The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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

This has to be wrong, or a bad construct. Any full forward rate measure shows positive rates until you get to the far end of the yield curve.

Posted by: David Merkel | March 16, 2015 at 05:56 AM

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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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May 30, 2013

At Least One Reason Why People Shouldn't Hate QE

You might not expect me to endorse an article titled "The 7 Reasons Why People Hate QE." I won't disappoint that expectation, but I will say that I do endorse, and appreciate, the civil spirit in which the author of the piece, Eric Parnell, offers his criticism. We here at macroblog, like our colleagues in the Federal Reserve System more generally, pride ourselves on striving for unfailing civility, and it is a pleasure to engage skeptics who share (and exhibit) the same disposition. What the world needs now is...well, maybe I'm getting carried away.

Let me instead appropriate some of Mr. Parnell's language. It is worthwhile to explore some of the reasons that people do not like QE from someone who does not share this opposing sentiment. In particular, let me focus on the first of seven reasons offered in the Parnell post:

First, a primary objection I have with QE is that it results in a government policy making and regulatory institution in the U.S. Federal Reserve directly determining how private sector capital is being allocated... in recent years, the Fed has dramatically expanded its policy scope into areas that are normally the territory of fiscal policy. This has included specifically targeting selected areas of the economy such as the U.S. housing market including the aggressive purchase of mortgage backed securities (MBS) since the outbreak of the financial crisis.

This statement seems to presume that monetary policy does not normally have differential impacts across distinct sectors of the economy. I think this presumption is erroneous.

The Federal Open Market Committee's (FOMC) asset purchase programs have long been seen as operating through traditional portfolio-balance channels. As explained by Fed Chairman Ben Bernanke in an August 2010 speech that set up the "QE2" program:

The channels through which the Fed's purchases affect longer-term interest rates and financial conditions more generally have been subject to debate. I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which holds that once short-term interest rates have reached zero, the Federal Reserve's purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public. Specifically, the Fed's strategy relies on the presumption that different financial assets are not perfect substitutes in investors' portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration. For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.

I think this is a pretty standard way of thinking about the way monetary policy works. But you need not buy the portfolio-balance story in full to conclude that even traditional monetary policy operates on "selected areas of the economy such as the U.S. housing market." All you need to concede is that policy works by altering the path of real interest rates and that not all sectors share the same sensitivity to changes in interest rates.

Parnell goes on to discuss other problems with QE: stress put on individuals living on fixed incomes, the promotion of (presumably excessive) risk-taking, and the general distortion of market forces. All topics worthy of discussion, and if you read the minutes of almost any recent FOMC meeting you will note that they are indeed key considerations in ongoing deliberations.

These issues, however, are not about QE per se, but about monetary stimulus generally and the FOMC's interest rate policies specifically. As the conversation turns to if, when, and how Fed policymakers will adjust the current asset purchase program, it will be important to clarify the distinction between QE and the broader stance of policy.

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


May 30, 2013 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink


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Sorry, but I think that there is an important difference between conventional monetary policy and current QE. When the Fed buys treasuries only, it is essentially dealing in state assets on both sides of its balance sheet, so any difference in the effects of monetary policy on different sectors of the economy are accidental. When the Fed buys mortgage securities, however, that deliberately, though the asset side of the Fed's balance sheet, favours housing activity. And I have little doubt that, if the US economy did not strengthen as fast as required, the Fed would end up, like the Bank of Japan, buying stocks. In my view (as a former central banker), the Fed has done too little to resist being drawn, by ill-informed politicians, into unsustainable stimulation of popular real economic activity.

Posted by: RebelEconomist | June 06, 2013 at 05:43 PM

I appreciate and agree with your narrow response to the column, "The 7 reasons why people hate QE."  However, it appears that people still have several more (unanswered) reasons for hating QE.  

It is an old debating tactic to take issue with the 1-2 weakest points of an opponent's otherwise strong argument to create the impression that the opponent is altogether wrong.  But debating tactics don't do anything to 'fix' monetary policy or the economy, so ultimately that is not a wise approach for the Fed (its officers) to take.  Unlike high school debates or courtroom arguments designed to persuade an uninformed jury, the 'judges' are monetary economists and money managers who recognize the difference between debating tactics and a response that goes to the core of the issue.

For example, your response to the article's criticism #1 was "even traditional monetary policy operates on "selected areas of the economy such as the U.S. housing market."  That is absolutely true.  But that neither recognizes nor explains why half of the Fed's current open market operations are conducted in mortgage backed securities and related debt instruments.  Aren't those particular bond purchases PURPOSELY geared toward the housing market to the exclusion of other sectors of the economy?

