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  • Cleveland Fed: What Substantial Labor Market Improvement Might Look Like

    The Federal Reserve policy-making committee, the FOMC, has stated that it will continue on its current monetary policy course until there is "substantial improvement" in labor market conditions. So Cleveland Fed researchers Mark Schweitzer and Murat Tasci took a little time to look into what improvement might look like. Here's an excerpt: In our model scenario projection, we estimate the trend and cyclical components of the labor force participation rate over time by projecting the historical behavior of the variables in the model forward. Since historical participation rate movements have been only mildly cyclical, the model predicts a very small cyclical component for the participation rate in the future. But this prediction might not be very reliable if the current episode represents a breakdown in this historical pattern—which seems a possibility, given that the response of the labor force participation rate in this recession has been exceptionally drastic relative to past recessions. Ultimately, the degree to which the labor force participation rate recovers will depend on how much of the recent decline in the rate is cyclical and how much is trend. This is hard to forecast, and there is evidence on both sides. It is very clear, for example, that demographic trends that are not related to cyclical factors have driven the participation rate up and down substantially over time. Since the 1950s, two key demographic trends have significantly altered the participation trend. First, from 1950 until around 2000, more women continuously joined the labor force, driving a strong secular increase in the overall participation rate (figure 1). Second, from the 1970s until the late 1990s, a large baby boom generation drove up the share of the population that was in its prime working years, which also served to boost the participation rate. Neither of these factors has boosted participation recently, and models which account for the demographic structure of the population have been projecting declines in participation for some time, for example, Fallick and Pingle 2007. Read What Constitutes Substantial Employment Gains in Today’s Labor Market? here .

  • Neil Irwin: The Fed is 'Keeping the Economy Afloat' and 'That's the Problem'

    At the Washington Post Wonkblog , Neil Irwin writes that the Fed is doing a remarkable job of propping up the U.S. economy, largely through its quantitative easing policy. But, he wonders, is that a good thing? And for whom? There is good reason to think that monetary easing is doing quite a bit of the work offsetting tighter fiscal policy. The Fed’s policies, including buying $85 billion in bonds each month with newly created money, are directly aimed at housing; $40 billion of those purchases are of mortgage-backed securities, meaning the money is being funneled directly toward the sector. And sure enough, a solidifying housing market is an important part of the economy’s holding up. And a second important consequence of Fed easing is to boost the prices of other financial assets, including the stock market. This isn’t rocket science: The Fed in September introduced a policy meant to boost housing and stock prices, and now, nine months later, housing prices and stock prices have risen quite a bit. Enough, indeed, to (so far) offset the impact of higher taxes that went into effect Jan. 1 and federal spending cuts that took effect March 1. So far so good. The bad news, though, is that these channels through which monetary policy affects the economy tend to offer the most direct benefits to those who already have high incomes and high levels of wealth. Data from the Fed’s Survey of Consumer Finances shows that nearly half of families in the upper 10 percent of income own some stocks, and that of those who did the average value of the portfolio was $489,000 in 2010. (It was over $650,000 in 2007, and now that stock prices are back to 2007 levels, it’s a reasonable guess that the 2013 number will turn out to be in that ballpark). Irwin goes on to discuss the impact of rising home prices, and argues that the benefits in one part of the economy aren't offsetting problems elsewhere. Read the full post here .

