Category Archive for: Monetary Policy [Return to Main]

Tuesday, October 18, 2016

Yellen Poses Important Post-Great Recession Macroeconomic Questions

Nick Bunker:

Yellen poses important post-Great Recession macroeconomic questions: Last week at a Federal Reserve Bank of Boston conference, Federal Reserve Chair Janet Yellen gave a speech on macroeconomics research in the wake of the Great Recession. She ... lists four areas for research, but let’s look more closely at the first two groups of questions that she elevates.
The first is the influence of aggregate demand on aggregate supply. As Yellen notes, the traditional way of thinking about this relationship would be that demand, a short-run phenomenon, has no significant effect of aggregate supply, which determines long-run economic growth. The potential growth rate of an economy is determined by aggregate supply...
Yellen points to research that increasingly finds so called hysteresis effects in the macroeconomy. Hysteresis, a term borrowed from physics, is the idea that short-run shocks to the economy can alter its long-term trend. One example of hysteresis is workers who lose jobs in recessions and then aren’t drawn back into the labor market bur rather are permanently locked out... Interesting new research argues that hysteresis may affect not just the labor supply but also the rate of productivity growth.
If hysteresis is prevalent in the economy, then U.S. policymakers need to rethink their fiscal and monetary policy priorities. The effects of hysteresis may mean that economic recoveries need to run longer and hotter than previous thought in order to get workers back into the labor market or allow other resources to get back into full use.
The other set of open research questions that Yellen raises is the influence of “heterogeneity” on aggregate demand. In many models of the macroeconomy, households are characterized by a representative agent... In short, they are assumed to be homogeneous. As Yellen notes in her speech, overall home equity remained positive after the bursting of the housing bubble, so a representative agent would have maintained positive equity in their home.
Yet a wealth of research in the wake of the Great Recession finds that millions of households whose mortgages were “underwater” and didn’t have positive wealth—a big reason for the severity of the downturn. Ignoring this heterogeneity in the housing market and its effects on economic inequality seems like something modern macroeconomics needs to resolve. Economists are increasingly moving in this direction, but even more movement would very helpful.
Yellen raises other areas of inquiry in her speech, including better understanding how the financial system is linked to the real economy and how the dynamics of inflation are determined. ... As Paul Krugman has noted several times over the past several years, the Great Recession doesn’t seem to have provoked the same rethink of macroeconomics compared to the Great Depression, which ushered in Keynesianism, and the stagflation of the 1970s, which led to the ascendance of new classical economics. The U.S. economy is similarly dealing with a “new normal.” Macroeconomics needs to respond this reality.

Fed Watch: Are Yellen and Fischer Really Worlds Apart?

Tim Duy:

Are Yellen and Fischer Really Worlds Apart?, by Tim Duy: This from Bloomberg surprised me:

Michael Gapen, chief U.S. economist at Barclays Plc in New York, said Fischer’s comments “reflect an ongoing divergence of opinion” at the central bank. Fischer “doesn’t see much room for running the economy hot” while Yellen’s views “seem to provide a wide-open door to do that. You have a chair and a vice chair who see policy differently right now,” he said.

I don't think there exists a yawning gap between Federal Reserve Vice-Chair Fischer and Federal Reserve Vice Chair Yellen. The perception of this gap stems in part from what I think was an aggressive reading of Yellen's speech last week. The line in question:

If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a "high-pressure economy," with robust aggregate demand and a tight labor market.

Is this a call for a "high-pressure economy"? My interpretation is somewhat more muted. Note that this was posed as a potential research question, along with three others, that macroeconomists should pursue in the wake of the Great Recession:

The Influence of Demand on Aggregate Supply
The first question I would like to pose concerns the distinction between aggregate supply and aggregate demand: Are there circumstances in which changes in aggregate demand can have an appreciable, persistent effect on aggregate supply?

My second question asks whether individual differences within broad groups of actors in the economy can influence aggregate economic outcomes--in particular, what effect does such heterogeneity have on aggregate demand?

Financial Linkages to the Real Economy
My third question concerns a key issue for monetary policy and macroeconomics that is less directly addressed by this conference: How does the financial sector interact with the broader economy?

Inflation Dynamics
My fourth question goes to the heart of monetary policy: What determines inflation?

She does not actually say that the Fed should run a high pressure economy. Nor should this be seen as a defense of current policy because this is decidedly not a high pressure economy. Instead, Yellen argues we need more research on the topic to understand the costs and benefits of such a policy approach:

More research is needed, however, to better understand the influence of movements in aggregate demand on aggregate supply. From a policy perspective, we of course need to bear in mind that an accommodative monetary stance, if maintained too long, could have costs that exceed the benefits by increasing the risk of financial instability or undermining price stability. More generally, the benefits and potential costs of pursuing such a strategy remain hard to quantify, and other policies might be better suited to address damage to the supply side of the economy.

Now, to be sure, she is willing to delay rate hikes to explore the possibility of drawing more supply from the labor market. From the press conference:

But with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.

Does this mean the economy is a running at a high pressure? Later in the conference:

And that is some news that we’ve received in recent months, that the labor market does have that potential to have people come back in without the unemployment rate coming down. So we’re not seeing strong pressures on utilization suggesting overheating, and my assessment would be, based on this evidence, that the economy has a little more room to run than might have been previously thought.

One reason Yellen is willing to delay rate hikes is because the economy is not overheating. Again, this is not a high pressure economy - and if it was, she would not be so willing to delay rate hikes. Indeed, willingness to accept a high pressure economy suggests that Yellen has abandoned preemptive policy. But:

So I think the notion that monetary policy operates with long and variable lags—that statement is due to Milton Friedman, and it is one of the essential things to understand about monetary policy, and it has not fundamentally changed at all. And that is why I believe we have to be forward looking, and I’m not in favor of a “whites of their eyes” sort of approach. We need to operate based on forecasts.

Compare this with Fischer, via the same Bloomberg story:

“If you go below the full employment rate, or peoples’ estimates of full employment, by a couple of tenths of percentage points, I don’t think there’s any danger in that,” Fischer said Monday in response to questions at an Economic Club of New York lunch. “But saying we should keep going until the inflation rate shows us we’re wrong, then you’re going to change too late.”

Then, back to Yellen:

One is the risk that the economy runs too hot, that unemploy—the labor market tightens too much, that unemployment falls to a very low level, that we need to tighten policy in a less gradual way than would be ideal, and in the course of doing that, because that is a very difficult thing to accomplish, to gently create a bit more slack in the labor market, we could cause a recession in the process.

So you get the idea. There is nothing here to suggest that Yellen looks to generate a high pressure economy. She holds the commonly held view within the Fed that policy makers need to prevent the unemployment rate from sinking too low because they cannot just nudge the rate higher. If anything, with the unemployment rate dancing on the edge of Fed estimates of the natural rate, she would almost certainly react to an acceleration in activity with an acceleration in the pace of rate hikes. So too would Fischer. But with growth around 2 percent per tracking estimates, labor force participation rising to meet job growth, and inflation below target, we do not have a high pressure economy and hence the need for immediate rate hikes dissipates. Yellen will let it play out a bit longer. But if the labor force participation rate stalls out and unemployment starts heading back down, Yellen would become nervous that the Fed is poised to fall behind the curve.

Bottom Line: The key debate within the Fed at the moment centers around the need for preemptive rate hikes. The hawks prefer more preemption, the doves favor less. Federal Reserve Lael Brainard pulled the FOMC to the dovish camp, primarily through her influence at Constitution Ave. Yellen is probably somewhat more sympathetic to Brainard than Fischer, but as I said last week, Fischer has moved substantially in Brainard's direction. It is really the presidents that are on the hawkish side of the aisle. There just isn't that much space between Yellen and Fischer at the moment.

Monday, October 10, 2016

Fed Watch: Jobs Data Keeps Hawks Sidelined

Tim Duy:

Jobs Data Keeps Hawks Sidelined: Federal Reserve hawks face an array of labor market data that threatens a key pillar holding up their policy view. That pillar is the assertion that monthly nonfarm payroll growth over roughly 100k will soon force unemployment far below the natural rate, thus placing the US economy in grave danger from inflationary forces. By this view, the decline of unemployment long ago justified further rate hikes. Hawks failed to anticipate that the unemployment rate would flatten out at 5 percent despite steady payrolls growth. This outcome does not fit in their worldview. Fundamentally, they were supply-side pessimists. The recent strength in labor force growth suggests their pessimism was sorely misplaced and undermines their argument for immediate rate hikes. The key elements of the FOMC - the permanent voters - now stand as supply-side optimists and are prepared to hold rates at current levels through the next meeting, and perhaps even longer. A December rate hike is still not a foregone conclusion. 
In recent speeches, Federal Reserve Chair Stanley Fischer appears to be now fully under the sway of Fed doves. Fischer's take on the employment report, from his speech this weekend:
Despite the strong job growth, the unemployment rate, at 5 percent in September, has essentially moved sideways this year as individuals have come back into the labor market in response to better employment opportunities and higher wages. As a consequence, the labor force participation rate has edged up against a backdrop of a declining longer-run trend owing to aging of the population. This increase is a very welcome development.
Four charts deserve attention here. First, "strong job growth:


Second, the unemployment rate has "moved sideways":


Third: "higher wages":


Fourth "labor force participation has edged up":


Overall, the October employment report justified the FOMC's decision to hold rates steady in September. The reasoning, according to Fischer:
But with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.
The Fed sees that demand-side policy triggers a supply side response, and consequently does not want to risk leaving millions in the ranks of the unemployed (and remaining workers with sub-optimal wage growth) with a premature tightening of policy. Moreover, the lack of substantial inflationary pressures continues to the bedevil the hawks. As Fischer notes, inflation expectations remain in check, or, if they have moved, have drifted down. And while inflation has indeed edged up in recent months, it remains below target:


And I would argue that much of the rise in inflation was attributable to January's gain:


Fischer also undercuts the hawks' argument that preemptive hikes are necessary because without them the Fed will fall behind the curve:
But since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future, and gradual increases in the federal funds rate will likely be sufficient to get monetary policy to a neutral stance over the next few years.
The key is that he sees policy as only modestly accommodative - a view that follows the Fed's epiphany on the persistence of a low natural rate of interest. Hence no massive catch-up would be needed even if future conditions require a faster pace of rate hikes.
I suspect that the hawks, now derailed by the employment data, will further pivot toward financial stability as they argue for a more rapid reduction of financial accommodation. Here too, however, Fischer is prepared to meet them head on. From last week:
Let me briefly mention a second reason for worrying about ultralow interest rates: The transition to a world with a very low natural rate of interest may hurt financial stability by causing investors to reach for yield, and some financial institutions will find it harder to be profitable. On the whole, however, the evidence to date does not point to notable risks to financial stability stemming from ultralow interest rates. For instance, the financial sector has appeared resilient to recent episodes of market stress, supported by strong capital and liquidity positions.
Overall, sounds to me that Fischer now embraces the intellectual framework pushed for over a year by his colleague, Federal Reserve Governor Lael Brainard. This likely is true also of all the permanent voting members. Within the context to the Board's current framework, the hawkish Fed president can do little more than squawk.  
Bottom Line: A November rate hike remains dead. We have two labor reports until the December meeting. A continuation of recent trends would leave a rate hike at that meeting in doubt. Odds favor that meeting currently, but it is not a foregone conclusion. The doves are supply-side optimists. They want to let this rebound run for as long as possible. And remember, those closest to Federal Reserve Chair Janet Yellen are now those that inhabit the halls of Constitution Ave. Be wary of the words of hawkish Fed presidents; they have been very misleading this year. 

Thursday, October 06, 2016

Trump’s Mudslinging Puts the Fed in Danger

An editorial at the FT:

Trump’s mudslinging puts the Fed in danger: So many extraordinary accusations and denunciations emanate from Donald Trump... One of the more potentially damaging is the contention that the Federal Reserve is setting policy to ensure the election of his opponent, Hillary Clinton.
Political criticism of the US central bank has been going on for decades. ...
Yet it is offensive and absurd to suggest that Janet Yellen, the Fed chair, and her colleagues are deliberately trying to engineer the election of another Democratic president. At a time when the Fed has a low standing in the public mind, perhaps more disturbing than Mr Trump’s eccentric claims is that congressional Republicans, who should know better, are joining in. ...
It is beyond hope that Mr Trump will see sense and moderate his attacks. His fellow Republicans, unless they are ready to endanger one of the pillars of US economic stability, should resist the urge to follow his example.

Wednesday, October 05, 2016

Fed Watch: Hard To Say That November Is Really "Live"

Tim Duy:

Hard To Say That November Is Really "Live," by Tim Duy: If there is one thing that I am fairly sure that monetary policymakers hate, it is the idea that the outcomes of their meetings are preordained. November appears to be just such a meeting. To be sure, Fed hawks want to believe the meeting is "live." The sizable group that dissented - or would have dissented if they were voting members - likely sees the case for a rate hike in November as even more pressing than in September. Remember, it is all about preemptive policy action from that contingent. If you thought delay was bad in September, it must be worse in November. But the doves - including a powerful group of permanent voting members - will likely have none of it. From their point of view, the case for a rate hike is no more pressing in November than September. Indeed, according to the the dot-plot, at least three would be happy taking a pass in December as well. And, although they would be loathe to admit it, within the context of a risk management framework the timing of the election argues against a hike as well. As I see it, the best the hawks can hope for is a strong statement about December. The data would have to very quickly turn very strong to give the hawks an upper hand in November.

I did get a chuckle out of this last week:

The only way to reinforce the idea that November is a "live" meeting is to continue to hold out the hope of a rate hike. But unless the doves budge between now and November, a rate hike is not happening. And the doves aren't likely to budge anymore than the hawks. It's kind of a stalemate at the moment, and everyone knows it. So reinforcing the the idea that a hike is going to happen when it isn't is not really an effective communication strategy. It is not exactly good policy guidance.

Cleveland Federal Reserve President Loretta Master would also like you to believe November is "live." From Monday, via Bloomberg:

Federal Reserve Bank of Cleveland President Loretta Mester said the economy is ripe for an interest-rate increase and repeated that the Fed’s November meeting should be viewed as “live” for a policy decision, despite its proximity to the U.S. presidential election.

“I would expect that the case would remain compelling” for a rate hike when the Federal Open Market Committee gathers in Washington Nov. 1-2, the week before Americans head to the polls, she told Kathleen Hays in an interview on Bloomberg Television Monday. Mester added that politics wouldn’t affect the decision.

Of course she wants November to be "live." She wanted to hike rates at the last meeting. And I suspect she believes that unless the hawks can push up rate hike expectations to something closer to 50% (from the current 13% or so), they have no chance of pushing through a rate hike. Not that I think they have much of a chance even then. Seems that his amounts to trying to manipulate market expectations to obtain an advantage at the FOMC meeting. I sense this is what hawks have attempted more than once this year. In my opinion, this too is not a good communications strategy.

Like the outcome of the November meeting, Mester's dissent is also preordained.

Mester also repeats the "politics are irrelevant" story. And, broadly, I agree. I don't believe, for example, the Federal Reserve Chair Janet Yellen is holding rates low simply to help President Obama or enhance Hillary Clinton's election chances. That is ludicrous. So if you are saying that the Fed won't hike in November for those reasons, I think you are wrong.

But I am going to give some on this issue in another dimension. Elections are risk events, and a risk management strategy thus demands that they be considered when making policy. And we know that in fact the Federal Reserve considers elections when making policy. New York Times reporter Binyamin Appelbaum caught Yellen by surprise at the press conference with this question:

BINYAMIN APPELBAUM. Binya Appelbaum, the New York Times. In the run-up to the Brexit vote earlier this year, several Fed policymakers cited it as a reason that they were reluctant to raise rates in June because of the uncertainty associated with that vote. In the run-up to the presidential election, I have not heard any Fed policymaker give that as a reason that they might want to delay raising rates in November. Could you explain why the Fed regards Brexit as a greater danger to the American economy than the presidential election that’s actually happening here? And, second, there were three dissents at this meeting. Could you explain what the cause of disagreement was, what those policymakers thought?

