Upside

Update: Bloomberg reports additional comments by Yellen:

Federal Reserve May Be Near Ending Interest-Rate Increases, Yellen Says

Update: Comments from Lacker:

Lacker says Fed not done yet on raising rates

Thursday, January 19, 2006

Fed Links

There were two speeches today by Fed officials. First, there was a speech by Fed Governor Susan Bies:

Productivity and Economic Outlook

Bottom line: Likes current situation, but worried about capacity and resource constraints driving up input prices and causing in inflationary pressure.

There was also a speech by Richmond Fed President Jeffrey M. Lacker:

The Economic Outlook for 2006

Bottom line: Likes current situation, but not sure that the pass-through risk from high energy prices to core inflation is over. One more rate hike, then assess incoming data to see where to go next.

Here's the Bloomberg write-up of the speeches:

Fed Officials See Inflation Risks From Oil, Rising Factory Use

And also from Bloomberg, Gene Sperling assesses Greenspan's record. He has quarrels with particular episodes such as the 2001 tax cut, but overall sees Greenspan's record in a positive light:

Time to Judge the Whole Record of Alan Greenspan

Update: Speeches by Yellen and Fisher

Friday, January 13, 2006

Chicago Fed's Moskow: Further Tightening May Be Needed

Chicago Fed president Michaels Moskow's speech begins with an extensive review of the outlook for economic growth and inflation. Since the review is essentially along the lines of other what other FOMC members have expressed previously, after a few summary statements I'll skip forward to his statements about policy. Given the robustness of economic growth, he favors increasing the target rate so long as there is any hint of long-run inflationary pressure and thus, for him, policy depends critically on new information concerning the outlook for inflation:

U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President, January 12, 2006: Over the last two years, real gross domestic product has been growing an average of 3.7 percent each year. This is somewhat faster than potential, or the rate of GDP growth that can be sustained without creating inflation pressures. ... The unemployment rate has fallen to 4.9 percent; at the Chicago Fed, we think that this rate is roughly consistent with an economy operating at potential. In addition, the capacity utilization rate in manufacturing has nearly reached its historical average. ... Finally, core inflation has changed only modestly in recent months. ... According to the Blue Chip consensus, real GDP growth is expected to average about 3-1/4 percent over the next two years—close to recent estimates for potential. And Blue Chip projects the unemployment rate will stay a bit below 5 percent through the end of next year. ... Given the fundamentals, I think the Blue Chip forecast is reasonable. But there certainly are some risks. ...

The latest readings on the core price index for personal consumer expenditures ... have been favorable.... Still, for most of this past year, core PCE inflation has been running close to 2 percent, which is at the upper end of the range that I feel is consistent with price stability. ... Fortunately, current financial market data and consumer surveys suggest that long-run inflation expectations remain contained. Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations contained. For me, this likely entails some further policy action. Whatever actions are taken, however, will depend on economic conditions. ...

Conceptually, it's easiest to think about the neutral—or equilibrium—rate as being the rate consistent with an economy growing steadily along its potential growth path over a long period of time. ... By such measures, we're currently in the bottom end of this range. Of course, this is a rough estimation. ... But there is another very important point to emphasize. Even if the funds rate were at neutral, further changes in policy might be appropriate. ...[A]s I mentioned earlier, there are risks to the inflation outlook—namely, the potential for energy cost pass through, pressures from increases in resource utilization, or rising inflationary expectations. ... My views about policy will depend importantly on how various cost factors play out and affect the outlook for inflation. ... if inflation or inflation expectations were to rise persistently, then policy clearly would have to be tightened further. Of course, other events could transpire that result in prospects for inflation and growth that would be consistent with a less firm policy stance. ... policy will not be a mechanical reaction to the next number on inflation or employment. ...

There is quite a bit more in the speech on these and other topics such as national savings and education.

Thursday, January 12, 2006

New York Fed's Geithner on the Fed's Response to Asset Price Movements

New York Fed president Geithner discusses the development of global asset markets and the impact of the development on monetary policy. The speech begins with a review of the past year which echoes many previous reviews from the Fed, so I will skip forward to his remarks on how asset prices should affect monetary policy. He believes that asset price movements must be considered in setting policy, but only if changes in asset prices affect forecasts of inflation and output. Asset prices should not be the goal of policy. He also explains why negative asset price movements should command more attention from policy makers than positive movements.

Bottom line: We don't know as much as we'd like about how asset prices are determined or how changes in asset values affect inflation and output, but these markets are increasing in importance so we need to learn more. In cases where we are confident we understand how an event in asset markets will affect forecasts of inflation and output, policy should respond:

Some Perspectives on U.S. Monetary Policy, by Timothy F. Geithner, New York Fed Chair: ... There is a well established, and I believe fundamentally correct, case against directing monetary policy at specific objectives for asset values or the future path of those values. ... [A]sset values should be neither a target nor a goal of monetary policy. ... Because we know so little about how to assess the appropriateness of asset values against fundamentals, ... [m]onetary policy does not today and is unlikely in the future to offer us an effective tool for directly reducing the incidence of large or sustained deviations of asset values from ... their fundamental values...

That said, monetary policy still has to take into account the impact of significant movements in asset values on output and inflation. ... History provides us with numerous examples in which significant movements in asset prices have had sizable effects on the path of output relative to potential and on price stability. And experience suggests that asset values can be very sensitive to ... perceptions of future policy moves. The challenge for central banks is to determine how movements in asset values and expected asset values affect the evolution of the economy. ...

