Tag Archives: Federal Reserve

Escape from Punchbowlism

This post was written by StatsGuy, a regular commenter here and very occasional guest contributor. We asked him to expand on the ideas he put forward in this comment on the relationships between monetary policy, international capital flows, and bank capital requirements.

Former Fed Chairman William McChesney Martin is most famous for his notorious quip that the job of the Fed is to “take away the punchbowl just as the party gets going.” It seems this has evolved into a full fledged theory of monetary management.

Unfortunately, structural problems – like trade imbalances, inadequate capital ratios, and weak financial regulation – severely constrain Fed monetary policy options by impacting currency flows and the value of the dollar. (Some specific mechanisms are listed in the previous comment.)

Why does this matter? Because it means the Fed cannot use monetary policy as effectively to keep the country going at full throttle and avoid a prolonged fall in utilization rates (unemployment and idle machines).  How can it be that capacity utilization is still lower than at the bottom of the 81/82 recession and we’re ALREADY raising the bubble/inflation alarm? (Paul Krugman discusses this here, and the answer is that the output gap is itself defined against neutral inflation, not just capacity utilization.)

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Secrecy and Moral Hazard

According to Reuters, the Federal Reserve recently got a stay of a federal district court’s order that the Fed must reveal details about which banks accessed its emergency loan programs during the financial crisis. The arguments on each side are pretty straightforward. Bloomberg, the plaintiff, is arguing that the public has a right to know where their taxpayer money,* via the Federal Reserve, is going. The Fed is arguing that if it reveals the names, that could trigger a run on those banks, because customers will worry about their solvency; it is also arguing that revealing names now will make banks less willing to access emergency lending programs in the future, taking away an important tool in a financial crisis.

I find both of the Fed’s arguments weak.

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Has Anyone Taken Responsibility For Anything? (Weekend Comment Competition)

With the anniversary of the Lehman-AIG-rest of the world debacle fast approaching, it seems fair to ask: Who accepts any blame for creating our excessively crisis-prone system?

Friends and contacts who work in the financial sector freely discuss their participation in activities they now regret.  But where is the mea culpa, of any kind, from a public figure – our “leadership”?

I suggest we divide the competition into three classes.

  1. Policymakers who now admit that any of their actions or inactions contributed to the Great Credit Bubble.  Blaming China gets a person negative points; this may hurt Fed officials.
  2. Private sector executives who concede they made mistakes or misjudged the situation so as to lose a lot of Other People’s Money.  Blaming Hank Paulson also earns negative points (too obvious). Continue reading

Can the Federal Reserve Protect Consumers?

Ben Bernanke, chairman of the Federal Reserve, insists that the Fed can protect consumers effectively against defective or dangerous financial products.  He and his allies are therefore signaling opposition to – and even defiance of – key parts of the Treasury’s plan for regulatory reform, which involve setting up a new Consumer Financial Protection Agency.

The Fed is a well-regarded institution in general and Bernanke is currently riding a wave of personal popularity and prestige, but are these claims vis-à-vis consumers plausible?

Not really. Continue reading

Much Ado About Bernanke

There has been a lot of talk recently about Ben Bernanke, he of the Wall Street Journal op-ed and the multiple Congressional appearances. (Hey, can anyone put me in touch with his agent?*) At the risk of seeming ignorant (or revealing myself to be ignorant), I must say I don’t really understand what the fuss is about.

The question seems to be whether the Fed will be able to tighten monetary policy fast enough when necessary to dampen the potential inflationary effect of its current expansive monetary policy (Fed funds rate at zero, buying long-term securities, etc.). My read on the situation is as follows:

  1. Almost everyone agrees that expansive monetary policy has been appropriate during the crisis and recession to date.
  2. Everyone agrees that at some point monetary policy will have to be tightened.
  3. No one knows when that will happen.
  4. Everyone agrees that because policy has been so expansionary recently, tightening monetary policy when necessary will be more difficult than usual.
  5. Everyone agrees more or less on what tools will be available to the Fed.
  6. No one is certain the Fed will or will not be successful, because there are no relevant datapoints to compare it to.
  7. No matter what Bernanke actually thought, he would still have to say exactly what he is saying this week.

I don’t see much in there worth arguing about.

As Catherine Rampell says, a more interesting question is when the Fed will start tightening policy. This is the kind of thing that can set the Fed against the administration, as stereotypically one focuses on inflation and the other on unemployment. But since most people think it is too early to start now, that debate would be purely speculative at the moment.

* He does need a grammar checker, though. His first sentence – “The depth and breadth of the global recession has required a highly accommodative monetary policy” – contains an error in subject-verb agreement.

By James Kwak

The Fed Makes A Bid

Policymakers like to make particular kinds of statements at a “low attention” moment, e.g., right before a holiday weekend.  This gets items onto the public record but ensures they do not get too much attention. And if you are asked about these substantive issues down the road, you can always say, “we told you this already, so it’s not now news” – usually this keeps things off the front page.

Released on July 3rd (a federal holiday), and buried inside the Washington Post on Saturday (p.A12): An important speech (from June 26th) by the New York Fed’s controversial President, William C. Dudley. Continue reading

Tracking the Household Balance Sheet

One concept that has gotten a lot of attention the last few months is the household balance sheet: the relationship between household assets and liabilities, and what that means for household behavior (consumption versus saving). Though not the precipitating factor in the current crisis, the weakening of household balance sheets (fewer assets, same liabilities, less net worth, more anxiety) has likely had a significant effect in depressing consumption, which has been the single largest factor in our recent decline in GDP. The Federal Reserve recently released a snapshot of the household balance sheet in its triennial Survey of Consumer Finances, so we can see what the situation looks like in some detail. The survey was actually taking in 2007, but with a few adjustments we can see what the current balance sheet looks like.

On the headline level, median income fell from $47,500 to $47,300 (all figures are in constant 2007 dollars), while median net worth (assets minus liabilities) grew from $102,200 to $120,300. No surprise there: we already knew wages stagnated, while real estate and stocks appreciated. However, since the survey was conducted in 2007, median net worth fell by 17.8% according to the Fed estimate, to $99,300, and that’s just to October 2008. Given that the cumulative returns of the stock market have been about -15% since October 31, and that housing prices have fallen as well (and the Fed used a housing index that has fallen less than the Case-Shiller index*), that net worth is probably between $90,000 and $95,000 – significantly less than in 2004, and back around 1998 levels ($91,300).

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Why Fiscal Stimulus Is Not Enough

Ben Bernanke gave a speech today that will be discussed for, well, at least a few days, outlining the Federal Reserve’s response to the financial crisis. We will probably devote a couple of posts to it (Simon already mentioned it below.)

Although the Obama team and Congress have been focusing on the politically popular fiscal stimulus plan, replete with hundreds of billions of dollars in tax cuts, Bernanke emphasized that stimulus will not be enough (something that Larry Summers seems to agree with, as Simon noted). Here’s the relevant passage:

with the worsening of the economy’s growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance sheet capacities of financial institutions.  Consequently, more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets.  A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions’ balance sheets.  The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending. . . . In addition, efforts to reduce preventable foreclosures, among other benefits, could strengthen the housing market and reduce mortgage losses, thereby increasing financial stability.

In a nutshell: as the economy gets worse, more and more loans default, eating into banks’ capital cushions; investors are still nervous about all those toxic assets; and the continuing collapse of the housing market hurts all of those mortgages and mortgage-backed securities banks are holding. And as banks teeter toward insolvency, people stop lending them money, and they stop lending people money.

On the plus side, the famous TED spread dipped below 1 today, a sign that credit markets are doing much better than back in September. (The Calculated Risk article behind that link shows improvements in other parts of the credit markets, not just interbank lending.)

On the minus side, CDS spreads have shot up on Citigroup and Bank of America in the last week – here’s Bank of America:

Bank of America

The main peaks you see are the Lehman bankruptcy, the buildup to the bank recapitalization announcement, and the Citigroup crisis. So while there seems to be general improvement in the credit markets, the underlying problems have not been solved.

Who’s Afraid of Deflation?

According to the Federal Open Market Committee’s (FOMC) minutes, released on Tuesday, some members think inflation targetting would be a useful way to persuade people that prices will not fall, i.e., forestall deflationary expectations.  WSJ.com seems to have the interpretation about right,

“The added clarity in that regard might help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low and support aggregate demand,” according to the minutes.

In other words, a commitment to an inflation target, say annual growth of 1.5% to 2%, would help keep prices from falling outright and prevent the kind of economic chaos that plagued Japan in the 1990s and the U.S. during the Great Depression.

The Congressional Budget Office thinks there is still time to prevent deflation (or perhaps it is the new measures already in the works that will keep inflation positive).  Their forecast for 2009 (see Table 1 in today’s testimony) predicts low inflation, e.g., the PCE price index is expected to be 0.6 percent for 2009 – but note that the CPI is seen as barely positive, at 0.1 percent, over the same period.

Meanwhile, the financial markets (e.g., inflation swaps) predict minus 4 percent inflation in 2009 (part of which is likely due to lower commodity prices) and then a small degree of deflation over the next few years.  According to this view, we should next see today’s price level again in about 5 or 6 years.

Of course, the financial markets could well be wrong.  It may be that the markets haven’t fully digested or understood the size of the fiscal stimulus, and it may be that further news about other parts of the Obama approach (including the directly on housing and banking) will significantly change inflation expectations.

But it is striking that financial market inflation expectations – e.g., over a five year horizon – have barely moved from their low/near deflation level since it became clear that Mr Obama would win the election or since we first realized that a massive fiscal stimulus would soon arrive (see slide 2 in my presentation from Sunday; the scale is hard to read, but the decline is from around 2% through the summer to around 0% currently).  At least for now, whether or not we are heading for deflation remains the key open question.

Global Outlook After the Fed Cut

I talked yesterday with Steve Weisman, my colleague at the Peterson Institute for International Economics, about where the global economy is likely heading.  Steve asked very good questions about U.S. monetary policy and what effects it will have.  You can listen to our conversation here.

Expansionary Monetary Policy is Infectious

The Federal Reserve’s announcement yesterday makes it clear that we should see its leadership as radical incrementalists.  They will move in distinct incremental steps, some small and some larger, but they will do whatever it takes to prevent deflation.  And that means they will do what it takes to make sure that inflation remains (or goes back to being?) positive.  If they need to err on the side of slightly higher inflation, then so be it.  This is pretty radical (and a good idea, in my opinion.)

What effect does this have on the rest of the world?  Continue reading