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Does the US Fed Chair need a PhD?

July 22, 2017 Leave a comment

How important is it to have an economics background to run the Federal Reserve? The FT’s US economics editor Sam Fleming talks to several leading economists on whether being versed in the theory is a basic requirement for a Fed chair.

Current US Fed Chair Janet Yellen could be heading into the final six months of her first term at Fed Chair. If Donald Trump does not give her a second term it may usher in new thinking from the US Government. There is no requirement for Donald Trump to appoint someone who is from the academic world of economics. They mention the success of Paul Volcker as Fed Chair who didn’t have a PhD in Economics but had a Masters Degree and also experience in  banking (Chase) and commercial sector. From the left you have – Janet Yellen, Paul Volcker, Alan Greenspan and Ben Bernanke.

Categories: Financial Markets Tags:

Yellen’s Taylor Rule suggest Fed Funds rate of 1.33%.

September 7, 2016 Leave a comment

From her Jackson Hole speech US Fed Chair Janet Yellen used the Taylor Rule to suggest that the Fed Funds rate today should already be around 1.33% – currently at 0.50%. She also used the Taylor rule to explain how US interest rates should have been negative after the Global Financial Crisis. This same rule suggests that the rate should already have been 1.25% in June – see Chart below.

Taylor Rule

Source: National Australia Bank: Australian Markets Weekly – 5th September

What is the The Taylor Rule?

This is a specific policy rule for fixing interest rates proposed by the Stanford University economist John Taylor. Taylor argued that when:

Real Gross Domestic Product (GDP) = Potential Gross Domestic Product and

Inflation = its target rate of 2%, then the Federal Funds Rate (FFR) should be 4% (that is a 2% real interest rate).

If the real GDP rises 1% above potential GDP, then the FFR should be raised by 0.5%.

If inflation rises 1% above its target rate of 2%, then the FFR should be raised by 0.5%.

This rule has been suggested as one that could be adopted by other central banks – ECB, Bank of England, etc for setting official cash rates. However, the rule does embody an arbitrary 2% inflation target rather than, say 3% or 4%, and it may need to be amended to embody alternative inflation targets at different times or by different central banks. The advantages of having such as explicit interest rate rule is that its very transparency can create better conditions for business decisions and can help shape business people’s and consumers’ expectations. Central banks prefer to maintain an air of intelligent discretion over the conduct of their policies than to follow rules, but to some extent they do unwittingly follow a Taylor rule. This makes the rule a useful benchmark against which actual policies can be judged.

Yellen, Bernanke, Greenspan and Volcker interview – US economy is fine and dandy

April 14, 2016 Leave a comment

A HT to Yr 13 student Albere Schroder for alerting me to this interview with the four most recent US Federal Reserve chiefs.

  • Janet Yellen, the current Federal Reserve chairwoman was joined by:
  • Ben Bernanke (2006-2014)
  • Alan Greenspan (1987-2006)
  • Paul Volcker (1979-1987)

Although the Fed Reserve chiefs served during widely divergent eras and are known to have different political views, the most notable take-away of the evening was the extent of their deep agreement.

There was a consensus that the Fed’s post-crisis rescue efforts have been successful and the economy is currently on a steady growth path, rather than rising thanks to a bubble that will soon burst. The remarks were a sharp rebuttal to the conventional wisdom of the contemporary Republican party and many grassroots conservatives that excessive stimulus from the Fed is either on the verge of sparking a drastic uptick in inflation, or already fostering a stock market or asset bubble.

“I’m not saying that the government should always be spending,” Bernanke said. “But at certain times, particularly in a recession, when the central bank is out of ammunition or ammunition is relatively low, then fiscal policy does have a role to play, yes.” Ben Bernanke

Greenspan had other ideas in that he disagreed with the idea that government spending should be increased during a downturn as this impacts on the country’s longer-term debt problem. Worth a look.

‘TED Spread’ up but unrelated to creditworthiness of banks

January 16, 2016 Leave a comment

TED Spread Jan 16The TED spread is the difference in rates between the interest rate that the US Government is charging for cash (three-month Treasury-Bills – the “T”) and three-month Eurodollars (the “ED”) contract as represented by the London Interbank Offered Rate (LIBOR).