The incorporation of asset price movements into monetary policy formation is hard to do, in part, because we don’t know that much about the transmission mechanism from movements in asset values to the underlying economic fundamentals we care about. ... And successfully integrating asset prices into monetary policy formulation is also hard to do because of the difficulty of assessing how ... monetary policy will ... affect asset values. ... But to acknowledge these complexities does not weaken the case for ... trying to make sensible judgments about how monetary policy should respond to asset price developments. Here are some considerations:

First, in circumstances where the central bank observes a large realized movement in asset prices and is confident in its knowledge of the impact ... on ... aggregate demand, monetary policy may need to follow a different path than might have seemed appropriate in the absence of those developments. .... Of course central banks must always be prepared to respond when factors threaten to push aggregate demand away from aggregate supply and impact the inflation outlook. Movements in asset prices certainly have the potential to be one of those factors...

Because some asset prices may fall more abruptly than they rise, and because the effects of downward moves in asset prices on demand may be larger due to the greater negative impact of deflation on the net worth of borrowers—witness the United States in the 1930s or Japan in the 1990s, the case for adjusting monetary policy in response to negative asset price shocks is commonly considered more compelling than in the alternative context. ...

More generally, despite the fact that policymakers can’t be completely confident in their assessment of the future path of asset prices, it seems unavoidable that these assessments will factor into policy decisions. ... [P]olicy, in some circumstances, will need to respond to asset price movements when those movements alter the central bank’s assessment of the risks to its outlook...

This leaves us with no simple or clear doctrine for the role of asset prices in monetary policy regimes. Asset prices probably matter more than they once did, but what that means for monetary policy necessarily depends on the circumstances. ...

Update: See Nouriel Roubini's extensive comments on the significance of these remarks.

Tuesday, January 10, 2006

Fed Presidents Hoenig and Guynn: Changes in Funds Rate Becoming Increasingly Data Dependent

Thomas M. Hoenig, president of the Kansas City Fed said today that future moves in monetary policy are becoming increasingly data dependent:

The National Economy and Monetary Policy in the New Year, Thomas M. Hoenig, Kansas City Fed President: ...Implications for monetary policy ...Over the course of the last year and a half, the FOMC gradually has raised its target for the federal funds rate... As a result ..., the funds rate now has returned to a more normal level and is within at least the lower range of ... neutrality. Whether the funds rate is now precisely at the point within the neutral range where it needs to be is a question I cannot answer with any degree of certainty. This depends on possible increases in resource utilization as well as elevated energy prices, and whether other factors add to inflation pressures.

More generally, when the funds rate is within the neutral range, as I believe it is now, changes in the funds rate target become more dependent on incoming economic data and on anecdotal information... If such evidence were to suggest that core inflation was increasing above the level associated with price stability, it might be necessary to move the funds rate target higher within the range of neutrality. Or, depending on the extent of upward price pressure, it might be necessary to move the funds rate above the neutral range to offset the tendency for inflation to rise. One indicator that would be of particular concern to me would be any upward movement in long-run inflation expectations....

In contrast, if incoming evidence suggested the expansion were faltering, it might be necessary to adjust the funds rate downward. As I suggested earlier, the burden of high energy prices or a desire by consumers to curtail their spending could lead to a slower-growth scenario. Depending on the outlook for inflation in such a scenario, it might be appropriate to move the funds rate lower within the neutral range or, potentially, below neutral to help stimulate spending and production.

On balance, while the current setting of monetary policy may be close to where it will ultimately need to be, we won't know this until new data are reported. The point is that we still must monitor closely incoming information as we seek to calibrate our policy in the months ahead.

Atlanta Fed president Guynn said much the same thing in his speech today. He also says he is not worried about the yield curve, he is worried about debt monetization, and he's open to explicit inflation targets. Here's Bloomberg's report:

Fed Policy Makers Scaling Back Rate Guidance, Watching Data, Guynn Says, Bloomberg: Federal Reserve policy makers are scaling back guidance on future interest-rate decisions because they don't know the "full economic effect'' of the 13 increases since June 2004, Atlanta Fed President Jack Guynn said. "Many of you may be wondering when enough is enough?'' Guynn said in a speech to the Rotary Club of Atlanta today. "The closer we get, the less explicit we can be on that point.'' ... "We don't know yet the full economic effect of the policy moves that we have already made,'' said Guynn, ... "In the months ahead, we'll have to watch the data very carefully to make sure that growth is still on track and inflation expectations are well anchored.'' ...

"While our policy direction has been quite clear over the past 18 months, in the less certain period ahead it's my personal opinion that as policy makers we should resist the temptation to say more than we know in any given time,'' said Guynn...

Guynn told reporters afterward that he is "not terribly concerned'' about the ... flattening yield curve. ... Guynn listed three longer-term economic risks: energy costs, workforce issues including job security and "strong downward pressure on wage growth,'' and the federal budget deficit. "It's hard to prove empirically that fiscal deficits cause inflation,'' Guynn said. "But history -- and I think common sense -- tells us that most inflation problems arise in economies with large fiscal deficits.''

Guynn said after the speech he would consider supporting a specific inflation goal for the Fed, a practice advocated by ... Ben Bernanke ... "I continue to be open to discussing whether some form of inflation targeting can improve our policy process,'' Guynn told reporters. "It has been implemented in many different ways in other economies. I think we should continue to talk about it.'' ...

Guynn said he is "very much attuned to potential inflationary pressures that I think are still at work in the economy,'' citing the desire of businesses to pass through higher energy costs to customers.

