Recently in Economics-Recession Category

Interesting question.  The Wall Street Journal Real Time Economics blog looks to the FOMC members for clarity and finds precious little.

Kansas City Fed President Thomas Hoenig continues to believe rates need to rise, which leaves him in opposition to the decision made just over a week ago to maintain the size of the Fed's balance sheet. St. Louis Fed President James Bullard, meanwhile, has talked of going even further than what's been done thus far, suggesting the Fed could again expand its balance sheet if the recovery falters further. Minneapolis Fed leader Narayana Kocherlakota thinks it's all a tempest in a tea cup, describing the Fed actions as technical and misunderstood by markets as a sign of growing worry over the outlook.

As the article later points out, Hoenig's position is of limited relevance as he is, and has remained, the lone voice calling for a rate increase.  The real action is between Bullard's and Kocherlakota's positions.  About them, the RTE blog continues...

Bullard, however, framed the issue in a way that lined up neatly with the prevailing market view. He told The Wall Street Journal in an interview "I thought we should be in a position to return to a quantitative easing program if we got further disinflation."

Kocherlakota muddied the waters Tuesday, saying the market got the issue wrong. Low rates are driving more mortgage prepayments than the Fed anticipated, so purely for technical reasons, the Fed needs to act to keep its portfolio size up. "I would say that there is no new information about the current state of the economy to be learned from the FOMC's actions or its statement," the policymaker said.

Kocherlakota is refreshingly direct about it.  To say that there is "no new information" certainly puts the markets in their place.  That sort of candor, along with a plausible technical reason, is helpful to outside observers, even if it seems to "muddy the waters."  Kocherlakota's view is consistent with the notion that the Fed needs to make sure that they don't accidentally contract.  Certainly, that is a sensible position.  The question is whether it goes far enough.

Bullard wants to make sure the Fed can go further if they need to.  Will they?  That remains to be seen.  And in the remainder of 2010, that will be the big question.

It remains somewhat unclear to me what the Fed can do to improve the labor market, which is the primary concern now.  Fiscal policy, in a perfect world, would be better suited for that although fiscal policy is being held hostage to politics, and probably will be for a while.  So everyone will be looking to the Fed to do something.  Aside from making sure they don't passively and unintentionally contract the credit supply, it's not clear how they can achieve the effects that people want.

Ultimately, you can't quite square the two positions. The best I can do is to say that I agree with Kocherlakota today, but Bullard might be right tomorrow.  Pulling the trigger too early could be destabilizing and may not necessarily have the positive effects you want.  Policy lags notwithstanding, I wouldn't be ready to take the risk yet.

David Leonhardt examines our predicament in today's NY Times.

Finally, the idea that the world's rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change.

In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that.

So true.  I, too, would be cautious about allowing the economy to slip.  But is it that we need more stimulus, or is it that the original stimulus wasn't done right?  If the latter, that's a problem if we really do need something more, as there's little hope that they'd get it right the next time.

That's right, don't take my word for it.  No less than Nobel Laureate Joseph Stiglitz--hardly my ideological compatriot, but an economist I certainly do respect--wrote in his latest book Freefall:

The cash-for-clunkers program also exemplifies poorly targeted spending--there were ways of spending the money that would have stimulated the economy more in the short run and helped the economy to restructure in the ways that were needed for the long run (p. 70).

Which is what I've been saying since August.  Thanks for having my back on this Prof. Stiglitz.

Brad DeLong finds a post on the White House website that makes him believe.

Wow!  Cash for Clunkers Worked!!  Graph of the Day for April 7, 2010:  That surprises me. But Christy Romer and Chris Carroll have a graph:

And here is that graph...

From Reuters:

SYDNEY (Reuters) - Australia's central bank raised its key cash rate by 25 basis points to 3.25 percent on Tuesday, as surprising economic strength allowed it to withdraw some of the exceptional stimulus doled out during the global credit crisis.

How long before others follow suit?

Edmunds.com:

Interest in the Cash for Clunkers program is slowing, and, if the current trend continues, vehicle sales could be back to pre-Cash for Clunkers levels by August 20, Edmunds.com calculates.

Edmunds.com's analysis of purchase intent on the car-shopping Web site shows sales activity tied to the government's Car Allowance Rebate System (CARS) remains well above the period leading up to its July 27 public launch.

However, activity is 15 percent below the peak of the Cash for Clunkers frenzy, which occurred the last week of July and specifically on July 29. Barring any intervention such as a major incentive program or a significant uptick in the economy, sales will be back to pre-clunker levels by next week. 

...

The funding for the original program was low relative to the size of the auto market, creating a Gold Rush mentality where consumers hurried to take advantage before funding ran out. In fact, it largely sopped up the pool of buyers who owned clunkers and had the ability to buy or finance a new vehicle. In addition, automakers are running extremely low on inventories of vehicles eligible and popular for clunker trades. 

With additional funding now approved, the sense of urgency to participate in the program is gone and the pool of eligible clunker owners who can buy a new vehicle has shrunk. Interest in the program is fading as fast as the first billion was used up. Quite possibly, some of the extra $2 billion will go untapped.

Despite this decline in clunker activity, however, Edmunds.com expects auto sales to be improved through the summer as the economy slowly improves and value-oriented consumers look for deals before the new 2010 models start arriving, said Jessica Caldwell, director of Industry and Pricing Analysis. "The real risk is this fall. Will the economy have picked up enough momentum to keep sales at these levels?"

Some of the extra $2 billion will go untapped?  I find that a little hard to believe.  But by the looks of it, CARS has already attracted the buyers who were on the fence and ready to jump.  It will get progressively harder to get additional buyers to take the plunge--simple marginal analysis in action there.  The low hanging fruit has been picked.

Remember also that the increase in sales at the end of the model year would have happened with or without CARS.  And remember that auto sales right now are so low (with or without CARS) that there is practically nowhere to go but up.  Look at the data (Econbrowser has some good charts).  We are down hundreds of thousands of units per month relative to the past few years.  And while the Big-Three's loss of market share means that some of that loss is permanent, a lot of it would have come back anyway.  If CARS uses all $3 billion, at $4,500 per car, that would mean a few hundred thousand unit sales.  According to this table, we're down about 30%, or just under 2 million unit sales YTD compared to 2008 (which was a really bad year as well).    By my back-of-the-envelope calculation, CARS cannot even come close to erasing the sales deficit experienced in the last 6 months.

And that means that any meaningful increase in production going forward would have happened anyway.  The increased sales from CARS could not possibly explain even a return of production to the levels of a year or two ago.  The sales declines have been too large, and the CARS program too small.

But I have to give the politicians credit for setting up the illusion that they made the recovery happen.  Sales (and production) will turn up eventually.  They have nowhere to go but up.  And when they do, CARS will get the credit, just you watch.

But make no mistake.  When and if production recovers, it won't be because of CARS.  The numbers just don't add up.

From the Bureau of Labor Statistics:

The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data--as measured by output per hour of all persons--for the second quarter of 2009. The seasonally adjusted annual rates of productivity change in the second quarter were:

6.3 percent in the business sector and 6.4 percent in the nonfarm business sector.

Productivity gains in both sectors were the largest since the third quarter of 2003, and were due to hours worked declining faster than output.

Brad DeLong says:

Wow. I knew this was coming, but even so... Wow!

Remember, folks, employment is a lagging indicator.  Productivity spikes like this and in 2003 are to be expected as GDP starts to turn back up before jobs.  Hence the title of DeLong's post "Let's give a warm welcome to the jobless recovery."

Things seem to be playing out as many expected.  Look for a recovery in GDP in the 2nd half, but unemployment probably hasn't peaked yet.  My own personal estimation is that this recession's drop in employment was more cyclical and less structural than in 2001, so the recovery in jobs should be somewhat more robust, but probably not much more so.

I'm working on a post or two on the labor market, but other duties will probably keep me busy for the rest of the day.

Mark Thoma makes a comment on his blog that is worth a response.

I've seen lots of objections to the Cash for Clunkers program based upon the fact that all the program does is shift consumption intertemporally, it doesn't actually create sales that wouldn't have occurred anyway.

But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy. When the economy is in recession, creating brand new things that wouldn't have existed otherwise to lift the economy back toward full employment is preferred, but generally there aren't enough opportunities along these lines to give the economy the help it needs. In the cases where we cannot create enough new output and consumption to bring the economy back to health, moving consumption from a time when the economy is overheated to a time when it is underperforming helps by bringing both time periods closer to the long-run trend.

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. But there is value in avoiding large cyclical swings in the economy, i.e. value in stability, and when we have the opportunity to shave the peak of housing and other booms - times when the overheating is dangerous as it could result in bubbles, inflation, and other problems - and then use the "shavings" to fill the troughs of recessions, we should do so.

Now, I don't think I was the only one to make the argument, but when you Google "cash for clunkers intertemporal substitution" I am at the top of the list.  So I guess I should respond.

Mark characterizes the intertemporal substitution argument thusly:  "it doesn't actually create sales that wouldn't have occurred anyway."

While that is certainly true, I took it a bit farther, particularly in my second post.  My point is that it might not even affect production much at all since the dealers were overstocked with inventory anyway.  The production took place before CARS, and it is unclear (unlikely in my estimation) that CARS will meaningfully stimulate production afterward.  The increase in consumption and the decrease in inventories create basically no effect on GDP.  In a world without CARS, the dealers would have had to slash prices at the end of the model year (which is fast approaching).  As I said before, the dealers benefit, but it is unclear if anyone else does.  (Ironically, the dealers are having problems getting paid, but that's a story for another day.)

Mark then says, "But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy."

I don't know.  If the program shifts consumption but not production, maybe it is a valid objection.  Don't you think?  Plus, there's the link in my first post that seems to have been overlooked.

I didn't quote from the article because I thought that people would read it, get the point, and see the connection.  But here it is in case you missed it.  The article is about the tech slowdown post Y2K, Internet boom, etc.

That has left many equipment and chip makers with much of the stuff they built in 2000. Motorola's Burgess figures that by and large, chip makers booked two years' worth of sales last year. The market for communications and networking chips grew 37% in 2000. But Burgess says "we got 12% last year that we shouldn't have had" because those sales were simply moved up from 2001. The result will be a decline in sales this year and continued slow growth next year. (emphasis mine)

The beauty of that article is that it was written after the fact, not speculating about what would happen.  Yes, I am speculating here, but I think I've got a pretty good script to work from.  I would not bet the farm on CARS providing a "stabilizing" force in the auto industry or beyond, and as noted in my second post, I don't think Detroit is either.

Again I ask, if the production has already occurred and would have occurred without CARS (and those workers were paid for that production before being laid off when demand slumped), then who benefits from the shift in consumption besides the dealers (who may have had to sell these cars at a huge discount without CARS)?  Remember, I don't dispute the fact that the dealers benefit.  And there is a (small) multiplier effect from that perhaps, but surely there are more effective ways to stimulate demand, aren't there?

Maybe Mark secretly agrees that there are better ways...

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. ...

I think Mark misses the point that effective stabilization policy does in fact intertermporally shift output--which should shift consumption as well because they are contemporaneously correlated.  And in fact, just about any policy is an attempt to intertemporally shift output.  Monetary policy surely is.  But an intertemporal shift in consumption and inventories alone (which this quote from Mark seems to acknowledge this is) really is of little value in the aggregate.

Of course, maybe Mark wasn't referring to my posts at all since there wasn't a link.

Just to be clear, my real issue with the "Cash for Clunkers" program is the same as the reasons that I oppose the income tax rebates brought to us by President Bush and the gas tax holidays embraced by politicians of all stripes.

These policies have almost no real stimulative impact.  Consumers don't benefit much from gas tax holidays.  And income tax rebates mostly get saved.  I will repeat what I said during the gas tax holiday debates:

My criteria for good public policy is that it be well out of the neighborhood of "pointless."

I apply this criteria without regard to the political party that advances the policy, and I encourage you to do the same.

Basically I get really irritated when any politician from any party tries to score points with a policy that is bound to be popular for obvious reasons even though it produces little or no real positive effect.  It irritates me that so many people can't see through the smoke and mirrors.  It irritates me that politically popular but nearly pointless policies crowd out other policies that are less politically popular but could produce far better results.

I've been irritated a lot in the last 10 years, and I don't see it getting better anytime soon--regardless of which party is in the big chair.

It is quite fashionable at the moment to refer to the "cash for clunkers" program as an example of the "broken window fallacy".  See here, for example (Seeking Alpha).  Well, at least "cash for clunkers" is not mandatory.  A hurricane or a tsunami doesn't give you a choice about whether to participate in the destruction.  That is certainly an important difference.  But as the article from Seeking Alpha makes clear, the real similarity that matters is that it results in a net loss of value.  Let's explore this idea.

