Posts Tagged ‘ben bernanke’

Fed talk is anything but cheap

24 June 2013

After last Wednesday, I bet Ben Bernanke can relate to this observation by George Carlin about his Catholic upbringing:

If you woke up in the morning and said, “I’m going down to 42nd street and commit a mortal sin!” Save your car fare; you did it, man!

It’s the thought that counts! The Fed didn’t “do” anything last Tuesday and Wednesday at its Federal Open Market Committee meeting. Bernanke’s concluding comments about the continuing slump were not much more specific than “This too shall pass, someday,” combined with the obvious point that normal times will bring normal monetary policies. The main news was that he thought normal times would come sooner than many people expected. But that was enough. Evidently, the bond market was expecting the economy to be flat on its back for most of the next decade: 10-year Treasury bond rates had lately been in the range of 2.1-2.2%, whereas the recent historical norm is about 5%. After Bernanke’s remarks, the rate jumped by 30 basis points (0.30% point) to a Friday close of about 2.5%. It jumped further this morning to 2.6%.

Two observations:

(1) Just as in Carlin’s church, Bernanke doesn’t actually have to do anything to tank the long-term bond market. Just thinking about it aloud is enough.

(2) The long-term bond market is really not the economy’s friend. What tanked the bond market is the prospect of interest rates rising a bit sooner and faster than expected, on account of the Fed reacting to a stronger economy. So in a weird sense the spike in bond rates is good news: Bernanke said better times were coming, the markets believed him, and they acted accordingly. Not to say that their action was malicious, just that it was predictable: if you are expecting interest rates to rise in the future, you should buy bonds in the future, not now.

If markets could talk

21 June 2013

The stock market would be telling the Fed something like this:

Image

Sounds crazy, but that’s how present discounted value works. (And thanks to my daughter for the meme.)

This week the Dow fell 3% this after Fed Chair Ben Bernanke’s announcement that eventually the economy would get better and then the Fed would gradually take its foot off the accelerator. That is, the Fed would taper off its quantitative easing (QE; emergency mass purchases of long-term bonds) when unemployment (now 7.6%) fell to 7.0% and then, as announced before, would start raising short-term interest rates back toward normal levels when unemployment fell to 6.5%. He didn’t say this was going to happen soon, and reiterated that the (near-) zero interest rate policy would continue until unemployment falls to 6.5%. Granted, he sounded mildly optimistic that the economy would recovery sooner than expected, but he presented no new data on that score, so it’s an easy prediction to shrug off. Not that the markets did.

The present-discounted-value approach to stock pricing says that a stock is worth its company’s expected future profits in all years to come, divided by a discount factor that is based on the long-term interest rate. The lower the interest rate, the higher the stock’s price should be. The odd thing here is that if the economy picks up, corporate profits should too, which should offset the higher interest rates that Bernanke is hinting at. It may be that corporate profits are already high and are not always easy to predict, whereas long-term interest rates are known now. The 10-year Treasury bond rate rose from 2.2% to 2.5% after Bernanke’s announcement, a 14% increase that is right about in line with the 15% drop in stock prices. (The 10-year Treasury yield is still at a near-historic low, by the way.)

The financial media tend to report any significant-looking drop in stock prices as an economic calamity, overlooking the most basic facts about the stock market, namely that it is volatile and its short-term swings have very little macroeconomic impact. The less we worry about short-term market reaction to the Fed, the better off we’ll be. Jared Bernstein has an excellent piece on the Fed’s announcement, to which I don’t have much to add, only to say that I don’t see much new in the announcement, other than some optimistic predictions and an exit strategy for QE (which had to end sometime).

What more could the Fed do? (cont’d)

11 August 2011

The New York Times joins the chorus of complaints that the Fed has not done enough to jump-start this stalling economy. In yesterday’s lead editorial the gray lady ruefully notes that Ben Bernanke basically ruled out further quantitative easing when he said at the Fed’s June meeting that it would not happen unless there was a heightened risk of deflation. Then the editorial offers a paragraph’s worth of additional measures the Fed could take. One by one:

‘For starters, the Fed could take modest steps, like shifting its portfolio toward bonds with longer maturities, which would help to keep long-term rates low and nudge investors into riskier investments.’

