Category Archives: Interest Rates

Plosser on ‘removing accomodation’

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Plosser Speach

Some comments below:

Let me begin by noting that the economy has gained significant strength and momentum since late last summer and seems to be on a much firmer foundation going forward. Consumer spending continues to expand at a reasonably robust pace, and business investment, particularly on equipment and software, continues to support overall growth. Labor market conditions are improving. Firms are adding to their payrolls, which will result in continued modest declines in the unemployment rate. The residential and commercial real estate sectors remain weak but appear to have stabilized. Nevertheless, I do not believe that weakness in these sectors will prevent a broader economic recovery. Indeed, the nonresidential real estate sector is likely to improve as the overall economy gains ground.

If this forecast is broadly accurate, then monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation it has supplied to the economy.

No it won’t. As the Fed’s own Kohn and Carpenter have stated, there is no ‘monetary channel’ from reserves to anything else.

Failure to do so in a timely manner could have serious consequences for inflation and economic stability in the future.

Not true.

But what matters is that pretty much the entire FOMC believes it to be true and will act accordingly.
Market participants also believe it to be true and shift portfolios accordingly.

To avoid this outcome, the Fed must confront at least two challenges. The first is selecting the appropriate time to begin unwinding the accommodation. The second is how to use the available tools to move monetary policy toward a more neutral stance over time.

Looks to me like the current situation- 2 years of very modest gdp growth, high unemployment that is forecast to fall only slowly, and very little signs of private credit expanding- is telling us policy is already relatively neutral, given the circumstances.

First, monetary policy should operate using the federal funds rate as its policy instrument. Because the Fed can now pay interest on reserves, monetary policy could use the interest rate on reserves (IOR) as its instrument, establishing a floor for rates and allow reserves to be supplied in an elastic manner.3 However, targeting the federal funds rate is more familiar to both the markets and policymakers than is an administered rate paid on reserves. To make the funds rate the primary policy instrument, the target federal funds rate would be set above the rate paid on reserves and below the discount or primary credit rate that banks pay when they borrow from the Fed.

This means the that at the margin the NY Fed has to keep the banks net borrowed to keep the fed funds rate above the floor, and net long to keep it below the ceiling.

Good luck and who cares if the rate paid on reserves equals the fund funds rate?

This operating framework is sometimes referred to as a corridor or channel system and is used by a number of other central banks around the world.4 I have argued elsewhere that our goal should be to operate with a corridor system instead of a floor system,

Yes, this greatly simplifies life for the NY Fed trading desk, especially if you allow fed funds to trade at the floor rate. The should have done it a long time ago, like most other CB’s in the world. And while they are at it, they should also drop reserve requirements, like Canada did a while back, and get rid of that anachronism. (I recall being at a monetary conference in Canada, where a senior monetary crank- sorry, I mean senior mainstream economist- was on a rant about how dropping reserve requirements to 0 was going to be hyper inflationary.)

in part because it constrains the size of the balance sheet while the floor system does not.

Like the salesman who went on after he made the sale and discredited himself. This last part again reveals is anachronistic, gold standard understanding of monetary operations.

The second element of the environment follows from the first. To ensure that the funds rate constitutes a viable policy instrument and thus is above the interest rate on reserves, the volume of reserves in the banking system must shrink to the point where the demand for reserves is consistent with the targeted funds rate. This will require a significant reduction in the size of the Fed’s balance sheet, with reserve balances falling by $1.4 trillion to $1.5 trillion to about $50 billion.

Yes, pretty much the problem I described above.
So why would the fed funds rate not be ‘a viable policy instrument’ if it equaled the rate of interest the Fed payed on reserves?

My proposed strategy involves raising rates and shrinking the balance sheet concurrently and tying the pace of asset sales to the pace and size of interest rate increases.8

The important thing here is not the wisdom of the policy, but that these statements are in fact what the FOMC is likely to be doing.

The first element of the plan to exit and normalize policy would be to move away from the zero bound and stop the reinvesting program and allow securities to run off as they mature. Thus, we would raise the interest paid on reserves from 25 basis points to 50 basis points and seek to achieve a funds rate of 50 basis points rather than the current range of 0 to 25 basis points.

This indicates the fed funds rate and the interest paid on reserves would be roughly equal, which makes sense operationally.

We would also announce that between each FOMC meeting, in addition to allowing assets to run off as they mature or are prepaid, we would sell an additional specified amount of assets. These “continuous sales,” plus the natural run-off, imply that the balance sheet, and thus reserves, would gradually shrink between each FOMC meeting on an ongoing basis.

Again, good to know what they plan on doing. And it seems this time around the all seem pretty much to be on the same page. At least so far.

Now the remaining question is whether the employment outlook will improve sufficiently and core inflation measures stabilize sufficiently in the FOMC’s comfort zone for them to begin ‘removing accommodation’ as they call it.