My last post on the subject made the observation that it just shifts the spending intertemporally, and therefore the auto industry will likely see a decrease in demand when it's all over.

Commenter "Lord" remarks that this is ok, even desirable.  It means a boost in production when you need it and a decline later that will reduce the threat of inflation.

First of all, it is unclear what effect this will have on production.  Sales have increased, and it is drawing down inventories.  But the automakers know that this might not be sustainable.  This article from Edmunds Auto Observer makes the point:

"If we can sustain this momentum in the industry, it will translate into having a very good ability - for the first time in a long time - to increase production," said Michael DiGiovanni, GM's executive director of global market analysis. "And that will help stem the rising tide of unemployment, and will feed on itself to revive the economy. Recoveries are usually fed by the auto sector."
 
But displaying appropriate caution, neither DiGiovanni nor any other auto company executives pledged immediately to boost production in the wake of CARS mania. LaNeve said that GM is "looking for ways to add production" during the third and fourth quarters, but he didn't make specific promises.

Read the rest of the article.  You will see that industry experts really don't know what will happen going forward after this rebate comes to an end.  Good for dealers?  Yes.  They get rid of inventory they've been unable to move.  Enough to save the Big-Three?  I don't see it.

If the argument is that this is a sort of Keynesian "pump-priming" that will get us out of a bad equilibrium (coordination failure, for all you grad students out there), then I admit to being skeptical.  I guess if 3rd quarter GDP is positive we can pretend it was CARS that did it (even though a lot of folks have been predicting that for a while anyway).

Commenter "Jake" concurs with "Lord" that it will end the recession faster and adds that the net effect of the program will be positive.  "Jake" doesn't go into detail about how he arrives at that conclusion.  So I'm left to try to fill in the blanks.  Luckily, people have made similar arguments about natural disasters (and committed the "broken windows fallacy").

One positive effect usually mentioned is the increased spending.  But as we've stated (and "Lord" would seem to agree), this is just intertemporal substitution.  If you don't buy the pump-priming argument, then this isn't a long-run benefit.  (Is a billion dollars really enough to prime the pump?  Seems like a drop in the bucket.)

The other positive effect is that we have exchanged--in aggregate--inefficient cars for more efficient ones.  We'll save energy and the environment.

Ok.  But as Mark Perry points out, with more fuel efficient cars people might drive more because it costs less.  I would stop short of saying that it would actually harm the environment without more information.  But it is perfectly reasonable economic logic to say that the environmental benefits will be less than advertised... especially in light of this.

But I'll be generous and say that there is some environmental benefit.

Now, those cars would have been taken off the road at some point anyway, right?  So the net present value of the environmental benefit would only be the reduced emissions that would have gone out from now until the time of that car's eventual disposal.

So again, it is less benefit than is being advertised.  But if the environment benefits at all, it's all good right?

Not necessarily.  There's no such thing as a free lunch.

It still cost the government something.  That's money that won't be spent on something else.  Granted, a lot of the praise for CARS is that it is a better way to spend money than bailing out banks and so on.  But a dollar of spending today equals a dollar of future taxes in present value terms.  No free lunches.  Are the environmental benefits worth the money being spent?  If not, then we're just breaking windows.

I don't know the answer to that question with certainty, nor do I think that Congress had enough information to answer that question.  The truth is that this program is easy to administer and easy to explain to people.  It's politically expedient, and that carries a lot more weight in Washington than its economic merits (or lack thereof).

As policies go, it's probably better than some ways to spend money and worse than others.  But to those who think it is undeniably a net benefit to the economy, then I would ask, why stop at cars?  Why not distort the prices of some other things that could be replaced with more energy efficient versions and let the government pick up part of the tab?  Why not tear down rodent and asbestos infested old inner-city school buildings and replace them with safer high-tech environmentally sound buildings?  Sure it would cost more upfront, but the energy savings and the environmental impact would be enormous.  And think of the jobs!

It's not about the environment or the jobs, is it?  It's about politics.

I'll keep this simple.

Consider a market for a good that most people purchase once every few years.  Suppose that the purchasing decisions of consumers is somewhat influenced by cyclical and seasonal swings in the overall economy, but that no other large external factors synchronize the buying habits of many people at once.

Now suppose that an external factor (such as a government policy) caused many people who would have purchased cars in the next few years to make those purchases now.

Intertemporal substitution, anyone?

And the implications for demand in that industry in the years that follow these synchronized purchases would be...?

Oh, right, this happened once before.

That is all.

Today's Washington Post gives us a glimpse of Obama's plan to restructure the regulatory environment.

The plan is built around five key points, according to a briefing last night by senior administration officials and a copy of the white paper obtained by The Washington Post.

The proposals would greatly increase the power of the Federal Reserve, creating stronger and more consistent oversight of the largest financial firms.

It also asks Congress to authorize the government for the first time to dismantle large firms that fall into trouble, avoiding a chaotic collapse that could disrupt the economy.

Federal oversight would be extended to dark corners of the financial markets, imposing new rules on trading in complex derivatives and securities built from mortgage loans.

The government would create a new agency to protect consumers of mortgages, credit cards and other financial products.

My response goes something like this.  We live in an imperfect world with imperfect regulations on financial markets.  Hence, there exist policies that would represent an improvement on the current system, but there are also many (more) ways to mess it up even worse.

It would be much easier if we could close our eyes, make a wish, and eliminate stupidity and dishonesty.  But since that won't happen, let's think about whether the Obama plan would represent an improvement.

Hopefully it would put a stop to the "too big to fail" argument.  Obama seeks to give the government (Fed) the ability to break up large bank holding companies that get into trouble.  But the only part of the white paper where this is directly mentioned (that I can find) is pages 74-76.  To say it is short on details would be charitable.  Granted, this is something where the rules would probably be written on the fly, but then, isn't that what we're doing now?  Is it enough to just say that we'll let the Fed do what it needs to do?  If we did write rules for this, could the end up being too constraining?  This is a really tough problem, and I don't think they've solved it.

On the plus side, the document does spend a few pages suggesting a larger role for the Fed in overseeing the payments, clearing, and settlement systems.  Now that's something that is actually within their proper scope of regulation anyway.  That seems like a winner.  (But also short on details.)

More rules on trade in derivatives is also something that I would support if done right.  I'll need to think more about what is the right way.

But the document also spends a disproportionate amount of pages discussing how to protect consumers from "financial abuse."  In fact, in my perusal of the document tonight, I see the most detail in this section.  Among other things, they would like to mandate that a traditional fixed-rate 30-year mortgage ("plain vanilla" as they put it) be offered alongside any other lawful mortgage products, and that the consumer be given the tools to compare the various products.

Sorry, I don't see this as making much difference.  We already have disclosure requirements that kill quite a few trees for every mortgage closing.  With all of the information shoved in front of the homebuyer, most people just shut up and sign.  Will giving them more information (as opposed to useful knowledge--which cannot just be given) really make a difference?  If you're an unethical mortgage broker, don't you think that there will be a way to game this system to your advantage (offering fixed-rate mortgages at exorbitant interest rates to discourage their use, for example)?

Yet this seems to be where the administration is focusing its efforts.

Fortunately, there was some other insightful comment on regulation today.  Arnold Kling writes in a guest column at the Washington Post:

In my view, the worst regulatory error was allowing bank capital regulations to be evaded. In the late 1980s, after many savings and loans had failed in the United States, international bank regulators developed the Basel capital accord. Although this was flawed in many respects, it did represent a formal requirement for banks to hold capital based on risk. Most assets required 8 percent capital. Some low-risk assets required 4 percent capital, and some government securities required even less.

Soon after the capital accords were rolled out, banks began to come up with ways to "game" the system. For mortgages, the two most important techniques were securitizing mortgages and creating off-balance-sheet vehicles. Securitization allowed banks to get large portions of their mortgage portfolios rated AAA, and these AAA ratings in turn lowered capital requirements, particularly after a revision to the capital requirements that was formalized on Jan. 1, 2002. The off-balance-sheet entities were an even bigger scam, because generally-accepted accounting principles (which the regulators copied) allowed the banks not to count the mortgage securities in these entities as assets at all.

All of this was done right under the nose of the regulators. An article in 2000 in the Journal of Banking and Finance,called "Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues," was written by a Federal Reserve staffer. Although such scholarly articles always carry disclaimers that the contents do not represent the opinions of the Fed, it clearly showed an awareness of how banks were using techniques to evade capital requirements. The author rationalizes this in part by suggesting that without the ability to evade capital requirements, banks would have been less competitive in the market to finance mortgage loans or other low-risk assets.

I think Kling is on the right track.  If financial market regulation is like firefighting, then to prevent this sort of gaming of the system would be like starving the fire of fuel.  A different tactic than pouring water on the fire, but still effective--sometimes more so.

At Marginal Revolution, Tyler Cowen writes:

The broader point is this.  Better regulation comes through many years of experience and gradual process improvements, built upon some reasonable methods for imposing regulatory accountability.  That's how the FDIC got to be good at much of what it does.  Better regulation does not come from sitting down, waving a wand, and hoping that a new name or box will address the problem you are concerned about.  Keep that in mind next time you hear that "now is the unique moment," etc.

Well put.  Doubling or tripling the amount of paper shoved in front of a home buyer at closing won't do it either.  There should be changes.  But there really isn't any need to rush something through by the end of the year. We're not in danger of a repeat of the circumstances that laid the groundwork for the crisis any time soon.  So take some time and do it right.  There might be a few good ideas in the Obama plan, but there is also a lot more alphabet soup without a lot of details about how it will all work.

Felix Salmon calls it a bust as well.

A lesson in moral hazard.

Had there been no FDIC, I would have asked questions, sought answers, and depending on those answers possibly moved my money.

But asking questions, seeking answers, and moving all of your auto debits from one bank to another is costly.  And the fact that there is an FDIC means that the individually rational decision for me is to sit tight, not incur the cost, and trust the FDIC.

Of course, the fact that people don't ask questions is how trouble like this gets started in the first place.

And yet, the notion of deposit insurance has always struck me as a pretty good deal for the banking public.  How much would you be willing to pay to ensure that there is zero probability that you will lose money if your bank fails?

There are those who oppose FDIC on libertarian grounds.  Fine.  I understand the argument that it causes moral hazard and raises costs.  I get that.

I get it, and I accept it.  Always have and always will.

Thanks, FDIC.

On May 22, 2009, Citizens National Bank , Macomb, Illinois was closed by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC) was named Receiver.  No advance notice is given to the public when a financial institution is closed.

The Fed speaks

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of financial and economic developments.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

And the bond market is feeling like a jilted lover.  John Jansen discusses the carnage.  As this Wall St. Journal article put it,

A surprisingly light-hearted take on the U.S. economy from the Federal Reserve's policy statement sent government bond prices tumbling Wednesday, and yields vaulting to their highest levels for this year.

"Light-hearted"?  Well, in a manner of speaking, yes.  What with the green shoots and all.

I told my intermediate macro class yesterday to look for signs of a more toward quantitative easing or a ramping up of long term bond purchases (not the same thing--and neither happened).  I told them I'd give it odds of 2:1 against.  In retrospect, I should have shorted the 10 year!  After looking at the GDP data this morning I would have upped it to 4 or 5 to 1 against.  The point is that it looks like the Fed is content right now to wait and see how some of the new lending facilities will work.  No need for any new stimulus at the moment.

The bond market was hoping for a bit more.  The yield on the 10 year stands higher than it did going into the March FOMC meeting (though still historically pretty low--we're talking basis points here).  The pattern is striking.  After the March meeting, the yield on the 10 year instantly fell 45 basis points (that move really was a surprise) and then gained it back over six weeks.

Bottom line:  Seems to me that if we really are turning the corner, it will be interesting to watch the bond market come to terms with it.  The Fed will really need to watch its step in announcing any further purchases (or not).  They've got a tiger by the tail.

Bureau of Economic Analysis

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 6.1 percent in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to advance estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3 percent.

First, the good news.  This decline is (slightly) smaller than the 6.3% decline in the 4th quarter of 2008.  If these early numbers are correct, then we might expect things to be (slowly) improving.

If you dig deeper into the report, you see however that this quarters numbers are buoyed somewhat by lower imports (which are subtracted from GDP).  This is not necessarily a good sign.  Gross domestic private investment was down at about a 50% annual rate.  This is a truly staggering rate of decline and I wouldn't expect it to continue for too long outside of a Great Depression scale event (which this is not).  In the words of Herb Stein, "Things that can't go on forever, won't."

