August 05, 2008
FOMC Statement
This was expected. Here's the statement.
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.
Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices 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, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.
Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. 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; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.
A few changes since the last statement. The part about the "substantial easing of monetary policy, ... should help to promote moderate economic growth" was moved from toward the end of the statement to near the beginning. The paragraph on inflation has been rewritten with more of a direct acknowledgment of inflation being high and the outlook uncertain.
But pay attention to the last paragraph.
August 5:
Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
... Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
The phrase about downside risks to growth having diminished has been taken out, as has the phrase about inflation expectations increasing (today they are, rather, a "significant concern").
So what does it mean to be a significant concern? Ask the stock market. As I write, the Dow Jones is up over 300 points.
The stock market doesn't seem to buy their concern. It looks like no change in rates for the foreseeable future.
Posted by William Polley at 03:40 PM | Comments (0) | TrackBack
June 25, 2008
FOMC holds steady as expected
You didn't really think they'd raise rates at this meeting, did you? Here's the full statement:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.
Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.
The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. 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; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.
Michael Mandel thinks that the Fed should have cut. I haven't seen too many others jump on that bandwagon. Barry Ritholtz thinks that statement is "too cheery on growth, not concerned enough about inflation -- and is totally irrelevant". Mark Thoma does the side-by-side with the last statement and writes that "There aren't many clues about the future in the statement..."
I don't know about that. I happen to think that this statement paves the way for standing pat for the rest of 2008. They seem to be extending the time horizon for when to expect inflation pressures to moderate ("later this year and next year") and they took out the part about it being necessary to "monitor inflation developments carefully".
So Mandel thinks a cut is in order. One can speculate about what a Greenspan Fed might have done in this situation. I certainly know what Wall Street would like. In the face of that, it seems that Mr. Bernanke might be following the right course. He's waiting for real rates to come up on their own as the economy recovers. I think that's the way to interpret it, and I think this course is less bad than some of the other options.
From the dissenters at the last couple of meetings, it looks like Fisher is trying to stay one step more hawkish than the chairman--now dissenting by voting for a rate hike in the face of the majority holding steady (previously he voted to hold steady when the majority wanted a cut). Plosser's votes (dissenting by voting to hold steady rather than cut in April but voting with the majority to hold steady now) are probably more fundamentally in line with Bernanke's thinking about where they want to be down the road (assuming the inflation forecasts are right), but he looks to have wanted a little bit more of a start at getting the real rate up where it should be.
If inflation shows any progress downward, I think they'll stay here as long as they can. If not, then rates probably go up in 2009. But this statement gives me the impression that they are prepared to give inflation some more time before they pull the trigger.
Posted by William Polley at 11:39 PM | Comments (0) | TrackBack
May 21, 2008
FOMC Minutes
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.
Posted by William Polley at 04:59 PM | Comments (0) | TrackBack
May 14, 2008
No more rate cuts for a while?
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.
Posted by William Polley at 09:02 PM | Comments (1) | TrackBack
May 07, 2008
Fed wants authorization to pay interest on reserves
Reuters carried the story a few days ago and somehow I missed it.
WASHINGTON (Reuters) - The Federal Reserve's Board of Governors will hold a closed meeting on Wednesday [Apr. 30] to discuss paying interest on bank reserves, one of a number of options officials have been mulling to address liquidity problems in financial markets in case measures taken to date fail to gain traction.
This is not a sudden development, as the article goes on to point out...
Congress in 2006 granted the Fed authority beginning in 2011 to pay interest on bank reserves. At the time, the central bank assigned staff to study the implications such a move could have on its operations.
The staff report is now ready and will be presented to the Fed during the regularly scheduled meeting of its interest-rate setting panel, a Fed official added, declining to comment further on whether the presentation is pegged to any imminent steps to boost liquidity.
This was scheduled to go into effect in 2011, but they are looking for approval to start doing it now. I think that's a good idea. It is certainly not without precedent. Other central banks do it, including our neighbor to the north.
Now, the fact that this was passed back in 2006 went largely unnoticed, but not here. In fact, I even gave you a scholarly reference...
The October minutes are on the Fed's web site. Here's the first thing that caught my eye.
The Chairman noted that the President had recently signed the Financial Services Regulatory Relief Act of 2006, which among its provisions gave the Federal Reserve discretion, beginning October 2011, both to pay interest on reserve balances and to reduce further or eliminate reserve requirements. The Act potentially has important implications for many aspects of the Federal Reserve's operations and the Chairman asked Vincent Reinhart, Director of the Division of Monetary Affairs, to form a committee of Federal Reserve System staff to consider these issues.
They could learn from Canada, the UK, and New Zealand, as this publication by Sellon and Weiner from the Kansas City Fed explains.
And here's a technical paper on how the Bank of Canada does it.
I'll go on the record that this is a good idea. It will help to smooth out the recent fluctuations in the funds rate that garnered so much consternation at this blog among other places. It would prevent interest rate policy from getting in the way of policies for directly injecting liquidity into the financial markets by effectively keeping a floor on the funds rate even during a big injection of liquidity.
Fed Governor Donald Kohn spoke about it back in 2004 as well.
Hat tip to Barry Ritholtz and the WSJ.
UPDATE: Mark Thoma thought of it too.
Posted by William Polley at 12:25 AM | Comments (2) | TrackBack
April 30, 2008
GDP and the Fed
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.
Posted by William Polley at 02:13 PM | Comments (1) | TrackBack
April 29, 2008
Federal Reserve Simulation
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.
Posted by William Polley at 06:09 PM | Comments (0) | TrackBack
April 03, 2008
Profile of John Taylor in F&D
The IMF publication Finance & Development profiles John Taylor.