Of course.  That's why your (correct as far as it goes) comment about monetary policy doesn't really address the first complaint of the columnist.  You leave the impression that QE is little different than standard open market operations, though of course differing in magnitude.

I hadn't read the "7 Reasons" column before you cited it in your piece, but after having read it, I was most persuaded by reason #2:

     #2 - Helping Some Market Participants At The Expense Of Others.
     By effectively locking interest rates at 0% since December 2008,
     the Federal Reserve has elected to provide direct and generous support
     to financial institutions and risk takers, some of which directly
     contributed to the cause of the crisis.

I believe that's an accurate description of how things have worked out, though I don't believe it portrays the Fed's motives or reasoning.  Nevertheless, it is incumbent upon Fed officials to consider this criticism to avoid future crises, economic downturns and taxpayer bailouts.

I've recently been reading (and learning from) Nicholas Dunbar's book "The Devil's Derivatives."  For at least the past 50 years, a pattern has emerged whereby well-compensated (highly motivated) bankers develop/discover ways of avoiding and evading the Fed's regulations, followed by the Fed's efforts to regulate the new activities, followed by further work-arounds by bankers.  This is a natural process, but the Fed is playing with both hands behind its back because a) top Fed officials are typically free-market economists with a philosophical appreciation for innovation and a general skepticism of policies which have unintended negative consequences, and b) bankers spend vast amounts of money to hire PhD economists and other smart, experienced people --- then their teams work night and day for months to develop innovative products that Fed officials don't understand and cannot effectively regulate.

This is part of the Regular Business Plans of big banks, not something that has inadvertently happened a time or two.  The not-infrequent outcome of these innovations is to create bubbles which eventually burst, placing major economic sectors at risk.  The next act in the play is a Fed rescue/bailout to "save the economy" --- but then Fed officials explain (with sad faces and shrugging shoulders) that the bad actors had to be saved to avoid another Great Depression.

The bailouts, too, are part of the long-term business plans of the big banks.  The problem is that the Fed doesn't get the joke, and continues playing the same role over and over.  As a historical fact, the Fed DOES provide aid and comfort to the major financial institutions at the expense of taxpayers, households and small business.  (How many times has the Fed saved Citi over the past 50 years?) 

As I said earlier, I do not for a minute believe this is the Fed's intentions: it occurs because the innovative bankers know how draw Fed officials into a game they are ill-equipped to play.  Fed officials aren't in the hip pockets of the big financial institutions because they're corrupt, but because they're ignorant: uninformed and inexperienced.

Now, the Fed can continue down this path ... or its officials could reflect on the pattern that has emerged over the decades and ask whether their appreciation for innovation is well-founded, whether the Fed has been an effective regulator when it has always been behind the curve of innovation, and where all of this is leading: too much leverage, moral hazard, huge risks to America's future economic prosperity, etc.

The strongest argument that bankers make for justifying their innovative activities is that "if we aren't allowed to do it, financial markets will move offshore ... but then same practices will occur anyway." 

That is a nonsense argument.  If America reigns in the profligate bankers, so will most of our closest trading partners.  Second, even if the big US banks became the US branches of foreign banks, the US economy would still receive financing and Americans would still have jobs working in those branches.  Third, future bailouts would fall to a far greater extent on the backs of foreign taxpayers rather than US taxpayers.  Fourth, if the Fed calls the bluff of big banks, the ability of bankers to extract future handouts would be far less (less moral hazard).

Fed officials have done a pretty good job over the past century perfecting its monetary policy tools. At the same time, however, they have been so focused on shorter-term issues that they have failed to appreciate the longer-term game the Fed has been drawn into, where it has become the enabler and protecter of institutions whose prosperity is not essential to the functioning of a modern economy.  The necessity of an efficient banking system does not prove (or even imply) that specific banks are must survive.  The only too-big-to-fail institution is the Fed.

The Fed's original job was to protect the economy by PREVENTING financial crises and panics.  We now know that despite the best of intentions the Fed has failed in that responsibility.  It has unwittingly become a tool of the banking sector, facilitating astronomically high compensation and the accumulation of great wealth --- for bankers --- just #2 of the "7 Reasons" essay claims.

Either the Fed can stay on the merry-go-round or get off of it ... but it can't stay on the merry-go-round and expect to arrive in a new destination one or two cycles hence.  Anyone who has been paying attention knows that. 

