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.

« April 2012 | Main | June 2012 »

May 31, 2012

What is shadow banking?

What is shadow banking? Announcing a new index—hat tip to Ryan McCarthy—Deloitte offers its own definition:

"Shadow banking is a market-funded, credit intermediation system involving maturity and/or liquidity transformation through securitization and secured-funding mechanisms. It exists at least partly outside of the traditional banking system and does not have government guarantees in the form of insurance or access to the central bank."

As the Deloitte study makes clear, this definition is fairly narrow—it doesn't, for example, include hedge funds. Though Deloitte puts the size of the shadow banking sector at $10 trillion in 2010, other well-known measures range from $15 trillion to $24 trillion. (One of those alternative estimates comes from an important study by Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky from the New York Fed.)

What definition of shadow banking you prefer probably depends on the questions you are trying to answer. Since the interest in shadow banking today is clearly motivated by the financial crisis and its regulatory aftermath, a definition that focuses on systemically risky institutions has a lot of appeal. And not all entities that might be reasonably put in the shadow banking bucket fall into the systemically risky category. Former PIMCO Senior Partner Paul McCulley offered this perspective at the Atlanta Fed's recent annual Financial Markets Conference (video link here):

"...clearly, the money market mutual fund, that 2a-7 fund as it's known here in the United States, is the bedrock of the shadow banking system...

"The money market mutual fund industry is a huge industry and poses massive systemic risk to the system because it's subject to runs, because it's not just as good as an FDIC bank deposit. We found out that in spades in 2008...

"In fact, I can come up with an example of shadow banking that really didn't have a deleterious effect in 2008, and that was hedge funds with very long lockups on their liability. So hedge funds are shadow banks that are levered up intermediaries, but by having long lockups on their liabilities, then they weren't part and parcel of a run because they were locked up."

The more narrow Deloitte definition is thus very much in the spirit of the systemic risk definition. But even though this measure does not cover all the shadow banking activities with which policymakers might be concerned, other measures of the trend in the size of the sector look pretty much like the one below, which is from the Deloitte report:

The Deloitte report makes this sensible observation regarding the decline in the size of the shadow banking sector:

"Does this mean that the significance of the shadow banking system is overrated? No. The growth of shadow banking was fueled historically by financial innovation. A new activity not previously created could be categorized as shadow banking and could creep back into the system quickly. That new innovation might be but a distant notion at best in someone's mind today, but could pose a systemic risk concern in the future."

Ed Kane, another participant in our recent conference, went one step further with a familiar theme of his: new shadows are guaranteed to emerge, as part of the "regulatory dialectic"—an endless cycle of regulation and market innovation.

In getting to the essence of what the future of shadow banking will (or should) be, I think it is instructive to consider a set of questions that were posed at the conference by Washington University professor Phil Dybvig. I'm highlighting three of his five questions here:

"1. Is creation of liquidity by banks surplus liquidity in the economy or does it serve a useful economic purpose?

"2. How about creation of liquidity by the shadow banking sector? Was it surplus? Did it represent liquidity banks could have provided?...

"5. If there was too much liquidity in the economy, why? Some people have argued that it was because of too much stimulus and the government kept interest rates too low (and perhaps the Chinese government had a role as well as the US government). I don't want to take a side on these claims, but it is an important empirical question whether the explosion of the huge shadow banking sector was a distortion that was an unintended side effect of policy or whether it is an essential feature of a healthy economy."

Virtually all regulatory reforms will entail costs (some of them unintended), as well as benefits. Sensible people may come to quite different conclusions about how the scales tip in this regard. A good example is provided by the debate from another session at our conference on reform of money market mutual funds between Eric Rosengren, president of the Boston Fed, and Karen Dunn Kelley of Invesco. And we could see proposals by the Securities and Exchange Commission in the future to enact further reforms to the money market mutual fund industry. But whether any of these efforts are durable solutions to the systemic risk profile of the shadow banking sector must surely depend on the answers to Phil Dybvig's important questions.

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

May 31, 2012 in Banking, Financial System, Money Markets | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference What is shadow banking?:


How has liquidity varied in the U.S., or perhaps OECD countries, since WWII? How have taxes affected the emergence of "shadow banking" if at all?

Posted by: Tom Shillock | June 01, 2012 at 12:53 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 24, 2012

The relative expansion of central banks’ balance sheets

Dave Altig's recent macroblog post on policy actions that affected the Fed's balance sheet made me wonder about how changes to the Fed's balance sheet since the financial crisis compared with other central banks.

Relative to before the financial crisis, the Federal Reserve's asset holdings are currently about 3.3 times larger. Initially, the source of that increase was the collateral associated with various temporary lending facilities that the Fed used to address the financial panic. Those assets were then replaced on net by purchases under the first large-scale asset purchase program in 2009. Then in late 2010, asset holdings increased further as a result of a second large-scale asset purchase program.

Of course, size isn't everything. While it might be tempting to try and interpret the change in the size of the central bank's balance sheet as a summary statistic of the degree of monetary policy accommodation, as Dave Altig's post points out, that interpretation is not so straightforward. Increasing the size of the balance sheet is not the only thing a central bank can do to ease monetary policy when short-term interest rates are very low. For example, in late 2011 the Fed began a maturity extension program that changed the composition of the assets on the balance sheet, but this program did not materially alter the size of the balance sheet.

