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 30, 2009

The undocumented and business survival in the United States

Based on the severe economic contraction during the past six months, it is obvious why the topic of the economy receives so much attention as the economy directly weighs on the lives of citizens and businesses here and throughout the world. But the weight of the economy can have indirect effects as well, including potentially shifting attention from other policy issues.

For instance, a recent Bloomberg News article describes how economic troubles may affect potential immigration reform legislation.

"The long campaign to overhaul U.S. immigration laws may be derailed for yet another year—this time by the deteriorating economy."

The immigration debate is multifaceted, complex, and, at times, contentious. There are myriad issues to consider when entering into the immigration reform discussion, many of which are best left to the political process to decide. But, as the Bloomberg article describes, there is an important economic component to the immigration discussion. Economists can make a modest contribution to the debate by supplying unbiased research that touches on various aspects of the immigration question.

In that spirit, I offer up the results of research I've done with my colleagues, Julie Hotchkiss of the Federal Reserve Bank of Atlanta and David Brown of Heriot-Watt University in Edinburgh. Our research looks into the potential impact of undocumented workers on firm survival and is based on confidential information from the state of Georgia, which between 2000 and 2008 experienced the fastest growth in the number of undocumented immigrants in the United States, according to the Department of Homeland Security.

In this research, we find that firms employing undocumented workers enjoy a competitive advantage over firms that do not employ undocumented workers. We also observe that firms engage in herding behavior, i.e., firms will employ undocumented workers if their competitors do. The herding behavior is a natural consequence of competitive pressure: Rival firms' undocumented workforce lowers a firms' survival probability, while a firm's own undocumented workforce strongly enhances that firm's survival prospects.

Our analysis suggests that cost savings enjoyed by firms employing undocumented workers is a result of paying these workers wages that are less than what is paid to comparable documented workers. Because the advantage of hiring undocumented workers is cost-related, herding behavior and competitive effects are weaker if firms have the option to shift labor-intensive production out of state or abroad.

Our findings have several implications relevant to the policy discussion. The most straightforward prediction would be that if immigration reform is successful in forcing firms to pay undocumented workers market wages, the competitive advantage of hiring these workers may disappear. As a consequence, the demand for undocumented workers might well dissipate.

In addition, reform efforts that reduced the supply of undocumented workers (e.g., through tougher border and worksite enforcement) would raise firms' production costs, which may have an impact on prices if firms pass through these additional costs to consumers. However, this last point is not a direct implication of our analysis.

One word of caution about this study: Our results are based on the payroll reports of employers. This study does not have information on the activities of undocumented workers that are not recorded on firms' official wage records.

There are, of course, many other aspects of immigration policy to be considered, and we are loath to characterize the results of our research as supporting any particular approach or conclusion. But we do hope it sheds some light on a debate that already has its fair share of heat.

By Myriam Quispe-Agnoli, research economist and assistant policy adviser at the Atlanta Fed

April 30, 2009 in Immigration | Permalink


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And why won't businesses, seeing the advantage of the undocumented as you report here, replace the now documented with new undocumented workers at their earliest convenience?

Second, I know of many businesses that pay under the table to avoid taxes. If the IRS can't find these businesses, why are businesses paying the undocumented under the table suddenly going to find them when these workers are documented?

This is why the enforcement side must be perfected first. Only then can we consider creating a GIGANTIC inducement to more illegal entry.

Posted by: djt | May 01, 2009 at 02:14 PM

As my favorite talk show host Thom Hartmann always says:

"We DON't have an illegal immigration problem, we have an ILLEGAL EMPLOYER PROBLEM."

Start prosecuting the EMPLOYERS and the "illegal" immigrant problem will take care of itself.

Posted by: aaronbav | May 01, 2009 at 02:39 PM

In other words, if another contractor uses undocumented cash labor without paying workers' comp, FICA or other payroll deductions, I'll be forced: a) raise my prices; b) make less profit; or c) hire undocumented cash labor myself. If I don't do one of those things, I'll be out of business.

I'm sorry, but ten years ago most reasonably observant Americans figured this out without an economist's "analysis". We also figured THIS out: the undocumented receiving $10 an hour can send $2 per hour home to support his family. The documented, who is earning $8.50 to compete with the undocumented (because his documentation requires the employer to pay workers' comp, FICA and unemployment insurance), will never be able to support a family on that wage. His family lives here, in a dollar economy.

So the cheat gets a living wage while the legal worker barely gets by. The honest employer is driven out of business while the illegal employer is rewarded.

