I have some comments on the Press Release from today's FOMC meeting at MoneyWatch:
Tuesday, September 21, 2010
Sunday, September 19, 2010
Tyler Cowen hopes to convince you that you need to be convinced:
Can the Fed Offer a Reason to Cheer?, by Tyler Cowen, Commentary, NY Times: ...Optimism, or lack thereof, may seem the province of psychology, not macroeconomics. But ... a deficit of optimism has much to do with why the United States economy remains stalled today.
The Federal Reserve, pondering what to do to stimulate the economy, has a number of tools at its disposal. But if it could just convince Americans that it was committed to monetary expansion and economic growth, it would help the economy pick up speed.
Yet that is easier said than done. ... If the Fed promises to keep increasing the money supply until prices rise by, say, 3 percent a year, people should eventually start spending. Otherwise, if they just held the money, it would be worth 3 percent less each year. ... Of course, if no one believes the Fed’s commitment to price inflation, spending and employment will not go up. The plan will fail, and people will view their skepticism as vindicated.
In other words, one of our economic problems can be solved, but only if we are willing to believe it can. ... Sadly, although Mr. Bernanke clearly understands the problem, the Fed hasn’t been acting with much conviction. This is understandable, because if the Fed announces a commitment to a higher inflation target but fails to establish its credibility, it will have shown impotence. It would be a long time before the Fed was trusted again, and the Fed might even lose its (partial) political independence. ...
The Fed lost some of its political independence during the financial crisis. It undertook major rescue operations in conjunction with the Treasury, and these bailouts proved extremely unpopular. ... When it comes to inflation, the Fed cannot easily turn to Congress and simply ask to be trusted.
This is the sad side story of our financial crisis: especially when it comes to financial matters, a great deal of trust has been lost. There is the prospect of a free lunch right before us, yet it is unclear that we will be able to grab it. ...
In failing to push harder for monetary expansion, is Mr. Bernanke a wise and prudent guardian of the limited discretionary powers of the Fed? Or is he acting like a too-hesitant bureaucrat, afraid to fail and take the blame when he should be gunning for success?
We still don’t know which narrative is more accurate, but the Fed is not receiving enough signals of support from Congress.
As high unemployment continues, more and more people, including top economists, are asking the Fed to promise a credible commitment to a more expansionary monetary policy. This approach will work only if the Fed finds a way to be bold — and if we find a way to believe in it.
This reminds me of an argument I made in June:
As for Tyler's (and others') call for monetary policy instead of fiscal policy, here's the problem. It relies upon changing expectations of future inflation (which changes the real interest rate). You have to get people to believe that the Fed will actually be willing to create inflation in the future when it comes time to do so. However, it's unlikely that it will be optimal for the Fed to cause inflation when the time comes. Because of that, the best policy is to promise that you'll create inflation, then renege on the promise when it comes time to follow through. Since people know that, and expect the Fed will not actually carry through, it's hard to get them to change their expectations now. All that credibility the Fed has built up and protected concerning their inflation fighting credentials works against them here.
Wednesday, September 15, 2010
In response to Japan's intervention on the Yen, Barry Eichengreen reminds us that in March 2009, he argued that coordinated cross-country quantitative easing by monetary authorities would be better than the competitive devaluation we seem to be heading towards since it avoids large, temporary swings in exchange rates:
Competitive devaluation to the rescue, by Barry Eichengreen, guardian.co.uk: Every day it seems more likely that we are destined – or should one say doomed? – to replay the disastrous economic history of the 1930s. We have had a stock market crash to rival 1929. We have had a banking crisis comparable to 1931. With the economic meltdown in eastern Europe we have the prospect of a financial crisis in Vienna, exactly as in 1931. We have squabbling among the major economies over the design of rescue loans, just as when the Bank for International Settlements was hamstrung in its efforts to contain the crisis in Austria. We have the prospect of a failed world economic conference in London to dash remaining hopes for a co-operative response, just as in 1933.
And if all this wasn't enough, now we have the dreaded specter of competitive devaluation. In the 1930s, one country after another pushed down its exchange rate in a desperate effort to export its way out of depression. But each country's depreciation only aggravated the problems of its trading partners, who saw their own depressions deepen. Eventually even countries that valued currency stability were forced to respond in kind.
In the end competitive devaluation benefited no one, it is said, since all countries can't devalue their exchange rates against each another. The only effects were to fan political tensions, heighten exchange rate uncertainty, and upend the global trading system. Financial protectionism if you will.
Now, we are warned, there are signs of the same. The Bank of England is not exactly discreetly encouraging the pound to fall. And just last week the Swiss National Bank intervened in the foreign exchange market to push down the franc. Will Japan, the United States and China be long to follow? Will we all yet again end up shooting ourselves in the foot?
In fact, this popular account is a misreading of both the 1930s and the current situation. In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.
It is true that the process was disorderly and disruptive. Better would have been for the countries concerned to co-ordinate their moves to a more stimulative monetary policy without sending exchange rates on a roller-coaster ride. But, not for the first time, they failed to agree. Those in the most precarious positions had no choice but to pursue the new policy unilaterally.
In any case, monetary easing achieved through a process of "competitive devaluation" was better than no monetary easing. ...
This, in a nutshell, is our situation again today. Sterling's weakness reflects, in part, the exceptional severity of the British slump. But it also reflects the fact that the Bank of England has moved further and faster in the direction of quantitative easing than any other central bank. ... Now the Swiss National Bank has followed suit...
Will other central banks, seeing their own currencies strengthen, conclude that the threat of deflation has grown more immediate and also now move quickly to quantitative easing? If so, exchange rates against sterling and the franc will revert to more normal levels. And, with quantitative easing all around, the world will receive the additional dose of monetary stimulus that it desperately needs.
Better of course would be for the major countries to agree to co-ordinate their monetary policy actions. Then exchange rates will not move by large amounts in one direction today and the opposite direction tomorrow. There will not be further disruptions to the global trading system. There will not be international recriminations over beggar-thy-neighbor policy. The G20 countries could even make such co-ordination part of their agreement at the 2 April summit in London. Or not.
Monetary policy works through lowering interest rates and encouraging new investment, but people seem to have forgotten all about the long and variable lags, particularly for monetary policy. The problem of finding "shovel ready" projects in not limited to the public sector. Even projects that are already planned take time to set in motion in response to lower interest rates (if producers are even willing to initiate new projects given the bleak outlook for sales).
We need to remember that policy takes time to work, that the risks are not symmetric, and that the consequences of failing to act in a timely manner could be very costly down the road. We need to take action now, and not just from coordinated monetary policy. A coordinated fiscal intervention is also needed, but, unfortunately for the jobless, that's not going to happen.
Now, suppose Japanese officials believe that intervention is required regardless of the G-20. Presumably, they will give US Treasury Secretary Timothy Geithner a phone call to at least keep him in the loop, if not to receive his implicit consent. One wonders if Geithner will recognize what he would be consenting to: Japanese intervention, if it occurs, means that Chinese authorities managed to get Japan to acquire their Dollar reserves for them. Instead of buying Dollars, China buys Yen, which in turn induces Japan to buy Dollars. This maintains the artificial capital flows to the US while allowing China to escape accusations of being a "currency manipulator."
Since then, Japan's currency challenge only intensified, culminating in last week's almost comical complaint from Japanese policymakers:Japan’s government said it will seek discussions with China over the nation’s record purchases of Japanese bonds as an appreciating yen threatens to undermine an economic recovery.Japan is closely watching the transactions and will seek to maintain close contact with Chinese authorities on the issue, Vice Finance Minister Naoki Minezaki told lawmakers in Tokyo. Finance Minister Yoshihiko Noda suggested at the same hearing that it’s inappropriate for China to buy Japan’s bonds without a reciprocal ability for Japanese to invest in China’s market.
Did policymakers recognize the irony of their situation? It is not exactly a secret that Japan has made frequent excursions into the currency markets. But apparently they feel that intervention should be limited to Dollar purchases. Surely another Asian nation wouldn't play the same game on them?
Alas, the Chinese did - under pressure to "loosen" the renminbi - and pushed the Japanese into intervening last night to tame the surging Yen. In effect, the Chinese managed to get the Japanese to do their Dollar buying for them. Honestly, I have a hard time faulting the Japanese. They are facing a serious deflation problem, and pumping Yen into the system is an appropriate response (although they might simply sterilize the intervention, which would be, in my opinion, a policy error).
What must be going through the head of US Treasury Secretary Timothy Geithner at this point? After all, as far as global imbalances are concerned, if he can't stop central banks from intervening in the Dollar, he really isn't going to be making much progress on reversing the deteriorating US trade deficit. And before anyone gets too excited about the most recent trade numbers, note the trend remains intact. Moreover, CR is tracking the LA ports data, and it looks ugly. Geithner is now out and about trying to jawbone Chinese officials. From his interview with the Wall Street Journal:WSJ: Are you satisfied with China’s progress on the yuan?Geithner: Of course not. China took the very important step in June of signaling that they’re going to let the exchange rate start to reflect market forces. But they’ve done very, very little, they’ve let it move very, very little in the interim. It’s very important to us, and I think it’s important to China, I think they recognize this, that you need to let it move up over a sustained period of time.
So, Geithner finally realizes the extent of the Chinese nonevent. Recall the press fanfare that accompanied the initial Chinese currency announcement - journalists falling all over themselves to speak brightly of China's economic maturation. How many of those stories were sourced by Treasury officials crowing about the breakthrough that allowed them to avoid labeling China a currency manipulator? And where does this leave Geithner? Either complicit in trumping up the most minor of policy adjustments, or completely sucker punched by his Chinese counterparts. Honestly, I don't know which is worse.
What it all boils down to is this: There apparently is no motivation for global central banks to stop directing capital inflows at the US in an effort to support mercantilist objectives. If it isn’t China, it will be some other economy. And equally apparent, there is no motivation among US policymakers to address such government directed capital flows. Which will leave politicians falling back on ultimately harmful trade barriers. The absolute inability of US policymakers to seriously address a global financial architecture where a rule of the game is "when in doubt, by Dollars" will ultimately have serious consequences via disruptive adjustment when the system can no longer be maintained, via either external or internal forces.
Monday, September 13, 2010
The Fair, by Tim Duy: A man takes his son to the county fair; the lights and sounds of the amusement rides are like a magnet to the boy. The boy, however, is penniless. His father, seeing the longing in his son's eyes, hands the boy a dollar for the rides, but quizzically adds "if it looks like you are about to have any fun with that dollar, I will take it back from you." The boy is puzzled. First, a dollar only buys three tickets, and the least expensive ride is four tickets. Plus, Dad said he would take the dollar back if he went to buy tickets. So what is the point of even trying to buy any tickets?
Consequently, the father and son stand at the edge of the midway, the father wondering why his son simply stands there while the son wonders why his dad doesn't want him to have any fun. They are soon joined by the boy's grandfather, who, assessing the situation, says that the father should never have given the son a dollar in the first place. "He will just buy candy, which will cost you more later when you have to take him to the doctor to treat diabetes." The father neither agrees or disagrees. Along comes a trusted uncle, who says to give the boy another dime, but " then if he looks like he will have any fun, take back a quarter."
The grandfather and uncle start bickering, loudly, in public, about what to do with the boy and his dollar. Soon another uncle rushes into the fray, proclaiming it is pointless to give the boy a dollar because all the workers are already busy helping other fairgoers. "He can't buy anything anyway, and if he tries, he will just drive up prices for all his cousins." The discussion becomes increasingly heated, drawing the boy's cousins away from the rides. The lights and noise of the fair fade as lines dwindle and the rides grow silent.
All the while, the confused boy is wondering why his father just stands there, refusing to criticize the grandfathers and uncles even as the argue increasingly silly positions. Finally, the father, realizing the boy's confusion, turns to him and says "Reaching consensus in the family is always more important than the fair." The arguing continues as employees begin to turn off the rides, one by one.
This, I believe, is an apt analogy of the current state of monetary policy. A policy that is supporting disinflationary expectations simply because it lacks a credible commitment to any other outcome.
Why does policy lack a credible commitment? First, as I think has been clear from day one of the Fed's quantitative easing policy, policymakers eagerly await the opportunity to reduce the balance sheet - the expansion of the balance sheet was never intended to yield a permanent increase in the money supply, and as such should have had little impact on long run expectations. As recently as Federal Reserve Chairman Ben Bernanke's July Congressional testimony, policymakers were stressing the ability of the Fed to reduce the balance sheet, clearly much more concerned about the inflationary potential of their actions than the ongoing disinflationary impact of being stuck at a subpar equilibrium. Only recently has attention turned to the possibility of additional action, and then only under critical pressure. When additional action is taken, it will almost certainly be in the context of a temporary action, the Fed will stand ready to withdraw the stimulus should it look like economic agents are having any fun with that infusion of cash.
Moreover, I do not believe the swelling of the balance sheet - albeit massive in the eyes of policymakers - sufficed to convince market participants that the Fed was committed to maintaining inflation expectations. St. Louis Federal Reserve Chairman James Bullard, in his "Seven Faces" paper, claims that the suggestions that the appropriate Federal Funds target should have been negative 6% are "nonsensical." And, of course, in a sense they are - zero is indeed the lower bound. But economists also suggested estimates of the quantitative equivalent of negative 6%, perhaps something on the order of a balance sheet expansion to $10 trillion, far beyond what Fed policymakers found tolerable. And I think that big number was important - it gave an indication of the size of monetary commitment consistent with previous policy response. The failure to meet that commitment could reasonably be interpreted by market participants as an indication the Fed was willing to accept the disinflationary impact of the Great Recession, perhaps so far as seeing the event as another opportunity for opportunistic disinflation.
Moreover, any sense that the policy action to date was acceptably insufficient was reinforced by the Fed's own forecasts, which undeniably reveal an expectation that policymakers anticipate an agonizingly long recovery, yet decline to add additional stimulus. Recall that the most recent FOMC decision only prevents premature tightening of policy, not a stimulus boost. Moreover, consider Bullard's remarks Friday:
Sunday, September 12, 2010
Two days ago, the Wall Street Journal published a "symposium," titled "What Should the Federal Reserve Do Next," with short pieces by John Taylor, Richard Fisher (Dallas Fed President), Frederic Mishkin, Ronald McKinnon, Vincent Reinhart, and Allan Meltzer. The WSJ picked a group of conservative economists with a considerable amount of accumulated policy experience among them, and including one sitting Federal Reserve Bank President (Fisher). One would think we could get something useful out of these guys. Well, apparently not.
While I mostly agree with what he says, I have a few quibbles. Stephen Williamson says:
Many central banks focus on "core" measures of inflation. I think that's nonsense. The idea is that we should ignore volatile prices when we think about inflation targeting, which seems akin to ignoring investment and consumer durables expenditures during recessions. Some people draw distinctions between prices that are "sticky" and those that are not, which seems like a related, and equally bad, idea. Since the costs of inflation are related to the fact that we write contracts in nominal terms, which makes inflation uncertainty bad, it seems we should aim for predictability in the rate of change in the broadest possible measure of the price level, which for me is the implicit GDP price deflator.
Monetary policy works with a lag, so we need to know about inflation in the future -- that's the target we are trying to hit. There is evidence core inflation is better than headline inflation at predicting future headline inflation. Here's Mike Bryan of the Cleveland Fed (see here too):
Michael Bryan, an economist at the Cleveland Fed, says the bank’s trimmed mean consumer price index does a better job in the short term at predicting future overall inflation than core inflation does. “It’s really reducing the noise and improving the signal,” Bryan said. “There’s almost no signal in the overall month-to-month CPI.”
The same is true for inflationary expectations. I should add that the evidence is a bit more mixed than this implies, e.g. there is one paper that argues the core inflation rate produces a biased estimate of future inflation, but my point is that there isn't an open and shut case against the use of core inflation even if you think headline inflation is the right quantity to target. We also differ on which price measure to use, I prefer the PCE index rather than the nominal GDP deflator since I think it produces a measure closer to what we have in mind in our theoretical models.
I should also add that the objection to using a weighted price index, perhaps one that includes wages and asset prices in addition to the usual components -- where the weights are based upon the degree of stickiness -- is really an objection to the underlying mechanism used to model price stickiness (the "Calvo Fairy"). If you accept the mechanism, then this approach has theoretical support (see here for a discussion from Woodford on this point).
He also objects to the use of the output gap in the Taylor rule, partly based upon measurement issues, and calls for pure inflation targeting. However, while I agree measurement is always a difficult issue, one that goes beyond concerns about how to measure the gap (e.g. which inflation measure is best?), that concern is not uncommon and not enough to pose an insurmountable objection. More importantly, the literature on divine coincidence (here and here) suggests that there can be advantages to a rule that includes gap measures. That is, a pure inflation target does not do as good a job of maximizing welfare as a rule that includes both inflation target and and output gap components.