[Text of Guynn's speech] For some reason, The Kansas City Fed does not provide president Hoenig's speeches in digital format, only as a pdf. Here's the entire text:

Continue reading "Fed Presidents Hoenig and Guynn: Changes in Funds Rate Becoming Increasingly Data Dependent" »

Sunday, January 08, 2006

Do I Make Myself Perfectly Clear?

Not exactly - according to this research, we get the direction of interest rate changes wrong more often than not after Fed speeches:

Fed Speeches Send Investors Wrong Way, Reinhart Says, Bloomberg: ...Interest rates after a Fed speech tend to move in the opposite direction from where they are eventually headed, according to research by Vincent Reinhart, director of the Fed's monetary affairs division, and Brian Sack, a former Fed economist who is now a private forecaster. ... Speeches by individual members of the Fed's policy-setting Open Market Committee cumulatively pushed down the yield on the two-year Treasury note during the first half of 2005, while the committee's official statements lifted it, the authors said ...

''Speeches are the least accurate form of communication,'' wrote Reinhart and Sack .... ''On average, the initial market reaction to speeches reversed over subsequent weeks.'' The paper's sample included 1,042 speeches since November 2001. That includes interviews by Fed members, which were classified in the same category. The Fed communicates with the public in four ways: FOMC statements ... released after each interest-rate meeting; minutes of those meetings, released three weeks later; semi- annual testimony to Congress on monetary policy; and speeches by individual committee members, of which there are about 250 a year.

''Statements were quite successful at pushing the yield in the appropriate direction, while speeches appear to have given the market a head fake'' the authors wrote. Congressional testimonies had the ''most accurate'' effects, ahead of statements, the research showed. Minutes of meetings were third. ...

The financial market reaction to Fed speeches, while often wrong, was the smallest of the four methods of communication studied by the authors. Testimonies produced the biggest moves, followed by statements and minutes. Speeches may have a small effect because ''the market realizes that the communications by any individual Committee member are a less accurate predictor of the Committee's actions than communications that have been sanctioned by the Committee as a whole,'' Reinhart and Sack wrote.

Fed Chairman Alan Greenspan's speeches moved the two-year Treasury yield more than 3 basis points, ''well above the effect attributable to other FOMC members,'' according to the research...

Saturday, January 07, 2006

"Boys dying in Vietnam, and Bill Martin doesn’t care!"

Dallas Fed president Richard Fisher tells economists gathered at the ASSA meetings in Boston that their econometric models aren't much help. He also stresses the importance of Fed independence by recounting a story from the 1960s about president Johnson and William Martin, Fed president at the time:

Coping with Globalization's Impact on Monetary Policy, by Richard W. Fisher, Dallas Fed President,January 6, 2006: Many of my fellow Federal Reserve Bank presidents are economists ... I am not. ... I do not mind admitting to some apprehension about speaking to an audience of economists on an economic topic. But I am very comfortable with ... one of the biggest challenges my colleagues and I must cope with: globalization’s impact on ... the economy and the making of monetary policy.

The literature on globalization is large. The literature on monetary policy is vast. But the literature examining the combination of the two is surprisingly small. ... The word “globalization” does not appear in the index of Michael Woodford’s influential Interest and Prices: Foundations of a Theory of Monetary Policy. Nor do the words “international trade” or “international finance.” What gives? Is the process of globalization disconnected from monetary policy? Is central banking totally divorced from globalization? I think not. I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold. ...

There are many convoluted definitions of globalization. Mine is simple: Economic potential is no longer defined or contained by political and geographic boundaries. ... Where does monetary policy come into play in this world? One of the first books I read as I prepared for my new job as Dallas Fed president was A Term at the Fed... by former Federal Reserve Governor Larry Meyer. ... Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC ... as the U.S. economy morphed into the new economic environment of the second half of the 1990s. At the time, economic growth was strong and accelerating. ... The prevailing views ... pointed to rising inflation. That is precisely what the Federal Reserve’s models were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents ... Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable.

They were frustrated by Chairman Greenspan’s insistence on postponing rate hikes, yet ... inflation ... kept falling. If the conventional wisdom had prevailed, the Fed would have caused the economy to seriously underperform. ... Greenspan ... was ... constantly talking ... to business leaders. And what they were telling him jibed with what he knew ... new technologies ... enhanced productivity. ... It is important to listen to our economy’s business operators. ... Our business managers are the nerve endings in Adam Smith’s invisible hand...

The ... creation of vast new sources of inputs and production have upset all the calculations and equations of the very best economics minds. How can economists quantify with precision what the United States can produce with existing labor and capital when we do not know the full extent and elasticity of the global labor pool? Or the totality of the financial and intellectual capital that can be drawn on to produce a nation’s GDP? How do we measure the inventory-to-sales ratio in a technologically advanced, hyper-interconnected world where offshore sources are expanding geometrically, if not exponentially? ...

The old models simply no longer apply in our globalized, interconnected and expanded economy. ... the economics profession needs to rejigger its econometric equations to better inform our understanding of the maximum sustainable levels of U.S. production and growth.

There are, of course, those who will argue, at least from a theoretical perspective, that globalization should not matter much in a world of flexible exchange rates. They contend that a central bank can tailor monetary policy to domestic objectives alone when it is not obliged to defend a specific value for the currency. ... The proposition, however, holds only under assumptions I do not think apply in the world we live in today. ... To be sure, not everyone buys into my proposition ... Even so, as a practical matter, globalization has important implications for monetary policymakers, flexible exchange rates or no. ...