But wait! There's more! If you complain about this situation, you're labeled a racist or a xenophobe, not a concerned American. And if you're that struggling documented worker who can't support a family on $8.50 an hour, you're derided as not willing to do the "hard work" that immigrants are willing to do.

Bottom line: pay our documented workers enough to support their families and they'll do any work you ask them to do. Enforce laws against hiring illegal workers (very easy to do with social security numbers) and the legal firms will survive. All it takes is political will.

Posted by: Jeffrey Goodrich | May 01, 2009 at 07:21 PM

'As my favorite talk show host Thom Hartmann always says:

"We DON't have an illegal immigration problem, we have an ILLEGAL EMPLOYER PROBLEM."

Start prosecuting the EMPLOYERS and the "illegal" immigrant problem will take care of itself.
nonsense...hartmanns been bashing those of us who want border laws enforced since 'last hours of ancient sunlight'
the problem goes way beyond employers...
do you think drug dealers/ prison guards union/ teachers union want u.s. population to level off?
hartmanns full of it

Posted by: kevin joseph | May 04, 2009 at 07:27 PM

from what i heard on several radio shows 5 MILLION illegals got low income home mortgages thru hud


Posted by: kevin joseph | May 04, 2009 at 07:42 PM

This is a bogus argument. Increased immigration is a sign of a booming economy. The construction business and low level service business was going gangbusters during the greater part of the 2000-2008 timeline. This means that there was a need for undocumented immigrants which flooded this country. This is simple market economics. If you don't like it, swim to Cuba and find out how it works. There was demand for labor and labor came. Who do you think built all the crappy homes in the Atlanta suburbs? Who staffed all the new McDonalds and malls that opened in the exurbs? The illegals. We Americans decided we wanted to spend rather than work hard for a living and now we are complaining about immigrants. Get a grip you all. Business is going to do what it has to in order to increase profits. That's the American way and that's why we are the most powerful country in the world.

Posted by: Michael | May 06, 2009 at 12:21 AM

The analysis and results are, indeed, quite obvious (as noted by JG at 7:21p, 5/1. That may not detract from their usefulness in the debate over immigration reform, however.

Posted by: don | May 12, 2009 at 10:01 PM

1) "Need" and "some people want" are two different things.

2) How come real wages have gone down in professions where illegals mostly work.

3) Doesn't #2 indicate there is no "need" and that it's merely rich people playing the labor arbitrage game.

4) Shouldn't we be importing marketers, lawyers and doctors based on "need"?

5) Can't a modest, legal only, non lawyer hassle, non employer holds the visa system be implemented?

Posted by: joe schomoe | May 14, 2009 at 09:18 AM

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April 24, 2009

Is the investment trend in the current recession “run of the mill”?

In the last macroblog post, David Altig examined personal consumption expenditures during recessionary periods. Reader Dave Backus, the Heinz Riehl Professor of International Economics and Finance at New York University's Stern School of Business, sent us a follow-up email asking about other components of gross domestic product, and investment in particular. Good question, so let's take a look at investment during the current and past recessions.

Earlier this year, the University of Chicago's Casey Mulligan, writing in the New York Times' Economix blog, examined real investment trends for the past four recessions and called the current investment trend in this recession "run of the mill." Employing the same basic idea from our previous macroblog post, below is a chart showing the percentage change from the first quarter to the trough of the last eight recessions, along with the percentage change from the current recession's first quarter to the first quarter of this year.


Prof. Mulligan's point emerges pretty clearly. Matched up against previous recessions, there is nothing spectacularly unusual about the declines in overall investment expenditure—not yet, at any rate. But that picture may be a bit deceiving. Here's the same sort of graph for fixed investment—that is, all investment expenditures other than changes in inventories.


The current recession—which is not yet over as far as we know—does not stack up so favorably when it comes to fixed investment spending. In fact it leads the pack in terms of investment decline among the eight recessions since 1960. This fact is not too surprising given the the relative impact of residential private investment in the current recession. This impact can be seen by comparing gross domestic private investment with gross domestic private investment excluding residential private investment. In all previous recessions apart from 1990, the percentage change in gross domestic private investment excluding residential private investment significantly exceeds the drop in gross private investment, and in the 1990 recession they were roughly comparable. In the current recession, gross domestic private investment excluding residential investment is significantly less than the gross domestic private investment.


In addition to that difference, the comparison of gross investment patterns is significantly affected by the behavior of inventory changes across recessions. The modest decline in overall inventories in the current downturn is the reason for the relatively benign view of investment highlighted in Casey Mulligan's Economix piece.


So, let's consider again whether the current investment trend in this recession is "run of the mill." Perhaps at first glance it is, but when we break down the components of gross domestic private investment, these charts inform us that the relative declines in the various components of gross domestic private investment are quite different in this recession. And just how benign that picture is depends, in part, on whether the slow pace of inventory decumulation thus far proves a lasting feature of this recession. On that, we will just have to wait and see.

By Courtney Nosal, economic research analyst at the Atlanta Fed

April 24, 2009 in Business Cycles, Data Releases | Permalink


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How much of the change in behavior of inventories can be attributed to 'just in time' efficiencies in inventory management that have caused the overall size of inventories to shrink?
My ad hoc analysis is that business investment has been depressed since the dotcom bust, so the decline for this current downturn is not from a robust base and so may not be comparable to previous recessions.

Posted by: don | April 24, 2009 at 04:29 PM

Can you add the chart for nonresidential fixed investments?

This is the category many think of when you are discussing investment.

Posted by: spencer | April 24, 2009 at 05:27 PM

Could you add a chart of non-residential fixed investment to the article.

That is what most people think of when you discuss investments.

Posted by: spencer | April 25, 2009 at 07:53 AM

If you look at the change in the capital stock this recession is also very different and much worse. In 2009 we will have the capital stock declining for the first time since the 1930s. That is in part because the net investment rate did not get very high during the expansion--despite all of the investment friendly tax cuts (partial expensing reduced rates on capital gains and dividends.

Posted by: rana | April 25, 2009 at 01:45 PM

Not only was investment's decline from a low base, a larger than usual share of the investment that comprised that low base was in commercial real estate rather than in manufacturing or natural resource development. What investment was directed to manufacturing by domestic corporations in recent years was disproportionately directed overseas. These circumstances augur poorly for domestic employment recovery.

Posted by: mrrunangun | April 25, 2009 at 02:03 PM

Just wanted to say HI. I found your blog a few days ago and have been reading it over the past few days.

Posted by: runescape money | April 27, 2009 at 02:08 AM

Could you add a chart of non-residential fixed investment to the article.

That is what most people think of when you discuss investments.

Posted by: runescape power leveling | May 31, 2010 at 09:05 PM

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April 17, 2009

Abnormal consumer spending—not quite

I was struck by this headline which led a Tuesday post in Economix, the economics blog of the New York Times—"Consumer Spending Declines: A Historical Oddity."

Sometimes these sorts of teasers are not great indicators of a more nuanced analysis that follows, but in this case the headline synopsis pretty well captured the plot.

"That the American consumer is cutting back spending is blindingly obvious these days, but it is still hard to overemphasize this central feature of the current recession. Americans borrowed like crazy for years against their home values, which have now fallen and are dragging consumption down with them.

"The sustained decline in consumer spending is also—as the European Central Bank points out in a tight piece of work synthesizing features of past recessions—a historical oddity of the first order."

That analysis is not, I think, quite so tight. Here's a chart that measures the cumulative percent change in real personal consumption expenditures from the beginning of each U.S. recession since 1960 to the lowest point of those expenditures over the recession's course:


The first very obvious feature of this picture is that there is nothing like a typical recession pattern when it comes to consumer spending. The second obvious feature is that the fall in household consumption in the current downturn looks entirely unremarkable when stacked up against past episodes.

For those of you still reading, it would be fair of you to remind me that the current recession is not over, so the record is yet incomplete. Though personal consumption expenditures actually increased in January and February, the most recent retail sales report might warrant caution. In fact, Economix has followed up with a cross-recession comparison of retail sales that definitely puts the current recession in a relatively bad light. That's fine, though I would note that retail sales are only a piece of overall personal consumption expenditures, a piece that does not really capture the increasing share of spending on services that has occurred over the postwar period.

But even if the turnaround in overall consumer spending proves durable, it is not entirely clear that there is much solace to be taken from such a development. If you are inclined to look to the darker side of things, the fact is that a turnaround in consumption generally comes well before a recession ends. In the long and relatively severe recessions of 1973–75 and 1981–82, consumer spending bottomed out a full year before the economy turned around in general. (The bottom was eight months before the end of the recession in the 1969–70 and 2001 recessions and two months before the end in the 1960–61, 1980, and 1990–91 recessions.)

For lots of reasons, then, I wouldn't want to overweight good (or even benign) news from the consumer spending front. But historical oddity? I don't believe so—yet.

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

April 17, 2009 in Business Cycles, Data Releases | Permalink


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David, that graph of real PCE changes is definitely interesting.