The TED measures the rate of return the banks are requiring over the risk-free Treasury Bill rate to lend to other banks. If the economy is healthy the TED spread tends to be at low levels as there is a lot more trust in the market and the risk of default or bankruptcy is low. On the contrary, when the economy goes through a downturn levels tend to be higher as banks become more prudent in their lending and this reflects some sort of risk or liquidity premium. As the spread increases, the risk of default is considered to be growing. Ultimately TED illustrates the level of anxiety banks have that other banks are going to default – some liken it to a kind of measure of the financial sector’s blood pressure.
In 2006 and for half of 2007 the TED was consistently under 1%, which is historically low. However in August 2007 with the advent of the sub-prime crisis there were indications that all was not okay on financial markets. This was soon followed by the freezing of funds by investment bank BNP Paribas and consequently the TED spiked at 1% for the first time in a decade. From this point on the credit crunch was accelerating and markets were becoming extremely volatile. With the collapse of Lehman Bros the credit market became very explosive and the TED went through the 3% level, which exceeded levels last seen in the crash of 1987. Subsequently, a number of US and European banks collapsed and interbank lending just about came to halt. Liquidity was reduced dramatically and the TED peaked at 4.65%, a point never witnessed previously. To counter this problem Governments around the world promised trillions of dollars in bailouts and bank guarantees that, in the end, restored some confidence in credit markets – the Ted fell from its peak to about 2.25%.

Recently the TED Spread moved from 0.21% at the end of 2015 to 0.43% on 11th January 2016 . That is its highest level since 2012, when markets were pressured by fears of a sovereign-debt crisis in Europe.

Treasury Bill Yields – down

In order to protect themselves from runs during market turbulence, investment companies are shifting funds to government stock which is more secure. That adds to demand for T-bills which increases their price and reduces their yield

Libor – up

Rising demand for T-Bills has reduced downward pressure on the Libor. Furthermore the increase in the US Fed rate last month resulted in  a rise in the Libor and a number of other benchmarks.

However the TED spread’s surge is a mechanical result of its two components moving in different directions for reasons mostly unrelated to the creditworthiness of banks. Treasury-bill yields are down, Libor is up, so the TED spread is up, too.  ‘Wall Street Journal’.

US economy – was it right to raise interest rates?

January 7, 2016 Leave a comment

Interest RatesData out of the US seemed to warrant the Federal Reserve’s decision to raise its benchmark interest rate by a quarter of a percentage point to between 0.25 percent and 0.50 percent on December 16th 2015. Below is the data:

  • Unemployment – was at 5% although the US lost 8.7m jobs during the recession it has gained 13m since then.
  • Wages – have been increasing to 4% in the Q3 2015 suggest that there is little surplus labour available.
  • Oil prices – may have bottomed out so this suggests inflation may pick up in 2016. As there is a pipeline effect with the impact of higher interest rates it may be prudent to increase rates sooner.

What are the concerns?

  • Wages increases maybe temporary especially if young workers are enticed back into the labour market.
  • Inflation is 0.2% which is well below the 2% target. Even when you take out energy and food prices core inflation is only 1.3%
  • Interest rates are still very low and there is little scope for cutting them if the increase has a slowing effect on the economy
  • With most Americans on fixed mortgages the interest rate increase has a limited impact on the cost of borrowing.
  • A higher US dollar will make exports less competitive and Americans manufacturers will struggle evenmore trying to sell in overseas markets.

Stanley Fischer, the Fed’s vice-chair, recently estimated that a 10% rise in the dollar reduces core inflation by half a percentage point within six months. The US Fed chair Janet Yellen is unlikely to persist with rapid rate rises if they push inflation too far below target in the short term.

Source: The Economist – 18th December 2015

Should the Fed look at bubbles not inflation?

March 16, 2015 Leave a comment

BubbleJohn Cassidy wrote a piece in The New Yorker which focused on the US Fed targeting the threat of bubbles rather than inflation when implementing policy instruments. In the mid 1990’s and early 2000’s the Fed set interest rates based on the supposed threat of inflation. However price rises never materialised so the low interest rates fueled borrowing especially for purchasing property.

