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May 16, 2014

Which Flavor of QE?

Yesterday's report on consumer price inflation from the U.S. Bureau of Labor Statistics moved the needle a bit on inflation trends—but just a bit. Meanwhile, the European Central Bank appears to be locked and loaded to blast away at its own (low) inflation concerns. From the Wall Street Journal:

The European Central Bank is ready to loosen monetary policy further to prevent the euro zone from succumbing to an extended period of low inflation, its vice president said on Thursday.

"We are determined to act swiftly if required and don't rule out further monetary policy easing," ECB Vice President Vitor Constancio said in a speech in Berlin.

One of the favorite further measures is apparently charging financial institutions for funds deposited with the central bank:

On Wednesday, the ECB's top economist, Peter Praet, in an interview with German newspaper Die Zeit, said the central bank is preparing a number of measures to counter low inflation. He mentioned a negative rate on deposits as a possible option in combination with other measures.

I don't presume to know enough about financial institutions in Europe to weigh in on the likely effectiveness of such an approach. I do know that we have found reasons to believe that there are limits to such a tool in the U.S. context, as the New York Fed's Ken Garbade and Jamie McAndrews pointed out a couple of years back.

In part, the desire to think about an option such as negative interest rates on deposits appears to be driven by considerable skepticism about deploying more quantitative easing, or QE.

A drawback, in my view, of general discussions about the wisdom and effectiveness of large-scale asset purchase programs is that these policies come in many flavors. My belief, in fact, is that the Fed versions of QE1, QE2, and QE3 can be thought of as three quite different programs, useful to address three quite distinct challenges. You can flip through the slide deck of a presentation I gave last week at a conference sponsored by the Global Interdependence Center, but here is the essence of my argument:

  • QE1, as emphasized by former Fed Chair Ben Bernanke, was first and foremost credit policy. It was implemented when credit markets were still in a state of relative disarray and, arguably, segmented to some significant degree. Unlike credit policy, the focus of traditional or pure QE "is the quantity of bank reserves" (to use the Bernanke language). Although QE1 per se involved asset purchases in excess of $1.7 trillion, the Fed's balance sheet rose by less than $300 billion during the program's span. The reason, of course, is that the open-market purchases associated with QE1 largely just replaced expiring lending from the emergency-based facilities in place through most of 2008. In effect, with QE1 the Fed replaced one type of credit policy with another.
  • QE2, in contrast, looks to me like pure, traditional quantitative easing. It was a good old-fashioned Treasury-only asset purchase program, and the monetary base effectively increased in lockstep with the size of the program. Importantly, the salient concern of the moment was a clear deterioration of market-based inflation expectations and—particularly worrisome to us at the Atlanta Fed—rising beliefs that outright deflation might be in the cards. In retrospect, old-fashioned QE appears to have worked to address the old-fashioned problem of influencing inflation expectations. In fact, the turnaround in expectations can be clearly traced to the Bernanke comments at the August 2010 Kansas City Fed Economic Symposium, indicating that the Federal Open Market Committee (FOMC) was ready and willing pull the QE tool out of the kit. That was an early lesson in the power of forward guidance, which brings us to...
  • ...QE3. I think it is a bit early to draw conclusions about the ultimate impact of QE3. I think you can contend that the Fed's latest large-scale asset purchase program has not had a large independent effect on interest rates or economic activity while still believing that QE3 has played an important role in supporting the economic recovery. These two, seemingly contradictory, opinions echo an argument suggested by Mike Woodford at the Kansas City Fed's Jackson Hole conference in 2012: QE3 was important as a signaling device in early stages of the deployment of the FOMC's primary tool, forward guidance regarding the period of exceptionally low interest rates. I would in fact argue that the winding down of QE3 makes all the more sense when seen through the lens of a forward guidance tool that has matured to the point of no longer requiring the credibility "booster shot" of words put to action via QE.