Will the tailwinds stay with us? Left to their own devices, I think they would ..., but we have to take into account the political dimension. I have expressed my concern about the implications of our fiscal deficits, vowing never to use my vote on the FOMC to monetize excess spending. I have also warned of the dangers of protectionism...

As a Texan, I am mindful of the story about William McChesney Martin, Fed chairman from 1951 to 1970. President Johnson invited him down to his Texas ranch for what turned out to be a one-on-one meeting. The president wanted a more accommodating monetary policy, and Martin, a strong advocate of Fed independence, tried to explain to him the consequences of that course of action. Johnson would have none of it and advanced on Martin, shoving him around the room and shouting, “Boys dying in Vietnam, and Bill Martin doesn’t care!” Years later, Martin expressed his regrets about shifting policy to suit the president. “To my everlasting shame,” he said, “I finally gave in to him.”[1]

Presidents Clinton and Bush have allowed the Fed to operate with a high degree of political independence from the administration. On the whole, Congress has also wisely refrained from interference. Without its independence from political interference, I doubt the Fed could have so successfully set the interest rates that have led to today’s favorable economic circumstances. Just as I doubt that, without independence from rigid econometric dicta, monetary policy could have so adroitly harnessed, and in turn lubricated, the forces of globalization.

"Boys dying in Iraq and Ben Bernanke doesn't care!" I trust Bernanke will withstand any such pressure.

Thursday, December 22, 2005

Are We There Yet?

The Fed is quite pleased with the economic outlook, at least as viewed through the eyes of Jeffrey Lacker, president of the Richmond Fed. There are worries, housing and energy prices foremost among them, and a little more tinkering  may be necessary to make sure inflation and inflation expectations are contained, but in general the trajectory is encouraging:

The Economic Outlook for 2006, by Jeffrey M. Lacker, Richmond Fed President: It is a pleasure to ... discuss the economic outlook for 2006 and beyond... because the economic outlook is fairly encouraging. Growth is on a solid footing ...  employment has resumed expanding at a healthy pace, consumer spending continues to grow briskly, and business investment spending is robust. Granted, housing activity seems to be softening, and at least some potential price level pressures remain, so it may be too soon to break out the eggnog. But inflation expectations remain contained, and we at the Fed are well-positioned to resist inflation pressures, should they emerge...

The really striking feature of the current outlook is the extent to which economic activity in general and consumer spending in particular has rebounded from the shock of the hurricane season. ...  With healthy income growth ahead and a reasonably strong overall job market, the outlook for consumer spending looks good. Housing market activity has been very strong over the last several years. The historically low level of inflation-adjusted mortgage interest rates explains much of that strength. ... In recent months, we have received widespread anecdotal reports of ... "a return to normalcy" in several housing markets in our District. ... At the same time, the aggregate measures of housing activity have so far shown only limited pull-back from their peaks and remain at historically high levels. Still, ... I would expect housing price appreciation to flatten out next year and aggregate residential investment to stop growing or perhaps even decline.

The fundamentals for business investment in equipment and software look quite sound. ... Productivity has grown at surprisingly strong rates ... - 3.4 percent since the end of 2000 - despite significantly lower rates of capital formation. Gains in labor productivity ... ultimately pass through to real incomes. ... If productivity growth continues at or above trend, as seems likely, then we should see healthy growth in real income next year... Labor markets have recovered from the recession of 2001. Although employment was stagnant for a time following the downturn, hiring picked up in 2003...

The overall outlook therefore is for a healthy expansion next year. Real GDP should grow at about 3.5 percent. ... but naturally there is some uncertainty attached to it. Economic fundamentals could depart from their anticipated trajectories in any number of ways ... For example, spot oil prices - or other commodity prices for that matter - could well turn out either above or below the path embodied in futures prices. ... Commodity price surprises in either direction could alter aggregate supply conditions and either add or subtract from output growth.

On the demand side, there is some uncertainty regarding the rate at which housing activity is likely to cool in the coming year. Although I do not think that a sharp fall in housing investment is likely, a range of forecasts from flat to moderately declining seem reasonable. And ... it is difficult to foresee with any certainty the scale of investment that businesses will find profitable to undertake, so spending growth in this category could well deviate from expectations...

Core inflation has been low and relatively steady in the last several years. ... within the 1-to-2 percent range that I and others have proposed as an announced target. ... Monetary policy should respond to energy shocks by remaining focused on price stability. ... While the lack of an upsurge in the core PCE inflation figures for September and October is somewhat encouraging, I think it is too soon to declare that pass-through risk is entirely behind us. ... Thus far, market participants appear to believe that core inflation will remain contained. ... Measures of expected inflation derived from ... inflation-protected U.S. Treasury securities drifted up a bit this fall, but ... have returned to mid-summer levels. To maintain credibility for price stability, it is essential that monetary policy should respond vigorously to any visible erosion in inflation expectations.

Assuming output growth remains healthy, the Fed is waiting to see if core inflation does indeed continue to moderate, in which case it considers pausing, or if higher energy prices pass through and begin showing up in incoming data, in which case it meets the price hikes aggressively. The Fed needs to be convinced, and it isn't there quite yet, that pass through of energy prices to core inflation is not a problem.

Friday, December 16, 2005

In Trade We Trust

Alan Greenspan sounds a familiar tune on the virtues of free markets. Here, he stresses the importance of implicit contracts in making free markets work. Trust, he says, is a key element in commerce and it is reemerging as an important asset in the global economy as we discover that government alone cannot provide the guarantees that are necessary to ensure integrity in business relationships. Only the market, by punishing the stock values of companies who commit business and financial transgressions, can serve this function:

Remarks by Chairman Alan Greenspan, Acceptance of honorary degree, New York University, New York, New York, December 14, 2005: ...I have had a front-row seat in observing the exceptional growth in world living standards. With all that exposure, it was inevitable that I would gain some useful insights into the role of open and competitive markets in engendering the wealth of nations. ... On average, world standards of living are rising, in large part because of the widening embrace of competitive free markets, especially by populous and growing China and India. ... Open and free markets ... rest not only on voluntary exchange but also on a necessary condition of voluntary exchange: trust in the word of those with whom we do business. To be sure, all market economies require a rule of law to function--laws of contracts, protection of property rights, ... Yet, if even a small fraction of legally binding transactions required adjudication, our court systems would be swamped and immobilized.

In ... virtually all our transactions, ... we rely on the word of those with whom we do business. If we could not do so, goods and services could not be exchanged efficiently. The trillions of dollars of assets that are priced and traded daily in our financial markets before legal confirmation illustrates the critical role of trust. ... Commerce is inhibited if we cannot trust ... commitments. ... This necessary condition for commerce was particularly evident in freewheeling nineteenth-century America, where reputation and trust became valued assets. Throughout much of that century, laissez-faire reigned ..., and caveat emptor was the prevailing prescription for... trading... A reputation for honest dealing was thus particularly valued. ... To be sure, the history of world business is strewn with Fisks, Goulds, and numerous others treading on, or over, the edge of legality. But they were a distinct minority. ...

Over the past half-century, societies have ... partially substituted government financial guarantees and implied certifications of integrity for business reputation. As a consequence, the value of trust so prominent in the nineteenth century seemed by the 1990s to be less necessary. Most analysts believe that the world is better off as a consequence of these governmental protections. But corporate scandals in the United States and elsewhere have clearly shown that the plethora of laws of the past century have not eliminated the less-savory side of human behavior.

We should not be surprised, then, to see a reemergence ... of the value placed by markets on trust and personal reputation in business practice. After the recent revelations of corporate malfeasance, the market punished the stock prices of those corporations whose behavior had cast doubt on the reliability of their reputations. There may be no better antidote for business and financial transgression. ... Our system works fundamentally on trust and individual fair dealing. We need only look around today’s world to appreciate the value of these traits and the consequences of their absence. While market economies have achieved much in this regard, more remains to be done.

Prejudice ... is unworthy of a society built on individual merit. A free-market capitalist system cannot operate effectively unless all participants in the economy have the opportunity to achieve their best. If we succeed in opening up opportunities to everyone, the affluence within our borders will almost surely become more equally distributed. ...

Tuesday, December 06, 2005

Fed Governor Olson: Fed Unlikely to Tighten Rates Too Much

Federal Reserve governor Olson gave a speech today on rural development. After the speech, he said he wasn't worried about over tightening:

Olson Isn't Worried the Fed Will Raise Rates Too Much, Bloomberg: Federal Reserve Governor Mark Olson said he isn't concerned the Fed will raise its benchmark interest rate too much because the central bank can respond quickly to changes in the economy. ''I don't worry about that,'' Olson ... told reporters after a speech in Sioux Falls, South Dakota. ''The economy doesn't typically move so rapidly that it would get away from us.'' ... Olson said the Fed has ''an opportunity to look at the economy continually,'' including between policy meetings, and because of that ''we have the ability to respond very quickly.'' ... Olson said that price measure, also known as ''core'' inflation, ''remains muted.'' ''We need to be continually watchful,'' he told reporters. Olson... said the decision facing Fed policy makers at next week's meeting is the extent to which higher prices are ''passing through into core inflation, and the extent to which we may consider removing that accommodation,'' or continuing to raise the benchmark interest rate. ...

It sounds more and more as though Federal Reserve members believe that inflation is coming under control and they are waiting for confirmation of this from new data over the next few months before stopping the campaign of incremental rate hikes. But any signs of inflation will be met with hawkish eyes.

I want to question one thing in these remarks. There are considerable lags between the time a policy is put into place and the time the policy takes effect, e.g. as long as a year and a half before the peak impact of the policy is felt on GDP and the effects of policy shocks can persit for as long as three years. Recessions can occur much faster than this and the idea that the Fed can always respond in time to catch any downward movement in activity fails to recognize the length of these lags and the uncertainty we have about them (see Jim Hamilton at econbrowser for more on this). I find the attitude that 'The economy doesn't typically move so rapidly that it would get away from us,'' surprising from a Fed official.

Saturday, December 03, 2005

Dallas Fed President Fisher on How Globalization Affects Monetary and Fiscal Policy

The following four posts contain summaries of four speeches by members of the Federal Reserve, two by Alan Greenspan (here and here) one by Janet Yellen of the San Francisco Fed, and one by Richard Fisher of the Dallas Fed in this post. There were also two speeches yesterday, one by William Poole of the St. Louis Fed (part 1, part 2), and one by Susan Bies from the Board of Governors, so there has been a small flurry of FedSpeak. If you are interested in the future course of monetary policy, Janet Yellen's speech is the most informative.

