Review for final.
August 14, 2014
August 12, 2014
Lecture 23 on Wednesday 8/13/2014
Brief Outline of Topics Covered in Lecture 23
Chapter 24 The Role of Expectations in Monetary Policy
The Lucas Critique of Econometric Policy Evaluation
Rules versus Discretion
- Discretion and Time-Inconsistency
- Types of rules
- The case for rules
- The case for discretion
- Constrained Discretion
The role of credibility and a nominal anchor
Credibility and aggregate demand shocks
- Positive and negative AD shocks
- AS shocks
- Credibility and anti-inflation policy
Extra Reading:
Tim Duy:
Heading Into Jackson Hole, by Tim Duy: The Kansas City Federal Reserve's annual Jackson Hole conference is next week, and all eyes are looking for signs that Fed Chair Janet Yellen will continue to chart a dovish path for monetary policy well into next year. Indeed, the conference title itself - "Re-Evaluating Labor Market Dynamics" - points in that direction, as it emphasizes a topic that is near and dear to Yellen's heart. My expectation is that no hawkish surprises emerge next week. Despite continued improvement in labor markets, Yellen will push the Fed to hold back on aggressively tightening monetary policy. And with inflation still below target, wage growth constrained, and inflation expectations locked down, she holds all the leverage to make that happen.
Today we received the June JOLTS report, a lagging, previously second-tier report elevated to mythic status by Yellen's interest in the data. The report revealed another gain in job openings, leading to further speculation that labor slack is quickly diminishing:
Anecdotally, firms are squealing that they can't find qualified workers. Empirically, though, they aren't willing to raise wages. Neil Irwin of the New York Times reports on the trucking industry as a microcosm of the US economy:
Yet the idea that there is a huge shortage of truck drivers flies in the face of a jobless rate of more than 6 percent, not to mention Economics 101. The most basic of economic theories would suggest that when supply isn’t enough to meet demand, it’s because the price — in this case, truckers’ wages — is too low. Raise wages, and an ample supply of workers should follow.But corporate America has become so parsimonious about paying workers outside the executive suite that meaningful wage increases may seem an unacceptable affront. In this environment, it may be easier to say “There is a shortage of skilled workers” than “We aren’t paying our workers enough,” even if, in economic terms, those come down to the same thing.The numbers are revealing: Even as trucking companies and their trade association bemoan the driver shortage, truckers — or as the Bureau of Labor Statistics calls them, heavy and tractor-trailer truck drivers — were paid 6 percent less, on average, in 2013 than a decade earlier, adjusted for inflation. It takes a peculiar form of logic to cut pay steadily and then be shocked that fewer people want to do the job.
A "peculiar form of logic" indeed, but one that appears endemic to US employers nonetheless. Meanwhile, from Business Insider:
Profit margins are still getting wider."With earnings growth (6.7%) rising at a faster rate than revenue growth (3.1%) in Q2 and in future quarters, companies have continued to discuss cost-cutting initiatives to maintain earnings growth rates and profit margins," said FactSet's John Butters on Friday.This comes at a time when profit margins are already at historic highs.Ever since the financial crisis, sales growth has been weak. However, corporations have been able to deliver robust earnings growth by fattening profit margins. Much of this has been done by laying off workers and squeezing more productivity out of those on the payroll.
Margins serve as a line of defense against inflation. In fact, I would imagine that Yellen's ideal world is one in which margins are compressing because stable inflation expectations prevent firms from raising prices while tight labor markets force wage growth higher. A goldilocks scenario from the Fed's perspective. This is also the scenario that is most likely to foster the tension in the FOMC as Fed's hawks argue for immaculate inflation while doves battle back about actual inflation. In any event, until wage growth actually accelerates, the likelihood of any meaningful, self-sustaining inflation dynamic remains very, very low.
Separately, a second justification for a moderate pace of tightening emerges. Via Reuters:
Approaching a historic turn in U.S. monetary policy, Janet Yellen has staked her tenure as chair of the Federal Reserve on a simple principle: she'd rather fight inflation than another economic downturn.Interviews with current and former Fed officials indicate that Yellen and core decision-makers at the U.S. central bank are determined not to raise interest rates too early and risk hurting the fragile U.S. economy......The nightmare scenario she wants to avoid is hiking rates only to see financial markets and the economy take such a hit that she has to backtrack. Until the Fed has gotten rates up from the current level near zero to more normal levels, it would have little room to respond if the economy threatened to head into another recession.
Gasp! Is the reality of the zero bound finally sinking in at the Fed? The basic argument is that the Fed needs to at least risk overshooting to pull interest rates into a zone that allows for normalized monetary policy during the next recession. And given that the Fed knows how to effectively tame inflation while stimulating the economy at the zero bound in more challenging, the costs of overshooting are less than the costs of undershooting.
(Note that I suspect overshooting in this context is the 2.25-2.5% range, but that still provides more leeway than a 2.25% cap.)
In addition, Yellen can point out that since the disinflation of the early 90's, the Fed has not faced an inflation problem, but instead has struggled with three recessions. This on the surface suggests that monetary policy has erred in being too tight on average.
Bottom Line: Anything other than a dovish message coming from the Jackson Hole conference will be a surprise. Tight labor markets alone will not justify an aggressive pace of tightening. An aggressive pace requires that those tight labor markets manifest themselves into higher wage growth and higher inflation. Yellen seems content to normalize slowly until she sees the white in the eyes of inflation.
August 10, 2014
August 08, 2014
August 07, 2014
August 06, 2014
Lecture 19 on Thursday 8/7/2014
Brief Outline of Topics Covered in Lecture 19
Chapter 22 Aggregate Demand and Supply Analysis [continued]
Equilibrium of AS and AD
- SR and LR response to AD shocks
- SR and LR response to AS shocks
Chapter 23 Monetary Policy Theory [probably won't get to this chapter]
Response of monetary policy to shocks
- Response to an AD Shock
- Response to a permanent supply shock
- Response to a temporary supply shock
- Summary
Extra Reading
Tim Duy:
Fed Hawks Squawk, by Tim Duy: How much leeway does Fed Chair Janet Yellen have in her campaign to hold interest rates low for a considerable period after asset purchases end later this year? If you listen to Fed hawks, you would believe that she is quickly running out of room. Dallas Federal Reserve President Richard Fisher argued that the liftoff date for interest rates is creeping forward. From Reuters:
"I think the committee, as I listen to them and I can only speak for myself around that table during two days of discussion, is coming in my direction, so I didn’t feel the need to dissent,” Dallas Federal Reserve Bank President Richard Fisher said on Fox Business Network."We are going to have to move the date of liftoff further forward than had been projected the last time we issued the 'dots'” he said, referring to the official Fed forecasts for short-term interest rates, last issued in June.
At the time of the June FOMC meeting, the most recent read on the unemployment rate was 6.3% (May), while the July rate was just a nudge lower at 6.2%. The inflation rate (core-PCE) at the time of the June FOMC meeting was 1.43% (April), compared to 1.49% in June. So the Fed is arguably just a little closer to its goals, but enough to dramatically move forward the dots just yet? Not sure about that, but a downward lurch of unemployment in the next report would likely elicit a reaction in the dots. If the dots don't move, Fisher promises a dissent at the next FOMC meeting.
The pace of the tightening, however, is in my opinion more important than the timing of the first rate hike. Richmond Federal Reserve President Jeffrey Lacker argues that the pace of rate hikes will be more aggressive than currently anticipated by market participants. Via Craig Torres at Bloomberg:
Investors may be underestimating the pace at which the Federal Reserve will raise interest rates over the next two years, said Jeffrey Lacker, president of the Federal Reserve Bank of Richmond.Short-term interest-rate markets have for months priced in a slower tempo of increases than policy makers themselves forecast. That’s risky because the misalignment, a bet against a rate path that the central bank alone controls, could lead to volatility if traders have to adjust rapidly, Lacker said.“When there is that kind of gap, it gets your attention,” Lacker, a consistent critic of the Fed’s record easing who votes on policy next year, said in an Aug. 1 interview at his Richmond office overlooking the James River. “It wouldn’t be good for it to be closed with great rapidity.”
How much should we listen to Lacker? Torres notes correctly that Lacker's track record on policy is not exactly the greatest:
Lacker’s forecasts haven’t always been on target, which he’s acknowledged in his speeches. In a March 2012 dissent, he indicated the federal funds rate would have to rise “considerably sooner” than late 2014 “to prevent the emergence of inflationary pressures,” according to minutes of the meeting. The benchmark rate is still close to zero, and inflation is below the Fed’s target.