All of this is to argue that QE, as practiced, is not a single policy, effective in all variants in all circumstances, which means that the U.S. experience of the past might not apply to another time, let alone another place. But as I review the record of the past seven years, I see evidence that pure QE worked pretty well precisely when the central concern was managing inflation expectations (and, hence, I would say, inflation itself).

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed


May 16, 2014 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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May 13, 2014

Pondering QE

Today’s news brings another indication that low inflation rates in the euro area have the attention of the European Central Bank. From the Wall Street Journal (Update: via MarketWatch):

Germany's central bank is willing to back an array of stimulus measures from the European Central Bank next month, including a negative rate on bank deposits and purchases of packaged bank loans if needed to keep inflation from staying too low, a person familiar with the matter said...

This marks the clearest signal yet that the Bundesbank, which has for years been defined by its conservative opposition to the ECB's emergency measures to combat the euro zone's debt crisis, is fully engaged in the fight against super-low inflation in the euro zone using monetary policy tools...

Notably, these tools apparently do not include Fed-style quantitative easing:

But the Bundesbank's backing has limits. It remains resistant to large-scale purchases of public and private debt, known as quantitative easing, the person said. The Bundesbank has discussed this option internally but has concluded that with government and corporate bond yields already quite low in Europe, the purchases wouldn't do much good and could instead create financial stability risks.

Should we conclude that there is now a global conclusion about the value and wisdom of large-scale asset purchases, a.k.a. QE? We certainly have quite a bit of experience with large-scale purchases now. But I think it is also fair to say that that experience has yet to yield firm consensus.

You probably don’t need much convincing that QE consensus remains elusive. But just in case, I invite you to consider the panel discussion we titled “Greasing the Skids: Was Quantitative Easing Needed to Unstick Markets? Or Has it Merely Sped Us toward the Next Crisis?” The discussion was organized for last month’s 2014 edition of the annual Atlanta Fed Financial Markets Conference.

Opinions among the panelists were, shall we say, diverse. You can view the entire session via this link. But if you don’t have an hour and 40 minutes to spare, here is the (less than) ten-minute highlight reel, wherein Carnegie Mellon Professor Allan Meltzer opines that Fed QE has become “a foolish program,” Jeffries LLC Chief Market Strategist David Zervos declares himself an unabashed “lover of QE,” and Federal Reserve Governor Jeremy Stein weighs in on some of the financial stability questions associated with very accommodative policy:


You probably detected some differences of opinion there. If that, however, didn’t satisfy your craving for unfiltered debate, click on through to this link to hear Professor Meltzer and Mr. Zervos consider some of Governor Stein’s comments on monitoring debt markets, regulatory approaches to pursuing financial stability objectives, and the efficacy of capital requirements for banks.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed.


May 13, 2014 in Banking, Capital Markets, Economic conditions, Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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January 31, 2014

A Brief Interview with Sergio Rebelo on the Euro-Area Economy

Last month, we at the Atlanta Fed had the great pleasure of hosting Sergio Rebelo for a couple of days. While he was here, we asked Sergio to share his thoughts on a wide range of current economic topics. Here is a snippet of a Q&A we had with him about the state of the euro-area economy:

Sergio, what would you say was the genesis of the problems the euro area has faced in recent years?

The contours of the euro area’s problems are fairly well known. The advent of the euro gave peripheral countries—Ireland, Spain, Portugal, and Greece—the ability to borrow at rates that were similar to Germany's. This convergence of borrowing costs was encouraged through regulation that allowed banks to treat all euro-area sovereign bonds as risk free.

The capital inflows into the peripheral countries were not, for the most part, directed to the tradable sector. Instead, they financed increases in private consumption, large housing booms in Ireland and Spain, and increases in government spending in Greece and Portugal. The credit-driven economic boom led to a rise in labor costs and a loss of competitiveness in the tradable sector.

Was there a connection between the financial crisis in the United States and the sovereign debt crisis in the euro area?

