August 18, 2010
Will the Fed do more?
If conditions deteriorate further, I believe the answer is yes.
Tim Duy is discouraged that the Fed has given up on trying to reduce the output gap, noting in particular the speech by Federal Reserve Bank of Kansas City President Thomas Hoenig last Friday. But what caught my eye in Hoenig's remarks was this:
The recovery is proceeding as many economists earlier this year outlined that it would. It is a modest recovery, with mixed results. Yet, GDP is likely to expand at somewhere around a 3 percent rate through the remainder of the year.
And here's what Hoenig considered to be the most important part of his message, if we can judge by what was included in his dissenting opinion to the Fed's August 10 FOMC statement:
Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.
There was much more in Hoenig's speech that one might choose to debate, but my inclination is that a key issue here is one of facts, not ideology. Either U.S. GDP growth for 2010 will end up above 3%, or it won't. And if, as many analysts fear, it won't, then I would expect Hoenig and the rest of the FOMC to respond.
Certainly Federal Reserve Bank of St. Louis President James Bullard is trying to communicate that the Fed needs to respond more if disinflation continues:
There has been disinflation. It has been at the low end of where I'd like to see it. For that reason I think we should supplement our quantitative easing program if we get further developments on that front. We should have a plan in place to take action if it moves lower.
My expectation is that Hoenig's forecast will prove optimistic, and that last week's modest easing is not the last we're going to hear from the Fed.
Posted by James Hamilton at August 18, 2010 07:54 AMdigg this | reddit
Wall Street firms are already calling for $1 - $2 trillion more in QE, and if there's any master Bernanke likes serving more than the Treasury Department, it's Wall Street.
Posted by: W.C. Varones at August 18, 2010 08:32 AM
Have they forgotten about lags in the policy process?
Posted by: Mark Thoma at August 18, 2010 08:56 AM
I hope you have (and suspect you have) mis-characterized Duy's meaning when you say stick his pessimism regarding Fed policy right next to his treatment of Hoenig's speech. Hoenig is a dissenter to current Fed policy, and has been one for some time. His views don't represent those of the mainstream FOMC voter and so cannot be taken as representative of mainstream thinking or likely future Fed policy.
Posted by: kharris at August 18, 2010 09:00 AM
kharris: Sorry, I thought it was understood that Hoenig's was the dissenting opinion and that Bullard is likely closer to the consensus.
Posted by: JDH at August 18, 2010 09:10 AM
The real question to ask is "will the Fed doing more help?".
QE does nothing to solve the current problem. I hope we can all agree lack of aggregate demand is the cause of the economic slowdown. Consumers have to much debt and are not willing to go further in debt to consume more. Investors are not willing to go into debt to invest in more production when they cannot sell current output. And banks will not lend for the same reasons. So how do you improve aggregate demand under the circumstance? NOT QE! Only govt net spending (spending above taxation) will solve the problem. I prefer a payroll tax holiday. Of course one must understand how a floating rate currency system works which most mainsteam economist do not (or maybe they do but are not willing to admit they have been wrong all these years).
Posted by: markg at August 18, 2010 09:11 AM
Lost in the noise here is another set of comments by another Fed President, Kocherlakota. He's starting to talk about another long-term risk of ZIRP and echoing Hoenig's remarks that the Fed may be inadvertently reinforcing deflation(and expectations thereof) even as it blows more asset bubbles.
"Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent."
Posted by: ndk at August 18, 2010 09:21 AM
When reading the model Globalization,business cycle and macro economic monitoring Aruoba,Diebold,Kose,Terrones
An endeavour to monitor the global business cycles and to capture major componenents of GDP, where disposable income,industrial production,retail sales,initial claims for unemployment are the key parameters.The same model refers to coincident models and still no reference to money supply in the list of parameters in survey.