I’d suggest that could be by Q4 if not for the global bias towards ‘fiscal responsibility’ along with the inflation fighting going on in China which threatens to keep output gaps wide and employment low.

And at least so far price pressures are mainly from crude oil, which the Fed (rightly) considers a ‘relative value story’ and from food prices, which are closely related to fuel prices through various bio fuels and fertilizer inputs. Wages and unit labor costs remain subdued and with productivity relatively high there are, so far, no signs of ‘pass through’ from food and fuel prices to core measures.

The second element of the plan would be to announce that at each subsequent meeting the FOMC will, as usual, evaluate incoming data to determine if the interest rate on reserves and the funds rate should rise or not. Monetary policy should be conditional on the state of the economy and the outlook. If the funds rate and interest on excess reserves do not change, the balance sheet would continue to shrink slowly due to run-off and the continuous sales. On the other hand, if the FOMC decides to raise rates by 25 basis points, it would automatically trigger additional asset sales of a specified amount during the intermeeting period. This approach makes the pace of asset sales conditional on the state of the economy, just as the Fed’s interest rate decisions are. If it were necessary to raise the interest rate target more, say, by 50 basis points, because the economy was improving faster and inflation expectations were rising, then the pace of conditional sales would also be doubled during the intermeeting period.10

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EU Daily | Europe’s Bank Signals It May Raise Interest Rates to Tamp Down Inflation

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So the ECB,
which is funding the entire euro zone banking system,
and for all practical purposes backstopping the funding of the national govts as well
to keep their funding costs manageable as they struggle with the terms and conditions of the austerity mandates,

That same ECB is now looking to raise rates, a proposal which is already working to increase the funding costs of those national govts.

They must think hiking rates is the tool to use to control the ‘inflation’ they are concerned about?

‘Inflation’ that’s come from tax hikes and relative value shifts in food and energy, as a foreign monopolist hikes crude prices and the burning up of our food supply for fuel hikes food prices?

Rate hikes that shift funds from borrowers, like the national govts they are supporting, to rentiers who will be getting the pay increase from higher rates?

And rising interest rates will require more austerity measures to offset the increased interest expense?

Yes, they also believe ‘inflation’ comes from elevated ‘inflation expectations’ but even that channel of causation, as far fetched as it is, has to be confused by the large output gap and general weakness of aggregate demand? Higher interest rates will somehow cause trade unions to soften demand for pay increases so their members can afford to eat?

Seems it goes back to the old Bundesbank dynamic, where the CB would threaten politically distasteful rate hikes if the govt didn’t tighten fiscal?

Well, today the ECB is already controlling fiscal, so it’s all moot.

But the old reflexes are still there.

Somewhat the like the old reflex with regard to export driven growth, but without the ideological option of buying dollars previously discussed.

So putting it all together, they have the export driven policy reflex without the dollar buying that’s undermining itself by driving the euro higher, working to limit demand from exports,
as the ECB both funds the financial structure and imposes austerity which is working against domestic demand.

And the rate hike reflex which won’t alter the price pressures from food, energy, and taxes.

And no telling what they may do next.
With their levels of unemployment, food price increases, and a general feeling that there are no ideas from on high to get them out of this mess, and large pools of newly arrived immigrants getting hurt them most, civil unrest is not impossible?

Maybe recognize that Europe is nothing more than a poorly managed theme park, and get a Disney exec to run it?

German Two-Year Yields Climb to Two-Year High on ECB Rate Bets

By Emma Charlton and Keith Jenkins

March 4 (Bloomberg) — German two-year government notes rose while their Greek equivalents fell, on concern higher borrowing costs may hamper the region’s most indebted countries, spurring demand for the euro zone’s safer assets.

Greece’s two-year yields reached the highest since May 10, the first trading day after the European Union and the international Monetary Fund announced the creation of a bailout fund to backstop the euro. European Central Bank President Jean- Claude Trichet said yesterday it’s “possible” that rates will rise at the central bank’s April meeting. His comments drove the German two-year yield up 23 basis points yesterday, the biggest increase since January 2009.

“There are some questions being asked about what tighter policy does for wider Europe, so that’s helping the bid toward core product,” said Eric Wand, a rates strategist at Lloyds Bank Corporate Markets in London. “Trichet was pretty clear that there would be a hike come April, so that’s going to underpin the German front-end going forward.”

The two-year note yield was two basis points lower at 1.76 percent as of 10:56 a.m. in London after reaching 1.84 percent, the highest since December 2008, according to data compiled by Bloomberg. The 1.5 percent security due March 2013 rose 0.035, or 35 euro cents per 1,000-euro ($1,387) face amount, to 99.49. The yield on German 10-year bunds, Europe’s benchmark government debt securities, was one basis point lower at 3.32 percent.