CHAIR YELLEN. So we are very focused on evaluating, given the way the economy is operating, what is the right policy to foster our goals, and I’m not going to get into politics.

Appelbaum nailed that one - we can't credibly believe that the Brexit vote is a more relevant risk for the US economy than this presidential election. Yet the Fed is asking us to believe exactly that. If you can't comment on how US elections impact Fed policy, you shouldn't comment on how foreign elections impact Fed policy. Just chalk it up to "global economic uncertainty" and move one. The Fed really messed up by identifying the Brexit vote as a reason to hold rates steady.

This also doesn't seem like a win for the Fed's communication strategy. Live and learn.

Finally, when considering the risk management issues, don't let New York Federal Reserve President William Dudley's latest speech slip by you. He questions the effectiveness of unconventional monetary policy:

Given the initial novelty of unconventional monetary policy tools, central banks did not have a well-developed body of research to draw on to design the programs and calibrate their impact. While it will take time to build this body of work, research to date varies in terms of the estimated effectiveness of unconventional policy. Several studies indicate that the FOMC’s first asset purchase program helped to reduce long-term interest rates, while the subsequent programs had smaller though still significant effects on rates. However, Professor Summers, who is participating in our program, has recently questioned the effectiveness of the Fed’s asset purchase programs when financial markets are well-functioning.

And then he considers the implications for monetary policy (emphasis added):

There is a related concern given that the federal funds rate is still close to zero at this point in the expansion. While I’m on record as saying that expansions do not simply die of old age, some economists are concerned that the risk of a recession is increasing. As I indicated earlier, the FOMC was able to reduce the federal funds rate by more than 5 percentage points in an effort to offset the effects of the last recession. If another recession were to happen in the next few years, it is likely that the FOMC would be unable to respond with a cut of such magnitude. In this case, the effectiveness of unconventional monetary policy in providing accommodation would again become a central issue, as Chair Yellen discussed in her recent Jackson Hole speech. A risk management approach to monetary policy would suggest that the more concerned one is with the effectiveness of these policies at the zero lower bound, the more cautious one would be in the process of removing accommodation. So, even though we are now slightly off the zero lower bound, an assessment of the effectiveness of unconventional monetary policy has implications with respect to the current stance of monetary policy.

Recessions don't die of old age, that's true. But the fact that Dudley even mentions rising risks of recession among "some economists" is notable. And note the time horizon of his concerns - the next few years! He must have a tingle in the back of his head saying that we are closer to the end than the beginning, and we still don't have adequate policy room, nor can we get adequate policy room by hiking rates because that will only accelerate the onset of the next recession. So the only thing they can do is delay (although not clear why he should consider a rate hike wise at all if he concedes to recession concerns). Such an argument will continue to dominate over the preemptive strike argument (see Richmond Federal Reserve President Jeffrey Lacker for the extreme view on that point) in November.

My takeaways on Fed communications over the last week are thus:

  • If you are only going to hike once a year, it is difficult to see why that hike would come at a meeting without a press conference. Clearly, it is not as if the timing of that one hike is really all that critical. You just have to learn to live with the reality that it will be hard to describe all eight meetings a year as "live" when you hike in only one of them. Live with the fact that at least half will end up effectively as "dead." And guess what? You determined which were "dead" with the decision to only have a press conference at every other meeting.
  • Don't try to talk up a rate hike with the only purpose of keeping the drama surrounding the meeting alive. That is not helping market participants understand the factors driving policy.
  • Don't try to talk up the market odds of a meeting just to attempt to gain a tactical advantage at that meeting. That seems to me to be what Fed hawks have been doing this year. The doves just aren't buying the preemptive strike argument. And they won't if market odds for a meeting are 50% rather than 15%. Wait until December.
  • If US politics are off limits, then foreign politics need to be off limits. It is very hard to explain why US politics don't matter for policy when foreign politics do matter.

Bottom Line: I am hard pressed to see the way forward to a November rate hike. Seems that delay will still dominate over preemptive strikes in November.

Monday, September 26, 2016

Fed Watch: December Looking Good. But...

Tim Duy:

December Looking Good. But..., by Tim Duy: FOMC doves squeezed out another victory at last week’s meeting. But can they do it again in December?
As was widely expected, the Fed held rates steady at the September FOMC meeting. That said, the meeting was clearly divisive, with three dissents, all from regional bank presidents. And the accompanying statement leaned in a hawkish direction – the committee noted that near-term risks were “balanced” and that the case for a rate hike had “strengthened.” Moreover, only three of the participants did not expect a rate hike before year end.
And if that was not enough, during her press conference, Federal Reserve Chair Janet Yellen suggested the bar to a December rate hike was low:
…most participants do expect that one increase in the federal funds rate will be appropriate this year and I would expect to see that if we continue on the current course of labor market improvement and there are no major new risks that develop and we simply stay on the current course.
Sounds like December is a go. But markets are not entirely convinced, with participants pricing in a roughly 60% chance of a rate hike. Perhaps this pricing reflects post-election economic risk. Or perhaps it reflects the possibility that the doves can stare down the hawks one more time before the composition of the Board changes next year.
Can they? That question requires understanding what happened to squash the parade of Fed presidents looking for a rate hike in September. What happened were Federal Reserve Governors Lael Brainard and Daniel Tarrullo. Brainard in particular laid down the intellectual framework ahead of the FOMC meeting, arguing that the potential for further labor market improvement and asymmetric policy risks justified a steady hand at this meeting. Yellen and the rest of the Board bought into this story. The hawks could squawk all they wanted, but the votes just weren’t going to go in their favor.
This episode provided two important lessons. The first is that if you haven’t been taking Brainard seriously this past year – ever since her bombshell speech last October – you have been doing it wrong. The second is that a small group of governors can have a much larger influence on policy than a large group of presidents. There are lots of presidents, and they talk a lot, so their message is louder. But the power rests in the Board.
Indeed, this asymmetry of power is why the relative lack of speeches from Board members is one of the Fed’s biggest communication failures. The people driving policy shouldn’t be waiting until the Friday before the blackout period to begin delivering their message.
Now consider the dots. There remain three “no hike” dots for 2016. I think it is reasonable to believe those three dots belong to Tarullo, Brainard, and Chicago Federal Reserve President Charles Evans. If true, that suggests that Tarullo and Brainard are at the present time considering making another dovish stand at the December meeting. To do so, they need to keep Yellen on their side.
During the press conference, Yellen revealed that she remains attached to a preemptive view of policy. Since monetary policy operates with long lags, it is important that policy responds to inflationary threats before they emerge. She also rejected a “whites of their eyes” approach to policy, or the suggestion by Evans that they Fed waits until core inflation hits two percent before they hike rates. These concerns are balanced against Brainard’s argument that they can’t be sure they have yet achieved full employment.
Hence, and as I said ahead of the meeting, I think that if unemployment dips between now and December, or progress on underemployment resumes, or inflation moves closer to target, the hawks will win as Yellen’s support will shift toward a rate hike. And these things can all be reasonably expected given the current course of job growth, which is in excess of the Fed’s estimate of what is necessary to absorb labor force growth. For the doves to have a decent chance of holding back the hawks one more time, progress on these points needs to remain stalled.
Regardless of a December hike or not, the Fed continues to mark down the expected path of policy. The median projected Fed funds rate dropped 50bp for both 2017 and 2018, continuing the pattern of the Fed moving toward the market rather than vice-versa. And note that the changing composition of the FOMC next year will allow for this dovish message to come through. This meeting’s dissenters will all be replaced with presidents that are on average more dovish. Consider this ordering of monetary policy makers via Julia Coronado of Graham Capital, modified to show the shift of voters for next year:


Voting presidents will be more aligned with the preferences of the governors. This should help ease some of the recent communications challenges even if the governors maintain their relative silence.
Bottom Line: Doves on the Board continue to delay the preemptive strike on inflation. Stalling gains on unemployment and underemployment gave them the ammunition to stand their ground. If those gains resume, doves will fall prey to the hawks at the next meeting. But they will have an easier time maintaining a shallow path of policy next year, and hopefully are better set to communicate that path.

Wednesday, September 21, 2016

Fed Votes 7-3 to Keep Rates on Hold

Several Fed presidents wanted a rate hike, but the Board stayed united:

Press Release, Release Date: September 21, 2016, For release at 2:00 p.m. EDT: Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year. Although the unemployment rate is little changed in recent months, job gains have been solid, on average. Household spending has been growing strongly but business fixed investment has remained soft. Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.

The Latest from the Bank of Japan

Ben Bernanke:

The latest from the Bank of Japan: The Bank of Japan’s (BOJ) policy announcement today had two main parts. First, the BOJ committed itself to continue expanding the monetary base until the inflation rate “exceeds the price stability target of 2 percent and stays above the target in a stable manner.” That is, the BOJ says it wants not only to reach its 2 percent inflation target but to overshoot it. Second, in a significant change, the BOJ will begin targeting the yield on ten-year Japanese government debt (JGBs), initially at about zero percent (that is, setting a target price for bonds). ..
I think the announcements are good news overall, since they include a recommitment to the goal of ending deflation in Japan and the establishment of a new framework for pursuing that goal. ... The follow-through will indeed be crucial: Japan has made significant progress toward ending deflation, but that progress could still be lost if the public questions the BOJ’s commitment to its inflation objective. ...
The most surprising, and interesting, part of the announcement was the decision to target the ten-year JGB yield. ... Targeting a long-term yield is closely related to quantitative easing... Pegging a long-term yield ... amounts to setting a target price rather than a target quantity. ...
In general, pegging a long-term rate carries some risks. Notably, in defending a peg, a central bank gives up control over the size of its balance sheet... In the extreme case, a central bank trying to hold down yields could find itself owning most or all of the eligible securities. That risk is particularly acute if the peg is not credible ... because then bondholders will have a strong incentive to sell as quickly as possible..., in the Japanese context these risks are probably manageable. ....
The BOJ’s announcement referred to “synergy effects” between Japanese monetary and fiscal policies, but in public statements Governor Kuroda has expressed his opposition to explicit monetary financing of government spending, so-called “helicopter money.” Exactly what constitutes helicopter money is a semantic debate, but a policy of keeping the government’s borrowing rate at zero indefinitely has some elements of monetary finance. ... The resemblance would become even more pronounced if the BOJ began targeting rates on very long JGBs (the Japanese government borrows at maturities out to forty years). I suspect that the BOJ is happy for now with “synergy,” as opposed to explicit fiscal-monetary cooperation. Whether such cooperation will emerge in the future will depend on whether the new framework proves powerful enough to decisively end deflation in Japan.

See also David Beckworth.

Tuesday, September 20, 2016

Fed Watch: Ahead Of The FOMC Meeting

Tim Duy:

Ahead Of The FOMC Meeting, by Tim Duy: A roundup of Fed-related stories and viewpoints ahead of the FOMC meeting. First, Jeanna Smialek at Bloomberg sees danger lurking in the new dot plot:

Janet Yellen will frame a decision this week to forgo an interest-rate increase as necessary to achieve the Federal Reserve’s economic goals. Donald Trump and his supporters are likely to frame it as political.

That’s because the central bank on Wednesday will also release fresh “dot plot” projections which will probably show policy makers see one quarter-point rate hike by the end of the year. Such a forecast would be widely interpreted as a sign that a hike is coming at the Fed’s December meeting, instead of at the November gathering, which comes a week before the U.S. presidential election and isn’t accompanied by one of the chair’s quarterly press conferences.

Problem is, having the dot plot signal a December move comes with political baggage...

The political baggage is the timing of the rate hike around a presidential election. Why wait on a rate hike now only to signal that one is coming in December? Detractors will claim that the Fed doesn't want to derail the economy and with it the Democrat's hope of retaining the White House. This despite, as Joe Gagnon notes in the article, politics has little if any impact on the rate setting decision. But this isn't about reality, it is about perception. And, politically, the optics just aren't great.

It seems to me that the Fed is taking a political hit on top of what is likely to be the communications hit if, as is reasonably assumed, the dot plot signals a quarter-point hike in December. That would be a pretty strong calendar-based signal of their intentions. Given there is only a few months left in the year, they have to be pretty confident in the outlook to send such a signal. Which raises the question that if you were so confident, why not hike rates now? And if you send such a strong signal now, is that lowering the bar on the kind of data you need to support a hike? And then are you hiking because of perceived past commitment, a need to maintain "credibility," rather than the data? But doesn't that make the Fed more susceptible to policy errors?

In my opinion, the dots outlived their usefulness when they signaled a pace of policy tightening that never happened. They were a great tool for credibly committing to zero for a long period. But that very credibility made them a terrible tool when the time came for tighter policy. They were perceived as a promise because such perception followed logically from the previous promise of low rates. Now they just appear as a series of broken promises. Worse yet, the Fed might feel tied to those promises when they shouldn't be.

The Fed really needs to rethink the dot plot. Use it as a tool when it can be most effective; pull it when it detracts from the message.

Meanwhile, former Minneapolis Federal Reserve President Narayana Kocherlakota, writing at Bloomberg View, says the Fed is about to make a mistake regardless of what they do:

More than seven years after the recovery began in mid-2009, inflation remains below the central bank's 2-percent target...Worse, markets appear to be losing confidence that the Fed will ever reach its target: Yields on Treasury bonds suggest that traders expect inflation to average less than 2 percent five to 10 years from now. As the experience of the Bank of Japan indicates, restoring such confidence is not easy...The Fed is also falling short of its goal of "maximum" employment.

Kocherlakota concludes that the Fed should be easing policy, so holding and raising rates are both mistakes at this juncture.

But one does not have to go far for an opposing view. The editorial board at Bloomberg has a different idea:

The best it can do is press cautiously ahead on normalizing monetary policy, explain what “normal” now means, and promise to keep an open mind as new information comes in. What this requires right now, it should also say, is a quarter-point rise in interest rates.

The editorial board dismisses Kocherlakota as missing the bigger picture:

What this kind of analysis leaves out is the growing threat to future financial stability. Very low interest rates (together with a massively enlarged central-bank balance sheet, courtesy of quantitative easing) have supported demand as intended, albeit with ever-diminishing effectiveness; at the same time, however, they’ve artificially boosted financial-asset prices and distorted normal patterns of risk-taking in financial markets.

Because interest rate are low, they must be "artificially" low and thus distorting something in the economy. The insinuation is that the Fed can simply raise interest rates and the economy will jump back into a happier equilibrium with no distortions and no negative impact. Good luck with that.

If interest rates were truly too low, then their should be much more economic activity and upward pressure on inflation than currently exists. Whatever distortions currently exist must not be exerting a broad impact and thus are fairly small; monetary policy is a blunt tool to use on small distortions. Nor is it evident that even a fairly large rate hike would stop an asset bubble - at least not without a cost. San Francisco Fed researchers concluded:

What is the takeaway then? Slowing down a boom in house prices is likely to require a considerable increase in interest rates, probably by an amount that would be widely at odds with the dual mandate of full employment and price stability. Moreover, the Fed would need a crystal ball to foretell house price booms. In restraining asset prices, while the power of interest rate policy is uncontestable, its wisdom is debatable.

So hiking rates now to try to stop a bubble will likely end in lower rates later. In other words, to use rate policy to try to calm financial markets, you better be very, very sure you are actually facing a widespread threat to the economy. And I don't see anything that justifies that level of certainty. The Financial Crisis was the last war; policymakers need to be wary about always fighting the last war.

Not everyone believes the Fed will hold steady tomorrow. Via Bloomberg:

Two of the Fed’s 23 preferred bond-trading partners -- Barclays Plc and BNP Paribas SA -- are betting against their peers and the bond market by forecasting officials will raise rates Wednesday. It’s the first time more than one dealer has gone against the consensus during the week of a policy meeting since last September, data compiled by Bloomberg show. Economists at both banks say traders have too steeply discounted officials’ intent to hike after the Fed has remained on hold for longer than expected.