Fed governor Bullard is reported to vote on interest rates with a proviso "adequate money supply" (econbrowser post,Menzie Chinn related to Fed members behavioral statistical survey as quantified by Fed economists)
M2ASL, M2A Money Supply (M1ASL plus Time Deposits at Commercial Banks other than Large CDs) (Discontinued Series)
Did that help or did that nurture banks loans and credit only?
Posted by: ppcm at August 18, 2010 09:40 AM
It's not rocket science to observe that in addition to the grande recession* , a maze of new governemnt regulation is going to dampen (is dampening) capital expenditures and employment. An obvious offset would be long dated tax credits for investment and hiring. We knew 2 years ago that reform was coming. We know today that slow/no growth looks probable for another 2+ years. All the FED can do is fill the tank with gas, they can't start the engine. We need business to start the engine. Tax breaks for consumers won't do it nor will more government spending aimed at special interests.
* grande recession - a deep recession accompanied by a contenious illegal immigration debate ;)
Posted by: tj at August 18, 2010 11:10 AM
Hoenig catiously laid out the facts you highlighted. He said 'expand at somewhere around a 3 percent'. Expecting further action if growth is below 3% and expecting further action only if growth is nowhere close to 3% are two very different things.
Next time he might shift to 'somewhere just below 3%' and then to 'somewhere around a small number'.
We might be waiting a good long while.
Or at least somewhere around a good long while.
Posted by: jay22 at August 18, 2010 12:04 PM
Its also useful to look at the latest numbers for the Survey of Professional Forecasters, just released Friday. (http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/2010/survq310.cfm)
P. 13 gives the breakdown of forecasters' density estimate of real GDP growth (annual-average over annual-average.) Those who expect growth of under 3.0% this year outnumber those who expect growth of over 3.0% by roughly two-to-one. For 2010-2011, a small majority still expect growth of under 3.0%
The same source also gives [p. 12] the Q by Q probabilities of a drop in real GDP. Those average 14% in Q3, 17% in Q4 and decline slightly thereafter. Those probablities are not particularly high by historical standards, and there's evidence that the forecasters tend to overestimate the odds of a contraction in the immediate aftermath of a recession.
Posted by: Simon van Norden at August 18, 2010 12:15 PM
A payroll tax holiday lets the private sector choose how the money is spent.
Posted by: KevinM at August 18, 2010 12:43 PM
"Lost in the noise here is another set of comments by another Fed President, Kocherlakota. He's starting to talk about another long-term risk of ZIRP and echoing Hoenig's remarks that the Fed may be inadvertently reinforcing deflation(and expectations thereof) even as it blows more asset bubbles."
If the Fed tries to set the nominal rate below the real rate when the nominal rate is stuck at zero, this implies negative inflation, a negative real interest rate, or a negative nominal interest rate. To my knowledge, we have non-trivial experience only with the first of these possibilities. Those who continue to insist that the Fed do more should explore which of the other possibilities they would prefer, and how they would get there. Would subsidies for bank loans to unprofitable investments be money better spent than fiscal stimulus? With overcapacity, is it a good idea to borrow AD from the future through this route?
I don't see, however, that the Fed's current stance does any more than make evident the true state of affairs. I don't think, for example, that an increase in the nominal interest rate would do anything to combat deflation. In fact, I would expect the deleterious effect on the economy to reinforce deflationary expectations.
Posted by: don at August 18, 2010 01:21 PM
The real question is will the fed doing more help or make things worse. I think it will make things worse. It will prop up the prices we need to fall and not affect the ones we need to rise (salaries/wages). It will increase uncertainty and decrease spending. When you expect your day to day expenses to rise, you must save more.
Posted by: aaron at August 18, 2010 01:54 PM
" ... trying to reduce the output gap ..."
Is there any other way to fill an output gap besides more debt, whether private or gov't?
Posted by: Get Rid of the Fed at August 18, 2010 02:06 PM
markg said: "I hope we can all agree lack of aggregate demand is the cause of the economic slowdown. Consumers have to much debt and are not willing to go further in debt to consume more. Investors are not willing to go into debt to invest in more production when they cannot sell current output. And banks will not lend for the same reasons."