With this caveat in mind, the following chart compares the proportionate changes in the size of asset holdings of five central banks over the period from the first quarter of 2007 through the first quarter of 2012: the Federal Reserve (FR), the Bank of England (BE), the European Central Bank (ECB), the Bank of Canada (BC), and the Bank of Japan (BJ).

Central Bank Asset Holdings

One take-away from the chart is the large variation from country to country. Here are some observations:

  1. Bank of England: Through mid-2011, the proportionate increase in the Bank of England's asset holdings was roughly similar to the Fed's. But then the Bank of England began a second round of large scale asset purchases that sharply increased the size of its balance sheet. By the first quarter of 2012, the Bank of England's asset holdings were about 4.2 times as large as they were before the financial crisis.

  2. European Central Bank: Through mid-2011, the ECB's asset holdings were about 1.7 times their precrisis level. But the sharp increase in the ECB's longer-term lending programs in recent months has resulted in a large increase in the size of ECB's balance sheet. By the first quarter of 2012, the ECB's asset holdings were about 2.5 times what they were before the financial crisis.

  3. Bank of Canada: In 2009, the Bank of Canada's asset holdings had increased to about 1.6 times their precrisis level—similar to the ECB's increase. But as liquidity pressures in Canadian financial markets eased, the Bank of Canada's asset holdings declined in 2010. By the first quarter of 2012, the Bank of Canada's asset holdings were around 1.3 times the precrisis level. (Note that the Bank of Canada's asset data are through February 2012.)

  4. Bank of Japan: The balance sheet of the Bank of Japan did not increase materially during the financial crisis, but has increased somewhat over the last year. By the first quarter of 2012 the Bank of Japan's asset holdings were about 1.2 times the pre-crisis level.

While size isn't everything, it is something. A large expansion in a central bank's balance sheets can create broad policy risks. This study by researchers at the St. Louis Fed suggests that large-scale balance sheet increases are a viable monetary policy tool, provided the public believes the increase will be appropriately reversed (citing the experience of Nordic countries in the early 1990s) or that the reserves created by the expansion will remain within the banking system (citing changes to bank settlement systems in the United Kingdom and New Zealand in the mid-2000s). New York Fed President Bill Dudley touched on some risks in an interview on CNBC today:

"...We've expanded our balance sheet a lot over the last few years. And additional actions do have costs, and so we have to weight them relative to the benefits...

"One set of cost is the extent we expand our balance sheet or we sell short-dated treasury securities and buy long-dated treasury securities, we have more risk, in terms of our portfolio, interest rate risks...

"The second issue, of course, is if we expand our balance sheet, we could create anxiety among some people that this might actually sow the seeds for future inflation. I don't think expansion of the balance sheet, in any way, compromises the Fed's ability to keep inflation in check over the longer term. But it doesn't matter just what I think. If people in the market think that expansion of the balance sheet could cause future inflation, we have to take those expectations into consideration as a potential cost of monetary policy."

John RobertsonJohn Robertson, vice president and senior economist in the Atlanta Fed's research department

May 24, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference The relative expansion of central banks’ balance sheets:


Bank of Japan:
Assets increased 50% between 1993-1999, from Y40 tril to Y60 tril, as the BOJ (belatedly?!) reacted to the bursting of Japan's asset bubble ca 1991. Assets then almost doubled between 2001-2003, rising to Y110 tril before dropped 25% to Y90 tril during 2005-6.

So the post-Lehman rise you trace ought to be set against that background -- going from Y90 tril to Y120 tril but against a base that was already up over 100%. (For perspective, est 2012Q1 nominal GDP is Y474 tril, down 8% since 2007.)

Posted by: Mike Smitka, Washington and Lee University | June 06, 2012 at 12:12 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 23, 2012

The three faces of postcrisis monetary policy

The latest edition of the San Francisco Fed's Economic Letter (written by Michael Bauer)has a nice review of the different channels through which the Fed's Large Scale Asset Purchase (LSAP) programs—QE, or quantitative easing more popularly—are thought to work:

"Central bank LSAPs potentially may affect interest rates through at least three channels. Notably, all three channels can broadly affect longer-term interest rates, extending beyond those securities that the central bank announces it will purchase:

  • A portfolio balance channel, because the supply of long-maturity bonds available to private investors is reduced. The reduced supply of longer-term securities targeted by the Fed lowers the amount of interest rate risk in investor portfolios. That in turn decreases the risk premium that they require to hold both the targeted securities and other assets of similar duration. Longer-term interest rates are lowered across the board as a result. Gagnon et al (2011) emphasize this channel for QE1.
  • A signaling channel, which arises when the Fed's announcements are interpreted as signals of its intent to hold down short-term interest rates further into the future. Bauer and Rudebusch (2011) argue that this channel played an important role for QE1.
  • A market functioning channel, because QE1 provided relief when conditions in financial markets were dire, liquidity very low, and panic widespread. The Fed's intervention calmed investor fears. Thus, the intervention substantially supported a range of asset prices, including MBS and corporate bonds, lowering their yields."

The article references include links to the Gagnon et al. paper and the Bauer and Rudebusch paper, but none to any studies addressing the "market functioning channel." So I'll provide one: "Did the Federal Reserve's MBS Purchase Program Lower Mortgage Rates?" by Diana Hancock and Wayne Passmore, both senior staff members for the Federal Reserve of Board of Governors. According to Hancock and Passmore, the market functioning channel is key to appreciating the impact of QE1:

"We use empirical pricing models for MBS yields in the secondary mortgage market and for mortgage rates paid by homeowners in the primary mortgage market to measure how distorted mortgage markets were prior to the Federal Reserve's intervention, and the course of market risk premiums during the restoration to normal market functioning...

