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Comments on Stanlely Fisher’s ‘Lessons from Crises, 1985-2014′

Posted by WARREN MOSLER on 18th March 2014

Lessons from Crises, 1985-2014

Stanley Fischer[1]


It is both an honor and a pleasure to receive this years SIEPR Prize. Let me list the reasons. First, the prize, awarded for lifetime contributions to economic policy, was started by George Shultz. I got my start in serious policy work in 1984-85, as a member of the advisory group on the Israeli economy to George Shultz, then Secretary of State. I learned a great deal from that experience, particularly from Secretary Shultz and from Herb Stein, the senior member of the two-person advisory group (I was the other member). Second, it is an honor to have been selected for this prize by a selection committee consisting of George Shultz, Ken Arrow, Gary Becker, Jim Poterba and John Shoven. Third, it is an honor to receive this prize after the first two prizes, for 2010 and for 2012 respectively, were awarded to Paul Volcker and Marty Feldstein. And fourth, it is a pleasure to receive the award itself.

When John Shoven first spoke to me about the prize, he must have expected that I would speak on the economic issues of the day and I would have been delighted to oblige. However, since then I have been nominated by President Obama but not so far confirmed by the Senate for the position of Vice-Chair of the Federal Reserve Board. Accordingly I shall not speak on current events, but rather on lessons from economic crises I have seen up close during the last three decades and about which I have written in the past starting with the Israeli stabilization of 1985, continuing with the financial crises of the 1990s, during which I was the number two at the IMF, and culminating (I hope) in the Great Recession, which I observed and with which I had to deal as Governor of the Bank of Israel between 2005 and 2013.

This is scheduled to be an after-dinner speech at the end of a fine dinner and after an intensive conference that started at 8 a.m. and ran through 6 p.m. Under the circumstances I shall try to be brief. I shall start with a list of ten lessons from the last twenty years, including the crises of Mexico in 1994-95, Asia in 1997-98, Russia in 1998, Brazil in 1999-2000, Argentina in 2000-2001, and the Great Recession. I will conclude with one or two-sentence pieces of advice I have received over the years from people with whom I had the honor of working on economic policy. The last piece of advice is contained in a story from 1985, from a conversation with George Shultz.


I. Ten lessons from the last two decades.[2]


Lesson 1: Fiscal policy also matters macroeconomically. It has always been accepted that fiscal policy, in the sense of the structure of the tax system and the composition of government spending, matters for the behavior of the economy. At times in the past there has been less agreement about whether the macroeconomic aspects of fiscal policy, frequently summarized by the full employment budget deficit, have a significant impact on the level of GDP. As a result of the experience of the last two decades, it is once again accepted that cutting government spending and raising taxes in a recession to reduce the budget deficit is generally recessionary. This was clear from experience in Asia in the 1990s.[3] The same conclusion has been reached following the Great Recession.

Who would have thought?…

At the same time, it needs to be emphasized that there are circumstances in which a fiscal contraction can be expansionary particularly for a country running an unsustainable budget deficit.

Unsustainable?
He doesn’t distinguish between floating and fixed fx policy. At best this applies to fixed fx policy, where fx reserves would be exhausted supporting the peg/conversion. And as a point of logic, with floating fx this can only mean an unsustainable inflation, whatever that means.

More important, small budget deficits and smaller rather than larger national debts are preferable in normal times in part to ensure that it will be possible to run an expansionary fiscal policy should that be needed in a recession.

Again, this applies only to fixed fx regimes where a nation might need fx reserves to support conversion at the peg. With floating fx nominal spending is in no case revenue constrained.

Lesson 2: Reaching the zero interest lower bound is not the end of expansionary monetary policy. The macroeconomics I learned a long time ago, and even the macroeconomics taught in the textbooks of the 1980s and early 1990s, proclaimed that more expansionary monetary policy becomes either impossible or ineffective when the central bank interest rate reaches zero, and the economy finds itself in a liquidity trap. In that situation, it was said, fiscal policy is the only available expansionary tool of macroeconomic policy.

Now the textbooks should say that even with a zero central bank interest rate, there are at least two other available monetary policy tools. The first consists of quantitative easing operations up and down the yield curve, in particular central bank market purchases of longer term assets, with the intention of reducing the longer term interest rates that are more relevant than the shortest term interest rate to investment decisions.

Both are about altering the term structure of rates. How about the lesson that the data seems to indicate the interest income channels matter to the point where the effect is the reverse of what the mainstream believes?

That is, with the govt a net payer of interest, lower rates lower the deficit, reducing income and net financial assets credited to the economy. For example, QE resulted in some $90 billion of annual Fed profits returned to the tsy that otherwise would have been credited to the economy. That, with a positive yield curve, QE functions first as a tax.

The second consists of central bank interventions in particular markets whose operation has become significantly impaired by the crisis. Here one thinks for instance of the Feds intervening in the commercial paper market early in the crisis, through its Commercial Paper Funding Facility, to restore the functioning of that market, an important source of finance to the business sector. In these operations, the central bank operates as market maker of last resort when the operation of a particular market is severely impaired.

The most questionable and subsequently overlooked ‘bailout’- the Fed buying, for example, GE commercial paper when it couldn’t fund itself otherwise, with no ‘terms and conditions’ as were applied to select liquidity provisioning to member banks, AIG, etc. And perhaps worse, it was the failure of the Fed to provide liquidity (not equity, which is another story/lesson) to its banking system on a timely basis (it took months to get it right) that was the immediate cause of the related liquidity issues.

However, and perhaps the most bizarre of what’s called unconventional monetary policy, the Fed did provide unlimited $US liquidity to foreign banking systems with its ‘swap lines’ where were, functionally, unsecured loans to foreign central banks for the further purpose of bringing down Libor settings by lowering the marginal cost of funds to foreign banks that otherwise paid higher rates.

Lesson 3: The critical importance of having a strong and robust financial system. This is a lesson that we all thought we understood especially since the financial crises of the 1990s but whose central importance has been driven home, closer to home, by the Great Recession. The Great Recession was far worse in many of the advanced countries than it was in the leading emerging market countries. This was not what happened in the crises of the 1990s, and it was not a situation that I thought would ever happen. Reinhart and Rogoff in their important book, This Time is Different,[4] document the fact that recessions accompanied by a financial crisis tend to be deeper and longer than those in which the financial system remains operative. The reason is simple: the mechanisms that typically end a recession, among them monetary and fiscal policies, are less effective if households and corporations cannot obtain financing on terms appropriate to the state of the economy.

The lesson should have been that the private sector is necessarily pro cyclical, and that a collapse in aggregate demand that reduces the collateral value of bank assets and reduces the income required to support the credit structure triggers a downward spiral that can only be reversed with counter cyclical fiscal policy.

In the last few years, a great deal of work and effort has been devoted to understanding what went wrong and what needs to be done to maintain a strong and robust financial system. Some of the answers are to be found in the recommendations made by the Basel Committee on Bank Supervision and the Financial Stability Board (FSB). In particular, the recommendations relate to tougher and higher capital requirements for banks, a binding liquidity ratio, the use of countercyclical capital buffers, better risk management, more appropriate remuneration schemes, more effective corporate governance, and improved and usable resolution mechanisms of which more shortly. They also include recommendations for dealing with the clearing of derivative transactions, and with the shadow banking system. In the United States, many of these recommendations are included or enabled in the Dodd-Frank Act, and progress has been made on many of them.

Everything except the recognition of the need for immediate and aggressive counter cyclical fiscal policy, assuming you don’t want to wait for the automatic fiscal stabilizers to eventually turn things around.

Instead, what they’ve done with all of the above is mute the credit expansion mechanism, but without muting the ‘demand leakages’/'savings desires’ that cause income to go unspent, and output to go unsold, leaving, for all practical purposes (the export channel isn’t a practical option for the heaving lifting), only increased deficit spending to sustain high levels of output and employment.

Lesson 4: The strategy of going fast on bank restructuring and corporate debt restructuring is much better than regulatory forbearance. Some governments faced with the problem of failed financial institutions in a recession appear to believe that regulatory forbearance giving institutions time to try to restore solvency by rebuilding capital will heal their ills. Because recovery of the economy depends on having a healthy financial system, and recovery of the financial system depends on having a healthy economy, this strategy rarely works.

The ‘problem’ is bank lending to offset the demand leakages when the will to use fiscal policy isn’t there.

And today, it’s hard to make the case that us lending is being constrained by lack of bank capital, with the better case being a lack of credit worthy, qualifying borrowers, and regulatory restrictions- called ‘regulatory overreach’ on some types of lending as well. But again, this largely comes back to the understanding that the private sector is necessarily pro cyclical, with the lesson being an immediate and aggressive tax cut and/or spending increase is the way go.

This lesson was evident during the emerging market crises of the 1990s. The lesson was reinforced during the Great Recession, by the contrast between the response of the U.S. economy and that of the Eurozone economy to the low interest rate policies each implemented. One important reason that the U.S. economy recovered more rapidly than the Eurozone is that the U.S. moved very quickly, using stress tests for diagnosis and the TARP for financing, to restore bank capital levels, whereas banks in the Eurozone are still awaiting the rigorous examination of the value of their assets that needs to be the first step on the road to restoring the health of the banking system.

The lesson remaining unlearned is that with a weaker banking structure the euro zone can implement larger fiscal adjustments- larger tax cuts and/or larger increases in public goods and services.

Lesson 5: It is critical to develop now the tools needed to deal with potential future crises without injecting public funds.

Yes, it seems the value of immediate and aggressive fiscal adjustments remains unlearned.

This problem arose during both the crises of the 1990s and the Great Recession but in different forms. In the international financial crises of the 1990s, as the size of IMF packages grew, the pressure to bail in private sector lenders to countries in trouble mounted both because that would reduce the need for official financing, and because of moral hazard issues. In the 1980s and to a somewhat lesser extent in the 1990s, the bulk of international lending was by the large globally active banks. My successor as First Deputy Managing Director of the IMF, Anne Krueger, who took office in 2001, mounted a major effort to persuade the IMF that is to say, the governments of member countries of the IMF to develop and implement an SDRM (Sovereign Debt Restructuring Mechanism). The SDRM would have set out conditions under which a government could legally restructure its foreign debts, without the restructuring being regarded as a default.

