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March 27, 2009
What do you mean “Fix It?”
Probably like you, I have been consuming mass quantities of commentary on the Treasury's plan to deal with "legacy assets" via its proposed Public Private Partnership Investment Program. The notices are too numerous to single out—Google "Geithner Plan" if you somehow feel you might have missed one—but the New York Times' Room for Debate feature is a reasonable place to get a one-stop view of some divergent opinions the plan has elicited.
I'm not taking sides on the argument, but I was taken with a metric of success that seemed to permeate the Times discussion:
I added emphasis here (with italics), as the notion of restoring the banking system to health (or not) popped up in various ways in the comments from the article's contributing panel of experts. From Paul Krugman:
"We had vast excesses during the bubble years, and I don't think we can fix the damage with the power of positive thinking plus a bit of financial engineering."
From Simon Johnson:
"Secretary Geithner's plan might work, in the sense of facilitating the removal of some 'toxic' assets from the balance sheets of major banks. But it is unlikely to work, in the sense of restoring the banking system to health."
From Mark Thoma:
"How will policymakers be able to tell if the plan is working? The first thing to watch for is whether private money is moving off the sidelines and participating in the program to the degree necessary to solve the problem."
From Brad DeLong:
"… the Geithner Plan seems to me to be legitimate and useful way to spend $100 billion of TARP money to improve—albeit not fix—the situation."
The phrases that interest me are "fix the damage," "to work, in the sense of restoring the banking system to health," "solve the problem," and "improve—albeit not fix—the situation." Each author gives some hint of what they mean by those terms, but in my reading the full meanings are not entirely clear—and I bet not uniform across the contributors.
Let me give an analogy that illustrates why these turns of phrase trouble me. Suppose I have a heart attack, which ultimately leads to bypass surgery. The surgery is successful (by its own measure) and the prognosis for recovery is excellent. Did the procedure "fix" the problem? Not exactly. The procedure put me on the road to recovery, but there will be a protracted period in which I am far from "normal." What's more, it will be an even longer period of time before I am fully up and running on full steam. (And along the way, incidentally, I'd better adopt a new set of rules and regulations governing my behavior, lest I find myself in the same condition again. That will take some getting used to as well.)
So, I wonder, what do most people have in mind when they refer to "fixing" the financial situation, of restoring the patient to health? Do they mean getting back to "normal" or simply being on the road to recovery (even if those travels are slow and painful for some time)?
Given that three of the four authors in the Times debate express the view that more policy steps will be needed, I believe there is an awful lot at stake in determining what success actually looks like.
By David Altig, senior vice president and director of research at the Atlanta Fed
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March 24, 2009
Careful with that language
No doubt about it. The decision last week by the Federal Open Market Committee (FOMC) to further expand its balance sheet by up to $1.15 trillion was momentous. But beyond that number, some commentators seem to have suggested that the FOMC took a qualitative leap into quantitative easing (QE):
The last article above comes from BBC News, where it is made clear that the QE theme is associated with the addition of long-dated Treasury securities to the list of assets that the FOMC has specifically asked the folks at the Open Market Desk at the New York Fed to purchase on their behalf:
"We've now had two weeks of quantitative easing in the UK. But as far as the world's concerned, this is Day One. That's because, as of today, the quantitative easers have the US Federal Reserve on their team.
"The US central bank's announcement yesterday that it would start buying US long-dated Treasury bills as part of a nearly $1.2 trillion stimulus programme came as a shock."
OK, let's repeat. Like any balance sheet, the Federal Reserve's has two pieces, the liability side and the asset side. The FOMC statement was explicitly about the asset side—the quantity and types of assets the Fed intends to purchase. Quantitative easing, on the other hand, is about the liability side. As reader Fischer points out in a comment to our previous macroblog post on the Bank of England's balance sheet:
"The entire point of quantitative easing is to put assets into the economy that increase the money supply..."
That exact point was made by Chairman Bernanke back in January:
"The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach—which could be described as 'credit easing'—resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental."
Of course, some think that such "incidental" expansions are far from trivial. John Taylor, for one, has a different view (registration may be required to see full article):
"An explosion of money is the main reason, but not the only one, to be concerned about last week's surprise decision by the Federal Reserve to increase sharply its holdings of mortgage backed securities and to start purchasing longer term Treasury securities."
I don't think anyone should be dismissive of that concern, which makes item 3 of yesterday's joint statement from the Treasury and Federal Reserve particularly noteworthy:
"3. Need to preserve monetary stability: Actions that the Federal Reserve takes, during this period of unusual and exigent circumstances, in the pursuit of financial stability, such as loans or securities purchases that influence the size of its balance sheet, must not constrain the exercise of monetary policy as needed to foster maximum sustainable employment and price stability. Treasury has in place a special financing mechanism called the Supplementary Financing Program, which helps the Federal Reserve manage its balance sheet. In addition, the Treasury and the Federal Reserve are seeking legislative action to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves."