Also the federal government's spending declined in this quarter.  Whatever your opinions about it, I think we have reason to believe that may reverse itself in the coming months.

And finally, personal consumption actually picked up a little.  Notably, consumption of durables rose for the first time since the 4th quarter of 2007.  This is certainly encouraging.

However, don't get too excited just yet.  In the last quarter, the early numbers showed a 3.8% decline that was later revised to 6.3%.  As this chart from the St. Louis Fed shows, in the last few quarters, the revision from advance to preliminary has been the most important (preliminary to final has been pretty close).


So there may be some green shoots, but I'd wait a month (at least) before calling a bottom.

James Hamilton at Econbrowser has more along these lines.

James Pethokoukis writes:

There is an economic downside to trying to keep people in their homes, even if underwater. Mike Feroli over at JPMorgan points out the Osward Hypothesis: "Higher homeownership rates increase the natural unemployment rate because it reduces geographical mobility and the ability to move someplace else to find a job."

Ceteris paribus, perhaps.  But ceteris is seldom paribus, and it is certainly dangerous to paint with a broad brush.  What is the relevant market?  Both housing markets and labor markets are regional to a very large extent.  Different markets are linked together in complex ways.  Examples abound of areas where home ownership is high and the natural rate of unemployment is low and vice versa.

The real problem today, of course, is a lack of liquidity.  People can own homes and still be mobile if a house can be sold in a reasonable amount of time.  It's not the rate of home ownership that matters so much as the ability of individuals to enter and exit.

Right now, exit from the housing market is more costly than usual.  As a result, people are likely to be less mobile and the natural unemployment rate may very well rise.

However, Pethokoukis and Feroli are only telling half of the story.  Policies designed to keep people in their homes may increase the unemployment rate, but only to the extent that such policies make voluntary exit from the market more difficult or costly.  Policies designed to keep people who are still employed (and likely to remain employed) in their homes with a minor modification to the loans are not going to have much of an effect on the natural rate of unemployment.

On the flip side, policies that allow people to voluntarily exit without any cost or penalty at all do pose a moral hazard problem.  I can imagine some creative yet politically and practically unrealistic policies to try to address this and get the incentives right, but I'm not confident that what we are going to get is going to get the incentives right.

But the point is that this is not an insoluble problem.  Furthermore, don't fall for the claim that home ownership is the problem.

Barely. Here's an update of the graph I created last month. Payroll figures continue to be ugly. The labor market is now deteriorating at a faster pace than the 1981 recession.

Brad DeLong thinks we need a bigger stimulus. I'll credit him for consistency in that he has argued for a larger stimulus all along. However, I don't think that today's data should really change anyone's opinion on what is necessary or advisable. I think we all knew when we went to bed last night that the morning news would not be pleasant. Next month's news will not be pleasant either, but I've already built that into my expectations. I am expecting continued losses but perhaps not the 600,000 numbers that we've been seeing lately. I'm hoping for under 500,000. That would be encouraging, but I'm not supremely confident.

The Wall St. Journal Real Time Economics blog asked a number of economists what people should do with the average $8/week reduction in taxes withheld from our paychecks.

One fun game to play is to try to guess how each economist would respond.

Some of them took it seriously, I think.  Here are some highlights.

Justin Wolfers gets the award for the fundamentalist Keynesian response.

Justin Wolfers, The Wharton School: Find a cash-strapped soup kitchen. If they are looking at having to make cutbacks, then your $8 donation really will yield $8 worth of extra soup purchases. A good Keynesian will point out that this $8 in extra spending will enter the circular flow, creating the much-needed economic stimulus. (By contrast, university giving may simply prop up a sagging endowment.) But more importantly, the $8 you spend helping the hungry really can have a big bang-for-the-buck at a time when food spending is plummeting and unemployment rising.

Mr. Cliggott and Mr. Kasriel must have thought the question was asking what you would do with an extra $8 million.  I'm not aware of too many venture capital investments or hedge funds that require just $8.

Doug Cliggott, Dover Investment Management: You should invest it, not consume with it. Preferably a venture capital investment that will have a significant multiplier effect. This is why tax cuts are the worst type of stimulus. They are usually consumed or invested in a secondary market with little or no multiplier.

Paul Kasriel, Northern Trust: I would use the extra cash to start a hedge fund, which would purchase newly-issued asset-backed securities. I would finance my position through the Fed's TALF program.

Ricardo Reis and Alan Blinder get the De Gustibus Non Est Disputandum Award for their answers.

Ricardo Reis, Columbia University: You should use the money in the way that is best for you and your family, whether that is saving or spending, buying this or paying that. Doing what is in your best interest usually leads to doing what is best for the economy. (And when it is not, the economic policymakers should have figured that out when deciding whether to, and how to, give you the $8, so that by pursuing your best interest you end up doing what is best for all.)

Alan Blinder, Princeton University: While I might have my own personal favorites, each citizen should spend the money on what he or she sees fit. The idea is to get more spending, more jobs, higher incomes, etc. in the nation's economy.

Martin Feldstein answered it like an exam question.  I give him an "A".

Martin Feldstein, Harvard University: I don't think individuals make spending decisions based on attempts at good citizenship. If they think this $8 is a permanent increase, they will add it to their overall budget. More likely, they will recognize that this is temporary and will use it to pay down debt or add to their liquid assets

Guessing Greg Mankiw's response is left as an exercise for the reader.  Hint:  He implicitly assumes that you'll save up a couple months worth of your $8/week.

And finally, the cleverest response was from the always clever Tyler Cowen.

Tyler Cowen, George Mason University: In my view, fixing the banking sector is more important than getting the stimulus right. So if you can afford to lose the money, go to a large bank (more likely to be insolvent), find their most overpriced service, and buy as much of it as you can. That way you are doing your part to recapitalize our banking system.

If you're stuck for ideas, just keep on using ATM machines, owned by other banks, so you can pay large fees to take out small sums of money from your checking account. When you need to, take all of your withdrawals and deposit them back in the account once again and start all over with the process.

Honestly, Letterman should have 10 of these economists record their answers for his top 10 list.  I would love to see a straight-faced Tyler read that as the number one thing to do with your $8/week stimulus.

What would I do?  I like Reis's and Blinder's answers as a general principle.  In fact, had I been asked, I might have said "whatever you want."  Why waste words?

Go read the other responses.

Oh, and it goes without saying that the WSJ readers have at it in the comment section.  Enjoy.

Bill Conerly raises an interesting question on his blog, Businomics, today.

A good question asked yesterday: Is this recession different from others in degree or in kind?  No recession hits the historic averages smack in the middle, so this one would have to be at least a little different in degree of severity or duration.  But might it be fundamentally different from the types of recession we've seen in the past?

...

Now we are in a bust and we hear "This time it's different."  Those are the most dangerous four words in economics.  I don't think this recession is different.  Oh, it's different in magnitude and duration, it's different in the specific combination of factors that led to the recession, and its different in the level of panic that policy-makers have expressed.  But the fundamental process of recession and recovery?  I think it will prove to be pretty much like the rest.

I wholeheartedly agree that the words "This time it's different" are some of the most dangerous words in economics.  Like Conerly, I'm trying to make the case that it's not all that different.  In fact, in my comments to this post, I converse with my readers about some of the ways that this is just nothing like a Great Depression and that it is more like pre-1990s recessions.

Also, while we're on the subject of trying to communicate about the recession, the stimulus, and other matters to the general public, here's an observation.  Non-economists (including politicians) tend to fall into two camps regarding the stimulus.  One camp maintains that we have to act quickly to create jobs building roads and bridges because this is the worst recession since the Great Depression and if we don't do something quickly we'll be in another depression.  The other camp says government is too large, so cut taxes.

I am not finding much in the way of middle ground.

Mark Thoma also suggests that opposition to the stimulus is driven by opposition to big government rather than belief in small multiplier.

I think that much of the discussion in the economics end of the blogosphere has been a little more nuanced.  I imagine that there are a lot of economists out there who acknowledge that the spending will have some multiplier effect, but that the efficiency of that spending may leave a lot to be desired.  Those of us that are predisposed to that sort of thinking may then also get our hackles up a little when we think about how some of the spending creeping in could come with a lot of strings attached that might actually stifle growth.

It's not different this time.

For as long as I can remember, I have heard pundits say that the American economy is in decline for one reason or another.  Depression has always been right around the corner.  Such predictions sell books.  So the fact that there are some people who are predicting complete collapse of Depression-like proportions is not surprising.  Those undercurrents have been with us for the last few recessions.  It's not different this time.  But by the same token, this recession is not the beginning of a prolonged decline in the long upward trend of economic growth.  At least, it does not have to be.

The U.S. economy is always in a state of flux--dynamic and ever-changing.  We face challenges today.  But so has every generation, and some of their challenges were much more serious.  Things are not perfect.  We have kids going to school in 100 year old buildings.  Access to broadband Internet lags behind Europe.  I could go on.  Government can and should take on these challenges, but not for the sake of short-term stimulus.  Take on the challenges that will lead us to a more dynamic and prosperous 21st century economy.

When we conflate the short-term stimulus with the long-term dyanamism of growth we get confused policy that does not serve our citizens well.  Further, we run the risk of constructing policies that are so ill-advised that we could end up slowing our growth.  It does not have to be that way.

I admit to being at a loss as to how to solve this problem.  Only a proper understanding of the economic history of this country will open people's eyes to what is happening.

Only a proper understanding of economic history will make people realize that it's not different this time.  Where we go from here depends on that understanding.

After writing these two rather more lengthy than usual posts, I read Brad DeLong.  Though DeLong and I disagree on a few things, I have always found him to be very reasonable on the things that really matter in economics.  To wit:


It is a bit of depressing news, but then I was already expecting that the next revision of GDP might show it a little lower.  So I can't say that I'm incredibly surprised.  And remember, I'm not saying that a fiscal boost would be a net negative.  Whatever the present plan does to shore up GDP will be appreciated.

But I'm still a skeptic.  And Brad himself said that's ok a few days ago!

Arnold Kling feels lonely and unloved:

I'm feeling somewhat lonely these days. My understanding of macroeconomics is closer to that of Paul Krugman, Mark Thoma, and Brad DeLong than it is to that of Robert Barro, John Cochrane, or Eugene Fama. And yet I am a stimulus skeptic...

It's fine to be a stimulus skeptic! But stimulus skeptics need to be stimulus skeptics for reasons that are (a) theoretically coherent and (b) empirically relevant. To be a stimulus skeptic because you fear that the bill that emerges from congress will have a very low bang-for-buck, or fear that the long-run drag from amortizing the extra debt will cost us more than we gain from the short-run fiscal boost.

I'm a little from column A and a little from column B.  Mostly I question the bang-for-the-buck, as I explain at length in the previous post.

I'm just trying to puzzle out in my head how the present stimulus package will materially affect the trajectory of this chart.  And I'm just not seeing it.

This is continued from part 1.

We are in a recession.  This is a more serious recession in many ways than the last two.  However it is far from the proportions of the Great Depression, and the constant comparisons are beginning to wear on me.

This fall I gave a couple of public talks on the economic situation.  This was before it was announced that the recession began in December '07.  I told my audiences that I did expect that a recession date would be announced soon and that the start date would be between December '07 and July '08.  But I was also very quick to point out that although the job losses were already substantial, this was nowhere near the level of severity of the Great Depression.  Furthermore, the lessons that we learned from the Great Depression would be key in preventing something like that from ever happening again.  Of course, monetary policy is just about tapped out (barring some more drastic maneuvers) having already done what it can to prevent an even more serious failure of the financial market, so this brings us to fiscal policy.

Do we need $800 billion in spending to keep another Great Depression at bay?

Opinions among economists vary widely concerning the stimulus.  There are those who support it because they believe it will work (the multiplier is significant) and are not philosophically against larger government.  There are those who oppose it because they are philosophically against larger government and therefore the size of the multiplier does not matter (though many of them suspect that the multiplier is small and therefore use that as a supporting argument).

There are those who support tax cuts as stimulus because they support tax cuts all the time.  There are those who oppose the tax cuts because they believe consumers will save rather than spend them.

You need a scorecard to sort it all out.  We are not speaking with one voice.

This post is already getting too long to get into all of the problems with macro.  Besides, Arnold Kling is all over that.  While I don't necessarily agree with everything he says, I have enjoyed following his comments. 

It will suffice to say that macro folks have some work to do.  This is an exciting prospect because it was the inability of macro to answer many of these questions (and the debates that raged as a result) was what captured my attention and made me want to study this crazy stuff.