"We argue that this return to normal pricing occurred because the Federal Reserve's announcement signaled a strong and credible government backing for mortgage markets in particular and for the financial system more generally...

"More specifically, we estimate that the Federal Reserve's MBS purchase program over the course of 16 months reestablished normal market pricing in the MBS market and resulted in lower mortgage rates of roughly 100 to 150 basis points for purchasing houses. Most of the decline in mortgage rates occurred between the announcement of the program, on November 25, 2008, and the implementation of the program in the first quarter of 2009. After this point, both mortgage rates and risk premiums remained relatively stable until the end of the Federal Reserve MBS purchase program."

Hancock and Passmore note that the portfolio balance channel may have played a role after the completion of the QE1 purchases once market functioning had normalized, but the biggest bang was that renormalization itself.

Bauer's observations align with Hancock and Passmore's conclusions:

"QE1 had very pronounced effects on interest rates. The key announcements led to decreases of close to one percentage point. The announcements not only lowered yields on targeted Treasury securities and MBS, but also on corporate bonds...

"The two other programs, QE2 and MEP [maturity extension program], also affected yields of securities that were not targeted for Fed purchases... Generally though, QE2 and MEP affected interest rates much less than QE1 did. One reason is that bond market functioning had largely returned to normal. In addition, expectations of future short-term interest rates were already very low when these programs were announced, leaving little room for further signaling effects. Finally, QE2 and MEP were smaller than QE1."

Earlier this week, in a speech delivered in Tokyo at the Institute of Regulation and Risk, Federal Reserve Bank of Atlanta President Dennis Lockhart provided his view on this evidence:

"In my view, these [the QE1] purchase programs played an important role in the transition away from the emergency lending facilities created earlier in the crisis. The emergency credit facilities worked well to stem the downward spiral of the immediate post-Lehman period. Financial markets began the process of repair during the first half of 2009 but were still suffering from relatively serious liquidity pressures. The QE1 operation sustained the liquidity support that had been previously provided by lending through the emergency facilities.

"Because asset purchases largely replaced emergency loans made during the crisis, the net increase in the Fed's balance sheet was relatively modest. In this sense, the quantitative easing label is misleading. The intent and effect of the policy was not to inject a new and sizable quantity of reserves into the economy. Rather, the effect was to sustain liquidity in still struggling and fragile financial markets, particularly those related to residential real estate. For that reason, I prefer the term ‘credit easing' to describe this policy action."

However, the smaller impact of QE2 leads Lockhart to a different conclusion regarding the largest contribution of that program:

"I view QE2 differently. The FOMC [Federal Open Market Committee] formally announced QE2 in November 2010, with its decision to purchase $600 billion in longer-term Treasury securities. However, the policy was signaled in an important speech from Federal Reserve Chairman Ben Bernanke in August of that year. The circumstances at the time were dominated by a falling trend in measured inflation, weakening inflation expectations, and rising probabilities of outright deflation. Each of these developments was effectively reversed as the expectations for QE2 took root, expectations that were ultimately validated by FOMC action.

"Unlike QE1, QE2 did materially expand the size of the Federal Reserve's balance sheet. In my view, this distinction is important. The intent and effect of the two rounds of asset purchases were different. QE1 served to maintain liquidity at a time when financial markets were exceptionally unsettled. In contrast, QE2 was a more traditional monetary action to preserve price stability."

In a sense, this places the effects of QE2 in the signaling channel category, albeit with an emphasis on inflation expectations rather than interest rates directly.

Bauer's article also covers post-QE2 policy—the maturity extension program (MEP, or "Operation Twist") and the insertion of specific calendar dates (currently at least late 2014) to provide forward guidance on the period of time that the FOMC anticipates that the federal funds rate will remain at exceptionally low levels. Lockhart also describes these policies in terms of the "signaling channel," though in these cases with interest rate effects front and center:

"In terms of intent and effect, I think of the explicit forward guidance and the MEP in similar terms. We have entered a phase of the recovery in which sustained monetary accommodation is warranted in order to preserve and advance what is still modest progress on employment and economic growth. Importantly, this modest progress is occurring in the context of what, for me, is acceptable performance with respect to our price stability mandate. Actions that reinforce the maintenance of policy accommodation are appropriate. It is through that lens that I view the MEP and explicit forward guidance on policy rates."

Lockhart's remarks provide his perspective on three somewhat distinct policy challenges—market dysfunction, disinflationary pressures, and a need to sustain monetary policy accommodation—that motivate his support for the three major policy initiatives of the postcrisis period:

"Let me summarize this brief tour of postcrisis monetary policy. I view the sequence of nontraditional monetary policy actions as tailored responses to the particular needs of the economy and financial system at the time they were implemented. My conclusion is that by and large policy actions have been appropriate to the diagnosis of circumstances at the time. And in my assessment they have worked pretty well."

In this light, President Lockhart delivers his policy punch line:

"I have reframed to some extent the original question of what more can be done around the point that policy actions must be matched to circumstances. The challenge policymakers face is judging appropriateness of a tool for circumstances. As popular as it might be in some quarters to rule out further LSAPs (QE3, as it is known), I do not think this option can be taken off the table. QE3 will work under the right circumstances. But I don't believe such circumstances prevail at this time."