In the past, expansionary monetary policy (low interest rates) would have acted as a catalyst to the real danger of a wage price spiral in which rising wages and prices become self-reinforcing, pushing inflation up. This was very apparent in the winter of 1974 in the US when inflation reached 12% and 15% by 1980. But today with the annual rate of inflation in the US at less than 2% for the past three years the threat of another wage price spiral is fairly dormant. It was forecast that that wage and price inflation would start to rise but average hourly earning rose by just 0.1% in January. Over the course of the past year, it has risen by 2%, which is a very modest rate of increase.

Economists have never been able to pin down the jobless rate at which inflation takes off—the so-called NAIRU, or Non-Accelerating Inflation Rate of Unemployment. Theoretically, the concept makes sense. Empirically, it’s extremely elusive, because it depends on many other things, such as the rate of productivity growth, tax rates, the labor-force participation rate, and the level of unionisation.

However higher wages will eventually surface with a tight labour market but the real dilemma for the Fed is the tradeoff between cheap money and financial instability. Keep interest rates too low for too long and you ignite another asset bubble or raise interest rates to alleviate the bubble risk but dampen growth in the economy?

US Fed – Dual Mandate Problem

January 15, 2015 Leave a comment

The US Fed currently have an interesting problem which other central bank would be happy to have. They have a dual mandate of Price Stability – 2% inflation and Full Employment – 5% unemployment. The current unemployment rate is 5.8%, the lowest level since 2008, and if it drops below 5% there could be labour shortages which will help to put pressure on wages and ultimately inflation. However the current inflation rate is only 1.3% and it is heading below 1% next year. There are two main reasons for this:

* The significant drop oil prices and
* A stronger US$ making imports cheaper

The concern for the US Fed is that inflation over the next couple of years stays well below the 2% threshold and interest rates remain close to 0%. As pointed out by The Economist the problem will be when the next recession rears its ugly head and Fed has no room to cut rates further as they cannot fall below 0%, since savers would simply convert their deposits into cash.

An option might be to let unemployment fall below 5% which make the labour supply more scarce bidding up wages and prices – with inflation reaching the target of 2%. Furthermore higher wages should entice workers back into the labour force. The risk is that with close to 0% interest rates inflation could rebound suddenly forcing the Fed to raise interest rates. How the Fed cope with the dual mandate next year will be interesting although the safe option could be to increase rates in the June this year. Below is a clip from Paul Solmon of PBS which explains the concern that the Fed have. It also stars Merle Hazard with a song about the dual mandate.

Categories: Inflation, Unemployment Tags:

QE is over – what now for Fed?

November 5, 2014 Leave a comment

Following on from Merle Hazard’s Dual Mandate song, here is a report from Paul Solman of PBS looking at the role of the Federal Reserve with the end of its QE money creation programmes. The US economy is still in recovery mode and the role of the Federal Reserve is being debated. While most central banks have one mandate – price stability – the US Fed has two:

1. Maintaining stable prices
2. Full employment

Paul Krugman doesn’t think the Fed is achieving either of their mandates and would have liked to have seen them continue their bond buying last longer since employment rates and wages are still depressed.

US Fed – Dual Mandate by Merle Hazard

November 2, 2014 Leave a comment

Here is the latest video from Merle Hazard. It looks at the difficulties of the dual mandate facing US Fed Chair Janet Yellen – reducing the unemployment figures whilst keeping prices stable.

Categories: Eco Comedy, Inflation, Unemployment Tags:

Dow Jones record high but is it a bubble?

December 1, 2013 Leave a comment

Another video by Paul Solman in which he discusses how the NYSE record high doesn’t reflect the fundamentals of the US economy. With interest rates at virtually 0% the US Federal Reserve is trying to lower unemployment by stimulating the economy. But, by doing so there has been a tendency for it to overstimulating the stock market in the process. And also lending to stock investors, whose margin debt to buy shares on credit has been hitting record highs. Last week the Dow ended above 16000, another record for the headline index of 30 major companies.