Here's Fisher's speech on how monetary and fiscal policy are affected by globalization. While Greenspan also talked about fiscal policy today, Fisher's remarks are more complete, more hard-hitting, and more connected to monetary policy. For example, he actually explains how bad fiscal policy can create bad monetary policy through pressures to monetize the debt, and how debt monetization is affected by globalization. I don't agree with everything he says, but I'm starting to like Fisher's willingness to say what he believes needs to be said:

Globalization and Government Policy, by Richard W. Fisher. Dallas Fed President: ...I wish George Shultz could be here. I’m sure many of you know him... He is a distinguished economist and public servant, who inside and outside government has been an advocate for fiscal sanity for decades. Shultz is now at Stanford University’s Hoover Institution. I spoke with him a few weeks ago and, sure enough, our conversation turned to one of his biggest concerns: our burgeoning structural fiscal deficits. He told me a story I want to share with you. When he was President Nixon’s budget director, Shultz became increasingly worried about the inability of Congress to cut spending. Sitting in his office at 2 in the morning, he turned to his venerable aide, Sam Cohen, and asked, “Sam, is there really any difference between Republicans and Democrats when it comes to spending?” After giving it some thought, Cohen replied, “They both spend money. The only difference is that Democrats enjoy it more.” It is no longer clear who enjoys it more, but it is crystal clear we need to have a little less enjoyment and a lot more fiscal rectitude. ... I am ... deeply concerned about the magnitude of deficits projected 20, 30 and 40 years into the future. Left unchecked, they will become a grave danger to our prosperity and run the risk of seriously undermining the progress we have made in taming inflation. That said, I believe the discussion of America’s fiscal deficits is not complete unless we take into account the forces of globalization...

Continue reading "Dallas Fed President Fisher on How Globalization Affects Monetary and Fiscal Policy" »

San Francisco Fed's Yellen on Prospects for Growth and Inflation in 2006

Janet Yellen reflects on the economy over the past year and the prospects for growth, high employment, and inflation in the coming year. She also discusses the future of monetary policy and I will focus on that part of her remarks:

The U.S Economy: 2005 in Review and Prospects for 2006, By Janet L. Yellen, San Francisco Fed President: ...As 2005 draws to a close, it's a good time to take a look back at the year that has passed and to think about what may lie ahead for the U.S. economy in 2006. ...I'm going to organize my remarks around three broad topics. The first is employment and output growth. The second is inflation. ... My third and last topic is the conduct of monetary policy ...

Continue reading "San Francisco Fed's Yellen on Prospects for Growth and Inflation in 2006" »

Greenspan on International Imbalances

Alan Greenspan discusses global imbalances. Although he expresses concern about the trend of the current account deficit for the U.S, he is relatively unconcerned about the deficit that exists today:

International imbalances, by Chairman Alan Greenspan: In November 2003, I noted that we saw little evidence of stress in funding the U.S. current account deficit ... Two years later, little has changed except that our current account deficit has grown still larger. Most policy makers marvel at the seeming ease with which the United States continues to finance its current account deficit. Of course, deficits that cumulate to ever-increasing net external debt, with its attendant rise in servicing costs, cannot persist indefinitely. At some point, foreign investors will balk at a growing concentration of claims against U.S. residents...

Continue reading "Greenspan on International Imbalances" »

Friday, December 02, 2005

Greenspan: Social Security and Medicare Must Be Cut to Solve the Budget Deficit Problem

Can closing the barn door after the horses have left restore a reputation? Alan Greenspan discusses the growing pressures on the budget deficit and potential solutions to the problem. He starts by saying he believes a revised version of the Budget Enforcement Act of 1990 is needed to curtail government spending. Thus, while he opposes an explicit inflation targeting rule for monetary policy because it undermines flexibility, he supports budget rules that limit flexibility for fiscal policy.

Greenspan identifies the usual suspects as the cause of current and growing budget deficit problems, Social Security and Medicare, and discusses the usual solutions. First, while productivity growth will help, he does not think it will accelerate fast enough to solve the problem. The other two solutions are tax increases and cuts in spending. His view is that tax increases alone cannot solve the budget problem because the size of the tax increases required would severely curtail economic growth. Thus, cuts in spending will be necessary. He then takes this a step further and says the problems should be solved "primarily, if not wholly" with cuts in spending, and identifies Social Security and Medicare as the targets for the cuts. I disagree that cuts in spending alone can meet the challenge, just as Greenspan disagrees that tax increases alone can solve the problem. It seems he cannot admit that his call for tax cuts contributed to the budget problem and therefore cannot admit that at least a partial reversal of the tax cuts would be helpful.

Finally, he talks about the need to increase saving and says our ability to meet future budget challenges will be heightened if saving increases because it will fund increases in the capital stock and increase growth. I expected he would issue a call for private Social Security accounts at this point as a means of increasing saving, but he simply says that the current Social Security structure has not proven an effective vehicle for promoting saving leaving the call for private accounts implied rather than explicitly stated:

Budget Policy, by Chairman Alan Greenspan (videotaped remarks): The U.S. economy has delivered a solid performance thus far in 2005. ... However, the positive short-term economic outlook is playing out against a backdrop of concern about the prospects for the federal budget over the longer run. ...[T]he latest projections ... suggest our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. As I recently testified, the necessary choices will be especially difficult to implement without the restoration of procedural restraints on the budget-making process. ... Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. ... I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age. ...