Sounds to me like the economy has gone from supply constrained to mostly demand constrained. Does this make most economic models based on the experience of the post WWII period irrelevant? Are most of those models based on spoiling the rich?
Posted by: Get Rid of the Fed at August 18, 2010 02:12 PM
markg said: "So how do you improve aggregate demand under the circumstance?"
There is the question. I would suggest "things" that the bankers, the mainstream economists, and the spoiled and rich would consider heresy.
Posted by: Get Rid of the Fed at August 18, 2010 02:15 PM
markg said: "Only govt net spending (spending above taxation) will solve the problem. I prefer a payroll tax holiday."
I don't believe the solution to too much debt is more debt. Specifically, I don't believe the solution to too much lower and middle class debt is more gov't debt.
I don't believe that is the only "policy" to consider.
Posted by: Get Rid of the Fed at August 18, 2010 02:18 PM
ndk said: "Lost in the noise here is another set of comments by another Fed President, Kocherlakota. He's starting to talk about another long-term risk of ZIRP and echoing Hoenig's remarks that the Fed may be inadvertently reinforcing deflation(and expectations thereof) even as it blows more asset bubbles."
That sounds to me like an imbalanced economy with wealth/income inequality.
Posted by: Get Rid of the Fed at August 18, 2010 02:27 PM
aaron said: "It will prop up the prices we need to fall and not affect the ones we need to rise (salaries/wages)."
IMO, the fed likes it that way, negative real earnings growth on the lower and middle class, especially the workers, but not on the bankers, the economists, and their favorite financial asset speculators.
And, "When you expect your day to day expenses to rise, you must save more."
Um, no? What if people start borrowing to keep up with day to day expenses and then in the future can't pay it back?
Posted by: Get Rid of the Fed at August 18, 2010 02:33 PM
"I don't think, for example, that an increase in the nominal interest rate would do anything to combat deflation."
In the short run, yes, and Kocherlakota says as much in his speech. I think we would all agree with you. In the long run, there is definitionally no other way to combat deflation. I'm getting very frustrated with people who wave there hands and *poof* land us at a point where ZIRP or monetization of assets leads to meaningful-yet-not-disastrous inflation in the real economy.
Kocherlakota himself has one of the ugliest such hand-waves I've ever seen in that self-same speech:
"Eventually, the real economy will improve sufficiently that the real return to safe short-term investments will normalize at its more typical positive level."
This, of course, contradicting everything we have seen in Japan, the gradual trend lower in U.S. real interest rates for several decades, the current collapse of real yields and breakeven inflation rates implied by TIPS despite their deflationary price floor, etc. etc. Everything we have seen suggests that the equilibrium achieved from this point is not one where economic growth magically rises to a high enough level to lead to positive nominal rates, but one where inflation gradually sinks into a Bose-Einstein-style deflationary condensate somewhere in the bottom of the magnetic trap.
"That sounds to me like an imbalanced economy with wealth/income inequality."
Kocherlakota thinks it's because of a mismatch between the labor force we have and the labor force we need. The way I've been phrasing it for a long time is that equilibrium real interest rates(a hypothetical rate that both prevents inflation and maintains full employment) have become negative, probably due to, among other things, large-scale misallocations in the economy.
While we differ on the underlying cause of the underutilization of labor, we generally agree that the Fed really can't do anything about the situation. It is becoming increasingly difficult to make a credible case that monetization of debts is a solution and there are many obvious issues with negative real rates/ZIRP. And yes, as Hoenig observed, "markets" are becoming have become addicted to free money.
And here, we have otherwise reasonable people like Hamilton suggesting we are going to get further easing. Whatever the hell that even means at this point, with investment-grade corporate, mortgages, and Treasury debt at record low interest rates, despite record rates of Treasury and junk bond issuance.