But I have no disagreement at all with his (mostly negative) comments regarding the contributions of Fisher, Taylor, and Meltzer. On Fisher he says:
Let's start with the low point. Fisher should win the bad analogy contest with this:One might assume that with more than $1 trillion in excess bank reserves and significant amounts of cash held by businesses, the gas tank of those who have the capacity to hire is reasonably full. One might also conclude that the Fed, having cut the cost of interbank overnight lending to near zero and used quantitative easing to coax the entire yield curve downward, has driven the cost of gas to virtually nil for businesses that are creditworthy. And yet businesses still aren't hiring.So, the gas is in the tank, the Fed has done all it can by making the cost of gas zero. So why won't the car go? Fisher says:If businesses are more certain about future policy, they'll release the liquidity they're now hoarding.He's talking about fiscal policy:Fiscal and regulatory authorities share significant responsibility for incentivizing economic behavior through taxes, spending and rule making.So, apparently the person driving the car, which is full of cheap gas, is paralyzed with fear - he or she might get stopped at the toll both, have to obey speed limits, etc. If Fisher is worried about policy uncertainty, he should probably clean his own house first (to use another analogy). What does the Fed intend to do with the more than $1 trillion in mortgage-backed securities (MBS) on its balance sheet. Will it hold those forever? Will they be sold off slowly? If so, when, and at what rate? What's with that "extended period" language in the FOMC policy statement? How long is that period? How do we know when it is time for the Fed to tighten? When the time comes to tighten, how does the Fed intend to do it - raise the interest rate on reserves, sell Treasuries, sell MBS?
Finally, Williamson doesn't discuss the contributions of Reinhardt, McKinnon, and Mishkin, and while Mishkin and McKinnon deserve to be ignored, I thought Reinhardt had the most reasonable answer, one I could support:
The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower trend would similarly be reassured that the Fed would not keep its foot on the accelerator for too long. Most importantly, by linking to economic conditions, the Fed would not be providing an open-ended promise to monetize the federal debt.
Friday, September 10, 2010
Too little too late is better than nothing at all:
Things Could Be Worse, by Paul Krugman, Commentary, NY Times: ...In the 1990s, Japan conducted a dress rehearsal for the crisis that struck much of the world in 2008. Runaway banks fueled a bubble in land prices; when the bubble burst, these banks were severely weakened, as were the balance sheets of everyone who had borrowed in the belief that land prices would stay high. The result was protracted economic weakness.
And the policy response was too little, too late. The Bank of Japan ... was always behind the curve and persistent deflation took hold. The government propped up employment with public works programs, but its efforts were never focused enough to start a self-sustaining recovery. Banks were kept afloat, but were slow to face up to bad debts and resume lending. The result of inadequate policy was an economy that remains depressed to this day.
Yet the picture is grayish rather than pitch black. Japan’s economy may be depressed, but it’s not in a depression. The employment picture has been troubled... But thanks to those government job-creation plans, the country isn’t suffering mass unemployment. Debt has risen, but despite constant warnings of imminent crisis — and even downgrades from rating agencies back in 2002 — the government is still able to borrow, long term, at an interest rate of only 1.1 percent.
In short, Japan’s performance has been disappointing but not disastrous. And given the policy agenda of America’s right, that’s a performance we may wish we’d managed to match.
Like their Japanese counterparts, American policy makers initially responded to a burst bubble and a financial crisis with half-measures. ... The question is: What happens now?
Republican obstruction means that the best we can hope for in the near future are palliative measures — modest additional spending like the infrastructure program President Obama proposed this week, aid to state and local governments to help them avoid severe further cutbacks, aid to the unemployed to reduce hardship and maintain spending power.
Even with such measures, we’ll be lucky to do as well as Japan did at limiting the human and economic cost of the economy’s financial woes. But it’s by no means certain that we’ll do even that much. If the Republicans go beyond obstruction to actually setting policy — which they might if they win big in November — we’ll be on our way to economic performance that makes Japan look like the promised land.
It’s hard to overstate how destructive the economic ideas offered earlier this week by John Boehner, the House minority leader, would be... Basically, he proposes two things: large tax cuts for the wealthy that would increase the budget deficit while doing little to support the economy, and sharp spending cuts that would depress the economy while doing little to improve budget prospects. Fewer jobs and bigger deficits — the perfect combination.
More broadly, if Republicans regain power, they will surely do what they did during the Bush years: they won’t seriously try to address the economy’s troubles; they’ll just use those troubles as an excuse to push the usual agenda, including Social Security privatization. They’ll also surely try to repeal health reform, which would be another twofer, reducing economic security even as it increases long-term deficits.
So I find myself almost envying the Japanese. Yes, their performance has been disappointing. But things could have been worse. And the case Democrats now need to make — the case the president finally began to make in Cleveland this week — is that if Republicans regain power, things will indeed be worse. Americans, understandably, are disappointed over, frustrated with and angry about the state of the economy; but disappointment is better than disaster.
Thursday, September 09, 2010
The WSJ asked several people, mostly on the right, about whether the Fed has the power to do more. John Taylor's answer was predictable, the problem is that they aren't following the Taylor rule and the sooner they get back to it, the better, so I'll move on to the next participant, Richard Fisher of the Dallas Fed.
Fisher is predictably hawkish, adopts the GOP line on business uncertainty causing problems, and concludes:
The minutes of the last Federal Open Market Committee (FOMC) meeting noted that "a number of participants reported that business contacts again indicated that uncertainty about future taxes, regulations, and health-care costs made them reluctant to expand their workforces." ... Can the Fed do more to propel job creation? Barring an unforeseen shock, I would be reluctant to expand the Fed's balance sheet... Of course, if the fiscal and regulatory authorities are able to dispel the angst that FOMC participants are reporting, further accommodation may not be needed. If businesses are more certain about future policy, they'll release the liquidity they're now hoarding.
The claim that business uncertainty is holding up the recovery will appear again below, so I'll hold off with the evidence against it.
Next is Frederic Mishkin. I wasn't sure how he'd answer. He's fearful that debt monetization will lead to lack of fiscal discipline, that losses on asset purchases might lead to a loss of Fed independence, and that all roads lead to inflation:
The ... Fed's recent announcement that it will reinvest payments from agency debt and mortgage-backed securities into long-term Treasurys has opened the door to large-scale asset purchases. Should the Fed pull the trigger?
Purchasing long-term Treasurys might suggest that the Fed is accommodating the fiscal authorities by monetizing the debt—thereby weakening the government's incentives to come to grips with our long-term fiscal problems. In addition, major holdings of long-term securities expose the Fed's balance sheet to potentially large losses if interest rates rise.
Such losses would result in severe criticism of the Fed and a weakening of its independence. Both the weakening of its independence and the perception that the Fed is willing to monetize the debt could lead to increased expectations for inflation sometime in the future. That would make it much harder for the Fed to contain inflation and promote a healthy economy.
Expanding the Fed's balance sheet through large-scale asset purchases can be necessary in extraordinary circumstances, such as during the depths of the recent financial crisis. But in relatively normal times, the costs of using this tool are sufficiently high that it should not be used lightly.
Relatively normal times? Now? Ah, he means relatively normal on Wall Street, not Main Street. Anyway, next up, Ronald McKinnon. He wants to "spring the near zero interest rate liquidity trap" by, essentially, increasing interest rates. That's a bad policy, so let's move on.
I didn't expect Vincent Reinhart to be the most reasonable of the bunch, though perhaps given the bunch that was selected it might have been a good bet. I could sign on to something along these lines:
The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower trend would similarly be reassured that the Fed would not keep its foot on the accelerator for too long. Most importantly, by linking to economic conditions, the Fed would not be providing an open-ended promise to monetize the federal debt.
Last up is Allan Meltzer, and he follows Taylor in calling for the Taylor rule, and he, like Fisher, adopts the "government policy is creating business uncertainty" line:
When Congress established the Fed in 1913, it gave it a dual mandate: high employment and price stability. In its nearly 100-year history, the Fed has achieved both objectives only rarely: 1923-1928, a few years in the mid-1950s and early 1960s, and from 1985 to 2004, when the Fed followed the Taylor rule that incorporates Congress's mandate. Those 20 years when the Fed followed the rule were the longest sustained period of stable growth and low inflation in Federal Reserve history.
In "A History of the Federal Reserve," I concluded that the principal mistakes the Fed has made have resulted from giving excessive attention to current events... By focusing on the short-term, the Fed neglects the longer-term consequences of its actions. ... A rule would change that. ... At times like the present, a rule helps the Fed to recognize that current problems are mainly the result of mistaken government policies that create massive uncertainty.
The Fed added more than a trillion dollars of excess reserves to respond to the financial crisis. ... Adding a few hundred billion to the trillion dollars already available would ... do little for the economy that banks could not do now.
There is very little that the Fed can do to change the near-term, but it can have important influence on the future. The Fed has sacrificed much of its independence during this crisis by helping the Treasury carry out fiscal policy. Adopting and following a rule, like the Taylor rule, is an effective way to regain independence.
The second to the last paragraph misstates the case that people are making for Quantitative Easing. First, as Ben Bernanke, Joe Gagnon, and others have pointed out, research indicates that the Fed could move long-term rates down a bit with QE. If the Fed does this, it then creates an incentive for more business investment and the purchase of more consumer durables. Yes, banks have plenty of funds to lend, and this would give them more, but the problem is lack of demand, and lower interest rates are intended to boost demand back up a bit. It's the demand side effects that matter, not the increased supply of funds. Now, I happen to think that those effects wouldn't be as strong as we need by themselves, fiscal policy needs to join the effort, but the Fed has a role to play.
As for the business uncertainty claim, here's Paul Krugman:
So I just read the latest speech from Richard Fisher of the Dallas Fed; it’s one of the most depressing things I’ve read lately, and given what I read that’s saying a lot.
Much of the speech is taken up with arguing that it’s not the Fed’s job to help the struggling economy, because the big problem there is business uncertainty about future regulation. Urk. Like others, I’ve tried to point out that there is no evidence for this claim: business investment is no lower than you’d expect given the state of the economy, while surveys say that weak sales, not fear of regulation, are holding back business expansion. Oh, and just to make it perfect, Fisher cites Mort Zuckerman to bolster his case.
Back in April, I said I had given up on policy makers, they weren't going to do anything more for the economy, at least nothing beyond "token help" that they could use to political advantage. Every once in awhile I get my hopes up that monetary or fiscal policy authorities might take action after all, but I shouldn't. Lucy always takes the football away.
Wednesday, September 08, 2010
Minnesota Fed president Narayana Kocherlakota says once again that there's little that monetary policy can do for the unemployment problem because it's largely structural (here's Brad DeLong's reaction, see here too). However, researchers at the Cleveland Fed say their estimates tell a different story:
The dramatic jump in the actual unemployment rate we have observed since the beginning of the recession is being interpreted in our flows-based analysis as largely a cyclical phenomenon, with little movement in the long-term rate. The long-run trend does appear to have increased from its prerecession level, but by only a small margin.
The natural rate of unemployment is not 9.6 percent, the current unemployment rate. It's not even close to that (the Cleveland Fed says it's "roughly 5.6 percent to 5.7 percent"). But even if it was as high as 7.5 percent (to be clear, this is a hypothetical), are we just going to give up on the other 2.1 percent? I think that the cyclical component is a lot larger than 2.1 percent, and that even if there is a sizable structural problem there are still things we can do to help the structural transition along, including using low long-term interest rates to encourage the investment that helps that structural change happen faster. But even if you think the natural rate has increased quite a bit, and there's nothing the Fed can do for the structurally unemployed, it hasn't gone up as high as 9.6% and there's no reason to give up on those who can be helped.
And they do need help. As the Cleveland Fed notes in the link given above, even though the problem is largely cyclical in their view, it's looking like a long recovery is ahead:
Since we have not seen a big rise in the long-term unemployment rate, we might expect to converge to this “natural” rate soon. Unfortunately, this is not likely to be the case, and there are several reasons to suspect that the adjustment might take a long time. The first is the sheer extent of the gap between the current and long-term unemployment rates, regardless of the specific long-term rate one believes holds (figure 6). ... When the U.S. economy experienced a similar-size gap after the 1981–1982 recession, it took several years for the observed unemployment rate to drop to levels closer to the trend.
And it might be even harder for the labor market to adjust this time around. The rate of adjustment depends on how fast workers are reallocated between unemployment and the available jobs. The slower rates of worker reallocation we have found may act to slow the closing of the unemployment gap.
There are other reasons to believe that unemployment rates may stay well above the long-term rate for an extended period of time. Because of the length of the recession, there is a considerable number of potential workers who are not formally in the labor force. We have seen one of the sharpest drops in the labor force participation rate in the postwar data, as many unemployed workers simply stopped looking for a job. If some of these discouraged workers decide to search for a job as aggregate economic activity picks up, unemployment might decline at an even slower rate because the pool of unemployed workers is being replenished with workers re-entering the labor force.
Another concern raised by our findings is the negative impact of long-term unemployment on the human capital of the workforce. Longer unemployment spells are a problem because unemployed workers who are unemployed for too long can lose industry- and job-specific skills. Losing skills can reduce their odds of finding a job during the recovery as well as lower their productivity when they finally do find one.
Ultimately, an increase in the demand for labor will determine how fast the unemployment stock will be depleted. ...
Continuing the last point, we are simply not doing enough to create the labor demand that is needed. And, unfortunately, the claim that the problem is almost all structural and therefore there's little we can do is one of the things standing in the way of giving labor markets the help that they need.
When I teach the History of Economic Thought, one thing we focus on is how views on the role of the state have changed over time. It has a natural cycle to it, with eras such as the highly interventionist Mercantilist years followed by Physiocratic and Classical views stressing minimal government intervention. This is followed by a rebound in the other direction, and so it goes with a Keynes followed by a Friedman in the 50s, a rebound back to Keynes in the 60s, to classical ideas following the experience of the 70s, and so on, and so on. We are involved in the same debate, and a smaller version of the grand historical lurches in each direction, yet again today:
What is the role of the state?, by Martin Wolf: It is ... a good time to ask ... the biggest question in political economy: what is the role of the state? This question has concerned western thinkers at least since Plato (5th-4th century BCE). It has also concerned thinkers in other cultural traditions... The perspective here is that of the contemporary democratic west.
The core purpose of the state is protection. This view would be shared by everybody, except anarchists... Contemporary Somalia shows the horrors that can befall a stateless society. Yet horrors can also befall a society with an over-mighty state. ...
Mancur Olson argued that the state was a “stationary bandit”. A stationary bandit is better than a “roving bandit”, because the latter has no interest in developing the economy, while the former does. But it may not be much better, because those who control the state will seek to extract the surplus over subsistence generated by those under their control.
In the contemporary west, there are three protections against undue exploitation by the stationary bandit: exit, voice ... and restraint. By “exit”, I mean the possibility of escaping from the control of a given jurisdiction, by emigration, capital flight or some form of market exchange. By “voice”, I mean a degree of control over, the state, most obviously by voting. By “restraint”, I mean independent courts, division of powers, federalism and entrenched rights.
This, then, is a brief background to ... the problem, which is defining what a democratic state ... is entitled to do. ...
There exists a strand in classical liberal or, in contemporary US parlance, libertarian thought which believes the answer is to define the role of the state so narrowly and the rights of individuals so broadly that many political choices (the income tax or universal health care, for example) would be ruled out a priori. ... I view this as a hopeless strategy...
So what ought the protective role of the state to include? Again, in such a discussion, classical liberals would argue for the “night-watchman” role. The government’s responsibilities are limited to protecting individuals from coercion, fraud and theft and to defending the country from foreign aggression.
Yet once one has accepted the legitimacy of using coercion (taxation) to provide the goods listed above, there is no reason in principle why one should not accept it for the provision of other goods that cannot be provided as well, or at all, by non-political means.
Those other measures would include addressing a range of externalities (e.g. pollution), providing information and supplying insurance against otherwise uninsurable risks, such as unemployment, spousal abandonment and so forth. The subsidization or public provision of childcare and education is a way to promote equality of opportunity. The subsidization or public provision of health insurance is a way to preserve life, unquestionably one of the purposes of the state. Safety standards are a way to protect people against the carelessness or malevolence of others or (more controversially) themselves. All these, then, are legitimate protective measures. The more complex the society and economy, the greater the range of the protections that will be sought.
What, then, are the objections to such actions? The answers might be: the proposed measures are ineffective..; the measures are unaffordable...; the measures encourage irresponsible behavior; and, at the limit, the measures restrict individual autonomy to an unacceptable degree. These are all, we should note, questions of consequences.
The vote is more evenly distributed than wealth and income. Thus, one would expect the tenor of democratic policymaking to be redistributive and so, indeed, it is. Those with wealth and income to protect will then make political power expensive to acquire and encourage potential supporters to focus on common enemies (inside and outside the country) and on cultural values. The more unequal are incomes and wealth and the more determined are the “haves” to avoid being compelled to support the “have-nots”, the more politics will take on such characteristics.
What are my personal views on how far the protective role of the state should go? In the 1970s, the view that democracy would collapse under the weight of its excessive promises seemed to me disturbingly true. I am no longer convinced of this... Moreover, the capacity for learning by democracies is greater than I had realized. The conservative movements of the 1980s were part of that learning. But they went too far in their confidence in market arrangements and their indifference to the social and political consequences of inequality. I would support state pensions, state-funded health insurance and state regulation of environmental and other externalities. I am happy to debate details.
The ancient Athenians called someone who had a purely private life “idiotes”. This is, of course, the origin of our word “idiot”. Individual liberty does indeed matter. But it is not the only thing that matters. The market is a remarkable social institution. But it is far from perfect. Democratic politics can be destructive. But it is much better than the alternatives. Each of us has an obligation, as a citizen, to make politics work as well as he (or she) can and to embrace the debate over a wide range of difficult choices that this entails.
Update: Read Martin Wolf’s response to readers’ comments
Protection, justice, correction of externalities, social insurance, and the provision of public goods (which I would like to have seen emphasized more above) are, in my view, legitimate roles of the state. I have more trouble when it comes to redistribution, I prefer that everyone have an equal chance in life with the chips falling where they may (with insurance against outcomes where individuals end up with too few chips). But redistribution to correct problems associated with, say, uncorrected market failures that redistribute income unfairly, or to compensate for an unequal playing field more generally, is another matter.