Simply put, after Lehman Brothers went bankrupt, we had a sudden stop of capital flows into the periphery, similar to that experienced in the past by many Latin American countries. The periphery boom quickly turned into a bust.

What do you see as the role for euro area monetary policy in that context?

It seems clear that more expansionary monetary policy would have been helpful. First, it would have reduced real labor costs in the peripheral countries. In those countries, the presence of high unemployment rates moderates nominal wage increases, so higher inflation would have reduced real wages. Second, inflation would have reduced the real value of the debts of governments, banks, households, and firms. There might have been some loss of credibility on the part of the ECB [European Central Bank], resulting in a small inflation premium on euro bonds for some time. But this potential cost would have been worth paying in return for the benefits.

And did this happen?

In my view, the ECB did not follow a sufficiently expansionary monetary policy. In fact, the euro-area inflation rate has been consistently below 2 percent and the euro is relatively strong when compared to a purchasing-power-parity benchmark. The euro area turned to contractionary fiscal policy as a panacea. There are good theoretical reasons to believe that—when the interest rate remains constant that so the central bank does not cushion the fall in government spending—the multiplier effect of government spending cuts can be very large. See, for example, Gauti Eggertsson and Michael Woodford, “The Zero Interest-rate Bound and Optimal Monetary Policy,” and Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo, "When Is the Government Spending Multiplier Large?

Theory aside, the results of the austerity policies implemented in the euro area are clear. All of the countries that underwent this treatment are now much less solvent than in the beginning of the adjustment programs managed by the European Commission, the International Monetary Fund, and the ECB.

Bank stress testing has become a cornerstone of macroprudential financial oversight. Do you think they helped stabilize the situation in the euro area during the height of the crisis in 2010 and 2011?

No. Quite the opposite. I think the euro-area problems were compounded by the weak stress tests conducted by the European Banking Association in 2011. Almost no banks failed, and almost no capital was raised. Banks largely increased their capital-to-asset ratios by reducing assets, which resulted in a credit crunch that added to the woes of the peripheral countries.

But we’re past the worst now, right? Is the outlook for the euro-area economy improving?

After hitting the bottom, a very modest recovery is under way in Europe. But the risk that a Japanese-style malaise will afflict Europe is very real. One useful step on the horizon is the creation of a banking union. This measure could potentially alleviate the severe credit crunch afflicting the periphery countries.

Thanks, Sergio, for this pretty sobering assessment.

John RobertsonBy John Robertson, a vice president and senior economist in the Atlanta Fed’s research department

Editor’s note: Sergio Rebelo is the Tokai Bank Distinguished Professor of International Finance at Northwestern University’s Kellogg School of Management. He is a fellow of the Econometric Society, the National Bureau of Economic Research, and the Center for Economic Policy Research.


January 31, 2014 in Banking, Capital and Investment, Economics, Europe, Interest Rates, Monetary Policy | Permalink

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January 14, 2014

A Football Field of Labor Market Progress

The December meeting of the Federal Open Market Committee (FOMC), as summarized in the minutes published last week, debated the context for tapering the quantitative easing (QE) program of asset purchases and adjusting the FOMC’s forward guidance on the federal funds rate. One of the issues debated was postrecession progress in the labor market. For example, participants struggled with the reasons for the large drop in labor force participation in recent years:

Some participants cited research that found that demographic and other structural factors, particularly rising retirements by older workers, accounted for much of the recent decline in participation. However, several others continued to see important elements of cyclical weakness in the low labor force participation rate and cited other indicators of considerable slack in the labor market, including the still-high levels of long-duration unemployment and of workers employed part time for economic reasons and the still-depressed ratio of employment to population for workers ages 25 to 54. In addition, although a couple of participants had heard reports of labor shortages, particularly for workers with specialized skills, most measures of wages had not accelerated. A few participants noted the risk that the persistent weakness in labor force participation and low rates of productivity growth might indicate lasting structural economic damage from the financial crisis and ensuing recession.

