June 27, 2011
Stimulating small business activity: Still a struggle
In testimony before Congress on June 22, U.S. Treasury Secretary Timothy Geithner laid out the disproportionate effect the financial crisis has had on small businesses and particularly their ability to raise funds:
"The banking and credit component of the economic crisis was especially damaging for small businesses, which are more dependent on bank loans for financing than are larger firms. Alternative forms of financing, through household credit via mortgages and credit cards, were also deeply compromised by the financial crisis. Mortgages and other loans account for four times the share of liabilities for non-corporate businesses as they do for corporate businesses. Total lending to non-financial businesses shrank for nine straight quarters starting in the fourth quarter of 2008, before turning slightly positive in the first quarter of 2011; on net, lending has declined by a cumulative $4.2 trillion since Fall 2008. Over the same period, larger businesses were able to raise $3.6 trillion by issuing debt securities."
Evidence from the Atlanta Fed's latest small business finance poll of approximately 182 firms in the Southeast confirms that many firms are still struggling with financing. Total financing received among repeat poll participants edged up only slightly in the first quarter of 2011 from the previous quarter. Further, 43 percent of participants overall reported that tighter lending practices are hindering access to credit. In addition, when offers of credit do occur, they often do not materialize into loans as a result of the unfavorable credit terms being offered. In fact, 41 percent of applications to community and regional banks and 57 percent of applications to large national banks were refused by the borrower, according to the first quarter poll.
In response to these ongoing problems, the Administration has created several programs to help small business obtain funding. One is the Small Business Lending Fund (SBLF). Created by the Small Business Jobs Act in September 2010, the fund began accepting applications in December 2010. The SBLF was set up to provide an incentive for financial institutions with less than $10 billion in assets (mostly community banks) to boost lending to small businesses.
Under the terms of the program, the more small business lending increases, the greater the benefit to the institution. In theory, shoring up the balance sheets of the banks in exchange for an increase in small business lending would result in an increase the amount of loanable capital. Further, there would be a greater opportunity cost for failing to bring loans to closure, and this cost could result in borrowers receiving more appealing credit terms. As a result, those small businesses currently rejecting loans based on the cost of funds could see credit terms ease, resulting in more acceptances and an expansion of small business loans. (You can read more about the details of the SBLF here.)
Unfortunately, the program, which closed out June 22, was not very popular. As of the morning of June 22, the Treasury had received 869 applications out of 7,700 eligible lenders. All together, they requested only $11.6 billion out of a possible $30 billion from the program.
Why was participation so low? One potential reason is lack of demand. According to Paul Merski, chief economist and executive vice president of the Independent Community Bankers of America, "You're not going to pull down capital unless you have loan demand."
If demand for small business loans is not expected to pick up, then what is restraining demand?
One possibility that we considered in a macroblog about a year ago is that demand is being restrained as a result of the perception of tight credit supply. Creditworthy borrowers could be assuming they will be denied so they are not applying. Another possibility is that demand is constrained because of economic weakness. To get a handle on the extent to which these factors are restraining demand, we turn back to our small business finance poll. In the poll, we ask those who did not seek credit in the previous three months why they didn't seek it. The chart below shows the responses to the question. (Note that survey participants can check more than one option.)
At first glimpse none of the reasons seem to dominate. However, if we categorize the responses into "I didn't need credit" and "I didn't think I'd able to get credit," the graph becomes a little more useful.
The graph below shows the responses placed into these two categories (where possible). Firms that only marked "sales/revenue did not warrant it," "sufficient cash on hand," or "existing financing meets needs" are put into the "I didn't need credit" category. Meanwhile, firms that only said "unfavorable credit terms" or "did not think lenders would approve" fall under "I didn't think I'd be able to get credit."
We do not claim that our survey is a statistically representative sample, and we of course can only reach existing businesses. The survey is silent on potential new businesses that were not formed because of credit issues that the SBLF could potentially address. With those caveats, we do find that the majority of firms (66 percent) did not borrow because they didn't need to or want to. Whatever the merits of the SBLF program, it appears that understanding why those businesses that are fully capable of expanding are not doing so is at least as important as understanding the slow pace of SBLF activity.
By Ellyn Terry, an analyst in the Atlanta Fed's research department
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June 13, 2011
Core cuts both ways
With the six-month average of annualized headline inflation running just over 5 percent, this Wednesday's consumer price index (CPI) report looms a little larger than usual. While it is dangerous to predict such things, there is every reason to believe that the measured increase in CPI inflation for May could be quite low. And there is every reason to believe that this softness will persist into June.
