Monday, June 29, 2015

BANKS | "Holidays"–Greece-2015 v FDR-1933

Monday morning, March 6, 1933, Day 1 of FDR's administration. The last column notes that FDR
authorized issuance of "scrip" to replace dollars. Instead, Secretary Woodin just printed more dollars.
June 29, 2015–Greece has declared a six-day bank holiday.

It applies to foreign banks operating in Greece. A cap has been imposed on withdrawals of deposits - a personal limit of €60 a day on withdrawals from ATM machines.

This sounds something like the four-day (Monday to Thursday) bank holiday that FDR declared on March 6, 1933, right after his inauguration.

FDR embargoed export of gold in the same way that Greece has put capital controls on transfers of deposits out of the country. Later, he made it illegal for individuals to own gold. Private holdings of gold for non-industrial use (with an exemption for holders of special gold coins in the hands of coin collectors) had to be turned in to be replaced with paper dollars. Months later, he significantly devalued the dollar against gold.

If you think of the U.S. link to gold as comparable to Greece's link to the euro, its imposition of capital controls shows some separation of the Greek financial system from the rest of Europe.

Greece is considering issuance of scrip to pay pensions and other internal obligations. One scenario is that the scrip could be the beginning of the reintroduction of the drachma.

Will Woodin, the incoming U.S. Secretary of the Treasury in March 1933, was authorized to issue scrip to the banks or to pay employees and pensioners when the bank holiday was over. But he said he had a "Eureka!" moment during a night of fitful sleeping when he realized that U.S. scrip would be the equivalent of printing new dollars.

Instead, he embarked on round-the-clock production of $2 billion of new greenbacks at the Bureau of Engraving and Printing. He personally supervised the printing and packing up of the greenbacks on trucks, and had film crews recording the event for the Pathe News shows at cinemas all across the country.

When the solvent banks reopened after having been subjected to stress tests, the panic that began in October 1929 and had intensified in the intervening three-and-a-half years was over. Once the panic stage ended, the Depression era settled into a fiscal and monetary battle over how much to stimulate the economy.

Then as now, sober people looked back on the previous era of profligacy that led to insolvencies, illiquidity and panic and were eager to mete out punishments. FDR had the common sense to see that the punishments would be a new crime against the unemployed who were bearing the brunt of the pain.

The difference between the United States then and Greece today is that the U.S. dollar was printed at the discretion of the Secretary of the Treasury under U.S. laws. Also, a crucial aspect was that the Treasury committed itself to reopening only solvent banks, promising deposit insurance (the Steagall part of the Glass-Steagall Act of 1933) and meanwhile standing behind the banks that were reopened.

The euro, on the other hand, is printed and minted by each national central bank under the control of the European Central Bank. The ECB announced in January its latest QE program, creating liquidity Europe-wide by buying $1.1 trillion of bonds over the next two years, injecting a steady stream of liquidity into the financial system. This has not been enough to stop the Greek panic.

Paul Krugman thinks Greece can't take any more austerity, and that - as in the United States of March 1933 - austerity measures are counter-productive. Today as in 1933, reforming the system needs to take a back seat to calming the panic and making sure that the economy is not further destroyed.

When speculators fail, they take their losses and move on. But when the economy fails, the biggest victims are unemployed people, who are innocent of the past crimes or excesses for which they are being punished.

Saturday, June 27, 2015

MUNI FINANCE | Cantwell and Ravitch (with Postscript)

Larry Cantwell (L) and Dick Ravitch at the East Hampton, NY Library.
This and following photo by JTMarlin.
This year the East Hampton Library initiated a high-quality series of lectures named after the late Tom Twomey, the library's former Chairman.

The lectures are held in the basement of the new addition to  the library and are financed by donations.

Patti Kenner told me she spoke with Twomey the day before he died, and what he wanted to talk about with her was his speaker series.

Yesterday, Larry Cantwell and Dick Ravitch spoke about municipal finance.
  • Ravitch is a national expert on the subject, having overseen financial controls on New York City and Detroit and elsewhere. (Stockton, Calif., is another bankruptcy that was discussed.) His expertise may be in demand in coming months and years as the debt chickens come home to roost.
  • Cantwell is an expert on local finances. Together, they provided a formidable range of expertise on the subject of municipal government and finance that may well be in demand in the coming months if the Federal Reserve goes ahead with its program to raise interest rates above its zero-bound level. Puerto Rico has already announced that it is drowning in its existing debt and can't pay them.
Ravitch was made Chairman of the Municipal Assistance Corporation when New York City became insolvent in 1974. Mayor Beame had been financing annual deficits by borrowing and the banks suddenly stopped lending. Ravitch formed an independent entity to which NYC sales taxes were pledged, and that entity assumed the debts and paid them off. Meanwhile NYC was under strict controls to prevent a return to financing deficits with debt.