The lesson is that foreign currency debt is to be avoided, and that legal recourse in the case of default should be limited.

Recent efforts to end too big to fail in the aftermath of the Great Recession are driven by similar concerns by the view that we should never again be in a situation in which the public sector has to inject public money into failing financial institutions in order to mitigate a financial crisis. In most cases in which banks have failed, shareholders lost their claims on the banks, but bond holders frequently did not. Based in part on aspects of the Dodd-Frank Act, real progress has been made in putting in place measures to deal with the too big to fail problem. Among them are: the significant increase in capital requirements, especially for SIFIs (Systemically Important Financial Institutions) and the introduction of counter-cyclical capital buffers for banks; the requirement that banks hold a cushion of bail-in-able bonds; and the sophisticated use of stress tests.

The lesson is that the entire capital structure should be explicitly at full risk and priced accordingly.

Just one more observation: whenever the IMF finds something good to say about a countrys economy, it balances the praise with the warning Complacency must be avoided. That is always true about economic policy and about life. In the case of financial sector reforms, there are two main concerns that the statement about significant progress raises: first, in designing a system to deal with crises, one can never know for sure how well the system will work when a crisis situation occurs which means that we will have to keep on subjecting the financial system to tough stress tests and to frequent re-examination of its resiliency; and second, there is the problem of generals who prepare for the last war the financial system and the economy keep evolving, and we need always to be asking ourselves not only about whether we could have done better last time, but whether we will do better next time and one thing is for sure, next time will be different.

And in any case an immediate and aggressive fiscal adjustment can always sustain output and employment. There is no public purpose in letting a financial crisis spill over to the real economy.

Lesson 6: The need for macroprudential supervision. Supervisors in different countries are well aware of the need for macroprudential supervision, where the term involves two elements: first, that the supervision relates to the financial system as a whole, and not just to the soundness of each individual institution; and second, that it involves systemic interactions. The Lehman failure touched off a massive global financial crisis, a reflection of the interconnectedness of the financial system, and a classic example of systemic interactions. Thus we are talking about regulation at a very broad level, and also the need for cooperation among regulators of different aspects of the financial system.

The lesson are that whoever insures the deposits should do the regulation, and that independent fiscal adjustments can be immediately and aggressively employed to sustain output and employment in any economy.

In practice, macroprudential policy has come to mean the deployment of non-monetary and non-traditional instruments of policy to deal with potential problems in financial institutions or a part of the financial system. For instance, in Israel, as in other countries whose financial system survived the Great Recession without serious damage, the low interest rate environment led to uncomfortably rapid rates of increase of housing prices. Rather than raise the interest rate, which would have affected the broader economy, the Bank of Israel in which bank supervision is located undertook measures whose effect was to make mortgages more expensive. These measures are called macroprudential, although their effect is mainly on the housing sector, and not directly on interactions within the financial system. But they nonetheless deserve being called macroprudential, because the real estate sector is often the source of financial crises, and deploying these measures should reduce the probability of a real estate bubble and its subsequent bursting, which would likely have macroeconomic effects.

And real effects- there would have been more houses built. The political decision is the desire for real housing construction.

The need for surveillance of the financial system as a whole has in some countries led to the establishment of a coordinating committee of regulators. In the United States, that group is the FSOC (Financial Stability Oversight Council), which is chaired by the Secretary of the Treasury. In the United Kingdom, a Financial Policy Committee, charged with the responsibility for oversight of the financial system, has been set up and placed in the Bank of England. It operates under the chairmanship of the Governor of the Bank of England, with a structure similar but not identical to the Bank of Englands Monetary Policy Committee.

Lesson 7: The best time to deal with moral hazard is in designing the system, not in the midst of a crisis.

Agreed!
Moral hazard is about the future course of events.

At the start of the Korean crisis at the end of 1997, critics including friends of mine told the IMF that it would be a mistake to enter a program with Korea, since this would increase moral hazard. I was not convinced by their argument, which at its simplest could be expressed as You should force Korea into a greater economic crisis than is necessary, in order to teach them a lesson. The issue is Who is them? It was probably not the 46 million people living in South Korea at the time. It probably was the policy-makers in Korea, and it certainly was the bankers and others who had invested in South Korea. The calculus of adding to the woes of a country already going through a traumatic experience, in order to teach policymakers, bankers and investors a lesson, did not convince the IMF, rightly so to my mind.

Agreed!
Nor did they need an IMF program!

But the question then arises: Can you ever deal with moral hazard? The answer is yes, by building a system that will as far as possible enable policymakers to deal with crises in a way that does not create moral hazard in future crisis situations. That is the goal of financial sector reforms now underway to create mechanisms and institutions that will put an end to too big to fail.

There was no too big to fail moral hazard issue. The US banks did fail when shareholders lost their capital. Failure means the owners lose and are financially punished, and new owners with new capital have a go at it.

Lesson 8: Dont overestimate the benefits of waiting for the situation to clarify.


Early in my term as Governor of the Bank of Israel, when the interest rate decision was made by the Governor alone, I faced a very difficult decision on the interest rate. I told the advisory group with whom I was sitting that my decision was to keep the interest rate unchanged and wait for the next monthly decision, when the situation would have clarified. The then Deputy Governor, Dr. Meir Sokoler, commented: It is never clear next time; it is just unclear in a different way. I cannot help but think of this as the Tolstoy rule, from the first sentence of Anna Karenina, every unhappy family is unhappy in its own way.

It is not literally true that all interest rate decisions are equally difficult, but it is true that we tend to underestimate the lags in receiving information and the lags with which policy decisions affect the economy. Those lags led me to try to make decisions as early as possible, even if that meant that there was more uncertainty about the correctness of the decision than would have been appropriate had the lags been absent.

The lesson is to be aggressive with fiscal adjustments when unemployment/the output gap starts to rise as the costs of waiting- massive quantities of lost output and negative externalities, particularly with regard to the lives of those punished by the government allowing aggregate demand to decline- are far higher than, worst case, a period of ‘excess demand’ that can also readily be addressed with fiscal policy.

Lesson 9: Never forget the eternal verities lessons from the IMF. A country that manages itself well in normal times is likely to be better equipped to deal with the consequences of a crisis, and likely to emerge from it at lower cost.

Thus, we should continue to believe in the good housekeeping rules that the IMF has tirelessly promoted. In normal times countries should maintain fiscal discipline and monetary and financial stability. At all times they should take into account the need to follow sustainable growth-promoting macro- and structural policies. And they need to have a decent regard for the welfare of all segments of society.

Yes, at all times they should sustain full employment policy as the real losses from anything less far exceed any other possible benefits.

The list is easy to make. It is more difficult to fill in the details, to decide what policies to
follow in practice. And it may be very difficult to implement such measures, particularly when times are good and when populist pressures are likely to be strong. But a country that does not do so is likely to pay a very high price.

Lesson 10.

In a crisis, central bankers will often find themselves deciding to implement policy actions they never thought they would have to undertake and these are frequently policy actions that they would have preferred not to have to undertake. Hence, a few final words of advice to central bankers (and to others):

Lesson for all bankers:
Proposals for the Banking System, Treasury, Fed, and FDIC

Never say never


II. The Wisdom of My Teachers

:(

Feel free to distribute, thanks.

Over the years, I have found myself remembering and repeating words of advice that I first heard from my teachers, both academics and policymakers. Herewith a selection:


1. Paul Samuelson on econometric models: I would rather have Bob Solow than an econometric model, but Id rather have Bob Solow with an econometric model than Bob Solow without one.

2. Herb Stein: (a) After listening to my long description of what was happening in the Israeli economy in 1985: Yes, but what do we want them to do?”

(b) The difference between a growth rate of 2% and a growth rate of 3% is 50%.

(c) If something cannot go on forever, it will stop.
3. Michel Camdessus (former head of the IMF):

(a) At 7 a.m., in his office, on the morning that the U.S. government turned to the IMF to raise $20 billion by 9:30 a.m: Gentlemen, this is a crisis, and in a crisis you do not panic

(b) When the IMF was under attack from politicians or the media, in response to my asking Michel, what should we do?, his inevitable answer was We must do our job.

(c) His response when I told him (his official title was Managing Director of the IMF) that life would be much easier for all of us if he would only get himself a cell phone: Cell phones are for deputy managing directors.

(d) On delegation: In August, when he was in France and I was acting head of the IMF in Washington, and had called him to explain a particularly knotty problem and ask him for a decision, You have more information than me, you decide.

4. George Shultz: This event happened in May 1985, just before Herb Stein and I were due to leave for Israel to negotiate an economic program which the United States would support with a grant of $1.5 billion. I was a professor at MIT, and living in the Boston area. Herb and I spoke on the phone about the fact that we had no authorization to impose any conditions on the receipt of the money. Herb, who lived in Washington, volunteered to talk to the Secretary of State to ask him for authorization to impose conditions. He called me after his meeting and said that the Secretary of State was not willing to impose any conditions on the aid.

We agreed this was a problem and he said to me, Why dont you try. A meeting was hastily arranged and next morning I arrived at the Secretary of States office, all ready to deliver a convincing speech to him about the necessity of conditionality. He didnt give me a chance to say a word. You want me to impose conditions on Israel? I said yes. He said I wont. I asked why not. He said Because the Congress will give them the money even if they dont carry out the program and I do not make threats that I cannot carry out.

This was convincing, and an extraordinarily important lesson. But it left the negotiating team with a problem. So I said, That is very awkward. Were going to say To stabilize the economy you need to do the following list of things. And they will be asking themselves, and if we dont? Is there anything we can say to them?

The Secretary of State thought for a while and said: You can tell them that if they do not carry out the program, I will be very disappointed.

We used that line repeatedly. The program was carried out and the program succeeded.

Thank you all very much.

[1] Council on Foreign Relations. These remarks were prepared for presentation on receipt of the SIEPR (Stanford Institute for Economic Policy Research) Prize at Stanford University on March 14, 2014. The Prize is awarded for lifetime contributions to economic policy. I am grateful to Dinah Walker of the Council on Foreign Relations for her assistance.

