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January 03, 2017
Following the Overseas Money
Though the holiday season has come to a close, the forthcoming policy season may bring with it serious debate about a holiday of a different sort: a tax "holiday" that would allow corporations to repatriate accumulated profits currently held overseas.
As with many of the policy proposals that the new Congress and administration will consider, our primary interest here at the Atlanta Fed is to assess how the policy, if enacted, will likely affect our own economic forecasts and the environment in which future monetary policy will be made.
The best starting point is usually to just determine the facts as we know them. In this case, the question is what we know about the nature of the foreign earnings of U.S. corporations.
U.S. corporations' undistributed foreign earnings have been accumulating rapidly for more than a decade, as companies have expanded their foreign operations. The income earned by U.S. domestic corporations' foreign subsidiaries is generally not subject to U.S. tax until the income is distributed to the parent corporation in the United States. According to a November 25, 2016, Wall Street Journal article, over the past decade total undistributed foreign earnings of U.S. companies have risen from about $500 billion to more than $2.5 trillion, a sum equal to nearly 14 percent of U.S. gross domestic product.
Though it is not uncommon to refer to these sums as "a pile of cash," this sort of terminology is perhaps a bit misleading. For one, some of that "pile of cash" is not cash at all. According to a report from the Joint Committee on Taxation , "the undistributed earnings may include more than just cash holdings as corporations may have reinvested their earnings in their business operations, such as by building or improving a factory, by purchasing equipment, or by making expenditures on research and experimentation."
More important, the portion of foreign earnings that hasn't been invested in business operations is not necessarily "trapped" or "stashed" overseas. In fact, much of it is in the United States, already working (albeit while untaxed) for the U.S. economy.
U.S. companies do not routinely disclose what their foreign subsidiaries do with undistributed earnings. To better understand the situation, in 2011 the Senate Permanent Subcommittee on Investigations conducted a survey of 27 large U.S. multinationals. Survey results showed that those companies' foreign subsidiaries held nearly half of their earnings in U.S. dollars, including U.S. bank deposits and Treasury and corporate securities (see the table).
A couple of years later, a June 13, 2013, Wall Street Journal report also found that Google, EMC, and Microsoft kept more than three-quarters of their foreign subsidiaries' cash in U.S. dollars or dollar-denominated securities.
So it turns out, then, that a large fraction of undistributed foreign profits is held at U.S. banks or invested in U.S. securities. Even dollar deposits held by U.S. companies in tax havens such as Ireland, the Cayman Islands, and Singapore ultimately live here in the United States because foreign banks typically hold their dollar deposits in so-called correspondent banks in the United States.
In fact, U.S. dollar balances always stay in the United States, even if they are controlled from outside the country. Those dollars in turn are available to be lent out to U.S. businesses. And when U.S. companies' foreign subsidiaries invest their cash holdings in U.S. Treasury bonds, they are in effect lending to the U.S. government.
Foreign subsidiaries of U.S. companies choose to invest their profits in dollar-denominated assets for much the same reasons that make the U.S. dollar an international reserve currency:
- the dollar maintains its value in terms of goods and services (the dollar is a global unit of account);
- U.S. financial markets are deep and liquid, providing ample investment choices; and
- U.S. government obligations are considered virtually risk-free, making them a safe haven during times of global stress and risk aversion.
Companies also have operational reasons for keeping surplus cash in U.S. dollars. Most of the international trade invoicing is done in dollars, so U.S. companies' foreign subsidiaries hold dollars to pay suppliers and deal with customers. Also, nonfinancial companies prefer to avoid foreign exchange risk and volatility. Finally, holding most of the funds, which are not invested in foreign operations, in dollars mitigates potential accounting losses, since U.S. companies are required to report in dollars on their consolidated financial statements.
None of this is to say that a tax holiday for U.S. corporations on undistributed foreign profits is a good or bad policy choice. But even without passing judgment, it may fall to macroeconomic forecasters to estimate the policy impact on business investment, job growth, and the like. Understanding the facts underlying the targeted funds is a reasonable starting point for answering the harder questions that may come.
November 13, 2012
(Fiscal) Cliff Notes
Since it is indisputably the policy question of the moment, here are a few of my own observations regarding the "fiscal cliff." Throughout, I will rely on the analysis of the Congressional Budget Office (CBO), as reported in the CBO reports titled An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022 and Economic Effects of Policies Contributing to Fiscal Tightening in 2013.
Since the CBO analysis and definitions of the fiscal cliff are familiar to many, I will forgo a rehash of the details. However, in case you haven't been following the conversation closely or are in the mood for a refresher, you can go here first for a quick summary. This "appendix" also includes a description of the CBO's alternative scenario, which amounts to renewing most expiring tax provisions and rescinding the automatic budget cuts to be implemented under the provisions of last year's debt-ceiling extension.
On, then, to a few facts about the fiscal cliff scenario that have caught my attention.