As for the stimulus package itself, I am a little disappointed.  I have my doubts about the size of the multiplier, but am willing to listen to evidence.  And while I'm cautious about increasing the size of government, I accept that there is a place for government in the economy.  But while watching the cable talk shows last night, the real reason for my skepticism bubbled to the surface.

Everyone is saying how the stimulus is going to "create jobs".  After all, job losses are the big story right now.   But will this stimulus actually create jobs?  Are we in a position to make this work?  Before you scoff, consider this:

The Federal Highway Administration has warned the state agency its payroll might be too depleted to handle the monstrous load of projects that a proposed $800 billion federal stimulus package could drop on Illinois' doorstep.

...

The Highway Administration is particularly concerned about professional positions such as engineers.

Good grief!  Has it not occurred to people that building roads and bridges is different in 2009 than it was in 1932?  Even minor projects need engineering support all the way from inception to completion.  How much of the $800 billion will go for that?  Do we have enough engineers to support that?

Then there is the fact that at the present time many of the layoffs I'm hearing about are temporary.  Unlike the last two recessions where plant closings and outsourcing were major factors.  I'm not hearing about plant closings and outsourcing this time.  Extensions of unemployment benefits and education tax credits would seem to be a reasonable way to address this.  I'm not sure a big construction push is the optimal way forward here.

Infrastructure and energy policy are laudable goals, but are they the way out of this recession?  I don't believe so.  My disappointment with the stimulus package and much of the debate around it in the media (as opposed to the professional debate among economists, which is of a higher quality) is that so many people think that building roads, bridges, and solar panels is the way to fight the recession.  That just doesn't wash.

The tax cuts will be saved rather than spent.  A lot of money will go to projects with questionable social value.   But yes, taken as a whole, the package will probably cushion the downturn somewhat.

And so once again, I am frustrated by the fact that this stimulus is being identified so closely with job creation.  I just don't think that in the final analysis there will be a lot of bang for the buck in terms of job creation, certainly not this year--which is when we really would need it.

Will it keep GDP from falling more than it would otherwise?  Sure it will!  Even a conservative estimate of the multiplier would concede that.  This bill is around 5% of GDP.  Even spread out over several years it will be felt.  But is it the right spending at the right time?  That is less clear.

I don't find anything in the bill that I believe is truly necessary to prevent a Great Depression scenario.  But could you argue that this amount of spending (on something, anything) is needed to shore up GDP?  You could argue it.  You could even argue that because of policy lags we need it now just in case the bottom falls out next year.  I'm skeptical but not dismissive.  I do believe that a certain amount of fiscal stimulus is a good insurance policy at a time like this, but I also suppose that I wouldn't be happy with any outcome of this political process.  So be it.

And that's the problem of fiscal policy in general.  Politicians like to believe that they can write legislation and create jobs.  It's not as simple as that.  There are no free lunches... no matter which party is in the big chair.

When the wheels started to come off the financial markets in September, I contended that swift action was necessary.  The Fed, for its part, did well in doing what it could within the bounds of its mission to prevent a complete collapse.  But the Fed was running out of options that were feasible for it to do on its own.  It was time to bring in the Treasury, and by extension, Congress.  I was not overly optimistic, but stood behind the effort.  I believed then, as I still do today, that if no legislation had been passed the probability of a further chain reaction in the financial markets during the presidential transition would be greatly elevated.  And the consequences of that would be potentially quite severe.  A legislative measure brought with it a measure of confidence during that transition.

$700 billion is a lot of money.  It's too much to risk letting go to waste, and still not enough to cover all of the potential losses out there.  Given the problems encountered so far, I believe it is prudent to slow things down.  We need triage.  Put the remaining TARP money where it will do the most good at preventing counterparty failures rather than frittering it all away on things of questionable value and purpose.

Yeah, right.  That's easier said than done now.  But no matter--buckle down and do the hard job.  Continue to let the market unwind.  The TED spread is way down from October, which is one sign that things are working themselves out.  There will be some more pain on Wall Street.  Accept that as inevitable, and do not prolong the inevitable.  Walking the fine line between preventing counterparty failures and not prolonging the inevitable pain is Mr. Geithner's job.  I think he's well equipped to walk that line, but the jury will be out for some time.

Now comes the fiscal stimulus.  This post is already getting long, so let's address that in part 2.

The BLS reported today that 598,000 nonfarm payroll jobs were lost in January and the unemployment rate climbed to 7.6%. No one is surprised by this.

For anecdotal evidence, as I move around the region listening to and reading the local news, I am hearing more stories of what seem to be classic demand-driven layoffs. The ripple effects of the housing slowdown and the global demand slump are being felt in more places than they were 6 months ago.

Nearly 600,000 jobs lost sounds like a lot. Certainly, we haven't seen those kind of absolute numbers for a very long time. However, the labor market is much larger than it was in past recessions. So let's go behind the numbers and look at the job losses as a percentage of total employment.

Let me be very clear about the methodology behind these charts. I am calculating the cumulative net job losses during all post-war recessions as a percentage of peak employment near the start of the recession. In some cases, employment dipped slightly and rose again before taking a larger downturn. In those cases, I considered the peak to be the month before the larger downturn.

Though all of these downturns are associated with NBER recessions, not all of the peak employment dates coincide exactly with NBER business cycle peaks. (For example, the NBER dates a business cycle peak in November 1973, but employment did not turn down until July 1974, so I used the July 1974 date for this chart.)

As an example, employment peaks in July 1953 at 50,536,000.  Thirteen months later, in August 1954, a total of 1,711,000 jobs were lost, which was about 3.39% of peak employment (dark green line). 



It is a fairly busy chart, but we can see the current recession (orange) is very similar to the 1981 recession (light green) in terms of job losses as a percentage of peak employment. But we have had sharper downturns in percentage terms.

If you believe that this recession is not fundamentally different from other demand-driven post-war recessions, then a forecast of job losses continuing for another 6 to 9 months would not be out of line. Furthermore, looking at past cycles, one would expect it will be at least a year (possibly more if the recovery looks more like that after the 2001 recession) before employment reaches the previous peak. Personally, my expectation is that it will take 18 to 24 months (from now) to get back to the previous peak.

Finally, here's a version of the chart with the last four recessions (including the current one) that is a little less cluttered.  I've also included the 1957 recession as an example of a sharper downturn in payrolls.

UPDATE:  Spencer at Angry Bear looks at household survey (CPS) data and concludes that the current downturn is the worst in the post-war period.  Actually, according to the household data the 1953 recession is worse, but that's a minor point.  But there is another issue to consider.  I'm not sure what to make of the fact that the household survey is subject to less variation (in both directions) than the payroll survey, especially during the '70s and '80s.  It is widely acknowledged that the household survey is a less reliable indicator of the labor market overall than the payroll survey.  So I am understandably nervous about the possibility of understating the severity of the employment declines in the '70s and '80s if we were to rely on that data.

Bureau of Labor Statistics

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 3.8 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent.

The carnage was pretty widespread with nearly every sector in decline.  Government, personal consumption of services, exports of services and imports of services posted weak gains.  Every component of fixed investment was down with no improvement in residential investment.  Ugly?  Yes, but not as bad as was expected.

The most interesting point for me was the change in inventories, which posted a gain of 6.2 billion dollars and contributed more than 1% to the growth rate (in the positive direction).  This is relevant because inventories have been decreasing for the previous four quarters.

Typically you might expect inventories to rise in the face of economic weakness as sales slow down.  However, better management has allowed firms to be more nimble.  Hence, even as the economy has been slowing over the last year, inventories continued to fall in anticipation of things getting worse over the next few quarters.  Now inventories rose (albeit by a small amount) just as the GDP figure turns the corner sharply negative.  Does this mean firms have already cut back in anticipation and it wasn't enough?  Does this mean things are on the verge of getting even worse?

Not so fast...

There is some reason to wonder about these numbers.  For that, we go to the Wall St. Journal's Real Time Economics blog:

Almost all the overshoot in GDP relative to consensus was in the inventory component; final sales fell at a 5.1% rate, with consumption down 3.5% and [business spending] on equipment and software down a massive 27.8% (biggest drop in 50 years) both worse than we expected. Net trade was much better than we expected, adding a hard-to-fathom 0.1% to growth; the BEA must have assumed much better December numbers than us. The big mystery, though, is the $6.2B rise in inventories, which bears no resemblance the monthly numbers. It makes us more bearish for the first quarter because this rise has to reverse in some size. In short, we are not comforted. -Ian Shepherdson, High Frequency Economics

For a possible reason why, one only had to look at the previous paragraph:

The inventory miss reflected a huge swing in the inventory valuation adjustment (or IVA). The fourth quarter IVA was +$211 billion vs -$97 billion in the third quarter -- a jump of more than $300 billion (or +11 percentage points of GDP at an annual rate). In the past 10 yrs, the next largest one-quarter swing in the IVA was $38 billion. The IVA is an adjustment used to translate the reported book value changes in business inventories to an economic value. We had expected to see a sizeable jump in IVA given the big drop in energy prices, but the actual outcome turned out to be several multiples of our model-based estimate, which relies on the historical relationship between the IVA, energy prices and other factors. -David Greenlaw, Morgan Stanley

In other words, the reason inventories didn't fall was because of the IVA.  So had it not been for the huge fall in energy prices, inventories would have decreased--perhaps be a large amount.  This would have caused the reported drop in GDP to be significantly worse than 3.8%.

Translation:  It's worse than you think.

But at the same time, the fact that it was the IVA that was responsible for the inventory numbers being high means that firms probably still are paring down inventories and not being caught unaware.

Translation:  The better than expected number today does not necessarily mean a worse than expected number next quarter.

I'm inclined to accept both implications.  Most importantly, the economy is likely contracting more than the headline number makes it appear.

All the usual caveats about the data being preliminary and subject to revision certainly apply--especially in situations such as this.

Let's turn back the clock to September 15 when we watched BofA acquire Merrill Lynch.  BofA CEO Kenneth Lewis was at the peak of smugness.  I wrote:

I watched the press conference with the John Thain and Kenneth Lewis (CEOs of Merrill Lynch and Bank of America, respectively) as well as the CNBC interview with Lewis.  Mr. Lewis looked like the cat that ate the canary.  He certainly gives the impression that this is the deal of a lifetime.  Who knows?  He may be right.

Of course, it was only after that press conference that the true magnitude of Merrill's problems became known.  Sort of like getting reservations to a five-star restaurant only to find when you get there that the chef has left the building.  So what do you do?  Well, you've been wanting to eat there all your life, and you're not going to get any reservations anywhere else now, so you dutifully take your seat and place your order.

And so BofA went right on with the deal because they've always wanted a piece of that business, and where else are they going to go?

Back at the restaurant without a chef, the only question is not if but how much will the quality suffer.

BofA had no idea how much Merrill had gone down hill.

Back at the restaurant, the food arrives.  It's lousy, but you swallow it down, not wanting to offend... or cause a run for the exits.

BofA considered it their patriotic duty.  (NY Times)

Mr. Lewis told analysts that he was surprised to learn in December, three months after the bank snapped up Merrill Lynch in a shotgun deal, that the magnitude of losses at the brokerage was far greater than expected. He said he had considered walking away from the deal at that point, but was persuaded not to, partly by regulators who feared that a failure to seal the deal could set off a new round of panic in the markets.

The decision to stick with Merrill despite its problems, he said, was patriotic. "I do think we were doing the right thing for the country," Mr. Lewis said.

And then you're handed the bill.  Only then does it sink in.

Mr. Lewis said he had considered trying to renegotiate the price once he learned the extent of Merrill's losses. But he feared that the length of time required for a new shareholder vote would put Merrill and the markets at risk. More important, he said, the government did not want to risk new turbulence in financial markets if the deal were to be delayed.

Rather than argue with the waiter (very undignified), you pay the bill and appeal to a higher authority.

"In recognition of the position that Bank of America was in, both the Treasury and the Federal Reserve gave us assurance that we should close the deal and that we would receive protection," Mr. Lewis said.

Oh, and did I mention that you're paying for this meal with someone else's money?

BofA shareholders aren't exactly thrilled about this patriotic act.

So where do they go from here?  Unfortunately, options are limited.  In the eyes of many, BofA is too big to fail.  They should get assistance from the TARP.  However, this will be a test of the system to see if the government can get an adequate stake in the bank to minimize risk to the taxpayer.  If this is more of a short-term solvency issue, then there is less to worry about.  But there are no easy answers.  The only thing that appears certain is that, ex post, BofA overpaid.  Tough luck.  Cover it with the TARP to contain the damage (this is probably a less objectionable use of it than some uses) and answer to the shareholders.