In other words, QE3, or QE2 on steroids. Normally the Fed targets the shortest of short-term rates (the fed funds rate) and does so through its open market purchases and sales of short-term T-bills. And T-bills are the security of choice because the Fed does not want to make too big a splash (at least not directly) in the markets for particular bonds. The logic here is the reverse: of course the Fed wants to make a splash in the bond market by lowering long-term interest rates — that’s the penultimate goal of monetary policy, behind stimulating business investment and consumer spending. In today’s extraordinary circumstances, ending the Little Depression seems more important than not disrupting the bond market. So it’s hard to argue against this one, other than to note that the Fed would probably be monetizing a lot more of the federal debt than otherwise, which could raise inflation fears. (Of note: In the early 1930s Keynes thought the central banks should buy up long-term debt so as to lower long-term interest rates, too. So this isn’t exactly a new idea.)

‘It could reduce the interest it pays on the banks’ huge reserves or even tax the reserves to try to encourage more lending.’

Absolutely. Reduce it to 0%, which was the rate on reserves prior to 2008. Bernanke’s main rationale paying interest on reserves, as I understand it, was to reassure the markets that the huge pools of bank reserves, which the Fed created in response to the crisis, would not lead to a runaway inflation when the economy began to recover and banks loaned those reserves out. The idea was that as the economy recovered the Fed would “soak up” those reserves by raising the interest rate on them so that banks would be less inclined to loan them out. At this point, however, hardly anyone seem to be worried about the inflation threat posed by those reserves. They’re more worried about how they continue to just sit there. Lowering the rate to zero can only help, though maybe not by much.

‘It could also resume buying Treasuries or other securities to provide additional monetary stimulus.’

This is a lot like the first suggestion. It could get more radical if the “other securities” are things like mortgage-backed securities, in which case it’s more like QE1 (when the Fed effectively bought up many of the toxic subprime securities, thereby taking them off the market). This brings to mind the dramatic proposal by Joseph E. Gagnon of the Peterson Institute for International Economics, which has gotten a lot of attention lately. Gagnon: “First and foremost, the Federal Reserve should announce an additional $2 trillion of asset purchases, including longer-term Treasury bonds, agency mortgage-backed securities (MBS), and foreign exchange. This is more than three times the size of the woefully underpowered quantitative easing of late last year (dubbed QE2) and it should be accompanied by a clear statement that more is forthcoming if the economy continues to underperform.” I haven’t digested Gagnon’s proposal yet, but this is what a radical proposal looks like. Krugman and Brad DeLong seem to like it.

‘A more aggressive strategy would be letting inflation rise above the Fed’s comfort level of 2 percent or so to, say, 4 percent. That could help the economy by easing the repayment of debt.’

This would have promise if the Fed could actually control the rate of inflation like that. As I’ve written before, I don’t think it can, not when the economy is in a depression and seems to be tending on its own more toward deflation than to 4% inflation. The Fed has already flooded the banking system with reserves; when they don’t get loaned out (as so many of them haven’t), they don’t raise aggregate demand, the money supply, or the price level.

In sum: The first two steps seem worth taking, but are probably too modest to have much impact. The third step can be about as big as the Fed wants it to be; it has the most potential, though as with QE1 just moving a lot of assets from the private sector onto the Fed’s balance sheet doesn’t necessarily generate a surge of private investment. The fourth step looks impossible at present, even without the inevitable political resistance to the Fed backing down on inflation.

Fed up with Bernanke?

31 July 2011

Greg Mankiw has a good column in today’s NYT in defense of embattled Fed Chair Ben Bernanke. How embattled is Bernanke? Mankiw notes an (admittedly unscientific) online CNBC poll from June, in which the question was “Do you have confidence in the way Ben Bernanke is handling the economy?” 95% of respondents answered no.

Mankiw says the Fed has done basically all it can to combat the Little Depression (unfortunately “all it can” is not enough), while steering clear of high inflation. The core inflation rate in recent years has been just 2%, widely believed to the Fed’s unofficial target inflation rate. Mankiw suggests making that 2% target official, but otherwise sees no obvious room for improvement in Bernanke’s performance.