1. Going over the cliff would put the federal budget on the path to sustainability.
If reducing the level of federal debt relative to gross domestic (GDP) is your goal, the fiscal cliff would indeed do the trick. According to the CBO:
Budget deficits are projected to continue to shrink for several years—to 2.4 percent of GDP in 2014 and 0.4 percent by 2018—before rising again to 0.9 percent by 2022. With deficits small relative to the size of the economy, debt held by the public is also projected to drop relative to GDP—from about 77 percent in 2014 to about 58 percent in 2022. Even with that decline, however, debt would represent a larger share of GDP in 2022 than in any year between 1955 and 2009.
Such would not be the case should the status quo of the CBO's alternative scenario prevail. Under (more or less) status quo policy, the debt-to-GDP ratio would rise to a hair under 90 percent by 2022:
The current debt-to-GDP ratio of 67 percent is already nearly double the 2007 level, which checked in at about 36 percent. However, though the increase in the debt-to-GDP ratio over the past five years is smaller in percentage terms, a jump to 90 percent from where we are today may be more problematic. There is some evidence of "threshold effects" that associate negative effects on growth with debt levels that exceed a critical upper bound relative to the size of the economy. At the Federal Reserve Bank of Kansas City's 2011 Economic Symposium, Steve Cecchetti offered the following observation, based on his research with M.S. Mohanty and Fabrizio Zampolli:
Using a new dataset on debt levels in 18 Organisation for Economic Co-operation and Development (OECD) countries from 1980 to 2010 (based primarily on flow of funds data), we examine the impact of debt on economic growth....
Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the number is about 85 percent of GDP.
Of course, causation is always a tricky thing to establish, and Cecchetti et al. are clear that their estimates are subject to considerable uncertainty. Still, it is clear that the fiscal cliff moves the level of debt in the right direction. The status quo does not.
2. The fiscal cliff moves in the direction of budget balance really fast.
By the CBO's estimates, over the next three years the fiscal cliff would reduce deficits relative to GDP by about 6 percentage points, from the current ratio of 7.3 percent to the projected 2015 level of 1.2 percent.
Deficit reduction of this magnitude is not unprecedented. A comparable decline occurred in the 1990s, when the federal budget moved from deficits that were 4.7 percent of GDP to a surplus equal to 1.4 percent of GDP. However, that 6 percentage point change in deficits relative to GDP happened over an eight-year span, from 1992 to 1999.
It is probably also worth noting that the average annual rate of GDP growth over the 1993–99 period was 4 percent. The CBO projects real growth rates over the next three years at 2.7 percent, which incorporates two years of growth in excess of 4 percent following negative growth in 2013.
The upshot is that, though the fiscal cliff would move the federal budget in the right direction vis à vis sustainability, it does so at an extremely rapid pace. I'm not sure speed kills in this case, but it sounds pretty risky.
3. The fiscal cliff heavily weights deficit reduction in the direction of higher taxation.
Over the first five years off the cliff, almost three-quarters of the deficit reduction relative to the CBO's no-cliff alternative would be accounted for by revenue increases. Only 28 percent would be a result of lower outlays:
The balance shifts only slightly over the full 10-year horizon of the CBO projections, with outlays increasing to 34 percent of the total and revenues falling to 66 percent.
Particularly for the nearer-term horizon, there is at least some evidence that this revenue/outlay mix may not be optimal. A few months back, Greg Mankiw highlighted this, from new research by Alberto Alesina, Carlo Favero, and Francesco Giavazzi:
This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions.
Of course, that in the end is a relatively short-run impact. It does not directly confront the growth aspects of the policy mix associated with fiscal reform. Controversy on the growth-maximizing size of government and the best growth-supporting mix of spending and tax policies is longstanding. The dustup on a Congressional Research Services report questioning the relationship between top marginal tax rates and growth is but a recent installment of this debate.
Here's what I think we know, in theory anyway: Government spending can be growth-enhancing. Tax increases can be growth-retarding. It's all about the tradeoffs, the details matter, and unqualified statements about the "right" thing to do should be treated with suspicion. (If you are an advanced student of economics or otherwise tolerant of a bit of a math slog, you can find an excellent summary of the whole issue here.)
In other words, there are lots of decisions to be made—and it would probably be better if those decisions are not made by default.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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October 17, 2011
State and local fiscal fortunes: Follow the money (collected)
Last week, we found ourselves in conversation with some colleagues discussing the issue of state and local fiscal conditions, which by pure coincidence coincided with the announcement that the city of Harrisburg, Pa., filed for bankruptcy. In the course of conversation, our attention was drawn to an interesting fact. Prior to 2000, according to U.S. Census Bureau data through 2008, annual growth of total revenues at the state and local level was closely aligned with direct expenditures at the same level. Since 2000, however, this pattern has decidedly changed. The main reason is the dramatic volatility of total revenue:
Revenues at the state and local level come from many sources. Taxes from income, sales, and property, of course, but also from various fees and charges associated from education, utilities, ports and airports, and so on. In addition, revenues come from transfers from the federal government and, importantly, asset income from trust fund portfolios.