I do not know how much more emphatically we can demonstrate that our problems do not lie in interest rate spreads or money supplies.
Posted by: ndk at August 18, 2010 04:42 PM
More generally, I am in rough agreement with "Get Rid of the Fed". I've been a Mellonite-style liquidationist since '08 and feel more strongly than ever that it would have been the right path.
I think there are such misallocations and overcapacities in the global economy (rich people and China, I'm particularly looking at you) that further efforts at reflation just pour down all-too-predictable holes and go nowhere especially useful. We have kept uneconomic production moving for decades, through primarily monetary policy in the West and fiscal policy in the East. All the spending power has accreted to the top 1% of earners, i.e. generally those individuals in the FIRE sector. Severe demand/supply mismatch, I guess, not really related to interest rates or money supply. General Glut's revenge.
Fight the general by destroying his army of misallocations and rebuild from there. Krugman's tariffs would have been a fine start.
But I'm less convinced it's the right path today. We have already inflicted irreparable harm on the social fabric of this country by government actions that directly contravene our general notions about what is fair and foul in this society of ours. The waters have been badly poisoned by bailouts, monetization, deliberate targeting of(or, assault upon) expectations, massive bonuses and trading profits largely through government assistance, and other happenings of the past 3 years.
In 2008, we could credibly have hunkered down together as one nation to endure the serial defaults of corporations and banks, along with the huge contractions in money supply (and savings and asset valuation) that would have come too. The rules could still have applied to all, and we could've committed to them.
Too late now. The societal damage is done. Otherwise reasonable people have become obsessed with gold as the one tangible, realistic, honest asset in this world. Hatred and misunderstanding of the financial sphere is at an apex. Everyone generally agrees that our political parties, leaders, government, etc. are all hideously corrupt. If the liquidation were to happen now, some of the more bizarre dire scenarios promulgated by Paulson et. al. may actually be prescient.
So I guess now I'm content to have decades of nothing muddling, the continued rise of an oligarchy, and ideally, a few scraps of government support for us plebs on the bottom of it all.
Posted by: ndk at August 18, 2010 05:03 PM
markg: "I hope we can all agree lack of aggregate demand is the cause of the economic slowdown."
This is not a very meaningful statement. Why is there a lack of demand? Because resources have been grossly misallocated. Misallocated because of very fundamental non-market prices (interest rates) mislead all participants.
Sustainable growth depends on someone having saved the money that someone else borrows. It needs market-generated money & interest rates.
Posted by: Bryce at August 18, 2010 06:52 PM
It is funny how Keynesian economics is now a euphemism for socialism, socialism itself being a euphemism for forced redistribution of wealth.
Posted by: Heterosexual at August 19, 2010 12:24 AM
Shouldn't we look to policies that are working. Obviously the policies in the US are not working. The recovery is a fantasy of wishful thinking formed by mercantilist minds. Germany, while only really implementing halfway policy is in an actual recover. The European are now actually seeing growth rates higher than the US as they reverse their failed mercantilist policies.
Why keep doing the same old thing when it obviously isn't working.
Posted by: RicardoZ at August 19, 2010 07:54 AM
"Shouldn't we look to policies that are working. Obviously the policies in the US are not working. The recovery is a fantasy of wishful thinking formed by mercantilist minds. Germany, while only really implementing halfway policy is in an actual recover."
The party line on this one is, I believe, that the mercantilists are the ones recovering because they are continuing to enjoy the rest of the world's aggregate demand. This ignores that Germany's current account surplus is actually contracting, but we'll let that be.
There's probably some truth to the matter. In a world of limited aggregate demand, we have another argument for imposing high tariffs.
There are certainly adverse effects that would arise from tariffs, but they are defensible both in theory and in empirical evidence.
Further monetization as a solution to persistent and unwelcome disinflation is not.