I can think of two factors that might make comparisons more complex.

First, how acute were the falls and recoveries? If real PCE falls 3% over four months and then recovers in four months, it would be a much different effect from having it fall 2% over a year and then staying down another year.

Second, does adjusting for inflation using the CPI distort anything? I've been thinking of this lately in regards to the inflation/deflation debate. For instance, in this recession, a huge part of the fall in PCE is from vehicle sales. But they make up a much smaller part of the CPI, and their prices might have gone in the opposite direction.

The most frequent problem with using the CPI to adjust to real figures is that it only measures consumer price inflation. But not wages. So adjusting home prices with the CPI seems a little off to me. If wages are flat and commodities spike, home prices will appear "flat" if they rise with the elevated CPI.

I know that adjusting for inflation is necessary, but I think using a particular measure it must inevitably muddy things in other ways.

Posted by: Bob_in_MA | April 18, 2009 at 09:46 AM

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April 15, 2009

Déjà vu all over again

I have, recently, been experiencing a strange sense of familiarity watching the Congressional Budget Office's (CBO) efforts to monitor the budgetary implications of the Troubled Asset Relief Program (TARP). On the one hand, the long-term costs are rising:

"Since January, CBO has raised its estimate of the net cost (on a present-value basis) of the transactions covered by the TARP by $152 billion for 2009 and by $15 billion for 2010. Those revisions stem from three factors—changes in financial market conditions, new transactions, and a small shift in the anticipated timing of disbursements."

On the other hand, the CBO wants to book less spending in the near term than what the Treasury has in mind, for reasons that have to do with accounting procedures and the pace of actual TARP spending:

"Budget accounting issues are clouding the deficit forecasts for this year. The above estimate of this year's deficit to date includes outlays of about $290 billion for the Troubled Asset Relief Program (TARP). Although the Treasury has been recording most spending for the TARP on a cash basis, CBO believes that the budget should record the program's activities on a net present-value basis adjusted for market risk. Using that approach, CBO estimates that outlays of $140 billion should be recorded for the TARP through March. That approach would yield an estimated deficit of $803 billion for the first half of the year."

After a few minutes of pondering why it seemed like I had seen this before, I flashed back to my early days in the Federal Reserve System and the saga of the Resolution Trust Corporation, the Congress-created vehicle that helped the country work its way through the aftermath of the 1980s savings and loan crisis. In August 1989, here's what the Congressional Budget Office was thinking:

"The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (Public Law 101-73) is a complex measure affecting federal government taxes, premiums, spending, borrowing, and regulation. While the bill strengthens the government's system for insuring commercial banks, its primary focus lies in addressing the huge liabilities forced on the government by failed and insolvent savings and loan institutions.

"… The legislation establishes a new Resolution Trust Corporation (RTC) to merge or close currently insolvent insured thrifts. The RTC is to spend a total of $50 billion on this task… The $50 billion in resources available to the RTC are sufficient, in the Administration's estimate, to cover the government's liabilities for currently insolvent thrifts with $10 billion left over to help defray interest costs…"

The CBO, however, was not convinced that the RTC's resolutions would come so cheap.

"… many observers, including CBO, doubt that this level of resources is enough."

And in January 1990, the CBO was unhappy with the Treasury's accounting procedures:

"Last year's Financial Institutions Reform, Recovery, and Enforcement Act effectively excluded about $30 billion of deposit insurance spending from budget totals in 1990 and 1991, by having the funds borrowed through a newly chartered, government-sponsored enterprise, the Resolution Financing Corporation (REFCORP).

"REFCORP's status as a government-chartered enterprise is critical to the budgetary treatment of its borrowing. Normally, the U.S. Treasury conducts any necessary financing for the government. Treasury borrowing finances the deficit; it does not reduce the deficit. Otherwise, the budget would always be balanced. But because REFCORP is technically private, the funds that it borrows and turns over to the (on-budget) Resolution Trust Corporation count as offsetting collections. These funds offset the associated spending to resolve failed savings and loans. …

"CBO believes that REFCORP is a government entity, that its borrowing is government borrowing, and that the budgetary treatment that has been adopted is inappropriate."

By accounting for things the way they thought they should be accounted for, the CBO estimated as of August 1991 that the costs of the resolution process would in fact be quite a lot higher than initially assumed:

"CBO now believes that the RTC will pay total losses of about $155 billion (in 1990 dollars) for a caseload of about 1,500 institutions."

What is more, the whole process was taking quite a bit more time than originally hoped:

"CBO assumes that the RTC continues resolving institutions through calendar year 1994, more than two years longer than originally scheduled."

In August 1992, even that time frame was looking optimistic…

"CBO assumes that the RTC or a successor will deal with a heavy caseload through 1998…"

But the news wasn't all bad:

"CBO estimates the cleanup's cost at $135 billion. Sobering as this figure is, it actually represents a glimmer of good news: CBO's former estimate was about $155 billion."

Movement in the right direction notwithstanding, Congress did not exactly jump at the opportunity to extend the RTC's life span. From the January 1994 Economic and Budget Outlook:

"The savings and loan cleanup is forging ahead after a prolonged interruption in its funding. From April 1992 until December 1993, the Resolution Trust Corporation (RTC) had only very limited authority to incur losses. It was largely confined to selling off its portfolio of assets and to resolving the occasional institution that could be closed or merged at little or no loss to the government; hence, the RTC recorded negative outlays in both 1992 and 1993.

"The Congress brought this drought to an end in late 1993 with the Resolution Trust Corporation Completion Act."

And when Congress eventually acted, the picture was brighter yet:

"There is good news on the RTC front: the agency will not fulfill the gloomy predictions that were common even a year or two ago. CBO now estimates the total value of losses covered by the RTC since its inception in 1989 at about $90 billion (expressed, by convention, in 1990 dollars)."

And that is about where it ended up:

"The total tab for the RTC lies somewhere between the sunniest and gloomiest projections made during its early years. CBO now estimates the total value of losses covered by the RTC and its successor through 2000 at about $90 billion (expressed, by convention, in 1990 dollars). …

"Four and a half years ago, CBO feared that the RTC's costs alone could be as high as $185 billion, and some outside experts were even more pessimistic. (The Bush Administration, in contrast, originally stated that $50 billion would be sufficient.)"

So there you have it. The last great experiment in working through financial crisis took longer than expected, involved some accounting pushing and shoving at the outset, confronted a skeptical Congress, and cost more than initially projected, but quite a lot less than feared.

Make of it what you will.

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

April 15, 2009 in Banking, Financial System | Permalink


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And might one add did the right thing by the country over the objections of the nay-sayers and posturings of the politicians. A comment you're probably not in a position to make so leave it to us casual outside observers.

Thanks for the history lesson. Sataynana lives !

Posted by: dblwyo | April 25, 2009 at 07:16 AM

It's a shame that it took so long and cost more than expected. Great article, very informative! Thanks

Posted by: Gary Sweeney | August 26, 2009 at 06:14 PM

I think we can all agree that the financial crises has left a shock wave that will forever change the way stocks, bond, options and even currency investments are traded. One of the biggest trends I have seen is the creation of a worldwide trading currency, although this is an old idea dating already from the 50’s, it is getting closer for implementation given the relative weakening of the US Dollar. But introducing such change it won’t be an easy task and will be a long term project , just by taking in consideration the regular ecommerce e-trade, Merchant accounts do not support this “new currency” and setting up the rules and conversions for settlements will be an outstanding challenge for world bank community.

Posted by: FX merchants | September 14, 2009 at 05:44 AM

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April 06, 2009

The mean and the variance of the longer-term inflation outlook

Ever hear the one about the statistician who had his head in the oven, his feet in the freezer, but who said he felt fine—on average? We kind of feel that way when we look at the recent distribution of inflation forecasts. Not only does the Federal Reserve Bank of Atlanta produce its own economic forecasts, but we’re also eager consumers of others’ forecasts. That’s because we believe there is useful information to be learned from varying views. For one thing, it helps to reveal the risks. The current inflation forecast is a good case-in-point.

Figure 1 shows the consensus CPI forecast for the Blue Chip panel of economic forecasters from March 10:


The “average” forecast shows CPI-measured inflation falling at a 2.25 percent (annualized) pace in the current quarter, followed by a modest .25 percent rise in the second quarter and then gradually climbing to a 2 percent growth trend in the second half of next year.

Our interpretation of the Blue Chip consensus inflation forecast (if such a thing is really possible, since it’s merely an average of many forecasts) is that falling energy and other commodity prices combined with a large amount of economic slack is likely to exert considerable downward pressure on inflation over the next few quarters. But as the economy gradually recovers, we should begin to see a gradual return of inflation to something closer to what the Federal Reserve sees as consistent with price stability.

OK, that’s the combined wisdom of the 50-some members of the consensus forecast panel. But there’s a bit more to the story than just the average forecast. Consider the 10 highest inflation forecasts relative to the 10 lowest. The inflation “optimists” see the CPI tracking at, or a shade under, 0.5 percent over the forecast horizon, while the pessimists see inflation continuing to move higher and topping 3 percent (annualized) in the second half of 2010. Now, some discrepancy in economic forecasts is to be expected, but the range of disagreement in the Blue Chip forecast about the longer-term inflation trend—at a little over 3 percentage points—is an exceptionally large spread. (By our calculations, it’s about twice the spread of the group’s longer-term average inflation prediction.)

However, we’ve got a pretty good idea of what’s causing such a large discrepancy. There likely are two competing and seemingly large risks within the consensus. First, some of these forecasters may believe the economy will not rebound in the way that is implied by the forecast average, which is to say that the economic slack (see Friday’s jobs report) putting downward pressure on inflation may be with us for some time. These forces could be exacerbated and prolonged if the public were to incorporate the lower near-term price behavior into their longer-term inflation expectations. We’re going to speculate that this is the inflation scenario the Blue Chip inflation “optimists” have in mind.

On the other side, some of these Blue Chip forecasters may believe the economy will do an abrupt about-face and climb out of the recession more adeptly than the consensus now predicts. In their view, if it does, and the Federal Reserve is not adept at shrinking the size of its balance sheet, there would be the proverbial inflationary scenario of “too much money chasing too few goods.” And, again, if the public incorporates this scenario into their expectations, the prediction of the inflationary pessimists comes to pass.

These competing inflation scenarios were a topic of conversation at the January Federal Open Market Committee (FOMC) meeting (below is a quote from the minutes of that meeting):

“Many [FOMC meeting] participants noted some risk of a protracted period of excessively low inflation, especially if inflation expectations were to move down in response to lower actual inflation and increasing economic slack, and a few even saw some risk of deflation.

“Several others, however, anticipated that longer-run inflation expectations would remain well anchored, supported in part by the Federal Reserve’s aggressive expansion of its balance sheet and the resulting growth of the monetary base…some noted a risk that expected inflation might actually increase to an undesirably high level if the public does not understand that the Federal Reserve’s liquidity facilities will be wound down and its balance sheet will shrink as economic and financial conditions improve.”

One risk has feet in the fire—the other in the freezer. Here’s hoping that the consensus is right.

Update from April 6, 2009:

The April 10 Blue Chip report came out today, showing a further widening of the spread between the forecasts for CPI inflation. While the mean forecast was revised only slightly, the difference between the top and bottom 10 forecasts for Q4 2010 increased by a full percentage point, from 3.3 to 4.3.


By Michael Bryan, vice president, and Laurel Graefe, economic analyst, in the research department at the Atlanta Fed

April 6, 2009 in Inflation | Permalink


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The "inflation pessimists" are right that inflation expectations of the public are for higher inflation. You can't read any media without being bombarded with stories about how much money is being spent (and printed) for bail outs. But the media are lying; the actual numbers for money supply and federal spending paint a more modest picture.

The "inflation optimists" are right that high unemployment will keep a damper on actual inflation (as opposed to expectations.) In fact, high inflation expectations are likely to restrain policy stimulus resulting in a weaker growth path than ideal.

Posted by: Rajesh Raut | April 06, 2009 at 12:30 PM

Now that is interestng. Thank you for you analysis. However, I'm wondering about the inference that can be made about the state of Economics. As the spread increases, does that imply that 'knowledge' decreases and 'quessing' increases? Interesting!

Posted by: Tom | April 07, 2009 at 06:51 AM

Two thumbs up, well done!

Posted by: runescape accounts | April 13, 2009 at 03:14 AM

It's incomprehensible to me that MacroEconomists can't find the integrity to demand the Gov't. update its principle economic gathering & reporting measurements be supported by population samplings. For 5 years we saw no inflation as measured by the CPI, when inflation for the majority of people in the U.S. was raging. Now Economists argue about deflation?
It's no wonder that so many of you cling to the absurdity that no one saw this catastrophy coming.

Posted by: bailey | April 14, 2009 at 09:48 AM

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April 01, 2009

Snapping ropes and breaking bricks

James Hamilton of Econbrowser is concerned about the current state of monetary policy. On the blog, Jim writes:

"I would suggest first that the new Fed balance sheet represents a fundamental transformation of the role of the central bank. The whole idea behind open market operations is to make the process of creating new money completely separate from the decision of who receives any fiscal transfers. In a traditional open market operation, the Fed buys or sells an existing Treasury obligation for the same price anyone else would pay for the security. As a result, the operation itself does not involve any net transfer of wealth between the Fed and the private sector. The philosophy is that the Fed should base its decisions on economy-wide conditions, and leave it entirely up to the market or fiscal authorities to determine where those funds get allocated.