I tend to agree that Bernanke’s Fed has done about all that monetary policy can do here, but Scott Sumner, one of the more interesting monetary thinkers I’ve come across lately, says the Fed actually has a lot more ammunition in its arsenal and compares the situation to the early 1930s, when the Fed increased the monetary base but needed to do a lot more to stem the massive tide of bank failures and monetary collapse. Unfortunately, I’ve yet to find the specifics of his argument, but I’ll share them with you when I do.

Sumner, by the way, loves the idea of a 2% inflation target and even suggests that Mankiw be appointed to the Fed’s Board of Governors. Maybe Mitt Romney (to whom Mankiw is an adviser) can do that next year.

The Fed does not print money

23 December 2010

The Fed creates reserves, not money.  I’ve covered this one before.  Fed Chair Ben Bernanke has been making the same distinction lately, though it seems he’s muddied it in the past.

Once again:  The Fed creates reserves, not money.  The Fed buys securities from banks and pays for them by giving the banks reserves, e.g., if it buys a $1000 Treasury bond from a bank, it pays the bank by adding $1000 to the bank’s reserve account  at the Fed.  This is not the same thing as giving the banks money, because it ain’t money unless it’s (1) cash circulating outside of the banking system or (2) in someone’s checking, savings, or other deposit account at a bank or money-market fund.

This distinction might sound nitpicky, but it’s all-important.  The process by which these reserves become money is the process by which monetary policy works, or fails to work.  What’s supposed to happen is this:

Fed creates reserves –> banks loan out reserves to households and businesses –> households and businesses spend those funds (raising the Consumption and Investment parts of GDP, hence raising GDP) –> whoever gets paid by them deposits some of those funds in the banks or in money-market funds, and spends some of it –> whoever gets that money deposits some of it and spends some of it –> etc.  Money does get created, indirectly, when those loans are deposited or redeposited in the banking system, but not before then.

That’s what happens when monetary policy works.  (And yes, there may be some inflation, if the increased demand for consumption and investment goods isn’t met by an increase in their availability.)  But that’s not what’s been happening since 2008 — the Fed has been creating reserves, and banks have mostly been sitting on those reserves.  Thus no big increase in Consumption, Investment, or GDP, and no corresponding increase in the money supply.

When someone says “The Fed prints money,” what they’re really saying is that they don’t know what they’re talking about.

Quote of the day (II)

24 January 2010

A good day for metaphors:

“Bernanke is an airline pilot who pulled off a miraculous landing, but didn’t do his preflight checks and doesn’t show any sign of being more careful in the future – thank him if you want, but why would you fly with him again (or the airline that keeps him on)?”

Simon Johnson, opposing the reappointment of Ben Bernanke as chairman of the Fed.  Johnson’s preferred alternative appointment is a surprising one — so surprising that he himself scotched the idea as “crazy.”

The next Federal Reserve Chairwoman

8 August 2009

. . . would of course be the first Federal Reserve Chairwoman.  But the word on the street is that San Francisco Federal Reserve Bank President Janet Yellen is said to be on the very short list of possible Fed Chair nominees, along with Larry Summers and a Ben Bernanke re-appointment.

Yellen is an intriguing possibility.  Hands-on experience as S.F. Fed president (including a seat right now on the Federal Open Market Committee, the Fed’s policy-making group), stints on the Fed Board of Governors and as chair of the Council of Economic Advisers during the Clinton Administration, longtime tenured economics professor at Berkeley. I’ve read a few of her papers on macro theory and policy, and she writes unusually well for an economist.  (Her review article on efficiency-wage theories of unemployment was probably the clearest thing I read in my entire first year of grad school.) And for what it’s worth, she’ll have good advice at the breakfast table: she’s married to economics Nobel laureate George Akerlof. (Democrats are big on the whole “two for the price of one” concept, no?)

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Selective-attention deficit disorder

15 June 2009
debt/gdp ratio

debt/gdp ratio

So who’s the party of fiscal responsibility again?  That mantle seems to be claimed by whichever party does not occupy the White House.  In the late 1970s, Ronald Reagan and other Republicans charged that Jimmy Carter’s deficits (although puny in retrospect) were inflationary and needed to be stopped.  As president in the 1980s, Reagan presided over the largest deficits ever (in absolute terms) and the first-ever major peacetime increase of the national debt-to-GDP ratio in history.   Leading Democrats pounded him for the deficits, and Reagan swatted them away as “born-again budget balancers.”  Dick Cheney said later (quoted in one of the Bush 43 administration tell-all books), “Reagan proved that deficits don’t matter.”  Economists by and large weren’t buying it, but aside from relatively high real interest rates and relatively low levels of business investment, the economy was prospering as it hadn’t in two decades, and Democratic attacks on Republican deficits found little traction.  Just ask Walter Mondale.