Cantwell, who is Supervisor of the Town of East Hampton and was previously Village Administrator of the Village of East Hampton, agreed with a questioner that East Hampton went through something of the same kind of crisis in 2007-2008. The Town borrowed to pay for current-year operating deficits, as described the New York State Comptroller in a scathing report.
Phyllis Italiano (L) and Bridget Fleming at the meeting.

Someone asked about school consolidation, since there are inequities in the school taxes paid by residents of the different school districts in East Hampton Town. One response is to push for consolidation of school districts. Another is to seek to address the inequities through subsidies for the communities with higher school burdens.

Larry Cantwell said that Assemblyman Fred Thiele, who has a district office in Bridgehampton, was the point man for discussion of this issue.

Bridget Fleming followed up by noting that an attempt to pass a law to help burdened school districts was introduced in Albany and lost by only 39 votes. She is continuing to press for such a law. Phyllis Italiano of East Hampton is a big fan of hers.

Postscript (July 1, 2015)

To the list of municipal insolvencies and control boards since New York City's, I should add Yonkers, Nassau County, the District of Columbia and Jefferson County, Alabama.

The National Governors Association has posted a MuniFactSheet questioning the idea that the number of municipal defaults is growing. It says that between 1970 and 2011 there were only 65 defaults on rated debt, excluding technical defaults.

Wednesday, June 24, 2015

THE FED | Moral Hazard

Paul Volcker
Wall Street on Parade in recent years has been playing the role that the Pecora Committee played in 1933.

Ferdinand Pecora was hired as general counsel to the Senate Banking Committee to investigate the causes of the 1929 Crash. His hearings in 1933 revealed many practices that tilted the financial marketplace against small investors. He laid the groundwork of public opinion to ensure passage of the Securities Acts of 1933 and 1934.

In the process, the testimony that Pecora extracted injured the reputations of many Wall Street leaders and their friends. Some practices were illegal. Others were attacked with the benefit of hindsight, in the new light of the Crash of 1929. What seemed normal in 1929 had become unethical or unfair... and with the new laws would become illegal.

Today's installment of Wall Street on Parade by Pam Martens and Russ Martens looks at the Latin American financial crisis of the early 1980s and cites from the transcript of the FOMC meeting of June 30, 1982 to examine why the Fed approved a loan to Mexico of $700 million. Mexico owed U.S. banks $21.5 billion. The Fed bailed out Mexico to bail out the banks that had loaned money to Mexico.

In an interview published in the fall of 2013, Harvard Professor Martin Feldstein asked former Fed Chairman Paul Volcker whether the high interest rates of the early 1980s caused debt problems in emerging economies. Volcker responded that U.S. bank loans were of great concern to his predecessor as Fed Chairman in the 1970s:
Arthur Burns, to his credit, was the Paul Revere on this thing. He'd go around and make speeches: "This can't continue. ... We've got to do something about it." The borrowing continued until the winter [1981-82] when a couple of banks stopped lending. Mexico ran out of money. What do you do? [my emphasis]... The big US banks and some of the big foreign banks had more exposure to Latin America than they had capital. It wasn't something you could just say: "Okay, knock off the loans by 50 percent or something and everybody will be happy." They all would have been bust. You look for other approaches, and it took nearly a decade until Mr. Brady [Nicholas Brady, Treasury Secretary, 1988-1993] came along and settled them [Brady bonds replaced Latin American debt, paying lower rates or reducing the face value, but with greater certainty of repayment].  (Martin Feldstein, "An Interview with Paul Volcker, Journal of Economic Perspectives, 27:4, Fall 2013, pp. 112-113.)
Wall Street on Parade argues that the too-big-to-fail attitude, on view in 1982, was behind the Fed and Treasury response to the financial crisis of 2007-2009.

These issues go back to the earliest years of the Fed. Founded in 1913, the Fed published a statement of its policy intentions in 1924, in its Tenth Annual Report in 1924. It announced that it would seek to encourage "productive" loans and discourage "speculative" ones. As loans to purchase securities rose the following year, the Fed tightened money. Benjamin Strong in 1927 complained about the tightening. Concerns about productive lending were shelved that year in favor of expansionary monetary policy - the Fed purchased government securities to add to liquidity.