Let us be clear: We are not trying to characterize the recent Federal Reserve decision one way or another. But as the Bank of England's current strategy and the Federal Reserve Chairman's comments noted above clearly indicate, expansions of the asset side of central bank's balance sheet—"credit policy," if you will—are conceptually, and if sterilized operationally, distinct from quantitative easing. The public discussion will be greatly enhanced if we keep those distinctions at the forefront.
David Altig, senior vice president and research director at the Atlanta Fed, and Daniel Littman, economist at the Cleveland Fed
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March 20, 2009
A look at the Bank of England’s balance sheet
The current financial crisis is global in scope, with central banks responding in various ways to mitigate the strains in their respective countries. The Federal Reserve is not the only central bank that has been aggressive in its response. For instance, the Bank of England's (BoE) Monetary Policy Committee, in its March 5 policy statement, explained the details of its new asset purchase program:
"…the Committee agreed that the Bank should, in the first instance, finance £75 billion of asset purchases by the issuance of central bank reserves. The Committee recognised that it might take up to three months to carry out this programme of purchases. Part of that sum would finance the Bank of England's programme of private sector asset purchases through the Asset Purchase Facility, intended to improve the functioning of corporate credit markets. But in order to meet the Committee's objective of total purchases of £75 billion, the Bank would also buy medium- and long-maturity conventional gilts in the secondary market. It is likely that the majority of the overall purchases by value over the next three months will be of gilts."
Thus, the BoE will purchase £75 billion of assets (approximately U.S. $108 billion as March 20 and U.S. $106 billion as of March 5), mostly intermediate-to-longer dated U.K. sovereign debt (or gilts) but also some "investment grade" corporate bonds. Along with this new asset purchase program, to ease strains in credit markets the BoE has previously implemented other efforts, such as purchasing commercial paper, asset-backed securities, and corporate bonds. But these earlier efforts were conducted in such a way that the BoE sterilized its purchases—that is, for every £1 of private assets it purchased, the BoE would issue £1 of its own debt (sterling bills), with the effect being that the money base (bank reserves plus currency in circulation) grew much less than the overall size of the balance sheet.
However, with the new asset purchase program, the BoE is targeting a quantity of U.K. sovereign debt to purchase in an unsterilized manner, hence the key phrase "by the issuance of central bank reserves." As stated, the BoE will be buying gilts, "with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target [2% CPI inflation] in the medium term."
The impact of the BoE's efforts to support private credit markets can be seen in this chart of the size and composition of the BoE's assets:
As the size of the asset side of the BoE's balance sheet grew, so did the liability-side:
Notice that much of the increase in the liabilities has come from "other liabilities" and "short-term open market operations" and not "reserve balances." But with the new asset purchase program, reserve balances will become much larger.
By Laurel Graefe and Andrew Flowers, economic analysts at the Atlanta Fed.
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March 17, 2009
A look at postrecession employment trends
Recent Blue Chip survey forecasts gross domestic product growth turning positive in the third quarter of 2009. But for those individuals who have lost jobs, what is foremost on their minds is when the labor market will recover. An examination of labor market performance during and after previous recessions suggests the employment recoveries vary in length, and the employment downturns are generally much longer than the actual recessions.
There have been large differences in employment patterns over previous recessions. For example, over the combined 1980 and 1981–82 recessionary periods the payroll employment loss amounted to 1.3 percent of the average employment level in the 12 months preceding the beginning of the 1980 recession. The share of employment lost was less in the 1990–91 and 2001 recessions, with 0.41 percent and 0.89 percent of jobs lost, respectively. In contrast, the share of employment lost during the current recession has been very large. Even if the recession ended today the share of jobs lost would be 2.7 percent.
Just as there has been volatility in the share of jobs lost, the time until employment has fully recovered (returned to prerecession levels) has also varied across past recessions, as shown in the chart below. The two most recent recessions, which had relatively low rates of job decline, had very drawn-out employment recoveries. In 2001, employment—growing at an average annualized rate of 0.3 percent—took 35 months (nearly three years) to return to prerecessionary levels. The average rate of employment growth was also approximately 0.3 percent after the 1990–91 recession. But because the share of employment lost was less, employment returned to prerecession levels in 19 months. Interestingly, the 1980–82 recessionary period, which had a much larger share of jobs lost, also had the quickest rate of recovery. Postrecession employment grew at an annualized rate of more than 2 percent and took just seven months to reach prerecession levels.
