Category: Macroeconomics

Fed Chairman Bernanke Submits 70 Answers to His Take-Home Exam

A few weeks ago, Fed Chairman Ben Bernanke appeared before the Senate Banking Committee for his confirmation hearing. Following the normal ritual, Committee members made their statements and peppered Bernanke with questions about every economic topic under the sun. That much is well-known (and was closely followed on CNBC).

What’s less well-known is that Bernanke went back to his office to discover an enormous stack of homework, including a 70-question take-home exam from Senator Jim Bunning.

Senator Bunning’s questions cover a lot of territory: Fed policy, fiscal policy, AIG, the dollar, etc. Chairman Bernanke’s answers are worth a read, when you have time for a 34-page, single-spaced document.

Here’s one important excerpt, reiterating the Fed’s view that Lehman could not have been saved with then-existing authorities:

54. What was your rationale for letting Lehman fail?

Concerted government attempts to find a buyer for Lehman Brothers or to develop an industry solution proved unsuccessful. Moreover, providers of both secured and unsecured credit to the company were rapidly pulling away from the company and the company needed funding well above the amount that could be provided on a secured basis. As you know, the Federal Reserve cannot make an unsecured loan. Because the ability to provide capital to the institution had not yet been authorized under the Emergency Economic Stabilization Act, the firm’s failure was, unfortunately, unavoidable. The Lehman situation is a clear example of why the government needs the ability to wind down a large, interconnected firm in an orderly way that both mitigates the costs on society as whole and imposes losses on the shareholders and creditors of the failing firm.

P.S. Calculated Risk also posts some good excerpts.

An Encouraging Jobs Report

This morning’s jobs report was encouraging not only in its headline figures, but also in its details:

  • Payrolls fell by 11,000 in November, the smallest decline since the recession began.
  • The unemployment rate declined to 10.0%, down from 10.2% in October.
  • Jobs losses in September and October were smaller than previously reported (by a combined 159,000).
  • Average weekly hours increased from 33.0 to 33.2.
  • Temporary help services, often viewed as leading indicator, added more than 52,000 jobs.
  • The underemployment rate (U-6) dropped from 17.5% to 17.2%.

In short, almost all the key measures moved in the right direction in November (the one disappointing figure was average hourly earnings, which increased only a penny in November).

It’s possible that some of these figures were helped by seasonal factors (last November was so bad that the seasonal adjustment process might give a little extra boost to this November’s figures). But the breadth of better news–including the revisions and the hours–gives me some confidence that these data do reflect real improvements in the labor market.

Still, we shouldn’t get too excited. We need the economy to add jobs–preferably 100s of thousands–each month if we are ever going to get unemployment down, so losing 11,000 is still bad news in an absolute sense. But today’s report is a step in the right direction.

Myths of Holiday Shopping

The holiday shopping season is now underway. According to the Wall Street Journal, consumers spent about $10.66 billion on Black Friday, a smidgen higher than last year.

And what does that portend for the holiday season and the economy overall? Short answer: No one knows.

As Karen Dynan notes in today’s Washington Post, the link between Black Friday sales and holiday sales isn’t as tight as many people think. And the link between holiday sales and the overall economy is even weaker. Those are two of the “5 Myths about Holiday Spending Sprees” that Karen identifies.

Her bottom line? “Much of the conventional wisdom linking holiday spending and the health of our economy turns out to have been exaggerated.”

Q3 Growth Revised Down to 2.8%

As expected, the Bureau of Economic Analysis revised down its estimate of Q3 GDP growth. BEA’s second estimate pegs growth at a 2.8% annual pace in Q3, down from 3.5% in the advance estimate.

The revision was driven by three main factors: consumer spending and business investment in structures were weaker than previously estimated, while imports were stronger.

As usual, I think a useful way to summarize the drivers of Q3 growth is to look at the contributions:

In principle, the solid growth in consumer spending and housing investment should be promising signs, given their previous weakness. However, both were boosted by temporary stimulus efforts. Cash-for-clunkers lifted consumer auto sales in Q3, for example, but we should expect some payback in Q4. Meanwhile, the tax credit for new home buyers helped housing investment record its first increase since late 2005, but some of that may have come at the expense of future housing investment (because potential home owners accelerated purchases when they thought the credit was going to expire; it’s since been extended and broadened).

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 2.9% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.1 percentage points (70% x 2.9%, allowing for some rounding) to third quarter growth.

Defending the Fed’s Independence, Part II

Back in July, I expressed concern that Congress might undermine a key pillar of U.S. economic policy: the independence of the Federal Reserve.

Why is that so important? Because independent central banks do a better job of controlling inflation. Inflation may not be an immediate threat to the U.S. economy, but as that day approaches, the Federal Reserve needs to be able to pull back on monetary stimulus without political interference.

Of course, the remarkable scale of Fed actions over the past 18 months requires close review. Both practically and politically, Congress needs to exercise careful oversight over a now-multi-trillion arm of the Federal government.