Hat tip: Greg Mankiw
Posted by William Polley at 10:17 PM | Comments (0) | TrackBack
March 19, 2008
Belly up to the bar: Investment banks are using the new facility
From Reuters:
Goldman Sachs plans to test the program sometime this week, a spokesman said. Morgan Stanley Chief Financial Officer Colm Kelleher said his bank has already tested the program, and a spokeswoman for Lehman said the investment bank has also done so.
The Wall Street Journal reports that there still might be some stigma attached to borrowing from the Fed, but that the banks "viewed the new funding source positively".
Posted by William Polley at 01:26 PM | Comments (0) | TrackBack
Funny they didn't mention anything about tightening credit markets
The Real Time Economics Blog collected some reactions from Wall Street concerning the rate cut. One firm chose to emphasize their concerns about inflation.
These actions were taken despite rising inflation pressures. The Fed expects these pressures will subside as energy and other commodity prices flatten out, and as unused resources rise. Our take, however, is that commodity price strength is in part a function of the easy stance of monetary policy and that inflation is headed higher. –Bear Stearns
Contrast this with what they said in December, also from the pages of the Real Time Economics Blog:
The Fed continues to couch its policy actions in terms of their impact on economic growth rather than admit that the primary motivation for Fed action is the turmoil in the financing market — turmoil which may become worse as a result of the miserly action on the discount rate. –Bear Stearns
I guess it's all a matter of your perspective at the time.
Posted by William Polley at 03:08 AM | Comments (0) | TrackBack
March 18, 2008
Quote of the day
From Felix Salmon:
I'm similarly skeptical about the idea that the Fed is "propping up" Bear Stearns. For a couple of months until it can be deleveraged and subsumed into JP Morgan, perhaps. But that's a world away from allowing banks to operate for years while marking distressed assets on their balance sheets at par, which is what happened in Japan. The Fed was happy leaving the carcass of Bear Stearns to the wolves at 270 Park: this was anything but a "propping up" operation.
Posted by William Polley at 05:23 PM | Comments (0) | TrackBack
FOMC cuts by 75 basis points
Here's the statement.
The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.
Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.
Inflation has been elevated, and some indicators of inflation expectations have risen. 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 has increased. It will be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner 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 less aggressive action at this meeting.
In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 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, and San Francisco.
I wonder what Fisher and Plosser would have preferred. 50? 25? 0? Maybe the minutes will tell us in a few weeks.
Parse it word by word if you want. Given the way that the last few days have gone, I'm not sure how much good it will do.
Judging by the way that Wall Street jumped in the first few minutes after, I would say that it was a little more than necessary. They could have gotten by with 50.
Anyway... got to run to class.
Posted by William Polley at 01:27 PM | Comments (0) | TrackBack
March 17, 2008
FOMC meeting tomorrow
Anyone care to hazard a guess as to what they will do tomorrow?
The Cleveland Fed shows the above graph with the probabilities based on the fed funds futures. 75 basis points is the leader right now with 50, 100, and 125 (!) basis points all getting votes. The futures market is predicting a 50% probability of 1.5% by the next meeting. Clearly there are two likely ways that could happen--either 75 bp twice or 100 tomorrow and 50 next month. I'm not saying it can't happen.
But let's look at this coldly and rationally as we always do. What in the world would a 100 bp cut do to help the liquidity crisis (and the solvency crisis) that was at the root of this weekend's troubles? Nada. The announcement of the new lending facility did much more to steady everyone's nerves than a full percentage point cut ever will. Let's see if that works before spending more interest rate ammunition. How about 75 bp? Again, I'm hard pressed to say it will help the ways that are necessary. The market expects it, and as much as I'd like to say that the Fed should have the guts to disappoint the market, I'm sensitive to the counterargument. This is a likely outcome.
How about 50? It's less likely, but more desirable in my view. It wouldn't drastically undercut the market. This was the expected outcome for all but the last couple days. It would probably contain the fall of the dollar (somewhat) and signal that the Fed expects a more stable environment going forward. I would applaud this choice.
How about 25? A bit risky from the Fed's point of view, I think. It would undercut the market more than is necessary on this given day. I'm sympathetic to the hawks, but given the totality of the situation, 50 is probably the better choice.
Going to be a fun day of class tomorrow! Until then...
Posted by William Polley at 08:45 PM | Comments (0) | TrackBack
Some thoughts on the day after: Bring back Glass-Stegall?
I couldn't resist watching a little CNBC tonight. Kudlow was talking about how the Fed should have opened the discount window up to investment banks sooner. After all, Glass-Stegall was repealed in 1999. Since then, the role of investment banks in the financial system has expanded, and they have become intertwined with commercial banks (i.e. depository institutions). But all this time, houses like Bear Stearns have been working without a net. They've been unable to tap the discount window.
So the Kudlows of the world would like to have seen the Fed open the discount window to investment banks sooner. That way, maybe they could have survived this crisis. Hmm... maybe... maybe not. It might have prolonged the agony and the result would have looked more like Continental Illinois which although it came to a head in a day, took weeks for the FDIC to finally take the assets. All the while, they had access to the window and to a number of other banks (who were presumably willing to lend to CI because it had access to the window) to help them liquidate. In terms of restoring confidence to the system, it was probably better this way. Here's the deal. Take it or leave it. They had no choice but to take it.
If it turns out that there is another Bear Stearns out there waiting to happen, you can bet that it will unfold differently now that investment banks have access to the discount window. Should this change be made permanent? Should investment banks have access to the discount window at all times?
That's a tougher question. First, look at the way the Fed's announcement actually reads. They aren't lending directly to the investment banks... they are going through the primary dealers. (It happens that Bear Stearns was a primary dealer so in that case it would have been direct, but it would not necessarily be so in every case.)
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets.... Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities.