That meeting will look a lot different than the Sept. 15 press conference.

... 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.

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?

T.S. Eliot wrote that April is the cruelest month.  In the academic year, November shares some similarities with April in that it's when we start to come to grips with the fact that this semester will end... and soon.  For me, blogging seems to take a hit in November.  I'd tell you what's been keeping me busy, but it really is academic minutiae.  You'd be bored to tears.

November has been a cruel month for the markets as well, especially the last couple days.  Some days I turn on CNBC and literally see things that I never thought I'd see.  Watching the 30 year Treasury yield take a dive like it did yesterday would be one of those things.  Seeing Citi at less than $4 would be another.  Hearing perfectly reasonable people fret about the possibility of deflation would be still another.

How do you title a blog post these days without sounding like a doom-and-gloomer?  I feel like I want to choose my words very carefully to avoid making things seem worse than they are.  (I know how you feel, King!)  But when you hear speculations of a pretty sizeable drop in GDP in the 4th quarter and graphs showing this to be the worst stock market decline since the Great Depression, it's easy to get caught up in it.

So as I work my way back into the swing of things over this Thanksgiving break, let's just set the stage.

The auto bailout:  Not a good idea, but probably going to happen in some way, shape, or form.  At the rate that they're burning cash, I don't see what a bailout would reasonably hope to accomplish.  A fast track to a government assisted bankruptcy would probably be better in the long run.  I would support proposals to protect the pensions of workers, especially those near retirement because that represents a past promise that people took into account when making decisions. That's probably a good topic for a future post.  But this decline has been a long time coming, and trying to stop it is just going to add to the problems later.

Paulson's reversal:  I, for one, found that episode at least somewhat refreshing.  Some say that he realized that $700 billion would not be nearly enough.  Perhaps.  But if that's the case, I'd rather he stopped at the brink of the canyon like he did rather than jumping in and then telling us.  Yes, we could use some more transparency in seeing where the money has gone so far.  But most importantly, the fact that they're holding back some of that money means that at least one agency is doing something to keep its powder dry.  Which brings us to...

What will the Fed do in December?   That's what my macro classes are working on figuring out.  After Thanksgiving, I'll be discussing Poole's 1970 QJE paper with my grad students.  I guess that will be as good a time as any to bring up this development: (Bloomberg)

``There has been a policy shift, but the Fed is not transparently announcing what it is doing and why,'' said former St. Louis Fed President William Poole, now a senior fellow at Cato. ``Monetary policy works best when the markets understand what the central bank is doing.''

Some analysts point to the surplus cash that banks keep on deposit at the Fed as a key gauge of the Fed's monetary-policy stance. The so-called excess reserves have ballooned to $363.6 billion from $2 billion in August as the Fed added to its emergency lending programs.

``It is a move to quantitative easing, to force lots and lots of reserves into the banking system with the expectation that banks will start to trade them for a higher-yielding asset,'' said Poole, a Bloomberg contributor, said yesterday in a Bloomberg Television interview.

Hat tip to Calculated Risk.

Indeed, when you see things like this, it makes you wonder what is going on.  I'm going to be thinking about that a lot this week during the break from classes.

So what about deflation?  I'm not in the camp that thinks it's a big problem yet.  It becomes a real problem if wage declines make it even more difficult for people to make their mortgage payments or if price declines are so widespread and expected that people hold off spending now as they expect prices to go down further.  I don't see us getting there yet, but I stand ready to revise my expectations as new data arrives.

And finally stock market:  I'm just as caught up in it as you are.  My explanations are no better than anyone else's.  It does appear that we're on the verge of something with Citi, and people are getting worried about commercial real estate.  Those make for some strong headwinds. 

As I go around town I hear comments both positive and negative.  Everyone complains about their 401(k)s, but local businesses are hiring.  I do think that we're in a recession as we would define one nationally.  However, the impact is going to be very different for various regions and economic sectors.  It's difficult to fight recessions like this because it becomes more tempting to try to target policies at one area or another, and that's not always good or successful.

But it does give us things to talk about.

FOMC press release:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

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 in coming quarters to levels consistent with price stability.

Recent policy actions, including today's rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

There are some new features in the exact wording, such as "the Committee expects inflation to moderate in coming quarters to levels consistent with price stability".  Seems like only six weeks ago that they expected "inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain."

Good to see that some scholars are thinking outside the box.  From the Wall St. Journal op ed by Andrew Caplin, Thomas Cooley, Noel Cunningham, and Mitchell Engler:

The federal government needs to give taxpayers an ownership stake in the future. The SAM does just this. For example, a homeowner unable to support payments on a house purchased for $200,000 that today is worth only $150,000 might be offered a write-down of up to $50,000. But this would not be a free lunch.

With the SAM, once the value began appreciating above $150,000, the mortgage holders would be due their share. The details of the write down and the appreciation sharing could be tailored to different circumstances. But one way to give lenders a share of the upside would be to pay back some of the write down if the house is later sold, in the scenario above, for more than $150,000. This is a model in which both parties benefit, preventing default while giving future taxpayers a fighting chance at some real upside to the investment we're forcing on them.

Read the whole thing.

From the NY Times:

Treasury Secretary Henry M. Paulson Jr. outlined the plan on Monday to nine of the nation's leading bankers at an afternoon meeting, officials said, in which he essentially told the participants that they would have to accept government investment for the good of the American financial system. This capital injection plan will use a huge chunk of the money authorized for Troubled Assets Relief Program.

Citigroup and JPMorgan Chase were told they would each get $25 billion; Bank of America and Wells Fargo, $20 billion each (plus an additional $5 billion for their recent acquisitions); Goldman Sachs and Morgan Stanley, $10 billion each, with Bank of New York Mellon and State Street each receiving $2 to 3 billion. Wells Fargo will get $5 billion for its acquisition of Wachovia, and Bank of America the same for amount for its purchase of Merrill Lynch.

The goal is to inject massive liquidity into the banking system. The government will purchase perpectual preferred shares in all the largest U.S. banking companies. The shares will not be dilutive to current shareholders, a concern to banking chie executives, because perpetual preferred stock holders are paid a dividend, not a portion of earnings.

The capital injections are not voluntary, with Mr. Paulson making it clear this was a one-time offer that everyone at the meeting should accept.

Two weeks ago, I would not have guessed I'd be writing this tonight.  But here we are.  Now we wait and see what these banks are able to accomplish with that money.  I am reminded of Matthew 25:14-30.

Robert Gordon is a member of the NBER Business Cycle Dating committee.  He recently talked to David Leonhardt who writes for the NY Times' Economix blog:

"I would be surprised if most people on the committee didn't agree we are in a recession," he said. "But we certainly don't have a consensus." The committee is likely to wait until after it receives more data on the third quarter, which ended on Sept. 30, before making any decisions.

The big debate, Mr. Gordon said, is likely to be about when the recession began. Since employment peaked at the end of last year, there is a good argument for some date around Jan. 1, 2008. But economic output continued to grow in the first half of 2008, which would argue for a starting date closer to August or September. "It's going to be difficult to agree on a date," Mr. Gordon said.

Usually employment lags a bit.  That makes dating this recession a bit unusual.  I could argue as early as December 2007, but I'm now starting to think that it will be May, June, or July.  August or September is too late, IMHO.

Greg Mankiw has a good idea on how to recapitalize the ailing financial sector.  Read the whole thing.

Readers wondering about why coordination among central bankers matters (as in today's coordinated rate cut) may benefit from this old post from 2006.  The subject is a NY Times piece by Hal Varian.

Since this is such an unusual event, I'm just going to print the entire press release complete with links to other central banks.

Joint Statement by Central Banks

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. 

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Federal Reserve Actions
The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures. 

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation. 

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability. 

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. 

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-3/4 percent.  In taking this action, the Board approved the request submitted by the Board of Directors of the Federal Reserve Bank of Boston.

Information on Actions Taken by Other Central Banks
Information on the actions that will be taken by other central banks is available at the following websites:

Bank of Canada
Bank of England
European Central Bank
Sveriges Riksbank (Bank of Sweden)
Swiss National Bank (51 KB PDF) 

Statements by Other Central Banks
Bank of Japan (65 KB PDF)

Press Release from the Fed:

The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.

This will bring a sigh of relief to the commercial paper market. Think of it this way.  The Fed is betting that there are a lot of mutually beneficial trades out there that are not happening because the participants either afraid that they will not get paid back or that they will not be able to liquidate the paper they hold if they need quick cash.  In normal times this action would not be necessary.  But these are not normal times.  John Jansen at Across the Curve has been reporting on the CP market for a while, and if what he's been saying is true then this was a very smart and very necessary move.

So says Reuters (and CNBC)

The statement came after U.S. business television channel CNBC reported the Fed was planning talks with the Chicago Mercantile Exchange, or CME, and the Intercontinental Exchange, or ICE, on the creation of a CDS exchange. The companies declined to confirm the report, although they said they would be willing to participate in any initiative.

And Calculated Risk says:

Apparently CNBC's Steve Leisman reported (I didn't see it) that the Fed might announce tomorrow morning some sort of program to buy commercial paper.

I had CNBC on in the background tonight and I think I heard that as well.  John Jansen says he has heard something to that effect from three sources.  And if you haven't been reading his blog lately, you're not fully informed.  From what I'm reading at his blog and other sources, it appears that the levels of risk aversion out there are just incredible.  Institutions are not lending because they have no way to assess the creditworthiness of their counterparties.  As a result, good trades are being passed over.  This cannot go on for very long without causing some significant problems. 

As I've said before, it's an information problem (which has led to a problem of risk assessment).  We are in need of transparency, pure and simple.  Unfortunately, getting it will not be that simple.

Alex Tabarrok at Marginal Revolution writes:

The consensus among economists is now clear, the best strategy for dealing with the financial crisis is to recapitalize the banks that need recapitalization.  Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan and many others all advocate some form of recapitalization as do Tyler Cowen and myself.  Krugman would prefer a recapitalization in the form of nationalization.  In my view, there is still plenty of private money to buy banks at the right price and my preferred model is the FDIC leading a speed bankruptcy procedure, as was done brilliantly with Washington Mutual (Cochrane also supports this model.)  In the middle are most of the others who have a variety of good ideas to require the banks to raise equity in various ways.

...

There is also a consensus among economists that the bailout bill is not the right policy.  None of the above economists, for example, is enthusiastic about the bailout.  My bet is that all of us think that the bailout has a substantial likelihood of failing.  The support that exists is born out of hope and fear not judgment and experience.  Nevertheless, the political consensus is that a bailout is what we will get whether it is likely to work or not.  

Count me among those not enthusiastic.  My grudging support is not out of fear, per se--that's too strong a word.  Rather, I am convinced that we're in for a bumpy ride either way, and even a suboptimal plan like this has the potential to make the ride less bumpy.  Furthermore, I think that the moral hazard risks are small in the short term, and there is plenty of time to deal with the long term later.

But what is done is done.  Payrolls fell another 159,000 in September.  The unemployment rate did not rise this month, but it will catch up in time.  And let's be clear once again.  This bailout bill will not prevent a recession.  As James Hamilton says, that's a "done deal".  This bill will not restore calm to the financial markets either.  The best we can hope for out of this bill is that it can help facilitate the revealing of information in the markets sooner than would take place without it.  That might prevent an unnecessarily protracted downturn.

You won't find me celebrating this bill, but I am looking ahead with anticipation to see if it can get counterparties trading with each other again.  If it can do that, it will achieve some measure of success.

It's a familiar phrase to anyone who regularly reads legislation.  Most people would call it "pork."  It's the extra stuff that goes into a bill to make it palatable to legislators who are not totally in favor of the main purpose of the bill.  These items are not necessarily enough to convert a staunch opponent, but enough to get those on the fence to come to your side.  It's a political application of the economist's old friend, "thinking on the margin."

With that as prelude, I offer you this link to the bill passed by the Senate and now before the House.  It is now 442 pages long.  The pork "other purposes," begin on page 110 and continues for the next 330 pages (there are a couple of essentially blank pages at the end).  The math works out nicely to be 75% "other purposes" by volume though not by money.

Ever since this latest and most intense phase of the ongoing crisis began a few weeks ago, I have been convinced of the need for a coordinated approach to unclogging the credit markets.  Efforts to manage the specific incidents (AIG, WaMu, etc.) have been generally pretty good--if pretty good means that there have been no runs on banks and no catastrophic failure of the financial system.  In fact, as I have pointed out in a couple of media interviews lately, the response of the FDIC has been superb.  So far, they have my vote for the "most valuable player" in the handling of the situation.  Because of their experience and efficiency in handling bank failures, I would fully support a measure that would guarantee that FDIC continues to have access to the Treasury to meet its mission.  FDIC was created for just this sort of thing, so let's utilize them.