March 25 Deadline

Trichet will speak alongside governing council members including Mario Draghi and Christian Noyer at a Banque de France conference in Paris today. The ECB’s anti-inflation stance comes as European Union leaders approach a March 25 deadline for a reinforced plan to aid debt-strapped countries.

Greece’s two-year yields surged 24 basis points to 15.16 percent. The yield difference between German 2-year notes and Greek securities of a similar maturity was 13.41 percentage points, the widest since May 7, according to data compiled by Bloomberg.

Ten-year bunds were higher before a U.S. labor market report that is forecast to show employers added 196,000 workers last month, after a 36,000 gain in January, according to the median forecast of 84 economists surveyed by Bloomberg News. The report may also show the jobless rate increased to 9.1 percent from 9 percent.

“Right in front of payrolls data, people aren’t going to want to set too much risk on their books,” Wand said.

German-U.S. Spread

The yield difference, or spread, between German two-year notes and U.S. securities of the same maturity, narrowed four basis points to 98 basis points. It reached 103 basis points yesterday, the highest since Dec. 30, 2008, as traders added to bets that the European Central Bank will raise borrowing costs before the Federal Reserve.

The Frankfurt-based central bank, which left its key rate at a record low of 1 percent yesterday, is concerned about so- called second-round inflation effects, when companies raise prices and workers demand more pay to compensate for soaring energy and food costs, Trichet said. Euro-area inflation accelerated to 2.4 percent last month.

Euribor futures fell, pushing the implied yield on the contract expiring in December 2011 up two basis points to 2.18 percent. Earlier it rose to 2.215 percent, matching the highest since Feb. 22, 2010, as investors added to bets that the ECB will increase borrowing costs.

Forward contracts on the euro overnight index average, or Eonia, signal investors think the ECB will increase the key rate 25 basis points by its July meeting, Deutsche Bank AG data shows.

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Gross misrepresentations

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My comments following Bill Gross’s comments:

I don’t know if the U.S. has reached a desperate point, but it is employing instruments and vehicles and policies that smack of desperation.

He fails to see the function of federal taxes is to regulate aggregate demand, and not to raise revenue per se.

We are not looking at a default here, but at years of accelerating inflation, which basically robs investors and labor of their real wages and earnings.

Apart from the possibility that he’s wrong, and that there will be no accelerating deflation, inflation per se does not make a nation poorer, and does not necessarily reduce real wages and earnings. In fact, real wages could very well be made to increase during an inflationary period. It’s all about policy responses and institutional structure. And as for investors, some will do well and some will do poorly, which most don’t consider an injustice.

We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential.

Maybe and maybe not on both scores.

The dollar may not depreciate.

And lower levels of public debt and higher growth potential do not necessarily mean a currency will appreciate.

For example, Japan has had perhaps the least growth potential and one of the strongest currencies for quite a while, and China has had a policy of keeping its currency weak which has been credited with fostering high growth, etc.

And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default.

No, it’s a policy option.

A default is a promise broken.

And there is no national promise by any nation to provide a real return to savers at the short end of the curve.

Ultimately creditors and investors are at the behest of a central bank and policymakers that will rob them of their money.

That’s a serious and groundless accusation of motivation of the Fed.
Robbing implies dishonesty and involuntary confiscation.

However no one is forced by the Fed or anyone else to hold dollars in money market accounts, investors buy securities with known nominal interest rates, and for all practical purposes investors know much the same information regarding inflation as the Fed does.

So when William Gross uses the word ‘rob’ he’s implying the Fed is deliberately publishing false inflation forecasts to trick investors into buying US govt securities at rates lower than if they knew the Fed’s actual inflation forecasts.

I suggest an immediate apology is in order for this groundless, inappropriate, and insulting remark.

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post boat ride recap and a reader’s questions answered

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After my brief recap is my response to a very good and typical inquiry I thought I’d pass along.

Meanwhile, the tax cuts were extended, and perhaps a bit of restriction removed, eliminating that source of risk of a sharp contraction that could have happened otherwise.

With the 2%, 1 year reduction in FICA taxes for individuals, arguably traceable to my efforts, there was some consideration of declaring victory and moving on, but I’m feeling more the opposite.

First, it’s tiny and at the macro level the propensity to spend of the recipients is trivial.

And it probably doesn’t even offset the drag from prices for imported crude and products.

And it may just be an interim step in letting the next Congress ‘pay for it’ with Social Security cuts.

The large increase in ‘spending cutters’ are about to take their seats in Washington, with many pledged to kick things off with a $250 billion spending cut, and then balance the Federal budget, along with what could be a majority ready to pass the doomsday bill for a balanced budget amendment to the US constitution.

And a President who seems to think that’s all a good idea as well.

And my nagging feeling that a 0 interest rate policy is highly deflationary, meaning that for a given size govt we need even lower taxes than otherwise, remains.

Lastly, for this post, China has been a first half/second half story, with much of their economic year front loaded into the first half, and they have apparently capped state sponsored lending, which could mean a relatively weak first half, or worse.

The euro zone is forecasting lower growth for next year as austerity bites and the ECB’s job becomes more problematic, as slower growth will slow the ‘fiscal improvement.’

And the recent extreme absurdity of the ECB raising more capital serves to highlight the risk of having incompetents in control.

Reader’s Questions:

I continue to review your book. A question or thought I come back to a lot lately is what is the long term implication of national debt.


– Should the federal deficit and associated payments be taken completely out of the budget discussion?

Yes, especially in conjunction with a permanent 0 interest rate policy and the tsy selling nothing longer than 3 mo bills.

That seems to be what is implied on page 32, when you state that “Nor is the financing of deficit spending of any consequence”. I take that whole section to mean that in any year the ability to consume output is not impacted by prior consumption and spending rather it is impacted by the current economic environment and ability to pay, and that payment on the national debt is not an issue (just moving money from one account to another).

Right. And potential consumption is always what goods and services we are physically capable of producing.

I understand that, but does value (rather than money) get added to the economic system when the transfers are made?

Yes, what’s called ‘nominal value’ is added- net financial assets such as tsy bonds, reserves at the fed, and cash are equal to the deficit spending.

Does it have any impact on inflation or taxation?

Not the deficit per se. Govt spending can drive up/support prices if the spending is on a ‘quantity basis’ vs a price constrained basis.

For example, if the govt offers a job to anyone willing and able to work that pays $8/hour and leave the wage at that level it won’t drive up wages.

But if it decides to hire, say, 5 million people and pay what it takes to get them to work it can drive up wages.

The first example is spending on a ‘price rule’ that says $8 max

The second is spending on a quantity rule that says we pay what it takes to get 5 million workers.

I guess the simple question is if we ran deficits every year forever would pricing or wages be impacted and if so how?

The spending and taxing will have the impact. The deficit is the difference between the two and equal to new savings of financial assets added to the economy. If the deficit spending matches ‘savings desires’ that means the spending and taxing are ‘in balance’ with regards to over all pricing pressures.

Is there a national security concern by having foreign governments having huge deposits in our currency? What if China, or whoever, just started selling their positions in dollars purposely to drive down the dollar’s value, accepting the risk that it would have on its own economy?

There is the risk that China might do that.

But also note that we are currently trying to force China to adjust its currency upward, which is a downward adjustment of the dollar. So at the current time driving the dollar down is actually a national policy objective, albeit one I don’t agree with.

Also, the level of one’s currency doesn’t alter the real wealth of the nation. With imports always real benefits and exports always real costs, the challenge is to optimize ‘real terms of trade’ which means get the most imports for any given level of exports. Here, again, we are going the wrong way as a nation, attempting to increase exports to proactively get our trade gap lower.

I guess what I am trying to reconcile is that if everything has a consequence, I don’t understand what consequence deficit spending has on the long term.

It allows available savings to be added to the economy.

For a given size of govt, there is a level of taxes which keeps the real economy in balance.

Over taxing is evidenced by unemployment/excess capacity, and under taxing is evidenced by excess spending that’s causing inflation.

My assumption, based on history is that there is no consequence. My hunch is that the deficit spending is what pushes the economy along

Yes, though I like to say it’s about removing the restriction of over taxation that allows the economy to move on it’s ‘natural’ course of some sort, of course massively influenced by the rest of our institutional structure.

and supports increases in pricing, which translates into inflation. Even at 2% per year after 100 years prices would be whatever 2% compounded annually over 100 years amounts to. And, in essence that is of no consequence.

Right, while ‘a’ dollar buys less than it used, all ‘the’ dollars are buying a lot more that’s being consumed. That is, real GDP is far higher than 100 years ago.

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Financial Obligation Ratios

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The charts are Fed numbers that show how high debt is compared to incomes. What it shows is that as the govt. deficits increased they added income and savings to the economy which resulted in higher incomes and lower total private debt. In the past the next credit expansion began after the financial obligations ratios came down in this manner.

These are June numbers, and federal deficit spending is what brings them down, so they should be that much lower today.

So while it’s impossible to say exactly how far the ratio of debt to income needs to fall before the next credit expansion will begin, I expect modest growth to continue as it has with very modest job growth and unemployment remaining too high until consumer credit expansion does begin to kick in, which could be anytime now, that the debt ratios are no longer an obstacle.

The right move in August 2008 was a full payroll tax (FICA) holiday which would have sustained demand and prevented the recession and kept unemployment at desired levels.
It was nothing more than policy response that allowed a financial crisis to spill over to the real economy.

The interest rate cuts unfortunately (but predictably) served mainly to reduce spendable interest income as income was transfered from savers to bank net interest margins, and as govt. interest payments to the economy were reduced by the lower rates.

Lowering rates was not ‘wrong,’ as there are positive supply side and distributional effects from lower rates, but what was missed was that lower rates needed to be accompanied by even lower taxes to offset the induced drag of the lower rates.

To date we remain grossly over taxed for the size govt we have and for the current credit conditions, as evidenced by the too large output gap and far too high unemployment rate.

So with China not collapsing as many feared, and the euro zone muddling through with ECB support, my outlook remains positive for the US economy, though from unfortunately high levels of unemployment and true misery due solely to policy blunders.

The Republicans got us into this and the Democrats failed to get us out, and all for the same reason- non of them understand how their own monetary system works.

So thanks in advance for kindly directing everyone you know ‘The 7 Deadly Innocent Frauds of Economic Policy’ here.

Homeowners Financial Obligation Ratio

Financial Obligation Ratio with Rental Payments

Financial Obligation Ratio for Renters

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Fears Grow over the Fate of Irish Economy, Banks

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The two external shocks of the summer were China, which historically has had second half slowdowns due to State lending front loaded to the first half, and the euro zone which became a ward of the ECB. China’s growth has slowed some, but not collapsed, and the ECB has continued its support of euro member solvency and funding capability in the short term markets.

There was no credible deposit insurance for the euro zone banks until the ECB ‘wrote the check’ by buying national govt debt in the secondary markets. It’s not the most efficient way to do things, but it does work to facilitate national govts being able to fund themselves, though mainly in the very short term markets (I still see my per capita distribution proposal as the better policy response). And that ability of the member nations to fund themselves means they can write the check for deposit insurance as needed.

The ECB also imposed ‘terms and conditions’ along with funding assistance, and as long as Ireland is in compliance, the ECB is for the most part responsible for the outcomes, so it seems logical the ECB will continue its support, perhaps changing its terms and conditions if not pleased with the outcomes. Additionally, the ECB will continue to supply liquidity directly to the banks, again, as with Ireland complying with the terms and conditions the ECB is now responsible for the outcomes.

But there is no question it is all a precarious brew, and there is no telling what might result in the ECB withdrawing support, so at this time steep yield curves for euro member nations due to credit risk make perfect sense.

Also, Europe and the rest of the world would like nothing more than to increase net exports to the US.

It’s all a golden opportunity for a decade or more of unparalleled US prosperity if we knew enough to again become the ‘engine of growth’ and implement the likes of a full payroll tax (FICA) holiday to provide Americans working for a living enough spending power to buy both everything we could produce at full employment and all the rest of the world wants to net sell us.

Unfortunately the deficit myths continue to cast a wet blanket over domestic demand as our leaders continue to let us down.

And with maybe 100 new Congressmen on the way, with most supporting a balanced budget and a balanced budget amendment which already has maybe 125 votes, there’s more than enough fiscal responsibility looming to create a true depression.

Hopefully their tax cutting agenda outweighs their balanced budget agenda.

And hopefully we get some kind of energy policy to decouple GDP growth from a spike in energy consumption.

Fears Grow over the Fate of Irish Economy, Banks

By Patrick Allen

September 8(CNBC) — The fate of the Irish economy is back in focus for investors across the world, after the former Celtic Tiger extended guarantees to its banking industry and depositors and with the spread on Irish bonds hitting record highs.

The country is also waiting for a decision from the European Commission on the fate of Anglo Irish, the troubled bank that was nationalized two years ago; uncertainty on whether Anglo Irish will be wound down or allowed to survive has weighed on sentiment towards the country.

Ireland is an example of a Western economy adjusting to both the banking crisis and, crucially, the emergence of Asia, Amit Kara, an economist at Morgan Stanley, said.

“Ireland has taken steps to overcome the hangover from the credit boom, but a successful outcome requires the economy to become more competitive and also, and more crucially, a global economic recovery,” Kara said.

He is confident the Irish economy will be able to roll over debt in the coming weeks and sees the chance for Irish debt to outperform the likes of Spain.

“Though Ireland faces serious long-term challenges, its liquidity position is healthy and its banks should have sufficient ECB-eligible collateral to significantly offset the funding impact of upcoming debt redemptions,” Kara explained.

“Given the underperformance of recent weeks, we see scope for Irish bonds to regain some ground against Portugal and Spain in particular, once the initial round of government-guaranteed bond redemptions has taken place over the first two weeks of September,” he added.

What is on Ireland’s Books?

The Irish banking system remains hooked on European Central Bank funding and investors are also worried about the risks posed by the scale of liabilities following Ireland’s decision to guarantee the country’s lenders.

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GS Skinny: The Administration’s New Fiscal Proposals

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The President’s proposal is now looking anemic at best.

Like I think Woody Allen once said, the food was bad and the portions were small.

This will cost the Dems even more seats in November.

