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.

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April 27, 2005

Roach To Fed: J'Accuse! (The End)

My obsession concludes.

I may appear to have been a bit defensive in this series of posts.  Perhaps it is so.  But statements like this...

The Fed is not only hard at work in the engine room in keeping the magic alive with a super-accommodative monetary policy but is has also become the intellectual architect of the New Macro. Time and again, since Alan Greenspan rolled out his New Paradigm theory in the late 1990s, senior Federal Reserve policy makers have taken the lead role as proselytizers of a new macro spin that condones the saving, debt, property bubble, and current-account excesses of the Asset Economy.

... are just plain silly.

OK.  I'll be generous and chalk that up to creative writing for effect.  But a really constructive conversation would tackle these sorts of questions:

-- I gather the prescription favored by those who feel the same as Stephen Roach is for the Fed to be more aggressive in tightening policy.  Fine, but is that what you really would have done in 1997, confronted with the circumstances at the time?  In 1998?  Would you have been impervious to the global financial stress I noted in the second post?

-- Would you choose to ignore the fact that employment growth in the U.S. has consistently struggled to gain traction?   Would you be confident enough that bubbles exist, and that monetary policy can do something about them if they do, to tighten monetary policy if you had some concerns about the underlying strength of the real economy?   

There is a reasonable debate to be had on all of these issues.  Let's have it.

Did you gather that I didn't particularly care for the Roach column?  Right. The critics, on the other hand, loved it: Resonance says "If you're into this topic, go read the whole thing"; The Housing Bubble bubbles "Mr. Roach is right on the mark again and the article is worth the few minutes it takes to read"; Bill Cara advises "I think you ought to be reading Stephen Roach’s daily commentary as I do"; The Cunning Realist claims "Stephen Roach, one of the few Wall Street pundits worth listening to, put out an excellent piece..."; James Wolcott agrees that, in that of which Roach speaks, "Fed chief Alan Greenspan has ignobly, disastrously, almost incomprehensibly failed"; The House of Cards endorses Wolcott;  Moon of Alabama exclaims "Go read the whole piece, it provides more in-depth explanations of how the Fed has dug itself deeper at every turn, by inflating a new, bigger bubble whenever the previous one threatened to burst".

UPDATE: In my initial post I complained about the dearth of critical reaction to Roach's comments.  Not to fear. Calculated Risk has filled the void.

April 27, 2005 in Federal Reserve and Monetary Policy | Permalink


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» Judging Fed Policy from Global Trader's Diary
While defending Roach's piece is a bit difficult, I am not that comfortable absolving the Fed either. [Read More]

Tracked on Apr 28, 2005 1:50:32 PM

» Judging Fed Policy from Global Trader's Diary
While defending Roach's piece is a bit difficult, I am not that comfortable absolving the Fed either. [Read More]

Tracked on Apr 28, 2005 1:53:57 PM


I believe that Fed Governor Don Kohn's speech set the stage for Stephen Roach's subsequent remarks. Perhaps not, but the speech caught my attention.

Defending Greenspan and Fedspeak after the fact with regard to consumer spending and further household debt accumulation is a bit much in my judgment. The effort was driven by low mortgage interest rates, home equity extraction, lack of substantial wage increases, and production of cheaper finished goods transferred overseas. The Fed wanted consumers to spend money. They did.

Let me begin.

Fedspeak on variable interest rate mortgages, equity extraction, consumer spending, household indebtedness, and retirement social programs.

Governor Don Kohn - Fedspeak - Fed policy contribution to higher asset prices, more household indebtedness, and mortgage refinancing, 22 April 2005.


"I am not disputing the argument that current policy has contributed to higher asset prices, more household indebtedness, and strong activity in interest-sensitive sectors such as housing. But I am questioning the apparently firm conclusion of some that these developments represent distortions or imbalances that are likely to correct in an abrupt and harmful manner. At the very minimum, one cannot reach this conclusion with a great deal of confidence... Nonetheless, I cannot rule out the possibility that destabilizing imbalances are building."

Stephen Roach - Fedspeak observer - Original Sin, 25 April 2005:


"The rhetorical flourishes of America's central bankers have dug the US economy -- and by definition, a US-centric global economy -- into a deep hole. One bubble has since begotten another -- from equities to bonds to fixed income spread products (i.e., emerging market and high-yield debt) to property."

"When consumers hear from a Fed chairman that it makes little sense to take on fixed rate debt, they rush to floating rate instruments; not by coincidence, the adjustable rate portion of newly originated mortgage debt shot up in the immediate aftermath of Chairman Greenspan's comments on consumer indebtedness. And should asset-dependent, saving-short, overly indebted American consumers feel at risk if the Fed assures them that there is no housing bubble -- that the asset-based underpinnings of their decision making are well grounded? A record consumption share in the US economy -- 71% of GDP since 2002 versus a 67% norm over the 1975 to 2000 period -- speaks for itself."

"To the extent that equity extraction from ever-rising property appreciation was viewed as a substitute for organic sources of labor income generation, hard-pressed consumers went deeply into debt to monetize the windfall. As a result, household sector indebtedness surged to nearly 90% of US GDP -- an all-time record and up over 20 percentage points from levels in the mid-1990s when the Asset Economy was born. Secure in the asset-driven spending posture that resulted, consumers saw no need to save the old-fashioned way out of earned labor income. That's why the personal saving rate has collapsed and currently stands near zero."

"Fedspeak has taken us into the greatest moral hazard dilemma of all -- how to wean an asset-dependent system from unsustainably low real interest rates without bringing the entire House of Cards down."

"In short, without low real interest rates, the Asset Economy -- and all of its inherent imbalances and excesses -- is nothing."

Not to be overlooked, though...

Greenspan warning PENDING retirees at the last moment...after you have convinced them to risk everything else, including their homes.

Greenspan - Fedspeak - The Ultimate Sin, 27 August 2004:


"As a nation, we owe it to our retirees to promise only the benefits that can be delivered. If we have promised more than our economy has the ability to deliver to retirees without unduly diminishing real income gains of workers, as I fear we may have, we must recalibrate our public programs so that pending retirees have time to adjust through other channels. If we delay, the adjustments could be abrupt and painful. Because curbing benefits once bestowed has proved so difficult in the past, fiscal policymakers must be especially vigilant to create new benefits only when their sustainability under the most adverse projections is virtually ensured."

So, while the Fed was encouraging all forms of consumer spending and home equity extraction, it was also recommending that government support for social support program be downsized or curtailed. Greenspan has continued since August 2004 to call for the vast reduction in federal program benefits to citizens.

Fedspeak at its finest.

Posted by: Movie Guy | April 28, 2005 at 02:15 AM

More evidence:

Greenspan Fedspeak on mortgage refinancing and home equity extraction.


Greenspan, 19 October 2004:

"The enormous wave of mortgage refinancing, which ended only in the fall of 2003, allowed homeowners both to take advantage of lower rates to reduce their monthly payments and, in many cases, to extract some of the built-up equity in their homes. In the aggregate, the cash flows associated with these two effects seem to have roughly offset each other, leaving the financial obligations ratio little changed."

"Indeed, the surge in cash-out mortgage refinancings likely improved rather than worsened the financial condition of the average homeowner. Some of the equity extracted through mortgage refinancing was used to pay down more-expensive, non-tax-deductible consumer debt or to make purchases that would otherwise have been financed by more-expensive and less tax-favored credit."

"In summary, although some broader macroeconomic measures of household debt quality do not paint as favorable a picture as do the data on loan delinquencies at commercial banks and thrifts, household finances appears to be in reasonably good shape."

"In addition, a significant decline in consumer incomes or house prices could quickly alter the outlook; nonetheless, both scenarios appear unlikely in the quarters immediately ahead. If lenders, including community bankers, continue their prudent lending practices, household financial conditions should be all the more likely to weather future challenges."

Greenspan message: Cash out home equity and pay off credit card debt. It's the thing to do. Keeping spending.

Posted by: Movie Guy | April 28, 2005 at 02:20 AM

More evidence, part II:

Greenspan Fedspeak on mortgage refinancing, home equity extraction, increased consumer expenditures, and low household savings rate.


Greenspan, 4 February 2005:

"An increase in household saving should also act to diminish borrowing from abroad. The growth of home mortgage debt has been the major contributor, at least in an accounting sense, to the decline in the personal saving rate in the United States from almost 6 percent in 1993 to its current level of 1 percent. The fall in U.S. interest rates since the early 1980s has supported both home price increases and, in recent years, an unprecedented rate of existing home turnover."

"This combination has led to a significant increase in home mortgage debt. The rise in home prices creates capital gains, which become realized with the subsequent sale of a home. The amount of debt paid off by the seller of an existing home averages about three-fifths of the mortgage debt taken on by the buyer, effectively converting to cash an amount of home equity close to the realized gain. This cash payout is financed by the net increase in debt on the purchased home, and hence on total mortgage debt outstanding."