In fact, the primary source of the increased volatility in state and local government revenues since 2000 is large swings in revenue going into insurance trust funds to finance compulsory or voluntary social insurance programs operated by the public sector.
Insurance trust revenue is derived from contributions, assessments, premiums, or payroll "taxes" required of employers and employees. It also includes any earnings on assets held or invested by such funds. Not surprisingly then, the volatility of insurance trust revenue is partly tied to volatility in financial markets, as the chart below clearly illustrates.
Though fluctuations in insurance fund revenues have been the largest source of fluctuations in overall state and local revenues over the past decade or so, volatility in general revenue is still an issue. Ups and downs in income tax revenues have been particularly sharp since 2000.
Interestingly, Census Bureau data for state government finances show tax revenue growth turned negative in 2009.
In research that focuses specifically on revenue variability at the state level, UCLA law professor Kirk Stark notes the possibility that state revenues have too much reliance on the same income-centric tax base that characterizes the federal revenue code:
"Perhaps the most obvious (yet little discussed) federal inducement for the design of state and local tax systems is the fact that Congress has established an elaborate and detailed legal framework for certain taxes—including, most notably, the individual and corporate income taxes—but not for others. The very existence of the Code, Treasury Regulations, IRS administrative guidance, and federal judicial case law creates an almost irresistible incentive for the states to adopt individual and corporate income taxes. The availability of the federal income tax base as a starting point in calculating state tax liability is an unqualified benefit. …
"At the same time, however, there are potentially significant costs associated with having states piggyback on the federal income tax. Taxes that might be suitable for use by a central level of government are not necessarily appropriate for use by state or local governments. Some of the most volatile state revenue sources are those upon which states rely by virtue of piggybacking on the federal income tax."
The theme of Professor Stark's article is the role that federal policy might play in generating revenue volatility at the state level:
"Through various inducements and limitations embedded in federal law, the federal government has stacked the deck in favor of state revenue volatility, unwittingly exacerbating the subnational fiscal crises that it is then called upon to mitigate through bailouts and general fiscal relief."
Some other examples of how federal tax policy can have an impact on state and local policy according to Stark include "differential treatment of alternative tax sources within the federal income tax deduction for state and local taxes" and "various specific provisions in federal law that limit state taxing authority."
Professor Stark is clear on the point that the research in this area has defied simple generic conclusions about how state and local tax codes can be constructed to minimize revenue volatility. And the work is largely silent on how the volatility question fits into the broader question of optimal tax-system design. But it is hard to argue with this conclusion:
"If the federal government is interested in reducing the likelihood and severity of future state fiscal crises, it should consider changes to federal law that would eliminate the current bias in favor of volatile state tax systems."
By Dave Altig, senior vice president and research director at the Atlanta Fed
John Robertson, vice president and senior economist in the Atlanta Fed's research department
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May 19, 2011
The long and short (runs) of tax reform
In an earlier part of my career, I spent a fair amount of time thinking about fiscal policy issues. The evolution of my responsibilities eventually moved my attentions in a somewhat different direction, but you never really forget your first research love. With questions of debt, government spending, and taxes at the top of the news, it isn't hard for my old fondness for the topic to reemerge.
So, in that context, I had a somewhat nostalgic response to an item at Angry Bear, written by contributor Dan Crawford. In essence, the Crawford post formally (through statistical analysis) asks the question "How is GDP growth related to marginal tax rates (that is, the tax rate applied to your last dollar of income)?" More specifically, Crawford analyzes how gross domestic product (GDP) growth next year is related to the marginal tax rate faced by the average individual and the marginal tax rate faced by the highest-income taxpayers.
I don't intend to quibble with the specifics of that experiment per se but rather highlight an aspect of taxation and tax reform that I think should not be forgotten. That is, the short run is no place for a decent discussion of tax policy to be hanging out. To say that more formally, the largest effects of tax policy accrue over time, and it is probably not a good idea to be too focused on the immediate—say, next year's—effects of any given policy or change in policy.
The following chart is based on tax reform experiments in a paper I co-authored over a decade ago with Alan Auerbach, Larry Kotlikoff, Kent Smetters, and Jan Walliser. (Note that the chart does not appear in the paper, but I created it using data from the paper—a publicly available version of the paper can be found here.) The chart depicts the cumulative percentage increases in national income that would be realized (in our model) in the years following three different tax reforms.
The three experiments depicted in this chart were as follows:
"[The clean income tax] replaces the progressive taxation of wage income with a single rate that is also applied to capital income. In addition, the clean income tax eliminates the major federal tax-base reductions including the standard deduction, personal and dependent exemptions, itemized deductions, the deductibility of state income taxes at the federal level, and preferential tax treatment of fringe benefits...
"Our flat tax experiment modifies the clean consumption tax by including a standard deduction of $9500. In addition, housing wealth, which equals about half of the capital stock, is entirely exempt from taxation."
Parenthetically, the "clean consumption tax"
"...differs from the clean income tax by including full expensing of investment expenditures. This produces a consumption-tax structure. Formally, we specify the system as a combination of a labor-income tax and a business cash-flow tax."