Saturday, September 04, 2010
The Fed has been under considerable pressure recently by those, me among them, who believe the Fed should use quantitative easing to lower long-term interest rates.
However, a temporary investment tax credit can provide the same incentives for business investment as a Fed induced fall in the long term interest rate, and then some, and that's not the only thing fiscal policy can do.The Fed can help, and should help, but fiscal policy can do even more.
Friday, September 03, 2010
Dennis Lockhart, president of the Atlanta Fed, makes it clear that presently he sees no need for more stimulus -- a slow, plodding recovery like we had in the previous two recession is the best we can expect. If we're on track to match those, there's no need to try to do better.
Here's David Altig of the Atlanta Fed discussing Lockhart's speech earlier today:
Optimism…pessimism…and a bit of perspective, by David Altig, macroblog: Here's how I'm tempted to summarize today's release of the August employment report from the U.S. Bureau of Labor Statistics: more of the same. That theme fits nicely with comments this morning from Atlanta Fed President Dennis Lockhart, in a speech at East Tennessee State University. Here he calls for a little perspective:
"Some commentators are reading recent economic data as suggesting the onset of a second recession and deflationary cycle. Quite naturally, business people and consumers aren't sure what to believe.
"At the last meeting of the Federal Open Market Committee (FOMC) in Washington, the committee made a decision that has been widely interpreted as signaling declining confidence in the strength and sustainability of the recovery….
"In my remarks today, I will provide a less alarmist interpretation of recent economic information and the Fed's recent policy decision. I will argue that, generally speaking, there was too much optimism in the early months and quarters of the recovery and now there may be excessive pessimism."
One point is that recoveries are not generally linear affairs:
"Growth at the end of last year and early part of this year was stronger than I anticipated while economic activity in the second and third quarters seems weaker than I expected.
"But such ups and downs are not unusual during a recovery. A little history: following the 2001 recession, gross domestic product (GDP) grew at the annualized rate of 3.5 percent in early 2002. Growth then decelerated to about 2 percent for the next two quarters then fell to almost zero in the fourth quarter. Entering 2003, growth edged up to a little over 1.5 percent and then accelerated from there to a sustained period of relatively strong growth for two years."
...Even in the rapid-growth, pre-1990 recoveries, there was generally a quarter or two of growth that underperformed. ...
But the better benchmarks will likely prove to be the slower-growth, low-employment recoveries post-1990. In addition to the 2001 experience noted by President Lockhart, the expansion that followed the 1990–91 recession stumbled along with quarterly growth rates of 2.7, 1.69, and 1.58 percent, before picking up to above-potential growth rates. Despite that, the eighth quarter after that recession's end clocked in at an anemic 0.75 percent.
So why are we content to match that performance instead of trying to improve? Why do we try to rationalize concerns instead (calling it "a bit of perspective")?:
What is more important is that there is a reasonably good explanation for why we might have hit a soft patch:
"Looking at the 2009–2010 recovery, it seems clear that some of the early strength was promoted by policies that pulled forward spending from the second and third quarters of this year. The recent sharp decline in housing-related indicators following the expiration of homebuyer tax credits is the most obvious example of this effect."
Given that expectation, wouldn't it have been nice to have someone, the Fed say, try to fill this hole until the private sector begins growing robustly on its own?
Back to David Altig:
Essentially, President Lockhart's is a simple message: don't ignore the short-term data, but be careful with getting too carried away with it as well.
"Simply stated, I was expecting a relatively modest recovery...
And he, along with other members of the Fed, is apparently content with that. Finally:
...with respect to that meeting, here is the main policy point:
"At the last meeting there were two important considerations as I saw it. First, as already discussed, some economic data came in weaker than expected, shifting the balance of risks to slower growth in the near term and further disinflation. Second, the Fed's holdings of MBS were projected to decline faster than previously thought because lower rates were generating heavy mortgage prepayments and refinancings.
"So, in the context of a softening economy, the FOMC was confronted with the prospect of unintended withdrawal of support for the recovery through a decline in the level of liquidity provided to the economy….
"That is how I interpret the decision announced following the August meeting—a small tactical change designed to preserve the level of liquidity provided to the system. I supported the committee's decision, but I do not view it as a fundamental change of outlook or strategy. I do not believe this change necessarily heralds the beginning of a period of further expansion of the Fed's balance sheet. Nor do I think the decision precludes a return to a policy of allowing the balance sheet to shrink on its own.
"I think the decision has been over-interpreted in some quarters."
So, again, the recovery is expected to plod along like we've seen in the past, at least that's the hope, and though the downside risk has increased and the Fed has the tools to try to help, it doesn't think it should use them.
My view is different.
David Beckworth pushes back against some posts that have appeared here and elsewhere recently (my view is that low interest rates played a role, as did regulatory failures, but these were not the only causes of the crisis):
What Role Did the Fed Play In the Housing Bubble?, by David Beckworth: I really did not want to revisit this question since I have already covered it here many times before. Folks, however, are talking about it again given its coverage at the Fed's Jackson Hole conference. Mark Thoma, for example, has posted several pieces on it in the past few days. Most of this renewed discussion has taken a less critical view of the Fed's role during the housing boom, specifically the role played by the Fed's low interest rate policy. I feel compelled to rebut this Fed love fest since there are compelling reasons to believe the Fed did play an important role in creating the housing boom. To be clear, I do not see the Fed as the only contributor--far from it--but it does appear to be one of the more important ones. Here is my list of reasons why:
(1) The Fed kept its policy interest rate, the federal funds rate, below the natural or neutral interest rate for an extended period. It is not correct to say the Fed kept interest rates very low and thus monetary policy was very loose. Interest rates can be low because the economy is weak, not just because monetary policy is stimulative. Interest rates only indicate a loosening of monetary policy if they are low relative to the neutral interest rate, the interest rate level consistent with a closed output gap ( i.e. the economy operating at its full potential). There is ample evidence that the Fed during the 2002-2004 period pushed the federal funds rate well below the neutral interest rate level. For example, see Laubach and Williams (2003) or this ECB study (2007). Below is graph that shows the Laubach and Williams natural interest rate minus the real federal funds rate. This spread provides a measure on the stance of monetary policy--the larger it is the looser is monetary policy and vice versa. This figure shows that monetary policy was unusually accommodative during this time. This figure also indicates an important development behind the large gap was that the productivity boom at that time kept the neutral interested elevated even as the Fed held down the real federal funds rate.
(2) Given the excessive monetary easing shown above, the Fed helped create a credit boom that found its way--via financial innovation, lax governance (both private and public), and misaligned incentives--into the housing market. Housing market activity was further reinforced by "the search for yield" created by the Fed's low interest rates. The low interest rates at the time encouraged investors to take on riskier investments than they otherwise would have. Some of those riskier investments end up being tied to housing. Thus, the risk-taking channel of monetary policy added more fuel to the housing boom.
(3) Given the Fed's monetary superpower status, its loose monetary policy got exported across the globe. As a result, the Fed helped create a global liquidity glut that in turn helped fuel a global housing boom. The Fed is a global monetary hegemon. It holds the world's main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy was exported to much of the emerging world at this time. This means that the other two monetary powers, the ECB and Japan, had to be mindful of U.S. monetary policy lest their currencies becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. As as result, the Fed's loose monetary policy also got exported to some degree to Japan and the Euro area. From this perspective it is easy to understand how the Fed could have created a global liquidity glut in the early-to-mid 2000s. Inevitably, some of this global liquidity glut got recycled back into the U.S. economy and further fueled the housing boom (i.e. the dollar block countries had to buy up more dollars as the Fed loosened policy and these funds got recycled via Treasury purchases back to the U.S. economy). Below is a picture from Sebastian Becker of Deutsche Bank that highlights this surge in global liquidity:
For these reasons I believe the Fed played a major role in the credit and housing boom during the early-to-mid 2000s. Let me close by directing you to Barry Ritholtz who gives more details on how the Fed's policy distorted incentives in financial markets.
Wednesday, September 01, 2010
Here's a summary of:
I also explain one reason I'm so furstrated with fiscal policymakers.
Tuesday, August 31, 2010
Via email, Jim Bullard, President of the St. Louis Fed, responds to Tim Duy:
I read your "Fed watch" column this morning in our news clips. You do an excellent job of summarizing important issues facing the FOMC. I have three comments, all of which I have made publicly recently, and I think they are critical ones for the direction policy will take:
--on the "raising interest rates" question: I am not sure if you have looked at my paper, "Seven Faces of the Peril," but if not please take a look at Figure 1 there (web page below) and contemplate the left hand side of the picture. This convinces me that staying with the near-zero interest rate policy alone--and promising to stay near-zero for a long time without doing anything else--risks a deflationary trap. To avoid this, I am recommending additional QE as a supplement to the near-zero rate policy as our best option. You actually have one of the world's experts on the question of the dynamics behind Figure 1 at the U. of Oregon: George Evans. Rajiv Sethi's summary of this issue as linked in your blog is very good, but citing Howitt--a fine paper, to be sure--is missing the more sophisticated analysis of Evans and Honkapohja that I cite in my paper. I am not saying I necessarily agree with the Evans and Honkapohja policy conclusions, but they have good analytics for framing these issues.
--on the effectiveness of QE: I do not agree that asset purchases are somehow ineffective. I talk about this in my CNBC interview at Jackson Hole (also posted on my web page). The direct empirical evidence on the effectiveness of QE both in the U.S. and the U.K. is fairly strong. For example, see the paper by Chris Neely of our staff cited in the "Perils" paper.
--on the "disciplined" QE program: The quote from Vince Reinhart, who is a great guy, gives the "shock and awe" view of QE. I do not think this is remotely correct. We know how monetary policy works: through the expected future path of policy, not through the actual move on a particular day. When we make 25 basis point moves on the federal funds rate, those are small viewed in isolation, but they have important effects for macroeconomic stabilization because they imply an expected interest rate path over the coming years. The same is true for QE. A move on a particular day may seem small, but it implies a path for future policy, and a series of smaller moves may add up to a very large move if the incoming data are consistent with such an outcome. The "shock and awe" view, if applied to interest rate targeting, would suggest very large interest rate movements in response to relatively small changes in incoming data, a policy that most would view as destabilizing for the macroeconomy. The same is true for QE. So the point is that QE moves should be commensurate with the incoming data (a.k.a. "state contingent"). Of course we can argue about the incoming data--and I know you have strong views on that--but I think my position on a "disciplined" QE program is correct and that the dangerous policy is to make destabilizing moves out of line with the incoming data. Concerning the data itself, your colleague Jeremy Piger will update his recession probabilities shortly so I will be anxious to see how that comes out.
I hope these comments are not too confused, I enjoyed your blog and I think you do a fine job of tracking the issues in the Fed.
I am about to do a video with George Evans who will explain the issues involved with dynamics at the zero bound, how Howitt fits in, how learning changes things, etc., so please stay tuned...
Tim Duy is "anything but" reassured by Ben Bernanke's recent speech outlining the Fed's possible policy actions, and what it will take to put them into action:
Unless every able American pitches in, Congress and I cannot do the job. Winning our fight against inflation and waste involves total mobilization of America's greatest resources—the brains, the skills, and the willpower of the American people. --- President Gerald Rudolph Ford, "Whip Inflation Now" Speech (October 8, 1974)Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. --- Federal Reserve Chairman Ben Bernanke, "The Economic Outlook and Monetary Policy" Speech (August 27, 2010)
Rereading Federal Reserve Chairman Ben Bernanke's recent speech and measuring it against the incoming data leaves me with a pit in my stomach. I sense Bernanke reveals in this speech he is the proverbial emperor without clothes, short on policy options but long on hope. A last ditch attempt to persuade us that as long as we don't believe deflation will be a problem, it will not be a problem. But he faces the same challenge as did then President Gerald Ford. All hat and no cattle. You need to be ready to back up your talk with credible policy options. While Bernanke outlined possible policy options, reading between the lines makes clear he lacks conviction in the viability of any of those options. Simply put, Bernanke is not ready to embrace the paradigm shift bold action requires.
First, it is worth considering the economic context of the policy environment via the lens of July Personal Income and Outlays report. Real gains fells short of what I believe to be already diminished expectations, with a clearly suboptimal trend in place:
When Bernanke expresses concern for the near term pace of economic growth, he is concerned with failing to track the current path of economic activity, as illustrated by the path of consumption since July of last year. This already is a substantial lowering of the bar, and appears to be a resignation that previous trends are unattainable. That is a problem in many respects, the most important of which is that previous trends were consistent with full employment. The failure to acknowledge the importance of re-achieving the previous path is, in my opinion, an admission of the willingness to accept a protracted period of high unemployment. This, of course, has been essentially admitted by Bernanke:Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.
As I have already commented, if unemployment is a concern, and there is no conflict between the Fed's dual mandate, then why is the Fed waiting for further evidence of disinflation before acting? Indeed, Scott Sumner saw a line in the sand in Bernanke's speech of a one percent inflation rate. The most recent PCE data suggests we are perilously close to testing that line already:
Monday, August 30, 2010
Let me explain, as simply as I can, the underlying reason for the strong reaction to Minnesota Fed president Narayana Kocherlakota's suggestion that raising interest rates would be helpful.
When a Federal Reserve president calls for an increase in interest rates while the economy is still struggling to recover, something that repeats the errors of 1937-38, all of his buddies in academia should expect a reaction. It comes with the job. The fact that he can point to a model that failed to provide much help with the situation we're in to justify the statement isn't of much comfort, and there are serious questions about the validity of the claim in any case.
This isn't just a theoretical exercise where finding novel, counter-intuitive results that may or may not have real world applicability draws the admiration of peers, people's livelihoods are at stake. Real people in the real world are depending on the Fed to get this right, and suggestions that the Fed raise interest rates to help with the recession go against every intuitive bone I have in my body. More importantly, for those who think those bones might be broken, it goes against the existing empirical evidence. This is not a game, actual policy is at stake that will affect people's lives, and we cannot be careless in how we approach it.
If I reacted strongly, it's because I don't want us to repeat the mistakes we made in the past, mistakes that would hurt people who have suffered enough already. Do the advocates of this policy really believe, way down deep, that raising interest rates is the right thing to do in this situation? Perhaps, but I sure don't, and I can't let it pass without comment.
Sunday, August 29, 2010
It falls to the Fed to fuel recovery, by Clive Crook, Commentary, Financial Times: The US recovery is stalling. As a matter of economics the balance of risks strongly favors further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America’s leaders are letting the country down. ...
Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.
The political problem is that US voters ... have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the ... first package...
One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession’s downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama’s defense of his policy has been strangely diffident. ...
Meanwhile, there is monetary policy. At the end of last week,... Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. ... Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. ... But the balance of risks has moved. They need to go further. ...
This has annoyed me for several years now. Why won't the Kansas City Fed make the papers for the Jackson Hole conference available until after the conference is over? What's the purpose of this? None that I can think of, other than making themselves special, but that's no way for a public agency to behave.
This is the opposite of transparency. I can understand waiting until the final versions are submitted, but at that point, why not post the papers so we can read them prior to the conference and give more informed commentary on the event? As it stands, I have to rely upon reporters to accurately tell me what's in the papers and, while I do trust some of them to mostly get things right (but not all), I'd like to be able to check the papers for myself. Sometimes participants will give a report after the event is over, but that's a bit late and even then I'd like to be able to come to my own conclusions, or at least verify the reports from reading the papers themselves. What's the point in locking them up? (As far as I can tell, the authors aren't even allowed to post the papers on their own sites.)
The pdfs will also be copy protected when they are posted, another step that places unnecessary hurdles in the way of commenting on the papers. Under the KC Fed's policy, which extends to speeches by the president of the KC Fed but isn't followed by other district banks, reproducing a graph or a few paragraphs then becomes tedious. The copy protection doesn't stop anyone who really wants to post a paragraph or two as you are permitted to do, it's simply harder and hence discouraging (and the speeches themselves are supposed to be in the public domain and hence fully reproducible). But why discourage conversation about these papers? Why make it so that we can't actually read the papers and comment on them until the conference is over and people have lost interest in the event. Why make it as hard as possible to even take small excerpts? How is that helpful?
Creating an exclusive event like this does give the people involved power, it makes them special, it gives them the power to include and exclude people, and so on. But their duty is to serve the public interests, not create a special little club that only some can participate in, and then dribble out the important information in a way that maintains their exclusivity and power.
I can live with the copy-protection, but the attempts to discourage access to the conference papers is puzzling when viewed through the Fed's mission to serve the public interest.
[Maybe I've missed something obvious, it certainly wouldn't be the first time that's happened, and there's a good reason for this policy. If someone at the KC Fed wants to explain why they can't do what most conferences do and make the papers available prior to or at the beginning of the conference, or at the very least at the time of or right after a session is over, I will post the explanation. It would be nice if the explanation also included the reasons for trying to lock up other documents such as Fed speeches, something no other Fed tries to do.]
Did low interest rates cause the financial crisis as John Taylor and others contend? (I've argued that the low interest rate policy contributed to the crisis, but by itself was not the major factor. That is roughly consistent with their conclusion, though their numbers on the degree to which interest rates mattered are lower than I would have predicted):
Can interest rates explain the US housing boom and bust?, by Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko: Between 2001 and the end of 2005, the Standard and Poor’s/Case-Shiller 20 City Composite House Price Index rose by 46% in real terms. By the first quarter of 2009 the index had dropped by about one-third before stabilizing. The volatility of the Federal Housing Finance Agency (FHFA) repeat-sales price index was less extreme but still severe. That index rose by 53% in real terms between 1996 and 2006 and then fell by 10% between 2006 and 2008. As many financial institutions had invested in or financed housing-related assets, the price decline helped precipitate enormous financial turmoil.