Continue reading "Greenspan: Social Security and Medicare Must Be Cut to Solve the Budget Deficit Problem" »

Thursday, December 01, 2005

Central Bank Communication

Here is William Poole's speech on Federal Reserve Communication of its policy stance. The first part of the speech talks about central bank credibility, rules versus discretion, and inflation targeting, and the speech discusses how these issues emerged as important issues in the rational expectations revolution. The topics in this part of the speech have been presented here many times, so I will skip forward to the section on central bank communication. As the Fed begins to consider how to alter communication about its policy stance, Poole makes several points:

  • First, better information about policy improves outcomes under rational expectations.
  • Second, it's harder to communicate clearly than is commonly appreciated.
  • Third, communicating intentions to the public clearly requires that policy intentions be understood clearly internally and this is an often overlooked benefit of Fed communication with the public.
  • Fourth, the main danger of communicating future intentions is that the Fed will get locked into an expected policy path and will find it difficult to deviate when data indicates it is necessary to do so. More importantly, deviating from the path that markets expect may undermine credibility which is very costly.
  • Fifth, communication of conditionality is, therefore, key. Markets must understand that the statements made by the Fed are conditional upon incoming information.

I want to emphasize that the tricky part of conditionality is getting markets to understand how the Fed will respond to incoming data. It's one thing to say that policy is conditional, but that does not tell markets when or how data will alter the course of policy. For example, will today's favorable inflation report change future policy? Unless the market knows how the Fed will respond as incoming data arrive, merely announcing policy is conditional does not necessarily stabilize market reactions:

Communicating the Fed's Policy Stance, William Poole, St. Louis Fed president: ...My plan is to discuss some of the evolution that has led to policy concern over central bank communication. ... I’ll discuss two aspects of central bank communication. One aspect is “body-language” communication through increased regularity of policy actions and the second is written and oral communication through policy statements, speeches and testimony. ...

Continue reading "Central Bank Communication" »

Is There a New Consensus in Macroeconomics?

William Poole, president of the St. Louis Fed, in response to the question "Is there a new consensus in macroeconomics?":

Communicating the Fed's Policy Stance, William Poole, St. Louis Fed president: My short answer to the question posed ... is “yes.” The fundamental issues that created an enormous gulf between macroeconomists in the 1960s have been resolved. Of course, ... agreement on the most important fundamentals does not eliminate controversy about many important details.

In the U.S context, the most important single issue was that in 1965, say, economists conducted modeling and policy exercises in a control-theoretic framework. A changed view of expectations led to appreciation of the importance of the distinction between real and nominal interest rates and the view that in the long run the Phillips curve was vertical. Somewhat later but certainly by 1985, say, almost everyone believed that expectations of private agents about what policymakers would do had to be incorporated in models and policy analyses.

In 1965, expectations were almost uniformly modeled in a backward-looking way. As the rational expectations analysis took hold, the argument concerned the extent of rationality in formation of expectations. Were expectations rational in the sense of Muth (1961) or were they based on backward-looking and/or rules-of-thumb calculations? I would not claim that there is a consensus today on how to model expectations, but would claim that all serious macro economists believe that expectations cannot be adequately viewed as totally lacking in rational elements.(1) That is, markets do reflect efforts of private agents to look ahead, however imperfectly they may be able to do so.(2) And “looking ahead” certainly includes forming expectations as to what policymakers will do.

Poole continues the discussion of "looking ahead" to what policymakers will do as he talks about the Fed's communication strategy, a key concern of the Fed right now. I will post that part of his speech later today.

Tuesday, November 22, 2005

Chicago Fed's Moskow on the Strength of Labor Markets and the Need to Continue Removing Accommodative Policy

If you are looking for news on the course of interest rates, this speech by Chicago Fed president Michael Moskow is fairly hawkish with respect to battling inflation. Combined with the evidence presented at macroblog, it seems a safe bet that rates will continue to rise at a measured pace in the near future unless incoming data alter the economic picture substantially. Many parts of the today's speech are almost identical to the speech Moskow gave on November 15 in which he supported the conclusion that further rate hikes are justified by noting:

  • GDP growth is above potential growth
  • Much of the slack in the economy has been eliminated
  • There are two risks to growth, a slowing of the housing market and high energy prices
    • He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
    • He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
  • Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward

There were also new parts in today's speech on the strength of the labor market, why it is sometimes necessary in the short-run to increase the interest rate beyond the long-run neutral rate, and longer term economic challenges of maintaining human and physical capital at optimal levels. Here's the part on the strength of the labor market where he spends quite a bit of time trying to convince us that slack in labor markets has been mostly eliminated and that statistics such as labor force participation rates do not alter this view:

U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: ... The unemployment rate deserves a bit of elaboration. Some analysts question whether that rate accurately reflects the "true" degree of labor market slack. Their concern is that an unusual number of those who want to work may have become so discouraged about their prospects of finding a job that they have given up looking for work. ... Indeed, the labor force participation rate, which is the fraction of the population either working or actively looking for work, is well below where it was prior to the 2001 recession. In contrast, 4 years after the 1990-91 recession, the labor force participation rate had returned to its prerecession level. So the question is, do we think the participation rate will return to its prerecession level? At the Chicago Fed, ... our best judgment is that we will not see a big rebound in participation. This suggests that the current low levels of labor force participation are not indicative of a slack labor market.

First, much of the unusual behavior of labor force participation during this cycle has been caused by a sharp decline in the percentage of teenagers in the labor force. This has occurred at the same time that there have been notable increases in summer school enrollments—a development that is unlikely to be reversed any time soon... Therefore, we don't expect to see teenagers flood back into the labor force. Trends in adult labor force participation are also important. While we have seen large secular increases in women's labor force participation for several decades, this was mostly due to differences in behavior between women born before and after 1960. ... So the increase in women's labor force participation appears to have largely run its course. Men's labor force participation, in contrast, has been declining since the 1950s, and we do not see any reason to expect a strong reversal. Finally, and perhaps most importantly, the aging of the baby boomers is putting downward pressure on labor force participation, because it increases the share of the population that is retired. Putting all these pieces together, I do not expect a large increase in labor force participation. Accordingly, the current unemployment rate is probably close to the level associated with a healthy economy and little labor market slack.