ISI's Krishna Guha suggests that the market expects that Fed Chair Janet Yellen's forecast will win the day. Via Matthew Boes:
"The market now appears to be tracking a guesstimate of the 'Yellen dot' rather than the median"—ISI's Krishna Guha pic.twitter.com/rhlox9dJe3
— Matthew B (@boes_) August 4, 2014
Where to begin? First, it is worth dispensing with the myth of "immaculate inflation." Fed hawks seem to believe that low unemployment is sufficient to send inflation screaming higher. They see the 1970s under ever carpet, behind every closet door. But the relationship between unemployment and inflation is simply very weak:
Generally, inflation has been within a range of 1.0% to 2.5% since the disinflation of the early 1990s. No immaculate inflation. What is missing to generate that immaculate inflation? Inflation expectations. After the decline in inflation expectations in the early 1980's:
inflation expectations have been remarkably stable:
As long as inflation expectations remain anchored, immaculate inflation remains unlikely. Stable inflation expectations thus clearly give Yellen room to pursue a less aggressive normalization strategy. Note that this does not mean waiting until inflation expectations begin to rise before tightening. Remember that the reason that inflation expectations remain anchored is because the Fed does in fact tighten policy in when conditions point toward above-target inflation. The Fed learned in the early 1980s that they do in fact have substantial control over inflation expectations, and they intend to retain that control. But without conditions that argue for a real threat to those expectations - including, notably, actual inflation above the 2.25% in the context of faster wage growth - Yellen will have justification to resist an aggressive pace of tightening.
Moreover, Yellen still has tepid wage growth on her side. And if unemployment dips below 6% as seem inevitable by the end of this year, I suspect we will move into a critical test of the Yellen hypothesis. Consider the relationship between wage growth and unemployment:
The downward slop looks obvious, but becomes even clearer if we isolate some of the movement associated with recessions:
At the moment, wage growth is on the soft side of where we might expect given the unemployment rate, consistent with Yellen's position. If that situation continues, then it follows that Yellen will have a strong hand to play with the FOMC. Lack of wage growth by itself would argue for a very gradual pace of rate hikes even in the face of higher inflation. Yellen - and the majority of the FOMC - will not see a threat to inflation expectations at the current pace of wage growth.
Bottom Line: At the moment, we are focused on wages as the missing part of the higher rate equation. But that is too narrow of an analysis. Also on Yellen's side is low actual inflation and anchored inflation expectations. To be sure, the Fed will be under increasing pressure to begin normalizing policy if unemployment drops below 6%. At that point the Fed will be sufficiently close to their objectives that they will believe the odds of falling behind the curve will rise in the absence of movement toward policy normalization. But without a more pressing threat to inflation expectations from a combination of actual inflation in excess of the Fed's target and wage growth to support that inflation, Yellen has room to normalize policy at a gradual pace. For now, the data is still on her side and the hawks will remain frustrated, much as they have for the past several years.
August 05, 2014
August 04, 2014
August 01, 2014
Lecture 15 on Friday 8/1/2014
Brief Outline of Topics Covered in Lecture 15
Chapter 21 The Monetary Policy and Aggregate Demand Curves [cont.]
The LM Curve and how it relates to the MP curve
- Derive the LM curve from Md-Ms diagram
- Shifts in the LM curve
Monetary and fiscal policy effectiveness
The Aggregate Demand Curve
- Shifts in the AD curve
Extra Reading:
Tim Duy once again:
July Employment Report, by Tim Duy: The overall tenor of the July employment report was consistent with the song that Yellen and Co. are singing. Labor markets are generally improving at a moderate pace, yet despite relatively low unemployment, there is plenty of reason to believe considerable slack remains in the economy.
The headline nonfarm payroll number was a ho-hum gain of 209K with some small upward revisions for the previous two months. Steady above 200k gains this year are lifting the 12-month moving average of jobs higher:
In the context of the range of indicators that Fed Chair Janet Yellen has drawn specific attention to:
Consistent with the consensus of the FOMC as revealed at the conclusion of this week's FOMC meeting, measures of underutilization of labor remain elevated. Notable is the flat wage growth - clearly a ball in Yellen's court. Moreover, these numbers should override any enthusiasm over yesterday's ECI report, which is obviously overtaken by events.
In other news, inflation remains below target:
although pretty much right at target over the past three months:
Numbers like these gave the Fed reason to upgrade its inflation outlook this week. If these numbers can hold up for the next several months, you will see the year-over-year number gradually converge to the Fed's target, clearing the way for the Fed's first rate hike in the middle of next year (my preference remains the second quarter over the third).
On the whole, these data continue to argue for a very gradual pace of tightening. The Fed will be in rush to normalize policy until labor underutilization approaches normal levels and wage growth accelerates. Since it's Friday and everyone is looking forward to the weekend, we can avoid re-inventing the wheel on this topic and just refer to Binyamin Appelbaum's report on the FOMC meeting, in which he quotes some random commentator:
The Fed’s chairwoman, Janet L. Yellen, and her allies have taken a more cautious view, arguing that the decline in the unemployment rate appears to overstate the improvement in the labor market, because it counts only people who are looking for work. Ms. Yellen has said she expects some people who dropped out of the labor force to return as the economy continues to improve, and she has pointed to tepid wage growth as evidence that it remains easy to find workers.“The recovery is not yet complete,” she told Congress this month.The statement suggested that the committee continued to back Ms. Yellen’s view, said Tim Duy, a professor of economics at the University of Oregon.“The committee as a whole is still willing to give Yellen the benefit of the doubt,” Mr. Duy said. “And honestly they have good reason. Until you get upward pressure on wages, it is terribly difficult to say that she’s wrong.”In recent conversations with Oregon businesses, Mr. Duy said, he heard repeatedly that it was becoming harder to hire workers, but also that businesses were unwilling to offer higher wages as an inducement, because they doubted their ability to recoup the cost through increased sales or higher prices.
Bottom Line: Nothing here to change the outlook for monetary policy.
July 30, 2014
Lecture 14 on Thursday 7/31/2014
Brief Outline of Topics Covered in Lecture 14
Chapter 20 The IS Curve [continued]
The IS curve
- The IS curve graphically, mathematically, and intuitively
- Shifts in the IS curve
- Slope of the IS curve
Chapter 21 The Monetary Policy and Aggregate Demand Curves [cont.]
The MP Curve
The Aggregate Demand Curve
- Shifts in the MP curve
- Slope of the MP Curve
- Derive AD curve algebraically and graphically
- Shifts in the AD curve
Extra Reading:
Tim Duy:
FOMC Statement, by Tim Duy: At the conclusion of this week's FOMC meeting, policymakers released yet another statement that only a FedWatcher could love. It is definitely an exercise in reading between the lines. The Fed cut another $10 billion from the asset purchase program, as expected. The statement acknowledged that unemployment is no longer elevated and inflation has stabilized. But it is hard to see this as anything more that describing an evolution of activity that is fundamentally consistent with their existing outlook. Continue to expect the first rate hike around the middle of next year; my expectation leans toward the second quarter over the third.
The Fed began by acknowledging the second quarter GDP numbers:
Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter.
With the new data, the Fed's (downwardly revised) growth expectations for this year remain attainable, but still requires an acceleration of activity that has so far been unattainable:
Despite all the quarterly twists and turns, underlying growth is simply nothing to write home about:
That slow yet steady growth, however, has been sufficient to support gradual improvement in labor markets, prompting the Fed to drop this line from the June statement:
The unemployment rate, though lower, remains elevated.
and replace it with:
Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.
While the unemployment rate is no longer elevated, this is a fairly strong confirmation that Federal Reserve Chair Janet Yellen has the support of the FOMC. As a group, they continue to discount the improvement in the unemployment rate. And as long as wage growth remains tepid, this group will continue to have the upper hand.
The inflation story also reflects recent data. This from June:
Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable...The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.
became this:
Inflation has moved somewhat closer to the Committee's longer-run objective. Longer-term inflation expectations have remained stable...The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat.
Rather than something to worry over, I sense that the majority of the FOMC is feeling relief over the recent inflation data. It is often forgotten that the Fed WANTS inflation to move closer to 2%. The reality is finally starting to look like their forecast, which clears the way to begin normalizing policy next year. Given the current outlook, expect only gradual normalization.
Finally, we had a dissent:
Voting against was Charles I. Plosser who objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends," because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.
We probably should have seen this coming; Philadelphia Fed President Charles Plosser raised this issue weeks ago. Clearly he is not getting much traction yet among his colleagues. I doubt they want to change the language before they have settled on a general exit strategy (which was probably the main topic of this meeting and will be the next). Somewhat surprising is that Dallas Federal Reserve President Richard Fisher did not join Plosser given Fisher's sharp critique of monetary policy in Monday's Wall Street Journal. Note to Fisher: Put up or shut up.