The political challenge is finding a way to provide such oversight, while defending the Fed’ independence. In today’s Wall Street Journal, Anil Kashyap and Rick Mishkin suggest one way to strike that balance:

  • Oppose the House bill (sponsored by Rep. Ron Paul) that would give the Government Accountability Office (an arm of Congress) broad auditing powers over Fed actions, including monetary policy.
  • Endorse a pending amendment (sponsored by Rep. Mel Watt) that would give the GAO specific authority to audit the various lending programs created under the 13(3) provision regarding “unusual and exigent circumstances.” As Anil and Rick describe it:

This audit would involve oversight of the operational integrity of these facilities’ accounting, internal controls, and protection against losses. It would also disclose the borrowers from these facilities one year after the facilities are closed. The audit would produce new, important information that is not otherwise available and would play to the strengths of the GAO. And the amendment would exempt the Fed’s normal monetary policy actions from the audit.

Unemployment from 3.6% to 48.5%

The New York Times has a fascinating graph showing how the unemployment rate has grown for every measured demographic group during the recession (ht: Ray).

Nationwide, unemployment has averaged 8.6% over the past twelve months, but that average conceals enormous variation.

At one extreme, unemployment has averaged just 3.6% for white women age 25 to 44 who have a college degree.

At the other extreme, unemployment has averaged 48.5% for black men age 15 to 24 who don’t have a high school degree.

(The NYT uses a twelve-month average in order to smooth out statistical noise in the estimates of unemployment for narrower demographic groupings. By way of comparison, note that the national unemployment rate was 10.2% in October, much higher than the twelve-month average of 8.6%.)

Booms, Busts, and the Leverage Cycle

Over the Wall Street Journal, Mark Whitehouse has a nice piece on John Geanakoplos, a finance guru in the worlds of both academia and Wall Street. Over the past ten years, he’s been exploring how leverage and the value of collateral can drive booms and busts in financial markets.

P1-AS318A_PARAD_NS_20091102195430

His research was sparked by the challenges his investment fund faced after the demise of Long-Term Capital Management in 1998:

A lender to the fund where Mr. Geanakoplos was a partner abruptly demanded more margin on a loan. The event, which nearly toppled the fund as the partners scrambled to raise cash by selling securities, drove home to Mr. Geanakoplos how margins could work two ways — stimulating asset buying as they go lower, but forcing fire sales as they rise.

In a 2000 academic paper, Mr. Geanakoplos offered a theory. He said that when banks set margins very low, lending more against a given amount of collateral, they have a powerful effect on a specific group of investors. These are buyers, whether hedge funds or aspiring homeowners, who for various reasons place a higher value on a given type of collateral. He called them “natural buyers.”

Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets. But if a jolt of bad news makes lenders uncertain about the immediate future, they raise margins, forcing the leveraged optimists to sell. That triggers a downward spiral as falling prices and rising margins reinforce one another. Banks can stifle the economy as they become wary of lending under any circumstances.

“It was evident to me that there was a cycle going on, not just in my little market, but all over the world,” says Mr. Geanakoplos, who is still a partner at Ellington Capital. The “leverage cycle,” he called it.

Well worth a read.

GDP Growth Returns in Q3

As expected, the economy grew at a healthy pace in the third quarter, expanding at a 3.5% annual pace according to this morning’s data from the Bureau of Economic Analysis.

Among the highlights:

  • Consumer spending grew at a 3.4% pace, the fastest since the first quarter of 2007. A substantial fraction of that growth reflects vehicle purchases, which were temporarily boosted by the cash-for-clunkers program.
  • Residential investment grew for the first time since late 2005, driven in part by the tax credit for new homebuyers.
  • Imports rose for the first time in two years. Most of that increase came from goods, which is consistent with the idea that auto imports increased in response to cash-for-clunkers.

You may notice a trend here, as government policies had a significant effect on the pattern of growth in the third quarter.

As I’ve mentioned before, I think one of the best ways to understand the pattern of growth is to look at the contributions that each major sector made to the overall growth rate:

Q3 Growth Contributions (2009 Advance)

As you can see, consumers, inventories, and exports were the main drivers of Q3 growth, while imports were the main drag.

Q3 represents a striking change from Q2 (shown in the next chart), when the economy contracted at a 0.7% pace and private spending was weak across the board:

Broad Weakness in Q2 GDP (Third)

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 3.4% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.4 percentage points (70% x 3.4%, allowing for some rounding) to third quarter growth.

Manufacturing on the Upswing

Earlier today, the Federal Reserve released its latest data on industrial production. Bottom line: production over the past three months has been surprisingly strong. Growth in September was more than expected, and the previous month was revised upward.

Industrial production has now increased for three straight months, as has a slightly narrower measure, manufacturing production:

Manufacturing IP - September

As you can see, manufacturing production turned consistently negative in January of 2008 and then fell off a cliff toward the end of the year. After declining in 17 of 18 months (driving manufacturing production down a total of 17%), manufacturing production has now risen for three straight months (for a cumulative rebound of about 3%).

Manufacturing still has a long way to go. But the recent strength in industrial production, generally, and manufacturing, specifically, adds weight to the view that the recession may have ended early this summer. (Recall that the last recession ended in November 2001, even though job losses continued long afterward.)