The last record was set in 2007, a few months before the Dow’s previous high watermark.But for all the talk of the Fed’s role there’s an alternative way to understand a record Dow and higher profits: a shift of power from workers to owners. The stock market would actually be much higher if the unemployment was much lower. I think the economy is still really fundamentally weak, and that slack that’s in the economy right now, with all the unemployed people, all the unemployed businesses, would actually bring up the stock market even further.

Lower Interest Rates – what should be happening?

December 16, 2012 Leave a comment

With near zero interest rates in the US and the promise of them to remain until 2015 those that are living off the interest on savings, mainly the retired, are finding their incomes squeezed. According to The Economist personal interest income has plummeted by 30% which equates to a $432bn annually and more than 4% of disposable income. Former IMF chief economist Raghuram Rajan describes the Fed’s policy as:

“expropriating responsible savers in favour of irresponsible banks”

How should lower interest rates work according to the textbook?

Lower Interest Rates

However today it seems that even with these really low interest rates businesses and consumers don’t want to borrow or cannot qualify due to the more stringent requirements required. Furthermore with less consumption in the circular flow you would think that there is less need to fuel anymore investment spending.

AS & A2 – Global and New Zealand Update for November exams

October 16, 2012 Leave a comment

It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.

Indicators that you might want to mention are as follows:

The New Zealand Economy
The New Zealand economy expanded by 0.6 percent in the June 2012 quarter, while economic growth in the March quarter was revised down slightly to one percent. Favourable weather conditions leading to an increase in milk production was a significant driver of economic growth over the June quarter. The current account deficit rose to $10,087 million in the year ended June 2012, equivalent to 4.9 percent of GDP. Higher profits by foreign-owned New Zealand-operated banks and higher international fuel prices were factors behind the increase in the deficit during the year. Unemployment is currently at 6.8% but is expected to fall below 6% with the predicted increase in GDP. Annual inflation is approaching its trough. It is of the opinion that it will head towards the top end of the Reserve Bank’s target band (3%) by late next year.

The Global Economy
After the Global Financial Crisis (GFC) the debt-burdened economies are still struggling to reduce household debt to pre-crisis levels and monetary and fiscal policies have failed to overcome “liquidity traps”. Rising budget deficits and government debt levels have become more unsustainable. The US have employed the third round of quantitative easing and are buying US$40bn of mortgage backed securities each month as well as indicating that interest rates will remain at near zero levels until 2015. Meanwhile in the eurozone governments have implemented policies of austerity and are taking money out of the circular flow. However in the emerging economies there has been increasing inflation arising from capacity constraints as well as excess credit creation. Overall the deleveraging process can take years as the excesses of the previous credit booms are unwound. The price to be paid is a period of sub-trend economic growth which in Japan’s case ends up in lost decades of growth and diminished productive potential. The main economies are essentially pursuing their own policies especially as the election cycle demands a more domestic focus for government policy – voter concerns are low incomes and rising unemployment. Next month see the US elections and the changing of the guard in China. In early 2013 there is elections in Germany. The International Monetary Fund released their World Economic Outlook in which they downgraded their formal growth outlook. They also described the risk of a global recession as “alarmingly high”.

QE3 and ECB bond purchase is not the elixir for recovery – Stiglitz

October 14, 2012 Leave a comment

Nobel Laureate Joseph Stiglitz came out strongly against the recent QE3 by the US Fed and the ECB’s announcement that it would buy government bonds of indebted eurozone member countries. With this announcement stock prices in the US reached post-recession highs although some worried about future inflation and significant government spending. According to Stiglitz these concerns are unwarranted as there is so much underutilisation and no serious risk of inflation. But the US Fed and the ECB sent three clear messages:

1. Previous actions didn’t work – ie QE1 and 2
2. The US Fed announcement that it will keep rates low until 2015 and buy $40bn worth of mortgage backed securities suggested the recovery is not going to take place soon.
3. The Fed and the ECB are saying that the markets won’t restore full employment soon – fiscal stimulus is needed.