"The philosophy behind the pullulating new Fed facilities is precisely the opposite of that traditional concept. The whole purpose of these facilities is to redirect capital to specific perceived priorities. I am uncomfortable on a general level with the suggestion that unelected Fed officials are better able to make such decisions than private investors who put their own capital where they think it will earn the highest reward."

After I looked up "pullulating," I found much to agree with in Professor Hamilton's description—or at least I did up to that last sentence. I certainly share his discomfort with a presumption that "Fed officials are better able to make… decisions than private investors," but that doesn't quite capture my view—and I emphasize my view—of how nontraditional policy is supposed to work. My own description of what the "fundamental transformation" of central bank policy is all about appears, hot off of the virtual press, in the first quarter issue of EconSouth, the Atlanta Fed's regional economics publication:

"I have a simple way of thinking about how monetary policy works. Imagine a long rope. At one of end of the rope are short-term, relatively riskless interest rates. Farther along the rope are yields on longer-term but still relatively safe assets. Off at the other end of the rope are multiple tethers representing mortgage rates, corporate bond rates, and auto loan rates—the sorts of interest rates that drive decisions by businesses and consumers. In the textbook version of central banking, the monetary authority grabs the short end of this allegorical rope, where the federal funds rate resides, and gives it a snap. The motion ripples down and hopefully reaches longer-term U.S. Treasury rates, which then relay the action to other market interest rates, where the changes reverberate throughout the economy at large.

"That's the story in normal times, and over the past year and a half the Federal Open Market Committee (FOMC) has done a fair bit of rope-snapping. In August 2007 the FOMC set the federal funds rate target—the overnight rate on loans made between banks—at 5.25 percent. As of December 2008, the rate target was lowered to a very low range of 0–0.25 percent. As the committee noted then (and reiterated in January), 'weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.'

"These FOMC statements held another extremely important message: 'The focus of policy going forward will be to support the functioning of financial markets and stimulate the economy.' In a speech to the National Press Club on Feb. 18, Federal Reserve Chairman Ben Bernanke elaborated:"

'Extraordinary times call for extraordinary measures. Responding to the very difficult economic and financial challenges we face, the Federal Reserve has gone beyond traditional monetary policy making to develop new policy tools to address the dysfunctions in the nation's credit markets.'

"One way to view the effects of those credit market dysfunctions is to imagine that someone had placed a series of bricks at strategic points along the segment of rope connecting short-term interest rates to broader market rates. With these bricks in place, it is simply not enough for a central bank to keep snapping short-term interest rates: The bricks—dysfunctions in the markets—will keep the impulse from being transmitted to the interest rates that are directly connected to market outcomes. Thus, a new set of policy instruments is needed, instruments that allow the monetary authority to circumvent blockages in the monetary transmission mechanism."

The "policy instruments" I have in mind, of course, are the pullulating new facilities that have Jim Hamilton worried. But it is worth emphasizing that many of these facilities are motivated by "unusual and exigent circumstances," a point emphasized in the recent Treasury-Federal Reserve statement (which is discussed in some detail by Tim Duy):

"As long as unusual and exigent circumstances persist, the Federal Reserve will continue to use all its tools working closely and cooperatively with the Treasury and other agencies as needed to improve the functioning of credit markets, help prevent the failure of institutions that could cause systemic damage, and to foster the stabilization and repair of the financial system."

How long will those conditions persist? Returning to my EconSouth commentary:

"No set timetable exists, but one would presume that as long as the bricks of market dysfunction are lying around, the tools will be necessary. Eventually, of course, markets will heal, the bricks will crumble, and the stage will be set to a return to business as usual in monetary policy and the economy. The sooner the better, but in the meantime it's helpful to have the tools in hand to start cracking the bricks."

That's my story, and I'm sticking to it.

By David Altig, senior vice president and research director of the Atlanta Fed

April 1, 2009 in Federal Reserve and Monetary Policy, Financial System, Money Markets | Permalink


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The Fed has terrible judgment. Just look at the past several years, it ignored cheap money from overseas ramping up credit growth because inflation was low while asset inflation was going to the moon, when the you-know-what hit the fan in August 07 they all believed it would be contained to housing and business capex would pick up the slack, then they started cutting rates when the problem was not the cost of money but in open market operations (ask some people off-the-record about dudley's performance at that time), and then the sharp eases that gave china and the other dollar-linked nations a boost that inflated energy and food prices then raising U.S. inflation to the point where the FOMC was adamant in having the forwards price a fed funds hike by year-end 2008. this fed has been wrong and wrong-headed all along the way and now Bernanke and the Fed are viewed as stewards of the financial order in need of broader regulatory power? as my grandmother used to say -- Oy! econmkts.blogspot.com

Posted by: steven blitz | April 01, 2009 at 03:07 PM

I'm not an economist, but heck, it's never stopped me before, so here goes.