I think this is highly unlikely. There are some heavy hitters pushing to holding rates steady. I would not underestimate the power of a few dovish board members, especially if they don't want to roll over on a rate hike like last December. Moreover, the Fed doesn't like to surprise market participants. They don't need 100% certainty, but they need something better than the current odds hovering between 10 and 20%. The hawks know this, and don't like the outcome of the meeting being a foregone conclusion. That said, if the Fed does hike, the handful of analysts who called for a rate hike will look brilliant. And they should get the credit where credit is due in that circumstance.

And for my views on the meeting, see my piece in Bloomberg this week.

Tuesday, September 13, 2016

Does a Higher Inflation Target Beat Negative Interest Rates?:

The beginning of a relatively long discussion by Ben Bernanke:

Modifying the Fed’s policy framework: Does a higher inflation target beat negative interest rates?: Nominal interest rates are very low, and in a world of excess global saving, low inflation, and high demand for safe assets like government debt, there’s a good chance that they will be low for a long time. That fact poses a potential problem for the Federal Reserve and other central banks: When the next recession arrives, there may be limited room for the interest-rate cuts that have traditionally been central banks’ primary tool for sustaining employment and keeping inflation near target.
That concerning possibility has led to calls for a new monetary policy framework, including by Fed insiders like John Williams, president of the San Francisco Fed. In particular, Williams has joined Olivier Blanchard and other prominent economists in proposing that the Fed consider raising its target for inflation, currently 2 percent.[1] If the Fed targeted a higher average level of inflation, the reasoning goes, nominal interest rates would also tend to be higher, leaving more room for rate cuts when needed. 
Interestingly, some advocates of a higher inflation target have been dismissive of the use of negative short-term interest rates, an alternative means of increasing “space” for monetary easing. For example, in a recent interview in which he advocated reconsideration of the Fed’s inflation target, Williams said: “Negative rates are still at the bottom of the stack in terms of net effectiveness.” Williams’s colleague on the Federal Open Market Committee, Eric Rosengren, also has suggested that the Fed may need to set higher inflation targets in the future while asserting that negative rates should be viewed as a last resort. My sense is that Williams’s and Rosengren’s negative view of negative rates is broadly shared on the FOMC. Outside the United States, Mark Carney, governor of the Bank of England, has expressed openness to targeting nominal GDP (which essentially involves targeting a higher inflation rate when GDP growth is low), but has also made clear that he is “not a fan” of negative interest rates.
As I explain below, negative rates and higher inflation targets can be viewed as alternative methods for pushing the real interest rate further below zero. In that context, I am puzzled by the apparently strong preference for a higher inflation target over negative rates, at least based on what we know now. ...

Wednesday, September 07, 2016

Fed Watch: Is Pushing Unemployment Lower A Risky Strategy?

Tim Duy:

Is Pushing Unemployment Lower A Risky Strategy?, by Tim Duy: The unemployment is closing in on the Fed's estimate of the natural rate of unemployment:


Consequently, Fed hawks are pushing for a rate hike sooner than later in an effort to prevent the economy from "overhearing." This overheating is argued to set the stage for the next recession. For instance, see San Francisco Federal Reserve President John Williams:
History teaches us that an economy that runs too hot for too long can generate imbalances, potentially leading to excessive inflation, asset market bubbles, and ultimately economic correction and recession. A gradual process of raising rates reduces the risks of such an outcome. It also allows a smoother, more calibrated process of normalization that gives us space to adjust our responses to any surprise changes in economic conditions. If we wait too long to remove monetary accommodation, we hazard allowing imbalances to grow, requiring us to play catch-up, and not leaving much room to maneuver. Not to mention, a sudden reversal of policy could be disruptive and slow the economy in unintended ways.
In his Bloomberg View column, former Minneapolis Federal Reserve President Narayana Kocherlakota questions whether there is much theory behind this contention:
Some Fed officials worry that “overheating” could trigger a recession. (I don’t understand the precise economic mechanism, but let’s leave that aside.)
Kocherlakota was specifically referring to the risks of undershooting the natural rate of unemployment. New York Federal Reserve President William Dudley summarized his perception of that risk in January of this year:
A particular risk of late and fast is that the unemployment rate could significantly undershoot the level consistent with price stability. If this occurred, then inflation would likely rise above our objective. At that point, history shows it is very difficult to push the unemployment rate back up just a little bit in order to contain inflation pressures. Looking at the post-war period, whenever the unemployment rate has increased by more than 0.3 to 0.4 percentage points, the economy has always ended up in a full-blown recession with the unemployment rate rising by at least 1.9 percentage points. This is an outcome to avoid, especially given that in an economic downturn the last to be hired are often the first to be fired. The goal is the maximum sustainable level of employment—in other words, the most job opportunities for the most people over the long run.
I don't know that there is an economic mechanism at work here. I don't know that there is a law of economics where the unemployment can never be nudged up a few fractions of a percentage point. But I do think there is a policy mechanism at play. During the mature and late phase of the business cycle, the Fed tends to overemphasize the importance of lagging data such as inflation and wages and discount the lags in their own policy process. Essentially, the Fed ignores the warning signs of recession, ultimately over tightening time and time again.
For instance, an inverted yield curve traditionally indicates substantially tight monetary conditions. Yet even after the yield curve inverted at the end of January 2000, the Fed continued tightening through May of that year, adding an additional 100bp to the fed funds rate. The yield curve began to invert in January of 2006; the Fed added another 100bp of tightening in the first half of that year.
This isn't an economic mechanism at work. This is a policy error at work.
Kocherlakota offers another important point:
It's easy to imagine, though, that many people would be willing to trade the risk of recessionary pain in 2019 and 2020 for the near-term gain of 2017 and 2018. They might even believe there's some chance that policy 2 will generate an outstanding outcome -- if, for example, the long-run unemployment rate is actually lower than the Fed thinks it is.
The Fed seems to place almost zero weight on the probability that the natural rate of unemployment is significantly below their estimates. In their view, only bad things happen when the unemployment rate drifts much below 5%.  
Bottom Line: The Fed thinks the costs of undershooting their estimate of the natural rate of unemployment outweigh the benefits. I am skeptical they are doing the calculus right on this one. I would be more convinced they had it right if I sensed that placed greater weight on the possibility that they are too pessimistic about the natural rate. I would be more convinced if they were already at their inflation target. And I would be more convinced if their analysis of why tightening cycles end in recessions was a bit more introspective. Was it destiny or repeated policy error? But none of these things seem to be true.

Tuesday, September 06, 2016

The Fed’s Complacency About Its Current Toolbox Is Unwarranted

Larry Summers:

The Fed’s complacency about its current toolbox is unwarranted: As I argued in the first blog in this series last week, I was disappointed in what came out of Jackson Hole for three reasons. The first reason, developed in that blog, was that the Fed should have signaled a desire to exceed its two percent inflation target during periods of protracted recovery and low unemployment and in this context to signal that a rate increase was off the table for September and quite likely the rest of the year. Friday’s employment report further strengthens the case for delay both by adding to the evidence on the absence of inflation pressures and by suggesting a less robust economy than most expected.
Even apart from the desirability of allowing inflation to rise above two percent in a happy economic scenario GDP, labor market and inflation expectations data all make a compelling case against a rate increase. Private sector GDP growth for the last year has averaged 1.3 percent a level that has since the 1960s always presaged recession. Total work hours have over the last 6 months grown at nearly their slowest rate since early 2010. And both market and survey measures of inflation expectations continue to decline.
My second reason for disappointment in Jackson Hole was that Chair Yellen, while very thoughtful and analytic, was too complacent to conclude that “even if average interest rates remain lower than in the past, I believe that monetary policy will, under most conditions, be able to respond effectively”. This statement may rank with Ben Bernanke’s unfortunate observation that subprime problems would be easily contained.
Rather I believe that countering the next recession is the major monetary policy challenge before the Fed. I have argued repeatedly that (i) it is more than 50 percent likely that we will have a recession in the next 3 years. (ii) countering recessions requires 400 or 500 basis points of monetary easing. (iii) we are very unlikely to have anything like that much room for easing when the next recession comes. ... [explains in detail] ...
On balance, I think the Fed’s complacency about its current toolbox is unwarranted. If I am wrong in either exaggerating the risks of recession or understating the efficacy of policy, the costs of taking out insurance against a recession that cannot be met with monetary policy are relatively low. If I my fears are justified, the costs of complacency could be very high. The right policy in the near term should be tilting as hard as possible against recession as argued in the first blog in this series. For the longer term the Fed will have to reconsider its broad policy approach. This will be subject of my next entry.

Fed Watch: Rate Hike Hopes Fading Fast

Tim Duy:

Rate Hike Hopes Fading Fast, by Tim Duy: The next FOMC meeting is just two weeks away. Fed hawks had hoped that this was their moment in the sun. I suspect they will need to wait another three months before their next opportunity to act. Signs of a second half rebound are likely too tentative for the doves to tolerate a rate hike. I don't think they will roll over as easily as they did last December.
The August employment report was not terrible. Not by any measure. On the positive side, labor supply is reacting to both demographic changes and stronger demand:


The demographic shift - essentially, the aging of the Millennials toward their prime age working years - is I believe a powerful secular force supporting the economy. That said, the Fed needs to ensure cyclical forces do not undermine the economy. And that is where the story becomes tricky. Is the economy slowing sufficiently on its own that the Fed should refrain from rate hikes? Or is the slowing still insufficient to quell the inflationary pressures Fed hawks in particular believe to be building?
On first take, the slowing in payroll growth is modest:


And arguably sufficient to place additional downward pressure on the unemployment rate. Cleveland Federal Reserve President Loretta Mester recently repeated this view, which is widely held within the FOMC. Via Reuters:
Mester, a voting member on the Fed's policy-setting committee, had earlier in the day told a philanthropy conference that the U.S. economy probably needs to generate between 75,000 and 150,000 jobs per month to keep the jobless rate stable.
Hiring has been stronger than that this year and the U.S. jobless rate is currently at 4.9 percent.
"The economy is basically at full employment," Mester said.
This "full employment" view is also evident in the Fed's estimate of the natural rate of unemployment:


This, not inflation directly, seems to be driving Fed hawks toward a rate hike. See former Federal Reserve President Narayana Kocherlakota here. It is the perceived threat of inflation, not the actual, realized threat of inflation.
Fed hawks will also point toward wage growth as evidence of tighter labor markets that foreshadows inflationary pressures:


Fed doves, however, will not be without their own interpretation of the data. The flattening of the unemployment rate could indicate supply side pessimism on the part of the hawks. That is the positive story that still fits with a no hike scenario. A more negative story is that the flat unemployment rate is consistent with late cycle patterns:


Similarly, progress toward reducing underemployment has stalled noticeably, leaving underemployment at very high levels:


Perhaps the household data is picking up a degree of slowing not yet evident in the establishment data? And on the establishment side, temporary help services payrolls are holding in a late cycle pattern as well:


As far as wages are concerned, Fed doves will say that wage growth is still anemic in comparison with past cycles and - they should add - that wages are a lagging indicator. The Fed should be paying much more attention to forward indicators. And those forward indicators remain tentative at best. The hawks' basic case is not just that the economy is at full employment, but that a second half rebound will send it beyond full employment. And while consumer spending supports the second half rebound story:


the ISM reports draw that into question. Today's service sector report was particularly disconcerting with weakness across the board - the sharp drop in new orders should give FOMC members reason for caution. Doves will thus say the Fed can't count their chickens before they hatch. And this is especially important given that the Fed continues to miss its inflation target, and a misstep at this juncture with overly tight policy will basically guarantee they miss it for the next five years as well.
Indeed, while Fed hawks such as Vice Chair Stanley Fischer and Boston Federal Reserve President Eric Rosengren see progress toward the inflation goals, Peter Olson and David Wessel, writing in the WSJ, conclude:
The inflation rate is higher now than it was in 2015. But over the course of 2016 we’ve seen no apparent progress toward the 2% inflation target. If anything, the inflation rate in January was closer to the Fed’s goal than in July. So it’s increasingly difficult for Fed officials to rely on current inflation numbers as a justification for raising rates. Higher inflation might be just around the corner, but we haven’t seen it yet.
I agree. The "progress" that Fischer and Rosengren point to occurred early in the year, mostly in January. Recent trends have been less promising.


The hawks "inflation is here" story is not particularly compelling. Indeed, I would say it borders on disingenuous. Moreover, I suspect the inflation numbers will prompt strong opposition to a rate hike this month. Recall from the recent minutes:
A couple of members preferred also to wait for more evidence that inflation would rise to 2 percent on a sustained basis.
I suspect these two members were Governors Lael Brainard and Daniel Tarrullo. My guess is that neither will roll over on a rate hike as they did last December; I think they probably question the wisdom of the outcome of that meeting. Furthermore, I think they pull Governor Powell and ultimately New York Fed President William Dudley to their side. St. Louis Federal Reserve President James Bullard is ambivalent about when the next 25bp hike occurs; in his framework, the Fed is already within spitting distance of the correct policy stance. He won't push for a hike. And I suspect that Chair Janet Yellen will thus ultimately see too little consensus to support a rate hike.
Bottom Line: Despite being near the consensus view of full employment, incoming data on the second half remains too tentative to support a rate hike this month. This is especially the case given lost momentum in the labor market, particularly with regards to underemployment, and the weak inflation numbers. Hence I do not anticipate a rate hike in September. Why might I be wrong? Aside from just being wrong on the Fed's likely interpretation of the incoming data, perhaps because I have underestimated the Fed's perception that the risks are not really asymmetric - that they have all the tools they need to fight the next recession even if they are at the zero bound - or that the Fed views financial stability concerns as trumping the inflation outlook.

Friday, September 02, 2016

Should the Fed Keep Its Balance Sheet Large?

Ben Bernanke:

Should the Fed keep its balance sheet large?: I attended the Fed’s recent gathering in beautiful Jackson Hole, Wyoming...
As usual, the media were most focused on divining the next policy move of the Federal Open Market Committee (FOMC), but I found the more interesting (and ultimately more consequential) discussions were about the Fed’s longer-term policy framework, the theme of the conference. In this post I’ll report on one important debate: the question of the optimal long-run size of the Fed’s balance sheet. It seemed to me that the strongest arguments made at the conference supported a strategy of keeping the balance sheet large (though comparable to other major central banks), rather than shrinking it to its pre-crisis level as the FOMC currently plans to do. ...
Overall, I think the FOMC’s plan to return to a pre-2008 balance sheet and the associated operating framework needs more thought. The appropriate size and composition of the Fed’s balance sheet inevitably depends on a range of complex decisions about the management of monetary policy and the role of the central bank in preventing and responding to financial crises. We’ve learned a lot about both areas since the crisis, and some important arguments have emerged for keeping the balance sheet larger than in the past. Maybe this is one of those cases where you can’t go home again.

[The full post explains why he believes that the balance sheet should be larger than in the past.]

