Posts Tagged ‘federal reserve’

Dammit Janet, I love you!*

9 October 2013

I am very pleased with the president’s nomination of Janet Yellen to be the next Federal Reserve Chair. Ms. Yellen has impeccable credentials, the best economic forecasting record of any recent Fed official, and appears to take the regulator part of the Fed Chair job seriously.

This last part is important. Larry Summers, the original front-runner for the job, helped push through the key deregulation of the late Clinton years, has dismissed the idea that it contributed to the bubble or crash, and has basically never admitted a mistake in this area. Alan Greenspan was essentially hostile to financial regulation, and bears as much responsibility as anyone for the housing bubble of the 2000s. Ben Bernanke has acknowledged that the Fed failed as a regulator during the housing bubble, but he was a Fed governor for most of that bubble and Chair for the last two years of it. Economist Bill Black finds Bernanke to have been sorely lacking as a regulator. The Fed’s main regulatory task is to try to detect and reduce systemic risk, i.e., risky activities that threaten the larger financial system and economy. Granted, Yellen told the Financial Crisis Inquiry Commission in 2010 that she failed to see several of those risks (securitization, credit rating agencies, Special Investment Vehicles) when she was San Francisco Fed President in 2004-2010, but on the other hand she was among the first at the Fed to publicly call attention to the housing bubble

Granted, monetary policy, not financial regulation, is the main part of the job. I agree with those who have said she will probably be very similar to Bernanke as far as that goes, and I’d call that a good thing. The Fed needs to do what it can to pull us out of this Little Depression, and since interest rates cannot fall below zero, additional measures like buying long-term bonds and mortgage-backed securities (i.e., quantitative easing, or QE) make sense, as long as they work. Yellen is often stereotyped as a “dove” because in recent years she favored expansionary policy and did not state that inflation was an imminent risk, but those recent years were the Little Depression that began in 2008. When unemployment is not the nation’s biggest problem, Yellen is more concerned about inflation. Such as in the roaring 1990s, when Yellen was Clinton’s Chair of the Council of Economic Advisers and then a Fed governor. With unemployment down to its lowest levels in decades, Yellen was an inflation “hawk,” as Matthew O’Brien details.

Whether the Senate is capable of that much nuance as it considers her nomination remains to be seen. I expect she’ll win majority support, including a handful of Republicans, and that Republicans will resist the temptation to filibuster her nomination. The right-leaning American Enterprise Institute offers several reasons why an anti-Yellen filibuster would be a disaster. Then again, flirting with disaster seems to be the Congressional Republicans’ game plan of late.

PS Here is a recent (Nov 2012) interview with Janet Yellen.

* Title stolen from EconoMonitor, who of course got it from Rocky Horror:

No taper, no problem

18 September 2013

The Federal Open Market Committee concluded one of its most anticipated meetings in a long time with the expected decision to keep its federal funds rate target near zero (0 – 0.25%) and, less expectedly, not to “taper,” i.e., announce that it would gradually reduce its monthly purchases of mortgage-backed securities and longer-term Treasury bonds. Those purchases are otherwise known as “quantitative easing” (QE).

From various market surveys and betting sites, it appeared that about half the market was expecting a taper. Just why is hard to figure. Excessive asset purchases by the Fed can be inflationary, but excessive is in the eye of the beholder, and inflation has been under, not over, the Fed’s target of 2%. There is the argument that these new and unusual QE policies are damaging to investor confidence, but they’re not that new anymore, and the investors in the stock market seem remarkably undamaged — the S&P 500 has more than doubled since early 2009, i.e., since shortly after the first round of QE was implemented. Then there is the opposite argument that QE has created a “sugar high” in the stock market and maybe the housing market, too. This last argument has to be taken seriously, in view of how the 2000s housing bubble was stoked in part by the Fed’s easy-money policies circa 2004, when economic recovery was well underway.

But not too seriously. The S&P 500 is only about 15% higher now than it was mid-2007; adjusting for inflation, it’s hardly any higher at all (and the jury’s still out over whether stocks, as opposed to housing, were a bubble in 2007). Moreover, corporate profits are at record highs, so the fundamentals look rather good. Home prices are rising fast, but they’re still at 2004 levels, and monthly mortgage payments are cheaper than rents. A true speculative bubble is when people are obviously overpaying for assets, especially when they do so knowingly, with the plan of selling to a greater sucker later on. Is there evidence of that here?