[2] I draw here on two papers I wrote based on my experience in the IMF: Ten Tentative Conclusions from the Past Three Years, presented at the annual meeting of the Trilateral Commission in 1999, in Washington, DC; and the Robbins Lectures, The International Financial System: Crises and Reform Several other policy-related papers from that period appear in my book: IMF Essays from a Time of Crisis (MIT Press, Cambridge, MA, 2004). For the period of the Great Recession, I draw on Central bank lessons from the global crisis, which I presented at a conference on Lessons of the Global Crisis at the Bank of Israel in 2011.

[3] This point was made in my 1999 statement Ten Tentative Conclusions referred to above, and has of course received a great deal of focus in analyses of the Great Recession.

[4] Carmen Reinhart and Kenneth Rogoff, This Time is Different, Princeton University Press, Princeton, NJ, 2009.

Posted in Banking, Bonds, CBs, Credit, Currencies, Deficit, ECB, Employment, Government Spending, Housing, Interest Rates | No Comments »

Remember all the talk about the deficit causing rates to go up in Japan?

Posted by WARREN MOSLER on 24th February 2014


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Posted in Bonds, Interest Rates, Japan | No Comments »

existing home sales chart, real final sales chart (pre weather)

Posted by WARREN MOSLER on 21st February 2014

Yes, the Fed doesn’t like QE and wants to taper, but seems to me they don’t want mortgage rates this high either. They know the only way the market will ‘bring down rates’ is if the economic weakness persists. And they suspect it very well may persist unless rates come down.

Their remaining option is TIRT (term interest rate targeting) which has yet to be discussed.

Existing Home Sales

Highlights
It’s more than just weather that’s clobbering the housing market. High prices and tight inventory aren’t helping either as existing home sales fell 5.1 percent in January to a 4.620 million annual rate. The year-on-year rate is also at minus 5.1 percent, a sharp contrast to the year-on-year median price which is up 10.7 percent.

Supply of homes relative to sales did rise to 4.9 months from 4.6 months but the improvement is tied mostly to the drop in sales. Prices did come down in the month but from already high levels with the median price down 4.5 percent to $188,900.

Weather was especially cold in January and no doubt contributed to the sales weakness, especially in the Midwest, where sales fell 7.1 percent in the month, and also the Northeast where the decline was 3.1 percent. But weather in California wasn’t a problem, yet sales in the West fell 7.3 percent which the National Association of Realtors points to as evidence of non-weather constraints.

Unattractive mortgage rates are another factor holding down sales. All cash buyers continue to hold up the market, accounting for 33 percent of all sales vs 32 percent in December. In contrast, first-time buyers, who are especially sensitive to the soft jobs market, continue to account for less sales, at 26 percent vs December’s 27 percent.

This is the 5th decline in the last 6 months for this series and lack of improvement in the jobs market, not to mention this month’s severe bout of heavy weather, point to more trouble for February. For the economy, the housing market needs to snap back sharply this spring. The Dow is showing little initial reaction to today’s report.


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Not exactly gang busters even before the weather reduced incomes.

And the bad weather it’s like hurricane sandy but without the insurance spending and federal relief spending.


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Posted in Fed, GDP, Housing, Interest Rates | No Comments »

Interest rates and consumption

Posted by WARREN MOSLER on 27th January 2014

Who would have thought?
;)

Thanks Art.

The equation at the core of modern macro

By Noah Smith

“…the Euler Equation says that if interest rates are high, you put off consumption more. That makes sense, right? Money markets basically pay you not to consume today. The more they pay you, the more you should keep your money in the money market and wait to consume until tomorrow. But what Canzoneri et al. show is that this is not how people behave. The times when interest rates are high are times when people tend to be consuming more, not less.”

Posted in Interest Rates | No Comments »

History will have a field day with this one!

Posted by WARREN MOSLER on 7th January 2014

After watching Japan for 20 years and the US for the last 5 he never did figure out that low rates impart a deflationary bias.

From Keynes:

Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

Book 4, Chapter 12, Section 5, p. 158

Posted in Fed, Interest Rates | No Comments »

Yes, the Fed can set mortgage rates if it wants to!

Posted by WARREN MOSLER on 20th December 2013

One of the main reasons for the Fed’s (near) 0 rate policy is to support the housing market. And after nearly 5 years of 0 rates, and mortgage rates dipping below 3.5%, though ‘off the bottom’ housing remains far below what would be considered ‘normal’.

And then, not long ago, and immediately after the Fed first hinted at reducing its QE purchases, mortgage rates spike by over 1%:


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And, since then, mortgage refinance activity has all but vanished, and the number of mortgage applications for the purchase of homes swung from increasing nicely to decreasing alarmingly:


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The ‘Fed speak’ for this rise in rates ‘tightening financial conditions’. And one of the Fed’s concerns about tapering QE purchases was the concern that higher mortgage rates would slow the recovery. Therefore, in addition to announcing the reduction in purchases of Treasury securities and mortgage backed securities, they were careful to emphasize what’s called their ‘forward guidance’ with regard to the Fed funds rate. That is, they stated that they expected to be keeping short term rates low for the next couple of years or so, and maybe even longer than that, maybe even after unemployment goes below 6.5%, and presuming their inflation measure stops decelerating and moves back up towards their target.

Unfortunately for the Fed mortgage rates moved higher after the announcement, and not due to a burst of mortgage applications (see above charts), and not due to any immediate drop in Fed purchases, which continue in large size. Instead, what the Fed sees is a market that believes the Fed changed course because it believes the economy is recovering, and with recovery just around the corner rate hikes will come sooner rather than later. And with rate hikes on the way, investors would rather wait for the higher yields they believe are just down the road, than take the lower yields today.

Therefore, if you want to borrow today to buy a house, you have to pay investors a higher interest rate. And if you don’t want to pay the higher rate today, investors are willing to wait for those higher rates, and the house doesn’t get sold. And when the house doesn’t get sold the Fed leaves rates low for that much longer and their forecast again (they’ve been over estimating growth for 5 years now) turns out to be wrong.

So with ‘forward guidance’ not doing the trick, is there anything else can the Fed can do if it wants mortgage rates back down? Yes!

First, they can simply announce that they are buyers of 10 year treasury notes at, say, a yield of 2%, in unlimited quantities.

This would immediately bring the 10 year yield down from 2.92% to no more than 2%, and most likely the Fed would buy few if any at that price. That’s because when people know the Fed will buy at a price, they know they can then buy at a slightly lower interest rate, knowing that ‘worst case’ they can always sell to the Fed at a very small loss. That way they can earn the, say, 1.99% yield for as long as they hold the 10 year Treasury note. And there’s always a chance yields come down further as well, which means their securities increased in value as well.

And the lower 10 year rate would quickly translate into much lower mortgage rates as well. And, of course, the Fed could also do the same thing with the mortgage backed securities its already buying, which more directly targets mortgage rates.

So why isn’t the Fed doing this? Probably out of fear of offering to buy unlimited quantities might lead to them buying ‘too many’ Treasury securities. This fear, unfortunately, stems from their lack of understanding of their own monetary operations. Treasury securities are simply dollar balances in securities accounts at the Fed. When the Fed buys these securities they just debit the owner’s securities account and credit the reserve account of his bank. And when the Treasury issues and sells new securities, the Fed debits the buyer’s bank’s reserve account and credits his securities account. Whether the dollars are in reserve accounts or securities accounts is of no operational consequence and imposes no particular risk for the Fed, so those fears are groundless.

Second, the Fed (or Treasury or the Federal Financing Bank) could lend directly to the housing agencies at a fixed rate of say, 3% for the further purpose of funding their mortgage portfolio of newly originated agency mortgages. The agencies would then pass along this fixed rate, with some permitted ‘markup’ and fees to the borrowers. The Fed would then be repaid by the pass through of the monthly payments including prepayments made by the new mortgages. This would target mortgage rates directly and, as these mortgages would be held by the agencies and not sold in the market place, dramatically reduce what I call parasitic secondary market activity.

Has any of this been discussed? Not publicly or seriously that I know of.

Here’s a piece I wrote several years ago on these and other proposals:
Proposals for the Banking System, Treasury, Fed, and FDIC

And this which includes why it’s the Fed that sets rates, and not markets:
The Natural Rate of Interest Is Zero

Posted in Bonds, Fed, Interest Rates | No Comments »

How Concerned is Bernanke about his possible legacy?

Posted by WARREN MOSLER on 18th December 2013

I suspect the Chairman is seriously concerned about living out his life with his legacy, as told by the mainstream, going something like this:

“Blindsided by an intense financial crisis, the Chairman, a champion of full employment and student of the Great Depression, did everything he could come up with to support growth and employment. However, after nearly 5 years of 0 rates and massive QE were beginning to hint at positive results, and just as his term ended, he fell asleep the switch, allowing mortgage rates to spike by over 1%, sending the economy back into recession.”

;)

The latest housing starts spike seems most likely to be revised lower or followed by a big drop.


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Purchase Applications:


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Housing Starts:


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Posted in Fed, Housing, Interest Rates | No Comments »

fed rate setting

Posted by WARREN MOSLER on 12th December 2013

Of course all they have to do is pay interest on all reserve balances…

Fed Moves Toward New Tool for Setting Rates (WSJ) An experimental bond-trading program being run at the Federal Reserve Bank of New York could fundamentally change the way the central bank sets interest rates. Fed officials see the program as a potentially critical tool when they want to raise short-term rates in the future to fend off broader threats to the economy. Launched this year, it is still in a testing stage and isn’t expected to be fully implemented for years. The Fed would use the facility to raise short-term interest rates by borrowing in the future against its large and growing securities portfolio. When it does want to raise rates, it will use securities it accumulated through its bond-buying stimulus programs as collateral for loans from money-market mutual funds, banks, securities dealers, government-sponsored enterprises and others. The rates it sets on these loans, in theory, could become a new benchmark for global credit markets.

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Federal Reserve Interest Rates Should Be Near Zero Forever

Posted by WARREN MOSLER on 6th December 2013

Federal Reserve Interest Rates Should Be Near Zero Forever

By Warren Mosler

Posted in Government Spending, Interest Rates, MMT | No Comments »

Bernanke and Yellen pushing back on higher mortgage rates

Posted by WARREN MOSLER on 20th November 2013

Seems to me the Fed is making an all out effort to push back on the higher longer term rates, particularly mortgage rates. However, at least so far those rates remain elevated and at least so far mortgage purchase applications remain down year over year.