"Even after accounting for the down payments on any subsequent home purchase, sellers receive, net, large amounts of cash, which they view as unencumbered. The counterpart of that cash, the increased debt taken on by the homebuyers, is supported by the new home values enhanced by capital gains. In addition, low mortgage interest rates have encouraged significant growth of home equity loan advances and cash-out refinancings, which are another channel for the extraction of previously unrealized capital gains on homes."

"All told, home mortgage debt, driven largely by equity extraction, has grown much more rapidly in the past five years than during the previous five years. Surveys suggest that approximately half of equity extraction shows up in additional household expenditures, reducing savings commensurately and thereby presumably contributing to the current account deficit."

"Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit. To be sure, correlation is not causation, and there have been many influences on both mortgage debt and the current account. Nevertheless, over the past two decades, major innovations in the United States have improved the availability and lowered the costs of home mortgages. These developments likely spurred homeowners to tap increasing home equity to finance consumer expenditures beyond home purchase. In contrast, mortgage debt is not so readily available among our trading partners as a vehicle to finance consumption expenditures."

Greenspan message: Consumers are extracting home equity to make other purchases. This is part of the reason why household savings are low. This contributes to the current account deficit.

Posted by: Movie Guy | April 28, 2005 at 02:22 AM

Never thought I'd see so much flaming. The stress level must be rising. Sorry, but you guys are arguing about how the deck chairs should have been arranged.

Posted by: Michael Paulding | April 28, 2005 at 03:41 AM

MP--well, just enjoy your little politically correct boring world.

I believe that Dave had ever reason to challenge Roach's comments. Good for him.

But I'm not letting Greenspan off the hook over his variable interest rate mortgage encouragements. Or his concurrent abandonment of retirees social programs. He's gone too far.

Posted by: Movie Guy | April 28, 2005 at 07:12 AM


We can go beyond a negative real federal funds rate to see signs of excessive monetary accomodation. For example, the significant credit growth as a % of GDP, the "search for yield" in emerging markets, the narrowing of spreads, and the run up in consumer debt, and the gap between the growth rate of the economy and the policy rate all at some level suggest monetary policy has been loose.

Roach is not singing solo on this issue. Other observers including The Economist and the IMF have also argued that the Fed has been too accommodative (See links below).

On a broader level, the loose U.S. monetary policy has been part of the excess global liquidity discussion. In fact, the Financial Stability Forum, whose participants included the Fed and other central bankers,called the excess global liquidity a risk:

"These [risks] included the current level of global funding and market liquidity and the associated low levels of risk premia and long-term interest rates." (see link below)

Strange that same central bankers who have significant influence over global liquidity are now concerned the level of it may pose a risk.


IMF http://www.imf.org/external/pubs/ft/GFSR/2005/01/pdf/chp2.pdf

Financial Stability Forum

Posted by: David | April 28, 2005 at 08:39 AM


During the period in question, the U.S. has experienced above trend productivity growth. This alone implies the real rate should higher: higher marginal product of capital => higher real interest rate...unless of course the monetary authority has been intervening.

Posted by: David | April 28, 2005 at 08:43 AM

Consumer behavior is convincing evidence for a Fed policy of screwing savers to bail out debtors. When whipped savers become afraid to reach for higher risk and return, their last remaining alternative is capital flight.

Posted by: psh | April 28, 2005 at 11:35 AM

Dear Movie Guy: If you only knew my world. Like Roach, you are fighting the last war. Greenspan is over, finished, done; he squandered his credibility. He was in the job too long.

Sure, Altig has some valid points. So does Roach, and so do you. But, it's now history. Most everyone agrees that the global economy is on a frightening trajectory, but few are offering any recommendations. Well?

Posted by: Michael Paulding | April 28, 2005 at 02:05 PM

There certainly is lots of blame to go around for the mess that has been created.

In the early 1990s, Ross Perot warned us about rising national debt and job losses from free trade. We tackled the national debt for most of that decade, but plunged into globalization and got our ass kicked. The problem is not with globalization but with the way it was implemented, allowing our current account to mushroom. Our politicians are to blame for not anticipating this.

Consumers have reacted by borrowing and running up 10 trillion $ in debt. This debt, which was growing by 8% per year in the late 1990s, is now growing by 11% per year. This is a national disaster with severe consequences yet to happen. I'll mostly blame the Fed for allowing this.

Investors are almost entirely to blame for the internet stock bubble, but the Fed should have put on the brakes to slow it down.

Foreigners shouldn't be blamed for any of this.

Posted by: touche | April 28, 2005 at 04:22 PM

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