Much academic and policy work has focused on the role of interest rates and other credit market conditions in this great boom-bust cycle.
- One common explanation for the boom is that easily available credit, perhaps caused by a “global savings glut,” led to low real interest rates that boosted housing demand (Himmelberg et al. 2005, Mayer and Sinai 2009, Taylor 2009).
- Others have suggested that easy credit market terms, including low down payments and high mortgage approval rates, allowed many people to act at once and helped generate large, coordinated swings in housing markets (Khandani et al. 2009).
Those easy credit terms may have been a reflection of agency problems associated with mortgage securitization (Keys et al., 2009, 2010, Mian and Sufi, 2009 and 2010, Mian et al. 2008).
If correct, these theories would provide economists with comfort that we understood one of the great asset market gyrations of our time; they would also have potentially important implications for monetary and regulatory policy. But economists are far from reaching a consensus about the causes of the great housing market fluctuation. For example, Shiller (2003, 2006) long has argued that mass psychology is more important than any of the mechanisms suggested by the research cited above.
Re-evaluating the missing link
Motivated by this question, we re-evaluate the link between housing markets and credit market conditions, to determine if there are compelling conceptual or empirical reasons to believe that changes in credit conditions can explain the past decade’s housing market experience.
The discussion starts around the 2:00 minute mark. Via C&L
Holtz-Eakin is encouraging us to balance the budget even though the economy is still relatively weak, and in doing so, to make the same mistake we made during the Great Depression. A quick look at recent data, and all the talk about the chance of a double dip we've been hearing, shows that we are anything but certain we we will be back at full employment anytime soon. Recovery from a financial crisis is often a long, drawn out process, and that may be true this time as well, but that means the economy needs more help over a longer period, not a premature return to austerity that risks sending the economy back into recession.
Why would we want to risk sending the economy back into a recession by beginning to balance the budget before the economy is growing robustly on its own? Republicans believe some sort of confidence effect from the decline in the deficit -- one that cannot actually be observed in the data but is, nevertheless, asserted to be there anyway -- will somehow more than offset the certain decline in demand from the reduction in the government deficit. But the problem is that the decline in demand will have it's own confidence effect on businesses, one that is negative, more certain, and likely much larger than any positive effects from deficit reduction.
And is anyone else getting tired of the "Obama is creating business uncertainty" argument from the Party that is creating most of the uncertainty and uneasiness about what crazy things might happen should they be elected? It worked out so well for the economy the last time they were in power and emphasized growth above all else. We're still trying to get out of that sinkhole -- talk about creating uncertainty. In any case, as noted by Paul Krugman on the video, there's nothing at all to indicate that businesses are, in fact, holding back due to uncertainties created by the administration's policies. Businesses face lots of uncertainties due to lack of demand for their products, and perhaps over what might change if Republicans take power, something that can hardly be blamed on the administration. But balancing the budget as Holtz-Eakin would have us do would reduce demand and cause fewer paying customers to walk through their doors. That makes the uncertainty problem worse, not better.
Putting it more succinctly, the Party in power when we got into this mess wants to be given another chance so it can try policies that failed during the Great Depression. And some people think that's a good idea.
Friday, August 27, 2010
Tim Duy is puzzled by Ben Bernanke's reasons for keeping the Fed on hold:
Driving Me Crazy, by Tim Duy: No time for a long post this afternoon, just a short comment.
Today's speech by Federal Reserve Chairman Ben Bernanke contains one of those little inconsistencies that drives me nuts. In his assessment of economy:
The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.
I was already beginning to view this as a throw away line, something that Bernanke feels he has to say but doesn't really intend to worry much about. That sense was reinforced later in his speech:
Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.
If in the current environment - note that traditionally "current" means "right now" - there is already disinflation and little or no conflict between the dual mandates, then why, why, WHY do we need to wait until conditions deteriorate and risk additional disinflation before monetary policymakers turn to the problem of high unemployment that Bernanke claims distresses him?
If there is no conflict, then there is room to maneuver. Not later, now. So either Bernanke actually believes there is a conflict, or his concern about unemployment is disingenuous. I still don't know which.
My reaction to Bernanke's speech:
What would you add?
Why aren't monetary and fiscal policymakers doing more to boost the economy?:
This Is Not a Recovery, by Paul Krugman, Commentary, NY Times: What will Ben Bernanke, the Fed chairman, say in his big speech Friday in Jackson Hole, Wyo.? Will he hint at new steps to boost the economy? Stay tuned. ...
Unfortunately,... this isn’t a recovery, in any sense that matters. ... The important question is whether growth is fast enough to bring down sky-high unemployment. We need about 2.5 percent growth just to keep unemployment from rising... Yet growth is currently running somewhere between 1 and 2 percent, with a good chance that it will slow even further in the months ahead. Will the economy actually enter a double dip, with G.D.P. shrinking? Who cares? If unemployment rises for the rest of this year, which seems likely, it won’t matter whether the G.D.P. numbers are slightly positive or slightly negative.
All of this is obvious. Yet policy makers are in denial.
After its last monetary policy meeting, the Fed released a statement declaring that it “anticipates a gradual return to higher levels of resource utilization” — Fedspeak for falling unemployment. Nothing in the data supports that kind of optimism. Meanwhile, Tim Geithner, the Treasury secretary, says that “we’re on the road to recovery.” No, we aren’t.
Why are people who know better sugar-coating economic reality? The answer, I’m sorry to say, is that it’s all about evading responsibility.
In the case of the Fed, admitting that the economy isn’t recovering would put the institution under pressure to do more. And so far, at least, the Fed seems more afraid of the possible loss of face if it tries to help the economy and fails than it is of the costs to the American people if it does nothing, and settles for a recovery that isn’t.
In the case of the Obama administration, officials seem loath to admit that the original stimulus was too small. True, it was enough to limit the depth of the slump..., but it wasn’t big enough to bring unemployment down significantly.
Now,... officials could, with considerable justification, place the onus for the non-recovery on Republican obstructionism. But they’ve chosen, instead, to draw smiley faces on a grim picture, convincing nobody. And the likely result in November — big gains for the obstructionists — will paralyze policy for years to come.
So what should officials be doing, aside from telling the truth about the economy?
The Fed has a number of options. ... Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.
The administration has less freedom of action, since it can’t get legislation past the Republican blockade. But it still has options. It can revamp its deeply unsuccessful attempt to aid troubled homeowners. It can use Fannie Mae and Freddie Mac ... to engineer mortgage refinancing that puts money in the hands of American families — yes, Republicans will howl, but they’re doing that anyway. It can finally get serious about confronting China over its currency manipulation...
Which of these options should policy makers pursue? If I had my way, all of them.
I know what some players both at the Fed and in the administration will say: they’ll warn about the risks of doing anything unconventional. But we’ve already seen the consequences of playing it safe, and waiting for recovery to happen all by itself: it’s landed us in what looks increasingly like a permanent state of stagnation and high unemployment. It’s time to admit that what we have now isn’t a recovery, and do whatever we can to change that situation.
Thursday, August 26, 2010
I know how much some of you will disagree with this, but I have a hard time ascribing bad motives to people at the Fed and using it to explain policy decisions. I think people at the Fed believe in their heart of hearts that they are doing what's best for the economy as a whole as opposed to what's best for a particular party or some small group of people pulling the strings, but they are relying on bad assumptions, questionable models, convenient interpretations, etc. To me, some of the beliefs held by the other side are astoundingly unbelievable, but they would, of course, say the same thing about me. I don't deny that those beliefs can be convenient for the person holding them, but the idea that people at the Fed are consciously holding down the larger economy in order to benefit Republicans or some group of people is hard for me to buy into. There are certainly ideological divides that lead the other side to policies that I think are misdirected, or even counterproductive, but the bad motive explanation is hard to swallow. I'm more inclined to think this goes on in Congress where to some, winning the election is the only thing, but even then it's hard to assert this as a general proposition. But perhaps I have too much belief that people mostly try to do the right thing, and I am hopelessly trusting and naive (though see here). I expect to be told that I am.
Here's Andy Harless:
The Real Activity Suspension Program, by Andy Harless: (Think of this as a guest post by the Cynic in me. I’m not sure my Cynic is entirely right on either the facts or the economics, but he has a provocative point. And I apologize for the fact that he misuses the word “recession” to include the period since our inadequate recovery began.)
Americans got angry when the federal government tried to bail out banks by buying assets or taking capital positions. Whatever you may think of those bailout programs, they at least had the advantage that taxpayers were getting something in return for their money. There is another bank bailout program going on now – one that allows the federal government to recapitalize banks with public money, receive nothing at all in return, and somehow escape criticism for doing so. That bailout program is called the Recession.
How does the Recession allow the government to bail out banks? With the recession going on, people are afraid to do anything risky with their assets, so they keep them deposited in banks, earning no interest. Banks can then invest these deposits in Treasury notes and credit the interest on those Treasury notes to their bottom line, thus improving their balance sheets. So the government pays to recapitalize banks while receiving nothing in return.
Now this bailout program is not without its risks. The biggest risk is that the economy will recover, which would be a disaster for the program. Suddenly, not only would banks be holding losses on their Treasury notes, but their cost of funds would go up, as depositors realized that there were more attractive investments available than zero-interest bank deposits.
Another risk, with similar implications, is an increase in the expected inflation rate. That would also lead to capital losses on the banks’ Treasury note holdings and an increase in their cost of funds.
Finally, there is reinvestment risk. Treasury notes mature and need to be rolled over, the coupon payments need to be reinvested, and banks have new inflows of funds that need to be invested. A substantial decline in the yields on Treasury notes (perhaps a continuation of what we are seeing now) would benefit banks in the short run because of the capital gains involved, but ultimately it would effectively terminate the bailout program, since banks would no longer be able to earn a large spread on their safe investments.
So the success of this bailout program depends on avoiding recovery, avoiding increases in inflation expectations, and avoiding major declines in Treasury note yields. Now do you understand why the Federal Reserve Bank presidents – representatives of the banking sector – are the most hawkish voices at the FOMC’s policy meetings?
I'm getting some pushback on my post entitled "Jaws are Dropping," which is derived from a statement in one of the links I provided in the post. I think it must be either the title of the post or, when correcting a typo, the afterthought I added about the right answer to the question of whether a low federal funds rate eventually leads to a fall in inflation that has some people so worked up (good to see that Williamson has taking a break from his exhibitions of Krugman Derangement Syndrome, bashing Krugman seems to be the main point of his blog lately). It can't be anything else I said since my main point was that I didn't have time to say much about the whole controversy due to an impending deadline.
The main issue revolves around this statement from Minnesota Fed President Narayana Kocherlakota:
To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation
I think the assertion that it "must" lead to that outcome is unsupportable, there are models where that isn't true, but he means "must" in terms of a very specific model of how the economy works, including an assumption of the super neutrality of money (which is asserted as an uncontroversial assumption, but I'd quarrel with that). So, yes, it's possible to write down a very specific model that has this as an implication, but does that make it generally true? Not to me.
In any case, here's an email from a friend of Narayana defending his statements:
And, he sends along an update:
I rarely comment on posts on blogs, since most of the discussion seems to be most interested in scoring political points than in economic analysis. However today I will make an exception since Kocherlakota's words come directly from any standard treatment of monetary theory, and hence, they should have been anything except controversial.
In a large class of monetary models, the Euler equation of intertemporal maximization is:
FFR = (1/beta) *(u'(ct)/u'(ct+1))*inflation
where u'(.) is the marginal utility of consumption, FFR is the federal funds rate, and beta is the discount factor (see, for instance, equation 1.21 in page 71 of Mike Woodford's Interest and Prices for a derivation in a simple context).
Let us take first the case where money is neutral, probably an implausible case but a good starting point. In this situation, the ratio of marginal utilities is unaffected by the change in inflation or the FFR. Thus, a lower FFR means lower inflation. Otherwise, there are arbitrage opportunities left on the table. What is more, in such a world, the Fed can control inflation by controlling the FFR, so the relation is causal in a well-defined sense.
Now, let's move to the much more empirically relevant case of a New Keynesian model (here I am thinking about the standard NK model people use these days to analyze policy in the style of Mike Woodford, Larry Christiano or Martin Eichenbaum, with a lot of nominal and real rigidities, so I will not discuss the assumptions in detail).
Imagine that the Fed is targeting the FFR and decides to lower the long run target from, let's say 4% to 2%. What happens? Well, in the very short run, nominal rigidities imply that we will have a transition where inflation might (but not necessarily, it depends on details of the model) be temporarily higher but, after the necessary adjustments in the economy had occurred (adjustments that can be quite painful, generate large unemployment, and might reduce welfare by a considerable amount), we settle down in the lower inflation path. Again, the reason is that in most New Keynesian models, the ratio of marginal utilities is independent of the FFR (this will happen even in many models with long-run non-neutralities) and the Euler equation will reassert itself: the only way we can have a real interest rate of 3% when the target FFR is 2% is with a 1% deflation.
Hence, in the long run, as Kocherlakota's speech explicitly says:
"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."
An alternative way to see this is to think about a Taylor rule of the form:
Rt/R = (πt/π)γ
where γ>1 (here I am eliminating extra terms in the rule for clarity) where Rt is the FFR, R is the long run target for the FFR, πt is inflation, and π is the long run target for inflation. In a general equilibrium model, the Fed can only pick either R or π but not both. If it decides to pick a lower R, the only way the rule can work is through a fall in π.
While one may disagree with many aspects of modern monetary theory (and I have my own troubles with it), one must at least acknowledge that Kocherlakota's treatment of this issue or the relation between the FFR and inflation in the long run is what would appear in any standard macro model.
One thing I forgot to mention: I guess that the intuition that most people have (and that reacts in a somewhat surprised way to Narayana's words) comes from a New Keynesian model, where lowering the FFR with respect to what the Taylor rule indicates (what we call a "monetary shock") increases inflation in the short run. But here we are not talking about the effects on inflation of a transitory monetary shock, but, as Narayana clearly says in his speech, about the long run effects of a change in the target of the FFR.
If you commit to a single class of models and the interpretation of the shocks within them, the kind of models and interpretations that Narayana Kocherlakota has questioned, at least in their standard forms, and if you buy all the embedded assumptions that are needed to obtain the result, not all of which are easy to defend (e.g. the assumption of long-run neutrality), then yes, "must" is correct. But "must" must be interpreted in a rather limited context, and in a more general setting it's not at all clear that this result will hold.
However, my real problem with this defense is that it doesn't deal with the assertion that if real rates normalize and the Fed doesn't raise its target rate in response, it will lead to deflation., i.e. it doesn't address Nick Rowe's point. If the target real rate is below the normal real rate, how does that cause deflation? That's the part that caused the objection in the first place, and the part that still leaves me puzzled. Here's Nick:
"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."
That could be interpreted two ways: a wrong way, and maybe, just maybe, a right way.
"When real returns are normalized, inflationary expectations could well be negative, and there may still be a considerable amount of structural unemployment. If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation."
Nope. He definitely meant it the wrong way. If the economy returns to normal, and the natural rate of interest rises, the Fed must raise its target rate of interest. (So far so good). If it doesn't, the result would be....deflation. ("Inflation" would be the right answer).
I also wonder if a permanent shock is the right way to think about this type of a policy, but I'll leave that as a question since I don't want to distract from Nick's point.
Update: Here's more from Nick:
What standard monetary theory says about the relation between nominal interest rates and inflation, by Nick Rowe: This is what I understand "standard" monetary theory to say about the relation between inflation and nominal interest rates.
I want to distinguish two cases.
In the first case the central bank pegs the time-path of the money supply. The money supply is exogenous. The nominal interest rate is endogenous. Standard monetary theory says that a permanent 1 percentage point increase in the growth rate of the money supply will (in the long run) cause both the nominal interest rate and the rate of inflation to rise by 1 percentage point. The Fisher relation holds as a long-run equilibrium relationship. The real interest rate is unaffected by monetary policy in the long run.
In the second case the central bank pegs the time-path of the nominal rate of interest. The nominal interest rate is exogenous. The money supply is endogenous. Start in equilibrium (never mind how we got there). Standard monetary theory says that if the central bank pegs the time-path of the nominal interest rate permanently 1 percentage point higher, this will cause the price level, and the rate of inflation, and the stock of money, to fall without limit. The Fisher relation will not hold, because there is no process that will bring us to a new long run equilibrium. The real interest rate will rise without limit.
These two cases are very different, because a different variable is assumed exogenous in each case.
I am assuming super-neutrality of money, in long-run equilibrium. The Fisher relation is a long run equilibrium relationship. We never get to the new long-run equilibrium in the second case, and so the Fisher relation does not hold.
Update: Brad DeLong comments.
Is Ben Bernanke about to "stake out a public position"?:
Fed to Outline Future Actions Friday, by Sewell Chan, NY Times: With fresh signs that the housing market is weakening,... Ben S. Bernanke, on Friday will offer his outlook on the economy, explain the Fed’s recent modest move to halt the slide and possibly outline other actions. ...
It is not known what Mr. Bernanke will say, but some insight may come from an episode in his past: his concern, soon after he became a Fed governor, that the economy was at risk of deflation as the nation gradually recovered from the dot-com bust a decade ago.