Again, seems to me it comes down to the notion that if forward guidance works to firm the economy, rates will move higher/sooner than if it doesn’t work to firm the economy.

This means forward guidance works to bring long rates down only if markets don’t believe it helps the economy.

So what’s a Fed to do to bring long rates down?
Seems to me the only tool left is unconditional guidance or purchasing securities on a price basis, rather than a quantity basis. Which does of course work, to the basis point.

That is, if the Fed announced it had a 2% bid for unlimited quantities of 10 year notes they would not trade higher than 2% while that bid was active. My recollection was that this was done during WWII.

And that we didn’t lose.
;)

Posted in Bonds, Fed, Housing, Interest Rates | No Comments »

Be the Fed

Posted by WARREN MOSLER on 25th October 2013

So imagine you are a moderate FOMC member.

Mortgage apps are down, new home sales marginal, and private sector job creation sagging. And you keep revising your GDP forecast lower at each meeting. Likewise inflation remains low, and you believe the risks are asymmetrical. That is, you know you can stop inflation and growth with rate hikes, but you’re not so sure about fighting deflation.

And so, as an FOMC member, you’d like to see mortgage rates back down. So how do you get them there? You might not like QE, and at least highly suspect it doesn’t have any first order effects, and you fear there are unknown costs, but you know tapering, for whatever reason- almost to the point the reason doesn’t matter- causes rates to go higher. And you know not tapering brought them down some, but not enough. Fed funds are already close to 0% so there’s no room there. Forward guidance, etc. has kept the short end low but not the long end. You are afraid to simply peg long rates with an unlimited bid for securities at your target rate. You know a weaker economic forecast will bring long rates down but that it would be intellectually dishonest to manipulate a forecast.

And maybe worst of all, if you do something that causes markets to believe the economy will do a lot better, mortgage rates go higher, presuming Fed rate hikes will accompany growth, and thereby make things worse instead of better.

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Fed–Williams uber dovish

Posted by WARREN MOSLER on 3rd October 2013

Looks to me like there’s been more push back on rates due to risks to housing, perceived to be the most rate sensitive ‘engine of growth’. I don’t think this Fed wants its legacy to be ‘just when things got going after 5 years of hard work the let rates go up and it all went bad again.’

The problem is that if markets believe these Fed tools do work to support higher rates of growth than otherwise, that means Fed rate hikes will actually be sooner/faster etc. which works to keep rates higher. So seems it’s a bit of a conundrum. The policy designed to keep term rates down can instead work to keep them higher.

And should the stock market ‘crater’, the Fed will likely look to ‘do more’ which could be anything from ‘more of same’- more QE, guidance, tolerances, etc- to outright rate caps, which are the only ‘reliable’ way to set lower term rates.

*FED’S WILLIAMS: AFTER FIRST RATE HIKE, ONLY GRADUAL INCREASES

*WILLIAMS SAYS UNEMPLOYMENT IS TOO HIGH, INFLATION TOO LOW

*FED’S WILLIAMS SEES UNCONVENTIONAL STIMULUS FOR NEXT FEW YEARS

*FED’S WILLIAMS: AFTER FIRST RATE HIKE, ONLY GRADUAL INCREASES

*WILLIAMS HAS SUPPORTED RECORD MONETARY POLICY STIMULUS

*WILLIAMS DOESN’T VOTE ON MONETARY POLICY THIS YEAR

*SAN FRANCISCO FED PRESIDENT JOHN WILLIAMS SPEAKS IN SAN DIEGO

*WILLIAMS SAYS UNEMPLOYMENT IS TOO HIGH, INFLATION TOO LOW

*FED’S WILLIAMS SEES UNCONVENTIONAL STIMULUS FOR NEXT FEW YEARS

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Comments on Volcker article

Posted by WARREN MOSLER on 1st October 2013

Here’s my take on the Volcker article

My comments in below:

The Fed & Big Banking at the Crossroads

By Paul Volcker

I have been struck by parallels between the challenges facing the Federal Reserve today and those when I first entered the Federal Reserve System as a neophyte economist in 1949.

Most striking then, as now, was the commitment of the Federal Reserve, which was and is a formally independent body, to maintaining a pattern of very low interest rates, ranging from near zero to 2.5 percent or less for Treasury bonds. If you feel a bit impatient about the prevailing rates, quite understandably so, recall that the earlier episode lasted fifteen years.

The initial steps taken in the midst of the depression of the 1930s to support the economy by keeping interest rates low were made at the Fed’s initiative. The pattern was held through World War II in explicit agreement with the Treasury. Then it persisted right in the face of double-digit inflation after the war, increasingly under Treasury and presidential pressure to keep rates low.

Yes, and this was done after conversion to gold was suspended which made it possible. And they fixed long rates as well/

The growing restiveness of the Federal Reserve was reflected in testimony by Marriner Eccles in 1948:

Under the circumstances that now exist the Federal Reserve System is the greatest potential agent of inflation that man could possibly contrive.
This was pretty strong language by a sitting Fed governor and a long-serving board chairman. But it was then a fact that there were many doubts about whether the formality of the independent legal status of the central bank—guaranteed since it was created in 1913—could or should be sustained against Treasury and presidential importuning. At the time, the influential Hoover Commission on government reorganization itself expressed strong doubts about the Fed’s independence. In these years calls for freeing the market and letting the Fed’s interest rates rise met strong resistance from the government.

Not freeing the ‘market’ but letting the Fed chair have his way. Rates would be set ‘politically’ either way. Just a matter of who.

Treasury debt had enormously increased during World War II, exceeding 100 percent of the GDP, so there was concern about an intolerable impact on the budget if interest rates rose strongly. Moreover, if the Fed permitted higher interest rates this might lead to panicky and speculative reactions. Declines in bond prices, which would fall as interest rates rose, would drain bank capital. Main-line economists, and the Fed itself, worried that a sudden rise in interest rates could put the economy back in recession.

All of those concerns are in play today, some sixty years later, even if few now take the extreme view of the first report of the then new Council of Economic Advisers in 1948: “low interest rates at all times and under all conditions, even during inflation,” it said, would be desirable to promote investment and economic progress. Not exactly a robust defense of the Federal Reserve and independent monetary policy.

But in my humble opinion a true statement!

Eventually, the Federal Reserve did get restless, and finally in 1951 it rejected overt presidential pressure to maintain a ceiling on long-term Treasury rates. In the event, the ending of that ceiling, called the “peg,” was not dramatic. Interest rates did rise over time, but with markets habituated for years to a low interest rate, the price of long-term bonds remained at moderate levels. Monetary policy, free to act against incipient inflationary tendencies, contributed to fifteen years of stability in prices, accompanied by strong economic growth and high employment. The recessions were short and mild.

I agreed with John Kenneth Galbraith in that inflation was not a function of rates, at least not in the direction they believed, due to interest income channels. However, the rate caps on bank deposits, etc. Did mean that rate hikes had the potential to disrupt those financial institutions and cut into lending, until those caps were removed.

In general, however, the ‘business cycle’ issues are better traced to fiscal balance.

No doubt, the challenge today of orderly withdrawal from the Fed’s broader regime of “quantitative easing”—a regime aimed at stimulating the economy by large-scale buying of government and other securities on the market—is far more complicated. The still-growing size and composition of the Fed’s balance sheet imply the need for, at the least, an extended period of “disengagement,” i.e., less active purchasing of bonds so as to keep interest rates artificially low.

Artificially? vs what ‘market signals’? Rates are ‘naturally’ market determined with fixed fx policies, not today’s floating fx.

In fact, without govt ‘interference’ such as interest on reserves and tsy secs, the ‘natural’ rate is 0 as long as there are net reserve balances from deficit spending.

Nor is there any technical or operational reason for unwinding QE. Functionally, the Fed buying securities is identical to the tsy not issuing them and instead letting its net spending remain as reserve balances. Either way deficit spending results in balances in reserve accounts rather than balances in securities accounts. And in any case both are just dollar balances in Fed accounts.

Moreover, the extraordinary commitment of Federal Reserve resources,

‘Resources’? What does that mean? Crediting an account on its own books is somehow ‘using up a resource’? It’s just accounting information!

alongside other instruments of government intervention, is now dominating the largest sector of our capital markets, that for residential mortgages. Indeed, it is not an exaggeration to note that the Federal Reserve, with assets of $3.5 trillion and growing, is, in effect, acting as the world’s largest financial intermediator. It is acquiring long-term obligations in the form of bonds and financing those purchases by short-term deposits. It is aided and abetted in doing so by its unique privilege to create its own liabilities.

The Fed creates govt liabilities, aka making payments. That’s its function. And, for example, the treasury securities are the initial intervention. They are paid for by the Fed debiting reserve accounts and crediting securities accounts. All QE does is reverse that as the Fed debits the securities accounts and ‘recredits’ the reserve accounts. So it can be said that all QE does is neutralize prior govt intervention.

The beneficial effects of the actual and potential monetizing of public and private debt, which is the essence of the quantitative easing program, appear limited and diminishing over time. The old “pushing on a string” analogy is relevant. The risks of encouraging speculative distortions and the inflationary potential of the current approach plainly deserve attention.

Right, with the primary fundamental effect being the removal of interest income from the economy. The Fed turned over some $100billion to the tsy that the economy would have otherwise earned. QE is a tax on the economy.

All of this has given rise to debate within the Federal Reserve itself. In that debate, I trust that sight is not lost of the merits—economic and political—of an ultimate return to a more orthodox central banking approach. Concerning possible changes in Fed policy, it is worth quoting from Fed Chairman Ben Bernanke’s remarks on June 19:

Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of [asset] purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program.

I would like to emphasize once more the point that our policy is in no way predetermined and will depend on the incoming data and the evolution of the outlook as well as on the cumulative progress toward our objectives. If conditions improve faster than expected, the pace of asset purchases could be reduced somewhat more quickly. If the outlook becomes less favorable, on the other hand, or if financial conditions are judged to be inconsistent with further progress in the labor markets, reductions in the pace of purchases could be delayed.

