November 20, 2013
The Shadow Knows (the Fed Funds Rate)
The fed funds rate has been at the zero lower bound (ZLB) since the end of 2008. To provide a further boost to the economy, the Federal Open Market Committee (FOMC) has embarked on unconventional forms of monetary policy (a mix of forward guidance and large-scale asset purchases). This situation has created a bit of an issue for economic forecasters, who use models that attempt to summarize historical patterns and relationships.
The fed funds rate, which usually varies with economic conditions, has now been stuck at near zero for 20 quarters, damping its historical correlation with economic variables like real gross domestic product (GDP), the unemployment rate, and inflation. As a result, forecasts that stem from these models may not be useful or meaningful even after policy has normalized.
A related issue for forecasters of the ZLB period is how to characterize unconventional monetary policy in a meaningful way inside their models. Attempts to summarize current policy have led some forecasters to create a "virtual" fed funds rate, as originally proposed by Chung et al. and incorporated by us in this macroblog post. This approach uses a conversion factor to translate changes in the Fed's balance sheet into fed funds rate equivalents. However, it admits no role for forward guidance, which is one of the primary tools the FOMC is currently using.
So what's a forecaster to do? Thankfully, Jim Hamilton over at Econbrowser has pointed to a potential patch. However, this solution carries with it a nefarious-sounding moniker—the shadow rate—which calls to mind a treacherous journey deep within the hinterlands of financial economics, fraught with pitfalls and danger.
The shadow rate can be negative at the ZLB; it is estimated using Treasury forward rates out to a 10-year horizon. Fortunately we don't need to take a jaunt into the hinterlands, because the paper's authors, Cynthia Wu and Dora Xia, have made their shadow rate publicly available. In fact, they write that all researchers have to do is "...update their favorite [statistical model] using the shadow rate for the ZLB period."
That's just what we did. We took five of our favorite models (Bayesian vector autoregressions, or BVARs) and spliced in the shadow rate starting in 1Q 2009. The shadow rate is currently hovering around minus 2 percent, suggesting a more accommodative environment than what the effective fed funds rate (stuck around 15 basis points) can deliver. Given the extra policy accommodation, we'd expect to see a bit more growth and a lower unemployment rate when using the shadow rate.
Before showing the average forecasts that come out of our models, we want to point out a few things. First, these are merely statistical forecasts and not the forecast that our boss brings with him to FOMC meetings. Second, there are alternative shadow rates out there. In fact, St. Louis Fed President James Bullard mentioned another one about a year ago based on work by Leo Krippner. At the time, that shadow rate was around minus 5 percent, much further below Wu and Xia's shadow rate (which was around minus 1.2 percent at the end of last year). Considering the disagreement between the two rates, we might want to take these forecasts with a grain of salt.
Caveats aside, we get a somewhat stronger path for real GDP growth and a lower unemployment rate path, consistent with what we'd expect additional stimulus to do. However, our core personal consumption expenditures inflation forecast seems to still be suffering from the dreaded price-puzzle. (We Googled it for you.)
Perhaps more important, the fed funds projections that emerge from this model appear to be much more believable. Rather than calling for an immediate liftoff, as the standard approach does, the average forecast of the shadow rate doesn't turn positive until the second half of 2015. This is similar to the most recent Wall Street Journal poll of economic forecasters, and the September New York Fed survey of primary dealers. The median respondent to that survey expects the first fed funds increase to occur in the third quarter of 2015. The shadow rate forecast has the added benefit of not being at odds with the current threshold-based guidance discussed in today's release of the minutes from the FOMC's October meeting.
Moreover, today's FOMC minutes stated, "modifications to the forward guidance for the federal funds rate could be implemented in the future, either to improve clarity or to add to policy accommodation, perhaps in conjunction with a reduction in the pace of asset purchases as part of a rebalancing of the Committee's tools." In this event, the shadow rate might be a useful scorecard for measuring the total effect of these policy actions.
It seems that if you want to summarize the stance of policy right now, just maybe...the shadow knows.
By Pat Higgins, senior economist, and
Brent Meyer, research economist, both of the Atlanta Fed's research department
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November 15, 2013
Is Credit to Small Businesses Flowing Faster? Evidence from the Atlanta Fed Small Business Survey
The spigot of credit to small businesses appears to be turning faster. As of June 2013, outstanding amounts of small loans on the balance sheets of banks were 4 percent higher than their September 2012 levels, according to the Federal Deposit Insurance Corporation. While they are still 12 percent off 2007 levels, the recent increase is encouraging.