But there is a limit to what FDIC can do.  The Fed can do a little bit more.  They have the authority to respond to emergencies by lending to entities outside their normal purview.  While there is always a danger that such authority could be used unnecessarily, in my estimation they have acted responsibly thus far.  But even the Fed is limited to the role of responding to emergencies rather than acting entirely proactively.  To act more proactively, that is, to systematically purchase troubled assets in a way that many think needs to be done, requires Congressional authority.  And that's why we're here having this discussion.

There are, however, many reasons to be cautious about granting that authority.  Obviously it requires transparency and oversight.  Provisions that limit golden parachutes and give the taxpayer a chance to share the upside are also unobjectionable to me.  Assessing financial institutions for a portion of the costs is also a good idea.  Handing the Treasury Secretary a blank check would clearly be a very bad idea.

The biggest problem right now is clearly a lack of information (asymmetric information as well, but in some cases it is truly lacking).  It is evident from the TED spread and other data that lending among the major institutions is being constrained by uncertainty over how to assess counterparty risk.  This is not healthy, and it's not going to go away until some more information is revealed.  Any bailout package should be designed with that in mind.  If the Treasury is allowed to take some of the bad assets off of a bank, it may send a signal to counterparties that they are less risky.  This would help to get funds moving again.

And let me just head off anyone who would say that we don't need to "get funds moving again" because that's what got us into that mess.  That's just wrong.  Getting the counterparties creditworthy again will not create an undue amount of moral hazard.  This market has been slammed--big time.  Getting the funds moving in a more normal way will not bring about a return to subprime, interest only, no-doc loans.  At least not for a long time, and in that time we can talk about smart regulation to prevent that from happening again.

In summary, here's what I like about the proposal going through Congress:

• Wall Street shares the cost (see pages 9-12 of the legislation)
• Limits on executive compensation
• Making the $700 billion available in tranches

Things I don't like as much:

• A temporary increase in the $100,000 per account limit on FDIC insurance to $250,000.  Why?  I don't like fiddling with such important institutions on a temporary basis.  That figure is due for an upward adjustment due to inflation (and an increase in the premiums banks pay).  Why not do that and make it permanent?  (UPDATE:  But don't do it during the crisis, see below).
  
• Ability of the Treasury to suspend mark-to-market rules.  Why?  Similar reasoning.  I rarely would favor a temporary change in rules that are meant to foster transparency.  Mark-to-market may be flawed, but I'm afraid that temporarily suspending it right now would only add to the confusion.

Things I just don't like:

• "...and for other purposes"  Why?  You figure it out.  (Look at page 294 for an example.)
  

Is this legislation better than nothing?  All week I've been wanting to be able to say yes, but I am finding it difficult to do so.  There is something to be said for having a plan in place in case we need it in the next three months that Congress is out of session.  And yet, I find myself disappointed in the process and not that crazy about the final product.

There is no doubt in my mind that on balance this legislation is worse than what was voted down on Monday, but this one might actually pass.  That's how Congress works.  This legislation is not something that we urgently need to prevent a depression, and it simply will not prevent whatever recession may be in the works.  If it passes, it might reduce some of the anxiety in the credit market sooner.  If it fails, the Fed will probably be called on to use its emergency lending authority again.  The latter is not optimal, but it is probably workable.

The really sad thing is that the "other purposes" are not really out of the normal realm of business.  While it grates at me, it is part of the legislative game.  But if you think that facilitating price discovery and getting institutions to show their cards well help reduce counterparty risk, then this might be the best plan you'll get.  It's not a solution.  A solution seems very far away at the moment.  But it's probably marginally better than doing nothing and hoping for the best.

And I think I'll just leave it at that.

For today's other commentary, see Arnold Kling (who has had very good material lately) and Tyler Cowen (with whom I am in general agreement).

UPDATE:  King Banaian doesn't like the increase in the FDIC limit either.  He is worried about the moral hazard and that it would lead to banks taking more risks to try to recover their losses (as in what led up to the S&L crisis).  He's right about that.  I still think the temporary aspect of it makes it worse.  Let me be clear.  I think the limit should be increased permanently to adjust for inflation, but it does not need to be done in this bill.  It is not an urgent matter.  And furthermore, if and when the limit is raised, the insurance premiums paid by banks should increase as well.  In the meantime, the present practice of the FDIC in insuring the first $100,000 with certainty and making any decision to insure deposits beyond that on a case-by-case basis is sufficient for now.

...is by David Altig.  (Though some of his commenters have dissenting views.)

Five days ago, I wrote:

So I am fairly confident that a "workable" solution will be reached before the markets open on Monday.  I do not look for an "optimal" solution.  If an optimal solution exists, it is undoubtedly too complicated to be "workable".  But I believe that a number of ideas on the table have the potential to avert a complete meltdown.  I think that when all the parties (including both McCain and Obama) meet behind closed doors and really come to grips with the magnitude of the problem and the fact that a workable solution exists, we'll get one.

I sure hope I'm right.

I was wrong.  At least for now.  There's always the possibility that something will happen later this week.  I don't know what the likelihood is.  Obviously the party whips don't know either--and they're the ones who should. 

At the moment, the way I am organizing my thoughts about the situation is in the form of questions and answers.  So here are the questions I've been asking myself, and my best attempts at some answers.

Q:  Did we need this bill?
A:  I would be careful not to say that we needed this bill.  That is, neither this bill nor any bill was or is a necessary condition for preventing financial Armageddon.  Certainly there were some other options out there other than this bill that I may have preferred.  But after the bill failed, the Federal Reserve announced additional lending measures.  This represents another stop-gap measure that hopefully will help us limp through tomorrow.  The Fed could (with the assistance of special treasury issues) continue to do this for some time.  But of course this is not what we like to see either.  It would be nice to get a legislative solution.  However, if Congress is too dysfunctional to do it, then so be it.  There are other ways.

Q:  What is the biggest mistake that Congress and others are making?
A:  Actually, I see two misconceptions being perpetrated out there.  One is the framing of this issue as Wall Street versus Main Street.  That is, that the government is taking from Joe Six-Pack to give to big bankers.  On the other side of the aisle, there are those who oppose this or any "bailout" out of an unwavering commitment to free market principles.  That is, the bailout is just socialism by another name and should be rejected outright.

Both views have an element of truth, but both views also miss the point.  I think most of my readers understand the connection between Wall Street and Main Street.  However, it is becoming clearer that many people have never made that connection.  And let's be clear, it's not about the stock market!  The fact that the stock market dropped over 700 points is a symptom--not the disease.  The reason to do the deal is not to prop up the stock market--though that certainly gets (and deserves) a lot of attention.  But the drop in the stock market is just an indicator of the drying up of liquidity.  If you doubt this, just read John Jansen's excellent blog (Across the Curve).  If this continues for much longer, it WILL cause firms to have difficulty meeting payroll, paying for inventory, and financing expansion.  At that point, Main Street is affected.  That is what happened in the Great Depression in a very big way.  We may be able to stave off a Great Depression, but there is the potential for a very severe recession.

Those who say the bailout is socialism may say that a severe recession may be the price we have to pay and is not an excuse for such an intervention.  I understand this argument, and it is not entirely without merit.  If the situation, as I understand it to be, was less dire, I might even agree.  But Ben Bernanke is a student of the Great Depression.  If he's worried, then I am too.  My own study of history tells me that this is the closest we have come to such a scenario since the Great Depression.  So I am willing to put aside the "bailout is socialism" argument and argue that a strong government response is warranted.

Let's take a look at some very smart words from Robert Shiller, an economist that I respect a great deal:

So is the government's bailout a major departure? Hardly. Today's federal involvement offers bailouts as a strictly temporary measure to prevent a system-wide financial calamity. This is entirely in keeping with our basic principles -- as long as the bailout promotes, rather than hinders, financial democracy.

Which, so far, it seems to. Congressional critics may be right to demand more help for homeowners and more accountability for Wall Street blunders, but the core idea of the plan is sound: to protect the financial infrastructure. Remember, Fannie Mae used to be a government entity, and by taking it over, the federal government is merely returning to the status quo ante. The measures to take toxic debts off the hands of financial and insurance firms are intended only to deal with a crisis, not to transform our financial system. The proposals do not represent any landmark change in the American way of prosperity. Everyone should take a deep breath. Changing our thinking about finance does not mean abolishing capitalism, but it does raise questions about what the changes mean.

Indeed.  Whatever "bailout" happens, if any, it will not be a permanent intrusion of socialism into the financial markets.  In fact, this represents a tremendous opportunity to modernize the financial system.  By "modernize", I don't mean the kind of derivatives that got us into trouble, but rather a sensible set of regulations that acknowledge the moral hazard problem and prevent institutions from doubling-down on a bad bet.  Read the rest of Shiller's column for more specifics.  I agree with his assessment.

This is a profoundly unique moment in our financial history.  The Fed and the Treasury will do what they can with or without Congress--they have made that clear.  Hopefully that will allow us to limp along.  But I am really starting to worry about the possibility of a stagnant economy for many months if the normal lending channels are not unclogged very soon.

... comes from Menzie Chinn:

So if we end up delaying until households and small firms individually experience the credit crunch directly for the sake of ideology, well, we'll know where to locate the responsibility.

So says a "smart friend" of Greg Mankiw.

For the last few days, I've been listening/reading rather than talking/writing.  Reflecting on what I have read and heard, there is one thing that stands out.

Everybody's got their own idea of how they would fix the financial markets.

Some are actually pretty good and might even work better than what we'll probably get.  Others sound good but probably wouldn't work in practice.  Others are downright nonsense.

But the purpose of this post is not to list and categorize all of the proposals floating through the blogosphere.  Nor will I offer a complete proposal of my own.  Rather, I just want to offer a few general observations.

I'm generally in favor of getting this toxic paper off of the balance sheets of the banks in the interest of unclogging the system and restoring a sense of normalcy in the markets.  I am genuinely concerned about what could happen if the banks continue to hold this paper for a long period of time.  The crisis of confidence and the inability to lend would lead to a stagnation not unlike Japan in the 1990s.

So if we agree to take this paper off the books of the banks, the next step is to agree on a way of valuing that paper.  Given that the market for this paper is not functioning very well, price discovery is a challenge.  The government would be making the market, and being the only buyer of any consequence, you'd think that they would be able to buy the paper at a pretty good discount.

But...

If the government buys the paper at fire sale prices, you still have the solvency problem and many financial firms could go under.  While many folks may not lose a lot of sleep over this, there still is the matter of making sure that the market participants are on sufficient footing to move forward in the aftermath.  With lots of insolvent firms out there, credit will still be constrained.

Since fire sale prices will not cure the insolvency problem and since paying more than market prices means taxpayers are more likely to lose, there is a reason to look for another way.  It would not be out of line to require troubled institutions to give up some equity in return for the above market price on the assets.  That way, the shareholders will bear some of the cost--as they should.

It is also not out of line to demand management changes and a reduction of the "golden parachutes".  I am not against multi-million dollar salaries for CEOs whose leadership is valued by the market.  But I do believe that some of the cases we have seen recently are evidence of a collective action problem in which the shareholders have been unable to exert the optimal level of control over compensation issues.  In the long run, that's a problem that deserves more study.  In the short run, in the case of insolvent firms dumping their toxic paper, a more direct approach may be in order.

I'm not against having the firms being "bailed out" suffer a little pain in the process.  But for the sake of the system, that pain cannot be so severe that it threatens the ability of the firms to function in the future.  If you're looking for my bottom line, there it is.

There will have to be regulatory changes going forward.  However, it is impractical, and I believe folly, to require those changes as a condition to passing this "bailout" package as some in Congress would like.

The world markets are watching.  At the moment, the world markets are extending their forbearance to us as they wait to see how we are going to handle the solvency crisis that now looms large even as the liquidity crisis enters its end game.  They have been very patient with their forbearance.  But if inaction means a significant risk of catastrophic failure of these institutions, then the world's patience will wear thin.  And that's a scary thought.

So I am fairly confident that a "workable" solution will be reached before the markets open on Monday.  I do not look for an "optimal" solution.  If an optimal solution exists, it is undoubtedly too complicated to be "workable".  But I believe that a number of ideas on the table have the potential to avert a complete meltdown.  I think that when all the parties (including both McCain and Obama) meet behind closed doors and really come to grips with the magnitude of the problem and the fact that a workable solution exists, we'll get one.

I sure hope I'm right.

By the way, today's award for the best job of explaining the consequences of inaction and the issues inherent in the different approaches to a solution goes to Peter Orszag of the CBO for his testimony to the House Budget Committee.  His complete statement is on the CBO Director's blog.  Excellent explanation.

From the NY Times:

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.

Worth a look.

Here's the NY Times article explaining it.  Calculated Risk explains why it's not quite like the RTC.  Actually, the buying of distressed mortgages from banks that don't want them sounds more like the original Fannie Mae.  There is an important difference from Fannie Mae in that this does not appear to be permanent.  Its temporary nature is one point of similarity with the RTC.  I think we'll just have to wait and see what it looks like when it's all said and done.

I haven't had time to think about it enough to have an opinion.  I'll probably wait until the details are out.  I do have some questions though.  One thing I don't have a feel for is how much of a discount will be taken when the government purchases these assets and what they'll be worth when the government sells them.  Just how quickly will the plan restore these balance sheets to something approaching normal?  For all the attention the other interventions have received, this one has the potential to really be The Big One.

Doesn't the fact that overseas markets are surging in response to this make you the least bit nervous about how this will be interpreted?

What will become of the $70 billion private liquidity fund?  Will it even be tapped now that The Big One is on the horizon?

My working hypothesis is that the connectedness of the markets made this simply impossible to unravel piece-by-piece.

It's been a while since I've said this, but my sentiment right now is approximated most closely by Paul Krugman's latest column.  Go.  Read.  Understand.

I've been in class all day, so I haven't had a chance to write about the days events.  Actually, there's not that much more to say other than that I really admire the fact that the Fed held the line on interest rates today.  As I said yesterday, the crisis is one of quantity, not of price.  The new lending facilities are much more important and useful than a 25 basis point cut in the funds rate.  So my confidence has been buoyed by this news.

Here's the link to the Fed's press release.

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner.

My quick take is that it is very noncommittal about whether any rate cuts are forthcoming.  The inflation pressure still figures prominently in the press release, though they do expect inflation to ease.  This is an announcement that leaves all avenues open--and that is a very good thing.

In my intermediate macro class today, I lectured against a backdrop of the live (well, actually slightly delayed) tick-by-tick chart of the fed funds futures on the CBOT.  I was teaching macroeconomics as it happened.  You don't get to do that very often.

Seems like the big questions on everyone's mind are whether there will be some kind of development with AIG tomorrow, which firms are most exposed to Lehman, and whether the Fed will cut interest rates.  It goes without saying that everyone is also wondering about whether and how much the Dow may fall.  As I write, the futures market is down, but not drastically, suggesting that the day may start on a down note.

I can't say much about the first two.  But let's think about the Fed for a minute.  When I wrote in the afternoon, it looked like the market was only pricing in a small probability of a rate cut.  Late night coverage on CNBC suggests that the probability has increased substantially now.

The Wall Street Journal acknowledges the uncertainty:

Federal Reserve officials aren't inclined to veer from plans to hold short-term interest rates steady at Tuesday's meeting, even though financial markets are putting strong odds on a quick rate cut.

The Fed's thinking could change, particularly if there is another sharp deterioration in markets and the financial sector Tuesday. And even if officials decide to stay on hold, they could signal in their end-of-meeting statement a greater willingness to consider rate cuts if the economy or markets worsen.

A rate cut would be a confidence booster, to be sure.  Ordinarily, one might expect a rate cut in this case would prevent the financial market problems from spreading to Main Street.  I'm not sure that 25 basis points (or even 50) would really have much of an effect in that regard.  Plus, if the Fed were to cut 50 b.p. tomorrow (as some are expecting), it leave only another 1.50% to go before hitting the zero lower bound.  Given that this could go on for a while, it is imperative that they hold back some ammunition just in case things get much worse.

But most importantly, I don't see how 25 points (or even 50) does anything substantial to ease the credit crisis that the expansion of the quantity of credit through the various lending facilities can't do.

In the end, they may decide that a 25 or 50 point move is necessary to inspire confidence.  I would like to think that in the last year the market has wised up in that regard and can understand that this problem will not be solved by a rate cut any time a financial firm runs into trouble.

These are momentous times, the likes of which we will be talking about for years to come.

I watched the press conference with the John Thain and Kenneth Lewis (CEOs of Merrill Lynch and Bank of America, respectively) as well as the CNBC interview with Lewis.  Mr. Lewis looked like the cat that ate the canary.  He certainly gives the impression that this is the deal of a lifetime.  Who knows?  He may be right.

At this point, I have begun to make a few inferences.  We'll see how accurate they turn out to be.

1. Based on CNBC's reporting, it sounds like Merrill Lynch really cleaned up their act (and their books) in the last few months.  They make it sound like Merrill might have even been able to survive this crisis without being sold.  That's encouraging.  Perhaps some of the other firms that are in less dire condition may be able to heal themselves, even if it takes some time for it to all work out.
2. Either Lehman's position in the market must have been significantly different than that of Bear Stearns a few months ago, or the market is better equipped to deal with a failure of that magnitude.  Both could be true as well.  There was no cataclysmic market meltdown this morning.  Contrast that with the speculation on what might have happened this spring if Bear Stearns had declared bankruptcy.  This is also encouraging.
3. Remember when people criticized the Fed for taking part in the rescue of Bear Stearns?  Remember when people said that it would create moral hazard and make it difficult for the Fed to say no next time?  Well, apparently the Fed is stronger than a lot of people gave them credit for.  While I don't think Mr. Bernanke expected it to play out exactly this way (who would have?), I do applaud him for taking the action with Bear Stearns to prevent the first incident from being such a shock to the system.  A lot of people wanted a sacrificial lamb.  Mr. Bernanke may have been correct in thinking that a better candidate than Bear Stearns would come along.
4. AIG's potential collapse sounds like it would have a greater impact than Lehman's.  I think the Fed is right to hold the line.  The announcement from the governor of New York will help.  The growing pool of private equity might help too.  And of course someone might ride to their rescue as well.
5. Expect another year of write-downs, bankruptcies, and mergers.  But I think that the end game has begun.  By that, I do not mean that the danger is over or that things will get eaiser.  When I say that the end game has begun, I mean that the deals will start happening at a quicker pace in the next 12 months than in the last 12 months and that each one will bring a bit of relief, however slight.  The financial markets will probably not be over this until 2010, and even then they won't be at pre-crisis strength.

So then there is the matter of the FOMC meeting tomorrow.  September futures on the Chicago Board of Trade jumped a little bit this morning on all of the news, but have pulled back a bit.  Traders are pricing in a significant probability of at least a 25 basis point cut.  However, it is far from a sure thing.  I'm hoping they don't.  I don't think they want to.  The expansion of the various lending facilities should do more to ease the strain than a 25 basis point cut anyway.  Plus there is the obvious fact that they would like to save some ammunition in case it is needed later if things don't play out as well as they might.

Let's see how things go tomorrow.

It certainly says something when firms that survived the Great Depression are falling victim to the aftermath of the last decade's credit binge.

And so the venerable Lehman Brothers passes from the scene at the age of 158.  When the sun rises in the morning, we will see how Wall Street deals with this development.  Of course, many people were expecting this, and undoubtedly made contingency plans.  By Friday, it seemed that a Sunday night announcement was almost a sure thing.  After all, we went through this once before with Bear Stearns.  Yet, even though this was possibility for the past few weeks and months, it is now reality.

It is interesting that Bank of America, which as of Friday many people were expecting to buy Lehman, took a pass on that deal and is instead buying the troubled (and storied) Merrill Lynch.  How's that for misdirection? 

But that's not all.  Showing once again that bad things do indeed come in threes, the insurance giant AIG is also in need of assistance.

With these three companies in such dire straits, the Federal Reserve did what it could... quoting in part:

The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities. 

"In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses," said Federal Reserve Board Chairman Ben S. Bernanke. "The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets."

"We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world," Chairman Bernanke said.

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

By expanding the types of collateral accepted, the Fed addressing the need for liquidity by immediately expanding the quantity available.  At this point, that is what is needed (as opposed to any action on interest rates).

Justin Fox has a pretty good summary:

We'll learn much more about the exact chain of events over the coming days and weeks and months, but the basics go something like this: New York Fed boss Tim Geithner (and his pals from Washington) tried to figure out some way to avert the failure of Lehman Brothers without offering any kind of federal guarantee. But nobody wanted to buy Lehman without help from Uncle Sam, so it looks like Lehman will go under. Which meant Merrill Lynch would take over Lehman's spot as Most Obviously Troubled Investment Bank. So Merrill sold out to Bank of America at $29 a share ($44 billion total). Which is an awful lot less than the $97 a share Merrill was selling for a year-and-a-half ago, but also a lot more than nothing.

So on Monday we'll get to see what the failure of an investment bank with $600 billion in assets looks like. And more important, we'll get to see if the obviously deeply flawed American financial system will be able to retain the confidence of the foreign lenders and investors who keep it going.

One crucial thing to remember in all of this is that none of the experts on Wall Street have any real idea of what they're dealing with. What has worked for the past quarter century or so has stopped working. And nobody knows what American financial institutions are going to look like going forward. Probably a lot more like the universal banks of Continental Europe. But anybody who says they know for sure is lying.

Want to read a little history about the last time something like this happened?  Here's what the NY Times had to say about Drexel Burnham Lambert in 1990.  It reads a lot like today's news, right down to the weekend meetings.  Just replace "junk bonds" with "subprime mortgages".

There are some differences, of course.  The biggest difference is that there are still so many firms in similar condition that there is no guarantee that this crisis is over.  I think that Fox is right in saying that "anyone who says they know [what American financial institutions will look like after this] for sure is lying."  But I am confident that the system will get through this very troubling time.

As this Wall Street Journal piece by Justin Lahart points out, there needs to be quick and decisive action to prevent something like what happened in Japan during the 1990s.  The sooner everybody confronts that reality, the quicker we can get back to business.  It is good to get the "unwinding" process started as soon as possible.  Make sure that the smaller firms don't become collateral damage from counterparty risk, and let the consolidation result in the inevitable (but probably only short-to-medium run) shrinkage of the sector.

Every time one of these trouble firms is finally taken aside and shown the handwriting on the wall, we take one more step toward the day when someone gets to write one pretty massive after-action report.  And of course, now that the extent of the damage to these three firms has been revealed, the rush is on to find who is next.  Until the answer to that question is "no one", there will be more rough days ahead.  I don't think we're there yet.

John Jansen has some excellent commentary and I'm sure will be adding more in the morning.  He is quite worried about how all of this will end.

Government has not been able to hold bank the forces which have taken down financial giant after financial giant. Capitalism demands pain. Good risk is rewarded and imprudent risk is punished. We were engaged in an orgy of imprudent risk taking for nearly a decade and now a heavy price will be paid for the violation of so many simple and common sense precepts of trading.

Very true.  On a related topic, Tyler Cowen opines in the NY Times:

There is a misconception that President Bush's years in office have been characterized by a hands-off approach to regulation. In large part, this myth stems from the rhetoric of the president and his appointees, who have emphasized the costly burdens that regulation places on business.

But the reality has been very different: continuing heavy regulation, with a growing loss of accountability and effectiveness. That's dysfunctional governance, not laissez-faire.

Blame enough to go around, to be sure.  Like I said, it's going to be some after-action report.

Mark Thoma has a good collection of links for your morning reading as well.

Buckle up.  It could be an interesting day.

UPDATE:  Here's one more comment on the AIG situation.  First the Wall Street Journal:

During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

Which prompted Yves Smith of Naked Capitalism to say:

That is not going to endear them to the Fed, turning down a deal, particularly when Merrill did the right thing and sold itself to avert a possible systemic event. This is brassy and risks overplaying their hand. If I were the powers that be, I'd tell them to stuff it and take the deal.

Indeed.  I think the Fed is really trying to limit the taxpayers' exposure on this one.  If AIG turns down a deal, it gives others license to do so.  I don't like where that leads.

From the BLS,

The unemployment rate rose from 5.7 to 6.1 percent in August, and non-farm payroll employment continued to trend down (-84,000), the Bureau of Labor Statistics of the U.S. Department of Labor reported today. In August, employment fell in manufacturing and employment services, while mining and health care continued to add jobs. Average hourly earnings rose by 7 cents, or 0.4 percent, over the month.

Series Id:           LNS14000000
Seasonal Adjusted
Series title:        (Seas) Unemployment Rate
Labor force status:  Unemployment rate
Type of data:        Percent
Age:                 16 years and over

One of the burning questions in my mind right now is when the NBER Business Cycle Dating Committee will declare that the recession began (and when they will make the announcement (see Brad DeLong's comment).