The reason is quite simple. Movements in gasoline and fuel prices really do push around the headline inflation number, and at long last it looks like that movement is in the downward direction. Here's the relevant picture:
Let's assume that, annualized, CPI excluding food and energy rises 2.1 percent, as it has so far this year, and food and nongasoline energy prices each rise at 5 percent. Then when you plug in gasoline prices already realized for May and EIA predictions for June, you get a 0.4 percent rise in the headline CPI in May and a 0.7 percent decline in June (both rates annualized).
Despite some probable relief on the headline inflation number, I remain aware of what that relief means and what it does not. Earlier in the year, Atlanta Fed president Dennis Lockhart had this to say:
"I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services…
"… The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere—events that cause prices of certain goods to rise and change your cost of living."
Two points, then. First, even if things evolve as the chart above suggests, the level of gasoline prices will remain relatively high by recent standards. Low inflation readings for the next couple of months would therefore leave the cost-of-living high by recent standards, a fact that is not lost on us here at the Atlanta Fed.
Second, as President Lockhart's comments reveal, we were reluctant to attribute the run-up in fuel prices to monetary policy. And I imagine we will be equally reluctant to credit monetary policy with any relief from that trend.
In fact, I will fearlessly predict that, should our guess here about headline inflation in the next couple of months be proved accurate, we will point to core inflation measures as reason to look through some very low inflation readings. See these comments from President Lockhart's most recent speech for some additional perspective:
"Are the recent outsized increases in headline inflation the best signals of the inflation trend going forward? Or are other statistics—like core inflation or measures of inflation expectations—yielding a truer picture of what lies ahead?
"The answer matters a lot. And it certainly weighs heavily on my thinking. I would not hesitate to support an exit from our current policy stance if I believed that the headline inflation number of the past six months is really indicative of the underlying trend inflation rate. I don't believe this to be the case. And I am wary of tightening monetary policy in the face of quite ambiguous economic circumstances unless doing so is absolutely necessary to meet the FOMC's price stability mandate."
And here's why it matters, quoting President Lockhart from an interview with Reuters last week:
"In the interview, Lockhart said maintaining an easy Fed policy stance should ensure the moderate U.S. recovery does not fall off the rails."
"How high would the bar be for further Fed easing?
"It would take 'a significant deterioration as reflected in the overall economy, a set of deflationary signals and also unemployment numbers that rise dramatically. Last fall (when the Fed launched QE2), by some measures, we were seeing declining inflation expectations that were headed in a pretty negative direction, and that was happening pretty rapidly. We were in a disinflationary environment. So the risk of deflation was plausible. We acted and the situation has turned around. That was, at least in my way of thinking, very central to supporting the policy. We don't have anything remotely like a deflationary risk at the moment, short of a shock of some kind.' "
If what I suggest above—falling headline inflation, stable core inflation—comes to pass in the near term, don't expect me to start ringing the disinflationary bell.
This isn't the last word on the usefulness of core inflation statistics, and the debate is certain to rage on (see here and here, for recent installments). But I do hope that this post is remembered the next time the Federal Reserve is accused of hiding inflationary pressures behind the rhetoric of core.
Update: The May CPI report is in, and once again the facts trump arithmetic. We got the flip in the headline/core measures right; the rest, not so much.
Update: Here's one way to construct a synthetic CPI:
CPIHeadline(T) is the calculated value of the seasonally adjusted CPI in month T > December 2010. CPIHeadline(Dec2010) is the reported seasonally adjusted headline CPI for December 2010. CPIFood, CPICore, CPIGas, CPIOtherFuel, and CPIHHenergy are the seasonally adjusted component level CPI indexes for the above mentioned components. Note that this formula will not exactly replicate the January through April 2011 headline CPI since the components are not granular enough. When using the above formula to compute CPIHeadline(Apr11) and CPIHeadline(May11), we compute one-month headline inflation in May 2011 as the percent difference between the values of CPIHeadline(Apr11) and CPIHeadline(May11), both calculated with the above formula (i.e., do not use the reported value of CPIHeadline(Apr11)). In our calculations we used the same inflation assumptions for "other motor fuels" and "household energy" (both increase at a 5 percent annualized rate in May and June). By Patrick Higgins, an economist at the Atlanta Fed
By Dave Altig, senior vice president and research director at the Atlanta Fed
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June 01, 2011
Should we even read the monthly inflation report? Maybe not. Then again...