The failure of the economy to recover despite the Fed adding $2 trillion in reserves to the banking system means that people do not trust the Fed's current policies to protect their jobs and wealth in the future --- so rather than taking risk and contributing to the economy, they're paying off debt and building up reserves for the next collapse.

Posted by: Thomas Wyrick | June 10, 2013 at 01:57 PM

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May 23, 2013

A Subtle View of Labor Market Improvement

In a speech delivered Tuesday to the Japan Society in New York City, Federal Reserve Bank of New York President William Dudley offered his view on how he might assess the appropriate pace of the Federal Open Market Committee's (FOMC) current $85 billion per month asset purchase program:

Let me give a few examples of how my own thinking may evolve. In terms of our asset purchase program, I believe we should be prepared to adjust the total amount of purchases to that needed to deliver a substantial improvement in the labor market outlook in the context of price stability. In doing this, we might adjust the pace of purchases up or down as the labor market and inflation outlook changes in a material way. For me, the base case forecast is not the sole consideration—how confident we are about that outcome is also important.

Because the outlook is uncertain, I cannot be sure which way—up or down—the next change will be. But at some point, I expect to see sufficient evidence to make me more confident about the prospect for substantial improvement in the labor market outlook. At that time, in my view, it will be appropriate to reduce the pace at which we are adding accommodation through asset purchases. Over the coming months, how well the economy fights its way through the significant fiscal drag currently in force will be an important aspect of this judgment.

My own boss, Atlanta Fed President Dennis Lockhart, expressed a similar view in a speech to the Birmingham, Alabama, Kiwanis Club last month:

The key word in the phrase "substantial improvement in the outlook for the labor market" is outlook. For my part, a critical consideration in judging how much longer asset purchases should continue will be confidence in the positive outlook. Confidence that is solidly grounded in improving economic data, accumulated over a sufficient span of time, will help me conclude that the work of the large-scale asset purchase program, as a temporary supplement to conventional interest-rate policy, is complete.

And there is this, from the minutes of the latest meeting of the FOMC (emphasis added):

Participants also touched on the conditions under which it might be appropriate to change the pace of asset purchases. Most observed that the outlook for the labor market had shown progress since the program was started in September, but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate.

Neither President Dudley nor President Lockhart (nor the minutes) indicates where we are on the confidence scale at the moment. But at least outside the Fed, there is some evidence confidence in the labor market forecast is increasing. The following chart shows year-over-year averages of the interquartile range of four-quarter-ahead unemployment rate forecasts from the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters:


The interquartile range is essentially the difference between the most optimistic one-fourth of the forecasts in the Philadelphia Fed's panel and the most pessimistic one-fourth of forecasts. It is thus a measure of dispersion, or forecast disagreement.

The trend in this measure of forecast disagreement is clearly—very clearly—downward. That doesn't exactly say that each individual forecaster is becoming more confident about his or her individual outlook (though this type of dispersion measure is often used as a proxy for overall uncertainty). Even less does it mean that forecast uncertainty has fallen to the level President Dudley, President Lockhart, or any other Fed official would deem sufficient to alter policy in any way. The FOMC minutes, for example, include this...

A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.

... and following his congressional testimony Wednesday, Chairman Bernanke engaged in a Q&A, and ABC News summed up the state of the policy discussion this way:

When asked by Kevin Brady, the Panel's chairman, whether the Federal Reserve could start winding it back before before September's Labour Day holiday, Mr Bernanke responded, "I don't know. It's going to depend on the data."

It really need not be emphasized that I don't know either. But the narrowing of opinions of where things are headed must signify some sort of progress.

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


May 23, 2013 in Employment, Federal Reserve and Monetary Policy, Labor Markets, Monetary Policy | Permalink


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The units in your chart are not displayed correctly. The "10" should be "1.0"

Posted by: glenn | May 24, 2013 at 10:52 AM

Thanks Glenn. Actually this is a case of not labeling/explaining things precisely. I used the Philadelphia Fed's D3 measure of dispersion, which is the log difference of the levels. So the units are the percent differences between the 75th percentile and the 25th percentile.

Posted by: Dave | May 30, 2013 at 03:19 PM


Posted by: Aldex | July 01, 2014 at 07:23 AM

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May 13, 2013

Labor Force Participation and the Unemployment Threshold

On Friday, my colleague Julie Hotchkiss shared in this space the results of her new research (with Fernando Rios-Avila, a Georgia State University colleague) on the recent and prospective behavior of the labor force participation rate (LFPR). The punch line, from my point of view, is this:

Our results suggest that relative to the average LFPR over the years 2010–12, the average LFPR over the years 2015–17 will rise by about a third of a percentage point—again, if the labor market returns to prerecession conditions. (Italics original)

As Julie notes:

[T]he Federal Open Market Committee has substantially raised the stakes on disentangling...movements in labor force introducing into its policy deliberations concepts like unemployment thresholds and qualitative assessments on "substantial" labor market improvement.