As we can see from the red line in the diagram, courtesy of my former professor Willem Buiter, the debt/GDP ratio (our best measure of the overall burden of federal deficits and debt):

  • mostly fell during the 1970s, as appears to be the norm for the economy in peacetime (at least in non-recession years);
  • more than doubled during the 1980s and all through Bush 41’s presidency, from about 24% to 54%, likely due to tax cuts, the Reagan military buildup, and the growth of health care costs and entitlements spending;
  • fell sharply during the Clinton years to about 34% in 2000, likely due mostly to the booming economy and the post-USSR “peace dividend”;
  • rose sharply in the Bush 43 presidency, likely due initially to the 2001 recession, tax cuts, and Medicare prescription drug expansion, then to the Iraq and Afghan wars, rising health care and entitlement costs, the aging of the population (including early baby boomer retirements), and of course the 2008 recession and bank bailouts.

So what? you ask . . .

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Symbiotic twin killings

11 June 2009

What caused the crisis?  It seems like most of the plausible answers I’ve heard come down to one of two basic explanations:

(1) “We were living beyond our means” — Congressman Dan Maffei (D-NY), in a WRVO Community Forum in Syracuse last week that included, um, me.  Sounded very reasonable coming from Congressman Maffei, less so coming from stockbroker/ investment advisor/ author Peter Schiff on the other night’s “Daily Show”, probably because of the diametrically opposite policy prescriptions the two draw.  Maffei backs the stimulus bill and wants to see the economy recover as soon as possible; Schiff is an adherent of the Austrian school and thinks a good old bloodletting (oops, “liquidation” or “correction”) is just what the doctor ordered.  Either way, this explanation has a lot going for it, as it explains the rash of subprime mortgage borrowing, home equity loans, maxed-out credit cards, etc.

(2) A “global savings glut” led to stock and housing bubbles, which finally burst — Fed Chairman Ben Bernanke, Nobel economist / NYT columnist Paul Krugman.  The idea here is that while we spendthrift Americans were running up huge debts, people in other countries, notably China and Japan, as well as the minority of wealthy Americans with high savings rates, had large pools of savings seeking a good risk-adjusted return.   And they invested much of it here, in Treasury bonds, thereby keeping U.S. interest rates low; in the stock market, reinflating the late 1990s bubble; in the corporate bond market, lowering rates on all bonds, even junk bonds; and in real estate, largely through securitized collections of other people’s mortgages.  (By some accounts, demand created its own supply of mortgage-backed securities — after the 2001 stock debacle, investors were looking for an alternative to stocks and thought real estate looked promising.)  A particular problem here seems to be that many investors opted for wildly risky investment vehicles, like investing in “diverse” portfolios of dodgy mortgages or blindly handing their money over to a Bernie Madoff or a Robert Allen Stanford, without realizing they were risky.

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Heckuva job, Brownie (UK edition)

8 June 2009

Paul Krugman has mixed feelings about the Labour Party’s shellacking in this week’s elections.   Me too.  It’s hard to feel sorry for Prime Minister Gordon Brown, who as Tony Blair’s Chancellor of the Exchequer was a Big Swinging Deregulator to rival the Greenspan-Rubin-Summers axis in the U.S.  Krugman:

‘Do Mr. Brown and his party really deserve blame for the crisis here? Yes and no.

‘Mr. Brown bought fully into the dogma that the market knows best, that less regulation is more. In 2005 he called for “trust in the responsible company, the engaged employee and the educated consumer” and insisted that regulation should have “not just a light touch but a limited touch.” It might as well have been Alan Greenspan speaking.

‘There’s no question that this zeal for deregulation set Britain up for a fall. Consider the counterexample of Canada — a mostly English-speaking country, every bit as much in the American cultural orbit as Britain, but one where Reagan/Thatcher-type financial deregulation never took hold. Sure enough, Canadian banks have been a pillar of stability in the crisis.’

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