In a speech on Monday, Atlanta Fed President Dennis Lockhart emphasized similar concerns. He posed the question of whether the improvement in the unemployment rate since the end of the recession, now having recovered about 65 percent of its 2007–09 increase, is overstating the actual progress in the utilization of the nation’s labor resources. President Lockhart observes:

But the unemployment rate is influenced by labor force participation, and there has been a sizable decline in the share of the population in the labor force since 2009. This explains how you could get a big drop in the unemployment rate with anemic job gains, as occurred in December.

The labor force participation rate has fallen from 65.8 percent of the population at the end of 2008 to 62.8 percent in December 2013. On this, President Lockhart notes:

Some of the decline in labor force participation since 2009 is due to the baby boomers retiring, but even among prime-age workers—those aged 25 to 54—the participation rate is down significantly [2.1 percentage points]. This suggests that other factors, such as low prospects of finding a job, are playing a role.

To examine this possibility, we can look at the sum of marginally attached workers. These are people who say they are willing to work and have looked for work recently but are not currently looking.

The marginally attached are not counted in the official labor force statistic. During the recession, the number of marginally attached swelled (from around 1.4 million at the end of 2007 to 2.4 million at the end of 2009). Since the end of 2009, the marginally attached rate (as a share of the labor force including marginally attached) has retraced only 12 percent of the recessionary increase. From this, President Lockhart concludes:

It’s accurate to say the country has a large number of people in the so-called “shadow labor force.”

Because the sharp decline in labor force participation is not fully understood, and because the unemployment rate decline conflates declines in participation with employment gains, President Lockhart suggests it is useful to also look at the share of the prime-age population that is employed. Between the end of 2007 and 2009 the employment-to-population rate for this group declined from 79.7 to 74.8 percent. Since 2009, employment gains for the core of the workforce have advanced only 27 percent toward the prerecession peak (for the entire population over age 16, the recovery is essentially zero). Variations on this theme can be seen here and here.

Usually, the employment to population rate and the unemployment rate move in lock step (because labor force movements are very gradual). But that has not been the case during this recovery.

In addition to unemployment, President Lockhart highlights the issue of underemployment:

Many Americans are working fewer hours than they would prefer because their employers are offering them only part-time work. The share of workers who are involuntarily working part-time doubled during the recession and has moved only about 30 percent lower since the recovery began.

So, on the question of whether the unemployment rate decline has overstated actual progress in labor utilization, Lockhart says yes:

To sum up, these comparisons of employment data suggest that the labor market is not as healthy as the improved unemployment rate might suggest. The unemployment rate drop may overstate progress achieved.

The Atlanta Fed has been featuring the labor market spider chart tool on its website as a way to track relative progress in a number of labor market indicators since the end of the recession. For the purposes of President Lockhart’s speech, the relative improvement in various indicators of the rate of labor utilization was presented graphically in the form of yardage gains from the goal-line of a football field. The changes can be seen here (the data are from the U.S. Bureau of Labor Statistics and Atlanta Fed calculations). The idea is that the labor utilization “team” was driven back to its own goal line from the end of 2007 through the end of 2009, and the graphic shows how many yards (percent) the team has recovered as of the January 10 labor report. (The use of a football field image is perhaps appropriate, given that the recent BCS championship game featured two teams from the Sixth District.)

Labor Utilization Recovery: How Far Have We Come?

President Lockhart also suggests a link between labor market slack and the weak pricing trends we have experienced in recent years:

It’s worth noting that wage and salary income growth remains weak. I hear very little from business contacts about upward wage pressures except in a few specialized job categories. Wage pressures usually accompany growing demand and rising inflation but, although demand appears to be growing, inflation is very soft.

Inflation Y-O-Y Percent Change

In fact, looking at the recent disinflation apparent in virtually all consumer price statistics relative to the FOMC’s longer-run objective, President Lockhart acknowledges the risk of an inflation “safety”:

...I think inflation will stabilize and begin to move back in the direction of the FOMC’s 2 percent objective as the economy gathers momentum. So I’m interpreting the soft inflation numbers as a risk signal. Through the lens of prices, the economy could be weaker than we currently believe.

John RobertsonBy John Robertson, a vice president and senior economist in the Atlanta Fed’s research department


January 14, 2014 in Labor Markets, Monetary Policy, Sports, Unemployment | Permalink

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January 08, 2014

Money as Communication: A New Educational Video by the Atlanta Fed

Roughly a year ago, the Federal Open Market committee (FOMC) switched from date-based forward guidance on the federal funds rate path to guidance based on economic conditionality. The idea, as Chairman Bernanke put it in his post-FOMC press conference, is that "[b]y tying future monetary policy more explicitly to economic conditions, this formulation of our policy guidance should also make monetary policy more transparent and predictable to the public."

Now, on the one hand, you can't be any more clear than to say that the policy interest rate will remain near zero until such-and-such a date. But if you really want to know the "reaction function" that guides monetary policy decisions, date-based guidance isn't going to speak very clearly to this question. Rather, you would probably rather know the economic conditions that would warrant the FOMC's decision to adjust the policy rate.

Let me suggest that clear communication is one of the foundations of good monetary policy because it's one of the foundational characteristics of good money.

A textbook description of money is usually just a recitation of its functions—it acts as a store of value, a medium of exchange, and a unit of account. This definition of money is a rather hollow one (as Minneapolis Fed President Narayana Kocherlakota noted back in his academic days) because it tells us only what money does but doesn't speak to the core issue—what is the problem that money solves?

The "unit of account" function, in particular, gets little development in the textbooks and has generally not carried much weight in the academic literature on the theory of money. (There are a few exceptions, like this NBER working paper by Matthias Doepke and Martin Schneider.) But if people are going to communicate with one another about value, those communications are going to be most effective if done using some standardized metric—and that's where money comes in. As a "unit of account," our money is how we communicate about value. It can be a physical thing, like a particular commodity, or it can be an abstract concept, like the broad purchasing power of a medium of exchange.

But this isn't to imply that all things are equally up to the job of being a good unit of account. Many economists, beginning with Adam Smith, have been critical of commodity-based monetary systems in this regard. In Congressional testimony in 1922 about stabilizing the purchasing power of our money, famed economist Irving Fisher argued that while gold may have been chosen as our money because it was a good medium of exchange, it had proven to be a poor choice as a unit of account on which contracts could be negotiated. Indeed, he argued for a system where the value of money was fixed in terms of a statistical index of its broad purchasing power, a system certainly similar in spirit to the one the Federal Reserve pursues today:

Is it not absurd to have a dollar also a unit in weight, when it is not intended to measure weight, but is intended to measure purchasing power. It is used in commerce in buying and selling, by debtor and creditor for lending and repaying; and we propose that the repayment shall be just. What does that mean? It does not mean that you shall return a given weight of gold or a given weight of anything; it means that you shall return to the lender something that is a just equivalent. Value is involved in there, and value is statistically increased by an index number average purchasing power.

In other words, it's essential that the unit of account conveys value so that the units expressed in trade, contracts, and financial accounts are both meaningful and durable. We recently produced a simple four-minute video on the subject. Give it a view and let us know what you think. We're big on getting our communications right.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist in the Atlanta Fed's research department


January 8, 2014 in Monetary Policy | Permalink

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I can't believe there is "price machine" in the 4 minute video! I expect that ideology from laypersons, but you should know better - and you are aware that you know better. Taking that video at face value, your price machine is generating shortages all over the place - conveniently ignored.

Posted by: Dan | January 14, 2014 at 12:46 AM

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December 23, 2013

Goodwill to Man

By pure coincidence, two interviews with Pennsylvania State University professor Neil Wallace have been published in recent weeks. One is in the December issue of the Federal Reserve Bank of Minneapolis’ excellent Region magazine. The other, conducted by Chicago Fed economist Ed Nosal and yours truly, is slated for the journal Macroeconomic Dynamics and is now available as a Federal Reserve Bank of Chicago working paper.