The question then becomes, what does previous experience imply for the path of employment after the current recession? If the current recession ended today with a 2.7 percent job decline, and postrecession employment growth resembled the recovery from the 1981–82 recession, then employment would return to prerecessionary levels in approximately 14 months. But if the employment growth path is more similar to the two most recent recessions, then it would take well over eight years for employment to return to prerecession levels. Of course, history is unlikely to repeat itself exactly, but what history does tell us is that the employment recovery will lag the recovery in overall economic activity, and possibly by a lot.
By Melinda Pitts, research economist and associate policy adviser at the Atlanta Fed
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March 11, 2009
Another side of the administration’s tax plan
While discussions of the Obama administration's tax plan focus on the expected impact on consumer spending and the federal deficit, not much attention has been given to the incentives of the plan for work effort. Different tax rates, deductions, and rebates provide varying degrees of incentives to work less or work more, and those incentives differ across income groups. Here I want to focus on just one of the proposed changes: the reinstatement of the 39.6 percent marginal tax rate for the wealthy.
Supply side economists tout low tax rates across the board as a way to provide incentives for people to work harder and thus for the economy to grow faster; with this thinking, people work harder because they get to keep more of the money they're working for.
Results in a recent working paper, with coauthor Robert Moore, confirm these predictions by finding that work effort increased across all income levels when tax rates were cut (among other things) in the 2001 Bush administration tax reform. But work effort increased much less among the more educated (higher income) families.
The administration's current budget plan includes a reversion of the marginal tax rate among the wealthiest to the pre-Bush tax rates—an increase from 35 to 39.6 percent. This tax rate increase is equivalent to reducing a worker's wage by 7 percent. The chart shows what the impact on work effort would be across education/income groups if wages were decreased for both groups by 7 percent; education and income are very highly correlated. The analysis found that husbands with a high school degree only would reduce their hours worked by about 63 hours per year (about 2.9 percent), whereas husbands with a college degree or more would reduce their work hours by only 42 hours per year (about 1.8 percent). Working wives in these families would also reduce their hours of work.
So, based on my research, if a need to raise some revenue means tax rates have to be increased for someone, raising them on the wealthiest will result in a smaller reduction in work effort than raising tax rates on the middle class.
The calculations here use results obtained from estimating a joint labor supply model for dual-earner families with different levels of education for the year 2000. A complete analysis of the work effort implications from the administration's tax plan would require accounting for all the changes to marginal tax rates, phase-outs of deductions, and tax credits simultaneously, as well as considering the impact on decisions of family members to enter or exit the labor market in response to the tax changes.
An additional relevant question remains: What is the implication of changing work effort for GDP growth? The relationship between work effort and value of output is not necessarily the same across income levels. In other words, one hour of high-income (higher education) labor is expected to yield a higher value of output in the economy than one hour of labor from a middle-income (lower education) worker. A complete analysis of the aggregate impact of the administration's tax plan would have to also take this into account.
By Julie Hotchkiss, research economist and policy adviser at the Atlanta Fed
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March 06, 2009
When smart people debate, something interesting is bound to come of it, so I have been reading an interchange over the past couple of days in the blogs of Greg Mankiw and Paul Krugman. Krugman's blog provides the necessary background on the source of the debate:
"Greg Mankiw challenges the administration's prediction of relatively fast growth a few years from now on the basis that real GDP (gross domestic product) may have a unit root—that is, there's no tendency for bad years to be offset by good years later.
"I always thought the unit root thing involved a bit of deliberate obtuseness—it involved pretending that you didn't know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall."
It is certainly true that when "unemployment is high, it tends to fall," but where it falls to is not always so obvious:
Prior to the 1973–75 recession, the average quarterly unemployment rate was 5 percent. If you had a forecast contemplating a return to "normal" following this particular recession you would have been holding your breath for a couple of decades.
Professor Krugman makes the central point, I believe, when he makes reference to the "difference between, say, low GDP growth due to a productivity slowdown… and low GDP growth due to a severe recession." That statement is, itself, recognition that the economy does periodically experience protracted episodes during which average growth and average unemployment simply do not revert to previous levels—at least not for a long time.
One of the striking things about the economic projections reported by the Reserve Bank presidents and Board's governors in the minutes from the last meeting of the Federal Open Market Committee was the rather large variation in views about GDP growth, even as far out as 2011:
That sense of uncertainty is shared by private forecasters:
What gives? There are lots of reasons for differences of opinions, and I obviously cannot (and should not) try to divine what is anyone else's deepest forecasting thoughts. But for me, "low growth due to severe recession" does not automatically imply a demand-driven downturn from which the economy will quickly spring back.