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


May 23, 2012 in Federal Reserve and Monetary Policy, Interest Rates, Monetary Policy | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference The three faces of postcrisis monetary policy:


"...places the effects of QE2 in the signaling channel category, albeit with an emphasis on inflation expectations rather than interest rates directly."

yep, also keep in mind:
1. if the Fed is credibly setting inflation expectations (inflation targeting) you cannot draw any conclusions about the output gap from inflation. Wages contracts are set based on expectations in the NK framework. The correct interpretation of the SF Fed letter (see below figure 2) is that for those with bargaining power, wage increases are based on expected inflation (about the mode of the non-zero wage increases).

Thus, a credible central bank targeting inflation will get it, regardless of the size of the output gap. (That's just the implication of the expectation-augmented Phillips curve)


2. now, lets talk about what are the right expectations to set (Figure 8):


nominal expectations!

3. "well, there is a lot of uncertainty about the output gap. " Yep: Orphanides 1999 paper actually tells you that under such uncertainty, ngdp targeting is superior and would have avoided the errors of the 1970s when we overestimated the output gap.

Posted by: dwb | May 23, 2012 at 06:33 PM

Will this really help the people?

Posted by: Tom Henry | June 12, 2012 at 05:28 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 17, 2012

Is inflation targeting really dead?

Harvard's Jeffrey Frankel (hat tip, Mark Thoma) is the latest econ-blogger to cast an admiring gaze in the direction of nominal gross domestic product (GDP) targeting. Frankel's post is titled "The Death of Inflation Targeting," and the demise apparently includes the notion of "flexible targeting." The obituary is somewhat ironic in that at least some of us believe that the U.S. central bank has recently taken a big step in the direction of institutionalizing flexible inflation targeting. Frankel, nonetheless, makes a case for nominal GDP targeting:

"One candidate to succeed IT [inflation targeting] as the preferred nominal monetary-policy anchor has lately received some enthusiastic support in the economic blogosphere: nominal GDP targeting. The idea is not new. It had been a candidate to succeed money-supply targeting in the 1980's, since it did not share the latter's vulnerability to so-called velocity shocks.

"Nominal GDP targeting was not adopted then, but now it is back. Its fans point out that, unlike IT, it would not cause excessive tightening in response to adverse supply shocks. Nominal GDP targeting stabilizes demand—the most that can be asked of monetary policy. An adverse supply shock is automatically divided equally between inflation and real GDP, which is pretty much what a central bank with discretion would do anyway."

That's certainly true, but a nominal GDP target is consistent with a stable inflation or price-level objective only if potential GDP growth is itself stable. Perhaps the argument is that plausible variations in potential GDP are not large enough or persistent enough to be of much concern. But that notion just begs the core question of whether the current output gap is big or small. At least for me, uncertainty about where GDP is relative to its potential remains the key to whether policy should be more or less aggressive.

In another recent blog item (also with a pointer from Mark Thoma), Simon Wren-Lewis offers the opinion that acknowledging uncertainty about size of the output gap actually argues in favor of being "less cautious" about taking an aggressive policy course. The basic idea is familiar. It is a simple matter to raise rates should the Fed overestimate the magnitude of the output gap. But with the short-term policy rates already at zero, it is not so easy to go in the opposite direction should we underestimate the gap.

No argument there. As I pointed out in a May 3 macroblog item, Atlanta Fed President Dennis Lockhart has said the same thing. But, as I argued in that post, this point of view is only half the story. Though I agree that the costs are asymmetric to the downside with respect to the FOMC's employment and growth mandate, they look to me to be asymmetric to the upside with respect to the price stability mandate. And I view with some suspicion the claim that we know how to easily manage policy that turns out to be too aggressive after the fact.

My issues are not merely academic. In an important paper published a decade ago, Anasthsios Orphanides made this assertion:

"Despite the best of intentions, the activist management of the economy during the 1960s and 1970s did not deliver the desired macroeconomic outcomes. Following a brief period of success in achieving reasonable price stability with full employment, starting with the end of 1965 and continuing through the 1970s, the small upward drift in prices that so concerned Burns several years earlier gave way to the Great Inflation. Amazingly, during much of this period, specifically from February 1970 to January 1977, Arthur Burns, who so opposed policies fostering inflation, served as Chairman of the Federal Reserve. How then is this macroeconomic policy failure to be explained? And how can such failures be avoided in the future?...

"The likely policy lapse leading to the Great Inflation …can be simply identified. It was due to the overconfidence with which policymakers believed they could ascertain in real-time the current state of the economy relative to its potential. The willingness to recognize the limitations of our knowledge and lower our stabilization objectives accordingly would be essential if we are to avert such policy disasters in the future."

With this historical observation in hand, it seems a short leap to turn Wren-Lewis's thought experiment on its head. Arguably, the last several years have demonstrated that nonconventional policy actions have been quite successful at short-circuiting the disinflationary spirals that pose the central downside risk when interest rates are near zero. (If you can tolerate a little math, a good exposition of both theory and evidence is provided by Roger Farmer.)

On the opposite side of the ledger, we know little about the conditions that would cause the Fed to lose credibility with respect to its commitment to its inflation goals, and very little about the triggers that would cause inflation expectations to become unanchored. Thus, I think it not difficult to construct a plausible argument about the risks of being wrong about the output gap that is exact opposite of the Wren-Lewis conclusion.

I end up about where I did in my previous post. Flexible inflation targeting, implemented in such a way that the 2 percent long-run inflation target rate exerts an observable gravitational pull over the medium term, feels about right to me. Despite what Frankel seems to believe, I think that idea is far from dead.