"Our [flat tax with transition relief] experiment adds transition relief to the flat tax by extending pre-reform depreciation rules for capital in place at the time of the tax reform."
Here's what I want to emphasize in all of this. If the change in policy you might be considering involves a reduction in effective marginal tax rates (implemented via a combination of changes in statutory rates and adjustments in deductions and exemptions), the approach taken by Crawford in his Angry Bear piece is probably acceptable. The clean income tax reform is in the spirit of Crawford's calculations, and in our results the long-run impact on output is realized almost immediately. If, however, the tax reform involves changing the tax base in a fundamental way (in both versions of our flat tax experiments the base shifts from income to consumption), then the ultimate effects are felt only gradually. In our flat tax experiments, the longer-run effects on income are in the neighborhood of three times as large as the near-term effects.
All of the experiments described were done under the assumption of revenue neutrality, so questions of the right policy for budget balancing exercises weren't explicitly addressed. (Nor is it the nature of the experiment contemplated in the Angry Bear post.) Nonetheless, they do suggest that deficit reduction exercises that involve changes in tax rates and the tax base will have differential effects over time, and realizing the full benefits of tax reform may require a modicum of patience.
Note: A user-friendly description of the paper that the chart above is based on appeared in an Economic Commentary article published by the Cleveland Fed.
Update: Though the item at Angry Bear was posted by Dan Crawford, Mike Kimel actually wrote it. I apologize for the mistake and draw your attention to Kimel's follow-up post.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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April 18, 2011
Can Keynesians be anti-Keynesian?
Follow any policy debate, and you are sure to find a list of economists who support or inspire those on both sides of the issue. In The Economist, we find some of those on the roster for the new Republican leadership in the House of Representatives, and why:
"When Republicans proposed slashing billions of dollars from federal spending this year, Democrats circulated predictions by economists that jobs and growth would be hit. John Boehner, the Republican speaker in the House of Representatives, countered with an economic expert of his own: John Taylor of Stanford University. 'Nothing could be more contrary to basic economics, experience and facts,' Mr. Taylor asserted on his blog, which Mr. Boehner cited. By cutting government spending, he said, the Republicans would 'crowd in' private investment and create jobs.
"… if there is one ideology that unites today's Republicans, it is Keynesianism, whose nefarious influence they are determined to stamp out. 'Young Guns,' the book-sized manifesto of Eric Cantor, Kevin McCarthy and Paul Ryan, leading Republican House members, devotes several pages to the evils of Keynesian activism and its exponents in the administration."
One of the interesting things about the article is that among the economists cited as being among the critics of "Keynesianism," you find the names John Taylor, Robert Mundell, and Kenneth Rogoff. I find that list interesting because if you follow the links I attached to those names you will find work with models that are decidedly Keynesian in structure. Works by Taylor and Rogoff are, in fact, seminal contributions to the "New Keynesian" paradigm that dominates macroeconomics today.
As far as I know, none of these men have repudiated the basic worldview that motivates the referenced work. In fact, as recently as last year John Taylor approvingly described, as he has many times, a key characteristic of the paradigm for monetary policy that was in place the decades before the financial crisis:
"… the central bank has a strategy, or rule, to adjust the interest rate depending on economic conditions: In general, the interest rate rises by a certain amount when inflation increases above its target and the interest rate falls when by a certain amount when the economy goes into a recession."
I added the emphasis to the last part of that passage as it is a feature of the so-called Taylor rule that is entirely built on the foundation of the New Keynesian model.
How, then, to explain the Keynesian predilections of the economists mentioned as presumed carriers of the anti-Keynesian mantle? The source of the confusion, I think, goes back to the historical, but somewhat obsolete, distinction between so-called Keynesianism and monetarism. The latter was, of course, personified in Milton Friedman and his dispute with what was the orthodoxy in the three decades following the Great Depression. Lost in the early-days labeling, however, was the fact that the disputes were more about the empirical details of theory rather than the theory itself.
In particular, Friedman did not deny the effectiveness of policy in principle but rather its wisdom or impact in practice. This sentiment is exactly the one he expressed in his prescient and transformative 1968 presidential address to the American Economics Association:
"In the United States the revival of belief in the potency of monetary policy was strengthened also by the increasing disillusionment with fiscal policy, not so much by its potential to increase aggregate demand as with the practical and political feasibility of so using it."
In a recent essay on Friedman's views about the ineffectiveness of fiscal policy, Tim Congdon notes Friedman's views on the issue:
"Friedman offered two informal theoretical arguments for the virtual irrelevance of fiscal policy, as he saw it. The second was that fiscal policy is much harder to adjust in a sensitive short-term way than monetary policy. But the first was the more telling and deserves detailed discussion.… In Friedman's words, 'I believe it to be true… that the Keynesian view that a government deficit is stimulating is simply wrong.' The explanation was the wider effects of the way the budget deficit is financed. To quote again, 'A deficit is not stimulating because it has to be financed, and the negative effects of financing it counterbalance the positive effects, if there are any, on spending.' "
Though Congdon emphasizes different channels (associated with the mix of monetary and fiscal policy associated with deficit spending), those who follow such things may recognize in Friedman's remarks the notion of Ricardian equivalence:
"This is the idea that increased government borrowing may have no impact on consumer spending because consumers predict tax cuts or higher spending will lead to future tax increases to pay back the debt.