The turnaround in small loan portfolios is not the only sign of improved credit flows to small businesses. The Fed’s October 2013 senior loan officer survey indicates that credit terms to small firms have gradually eased since the second quarter of 2010. Approval ratings of banks and alternative lenders, as measured by Biz2Credit’s lending index, have also risen steadily over the past two years.
In addition to these positive signs, the Atlanta Fed’s third-quarter 2013 Small Business Survey has revealed signs of improvement among small business borrowers in the Southeast. The survey asked recent borrowers about their requests for credit and how successful they were at each place they applied. We also asked, “Over ALL your applications for credit, to what extent were you total financing needs met?” This measure of overall financing satisfaction showed some signs of improvement in the third quarter.
Chart 1 compares the overall financing satisfaction of small business borrowers in the first and third quarter of 2013. The portion of firms that received the full amount requested rose from 28 percent in the first quarter to 42 percent in the third quarter. Meanwhile, the portion that received none of the credit requested declined from 31 percent of the sample in the first quarter to 22 percent in the third quarter.
Further, financing satisfaction rose across a variety of dimensions. Chart 2 shows how average financing satisfaction changed for young firms and mature firms, across industries and by recent sales performance. In all cases, there were increases in the average amount of financing received from the first to the third quarter of 2013.
This broad-based increase in overall financing satisfaction is encouraging. Greater financial health of the applicant pool helped fuel the improvement in borrowing conditions. In the October survey, 52 percent of businesses reported that sales increased while 34 percent reported decreases. Sales have improved significantly from a year ago, when about as many firms reported sales increases as reported decreases. Measures of hiring and capital improvements over the year have also improved for the average firm in the survey (see chart 3).
Lending standards have been improving and small businesses have been slowly gaining momentum, but many obstacles remain. Open-ended questions in our survey revealed that small businesses are still concerned about a number of factors, including the general political and economic uncertainty, the impact of the Affordable Care Act, the higher collateral and personal guarantees required to obtain financing, and regulatory requirements that restrict lending. So while conditions on the ground seem to be improving for small businesses, there still appear to be headwinds that may be holding back a greater pace of improvement.
By Ellie Terry, an economic policy analysis specialist in the Atlanta Fed’s research department
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November 14, 2013
Atlanta Fed's Jobs Calculator Drills Down to the States
In March 2012, the Federal Reserve Bank of Atlanta launched its Jobs Calculator, an application that illustrates the relationship between the unemployment rate, growth in payroll employment, the labor force participation rate, and a few other variables to boot. Most notably, it tells us how many jobs need to be created to achieve a specific unemployment rate within a given period of time. This tool has turned out to be a useful one for anchoring discussions about national employment growth and unemployment among policy makers and the media.
However, the national employment situation masks significant differences in state labor markets. For example, at the trough of the business cycle (June 2009), the national unemployment rate was 9.5 percent, but it ranged from 4.2 percent in North Dakota to 15.2 percent in Michigan. State policy makers, in managing the dynamics of their own employment situation, need to know the data on a state level.
We are pleased to announce that the Atlanta Fed recently unveiled the state-level Jobs Calculator. The same tool that has been used for national discussions is now available for state-level analyses (see the figure below).
Not only does this state tab allow a quick overview of the historical employment growth in each state (see, for example, Alabama's historical employment growth in the figure below), but it also has the same functionality as the national Jobs Calculator. (Because of the recent partial government shutdown, the data are updated only through August; state-level employment data for October will be available November 22.)
Like the national Jobs Calculator, the state-level version allows the user to input a target unemployment rate, choose the number of months desired to hit the target rate, and find out how many new jobs are required per month to get there. But the calculator is flexible enough to allow other interesting experiments as well.
Consider the case of Florida. During the recession, Florida experienced a significant decline in its population growth. It has gone from a high of about 0.2 percent growth per month (roughly 2.4 percent per year) to its current 0.115 percent growth per month (about 1.38 percent per year; see the figure below). Suppose policy makers in Florida want to know how a return to prerecession population growth might affect the number of jobs needed to maintain its current unemployment rate over the next 12 months. (Note that as of August, the unemployment rate in Florida was 7 percent.)
The calculator's default settings always answer the question, “How many jobs per month does it take to maintain today's unemployment rate over the next 12 months?” To answer our hypothetical policy makers' question, all they would have to do is enter a prerecession monthly population growth rate of 0.2 percent into Florida's state Jobs Calculator, leaving everything else the same. Given the current data in hand, we would discover that Florida would need to generate about 6,000 more jobs per month at the higher population growth than at the current—and lower—population growth to stabilize the unemployment rate at 7 percent.