Bottom Line: Remember that we should see the statement shift in response to the data relative to the outlook. In short, the statement needs to remain consistent with the reaction function. The changes in the July statement reflect that consistency. The data continues to evolve in such a way that the Fed can remain patient in regards to policy normalization. We will see if that changes with the upcoming employment report; focus on the underlying numbers, as the Fed continues to discount the headline numbers.
July 29, 2014
Lecture 13 on Wednesday 7/30/2014
Brief Outline of Topics Covered in Lecture 13
Chapter 19 Money Demand [continued]
Is velocity a constant?
Portfolio theories of money demand
Chapter 20 The IS Curve
The IS curve
- Investment and the interest rate
- Net exports and the interest rate
- Equilibrium in the godds market
- The IS curve graphically, mathematically, and intuitively
- Shifts in the IS curve
- Slope of the IS curve
Chapter 21 The Monetary Policy and Aggregate Demand Curves
The MP Curve
- Shifts in the MP curve
- Slope of the MP Curve
[If time permits, we will go on to aggregate demand.]
Extra Reading:
The Wage Growth Gap for Recent College Grads, by Bart Hobijn and Leila Bengali, FRBSF Economic Letter: Median starting wages of recent college graduates have not kept pace with median earnings for all workers over the past six years. This type of gap in wage growth also appeared after the 2001 recession and closed only late in the subsequent labor market recovery. However the wage gap in the current recovery is substantially larger and has lasted longer than in the past. The larger gap represents slow growth in starting salaries for graduates, rather than a shift in types of jobs, and reflects continued weakness in the demand for labor overall.
Starting wages of recent college graduates have essentially been flat since the onset of the Great Recession in 2007. Median weekly earnings for full-time workers who graduated from college in the year just before the recession, between May 2006 and April 2007, were $653. Over the 12 months ending in April 2014, the earnings of recent college graduates had risen to $692 a week, only 6% higher than seven years ago.
The lackluster increases in starting wages for college graduates stand in stark contrast to growth in median weekly earnings for all full-time workers. These earnings have increased 15% from $678 in 2007 to $780 in 2014. This has created a substantial gap between wage growth for new college graduates and workers overall.
In this Economic Letter we put the wage growth gap in a historical context and consider what is at its heart. In particular, we find that the gap does not reflect a switch in the types of jobs that college graduates are able to find. Rather we find that wage growth has been weak across a wide range of occupations for this group of employees, a result of the lingering weak labor market recovery.
College graduates’ wage growth gap in a historical perspective
We compare wages of recent college graduates to the overall population over time using monthly data at an individual level from the Current Population Survey (CPS). The CPS is used by the Bureau of Labor Statistics (BLS) to calculate the official estimates of the unemployment rate, employment, and median weekly earnings. The CPS does not specifically identify recent college graduates, so we define them as workers who have a college degree and are between ages 21 and 25.
Figure 1
Median weekly earnings: Overall vs. recent graduates
Source: BLS/Haver Analytics, CPS, and authors’ calculations.
Figure 1 shows a comparison of full-time employees’ median weekly earnings for our CPS measure of recent college graduates and for the overall population, taken from the BLS. We use our results for graduates in the year before the recession began as a benchmark, indexing values to 100 in 2006:Q4. In this way, the lines after that point show by what percent median weekly earnings have grown since the recession started.
Typically, at least over the time period shown, the median weekly earnings of recent college graduates have tracked overall earnings relatively well, with some deviation. New graduates tend to exhibit stronger wage growth during economic booms, and slower wage growth in downturns (shown by gray bars) and subsequent recoveries. Put another way, wage growth for recent college graduates tends to fall during recessions and not pick up again until long into recoveries. In this context, the striking pattern we see since the 2007–09 recession is not without precedent. For example, a similar pattern would emerge if Figure 1 ended around the middle of 2005, in the later stages of the labor market recovery after the 2001 recession. Over this period, wage growth for recent graduates appeared to stall for a number of years after the recession, while overall wage growth continued to increase. Although the pattern in that earlier recovery is similar to recent years, wage growth for college graduates in the current recovery has remained flat for a longer period. Furthermore, the gap between the two groups of employees appears to be substantially wider and their paths appear more divergent.
Broad-based weakness in earnings growth
Even though the recent slow wage growth is not unprecedented, its apparent persistence raises the question of why it has remained so slow for so long. We explore two potential explanations. One is that recent graduates are now getting different types of jobs than they were before the recession, particularly jobs typically associated with lower wages and thus lower earnings. If this were true, comparing the occupational distribution of recent graduates before and after the recession should reveal a shift towards low-paid occupations and away from high-paid occupations, with reasonably stable earnings in each group. Another possibility is that recent college graduates are getting jobs in similar occupations as they did before the recession, but within each occupation, growth of starting wages has been slow. If this were the case, we would expect to see similar percentages of recent graduates in each occupation over time, but little wage growth within each occupation. Note that more recent graduates taking part-time jobs, which may generate lower weekly earnings, would not explain the gap in wage growth in Figure 1, which shows only full-time workers.
To explore our two potential explanations, we use the information about each respondent’s major occupation as reported in the CPS. For this and subsequent analysis, we redefine years as May of the prior year through April of the current year; this is to make the groups correspond more closely to annual cohorts of college graduates, who likely graduate starting in May. For example, 2014 runs from May 2013 to April 2014. We report data for three points in time: 2007, a year before the start of the recession; 2011, around the start of the recovery; and 2014, the most recent year of data available.
Table 1
Recent graduates in occupations, labor marketsTable 1 presents the shares of recent college graduates employed in major occupations and according to labor market status. Occupational categories for full-time employment are rather broad, but they show recent college graduates were employed in a similar distribution of occupations before and after the recession. Notably, some of the changes between 2007 and 2011 were at least partially reversed by 2014, such as in the categories for professional and related occupations; management, business, and finance; office and administrative occupations; and “other” occupational skill groups, classified roughly according to Autor (2010). Although there have been some notable shifts towards a few categories such as service occupations, occupational distributions have remained generally stable. Next we turn to our second explanation, that recent college graduates are getting the same kinds of jobs, but at lower wages. The right side of the table presents median weekly earnings for recent college graduates. For 2007 the table shows the level of earnings, and the columns for 2011 and 2014 list the percent change relative to 2007. Also shown are overall earnings and earnings for recent graduates working part-time. With few exceptions, wage growth has been limited in all occupational groups for recent graduates. Note that professional and related occupations and management, business, and finance, which are the two most popular categories for recent graduates, have seen particularly low wage growth. The table also shows that earnings for recent graduates working part-time have fallen since the start of the recession, due to a combination of fewer hours worked and lower hourly wage growth.
Thus, while comparing occupational distributions across years indicates some stability, there is a clear pattern of low earnings growth for most categories. In fact, for almost all occupations and skill groups for which we have enough data to compare recent graduates to all others, we find that recent graduates experienced lower wage growth than other workers.
It turns out that the sluggish wage growth of recent college graduates is fully accounted for by the slowdown in wage growth across occupations. When we calculate a change in wages by keeping the types of jobs held by recent graduates fixed at their 2007 occupational composition, we find that wage growth is exactly the same as when we use the actual distribution.
Macroeconomic and individual-level implications
The broad-based weakness in earnings growth for recent college graduates has both larger economic and individual-level implications.
The wage growth gap points to continued weakness in the overall labor market. This is largely because recent college graduates are the “marginal” high-skilled workers in the economy, who are not protected by factors that make other workers’ wages rigid and slow to adjust to conditions such as recessions (see Hobijn, Gardiner, and Wiles 2011, who argue that this labor market weakness is cyclical rather than structural). Because the wages of recent college graduates are less affected by wage rigidity, they are a good indicator of the true price of labor and thus of the underlying state of the labor market.
Other signs of the continued weakness in the labor market are the shares of recent graduates not in the labor force, unemployed, or working part-time, which are still elevated compared with the start of the recession (see bottom of Table 1).
At the individual level, the persistent wage growth gap has implications for both recent graduates and potential graduates. Potential graduates, seeing the difficulties faced by current graduates in finding any job, particularly a full-time job, might interpret this as a signal that it is not worth going to college. However, recent evidence suggests that this is a misguided conclusion. It is important to note that the relevant metric for the returns of a college education accounts for the cost of education in comparing the earnings of college graduates relative to the earnings of nongraduates.