Thursday, September 01, 2016

Fed Watch: Thoughts Ahead Of The Employment Report

Tim Duy:

Thoughts Ahead Of The Employment Report, by Tim Duy: The August employment report has come to be seen as the deciding factor in the Fed's upcoming decision on rates. See Sam Fleming at the Financial Times here. Maybe this is the case, maybe not. I hope not. Hinging policy on the first print of nonfarm payrolls - a volatile, heavily revised number - would be pretty low quality policy making. 
I keep coming back to this by Federal Reserve Chair Janet Yellen from back in December: real private domestic final purchases (PDFP)--which includes household spending, business fixed investment, and residential investment, and currently represents about 85 percent of aggregate spending--has increased at an annual rate of 3 percent this year, significantly faster than real GDP. Household spending growth has been particularly solid in 2015, with purchases of new motor vehicles especially strong.  
This was Yellen's way of justifying a rate hike last December in spite of faltering GDP numbers. Trouble is that PDFP continued a downward slide since then:


Final sales here are off roughly 1.5 percentage points from their cycle highs. That is a nontrivial swing. It is no wonder that job growth accelerated in 2013-14 and then decelerated in 2015:


I tend to think there is room for some further deceleration. Note too that progress on reducing underemployment slowed markedly:


and the unemployment rate is flattening out:


Now, you might say that the Fed needs to hike because wages are rising. But I would say that wages are a lagging indicator


and are likely to continue rising even after a recession begins. Overly shifting the policy focus to wage growth would a red flag in my opinion. I think the Fed tends to focus too much on lagging indicators in the later stages of a business cycle while ignoring their own policy lags. The end result is overly tight policy.
So when I look at the data, I don't see that the August employment report should be a critical factor in a rate hike decision. I think the critical factors should be the Fed's confidence that growth is set to rebound in the second half of the year and the balance of policy risks.
On the first point, while early signals on growth are positive - see the Atlanta Fed GDPNow measure, for example - they are still just early signals. And today's ISM release doesn't indicate that a manufacturing rebound is right around the corner, so maybe that rebound in investment spending just might take more time as well. And auto sales look to have peaked and are flattening out, so that is not likely to be a source of growth and might be slight drag. So, overall, I don't think we have enough data to be confident that growth will rebound just yet.
Regarding the balance of policy risks, that asymmetry has not magically gone away. The Fed has less room to ease than tighten. And inflation remains mired below target:


So I don't see that that the basic calculus here has changed. If the Fed errors by being too loose now, they have plenty of wiggle room on inflation and policy to respond. If they error on by being too tight, they don't have much policy room and they risk holding inflation below 2 percent for another decade. What's that going to do for inflation expectations?
All that said, there appears to be a movement among FOMC members to minimize the asymmetry of the policy risks. First you have Federal Reserve Vice Chair Stanley Fischer arguing that inflation is close enough to target that it shouldn't be a concern. Via Greg Robb at MarketWatch:
And the core measure of the personal consumption expenditure index — the Fed’s favorite measure of inflation — at 1.6% “is within hailing distance” of the central bank’s 2% target, Fischer added.
I starting to think Fischer is still living in the 1970s. But perhaps more disconcerting is Yellen's final line from her Jackson Hole speech:
But even if average interest rates remain lower than in the past, I believe that monetary policy will, under most conditions, be able to respond effectively.
She is playing down the asymmetric policy risk issue here. Given the experience of the past decade, she is way too complacent in my opinion. And her complacency hinges on the assumption that they now know they (nominal) natural rate of interest is 3 percent. But that has been a moving target. And I don't think that is the signal being sent by the long end of yield curve. 
Then there is the financial stability argument. All I will say on that is the Fed had better be damn certain that they are facing a real risk to the economy before they pull the trigger on that argument. And I don't see how they can be that certain.
Bottom Line: Regardless of the outcome of the employment report, good or bad, I don't see good case for moving next this month. Too many questions about the forecast, and they still face persistently low inflation and asymmetric policy risks. But all that said, there seems to be a large swath of voting members ready to get behind a rate hike. I think the low odds on a rate hike in September is the market's way of telling the Fed that if they do hike, it would be a mistake.

Monday, August 29, 2016

Disappointed by What Came out of Jackson Hole

Larry Summers:

Disappointed by what came out of Jackson Hole: I had high hopes for the Federal Reserve’s annual Jackson Hole conference. The conference was billed as a forum that would look at new approaches to the conduct of monetary policy—something that I have been urging as necessary given secular stagnation risks and the sharp decline in the apparent neutral rate of interest. And Chair Yellen’s speech in a relatively academic setting provided an opportunity to signal that the Fed recognized that new realities required new approaches. ...
On balance though, I am disappointed by what came out of Jackson Hole... First, the near term policy signals were on the tightening side which I think will end up hurting both the Fed’s credibility and the economy. Second, the longer term discussion revealed what I regard as dangerous complacency about the efficacy of the existing tool box. Third, there was failure to seriously consider major changes in the current monetary policy framework. ...
The right signal to have sent in my view was very dovish. ...
Even if the September employment report is strong, I do not see a case for a September rate increase. There is no imminent danger of repeating the 1970s experience where inflation expectations ratcheted up leading to stagflation. If a greater than 1/3 chance of a rate increase in September was not in markets, the cost of credit for small business would be lower and mortgage rates would decline. Employers would be more confident about hiring. And pressures would be removed from emerging markets. The world economy would be more robust.

Thursday, August 25, 2016

Why Do We Talk About ''Helicopter Money''?

Brad DeLong:

Why Do We Talk About “Helicopter Money”?: Why do we talk about “helicopter money”? We talk about helicopter money because we seek a tool for managing aggregate demand–for nudging the level of spending in an economy up to but not above the economy’s current sustainable productive potential–that is all of:

  1. Effective and successful–even in the very low interest rate world we appear to be in.
  2. Does not excite fears of an outsized central bank balance sheet–with its vague but truly-feared risks.
  3. Does not excite fears of an outsized government interest-bearing debt–with its very real and costly amortization burdens should interest rates rise.
  4. Keeps what ought to be a technocratic problem of public administration out of the mishegas that is modern partisan politics.

Right now the modal projection by participants in the Federal Reserve’s Open Market Committee meetings is that the U.S. Treasury Bill rate will top out at 3% this business cycle. It would be a brave meeting participant who would be confident that we would get there–if we would get there–with high probability before 2020. That does not provide enough room for the Federal Reserve to loosen policy by even the average amount of loosening seen in post-World War II recessions. Odds are standard open market operation-based interest rate tools will not be able to do the macroeconomic policy stabilization job when the next adverse shock hits the economy.

The last decade has taught us that quantitative easing on a scale large enough to rapidly return economies to full employment is one bridge if not more too far for central banks as they are currently constituted–if, that is, it is possible at all. The last decade has taught us that bond-funded expansionary fiscal policy on a scale large enough to rapidly return economies to full employment is at least several bridges too far for our political systems, at least as they are currently constituted.

If we do not now start planning for how to implement helicopter money when the next adverse shock comes, what will our plan be? As a candidate for a tool capable of doing all four of these things, helicopter money–giving the central bank the additional policy tool of printing up extra money and either mailing it out to households as checks or getting it into the hands of the public by buying extra useful stuff–is our last hope, and, if it is not our best hope, then I do not know what our best hope might be. ...

[The post also includes a list of links to other discussion of this topic.]

Friday, August 19, 2016

The Fed’s Effect on Black Americans

Narayana Kocherlakota:

The Fed’s Effect on Black Americans: The U.S. Federal Reserve appears to be paying more attention to how its policies affect black Americans. This is a wise move...
Imagine we’re in the midst of a severe recession. In deciding how aggressively to respond by lowering interest rates or buying assets, Fed officials must weigh the risk of unduly high inflation against the benefit of reducing unemployment. That benefit will be much greater for blacks..., any policy that reduces the overall unemployment rate by one percentage point ... reduces their unemployment rate by nearly two percentage points.
The differential impact also matters now, as the Fed contemplates removing stimulus. ...
The Fed rightly aims to pursue policies that are best for the economy as a whole. But I don’t believe that it will be seen as truly representative of all Americans unless it understands the differential impact of its policy choices on key demographic subgroups. It’s good to see from the minutes that the central bank is engaged in doing so.

Tuesday, August 09, 2016

Murky Macroeconomics

Paul Krugman:

Murky Macroeconomics: ...I realized something not too flattering about myself: I’m feeling nostalgic for 2011 or so.
Why? It was, of course, a terrible time for much of the world, and especially for anyone without a job. But for ... an economist ... it was a time of wonderful intellectual clarity. Liquidity-trap macroeconomics ... had become the story of the day. And the basic message of the models — that everything changes when you hit the zero lower bound — was being overwhelmingly confirmed by experience.
The thing is, it was all beautifully hard-edged: a crisp boundary at zero, a sharp change in the impact of monetary and fiscal policy when you hit that boundary. And the predictions we made came out consistently right.
But now things have gotten a bit, well, murky. The zero lower bound is not, it turns out, quite as hard a boundary as we thought. ...I’d be surprised if any central bank is willing to go much if at all below minus one percent — but it turns out to be a sort of a fuzzy no-man’s-land rather than a line that cannot be crossed.
More important, probably, is the fact that two of the major advanced economies — the US and, believe it or not, Japan — are arguably quite close to full employment. We don’t know how close... But you can no longer argue that supply limits are no longer relevant.
Correspondingly, you can also no longer argue with confidence that there can be no crowding out, because the Fed won’t raise rates. You can argue that it shouldn’t — and I would — but we are maybe, possibly, on our way out of the liquidity trap.
So we’re not in the simple, depressed-economy world of 2011 anymore. But here’s the thing: we’re not in what we used to call a normal macroeconomic situation either. Maybe we’re close to full employment, but maybe not, and that’s with near-zero interest rates; also, it’s all too easy to imagine adverse shocks in the near future, and not at all clear how the Fed could or would respond. We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.
What I would argue is that in this murky, fragile situation we should be conducting policy largely as if we were still in the trap — because we badly need to get both feet firmly on dry land with some distance between us and the quicksand. ... But it’s not the crystalline case we used to be able to make.
Still, we need to deal with this murky situation right, which means embracing the uncertainty as part of the argument. Make murkiness great again!

Monday, August 08, 2016

The Fed’s Shifting Perspective on the Economy and Its Implications for Monetary Policy

Ben Bernanke:

The Fed’s shifting perspective on the economy and its implications for monetary policy: ...The Federal Reserve has ... been revising its views on some key aspects of the economy, and that’s been affecting its outlook both for the economy and for monetary policy...
In short, over the past few years, and especially during the past 12 months, FOMC participants have significantly revised down their estimates of potential long-run U.S. economic growth, the long-run or “natural” rate of unemployment, and the long-run (“terminal”) value of the federal funds rate...
The two changes in participants’ views that have been most important in pushing the FOMC in a dovish direction are the downward revisions in the estimates of r* (the terminal funds rate) and u* (the natural unemployment rate). As mentioned, a lower value of r* implies that current policy is not as expansionary as thought. ... Likewise, the decline in estimated u* implies that bringing inflation up to the Fed’s target may well take a longer period of policy ease than previously believed. The downward revisions in estimated u* likely have also encouraged FOMC participants who see scope for further sustainable improvement in labor market conditions.
The downward revisions to estimates of y* have mixed implications for policy. On the one hand, lower potential output growth suggests that slow GDP growth may not be due primarily to inadequate monetary or fiscal policy support for aggregate demand, but rather reflects constraints on the supply side of the U.S. economy. ...
On the other hand, as mentioned earlier, the recent decline in productivity growth (and thus in potential output) has been both large and mostly unexpected. Some have hypothesized that this decline is not purely exogenous but has been influenced, to some extent, by short-term economic conditions. ... The ... possibility, that stronger economic growth today might have positive and lasting effects on the economy’s ability to grow, is for some an argument for erring on the side of more stimulative policies.
The bottom line is that, broadly speaking... The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates. ...

Thursday, August 04, 2016

If Only Someone Had Warned Us

Simon Wren-Lewis:

If only someone had warned us: The title is pinched from a tweet by Tony Yates, who was one of many economists who did warn of the impact of Brexit. Of course we economists need to ask ourselves if and why our message was ignored, but that is no reason to stop us feeling angry that it happened. This post from the economist who did more than most to try and get the message across, John Van Reenen, expresses that anger better than I could.
What John’s work showed, backed up by similar analysis in the Treasury and elsewhere, is that Brexit would not just cause a short term economic downturn: cutting wages and increasing unemployment for just a year or two. By making it harder to trade with our immediate neighbours it will reduce UK trade overall, and the evidence suggests that this will permanently reduce people’s living standards. ...
The tricky thing to do now is know how much the current downturn is just a foretaste of that, and how much is something over and above that. To the extent that it is the latter, how much of that is offset by some short term benefit to exporters (before the impact of actual Brexit kicks in) as a result of the depreciation? That is initially the Bank of England’s problem.
Their response today, a cut of 0.25% plus more QE, tells us it is not just their problem. We are back at the lower bound for nominal interest rates, which is why the Bank is doing more QE. Because the impact of the QE is extremely uncertain, and in the absence of helicopter money, we now need fiscal action to back up this interest rate cut. ... When interest rates are at the lower bound, forget about the deficit and focus fiscal policy on avoiding a recession. As the Bank’s QE action makes clear, there is no good reason to delay this: it should happen now.
But Brexit was not the first time economists have been ignored. For some years now the clear consensus among academic economists is that, when rates are at their lower bound, you need fiscal stimulus. Although Conservatives have disowned 2015 Osborne austerity, they appear not to have backtracked on his 2010 version. If they do nothing now, we will know that they are wedded to pre-Keynesian 1930s economics.

Wednesday, July 27, 2016

Fed Policy Unchanged

Here's a link to the Fed's statement on its policy decision today:

FOMC statement - FRB

Policy is unchanged, sees improvements in the economy, says short-term risks have fallen.

July FOMC Preview

Tim Duy:

July FOMC Preview on Bloomberg: How long can doves at the Federal Reserve stand their ground?
The fight within the U.S. central bank continues at this week's Federal Open Market Committee (FOMC) meeting as both hawks and doves jockey for dominant position. This battle will go to the doves; the Fed is not expected to raise its interest rate target just yet. Both the hawks and the doves know this. Both camps also know that this meeting is about laying down markers for the September meeting. And while the doves have the upper hand this month, the current flow of data will increasingly place them on the defensive as the second half of the year progresses.
Continued at Bloomberg....

Monday, July 25, 2016

Central Bank Digital Currency: The End of Monetary Policy As We Know It?

Marilyne Tolle at the Bank of England's Bank Underground blog:

Central bank digital currency: the end of monetary policy as we know it?: Central banks (CBs) have long issued paper currency. The development of Bitcoin and other private digital currencies has provided them with the technological means to issue their own digital currency. But should they?
Addressing this question is part of the Bank’s Research Agenda. In this post I sketch out how a CB digital currency – call it CBcoin – might affect the monetary and banking systems – setting aside other important and complex systemic implications that range from prudential regulation and financial stability to technology, operational and financial conduct.
I argue that taken to its most extreme conclusion, CBcoin issuance could have far-reaching consequences for commercial and central banking – divorcing payments from private bank deposits and even putting an end to banks’ ability to create money. By redefining the architecture of payment systems, CBcoin could thus challenge fractional reserve banking and reshape the conduct of monetary policy. ...

Thursday, July 21, 2016

Yellen Needs to Make More Speeches

Narayana Kocherlakota:

Yellen Needs to Make More Speeches: What does the U.S. Federal Reserve think about the repercussions of Britain's vote to leave the European Union? Amazingly, we still don’t really know...
Fed officials give a lot of speeches, and many have addressed Brexit in recent weeks. But, as they always say, they don’t speak on behalf of the Federal Open Market Committee...
Only one official, Fed Chair Janet Yellen, has the authority to speak on the committee's behalf, and she does so rarely. ... In all, according to the Fed's website, she has discussed policy at six formal public appearances this year. Her next won’t come until the Kansas City Fed's Jackson Hole conference in late August and the committee meeting of Sept. 20 to 21. ...
The Fed hasn’t always been so taciturn. In 2004, at the beginning of the central bank's last tightening cycle, Chairman Alan Greenspan spoke or testified on 29 separate occasions... Granted, his language was famously hard to parse. But by speaking nearly three times a month, he left no confusion among the public or Fed watchers about who to follow if they wanted to know the future course of monetary policy.
Today, people are a lot more concerned about the state of the global economy than they were in 2004... So if anything, the Fed should be communicating more. That means having a press conference after every open-market committee meeting, and having Yellen make a lot more public speeches. ...