  • What the End of QE Might Look Like

    Antonio Fatas wants us to consider the not-so-distant future, when the red line (short term interest rates) in the chart below catches up with the blue line (long term interest rates). At that point--or shortly before--the Fed will announce an end to Quantitative Easing. Fatas: What will we learn the day Ben Bernanke announces that we are starting that path towards normalization? It might be that we simply learn that he is becoming optimistic about growth in the US. This will be good news. It might not be a surprise to some who expected that type of growth going forward, but it could be a positive surprise to others that thought growth would never come back. In this scenario, it is difficult to think about such an announcement as bad news. We know that QE will end one day, we know that short-term rates will have to increase, so if the announcement was to be a surprise in the sense that it is coming too early, it would mean that there is a positive surprise in terms of growth happening early than expected -- and this has to be good news. There is a second and more pessimistic scenario: the day Ben Bernanke announces that QE is ending we learn that the economy is not doing much better but that the FOMC has simply changed their mind. That they do not care about low growth, that they want to be tough and that they are ready to stop QE to signal a change in policy. This would be bad news because it represents a change in policy and not a change in our expectations about growth. Understanding what will happen to markets when QE ends requires to decide about which of the two scenarios above is more likely. I personally see the first scenario more likely than the second one. I do not see a policy reversal in the near future but I do see the end of QE as good news accumulate. But this is my view, what matters is how the stock market will read the communications of the central bank. The words chosen to communicate their actions at that point as well as their credibility will make a great difference. Read Looking forward to the end of QE here .

  • Central Bankers Failing to Hit Inflation Targets

    With the CPI release last week showing prices in the U.S. have risen just 1.1 percent over the last year, The Washington Post 's Neil Irwin notes that there is an inflation problem in developed economies around the globe. Inflation, Irwin writes, "is too low." The below-trend inflation is partly attributable to falling commodities prices, and just as policy shouldn’t overreact when a short-term commodity blip causes inflation, it shouldn’t make the same mistake in reverse. But even excluding food and energy, U.S. CPI was up only 1.7 percent, still below the level of inflation the Federal Reserve is aiming for. And the situation in Europe is particularly worrisome; if the euro zone is going to have any hope of rebalancing its economy without a prolonged depression, it will need higher inflation in core European countries like Germany and France, offset by lower inflation in countries like Greece and Spain. Instead, prices are rising too slowly even in the core, and there is deflation, or falling prices, in Greece. The biggest conclusion to draw from all of this is that warnings that massive quantitative easing efforts would spark explosive inflation are turning out to be as wrongheaded as can be. In the United States and Japan, central banks now have open-ended policies of printing money to buy assets. But while the money seems to be finding its way into asset markets, such as for stocks and corporate debt, it isn’t being circulated so widely as to drive up prices for consumers. This is the opposite of what the currency war alarmists have warned about. Instead of creating rounds of vicious inflation while trying to expand the money supply in a race to the bottom, central banks are all trying to get inflation up to their target and coming up short. Deflation is looking like a greater risk that inflation, despite the extensive hand-wringing over the latter in the last several years. It’s a currency war in which almost every country is losing. Read Surprise! Inflation is too low almost everywhere on earth here .

  • Cleveland Fed: The Past, Present, and Future of the Federal Reserve

    On the occasion of the Federal Reserve 's centennial, the Cleveland Fed turned its latest annual report into a helpful historical summary. Cleveland Fed President Susan Pianalto writes, "we cannot hope to understand modern-day Federal Reserve policies without this context. You can read the full report here . There are also several videos that accompany the report. This one features economists discussing the past, present and future of the Fed:

  • A Tale of Two Central Banks and Two Economic Histories

    At Project Syndicate , Barry Eichengreen argues that the Federal Reserve and the European Central Bank are guilty of too much analogical reasoning. Or at least of focusing their reasoning too much on a particular analogy. In evaluating potential economic dangers, the Fed focuses too much on the Great Depression and is "hyperactive" in its response. The ECB, meanwhile, remembers the hyperinflation of the post WWI period, and "is unflappable." Eichengreen: The Fed might also consider policy in 1924-1927, when low interest rates fueled stock-market and real-estate bubbles, or 2003-2005, when interest rates were held down in the face of serious financial imbalances. At a minimum, the Fed might develop a “portfolio” of analogies, test them for fitness, and distill their lessons, as President John F. Kennedy famously did when weighing his options during the Cuban missile crisis in 1962. Similarly, the ECB might consider not only how monetary accommodation allowed governments to run large budget deficits in the 1920’s, but also how central bankers’ failure to respond to the financial crisis of the 1930’s fed political extremism and undermined support for responsible government. Again, rigorous analysis requires testing these historical analogies for fitness with current circumstances. Anyone who does so will find it hard to defend the ECB and its stubborn inaction in the face of events. There is exactly zero evidence in Europe today that inflation is just around the corner. And, if current European governments are not committed to austerity and fiscal consolidation, then which governments are? When I consider the European economy, the ECB’s failure to provide more monetary support for economic growth appears to be directly analogous to Europe’s disastrous monetary policies in the 1930’s. The political consequences could be similarly devastating. Europeans should ponder why the inflationary 1920’s, rather than the politically catastrophic 1930’s, have become the historical lodestar for current monetary policy. On the other hand, when I contemplate the US economy, I conclude that recovery from the Great Depression, and not 1924-1927 or 2003-2005, is the episode that most closely resembles current circumstances. Only in the 1930’s were interest rates near zero. Only in the 1930’s was the economy digging itself out from a major financial crisis. Read The Use an Abuse of Monetary History here .