"If this theory is true, it would mean a tax cut financed by higher borrowing would have no impact on increasing aggregate demand because consumers would save the tax cut to pay the future tax increases."
My point is not to dispute or defend the truth of the Ricardian proposition. My point is that it has absolutely nothing to do with whether one believes (or does not believe) that the New Keynesian framework is the right way to view the world. The essential policy implications of the New Keynesian idea (like the old Keynesian idea) is that changes in gross domestic product can be driven by changes in desired spending by households, businesses, foreigners, and the government in sum. You can believe that and still believe in fiscal policy ineffectiveness, as long as you believe that total spending is unaltered by a particular policy intervention.
There are, of course, plenty of arguments against fiscal policy activism that do not require adherence to Ricardian equivalence, in total or in part. The most obvious would be the position that any short-term rush from stimulative policies is more than reversed in the long run by the negative consequences of higher tax rates on productive activity, or the redirection of private investment to lower return public spending. Again, the point is that a self-professed adherent to a Keynesian reality need suffer no doubts about the coherence of his or her intellectual framework if he or she objects to fiscal policies aimed at juicing the economy through greater government spending.
This whole discussion may seem like a bit of inside baseball, and perhaps it is. But the stakes in this debate are high, as clearly illustrated by today's announcement from rating agency Standard & Poor's that it reduced its outlook to negative on the triple-A credit rating of the United States. In my view, productive discussions about the truly pressing issues of our day are unlikely unless we understand where the disagreements lie—and where they do not.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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November 23, 2010
Federal Reserve policies focused
This blog posting was originally an article in the Sunday, November 21, edition of the Atlanta Journal-Constitution. The article was written by Atlanta Fed Senior Vice President and Research Director David Altig.
On Nov. 3, the Federal Open Market Committee (FOMC)—the group within the Federal Reserve charged with formulating monetary policy for the United States—announced its plans to purchase, over the course of the next eight months, up to $600 billion worth of longer-term Treasury securities.
In many circles (maybe including yours), this decision has generated some controversy. A good deal of the controversy revolves around the view that this monetary policy decision is aimed at buying up government debt for the purpose of making it easier for the country to continue on the path of deficit spending. This view is inaccurate.
I understand the concerns that are triggered when the Fed announces a significant Treasury purchase program at a time when the fiscal situation is so challenging and unsettled. Be it the hyperinflations of Germany's Weimar Republic in the period between the two world wars; Hungary after World War II; or the more recent case of Zimbabwe, most of us have heard or read of extreme examples of countries that ended up creating big problems trying to finance government by printing money.
Generating government revenues via the printing press is a policy that is often referred to as "monetizing the debt." I think the emphasis in that sentence should be on the word policy. A policy is really a sort of rule—sometimes explicit, sometimes only implicit—that lays out a decision maker's objectives and how they are going to be attained. The objective of a policy of monetizing the debt is to create inflation as a means of lowering the burden of government debt by lowering the value of the debt and interest the government must repay in inflation-adjusted terms.
Monetizing debt is decidedly not the current policy of the Federal Reserve, at least not according to Federal Reserve Chairman Ben Bernanke. Speaking at a recent conference hosted by the Federal Reserve Bank of Atlanta, Chairman Bernanke was unequivocal: "We are not in the business of trying to create inflation."
So what business is the Fed in?
In short, the Fed's so-called dual mandate charges the FOMC with promoting sustainable growth and low and stable inflation. Though the economy is moving forward, it is doing so at a pace that is only slowly yielding job growth. This forward momentum has not yet proved robust or sustained enough to dent the unemployment rate.
More important, the economic landscape at the end of the summer was colored by the continuation of a declining inflation trend that was bleeding into expectations about the probability of deflation. In a still-recovering economy with very low interest rates, the emergence of deflation expectations would be a most unwelcome development that could seriously impede the prospect for continued recovery.
As Atlanta Fed President Dennis Lockhart has said, stabilizing inflation expectations is a key to policy success, and "managing inflation expectations requires following through with policy actions consistent with stated objectives—in this case ensuring that inflation trends remain in a desired zone. The FOMC's November decision should be seen in that light."
The policy represented by the November decision appears to be working. As markets came to expect the November announcement, price expectations that had been declining all summer began to stabilize and have now returned to pre-summer levels.
Could the policy be too successful? That is, there a risk that the policy will overshoot and replace declining inflation rates with too-high inflation rates?
There are, of course, always risks to action and inaction. Now that the FOMC's action has apparently mitigated the risk of a recovery-threatening disinflationary spiral, at some point it will be appropriate to turn attention to inflation risks. As President Lockhart recently commented, we at the Atlanta Fed are confident these decisions will be made independent of fiscal considerations.
The current focus is on rising commodity prices, and the Federal Reserve, including the Atlanta Fed, is watching those developments too.
As one of the 12 Federal Reserve Banks charged with bringing a real-time sense of the economy to the monetary policy process, the Atlanta Fed queries hundreds of contacts every month. In general, our contacts, while acknowledging some rising cost pressures, do not indicate they are likely to respond with price hikes of their own.
But we will keep asking, watching for signs that things are changing, and preparing in the event that a change in course is warranted.
And this vigilance is precisely the point. Intentions do matter, and President Lockhart has made his very clear: "Rest assured, should inflation begin to move above desired levels, I am confident the FOMC will work hard to keep it from getting away from us."
By Dave Altig, senior vice president and research director at the Atlanta Fed
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October 27, 2010
Real estate and municipal revenue
It's no secret that state and local governments are currently experiencing substantial revenue declines. One popular explanation is that deteriorating local real estate conditions are responsible for a portion of that decline, but it turns out that this explanation is not the main cause, at least not yet. One of the sessions in the conference featured attempts by three economists from the Federal Reserve Board of Governors (Lutz, Molloy, and Shan) and two from Florida State University (Doerner and Ihlanfeldt) to estimate the direct impact of the decline in real estate values on local tax revenues. Both papers examined the multiple channels of influence between the decline in real estate values and local revenues.
The largest channel, of course, is the decline in property tax income related to declining assessed property values. Of course, property owners don't pay property taxes based on the current value of their home. They pay based on an assessment that is at least a year old. Thus, the decline in property values takes considerable time to work its way through the assessment process and into property tax revenues. Consequently, declines in property values have only more recently started to be reflected in lower property tax revenues. Experts expect the decline in those revenues to continue for another couple of years, with the worst shortfall two or three years out. Some of the assessments are fairly gloomy.
To illustrate that point, I've pulled a few charts from the Lutz, Molloy, and Shan paper. The first chart illustrates the decline in revenues led by individual and sales taxes. Notably, property tax collections grew at an increasing rate in 2009 over 2008.
The next chart directly depicts the relationship (or the short-run lack thereof) between housing price growth changes and property tax revenue. Lags in changes in assessments and the ability of local governments to change property tax rates can go a long way in explaining why overall property tax revenue continues to grow.
Finally, Lutz, Molloy, and Shan broke down the data by some states, and I include the case of Georgia below. (The Ihlanfeldt and Doerner paper does something similar—and in great detail for the state of Florida.) The Georgia case clearly shows the effect of the lags: property values rose through the first part of the last decade and, even though tax rates were falling, overall tax revenue rose. Post-2007, however, market values of homes declined while the aggregate assessed values continued to rise through 2009 (along with property tax revenue).
It is hard to imagine the trend of aggregate increased assessed valuation continuing. If the assessed values begin to track the market values, pressures will emerge on the government entities that depend on property taxes. The picture suggests that tax rates and/or spending on programs are likely to change notably during the coming few years.
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December 08, 2009
Another rescue plan comes in below the original price tag
Though the tab to taxpayers could still be substantial when all is said and done, it now appears the taxpayer cost of the Troubled Asset Relief Program (TARP) will be substantially lower than was thought not too long ago:
"The Obama administration expects the cost of the Troubled Asset Relief Program to be $200 billion less than projected, helping to reduce the size of the budget deficit, a Treasury Department official said yesterday.
"The administration forecast in August that the TARP would ultimately cost $341 billion, once banks had repaid the government for capital injections and other investments. Congress authorized $700 billion for the program in October 2008."
There is precedent for such good news. Travel back for a moment to the formation and operation of the Resolution Trust Corporation (RTC), the agency formed to purchase and sell the "toxic assets" of failed financial institutions following the savings and loan crisis of the 1980s. As noted in a postmortem by Timothy Curry and Lynn Shibut of the Federal Deposit Insurance Corporation (FDIC), the cost projections for the RTC ballooned in the early days of its operations:
"Reflecting the increased number of failures and costs per failure, the official Treasury and RTC projections of the cost of the RTC resolutions rose from $50 billion in August 1989 to a range of $100 billion to $160 billion at the height of the crisis peak in June 1991..."
In the end, however, the outcome, though higher than the very first projections, came in well below the figures suggested by the worst case scenario:
"As of December 31, 1999, the RTC losses for resolving the 747 failed thrifts taken over between January 1, 1989, and June 30, 1995, amounted to an estimated $82.7 billion, of which the public sector accounted for $75.6 billion, or 91 percent, and the private sector accounted for $7.1 billion, or 9 percent."
While people may debate the approaches taken, it is heartening to see evidence that TARP, like the RTC before it, is ultimately costing considerably less than estimated.
By David Altig, senior vice president and research director of the Atlanta Fed
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May 29, 2009
A new accord?