When the Fed tightened again in 1928, it created the disastrous crisis of 1929-30, and the expansion of 1927 was viewed as the root cause. When banks started to fail, the Fed often refused to lend to them. Not until April 1932 did it expand the money supply, and this ended by August. Julio Rotemberg, "Shifts in US Federal Reserve Goals and Tactics for Monetary Policy: A Role for Penitence?", Journal of Economic Perspectives, 27:4, Fall 2013, 67-69.

Thus a "too-big-to-fail" attitude emerged from the panics caused by a tough line on the banks in 1929-32, which was motivated by a reaction to the expansion of 1927. The "too-big-to-fail" idea creates moral hazard, as Wall Street on Parade notes. As long as that is not addressed, speculative lending will grow and the global financial structure remains shaky.

Wednesday, June 17, 2015

JOBS | Is Uber Driver an Employee? Yes and No.

Taxi Union Drivers Protest Über.
Is an Über driver an employee?

  • California says yes.
  • East Hampton says yes.
  • Über says no.

The California Labor Commission has decided that a person who drives for Über is an employee, not a contractor. This has possible implications for Über's operations in other states, and for other emerging services such as Lyft, TaskRabbit, and Homejoy.

The June 3 ruling became better known on Tuesday when Über appealed it in a filing in state court in San Francisco, where the company and driver in the case are based.

Meanwhile, the Town of East Hampton, N.Y. is exasperated with Über drivers who ignore new laws requiring drivers and companies they work for to be licensed with a local office. The word Über in the company's name, from the Town's perspective, seems to translate to "Above the Law". The Town is going after 23 Über drivers and is said to be seeking jail time for them.

Wednesday, June 10, 2015

FED | Getting Ready to Start to Crunch.

Janet Yellen, Chair of the Federal Reserve Board.
When the Fed starts to crunch, it's time to go to lunch.

The FOMC meets next week. There is talk of moving out of the zero-bound zone. Scary.

Especially when it's been nearly seven years since the 2008 meltdown and there are young people on Wall Street who have never lived through such a crisis.

As Bernard Shaw said: "We learn from history that we learn nothing from history."

Federal Reserve Bank of New York William Dudley's understated ruminations about financial market challenges ahead ahead are being echoed more loudly and nervously elsewhere by comments and stories from:
The rest of this post provides a summary of the difficult options facing the Fed and the implications for financial markets by Risk Management Advisors LLC in their June Chartbook. I am grateful to Noralyn Marshall for sending this to me and for allowing me to excerpt here from her chart book.

The zero-bound interest-rate policy that the Fed has pursued and other central banks have echoed has helped in the seven years since 2008 to restore some financial stability, at the expense of huge debt and a loss of the usual tools of monetary policy.

Risk Management Advisors sums up the perilous situation as one dominated by global central bank policy. We know that

  • Risk assessment has been distorted by a sea of liquidity and very low policy rates. The reach for yield has favored weaker credits, longer durations, and equities.
  • Debt is higher than it would have been under normal conditions, despite knowing that the great recession was the result of a debt-fueled bubble.
  • Some people have assumed debt based on excessively optimistic interest rate assumptions.
  • Credit has been granted by those with little experience in evaluating and managing credit risk (crowd funding for example).
  • Volatility-based measures of risk are understating future volatility when the Fed no longer dampens it.
  • Boosting financial assets has widened the wealth gap. 
  • The major economies all face fiscal constraints. [And so do state and local governments.]
  • Central bank purchases have temporarily removed market risk from government financing and dramatically lowered its cost.
What we don’t know is how central banks in the US, Japan, EMU, and the UK will navigate out of their iron grip on markets and bloated balance sheets.

Tuesday, June 9, 2015

U.S. Monetary Policy - William Dudley, NYFRB

William C. Dudley, President and CEO, FRBNY
Remarks at the Economic Club of Minnesota’s June Luncheon, Minneapolis, June 5, 2015 on "The U.S. Economic and Monetary Outlook" by William C. Dudley, President and Chief Executive Officer, Federal Reserve Bank of NY:

Good morning.  It is a pleasure to be here in Minneapolis today and to have the chance to speak to all of you.  As chairman of the Economic Club of New York, I particularly appreciate the role that the Economic Club of Minneapolis has played in organizing this event.