Low growth in starting wages does not mean that going to college is a poor investment. It just reflects that it will take longer to recoup the cost of the college education for current graduates. Supporting this idea, Kahn (2010) finds that those who graduate from college during a recession have lower earnings than other grads, even many years in the future. Taking into account the relative costs and benefits of a college education, Daly and Bengali (2014) find that a college education is still a very worthwhile investment, it may simply have relatively lower returns and take longer to pay off for recent graduates than for those who graduate during economic booms.
Conclusion
In this Letter we explore evidence that recent college graduates were and continue to be hit hard following the 2007–09 recession. The past several annual cohorts of graduates have experienced low earnings growth across almost all occupations compared with the overall population. While this post-recession pattern was also present after the 2001 recession, earnings growth following the most recent recession has been held down longer than in the past, which reflects the depth and severity of the recession. Because college grads face wages and hiring conditions that are especially responsive to business cycle conditions, this low earnings growth, together with shifts in the distribution of graduates’ labor market status, suggests continued weakness in the overall economy.
References
Abel, Jaison R., Richard Deitz, and Yaqin Su. 2014. “Are Recent College Graduates Finding Good Jobs?” FRB New York Current Issues in Economics and Finance 20(1).
Autor, David. 2010. “The Polarization of Job Opportunities in the U.S. Labor Market: Implications for Employment and Earnings.” Paper jointly released by the Center for American Progress and the Hamilton Project.
Daly, Mary C., and Leila Bengali. 2014. “Is It Still Worth Going to College?” FRBSF Economic Letter 2014-13 (May 5).
Hobijn, Bart, Colin Gardiner, and Theodore Wiles. 2011. “Recent College Graduates and the Labor Market.” FRBSF Economic Letter 2011-09 (March 21).
Kahn, Lisa B. 2010. “The Long-Term Labor Market Consequences of Graduating from College in a Bad Economy.” Labour Economics 17, pp. 303–316.
July 28, 2014
July 27, 2014
July 24, 2014
July 23, 2014
July 22, 2014
July 21, 2014
Lecture 6 on Monday 7/21/2014
Brief Outline of Topics Covered in Lecture 6
Chapter 14 Multiple Deposit Creation and the Money Supply Process
Three Players in the Money Supply Process
The Fed’s Balance Sheet
- Liabilities
- Assets
Control of the Monetary Base
- Open Market Operations with Bank
- Open Market Operations with an Individual and shifts between
The Money Supply Model and the Money Multiplier
- Deriving the Money Multiplier
Factors That Determine the Money Multiplier
- Changes in the Required Reserve Ratio, r
- Changes in the Currency Ratio, c = C/D
- Changes in the Excess Reserves Ratio, e = ER/D
Additional Factors That Determine the Money Supply
- Changes in the Nonborrowed Monetary Base, MBn
- Changes in Borrowed Reserves, BR, from the Fed
Chapter 15 Tools of Monetary Policy
The Market for Reserves and the Federal Funds Rate
- Supply and Demand in the Market for Reserves
- Tools of monetary policy: Open Market Operations, Discount Policy, and Reserve Requirements
Application:
Why Do Banks Feel Discount Window Stigma?,by Olivier Armantier, Liberty Street, FRBNY: Even when banks face acute liquidity shortages, they often appear reluctant to borrow at the New York Fed’s discount window (DW) out of concern that such borrowing may be interpreted as a sign of financial weakness. This phenomenon is often called “DW stigma.” In this post, we explore possible reasons why banks may feel such stigma.
The problem of stigma has been a lingering issue throughout the history of the DW. Prior to 2003, banks in distress could borrow from the DW at a rate below the fed funds target rate. Because of the subsidized rate, the Fed was concerned about “opportunistic overborrowing” by banks. Accordingly, before accessing the DW, a bank had to satisfy the Fed that it had exhausted private sources of funding and that it had a genuine business need for the funds. Hence, if market participants learned that a bank had accessed the DW, then they could reasonably conclude that the bank had limited sources of funding. The old DW regime therefore created a legitimate perception of stigma.
To address such stigma concerns, the Fed fundamentally changed its DW policy in 2003. In Regulation A, as revised in 2003, the Fed classified DW loans into primary credit, secondary credit, and seasonal credit. Financially strong and well-capitalized banks can borrow under the primary credit program at a penalty rate above the target fed funds rate (rather than a subsidized rate, as in the past). Other banks can use the secondary credit program and pay a rate higher than the primary credit rate. Finally, seasonal credit is for relatively small banks with seasonal fluctuations in reserves. For banks eligible for primary credit, the new DW is a “no-questions-asked” facility. Namely, the Fed no longer establishes a bank’s possible sources and needs for funding to lend under the primary credit program. Instead, primary credit for overnight maturity is allocated with minimal administrative burden on the borrower. Hence, access to primary credit need not be motivated by pressing funding needs nor signal financial weakness. In other words, there’s no structural reason why stigma should be attached to the new DW.
Nevertheless, stigma concerns resurfaced in 2007 at the onset of the recent financial crisis. In fact, as adverse liquidity conditions in the interbank markets persisted at the end of 2007, the Fed had to put in place a temporary facility, the Term Auction Facility (TAF), which was specifically designed to eliminate any perception of stigma attached to borrowing from the DW. Further, as discussed in a previous post, there’s strong evidence that banks experienced DW stigma during the most recent financial crisis.
So why do banks still feel DW stigma? In a recent staff report, we explored different hypotheses related to factors that may exacerbate or attenuate DW stigma. To conduct our analysis, we compared the DW rate with the bids each bank submitted at the TAF between December 2007 and October 2008. As explained in our paper, it can be shown with a simple arbitrage argument that, absent DW stigma, a TAF bidder should never bid above the prevailing DW rate. We therefore interpreted a bank bidding above the DW rate as evidence of DW stigma. Then, we conducted an econometric analysis to identify a bank’s possible determinants of DW stigma. Among the various hypotheses we tested, we report here the most interesting.
- Banks outside the New York District: A necessary condition for DW stigma to exist is that banks must believe there’s a chance their identities will be made public soon after they borrow from the DW. Although central banks don’t immediately disclose the borrower’s identity, it’s been argued that DW borrowers may be identified from the Fed’s weekly public report, in which DW borrowings aggregated by Federal Reserve District are published. This identification channel may be especially relevant for banks in smaller Districts. Indeed, DW borrowing by an institution in a smaller District may be easier to detect. To test this hypothesis, our study focused on the Second Federal Reserve District (which covers the New York region) — the largest of the twelve Federal Reserve Districts in terms of the number of banks supervised. Consistent with the hypothesis, our results showed that banks in the New York District were 14 percent less likely to experience DW stigma than their counterparts in smaller Districts.
- Foreign banks: It’s also possible that foreign institutions with access to primary credit at the Fed are especially sensitive to DW stigma. Indeed, in contrast with their U.S. counterparts, foreign banks typically don’t have access to retail dollar deposits that are insured by the Federal Deposit Insurance Corporation. As a result, foreign banks must often rely on wholesale debt investors (such as money market funds), which are highly sensitive to credit risk. In other words, because their investors may be sensitive to any negative information, foreign banks may be particularly concerned about the risk of being detected taking a loan at the DW. Again, we found strong evidence to support this hypothesis. Specifically, our results suggested that branches and agencies of foreign banks were 28 percent more likely to experience DW stigma than their U.S. counterparts with otherwise similar characteristics.
- Herding effect: Intuitively, DW stigma may be expected to reflect a coordination problem. If an institution is the only one borrowing at the DW, then it’s likely to be stigmatized. However, the stigma from accessing the DW should be lower if many other institutions do so at the same time. However, we found no support for this hypothesis. Specifically, our results suggested that the stigma attached to borrowing at the DW didn’t decline when more banks accessed it during the 2007-08 period. To explore this question in more detail, we also tested whether there’s a form of herding or contagion effect, whereby a bank’s DW stigma declines when more banks within its own peer group (as measured by asset size) go to the DW. Again, the results from our regressions provided no evidence of such a herding effect.
- Market conditions: In times of financial crises, there’s often intense speculation about the health of various financial institutions. In particular, public news that may be considered negative (such as a bank visit to the DW that becomes public) is likely to be amplified beyond its informational content. As a result, banks may go to greater expense to avoid borrowing at the DW. One may therefore expect DW stigma to increase when financial markets become more stressed. To test this hypothesis, our study considered three variables that capture aggregate funding conditions and volatility in financial markets: the Libor-OIS spread, a stress indicator for the interbank and money markets; the VIX level, a measure of the forward-looking volatility of the U.S. stock market as implied by options prices; and the CDX IG index of CDS prices, a measure of economy-wide default probability. Consistent with the hypothesis, we found that DW stigma was positively related to each of the three measures of stress in financial markets.