Tuesday, July 19, 2016

Why the Fed Can't and Shouldn't Raise Interest Rates

Tim Duy at Bloomberg:

Why the Fed Can't and Shouldn't Raise Interest Rates: ... The flattening of the U.S. yield curve as investors see little chance of rates rising in the longer term should serve as a red flag that their focus on short-term interest rates may be doomed to failure.

One of the defining features of this tightening cycle is the same as the cycles that came before – the yield curve is flattening, and very quickly. The spread between 10-year and two-year U.S. Treasuries has collapsed to 88 basis points at a time when the federal funds target rate is 25-50bps. This suggests that the Fed actually has very little room to raise short-term rates. If additional rates hikes compress the yield curve further, the capacity for maturity transformation – effectively the process of borrowing on shorter time frames to lend on longer time frames – will soon be compromised. ...

... Bottom Line: The Fed needs to remember that how they got into this policy stance may offer a lesson for how to get out. Policy makers cut rates to zero and then instituted quantitative easing. Now they should consider selling assets before raising rates. Or, at a minimum, utilizing a mixed strategy of rate hikes and asset sales. The objective of meeting the Fed's mandate in the context of maintaining financial stability may be unattainable using the interest rate tool and associated forward guidance alone. Unfortunately, the Fed does not appear to be debating the policy mix — at least not in public. They remain focused on interest rates, delaying balance sheet policy to a later date. On the current trajectory, however, that later date may never come.

Don't Try This Crazy Trick on the Economy

Narayana Kocherlakota:

Don't Try This Crazy Trick on the Economy: Some economists argue that the Federal Reserve should take a highly unconventional approach to ending a long period of below-target inflation: Instead of keeping interest rates low to spur economic activity and push up prices, it should raise rates.
Labeled "Neo-Fisherism" ... (after the famous monetary economist Irving Fisher), it's an idea I once entertained. Allow me to explain why I now think it’s dangerous. ...

Monday, July 18, 2016

Why Has Transparency Been So Damn Confusing?

Jon Faust:

Why has transparency been so damn confusing?: The theme of our recent series of posts on understanding FOMC actions and communications has been the well-disguised, steady predictability of FOMC policy. The basic story is that policy is driven by a consensus on the FOMC. The consensus tends to evolve slowly and predictably, and for some time now, the consensus has behaved consistently as if driven by two principles:
So long as steady job market gains persist, continue a gradual, pre-announced removal of accommodation.
So long as inflation remains below target, take a tactical pause if credible evidence arises that the job gains might soon falter.
The factual record, I argued, is unambiguous: over the last three years, we’ve gotten normalization at a preannounced pace as in to the first principle, punctuated only by brief (so far) tactical pauses as under the second.[1]
But the fact that my low-drama story lines up with the facts doesn’t make it correct. And my story directly contradicts the popular narrative of a skittish, market-obsessed Fed flip-flopping at every opportunity. This is where the well-disguised part comes in.
Before continuing, however, I want to emphasize that I came to the views I’m describing during my years working on transparency and communications on behalf of the chairs Bernanke and Yellen—a job that ended about 2 years ago now. Yes, I did my small part in making the mess. But the FOMC members and Fed staffers like me also worked pretty hard to understand what was going wrong and attempting to improve the situation. This series of posts is essentially the lessons I took from these efforts. It would be inappropriate for me to say who among my former colleagues subscribes to these views, but I similarly don’t want to claim the ideas as my own. For now,[2] I’ll be deliberately and appropriately vague in saying that all the points I’m making were in the air at the Fed while I was there. In this post, I’ll sketch the basics, leaving details and support for subsequent posts. ...

Sunday, July 17, 2016

Helicopter Money

Jim Hamilton:

Helicopter money: Despite aggressive actions by central banks, many of the world’s economies are still stagnating and facing new shocks, leading to renewed calls for helicopter money as a serious policy prescription for countries like Japan and the U.K.. And, if things go badly, maybe the United States? ...

After discussing helicopter money, he concludes with:

... If helicopter money is no more than a combination of fiscal expansion and LSAP, and if we think LSAP hasn’t been able to do that much, it’s clear that the fiscal expansion part is where the real action is coming from. On the other hand, if we think both components make a difference, there’s no inherent reason that the size of the fiscal operation has to be exactly the same as the size of the monetary operation.

Nevertheless, as has been true with LSAP, there might be some psychological impact, if nothing else, from announcing this as if it were a new policy. For example, I could imagine the Fed announcing that for the next n months, it will buy all the new debt that the Treasury issues. For maximal effect this would be coupled with a Treasury announcement of a new spending operation. Doubtless the announcement would bring out calls from certain quarters that the U.S. was going the route of Zimbabwe. And just as in the previous times we heard those warnings, those pundits would be proven wrong, as indeed the effects would not be that different from what we’re already getting from central bank expansions around the globe.

Helicopter money is no bazooka for stimulating the economy. Ben Bernanke offered this reasonable summary:

Money-financed fiscal programs (MFFPs), known colloquially as helicopter drops, are very unlikely to be needed in the United States in the foreseeable future. They also present a number of practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank. However, under certain extreme circumstances– sharply deficient aggregate demand, exhausted monetary policy, and unwillingness of the legislature to use debt-financed fiscal policies– such programs may be the best available alternative. It would be premature to rule them out.

Friday, July 15, 2016

Fed Watch: Data Dump

Tim Duy:

Data dump, by Tim Duy: Interesting mix of data today that will give monetary policymakers plenty of food for thought. My guess is that it will probably drive a deeper division in the Fed between those who looking to secure two hikes this year rather and those good with just one or none at all.
Retail sales came in stronger than expected, although prior months were revised down. Various measures of sales excluding gas are perking up compared to last year:


While prior expansions churned out some better spending numbers, the consumer is clearly not in some kind of recessionary free-fall. Remember, 2% growth is the new 4%. These data will help reassure the Fed that the bulk of economic activity - that directed by consumers - remains solid.
Industrial production rose, albeit on the back of autos. Compared to a year ago, factory activity remains in negative territory. Still, softness in the sector does not exhibit the degree of dispersion typically experienced in recessions:


Still looks to me more like a mid-cycle slowdown like the mid-80s and 90s rather than a recession. Containing such a slowdown argues for keeping rates low for now.
Inflation as measured by the consumer price index continues to firm. Core CPI inflation came in at 0.2 percent m-o-m and 2.3 percent y-o-y. Of course, the Fed targets PCE inflation, and there the core number is weaker:


See Calculated Risk for more measures of inflation. The key point here is that the Fed's preferred measure is tracking lower than other measures. Watch for the hawks to press their case on those higher measures; the doves should keep a focus on PCE. The doves should win this battle. If they don't win, the Fed will be effectively targeting a different inflation rate than stated in their long-run policy objectives. That would then render those objectives and likely future similar missives essentially worthless.
The Atlanta Fed released its wage measures for June. These measures - which track persons steadily employed over the past twelve months - continue to exceed the average measures of the employment report:


The Atlanta Fed measure just about in the pre-recession territory; while the standard measures still have a ways to go. The Atlanta Fed measure tells the Fed that cyclical labor market dynamics are not terribly different than the past. When unemployment goes down, wage growth accelerates:


Demographic effects - the exit of higher earning Boomers from the labor force, replaced by lower earning Millennials - appear to be weighing on average wage growth. Which one is the better guide for monetary policy? Policymakers will again find themselves at odds along the obvious lines. The San Francisco Fed gives mixed guidance on the issue:
How to best gauge the impact of wage growth on overall inflation is less clear. As long as employers can keep their wage bills low by replacing or expanding staff with lower-paid workers, labor cost pressures for higher price inflation could remain muted for some time. If, however, these lower-wage workers are less productive, continued increases in unit labor costs could be hiding behind low readings on measures of aggregate wage growth.
On net, when the Fed faces a mixed message, they tend to move slower than faster. So given the low core-PCE environment, the doves will likely remain in control.
Separately, the Wall Street Journal has a story on which Fed speakers are most useful as policy guides. The article is behind the WSJPro paywall, but via Twitter came this graphic:


Granted, this type of list is always in flux. That said, I would definitely move Brainard, Powell, and Tarullo up with Yellen and Dudley. I find it very rare that you would learn less from a Board member than a regional president. This is especially true given the caliber of these three speakers. And remember that Tarullo doesn't talk a lot about monetary policy, but when he does you probably should listen. Brainard has been driving policy since last fall. Of the regionals, I would place Evans at the top. Williams has been too hawkish in his guidance the past couple of years; you really need to put a negative delta on any rate forecast you glean from him. Rosengren steered you wrong this year as he joined Williams in trying to set the stage for a June rate hike. I don't see where Lockhart should be in the top half of this list. And I don't know what to make of Fischer. He has leaned hawkish this cycle as well, to the point of being one who scolds markets for thinking differently. He appears to me to be an outlier on the Board at the moment, not one driving the policy debate.
Bottom Line: Generally solid data sufficient to keep the prospect of a rate hike or two alive for this year. But soft or mixed enough on key points to lean policy closer to the former than the latter.

Tuesday, July 12, 2016

Fed Watch: Catching Up

Tim Duy:

Catching Up: I snuck out of town last week and am catching up on Fed/economy news. Highlights from the past week:
1.) The labor report comes in better than expected. Nonfarm payrolls rose by 287k in June compared to the downwardly revised 11k gain in May. These results speak to the volatility typically seen in the employment data. See also Matthew Boesler on impact of end of the school year on the data. On a twelve month basis, job growth has eased only moderately. But on a three month basis, the slowdown is more pronounced:


You have to decide if this is one of those situations when the longer term trend is missing a more severe turning point in the data.
My sense is that these numbers are sufficient to convince many Fed officials that the unemployment rate will decline further in the months ahead. But many will also see reason for caution. First, as noted earlier, near term trends reveal a moderation in the pace of job growth. And the rate of improvement in the unemployment rate has slowed markedly in recent months:


This raises the prospect that job growth is actually not that much higher than that necessary to hold the unemployment rate constant. Moreover, progress toward reducing unemployment has slowed or stalled:


And while wage gains are accelerating, the pace remains tepid, roughly 100bp below the pre-recession rates:


It would be disappointing if wage growth stalled out here. Note also that the long-leading indicator of temporary help employment is tracking sideways to slightly down:


All of these indicators may be headed for upside breakouts in the months ahead, but at the moment I sense some loss of momentum in labor market improvement. This, I think, places the Fed on some precarious ground, something that the bulk of the FOMC likely recognizes. It's not that the fundamentals of the economy have necessarily broken down; it's that the Fed needs to maintain a sufficiently accommodative policy to allow those fundamentals to exert themselves.

2.) Influential policymakers urge patience. Federal Reserve Governor Dan Tarullo came out strongly against additional rate hikes at this time. Via MarketWatch:

“Inflation is not at our stated target, not near our stated target, and hasn’t been so in quite some time,” Tarullo said in a conversation at a Wall Street Journal breakfast.

“This is not an economy that is running hot,” he added.

“For some time now I thought it was the better course to wait to see more convincing evidence that inflation is moving toward and would remain around the 2% target,” Tarullo said.

“To this point, I have not seen that type of evidence,” he said.

It seems to me that Tarullo is looking for something close to the proposed Evans Rule 2.0 - no rate hikes until core-inflation hits 2 percent year-over-year. Even more interesting is this:

Tarullo said he didn’t think that the worry that low interest rates may fuel asset bubbles was an “immediate concern.”

The Fed governor, who is the quarterback of the Fed’s efforts to regulate banks, questioned whether raising rates would ease financial stability concerns in an environment where the market was pessimistic about the economic outlook.

“If markets do regard economic prospects as only modest or moderate going forward, then raising short-term rates is almost surely going to flatten the yield curve, which generally speaking is not good for financial intermediation, and in some sense could exacerbate financial stability concerns,” Tarullo said.

When rates are low, regulators should pay more attention to financial stability issues “but it doesn’t translate into ‘therefore raise rates and all will be well,’” he added.

Tarullo is obviously not pleased that the yield curve continues to flatten


and is not interested in hiking into such an environment. New York Federal Reserve President William Dudley echoes this concern:

Federal Reserve Bank of New York President William Dudley voiced concern Wednesday about very low yields on 10-year Treasury notes, which could be a sign that investor expectations for growth and inflation are waning. Mr. Dudley, who had been meeting with local leaders at Binghamton University in New York, said low yields weren’t “completely good news.”

This suggests these two policymakers would prefer to hike if long-term yield were rising, pulling the Fed along for the ride. Low yields are only feeding into the Fed's suspicion that their expectations of where rates are headed are wildly optimistic.

3.) Williams interview. Gregg Robb of MarketWatch has a long interview with San Francisco Federal Reserve President John Williams. The whole interview is worth a read. Two points. First, Williams is in the camp that the Fed need to act sooner than later to forestall the growth of imbalances:

The risk I think we face in waiting too long, or waiting maybe as long as some of these market expectations are, is that the economy is already pretty strong and if we wait too long in further removal of accommodation I do think imbalances will form more generally. It could show up as more inflation pressures down the road, we’re not seeing those yet, but I think that you do see some of this in terms of real-estate markets and other asset markets which are being priced to perfection based on an outlook of very low interest rates. You are seeing extremely high asset valuations in real estate, commercial real estate, the stock market is very strong relative to fundamentals. That is a natural result from low interest rates, that’s one of the ways monetary policy affects the economy. But if asset prices, real estate prices, continue to go further and further away from longer-term fundamentals I think that creates risk for the economy, I think it creates risks eventually for the financial system.

Note that this runs counter to Tarullo, who argued that the flattening yield curve could worsen, not improve, the financial stability situation. The need to rates rates in the name of financial stability is a growing fault line within the Fed.

Second, Williams gives his view of the disconnect between financial markets and the Fed:

In term of the private-sector forecasts, I think it’s very hard to fully understand what the Fed’s decision-making is given that we haven’t done many active policy steps in the last few years. I mean we did obviously as I mentioned the asset purchases during that period, but since we’ve ended that, we talked a lot about raising rates, we’ve given a lot of “dot plots” about raising rates, we did one rate increase in December, but then it has been over six whole months since then, and - I try to put myself in the shoes of a private sector forecaster - one of the hard things to do is kind of see what is our reaction function. What is it that is driving our decision?...

...Right now we’re just in a situation where there is just not a lot of data on actual actions because, for various reasons we’ve held off a long time on our first rate increase and then we held off so far on a second rate increase.

This I think is wrong; lack of action is a policy choice as much as action. Williams seems to think the only useful information about the Fed's reaction function comes when the Fed changes rates. This implies that holding policy steady conveys no information. I would argue that steady policy is in fact signaling the Fed's reaction function, and hence, in combination with the data flow, financial market participants are concluding that the Fed will continue at a glacial pace regardless of what the "dots" say. Indeed, I would say that financial market participants are signaling that the Fed's stated policy path would be a policy error, an error that they don't expect the Fed to make. I guess you could argue that the market doesn't think the Fed understands it's own reaction function. And given the path of policy versus the dots, the market appears to be right.

4.) Mester, seriously? Cleveland Federal Reserve President Loretta Mester dropped this line in a July 1 speech (emphasis added):

But there are also risks to forestalling rate increases for too long when we are continuing to make cumulative progress on our policy goals. Waiting too long increases risks to financial stability and raises the chance that we would have to move more aggressively in the future, which poses its own set of risks to the outlook. I believe waiting too long also jeopardizes our future ability to use the nontraditional monetary policy tools that the Fed developed to deal with the effects of the global financial crisis and deep recession. If we fail to gracefully navigate back toward a more normal policy stance at the appropriate time, then I believe there is a non-negligible chance that these tools will essentially be off the table because the public will have deemed them as ultimately ineffective. This is a risk to the outlook should we ever find ourselves in a situation of needing such tools in the future. Of course, such a risk is hard to measure and is not one we typically consider. But we live in atypical times, and we need to take the whole set of risks into account when assessing appropriate policy.

The part about low rates and financial instability is, as I noted earlier, a growing fault line within the Fed. But the next part about needing to "gracefully" return to a normal policy stance to regain policy effectiveness of nontraditional tools was unexpected. This a variation on a theme. There is a common misperception that policymakers need to raise rates not because the economy needs it, but because it needs tools to fight a future recession. Completely backwards logic, of course. Premature rate hikes only speeds up the arrival of next recession and ensures that policymakers lack room to maneuver. They don't, as Mester suggests, preserve your options. A central banker should know this.

5.) The minutes. My short takeaway from the minutes is that the divide among FOMC participants is greater than the divide among FOMC members. In other words, a larger percentage of participants are looking to hike rates sooner than members. Until the balance on the FOMC shifts, discount hawkish Fedspeak.

Bottom Line: I am keeping an eye on Tarullo; he has been more public on his monetary policy views in recent months. And those views are fairly dovish. My guess is that he and other doves regret taking one for the team last December and falling in line with a rate hike. They won't go down so easily this time around.

Wednesday, July 06, 2016

A Remarkable Financial Moment

Larry Summers:

A Remarkable Financial Moment: The US 10 and 30 year interest rates today reached all time low levels of 1.32 percent and 2.10 percent. Record low 10 year interest rate were also registered in Germany, France, Switzerland and Australia. Notably Swiss 50 year interest rates are now for the first time negative. Rates out 15 years are negative in Germany and 9 years in France. ...

Remarkably the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates.
I believe that these developments all reflect a growing awareness of the importance of the secular stagnation risks that I have highlighted over the last several years. ...
Unfortunately markets have been much more aggressive in responding to events than policymakers. ... Having the right world view is essential if there is to be a chance of making the right decisions. Here are the necessary adjustments.
First..., neutral real interest rates are likely close to zero going forward. ...
Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation. ...
Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded. ...Brad Delong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.
Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment... Indeed in the presence of chronic excess supply structural reform has the risk of spurring disinflation rather than the contributing to a necessary increase in inflation. There is in fact a case for strengthening entitlement benefits so as to promote current demand. ...

Tuesday, July 05, 2016

How Martin Feldstein Learned to Stop Worrying and Love Inflation

David Glasner:

How Martin Feldstein Learned to Stop Worrying and Love Inflation: Martin Feldstein and I go back a ways. Not that I have ever met him, which I haven’t, or that he has ever heard of me, which he probably hasn’t, but I have been following his mostly deplorable commentary on Fed policy since at least 2010 when he published an op-ed piece in the Financial Times, “QE2 is risky and should be limited,” which was sufficiently obtuse to provoke me to write a letter to the editor in response. A year and a half later, after I had started this blog – five years ago to the day on July 5, 2011 – Feldstein wrote an op-ed (“The Federal Reserve’s Policy Dead End”) in the Wall Street Journal, to which he is a regular contributor, in which he offered another misguided critique of quantitative easing, eliciting a blog post from me in response.
Well, now, almost six years after our first encounter, Feldstein has written another op-ed (“Where the Fed Will Be When the Next Downturn Comes“) for the Wall Street Journal which actually shows some glimmers of enlightenment on Feldstein’s part. Always eager to offer encouragement to slow learners, I am glad to be able to report that Feldstein seems to making some headway in understanding how monetary policy operates. He is still far from having mastered the material, but he does seem to be on the right track. If he keeps progressing, the Wall Street Journal will probably stop publishing his op-eds, which would be powerful evidence that he had progressed in understanding of the basics of monetary policy. ...

Wednesday, June 29, 2016

Fed Watch: Powell First Out Of The Gate

Tim Duy:

Powell First Out Of The Gate, by Tim Duy: The first Fed speaker of the post-Brexit era delivered a decidedly dovish message. Confirming the expectations of market participants, Federal Reserve Governor Jerome Powell made clear that the Fed was in a holding pattern until the dust settles. Much of the material is similar in content to his May speech, but the shift in emphasis and nuance indicate a substantially policy path.

Powell summarizes the economic situation as:

How should we evaluate our current performance against the dual mandate? I would say that we have made substantial progress toward maximum employment, although there is still some room for improvement. We have more work to do to assure that inflation moves back up to our 2 percent goal.

Both points are important. On the first point, Powell sees evidence of labor market slack in low participation rates, high numbers of part-time workers, and low wage growth. Recent labor reports concern him:

While I would not want to make too much of two monthly observations, the strength of the labor market has been a key feature of the recovery, allowing us to look through quarterly fluctuations in GDP growth. So the possible loss of momentum in job growth is worrisome.

My guess is that they will want to see a string of 2 or 3 solid labor reports before they breathe easier. Still, by acknowledging that the economy is operating near full employment, does he open the door to concerns about inflation? No:

When I was first exposed to macroeconomics in college, more than four decades ago, the view was that inflation was strongly influenced by the amount of slack in the economy. But the relationship between slack and inflation has weakened substantially over the years.

Or, in other words, the Phillips Curve is flat. Not quite flat as a pancake, but pretty darn flat. More important:

In addition, inflation depends importantly on the inflation expectations of workers and firms. A widely shared view among economists today is that, unlike during the 1970s, expectations are no longer heavily influenced by fluctuations in inflation, but are fairly constant, or anchored. For both these reasons, inflation has become less responsive to cyclical changes in the economy.

And what is happening to inflation expectations:

We measure inflation expectations through surveys of forecasters and the general public, and also through market readings on inflation swaps and "breakevens," which represent inflation compensation as measured by the difference between the return offered by nominal Treasury securities and that offered by TIPS. Since mid-2014, these market-based measures have declined significantly to historically low levels. Some of this decline probably represents lower risk of high inflation, or an elevated liquidity preference for much more heavily traded nominal Treasury securities, rather than expectations of lower inflation. Some survey measures of inflation expectations have also trended down.

The signs are worrisome:

Given the importance of expectations for determining inflation, these developments deserve, and receive, careful attention. While inflation expectations seem to me to remain reasonably well anchored, it is essential that they remain so. The only way to assure that anchoring is to achieve actual inflation of 2 percent, and I am strongly committed to that objective.

By downplaying the importance of slack while emphasizing the importance of inflation expectations, he is neutering the primary argument of Fed hawks who insist that approaching full employment necessitates higher interest rates to stay ahead of inflationary pressures. The line about achieving actual inflation of 2 percent could be a nod toward Evans Rule 2.0. Something to keep an eye on.

The impact of Brexit and the subsequent market turmoil is straightforward:

These global risks have now shifted even further to the downside, with last week's referendum on the United Kingdom's status in the European Union. The Brexit vote has the potential to create new headwinds for economies around the world, including our own. The risks to the global outlook were somewhat elevated even prior to the referendum, and the vote has introduced new uncertainties.

And the implication for monetary policy:

It is far too early to judge the effects of the Brexit vote. As the global outlook evolves, it will be important to assess the implications for the U.S. economy, and for the stance of policy appropriate to foster continued progress toward our objectives of maximum employment and price stability.

Notice that he does not warn that rate hikes are coming! Compare to his May speech:

If incoming data continue to support those expectations, I would see it as appropriate to continue to gradually raise the federal funds rate. Depending on the incoming data and the evolving risks, another rate increase may be appropriate fairly soon.

He is wisely now mum on the timing of the next rate hike. More Fed speakers will follow him than not.

But Brexit alone is not the only factor depressing the rate outlook:

I am often asked why rates remain so low now that we are near full employment. A big part of the answer is that, at least for the time being, the appropriate level of rates is simply lower than it was before the crisis. As a result, policy is not as stimulative as it might appear to be. Estimates of the real interest rate needed to keep the economy on an even keel if it were operating at 2 percent inflation and full employment--the "neutral rate" of interest--are currently around zero. Today, the real short term interest rate is about negative 1-1/4 percent, so policy is actually only moderately stimulative. I anticipate that the neutral rate will move up over time, as some of the headwinds that have weighed on economic growth ease.

The Fed increasingly recognizes that policy is not highly accommodative simply because rates are zero. The stance of policy is relative to the real interest rate, and a lower real rate means that policy is actually only "moderately" stimulative. Translation: There is no need to hike rates soon because policy is not particularly accommodative.

Missing now is this warning from May:

There are potential concerns with such a gradual approach. It is possible that monetary policy could push resource utilization too high, and that inflation would move temporarily above target. In an era of anchored inflation expectations, undershooting the natural rate of unemployment should result in only a small and temporary increase in the inflation rate. But running the economy above its potential growth rate for an extended period could involve significant risks even if inflation does not move meaningfully above target. A long period of very low interest rates could lead to excessive risk-taking and, over time, to unsustainably high asset prices and credit growth. Macroprudential and other supervisory policies are designed to reduce both the likelihood of such an outcome and the severity of the consequences if it does occur. But it is not certain that these tools would prove adequate in a financial system in which much intermediation takes place outside the regulated banking sector. Thus, developments along these lines could ultimately present a difficult set of tradeoffs for monetary policy.

By not reiterating this risk, Powell removes an argument to raise rates even inflation remains below target, the financial stability risk. But how much of a risk is it? If the natural rate of interest is lower, than the potential for financial market instability is also lower for a given interest rate. Or, in other words, since monetary policy is not as accommodative as previously believed, the risk of financial instability is lower.

Bottom Line: Powell embraces the lower real interest rate story as a reason that monetary policy is only moderately accommodative, warns that downside risks are rising, replaces expectations of a rate hike in the imminent future with only guidance that rates will be appropriate to foster economic growth, and drops concerns about the risks of a sustained low rate environment. The key takeaway - no expectation that an imminent rate hike will be needed. Gradual to glacial to just nothing.

Monday, June 27, 2016

Fed Watch: Fed Once Again Overtaken By Events

Tim Duy:

Fed Once Again Overtaken By Events, by Tim Duy: With global financial markets reeling in the wake of Brexit - Britain's unforced error as a political gamble went too far - the Fed is back on the sidelines. A July hike was already out of the question before Brexit, while September was never more than tenuous, depending on the data falling in place just right. Now September has moved from tenuous to "what are you thinking?" Indeed, the debate has shifted in the opposite direction as market participants weigh the possibility of a rate cut. The Fed is probably not there yet, but internally they are probably increasingly regretting the unforced error of their own - last December's rate hike.

The primary economic challenge now is the uncertainty created by the British decision. No one knows what the ultimate end game will be, and how long it will take to get there. Indeed, given the political vacuum in the UK, it appears that pro-Leave politicians really had no plan because they never thought it would actually happen. At lest partially in consequence, any exit promises to be a long process that if recent European history is any guide will prove to be repeated games of chicken between the UK and the EU.

So uncertainty looks to dominate in the near term. And market participants hate uncertainty. The subsequent rush to safe assets - and with it a tightening of financial conditions - is evident in plunging government bond yields and a resurgent dollar. The Fed's initial response was a fairly boilerplate statement:

The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union. The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.

More direct action depends on the length and depth of the financial turmoil currently underway. I think the Fed is far more primed to deliver such action than they were a year ago. And that ultimately is good news for the economy as it will minimize the domestic damage from Brexit.

The Fed began 2015 under the direction of a fairly hawkish contingent that viewed rate hikes as necessary to be ahead of the curve on inflation. Better to raise preemptively than risk a sharper pace of rate hikes in the future. In other words, it was important to remove financial accommodation as the headwinds facing the economy receded and labor markets approached full employment. As the year progressed, however, the need for less financial accommodation never became evident. Indeed, I would argue that asset markets were telling exactly the opposite, that there was far less accommodation than the Fed believed. Fed hawks were slow to realize this, and, despite the financial turmoil of last summer, forced through a rate hike in December. I think this rate hike had more to do with a perceived need to be seen as "credible" rather than based in economic necessity. I suspect doves followed through in a show of unity for Chair Janet Yellen. They should have dissented.

Markets stumbled again in the early months of 2016, and, surprisingly, Fed hawks remained undeterred. Federal Reserve Vice Governor Stanley Fischer scolded financial market participants for what he thought was an overly dovish expected rate path. And even as recently as prior to the June meeting, Fed speakers were highlighting the possibility of a June rate hike, evidently with the only goal being to force the market odds of a rate hike higher.

But I think that as of the June FOMC meeting, the hawkish contingent has been rendered effectively impotent. Simply put, had they been correct, the US economy should have been surging ahead by now, with more evident inflationary pressures. The hawks were far too early with such a prediction. It became increasingly apparent that maybe the yield curve was telling an important story they should heed. Low long-term yields were never consistent with the Fed's outlook, and, when combined with tepid activity, suggested that the Fed's long-term guide, the natural rate of interest, was much lower than anticipated.

Consequently, I suspect the Fed will be much more responsive to the signal told by the substantial drop in long-term yields that began last Friday (as I write the 10 year is hovering about 1.46%) then they may have been a year ago. The drop in yields will feed into their current anxiety about the level of the natural rate of interest, and as a consequence they will more quickly realize the need to accommodate financial markets to limit any undesirable tightening of financial conditions. I expect some or all of the following options depending on the degree of financial market and real economic distress:

1.) Forward guidance I. Fed speakers will concur with financial market participants that policy is on hold until the dust begins to settle. Optimally, they will dispense with all talk of rate hikes as it is unnecessary and unhelpful at this juncture.

2.) Forward guidance II. They will reinforce point I in the next FOMC statement. Watch for the balance of risks to reappear - it seems reasonable to believe they have shifted decidedly to the downside.

3.) Forward guidance III. This would be an opportune time for Chicago Federal Reserve President Charles Evans to push through Evans Rule 2.0. No rate hike until core inflation hits 2% year-over-year. The Fed could justify such a move as a response to the uncertainty surrounding the natural rate. Essentially, rather than using an unknown variable as a guide, use a know variable.

4.) Forward guidance IV. A lower path of dots in the next Summary of Economic projections to validate market expectations.

5.) Rate cut. Former Minneapolis Federal Reserve President Narayana Kocherlakota argues that the Fed should just move forward with a rate cut in July. I concur; I continue to believe that the Fed has the best chance of exiting the zero bound at some point in the future by utilizing more aggressive policy now. That said, I don't expect this to be the Fed's first option. Moving beyond forward guidance will require evidence that the US economy is set to slow sufficiently to push the employment and inflation mandates further out of reach.

6.) If all else fails. If some combination of 1 through 5 were to fail, the Fed will turn to more QE and/or negative rates. I think the former before the latter because it is more comfortable for them.

Bottom Line. The Fed will stand down for the moment; where they go down the road depends upon the depth and length of current disruption. I think at this point it goes without saying that if you hear a Fed speaker talking about July being on the table or confidently warning about two or three rate hikes this year, you should ignore them. Perhaps we can have that conversation later with regards to the December meeting, but certainly not now. Most Fed officials will stick to the script and downplay the possibility of a rate hike and instead focus on the Fed moves to the sidelines angle. I still think an interesting scenario is one in which the Fed needs to accept above target inflation because global financial stability will depend on a very accommodative Federal Reserve, but that hypothesis will only be tested once inflation actually hits target.

A Primer on Helicopter Money

Cecchetti & Schoenholtz:

A Primer on Helicopter Money: ... We are wary of joining the cacophony of commentators on helicopter money, but our sense is that the discussion could use a bit of structure. So, as textbook authors, we aim to provide some pedagogy. (For the record, here are links to Ben Bernanke’s excellent blog post, to a summary of Vox posts, and to Willem Buiter’s technical paper.)
To understand why helicopter money is not just another version of unconventional monetary policy, we need to describe both a bit of economic theory and some relevant operational practice. We use simple balance sheets of the central bank and the government to explain.
First, some background. In the 1960s, Milton Friedman described what he believed to be a surefire mechanism that central banks could use to generate inflation (were that desired): drop currency straight from helicopters on to the population, while promising never to remove it from circulation. The result would be higher prices (and, if you keep doing this, inflation). ...
Now, there are three problems with this thought experiment. First, transferring funds to households is what fiscal policymakers do, not central bankers. The latter issue central bank money to acquire assets. Second, except when interest rates are at the effective lower bound (ELB), monetary policymakers today control interest rates, not the monetary base (or another monetary aggregate). The monetary base is determined by the demand of individuals to hold currency and of banks to hold reserves at the central bank’s interest rate target. In practical terms, this means that the central bank cannot credibly promise to permanently increase the monetary base. Third, 21st century central banks pay interest on reserves. And they do so precisely to control the level of interest rates in the economy.
What this means is that the notion of helicopter money today is necessarily different from what Friedman had in mind. ...
Does this make any difference? Is helicopter money in this setting any different from standard QE when the Fed purchased long-term bonds in exchange for reserves in an effort to flatten the yield curve? Since the alternative is for the fiscal authorities to sell long-term bonds, the answer is no. ...
We are left with a simple conclusion. Helicopter money today is different from what Milton Friedman imagined; it is expansionary fiscal policy financed by central bank money. And, if interest rates have fallen to the ELB, it is neither more nor less powerful than any bond-financed cut in taxes or increase in government spending in combination with QE. 

[There is quite a bit more detail and explanation in the full post.]

Wednesday, June 22, 2016

Why the Fed has a Rate-Setting Problem

At MoneyWatch:

Why the Fed has a Rate-Setting Problem, by Mark Thoms: Many people think they know how interest rates get set: The Federal Reserve does it.
But that's not quite how it works...

Saturday, June 18, 2016

A Question For the Fed

Paul Krugman:

A Question For the Fed: There is a near-consensus at the FOMC that rates must eventually move up. But here’s my question: why, exactly? Specifically, which component of aggregate demand do we believe will continue to strengthen in a way that will require monetary tightening to avoid an overheating economy?
Here’s a look at two obvious candidates...
Nonresidential investment has basically recovered from the recession-induced slump. Residential investment is still a bit low by historical standards, but not as much as you might think if your baseline is the boom of the mid-naughties. And given the slowing growth of the working-age population — down from more than 1 percent a year to less than 0.5 — should’t we expect some reduction in home construction?
So I don’t see an obvious reason to believe that current rates are too low. Yes, they’re near zero — but that in itself doesn’t mean too low.
Like others, notably Larry Summers, I think the Fed is trying to return to a normality that is no longer normal.

Roger Farmer:

Forecasting that the Unemployment Rate will stay Constant is a Bad Idea: Jim Bullard, President of the St Louis Fed, has released a new, St Louis Fed model, for thinking about the way the Fed forecasts. According to the St Louis model, we should think about 'regimes'. There are three components to regimes. 1) Is the economy in a recession: YES or NO? 2) Is the short-term real interest rate HIGH or LOW? 3) Is productivity growth HIGH or LOW? 

Putting these pieces together, there are eight possible states. Recession can be YES or NO, productivity can be HIGH or LOW and the natural real interest rate (Jim calls this R Dagger) can be HIGH or LOW.

In Bullard's view the current regime is Recession: NO, Productivity growth: LOW, R Dagger: LOW
Using regime dependent forecasting, Jim thinks the best forecast of the US economy, moving forwards, is that productivity growth will stay low and the unemployment rate will stay where it is. That implies, according to Bullard, that the Fed should hold the interest rate at 63 basis points through 2018. 
I have one big problem with this forecasting framework..., there is no period in the post-war period when the unemployment rate was even approximately constant. It was either increasing or it was decreasing.  If we stick with the regime dependent paradigm, I would replace, [Recession = Yes or NO], with, [Unemployment = INCREASING or DECREASING].
That may seem like a semantic change. But it makes a big difference to a regime dependent forecasting model because the unemployment rate cannot keep falling forever. That suggests that, the longer we are in the [Unemployment = DECREASING] state, the higher is the probability of a regime switch into [Unemployment = INCREASING]. That suggests to me, that the risk of another recession while productivity and the natural real interest rate are low is higher than Jim Bullard thinks. ...

From an interview of Lars Svensson:

...Eugenio Cerutti: How much can countries rely on monetary policy to lead the recovery from the global financial crisis?
Lars Svensson: I think monetary policy can do more in the United States, Japan, and the euro zone. One can get policy rates further into the negative range, and one can avoid premature liftoffs. Particularly in the euro zone, monetary policy can and should do more. ... Fiscal policy could do more. There are some countries where fiscal policy is unsustainable, but in other countries, fiscal policy can definitely be more expansionary. In terms of monetary policy, there are still things that haven’t been tried, such as monetary financing of government expenditures. Monetary financing of government expenditures should definitely work in increasing nominal aggregate demand, and thereby increasing both real activity and inflation.

Friday, June 17, 2016

Did Negative Rates in Europe Trigger Massive Cash Hoarding?

Anna Malinovskaya and David Wessel at Brookings:

Did negative rates in Europe trigger massive cash hoarding?: For a long time, economists believed that negative interest rates – charging savers to keep money in the bank instead of paying them interest – were close to impossible. If confronted with negative rates, people and institutions would hoard currency, economists reasoned. After all, earning zero interest on $500 in currency is better than paying a fee to keep $500 in the bank. Recently, however, central banks in Denmark, Sweden, Switzerland, the euro zone and Japan cut their rates below zero, testing those long-standing beliefs. ... A ... a quarter of the world’s economy is now experiencing negative interest rates as central banks seek to spur economic growth.
According to the available evidence, it doesn’t appear that cash hoarding is a problem right now in the economies with negative interest rates. ...
The most obvious reason that households haven’t begun to hoard cash is that, in most countries, negative rates haven’t affected most ordinary customers—just the banks themselves. That’s in part because of the way central banks have structured negative rates and in part because of business decisions that banks have made to shield their retail customers. Another reason is that rates are only slightly negative... That may not be enough to justify the costs involved in storing large amounts of cash – buying safes, arranging insurance and so on.
Economists agree that the longer negative rates are maintained (or the longer people believe they will be maintained), and the more negative the rates go, the more likely banks are to charge small depositors a negative rate and the more likely banks and their customers are to switch to holding cash. ... If more banks follow suit and customers begin to feel the impact of negative rates, the evidence may tell a different story.

Wednesday, June 15, 2016

Fed Leaves Target Range for the Federal Funds Rate Unchanged

The Fed decides to leave the federal funds rate unchanged, lowers the expected path though the end of the year. No dissent:

Press Release, Release Date: June 15, 2016: Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up. Although the unemployment rate has declined, job gains have diminished. Growth in household spending has strengthened. Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft. Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to closely monitor inflation indicators and global economic and financial developments.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.

Tuesday, June 14, 2016

The Fed is Making the Same Mistakes Over and Over Again

Larry Summers:

The Fed is making the same mistakes over and over again: As the Federal Reserve meets today and tomorrow, I am increasingly convinced that while they have been making reasonable tactical judgement, their current strategy is ill adapted to the realities of the moment. Exuding soundness is the task of policymakers. Provoking thought is the task of academics. So here are some not-entirely-formed reflections. ...

Sort of what I was trying to say (Brad DeLong also), particularly this part:

... Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more “normal” stance.  But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon...

The Fed should be clear now that its priority is not preventing a small step up in inflation, which in fact should be welcomed, or returning interest rates to what would have been normal to a world gone by.

Instead the Fed should focus on assuring adequate growth in both real and nominal incomes going forward.

FOMC Preview

Tim Duy:

FOMC Preview: The best-laid plans can come undone by the tiniest of things. In this case a slip in the data—a low print on nonfarm payrolls that may prove no more than a statistical bump—put a June interest rate hike out of reach for the Federal Reserve and probably a July one as well. That leaves September in focus as the next chance for the U.S. central bank to tighten policy—if the data hold... Continued at Bloomberg ...

The Fed Should Wait for Clarity Before Raising Rates

 I was going to write about something else, but it didn't come together like I thought it would, so I cobbled this together at the last moment:

The Fed Should Wait for Clarity Before Raising Rates: Most analysts believe that the Fed will leave interest rates unchanged when it concludes its two-day monetary policy meeting this week. Let’s hope so. Both inflation and inflationary expectations remain below the Fed’s target level of 2 percent, inflationary expectations have been falling, and the most recent employment report points to a slower job market than anticipated. 
Even though recent data point to weakness in the economy, some members of the Fed seem anxious to implement the next round of rate increases, perhaps when the Fed meets again in July. This continues a pattern. Time and again the Fed has indicated that a rate increase is coming soon, perhaps at the next meeting, based upon its forecasts of the future strength of the economy. Then it has been forced to delay the increase as new data arrives indicating the economy is not as robust as expected. 
Will the economy be strong enough to justify a rate increase in July, or will we see the same pattern once again? ...

Monday, June 13, 2016

Tim Duy’s Five Questions for Janet Yellen

Brad DeLong:

Tim Duy’s Five Questions for Janet Yellen: A very nice piece here from the very-sharp Tim Duy:

Tim Duy: Five Questions for Janet Yellen ... These five questions–“What’s the deal with labor market conditions?… Has the effect of QE been underestimated?… Optimal control or no?… An Evans Rule for all?… Just how much do you care about the rest of the world?”–are the right questions to ask. And Tim’s bottom line–“Push Yellen to explain her past positions in light of the current data and actions. I think understanding how and why her positions change is critical…. Making the so-called ‘reaction function’ clear remains the most important piece of the Fed’s communication strategy”–is the right bottom line.

After all, does this look like an economy crossing the line of potential output in an upward direction with growing and substantial gathering inflationary pressures to you? ...

The Federal Reserve is simply not doing a good job of communicating its reaction function. It is not doing a good job of linking its model of the economy to current data and past events. Inflation, production, and employment (but not the unemployment rate) have been disappointingly low relative to Federal Reserve expectations for each of the past nine years. These events should have led to substantial rethinking by the Federal Reserve of its model of the economy. And yet the model set forward by Yellen and Fischer (but not Evans and Brainard) appears to be very much the model they held to in the late 1990s, which was the model they believed in in the early 1980s: very strong gearing between recent-past inflation and expected inflation, and a Phillips Curve with a pronounced slope, even with inflation very low.

Unless my Visualization of the Cosmic All is grossly wrong along the relevant dimensions, this is not the right model of the current economy. There was never good reason to think that the bulk of the runup in inflation in the 1970s was due to excessive demand pressure and unemployment below the natural rate–it was, more probably, mostly due to supply shocks plus the lack of anchored expectations. ... Thus the way to bet is that the economy on its current trajectory will produce less upward pressure on current inflation and also on inflation expectations than the Federal Reserve currently projects.

But how will it react when the data once again disappoints Federal Reserve expectations–as it has? ...

In an environment of economic volatility like the one in which we find ourselves today, a prudent central bank should do everything it can to raise expected and actual inflation, in order to gain the ability to stabilize the economy in any direction. If interest rates were well above zero, the Fed would have scope to raise them further in case of overheating or to lower them in response to adverse demand shocks.

But the Fed continues to neglect asymmetry...

I cannot help but be struck by the difference between what I see as the attitude of the current Federal Reserve, anxious not to do anything to endanger its “credibility”, and the Greenspan Fed of the late 1990s, which assumed that it had credibility and that because it had credibility it was free to experiment with policies that seemed likely to be optimal in the moment precisely because markets understood its long-term objective function and trusted it, and hence would not take short-run policy moves as indicative of long-run policy instability. There is a sense in which credibility is like a gold reserve: It is there to be drawn on and used in emergencies. The gold standard collapsed into the Great Depression in the 1930s in large part because both the Bank of France and the Federal Reserve believed that their gold reserves should never decline, but always either stay stable of increase.

And I cannot help but be struck by the inconsistency between the two vibes. The claim that we need not worry about asymmetry because we are willing to undertake radical policy experimentation fits very badly with the claim that we dare not rock the boat because the anchoring of inflation expectations on the upside is very fragile. Combine these with excessive confidence in the current model–with a tendency to make policy based on the center of the fan of projected outcomes with little consideration of how wide that fan actually is–and I find myself with much less confidence in today’s Fed than I, four years ago, thought I would have today.

Sunday, June 12, 2016

Fed Watch: Janet Yellen's Inflation Problem

Tim Duy:

Janet Yellen's Inflation Problem, by Tim Duy: Federal Reserve Chair Janet Yellen has been vexed by an inflation problem. Now she is also vexed by an inflation expectations problem. Last week she said (emphasis added):
Uncertainty concerning the outlook for inflation also reflects, in part, uncertainty about the behavior of those inflation expectations that are relevant to price setting. For two decades, inflation has been relatively stable, reacting less persistently than before to temporary factors like a recession or a swing in oil prices. The most convincing explanation for this stability, in my view, is that longer-term inflation expectations have remained quite stable. So it bears noting that some survey measures of longer-term inflation expectations have moved a little lower over the past couple of years, while proxies for these expectations inferred from financial market instruments like inflation-protected securities have moved down more noticeably. It is unclear whether these indicators point to a true decline in those inflation expectations that are relevant for price setting; for example, the financial market measures may reflect changing attitudes toward inflation risk more than actual inflation expectations. But the indicators have moved enough to get my close attention. If inflation expectations really are moving lower, that could call into question whether inflation will move back to 2 percent as quickly as I expect.
Subsequently, the University of Michigan's read on long-run inflation expectations plunged to a series low: INFEXP0616
Just for reference, consider the behavior of the inflation expectations during the last three tightening cycles:


Spot the odd man out.
This, one would think, should grab Yellen's attention. There is speculation of what this means for this week's FOMC statement. For example see here:
“The key thing to watch will be whether the Fed changes its language on inflation expectations” in the statement it publishes after its meeting, said Neil Dutta, head of U.S. economics at Renaissance Macro Research in New York.
They should change the language, but I don't think the will. The problem is that if the Fed acknowledges serious concern about declining inflation expectations, they have to deal with this line from the FOMC statement:
The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.
It makes no sense to show concern with the possibility of unanchored inflation expectations to the downside while at the same time stating that you anticipate the next policy action will be a hike. If inflation expectations are no longer stable, then any rational central banker must act accordingly, and this this case that means easing policy. Anything else is simply irrational, and the Fed should be called out for it.
Do any of us believe the Fed is about to ease policy?
Chicago Federal Reserve President Charles Evans opened the door to an easier policy stance by offering Evans Rule 2.0: Commit to holding steady on rates until core inflation has reached the Fed's inflation target. But think of how big of a leap that would be for the Fed. The Chair just gave a relatively optimistic outlook for the US economy, reiterating her belief that higher rates were coming. Up until the May employment report (a report that Yellen downplayed), policy makers were falling over each other to put the June meeting in play, pushing the message that was eventually revealed in the minutes of the April meeting. Unemployment is at 4.7 percent, a level generally believed within the Fed as consistent with full employment. Second quarter growth looks to be respectable in the 2.0-2.5 percent range. Financial markets stabilized after a tumultuous first quarter. Oil prices moved higher. In short, there is a reason Fed officials put June into play.
It's hard to see the Fed moving from "we plan to hike rates as early as June" to "rate hikes are off the table until inflation hits 2 percent" in just a few weeks. Moreover, adopting Evans Rule 2.0 would dramatically jack up the odds that the Fed would subsequently need to hit the inflation target from above. But the Fed has shown little willingness to consider anything other than hitting the target from below. A shift to Evans Rule 2.0 would take a sea change of sentiment at the Fed. I don't see it happening in just a few weeks on the basis of essentially one number.
So my expectation is that the Fed does not change its inflation expectations language in this week's FOMC statement. If they do, they have to understand that they market participants will price out rate hikes until 2017. I don't think they want this; I think instead the Fed will be working to keep July in play (a tall order in my opinion).
There is now a natural press conference question to add to my existing list:
Chair Yellen, last week you said that inflation expectations were low enough to be on your radar. Now they have turned even lower, but the FOMC declined to acknowledge the weakness in this FOMC statement. Just how low do inflation expectations need to be before the Fed acts?
I would guess that this is the first question for Yellen.
Bottom Line: It is reasonable to think that the Fed will change their inflation expectations language at this week's FOMC meeting. Completely rational considering Yellen's comment last week. A comment that I suspect she now regrets. But a change to the language requires a policy response I don't think the Fed is ready to make. If I am wrong, if the Fed is much more dovish than recent comments, or the most recent minutes, suggest.