In my remarks, I am going to focus on the economic outlook and the implications of that outlook for monetary policy.  Today, I come before you as the proverbial
 two-armed economist. [President Truman said: "Give me a one-handed economist! All my economists say, On the one hand on the other."- CityEconomist]
  • On one hand, the economy’s forward momentum has slowed sharply during the first half of the year and inflation remains below the level the Federal Open Market Committee (FOMC) views as consistent with price stability.  
  • On the other hand, I think it is also fair to say that we are still making progress towards our dual mandate objectives.  However, recent solid job gains and a further decline in the unemployment rate have occurred only because productivity growth has slowed markedly.
During the remainder of the year, I expect growth to pick up somewhat.  However, productivity growth will also likely rise.  So there remains some uncertainty about whether growth will be strong enough to lead to further improvement in the labor market.

With respect to inflation, as long as growth remains strong enough to lead to further improvement in labor market conditions—and this is an important caveat—I am becoming more confident that inflation will move up toward the FOMC’s 2 percent objective over the medium term.  The firming of inflation that I anticipate reflects my expectation that resource utilization will increase and the fact that some of the factors that have pulled down inflation, such as lower oil and gas prices and a firmer dollar, have already stabilized or partially reversed.

Putting this all together, I still think it is likely that conditions will be appropriate to begin monetary policy normalization later this year.  But the likelihood and timing will depend on the economic outlook, and that will be largely shaped by the incoming economic data.

When the FOMC begins to raise short-term interest rates, this will occur in a very different environment than in the past.  Reserves in the banking system are very plentiful, reflecting the large increase in the Federal Reserve’s balance sheet over the past few years.  But this circumstance should not adversely affect our ability to push the federal funds rate into a higher target range.  We have the appropriate tools to push up short-term interest rates.  However, lift-off may not go so smoothly in terms of the impact on financial asset prices.  After all, lift-off will represent a regime shift after more than six years at the zero lower bound.

More important for financial market asset prices than the precise timing of lift-off is the expected trajectory of short-term rates over the next few years following lift-off.  Most likely, this will be a shallow, upward path.  Because of the persistent headwinds associated with the recent financial crisis, the level of real short-term interest rates consistent with a neutral monetary policy seems considerably lower now than in the past.  And, if potential GDP growth is much lower—due to slower labor force growth and productivity growth—the long-run equilibrium real short-term rate is also likely to remain lower than normal in the future even after those headwinds fully dissipate.
But there must be considerable uncertainty about the path for short-term interest rates.  After all, the economic outlook is uncertain.  Moreover, the appropriate stance of monetary policy will be influenced by how financial market conditions respond to the Federal Reserve’s actions.  All else equal, if financial conditions tighten sharply, then we are likely to proceed more slowly.  In contrast, if financial conditions were not to tighten at all or only very little, then—assuming the economic outlook hadn’t changed significantly—we would likely have to move more quickly.  In the end, we will adjust the policy stance to support the financial market conditions that we deem are most consistent with our employment and inflation objectives.

As always, what I have to say today reflects my own views and not necessarily those of the FOMC or the Federal Reserve System.

The Economic Outlook

Turning first to the economic outlook, the real GDP growth rate appears to have slowed sharply during the first half of 2015.  Based on the revision we received last week, first-quarter real GDP fell by 0.7 percent at an annualized rate. Although most projections anticipate a pickup in growth to around 2 percent or slightly higher in the current quarter, there is little question that economic growth has slowed significantly from last year’s second-half pace.

As I see it, the contraction in GDP growth in the first quarter represents a mix of factors.  These include another unseasonably cold and snowy winter, a sharp contraction in oil and gas investment, a deterioration in the trade balance due—in large part—to the stronger dollar and sluggish foreign demand, and a slowdown in consumer spending growth after a very strong fourth quarter.

After adjusting for weather effects, I think seasonal adjustment issues probably also played some role.  For example, real defense spending has declined eight times in the past nine years in the first quarter, suggesting there is a seasonal adjustment issue.  But I judge that this has had only a modest effect on measured real GDP growth.

Because weather effects are by their nature temporary, the widely held expectation coming into the second quarter was that there would be a sharp rebound in growth similar to what took place last year. But current data suggests that the rebound has been relatively muted.  I think this is because some of the non-weather factors evident in the first quarter—such as the drag from the sharp drop in oil and gas investment—have persisted into the second quarter. 