In summary, our study provided a better understanding of the reasons why banks may feel DW stigma. In particular, we found that the incidence of DW stigma was higher for foreign banks, banks that could be identified more easily, and banks outside the New York Federal Reserve District, as well as after financial markets became stressed. In contrast, we found no evidence that DW stigma may be due to a lack of coordination among banks when accessing the DW.
Disclaimer
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.
Olivier Armantier is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.
July 18, 2014
July 17, 2014
Lecture 5 on Friday 7/18/2014
Brief Outline of Topics Covered in Lecture 5
Chapter 13 Structure of Central Banks and the Federal Reserve System [continued]
Structure of the Federal Reserve System
- Board of Governors of the Federal Reserve System
- Federal Open Market Committee (FOMC)
- The Federal Advisory Council
Chapter 14 Multiple Deposit Creation and the Money Supply Process
Three Players in the Money Supply Process
The Fed’s Balance Sheet
- Liabilities
- Assets
Control of the Monetary Base
- Open Market Operations with Bank
- Open Market Operations with an Individual and shifts between
The Money Supply Model and the Money Multiplier
- Deriving the Money Multiplier
Materials related to class:
Central Bank Independence and Inflation
From "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162 (the link will work on UO net, but I don't expect you to read the paper as it is a bit technical):
This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.
Extra Reading:
Tim Duy:
Yellen Testimony, by Tim Duy: Fed Reserve Chair Janet Yellen testified before the Senate today, presenting remarks generally perceived as consistent with current expectations for a long period of fairly low interest rates. Binyamin Applebaum of the New York Times notes:
Ms. Yellen’s testimony is likely to reinforce a sense of complacency among investors who regard the Fed as convinced of its forecast and committed to its policy course. She reiterated the Fed’s view that the economy will continue to grow at a moderate pace, and that the Fed is in no hurry to start increasing short-term interest rates.
A key reason that Yellen is in no hurry to tighten is her clear belief that an accommodative monetary policy is warranted given the persistent damage done by the recession:
Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level. Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.
Another reminder to watch compensation numbers. Without an acceleration in wage growth, sustained higher inflation is unlikely and hence the Fed sees little need to remove accommodation prior to reaching its policy objectives.
The only vaguely more hawkish tone was that identified by Applebaum:
But Ms. Yellen added that the Fed was ready to respond if it concluded that it had overestimated the slack in the labor market, a more substantial acknowledgment of the views of her critics than she has made in other recent remarks.
The exact quote:
Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.
Her choice of words is important here. Note that she does not say "If the labor market improves more quickly". Yellen says "continues to improve more quickly" which means that the economy is already converging towards the Fed's objective more quickly than anticipated by current forecasts. This is a point repeatedly made by St. Louis Federal Reserve President James Bullard in recent weeks. For example, via Bloomberg:
Federal Reserve Bank of St. Louis President James Bullard said a rapid drop in joblessness will fuel inflation, bolstering his case for an interest-rate increase early next year.“I think we are going to overshoot here on inflation,” Bullard said yesterday in a telephone interview from St. Louis. He predicted inflation of 2.4 percent at the end of 2015, “well above” the Fed’s 2 percent target.“That is a break from where most of the committee seems to be, which is a very slow convergence of inflation to target,” he said in a reference to the policy-making Federal Open Market Committee.
His picture:
With Yellen at least acknowledging this point, it brings into question whether or not the Fed should maintain its "considerable period" language:
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends...
Fed hawks, such as Philadelphia Federal Reserve President Charles Plosser, increasingly see the need to remove this language from the statement, and for some good reason. The Fed foresees ending asset purchases in October and can reasonably foresee raising interest rates in the first quarter given the trajectory of unemployment. Hence it is no longer clear that a "considerable period" between the end of asset purchases and the first rate hike remains a certainty.
To be sure, there will be resistance to changing the language now - the Fed will want to ensure that any change is interpreted as the result of a change in the outlook rather than a change in the reaction function. But the hawks will argue that the communications challenge is best handled by dropping the language sooner than later - later might appear like an abrupt change and be more difficult to distinguish from a shift in the reaction function. This I suspect is the next battlefield for policymakers.
Bottom Line: A generally dovish performance by Yellen today consistent with current expectations. But notice her acknowledgement of her critics, and watch for the "considerable period" debate to heat up as October approaches.
July 16, 2014
July 15, 2014
Lecture 3 on Wednesday 7/16/2014
Brief Outline of Topics Covered in Lecture 3
Chapter 3 What is Money? [continued]
Evolution of the Payments System
Commodity Money
Partially backed paper money
Full backed paper money
Fiat MoneyMeasuring Money
The Federal Reserve’s Monetary Aggregates
How Reliable Are Money Data?
Chapter 4 Understanding Interest Rates [pages 81-84]
Why Interest Rates and the Price of Bonds are Inversely Related
The Distinction between Real and Nominal Interest Rates
Nominal interest rates
Ex-ante real rates
Ex-post real rates
Chapter 13 Structure of Central Banks and the Federal Reserve System
Origins of the Federal Reserve System
- Distribute power to geographic regions, the public sector, the private sector, the business sector, and the financial sector
Structure of the Federal Reserve System
- Federal Reserve Banks
- Member Banks
- Board of Governors of the Federal Reserve System
- Federal Open Market Committee (FOMC)
- The Federal Advisory Council
Materials from class:
The Twelve Federal Reserve Districts
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Extra Reading: Ben Bernanke: Five Questions about the Federal Reserve and Monetary Policy
Five Questions about the Federal Reserve and Monetary Policy, Speech, Chairman Ben S. Bernanke, At the Economic Club of Indiana, Indianapolis, Indiana, October 1, 2012: Good afternoon. I am pleased to be able to join the Economic Club of Indiana for lunch today. I note that the mission of the club is "to promote an interest in, and enlighten its membership on, important governmental, economic and social issues." I hope my remarks today will meet that standard. Before diving in, I'd like to thank my former colleague at the White House, Al Hubbard, for helping to make this event possible. As the head of the National Economic Council under President Bush, Al had the difficult task of making sure that diverse perspectives on economic policy issues were given a fair hearing before recommendations went to the President. Al had to be a combination of economist, political guru, diplomat, and traffic cop, and he handled it with great skill.
My topic today is "Five Questions about the Federal Reserve and Monetary Policy." I have used a question-and-answer format in talks before, and I know from much experience that people are eager to know more about the Federal Reserve, what we do, and why we do it. And that interest is even broader than one might think. I'm a baseball fan, and I was excited to be invited to a recent batting practice of the playoff-bound Washington Nationals. I was introduced to one of the team's star players, but before I could press my questions on some fine points of baseball strategy, he asked, "So, what's the scoop on quantitative easing?" So, for that player, for club members and guests here today, and for anyone else curious about the Federal Reserve and monetary policy, I will ask and answer these five questions:
- What are the Fed's objectives, and how is it trying to meet them?
- What's the relationship between the Fed's monetary policy and the fiscal decisions of the Administration and the Congress?
- What is the risk that the Fed's accommodative monetary policy will lead to inflation?
- How does the Fed's monetary policy affect savers and investors?
- How is the Federal Reserve held accountable in our democratic society?
What Are the Fed's Objectives, and How Is It Trying to Meet Them?
The first question on my list concerns the Federal Reserve's objectives and the tools it has to try to meet them.As the nation's central bank, the Federal Reserve is charged with promoting a healthy economy--broadly speaking, an economy with low unemployment, low and stable inflation, and a financial system that meets the economy's needs for credit and other services and that is not itself a source of instability. We pursue these goals through a variety of means. Together with other federal supervisory agencies, we oversee banks and other financial institutions. We monitor the financial system as a whole for possible risks to its stability. We encourage financial and economic literacy, promote equal access to credit, and advance local economic development by working with communities, nonprofit organizations, and others around the country. We also provide some basic services to the financial sector--for example, by processing payments and distributing currency and coin to banks.
But today I want to focus on a role that is particularly identified with the Federal Reserve--the making of monetary policy. The goals of monetary policy--maximum employment and price stability--are given to us by the Congress. These goals mean, basically, that we would like to see as many Americans as possible who want jobs to have jobs, and that we aim to keep the rate of increase in consumer prices low and stable.
In normal circumstances, the Federal Reserve implements monetary policy through its influence on short-term interest rates, which in turn affect other interest rates and asset prices.1 Generally, if economic weakness is the primary concern, the Fed acts to reduce interest rates, which supports the economy by inducing businesses to invest more in new capital goods and by leading households to spend more on houses, autos, and other goods and services. Likewise, if the economy is overheating, the Fed can raise interest rates to help cool total demand and constrain inflationary pressures.
Following this standard approach, the Fed cut short-term interest rates rapidly during the financial crisis, reducing them to nearly zero by the end of 2008--a time when the economy was contracting sharply. At that point, however, we faced a real challenge: Once at zero, the short-term interest rate could not be cut further, so our traditional policy tool for dealing with economic weakness was no longer available. Yet, with unemployment soaring, the economy and job market clearly needed more support. Central banks around the world found themselves in a similar predicament. We asked ourselves, "What do we do now?"
To answer this question, we could draw on the experience of Japan, where short-term interest rates have been near zero for many years, as well as a good deal of academic work. Unable to reduce short-term interest rates further, we looked instead for ways to influence longer-term interest rates, which remained well above zero. We reasoned that, as with traditional monetary policy, bringing down longer-term rates should support economic growth and employment by lowering the cost of borrowing to buy homes and cars or to finance capital investments. Since 2008, we've used two types of less-traditional monetary policy tools to bring down longer-term rates.
The first of these less-traditional tools involves the Fed purchasing longer-term securities on the open market--principally Treasury securities and mortgage-backed securities guaranteed by government-sponsored enterprises such as Fannie Mae and Freddie Mac. The Fed's purchases reduce the amount of longer-term securities held by investors and put downward pressure on the interest rates on those securities. That downward pressure transmits to a wide range of interest rates that individuals and businesses pay. For example, when the Fed first announced purchases of mortgage-backed securities in late 2008, 30-year mortgage interest rates averaged a little above 6percent; today they average about 3-1/2 percent. Lower mortgage rates are one reason for the improvement we have been seeing in the housing market, which in turn is benefiting the economy more broadly. Other important interest rates, such as corporate bond rates and rates on auto loans, have also come down. Lower interest rates also put upward pressure on the prices of assets, such as stocks and homes, providing further impetus to household and business spending.
The second monetary policy tool we have been using involves communicating our expectations for how long the short-term interest rate will remain exceptionally low. Because the yield on, say, a five-year security embeds market expectations for the course of short-term rates over the next five years, convincing investors that we will keep the short-term rate low for a longer time can help to pull down market-determined longer-term rates. In sum, the Fed's basic strategy for strengthening the economy--reducing interest rates and easing financial conditions more generally--is the same as it has always been. The difference is that, with the short-term interest rate nearly at zero, we have shifted to tools aimed at reducing longer-term interest rates more directly.
Last month, my colleagues and I used both tools--securities purchases and communications about our future actions--in a coordinated way to further support the recovery and the job market. Why did we act? Though the economy has been growing since mid-2009 and we expect it to continue to expand, it simply has not been growing fast enough recently to make significant progress in bringing down unemployment. At 8.1 percent, the unemployment rate is nearly unchanged since the beginning of the year and is well above normal levels. While unemployment has been stubbornly high, our economy has enjoyed broad price stability for some time, and we expect inflation to remain low for the foreseeable future. So the case seemed clear to most of my colleagues that we could do more to assist economic growth and the job market without compromising our goal of price stability.
Specifically, what did we do? On securities purchases, we announced that we would buy mortgage-backed securities guaranteed by the government-sponsored enterprises at a rate of $40 billion per month. Those purchases, along with the continuation of a previous program involving Treasury securities, mean we are buying $85 billion of longer-term securities per month through the end of the year. We expect these purchases to put further downward pressure on longer-term interest rates, including mortgage rates. To underline the Federal Reserve's commitment to fostering a sustainable economic recovery, we said that we would continue securities purchases and employ other policy tools until the outlook for the job market improves substantially in a context of price stability.
In the category of communications policy, we also extended our estimate of how long we expect to keep the short-term interest rate at exceptionally low levels to at least mid-2015. That doesn't mean that we expect the economy to be weak through 2015. Rather, our message was that, so long as price stability is preserved, we will take care not to raise rates prematurely. Specifically, we expect that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economy strengthens. We hope that, by clarifying our expectations about future policy, we can provide individuals, families, businesses, and financial markets greater confidence about the Federal Reserve's commitment to promoting a sustainable recovery and that, as a result, they will become more willing to invest, hire and spend.
Now, as I have said many times, monetary policy is no panacea. It can be used to support stronger economic growth in situations in which, as today, the economy is not making full use of its resources, and it can foster a healthier economy in the longer term by maintaining low and stable inflation. However, many other steps could be taken to strengthen our economy over time, such as putting the federal budget on a sustainable path, reforming the tax code, improving our educational system, supporting technological innovation, and expanding international trade. Although monetary policy cannot cure the economy's ills, particularly in today's challenging circumstances, we do think it can provide meaningful help. So we at the Federal Reserve are going to do what we can do and trust that others, in both the public and private sectors, will do what they can as well.
What's the Relationship between Monetary Policy and Fiscal Policy?
That brings me to the second question: What's the relationship between monetary policy and fiscal policy? To answer this question, it may help to begin with the more basic question of how monetary and fiscal policy differ.In short, monetary policy and fiscal policy involve quite different sets of actors, decisions, and tools. Fiscal policy involves decisions about how much the government should spend, how much it should tax, and how much it should borrow. At the federal level, those decisions are made by the Administration and the Congress. Fiscal policy determines the size of the federal budget deficit, which is the difference between federal spending and revenues in a year. Borrowing to finance budget deficits increases the government's total outstanding debt.
As I have discussed, monetary policy is the responsibility of the Federal Reserve--or, more specifically, the Federal Open Market Committee, which includes members of the Federal Reserve's Board of Governors and presidents of Federal Reserve Banks. Unlike fiscal policy, monetary policy does not involve any taxation, transfer payments, or purchases of goods and services. Instead, as I mentioned, monetary policy mainly involves the purchase and sale of securities. The securities that the Fed purchases in the conduct of monetary policy are held in our portfolio and earn interest. The great bulk of these interest earnings is sent to the Treasury, thereby helping reduce the government deficit. In the past three years, the Fed remitted $200 billion to the federal government. Ultimately, the securities held by the Fed will mature or will be sold back into the market. So the odds are high that the purchase programs that the Fed has undertaken in support of the recovery will end up reducing, not increasing, the federal debt, both through the interest earnings we send the Treasury and because a stronger economy tends to lead to higher tax revenues and reduced government spending (on unemployment benefits, for example).
Even though our activities are likely to result in a lower national debt over the long term, I sometimes hear the complaint that the Federal Reserve is enabling bad fiscal policy by keeping interest rates very low and thereby making it cheaper for the federal government to borrow. I find this argument unpersuasive. The responsibility for fiscal policy lies squarely with the Administration and the Congress. At the Federal Reserve, we implement policy to promote maximum employment and price stability, as the law under which we operate requires. Using monetary policy to try to influence the political debate on the budget would be highly inappropriate. For what it's worth, I think the strategy would also likely be ineffective: Suppose, notwithstanding our legal mandate, the Federal Reserve were to raise interest rates for the purpose of making it more expensive for the government to borrow. Such an action would substantially increase the deficit, not only because of higher interest rates, but also because the weaker recovery that would result from premature monetary tightening would further widen the gap between spending and revenues. Would such a step lead to better fiscal outcomes? It seems likely that a significant widening of the deficit--which would make the needed fiscal actions even more difficult and painful--would worsen rather than improve the prospects for a comprehensive fiscal solution.
I certainly don't underestimate the challenges that fiscal policymakers face. They must find ways to put the federal budget on a sustainable path, but not so abruptly as to endanger the economic recovery in the near term. In particular, the Congress and the Administration will soon have to address the so-called fiscal cliff, a combination of sharply higher taxes and reduced spending that is set to happen at the beginning of the year. According to the Congressional Budget Office and virtually all other experts, if that were allowed to occur, it would likely throw the economy back into recession. The Congress and the Administration will also have to raise the debt ceiling to prevent the Treasury from defaulting on its obligations, an outcome that would have extremely negative consequences for the country for years to come. Achieving these fiscal goals would be even more difficult if monetary policy were not helping support the economic recovery.
What Is the Risk that the Federal Reserve's Monetary Policy Will Lead to Inflation?
A third question, and an important one, is whether the Federal Reserve's monetary policy will lead to higher inflation down the road. In response, I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years.With monetary policy being so accommodative now, though, it is not unreasonable to ask whether we are sowing the seeds of future inflation. A related question I sometimes hear--which bears also on the relationship between monetary and fiscal policy, is this: By buying securities, are you "monetizing the debt"--printing money for the government to use--and will that inevitably lead to higher inflation? No, that's not what is happening, and that will not happen. Monetizing the debt means using money creation as a permanent source of financing for government spending. In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size. Moreover, the way the Fed finances its securities purchases is by creating reserves in the banking system. Increased bank reserves held at the Fed don't necessarily translate into more money or cash in circulation, and, indeed, broad measures of the supply of money have not grown especially quickly, on balance, over the past few years.
For controlling inflation, the key question is whether the Federal Reserve has the policy tools to tighten monetary conditions at the appropriate time so as to prevent the emergence of inflationary pressures down the road. I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. For example, the Fed can tighten policy, even if our balance sheet remains large, by increasing the interest rate we pay banks on reserve balances they deposit at the Fed. Because banks will not lend at rates lower than what they can earn at the Fed, such an action should serve to raise rates and tighten credit conditions more generally, preventing any tendency toward overheating in the economy.
Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to "take away the punch bowl" is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions.
How Does the Fed's Monetary Policy Affect Savers and Investors?
The concern about possible inflation is a concern about the future. One concern in the here and now is about the effect of low interest rates on savers and investors. My colleagues and I know that people who rely on investments that pay a fixed interest rate, such as certificates of deposit, are receiving very low returns, a situation that has involved significant hardship for some.However, I would encourage you to remember that the current low levels of interest rates, while in the first instance a reflection of the Federal Reserve's monetary policy, are in a larger sense the result of the recent financial crisis, the worst shock to this nation's financial system since the 1930s. Interest rates are low throughout the developed world, except in countries experiencing fiscal crises, as central banks and other policymakers try to cope with continuing financial strains and weak economic conditions.
A second observation is that savers often wear many economic hats. Many savers are also homeowners; indeed, a family's home may be its most important financial asset. Many savers are working, or would like to be. Some savers own businesses, and--through pension funds and 401(k) accounts--they often own stocks and other assets. The crisis and recession have led to very low interest rates, it is true, but these events have also destroyed jobs, hamstrung economic growth, and led to sharp declines in the values of many homes and businesses. What can be done to address all of these concerns simultaneously? The best and most comprehensive solution is to find ways to a stronger economy. Only a strong economy can create higher asset values and sustainably good returns for savers. And only a strong economy will allow people who need jobs to find them. Without a job, it is difficult to save for retirement or to buy a home or to pay for an education, irrespective of the current level of interest rates.
The way for the Fed to support a return to a strong economy is by maintaining monetary accommodation, which requires low interest rates for a time. If, in contrast, the Fed were to raise rates now, before the economic recovery is fully entrenched, house prices might resume declines, the values of businesses large and small would drop, and, critically, unemployment would likely start to rise again. Such outcomes would ultimately not be good for savers or anyone else.
How Is the Federal Reserve Held Accountable in a Democratic Society?
I will turn, finally, to the question of how the Federal Reserve is held accountable in a democratic society.The Federal Reserve was created by the Congress, now almost a century ago. In the Federal Reserve Act and subsequent legislation, the Congress laid out the central bank's goals and powers, and the Fed is responsible to the Congress for meeting its mandated objectives, including fostering maximum employment and price stability. At the same time, the Congress wisely designed the Federal Reserve to be insulated from short-term political pressures. For example, members of the Federal Reserve Board are appointed to staggered, 14-year terms, with the result that some members may serve through several Administrations. Research and practical experience have established that freeing the central bank from short-term political pressures leads to better monetary policy because it allows policymakers to focus on what is best for the economy in the longer run, independently of near-term electoral or partisan concerns. All of the members of the Federal Open Market Committee take this principle very seriously and strive always to make monetary policy decisions based solely on factual evidence and careful analysis.
It is important to keep politics out of monetary policy decisions, but it is equally important, in a democracy, for those decisions--and, indeed, all of the Federal Reserve's decisions and actions--to be undertaken in a strong framework of accountability and transparency. The American people have a right to know how the Federal Reserve is carrying out its responsibilities and how we are using taxpayer resources.
One of my principal objectives as Chairman has been to make monetary policy at the Federal Reserve as transparent as possible. We promote policy transparency in many ways. For example, the Federal Open Market Committee explains the reasons for its policy decisions in a statement released after each regularly scheduled meeting, and three weeks later we publish minutes with a detailed summary of the meeting discussion. The Committee also publishes quarterly economic projections with information about where we anticipate both policy and the economy will be headed over the next several years. I hold news conferences four times a year and testify often before congressional committees, including twice-yearly appearances that are specifically designated for the purpose of my presenting a comprehensive monetary policy report to the Congress. My colleagues and I frequently deliver speeches, such as this one, in towns and cities across the country.
The Federal Reserve is also very open about its finances and operations. The Federal Reserve Act requires the Federal Reserve to report annually on its operations and to publish its balance sheet weekly. Similarly, under the financial reform law enacted after the financial crisis, we publicly report in detail on our lending programs and securities purchases, including the identities of borrowers and counterparties, amounts lent or purchased, and other information, such as collateral accepted. In late 2010, we posted detailed information on our public website about more than 21,000 individual credit and other transactions conducted to stabilize markets during the financial crisis. And, just last Friday, we posted the first in an ongoing series of quarterly reports providing a great deal of information on individual discount window loans and securities transactions. The Federal Reserve's financial statement is audited by an independent, outside accounting firm, and an independent Inspector General has wide powers to review actions taken by the Board. Importantly, the Government Accountability Office (GAO) has the ability to--and does--oversee the efficiency and integrity of all of our operations, including our financial controls and governance.
While the GAO has access to all aspects of the Fed's operations and is free to criticize or make recommendations, there is one important exception: monetary policymaking. In the 1970s, the Congress deliberately excluded monetary policy deliberations, decisions, and actions from the scope of GAO reviews. In doing so, the Congress carefully balanced the need for democratic accountability with the benefits that flow from keeping monetary policy free from short-term political pressures.
However, there have been recent proposals to expand the authority of the GAO over the Federal Reserve to include reviews of monetary policy decisions. Because the GAO is the investigative arm of the Congress and GAO reviews may be initiated at the request of members of the Congress, these reviews (or the prospect of reviews) of individual policy decisions could be seen, with good reason, as efforts to bring political pressure to bear on monetary policymakers. A perceived politicization of monetary policy would reduce public confidence in the ability of the Federal Reserve to make its policy decisions based strictly on what is good for the economy in the longer term. Balancing the need for accountability against the goal of insulating monetary policy from short-term political pressure is very important, and I believe that the Congress had it right in the 1970s when it explicitly chose to protect monetary policy decision making from the possibility of politically motivated reviews.
Conclusion
In conclusion, I will simply note that these past few years have been a difficult time for the nation and the economy. For its part, the Federal Reserve has also been tested by unprecedented challenges. As we approach next year's 100th anniversary of the signing of the Federal Reserve Act, however, I have great confidence in the institution. In particular, I would like to recognize the skill, professionalism, and dedication of the employees of the Federal Reserve System. They work tirelessly to serve the public interest and to promote prosperity for people and businesses across America. The Fed's policy choices can always be debated, but the quality and commitment of the Federal Reserve as a public institution is second to none, and I am proud to lead it.Now that I've answered questions that I've posed to myself, I'd be happy to respond to yours.
1. The Fed has a number of ways to influence short-term rates; basically, they involve steps to affect the supply, and thus the cost, of short-term funding.
July 14, 2014
Lecture 2 on Tuesday 7/15/2014
Brief Outline of Topics Covered in Lecture 2
Chapter 2: An Overview of the Financial System (continued)
Structure and Functions of Financial IntermediariesExample to illustrate functions of intermediaries
Chapter 3 What is Money?
Meaning of Money
Functions of MoneyMedium of Exchange
Unit of Account
Store of Value
Extra Reading:
The stone money of Yap is an interesting case to consider when thinking about what money is and what role it plays in the economic and social affairs of a community. This article by Michael Bryan of the Federal Reserve Bank of Cleveland describes the stone wheels of Yap, how they were obtained and used as gift markers both within and between tribes, and whether the stones fit the textbook definition of money:
Federal Reserve Bank of Cleveland, Island Money, by Michael F. Bryan: ...In this Commentary, I … consider… the unique and curious money of Yap, a small group of islands in the South Pacific. … For at least a few centuries leading up to today, the Yapese have used giant stone wheels called rai when executing certain exchanges. The stones are made from a shimmering limestone that is not indigenous to Yap, but quarried and shipped, primarily from the islands of Palau, 250 miles to the southwest. The size of the stones varies; some are as small as a few inches in diameter and weigh a couple of pounds, while others may reach a diameter of 12 feet and weigh thousands of pounds. A hole is carved into the middle of each stone so that it may be carried, either by coconut rope strung through the smaller pieces, or by wooden poles inserted into the larger stones. These great stones require the combined effort of many men to lift. Expeditions to acquire new stones were authorized by a chief who would retain all of the larger stones and two-fifths of the smaller ones, reportedly a fairly common distribution of production that served as a tax on the Yapese. In effect, the Yap chiefs acted as the island’s central bankers; they controlled the quantity of stones in circulation...
The quarrying and transport of rai was a substantial part of the Yapese economy. In 1882, British naturalist Jan S. Kubary reported seeing 400 Yapese men producing stones on the island of Palau for transport back to Yap. Given the population of the island at the time … more than 10 percent of the island’s adult male population was in the money-cutting business. Curiously, rai are not known to have any particular use other than as a representation of value. The stones were not functional, nor were they spiritually significant to their owners, and by most accounts, the stones have no obvious ornamental value to the Yapese. If it is true that Yap stones have no nonmonetary usefulness, they would be different from most “primitive” forms of money. Usually an item becomes a medium of exchange after its commodity value—sometimes called intrinsic worth—has been widely established...
Precisely how the value of each stone was determined is somewhat unclear. We know that size was at best only a rough approximation of worth and that stone values varied depending upon the cost or difficulty of bringing them to the island. For example, stones gotten at great peril, perhaps even loss of life, are valued most highly. Similarly, stones that were cut using shell tools and carried by canoes are more valuable than comparably sized stones that were quarried with the aid of iron tools and transported by large Western ships. The more valuable stones were given names, such as that of the chief for whom the stone was quarried or the canoe on which it was transported. Naming the stone may have secured its value since such identification would convey to all the costs associated with obtaining it...
Consider the case of the Irish American David O’Keefe from Savannah, Georgia, who, after being shipwrecked on Yap in the late nineteenth century, returned to the island with a sailing vessel and proceeded to import a large number of stones in return for a bounty of Yapese copra (coconut meat). The arrival of O’Keefe (and other Western traders) increased the number and size of the stones being brought back to the island, and by one accounting, Yap stones went from being “very rare” in 1840 to being plentiful—more than 13,000 were to be found on the island by 1929. No longer restricted by shell tools and canoes, the largest stones arriving grew from four feet in diameter to the colossal 12-foot stones that are now a part of monetary folklore. Yet the great infusion of stones did not inflate away their value. Since the stones of Captain O’Keefe were obviously more easily obtained, they traded on the island at an appropriately reduced value relative to the older stones gotten at much greater cost. In essence, O’Keefe and other Westerners were bringing in large numbers of “debased” stones that could easily be identified by the Yapese.
While it’s clear that the Yap stones have value for the Yapese, can the stones really be called money? The answer, of course, depends upon how you define money. If you rely on a standard textbook definition, you’d describe money in terms of its functions, for example, “Whatever is used as a medium of exchange, unit of account, and store of value.” Certainly, Yap stones performed at least one of these functions quite well—they were an effective store of value (form of wealth). But every asset—from bonds to houses—stores value and is not necessarily labeled money.
To be called money, at least according to the textbook definition, an asset must serve two other functions. It must be a medium of exchange, meaning that it can be readily used either to purchase goods or to satisfy a debt, and it must be a unit of account, or something used as a measure of value. Yap stones were not the unit of account for the islands. Pricing goods and services in terms of the stones would probably have been difficult for the average islander. ... According to Paul Einzig, prices on the islands were set in terms of baskets of a food crop, taro, or cups of syrup, staples that would be easy for a typical islander to appreciate. Furthermore, there is some question whether Yap stones were commonly used as a medium of exchange. To be used in exchange, an item must possess certain characteristics—it must be storable, portable, recognizable, and divisible. Certainly, the stones were storable; they can still be found in abundance on Yap, and they have maintained their purchasing power reasonably well over time (particularly compared with other fiat monies, including dollars). And while it is sometimes claimed that Yap stones suffer as an exchange medium because they lack portability, this may not be completely accurate. In the case of the larger, more easily identified stones, physical possession is not necessary for the transfer of purchasing power. Those involved in the exchange need only communicate that purchasing power has been transferred…
But while storability and portability may not have limited the use of these stones as a medium of exchange, the other two characteristics—recognizability and divisibility—probably did. The stones were primarily used in exchanges between Yap islanders. … Yap historically did not have close cultural ties with any of its trading partners and trade with off-islanders was somewhat infrequent, the stones did not facilitate transactions on these occasions. When transacting with other islands, the Yapese used woven mats (a common exchange medium throughout the South Pacific), while trade with Westerners often involved an exchange of coconuts. Even on the island, the indivisibility of the stones necessitated the use of other items as media of exchange for most transactions. Most rai are highly valued: By one account, a stone of “three spans” (about 25 inches across) would have been sufficient in the early twentieth century to purchase 50 baskets of food or a full-sized pig, while a stone the size of a man would have been worth “many villages and plantations.” Obviously, these stones do not change hands very frequently, since expenditures of such magnitude are rare. For more ordinary transactions, the Yapese either used pearl shells or resorted to barter. Clearly the stones of Yap do not fit neatly within the textbook definition of money…
But … what role do the stones play and how is that role similar to that played by dollars?... [T]he stones, particularly the larger ones, acted as markers, changing hands in recognition of a “gift.” Stones were often merely held until the gift was reciprocated and the stone could be returned to its original owner. For example, islanders wishing to fish someone’s waters might do so by leaving a stone in recognition of the favor. After an appropriate number of fish were given to the owner of the fishing waters, the stone would simply be reclaimed. Occasionally a stone was “exchanged” when one tribe came to the aid of another, say for support against a rival tribe or in celebration of some event. But the stone would reside with the new tribe only until such time as aid of a similar value could be given in return. The stones, then, act as a memory of the contributions occurring between islanders. Anthropologists refer to this as a “gift economy,” where goods aren’t traded as much as they are given with the expectation of a comparable favor at some later date. So Yap stones serve as a memory of one’s contributions on the island. … But this raises an intriguing question. If the stones of Yap were merely markers and nothing more, why did the Yapese expend such great resources to carve them out of the mountains of Palau and carry them all the way back to their island? Wouldn’t any marker work just as well? It may be that the Yap chiefs did not have sufficient “credibility” to simply decree an object’s value. That is, the Yapese may have needed some assurance that the object on which value has been assigned could not be easily replicated for the mere benefit of the issuer...
July 12, 2014
Lecture 1 on Monday 7/14/14
Brief Outline of Topics Covered in Lecture 1
Chapter 1: Why Study Money, Banking, and Financial Markets?
Why Study Money and Monetary Policy?
Why Study Banking and Financial Institutions?
Why Study Financial Markets?
Chapter 2: An Overview of the Financial System (pgs 25-27, 36-41)
Direct versus Indirect Finance
Structure and Functions of Financial Markets
Structure and Functions of Financial Intermediaries
Examples to illustrate functions of intermediaries
Chapter 3: What is Money?
Meaning of Money
Functions of MoneyMedium of Exchange
Unit of Account
Store of Value
Materials from class:
Extra Reading:
A Short History of American Money, From Fur to Fiat, by David Wolman, The Atlantic: What do animal pelts, tobacco, fake wampum, gold, and cotton-paper bank notes have in common? At one point or another, they've all stood for the same thing: U.S. currency.
Before independence, America's disparate colonial economies struggled with a very material financial hang-up: there just wasn't enough money to go around. Colonial governments attempted to solve this problem by using tobacco, nails, and animal pelts for currency, assigning them a set amount of shillings or pennies so that they could intermix with the existing system.
The most successful ad hoc currency was wampum, a particular kind of bead made from the shells of ocean critters. But eventually the value of this currency, like that of other alternative currencies of the day, was undermined by oversupply and counterfeiting. (That's right: counterfeit wampum. They were produced by dyeing like-shaped shells with berry juice, mimicking the purple color of the real thing.)
It was a crew of Puritans from Boston who first put their faith in paper. Initially, the Massachusetts Bay Colony tried to issue colonial coinage. The pieces themselves, struck in 1652, were made from a mash-up of poor-quality silver and were soon outlawed by the Brits. Less than a decade later the colonists tried again. They were forced to, really, because they owed money to the crown to help fund Britain's war against France, yet lacked any currency with which to pay up. They called the paper "bills of credit." The local government essentially said to the people: Here, just use this. It's real money. We'll sort out redeemability later.
There were endless debates, from prairie farmlands to the floor of Congress, about whether this paper was real money or just a smoke-and-mirrors scheme destined to end badly. ...[continue]...
July 11, 2014
Economics 470
Mark Thoma
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