Posted by: ndk at August 19, 2010 09:05 AM
Here's a (admittedly self serving) idea that will have some near term benefit. There are a lot of small real estate investors like me who have low LTV in properties that we have been paying down since the 90s.
The Fed/Treasury figures out how to refinance my notes into 0% 30 year notes and allow me to cash out, say $15-20K/property. The cash out must be used for energy efficiency improvements (my houses could use many). Treasury kicks in a tax credit (since AMT will take away the 100% depreciation I would otherwise get).
The 0% loan covers the higher balance. Capping it at, say a million focuses most of the benefit on the small rel estate investor and increases our cash flow which would flow through to consumption because we are sure not going to try to pay down those 0% notes early.
Posted by: Robert at August 19, 2010 09:23 AM
ndk said: "Kocherlakota thinks it's because of a mismatch between the labor force we have and the labor force we need."
I would say that is only PARTIALLY true.
And, "The way I've been phrasing it for a long time is that equilibrium real interest rates(a hypothetical rate that both prevents inflation and maintains full employment) have become negative, probably due to, among other things, large-scale misallocations in the economy."
Did you mean the nominal interest rate needs to be negative? If so, what are negative nominal interest rates telling you about the money supply (some might say the fungible money supply)?
Are a lot of those misallocations in the economy actually misallocations in time between supply and demand?
And, " I do not know how much more emphatically we can demonstrate that our problems do not lie in interest rate spreads or money supplies."
Money supplies or debt supplies?
Posted by: Get Rid of the Fed at August 19, 2010 11:47 PM
ndk said: "More generally, I am in rough agreement with "Get Rid of the Fed". I've been a Mellonite-style liquidationist since '08 and feel more strongly than ever that it would have been the right path."
I'm anti-debt, not necessarily a liquidationist.
And, "All the spending power has accreted to the top 1% of earners, i.e. generally those individuals in the FIRE sector."
How about most spending power WITHOUT DEBT has accreted to the top 1% of earners, i.e. generally those individuals in the FIRE sector? And, yes the FIRE sector is a huge problem.
And, "Severe demand/supply mismatch, I guess, not really related to interest rates or money supply. General Glut's revenge."
I would actually say that the mismatch is related to interest rates or the money supply.
Posted by: Get Rid of the Fed at August 19, 2010 11:54 PM
Bryce said: "This is not a very meaningful statement. Why is there a lack of demand?"
How about because the very few have extremely high real earnings growth and don't spend more when interest rates fall along with the many who are suffering negative real earnings growth and have too much debt so they don't spend more with debt when interest rates fall?
And, "Sustainable growth depends on someone having saved the money that someone else borrows."
Are you suggesting a 100% capital requirement?
Posted by: Get Rid of the Fed at August 20, 2010 12:00 AM
GRotF, debt is money is credit in a fiat system. A 100% reserve system strikes me as the least likely of all worlds because, excusing the occasional explosion, there are dramatic economic benefits associated with fractional reserve money systems.
For a primer on equilibrium interest rates, try:
and on their possible negativicity and the implications for policy:
Posted by: ndk at August 20, 2010 10:12 AM
It now appears that conditions already have deteriorated further. So perhaps we can expect more action at the next Fed meeting.
Posted by: Andy Harless at August 21, 2010 10:48 AM
I agree with those commenters who question whether more and more easing is appropriate. At some point, the Fed ought to ask themselves the question: is this continuing downturn best tackled by us, or is it a structural problem that requires re-engineering the economy? I am afraid that a weak Fed is simply accepting the politicians' presumption that it is the Fed's responsibility to tackle the problem. As it is, it seems to me that the Fed is sleepwalking into an inflationary reset of relative prices, which would generate its own collateral damage. Like ndk, I have always thought that liquidation of bad assets (not necessarily assets in general as in "farmers") should have preceded easing, but that will not be seriously considered as long as the Fed provide a softer path to a half-baked solution.
Posted by: RebelEconomist at August 22, 2010 03:31 AM