Also, real disposable income growth has slowed over the past three months as aggregate hours worked have grown more slowly and crude oil and gasoline prices have partially recovered.  This means that the fundamentals for consumer spending are not as strong as they were at the beginning of the year.

1. Some of the forces that have been restraining growth are likely to fade later this year. For example, consider oil and gas investment.  The U.S. oil and gas rig count dropped precipitously during the first quarter, but the rate of decline has slowed during the current quarter.  Combined with the partial recovery in crude oil prices, this implies that oil and gas investment is likely to stabilize during the second half of the year.

2. Business fixed investment outside of oil and gas seems likely to advance, reflecting strong fundamentals.  For example, the cost of capital remains low and cash flows are high.

3. There is plenty of room for further gains in residential investment.  Housing starts have been running at an annual pace of only about one million so far this year.  This is low relative to both the rate of household formation that one would expect given underlying demographics and the rate of job formation.  Moreover, continued improvement in mortgage credit availability should support the demand for new housing.  Household credit worthiness is improving as the scars of the financial crisis heal, and underwriting standards may be relaxed somewhat in response to the excellent performance of recent mortgage vintages.

4. Household finances generally are in good shape with debt service burdens at historically low levels.  Nonetheless, household borrowing has been rising only very slowly, and the personal saving rate is somewhat elevated relative to what one would expect given the level of household net worth relative to income.  This suggests that if households become more confident about their finances, consumer spending should grow at least as fast as income growth over the remainder of the year.

But I can’t be completely confident about this forecast.  After all, several times during this expansion we have been fooled by sharp rises in the growth rate that appeared to presage a sustained pickup, but that subsequently proved fleeting.  Moreover, faster consumption growth is not a given.  It will depend, in part, on the pace of employment and wage growth. A downside risk is that wage growth remains subdued, which would undercut consumer spending. And, the trade sector looks likely to remain a drag on growth over the remainder of the year.  Although the dollar has depreciated slightly on a broad trade-weighted basis recently, it still is more than 10 percent higher than it was a year ago. 

Despite the sharp slowdown in growth evident during the first half of the year, we have seen continued job gains and further falls in unemployment so far this year.  Consequently, we still seem to be making progress toward our objective of maximum employment in a context of price stability. 

Today’s payroll and household employment reports indicate that this progress continued into May.  Even with a weak month in March, job gains this year have been averaging almost 220,000 per month.  The gain in May was even stronger at 280,000 and was widespread across industries.  Although the 12-month change in average hourly earnings is still low at 2.3 percent, it is a bit higher than we have seen in recent years.  At the same time, there is still some ways to go.  The unemployment rate has changed little in the past four months at about 5½ percent, with the levels of part-time workers for economic reasons, and long-duration unemployed, remaining elevated.

This combination of slow output growth and continued job gains has meant that productivity growth has been unusually weak, with non-farm business productivity declining significantly during the past two quarters and rising by only 0.3 percent over the past year.  It also implies that the future path of productivity growth will be important in determining the outlook for employment growth and the prospects for further progress in U.S. labor market conditions. 

Because it is unclear exactly why productivity growth has slowed recently, it is difficult to be confident about what it will do in the future.  One reading of the data is that some of the slowing seems likely to be persistent.  For instance, the weakness in capital spending evident during much of this economic expansion means that the contribution to productivity from capital deepening has dropped sharply in recent years.2  Also, the U.S. labor market appears to have become less dynamic—perhaps due, in part, to an older workforce.  Less movement of workers across jobs could lead to a less efficient allocation of workers’ skills, which would hurt productivity growth. 

That said, it seems unlikely that productivity growth will remain as weak as it has been over the past year.  There is considerable evidence that technological progress continues at a healthy pace.  Just look at the advances that have occurred in health care, oil and gas extraction and the development of smartphones.  Moreover, because it takes time for technological advances to be adopted broadly throughout the economy, it seems unlikely that the productivity gains from recent innovations have yet been fully realized. 

Because I am uncertain about the near-term trends of GDP growth and productivity growth, I am also uncertain about whether we will see further progress in the labor market over the remainder of the year.  There are many possible outcomes to consider.  For example, if real GDP growth were to pick up more than productivity growth, then employment growth would likely remain sufficiently firm to lead to further tightening of the U.S. labor market.  But, if the reverse occurs, then payroll gains could slow even as GDP growth strengthens.  

In contrast to my uncertainties about growth and the labor market, I am becoming more confident that inflation will return to our 2 percent objective over the medium term, as long as the labor market continues to improve—an important caveat.  The reasons here are straightforward.

1. A number of factors that threaten to keep inflation below our 2 percent objective appear to be transitory.  In this camp, I put the sharp decline in oil and gasoline prices that began in mid-2014, and the weakness we have seen in nonpetroleum import prices due to the strength in the dollar.  When the effects of these transitory influences wane, inflation will begin to move closer to our 2 percent objective for the personal consumption expenditures deflator. 

2. The tightening of the labor market may soon lead to some strengthening in the labor compensation trend.  Although the recent data are as a whole inconclusive, I find it noteworthy that the four-quarter change of the Employment Cost Index for all civilian workers, which I view as the most reliable indicator of labor cost trends, rose by 2.6 percent as of the first quarter of this year, up from around 2 percent in the first quarter of 2014.  Also, work done by my staff suggests that we are at that point in the labor market recovery where, in the past, we have typically seen a pickup in wage compensation.

3. The risk that inflation expectations, which are important in influencing inflation outcomes, might become unanchored to the downside seems to have diminished.  In particular, anxieties created by the decline in breakeven inflation compensation measures based on the relative yields of nominal Treasuries versus TIPs have lessened.  For example, the 5-year forward, 5-year inflation compensation measure has climbed by about 25 basis points from its low point in late January.3  

Implications for Monetary Policy

So what are the implications of the economic outlook for U.S. monetary policy?  As the FOMC noted in its most recent statement in late April, the Committee is looking for two conditions to be satisfied for the normalization of monetary policy to start: “further improvement in the labor market” and that the Committee “is reasonably confident” that inflation will return to the FOMC’s objective over the medium term.  I think these are reasonable criteria.

I would note that these criteria are not independent.  All else equal, for example, further improvement in the labor market should make one more confident about the inflation outlook.  But improvement in the labor market, while necessary, is not a sufficient condition.  For example, if labor market improvement were not accompanied by a meaningful uptick in wage compensation and if inflation expectations also fell, then one likely would not be reasonably confident about inflation returning to 2 percent over the medium term. 

For me, at present, the uncertainties rest more on the outlook of the labor market.  If the labor market continues to improve and inflation expectations remain well-anchored, then I would expect—in the absence of some dark cloud gathering over the growth outlook—to support a decision to begin normalizing monetary policy later this year.

When the normalization process starts and we raise the target range for the federal funds rate, what should we anticipate?  I anticipate a smooth lift-off in terms of the ability of the FOMC to push the federal funds rate up into a higher range.  Less clear is what the financial market reaction will be.  Will it be more like the turbulent taper tantrum of 2013 in response to Chairman Bernanke’s remarks that we might at some point begin to taper our asset purchases, or the benign response when the FOMC actually tapered in 2014?  Let me consider these two issues in turn. 
  • I am very confident that the Federal Reserve has the tools in place to ensure that the FOMC can successfully raise the federal funds rate into a new, higher target range when the time comes to do so.  This reflects several factors.  Most importantly, we have demonstrated that the interest rate paid on banks’ reserve balances (IOER)—which is our primary tool to raise the federal funds rate target—and daily overnight reverse repo (ON RRP) operations—which is a supplementary tool to help put a floor under money market rates—have been effective in keeping the federal funds rate well within the FOMC’s desired target range.  Moreover, in the unlikely event that the rates we initially selected for the IOER and ON RRP were insufficient to move the federal funds rate into the desired range, we could alter the level of these rates and/or the spread between these rates so as to move the federal funds rate into the desired range.  Finally, we also have other tools, such as the Term Deposit Facility and term reverse repo that could be used if needed to help achieve the targeted range for the federal funds rate.  While I don’t expect that these tools will prove necessary, it is nice to have them available should we need to deal with unanticipated contingencies. 
  • How will financial markets react to the onset of normalization?  My own view is that there likely will be some turbulence.  After all, lift-off will represent a regime change after more than six years at the zero lower bound.  Recognizing this, we have a responsibility to minimize the amount of potential turbulence by communicating clearly in order to reduce uncertainty about conditions surrounding lift-off and the likely aftermath of lift-off.  This means being clear about what factors are important in driving the timing of lift-off.  However, this does not mean providing advance notice about precisely when lift-off will occur because the timing should depend on the incoming economic news and how this influences the economic outlook.  Instead, if you pay attention to the incoming economic news and listen to our assessment about how the outlook is evolving, then I think you will be able to judge for yourself when lift-off is likely. 
What also matters for financial asset prices is the likely post-lift-off trajectory of short-term rates over the medium- to longer-term. In fact, this should be more important than the particular month in which the normalization process starts.  On this score, I think it is hard to be precise about the expected path of short-term rates.  That is because it depends on two important factors: (1) how the economic outlook evolves, which depends, in part, on how loose or tight monetary policy actually is at a given level of short-term rates, and (2) how financial conditions broadly react to changes in the level of short-term rates.