Indeed, should it be needed, the Committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.

Implying QE works to do that.

I do not doubt the ability and understanding of Chairman Bernanke and his colleagues. They have a considerable range of instruments available to them to manage the transition, including the novel approach of paying interest on banks’ excess reserves, potentially sterilizing their monetary impact.

Reserves can be thought of as ‘one day treasury securities’ and the idea that paying interest sterilizing anything is a throwback to fixed fx policy, not applicable to floating fx.

What is at issue—what is always at issue—is a matter of good judgment, leadership, and institutional backbone. A willingness to act with conviction in the face of predictable political opposition and substantive debate is, as always, a requisite part of a central bank’s DNA.

A good working knowledge of monetary operations would be a refreshing change as well!

Those are not qualities that can be learned from textbooks. Abstract economic modeling and the endless regression analyses of econometricians will be of little help. The new approach of “behavioral” economics itself is recognition of the limitations of mathematical approaches, but that new “science” is in its infancy.

Monetary operations can be learned from money and banking texts.

A reading of history may be more relevant. Here and elsewhere, the temptation has been strong to wait and see before acting to remove stimulus and then moving toward restraint. Too often, the result is to be too late, to fail to appreciate growing imbalances and inflationary pressures before they are well ingrained.

Those who know monetary operations read history very differently from those who have it wrong.

There is something else that is at stake beyond the necessary mechanics and timely action. The credibility of the Federal Reserve, its commitment to maintaining price stability, and its ability to stand up against partisan political pressures are critical. Independence can’t just be a slogan. Nor does the language of the Federal Reserve Act itself assure protection, as was demonstrated in the period after World War II. Then, the law and its protections seemed clear, but it was the Treasury that for a long time called the tune.

And didn’t do a worse job.

In the last analysis, independence rests on perceptions of high competence, of unquestioned integrity, of broad experience, of nonconflicted judgment and the will to act. Clear lines of accountability to Congress and the public will need to be honored.

And a good working knowledge of monetary operations.

Moreover, maintenance of independence in a democratic society ultimately depends on something beyond those institutional qualities. The Federal Reserve—any central bank—should not be asked to do too much, to undertake responsibilities that it cannot reasonably meet with the appropriately limited powers provided.

I know that it is fashionable to talk about a “dual mandate”—the claim that the Fed’s policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory. It is operationally confusing in breeding incessant debate in the Fed and the markets about which way policy should lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic. It is illusory in the sense that it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience.

The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity.

Completely wrong. With floating fx, it can only set rates. It’s always about price, not quantity.

Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.

Back in the 1950s, after the Federal Reserve finally regained its operational independence, it also decided to confine its open market operations almost entirely to the short-term money markets—the so-called “Bills Only Doctrine.” A period of remarkable economic success ensued, with fiscal and monetary policies reasonably in sync, contributing to a combination of relatively low interest rates, strong growth, and price stability.

Yes, and the price of oil was fixed by the Texas railroad commission at about $3 where it remained until the excess capacity in the US was gone and the Saudis took over that price setting role in the early 70′s.

That success faded as the Vietnam War intensified, and as monetary and fiscal restraints were imposed too late and too little. The absence of enough monetary discipline in the face of the overt inflationary pressures of the war left us with a distasteful combination of both price and economic instability right through the 1970s—a combination not inconsequentially complicated further by recurrent weakness in the dollar.

No mention of a foreign ‘monopolist’ hiking crude prices from 3 to 40?

Or of Carter’s deregulation of nat gas in 78 causing OPEC to drown in excess capacity in the early 80′s?

Or the non sensical targeting of borrowed reserves that worked only to shift rate control from the FOMC to the NY fed desk, and prolonged the inflation even as oil prices collapsed?

We cannot “go home again,” not to the simpler days of the 1950s and 1960s. Markets and institutions are much larger, far more complex. They have also proved to be more fragile, potentially subject to large destabilizing swings in behavior. There is the rise of “shadow banking”—the nonbank intermediaries such as investment banks, hedge funds, and other institutions overlapping commercial banking activities.

Not to mention restaurants letting people eat before they pay for their meals. This completely misses the mark.

Partly as a result, there is the relative decline of regulated commercial banks, and the rapid innovation of new instruments such as derivatives. All these have challenged both central banks and other regulatory authorities around the developed world. But the simple logic remains; and it is, in fact, reinforced by these developments. The basic responsibility of a central bank is to maintain reasonable price stability—and by extension to concern itself with the stability of financial markets generally.

In my judgment, those functions are complementary and should be doable.

They are, but it all requires an understanding of the underlying monetary operations.

I happen to believe it is neither necessary nor desirable to try to pin down the objective of price stability by setting out a single highly specific target or target zone for a particular measure of prices. After all, some fluctuations in prices, even as reflected in broad indices, are part of a well-functioning market economy. The point is that no single index can fully capture reality, and the natural process of recurrent growth and slowdowns in the economy will usually be reflected in price movements.

With or without a numerical target, broad responsibility for price stability over time does not imply an inability to conduct ordinary countercyclical policies. Indeed, in my judgment, confidence in the ability and commitment of the Federal Reserve (or any central bank) to maintain price stability over time is precisely what makes it possible to act aggressively in supplying liquidity in recessions or when the economy is in a prolonged period of growth but well below its potential.

With floating fx bank liquidity is always infinite. That’s what deposit insurance is all about.
Again, this makes central banking about price and not quantity.

Feel free to distribute.

Posted in Currencies, Employment, Fed, Inflation, Interest Rates | No Comments »

Whither QE?

Posted by WARREN MOSLER on 11th September 2013

Mtg rates are up by over a full 1%, because the Fed may scale back on QE. But it hasn’t scaled back yet. But rates are way higher anyway.

So the question is, does QE per se keep down rates?
Or does it just about signals?

So when this last round of QE began, why did rates go down? It couldn’t have been just because the Fed was going to buy, which would then drive rates down, because it’s now already bought, and will continue to buy, yet rates are suddenly far higher.

Nor did rates fall with QE because market participants though it would make the economy worse?

It’s about rates falling on the belief that Fed buying per se would bring them down, and now rates are higher on the belief that the Fed not buying as much means rates go higher. Even though it’s been demonstrated that the amount or pace of Fed buying per say doesn’t do that.

There is no way to make any sense out of it.
It’s just knee jerk reactions in a sea of ignorance.

Posted in Fed, Interest Rates | No Comments »

Mtg apps down a bunch more

Posted by WARREN MOSLER on 11th September 2013

Graph looks like it fell off a cliff.
Who would’ve thought…

U.S. Mortgage Applications Down

September 11 — The number of mortgage applications filed in the U.S. last week fell 13.5% from the prior week on a seasonally adjusted basis as interest rates increased, the Mortgage Bankers Association said Wednesday.

On an unadjusted basis, MBA reported the market composite index declined 23%. The refinance index slipped 28% from a week earlier, while the seasonally adjusted purchase index slid 2.7%.

Higher rates had curbed demand for buy new homes and made refinancing less attractive.

The share of applications filled to refinance existing mortgages fell to 57% from 61% a week earlier. In the latest week, adjusted-rate mortgages, or ARMs, represented 7.1% of total applications.


Full size image

Posted in Housing, Interest Rates | No Comments »

brazil hikes rates to fight inflation

Posted by WARREN MOSLER on 30th August 2013

Fundamentally this increases govt deficit spending/interest income for the private sector, a negative for the currency and inflation, especially as it adds to costs.

However it also adds to spending/output/employment which causes policy makers to think they got it right by hiking as the stronger economy ‘needs’ the higher rates, etc.

Brazil in fourth consecutive rate rise

(FT) Brazil’s central bank has moved to restore investors’ confidence in Latin America’s biggest economy by resorting to its fourth consecutive interest rate increase to tame stubbornly high inflation. The central bank’s monetary policy committee, Copom, raised Brazil’s benchmark Selic rate by 50 basis points to 9 per cent late on Wednesday, the latest increase in a 175 basis point tightening cycle since April. “The committee evaluates that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year,” it said, repeating the brief statement issued at its last meeting in July. On Thursday last week Alexandre Tombini, Brazil’s central bank president, launched an unprecedented $60bn intervention programme to halt the plunge of the real.

Posted in CBs, Interest Rates | No Comments »

purch apps and related comments

Posted by WARREN MOSLER on 28th August 2013


Full size image

This shows what’s happened to the number of home mortgage purchase applications since rates went up (they’ve gone down!).

While higher rates help savers as much as they hurt borrowers, the borrowing at the higher rates has to take place for the savers to get helped.

Yes, Tsy auction rates are higher, but the Fed is buying pretty much the same amount of securities that the Tsy is selling, so no help there.

It’s when the economy is ‘strong enough’ such that borrowing continues even at the higher rates that those rates ‘feed back into the economy’ through savers.

However, it is now the case that ‘investors’ hiked mtg rates due to various Fed fears, etc. with the open question being whether or not prospective home buyers will in fact borrow at those rates. If they don’t, no savers get helped and housing adds less to GDP.

Meanwhile, the Fed wants to exit QE on it’s ‘risk/reward’ analysis and has stated that improvement in the ‘labor market’ is what warrants the exit. And if ‘market forces’ have moved rates higher due to the economic outlook that’s ok too, so the current level of rates and weaker housing is unlikely to alter tapering plans, leaving the coming August jobs report as the critical data point. At the same time, the Fed wants to remain highly ‘accommodative’ and so will likely take communicative measures to attempt to keep longer rates lower, as they seem to have run out of operational alternatives.

So in my search for the agents who will increase their ‘borrowing to spend’ sufficiently to offset this year’s decrease in the govt’s deficit spending, seems I can scratch off ‘housing’.

And if any of you notice any signs of ‘borrowing to spend’ I’m missing please let me know- it’s lonely (and depressing!) being the only one to see the kind of downside risk to GDP growth I’m seeing…

Posted in Fed, GDP, Housing, Interest Rates | No Comments »

Fed minutes, comments on full text

Posted by WARREN MOSLER on 21st August 2013

Comments in below and highlights mine:

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account reported on developments in domestic and foreign financial markets as well as the System open market operations during the period since the Federal Open Market Committee (FOMC) met on June 18-19, 2013. By unanimous vote, the Committee ratified the Open Market Desk’s domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System’s account over the intermeeting period.