The next new part relative to the previous speech begins with the third sentence where he explains why, in the short-run, it can be necessary to increase the federal funds rate beyond what is required for long-run neutrality:

Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations contained. For me, at this time such policy likely entails further removal of policy accommodation. [start of new part] ... Conceptually, it's easiest to think about the neutral—or equilibrium—rate as being the rate consistent with an economy growing steadily along its potential growth path over a long period of time. ... we're currently near the bottom of this range. Of course, ... we have to recognize that many factors can cause differences between the longer-run concept of neutral policy and what may be neutral policy over the short or medium term. For example, ... [e]ven if the funds rate were at neutral, further changes in policy may be appropriate. ... With inflation at the upper end of my comfort zone, an unexpected increase in inflation would be a serious concern, while a decline in inflation would be beneficial. My views about policy will depend importantly on how these cost factors play out and affect the outlook for inflation. ... or inflation expectations ... What I've just described is the conditionality of monetary policy. As we've said many times, the FOMC will react to changes in economic prospects. Future policy will not be a mechanical reaction to the next number on inflation and employment. ...

This last substantive change is the addition of a section on the longer term challenges of how to maintain sufficient investment in both physical and human capital in with economic issues such as low savings rates and growing budget deficits making this task more difficult:

The risks I've talked about so far primarily relate to the near-term economic outlook. But in the long term, we face a different set of challenges. In order to support productivity growth and maintain a solid trend in economic growth, we need to continue to invest in physical and human capital at sufficiently high rates. In the case of physical investment in plant and equipment, the long-term challenge will be financing. Spending on physical capital must be financed by our national savings... [O]verall national saving has fallen in recent years. Fortunately, the rest of the world has viewed the United States as a good place to invest. ... Unfortunately, such deficits are not sustainable indefinitely. ... This means that if we are to maintain our current rates of capital investment, national saving will have to rise ... This will be happening at the same time that the aging of our population will put increasing pressure on our Social Security and Medicare spending. ... Medicare outlays will account for a rapidly expanding share of the national budget. Without changes in spending or taxes or both, this increased demand for social insurance will further increase government deficits and decrease net national saving.

Finally, another factor that will affect our future economic growth is our ability to improve the quality of our workforce. This requires us to do a better job educating our school age population and providing further opportunities for training and retraining of those already in the workforce. Education has historically been a strength of the United States, but some current trends are worrisome. ...

Given that the economy currently looks healthy, now is a good time to attack some of our longer-term challenges. How we generate increases in national savings and improve education are important issues for our nation. ...

Friday, November 18, 2005

St. Louis Fed President Poole on Tracking Inflation

William Poole, president of the St. Louis Fed, discusses how the Fed tracks and forecasts inflation in conducting policy. He also talks about his view of current inflation trends and says "...the FOMC has tightened its policy stance considerably." and "... core inflation and inflation expectations have been contained, but underlying determinants of inflation suggest caution." Here are excerpts from the speech:

Tracking Inflation, by William Poole, St. Louis Fed President:  ...I have said previously that I favor a goal of zero inflation, properly measured. In practice, because of various statistical problems in measuring prices, that goal translates, approximately, to price changes of something like a 1 percent annual rate of increase in the chain-price index for Personal Consumption Expenditures—the PCE ... for short. In its day-to-day policymaking, the Fed focuses on the core PCE price index, which excludes volatile food and energy prices... On average over time, the total and core indexes change at almost identical rates. Even putting volatile food and energy prices aside, it is not possible to achieve an inflation target precisely year by year; thus, my goal might be stated as a change in the core PCE index of 0.5 to 1.5 percent per year. That range itself needs to be a bit elastic to allow for special circumstances that might be important in a particular year. ... I believe that all of us have in mind inflation goals that are so close one to the other that differences in the goal are not really an issue. However, there is an important issue that I struggle with every time I go to an FOMC meeting: What policy will yield an outcome close to the inflation goal? ...

Continue reading "St. Louis Fed President Poole on Tracking Inflation" »

Wednesday, November 16, 2005

Explicit Inflation Targets and Flexibility

Fed Chair nominee Ben Bernanke reaffirmed his support of explicit inflation targets or ranges in today's confirmation hearing and one of the main questions concerning inflation targeting is how it affects flexibility. This is not a new question. Here's former Fed Governor Laurence H. Meyer at the University of California at San Diego Economics Roundtable,  July 17, 2001 with a common view on this topic:

Inflation Targets and Inflation Targeting, by Fed Governor Laurence Meyer: Retaining Flexibility with the Dual Mandate The key issue for me is whether setting an explicit inflation target would reduce the flexibility of policymakers to pursue a dual mandate and select the preferred point along the tradeoff between output and inflation variability. ... Specifically, would implementing an explicit inflation target inevitably also raise the response parameter on the inflation gap relative to that on the output gap? In my view, the answer is that this need not be the case, but I agree that there is some risk of this outcome. It seems to me, however, that it is less likely if the move to an explicit inflation target is taken in the context of a reaffirmation of the dual mandate.

Quoting Bernanke in his opening statement today on implementing explicit inflation targets:

I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment.