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  • Reactions to Fed's Quantitative Easing Efforts

    The Federal Open Market Committee announced yesterday that it has begun another round of quantitiative easing . Though they did not use that term. From the announcement: To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. There has been a lot of public discussion among economists over whether this monetary policy measure is the right move. Karen Dynan , Vice President and Co-Director, Economic Studies at the Brookings Institution , thinks it is, pointing to inflation being below the Fed's target and unemployment being, in a word, "weak": For more of Dynan's analysis, click here . Meanwhile, writing in the Financial Times , Martin Feldstein calls the policy a "dangerous gamble": Mr Bernanke’s argument for QE is based on the “portfolio balance” theory which stresses that, when the Fed buys bonds, investors increase their demand for other assets, particularly equities, raising their price and increasing household wealth and spending. Equity prices have already risen by 10 per cent since Mr Bernanke discussed this approach. But how much further will equity prices rise and what will that do to GDP? Neither theory nor past experience can answer the first question. Much of the share price increase induced by QE may already have occurred based on expectations. An optimistic guess would be another 10 per cent. Since households have about $7,000bn in equities, that would imply a wealth gain of $700bn, raising consumer spending by about one-quarter of one per cent of GDP, a welcome but trivially small effect on incomes and employment. The other ways in which QE would raise GDP are also small. A 20-basis-point reduction in mortgage rates would have little effect on homebuying at a time when house prices are again falling. The increase in banks’ liquidity would do nothing since banks already have massive excess reserves. Big corporations are sitting on vast amounts of cash. Small businesses that are not spending because they cannot get credit will not be helped, because the banks on which they depend have a shortage of capital. Read Feldstein's op-ed here .

  • FOMC Keeps Target Interest Rate

    Citing a laundry list of signs that point to an ongoing economic recovery that will be sluggish at best, the Federal Open Market Committee announced yesterday that the Fed will keep the target range for federal funds at 0-0.25%: Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term. Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate. Read the full release from the Fed here .

  • St Louis Fed President Tells Dow Jones That No More Fed Aid is Needed

    James Bullard , president of the Federal Bank of St. Louis , believes the Fed has done its job in working to right the economy. And though the recovery is not exactly humming along, Bullard views the recent "mixed " reports on housing and jobs as relatively positive, and he sees signals that we are in a "soft patch in the recovery." He spoke with Dow Jones Newswires' Michael Derb y about the state of the economy:

  • A Call for More Active Monetary Policy: Clive Crook Puts the Onus on Bernanke and the Fed

    In his speech opening the Jackson Hole Conference , Ben Bernanke stated that "the Federal Reserve remains committed to playing its part to help the U.S. economy return to sustained, noninflationary growth." And he outlined a series of tools available to him and the Fed in countering further economic decline. (Read the speech here ). But Financial Times columnist Clive Crook argues that a "divided Fed" is "letting the country down" and needs to take additional monetary policy steps now: Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. Divided on the point, they have taken a modest further step by preventing the maturing of debt they hold from tightening monetary conditions, as it otherwise would have. They are right to worry about their exit strategy; they are also right to be nervous about being in uncharted terrain. But the balance of risks has moved. They need to go further. George Magnus of UBS argued on this page last week that deflation poses a greater risk for the US than inflation. That seems right: inflation expectations, as revealed by rates on index-linked US debt, are very low. Mr Magnus was surely correct to say this points to the need for further monetary easing – but wrong, I think, to say that “unreconstructed monetarists will not be persuaded”. His point was that monetarists would see the policy rate at zero and banks holding enormous reserves at the Fed and conclude that money was already too loose. As the monetary economist Scott Sumner has pointed out, Milton Friedman – name me a less reconstructed monetarist – talked of “the fallacy of identifying tight money with high interest rates and easy money with low interest rates”. When long-term nominal interest rates are very low, and inflation expectations are therefore also very low, money is tight in the sense that matters. When money is loose, inflation expectations rise, and so do long-term interest rates. Unreconstructed monetarists ought therefore to agree with Mr Magnus’s main point: under current circumstances, better to print money and be damned. Read It falls to the Fed to fuel recovery here .

  • Economists Weigh in on What the Fed Should be Doing Now

    In its Economics by Invitation series, The Economist asks economists to weigh in on vital contemporary issues. Last Friday, the question was "What actions should the Fed be taking?" , and compelling answers keep rolling in from top academics. Rutgers economist Michael Bordo calls for a "credible" commitment to a price level target . The University of Oregon's Mark Thoma puts forward ways in which the Fed can continue to lower interest rates. Columbia's Guillermo Calvo thinks the first order of business is to " address Main Street's credit crunch ." And Boston University's Lawrence Kotlikoff argues that " if the Fed is ultimately going to need to print money to pay the government's bills, this is the time to do it or, at least more of it."... The danger, though, is that when the economy returns to normal, there will be so much money sloshing around that prices will rise dramatically. The Fed is very worried about this outcome having printed $1.152 trillion since August 2007 and jacked up the monetary base by a factor of 2.4. Indeed, the Fed is so worried about this extra money getting into the economy's bloodstream that it's been bribing banks to horde this money as excess reserves. The bribe is coming in the form of paying interest on the excess reserves. This bribe has also been used to pass money under the table to the banks so they could "earn" money in a completely safe manner and, thereby, remain solvent. In worrying about inflation and in keeping the banks afloat via payment of interest on excess reserves, the Fed has undermined its other objective, namely getting the banks to make more loans to the private sector. I think it's time to focus on that objective. Hence, I'd also recommend that the Fed stop paying interest on deposits and take the risk on inflation. Jobs, at this point, are more important than prices. Read Kotlikoff's full post here .

  • St. Louis Fed President Bullard on the 'Perils' of Deflation

    James Bullard , President of the Federal Reserve Bank of St. Louis , is still concerned about deflation and sees a very real threat of prices dropping. In a just-released paper, Bullard explores the dangers of deflation. In Seven Faces of "The Peril" , Bullard compares current US monetary policy to the policy followed by Japan since 2002. And he sees a lot of similarities. He notes the similarities between the two policies revealed by this chart, and how it appears to show US policy developing a "low nominal interest rate outcome": Bullard writes: To maintain international comparability to the extent possible, all data are taken from the OECD main economic indicators. The short-term nominal interest rate is taken to be the policy rate in both countries. the overnight call rate in Japan and the federal funds rate in the U.S. In.ation is measured as the core consumer price index inflation rate measured from one year earlier in both countries. The data in the Figure never mix during this time period: The U.S. data always lie to the northeast, and the Japanese data always lie to the southwest. This will be an essential mystery of the story. Benhabib, et al., wrote about the two lines in the Figure. The dashed line represents the famous Fisher relation for safe assets, the proposition that a nominal interest rate has a real component plus an expected inflation component. I have taken the real component (also the rate of time preference in the original Benhabib et al. analysis) to be .xed and equal to 50 basis points in the Figure. Practically speaking, any macroeconomic model of monetary phenomena is going to have a Fisher relation as a part of the analysis, and so this line is hardly controversial. The solid line in the Figure represents a Taylor-type policy rule: It describes how the short-term nominal interest rate is adjusted by policymakers in response to current inflation. In the right half of the Figure, when inflation is above target, the policy rate is increased, but more than one-for-one with the deviation of inflation from target. And when inflation is below target, the policy rate is lowered, again more than one-for-one. When the line describing the Taylor-type policy rule crosses the Fisher relation, we say there is a steady state at which the policymaker no longer wishes to raise or lower the policy rate, and, simultaneously, the private sector expects the current rate of inflation to prevail in the future. It is an equilibrium in the sense that, if there are no further shocks to the economy, nothing will change with respect to inflation or the nominal interest rate. In the Figure as it is drawn, this occurs at an inflation rate of 2.3 percent and a nominal interest rate of 2.8 percent. This is sometimes called the targeted steady state. Read the full paper here . And listen to Bullard speaking with NPR's Michele Norris about deflation on yesterday's All Things Considered :