My own view is that the upward trajectory of short-term rates is likely to be relatively shallow.  This reflects several factors.  

1. The lack of strong forward momentum in the economy despite the low level of short-term interest rates suggests that U.S. monetary policy is not as accommodative as one might think.  In particular, the lack of strong momentum suggests that the real equilibrium federal funds rate today is considerably lower than the 2 percent rate assumed in the standard Taylor Rule formulation.  Work done by my Federal Reserve colleagues, Thomas Laubach and John Williams, suggests that the so-called neutral real federal funds rate today may be close to zero.4  This presumably reflects still-persistent headwinds from the financial crisis, such as the constraints on mortgage credit availability to prospective borrowers with lower FICO scores.  

2. One might expect that it will still take additional time for these headwinds to fully subside.  This implies that the neutral short-term rate may be depressed for some time.  

3. My assessment is that the long-run equilibrium real federal funds rate is lower now than in the past, reflecting the likelihood that potential real GDP growth is lower due to slower growth of the labor force and more moderate productivity growth performance.

Another important factor that will affect the trajectory of short-term rates is how financial market conditions respond to a rise in short-term rates.  Monetary policy works on the economy through how it affects financial market conditions.  Economic conditions at any point in time warrant a particular set of financial market conditions so the FOMC can best achieve its objectives of maximum employment and price stability.  The FOMC chooses a policy stance to help support financial market conditions that will lead to economic outcomes consistent with its objectives. 

An important aspect of current financial market conditions is the very low bond term premia around the globe.  If a small rise in short-term rates were to lead to an abrupt increase in term premia and bond yields, resulting in a significant tightening in financial market conditions, then the Federal Reserve would likely move more slowly—all else equal.  As an example, consider the experience of the 1994-95 tightening cycle.  Bond yields rose sharply and the Federal Reserve tightened less than what was ultimately priced in by market participants.  Conversely, if term premia and bond yields were to remain low and the economic outlook suggested that financial conditions needed to be tighter and a rise in short-term rates did not generate this outcome, then the FOMC would likely need to raise short-term rates further than anticipated.  The 2004-07 tightening cycle might be a good example of this.  The FOMC ultimately pushed the federal funds rate up to a peak of 5.25 percent, in part, because the earlier rise in short-term rates was generally ineffective in tightening financial market conditions sufficiently over this period.5  

This means that there is uncertainty about the trajectory of short-term rates from two distinct sources: (1) the economic outlook and what setting of financial conditions this implies is appropriate, and (2) what setting of short rates is consistent with the financial market conditions that the FOMC is seeking to generate.  

This also suggests that market participants should be cautious in interpreting the Summary of Economic Projection “dot plots” that show the FOMC participants’ modal outlooks for the short-term rate trajectory.  If the participants were to provide confidence bands around their paths, they probably would be very wide because the economic outlook is uncertain and the linkage between the instrument of monetary policy—the federal funds rate target range—to financial market conditions is loose and variable.
In conclusion, I believe that the FOMC is continuing to make progress towards our dual mandate objectives.  However, I have become somewhat more uncertain about the growth outlook given the lack of a sharp rebound in economic activity in recent months from the weak first quarter.  With respect to inflation, as long as we see further improvement in the labor market and anchored longer-term inflation expectations, I am somewhat less worried that inflation will stay too low.  Thus, I continue to expect that monetary policy normalization is likely to begin later this year.

Longer-term, I expect that the trajectory of short-term interest rates after lift-off will likely be relatively shallow.  This is due, in part, to my reading that monetary policy today is not as accommodative as one might think judging just from the level of short-term rates.  But, the path will ultimately be determined by how the economic outlook evolves and how financial market conditions respond to monetary policy.  I expect that there will be many twists and turns in the road ahead.  As we make this journey, I will do my best to explain what I am seeing and how I think I might react as conditions change in the future. 

Thank you so much for your kind attention.  I would be happy to take a few questions.  