The fact of the matter is that now that this is out there it will be tough to put the genie back in the bottle. It's definitely a good idea in times of crisis. It is probably also a good thing to have on the books so that you don't get caught off-guard in the future. I would only amend it so that the credit is available at a penalty rate. Read Bagehot for the reason why.
Is it necessary to open the window directly to investment banks who are not primary dealers? No, and probably not a good idea either--except as already provided under statute in exigent circumstances. Let's see how this works, and if it works, just keep it on the books as it was announced yesterday.
Now let's look at the other end of the spectrum. For each person like Kudlow who would want to open the discount window to investment banks directly, there is probably a person who would want to reinstate Glass-Stegall and put the wall of separation between investment banks and commercial banks back up again.
But I don't see that as being the problem.
Glass-Stegall was meant to keep the commercial banks from engaging in speculative investment activities that would put customer deposits at risk. That's not what happened here, nor is it likely to be a big issue. The problem is that investment banks dependent on short term repos for daily financing are now as critical (if not more critical) for the stability of the system than the commercial banks of old. They also seem to be as prone (if not more prone) to the kinds of lapses in judgment that led to what we saw this weekend. But walling them off, even if it were realistic to do so now, would not make them go away, get smaller, or suddenly get better judgment.
So how do you get them to behave? Act as their lender of last resort? Lots of moral hazard, not enough moral authority. But perhaps by allowing their peers (here I am referring to the primary dealers) to be their lender (or buyer) of last resort you enforce a kind of market discipline that the Fed alone would have trouble enforcing. Was Bear Stearns a sacrificial lamb on this altar, as many are suggesting? Perhaps. And although I cannot do anything other than speculate as to whether that was the intent, it certainly was the way it worked out. It's too late to do anything about that now, and perhaps it was too late even last week. We'll never know.
But now that a mechanism is in place, I would simply prefer that next time it be done by lending to them at a penalty rate instead of buying at a discount.
Posted by William Polley at 07:29 PM | Comments (0) | TrackBack
Welcome new readers
Welcome to listeners of Ed Morrissey's show on BlogTalkRadio. I had the honor of visiting with Ed on the air today about the Fed and Bear Stearns. Thanks for dropping by.
Posted by William Polley at 03:20 PM | Comments (0) | TrackBack
If you read one article today...
...about the Fed's role in the buyout of Bear Stearns by JPMorgan, let it be this article by Greg Ip in the Wall Street Journal. An excerpt:
In some ways, the initiatives better equip the Fed to help a financial system that has changed drastically from one based on banks for most of its 95-year existence. It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.
Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.
Also check out the Real Time Economics Blog.
Posted by William Polley at 12:12 PM | Comments (0) | TrackBack
Link roundup
Some assorted links that didn't make their way into my previous three posts on tonight's events.
Felix Salmon is optimistic about the effect of the sale of Bear Stearns on the financial markets.
John Jansen has some comments and links on the overnight happenings.
The WSJ Real Time Economics Blog has an absolutely excellent post. Choice quotes:
Fed officials went out of their way to say Bear Stearns was unique in the problems it faced. No other major securities firms are in a similar situation, an official said.
and...
So how much has the financial system changed? Consider securities repo, an essential grease that enables dealers to make markets in a wide variety of credit instruments. In 1990, securities repo credit, at $372 billion was about 13% the size of federally insured bank deposits, at $2.8 trillion.
By last year, securities repo credit had ballooned to $2.6 trillion, 60% of the value of federally insured deposits at $4.3 trillion.
Gross repo among the primary dealers alone (that is, excluding banks but including loans among dealers) was $4.5 trillion on March 5, according to the New York Fed.
How secure is that funding base? Well, consider that two-thirds of repo loans mature or must be rolled over each day. And there is no government guarantee behind them (although Treasurys often collateralize them.) No wonder the Fed worried about a run on the repo market if Bear failed.
They also link to this article from 1992 by Anna Schwartz on "The Misuse of the Fed's Discount Window." That brought back memories for me. The article was required reading in my Money and Banking class back in college.
Calculated Risk links to CBOT Dow Futures. Look out below.
I could paraphrase Paul Krugman thusly: You ain't seen nothin' yet.
Reuters reports that Bear Stearns executives won't be getting any golden parachutes. Good.
Tim Duy expects a big fed funds move (75 or 100 basis points) on Tuesday and worries about a destabilizing fall of the dollar. He uses the word "monetization." Let's hope it doesn't come to that. Check back with me on Tuesday.
Posted by William Polley at 02:59 AM | Comments (0) | TrackBack
March 16, 2008
Whatever happens in the morning, we'll still be writing about this twenty years from now
This is part three in a series of posts relating to this weekend's sale of Bear Stearns to JPMorgan and the Fed's role in the matter. (First post, second post)
The previous post highlighted a few of the reasons that some will be cynical about what happened tonight. The cynics make some relevant points. Moral hazard is a concern. Some will say that the Fed's role in backing JPMorgan is troubling. Similar points were made during the LTCM debacle. And yes, there might be other episodes like this. All true, and yet....
When I take my students up to Chicago to tour places like the Chicago Fed and the Board of Trade, I make sure to give them a little history lesson. At the corner of Jackson and LaSalle stands a reminder of another financial crisis with particular relevance to today--the old Continental Illinois building. Bank of America now occupies the space, but the name remains carved in stone as a mute testimony to what once was. The name faces out over LaSalle St. directly across from the main entrance to the Chicago Fed building. I have often thought, as I enter the Fed building, that having that name as a constant presence across the street must give anyone who works at the bank a sense of purpose. The Fed's very existence (and that of other regulators) is meant to prevent such bank failures and when prevention fails, to cushion the greater economy from the effects.