Mr. Bernanke’s worry then is similar to what troubles the Fed now, and his views will have no small bearing on the Fed’s course of action. ... Whether policy makers should take big steps to tackle the economic doldrums — by printing even more money and buying even more assets — [is] the dominant question...
Within the central bank, several officials are alarmed at the threat of the economy falling into a dangerous cycle of declining demand, wages and prices not experienced since the Depression. They say that a deflationary, double-dip recession is unlikely, but want to formulate concrete steps to ward it off.
Other officials contend the economic indicators, while dismaying, do not represent an immediate threat, and worry that additional monetary stimulus by the Fed could erode the already shaky confidence of the markets, or even backfire by eventually spurring uncontrolled inflation. ...
The risks are not symmetric. An extended period of stagnation is a highly undesirable outcome, and the Fed needs to take steps to try to prevent this from happening.
Wednesday, August 25, 2010
Minnesota Fed President Narayana Kocherlakota recently argued that low interest rates will eventually cause inflation deflation (sorry for the typo, it's hard to write the wrong answer). I'm trying to understand why people at the Fed are so reluctant to do more to help the economy, what the reasoning is, etc., but I have to meet a deadline and need to stop using the blog as a distraction. So let me just note that there is a lot of "jaw dropping" over Kocherlakota's claim. See, for example, Andy Harless, Nick Rowe, and Robert Waldmann. [Please see the update to this post.]
More bad news about the economy. New home sales were at a record low during July:
Sales of new single-family houses in July 2010 were at a seasonally adjusted annual rate of 276,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 12.4 percent (±10.8%) below the revised June rate of 315,000 and is 32.4 percent (±8.7%) below the July 2009 estimate of 408,000.
And durable goods orders also came in well below expectations:
New orders for manufactured durable goods in July increased $0.6 billion or 0.3 percent to $193.0 billion, the U.S. Census Bureau announced today. This increase followed two consecutive monthly decreases including a 0.1 percent June decrease. Excluding transportation, new orders decreased 3.8 percent.
I wonder if the people at the Fed who are standing in the way of more help for the economy will revise their belief that the recovery is underway and, although it is proceeding slower than they'd like to see, nothing needs to be done, nothing more can be done, to help? I doubt they will, instead they'll find a way to fit this into the narrative they want to believe in. I'd ask a similar question about Congress, fiscal policy is likely to be more effective than monetary policy in a severe recession, but I gave up on them long ago.
Tuesday, August 24, 2010
The meeting was a case study in Mr. Bernanke's management style, which reflects his days as chairman of Princeton University's economics department when he had to manage a collection of argumentative academics with strong personalities and often divergent views. Mr. Bernanke encourages debate and disagreement, and then weighs in at the end with his own decision, which has helped him win loyalty at the Fed, even among those who disagree with him, several officials say.
Tim Duy responds:
Uuhhg – I am too tired to address the WSJ Fed piece, and I don’t have time to tackle the piece, but you can add this if you wish:
I understand why his colleagues appreciate Bernanke’s management style, and why the media likes to ooze quiet praise on that style, but shouldn’t he be showing some leadership in the public as well? After all, the Federal Reserve, last time I checked, was not a University economics department. It is not the same. As we like to say in academics, the disputes are bitter because so little is at stake. Not so for the Fed. As an institution, it serves the public directly, and much, much is at stake. Perhaps it is time for Bernanke to stake out a public position. How exactly does he view the current economic situation in light of his work on Japan? For many of us, that work points to a much more aggressive policy stance. Is this the direction Bernanke wants to take? If so, why is he dragging his heels? If not, then what is different? This is the conversation I want to see him have with the public, on the record. And the sooner, the better.
What good is served by leaving so much uncertainty over what the Fed is likely to do next if various scenarios such as a stronger, weaker, or stagnant economy unfold? What could be the reason for Bernanke's reluctance to take his case to the public?
If Bernanke takes a particular position on future policy, that makes it very difficult for the Fed to do anything else without losing its credibility, and hence makes it difficult for other members of the FOMC to vote against such a proposal no matter how much they might disagree. If the Fed chair indicates one thing, and then the Fed lurches in another direction, that will hurt the Fed's credibility at a time when it doesn't have any credibility to waste. Even if Bernanke tries to make it clear that he is expressing his own views and not speaking on behalf of the FOMC, his views will still set the benchmark for thinking about where the Fed is headed next.
Unlike the Fed under Greenspan where the Fed chair used his influence to determine policy pretty much on his own, Bernanke has attempted to make the Fed a "a collection of argumentative academics" where everyone is allowed to have a say in the outcome. If he goes out in public and binds the Fed in advance, that undermines the more democratic committee process he has tried to create.
Should we worry about that?
I'm not sure I want to go back to the days of Greenspan, the other members of the committee should at least have some say in the policy decisions. It's true that the chair of the Fed should have the most influence over policy, that's intended in the design of the Fed as an institution, but the Chair should not run the entire show.
However, when there is considerable uncertainty due to disagreement on the FOMC, the Fed chair needs to use the influence bestowed upon him or her by the Fed's institutional arrangements, set a firm course for policy, and resolve the uncertainly. That might mean having lots of informal discussions with other members of the FOMC to make sure their views get a fair hearing, and some back and forth in the process, but at some point the Fed chair needs to step up and lead. Right now is one of those times.
Monday, August 23, 2010
This gives us a better idea of who to blame for standing in the way of more aggressive policy from the Fed:
Fed Split on Move to Bolster Sluggish Economy, by Jon Hilsenrath, WSJ: The Aug. 10 meeting of top Federal Reserve officials was among the most contentious in Ben Bernanke's four-and-a-half year tenure as central bank chairman.
With the economic outlook unexpectedly darkening, the issue was a seemingly technical one: whether to alter the way the Fed manages its huge portfolio of securities.
But it had big implications: Doing so would plunge the Fed back into the markets and might be a prelude to a future easing of monetary policy, moves that divided the men and women atop the central bank. ... At the end of an extended debate, Mr. Bernanke settled the issue by pushing successfully to proceed with the move. ...
Before the meeting, officials at the Federal Reserve Bank of New York, which manages the Fed's portfolio, had grown concerned ... the ... Fed's portfolio of mortgage-backed securities was about to begin shrinking much more rapidly than anticipated, as low mortgage rates led more Americans to refinance their mortgages. ... A shrinking portfolio in the face of slowing economic growth was unwelcome to many officials, including New York Fed President William Dudley. It amounted to prematurely applying the brakes. ...
The declining mortgage portfolio was the focal point of debate. ... Officials spent very little time discussing the idea of expanding the securities portfolio beyond its current size. ...
Officials were clustered in two camps. In one camp, Mr. Dudley, and the presidents of the Boston and San Francisco Fed banks, Eric Rosengren and Janet Yellen, were distressed that the Fed was far from its objectives of low unemployment and stable inflation. ... This camp was more inclined to act.
The other camp was skeptical. Fed governor Kevin Warsh, a former Wall Street investment banker..., Richard Fisher, president of the Dallas Fed,... Narayana Kocherlakota, president of the Minneapolis Fed,... president of the Philadelphia Fed, Charles Plosser,.., Thomas Hoenig of Kansas City, and Jeffrey Lacker of Richmond...
After listening intently, Mr. Bernanke summed up the debate, acknowledged the disagreements, and then said that the Fed shouldn't allow the passive tightening of financial conditions that was being caused by its shrinking balance sheet. In practice, that would mean taking proceeds from nearly $400 billion in maturing mortgage bonds and buying Treasury debt. The Fed also needed to acknowledge the slower growth outlook, he said. ...
The formal vote—9 to 1—disguised the disagreements. ... [Only] Mr. Hoenig, as he has at every opportunity this year, formally dissented. ...
Now the internal debate turns to the future, particularly whether to do more, and if so whether to make small or large steps. ...
My view is that it will take even more bad news about the economy before the Fed will consider additional moves, and if it does move, it will move gradually.
The Fed has been behind the curve since before the crisis started. It didn't see the crisis coming, when the crisis did come it was going to be contained rather than spread and cause bigger problems, and when the problems spread they were going to be short-lived -- Bernanke saw green shoots long, long ago. Now we have Fed officials hesitating once again based upon their relatively rosy expectations for the recovery.
One of the lessons the Fed thinks it learned about inflation is that when you see it, you need to move aggressively. Interest rates should rise by more than one to one with the rise in inflation expectations (this is called the Taylor principle). If you chase inflation upward with gradual steps instead of getting out in front of it and capping it off, you won't catch it until it reaches a very high level, and you may not catch it at all in extreme cases.
But when it comes to the other half of the Fed's mandate, unemployment, there is no sense of urgency, gradualism is fine. But just like inflation, a strategy of delaying and only gradually responding to signals that a problem exists is asking for trouble. Policymakers learned this lesson when inflation was the big problem in the economy, but they haven't figured out that the same lesson applies to situations like we're in (because it's not a feature of models with Calvo price stickiness, the standard model used to evaluate such questions, but that model doesn't do a very good job of capturing the essential elements of our present situation).
Hesitation and gradualism has already allowed unemployment to move far ahead of policy. We need an aggressive move from the Fed to try to catch up, trying to close the gap with small steps in not going to work. But even if the outlook deteriorates further, I doubt that's what we'll get.
Tuesday, August 17, 2010
Here is my first column for the Fiscal Times, and there will be more to follow:
Some of you will be unhappy with the outlet. But I can't change the minds of people I can't talk to, and when it comes to certain groups, they aren't coming to me. So into the belly of the beast to stop the beast from being starved. Or something like that. I should add that I expect to have complete freedom in what I can say. If that turns out to be a false expectation, then I will stop doing this and I will let people know why. Also, I chose to begin by talking about the Fed's relationship to Congress, but it occurs to me that given how much many of you disagree with my views on the Fed, I might have chosen a different topic to start this off.
Monday, August 16, 2010
The Economist asks:
My stock answer is here. I decided to stay on message with regard to fiscal policy. I don't think we should let Congress off the hook as we criticize the Fed for its inadequate response. There are also responses from Viral Acharya, Laurence Kotlikoff, Guillermo Calvo, Michael Bordo, and Tom Gallagher, with (perhaps) more to follow. (all responses)
There is another question:
I didn't answer this one, but there are responses from Ricardo Hausmann, Alberto Alesina, Lant Pritchett, Daron Acemoglu, and Arvind Subramanian. Again, additional responses may follow. (all responses)
A Bleak View, by Tim Duy: Deferring to the faltering economy, the Federal Reserve stepped up its policy efforts last week. Barely. Almost imperceptibly. Indeed, it is almost as if the Fed could muster nothing better than throwing a bone to its critics. Will they throw more bones in the coming months? In this environment, I suspect the Fed will continue to do more than I expect, but less than is necessary.
The few data releases since the FOMC meeting have not been particularly encouraging. The trade deficit expanded, implying a downward revision to the Q2 GDP numbers. Initial unemployment claims continue to hover at levels consistent with weak job growth. University of Michigan consumer sentiment ticked up, but signals that households remain under severe pressure. Retail sales edged up in July, reinforcing the long standing trend of this recovery - an inability to grow fast enough to reestablish the previous trend:
One can argue that the previous trend was unsustainable, driven on the back of a clearly faulted debt-fueled asset bubble dynamic. But even accepting that hypothesis, that spending was critical to ensuring full employment. If consumers fall back, some other sector needs to step up to the plate. Otherwise, the economy will continue to limp along a suboptimal growth path.
Will FOMC members continue to accept that path? Acceptance is dependent on the inflation outlook. And on that point, the July CPI release, which revealed a slight increase in core inflation, leaves me unsettled. Given downward nominal wage rigidities, it is not that difficult to imagine an economy stuck significantly below potential output, but with just enough price pressures to sustain a slightly positive inflation rate. Absent a substantial output decline, would the Fed be inclined to significantly expand quantitative easing in the face of low, but positive, inflation, combined with positive inflation expectations? Apparently no, as this is a description of the current situation. More of the same is likely to produce little drips of monetary easing here and there, but it is difficult to see, for example, a commitment to purchase $200 billion of Treasuries each quarter until unemployment stands at 7%.
Is dramatic action necessary? I believe so, which, ironically, brings me to last Friday's speech by arch-hawk Kansas City Federal Reserve President Thomas Hoenig. Hoenig is stepping up his public criticism of the FOMC, lambasting his colleagues for setting the stage for another financial crisis. In short, Hoenig sees parallels to the deflation scare of 2003, which prompted the Fed to lower rates to 1%. Shortly thereafter, economic activity accelerated on the back of the housing bubble. We all know how that story ended. In Hoenig's view, this was essentially a repeat of the experience of the late 90's equity bubble and subsequent collapse. Hoenig concludes that it is important to break the cycle; he suggests dropping the "extended period" language, moving the Federal Funds rate to 1%, pausing, and then make a final move to 2%. He does not view this as tight policy, but instead accommodative yet firmer policy. Tough love.
Hoenig's story of policy induced bubbles is certainly not new. Indeed, the fluctuations in household net worth appear to be intimately related to the business cycle since 1995:
We tend to view these asset bubbles as "bad," but I think this pattern also poses an interesting question. If you remove the asset bubbles, what is left? It sure looks like nothing more than an economy stuck in a subpar equilibrium. Perhaps rather than diverting capital from productive investments, capital flowed into asset bubbles due to a lack of investment opportunities. It is not so far fetched; we know that firms are sitting on nearly two trillion dollars of cash yielding low returns.
In other words, were the asset bubbles critical to maintaining full employment? And if so, how can we reflate the economy in their absence? Hoenig believes we will restructure the economy over time, but his story is woefully incomplete:
… then how might GDP and important components perform? Let me start with consumption, which for decades amounted to about 63 percent of GDP. During the boom it rose to 70 percent. It seems reasonable that the consumer will most likely return toward more historical levels relative to GDP and then grow in line with income. If so, the consumer will contribute to growth but is unlikely to intensify its contribution to previously unsustainable levels….
…While businesses need to rebalance as well, they are essential to the strength of the recovery. Fortunately, they are in the early stages of doing just that. Profits are improving and corporate balance sheets for the nonfinancial sector are strengthening and are increasingly able to support investment growth as confidence in the economy rebuilds. Also, although credit supply and demand may be an issue impeding the recovery to some extent, a shortage of monetary stimulus is not the issue. There is enormous liquidity in the market, and it can be accessed as conditions improve.
Finally, the federal government needs to rebalance its balance sheet as well. Federal and state budget pressures are enormous, and uncertain tax programs surely are a risk to the recovery. This adds harmful uncertainty upon both businesses and consumers. However, while these burdens are a drag on our outlook, they are not new to the U.S. and, by themselves, should not bring our economy down unless they go unaddressed.
It appears Hoenig believes both consumer and government spending are set to become less important to the growth mix. Yet, he also believes in such an environment, firms will continue to invest in new capital as confidence grows. But how are we to expect that firms will have any confidence in the absence of a strong consumer outlook or a government backstop? Indeed, the strains of such a dynamic emerge already. From Bloomberg:
Weaker-than-forecast sales at Cisco Systems Inc. and International Business Machines Corp. may signal a slowdown in the corporate spending that has led the U.S. recovery.
“It’s been business investment, particularly technology, that’s been in the driver’s seat,” said Stuart Hoffman, chief economist at PNC Financial Services in Pittsburgh. Should equipment spending slow significantly, “unless something else picks up the pace, it means the outlook for the economy is going to be that much dimmer.”
Note too that he conspicuously offers no mention of the external sector - perhaps no surprise given that an external impetus has been noticeably absent during this recovery. Simply put, if we take consumer, government, and external spending off the table, I don't see any path that leads to Hoenig's promised land.
Nor do I see a path to the promised land in the current stance of monetary policy. Nor do I see a path in what I suspect is the likely path - drips of easing here and there. Moreover, given the propensity of firms to offshore productive capacity, I am wary that even aggressive easing will stimulate investment activity. I think the latest trade release clearly show that stronger domestic demand is likely to get translated straight into imports. The same goes for consumer spending - the recession has ravaged credit ratings, leaving the pool of potential borrowers shriveled. And even if we can induce households to buy more flat screen TV's, such stimulus is more of a economic boost for the Port of Long Beach than anything else.
So, increasingly I worry the most effective policy paths are less than palatable for policymakers. And I can't say that I am particularly comfortable with said paths as well. But, at the risk of oversimplifying channels of monetary transmission, if future quantitative easing is to work, I suspect it needs to flow through one of two channels. The first is the via an explosion of net worth. In other words, a fresh asset bubble. I don't think this will happen spontaneously. Via financial reform, policymakers are in the process of injecting enough glue into the financial markets to keep asset bubbles at bay, at least for the time being. The other channel is via a sharp decline in the value of the Dollar. Undoubtedly, this would stimulate export and import-competing sectors (I tend to think the latter is actually the most important). The rest of the world, however, would be likely to lean against such a decline.
This is a depressing outlook, as it suggests that even aggressive monetary easing might not be enough unless such easing can be induced to work along one of two channels policymakers will resist. Indeed, I think it would be most effective if the Fed could eliminate the middleman of Treasury purchases. Accumulate equities to drive up net worth and thus sustain consumer spending, enough of which would be spent on nontradables (the beauty of the housing bubble, by the way) that the stimulative effect would remain in the US. This option, however, is not legally available to the Fed. But the Fed could accumulate foreign sovereign debt, thereby inducing a decline in the value of the Dollar. Alas, that option might as well be illegal as well, and it will never happen. It would be seen as a.) stepping on Treasury's turf, b.) risking retaliatory devaluations, and c.) setting the stage for an actual currency crisis.