In a recent issue of Economic Synopsis, our colleague Dan Thornton of the St. Louis Fed questions the usefulness of the traditional core inflation statistics—the consumer price index (CPI), or the personal consumption expenditure price index that strips out food and energy costs. Specifically, Dan asks whether the core inflation statistic is a better predictor of future inflation over the medium term (say, the next two or three years), than the headline inflation statistic. His conclusion is that:
"[F]or the most recent period, there is no compelling evidence that core inflation is a better predictor of future headline inflation over the medium term."
But Dan also invites the following:
"[I]n the interest of greater transparency and to allow the public to better understand its focus on core measures, the FOMC [Federal Open Market Committee] should provide evidence of the superior forecasting performance of the core measure it uses."
Well, of course neither writer of this blog post is on the FOMC, and equally obvious is the fact that we don't speak for anyone who is. Moreover, we're not very big fans of the traditional core measures, and we much prefer trimmed-mean estimators of inflation when thinking about recent price behavior.
Nevertheless, we'd like to attempt an answer to Dan's call, even if it wasn't aimed at us.
Here's the experiment run by Dan: He used the past 36-month trend in the traditional core inflation measure and the ordinary headline inflation measure and tested which one most accurately predicted the next 36 months of headline inflation. He found that they're about the same. A similar look at 24-month trends yielded a similar result.
The upshot of these experiments can be seen in the figure below (which is a figure of our construction, not his).
The chart shows how accurately we can predict headline CPI inflation over the next three years using only headline CPI price data or, alternatively, using only core CPI price data. The essence of the conclusion reached in the Economic Synopsis is summarized within the shaded box. The forecast accuracy of the two- and three-year trends of the core CPI price measure doesn't seem to be a significant improvement to the plain-vanilla headline CPI.
But we wonder whether the contribution of the core inflation statistic is being accurately reflected in this experiment. For us, the power of a core inflation measure—whether it be the traditional ex-food and energy measure, or some more statistical construct like the trimmed-mean estimators—can't be seen by comparing data trends of this sort. The volatility of an inflation statistic, what we would characterize as "noise," dissipates rather quickly, generally within a few months (although for food and energy, it could play out over a longer period of time, we understand).
At issue is how much the most recent month's or quarter's inflation data should inform one's thinking about the future path of inflation. Implicit in the experiments reported above is that they shouldn't—well, only as much as the most recent monthly or quarterly data influence the trend of the past two or three years.
It may be that the most recent monthly or even quarterly data are so noisy that they have nothing useful to contribute to our perception of the future inflation trend. But then again, an experiment that assumes there is no useful information in the most recent inflation data does not necessarily make it so.
We'd like to call your attention to the remainder of the figure above, where we ask the question, what happens if you try to predict headline CPI inflation over the next three years using only the most recent price data? For example, what if we restrict ourselves to looking only at the most recent month's CPI report? What we see is that the core inflation statistic provides a much improved prediction of the future inflation trend compared to the headline measure. Specifically, forecast accuracy is improved by nearly 50 percent if you use the core inflation measure. (For you wonks, the root mean square error, or RMSE, of the core CPI prediction is about 1.4 percent, compared with a RMSE of 2.7 percent for headline CPI inflation.)
Now consider the behavior of CPI prices over the past three months. How informative of the future inflation trend are these prices? Well, the accuracy of the headline inflation statistic improves relative to the one-month percent change because averaging the data over time in this way necessarily reduces the transitory fluctuations in the data. But again, the three-month core CPI price statistic provides a much better prediction of future headline inflation than does the three-month trend in the ordinary CPI statistic. In other words, if you're wondering what the past-three months of data tell you about developing inflation pressure, you're much better off considering the core statistic than you are the headline number.
Here's another observation we'd like to make: The most recent three-month trend in the core CPI inflation measure appears to be a more accurate predictor of future inflation than the 12-month headline CPI trend. Moreover, the three-month trend in the core measure is roughly as accurate as its longer-term trends. This observation suggests that paying attention to the core measure may allow you to spot changes in the inflation trend much more quickly than using headline alone.
Again, to be clear, we aren't endorsing the core inflation statistic. We're fans of trimmed-mean estimators and think they do an even better job of informing thinking about what the most recent price data tell us about the likely future path of inflation. (As evidence, we included in the chart above the same forecasting results for the median CPI.) We only want to make one simple point—the usefulness of a core inflation measure is best seen in the monthly and quarterly intervals that span FOMC meetings, not in the two- or three-year trends which are, by construction, largely silent about the most recent data.
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