Though the meaning of "substantial labor market improvement"—a condition for adjusting the FOMC's current large-scale asset purchase program—is somewhat ambiguous, the unemployment threshold for considering moving the federal funds rate off the near-zero mark is less so. As the Committee indicated in its May press release:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

It is widely understood (a sign of the times, no doubt) that changes in the unemployment rate are not entirely independent of what is happening with the participation rate. We have discussed this issue before here in macroblog. But in light of the new research coming from our own shop (and other research cited in Julie's post), it seems like a good time for a refresher.

First, a step back. Multiple upward revisions to the employment situation since the December jobs report—you can follow the trail courtesy of Calculated Risk here, here, here, here, and here—have led to a more robust picture of the labor market than certainly I was thinking. Here is what the record looks like for most of the recovery:

With an assist from the Atlanta Fed Jobs Calculator, we can provide further perspective on these numbers. In particular, under the assumption that the labor force participation rate will remain at its current level of 63.3 percent (among other things held constant), we can map the recent job growth numbers to a rough date when the unemployment rate will reach 6½ percent.

That looks interesting, but then taking the Hotchkiss and Rios-Avila research onboard means the assumption of a constant labor force participation rate may not be justified. So, turning again to the Jobs Calculator, the following table answers this question: If we continue on the 208,000-per-month pace of job creation of the last six months, and the labor force participation rate is X, what would the unemployment rate be by June of next year? For reference, the first row of the table replicates the earlier result under the assumption that the participation rate will maintain its current level; the second row takes into account the Hotchkiss and Rios-Avila research; and the third assumes an even larger bounce back in participation:

It is probably worth noting that the full increase in the Hotchkiss and Rios-Avila estimates happens in the 2015–17 timeframe, raising the interesting possibility that the threshold for considering interest rate increases could occur sometime before the unemployment rate moves back above the threshold.

Also, it is not at all obvious that rising labor force participation would necessarily arrive along with a rising unemployment rate. From 1996 through 1999, for example, the participation rate rose by nearly by 0.7 percentage point (the difference between the rates in the first and third rows in the table above), even as the unemployment rate fell by just over 1½ percentage points. The key was the strong employment growth over that period—almost 260,000 payroll jobs per month on average.

All of that, as should be clear by now, embeds a whole bunch of assumptions, which may make this the most important part of the FOMC's decision criteria:

In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions...

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

May 13, 2013 in Employment, Labor Markets, Monetary Policy | Permalink


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March 08, 2013

Will the Next Exit from Monetary Stimulus Really Be Different from the Last?

Suppose you run a manufacturing business—let's say, for example, widgets. Your customers are loyal and steady, but you are never completely certain when they are going to show up asking you to satisfy their widget desires.

Given this uncertainty, you consider two different strategies to meet the needs of your customers. One option is to produce a large quantity of widgets at once, store the product in your warehouse, and when a customer calls, pull the widgets out of inventory as required.

A second option is to simply wait until buyers arrive at your door and produce widgets on demand, which you can do instantaneously and in as large a quantity as you like.

Thinking only about whether you can meet customer demand when it presents itself, these two options are basically identical. In the first case you have a large inventory to support your sales. In the second case you have a large—in fact, infinitely large—"shadow" inventory that you can bring into existence in lockstep with demand.

I invite you to think about this example as you contemplate this familiar graph of the Federal Reserve's balance sheet:


I gather that a good measure of concern about the size of the Fed's (still growing) balance sheet comes from the notion that there is more inherent inflation risk with bank reserves that exceed $1.5 trillion than there would be with reserves somewhere in the neighborhood of $10 billion (which would be the ballpark value for the pre-crisis level of reserves).

I understand this concern, but I don't believe that it is entirely warranted. My argument is as follows: The policy strategy for tightening policy (or exiting stimulus) when the banking system is flush with reserves is equivalent to the strategy when the banking system has low (or even zero) reserves in the same way that the two strategies for meeting customer demand that I offered at the outset of this post are equivalent.

Here's why. Suppose, just for example, that bank reserves are literally zero and the Federal Open Market Committee (FOMC) has set a federal funds rate target of, say, 3 percent. Despite the fact that bank reserves are zero there is a real sense in which the potential size of the balance sheet—the shadow balance sheet, if you will—is very large.