Bottom Line: The Fed took a baby step forward last week. It is natural to interpret that step as a signal that more easing is coming. On the surface, however, such an interpretation is premature. If the economy continues to produce more of the same - steady growth with minimal inflation - policymakers are likely to keep additional policy responses to a minimum, more as an effort to placate critics than to affect meaningful changes to the economic path. Such meaningful policy might simply be a bridge too far for policymakers, especially if the asset bubbles during the past two business cycles were key to generating full employment. In such a framework, the Fed would either need to accept, and even support, a fresh asset bubble or a sharp decline in the value of the Dollar. Neither option looks acceptable at this time.
Update: Tim, who is on a camping trip, emails an update (he wrote the post before he left):
One could argue that government backed debt is the latest bubble supported by the Fed. But, in the context of the ongoing disruptions in lending channels, at least relative to what is necessary to hold the economy near potential, it is not a particularly effective bubble, absent a more committed fiscal complement.
Friday, August 13, 2010
Fiscal policymakers deserve their share of the blame for not responding adequately to the crisis, and I blame them first foremost, but monetary authorities have not responded adequately either. Disappointingly, and to the disadvantage of those hoping to find employment sooner rather than later, the Fed hasn't even taken the steps that Bernanke urged Japan to take when it faced similar circumstances:
Paralysis at the Fed, by Paul Krugman, Commentary, NY Times: Ten years ago, one of America’s leading economists delivered a stinging critique of the Bank of Japan, Japan’s equivalent of the Federal Reserve, titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” With only a few changes in wording, the critique applies to the Fed today.
At the time, the Bank of Japan faced a situation broadly similar to that facing the Fed now. The economy was deeply depressed and showed few signs of improvement, and one might have expected the bank to take forceful action. But short-term interest rates — the usual tool of monetary policy — were near zero and could go no lower. And the Bank of Japan used that fact as an excuse to do no more.
That was malfeasance, declared the eminent U.S. economist: “Far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.” He rebuked officials hiding “behind minor institutional or technical difficulties in order to avoid taking action.”
Who was that tough-talking economist? Ben Bernanke... So why is the Bernanke Fed being just as passive now as the Bank of Japan was a decade ago? ...
What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of “nonstandard” assets... The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March. ...
Back in 2000, Mr. Bernanke also suggested that the Bank of Japan could ... make private-sector borrowing more attractive by announcing that it would keep interest rates low until deflation had given way to 3 percent or 4 percent inflation — an idea originally suggested by yours truly. ... But as chairman of the Fed, Mr. Bernanke has explicitly rejected any such move.
What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.
And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.
Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly — his nominees still aren’t in place — the Fed might be less passive.
But whatever the reasons, the fact is that the Fed — which is required by statute to promote “maximum employment” — isn’t doing its job. Instead, like the rest of Washington, it’s inventing reasons to dither in the face of mass unemployment. And while the Fed sits there in its self-inflicted paralysis, millions of Americans are losing their jobs, their homes and their hopes for the future.
Tuesday, August 10, 2010
I posted a brief reaction to the FOMC Press Release:
Update: Paul Krugman reacts:
What the FOMC announced was a slight change in policy: rather than allowing its balance sheet to shrink as the mortgage-backed securities it owns mature, it will maintain the balance sheet’s size by reinvesting the proceeds in long-term government bonds. Roughly speaking, it has gone from a completely crazy policy of monetary tightening in the face of massive unemployment and incipient deflation, to a policy of standing pat in the face of same. Whoopee.
And it’s a very strange decision, if you think about it. Presumably there’s some optimal size of the Fed’s balance sheet, given the state and prospects of the economy. What are the odds that the optimal size of that balance sheet is precisely the size it’s currently at? ...
So why freeze the size of the balance sheet right where it is? The answer is that it was, literally, the least the Fed could do. If it had continued to let the balance sheet shrink, the reaction both from Fed critics and from the markets would have been terrible. In effect, reinvesting the funds from expiring securities became a focal point, an essentially arbitrary location in the space of policy responses that nonetheless had come to have “salience”, because it was what everyone was watching.
So why am I even slightly encouraged? Because the critics did, at least, succeed in moving the focal point. Not long ago gradual Fed tightening was the default strategy; but as I said, at this point the Fed realized that continuing on that path would have unleashed both a firestorm of criticism and a severe negative reaction in the markets.
What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.
I know: it’s a heck of a way to make policy. In a better world, the Fed would look at the state of the economy and do what was right, not the minimum necessary. But wishing for that kind of world is like wishing that Ben Bernanke were running the place.
Part of what I said in the link above is that "It's something, and it indicates more awareness of the struggles the economy is having than some recent commentaries from FOMC members would suggest. But more aggressive action -- an actual expansion of the balance sheet -- is needed." So I certainly agree that more expansionary policy is needed, though it's probably hoping against hope for FOMC members to radically change course without external pressure. However, I have to hope anyway -- FOMC meetings are five to six weeks apart -- and pushing policy using a "meeting to Meeting" strategy of constant pressure will take forever, or so it will seem from the perspective of those waiting for an improvement in labor market conditions and hoping that their resources don't run out before they can find another job.
Monday, August 09, 2010
Here's part of the introduction and conclusion from the latest SF Fed Economic Letter by Travis J. Berge and Òscar Jordà. They find that "the macroeconomic outlook is likely to deteriorate progressively starting sometime next summer":
Future Recession Risks, by Travis J. Berge and Òscar Jordà, Economic Letter, SF Fed: By now, there is little disagreement that the Great Recession, as the last recession is often called, ended sometime in the summer of 2009 (see Jordà 2010), even though the National Bureau of Economic Research (NBER) has yet to formally announce the date of the trough in economic activity that marks the beginning of the current expansion phase. Intriguingly, just as we seemed to be leaving the recession behind, talk of a double dip became increasingly loud. ... A quick look at the number of Google searches and news items for the term "double-dip recession" reveals no activity prior to August 29, 2009, but a dramatic increase in search volume since then, especially in the past two months. Such concern is likely motivated by a string of poor economic news. ... It is understandable that the NBER has hesitated to call the end of the recession.
This spate of bad news has prompted a heated policy debate pitting those eager to mop up the gush of public debt generated by the recession and the fiscal stimulus package designed to counter it against those who would prefer to douse the glowing recession embers with another round of stimulus. ... In this Economic Letter, we calculate the likelihood that the economy will fall back into recession during the next two years. ...
Conclusion Any forecast 24 months into the future is very uncertain. ... Nevertheless, [Leading Economic Indicator] LEI forecast trends indicate that the macroeconomic outlook is likely to deteriorate progressively starting sometime next summer, even if the data suggest that a renewed recession is unlikely over the next several months. Of course, economic policy can strongly influence the outcome. The policies that are adopted today could play a decisive role in shaping the pace of growth.
We shall see what policies are adopted by the Fed today that "could play a decisive role in shaping the pace of growth," or at least we'll find out on Wednesday when the Fed announces the outcome if its latest FOMC meeting. But it sounds like, as Tim Duy said, opinion within the Fed is that the Fed needs to be more aggressive.
What is the Fed likely to do at its meeting this week?:
Waiting for Nothing?, by Tim Duy: Incoming data give the Fed a green light to ease further. There is frequent chatter from unnamed sources that the Fed can do more and will consider more at this Tuesday's FOMC meeting. The public stance of Fed officials in recent weeks has tended to downplay the necessity for action at this juncture. This combination leaves the outcome of this week's FOMC meeting in doubt. My baseline expectation is that the FOMC statement acknowledges the weakness in recent data, but leaves the current policy stance intact. There is a nontrivial possibility that the Fed either implicitly or explicitly ends the policy of passive balance sheet contraction. I believe it very unlikely that the Fed sets in motion an expansion of the balance sheet.
Much has already been written on the disappointing employment report. Excluding Census workers, the economy added a decidedly pathetic 12k employees. Private sector job growth came in at just 71k, while state and local governments shed 48k employees. While some commentators have highlighted the 630k private sector gain since the beginning of the year, the bulk of that gain - 399k - came in March and April. Since then, the private sector has added a scant 51k jobs a month. Enough jobs to be sustainable. Maybe, although this is even questionable given the decline in temporary help hiring, which may signal even softer numbers in the months ahead. But even if sustainable, certainly extremely vulnerable to negative shocks. And even if sustainable, the current rate is sure to decrease unemployment only if job seekers continue to exit the labor force.
Indeed, the labor force numbers turned south, sending the participation rate down as well. Although the technical recovery - at least as measured by GDP growth - has been in place for four quarters, participation rates still fall short of year ago levels. The gains of earlier this year appear to be as ephemeral as Census hiring. Indeed, it is likely that hiring, not any broader improvement in labor markets, drew people back into the labor force. Who says the government can't create jobs?
Not that below trend job growth should be any surprise given the trend in output growth. The math is easy on this one - the pace of growth has decelerated sharply since the end of 2009. Job growth is simply following this trend. Nor is their much hope for a substantial reacceleration. Factors that supported Q2 growth, especially inventory correction, residential investment, and government spending, are all expected to wane as the year progresses, while consumer spending growth is expected to remain lackluster. In that environment, it is even doubtful that the solid run of equipment and software gains can be sustained.
In reality, the story is effectively unchanged from four quarters ago. It has always been the case that meaningful labor market recovery required growth of real final sales of at least three times the numbers we have seen. That just is not going to happen without substantially more stimulus efforts.
Are such efforts forthcoming? I think that everyone has pretty much written off any possibility of fiscal stimulus coming to the rescue anytime soon. To be sure, there may be a few billion here, a few billion there that show up, but no one expects any serious effort to, for example, attempt to close the output gap. Administration efforts have shifted to trying to spin the data as a solid recovery. Along those lines, we saw US Treasury Secretary Timothy Giethner lift the "Mission Accomplished" move right out of the Bush II Administration's playbook with his NYT editorial, which can be summarized as "growth is positive, we did that, quit whining because you don't have a job." Simply put, if the Administration is content with the numbers we see, they are effectively content with a sustained, substantial output gap and the associated unemployment. They must be, as there is no urgency to do more. The pendulum has shifted. The Administration must feel it necessary to believe the recovery is sufficient and intact, otherwise they will be accepting the Republican claim that the stimulus package failed. Moreover, I think they genuinely believe that the deficit needs to be brought under control sooner than later. This, I think, is the problem of an Administration that is a reload of the Clinton Administration. They believe Rubinomics will work its magic again, rather than recognize that the today's economic challenges are very different than those of the mid-1990's.
With fiscal policy off the table, our last hope is monetary policy. It seems clear that persistent unemployment tilts the odds towards deflation, but the Fed appears to be like a deer stuck in the headlights. Like Geithner, Federal Reserve Chairman Ben Bernanke showed no urgency in his speech last week to accelerate the path to achieving the Fed's dual mandate. Moreover, leadership at the Fed may be as out of touch as that in the Administration. As Mark Thoma and Dean Baker note, Bernanke expects higher wages to support spending in the months ahead, despite the weak incoming wage data. Remember - Bernanke gave that speech after having the weekend to dissect the GDP report.
Presumably Bernanke is referring to data such as the following:
While Washington appears content with the numbers as long as they are trending in the right direction, I believe the focus should be the gap between where personal income less transfer payments would have been in absence of the recession, and the likely trajectory now. That trajectory, in my opinion, is clearly subpar. Enough so that it fills me with an increasing sense of urgency. This is lost income for Americans. Income that pays for food and shelter. Medical care and vacations. Retirement and college savings. The costs of failure are immense.
Did the July employment report shift the odds toward more easing? It should, but I believe the most likely scenario is that it merely confirms the Fed's priors - that the pace of labor market improvement will be glacially slow. They have never expected anything else. Indeed, to what extent is the data really that different from those expectations. It seems to me that what is most different is that the upside risk is essentially off the table - the V is not meant to be. Does the magnitude of the downside risk warrant additional action? Yes, with the V-shaped recovery off the table, so too are the "risks" of additional easing, notably the risk of higher inflation. Fed leadership, however, appears to view the downside risks as relatively limited giving the amount of stimulus (expansion of the balance sheet and low interest rates) already in place. Any more is a venture into the unknown, a trip that is still unwarranted in the absence of economic freefall.
That said, despite Fedspeak that appears resistant to further easing, the press has been fueling speculation that more easing - albeit largely symbolic - is imminent. From where does this chatter emanate, other that unnamed sources? Perhaps from high ranking staff. Word on the street is that Fed staff are increasingly frustrated with the lack of action from leadership. Why exactly is Bernanke showing such deference to the more hawkish elements such as Kansas City Federal Reserve President Thomas Hoenig, Dallas Federal Reserve President Richard Fischer, and Philadelphia Fed President Charles Plosser? If you seek more easing, you are not alone. Board staff are increasingly your allies.
Why the lack of additional action? A set of possible impediments:
- As described above, incoming data is not sufficiently different from the Fed's forecast to justify additional action. This is my primary reason to expect little action from the Fed tomorrow.
- Similarly, additional action requires nonconventional monetary policy, of which the impacts are unknown. I think one of the potential impacts of concern is possibility that additional easing fuels a new asset bubble, in addition to the specter of inflation.
- Concern that additional easing will be interpreted as deficit monetization, and thereby unhinge inflation expectations.
- Fears that additional easing will trigger a disorderly devaluation of the Dollar. Of course, this may be what exactly what we need.
- Possibly that more action will be a repudiation of the Administration's claim that the economy in on the mend.
That said, the internal and external pressure suggests the possibility for a small change at tomorrow's meeting. From the Wall Street Journal:
At their policy meeting Tuesday, Fed officials plan to discuss whether to take the small but symbolically important step of reinvesting proceeds from its portfolio of mortgage-backed securities to maintain support for the economy. The weak jobs numbers add to the case for taking action, though officials must assess whether taking even a tiny step could create expectations for larger actions in coming months.
Note the final sentence - the concern that more now is essentially a guarantee for more later. If the Fed eases more now, with the data largely in line with there already weak forecast, how could officials argue against additional easing later when the data continues to support their forecast?
Bottom Line: The incoming data appears largely consistent with the Fed's priors - especially expectations of glacially slow improvement in the labor market. Yet the probability of any upside risk to the forecast have diminished markedly. The V-shaped recovery has not emerged. The elimination of that upside risk argues for additional easing, but the Fed appears hesitant to do more. Uncertainty about the effectiveness of additional easing argues against more action, especially given relatively quiescent financial markets and positive, albeit lackluster, growth. Moreover, any additional action now is essentially a promise to do more later, even if growth remains along its current trajectory. All of these points argue against additional easing tomorrow, and that remains my baseline scenario. The case becomes muddied by internal, staff level pressure to do more now, combined with rising expectations of imminent easing given the steady flow of leaks to the press. This opens the possibility of a small policy adjustment that eliminates that passive reduction of the balance sheet. Any more is off the table.
Saturday, August 07, 2010
In the short term, it is important that monetary policy in the US and Europe vigilantly fight Japanese-style deflation, which would only exacerbate debt problems by lowering incomes relative to debts. In fact,... it would be far better to have two or three years of mildly elevated inflation, deflating debts across the board, especially if the political, legal, and regulatory systems remain somewhat paralyzed in achieving the necessary write-downs.
With credit markets impaired, further quantitative easing may still be needed. As for fiscal policy, it is already in high gear and needs gradual tightening over several years, lest already troubling government-debt levels deteriorate even faster. Those who believe – often with quasi-religious conviction – that we need even more Keynesian fiscal stimulus, and should ignore government debt, seem to me to be panicking.
Since we're giving opinions -- let's call them "seems to me-isms" -- rather analysis, let me give mine:
Those who believe – often with quasi-religious neoclassical conviction – that no further Keynesian fiscal stimulus is needed, and that government debt cannot be ignored, seem to me to be insensitive to the needs of the millions of unemployed, and at odds with the available evidence.As for the snide remark about "panicking," for those who are truly panicking due to the struggles they face finding a job, paying the bills, and so on, some urgency from policymakers would be much appreciated.
Friday, August 06, 2010
The employment report came out today. Calculated Risk shares my assessment of the overall picture that emerges from the numbers in the report:
This is a very weak report, especially considering the downward revision to June. The participation rate declined again, and that is why the unemployment rate was steady - and that is bad news.
Many observers are looking for "glimmers of hope" in the report and pointing to private sector job growth of 71,000, which is higher than in previous months and thus evidence of acceleration in job growth, to an increase in hours worked, an increase in wages, and a fall in workers involuntarily working part-time.
However, as noted in the "glimmers of hope" link, and as I have noted many, many times, we need 100,000-150,000 jobs per month just to keep up with population growth, and even more than that if we want to make up for past losses. That is, we need faster growth than 100,000-150,000 per month if we want the economy to do more than just keep up with population growth and reemploy the millions and millions of people who are now out of work. So job growth of 71,000 still represents a declining labor market, and does nothing to offset past losses.
Dean Baker reviews the numbers, and adds cautionary notes as to why the glimmers of hope aren't quite the positive signs they might appear to be at first glance:
Job Loss Sends Employment Ratio Downward, by Dean Baker: For the second consecutive month, the economy created virtually no jobs, net of temporary Census jobs. The Labor Department reported that the economy lost 131,000 jobs in July, 12,000 less than the 143,000 drop in the number of temporary Census workers. ...