Fortunately the federal deficit is already large enough to support a bit of modest growth.

All looking very L shaped to me, with a hint of growth.

Gasoline consumption has recovered and showing signs of growth year over year, but very modest.

Modest recoveries from the lows and leveling off.

Continued modest improvement from the lows

Manufacturing, the smaller component of GDP, led from very low levels

Looking very L shaped.

These are March numbers, June should be out soon and show further balance sheet repair as deficit spending continues are relatively high levels, adding income and net financial assets to the non govt. sectors.

Lots of signs of leveling off at modest levels of top line growth.

Waiting for the handoff to private sector credit expansion as balance sheets repair, or another fiscal adjustment.

GS Skinny: The Administration’s New Fiscal Proposals
(CLEARED FOR EXTERNAL USE)

September 7, 2010

The White House has announced three new measures to stimulate growth: 100% up-front depreciation of capital investments; a permanent and slightly expanded R&D tax credit; and $50 bn in infrastructure spending. They could be helpful but are unlikely to have a large effect on growth for four reasons: (1) some of them cover multiple years, spreading out the fiscal impulse; (2) the incremental effect is smaller than the headline numbers imply, as some are modifications of existing proposals or policies and one is essentially an interest free loan; (3) the president proposes offsetting the cost of some of the proposals with targeted corporate tax increases of an equal amount; and (4) the likelihood of enactment of some of these proposals is low.

Key points:

1. Bonus depreciation. The president proposes to allow companies to deduct 100% of the cost of capital investments (not including real estate) made in 2010 and 2011. Press reports cite White House estimates that the proposal would lower corporate tax receipts by $200bn. However, almost all of this revenue loss would be temporary, since the additional deductions taken now would lower deductions in future years, effectively making this an interest free loan. Given current low levels of capacity utilization, the benefit of additional investment is low to begin with. Our previous analysis indicated that the 50% bonus depreciation provision effective for 2008 and 2009 had a relatively small effect on investment. To the extent it does have an effect, it is likely to pull forward demand into the quarter just before expiration (in this case Q4 2011) so the near term effect should be even more modest (and indeed the effect in early 2012 would be negative). Whatever effect the provision would have would also be weakened somewhat by the proposal to raise corporate tax revenues (through closing of “loopholes”) to offset the proposal’s cost.

2. R&D Tax credit. The president is expected to propose to increase and make permanent the research and development tax credit, at a cost of $100bn over ten years. This proposal is somewhat less than meets the eye, since the president has already proposed to make the credit permanent at a cost of $80bn. This leaves an incremental proposal worth around $20bn, or $2bn per year. Nevertheless, enactment of this proposal would be helpful on the margin, since the existing R&D credit lapsed at the end of last year and has yet to be renewed by Congress.

3. Infrastructure. The president proposes to spend $50bn on transportation infrastructure projects, as part of a six-year plan. We take this to mean a front-loading or incremental investment on top of the six-year reauthorization of surface transportation spending programs that has been pending in Congress for most of the year. For context, a $50bn addition to infrastructure spending is roughly on par with the investments made in that sector in the 2009 Recovery Act. If enacted, this could provide an important boost to growth, particularly in 2011. However, the likelihood of enactment in the near term appears low. Also, offsetting the otherwise positive effect is the proposal to offset the entire cost with the repeal of tax incentives for oil and gas companies.

4. Process from here. There are two likely scenarios for consideration of the tax-based measures. First, the Senate will vote on small business legislation next week, which already includes a 50% depreciation bonus for 2010. This provision could simply be modified, to bring it into line with the president’s depreciation proposal, in which case it could be enacted in the next few weeks. The second scenario is that the tax measures could be added to upcoming legislation to extend the expiring 2001/2003 tax cuts, which will be debated in late September. Adding corporate tax cuts to that legislation might allow Democratic leaders to attract enough votes for passage without extending the upper-income tax rates that most Republicans support. However, given that legislation’s uncertain prospects, adding these measures to it could also risk delaying enactment until after the November election. Infrastructure spending would be dealt with separately from the tax measures; the most likely scenario is that it could be considered after the election as part of the next stop-gap extension of the highway program, which expires December 31.

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Mosler proposal for the housing agencies

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Have the Fed Financing Bank fund the agencies with fixed rate amortizing term funding.

Have the FFB eat the convexity and allow prepayments of advances at par as mtgs pay down.

Have Congress set the FFB’s advance rate for the mtgs for public purpose.

Have fed member banks originate agency mtgs on
Congressionally dictated terms as agents for the agencies on a fee basis.

Have the agencies hold all these newly issues loans in portfolio.

Have the banks do the servicing for a fee.

This would lower mtg rates maybe 1%.

Have the agencies offer refi’s for existing agency loans at current rates without new appraisals or income statements.

Am i missing anything?

Feel free to distribute!

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Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says – Bloomberg

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If they actually understood how it all works they’d be calling for tax cuts rather than interest rate increases.

>   
>   (email exchange)
>   
>   On Mon, Aug 23, 2010 at 12:18 PM, wrote:
>   
>   Yes, Krugman criticised this today and I put in a kind word
>   for Mr Rajan in the comments section.
>   

I suspect Rajan is looking in part at the deflationary impact of the “fiscal channel” via the current 0% interest rate. Your NY Times colleague, Gretchen Morgenson, had a very good piece on this in the Sunday NY Times. Of course, the impact of this policy would, as you suggest, be ruinous for borrowers and highlights the comparatively diffuse impact of monetary policy, vs fiscal policy in terms of solving the problem of aggregate demand. Overall, this uncertainty points to the problems involved in using monetary policy to stimulate (or contract) the economy. It is a blunt policy instrument with ambiguous impacts.

The major problem facing the economy at present is that there is not a willingness to spend by the private sector and the resulting spending gap, has to, initially, be filled by the government using its fiscal policy capacity. I prefer direct public sector job creation to be the principle fiscal vehicle. But fiscal policy it has to be. Then when the negative sentiment is turned around, private borrowing will recommence and investment spending will grow again. Then the economy moves forward some more and the budget deficit falls.

Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says

By Scott Lanman and Simon Kennedy

Aug. 22 (Bloomberg) — Raghuram Rajan accurately warned central bankers in 2005 of a potential financial crisis if banks lost confidence in each other. Now the International Monetary Fund’s former chief economist says the Federal Reserve should consider raising rates, even as almost 10 percent of the U.S. workforce remains unemployed.

Interest rates near zero risk fanning asset bubbles or propping up inefficient companies, say Rajan and William White, former head of the Bank for International Settlements’ monetary and economic department. After Europe’s debt crisis recedes, Fed Chairman Ben S. Bernanke should start increasing his benchmark rate by as much as 2 percentage points so it’s no longer negative in real terms, Rajan says.

“Low rates are not a free lunch, but people are acting as though they are,” said White, 67, who retired in 2008 from the Basel, Switzerland-based BIS and now chairs the Economic Development and Review Committee at the Paris-based Organization for Economic Cooperation and Development. “There will be pressure on central banks to follow an expansionary monetary policy, and I worry that one can see the benefits, but what people inadequately appreciate are the downsides.”

He and Rajan will have the chance to make their case at the Fed’s annual symposium in Jackson Hole, Wyoming, this week. In 2003, White told attendees central banks might need to raise rates to combat asset-price bubbles. In 2005, Rajan, 47, said risks in the banking system had increased. They were met with skepticism from then-Fed Chairman Alan Greenspan, 84, and Governor Donald Kohn, 67.

Losing Confidence

While the Fed did boost its target rate for overnight loans among banks in quarter-point steps to 5.25 percent by 2006 from 1 percent in 2004, that didn’t prevent a housing bubble, which began to pop in 2006. Banks began losing confidence in August of the same year and started charging other financial institutions higher interest on loans.

A minority of policy makers are increasingly echoing Rajan and White’s current worries, including Kansas City Fed President Thomas Hoenig, who is hosting the Aug. 26-28 symposium, and Andrew Sentance, one of nine members on the Bank of England’s monetary-policy committee.

Hoenig has dissented from all five Fed policy decisions this year, preferring to jettison a pledge to keep rates low for an “extended period.” Sentance was defeated for a third month in August in his bid to withdraw emergency stimulus by increasing the benchmark interest rate.

Few Converts

The naysayers may fail to win many converts any time soon as the recovery slows and U.S. unemployment, at 9.5 percent in July, remains near a 26-year high. The resulting extension of low rates may increase volatility of government bonds, especially in response to any stronger-than-anticipated economic data, said Marc Fovinci, head of fixed income at Ferguson Wellman Capital Management Inc.

Indications that growth will be at least 3 percent “in the coming months” would cause yields on 10-year Treasuries, which were 2.61 percent on Aug. 20, to rise to 3 percent within about a week, said Fovinci, who is based in Portland, Oregon, and helps invest $2.5 billion.

JPMorgan Chase & Co. reduced its forecast last week for growth in this quarter to an annual rate of 1.5 percent from 2.5 percent and in the last three months of 2010 to 2 percent from 3 percent.

“I’m not worried about inflation, because the economy appears to be weak,” Fovinci said. At the same time, the bond market seems to be “tightly coiled up like a spring.”

Rising Yields

Between June 3 and June 8, 2009, yields on 10-year Treasuries rose to 3.88 percent from 3.54 percent after the smallest drop in U.S. payrolls in eight months and European Central Bank President Jean-Claude Trichet’s forecast for economic growth in 2010. Two-year Treasury yields rose to 1.4 percent from 0.91 percent in the same period.