Friday, June 10, 2016

Five Questions for Janet Yellen

Tim Duy:

Next week's meeting of the Federal Open Market Committee (FOMC) includes a press conference with Chair Janet Yellen. These are five questions I would ask if I had the opportunity to do so in light of recent events.
1. What's the deal with labor market conditions?
You advocated for the creation of the Federal Reserve's Labor Market Conditions Index (LMCI) to serve as a broader measure of the labor market and as an alternative to a narrow measure such as the unemployment rate...
Continues at Bloomberg....

Monday, June 06, 2016

Fed Watch: Employment Report, Yellen, and More

Tim Duy:

Employment Report, Yellen, and More, by Tim Duy: Lot's of Fed news over the past few days that add up to a simple takeaway: June is off the table (again), the stars have to align just right for a July rate hike (not likely), and September is coming into focus as the next possible rate hike opportunity. September, however, assumes that the employment report is more of an outlier than part of a trend. that's what the Fed will be taking out of the data in the coming months.
Nonfarm payrolls grew by a disappointing 38K in May, low even after accounting for the Verizon strike. Downward revisions struck previous months, leaving behind a marked deceleration in job growth:


Slowest three-month average since 2011. Perversely, the unemployment rate dropped to 4.7 percent, breaking a long period of stagnate readings. The decline, however, was driven by an exit from the labor force - not exactly the improvement we were hoping for. Measures if underemployment continue to track generally sideways at elevated levels:


By these metrics, progress toward full employment has slowly noticeably. Wage growth, however, is showing signs of improvement, and should get a boost next month from base year effects:


How should we interpret the mess that is the May employment report? One take is to treat it as an anomaly, simply a bad draw. Federal Reserve Chair Janet Yellen leaned in this direction in today's speech. After characterizing the economy as near full employment, she added:
So the overall labor market situation has been quite positive. In that context, this past Friday's labor market report was disappointing...Although this recent labor market report was, on balance, concerning, let me emphasize that one should never attach too much significance to any single monthly report. Other timely indicators from the labor market have been more positive. For example, the number of people filing new claims for unemployment insurance--which can be a good early indicator of changes in labor market conditions--remains quite low, and the public's perceptions of the health of the labor market, as reported in various consumer surveys, remain positive...
Still, the data disappointed sufficiently to push her to the sidelines:
That said, the monthly labor market report is an important economic indicator, and so we will need to watch labor market developments carefully.
Later she adds:
Over the past few months, financial conditions have recovered significantly and many of the risks from abroad have diminished, although some risks remain. In addition, consumer spending appears to have rebounded, providing some reassurance that overall growth has indeed picked up as expected. Unfortunately, as I noted earlier, new questions about the economic outlook have been raised by the recent labor market data. Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015? Does the latest reading on the unemployment rate indicate that we are essentially back to full employment, or does relatively subdued wage growth signal that more slack remains? My colleagues and I will be wrestling with these and other related questions going forward.
Will Yellen be able to answer these questions with enough confidence to hike in July? Doubtful, in my opinion. A strong report for May would have been sufficient to put them on track for a July hike. But now a July hike requires a sharp rebound in June payroll growth plus substantial upward revisions to the May numbers (in addition to the rest of the data falling into place). That is not likely, and may account for Yellen dropping the "coming months" language when referring to the expected policy path. June or July looked like reasonable possibilities last week, but not so much now.
A second interpretation, however, is more ominous. In this interpretation, the employment data is finally catching up with the slower pace of GDP growth:


The acceleration that began in 2013 looks to have played itself out by the middle of last year. Job growth remained strong, however, pushing productivity growth into negative territory. This, as David Rosenberg explains at Business Insider, was not sustainable. Something had to give, and the labor market finally gave. Similarly, wage growth is a lagging indicator - if the labor market is faltering, the current pace of gains will not be sustainable.
Similarly, note that the ISM services data looks to be catching up to this story as well:


In addition, temporary employment payrolls is flashing a yellow light:


If this is the story, the the Fed will move to the sidelines for an extended period of time, pushing out any hope of a rate hike until December. That assumes the Fed does not make a policy error by rushing to raise rates in these circumstances.
In other news, Federal Reserve Governor Daniel Tarullo, who rarely speaks publicly on monetary policy, defined the current dynamic within the FOMC as those looking to hike versus those looking not to hike. Via MarketWatch:
In an interview with Bloomberg TV, Tarullo said he is in the camp of Fed officials that backs further, gradual, rate hikes but said he is more cautious about a move than some others in that camp.
One group favoring gradual rate hikes wants to hike “unless there is a reason not to” in order to avoid problems with inflation later on, he said.
The other camp, where he sits, wants “an affirmative reason to move” and asks “why do we need” an interest rate hike. Tarullo said.
“The second approach I’ve been a little bit more inclined towards is to say ‘gee, you know, it is not clear what full employment is, we’re in a global environment that is not inflationary, we can perhaps get some more employment and some higher wages which will be particularly useful to those more on the margins of the labor force,’” Tarullo said.
Positioning himself ahead of the FOMC meeting as opposing a rate hike. And this was before the employment report.
Federal Reserve Governor Lael Brainard also put down her marker ahead of the meeting:
Prudent risk-management would suggest the risks from waiting until the totality of the data provides greater confidence in a rebound in domestic activity, and there is greater certainty regarding the "Brexit" vote, seem lower than the risks associated with moving ahead of these developments. This is especially true since the feedback loop through exchange rate and financial market channels appears to be elevated. In light of this amplified feedback loop, when conditions are appropriate for a policy move, it will be important that it be understood that any subsequent moves would be conditioned on further evidence confirming continued progress toward our objectives and not as inevitable steps on a preset course.
I think these are both key influencers within the FOMC; Brainard's resistance to rate hikes in particular is something that hawks would need to overcome to get their way. I don't think that will be easy.
Chicago Federal Reserve President Charles Evans called for an Evans Rule 2.0:
The question is whether such upside risks would increase substantially under a policy of holding the funds rate at its current level until core inflation returned to 2 percent. I just don’t see it. Given the shallow path of market policy expectations today, there is a good argument that inflationary risks would not become serious even under this alternative policy threshold. And when inflation rises above 2 percent, as it inevitably will at some point, the FOMC knows how to respond and will do so to provide the necessary, more restrictive financial conditions to keep inflation near our price stability objective.
So one can bet he would oppose a rate hike in June. Or July. And even St. Louis Federal Reserve President James Bullard has lost his appetite for a near-term rate hike. Via the Wall Street Journal:
Federal Reserve Bank of St. Louis President James Bullard said in an interview Monday that he is leaning against supporting a rate rise at the central bank’s coming meeting.
If the Fed is going to raise its short-term interest-rate target, “I’d rather move on the back of good news about the economy,” Mr. Bullard told The Wall Street Journal. And since the Fed will be meeting following the release of the underwhelming May jobs data, it is a “fair assessment” the argument for raising rates is now considerably weaker than it had been
Meanwhile, Atlanta Federal Reserve President Dennis Lockhart worked to keep July in play:
“I don’t personally see a lot of cost to being patient to the July meeting at least,” Lockhart said Monday in a Bloomberg Television interview with Michael McKee in New York. “I think we can be watchful and see how things develop over the next few weeks.”
There will be resistance to letting the markets price out July. That will play into the FOMC's crafting of their statement next week as well as Yellen's press conference.
Bottom Line: The May employment report killed the chances of a rate hike in June. And it was weak enough that July no longer looks likely as well. I had thought that, assuming a solid May number they would set the stage for a July hike. That seems unlikely now; they will probably need two months of good numbers to overcome the May hit. The data might bounce in the direction of July, to be sure. Hence Fed officials won't want to take July off the table just yet, so expect, in particular, the more hawkish elements of the FOMC to keep up the tough talk.

A Pause That Distresses

If the economy goes into recession, Republicans will stand in the way of the needed response from monetary and fiscal policy:

A Pause That Distresses, by Paul Krugman, NY Times: Friday’s employment report was a major disappointment: only 38,000 jobs added, a big step down from the more than 200,000 a month average since January 2013. Special factors, notably the Verizon strike, explain part of the bad news, and in any case job growth is a noisy series... Still, all the evidence points to slowing growth. It’s not a recession, at least not yet, but it is definitely a pause in the economy’s progress. ...
So what is causing the economy to slow? My guess is that the biggest factor is the recent sharp rise in the dollar, which has made U.S. goods less competitive on world markets. The dollar’s rise, in turn, largely reflected misguided talk by the Federal Reserve about the need to raise interest rates. ...
Whatever the cause of a downturn, the economy can recover quickly if policy makers can and do take useful action. ...
But that won’t — in fact, can’t — happen this time. Short-term interest rates, which the Fed more or less controls, are still very low... We now know that it’s possible for rates to go slightly below zero, but there still isn’t much room for a rate cut.
That said, there are other policies that could easily reverse an economic downturn. ... For the simplest, most effective answer to a downturn would be fiscal stimulus...
But unless the coming election delivers Democratic control of the House, which is unlikely, Republicans would almost surely block anything along those lines. Partly, this would reflect ideology... It would also reflect an unwillingness to do anything that might help a Democrat in the White House. ...
If not fiscal stimulus, then what? For much of the past six years the Fed, unable to cut interest rates further, has tried to boost the economy through large-scale purchases of things like long-term government debt and mortgage-backed securities. But it’s unclear how much difference that made — and meanwhile, this policy faced constant attacks and vilification from the right, with claims that it was debasing the dollar and/or illegitimately bailing out a fiscally irresponsible president. We can guess that the Fed will be very reluctant to resume the program...
So the evidence of a U.S. slowdown should worry you. I don’t see anything like the 2008 crisis on the horizon (he says with fingers crossed behind his back), but even a smaller negative shock could turn into very bad news, given our political gridlock.

Wednesday, June 01, 2016

Fed Watch: Waiting For The Employment Report

Tim Duy:

Waiting For The Employment Report, by Tim Duy: Last week Federal Reserve Chair Janet Yellen gave the green light for a rate hike this summer. Via the Wall Street Journal:
“It’s appropriate…for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in the coming months such a move would be appropriate,” she said during a panel discussion at the Radcliffe Institute for Advanced Study at Harvard University.
This follows on the back numerous Fed speakers, as well as the minutes of the last meeting, that helped place June into play. Of course, Yellen's "coming months" could easily be beyond June, and I suspect that her concern about underemployment and low wage growth will induce her to proceed cautiously and take a pass on June. That said, the meeting is clearly in play and the bar for the next rate hike appears relatively low.
The personal income and spending report bolstered the hawkish position that first quarter economic jitters were much ado about nothing. Real spending jumped 0.6 percent on the back of a lower savings rate, helping to put a floor under the year-over-year numbers:


The consumer stubbornly refuses to believe that a recession is underway.
Inflation firmed somewhat for the month:


Two of the last three monthly readings on the core were just above 2 percent annualized, something that will also give confidence to Fed hawks that their inflation forecast will play out (they will assume headline will head in that direction). Compared to a year ago, however, core inflation continues to languish below target.
The ISM report came in somewhat better than expected considering weak regional surveys. Most of the action was in suppliers delivers (slower), customers' inventories (flat), and prices (higher). New orders held up well; employment still a touch below 50:


On net, neither a great relief nor a disaster. But then it is probably too early to expect the healing touch of a weaker dollar and stronger oil to be evident in the manufacturing data.
In addition, construction spending was down (see Calculated Risk), which, in addition to the ISM report brought the Atlanta Fed estimate of Q2 GDP growth down to a still respectable 2.5 percent from 2.8 percent. If the Fed could be confident in the number, they would have a strong incentive to hike. But I suspect they will wanted an even clearer picture that won't be available until the July meeting at the earliest.
The Beige Book was fairly uneventful on most accounts. Growth was still just "modest" but with an optimistic outlook:
Information received from the 12 Federal Reserve Districts mostly described modest economic growth since the last Beige Book report. Economic activity in April through mid-May increased at a moderate pace in the San Francisco District, while modest growth was reported by Philadelphia, Cleveland, Atlanta, Chicago, St. Louis, and Minneapolis. Chicago noted that the pace of growth slowed, as did Kansas City. Dallas reported that economic activity grew marginally, while New York characterized activity as generally flat since the last report. Several Districts noted that contacts had generally optimistic outlooks, with firms expecting growth either to continue at its current pace or to increase.
There was some anecdotal evidence that hawks will use to justify a rate hike:
Employment grew modestly since the last report, but tight labor markets were widely noted; wages grew modestly, and price pressure grew slightly in most Districts.

In my opinion, modest wage growth and slight price pressures do not sound particularly worrisome.

Auto sales ran at estimated 17.4 million annual rate in May. Bloomberg suggested that the numbers might scare the Fed straight:
U.S. auto sales were softer than predicted in May, a bellwether month that may help Federal Reserve decision makers determine whether the economy can handle an interest-rate hike this summer.
My guess is that the Fed already knows that auto sales are leveling out and are not likely to be a significant source of growth going forward. In other words, I have to imagine it is already in the forecast.

Another Bloomberg story to keep an eye on:

Softening apartment rents in New York and San Francisco have forced landlord Equity Residential to lower its revenue forecast for the second time this year, as newly signed leases aren’t meeting the company’s expectations.
Equity Residential said it expects revenue growth from properties open at least a year to be no higher than 4.5 percent this year, according to a statement Wednesday. The reduction follows one made in April, when the Chicago-based real estate investment trust set the upper limit at 5 percent, down from a previous estimate of 5.25 percent.
Two thoughts. First is that maybe multifamily construction has finally caught up with demand, thus rent growth will slow and so will its impact on inflation. Second thought is that if demand for apartments is tapering off, then it may be that millennials are growing out of apartments and into single family housing. This handoff is thus likely to continue:


Look for softer underwriting conditions and marketing campaigns to help encourage this shift.
The Verizon strike likely negatively impacted the headline nonfarm payrolls numbers in the May employment report, so adjust your expectations accordingly. I would pay special attention to the unemployment rate and metrics of underemployment; the Fed would be more inclined to hike rates if progress on these from resumed.
Bottom Line: Nothing here suggests to me that the Fed will soon reject their expectation of a rate hike in the "coming months."

There Goes the Fed's Credibility

Narayana Kocherlakota:

There Goes the Fed's Credibility, by Narayana Kocherlakota: Back in January 2012, the Federal Reserve promised to keep its preferred measure of inflation close to 2 percent over the longer run. More than three years later, that promise remains unfulfilled, casting doubt on the central bank's willingness to deliver.
The latest reading for the measure, known as the price index for personal consumption expenditures, showed annual inflation running at only 1.1 percent in April. Excluding volatile food and energy prices, the inflation rate was 1.6 percent. ...
Some would say that central banks are out of ammunition... Actually, though, the Fed has been deliberately tightening monetary policy over the past three years. ...
To understand the Fed's motivations, consider this: Would it have started pulling back on stimulus in May 2013 if its short-term interest-rate target had been at 5 percent instead of near zero, and if it hadn’t been holding trillions of dollars in bonds? I strongly suspect that the Fed would instead have added stimulus by lowering interest rates. If so, then the Fed's current course is driven not by state of the economy, but by a desire to get interest rates and its balance sheet back to what is considered "normal." ...