No one in the private economy is spending their buck, so you spend the government buck.

When banks leave the field of battle, the Fed and the Treasury step in and provide a minimal amount of lending/spending, thus limiting the near term damage to ordinary people of all sizes and stripes.

This all works a lot better if the Fed and Treasury don't have to pay any interest on their borrowing.

Yield curve gets an upward, healthier slope. Credit markets notice this.

Once the now chastened (and poorer) private money returns to the playing field, the Fed and the Treasury recall their money and lessen the sovereign debt.

Depression avoided. At least for now.

Posted by: Beezer | April 02, 2009 at 09:45 AM

I follow Prof Altig's logic, but disagree on the bricks. Are the bricks market related, or there because of fiscal and fed policy? Had the elected wonks let AIG and the rest go bankrupt, surely we would have seen a melt down in the market. However, all the intervention has created a different conundrum. We are still in a liquidity trap. Since the Fed action of last Wednesday, long term rates have seeped higher. Only active Fed action will keep those long term rates low, since expectations are driving them higher. The short end of the curve is complacent. It's hard to snap the rope when rates are zero.

Fiscal policy is dismal, since it is anti-growth, and highly inflationary. The rhetoric coming out of the Congressional chambers is not helpful either. The government has bred a climate of fear-and the savings rate has climbed significantly higher.

It brings me back to the bricks. I am convinced that all of the insolvent banks and counter parties should have been allowed to fail, or taken a lot of pain. The market would have unfrozen quicker (bankruptcy does that) and we would be hurt but recovering. Now we are limbo.

When we watch Washington instead of LaSalle and Wall Street, we are in trouble.

Posted by: jeff | April 02, 2009 at 10:28 PM

While the analogy makes sense, I do not believe it is the Fed's job to fix these 'bricks'. I could understand this in the case of panic, but we are beyond that. Liquidity in particular appears under control - large bid-ask spreads are natural in a recession on complex products that have not gone through a deep recession along with massive gov't interventions.

Higher long rates are not a problem, its actually a necessary condition for banks to generate attractive returns on new loans which could draw new private capital. If the fed wants cheap loans to consumers and businesses then the gov't will have to directly or indirectly provide all of the loans, with no expectations of willing private capital. If consumers and businesses can not afford high rates then much safer to use fiscal policy to soften the blow. Not least it encourages good behavior, not the over leveraged. Also If inflation sets in rates will presumably go up considerably, creating a recession far worse than what we have already.


Posted by: GB | April 05, 2009 at 01:10 AM

What is needed is for the Federal Reserve to think out of the box and seriously consider ways to enforce significantly negative short term interest rates.

In order to achieve that, it should not add numerous policy instruments but remove the one that blocks the system : cash banknotes (you know, the actual green paper thing !).
It is easier than one thinks : just consider the percentage of one's expense that one actually settles with paper cash : 5%,3% ? The US (and most of the industrial world actually) has already the "plastic" infrastructure in place. Volker is wrong about the ATM being the only innovation in finance since the 70's ! Ubiquitous retail electronic payment is a very significant one and is indeed a big difference between today and the 30's.
Roosevelt had to abolish (in practice) private ownership of gold to monetarily kick start the New Deal. The equivalent for Obama is to abolish paper cash. Once this is done (actually, once it is announced with a short deadline !), the Fed can get rates into negative territory. Reserves at the Fed would COST money to depositing banks, that would transmit this cost to deposit holders,that would impact the whole yield curve both on treasuries and corporates.

Bottom line : the Fed is back in the game with a full powered monetary policy. As a non-negligible side benefit, underground economy, especially the illegal one, finds it much more difficult to operate.

If it is so easy, why hasn't this been done in Japan ? Two reasons,the second being the most important :
- It would have sent the Yen to the bottom, raising the ire of the US at that time.
- The social groups that were the biggest holder of cash at the end of "The Bubble" in Japan were (and are still) at the same time the biggest "constituencies" of the LDP.

Posted by: Charles Monneron | April 05, 2009 at 10:05 PM

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