Today’s humor break: Remy does the Debt Ceiling Rap (with some asides about monetary policy):
Best line: “I got a monetary plan, and it involves a lot of toner.”
Raise the Debt Ceiling Rap
Category: Macroeconomics
Ranking U.S. Economic Recoveries
The Wall Street Journal has a lovely graphic this morning illustrating the strengths and weaknesses of U.S. economic recoveries since World War II.
No surprise, the current recovery is long on weaknesses and short on strengths:
The graphic is based on a very similar one the IMF included in its recent overview of the U.S. economy (officially known as the 2011 Article IV Consultation). I’ve pasted the original IMF graphic below.
Fedspeak on Quantitative Accommodation
In case you haven’t heard of him, let me introduce Brian Sack. As Executive Vice President at the New York Fed, he’s the guy in charge of implementing the Federal Reserves’s monetary policy efforts including all the purchases of agency securities and Treasury bonds in QE1 and QE2 (LSAP1 and LSAP2 in Fedspeak, where they are known as large-scale asset purchases).
Sack gave an interesting speech last week on the Fed’s $2.654 trillion portfolio. Among other things, he reiterated the Fed view that the impact of the portfolio comes from the owning, not just the buying:
Lastly, I should note that the market seems to have adjusted fairly well so far to the end of the purchase program. The pace of the Desk’s purchases fell back sharply at the end of June, as we moved from expanding the portfolio to simply reinvesting principal payments. In particular, our purchases slowed from an average pace of about $100 billion per month through June to an anticipated pace of about $15 billion per month going forward. We do not expect this adjustment to our purchases to produce significant upward pressure on interest rates or a tightening of broader financial conditions, given our view that the effects of the program arise primarily from the stock of our holdings rather than the flow of our purchases. While there has been considerable volatility in Treasury yields over the past several weeks, we attribute those movements primarily to incoming economic data and to broader risk events. However, we will continue to watch the markets and assess their adjustment to the end of the purchase program.
…
As noted earlier, the current directive from the FOMC is to reinvest principal payments on the securities we hold in order to maintain the level of domestic assets in the SOMA portfolio. This approach can be interpreted as keeping monetary policy on hold. Indeed, one can generally think of the stance of monetary policy in terms of two tools—the level of the federal funds rate, and the amount and type of assets held on the Federal Reserve’s balance sheet. The FOMC has decided to keep both of these tools basically unchanged for now. (Emphasis added)
In short, quantitative easing is over, but quantitative accommodation is still boosting the economy.
Sack also offered a rule of thumb equating each $250 billion in asset purchases to a 25 basis point reduction in the federal funds rate. By that metric, the $1.6 trillion in asset purchases has been the equivalent of lowering short-term rates by about 1.6 percentage points. (Over at Econbrowser, however, James Hamilton suggests that impact may be significantly smaller.)
How Will Quantitative Tightening Work?
The Fed’s second round of quantitative easing ended in late June. That means we are now in a period of quantitative accommodation. The Fed continues to hold a hefty portfolio of mortgage-backed securities and longer-term Treasuries — thus providing continued, unconventional monetary stimulus — but it’s not adding more.
At the FOMC’s June 21-22 meeting, the members discussed how it would someday exit from this unusual policy posture. In short, the Fed discussed the roadmap for quantitative tightening.
Here’s how it will work:
To begin the process of policy normalization, the Committee will likely first cease reinvesting some or all payments of principal on the securities holdings in the [System Open Market Account].
At the same time or sometime thereafter, the Committee will modify its forward guidance on the path of the federal funds rate and will initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the federal funds rate when appropriate.
When economic conditions warrant, the Committee’s next step in the process of policy normalization will be to begin raising its target for the federal funds rate, and from that point on, changing the level or range of the federal funds rate target will be the primary means of adjusting the stance of monetary policy. During the normalization process, adjustments to the interest rate on excess reserves and to the level of reserves in the banking system will be used to bring the funds rate toward its target.
Sales of agency securities from the SOMA will likely commence sometime after the first increase in the target for the federal funds rate. The timing and pace of sales will be communicated to the public in advance; that pace is anticipated to be relatively gradual and steady, but it could be adjusted up or down in response to material changes in the economic outlook or financial conditions.
Once sales begin, the pace of sales is expected to be aimed at eliminating the SOMA’s holdings of agency securities over a period of three to five years, thereby minimizing the extent to which the SOMA portfolio might affect the allocation of credit across sectors of the economy. Sales at this pace would be expected to normalize the size of the SOMA securities portfolio over a period of two to three years. In particular, the size of the securities portfolio and the associated quantity of bank reserves are expected to be reduced to the smallest levels that would be consistent with the efficient implementation of monetary policy.
