August 9, 2011

Fed Sees Growing Concern

Today, the Federal Reserve expressed growing concern for the anemic growth in the economy.  The Federal Open Market Committee (FOMC) voted to keep rates at the near-zero levels through at least mid-2013.  Below is the text from the FOMC statement:

Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected.  Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.  Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand.  Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity.  Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions.  More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks.  Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.  Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further.  However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.  The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.  The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.  It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.

Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.

August 4, 2011

Ideas for Growth

Amid the slew of weak economic data coming this week, the stock market has lost the gains (the DJIA dropped 4.31% today alone) created by the Federal Reserve's quantitative easing.  This comes as we await, what is expected to be a weak, July's jobs report - consensus estimates are for 75k new jobs, far below what is needed to bring down unemployment.

Last week, I suggested that the focus, in the immediate term, should be on economic growth rather than balancing the federal budget.  Apparently investors are much more concerned with the growth prospects of the U.S. than its balance sheet.  And the concern is heightened due the Fed's limited number of tools for stoking growth.  How, then, do we get the economy growing again?

Rather than re-open the debate about the level of governmental support that is needed and should be in place, David Wessel of the Wall Street Journal suggests a more strategic shift in the way the U.S. does business (the accompanying video further elaborates on this idea).  Mr. Wessel points to NYU professor Paul Romer who identifies our economy's over-weighted investment in financial services and health care.  Mr. Romer points out that the financial services industry has destroyed a lot of value over the past decade, and that skyrocketing health care spending has not translated into greater health for Americans.

What Mr. Romer and Mr. Wessel are advocating is a reallocation of economic resources toward value creation through business investment, export growth and innovation.

July 31, 2011

Taking Their Eye Off the Ball

Friday's GDP (advance estimate) release for the second quarter shows that the economy is stalling, and benchmark revisions show that the 'Great Recession' was deeper than originally thought.  This comes amid continued impasse, both within Congress and with the Obama Administration, regarding the Federal Government's debt ceiling and long-term deficits.

With regard to the debt ceiling/deficit-reduction negotiations, two things are certain:
  1. Failure to raise the debt ceiling before the deadline (estimated to be August 2nd) forces the federal government to choose which of its current obligations it will and will not meet.  A default can, and would likely, be avoided by paying foreign creditors ahead of any domestic spending.
  2. A credible longer-term deficit reduction plan is needed to prevent a downgrade of the U.S. AAA credit rating.  It is this AAA rating that allows the federal government to finance expenditures, that revenues don't cover, so cheaply.
The Congress, along with the President, must make tough decisions in order to address the deficit, which will require addressing rising health care spending and falling tax revenues.  The financial crisis of 2008 and the ensuing recession led to massive bailouts and stimulus spending, as well as a decline in tax receipts - exacerbating the deficit problem.  (For the record - it is my belief that these were necessary.)  The lack of a credible plan and a potential downgrade are creating greater uncertainty among already cash-hoarding companies and cautious consumers.

This begs the question: should the government, instead, be focused on bolstering the economy?

In the second quarter, the economy grew 1.3% - a rate that barely keeps up with inflation yet is not robust enough to make a dent into the 9.2% unemployment rate.  Consumer spending, which makes up about two-thirds of the economy, grew a paltry 0.1%.  While controlling deficits is important, policy maker's priority should be to spur economic growth and get people working again.  They must also be careful not to create a further drag on the economy in their attempt to address the deficit.  Any cuts in federal spending, in the short-term, would end payments to private contractors hired by the government and wages to government employees who would then have to cutback themselves.  Likewise, any immediate tax increase would take from both corporations and individuals, further constraining business investment and consumer spending.

In 1935, two years after the Great Depression had ended, the economy was roaring with double-digit growth and moderate inflation of 3% when the government decided to introduce the payroll tax and tighten monetary policy.  By 1937 the country had fallen back into recession.  We are currently two years removed from the end of the 'Great Recession', growth remains below potential, unemployment has barely budged and inflation is within the Federal Reserve's comfort zone of 2%.  An introduction of austerity measures would surely push the U.S. into recession.  The government's focus should be on spurring economic growth that creates jobs.

The trouble is, there isn't much appetite in Washington for further stimulus, and the Fed has already lowered interest rates to near-zero and pumped trillions of dollars into the money supply.  Another option is inflation.  The difficulty is then to rein in that inflation before it becomes rampant.  Meanwhile consumer are saving and corporations are sitting on record profits.  So what can be done to spur consumer demand and business investment?

There is pent-up demand, the goal is to get people spending now.  To do that, we need to dis-incentivize savings.  The Fed could begin to charge interest on excess bank reserves to encourage lending.  The Fed could also communicate to the market that interest rates will go up once specific "economic performance checkpoints" have been reached.   This would encourage consumers to make the home purchase that they have been on the fence about before rates rise.  It would also push companies to purchase plant and equipment sooner, make acquisitions and take on additional payrolls.  Whatever the action taken, it needs to lead to spending now, rather than later.

The challenge is great.  Perhaps that is why Congress has turned its attention toward the deficit - apparently no easy task either.

April 29, 2011

Keynes vs Hayek

This is a very funny video portraying the opposing views of legendary economists.  It is quite accurate too, enjoy.

December 30, 2010

Economic Commentary

Here are a couple of smart guys discussing the current global economic environment and their predictions for 2011 on's "The Big Interview":

Both are supportive of the Obama Adiminstration's as well as the Fed's recent policies aiming to bolster the U.S. economy.  They also discuss the European sovereign debt crisis as well as the possibility of rising inflation in China.

December 6, 2010

QE2 vs Stimulus 3

Citing weak consumer spending and low inflation expectations, in its November 3rd statement, the Federal Open Market Committee (FOMC) announced that:

The committee will maintain its existing policy of reinvesting principal payments from its securities holdings.  In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011...The committee will [also continue to] maintain the target range for the federal funds rate at 0 to 1/4 percent...

These purchases would bring the Fed's balance sheet to nearly $3 trillion.  As of the week the FOMC's announcement, the Fed owned more than $2.3 trillion in financial assets, including $870 billion in Treasuries.

As shown in the graphic above, the Fed began its quantitative easing in the fall of 2008 and continuously altered its assets purchase programs in order to stabilize financial markets and act a buyer of last resort of mortgage-backed securities.  To that extent, the Fed's actions were successful.  The interest rate institutions charge each other to provide overnight lending has stabilize, mortgage rates are at record lows, and short-term rates are very conducive to spending.

What kind of impact will another $600 billion in liquidity actually have?  

Critics are concerned that the Fed's actions will cause inflation to runaway as the recovery gains steam.  Others, including Kansas City Federal Reserve Bank President Thomas Hoenig, worry that an extended period of cheap money will create another asset bubble.  However, Federal Reserve Chairman Ben Bernanke defended the Fed's decision on 60 Minutes last night.  Mr. Bernanke points to the extremely low inflationary environment and continued weakness in the job market.  The aim is to keep longer-term interest rates low to stoke investment and spur job growth.

Despite all of the Fed's intervention through rate cuts and asset purchases, consumers continue to save their money and payoff debts, the housing market is still struggling to find its legs, and banks are now sitting on nearly $1 trillion of excessive reserves.

Perhaps that is why Mr. Bernanke also called for the Obama Administration and Congress to provide assistance on the fiscal side.  It would seem that the his plight did not fall on deaf ears.  Today a deal on the Bush tax cuts and unemployment aid was announced that would allow the "Make Work Pay" program to lapse and make room for a payroll tax holiday for one year.  It appears that Congress is coming around to the idea of short-term deficit spending as a means to bolster the flagging economy.

While the extension of the Bush tax cuts and the extension of unemployment benefits will certainly provide aid to a sputtering recovery, its the payroll tax reductions that have the potential to really provide a boost.  A payroll tax holiday, which was not a part of last year's $800 billion stimulus package, puts money in people's pockets instantly.  This would provide an immediate stimulus, with every paycheck, giving consumers additional discretionary dollars.  Although not currently on the table, granting payroll tax reductions to employers as well (employees and employers both pay payroll taxes) would give small businesses much needed relief.  It would also lower the cost of employment for all employers creating disincentives to further job cuts while reducing the costs associated with new hiring.  Furthermore, a payroll tax holiday for businesses would free up capital for investment and equipment purchases.

The proposed compromise, while tentative, could prove to be the final shot in the arm that the economy needs to really get going.  Prior to passage of stimulus 2 (President Bush's tax refund checks were the first dose), Nobel-winning economist Paul Krugman called for a stimulus package double the size of what was eventually passed.  He warned that the $800 billion package would not suffice.  The proposal at hand is estimated to cost $900 billion.  Let us hope that Mr. Krugman's estimations are right, and that late is better than never.

September 30, 2010

Structural and Cyclical Unemployment

Nobel Prize winning economist, Paul Krugman recently reiterated that the U.S. has serious structural problems, and that the current level of unemployment is not structural but rather the result of a major recession.

While normally, Krugman has me nodding in agreement, I do not believe that all of the jobs lost during the Great Recession are temporary job losses.  I liken the jobs crisis, as he puts it, to a shelf:

You have a shelf (U.S. economy) that is generally strong and has been working properly for year.  You recently put a heavy TV (recession) on it, and it cracks.  Obviously, the first thing to do is to remove the heavy TV (provide stimulus).  However, the shelf is still cracked and needs repair (structural improvement to the economy).

With global competition rising, the U.S. economy must evolve and differentiate itself.  Many of the manufacturing jobs lost in the auto industry will not return, as the U.S. consumer demands more efficient cars.  Residential housing construction will not return to its 2002-2006 levels leading up to the housing bust.  The impact of the recently passed financial regulation on the banking industry is still unclear.

These are not temporary changes to these industries.  The 'new normal,' as it is described, includes a more cautious American consumer, much tighter credit conditions and consolidation within industry.  This forces corporations to be leaner while dramatically slowing growth of small businesses; all of which creates slack in the labor market.