The margin for error is “incredibly thin,” said Derrick Wulf, a portfolio manager at Dwight Asset Management Co. in Burlington, Vermont, which oversees $64.3 billion. “A lot of investors have become complacent about being long” in Treasuries.

Rajan, now a professor at the University of Chicago’s Booth School of Business, says near-zero interest rates are a crisis tool and economists don’t know if the benefits from using them for longer periods outweigh the costs. While inflation isn’t the main threat now, “you can’t be totally comfortable,” he said in an Aug. 18 interview. People think “there is significant unused capacity in the economy” and that assumption may be mistaken.

‘Bad Incentives’

Near-zero rates create “bad incentives” for financial firms, he added.

“Blow the system up, we’ll come back and reward you with very low interest rates that allow you to build up capital, and then you could try it again next time around,” Rajan said.

The Fed also may be “prolonging pain” by propping up the housing market and keeping home prices from falling, he said.

Companies are sending mixed signals.

“Demand is very low across the country” for houses, Richard Dugas, chief executive officer of Bloomfield Hills, Michigan-based Pulte Group Inc., said Aug. 20 on Bloomberg Television’s “In the Loop with Betty Liu.” Meanwhile, Caterpillar Inc., the world’s largest maker of construction equipment, may add as many as 9,000 workers worldwide this year, Doug Oberhelman, chief executive officer of the Peoria, Illinois-based company, said Aug. 19.

Another Bubble

White, a Bank of Canada deputy governor from 1988 to 1994, says the benefits of low rates may already be waning “in a world with so much debt, especially household debt,” which in the U.S. totaled a near-record $11.7 trillion at the end of June. There’s also a danger they might create another bubble, he said.

Another risk is that near-zero rates allow companies to roll over nonviable loans, a practice known as “evergreening” that can create so-called zombie businesses, which happened in Japan, he added.

Rajan and White’s arguments aren’t winning over Keith Hembre, chief economist at U.S. Bancorp’s FAF Advisors Inc. in Minneapolis, where he helps oversee $86 billion.

“There’s little evidence that the very low rates today are inflicting any harm,” said Hembre, a former Fed researcher. While he has “some longer-term sympathy with the argument,” it’s “just off-base today, given the evidence available from both real-time and market indicators.”

Bernanke, 56, and the majority of Fed officials show little inclination to change course. The Fed lowered its benchmark rate to a range of zero to 0.25 percent in December 2008 and said after each policy meeting since March 2009 it will likely stay very low for an “extended period.”

Emergency Measures

The ECB has kept its main refinancing rate at 1 percent since May 2009, and the Bank of England’s key rate has been 0.5 percent since March 2009. Axel Weber, an ECB council member, said in an Aug. 19 Bloomberg Television interview that policy makers should keep emergency liquidity measures in place at least through the end of the year, beyond Trichet’s October guarantee. Bernanke and Trichet will speak at the Fed symposium Aug. 27.

White and Rajan have ruffled central-bank feathers before at Jackson Hole, where policy makers, academics, analysts and money managers from dozens of countries mix hiking and rafting in Grand Teton National Park with debate over monetary policy and bank regulation.

In 2003, White and then-colleague Claudio Borio, who was head of BIS research and policy analysis, told central bankers they might need to raise interest rates to “lean against” asset-price bubbles.

‘Cannot Work’

“The one thing I am sure about is that a mild calibration of monetary policy to address asset-price bubbles does not and cannot work,” Greenspan, who retired in 2006, responded at the conference.

Bernanke, then a Fed governor, told attendees that Japan raised rates in 1989 to prick a bubble, and as a result, “asset prices collapsed and they had a 14-year depression.”

In 2005, Rajan warned that if banks lost confidence in each other, “the interbank market could freeze up, and one could well have a full-blown financial crisis.”

Kohn disagreed in a speech after Rajan’s presentation.

“As a consequence of greater diversification of risks and of sources of funds, problems in the financial sector are less likely to intensify shocks hitting the economy and financial market,” he said.

More Open

Bernanke has since become more open to White’s view. While low interest rates didn’t cause the U.S. housing bubble, he said in a January speech, if the next wave of regulation proves “insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks.”

Kohn, the Fed’s vice chairman from 2006 through June, said in a March speech that “serious deficiencies” with securitization of loans “exposed the banking system to risks that neither participants in financial markets nor regulators fully appreciated.”

Spyros Andreopoulos, a London-based global economist at Morgan Stanley, says he worries about the inflationary implications of extreme monetary accommodation beyond the next two to three years, with policy makers likely to lean toward low rates because of the fear of deflation.

“Imagine a car that’s stuck in the mud,” he said. “When you press on the gas, the car doesn’t emerge smoothly; it jumps up. My fear is when economies pick up after the stimulus, you’ll see inflation faster than was expected.”

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