  • Short History of Quantitative Easing in the 1930s

    Quantitative easing became a hot topic last year, as the Federal Reserve dropped the target for federal funds rate to near zero. But Richard Anderson of the St. Louis Fed reminds us that this was the second time in US history that the "monetary authorities" tried quantitative easing: During 1932, with congressional support, the Fed purchased approximately $1 billion in Treasury securities (half, however, was offset by a decrease in Treasury bills discounted at the Reserve Banks). At the end of 1932, short-term market rates hovered at 50 basis points or less. Quantitative easing continued during 1933-36. In early April 1933, Congress sought to prod the Fed into further action by passing legislation that (i) permitted the Fed to purchase up to $3 billion in securities directly from the Treasury (direct purchases were not typically permitted) and, if the Fed did not, (ii) also authorized President Roosevelt to issue up to $3 billion in currency.2 The Fed began to purchase securities in the open market in April at the modest pace of $50 million per week. Read the rest of Anderson's short history of quantitative easing in the Thirties in the latest Monetary Trends , here .

  • Janet Yellen on Limited Strength of Recovery

    San Francisco Fed President Janet Yellen spoke in Phoenix yesterday, and she presented a relatively reserved view of the economy. it was her first speech since the economy entered its current recovery phase, and she defended and commended government action in fighting off economic meltdown. But she also warned that this recovery is going to be very slow. And she focused on two key factors--household spending and the woeful labor market: Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again. But I wouldn’t count on them leading a strong recovery. They face high and rising unemployment, stagnant wages, and heavy debt burdens. Their nest eggs have shrunk dramatically as house and stock prices have fallen, and their access to credit has been squeezed. It may be that we are witnessing the start of a new era for consumers following the harsh financial blows they have endured. 2 We often hear the word “deleveraging” used to describe the push by financial institutions to scale back debt and build equity. Households too have now begun to pay down debt and rebuild their savings. This phenomenon can be seen not only in the United States, but in most countries that experienced similar housing booms. The United States was hardly the only country where households borrowed heavily just before a severe housing bust set in. And those countries with greater increases in debt relative to income before the crisis experienced greater declines in consumption spending once the crisis began. In the United States, the personal saving rate, which had fallen to an incredibly low 1 percent in early 2008, has averaged 4 percent so far this year and may well rise higher. In the current environment, such belt-tightening makes great sense from the standpoint of individual households. In fact, some households may have no other option because their access to credit has been crimped. Over the long run, higher saving is surely a good thing for our economy because it provides capital that can be devoted to modern infrastructure, technology, and other productive investments that enhance our standard of living. All the same, the transition to a higher saving plane could be painful if it reduces the growth rate of consumer spending for an extended period. Weakness in the labor market is another factor that may keep the recovery sluggish for quite some time. Payroll employment has been plummeting for more than a year and a half, and, even though the pace of the decline has slowed, unemployment now stands at its highest level since 1983. In addition, many workers have seen their hours cut or are experiencing involuntary furloughs. To bolster earnings in the face of weak revenue growth, employers have been aggressive in cutting labor costs and jobs, and my business contacts say they will be reluctant to hire again until they see clear evidence of a sustained recovery. Weak demand for workers is also putting a lid on paychecks. Wages are barely rising. A well-known measure of overall employment costs rose by only 1¼ percent over the past year, the smallest increase in the history of the series. High unemployment, weak job growth, and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery. The U.S. experienced so-called jobless recoveries following the previous two recessions in 1991 and 2001, when job creation remained weak for several years following the business cycle trough. In both cases, output growth was less robust than in the typical recovery and, unfortunately, things seem to be shaping up similarly this time around. Since she gave the speech in Phoenix, Yellen's comments about the real estate market were both interesting and relevant to the local crowd. And she also addresses the Fed's monetary policy, past and present. Read the full speech here .