The data behind the state-level Jobs Calculator come from the U.S. Census Bureau's Establishment Survey, the same data used for the national Jobs Calculator, combined with the Local Area Unemployment Statistics (LAUS) programs run by each state. The LAUS contain the regional and state employment statistics that are consistent with data from the Census Bureau's Current Population Survey. State-level population estimates are provided by the U.S. Census Bureau (and are described in more detail here). You'll note that the LAUS data, especially for very small states, look more erratic than national or larger states' numbers—the unfortunate consequence of small sample sizes.
LAUS data are generally issued about the third Friday of each month following the reference month, which means that the state-level Jobs Calculator statistics will be updated about two weeks after the national Jobs Calculator. The schedule of release dates is available from the U.S. Bureau of Labor Statistics.
By Julie Hotchkiss, a research economist and policy adviser in the Atlanta Fed's research department
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November 12, 2013
The End of Asset Purchases: Is That the Big Question?
Last Friday, Atlanta Fed President Dennis Lockhart delivered a speech at the University of Mississippi, the bottom line of which was reported by the Wall Street Journal's Michael Derby:
Federal Reserve Bank of Atlanta President Dennis Lockhart said Friday that central bank policy must remain very easy for some time to come, although he cautioned the exact mix of tools employed by the central bank will change over time...
"Monetary policy overall should remain very accommodative for quite some time," Mr. Lockhart said... "The mix of tools we use to provide ongoing monetary stimulus may change, but any changes will not represent a fundamental shift of policy"...
That's a pretty accurate summary, but Derby follows up with commentary that feels somewhat less accurate:
The big question about Fed policy is what the central bank does with its $85 billion-per-month bond-buying program. It had widely been expected to start slowing the pace of purchases starting in September, but when it didn't do that, expectations went into flux. Ahead of the jobs data Friday, many forecasters had gravitated to the view bond buying would be trimmed some time next spring. Now, a number of forecasters said the risk of the Fed slowing its asset buying sooner has risen.
Now, the views that I express here are not necessarily those of the Federal Reserve Bank of Atlanta. But in this case, I think I can fairly claim that what President Lockhart was saying was that the big question is not "what the central bank does with its $85 billion-per-month bond-buying program." The following part of President Lockhart's speech—reiterated today in a speech in Montgomery, Alabama—is worth emphasizing:
The FOMC [Federal Open Market Committee] is currently using two tools to maintain the desired degree of monetary accommodation—the policy interest rate and bond purchases. Importantly, the FOMC has stated that it intends to keep the short-term policy rate low at least until the unemployment rate falls below 6 1/2 percent. This "forward guidance" is meant to convey a sense of how long short-term interest rates will stay near current levels.
There is some confusion about how the Fed's forward guidance and asset purchase program relate to each other. I will give you my view.
In the toolkit the FOMC has at its disposal, there is a sense in which asset purchases and low policy rates are complementary. Asset purchases and forward guidance on interest rates are complements in the sense that they are both designed to put downward pressure on longer-term interest rates....
But there is also a sense in which these tools are substitutes. By substitutes I mean that guidance pointing to a sustained low policy rate and asset purchases are discrete tools that can be deployed independently or in varying combinations. They can be thought of as a particular policy tool mix chosen to fit the circumstances at this particular phase of the recovery.
In other words, there is an important difference between changing the amount of monetary stimulus and changing the tools deployed to provide that stimulus. When the only tool in play is the federal funds rate, equating adjustments in the Fed's policy rate with changes in the stance of monetary policy is, while not completely straightforward, relatively simple. With multiple tools in use, however, gauging the stance of monetary policy requires that the settings of all policy instruments be considered.
Suppose that the FOMC does scale back or end its asset purchases? Can that possibly be consistent with maintaining a constant degree of monetary stimulus? Sure, and one obvious option is to use adjustments to the forward guidance portion of the FOMC's current policy to provide additional stimulus as asset purchases are scaled back. There are pros and cons to that approach, many of which surfaced in the discussion of this paper, by the Federal Reserve Board's Bill English, David Lopez-Salido, and Bob Tetlow, which circulated last week. (See, for example, here, here, and here.)
In any event, a decision to replace asset purchases with some other form of stimulus—be it extending forward guidance or another alternative—would necessarily raise the question: Why bother? One answer might arise from the cost and efficacy considerations that the FOMC has identified as part of the calculus for whether to continue with asset purchases.
Here again, the fact of multiple tools is germane. With the option of different policy mixes, altering the asset purchase program on grounds of cost or efficacy need not mean that the costs of the program are large or the purchases themselves lack effect. It need only mean that the costs might be larger, or the purchases less effective, than providing the same set of stimulus with some alternative set of tools. I give the last word to President Lockhart:
Going forward, it may be appropriate to adjust the policy tool mix. That will depend on circumstances and the economic diagnosis of the moment.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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