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

May 17, 2012 in Deflation, Economic Growth and Development, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference Is inflation targeting really dead?:


"The obituary is somewhat ironic in that at least some of us believe that the U.S. central bank has recently taken a big step in the direction of institutionalizing flexible inflation targeting."

Well, sort of. First of all, the Fed's forecasts certainly look like 2% PCE is an upper limit not an average, most commentators rightly called foul after the last quarterly set of forecasts. There is no de-facto difference right now between strict inflation targeting with a 2% ceiling and what the fed is doing. ther is no "flexible" in the target, and the range of full employment forecasts is 5-7%, we are still well above that yet there is no tolerance for higher inflation. So no I would not say "we took a big step forward."

In fact, nominal expectations have collapsed (see beckworth and the Evans new paper) so i would say the Fed has zero credibility on the unemployment side of the mandate. unsurprisingly, confidence and planned expenditures have collapsed. Its not a structural thing.

TIPS markets are screaming: epic fail.

Second, the fed cannot promise to control import prices (and indeed, tightening in response to a supply shock is textbook bad macro). The Fed should only focus on the price of domestically produced goods (gdp deflator). The Fed should have payed more attention to the gdp deflator and less to the PCE during the 2003-2008 period. Cheap imports depressed the PCE early, then expensive oil pushed it up in 2008. Policy would have been tighter, earlier.

At Sept 16th 2008 meeting, despite declining employment, tight credit, high mortgage delinquencies, housing market is recession since 2006, and declining GDP deflator, the Fed was concerned about inflation - not the clearly weakening economy (because oil and commodities prices were high). 3 days later Lehman collapsed and 3 weeks later they eased.

If you think the Fed follows a "balanced Taylor Rule" using output and inflation (use the GDP deflator as i said above) thats just ngdp targeting, except that the Fed promises to correct its own errors over a 5 year period so that the average works out.

Also, another aspect of ngdp targeting is that it prevents a debt-deflation spiral that happened in 2008 (and i think this is what prevented the 1990 real estate bubble from becoming worse in 1990s).

So, yes, IT is dead. RIP and good riddance.

Posted by: dwb | May 17, 2012 at 11:34 PM

thanks for reading comments, this is an interesting debate. Just a couple points as I forced myself to go back and reread Orphanides paper.

1) He used the GDP deflator. I view the conclusions as applied to the Fed framework with suspicion there since the Fed targets PCE and we know they sent very different signals during 2008;

2)The Taylor rule performs worse under imperfect information about the output gap (see figure 9); in fact ngdp targeting still is better under perfect information than strict inflation targeting. This is consistent with McCallum's 1998 results as well as i recall.

3)His ngdp rule is a *growth rule* not a path rule; Sumner and Beckworth propose a path rule (i.e. the Fed promises to correct errors so that the 5 year average (say) is on a target path. Important difference.

4)The chief criticism is that we do not know what potential output is, therefore do not know what to set the path to. But we can observe the trend GDP deflator and adjust the path as needed to be consistent.

I think that if you were to compare Sumner/Beckworth ngdp path level targeting to gdp deflator path level targeting, or inflation targeting using the GDP deflator, then there would only be a very mild difference.

The crucial differences are: the response to supply shocks (the Fed can only control domestic goods prices); and all the theory and evidence that ngdp targeting avoids debt-deflationary spirals like we saw in 2008. Again, compare the response to the housing real estate in the early 90s (yes, we had a housing crisis then too!).

Posted by: dwb | May 19, 2012 at 02:31 PM

Another reason NGDP level targeting trumps inflation targeting: it would not allow expectations of nominal income growth to collapse.


Posted by: Anon1 | May 19, 2012 at 10:00 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 11, 2012

Labor force nonparticipants: So what are they doing?

As Dave Altig, Atlanta Fed research director, pointed out earlier this week in this blog post, there is a great deal of interest these days in the labor force participation rate—particularly its level and the direction it's going. The question that seems to be on everyone's mind is how many of the nonparticipants in the labor force can we expect to return to the market. The answer to this question has immediate implications for the unemployment rate (especially if all these nonparticipants were to return to unemployment rolls), and longer-term implications for economic growth—our economy needs workers to fuel production.

The analyses that I can find to date are all primarily focused on a statistical detangling of demographic versus behavioral changes, structural versus cyclical changes, and employment trend versus employment gap debates. But all of this discussion begs the question that my colleague, Melinda Pitts, and I have been investigating: What are these labor force nonparticipants doing? Perhaps an answer to that question will help us get a better handle on which nonparticipants are likely to return to the labor force in the near future.

The Current Population Survey (CPS), administered by the U.S. Bureau of Labor Statistics (BLS), asks labor force nonparticipants about their reason for absence (details of the CPS questionnaire are available from the NBER). The reason given by nonparticipants that gets most of the attention is "discouraged over job prospects." In April 2012, these people accounted for only 1.1 percent of all nonparticipants (41 percent of the marginally attached—those who want a job, are available to work, and searched in the previous year). The vast majority of nonparticipants are absent because of retirement, disability, going to school, caring for household members, or other reasons.

Using the latest survey data we have available (November 2011), we find that most nonparticipants are retired (48 percent); the share who are in school, disabled, or taking care of household members are 18 percent, 16 percent, and 15 percent, respectively; and the share in the category termed "Other" comes in at about 2 percent.