The job loss corresponds to a decline in labor force participation. While the unemployment rate has edged down by 0.2 percentage points to 9.5 percent since May, this is attributable to people who gave up looking for work and left the labor force. The employment to population ratio fell by 0.3 percentage points to 54.4 percent, only slightly above the 54.2 percent low in December. ...
There were substantial declines in all the measures of duration of unemployment. This likely reflects many long-term unemployed dropping out of the workforce after losing benefits. The percent of multiple jobholders dropped by 0.3 percentage points to the lowest on record. This presumably reflects difficulty in getting jobs.
There are very few obvious sources of job growth on the establishment side. Manufacturing added 36,000 jobs, but most of this increase was attributable to a 20,500 rise in jobs in the auto industry and a 9,100 increase in jobs in fabricated metals. Most of these rises are attributable to the fact that Detroit auto makers did not shut down in July to change models. The underlying rate of job growth in manufacturing is very weak, even if at all positive.
Retail trade added 6,700 jobs, but with a 13,000 downward revision to last month’s job loss number, employment is still 14,000 below the May level. Financial services lost 17,000 jobs, with real estate counting for more than half of the loss. Professional and business services are now shedding jobs, with the sector losing 13,000 jobs last month. Employment services lost 23,300 jobs, a bad harbinger for future job growth. Even the restaurant sector is losing jobs, shedding 10,600 workers in July, the 3rd consecutive decline.
State and local governments shed 48,000 jobs in July, a result of budget cutting coinciding with the new fiscal year. The only sectors that added substantial numbers of jobs were health care (27,800) and, strangely, ground transit which added 10,600 jobs in July, 2.5 percent of employment in the sector.
There was a small uptick in average hours (all in the goods-producing sector), but this just returned hours to the May level. ... Nominal wages rose at just a 1.4 percent annual rate, also not a good sign.
With the end of the inventory cycle, a huge wave of state and local cutbacks and further declines in house prices on the way, the situation looks bleak for the second half of 2010.
Robert Reich emphasizes many of the same points:
The economy is still in a deep hole, and we’re not climbing out.
Remember, we need 125,000 new jobs per month simply to keep up with the growth of the American population seeking jobs. But according to this morning’s job’s report, private-sector employers added just 71,000 jobs in July. ... In other words, the hole keeps getting deeper. ...
The only slightly bright news is that manufacturing payrolls increased by 36,000 in July, but those gains are almost surely going to evaporate in August. Manufacturing expanded in July at the slowest pace of the year as orders and production decelerated.
All this blur of numbers means two things: An extraordinary number of Americans are still hurting. And it’s more important than ever for the US government to step in with a larger stimulus that puts more people to work (a WPA, for example), and tax cuts for people who will spend them (a two-year payroll tax holiday on the first $20K of income). We cannot get out of this hole without major federal action.
Many of us who worried this was coming have been calling for more action for well over a year now, but to no effect. As the WSJ notes, this will set off a debate within the Fed about whether to try to give the economy more help at it's monetary policy meeting this week. My own view is they will continue to rationalize -- perhaps with those so-called glimmers of hope discussed above -- why there's nothing more they can and should do, and they will continue to sit on their hands. There's more than enough evidence to justify more action, and that was true before this report added to it, but the Fed refuses to see it.
I should add one more thing. My first choice in trying to help the economy would be fiscal policy, I think that has a much better chance of working, creating jobs in particular, than monetary policy. Take a look at what happened to state and local hiring, one place where fiscal policy could clearly help. Thus, I don't want criticism of the Fed to be used to deflect criticism from Congress for their (lack of) response. Fiscal policy authorities have not responded adequately to this crisis, and we see the results in today's report. So we shouldn't let fiscal authorities off the hook as we also criticize the Fed's failure to do more.
Update: Let me add this note on the numbers. Above, Dean Baker says the private sector job loss was 12,000 and Calculated Risk says the same thing. However, most reports are citing a figure of 71,000. Why the difference?:
Employment Report: Why the different payroll numbers?, by Calculated Risk: Once again there is some confusion about which payroll number to report.
Basically the media is confusing people. I explained this last month: ...The headline payroll number for July was minus 131,000. The number of temporary decennial Census jobs lost was 143,000.
To be consistent with previous employment reports (and remove the decennial Census), the headline number should be reported as 12,000 ex-Census. ... Instead most media reports have been using the private hiring number of 71,000 apparently because of the complicated math (subtracting -143,000 from -131,000). Private hiring is important too, but leaves out changes in government payroll and is not consistent.
I've posted all the numbers, but I've led with the headline number ex-Census - and that is especially important now since state and local governments are under pressure.
I probably should have noted this earlier and explained why the 12,000 figure should be used, hence the second thoughts and this update only minutes after this was posted. But I thought it would simply confuse the issue and deflect attention from the important point which is that job growth is very weak no matter how it is measured.
Wednesday, August 04, 2010
Inflation Expectations Are Not Stable!, by David Beckworth: Many observers, including myself, have been puzzled by the Fed's lack of urgency in recent months over the apparent slowing down of aggregate demand. The one thing monetary policy is capable of doing is stabilizing total current dollar spending, but it isn't and this inaction effectively amounts to a tightening of monetary policy. There have been many reasons given for this seeming complacency by the Fed: internal divisions over policy, fear of political backlash, opportunistic disinflation, fear of awakening bond vigilettentes, and sheer exhaustion. Another potential reason is that the Fed simply doesn't see this aggregate demand slowdown in the data. I actually considered this possibility some time ago but never put too much weight on it since this is the Federal Reserve after all. It has far more resources than I do and surely sees what I see in the data. However, after Fed Chairman Ben Bernanke's speech yesterday I am beginning to wonder if the Fed is actually missing something in the data. In particular, I was stunned to read this sentence in the speech:Meanwhile, measures of expected inflation generally have remained stable.
Uhm, unless I have been living in parallel universe and just got phased into a different one this statement is completely wrong. Inflation expectations, as I show below, have been persistently declining since the start of 2010. Not only that, but Bernanke's claim that inflation expectations are stable has huge policy implications. It is widely understood that expectations of future inflation are a key determinant of current aggregate demand. If expectations of inflation are stable as Bernanke claims then aggregate demand growth should also be relatively stable. On the other hand, if inflation expectations are falling and have been doing so for some time as I claim then it is likely that current aggregate demand growth also has been falling.*
If Bernanke really believes inflation expectations are stable then one must give him credit for implementing monetary policy in a manner consistent with that understanding. However, I simply cannot understand how he or anyone else at the Fed could hold such a view. The best indicators of inflation expectations have been screaming red alert for some time now. How the Fed could have missed this red alert is unfathomable to me, but on the off chance that they have and are reading this post I ask that they please take note of the following set of figures.
The first figure shows the term structure of expected inflation over the first half of 2010. The plotted curves in the figure show the average expected inflation rate at various yearly horizons for the first six months of 2010. The data comes from the Cleveland Fed. This figure makes clear that inflation expectations have been trending down across all horizons since the start of the year. Note that the 1-year horizon has seen inflation expectations drop by about 100 basis points. (Click on figure to enlarge)
Now to put this figure into perspective let's look at the term structure of inflation expectations the last time expected inflation fell rapidly and caused aggregate demand to tank. Yes, that would be the late 2008, early 2009 period. Here is the figure for this time. Notice any similarities? (Click on figure to enlarge.)
Here too we see a decline across all horizons with the 1-year having the sharpest decline. Now current inflation expectations have not fallen as much as these above but they are persistently falling. And we know from the late 2008, early 2009 experience what happens to aggregate demand when inflation expectations are allowed to continue to fall: you get the greatest decline in nominal spending since the Great Depression.
Now the dire picture painted by the Cleveland Fed data is wholly corroborated by the inflation expectations implied by the the difference between the nominal interest rates on regular treasury securities and the real interest rates on treasury inflation protected securities (TIPS). This measure of inflation expectations is graphed below using daily data on 5-year treasuries for the period January 4, 2010 - July 29, 2010: (Click on figure to enlarge.)
Here again there is a clear downward trend. Inflation expectations are falling and there is currently no end in sight. Given all of this evidence, how can Ben Bernanke assert that inflationary expectations are stable? I am truly bewildered by that claim. I hope Fed officials who have read this far are also bewildered and are now reconsidering their views. Let me be very clear what all of this implies: by failing to stabilize inflation expectations the Fed is effectively tightening monetary policy at a most inopportune time. I hope this is not how the Fed wants to be remembered.
Tuesday, August 03, 2010
When I saw this:
Federal Reserve Chairman Ben S. Bernanke said rising wages would probably spur household spending in the next few quarters, even as weak job gains dragged down consumer confidence.
I wondered what Bernanke was talking about. Dean Baker had the same reaction:
The NYT headline told readers that, "Bernanke Says Rising Wages Will Lift Spending." Real wages have been virtually unchanged over the last year. Let's hope that the NYT got the story wrong and that Bernanke knows this.
What do the latest data show?:
Personal incomes were ... flat in June as private wages and salaries fell.
There have been several instances lately where things Bernanke has said make me wonder how familiar he is with what recent data are telling us about the economy. Lately the Fed seems more interested justifying why it doesn't need to do anything more to boost the economy rather than grappling with actual data showing that the economy needs more help from the Fed. Maybe Bernanke is right and the next few quarters will show rising wages leading to higher spending and that will lead to a more robust recovery, but there's nothing in the current data to give me confidence that is going to happen and I don't think policy should be based upon this expectation.
Handicapping the Next FOMC Meeting, by Tim Duy: The game is on. The relatively weak data flow in recent weeks, culminating with the clearly subpar GDP report, has combined with rumblings from the Federal Reserve that yes, we can do more. The net result is growing expectations that additional easing will occur sooner than later. As early as next week, in fact. Logically, the story hangs together reasonably well except for one key ingredient - the top dog, Federal Reserve Chairman Ben Bernanke, does not appear overly concerned with the economic outlook. But the chatter is becoming almost undeniable. Someone is sourcing the press to believe that a policy change is imminent. And Fedspeak aside, that source cannot be ignored.
Japan's Nomura has become the first investment bank to predict the Federal Reserve will begin to ease monetary policy following the recent slowdown in growth in the world's biggest economy.
The deterioration in expectations for growth and inflation argues for an easing of monetary policy, Paul Sheard, the global chief economist at Nomura, wrote in his latest report.
"We expect the Fed to at least stop the passive contraction of its balance sheet," he added.
More than one analyst recognizes the Fed's policy to allowing mortgage assets to mature from the balance sheet (or as they are prepaid) as contractionary. A small step forward would be to acquire an offsetting amount of Treasuries as mortgages mature, thus at least holding policy steady. The report continues:
"Perceptions about sustainability are not binary, but lie along an unobservable continuum. A concerned and forward-looking policymaker would presumably take action some time before the economy had irreversibly slipped from sustainability," Sheard wrote.
"We now believe that current conditions have moved policymakers into action and that the FOMC will adopt a more accommodative stance at its 10 August meeting," he added.
The Fed is likely to stop shrinking its huge balance sheet for the moment, a subtler form of easing than just buying assets again, according to the research...
..."To the extent that the size of the Fed's balance sheet matters, this, in effect, amounts to a gradual tightening of monetary policy. Further shrinkage of its asset holdings now seems inappropriate in light of downside risks to growth," he explained.
"We therefore think the committee will return to the explicit language of early 2009, in which it articulated a commitment to 'keep the size of the Federal Reserve's balance sheet at a high level,'" he added.
The idea is pushed even further in today's Wall Street Journal:
Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.
The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed's forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.
This is relatively strong language - strong enough, in fact, to imply that it is already a done deal. Why source a piece to raise expectations when you know you are going to dissappoint?
The basic - and reasonable - argument is that risks are now sufficiently weighted to the downside to justify, in the minds of monetary policymakers, an easier policy stance. And holding the balance sheet steady could be a middle ground for opposing camps in the FOMC. Still, while policymakers have shaded down their growth forecasts, they appear relatively at ease with the current level of downside risk. Bernanke's basic outlook today:
After a precipitous decline in late 2008 and early 2009, the U.S. economy stabilized in the middle of last year and is now expanding at a moderate pace. While the support to economic activity from stimulative fiscal policies and firms' restocking of their inventories will diminish over time, rising demand from households and businesses should help sustain growth. In particular, in the household sector, growth in real consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions. In the business sector, investment in equipment and software has been increasing rapidly, in part as a result of the deferral of capital outlays during the downturn and the need of many businesses to replace aging equipment. At the same time, rising U.S. exports, reflecting the expansion of the global economy and the recovery of world trade, have helped foster growth in the U.S. manufacturing sector.
Notably, he again highlights his expectation for stronger household spending despite the consumer slowdown evident in the latest GDP report. In other words, he still anticipates that the private sector will pick up where the public sector leaves off. He also reiterates the dismal labor market picture:
Importantly, the slow recovery in the labor market and the attendant uncertainty about job prospects are weighing on household confidence and spending. After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, an improvement but still a pace insufficient to reduce the unemployment rate materially. In all likelihood, significant time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects.
Notice that he offers no reason to believe that he has the power to change the state of the labor market. He simply takes it as given a depressingly long wait until unemployment rates decline meaningfully. And as far as long-term unemployment, interesting and worrisome, but not much we can do about it. As far as disinflation:
Inflation has been low, with consumer prices rising at an average annual rate of about 1 percent in the first half of this year, and we anticipate it will remain subdued over the next couple of years. Slack in labor and product markets has damped wage and price pressures, and rapid productivity increases have helped firms control their production costs. Meanwhile, measures of expected inflation generally have remained stable.
No mention of further disinflation, just subdued inflation. And, critically, no concern that inflation expectations have taken a turn to the downside. I think that such a turn would prompt further action, but in their mind it hasn't happened.
In my opinion, Bernanke offers a reasonable optimistic assessment of US growth, optimistic at least compared to those of us worried about a protracted period of weakness. He just doesn't sound like someone concerned enough to push on the economic gas.
And, of course, we also have the ever colorful Dallas Fed President Richard Fischer. Paul Krugman has the analysis. In short, Fischer a.) is comfortable with current inflation forecasts, b.) views Administration-induced uncertainty as the chief impediment to economic growth, and c.) is very worried that additional asset purchases would be akin to deficit monetization. A relatively right-winged approach to policy. One wonders to what extend Bernanke shares his views. It is often easy to forget that the Fed chief is a Republican.
At the other end of the scale is the door opened by St. Louis Federal Reserve President James Bullard. Similar to Fischer, Bullard likes to talk, but at least retains intellectual coherency. From Bloomberg:
“The U.S. is closer to a Japanese-style outcome today than at any time in recent history,” Bullard said, warning in a research paper released yesterday about the possibility of deflation. “A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”
Is this, however, a call for an imminent policy shift? Bullard continues:
“The most likely possibility from where we sit today is that the recovery will continue through the fall, inflation will start to move up and this issue will all go away,” Bullard said to reporters on a conference call yesterday. “Suppose we get another negative shock, another surprise. We have to be prepared in that event to have a plan in place to do something."
Again, his basic outlook is relatively sanguine. He is looking for another negative shock. But how big does that shock need to be? I don't think we have seen it yet.
Note to that Bullard is laying the groundwork to avoid a discussion on extending or terminating the "extended period" language from the FOMC statement:
“The academics will tell you what you have to do is sort of dump interest-rate targeting and switch to something else,” he said. “In the policy debate, that is not really happening. So we need a sharper departure from interest-rate targeting if we are going to get out of this problem.”
I think this is a good interpretation:
Bullard’s stance aims to bridge the gap between two camps at the Fed, said Vincent Reinhart, a former Fed monetary-affairs director. Bernanke is in one group believing that the path of short-term rates is important, while Kansas City Fed President Thomas Hoenig is among officials uncomfortable with the “extended period pledge,” Reinhart said.
I am not particularly confident, however, that Hoenig will embrace a fresh round of asset purchases, extended period pledge or not. One point of worry:
Bullard, who has voiced concerns with the extended-period language since early March, said during the call he wanted to spark debate and his preference has been not to dissent.
Is he seeking to spark debate or generate publicity for himself? If the latter, is he leading us to a premature policy conclusion by so vocally identifying his preferred policy choice? I admit to being concerned that Bullard is leading market participants to expect more sooner than Bernanke is willing to deliver. In any event, Bullard is setting the stage for an expansion of quantitative easing. The most we will get next week is holding steady on the balance sheet.
Bottom Line: The weak GDP report should, on the margin, push the Fed toward further easing. But Bernanke's speech today, like his testimony on two weeks ago, did not indicate much of a push at all. And a credibly sized contingent of policymakers appear to be dead set against additional easing. On the other side, you see chatter, largely anonymously sourced, about additional easing policies the Fed could pursue. Is this contingent trying to manipulate expectations to push the Fed into additional action? Regardless, a straightforward interpretation is this: The FOMC has downgraded its growth expectations slightly, and need to lean against that with a small - possibly more symbolic than anything else - shift to hold the balance sheet steady and prevent premature
easingtightening. It is not clear that we are getting this from publicly available Fedspeak, especially from Bernanke, but the press seems increasingly certain. Still, any handicapping might simply be premature as we look forward to the Friday's employment report. A game changer, or just another indication that the economy has settled into a subpar growth path, pretty much what the Fed already expects and is not acting on?
I see Bloomberg is running a "hold steady" story:
Federal Reserve policy makers signaled they will probably pass on providing more stimulus at their Aug. 10 meeting and wait to see if signs of weaker economic growth persist.
Chairman Ben S. Bernanke told lawmakers in South Carolina yesterday that consumer spending is “likely to pick up” amid a “moderate” expansion. St. Louis Fed President James Bullard said on July 29 that he expects the “recovery will continue through the fall.” Three days earlier, Philadelphia Fed President Charles Plosser said in a Bloomberg News interview that calls for more Fed stimulus “are premature.”
This, I believe, is the correct analysis of the Fedspeak and data flow. The willingness of someone to source a different story to the Wall Street Journal, however, calls this analysis into question.
Monday, August 02, 2010
Before the crisis hit, the dynamic nature of the US economy was cited as one of its strong points by free marketeers, especially in comparison with European economies. Economic shocks, we were told, would be bring about a quick adjustment in a relatively free economy like the US. There was no need for government intervention. The price system would send the necessary signals and in no time at all the economy would be back at full employment running just as well, if not better, than before. That is, so long as things like oversized government, social insurance, and unions don't get in the way (like they supposedly do in Europe).
So it will be interesting to see if the same people who promoted the economy's ability to quickly respond to shocks and reabsorb unemployed labor and other resources now blame structural factors for the slow recovery, particularly the slow reabsorbtion rate for labor. As noted below by Paul Krugman, blaming structural factors serves as an excuse for the Fed and Congress to say there's nothing more they can do to help, the economy will just have to heal on its own. Some people will also try to blame government for the slow recovery in order to resolve the inconsistency between their prior claim that the US economy could handle anything thrown at it (citing things like 911 and Hurricane Katrina as examples), and the slow recovery that we are actually experiencing. They'll say it's unemployment compensation stopping people from working, fear of deficits, uncertainty surrounding regulation, etc., etc.
Thus, we'll hear that it's structural factors, it's government, it's whatever it takes for policymakers to rationalize why they shouldn't do any more (and hence avoid any associated risks, real or perceived). And it's whatever it takes, real or imagined, evidence based or not, for those who oppose government intervention generally, and government spending most particularly, to stop any further action to help the economy and to discredit what has already been done:
Defining Prosperity Down, by Paul Krugman, Commentary, NY Times: I’m starting to have a sick feeling about prospects for American workers — but not, or not entirely, for the reasons you might think.
Yes, growth is slowing, and the odds are that unemployment will rise, not fall, in the months ahead. That’s bad. But what’s worse is the growing evidence that our governing elite just doesn’t care — that a once-unthinkable level of economic distress is in the process of becoming the new normal. ...
First, we see Congress sitting on its hands, with Republicans and conservative Democrats refusing to spend anything to create jobs, and unwilling even to mitigate the suffering of the jobless.
We’re told that we can’t afford to help the unemployed — that we must get budget deficits down immediately or the “bond vigilantes” will send U.S. borrowing costs sky-high. Some of us have tried to point out that those bond vigilantes are ... figments of the deficit hawks’ imagination... But the fearmongers are unmoved: fighting deficits, they insist, must take priority over everything else — everything else, that is, except tax cuts for the rich, which must be extended, no matter how much red ink they create.
The point is that a large part of Congress — large enough to block any action on jobs — cares a lot about taxes on the richest 1 percent of the population, but very little about the plight of Americans who can’t find work.
Well, if Congress won’t act, what about the Federal Reserve? The Fed, after all, is supposed to pursue two goals: full employment and price stability, usually defined in practice as an inflation rate of about 2 percent. Since unemployment is very high and inflation well below target, you might expect the Fed to be taking aggressive action to boost the economy. But it isn’t.
It’s true that the Fed has already pushed ... short-term interest rates, its usual policy tool,... near zero. Still, Ben Bernanke ... has assured us that he has other options... But the Fed hasn’t done any of these things. Instead, some officials are defining success down.
For example, last week Richard Fisher, president of the Federal Reserve Bank of Dallas, argued that the Fed bears no responsibility for the economy’s weakness, which he attributed to business uncertainty about future regulations — a view that’s popular in conservative circles, but completely at odds with all the actual evidence. In effect, he responded to the Fed’s failure to achieve one of its two main goals by taking down the goalpost.
He then moved the other goalpost, defining the Fed’s aim not as roughly 2 percent inflation, but rather as that of “keeping inflation extremely low and stable.”
In short, it’s all good. And I predict — having seen this movie before, in Japan — that if and when ... below-target inflation becomes deflation, some Fed officials will explain that that’s O.K., too. ...
Here’s what I consider all too likely: Two years from now unemployment will still be extremely high, quite possibly higher than it is now. But instead of taking responsibility for fixing the situation, politicians and Fed officials alike will declare that high unemployment is structural, beyond their control. And ... over time these excuses may turn into a self-fulfilling prophecy, as the long-term unemployed lose their skills and their connections with the work force, and become unemployable.
I’d like to imagine that public outrage will prevent this outcome. But while Americans are indeed angry, their anger is unfocused. And so I worry that our governing elite, which just isn’t all that into the unemployed, will allow the jobs slump to go on and on and on.
Sunday, August 01, 2010
More on Disinflation, by Tim Duy: Paul Krugman pulls together three charts to illustrate the link between high unemployment and disinflation in two major disinflationary episodes, 1974-1977 (Series 1 in chart below) and 1980-1986 (Series 2). He then tracks the pattern of the current cycle (Series 3), which suggests that the combination of high unemployment and past disinflationary responses to such unemployment is very likely deflationary. Krugman asks:
How can you look at this record and not conclude that deflation is a very real risk? I have no idea where the complacency of many at the Fed comes from.
An explanation for the Fed's complacency can be found by plotting all three episodes on the same chart:
I believe when monetary policymakers look at this chart, they ask a different question: Why has the disinflationary response been so muted in this cycle? It would have been reasonable to conclude that unemployment rates at this magnitude should have long ago pushed the US economy into deflationary territory. What is the Fed's explanation for the relatively tame disinflation? Krugman already has the answer:
All of this was to be understood in terms of a Phillips curve in which actual inflation at any point in time depends both on the unemployment rate and on expected inflation….
Fed officials will say that inflation expectations are currently well anchored. Indeed, the early 1980's experienced a period of rapid disinflationary expectations:
Note that expectations by this measure are stable. What about financial market expectations? The difference between 5 year Treasuries and 5 year TIPS fell slightly in recent months, but nothing like the clear taste of deflationary expectations at the end of 2008:
But are stable inflation expectations written in stone? Krugman concludes the above sentence with:
...and expected inflation gradually adjusts in the light of experience.
The implication is that the Fed should not get too complacent as persistently high unemployment will eventually erode those expectations.
Now - just thinking out loud - suppose downward rigidity of nominal wages, with workers unwilling to accept nominal wages declines. Does this support positive - albeit low - inflation expectations? Which thus prevents deflationary expectations from forming…which is good, but prevents the Fed from further action despite high unemployment rates? And the lack of action that increases structural unemployment, ensuring NAIRU increases? Something else to chew on...
Saturday, July 31, 2010
Does paying interest on reserves discourage lending? Are there good reasons to pay interest on reserves?:
Some Observations Regarding Interest on Reserves, by David Altig: One of the livelier discussions following Federal Reserve Chairman Ben Bernanke's testimony to Congress on monetary policy has revolved around the issue of the payment of interest on bank reserves. Here, for what it's worth, are a few reactions to questions raised by that discussion: ...
What is the opportunity cost of not lending?
...[C]ertainly the real issue about the IOR policy concerns the presumed incentive for banks to sit on excess reserves rather than putting those reserves into use by creating loans. This, from Bruce Bartlett, is fairly representative of the view that IOR is, at least in part, to blame for the slow pace of credit expansion in the United States:
"… As I pointed out in my column last week, banks have more than $1 trillion of excess reserves—money that the Fed has created that banks could lend immediately but are just sitting on. It's the economic equivalent of stuffing cash under one's mattress.
"Economists are divided on why banks are not lending, but increasingly are focusing on a Fed policy of paying interest on reserves—a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute."
OK, but the spread that really matters in the bank lending decision is surely the difference between the return on depositing excess reserves with the Fed versus the return on making loans. In fairness, it does appear that this spread dropped when the IOR was raised from its implicit prior setting of zero…
… but it's also pretty clear that this development largely reflects a general fall in market yields post-October 2008 as much is it does the increase in IOR rate...
And here's another thought: As of now, the IOR policy applies to all reserves, required or excess. Consider the textbook example of a bank that creates a loan. In the simple example, a bank creates a loan asset on its book by creating a checking account for a customer, which is the corresponding liability. It needs reserves to absorb this new liability, of course, so the process of creating a loan converts excess reserves into required reserves. But if the Fed pays the same rate on both required and excess reserves, the bank will have lost nothing in terms of what it collects from the Fed for its reserve deposits. In this simple case, the IOR plays no role in determining the opportunity cost of extending credit.
Of course, the funds created in making a loan may leave the originating bank. Though reserves don't leave the banking system as a whole, they may certainly flow away from an individual institution. So things may not be as nice and neat as my simple example. But at worst, that just brings the question back to the original point: Is the 25 basis point return paid by the central bank creating a significant incentive for banks to sit on reserves rather than lend them out to consumers or businesses? At least some observers are skeptical:
"Barclays Capital's Joseph Abate…noted much of the money that constitutes this giant pile of reserves is 'precautionary liquidity.' If banks didn't get interest from the Fed they would shift those funds into short-term, low-risk markets such as the repo, Treasury bill and agency discount note markets, where the funds are readily accessible in case of need. Put another way, Abate doesn't see this money getting tied up in bank loans or the other activities that would help increase credit, in turn boosting overall economic momentum."
Are there good reasons for paying interest on reserves?
Even if we concede that there is some gain from eliminating or cutting the IOR rate, what of the costs? Tim Duy, quoting the Wall Street Journal, makes note (as does Steve Williamson) of the following comment from the Chairman:
From an interview of Alan Greenspan:
Lunch with the FT: Alan Greenspan, by Alan Beattie, FT: ...He has admitted to having been “30 per cent wrong” in his time as Fed chairman, particularly in assuming that banks and financial institutions would closely monitor the creditworthiness of the people with whom they were doing business. But his present plan for preventing a recurrence of the global financial crisis still shows a predilection for the light touch: make banks hold more capital to back their lending, demand higher collateral that can be seized if financial transactions go wrong, and keep more cash on hand in case of emergencies.
In extremis, he says, banks might have to be broken up by law if they become too big to fail without bringing down the whole financial system. But he makes clear that he regards such an intervention as a last resort. He retains faith in markets and doesn’t even think that US-style finance capitalism will lose ground to the softer, more regulated model of European social democracy... It is a question of making precise technocratic adjustments. ...
His approach to everything is the same. Look at the data; calculate the probabilities; make a dispassionate calibrated decision. Just before we leave, he bemoans the calls on “poor Obama” to be seen to be caring more about the oil spill in the Gulf of Mexico. “I complained when people were saying he’s not showing enough empathy,” he says. “I said, ‘That’s not what I want to see.’ I want to see cold, cool, deliberative action. Empathy is not going to solve this problem.” ...
I don't think I want to hear Obama say "I feel your pain," but there may be a reason to combine "cold, cool, deliberative action" to solve a problem with empathy for those affected by it. Empathy shows that you understand the significance and urgency of the problem, and that you are willing to devote the resources needed to find a solution. Perhaps a Fed chair, unlike a president, can get away with cold dispassionate calculation, but a little more empathy might have served Greenspan well.
Tuesday, July 27, 2010
Policymakers should be more concerned about the possibility of rising long-term unemployment:
Mankiw's broader point is that since we have seen nothing like this before except for the Great Depression, we should be humble and risk averse--and hence have the government stand back and wash its hands of the situation.
Paul Krugman concurs, adding a sense of urgency to the current situation:
Quite. I really don’t think people appreciate the huge dangers posed by a weak response to 9 1/2 percent unemployment, and the highest rate of long-term unemployment ever recorded…
...Right now, I’m reading Larry Ball on hysteresis in unemployment (pdf) — the tendency of high unemployment to become permanent. Ball provides compelling evidence that weak policy responses to high unemployment tend to raise the level of structural unemployment, so that inflation tends to rise at much higher unemployment rates than before. And the kind of unemployment we’re experiencing now, with many workers jobless for very long periods, is precisely the kind of unemployment likely to leave workers permanently unemployable.
And there are already indications that this is happening. Bill Dickens, one of the people has who worked on downward nominal rigidity, tells me that the Beveridge curve — the relationship between job vacancies and the unemployment rate — already seems to have shifted out dramatically. This has, in the past, been a sign of a major worsening in the NAIRU, the non-accelerating-inflation rate of unemployment.
Mankiw said something eerily familiar recently:
This recession looks very different, and much more troubling, than those in the recent past. I wonder how this dramatic change in the nature of unemployment will alter traditional macroeconomic relationships, such as Okun's Law and the Phillips curve.
Some research suggests that the long-term unemployed put less downward pressure on inflation. If that is indeed the case, then the increase in long-term unemployment may mean that we will see less deflationary pressure than we might have expected from the high rate of unemployment. In other words, the NAIRU may have risen, perhaps quite substantially. This is mostly conjecture, however. It seems likely we will see more work on this topic in the coming years.
So Mankiw recognizes the problems posed by protracted periods of economic weakness, yet in his criticism appears to push for more caution while overlooking an obvious reason why the impact of fiscal policy was insufficient to significantly alleviate the recession. It was simply too small - as economists predicted at the time. Indeed, if he is so worried about the risk of rising NAIRU, he should be pushing for policymakers to pull out all the stops.
Mankiw is not alone in seeing the challenges posed by protracted unemployment. From Federal Reserve Ben Bernanke's Congressional testimony:
Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects.
The difference between Mankiw and Bernanke is that the latter not only recognizes the problem, but could also do something about it. Not that he is inclined to. Of course, he is not alone. Philadelphia Fed President Charles Plosser was quoted today:
“Lowering the interest rates closer to zero could have very disruptive effects on the financial markets,” Plosser said. “If we bought Treasury bills we could un-anchor expectations of inflation because the public might begin to think we are going to buy up the public debt.”
Plosser repeats the credibility story, arguing that additional action as suggested by Joe Gagnon will trigger an inflationary spiral. Likewise, San Francisco Fed President Janet Yellen expressed an unwillingness to adopt a new inflation target:
Janet Yellen, President Barack Obama’s pick to be the Federal Reserve’s next vice chairman, said it would be “risky” to adopt a long-run inflation goal of 4 percent, and that supervision and regulation are “the first line of defense” against risks to the financial system.
She made the comments in written responses to questions posed by U.S. Senator Richard Shelby, a Republican from Alabama, following her July 15 hearing before the Senate Banking Committee. Yellen, president of the San Francisco Fed, is awaiting confirmation, along with Obama’s other nominees, Sarah Bloom Raskin and Peter Diamond…
...She said that while a higher long-run inflation goal would “give the Fed more maneuvering room in the future,” she agrees with Bernanke that such a move “would be a risky policy strategy.” Most policy makers regard 2 percent as a level consistent with price stability.
I would think that, despite having to endure a higher inflation target, Yellen would be eager to have more maneuvering room. After all, there is not a lot of working room for conventional policy in a liquidity trap. Yet Fed officials seem to prefer the idea that unemployment becomes a long term challenge rather than a short run cyclical issue over the risk of inflation. Like fiscal policy, monetary policy is now limited by imaginary obstacles.
It is worth noting that the long term challenge may already be upon us. David Altig puzzles over the implications of a shifting Beveridge curve, suggesting that extended unemployment benefits may have a role. He then hones in on the possibility of a skills mismatch:
Now I realize that a few anecdotes don't make facts, but I have been in more than a few conversations with businesspeople who have claimed that the productivity gains realized in the United States throughout the recession and early recovery reflect upgrades in business processes—bundled with a necessary upgrade in the skill set of the workers who will implement those processes. This dynamic suggests that the shift in required skills has been concentrated within individual industries and businesses, not across sectors or geographic areas that would be captured by our most straightforward measures of structural change.
To be honest, I hear this complaint too, but have trouble swallowing it. I believed it in the mid and late 1990's, but now? The eight million people dropped into unemployment are all unemployable? Firms are willing to lose profits than do the unthinkable, on the job training, actually invest in their employees? I also have heard the opposite story, of overeducated temporary Census workers desperate for employment, completing assignments in a fraction of the expected time, not realizing that their productivity would only be rewarded with a shorter stint of employment. And if we are experiencing all these magical productivity gains and a shortfall of workers, then wages should be rising quite smartly. But from one of the articles cited by Altig:
Here in this suburb of Cleveland, supervisors at Ben Venue Laboratories, a contract drug maker for pharmaceutical companies, have reviewed 3,600 job applications this year and found only 47 people to hire at $13 to $15 an hour, or about $31,000 a year.
You get what you pay for. To put this into perspective, the average national wage for Wal-Mart was $11.24/hour in 2009. I would hope, however, that Ben Venue Laboratories pays better benefits.
I would really appreciate a good story that explained why we should be happy about high productivity growth if real wage growth is not surging. The lack of the latter makes me question the reality of the former.
Putting my skepticism aside, if a skills mismatch is really a problem, then the solution is to ramp up activity until labor shortages raise wages and force employers to reach deeper into the barrel and in turn bring more people into the labor force to gain those missing skills. Better to do it sooner than later. If the productivity gains are real, the wage gains should not be inflationary. This was the story of the 1990s. Otherwise, policymakers sit and wait as the potential structural rigidities deepen, thereby ensuring a higher NAIRU in the future. And, driven by fear of inflation, this appears to be exactly what policymakers intend to do.