To be sure, there are some similarities as well as many striking differences between the Bear Stearns situation and that of Continental Illinois over twenty years ago. Continental Illinois was a commercial bank. Deposits were at risk. In that way, it was quite different from the situation we see today.
Despite these differences, one similarity between Continental Illinois and Bear Stearns is that they will both go down in the history books as a milestone in the Fed's evolution as a lender of last resort. For a great recounting of the Continental Illinois collapse, check out this document on the FDIC website: "History of the Eighties--Lessons for the Future." In particular, look at chapter 7, which details how the events unfolded and what was learned. This passage from page 249 is the appropriate text for today.
As has been noted, however, [Too Big To Fail] was an inaccurate term: too big to liquidate would have been more appropriate. Large banks did fail during the period, with shareholders losing their investments and managements being removed. In significant ways, Continental failed. But as one regulator observed, the banking agencies were reluctant to tolerate the sudden and uncontrolled failure of large institutions and therefore generally opt[ed] for managed shrinkage, merger, or recapitalization. There were several reasons for adopting such an attitude, the most important of which was systemic risk. This rubric covered potential spillover effects leading to widespread depositor runs, impairment of public confidence in the broader financial system, or serious disruptions in domestic and international payment and settlement systems. In addition to systemic risk, the logistical difficulties and potential expense of liquidating a large bank also contributed to regulatory reluctance to close such a bank and pay off insured depositors. Moreover, liquidation would mean tying up uninsured depositors funds during the lengthy proceedings, a situation that could have a very disruptive effect on a banks community. For all these reasons combined, the larger the bank, the more likely it was that bank regulators would look for alternatives to closing the bank and paying off the insured depositors.
Except for the part about depositors, it could have been written about this weekend. Indeed, Bear Stearns failed. But it proved too big to liquidate without assistance. Continental Illinois essentially did go into receivership. The FDIC guaranteed everything, even beyond the $100,000/deposit limit. The Fed provided the backstop liquidity. It was not without controversy. And it took months to come to a head, and months to finally work out.
How things have changed. When this story first broke, the NY Times reported:
The developments may only postpone the eventual sale of all or part of Bear Stearns, which has had crippling losses on mortgage-linked investments. To keep the 85-year-old firm solvent, JPMorgan, backed by the New York Fed, extended a secured line of credit that gives Bear Stearns at least 28 days to shore up its finances or, more likely, to find a buyer.
One day, folks. One day and the deal was done. Would the markets have gone into a tailspin if it didn't get done that fast? Hard to say. What is not hard to say is that no one wanted to take that chance. You know that everyone involved at the Fed knows that they are doing something that will be scrutinized and criticized. They know about the moral hazard problem. They know that this could have negative consequences. They know that there is only one reason to do it--and that is that the consequences of not doing it are potentially much worse. Mr. Bernanke, scholar of the Great Depression, knows that better than most.
By pulling out all the stops the way that he has, Mr. Bernanke is probably already the most innovative Fed chair in history. I'm sure he would rather not have that distinction, but there are worse ways to distinguish oneself. And so in the final analysis (at least for tonight) I have to applaud Mr. Bernanke and the Fed for taking the steps to allow for an orderly liquidation of a failed institution--a very different thing from a bailout (Ritholtz agrees). JPMorgan can probably liquidate the assets more efficiently than the government could in a short amount of time. With the way that financial markets are connected and positions are so heavily leveraged they could not afford to shop Bear Stearns around the way that they did Continental Illinois. If we are to believe what we're hearing, the wheels were about to come off. The "repo" market moves too quickly and is less forgiving than a depositor in a commercial bank. Undoubtedly banks and other institutions had loaned Bear Stearns large amounts in the repo market and if they didn't get paid, well, that would indeed be the sort of thing that causes the whole market to seize up very suddenly, perhaps catastrophically. Not a slow motion deposit-driven meltdown.
Kind of makes Continental Illinois look like a minor hiccup in comparison. And yet here we are twenty-some years later talking about that event--its aftermath coloring our perception of today's events.
The Fed was presented with a tough choice and probably made a good call. And while some of the critics objections are reasoned (Buiter), some just don't get it. Today's public flogging of the MSM is outsourced to Brad DeLong.
As Buce of Underbelly puts it, Gretchen Morgenson fails to understand the distinction between preserving the lines of business that are the enterprise and rescuing the holders of the equity in the firm:
Rescue Me: A Fed Bailout Crosses a Line: WHAT are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year?
Or all of the above?
Stick around, because we'll soon find out. And it's not going to be pretty.
Agreeing to guarantee a 28-day credit line to Bear Stearns, by way of JPMorgan Chase, the Federal Reserve Bank of New York conceded last Friday that no sizable firm with a book of mortgage securities or loans out to mortgage issuers could be allowed to fail right now.... But why save Bear Stearns? The beneficiary of this bailout, remember, has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach.... Let's not forget that Bear Stearns lost billions for its clients last summer, when two hedge funds investing heavily in mortgage securities collapsed. And the firm tried to dump toxic mortgage securities it held in its own vaults onto the public last summer in an initial public offering of a financial company called Everquest Financial. Thankfully, that deal never got done.... And so, Bear Stearns, a firm that some say is this decade's version of Drexel Burnham Lambert, the anything-goes, 1980s junk-bond shop dominated by Michael Milken, is rescued. Almost two decades ago, Drexel was left to die...
It does not seem that she gets it.
I have to agree with DeLong. This is far a desirable outcome, but the consequences of inaction were worse. I admit to being uncomfortable with the Fed as a backstop and I worry about the precedent this sets. Tell me who is comfortable with it? It should make one very uncomfortable, and I'm sure that a lot of folks at the Fed are not sleeping well tonight. But sometimes you need to make the uncomfortable choice.