For purposes of better understanding the decline in labor force participation, however, we look at the reasons for absence given by people who leave the labor force. Those who have left the labor force are arguably more likely to return (depending on the reason, of course) than those who have never been in the labor force. A feature of the CPS allows us to track certain individuals from one year to the next, so we are able to identify people who leave the labor force. Chart 1 illustrates how individuals who are not in the labor force—but who were employed or unemployed the previous year—are distributed across the reasons for nonparticipation. The raw data are not seasonally adjusted, of course, so we plot the numbers as a 12-month moving average—this approach does not affect the overall observed trends in the data. In addition, we restrict our analysis here to those between the ages of 25 and 54, since retirement overwhelmingly dominates the nonparticipation decisions of older workers, and schooling dominates the nonparticipation decisions of younger workers.

Chart 1 illustrates what the labor force participation rates have been telling us. For every reason given for absence, except perhaps "Retired," the number of people leaving the labor force has increased during or after the recession of 2008. The most dramatic increases are seen among those people giving "School" and "Other" as a reason. However, since we are in search of changes in reasons that might be out of the ordinary, especially any significant upward shifts in nonparticipants giving a particular reason during and after the recession, we also look at how these folks leaving the labor force are distributed across the different reasons. This information will tell us whether the number of people giving one particular reason increased disproportionately compared with the other reasons.

Chart 2 plots the shares of all of those leaving the labor force (ages 25–54) giving each reason for their absence. Since the beginning of the recession, there has been a significant shift toward the reasons of "School" and "Other" among nonparticipants who have left the labor force within the previous year. The share levels attained by the reasons of "School" and "Other" are historically unprecedented by the end of the data series. These shifts also appear to have come mostly from a decline in the share of people leaving the workforce to take care of household members (HHcare). This is evidenced through the dramatic drop in the share giving the "HHcare" reason at the same time.

It is difficult to interpret the implications of the rise in share of "Other" as a reason for nonparticipation among those leaving the labor force, although this category may be capturing some of the discouraged workers. The implication for the rise in "School" is unmistakable, however. With reasonable expectations, these individuals should re-enter the labor force with enhanced—or at least better-aligned—skills that will be able to make a positive contribution to overall economic growth.

Julie HotchkissBy Julie Hotchkiss, research economist and policy adviser in the Atlanta Fed's research department


May 11, 2012 in Data Releases, Employment, Labor Markets | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference Labor force nonparticipants: So what are they doing?:


What % of the 100k uptick in school attendees are military personnel with GI bill funding? This is a non-trivial surge in the % of people that have been previously employed, and who are now going back to school. Correcting for this trend would remove the noise of politically-based decisions from the signal of economically-based decisions, and so give us more insight into long term expectations.

Posted by: fischbone | May 13, 2012 at 04:35 PM

The unemployment problem and the labor force deterioration problem have to be considered aspects of the same phenomenon unless there is a good reason not to.

People are going back to school to improve their job skills in hopes there will be work for them when they return. This is advocated by many. They will return to Starbucks with heavy debt loads.

We've seen computer skills over-learned, then financial sector training left millions in the lurch with high debts. The problem with the job market is the private sector is not producing jobs in the U.S. and the public sector is paralyzed.

The Fed's idea that it will lower rates and improve investment metrics or increase the wealth effect is convoluted and certainly is not working.

Posted by: demandside | May 14, 2012 at 12:57 PM

You really need to integrate these flow values. When you look at the employment-population ratio, that is a level number, while these are flows. If you looked at the number of working age people who were out of the labor force for different reasons, and chart that vs time, you will get a picture of the size of the crisis and why XX million people are not participating because of YY reason.

Posted by: Jim Caserta | May 15, 2012 at 08:14 AM

The numbers listed in the body of the text don't seem to match the color coded charts. What is the response rate of the survey? Also, what about illegal aliens leaving the country and people working under the table? Those numbers have to be substantial.

Posted by: Diogenes II | May 15, 2012 at 11:23 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 10, 2012

A take on labor force participation and the unemployment rate

By now, if you've been paying attention to the coverage following the April employment report, you know the following:

  • The March to April decline in the unemployment rate from 8.2 percent to 8.1 percent was arithmetically driven by yet another decline in the labor force participation rate (LFPR).
  • The decline in the LFPR, now at its lowest level since the early 1980s, is itself being influenced by a confounding mix of demographic change and other behavioral changes that nobody seems to understand—a point emphasized by a gaggle of blogs and bloggers such as Brad DeLong, Carpe Diem, Conversable Economist, Free Exchange, and Rortybomb, to name a few.

With respect to the first observation, in a previous post my colleague Julie Hotchkiss described how to use our Jobs Calculator to get a ballpark sense of what the unemployment rate would have been had the LFPR not changed. If you follow those procedures and assume that the LFPR had stayed at the March level of 63.8 percent instead of falling to 63.6 percent, the unemployment rate would have risen to 8.4 percent instead of falling to 8.1 percent.

It is clear that interpreting this sort of counterfactual experiment depends critically on how you think about the decline in the LFPR. The aforementioned post at Rortybomb cites two Federal Reserve studies—from the Chicago Fed and the Kansas City Fed—that attempt to disentangle the change in the LFPR that can be explained by trends in the age and composition of the labor force. These changes are presumably permanent and have little to do with questions of whether the labor market is performing up to snuff.

