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June 24, 2019
Mapping the Financial Frontier at the Financial Markets Conference
The Atlanta Fed recently hosted its 24th annual Financial Markets Conference, whose theme was Mapping the Financial Frontier: What Does the Next Decade Hold? The conference addressed a variety of issues pertinent to the future of the financial system. Among the sessions touching on macroeconomics was a keynote speech on corporate debt by Federal Reserve Board chair Jerome Powell and another on revitalizing America by Massachusetts Institute of Technology (MIT) professor Simon Johnson. The conference also included a panel discussion of the Fed's plans for implementing monetary policy in the future. This macroblog post reviews these macroeconomic discussions. A companion Notes from the Vault post reviews conference sessions on blockchain technology, data privacy, and postcrisis developments in the markets for mortgage backed securities.
Chair Powell's thoughts on corporate debt levels
Chair Powell's keynote speech focused on the risks posed by increases in corporate debt levels. In his speech, titled "Business Debt and Our Dynamic Financial System" (which you can watch or read), Powell began by observing that business debt levels have increased by a variety of measures including the ratios of debt to gross domestic product as well as the debt to the book value of corporate assets. These higher debt ratios alone don't currently pose a problem because corporate profits are high and interest rates are low. Powell noted some reasons for concern, however, including the reduced average quality of investment-grade bonds, with more corporate debt concentrated in the "lowest rating—a phenomenon known as the 'triple-B cliff'".
Powell noted several differences between the recent increase in corporate debt and the increase in household debt prior to the 2007–09 crisis that offset these risks. These differences include a more moderate rate of increase in corporate debt, the lack of a feedback loop from debt levels to asset prices, reduced leverage in the banking system, and less liquidity risk.
Powell concluded his remarks by saying that although business debt does pose a risk of amplifying a future downturn, it does not appear to pose "notable risks to financial stability." Finally, he noted that the Fed is working toward a more thorough understand of the risks.
Simon Johnson on jumpstarting America
Simon Johnson started his keynote speech by discussing Amazon's search for a second headquarters city. The company received proposals from 238 cities across the country (and Canada). However, in the end, it selected two large metropolitan areas—New York and Washington, DC—that were already among the leaders in creating new tech jobs. Although many places around the country want growth in good jobs, he said the innovation economy is "drawn disproportionately to these few places."
Johnson's remedy for this disproportionate clustering is for the federal government to make a deliberate effort to encourage research and development in various technical areas at a number of research universities around the country. This proposal is based on his book with fellow MIT economist Jonathan Gruber. They argue that the proposal encourages "exactly what the U.S. did in the '40s, '50s, and '60s," which was to help the United States develop new technology to be used in World War II and the Cold War.
Johnson proposed that the funding for new technical projects be allocated through a nationwide competition that intentionally seeks to create new tech hubs. In making his case, Johnson observed that the view that "all the talent is just in six places is fundamentally wrong." Johnson said that he and his coauthor found 102 cities in 36 states that have a substantial proportion of college graduates and relatively low housing prices. Moreover, Johnson observed that existing tech centers' cost of living has become very high, and those cities have substantial political limits on their ability to sustain new population growth. If some of these 102 potential hubs received the funding to start research and provide capital to business, Johnson argued, overall growth in the United States could increase and be more evenly distributed.
Discussing the implementation of monetary policy
The backdrop for the session on monetary policy implementation was postcrisis developments in the Fed's approach to implementing monetary policy. As the Fed's emergency lending programs started to recede after the crisis, it started making large-scale investments in agency mortgage backed securities and U.S. Treasuries. This program, widely (though somewhat misleadingly) called "quantitative easing," or QE, pumped additional liquidity into securities markets and played a role in lowering longer-term interest rates. As economic conditions improved, the Fed first started raising short-term rates and then adopted a plan to shrink its balance sheet starting in 2018. However, earlier this year, the Fed announced plans to stop shrinking the balance sheet in September if the economy performs as it expected.