And so now we'll just have to wait and see how much the new lending facility gets used.
I didn't even get to talking about the discount rate. In light of everything else going on, it's a minor part of the story, and the fact that they lowered it is maybe a little bit of overkill. If someone can explain why an extra quarter point today as opposed to Tuesday is going to help the liquidity issues, I'm all ears.
Posted by William Polley at 11:10 PM | Comments (0) | TrackBack
How tonight's Fed announcement paves the way for more emergency financing of investment banks
This post continues the discussion from here. The immediate question is, of course, whether the Fed's facilitation of JPMorgan's rescue of Bear Stearns was a good idea. Here is a "no" vote from Willem Buiter (via Felix Salmon)
The Federal Reserve Act (1913) allows the Federal Reserve to lend, in a crisis, to just about any institution, organisation or individual, and against any collateral the Fed deems fit. Specifically, if the Board of Governors of the Federal Reserve System determines that there are “unusual and exigent circumstances” and at least five (out of seven) governors vote to authorize lending under Section 13(3) of the Federal Reserve Act, the Federal Reserve can discount for individuals, partnerships and corporations (IPCs) “notes, drafts and bills of exchange indorsed or otherwise secured to the satisfaction of the Federal Reserve bank…”.
The combination of the restriction of “unusual and exigent circumstances” and the further restriction that the Federal Reserve can discount only to IPCs “unable to secure adequate credit accommodations from other banking institutions”, fits the description of a credit crunch/liquidity crisis like a glove. So why hasn’t the Fed declared “unusual and exigent circumstances” yet, so non-deposit-taking financial and other institutions in need of liquidity and blessed with eligible collateral can go directly to the discount window? When in doubt, leave the middleman out.
...
Since Bear Stearns is not a deposit-taking institution, and appears to be of no other systemic significance, there is no need for a special resolution regime of the kind managed by the FDIC for troubled deposit-taking institutions. The firm could have been left to go into receivership.
If the Fed fears the risk of contagion effects and financial panic, it could have requested the nationalisation of the investment bank. This should have been done at a zero price. The existing shareholders could, if the US government were feeling generous, be granted the privilige of claim on whatever value is left after all other creditors have been paid off.
But the shareholders of Bear Stearns are eating their cake and having it. Shares may have dropped 43 percent in value, but what is left still beats nothing. And nothing seems the only possible fair value for what Bear Stearns would be worth without Fed assistance. Why was Bear Stearns not taken into public ownership, preferably at a zero price?
One would hope that, as soon as the rescue was announced, the existing management and board of Bear Stearns would have resigned en-masse, and without any golden handshakes of the CEO of Citigroup and Merrill Lynch -variety. This should have been a condition of the loan being made. The argument that only the existing management understands the business well enough to see it through the storm is unconvincing, as these are the very people that screwed it up in the first place. Why are the old top management and board members still in their jobs?
Another key issue concerns the terms on which Bear Stearns now borrows. I have always considered the Fed’s decision to lower the spread between the discount rate and the Federal Funds target rate to be a mistake - an inframarginal subsidy to those lucky enough to have access to the facility. Now we see why. If Bear Stearns can borrow at 50 bps over the 28-day OIS rate, or anything in that ballpark, it would be scandal.
Good points. And the first of those points (unusual and exigent circumstances) is what tonight's announcement by the Fed addresses--in a new and innovative way. From the press release,
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
So there it is. A new lending facility which appears to be inspired by the spirit of the "unusual and exigent circumstances" clause to which Buiter refers. But as path-breaking as this is, it is not quite as drastic as if the Fed had invoked that phrase and opened the door even wider. It is limited to primary dealers, which are listed here. These are the institutions that the New York Fed works with on a daily basis in the conduct of open market operations. One could argue that the Fed already uses them as a conduit for routine monetary policy, so they are the natural choice for facilitating these emergency actions.
If they are simply acting as a conduit for loans, that would be odd--sort of a regulatory quirk reflecting a holdover of the post-Depression wall that has now fallen between deposit institutions and investment institutions. It's a patch rather than a permanent fix while we try to figure out how to keep this from happening again and how to address it more effectively if it does. Not what I would suggest if I were designing the system de novo, but an understandable thing to do in the heat of battle.
But if it leads to the primary dealers swallowing up troubled institutions, then it does raise some issues of the sort that Buiter outlines in the second part of the quote. Why not take Bear Stearns (and whoever may be next in line) into public receivership directly?
Such questions are all the more relevant tonight as news comes of the sale of Bear Stearns to JPMorgan for $2 a share.
Reflecting Bear Stearns’s dire straits, JPMorgan agreed to pay just $236 million for the firm, a figure that includes the price of Bear’s soaring headquarters on Madison Avenue in Manhattan. At $2 a share, JPMorgan is buying Bear Stearns for a third of the price at which the troubled firm went public in 1985. Only a year ago, Bear’s shares fetched $170. The cut-rate price reflects deep misgivings about the firm’s prospects.
JPMorgan said it was guaranteeing the trading obligations of Bear Stearns and its subsidiaries, effective immediately. “JPMorgan Chase stands behind Bear Stearns,” Jamie Dimon, JPMorgan’s chief executive, said in a statement. “Bear Stearns’s clients and counterparties should feel secure that JPMorgan is guaranteeing Bear Stearns’s counterparty risk.”
The companies said that the Federal Reserve would provide special financing in connection with the transaction and that the Fed had agreed to fund up to $30 billion of Bear Stearns’s “less-liquid assets.”
If you're a fan of the movie It's a Wonderful Life, this is where George Bailey says "Potter's not selling. Potter's buying!" I mean, the Bear Stearns building alone must be worth....
But it's the last paragraph I quoted that leads to headlines like this, from a blog on the L.A. Times: "With Fed financing, JP Morgan buys Bear Stearns".
I suspect that's not how Mr. Bernanke wants this to be viewed.
But the cynic who has moral hazard on his mind can't help but ask... If they do it once like this, what if it happens again? What if another entity considered too big to fail gets special financing from one of the primary dealers through this new facility? As we saw tonight, it is but a small step from a loan guarantee to a fire sale.
This is a good time to link to Brad DeLong's excellent post in which he tells us what Bernanke, Paulson, et al. should have done this weekend. He would have the Treasury set a (discounted) price for mortgages that look a little shaky, buy them, push the market back to equilibrium, and make money for the taxpayer in the process.
If I were working for the Treasury right now, I would be saying: make this happen on Monday. There isn't time to set up a new bureaucrtacy--a HOLC, which is what Alan Blinder wanted to do as of three weeks ago. So use an existing bureaucracy: Fannie Mae. If I were Treasury Secretary Hank Paulson, I would spend the weekend building a legislative vehicle to introduce Monday morning on an emergency basis to give Fannie Mae the resources and the mission to undertake this mortgage rescue operation, and I think Fannie Mae is the right institution for the task: why does it have its government-sponsored status and guarantee if not to be used for purposes like these at times like these?
And if I were Ben Bernanke and Tim Geithner, I would be spending this weekend thinking about how to first thing Monday morning punish bear speculators on Bear Stearns, Lehman, and others by pushing their CDS spreads back to more normal levels. It seems to me that people on Wall Street need to be taught that betting that the Fed will not intervene to stabilize or that its interventions to stabilize will be unsuccessful is an unhealthy thing to do.
The Bear Stearns sale notwithstanding, it's not too late to do something approximating DeLong's (and Blinder's) suggestions to head off future episodes. (Who thinks that this is the end?)
Whether $2 a share is sufficient punishment for the speculators is left to the reader.
Some closing thoughts (at least for tonight) in the next post.
Posted by William Polley at 09:33 PM | Comments (0) | TrackBack
When was the last time the Fed made a policy announcement on a Sunday?
I do not know the answer to my title question, but if anyone does, I am curious. Anyway, here is the announcement from the Fed, and this is the first in what will be at least two posts on the subject by me tonight. If it were just one post, it would be far too long. So let's get started.
This story starts as a bank run... not like the one in It's a Wonderful Life, but a run on an investment bank. Less of a public spectacle, but just as nerve-wracking. (NY Times)
Just three days ago, the head of Bear Stearns, the beleaguered investment bank, sought to assure Wall Street that his firm was safe.
But those assurances were blown away in what amounted to a bank run at Bear Stearns, prompting JPMorgan Chase and the Federal Reserve Bank of New York to step in on Friday with a financial rescue package intended to keep the firm afloat.
...
The developments may only postpone the eventual sale of all or part of Bear Stearns, which has had crippling losses on mortgage-linked investments. To keep the 85-year-old firm solvent, JPMorgan, backed by the New York Fed, extended a secured line of credit that gives Bear Stearns at least 28 days to shore up its finances or, more likely, to find a buyer.
Comment #1: This article is from yesterday--March 15. The sale of Bear Stearns will probably be consummated tonight. That is an indication of just how quickly these things are moving. So quickly that the financial reporters who spend their days enmeshed in these stories are underestimating how rapidly the events will unfold.
News of the bailout ignited fears that other big banks remain vulnerable to the continuing credit crisis, and stocks tumbled in another rocky day for the markets. Financial shares led the way, with shares of Bear Stearns plunging 47 percent. Hours after the rescue was announced, another Wall Street firm, Lehman Brothers, said it had secured a three-year credit line from banks. Its stock fell 15 percent.
Comment #2: Counterparty risk and systemic risk--look them up.
The Fed’s intervention highlights the problems regulators face as they contemplate the prospect that investment banks, saddled with toxic securities tied to subprime mortgages, are losing the trust of their lenders and clients — the kiss of death on Wall Street, where confidence has always been the most precious asset of all.
Traditionally regulators have helped commercial banks in financial panics, but not investment banks, which do not hold customer deposits. But the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated investment banks and commercial banks, led to consolidation within the financial industry that has made such distinctions harder to make.
“I don’t remember a Fed action aimed at a noncommercial bank; this is the kind of thing you see in this post-regulatory environment,” said Charles Geisst, a Wall Street historian at Manhattan College.
Comment #3: Indeed this is a sign of our times. The consequences of investment bank versus commercial bank failure are different and so are the reasons for rescuing them. In the movie It's a Wonderful Life, when the Bailey Building and Loan faces a bank run, the deposits of the townspeople (the "little guys", if you will) are directly at risk. But when Bear Stearns cannot meet its obligations to its creditors (who are anything but "little guys"), it means that those creditors may face difficulty in meeting their obligations. Eventually, as the crisis deepens, it will begin to threaten commercial banks that do have more of a connection to "real people" with deposits that FDIC will make sure are protected. Certainly that is the worst-case scenario that everyone wants to avoid.
So did the Fed do the right thing by intervening? There are many reasons to say yes, but not everyone thinks so. This post is getting long, and a full answer to this question deserves it's own. To be continued...
UPDATE: John Jansen informs us that October 6, 1979 was a Saturday. Close enough. Students of monetary policy need only read the date to know what that was about.
Posted by William Polley at 07:53 PM | Comments (3) | TrackBack
March 12, 2008
How much more can the Fed do?
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?
Posted by William Polley at 06:02 PM | Comments (2) | TrackBack
March 05, 2008
Beige Book.... now available as a PDF
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.
Posted by William Polley at 02:35 PM | Comments (2) | TrackBack
March 03, 2008
Today's required reading...
... is from the Wall Street Journal's Greg Ip. In today's piece, "For the Fed, a Recession -- Not Inflation -- Poses Greater Threat", he writes:
So why is the Fed more worried about growth than inflation? First, it thinks run-ups in commodity prices explain the increases, not only in overall inflation but also in core inflation: higher energy costs have "passed through" to other goods and services. Core inflation rose and fell with energy inflation between early 2006 and mid-2007, and the Fed thinks the same thing is probably happening now. If energy and food prices stop rising -- they don't have to actually fall -- both overall and core inflation should recede.
...
For the current high inflation rates to become permanent, the Fed believes it has to become embedded in how workers and businesses set wages and prices. So far, surveys suggest consumers haven't raised their expectations of inflation much. In last year's fourth quarter, hourly wages and benefits were up just 3% from a year earlier, a slowdown from 2006, even though unemployment was below 5% for almost all that period. A wage-price spiral requires wages to cooperate.
Wages are even less likely to accelerate if unemployment, now 4.9%, rises to 5.25% this year and falls only gradually to 5% by 2010, as the Fed's Federal Open Market Committee forecasts. That implies three years with the unemployment rate above the FOMC's estimated "natural" rate of about 4.9%, and thus steady downward pressure on inflation.
The notion that higher unemployment reduces inflation has its skeptics, even at the Fed. "All you have to do is recall the 1970s, when we experienced both high unemployment and high inflation, to appreciate that slow economic growth and lower inflation don't necessarily go hand in hand," Federal Reserve Bank of Philadelphia President Charles Plosser said last month.
I must say that I get a little nervous about pinning my hopes for inflation reduction on a forecast that unemployment will be a couple tenths of a percent over the supposed "natural" rate. Even if you believe in some kind of an expectations augmented Phillips curve, you have to wonder about what has been happening in recent weeks. The genie may not be out of the bottle yet, but it's beginning to look like someone popped the cork.
Ip continues,
Critics say the Fed also took too long to reverse the ultralow rates of 2001-2003, thereby fueling the housing bubble -- if not rampant inflation -- whose collapse now threatens the economy. Federal Reserve Bank of St. Louis President William Poole became one of the first people who participated in that decision to repudiate it. "With the benefit of hindsight...it is not hard to argue that the [Fed] was too slow to raise the federal-funds target after taking the target down to 1% in 2003," he said at a conference on Friday.
Even Fed officials who don't share that view agree that both that episode and the 1970s experience argue for promptly reversing rate cuts once the current crisis passes.
That's easier said than done. The Fed is unlikely to face an outlook so unambiguously positive anytime soon that such a reversal will be a slam-dunk, and during an election year, it will face intense political pressure not to raise rates.
Whether the Fed reverses course "on an appropriate schedule" will be clear in five years or so, Mr. Poole said.
This is not the first place I've seen this sentiment (of rate hikes as soon as this crisis passes) expressed recently. That makes me think that there is a concerted effort to manage expectations here. At this point, I'd say the most likely time for the Fed to want to begin tightening again (barring any unforeseen developments) will probably be very close to election time. It will be a tough sell. Better start paving the way soon.
And Poole's final comment is very much on the money.
Posted by William Polley at 01:39 PM | Comments (4) | TrackBack
February 26, 2008
News from the inflation front
The news isn't good. The PPI is on the rise. (MSNBC)
WASHINGTON - Battered by bad economic news, consumer confidence plunged while wholesale food, energy and medicine costs soared, pushing inflation up at the fastest pace in a quarter century.
The Labor Department said Tuesday that wholesale inflation jumped by 1 percent in January, more than double the increase that analysts had been expecting.
The next paragraph isn't about inflation, but isn't great either...
Meanwhile, the New York-based Conference Board reported that its confidence index fell to 75.0 in February, down from a revised January reading of 87.3. The drop was far below the 83 reading that analysts had forecast and put the index at its lowest level since February 2003, a period that reflected anxiety in the lead up to the Iraq war.
And on another note, I was revising my homework solutions for my principles of macro course this semester. I always ask students to find the most recent rate of inflation by the CPI (12 month % change). Last semester, the answer was 2.0% at the time I asked the question. The answer now? 4.4%. (4.3% not seasonally adjusted)
Uh oh.
Posted by William Polley at 10:49 AM | Comments (2) | TrackBack
February 19, 2008
He never actually says "liquidity trap"
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.
Posted by William Polley at 10:28 PM | Comments (0) | TrackBack
February 12, 2008
More divergent views on whether we are in or near a recession
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.
Posted by William Polley at 03:01 PM | Comments (3) | TrackBack
February 11, 2008
Poole reflects on 10 years at the St. Louis Fed
Outgoing St. Louis Fed president William Poole gave a speech to the St. Louis NABE today. I linked to the Reuters story in the previous post. Now, I would like to post some excerpts from the speech that didn't make the wires. Most of the speech has to do with central bank communications.
My general approach has been to speak primarily about the policy process rather than the specific situation facing the FOMC at its next meeting. I try to think of myself as speaking to portfolio managers who have a medium-term horizon rather than to traders who have a horizon measured in hours or a few days. I do not disparage traders—they perform an important function. Obviously, I have had internal information that would be of interest to traders but it would be entirely inappropriate—indeed illegal—to disclose confidential FOMC information.
Traders, portfolio managers and many others always want to know my forecast of what will happen at the upcoming FOMC meeting. My standard answer is that I do not forecast monetary policy decisions—my job is to participate in making those decisions. I confess that, initially, this response was something of a dodge, because I usually had a pretty good idea weeks in advance of what my own position at a meeting would be. However, over the years I have become impressed by how often my own position would change even in the days just before a meeting as a consequence of the arrival of new information, including staff analysis and sound arguments by my FOMC colleagues. It is not that my views are pushed this way and that by arrival of the latest economic data reports. What happens is that, from time to time, compelling new information does arrive. I hope that my policy outlook was stable even as my view on the appropriate policy action might change in the light of incoming data.