The evidence about the general state of the economy is much stronger, and the evidence is that it’s still pretty weak. In particular, employment — the indicator that the Fed is supposed to focus on, along with inflation — is dismal. The employment-to-population ratio is still under 76%, or 4 points below where it was before the crisis. (The graph below, by the way, is of the “prime-age” population, 25-54 year-olds; if it included 16-24 year-olds, it would look even worse.)


For more on unemployment and tape:


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:


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).

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.

The economic crisis explained in six words

14 July 2010

“the big banks blew themselves up”

Simon Johnson

What, you want more?  How about this primer, one clause at a time:

The big banks blew themselves up,

along with a gigantic housing bubble that they did much to inflate.

The collapse of house prices meant the collapse of the largest component of Americans’ wealth.

With banks in trouble and consumers having less money in their house-shaped piggy banks,

credit got harder to obtain

and consumers spent less,

which also caused firms to invest less.

Those last two things caused unemployment to skyrocket.

The Fed and Congress bailed out the banks,

which stabilized the banks,

but couldn’t get them to lend money

and couldn’t get nervous, indebted consumers and businesses to borrow money.

The Fed did practically everything it could to boost the credit markets,

by cutting its main interest rate to zero and creating lots of bank reserves,

but it wasn’t enough.

The government passed spending and tax stimulus bills to boost the economy,

but the stimulus was too small.

Another stimulus could help close the gap,

but the same folks who didn’t object to deficit spending for wars and tax cuts,

have a big problem with deficit spending for other purposes.

Let’s just hope the economy comes back on its own,

because that seems to be the only hope right now.

Exiled From Main St. / Start Breaking Up

18 April 2010

Thomas Hoenig, president of the Kansas City Fed and one of the most incisive critics of the “too big to fail” policy, has an op-ed in today’s NYT about the current financial reform bill before Congress.  He says it does far too little to end “too big to fail” — while it sets up a mechanism for big failing financial institutions to be put under FDIC receivership, those financial institutions would still have the political clout to snag a bailout instead.

This may be true, but it seems to be a drawback in any financial reform bill that doesn’t call for the biggest financial institutions to be broken up into smaller ones that are not too big to fail, i.e., which can go bankrupt without significant systemic risk to the economy.  Koenig has spoken elsewhere on the need to break up the biggest banks.  It’s a position that finds favor among many liberal economists,including James Kwak of the Baseline Scenario (see previous link).  Rep. Paul Kanjorski of Scranton, PA has proposed an amendment to give the government power to preemptively break up any financial institution whose failure would impose giant costs on the U.S. economy, but the Senate Banking Committee apparently has nothing like that on the table yet.  Alas, the political clout of the big banks may well be enough to make bank size restrictions a non-starter in the Senate.  Simon Johnson of The Baseline Scenario says much the same thing here.

Hoenig says that another provision of the bill actually makes things worse by narrowing the Fed’s supervisory role to just the nation’s 12 largest banks, most of which are headquartered in NYC.  I do not know what the logic of this provision is, and Hoenig doesn’t say; maybe the idea is for the other banks to be supervised by the FDIC and/or other agencies instead.  Whatever it is, Hoenig thinks the Fed needs to give just as much attention to the other 6,700 as to the top 12.  As he points out, that would seem to be the whole point of having 11 regional Fed banks besides the one in New York.

UPDATE:  Simon Johnson puts it a lot more plainly right here.  For the record, Paul Krugman has his doubts that breaking up the banks would help much — see the last three paragraphs of this recent column.  I’m with Simon Johnson here.  By all means, crack down on fraudulent finance at institutions large and small, but I don’t see how you limit the power of the big banks without limiting their size, too.

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.”

Barack Hoover Obama? (updated Dec. 4)

13 November 2009

The administration has apparently ditched Keynesian economics in favor of Philistine economics, calling for a domestic spending freeze or even spending cuts in the midst of double-digit unemployment.

The Associated Press has the story here.

Focusing on deficit reduction during a depression did not work for Herbert Hoover in 1932, and I’m at a loss to see why Obama’s economists are embracing spending cuts now.  The article does quote budget director Peter Orszag as saying cutting spending too fast could undermine the recovery, so I can only hope that they do not mean to make these cuts until recovery is well underway.  (Then again, the article implies that Obama’s budget next February will ask every agency for spending freezes or 5 percent cuts.)  Given the dim prospects for a rapid recovery, the economy may not be ready to absorb any deep spending cuts for many years to come.