If you have any interest at all in the history of monetary theory over the past 40 years or so, I highly recommend to you these conversations. As Ed and I note of Professor Wallace in our introductory comments, very few people have such a coherent view of their own intellectual history, and fewer still have lived that history in such a remarkably consequential period for their chosen field.

Perhaps my favorite part of our interview was the following, where Professor Wallace reveals how he thinks about teaching economics, and macroeconomics specifically (link added):

If we were to construct an economics curriculum, independent of where we’ve come from, then what would it look like? The first physics I ever saw was in high school... I can vaguely remember something about frictionless inclined planes, and stuff like that. So that is what a first physics course is; it is Newtonian mechanics. So what do we have in economics that is the analogue of Newtonian mechanics? I would say it is the Arrow-Debreu general competitive model. So that might be a starting point. At the undergraduate level, do we ever actually teach that model?

[Interviewers] That means that you would not talk about money in your first course.

That is right. Suppose we taught the Arrow-Debreu model. Then at the end we’d have to say that this model has certain shortcomings. First of all, the equilibrium concept is a little hokey. It’s not a game, which is to say there are no outcomes associated with other than equilibrium choices. And second, where do the prices come from? You’d want to point out that the prices in the Arrow-Debreu model are not the prices you see in the supermarket because there’s no one in the model writing down the prices. That might take you to strategic models of trade. You would also want to point out that there are a lot of serious things in the world that we think we see that aren’t in the model: unemployment, money, and [an interesting notion of] firms aren’t in the Arrow-Debreu model. What else? Investing in innovation, which is critical to growth, isn’t in that model. Neither is asymmetric information. The curriculum, after this grounding in the analogue of Newtonian mechanics, which is the Arrow-Debreu model, would go into these other things. It would talk about departures from that theory to deal with such things; and it would describe unsolved problems.

So that’s a vision of a curriculum. Where would macro be? One way to think about macro is in terms of substantive issues. From that point of view, most of us would say macro is about business cycles and growth. Viewed in terms of the curriculum I outlined, business cycles and growth would be among the areas that are not in the Arrow-Debreu model. You can talk about attempts to shove them in the model, and why they fall short, and what else you can do.

Of the many things that I have learned from Professor Wallace, this one comes back to me again and again: Talk about how to get the things in the model that are essential to dealing with the unsolved problems, honestly assess why they fall short, and explore what else you can do. To me, this is not only a message of good science. It is one of intellectual generosity, the currency of good citizenship.

I was recently asked whether I align with “freshwater” or “saltwater” economics (roughly, I guess, whether I think of myself as an Arrow-Debreu type or a New Keynesian type). There are many similar questions that come up. Are you a policy “hawk” or a policy “dove”? Do you believe in old monetarism (willing to write papers with reduced-form models of money demand) or new monetarism (requiring, for example, some explicit statement about the frictions, or deviations from Arrow-Debreu, that give rise to money’s existence)?

What I appreciate about the Wallace formulation is that it asks us to avoid thinking in these terms. There are problems to solve. The models that we bring to those problems are not true or false. They are all false, and we—in the academic world and in the policy world—are on a common journey to figure out what we are missing and what else we can do.

It is deeply misguided to treat models as if they are immutable truths. All good economists appreciate this intellectually. And yet there is an awful lot of energy wasted, especially in the blogosphere, on casting aspersions at those who are perceived to be seeking answers within other theoretical tribes.

Some problems are well-suited to Newtonian mechanics, some are not. Some amendments to Arrow-Debreu are useful; some are not. And what is well-suited or useful in some circumstances may well be ill-suited or even harmful in others. Perhaps if we all acknowledge that none of us knows which is which 100 percent of the time, we can make just a little more progress on all those unsolved problems in the coming year. At a minimum, we would air our disagreements with a lot more civility.