The following chart, which throws our own estimates into the mix, illustrates the evolution of the actual LFPR along with an estimate of the LFPR adjusted for demographic changes:

As the header on the chart indicates, our estimates suggest that roughly 40 percent of the change in the LFPR since 2000 can be accounted for by changes in age and composition of the population—in essentially the same range as the Chicago and Kansas City Fed studies. (If you are interested in the technical details you can find a description of the methodology used to generate the chart above, based on work by the University of Chicago's Rob Shimer.

In other words, 0.9 percentage points of the decline in the LFPR since the beginning of the past recession can be explained by demographic trends (as the baby boomers age, the labor force will grow more slowly than the total population [ages 16 and up]). Subtracting the demographic trends still leaves 1.5 percentage points to be explained, a number right in line with Brad DeLong's back-of-the-envelope calculation of "cyclical" LFPR change.

As DeLong's comments make clear, the interpretation of the nondemographic piece of the LFPR change requires, well, interpretation. And the consequences of connecting the dots between changes in the unemployment rate and broader labor market performance are enormous.

In the recently released Summary of Economic Projections following the last meeting of the Federal Reserve's Federal Open Market Committee, the midpoint of the projections for the unemployment rate at the end of 2013 is 7.5 percent. Turning again to our Jobs Calculator, we can get a sense of what sort of job creation over the next 20 months will be required given different values of the LFPR. For these estimates, I consider three alternatives: The LFPR stays at its April level, the LFPR reverts to our current estimate of the demographically adjusted level (that is, increases by 1.5 percentage points), and an intermediate case in which the LFPR increases by 0.7 percentage points—the lower end of DeLong's estimate of "people who really ought to be in the labor force right now, but who are not."

DeLong asks:

"Are [people who really ought to be in the labor force right now, but who are not] now part of the 'structurally' non-employed who we will never see back at work, barring a high-pressure economy of a kind we see at most once in a generation?"

As you can see, the answer to that question matters a lot to how we should think about progress on the unemployment rate going forward.

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


May 10, 2012 in Data Releases, Employment, Labor Markets | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference A take on labor force participation and the unemployment rate:


Seeing as there was an event, the Great Financial Crisis, and employment and participation have both trended in the down direction, perhaps we should look at them as aspects of the same thing, a decaying job market. Thus, the jobs calculator is a good thing -- the unemployment rate adjusted to a steady participation rate is a very good metric for gauging the real state of the labor market.

To say that part of the change in participation is due to demographics certainly cannot be proven by the relatively primitive analysis cited from the University of Chicago. In previous times of stagnating wages, for example, participation went up, thinking of the late 1970s into the late 1980s.

The layman's take is that participation is going down because jobs cannot be had and people are making other arrangements, whether taking disability, early retirement, borrowing to go to school, or adapting in another manner. Certainly it is a common perception that if the economy picks up, there will be more people entering the labor force.

Posted by: demandside | May 10, 2012 at 10:49 PM

I posted this on Mark Thoma's "Economist's View" in response. I thought I'd repeat it here, too.
Something is wrong here.

I perused the linked reports from the Chicago and Kansas City Fed's. The data in both reports show an INCREASE in Labor Force Participation Rate (LFPR) for workers over 55 between 2001 and 2011. Look at Chart 8 in the Kansas City report and Table 4 in the Chicago report. The LFBR increases for older workers.

The Kansas City report even offers a reason for the increase:

"The rise can be explained by longer term developments, such as improving health and longevity, the need to build retirement savings due to the shift away from defined-benefit pensions, and decreased availability of retiree health benefits (Kwok and others)."

But then BOTH reports go on to say that overall LFPR is declining due to older workers LEAVING the workforce. This is directly at odds with the data.

A LARGER percentage of of older workers are putting off retirement, and this proves that more older workers are retiring earlier??

I'm no economist (obviously), but as a layperson, I don't think I'd buy this product.

It doesn't make sense.

Posted by: havnaer | May 12, 2012 at 07:51 PM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

May 03, 2012

Symmetric goals, asymmetric risks

Mark Thoma has been hanging out with my boss or at least was at the same conference, where Thoma had a chance to try out his reporter chops:

"I just got out of a press conference with Dennis Lockhart (Atlanta Fed president) and Charles Evans (Chicago Fed president). I can't say there was any real news, but I did manage to ask a question... I asked whether the 2% inflation target was truly symmetric."

Thoma got an answer, though seemingly not one that left him totally convinced:

"Both insisted that the target is symmetric. However, Lockhart said that we know much more about the effects of inflation than deflation, and that preventing deflation was therefore job number one (which doesn't really answer the question). He didn't explain what he is so afraid of if inflation goes up...

"Evans, while explicitly agreeing the target was symmetric, made comments that indicated that it may not be. He said the Fed has not done a very good job of communicating its tolerance around the 2 percent target, both up and down, and they need to improve. But if the target is really symmetric, simply saying that (along with the tolerable range) is all that is required. Talking separately about tolerance for over and under-shooting isn't needed."

Evans' and Lockhart's statements stand on their own, but we've collected some information via the Atlanta Fed's Business Inflation Expectations survey that helps me think about the Thoma question. The chart below plots the answers, collected in the February and April surveys, to the following query: "Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to unit costs per year over the next five to 10 years."

Distribution of Respondent Expectations for Unit Costs

The question focuses on unit labor costs in order to elicit responses about what businesses may actually be planning for, as opposed to their guesses about a more abstract concept of overall inflation. The question focuses on expectations five to ten years into the future because the inflation goal of the Federal Open Market Committee (FOMC) is explicitly a long-run objective.