Thinking through the matter led me to a bit of research. Working with Bob Rasche, the St. Louis Fed research director, I had already studied the accuracy of market expectations about FOMC decisions using data from the federal funds futures market the day before each FOMC meeting. Given that those futures market forecasts have proven to be quite accurate, an obvious question was forecast accuracy longer in advance. Bob and I studied futures market predictions of the fed funds rate three and six months in advance and found that the accuracy was pretty low. The reason these forecasts have not been very good is that new information arrives that calls for a changed expectation on the monetary policy setting, both for the markets and for the FOMC. I not only became more aware of the need for me to keep my mind open but also thought it important to explain to my audiences how the policy process worked to be responsive to new information.
...
I also became troubled by the following argument. If current economic conditions were such to suggest a high probability that future economic conditions would justify a future increase in the funds rate target, why not just raise the rate at the current meeting? Given lags in the effects of policy actions, the current policy had to be based on the future outlook. On the other hand, if the probability were low, would it serve the cause of good communication to state a bias? Wouldn’t it be more helpful to work harder to articulate the conditions under which the committee might change the target—to explain in more detail the nature of the policy rule or response function?
Another problem with forward policy guidance was that a slow accumulation of information sometimes made the prior balance-of-risks language out of date, but it was not easy to take it out of the statement without sending a message, or seeming to, that a future policy adjustment in the other direction was contemplated. This problem arose in 2006. In August 2006, the committee kept the funds rate target unchanged, after increasing it by 25 basis points at each of its previous 17 meetings. However, the statement indicated a bias toward a further increase by saying this: “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” Just ahead of the August meeting, the market had assigned a probability of about 0.8 on an FOMC target fed funds rate of 5.25 percent and a probability of about 0.2 on a target rate of 5.5 percent.
Just after the August 2006 FOMC meeting, the market assigned these probabilities to the FOMC decision at its forthcoming September meeting: a target of 5.25 percent had a probability of about 0.78, a target of 5.5 percent had a probability of about 0.2 percent, and a target of 5.75 percent had a probability of about 0.02 percent. Although the FOMC retained the language that “firming may be needed” at subsequent meetings, over time the market lowered its probability that the FOMC would in fact raise the target rate. Ahead of the FOMC meeting of Jan. 30-31, 2007 the market placed essentially zero probability on any target rate above the prevailing rate of 5.25 percent.
At its meeting of March 20-21, 2007, the committee dropped the language referring to possible firming. Doing so made little difference given that the market had discounted the possibility of firming for some time.
Here's the key paragraph of the whole thing...
I have recounted several of these episodes in some detail to illustrate the general issue. As a consequence of observing this process for 10 years, I have concluded that an FOMC attempt to provide forward guidance in the policy statement causes more communications difficulties than it solves. A key reason is that the economy is subject to more shocks and reversals than one might think. These shocks sometimes require more frequent policy actions than I would have thought likely when I came to St. Louis. At a minimum, changing economic conditions change the likelihood that the FOMC will want to adjust the fed funds target in the direction previously thought. Directional language tends to remain in the FOMC policy statement beyond the time it applies and removing the language creates the possibility of miscommunication. Every change in the policy statement leads naturally to market questions as to what the change means and whether the change is meant to provide a hint about the future direction of policy. To my mind, every time new language is inserted into the policy statement, there needs to be as much thought given as to how to exit from the language as to the rationale for inserting it. (Emphasis mine)
Oh, how true. I blogged about this over two years ago. At the time, I was hopeful that this was a solvable problem. The intervening two years have made me less optimistic--apparently, I'm not alone.
Now, some might be surprised or taken aback by his talk of "hunches" in the next paragraph, but I think most veteran Fed watchers know what he means. I know I do.
I know that market participants are hungry for insight into the FOMC’s thinking and into the likelihood of future adjustments in the target federal funds rate. My judgment is that, most of the time, the committee cannot provide what the market wants because the committee itself is not clairvoyant. No one knows how the economy is going to evolve and how events will change the appropriate setting of the federal funds target rate. Most of the time over the past 10 years I had hunches about the policy direction I would be advocating at the next FOMC meeting, but “hunches” really is the right word. I had hunches and not settled convictions. Furthermore, the more I reflected and the more experience I accumulated, the more I realized how frequently surprise changes in conditions required that I change my hunches. I should not be misinterpreted as saying that I necessarily changed my view on the appropriate setting of the fed funds rate target. But when the information on which my prior hunch was based changed significantly, I had to start over, in a sense, to figure out whether the new information required a change in the policy stance.
This one's going on the reading list.
Posted by William Polley at 11:54 PM | Comments (4) | TrackBack
February 08, 2008
Around the web
Lawrence White explains why the gold standard may not be such a bad idea. It's a Cato podcast... with a briefing paper to go along with it.
Tim Duy gets frustrated with people comparing our current problems with Japan in the 1990s. Me too. He also gives his take on Plosser's speech and more.
Jeff Frankel is blogging. Go. Read. Now.
Andrew Samwick is disappointed with congress over the stimulus package.
Posted by William Polley at 05:29 PM | Comments (0) | TrackBack
February 06, 2008
Did the Fed raise interest rates too much too quickly?
Michael Mandel thinks so.
Here’s a thought…maybe part of the reason the credit markets are in such bad shape because the Fed raised rates too fast and too high. Think about it—they started raising rates in June, 2004. It was a quarter point increase, from 1 to 1.25. Two years later, the Fed funds rate was up to 5.25. That’s four percentage points in only two years.
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