Happy holidays.

David Altig By Dave Altig, executive vice president and research director at the Atlanta Fed


December 23, 2013 in Economics, Education, Monetary Policy | Permalink

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This's surprisingly simplistic point of view, c'mon. That particular debate is not about which model is right (all are wrong in one way or another, yes), but about what economists should do when their model turns out to not reflect real developments nearly as good as the other models do

Posted by: Konstantin | December 25, 2013 at 08:39 AM

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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 ratewhich 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.

Photo of Pat HigginsBy Pat Higgins, senior economist, and

 

Photo of Brent MeyerBrent Meyer, research economist, both of the Atlanta Fed's research department


November 20, 2013 in Fed Funds Futures, Federal Reserve and Monetary Policy, Forecasts, Interest Rates, Monetary Policy | Permalink

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'The shadow rate ... is estimated using Treasury forward rates out to a 10-year horizon.'

The Wu-Xia paper mentions forward rates, but it also describes a three-factor model incorporating 97 different macro series.

Since June 2013, the shadow policy rate has declined from -0.80% to a series-low -1.98%, while forward rates have been rising.

Is this sharp decline in the shadow policy rate due to changes in the macro series (e.g. accelerating GDP growth, to name one example), changes in forward rates, or both?

Posted by: Jim Haygood | January 13, 2014 at 04:45 PM

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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.  

David Altig By Dave Altig, executive vice president and research director at the Atlanta Fed


November 12, 2013 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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A few questions:

1) Is lowering the unemployment rate stimulative, or is the FOMC just telling us that NAIRU is lower than they thought when the 6.5% threshold was first established? Or is the FOMC lowering its estimate for the equilibrium rate (as Larry Summers suggested at the IMF?)

2) If lowering the threshold is stimulative (presumably the FOMC wants lower rates for a given level of the output gap), then is changing the mix adding stimulus, keeping it the same, or providing less? How does a policymaker trade tapering for a lower threshold?

Posted by: Money "Bob" | November 12, 2013 at 03:40 PM

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August 02, 2013

What a Difference a Month Makes? Maybe Not Much

By most accounts, the July employment report released this morning was something of a disappointment, perhaps more because it fell short of expectations than for any absolute signal it sends about the state of the economy. To be sure, the 162,000 net jobs created in July were below June’s 12-month average, which itself ticked down a bit as a result of negative revisions to the May and June statistics.

“Ticked down a bit” is the operative phrase, as the average monthly jobs gain from May 2012 through June 2013 now registers at 189,000 as opposed to the 191,000 reported last month. With this month’s new data, the 12-month average gains (from June 2012 to July 2013) clock in at 190,000 jobs per month, still right on the trend that has prevailed over the past couple of years. In other words, not much has changed in the longer view of things.

Our interests here at macroblog run to the policy implications, of course. Not too surprisingly, focal points are 1) the 7 percent unemployment rate neighborhood that Chairman Bernanke has associated with Federal Open Market Committee forecasts of what will prevail around the time that the Fed’s current asset purchase program might be ending and 2) the benchmark 6 1/2 percent unemployment that the statement following this week’s FOMC meeting continued to identify as the earliest possible point at which adjustments to the Committee’s interest rate target will be considered.

Following last month’s employment report I offered up calculations from the Atlanta Fed’s Jobs Calculator™ regarding the dates at which these unemployment thresholds might be reached, under the assumptions that jobs gains average 191,000 per month going forward, the participation rate remains constant at the reported June level, and there will be no change in the relationship between employment statistics from the payroll (or establishment) survey (whence comes the headline jobs number) and the employment statistics from the household survey (statistics used to calculate the unemployment rate). All of these figures change month to month, so it may be useful to update that exercise with current statistics (with last month’s calculations noted parenthetically):

Job growth and unemployment rates as of July 2013 (June 2013) employment reports


Not much change there. In fact, the unemployment rates in these calculations fall a little faster than last month’s calculations suggested, in part due to the ancillary assumptions on participation rates and the payroll-employment /household-employment ratio.