In support of the Committee’s longer-run planning for improvements in the implementation of monetary policy, the Desk report also included a briefing on the potential for establishing a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates. The presentation suggested that such a facility would allow the Committee to offer an overnight, risk-free instrument directly to a relatively wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks and thereby improving the Committee’s ability to keep short-term market rates at levels that it deems appropriate to achieve its macroeconomic objectives. The staff also identified several key issues that would require consideration in the design of such a facility, including the choice of the appropriate facility interest rate and possible additions to the range of eligible counterparties. In general, meeting participants indicated that they thought such a facility could prove helpful; they asked the staff to undertake further work to examine how it might operate and how it might affect short-term funding markets. A number of them emphasized that their interest in having the staff conduct additional research reflected an ongoing effort to improve the technical execution of policy and did not signal any change in the Committee’s views about policy going forward.

This would tend to work against the larger banks to the extent larger depositors could access the Fed directly.

Staff Review of the Economic Situation
The information reviewed for the July 30-31 meeting indicated that economic activity expanded at a modest pace in the first half of the year. Private-sector employment increased further in June, but the unemployment rate was still elevated. Consumer price inflation slowed markedly in the second quarter, likely restrained in part by some transitory factors, but measures of longer-term inflation expectations remained stable. The Bureau of Economic Analysis (BEA) released its advance estimate for second-quarter real gross domestic product (GDP), along with revised data for earlier periods, during the second day of the FOMC meeting. The staff’s assessment of economic activity and inflation in the first half of 2013, based on information available before the meeting began, was broadly consistent with the new information from the BEA.

Modest growth and inflation low and stable.

Private nonfarm employment rose at a solid pace in June, as in recent months, while total government employment decreased further. The unemployment rate was 7.6 percent in June, little changed from its level in the prior few months. The labor force participation rate rose slightly, as did the employment-to-population ratio. The rate of long-duration unemployment decreased somewhat, but the share of workers employed part time for economic reasons moved up; both of these measures remained relatively high. Forward-looking indicators of labor market activity in the near term were mixed: Although household expectations for the labor market situation generally improved and firms’ hiring plans moved up, initial claims for unemployment insurance were essentially flat over the intermeeting period, and measures of job openings and the rate of gross private-sector hiring were little changed.

Manufacturing production expanded in June, and the rate of manufacturing capacity utilization edged up. Auto production and sales were near pre-recession levels, and automakers’ schedules indicated that the rate of motor vehicle assemblies would continue at a similar pace in the coming months. Broader indicators of manufacturing production, such as the readings on new orders from the national and regional manufacturing surveys, were generally consistent with further modest gains in factory output in the near term.

Real personal consumption expenditures (PCE) increased more slowly in the second quarter than in the first. However, some key factors that tend to support household spending were more positive in recent months; in particular, gains in equity values and home prices boosted household net worth, and consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers rose in July to its highest level since the onset of the recession.

Slower PCE increase and stocks and the Michigan survey mentioned subsequently reversed some.

Conditions in the housing sector generally improved further, as real expenditures for residential investment continued to expand briskly in the second quarter. However, construction activity was still at a low level, with demand restrained in part by tight credit standards for mortgage loans. Starts of new single-family homes were essentially flat in June, but the level of permit issuance was consistent with gains in construction in subsequent months. In the multifamily sector, where activity is more variable, starts and permits both decreased. Home prices continued to rise strongly through May, and sales of both new and existing homes increased, on balance, in May and June. The recent rise in mortgage rates did not yet appear to have had an adverse effect on housing activity.

Subsequently mortgage apps continued to fall as rates rose.

Growth in real private investment in equipment and intellectual property products was greater in the second quarter than in the first quarter.2 Nominal new orders for nondefense capital goods excluding aircraft continued to trend up in May and June and were running above the level of shipments. Other recent forward-looking indicators, such as surveys of business conditions and capital spending plans, were mixed and pointed to modest gains in business equipment spending in the near term. Real business expenditures for nonresidential construction increased in the second quarter after falling in the first quarter. Business inventories in most industries appeared to be broadly aligned with sales in recent months.

Real federal government purchases contracted less in the second quarter than in the first quarter as reductions in defense spending slowed. Real state and local government purchases were little changed in the second quarter; the payrolls of these governments expanded somewhat, but state and local construction expenditures continued to decrease.

Didn’t mention tax collections were up.

The U.S. international trade deficit widened in May as exports fell slightly and imports rose. The decline in exports was led by a sizable drop in consumer goods, while most other categories of exports showed modest gains. Imports increased in a wide range of categories, with particular strength in oil, consumer goods, and automotive products.

Exports subsequently firmed some.

Overall U.S. consumer prices, as measured by the PCE price index, were unchanged from the first quarter to the second and were about 1 percent higher than a year earlier. Consumer energy prices declined significantly in the second quarter, although retail gasoline prices, measured on a seasonally adjusted basis, moved up in June and July. The PCE price index for items excluding food and energy rose at a subdued rate in the second quarter and was around 1-1/4 percent higher than a year earlier. Near-term inflation expectations from the Michigan survey were little changed in June and July, as were longer-term inflation expectations, which remained within the narrow range seen in recent years. Measures of labor compensation indicated that gains in nominal wages and employee benefits remained modest.

Inflation remained low.

Foreign economic growth appeared to remain subdued in comparison with longer-run trends. Nonetheless, there were some signs of improvement in the advanced foreign economies. Production and business confidence turned up in Japan, real GDP growth picked up to a moderate pace in the second quarter in the United Kingdom, and recent indicators suggested that the euro-area recession might be nearing an end. In contrast, Chinese real GDP growth moderated in the first half of this year compared with 2012, and indicators for other emerging market economies (EMEs) also pointed to less-robust growth. Foreign inflation generally remained well contained. Monetary policy stayed highly accommodative in the advanced foreign economies, but some EME central banks tightened policy in reaction to capital outflows and to concerns about inflationary pressures from currency depreciation.

Not much prospect for meaningful export growth.

Staff Review of the Financial Situation
Financial markets were volatile at times during the intermeeting period as investors reacted to Federal Reserve communications and to incoming economic data and as market dynamics appeared to amplify some asset price moves. Broad equity price indexes ended the period higher, and longer-term interest rates rose significantly. Sizable increases in rates occurred following the June FOMC meeting, as investors reportedly saw Committee communications as suggesting a less accommodative stance of monetary policy than had been expected going forward; however, a portion of the increases was reversed as subsequent policy communications lowered these concerns. U.S. economic data, particularly the June employment report, also contributed to the rise in yields over the period.

Stocks down, term interest rates higher, job growth a bit lower subsequently.

On balance, yields on intermediate- and longer-term Treasury securities rose about 30 to 45 basis points since the June FOMC meeting, with staff models attributing most of the increase to a rise in term premiums and the remainder to an upward revision in the expected path of short-term rates. The federal funds rate path implied by financial market quotes steepened slightly, on net, but the results from the Desk’s July survey of primary dealers showed little change in dealers’ views of the most likely timing of the first increase in the federal funds rate target. Market-based measures of inflation compensation were about unchanged.

Over the period, rates on primary mortgages and yields on agency mortgage-backed securities (MBS) rose about in line with the 10-year Treasury yield. The option-adjusted spread for production-coupon MBS widened somewhat, possibly reflecting a downward revision in investors’ expectations for Federal Reserve MBS purchases, an increase in uncertainty about longer-term interest rates, and convexity-related MBS selling.

Spreads between yields on 10-year nonfinancial corporate bonds and yields on Treasury securities narrowed somewhat on net. Early in the period, yields on corporate bonds increased, and bond mutual funds and bond exchange-traded funds experienced large net redemptions in June; the rate of redemptions then slowed in July.

Market sentiment toward large domestic banking organizations appeared to improve somewhat over the intermeeting period, as the largest banks reported second-quarter earnings that were above analysts’ expectations. Stock prices of large domestic banks outperformed broader equity indexes, and credit default swap spreads for the largest bank holding companies moved about in line with trends in broad credit indexes.

Municipal bond yields rose sharply over the intermeeting period, increasing somewhat more than yields on Treasury securities. In June, gross issuance of long-term municipal bonds remained solid and was split roughly evenly between refunding and new-capital issuance. The City of Detroit’s bankruptcy filing reportedly had only a limited effect on the market for municipal securities as it had been widely anticipated by market participants.

Credit flows to nonfinancial businesses showed mixed changes. Reflecting the reduced incentive to refinance as longer-term interest rates rose, the pace of gross issuance of investment- and speculative-grade corporate bonds dropped in June and July, compared with the elevated pace earlier this year. In contrast, gross issuance of equity by nonfinancial firms maintained its recent strength in June. Leveraged loan issuance also continued to be strong amid demand for floating-rate instruments by investors. Financing conditions for commercial real estate continued to recover slowly. In response to the July Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), banks generally indicated that they had eased standards on both commercial and industrial (C&I) and commercial real estate loans over the past three months. For C&I loans, standards were currently reported to be somewhat easy compared with longer-term norms, while for commercial real estate loans, standards remained somewhat tighter than longer-term norms. Banks reported somewhat stronger demand for most types of loans.

Financing conditions in the household sector improved further in recent months. Mortgage purchase applications declined modestly through July even as refinancing applications fell off sharply with the rise in mortgage rates. The outstanding amounts of student and auto loans continued to expand at a robust pace in May. Credit card debt remained about flat on a year-over-year basis. In the July SLOOS, banks reported that they had eased standards on most categories of loans to households in the second quarter, but that standards on all types of mortgages, and especially on subprime mortgage loans and home equity lines of credit, remained tight when judged against longer-run norms.

Mortgage purchase applications subsequently continued to fall as rates rose.

Increases in total bank credit slowed in the second quarter, as the book value of securities holdings fell slightly and C&I loan balances at large banks increased only modestly in April and May. M2 grew at an annual rate of about 7 percent in June and July, supported by flows into liquid deposits and retail money market funds. Both of these components of M2 may have been boosted recently by the sizable redemptions from bond mutual funds. The monetary base continued to expand rapidly in June and July, driven mainly by the increase in reserve balances resulting from the Federal Reserve’s asset purchases.

Ten-year sovereign yields in the United Kingdom and Germany rose with U.S. yields early in the intermeeting period but fell back somewhat after statements by the European Central Bank and the Bank of England were both interpreted by market participants as signaling that their policy rates would be kept low for a considerable time. On net, the U.K. 10-year sovereign yield increased, though by less than the comparable yield in the United States, while the yield on German bunds was little changed. Peripheral euro-area sovereign spreads over German bunds were also little changed on net. Japanese government bond yields were relatively stable over the period, after experiencing substantial volatility in May. The staff’s broad nominal dollar index moved up as the dollar appreciated against the currencies of the advanced foreign economies, consistent with the larger increase in U.S. interest rates. The dollar was mixed against the EME currencies. Foreign equity prices generally increased, although equity prices in China declined amid investor concerns regarding further signs that the economy was slowing and over volatility in Chinese interbank funding markets. Outflows from EME equity and bond funds, which had been particularly rapid in June, moderated in July.

Staff Economic Outlook
The data received since the forecast was prepared for the previous FOMC meeting suggested that real GDP growth was weaker, on net, in the first half of the year than had been anticipated. Nevertheless, the staff still expected that real GDP would accelerate in the second half of the year. Part of this projected increase in the rate of real GDP growth reflected the staff’s expectation that the drag on economic growth from fiscal policy would be smaller in the second half as the pace of reductions in federal government purchases slowed and as the restraint on growth in consumer spending stemming from the higher taxes put in place at the beginning of the year diminished. For the year as a whole, the staff anticipated that the rate of growth of real GDP would only slightly exceed that of potential output. The staff’s projection for real GDP growth over the medium term was essentially unrevised, as higher equity prices were seen as offsetting the restrictive effects of the increase in longer-term interest rates. The staff continued to forecast that the rate of real GDP growth would strengthen in 2014 and 2015, supported by a further easing in the effects of fiscal policy restraint on economic growth, increases in consumer and business confidence, additional improvements in credit availability, and accommodative monetary policy. The expansion in economic activity was anticipated to lead to a slow reduction in the slack in labor and product markets over the projection period, and the unemployment rate was expected to decline gradually.

The staff’s forecast for inflation was little changed from the projection prepared for the previous FOMC meeting. The staff continued to judge that much of the recent softness in consumer price inflation would be transitory and that inflation would pick up somewhat in the second half of this year. With longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be modest, and significant resource slack persisting over the forecast period, inflation was forecast to be subdued through 2015.

The staff continued to see numerous risks around the forecast. Among the downside risks for economic activity were the uncertain effects and future course of fiscal policy, the possibility of adverse developments in foreign economies, and concerns about the ability of the U.S. economy to weather potential future adverse shocks. The most salient risk for the inflation outlook was that the recent softness in inflation would not abate as anticipated.

Participants’ Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation, meeting participants noted that incoming information on economic activity was mixed. Household spending and business fixed investment continued to advance, and the housing sector was strengthening. Private domestic final demand continued to increase in the face of tighter federal fiscal policy this year, but several participants pointed to evidence suggesting that fiscal policy had restrained spending in the first half of the year more than they previously thought. Perhaps partly for that reason, a number of participants indicated that growth in economic activity during the first half of this year was somewhat below their earlier expectations. In addition, subpar economic activity abroad was a negative factor for export growth. Conditions in the labor market improved further as private payrolls rose at a solid pace in June, but the unemployment rate remained elevated. Inflation continued to run below the Committee’s longer-run objective.

Participants generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter. Factors cited as likely to support a pickup in economic activity included highly accommodative monetary policy, improving credit availability, receding effects of fiscal restraint, continued strength in housing and auto sales, and improvements in household and business balance sheets. A number of participants indicated, however, that they were somewhat less confident about a near-term pickup in economic growth than they had been in June; factors cited in this regard included recent increases in mortgage rates, higher oil prices, slow growth in key U.S. export markets, and the possibility that fiscal restraint might not lessen.

Consumer spending continued to advance, but spending on items other than motor vehicles was relatively soft. Recent high readings on consumer confidence and boosts to household wealth from increased equity and real estate prices suggested that consumer spending would gather momentum in the second half of the year. However, a few participants expressed concern that higher household wealth might not translate into greater consumer spending, cautioning that household income growth remained slow, that households might not treat the additions to wealth arising from recent equity price increases as lasting, or that households’ scope to extract housing equity for the purpose of increasing their expenditures was less than in the past.

The housing sector continued to pick up, as indicated by increases in house prices, low inventories of homes for sale, and strong demand for construction. While recent mortgage rate increases might serve to restrain housing activity, several participants expressed confidence that the housing recovery would be resilient in the face of the higher rates, variously citing pent-up housing demand, banks’ increasing willingness to make mortgage loans, strong consumer confidence, still-low real interest rates, and expectations of continuing rises in house prices. Nonetheless, refinancing activity was down sharply, and the incoming data would need to be watched carefully for signs of a greater-than-anticipated effect of higher mortgage rates on housing activity more broadly.

Subsequently mtg purchase apps fell further and there has been anecdotal evidence of mortgage originators cutting staff, while homebuilder confidence has continues to firm.

In the business sector, the outlook still appeared to be mixed. Manufacturing activity was reported to have picked up in a number of Districts, and activity in the energy sector remained at a high level. Although a step-up in business investment was likely to be a necessary element of the projected pickup in economic growth, reports from businesses ranged from those contacts who expressed heightened optimism to those who suggested that little acceleration was likely in the second half of the year.

Participants reported further signs that the tightening in federal fiscal policy restrained economic activity in the first half of the year: Cuts in government purchases and grants reportedly had been a factor contributing to slower growth in sales and equipment orders in some parts of the country, and consumer spending seemed to have been held back by tax increases. Moreover, uncertainty about the effects of the federal spending sequestration and related furloughs clouded the outlook. It was noted, however, that fiscal restriction by state and local governments seemed to be easing.

No mention of increased state and loval tax collection.

The June employment report showed continued solid gains in payrolls. Nonetheless, the unemployment rate remained elevated, and the continuing low readings on the participation rate and the employment-to-population ratio, together with a high incidence of workers being employed part time for economic reasons, were generally seen as indicating that overall labor market conditions remained weak. It was noted that employment growth had been stronger than would have been expected given the recent pace of output growth, reflecting weak gains in productivity. Some participants pointed out that once productivity growth picked up, faster economic growth would be required to support further increases in employment along the lines seen of late. However, one participant thought that sluggish productivity performance was likely to persist, implying that the recent pace of output growth would be sufficient to maintain employment gains near current rates.

Recent readings on inflation were below the Committee’s longer-run objective of 2 percent, in part reflecting transitory factors, and participants expressed a range of views about how soon inflation would return to 2 percent. A few participants, who felt that the recent low inflation rates were unlikely to persist or that the low PCE inflation readings might be marked up in future data revisions, suggested that, as transitory factors receded and the pace of recovery improved, inflation could be expected to return to 2 percent reasonably quickly. A number of others, however, viewed the low inflation readings as largely reflecting persistently deficient aggregate demand, implying that inflation could remain below 2 percent for a protracted period and further supporting the case for highly accommodative monetary policy.

Both domestic and foreign asset markets were volatile at times during the intermeeting period, reacting to policy communications and data releases. In discussing the increases in U.S. longer-term interest rates that occurred in the wake of the June FOMC meeting and the associated press conference, meeting participants pointed to heightened financial market uncertainty about the path of monetary policy and a shift of market expectations toward less policy accommodation. A few participants suggested that this shift occurred in part because Committee participants’ economic projections, released following the June meeting, generally showed a somewhat more favorable outlook than those of private forecasters, or because the June policy statement and press conference were seen as indicating relatively little concern about inflation readings, which had been low and declining. Moreover, investors may have perceived that Committee communications about the possibility of slowing the pace of asset purchases also implied a higher probability of an earlier firming of the federal funds rate. Subsequent Federal Reserve communications, which emphasized that decisions about the two policy tools were distinct and underscored that a highly accommodative stance of monetary policy would remain appropriate for a considerable period after purchases are completed, were seen as having helped clarify the Committee’s policy strategy. A number of participants mentioned that, by the end of the intermeeting period, market expectations of the future course of monetary policy, both with regard to asset purchases and with regard to the path of the federal funds rate, appeared well aligned with their own expectations. Nonetheless, some participants felt that, as a result of recent financial market developments, overall financial market conditions had tightened significantly, importantly reflecting larger term premiums, and they expressed concern that the higher level of longer-term interest rates could be a significant factor holding back spending and economic growth. Several others, however, judged that the rise in rates was likely to exert relatively little restraint, or that the increase in equity prices and easing in bank lending standards would largely offset the effects of the rise in longer-term interest rates. Some participants also stated that financial developments during the intermeeting period might have helped put the financial system on a more sustainable footing, insofar as those developments were associated with an unwinding of unsustainable speculative positions or an increase in term premiums from extraordinarily low levels.

Equities are subsequently down substantially.

In looking ahead, meeting participants commented on several considerations pertaining to the course of monetary policy. First, almost all participants confirmed that they were broadly comfortable with the characterization of the contingent outlook for asset purchases that was presented in the June post meeting press conference and in the July monetary policy testimony. Under that outlook, if economic conditions improved broadly as expected, the Committee would moderate the pace of its securities purchases later this year. And if economic conditions continued to develop broadly as anticipated, the Committee would reduce the pace of purchases in measured steps and conclude the purchase program around the middle of 2014. At that point, if the economy evolved along the lines anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward the Committee’s 2 percent objective. While participants viewed the future path of purchases as contingent on economic and financial developments, one participant indicated discomfort with the contingent plan on the grounds that the references to specific dates could be misinterpreted by the public as suggesting that the purchase program would be wound down on a more-or-less preset schedule rather than in a manner dependent on the state of the economy. Generally, however, participants were satisfied that investors had come to understand the data-dependent nature of the Committee’s thinking about asset purchases. A few participants, while comfortable with the plan, stressed the need to avoid putting too much emphasis on the 7 percent value for the unemployment rate, which they saw only as illustrative of conditions that could obtain at the time when the asset purchases are completed.

Second, participants considered whether it would be desirable to include in the Committee’s policy statement additional information regarding the Committee’s contingent outlook for asset purchases. Most participants saw the provision of such information, which would reaffirm the contingent outlook presented following the June meeting, as potentially useful; however, many also saw possible difficulties, such as the challenge of conveying the desired information succinctly and with adequate nuance, and the associated risk of again raising uncertainty about the Committee’s policy intentions. A few participants saw other forms of communication as better suited for this purpose. Several participants favored including such additional information in the policy statement to be released following the current meeting; several others indicated that providing such information would be most useful when the time came for the Committee to begin reducing the pace of its securities purchases, reasoning that earlier inclusion might trigger an unintended tightening of financial conditions.

Finally, the potential for clarifying or strengthening the Committee’s forward guidance for the federal funds rate was discussed. In general, there was support for maintaining the current numerical thresholds in the forward guidance. A few participants expressed concern that a decision to lower the unemployment threshold could potentially lead the public to view the unemployment threshold as a policy variable that could not only be moved down but also up, thereby calling into question the credibility of the thresholds and undermining their effectiveness. Nonetheless, several participants were willing to contemplate lowering the unemployment threshold if additional accommodation were to become necessary or if the Committee wanted to adjust the mix of policy tools used to provide the appropriate level of accommodation. A number of participants also remarked on the possible usefulness of providing additional information on the Committee’s intentions regarding adjustments to the federal funds rate after the 6-1/2 percent unemployment rate threshold was reached, in order to strengthen or clarify the Committee’s forward guidance. One participant suggested that the Committee could announce an additional, lower set of thresholds for inflation and unemployment; another indicated that the Committee could provide guidance stating that it would not raise its target for the federal funds rate if the inflation rate was expected to run below a given level at a specific horizon. The latter enhancement to the forward guidance might be seen as reinforcing the message that the Committee was willing to defend its longer-term inflation goal from below as well as from above.

Committee Policy Action
Committee members viewed the information received over the intermeeting period as suggesting that economic activity expanded at a modest pace during the first half of the year. Labor market conditions showed further improvement in recent months, on balance, but the unemployment rate remained elevated. Household spending and business fixed investment advanced, and the housing sector was strengthening, but mortgage rates had risen somewhat and fiscal policy was restraining economic growth. The Committee expected that, with appropriate policy accommodation, economic growth would pick up from its recent pace, resulting in a gradual decline in the unemployment rate toward levels consistent with the Committee’s dual mandate. With economic activity and employment continuing to grow despite tighter fiscal policy, and with global financial conditions less strained overall, members generally continued to see the downside risks to the outlook for the economy and the labor market as having diminished since last fall. Inflation was running below the Committee’s longer-run objective, partly reflecting transitory influences, but longer-run inflation expectations were stable, and the Committee anticipated that inflation would move back toward its 2 percent objective over the medium term. Members recognized, however, that inflation persistently below the Committee’s 2 percent objective could pose risks to economic performance.

In their discussion of monetary policy for the period ahead, members judged that a highly accommodative stance of monetary policy was warranted in order to foster a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability. In considering the likely path for the Committee’s asset purchases, members discussed the degree of improvement in the labor market outlook since the purchase program began last fall. The unemployment rate had declined considerably since then, and recent gains in payroll employment had been solid. However, other measures of labor utilization–including the labor force participation rate and the numbers of discouraged workers and those working part time for economic reasons–suggested more modest improvement, and other indicators of labor demand, such as rates of hiring and quits, remained low. While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all Committee members agreed that a change in the purchase program was not yet appropriate. However, in the view of the one member who dissented from the policy statement, the improvement in the labor market was an important reason for calling for a more explicit statement from the Committee that asset purchases would be reduced in the near future. A few members emphasized the importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases. At the same time, a few others pointed to the contingent plan that had been articulated on behalf of the Committee the previous month, and suggested that it might soon be time to slow somewhat the pace of purchases as outlined in that plan. At the conclusion of its discussion, the Committee decided to continue adding policy accommodation by purchasing additional MBS at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month and to maintain its existing reinvestment policies. In addition, the Committee reaffirmed its intention to keep the target federal funds rate at 0 to 1/4 percent and retained its forward guidance that it anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Members also discussed the wording of the policy statement to be issued following the meeting. In addition to updating its description of the state of the economy, the Committee decided to underline its concern about recent shortfalls of inflation from its longer-run goal by including in the statement an indication that it recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, while also noting that it continues to anticipate that inflation will move back toward its objective over the medium term. The Committee also considered whether to add more information concerning the contingent outlook for asset purchases to the policy statement, but judged that doing so might prompt an unwarranted shift in market expectations regarding asset purchases. The Committee decided to indicate in the statement that it “reaffirmed its view”–rather than simply “expects”–that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.

At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

“Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to 1/4 percent. The Committee directs the Desk to undertake open market operations as necessary to maintain such conditions. The Desk is directed to continue purchasing longer-term Treasury securities at a pace of about $45 billion per month and to continue purchasing agency mortgage-backed securities at a pace of about $40 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability.”

The vote encompassed approval of the statement below to be released at 2:00 p.m.:

“Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”

Voting for this action: Ben Bernanke, William C. Dudley, James Bullard, Elizabeth Duke, Charles L. Evans, Jerome H. Powell, Sarah Bloom Raskin, Eric Rosengren, Jeremy C. Stein, Daniel K. Tarullo, and Janet L. Yellen.

Voting against this action: Esther L. George.

Ms. George dissented because she favored including in the policy statement a more explicit signal that the pace of the Committee’s asset purchases would be reduced in the near term. She expressed concerns about the open-ended approach to asset purchases and viewed providing such a signal as important at this time, in light of the ongoing improvement in labor market conditions as well as the potential costs and uncertain benefits of large-scale asset purchases.

It was agreed that the next meeting of the Committee would be held on Tuesday-Wednesday, September 17-18, 2013. The meeting adjourned at 12:30 p.m. on July 31, 2013.

Notation Vote
By notation vote completed on July 9, 2013, the Committee unanimously approved the minutes of the FOMC meeting held on June 18-19, 2013

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Michigan survey and a small rant

Posted by WARREN MOSLER on 16th August 2013

Funny how sentiment follows stocks…

And how housing has gone flat all year is dismissed.

Not to forget jobless claims are about people losing their jobs and not about anyone getting a job. Yes, claims have correlated to new jobs, but that’s a different matter. For example, ‘at the limit’, you could have 0 claims as no one loses their job, but also no new jobs.

And how about the Fed not pushing back on the higher rates that have slowed mortgage purchase applications? No more ‘doing what it takes’ to error on the side of ‘ease’, because new jobs have been holding at close to a measly 200,000, just enough to keep the participation rate at 30+ year lows? Feels a lot to me like ‘outside pressure’ as discussed? Hard to believe the chairman wants his legacy to be ‘just when things finally looked to be turning he allowed rates to spike and quash it all’???

All in the context of ‘austerity didn’t work in the euro zone or the UK, and now the US is ‘proving’ the same, as private sector credit expansion fails to step up to plate as the public sector deficit is proactively cut and auto stabilizers and demand leakages continue aggressively.

US consumer sentiment much lighter than expected in August

August 15 (CNBC) — U.S. consumers, bracing for higher interest rates and slightly slower economic growth, were a bit less optimistic in August as sentiment retreated from last month’s six-year high, a survey released on Friday showed.

The Thomson Reuters/University of Michigan’s preliminary reading on the overall index on consumer sentiment slipped to 80.0 from 85.1 in July, the highest since July 2007.

August’s result was well below the 85.5 reading expected by economists.

Consumers’ view of current economic conditions showed the biggest decline, and most expected the pace of growth to ease slightly. However, these changes were not large enough to upend “the prevailing view that the economic expansion will continue,” survey director Richard Curtin said in a statement.

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Bernanke

Posted by WARREN MOSLER on 17th July 2013


Karim writes:

Something for everyone (even uses on the other hand in his remarks); base case remains in place for tapering in September. First mention Ive seen on nature of rate hike cycle: will be gradual. Seems to be looking past the first hike!

Sequencing in these paragraphs is telling. Base case first; risks second(bold). Same pattern appeared in the Minutes. Effective way to stick to your forecast but to try and keep rates in check.

  • substantial increases in home prices are bolstering household finances and consumer spending while reducing the number of homeowners with underwater mortgages. Housing activity and prices seem likely to continue to recover, notwithstanding the recent increases in mortgage rates, but it will be important to monitor developments in this sector carefully.
  • The price index for personal consumption expenditures rose only 1 percent over the year ending in May. This softness reflects in part some factors that are likely to be transitory. Moreover, measures of longer-term inflation expectations have generally remained stable, which should help move inflation back up toward 2 percent. However, the Committee is certainly aware that very low inflation poses risks to economic performance–for example, by raising the real cost of capital investment–and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time.
  • The pickup in economic growth projected by most Committee participants partly reflects their view that federal fiscal policy will exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish. The Committee also believes that risks to the economy have diminished since the fall, reflecting some easing of financial stresses in Europe, the gains in housing and labor markets that I mentioned earlier, the better budgetary positions of state and local governments, and stronger household and business balance sheets. That said, the risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery. More generally, with the recovery still proceeding at only a moderate pace, the economy remains vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated.

Same for Tapering:

  • If the incoming data were to be broadly consistent with these projections, we anticipated that it would be appropriate to begin to moderate the monthly pace of purchases later this year. And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective. Such outcomes would be fully consistent with the goals of the asset purchase program that we established in September.
  • I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions–which have tightened recently–were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer. Indeed, if needed, the Committee would be prepared to employ all of its tools, including an increase the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.
  • 6.5% threshold and first mention (that Ive seen) on the pace of rate hikes

  • if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 6-1/2 percent as a sufficient reason to raise its target for the federal funds rate. Likewise, the Committee would be unlikely to raise the funds rate if inflation remained persistently below our longer-run objective. Moreover, so long as the economy remains short of maximum employment, inflation remains near our longer-run objective, and inflation expectations remain well anchored, increases in the target for the federal funds rate, once they begin, are likely to be gradual.

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