But this is an odd one, in part for the reasons stated by David Altig.  Altig stops short of calling this a recession, but contrasts the strong GDP data and the weak employment data as he pities the Business Cycle Dating Committee for the tough job they have ahead.

How do you square 3.3% GDP growth with a 0.4% increase in the unemployment rate?

As I pointed out earlier, the GDP growth is largely due to the falling dollar.  It's great if you're an exporter, but it does nothing to ease the pain in the housing sector.    And as the WSJ Real Time Economics blog pointed out, Gross Domestic Income paints a somewhat less rosy picture.  The unemployment rate, usually a lagging indicator, is looking more coincident, but that may be because the weakness in the economy is being masked somewhat.

There is little doubt in my mind that we are in a period that should be called a recession.  I could guess at when the starting date would be, but it would be just that--a guess.  I could make a case for sometime in the spring or summer.  And while I admit to being troubled by thinking of a recession in the shadow of 3.3% GDP growth, I am struck by some very strong differences between this recession (if it is one) and the last two.  The usual definitions aren't fitting well.

There's going to be a lot to talk about this fall.  I'm working on the local economic outlook and giving a presentation on it a week from tomorrow.  Lucky me.

The Fed posted their minutes from the last FOMC meeting today. Check out the charts at the back that show the shift in the forecasts of the participants on variables such as GDP and inflation going out to 2010. There has been a noticeable shift since January. However, it does appear that the last meeting will be the last rate cut for a while. The Wall Street Journal's Brian Blackstone has a good summary of the minutes.

See also Donald Kohn's speech from yesterday.

Janet Yellen is on the lecture circuit. (Reuters)

"The 1970s were a horrible period. If there's one thing that has to be very high priority, we don't want to go back to a period that is anything like that," she said, critiquing presentations on the economy at a symposium for college students in Tacoma, Washington.

She is, of course, talking about inflation (not bell-bottoms or disco).

"During the 1970s the Fed failed to keep inflation low in the face of supply shocks (which) became incorporated into inflation expectations," Yellen said.

She acknowledges, as I think most of us do, that this is not a simple problem with a simple answer. She's worried about the prospects of lower growth as well. But the fact that she, as one of the more dove-ish members of the committee, is talking about inflation risks is a sign that the tide may have turned.

My class was right... including about who the dissenters would be. (Though they actually predicted more dissent, I cautioned them that two was probably the most you'd see in the vote.) Not that this was a particularly hard call. On the surprise meter, today's move by the Fed--from the amount and direction of the change to the dissenters to the apparent shift in stance going forward--barely registers. Indeed, what is there to say that hasn't been said already?

For the record, here is the statement from the Fed:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.

There are two very obvious differences between this statement and the last (in addition to a few more subtle variations of the wording that are also consistent with the overall shift but probably not worth obsessing over). Those two obvious differences are that what was

Recent information indicates that the outlook for economic activity has weakened further.

is now...

Recent information indicates that economic activity remains weak.

The interpretation being that we may have "hit bottom," to put it rather bluntly. The other is that the sentence in the last statement...

However, downside risks to growth remain.

... is simply gone. Hard to be more obvious than that.

The inflation paragraph is interesting. There is some acknowledgment of the improvement in the core numbers. Also, the sentence in the last statement,

Still, uncertainty about the inflation outlook has increased.

Is now...

Still, uncertainty about the inflation outlook remains high.

As with the statement about economic activity, the implication is that while there hasn't been much improvement in the level, the first derivative looks better. It's almost as if an academic economist had a hand in crafting it.

Barring any new developments, expect no change in June.

Now, over to the GDP report. James Hamilton's post on the subject is my pick of the day for excellent analysis of the report. To tell you the truth, the GDP figure was pretty close to what most of us were expecting. Most expectations that I saw were in the positive-but-under-1-percent range. Also, it is important to remember that it is subject to revision, so I wouldn't make any big deal out of it beating expectations by a small fraction of a percent. It's what we expected, and it is not particularly good. The difference in economic activity over a 6 month period between growth of 3.5% and growth of 0.6% is a couple hundred billion dollars. Far from pocket change, that amount of lost economic activity in 6 months is roughly comparable to the current annual federal budget deficit.

But is it a recession? No. Not yet, anyway. And though some forecasts show an improvement in the 2nd half of 2008, we're not out of the woods yet. The increase in inventories and the accompanying decline in real final sales is particularly worrisome going into the 2nd quarter. The recovery from this slowdown (if not recession) will take some time.

In my intermediate macroeconomics course, the final project is a simulation of an FOMC meeting where members of the class play the roles of Fed officials. They did exceptionally well. The presentations and discussion were excellent.

My class voted 9 to 7 to cut by another quarter point. (The 7 wanting to hold rates steady)

As far as I can remember, my class has never been wrong, and also as far as I can remember, when the class predicts dissent, there usually, if not always, is (though never as much in the real vote).

It's an unscientific indicator, to be sure. But it is very rewarding to see the students take it so seriously and really learn about how the Fed works.

The real meeting, of course, is tomorrow. More on that later.

I'm in the middle of a few things that are keeping me from blogging an extended analysis of the Fed's recent actions. But I did come across something today that will interest my readers. The WSJ Real Time Economics Blog opens a post with this:

Back in 2003, when the Federal Reserve cut interest rates to 1%, the world worried that the Fed was running out of ammunition and would soon have to turn to unconventional tools.

Now, in 2008, it’s worth asking if the Fed could run out of unconventional ammunition. Tuesday’s offer to lend $200 billion of its Treasury holdings to primary dealers in return for mortgage-backed securities both guaranteed by the government-sponsored enterprises (Fannie Mae and Freddie Mac) and not (private-label MBS) means it will have eventually sold or pledged half of its Treasurys, limiting how many more of these tricks it can pull off.

My first thought when I heard about this innovative move the Fed was that it would take the pressure off for a few days--maybe a week or two. And what then?

Here's a link to the new PDF version of the Beige Book. Here's the old html version.

The Wall Street Journal headline is "Beige Book Hints at Stagflation Amid Slow Growth, Prices Pressures"

I'm heading out the door, but I know what I'll be reading tonight.

But Martin Feldstein does say this in Wednesday's Wall St. Journal:

The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy as it has been in the past. Monetary policy may simply lack traction in the current credit environment.

As they say, read the whole thing.

Ouch.

Feb. 15 (Bloomberg) -- Confidence among U.S. consumers fell more than expected this month, reaching a 16-year low, as the labor market cooled and expectations about inflation rose.

The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 69.6, the lowest since February 1992, from 78.4 in January.

UPDATE: FRED has not updated their series to reflect today's data, so I have drawn in where the new data point will be. The series has been noisy in the current (I'm still using present tense) expansion. The reader is left to draw his or her own conclusions.

Believe it or not, this sort of dovetails with my previous post. Here's Robert Reich in the NY Times:

We're sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn.

...

The only lasting remedy, other than for Americans to accept a lower standard of living and for businesses to adjust to a smaller economy, is to give middle- and lower-income Americans more buying power — and not just temporarily.

...

The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. That would only drive up the prices of everything purchased from abroad. Most routine jobs are being automated anyway.

A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. The current supplement for a worker with two children who earns up to $16,000 a year is about $5,000. That amount declines as earnings increase and is eliminated at about $38,000. It should be increased to, say, $8,000 at the low end and phased out at an income of $46,000.

Median household income is about $48,000. What would be the ramifications of making almost half of all households receive the earned income tax credit? The EITC is a great program, and probably could be expanded in the sense of giving a larger amount to the lower income earners. It's the closest thing we have to Milton Friedman's negative income tax. It is a potentially powerful anti-poverty program.

But I'm less sanguine about making the EITC a middle class entitlement, which is exactly what would happen if we were to follow Reich's advice. I'm not sure a middle class entitlement is what Friedman had in mind.

Reich is right about one thing though.

Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.

Except that he forgets to mention that it also requires a change in the way we fund schools at the state and local level. The federal government is impotent to do anything about that, and that's probably a good thing. Though it is tempting to think that the federal government could swoop in with a grand fix, I fear that they would make things worse. Our recent record on federal government intervention in K-12 education is not exactly stellar.

Yesterday, I pointed to comments by William Poole. There were also similar remarks from Janet Yellen and Charles Plosser. Both remain concerned about inflation, with Plosser appearing to be more skeptical of the anticipated moderation of inflation coming this year. (Hat tip to Greg Mankiw for the links.)

In contrast, the Philly Fed is concerned. So are many economists on Wall St.

But then we have this interesting piece from King Banaian (SCSU Scholars). He quotes from this article in his local paper. The article raises the following question in my mind: Are American households really worried about a traditional recession or are they concerned about changing relative prices causing them to adjust their expenditures? Before you dismiss the question, take a look... this could be any newspaper in any city.

Cindy Haupert's life has changed since the economy took a dive.

Haupert, 36, once lived comfortably with her husband and two children in St. Cloud. She was a stay-at-home mom, working every other weekend. Her husband is an attorney. They made ends meet.

But gas prices would rise. Costs for homemade dinners and lunches would increase. And in September, when it was time for her son to go to kindergarten, she wanted him to go all-day, every day, so he could be ready for first grade. But that meant a $184 hit to the family checkbook each month. That doesn't even count lunch money.

"Now it's like we're living paycheck to paycheck. I can definitely see a change," she said.

Prices rising faster than wages Lifestyle changes. There's nothing so far about a real recession in the classical sense. As King points out, she didn't have to pay for all-day kindergarten. The writers says this all happened since the economy "took a dive"? Did their income fall? That question is not addressed.

But the writer understands that cost of living increases is just inflation by another name...

The consumer price index for Midwestern states, including Minnesota, increased 3.8 percent from December 2006 to December 2007. That reflects the increased cost of living.

So what's a person to do?

Haupert feels it. She now works an additional four days a week at Office Depot as a cashier while her fifth-grader and kindergartner are in school.

Wait... what? She's increasing her hours worked? Isn't that contrary to what happens in a traditional recession? Sure, we shouldn't generalize from one person's experience. But this is what the newspaper is giving us, and I don't think this is the only story of its kind in the media. Is the new face of "recession" someone who has to work harder to maintain their standard of living with higher gas prices, etc.?

She tries to make up for extra costs. She clips coupons and budgets meticulously. She's allowed herself and her husband $90 per week for gas and $125 per week for groceries.

She takes advantage of mail-in rebates and uses gas coupons. She rides the bus when she can and doesn't take frivolous drives.

When she and her husband bought a new TV to accommodate the high-definition requirement for 2009, they shopped around. They checked prices to see where they could get the best deal.

When they settled on one with a better warranty, they got an extra 10 percent off for comparing prices.

Again I ask, is shopping around to get an extra 10% off an HDTV a sign of a weak economy or a smart consumer facing different relative prices?

(By the way, if they have cable or satellite, they don't need a new TV in 2009, at least not right away.)

I don't mean to diminish the cases where people have lost their jobs due to slack demand in construction or manufacturing, etc. There are certainly people who are feeling the effects of the slowing economy. And while those people may be larger in number today than, say, a year ago, they still represent a fairly small slice of the population.

Yet, so many people surveyed by the major media have a profoundly dismal view of the economy--even if they are not unemployed or particularly at great risk of becoming unemployed. And I am seeing more and more anecdotal stories like this one where what people are really concerned about boils down to the increasing cost of living (inflation) and the choices that one has to make to cope with the increased cost. Gas prices are higher. Real incomes have not increased as rapidly. Thus, one will need to cut back on gas or cut back on something else. If that means shopping around for the best deal on an HDTV or getting one that is a couple inches smaller, then that's just the way it is.

We are now experiencing somewhat slower and more uneven growth of real income than at other times in our history. The current inflation we are experiencing is also uneven in the sense that some prices are rising faster than others. Some prices (like HDTVs) are even falling. And that does create some distortions. But there's little that the Fed can do to reverse the long trend of slower wage growth. That is largely a structural problem that transcends the current recession or non-recession. There's little that the Fed or congress can do to address changes in relative prices which are the real source of dissatisfaction with the economy for so many people.

So at the end of the day, I'm not sure what to make of this. Is this just a bad article and a bad interview subject for the point the writer was trying to make? Or is this indicative of the reasons behind the dissatisfaction with the economy for a significant number of people? If the former, then this post is a cautionary tale for journalists and we can perhaps leave it at that. But if the latter, then we really need to have a talk about the difference between a real recession and other economic events that can also cause households some distress such as changing relative prices that are not necessarily recessionary.