When I look ahead, I envision the U.S. economy over the next several years in terms of a simultaneous process of recovery and reformation: Recovery in the sense that the actual contraction of GDP will end, but reformation in the sense of structural transformation in financial markets, consumer behavior, and perhaps an adjustment of the global imbalances that are arguably at the root of much of the financial instability that has characterized the past decade.
If we are right, the long run is indeed rosy, but the long run will only arrive after some significant and protracted headwinds abate. And that is not a picture that suggests a rapid bounce back to "normal" growth.
By David Altig, senior vice president and research director at the Atlanta Fed
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March 03, 2009
Yet another cut at the recent retail price data
Much of modern business cycle theory—and the policy prescriptions that accompany it—rest on the idea that something interferes with markets. After all, if markets are working efficiently, there isn't anything that policy can do to improve matters. What that "something" is remains the great unknown in macroeconomics, but there is a common belief that price "stickiness" lies at the heart of the problem.
While economists wrestle with the question of what, exactly, causes prices to be sticky—that is, adjust more slowly than they would in the absence of whatever is getting in their way—some have taken on the tedious task of documenting the speed at which prices adjust. And, as you might imagine, it turns out that some prices adjust very quickly while others adjust at a glacial pace.
One of the most comprehensive investigations into the evidence of price stickiness was published a few years ago by economists Mark Bils of the University of Rochester and Peter Klenow of Stanford. Bils and Klenow dug through the unpublished data that are used to construct the consumer price index (CPI) and computed the frequency of price changes for 350 detailed spending categories. They concluded that between 1995 and 1997, half of these categories changed their prices at least every 4.3 months. Some categories changed their prices much more frequently. Price changes for tomatoes occurred about every three weeks. And some, like coin-operated laundries, changed prices on average only every 6½ years or so.
It has been argued—notably by Kosuke Aoki of the London School of Economics—that sticky prices are likely to incorporate forward-looking expectations and are therefore "a good candidate for a measure of core inflation."
We decided to take the data we use to compute another measure of core inflation—the median CPI—to produce a "sticky-price" and "flexible-price" CPI. There are some complications to this seemingly simple exercise. First, it isn't clear where one should draw the line between a sticky price and a flexible price. We rather arbitrarily decided to draw two lines, one at four months and another at six months. If price changes for a particular CPI component occur on average every four months or more frequently, we called that component a "flexible" price good and, if changes occurred less often than every six months, we labeled it a "sticky" price good. (We have called goods that change prices somewhere between every four and six months "semiflexible" and are generally ignoring them in this particular exercise.)
Second, since we're dealing with considerably fewer spending categories than Bils and Klenow did, we could only imperfectly match our data set to their results, so admittedly some art was applied in instances where sticky price goods and flexible price goods coexisted in the same spending category.
Those cautions aside, here's what we came up with, looking at data between 1998 and 2009.
Figure 1 shows the weighted distribution of the CPI market basket on the basis of its degree of price stickiness. In terms of the overall, or "headline" CPI, we judge that a little more than 50 percent of the index is composed of sticky price goods, 40 percent of the index is made up of flexible price goods, and the remainder is somewhere in between.
So, what do these measures tell us? Figure 2 below shows the four-month percent change in the sticky CPI and the flexible CPI, with the headline and the traditional core CPI included as dotted lines for reference.
Clearly the sticky-price CPI exhibits relatively smooth patterns, very similar to that exhibited by the traditional core CPI, while the flexible price CPI behaves in a way more consistent with the headline CPI. Such a correspondence between the core measure and the sticky-price measure isn't very surprising since food and energy items are heavily (though not exclusively) flexible price goods (see again figure 1).
So we also produced "core" measures of the sticky and flexible CPI (the sticky and flexible price CPI measures less food and energy), and these data are shown in figure 3.
One observation from this calculation is that sticky prices have tended to rise at a pace above the core flexible prices for a considerable period of time. Obviously something more than degree of price flexibility distinguishes these two price measures. But as an exercise in reading the incoming price data, the sharp drop in the flexible component of the core CPI is another clear indication of the strong disinflationary pressure on retail prices in recent months. Over the past four months, the core flexible CPI has fallen at a 2.6 percent pace, just a shade more than what we saw during the disinflation of 2003. And the sticky price core CPI? Well, it hasn't moved much—it's sticky. But the longer the disinflationary pressures on the economy persist, the more these prices will likely become unstuck as they too begin to reflect the price adjustments being reflected elsewhere in the consumer's market basket.
By Michael Bryan, Federal Reserve Bank of Atlanta, and Brent Meyer, Federal Reserve Bank of Cleveland
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