1 Jonathan McCarthy, Richard Peach, Paolo Pesenti and Joseph Tracy assisted in preparing these remarks.
2 For example, see Alan Blinder, “The Mystery of Declining Productivity Growth,” Wall Street Journal, May 14, 2015.
3The data on inflation compensation come from the Federal Reserve Board of Governors website at and is based on Refet Gurkaynak, Brian Sack, and Jonathan Wright (2010), “The TIPS Yield Curve and Inflation Compensation,” American Economic Journal: Macroeconomics 2(1), 70-92.
4 Thomas Laubach and John Williams (2003), “Measuring the Natural Rate of Interest,” Review of Economics and Statistics 85(4), 1063-70. The FRBNY DSGE model also estimates that the natural rate of interest is currently close to zero. See Marco Del Negro, Marc Giannoni, Matthew Cocci, Sara Shahanaghi and Micah Smith, Why Are Interest Rates So Low? Liberty Street Economics blog, May 20, 2015.
5 With the benefit of hindsight, one could argue that the Federal Reserve should have raised short-term interest rates more aggressively over this period [i.e., the early part of 2004-2007 - CityEconomist].

Friday, June 5, 2015

June 5 - FDR Signs Ban (Superseded)

FDR Signs Ban on Private Ownership of Gold

This post has been merged with this one:

This post is kept up to maintain links.

Thursday, June 4, 2015

STOCK BUYBACKS | More Risk, Inequality

Source: IZA
Business school professors have struggled with aligning the interests of executives with the interests of company owners. It is called the principal-agent problem, or just agency problem.

One idea is stock options to reward executives when stock prices rise.

It was understood from the inception of this idea that some long-run measure of stock price should be used to avoid gaming the system. Michael Porter recommended that stock options not be exercisable for five years, and then only a portion of them. Those who have studied abuses of stock options recommend that averages of stock prices over several years be used, again to avoid executives goosing the stock price at a benchmark date.

Sadly, those who have studied the impact of executive pay on stock prices find a negative correlation. CEOs with pay that is in the top ten percent of their industry and size have stock prices that are 13 percent lower for periods up to five years after the high payouts.

OMG, how could this happen? Researchers try to explain the result as overconfidence among executives or investor mistrust of companies with high-paid executives, or both.

Now a better explanation of what has been going on has been presented by none other than Goldman Sachs. A big problems seems to lie in the timing of stock buybacks. What is going on is worrisome both from a social welfare standpoint and from the perspective of managing risks in financial markets. I am grateful to Wall Street on Parade for noting the implications.

In a research note, Goldman has compared the buybacks at high market multiples to the bad investment decisions that corporations made in this arena just before the market crash of 2008:
[B]uybacks peaked in 2007 (34 percent of cash spent) and troughed in 2009 (13 percent). Firms should focus on M&A [mergers and acquisitions] rather than pursue buybacks at a time when P/E [price to earnings] multiples are so high.
Goldman's alert picks up on an article in the September Harvard Business Review, “Profits Without Prosperity”, which notes that corporate profits have been high, but are not being passed through to workers or shareholders. The culprit? Stock buybacks.

[I]n the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42 percent of their compensation came from stock options and 41 percent from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.
In calendar years 2006-2013, says Birinyi Associates, public corporations authorized $4.14 trillion in buybacks of their U.S.-traded stock; in 2013 alone, corporations borrowed $782 billion, almost all paid out for stock buybacks.

In the past two quarters, investment-grade non-financial companies have issued $366 billion in bonds; the $195 billion of bonds they sold in the first quarter alone was a record.  Companies in the S&P 500 are expected to spend more than $1 trillion - two-thirds of their cash - buying back stocks and repaying dividends in 2015.

The debt these companies are taking on to prop up their stock prices is diverting corporate profits to executive pay, and is making the U.S. stock market a riskier place to put money. It helps explain why the prosperity at the top of the companies is not trickling down to the 99 percent very fast.

Tuesday, June 2, 2015

CITYECONOMIST | June 2, 2015–170K Pageviews; Most Popular

Thank you for reading and have a good month.
The CityEconomist Blog reached 170,000 Page Views today, June 2. That's 10,000 Page Views in five weeks, or 2,000 per week.

I appreciate your clicking on this blogsite.

The most-viewed posts in the last month, in order of number of Page Views are:

May 22, 2015

May 5, 2015

May 18, 2015

May 21, 2015

May 11, 2015

Jan 26, 2015

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Jan 29, 2015

May 29, 2015

May 8, 2015