The obvious pattern in these survey responses is their asymmetry to the upside. The most probable outcome, according to the respondents, is that long-term costs will rise in a range that includes the FOMC's long-run inflation objective. But they also put an almost 50 percent probability on annual outcomes higher than 3 percent. Less than 20 percent probability is placed on costs rising at rates of less than 1 percent.

This picture is one of asymmetric risks to the inflation outlook, and as such it is an important element in thinking through policy choices. Symmetry in the sense of having an equal distaste for misses on either side of an objective does not necessarily imply symmetry with respect to the risks of meeting that objective.

To begin with, the Fed does have a dual mandate. Disinflation or, in the extreme, deflation has the potential to be problematic for growth and employment when interest rates are very low. The reason, if you buy the analysis, is that, with no room for rates to move lower, a decline in inflation raises the real cost of borrowing. A higher cost of borrowing restrains spending, creating an additional drag on economic activity in already tough circumstances.

The reverse argument has, of course, been made for temporarily tolerating inflation that is somewhat higher than the long-run objective. But even if you aren't quite sold on the wisdom of that approach—and I'll get to that in a bit—it is clear that, with policy rates near zero, misses to the downside on inflation bring risks to the Fed's growth mandate that are not implied by misses to the upside. Hence President Lockhart's comment regarding the importance of preventing deflation.

So why not respond to this asymmetric risk to growth by taking a chance on higher inflation? That question takes us back to the chart above. Taken at face value, the probabilities reported by our survey respondents suggest that the FOMC has been pretty successful in convincing folks that very low rates of inflation or deflation will not be allowed to set in. Perhaps this conviction is not surprising given the relatively aggressive responses of the committee to the disinflation scares of 2003 and 2010.

But the response to asymmetric risks to growth at low inflation rates may have had the effect of inducing asymmetric risks to the upside with respect to Fed's price stability mandate. Again taken at face value, the results of our business inflation expectations survey definitely imply a one-sided bet by businesses on how the FOMC might miss on its inflation objective. That could well explain why one would be so concerned if inflation rises. Just as there are asymmetric risks associated with below-objective inflation when it comes to the Fed's growth and employment mandate, there are asymmetric risks associated with above-objective inflation when it comes to the price stability mandate.

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

May 3, 2012 in Business Inflation Expectations, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink


TrackBack URL for this entry:

Listed below are links to blogs that reference Symmetric goals, asymmetric risks:


1. wheres the equivalent chart for unemployment or jobs? there is a dual mandate you know.
2. its not just about the miss, but the costs. how does 3% inflation compare to 8% uemployment?
3. do we know whether this is biased or not over the long term, or how this sample compares with a representative slice of gdp?

Posted by: dwb | May 03, 2012 at 03:36 PM

i looked at the data and I'm pretty skeptical this makes the point inflation risks are skewed. Its based on ~160 respondents, many of whom don't answer all the questions and some of whom only answered 5%+. The data series only goes back 2 years so its impossible to assess bias (but over the last two years the mean is stable at ~2%). There seems to be a break 1/2 through the series where 5%+ was added.

There is always going to be some distribution of relative unit costs: some industries are doing really well and some not (for example several of the >5% respondents are in the legal and professional services, not representative of the whole economy). Raising inflation might move the <-1% and -1 and 1% category into the 1 to 3% category, without impacting the rest - raising the mean only somewhat.

also, its dangerous to generalize individual business results to the overall economy, when unemployment is 8% and wages are sticky: There is a large pool of workers stuck at 0% wage growth, See here: http://www.frbsf.org/publications/economics/letter/2012/el2012-10.html

Wages are ultimately ~70% of gdp, which means higher demand will flow back into wages. Unit costs could go up or down depending on productivity.

A broader, better, forward-looking assessment of inflation is here: http://www.bloomberg.com/quote/USGGBE03:IND/chart

Posted by: dwb | May 04, 2012 at 07:48 AM

i cannot find an update of this CPI diffusion index below (seems like a really useful metric but i cannot find it on the inflation dashboard). Seems to me that what you really want to do is compare the probabilities in the survey relative to the distribution of changes ordinarily seen in the CPI, to see if its really that skewed.


Posted by: dwb | May 04, 2012 at 12:20 PM

But what would this chart look like if unit labor costs were "deflated" by expected productivity gains across the same ten years? The modal expectation falls below 2%.

Posted by: Bo Parker | May 04, 2012 at 02:14 PM

From Nicholas Parker, Economic Research Analyst: On http://www.frbatlanta.org/research/inflationproject/dashboard/ if you click on the "Retail Prices" category, you will see its underlying series, including the Consumer Price Index (CPI). Currently, the CPI data reflect the most recent release (April, containing the March data), and the next update is scheduled for May 15.

Posted by: Webmaster | May 04, 2012 at 03:51 PM

Consumer or commodity price inflation and asset price inflation are two different animals. It is disturbing to see the primitive understanding of this point at the Fed and elsewhere.

It is deflation in asset prices, particularly real working plant and equipment, facilities and real estate(as opposed to financial assets) that starves the economy of the investment it needs. One only has to look at the paucity of real investment we are now experiencing to see that this has not been avoided.

The fact that we have had zero interest rates for, what, four years and have seen nothing more than low single digits illustrates there is something missing from the guvna's analysis.

Posted by: demandside | May 15, 2012 at 01:11 AM

Post a comment

Comments are moderated and will not appear until the moderator has approved them.

If you have a TypeKey or TypePad account, please Sign in

Google Search

Recent Posts



Powered by TypePad