The reason is that when the FOMC sets a target for the federal funds rate, it is sending very specific instructions to the folks from the Open Market Desk at the New York Fed, who run monetary policy operations on behalf of the FOMC. Those instructions are really pretty simple: If you have to inject more bank reserves (and hence expand the size of the Fed's balance sheet) to maintain the FOMC's funds rate target, do it.

To make sense of that statement, it is helpful to remember that the federal funds rate is an overnight interest rate that is determined by the supply and demand for bank reserves. Simplifying just a bit, the demand for reserves comes from the banking system, and the supply comes from the Fed. As in any supply and demand story, if demand goes up, so does the "price"—in this case, the federal funds rate.

In our hypothetical example, the Open Market Desk has been instructed not to let the federal funds rate deviate from 3 percent—at least not for very long. With such instructions, there is really only one thing to do in the case that demand from the banking system increases—create more reserves.

To put it in the terms of the business example I started out with, in setting a funds rate target the FOMC is giving the Open Market Desk the following marching orders: If customers show up, step up the production and meet the demand. The Fed's balance sheet in this case will automatically expand to meet bank reserve demand, just as the businessperson's inventory would expand to support the demand for widgets. As with the businessperson in my example, there is little difference between holding a large tangible inventory and standing ready to supply on demand from a shadow inventory.

Though the analogy is not completely perfect—in the case of the Fed's balance sheet, for example it is the banks and not the business (i.e., the Fed) that hold the inventory—I think the story provides an intuitive way to process the following comments (courtesy of Bloomberg) from Fed Chairman Ben Bernanke, from last week's congressional testimony:

"Raising interest rate on reserves" when the balance sheet is large is the functional equivalent to raising the federal funds rate when the actual balance sheet is not so large, but the potential or shadow balance sheet is. In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit. The only difference is that, in the former case, the available reserves are explicit, and in the latter case they are implicit.

The Monetary Policy Report that accompanied the Chairman's testimony contained a fairly thorough summary of costs that might be associated with continued monetary stimulus. Some of these in fact pertain to the size of the Fed's balance sheet. But, as the Chairman notes in the video clip above, when it comes to the mechanics of exiting from policy stimulus, the real challenge is the familiar one of knowing when it is time to alter course.

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


March 8, 2013 in Banking, Fed Funds Futures, Federal Reserve and Monetary Policy, Monetary Policy | Permalink


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One potential risk this time is that the Fed has been buying lots of assets that aren't treasuries, and some of the riskier assets can no longer be sold for the same price at which it was bought. In theory that situation could leave the Fed unable to recall all the money it put into circulation.

That said, you are right that interest on reserves could still be raised to have the same effects.

Posted by: Matthew Martin | March 08, 2013 at 03:30 PM

"In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit."

Banks cannot lend their reserves. In fact, there is no balance sheet transaction that will allow a central bank liability to be loaned to a "non-bank" entity. Banks make loans by issuing a demand deposit and not by issuing reserves. Bank lending is never constrained by a reserve position.

The IoER policy implemented in 2008 moved the Federal Reserve out of a "corridor system" and into a "floor system". Under a floor system the level of reserves and the overnight interest rate are divorced. The IoER or "floor level" also becomes the deposit level. This disconnect works as long as there are sufficient excess reserves within the system, which in the case of the US, there are adequate excess reserves.

It should also be noted that future increases in the overnight rate are simply announced with the lending and deposit rates changing in tandem. Traditional models of draining reserves via FOMO are no longer required. Reserves are not the dual of overnight interest rates. Thus, when the Fed would like to "tighten" policy it will not be required to reduce the size of it's balance sheet as draining operations are no longer required to hit the overnight target.

Posted by: JJTV | March 08, 2013 at 05:58 PM

How about changing how monetary policy is conducted? Instead of using the blocked and saturated credit markets for monetary policy just bypass them and modify the fed so it deals directly with the public.

Posted by: Daniel | March 09, 2013 at 12:55 AM

If the fed marks up its long position and passes the gain to the treasury wont it have to pass the loss when it hikes the fed rate? and what will be the impact to treasurys when it hikes the fed rate? wont it raise the cost to the government budget when rates go up and it has to finance the debt at 110% debt to gdp and a duration of less than 5 thanks to the fed? Aren't we underestimating the potential damage to hiking rates?

Posted by: Emilio Lamar | May 01, 2013 at 02:33 PM

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