As days go in the U.S. Treasury market, Wednesday was a rough one. Bloomberg News described the day's developments as follows:
"The difference in yields between Treasury two- and 10-year notes widened to a record on concern surging sales of U.S. debt will overwhelm the Federal Reserve's efforts to keep borrowing costs low. …
"The unprecedented government borrowing has created concern about a rise in consumer prices. Policy makers have expanded the Fed's balance sheet to $2.2 trillion while excess reserves at U.S. banks have increased to $896.3 billion.
" 'Inflation is in the headlight of many investors,' wrote Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc., in a note to clients today."
By cosmic coincidence, I was reading that story in Tokyo as I prepared to chair a session at the Bank of Japan's 2009 International Conference on Financial System and Monetary Policy Implementation in which Marvin Goodfriend (Carnegie-Mellon professor and former Richmond Fed policy adviser) presented his thinking on keeping the central bank's inflation objectives firmly in hand at a time of rapidly rising government debt and large increases in the Fed's balance sheet. Professor Goodfriend's case is laid out in a paper titled "Central Banking in the Credit Turmoil: An Assessment of Federal Reserve Practice" (which was also presented at a conference devoted to research on the interactions between monetary and fiscal policy—that is, government spending and tax—co-sponsored by Princeton University's Center for Economic Policy Studies and Indiana University's Center for Applied Economics and Policy Research). Goodfriend pulls no punches:
"The 1951 'Accord' between the United States Treasury and the Federal Reserve was one of the most dramatic events in U.S. financial history. The Accord ended an arrangement dating from World War II in which the Fed agreed to use its monetary policy powers to keep interest rates low to help finance the war effort. The Truman Treasury urged that the agreement be extended to keep interest rates low in order to hold down the cost of the huge Federal government debt accumulated during the war. Fed officials argued that keeping interest rates low would require inflationary money growth that would destabilize the economy and ultimately fail.
"The so-called Accord was only one paragraph, but it famously reasserted the principle of Fed independence so that monetary policy might serve exclusively to stabilize inflation and the macroeconomic activity. …
"The enormous expansion of Fed lending today—in scale, in reach beyond depository institutions, and in acceptable collateral—demands an accord for Fed credit policy to supplement the accord on monetary policy. A credit accord should set guidelines for Fed credit policy so that pressure to misuse Fed credit policy for fiscal purposes does not undermine the Fed's independence and impair the central bank's power to stabilize financial markets, inflation, and macroeconomic activity."
Goodfriend's "new accord" amounts to asserting a set of principles that would reinforce price stability as the central goal of monetary policy, set the Fed down the road of extricating itself from the extraordinary credit market interventions of the past year-and-a-half, and join the central bank and Treasury in common cause toward the goal of doing everything possible to make sure that the Fed and Treasury don't go there again.
The paper was provocative, but it also raised a couple of fundamental questions. In particular, what is the degree of autonomous fiscal risk-taking appropriate to allocate to a central bank? If such powers are granted, how often and under what conditions ought those powers be exercised? And how far should the powers reach? If, as Goodfriend states, "the central bank's power to stabilize financial markets, inflation, and macroeconomic activity" requires lender-of-last-resort interventions—and hence pure credit policy interventions—what does that imply about the appropriate scope of monetary and regulatory authorities going forward? If the "shadow banking system" is the de facto banking system of the modern era—as Yale University's Gary Gorton argued in a paper presented at the Atlanta Fed's annual Financial Markets Conference held earlier this month—is the central bank's lender-of-last-resort function meaningful if narrowly construed (that is, if it fails to reach the shadow banking system)?
These, really, are first-order questions. On to the debate.
By David Altig, senior vice president and research director of the Atlanta Fed
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February 24, 2009
Foreclosure mitigation: What we think we know
One of the most important challenges facing policymakers today is reducing the rate of mortgage foreclosures. It is a goal many think is at the heart of a sustained recovery in the U.S. economy. But as past attempts to reduce financial stress on homeowners have shown, the task is not easy. One of the complicating factors in formulating successful foreclosure mitigation policy is getting at the heart of the relationship between negative equity (the situation where the remaining mortgage balance is greater than the value of the house) and actual foreclosure.
Economic theory poses one categorical prediction about this relationship, which is that negative equity is a necessary condition for default. In other words, if a borrower is not in a position of negative equity, then he or she should never default. This conclusion follows simply from the fact that positive equity implies a borrower can sell the house, pay off the mortgage, and keep the difference—a better outcome under any circumstance compared with stopping payment on the mortgage and leaving the home.
What economic theory does not say is that if a borrower has negative equity, he or she should always default. The reason for this is that the owner could always default in the future, and thus there is value in waiting to see if house prices recover. Now, this value to waiting differs across borrowers and is sensitive to both the depth of negative equity and a borrower's financial situation. Why does a borrower's financial health matter? Well, the cost of waiting includes the monthly mortgage payment the borrower must continue to make. Borrowers who have plenty of wealth and a steady stream of income will be more willing to continue making payments than borrowers who are in financial distress, perhaps related to an unemployment spell or some other adverse financial shock.