Julia Coronado, president of MacroPolicy Perspectives, led the discussion of the Fed's plans, and a large fraction of that discussion addressed its plans for the size of the balance sheet. Kevin Warsh, former Federal Reserve governor and currently a visiting fellow at Stanford University's Hoover Institution, provided some background information on the original rationale for QE, when many financial markets were still rather illiquid. However, he argued that those times were extraordinary and that "extraordinary tools are meant for extraordinary circumstances." He further expressed the concern that using QE at other times and for other reasons, such as in response to regulatory policy, would increase the risk of political involvement in monetary policy.
During the discussion, Chicago Fed president Charles Evans argued that QE is likely to remain a necessary part of the Fed's toolkit. He observed that slowing labor force growth, moderate productivity growth, and low inflation are likely to keep equilibrium short-term interest rates low. As a result, the Fed's ability to lower interest rates in a future recession is likely to remain constrained, meaning that balance sheet expansion will remain a necessary tool for economic stimulus.
Ethan Harris, head of global economics research at Bank of America Merrill Lynch, highlighted the potential stress the next downturn would place on the Fed. Harris observed that "other central banks have virtually no ammunition" to fight the next downturn, a reference to the negative policy rates and relatively larger balance sheets of some other major central banks. This dynamic prompted his question, "How is the Fed, on its own, going to fight the next crisis?"
The conference made clear the importance of the links between financial markets and the macroeconomy, and this blog post focused on just three of them. I encourage you to delve into the rest of the conference materials to see these and other important discussions.
June 07, 2019
The Tax Cut and Jobs Act, SALT, and the Blue State Blues: It's All Relative
Nearly two months have passed since tax day, but the full impact of the 2017 Tax Cut and Jobs Act (TCJA) has yet to be fully assessed. Both the data, and in fact the rules themselves, are still incomplete. Nonetheless, conventional wisdom seems to hold that the legislation created winners and losers, and that the losers primarily reside in so-called "blue" states—those where the majority of voters have consistently gone for the Democratic presidential candidate in recent elections.
The source of this belief springs from the newly imposed limitations on federal deductions of state and local taxes, or SALT, and the disproportional impact of these limitations on taxpayers in high-tax, high-income states—the majority of which are blue. A CNBC report from last week on pushback from blue-state politicians summarizes a typical reaction: "Lawmakers from high-tax districts say their constituents have suffered from the provision in the tax plan."
Is this view justified? In our own research, we focus on the long-term effects of the TCJA with the assumption that the legislation's provisions eventually become permanent. (The individual tax cuts are currently scheduled to expire in 2025.) Examining individual households from the 2016 Federal Reserve Board of Governors' Survey of Consumer Finances and incorporating state-specific tax provisions, we reached a few major conclusions regarding TCJA's impact.
First, the overwhelming majority of taxpayers across the country stand to enjoy lifetime gains in after-tax income as a result of the TCJA. The following chart documents our estimates of lifetime gains in every state and the District of Columba, by state-specific wealth quintile. (Wealth here is defined inclusive of human wealth—that is, it includes the present-value of expected wage and salary income.) The chart has a lot of information, but the key point here is the preponderance of blue-shaded areas, which represent the proportion of gainers in each wealth quintile, in each state. Outright losers—represented in the chart by the red shaded areas in each row—are confined to a very small proportion of the wealthy.
What is true is that the tax cuts were relatively more favorable, in percentage terms, to red-state residents. Our estimates show that the percentage reduction in the present value of lifetime taxes for red states is nearly twice that of blue states—but not in absolute terms. We calculate the average change in lifetime after-tax income for individuals in blue states to be $25,781, compared to a $23,094 average for red states. (In absolute terms, "purple" states—those averaging less than a 5 percent margin for either party over the past five election cycles—had the largest average gain of all, at $27,042.)
Another point worth emphasizing: the relatively smaller blue-state gains don't result from the fact that they are high-income states but instead result from the fact that they are high-tax states. When we control for the demographic make-up of states—and hence keep the income distribution across states constant—we get essentially the same implications for the distribution of TCJA tax gains.
It is likely true that blue-state taxpayers didn't gain as much as their red-state counterparts as a result of the TCJA. But for the most part, our estimates suggest they did indeed gain.
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