In the spirit of pessimism—an economist’s university-given right—I’ll ask: what if the latest 162,000-job-gain number is closer than the trailing 12-month average to what we will experience going forward? Easiest enough to explore:

Unemployment rates under the assumption of 162,000 jobs created per month going forward


I will leave it to you to decide whether the differences imply important policy distinctions.

Side note: For a broader look at labor market conditions, take a look at the Atlanta Fed’s spider chart, updated as of today’s employment report.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed


August 2, 2013 in Data Releases, Employment, Labor Markets, Monetary Policy | Permalink

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June 05, 2013

The Semantics of Monetary Policy

Tim Duy has some questions for the head man at the Atlanta Fed:

...Atlanta Federal Reserve President Dennis Lockhart...was on the speaking circuit today. Via the Wall Street Journal...

If the Fed does slow the pace of its bond buying, "this is not a decisive removal of accommodation. This is a calibration to the state of the economy and the outlook. It is not a big policy shift, and I would hope the markets understand that," Mr. Lockhart said.

I know that the Fed does not want market participants to associate a slowing of asset purchases with tighter policy. I am not sure, however, that it will be easy to persuade Wall Street otherwise. After all, if the Fed wanted looser policy, they would increase the pace of asset purchases. If more is "looser," then why isn't less "tighter?" Alternatively, is "less accommodative" really different from "tighter"?

I'm reminded of one of my favorite exchanges from the Greenspan years, with the Chairman responding to Senator Jim Bunning about the motivation for rate increases in 1999:

We did raise interest rates in 1999, and the reason is real long-term interest rates were beginning to accelerate. Had we not raised the federal funds rate during that particular period, we could have held it in check only by expanding the money supply at an inordinately rapid rate.

My interpretation has always been that Mr. Greenspan was saying something like the following: A set federal funds rate target means that the Fed stands ready to supply as much money as demanded at that rate. (More precisely, the Fed stands ready to supply the quantity of bank reserves demanded at that rate.)

If the structure of market interest rates changes and the demand for bank reserves accelerates—say, because economic growth picks up—maintaining a set target means that monetary policy will become increasingly expansionary. In other words, in such circumstances, standing pat on a federal funds rate target does not mean that the stance of monetary policy stays the same. Quite the opposite.

Jerry Jordan, my former boss at the Federal Reserve Bank of Cleveland and an avid sailor, used to explain it this way: When a person sets out to sail across a body of water, you will notice that he will often adjust the position of the sails, the orientation of the boat, and so on. If you know something of sailing, you will realize that he is very likely reacting to changes in the currents, the winds, and other environmental factors. And if that is indeed what he's doing, you would not infer that he has changed anything about where he's headed and why he's heading there. In fact, you would infer that without such adjustments he must have fundamentally changed his intentions.

Of course, we are in the current context referring not to federal funds rate adjustments but to the pace and ultimate quantity of asset purchases. But I think the principle is the same: A given pace or total quantity of purchases does not mean the same thing in all economic circumstances. If circumstances change, so does the degree of "accommodation" associated with any particular course of asset purchases.

Semantics? I don't think so, and perhaps this is instructive: In the April survey of primary dealers conducted by the New York Fed, the median response to question of when asset purchases will end was the first quarter of next year. At the same time, the median view on what the unemployment rate would be at that time was 7.1 percent. That view would not be out of line with what you might guess on the basis of the Summary of Economic Projections that the Federal Open Market Committee published following its March meeting.

But, as we noted here following the April employment report, the facts on the ground seem to be shifting. We will, as you know, get an update on the employment situation on Friday, and perhaps today's ADP report (for what it's worth) wasn't encouraging. In any event, in our shop we will process these reports by considering exactly what it means to keep policy about where it is.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

June 5, 2013 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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