  • Ben Bernanke on Monetary Policy and the Gold Standard

    In a speech at the London School of Economics yesterday, Fed Chair Ben Bernanke discussed lessons from the financial crisis. Bernanke said the recent crisis was a "classic financial panic," and he gave a brief history lesson on exchange rates and developed economies moving away from the gold standard. The uncoordinated abandonment of the gold standard in the early 1930s gave rise to the idea of "beggar-thy-neighbor" policies. According to this analysis, as put forth by important contemporary economists like Joan Robinson, exchange rate depreciations helped the economy whose currency had weakened by making the country more competitive internationally.5 Indeed, the decline in the value of the pound after 1931 was associated with a relatively early recovery from the Depression by the United Kingdom, in part because of some rebound in exports. However, according to this view, the gains to the depreciating country were equaled or exceeded by the losses to its trading partners, which became less internationally competitive--hence, "beggar thy neighbor." Over time, so-called competitive depreciations became associated in the minds of historians with the tariff wars that followed the passage of the Smoot-Hawley tariff in the United States. Both types of policies were decried--and in some textbooks, still are--as having prolonged the Depression by disrupting trade patterns while leading to an ultimately fruitless and destructive battle over shrinking international markets. Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression. However, modern research on the Depression, beginning with the seminal 1985 paper by Barry Eichengreen and Jeffrey Sachs, has changed our view of the effects of the abandonment of the gold standard.6 Although it is true that leaving the gold standard and the resulting currency depreciation conferred a temporary competitive advantage in some cases, modern research shows that the primary benefit of leaving gold was that it freed countries to use appropriately expansionary monetary policies. By 1935 or 1936, when essentially all major countries had left the gold standard and exchange rates were market-determined, the net trade effects of the changes in currency values were certainly small. Yet the global economy as a whole was much stronger than it had been in 1931. The reason was that, in shedding the strait jacket of the gold standard, each country became free to use monetary policy in a way that was more commensurate with achieving full employment at home. Moreover, and critically, countries also benefited from stronger growth in trading partners that purchased their exports. In sharp contrast to the tariff wars, monetary reflation in the 1930s was a positive-sum exercise, whose benefits came mainly from higher domestic demand in all countries, not from trade diversion arising from changes in exchange rates. The lessons for the present are clear. Today most advanced industrial economies remain, to varying extents, in the grip of slow recoveries from the Great Recession. With inflation generally contained, central banks in these countries are providing accommodative monetary policies to support growth. Do these policies constitute competitive devaluations? To the contrary, because monetary policy is accommodative in the great majority of advanced industrial economies, one would not expect large and persistent changes in the configuration of exchange rates among these countries. The benefits of monetary accommodation in the advanced economies are not created in any significant way by changes in exchange rates; they come instead from the support for domestic aggregate demand in each country or region. Moreover, because stronger growth in each economy confers beneficial spillovers to trading partners, these policies are not "beggar-thy-neighbor" but rather are positive-sum, "enrich-thy-neighbor" actions. Read the full speech here .

  • Hank Greenberg on "The AIG Story"

    It is time for you to play juror. Maurice "Hank" Greenberg is on the stand and Charlie Rose is playing questioner (we hesitate to call him prosecutor given his approach to the questioning). Greenberg, you may remember, was CEO of AIG for 40 years. He resigned in 2005 amid allegations of improper accounting (New York State is still pursuing civil civil charges against him). Three years later the global financial crisis hit and AIG nearly went under, only to be rescued by the Federal Reserve in the largest bailout of a public company in U.S. history. Now, Greenberg is suing the federal government on behalf of AIG shareholders, and he has written a book on the history of AIG. And he plead his case to Rose. Greenberg says he and his former management team "had controls so good there is no possibility [the liquidity crisis and government bailout] would have happened." Watch a short excerpt of the interview: You can watch the full interview here .

  • Lagarde Implores Policymakers to Follow Central Bankers' Lead and Push Recovery

    IMF Managing Director Christine Lagarde was at the Peterson Institute in Washington yesterday, where she urged policymakers to put their feet on the gas pedal. Lagarde argued that recent monetary policy moves have presented an opportunity to build momentum (and, in turn, growth). Let me begin by saying that many of the right decisions have been taken. Most recently, initiatives by major central banks—the European Central Bank’s OMT bond-purchasing program, QE3 by the U.S. Federal Reserve, the Bank of Japan’s expanded Asset Purchase Program—are big policy signals in the right direction. They point the way forward and create an opportunity to build on what has been done; an opportunity to make a decisive turn in the crisis. Just as the Central Banks were misguided during the Great Depression and accelerated that crisis, it may well be that Central Banks will have played a significant role in pulling the global economy out of this great recession. But we should not get ahead of ourselves. The global economy is still fraught with uncertainty, still far from where it needs to be. The situation is a bit like a jig-saw puzzle. Some of the pieces are in place and we know what the picture should look like. But, to complete the picture, we need all the pieces to come together. That will depend on delivering on the policy commitments that have been made and in that respect, there is still a long way to go. You can read the full speech here . And watch Lagarde's address below:

  • European Central Bank's Bond Buying Program: Solution to Weight of Massive Debt or "Printing Money' with Little Impact?

    While the Federal Reserve is embarking on additional quantitative easing, the European Central Bank has started its Outright Monetary Transactions bond-buying program. Wharton School professor of finance Franklin Allen is not a fan. Allen sees the plan as little more than "printing money," and he sees such action as having little long-term impact on Europe's problems:

  • Looking for Signs of Monetary Policy Moves in Ben Berkanke's Jackson Hole Keynote

    Ben Bernanke spoke at the Jackson Hole Economic Symposium today, but he did not announce any new moves coming from the Fed. However, much of his speech reads as a defense of past quantitative easing moves. That does not mean more are coming any time soon, but it sure seems to leave the door open: Early in my tenure as a member of the Board of Governors, I gave a speech that considered options for monetary policy when the short-term policy interest rate is close to its effective lower bound.31 I was reacting to common assertions at the time that monetary policymakers would be "out of ammunition" as the federal funds rate came closer to zero. I argued that, to the contrary, policy could still be effective near the lower bound. Now, with several years of experience with nontraditional policies both in the United States and in other advanced economies, we know more about how such policies work. It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred. As I have discussed today, it is also true that nontraditional policies are relatively more difficult to apply, at least given the present state of our knowledge. Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally: Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-tune economic outcomes. As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years. Read the full speech here .