So why does all of this matter in terms of thinking about a successful foreclosure mitigation program? Well, the appropriate policy prescription depends on the particular reason a borrower is currently considering default. I think it is useful to break things down in terms of three (not necessarily mutually exclusive) groups of mortgage borrowers:
- those in unaffordable mortgages from the very beginning, who were implicitly relying on increasing house prices to refinance or sell for a profit;
- those who have been hit by an adverse, but temporary, income/financial shock; and
- those who purchased the house for strictly investment purposes and now see little or no hope of making a profit.
Borrowers may find themselves with unaffordable mortgages for many reasons. One might be an unscrupulous mortgage broker, who steered the borrower into an unaffordable subprime loan in order to generate high origination fees. Another, related situation would be an unaffordable interest rate reset on a subprime adjustable-rate mortgage. Finally, some mortgages may be permanently unaffordable because a buyer misrepresented income or assets during the origination process, a situation made easier by the growth of low documentation mortgages.
A large part of the administration's new housing plan—summarized succinctly by the New York Times, with lots of commentary (negative and positive) rounded up at Economist's View—is reasonably interpreted as being directed squarely at borrowers in the unaffordable-mortgage group. If policy is to be aimed at helping this group, the prescription is to offer the borrower a permanent reduction in monthly payments, whether it comes from lowering the interest rate, lengthening the maturity, and/or reducing the outstanding principal balance on the loan. The measuring stick often used in such plans is the debt-to-income ratio (DTI), which is the borrower's monthly mortgage and/or total required debt payments relative to his or her gross monthly income. While the administration's plan would succeed in lowering DTIs, the policy is temporary in nature (five years), and it is unclear what would happen to these borrowers after the plan runs its course—especially if negative equity is still an issue.
Many borrowers might have been able to afford their mortgages while employed but can no longer do so after they have lost their jobs. When housing prices are rising and homeowners enjoy positive equity, then distressed borrowers are able to sell their homes to pay off their mortgages. Alternatively, such borrowers can undertake cash-out refinances to gain some much-needed liquidity. Note that problems can occur for people in this situation even when positive future equity is a realistic hope. If the borrower is unemployed and liquidity constrained, the cost of waiting to default is very high and potential future price gains are of little value. Default in this case is much more likely, even though future prospects might be reasonably good. In this case, foreclosure-prevention policy could simply be used to eliminate the financial friction. In this case a lender would offer "forbearance," in which the borrower pays significantly lower payments for some period, with the arrears made up (with interest) later on. In this light, it is notable that the administration's key payment reduction plan has a five-year window.
However, one important concern regarding the plan is that servicers/investors don't have enough incentives to substantially decrease current DTI ratios. For example, if a household has a DTI of 60 or 70 because of a job loss, the servicer is responsible for modifying the loan to get DTI down to 38 and then still has to kick in a 50 percent match to further reduce it to 31. The costs borne by the servicer/investor are much larger than those borne by the government, which may not be such a bad thing in principal but in practice may result in low participation rates.
Note also that while permanent relief is the prescribed course for borrowers in the unaffordable-mortgage group, temporary relief is indicated for those in the temporary economic distress group. This highlights the difficulties in constructing policies when the underlying sources of stress differ by individual. The existence of a class of borrowers that purchased and financed residential real estate primarily for investment purposes further complicates matters. People in this group are in much different circumstances than those in the other groups and will default much more ruthlessly. A so-called "ruthless defaulter" has given up hope of positive future equity and hence there are no potential price gains to value. Under the theory of ruthless default, one effective policy intervention is to lower the outstanding balance of the mortgage so that positive equity—or even the hope of positive equity in the near future—is restored. Alternatively, the lender could forestall default at least temporarily by cutting the monthly payment below the cost of renting an otherwise observable house.
Aimed as it is at owner-occupied housing, the administration's plan does not offer direct assistance to those in the investment class. That may not be too surprising, as it is hard to generate much political sympathy for a group carrying a label like "ruthless defaulter." In addition, the perverse incentives of government assistance that usually go by the name of moral hazard are arguably more severe for individuals who purchase properties for investment purposes. However, abandoned properties do add to the stock of unsold homes, independent of who owned them or why they owned them. This does not necessarily argue for policy relief for investment buyers, but it is potential issue that bears watching.
Finally, there may be commentators with the view that loan modifications are a failing proposition as a few studies have shown extremely high default rates on modifications performed in early 2008 (for example, see OCC and OTS Mortgage Metrics Report, Third Quarter 2008). But, according to the table below (based on my calculations), the problem seems to be that the wrong type of modification was being performed. Approximately two-thirds of the modifications performed by servicers in the first two quarters of 2008 had the effect of increasing the principal balance of the mortgage and, as a result, also increased the borrower's monthly mortgage payment. In light of the above discussion, we should not be surprised by high re-default rates on these loans. On the other hand, there is reason to believe that successful implementation of payment reduction programs may indeed help to stem the pace of foreclosures.
By Kristopher Gerardi, research economist and assistant policy adviser at the Atlanta Fed
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