Bottom line: (1) stop reinvesting principal on securities (both MBS and Treasuries, presumably), (2) modify guidance about federal funds rate, (3) raise federal funds rate (and interest on reserves), (4) sell agency securities. If I am reading this correctly, selling Treasuries is not part of the exit strategy. The Fed’s Treasury portfolio will thus decline soley as principal payments are made.
If QE2 Is Over, Does That Mean QA2 Just Started?
Everyone has been writing epitaphs for the “end” of QE2, the Federal Reserve’s program to buy $600 billion in Treasury bonds.
In a narrow sense, they are right: the Fed just completed those purchases. What most coverage misses, however, is that the effects of “quantitive easing” depend at least as much on the Fed’s owning the bonds as buying them. The stock matters at least as much as the flow.*
The epitaphs apply only to the buying. The stock–Fed ownership of $600 billion in Treasury bonds–is still with us.
Which brings us to today’s question: What should we call that? To say that QE2 is over leaves the impression that the program is over. It’s not.
One answer would be to expand the definition of QE2 to include the owning as well as the buying. In that case, we’d simply say that QE2 is still in place.
That strikes me as the cleanest solution except for one thing: almost everyone seems to want to believe that QE2 is over. So we need a new name.
To get some inspiration, consider the three stages of traditional monetary policy. You know, the kind where the Federal Reserve moves short-term interest rates up and down:
- Cutting rates (easing)
- Keeping rates low (accommodation)
- Raising rates (tightening)
The Fed’s asset purchases will go through three stages as well:
- Buying assets (quantitative easing)
- Owning assets (quantitative accommodation)
- Selling assets (quantitative tightening)
Stage 1, quantitative easing, just ended. When the Fed someday starts selling, that will clearly be quantitative tightening.
But what about stage 2? The best I can come up with is quantitative accommodation, QA for short.
That doesn’t really flow off the tongue, and better suggestions would be welcome.
For now, though, here’s my recommendation: If you insist on saying that QE2 is over, you should also be saying that QA2 just began.
* For example, here’s Chairman Bernanke discussing stocks and flows at his inaugural press conferencein April:
[W]e subscribe generally to what we call here the stock view of the effects of securities purchases, which—by which I mean that what matters primarily for interest rates, stock prices, and so on is not the pace of ongoing purchase, but rather the size of the portfolio that the Federal Reserve holds. And so, when we complete the program, as you noted, we are going to continue to reinvest maturing securities, both Treasuries and MBS, and so the amount of securities that we hold will remain approximately constant. Therefore, we shouldn’t expect any major effect of that. Put another way, the amount of ease, monetary policy easing, should essentially remain constant going forward from—from June.
What Would We Need for Persistent 5% Growth?
Last week, I argued that Governor Tim Pawlenty’s aspiration for 5% economic growth over a full decade is implausible since the United States has achieved such steady growth only once since World War II.
Over at Economics One, Stanford economics professor John Taylor offers a more positive take, defending the goal and offering a recipe for achieving it: 1% from population growth, 1% from employment growing faster than the population, and 2.7% from productivity growth.
Add it all up and you get 4.7% growth, a bit short of Pawlenty’s target but close enough for government work.
That sounds great, and I hope it happens, regardless of who is president. But let’s take a moment to kick the tires on Taylor’s assumptions.
Two seem fine:
- His population growth assumption is perfectly reasonable. Indeed, it matches the estimate used by the President’s Council of Economic Advisers in its most recent Economic Report of the President (Table 2-2).
- His productivity growth assumption is optimistic, but realistically so. Nonfarm productivity has grown at a 2.7% pace, on average, since 1996. Few analysts see that persisting. CEA forecasts assume 2.3%, for example. But the U.S. economy has demonstrated that 2.7% productivity growth is possible for a decade or more.
Three other assumptions are problematic.
- Taylor uses a very optimistic assumption about how much employment growth can exceed population growth. Today, about 58% of the working age population has a job. That woefully low level ought to rise as the Great Recession recedes. Taylor assumes that we can boost that ratio back to its 2000 level of almost 65%. But 2000 was the tail end of a technology boom that lifted America’s employment-to-population ratio to record heights. Since then, the working population has aged, so the employment-to-population ratio will be persistently lower even in good times. CEA thus forecasts that labor force changes will trim about 0.3% annually from potential growth in coming years. Getting the employment-to-population ratio back up to 65% thus won’t happen unless we have an even bigger boom than the late 1990s delivered.
- Taylor assumes that workers will keep working the same number of hours that they do today. That sounds innocuous except for one thing: average hours have been declining. CEA estimates that trimmed 0.3% per year from potential economic growth from 1958 to 2007 and will trim another 0.1% per year from 2010 through 2021.
- Taylor assumes that the rest of the economy will enjoy the same productivity growth as the nonfarm business sector. In reality, the other parts of the economy – most notably government – are lagging behind. CEA estimates that slower productivity growth outside the nonfarm business sector trimmed 0.2% from potential economic growth from 1958 to 2007 and sees an even bigger bite, 0.4% annually, in the coming decade.
Taylor’s scenario thus assumes that everything breaks right for the U.S. economy for a full decade, with remarkable job growth and remarkable productivity growth in the economy as a whole. Not impossible but, unfortunately, not likely either.
Chain, Chain, Chain, Chain CPI
Over at the Moment of Truth project (a continuation of the president’s fiscal commission), Adam Rosenberg and Marc Goldwein make a compelling case that the government should use a different inflation measure when calculating cost of living increases and indexing the tax code:
Maintaining purchasing power in spending programs and indexing various parts of the tax code is an important policy goal. However, policymakers should ensure that the most accurate measure of inflation is being used.
To correct the problem of over-indexation, many have proposed switching to the chained CPI [consumer price index] to provide a more accurate measure of inflation for indexed provisions in the federal budget. This switch was recommended by the National Commission on Fiscal Responsibility and Reform (“Fiscal Commission”) and the Bipartisan Policy Center ‘s Debt Reduction Task Force (“Domenici-Rivlin”). It has been incorporated into a large number of other plans, including from the Heritage Foundation on the right and the Center for American Progress on the left. An overwhelming majority of economists from both parties agree that the chained CPI is far more accurate measure of inflation than the CPI measurements currently in use.
In addition to improving technical accuracy, switching to chained CPI would have the secondary benefit of reducing the deficit – by about $300 billion over the next decade alone.
For the reasons they mention, I endorse this change and predict it will be part of any “grand bargain” on America’s budget.
With apologies to Aretha Franklin (and any of you with sensitive music sensibiities), let me suggest a theme song for the effort:
Chain, Chain, Chain, Chain CPI
Chain, chain, chain, chain, chain, chain
Chain, chain, chain, chain CPI
For these long years, we have indexed all wrong
We pay too much, that leads to fiscal pain
And now money’s getting tight
But we have no need to cry
We know what to do, oh a better measure we can try
Chain, chain, chain, chain CPI
P.S. To my readers who believe that the regular CPI understates inflation, rather than overstating it: Yes, Aretha’s song is “Chain of Fools”. And yes, that makes it easy for you to make up lyrics that mock the chain CPI rather than endorse it. Have fun.
Uncertainty Still Reigns in the Latest Blogger Word Cloud
Tim Kane at the Kauffman Foundation is out with his latest survey of economics bloggers (full disclosure: I am both an adviser to the survey and a participant in it).
My favorite feature is a word cloud of adjective that respondents offered to an open-ended question about the U.S. economy:
Uncertainty still reigns (as it should), but ”recovering”, “improving”, and “growing” hold some prime real estate. As do “weak”, fragile”, and “sluggish.”
For comparison, here’s last quarter’s word cloud:
A Tepid Quarter for GDP
Thursday morning brought the first official look at GDP growth in the first quarter. Headline growth was a disappointing, if not surprising, 1.8%.
Here’s my usual graph of how various components of the economy contributed to overall growth:
Consumers continued to spend at a moderate pace; their spending grew at a 2.7% rate, thus adding 1.9 percentage points to overall growth. Equipment and software investment (up at a 12.6% rate), inventories, and exports also contributed to growth.
Residential investment fell back into negative territory, reflecting the latest down leg in the housing market. But the real negatives were structures (down at a 21.7% rate, thus cutting 0.6 percentage points from growth) and government (down at a 5.2% rate). Defense spending fell sharply (11.7% rate), and state and local continued its decline (down at a 3.3% rate).
Note: As usual, imports subtracted from growth as conventionally measured. As discussed in this post and this post, I’d like to see GDP contributions data that allocate imports across the other sectors. Such data would reveal, for example, how much consumer spending contributed to growth in the U.S. economy itself. Presumably it’s less than the 1.9 percentage points shown in the chart, which reflects consumer spending that was satisfied by both domestic and international production, but we don’t know by how much.
Fight of the Century: Keynes vs. Hayek Round Two
And here’s Round One, the Keynes vs. Hayek Rap.