  • James Hamilton on Five Years of Fed Moves

    On Thursday, the New York Fed announced that, after nearly four years, it had sold off all the securities in the Maiden Lane III portfolio , which had been set up to rescue AIG. And they did so at a profit of "approximately $6.6 billion." At Econbrowser , James Hamilton has taken this occasion to "review the various measures that the Fed implemented over the last 5 years." Hamilton: I was surprised to see that the Fed ended up making a profit on AIG-- my understanding had been that the Fed's strategy had been to mark these down at a loss over time. I was unable to discover the details of how this ended up favorably for the Fed. Thursday's statement indicates that more information will be provided on November 23. But the fact that the Fed ended up making a profit from these transactions is an important detail. The key uncertainty for policy makers at the time (just as it is the key dilemma for the ECB at the moment) was determining whether the crisis is one of illiquidity or insolvency. If the problem is just that assets are temporarily undervalued as a result of the financial panic (i.e., the assets are temporarily illiquid), the central bank can solve the problem by stepping in as a lender of last resort. If instead the problem is that the assets are correctly valued (i.e., the borrowers are fundamentally insolvent), all the central bank can do is transfer these losses from existing creditors to the taxpayer (possibly in the form of an inflation tax). A key indication that the central bank did exactly the right thing is if, as a result of their stepping in, the long-run value of the asset is restored, in which case the Fed would end up making a profit out of the transaction. Some have criticized the Fed's emergency lending on the grounds that the Fed took all these extraordinary actions and yet the economy still performed very badly in 2008:Q4 - 2009:Q2. I think this misses the point. I don't believe that it was ever within the Fed's (or anyone else's power) to bring the economy quickly back to full employment. Instead, the purpose of the Fed's emergency lending was to prevent a very bad situation from becoming even worse than it needed to be. The evidence we now have suggests that the Fed indeed accomplished exactly this. See for example the recent post-mortems by Adrian and Schaumburg on the CPFF and the PDCF. But let me now return to the first graph (below) to briefly discuss what I see as a very different strategy that the Fed has been following since winding down these emergency lending programs. The Fed replaced the emergency lending with significant growth in its holdings of U.S. Treasury securities, debt issued by Fannie Mae and Freddie Mac, and mortgage-backed securities guaranteed by Fannie and Freddie. These are fundamentally very different from the aggressive lending in the fall of 2008 in that they involved no new transfer of private risk to the taxpayers. The reason is that, before the Fed bought any agency debt or MBS, the U.S. Treasury had already assumed financial responsibility for these agency obligations. Rather than trying to serve as lender of last resort, these more recent measures (sometimes referred to as "QE1" and "QE2") were instead just intended to help keep long-term borrowing costs low and to make sure that the U.S. did not experience a Japanese-style deflation. Read U.S. monetary policy since the financial crisis here .

  • Paddy Hirsch Explains a Floating-Rate Note

    The Treasury Department is working on a new product: floating-rate notes. The notes should be available in about a year, and they are designed to provide a less risky option for investors. So what are they exactly? Paddy Hirsch explains at the Marketplace Whiteboard :

  • Boston Fed President: U.S. Economy 'Treading Water,' Calls for More Fed Action

    With the U.S. economy effectively stalled, Boston Fed President Eric Rosengren is calling for the Fed to do more to spur economic growth. In an interview with the Binyamin Applebaum of the New York Times , Rosengren, who is not currently one of the voting member of the Federal Open Market Committee (the five voting slots rotate among Fed branch presidents), called for the Fed to buy more mortgage bonds and Treasury securities. And then buy some more. Until... “You continue to do it until it’s clear that you’re no longer treading water,” Mr. Rosengren said in an interview. “You continue to do it until you have documented evidence that you’re getting growth in income and the unemployment rate consistent with your economic goals.” The government estimated that payrolls increased by 163,000 in July, more than in the last several months and more than analysts had predicted. But Mr. Rosengren emphasized that several indicators, including the unemployment rate and the share of the population in the work force, had retreated to their levels at the beginning of the year. “For the last seven months we’ve been treading water. That’s different from what we expected at the beginning of the year,” he said. “I think it’s time to swim to shore.” Read Fed Officials Underscore Divisions Over Action here .

  • Fed Lowers GDP Projections, Puts More Funds Toward Operation Twist

    The Federal Reserve opted against more dramatic monetary policy measures during its June meeting--like another round of q uantitative easing , for example. Instead, the Fed will be putting an additional $267 billion toward its "Operation Twist" program. The aim is to keep borrowing costs down. Fed Chair Ben Bernanke did say that, with projected growth for the U.S. economy now lower than what the Fed was projecting back, that members of the Fed are " prepared to do what is necessary." And that could mean further monetary stimulus measures in the future. Here are the projections for overall GDP growth and unemployment from the at the conclusion of the Federal Open Market Committee June meetings today: From the release: Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee anticipates that inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate. To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability. Read the full FOMC release here .
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