Perhaps a better analogy than Hoover in 1932 is Franklin D. Roosevelt in 1936-37.  At that time the U.S. economy had been recovering for about four years (after bottoming out in early 1933) but was still in depression, with unemployment above 9%.  But FDR, deciding it was time to focus on the budget deficit instead of the economy, cut spending and raised taxes (as the Fed doubled bank reserve requirements to soak up the vast excess reserves out there — which also sounds like a recent conversation), and the economy nosedived.  Had FDR and the Fed been less leery of deficits and excess reserves, the depression might not have lasted until World War II.

UPDATE, 18 November 2009:  Edward Harrison of Credit Writedowns, writing on the Naked Capitalism site, makes a similar argument with a lot more detail.

UPDATE, 21 November 2009: Krugman has an excellent piece on the matter here, and a “wonkier” one on deficits and interest rates here.

By the way, I changed the heading from “Barack Hoover Roosevelt?” to the current one, because FDR is so widely associated with pro-active steps like the Works Progress Administration and other jobs programs, fixing and reforming the banking and financial system, and ending the early-’30s deflation by going off the gold standard.  While his budget-balancing disaster of 1936-37 and his too-small budget deficits in other years show that he was no Keynesian when it came to fiscal policy, I’d be delighted to see Obama commit to policies that created three million relief jobs per year, as FDR did.  The stimulus is creating a fraction of that number, which seems unsurprising considering that the job creation is indirect:  rather than create new agencies to directly employ workers in various projects, the government is handing out money to lucky companies in the hope that they’ll hire people.  The fear of creating new federal government employees seems even stronger than the fear of deficits.

UPDATE, 4 December 2009:  Obama may have talking out of school when he said that last month.  In an interview yesterday just prior to the jobs summit, he said the following:

He ruled out an immediate effort to reduce the $1.4 trillion budget deficit until the economy rebounds further and the 10.2% unemployment rate begins to decline. Focusing on the deficit too soon, he said, could risk a “double-dip recession.”

“If we move too abruptly in that direction and we’re not thinking about all the people out there who aren’t working and businesses who aren’t making money, then we’re going to be in a negative spiral that I think would be very destructive,” the president said.

Instead, Obama said, any additional spending and tax cuts intended to spur job growth should be balanced later with deficit-reduction efforts. “The most important thing we could do for our deficits is to have robust economic growth and have people working and businesses selling products and they’re paying taxes,” he said. “That’s a hole that we can fill.”

On the other hand, he also said, “It is not going to be possible for us to have a huge second stimulus, because frankly, we just don’t have the money.”  Apparently the government jobs initiatives that the article mentions will somehow not involve government money.  Nice free lunch if you can get it.

So what we have is a mixed bag, but I’d say the bag is more empty than full.  While it is a relief to hear the president say that he’s aware that sudden deficit-reduction measures could trigger a double-dip recession, he has yet to retract his earlier remark, i.e, this one to Fox News:

“It is important though to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession,” he said.

Yes, if in a spontaneous shower of sparks, holders of U.S. Treasury bonds suddenly decided that mid-1990s debt/GDP ratios (like we have now) were completely unacceptable and decided to dump their T-bonds, interest rates would go up and the economy would go south.  Except the economy has already gone south.  And the debt-doomsday scenario (which some people have been predicting for decades) just ain’t very plausible.  What is plausible, and seems to be the consensus forecast of economists, is that unemployment stays in double digits well into next year and even rises (despite the good news for November).  By ruling out any more stimulus spending to counter that unemployment, Obama seems to be ruling in a depression.

The Hold Steady

13 August 2009

No big surprise today — the Federal Reserve decided to keep its short-term interest rate target unchanged at 0 – 0.25%.  Nobody expected them to raise rates, and there was no real way to lower them, so voila!

The bigger story, which is really not all that big but is being presented as a Fed statement that the recession is all but over, is that the Fed said it would wrap up its $300 billion purchase of Treasury securities a bit ahead of schedule, by the end of October.  Considering that the Fed has already bought $253 billion of those securities, this is no big deal and doesn’t preclude another big monetary stimulus if conditions worsen in the next few weeks.  (The conspiratorially minded could even charge that the Fed is ramping up its monetary stimulus by buying all those bonds sooner, but nobody appears to be saying that.)

It’s all a good excuse for a video clip from a good and acclaimed band that I’m still hoping to develop a passion for someday: