December 2008 Archives

More regular posting in a few days.  I have been preoccupied with way too many other things, but they will settle down soon.  My New Year's resolution is to do some work on the blog.  Importantly, I need to investigate what sort of blogging tools there are out there to make my life easier.  Suggestions are welcome!

It has not been the easiest year from the standpoint of the macroeconomy.  It has been an interesting year to be an economist however.  Here's hoping that 2009 will be slightly more normal.

A very happy New Year to you and yours... I promise plenty of interesting posts in the new year.

Reuters is reporting that President-elect Obama will nominate Georgetown law professor Daniel Tarullo for one of the two open seats on the Federal Reserve Board of Governors.  Story here.  Tarullo's bio here.

From the looks of his qualifications, Tarullo will add some expertise to the Board in the area of financial regulation.  Having a legal scholar on the Board will be quite beneficial for the Fed as it copes with changing regulations, both those that they write and those that affect the environment in which they operate.

Oh, come on, you knew he would get it, right?  (Time magazine)

Actually, since 1964 every president except Nixon and George H.W. Bush received the honor in the year they were first elected.  (See full list)

That's right.  Johnson, Carter, Reagan, Clinton, and George W. Bush all were Person of the Year in the year of they were first elected.

So this should not come as that much of a surprise.

... to have a zero funds rate.  Well, almost zero.  When I got up this morning to give my final exams, I thought how the FOMC will almost certainly go down to 25 b.p.  They'll want to go all the way to zero, but something in them just doesn't want to say "zero".  They need a way to go to zero without really saying that they're going to zero.

And so they did.  (FOMC Statement)

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. 

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.  Financial markets remain quite strained and credit conditions tight.  Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably.  In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.  In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. 

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

It had to be done.  If we were to go another 6 weeks speculating about whether and when we would actually have quantitative easing, I'm not sure the market could cope with the uncertainty.  To go down to 25 b.p. is effectively an admission that they need to go to zero, so you might as well just do it.

Now the game has changed.  Say what you will about the fact that the normal monetary policy channels haven't been working for some time.  That is history now.  Tomorrow when they get up and go to work, they will have to come to terms with the fact that they have committed to operating in a whole new environment.  December 16, 2008 will be right up there with October 6, 1979 in the short list of monetary turning points--but the turn is in the opposite direction.

Tomorrow their real work begins--revealing to the world what it means to "employ all available tools".  That phrase is going to be ringing in my head all night.

Nonfarm payroll employment down 533,000 in November.  (Full text)

No nice way to spin that news.  The things I'm reading lead me to expect December to be nearly as bad.

I'm giving a seminar in a bit, so I don't have time for more now.  Hopefully more time this weekend.

UPDATE:  David Henderson at EconLog points out that the 533,000 is a smaller percentage of the labor force than it was in the 1970s.  True.  That's one of the aspects of the problem I intend to think about this weekend.  Also, see the comments to his post for more discussion.  I think it is safe to say that in percentage terms the job losses from this recession are going to exceed the last two recessions, and rival those of the '70s and '80s.  More later.

Perhaps the better question is:  "Should the government back mortgages at 4.5%?"

Before you answer, look at the yield curve.

Then read this from the Wall Street Journal:  (Hat tip to Calculated Risk)

WASHINGTON -- The Treasury Department is considering a plan to revitalize the U.S. home market that would push down interest rates for loans to purchase a home, according to people familiar with the matter.

The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%, more than a full point lower than prevailing rates for standard 30-year fixed-rate mortgages.

Government officials are under pressure to address falling home prices and mounting foreclosures, which underpin the financial crisis. The Treasury has struggled for months to come up with a plan that would ease the strains on borrowers without appearing to bail out homeowners and lenders.

"...without appearing to bail out homeowners and lenders."  One out of two ain't bad.  Continuing...

Treasury views this plan as potentially halting the slide in home prices by enabling borrowers to afford bigger loans, thus increasing demand and pushing up home values. The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.

Aww, shucks.  Well, maybe they'll offer it for refis next week.

One problem I see is that this looks like it will have a lot of moving parts.  That is, it relies on "encouraging banks to lend" and then backing the mortgages using "the clout of...Fannie Mae and Freddie Mac."

Show of hands everyone who thinks that'll work?  I thought so.  No, this has all the earmarks of being a pretty lousy idea.

But wait, remember what I said about the yield curve?  What if the government issued a special series of 30 year mortgage bonds and then (*gulp*)... well, you complete the sentence because I can't bring myself to do it (hint: it includes the word "nationalize").

Made you think, didn't it?  And that's what is so unique (and more than a little worrying) about this whole situation.  This could potentially be a moneymaker for the Treasury (at least this week--one must strike while the iron is hot), but long term it's a bad idea.  Because once you do it, it won't go away.  My message to the outgoing and the incoming administrations is to think very, very carefully before jumping on something like this.

I remember distinctly an interview I gave almost exactly a year ago (almost to the day) in which I cautioned that the wrong solution could just end up prolonging the inevitable (with regard to the subprime mess, foreclosures, etc.).  That was a year ago.  I'm saying it again here today.  Will I be saying it again a year from now?

The last paragraph is, to me at least, the most troubling thing I have written to date on the crisis.

Clearly the markets have unwound considerably in the last year, and they have a good distance to go.  I'm all for the Fed and the Treasury protecting the integrity of the payments system, but that side of things appears to be somewhat more stable now.  Perhaps its time to let things sort themselves out a bit before putting in a false bottom.

Full text of speech at the Fed's website.

Here's the money quote:

Regarding interest rate policy, although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited. Indeed, the actual federal funds rate has been trading consistently below the Committee's 1 percent target in recent weeks, reflecting the large quantity of reserves that our lending activities have put into the system. In principle, our ability to pay interest on excess reserves at a rate equal to the funds rate target, as we have been doing, should keep the actual rate near the target, because banks should have no incentive to lend overnight funds at a rate lower than what they can receive from the Federal Reserve. In practice, however, several factors have served to depress the market rate below the target. One such factor is the presence in the market of large suppliers of funds, notably the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which are not eligible to receive interest on reserves and are thus willing to lend overnight federal funds at rates below the target. We will continue to explore ways to keep the effective federal funds rate closer to the target.

Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand. Indeed, last week the Fed announced plans to purchase up to $100 billion in GSE debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. It is encouraging that the announcement of that action was met by a fall in mortgage interest rates.

Translation:  They're not done yet.

The recession began in December 2007 according to the NBER.

This was a tough one to date for a host of reasons, many of which have been discussed on this and other blogs.  So let's go to the NBER's press release for their explanation which, I think, says it quite well.  I'll supply the questions... they supplied the answers.

First of all, did any of their indicators clearly indicate a peak in a specific month?

The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then.

But what about GDP?

The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis.  In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales.  However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.

What about any other series that might shed light on the peak month?

Other series considered by the committee--including real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment estimates based on the household survey--all reached peaks between November 2007 and June 2008.

In other words, GDP and GDI have been bouncing around since last fall.  Other indicators all peaked at different times, but employment peaked in December.

In retrospect, the December date seems more obvious when you look at the last announcement of a peak just over 7 years ago:

Q: Regarding movements of income as an indicator of recessions, isn't it true that real income has not fallen substantially during five of the past nine recessions.

A: That is why employment is probably the single most reliable indicator.

When there is disagreement among the indicators, it looks like the committee goes with the employment peak.  That is, I think, a defensible practice since the peak of employment may often slightly lag manufacturing output declines and leads certain other indicators.  File that away for future reference.  And while I'm on the subject of the 2001 announcement, let me just say that I'm disappointed that the NBER did not include graphs with the latest release like they did in 2001.

Well, it was just a matter of time.  I've been saying in class and publicly that we are probably in a recession and it probably began between December and June.  I think the weight of evidence points to the latter part of that period, but if employment is the clincher, then so be it.  File that away for next time and impress your friends with your forecasting ability.

Anyway, back to the current situation.  Is the decline in activity substantial enough to merit being called a recession?

The committee determined that the decline in economic activity in 2008 met the standard for a recession, as set forth in the second paragraph of this document.  All evidence other than the ambiguous movements of the quarterly product-side measure of domestic production confirmed that conclusion. Many of these indicators, including monthly data on the largest component of GDP, consumption, have declined sharply in recent months.

Yes, and more than anything it was probably the last GDP and employment figures that tipped the scale.  While it is unusual for the announcement of the peak to be so long after the fact, I think they were waiting for that confirmation.  Well, they got it, and there's probably more where that came from.  The fact that GDP and GDI couldn't seem to make up their mind for several months seems to be what really made the call tricky.  Prior to the latest round of financial market crisis this fall, there was still a faint glimmer of hope that a recession could be avoided.

But in retrospect, we had avoided recession for some time when many people thought it was right around the corner.

It was 2005 when a lot of commentators (bloggers and otherwise) started to predict doom and gloom ahead.  Case in point:  Calculated Risk's post of April 12, 2005 where he issued his "Mug's Game Challenge:  Predict the Start of the Next Recession".  Check out the guesses--most were 2005 and 2006.  There were a few who said 2008 (perhaps out of the belief that any normal expansion would be running its course by then).  One commenter said 2011.  Even I would have labeled that wishful thinking.  But the point is that nearly every one of the commenters thought a recession was imminent.

In the end, many of who spoke of doom and gloom in 2005 were at least partially right about the "why" and quite wrong about the "when".

But then, think about the previous recession which started in 2001.  Were there similar manifestations of doom and gloom in 1999?  Yes.  Were they shouted down by the perpetual cheerleading crowd?  Yes, (the book Dow 36,000 came out in 1999...remember?)  Were the pessimists right about the "why" and wrong about the "when"?  In some cases, yes.

Now, I'm not suggesting something as simple as saying that when the perpetual doom and gloomers come out of the woodwork you've got two years to go.  That's not the point.  The point is that no expansion lasts forever, and the seeds of the next recession really are sometimes sown in the current recovery.  As Herb Stein put it, things that can't go on forever, won't.  And perhaps 2005 is when it should have been more obvious that something was happening that couldn't go on forever.

The thing is though, realizing that fact still doesn't tell you when and how it will stop.

Coming soon:  How wrong were we and what can we learn?

I'm not going to quote the whole thing.  But read it all.

I sometimes get worked up about such claims too, but it does as much good as throwing a brick at the TV during a football game, apparently.  Our work will never be done.

But I've got to say that David's tirade is one of the best I've seen.