In textbook economics increased liquidity means more lending, mostly to investors thereby shifting the AD curve to the right and thereby increasing demand and employment. But if you consider Spain an increase in liquidity will be cancelled out by an austerity package.

For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. Joseph Stiglitz

New Zealand Dollar in September

October 3, 2012 1 comment

Here is a great graphic from the BNZ showing how the NZ dollar performed in September. You could say that it strengthened on the back of notably QE3 from the US Fed and the improving global growth sentiment. Furthermore the NZ economy has performed well under trying circumstances.

June quarter GDP accounts revealed the NZ economy finished Q2 1.6% bigger than where it began the year. That is solid economic growth under ordinary circumstances. But given the ongoing challenging and uncertain global economic environment we should not under sell this achievement. It is the strongest six month expansion we have seen in the past five years. Source: BNZ

WSJ Graphic – Federal Reserve Stimulus And Its Impact On Yields

September 30, 2012 Leave a comment

Here is a cool graphic from the WSJ that looks at the impact of the US Fed’s monetary policy of dumping trillions of dollars into the economy in order to stimulate economic activity – it covers the period from September 2008 through to today. The graphic shows the impact on the following:
* 10 year treasury yields
* DJIA – Dow Jones Industrial Average
* WSJ US dollar index

Click WSJ Interactive Graphic to go to the page.

Bernanke turns on the taps once again – NZ$ on the rise

September 16, 2012 3 comments

It is the US Fed’s intention to buy volumes of mortgage backed securities and keep borrowing rates at near zero (0-0.25%) until the job market and broader economy pick up. Basically they are going to print money until there is some improvement in unemployment figures. Unemployment is at 8.1% and the Fed estimate that it will fall no lower than 7.6% in 2013 and 6.7 in 2014. Inflation is forecast to remain at or below 2% until 2015.

How does it work?
The Fed will buy $40 billion a month in mortgages and will keep doing this until unemployment starts to fall. This will have a couple of effects:

1. It might lower mortgages rates by another 0.25% (already quite low). The 30-year mortgage rate is 3.5% and could go down to 3.25%
2. When mortgage rates go down, the price of houses tends to go up which is beneficial even if you are not refinancing a mortgage
3. Investors tend to move out of low interest earning investments and put their money into stocks. The DJIA closed up more than 200 points and was 625 points off its all-time high.

Impact on NZ$
With the flood of US$ into the market this has put downward pressure on the US$ which will make its export market more competitive and imports more expensive. However risk currencies like the NZ$ and AUS$ have rallied. Looking at the NZ$, this has appreciated considerably against the US$ and will make NZ exports more expensive and NZ imports cheaper. This will not only hurt the export industry as the price of goods become more expensive but the domestic sector have now got to compete with cheaper imports. The NZ$ reached US$0.84 yesterday.

Stimulus doesn’t get unemployment figures down

September 12, 2012 1 comment

Here is an interesting graph from the Economist “Free Exchange” column. What the article states is that all these stimulus actions haven’t led to any sort of growth but higher levels of unemployment – see graph.

There has been many research papers as to why this has happened. Here are some of the findings from them:

1. One school of thought is that a high unemployment rate is structural and immune to the stimulative effects of monetary policy.

2. That the US Fed commit to keeping policy easy until the economy reaches a particular target, such as nominal GDP (ie, output unadjusted for inflation) returning to its pre-recession path.

3. The Bank of England is doing by providing subsidised credit to banks that lend more.

4. Monetary easing usually works by encouraging businesses and households to move future consumption and investment forward to today. But it also has “redistributive” effects. For example, low short-term interest rates redistribute income from depositors to banks, which allows them to rebuild capital and encourages them to lend more.

5. Raising banks’ profits has not done much to restart demand because the real problem is that indebted households cannot or will not borrow. There is evidence that retail spending and car sales have been weaker in states that entered the recession with higher household debt.

With the Fed now looking at QE3 and the ECB discussing a resumption in purchases of bonds of peripheral euro-zone members one wonders if “more of the same” will have any impact on unemployment.

Every Breath You Take – Every Change of Rate (Fed Funds Rate)

August 25, 2012 Leave a comment

Here is a really funny video by the students of Columbia Business School (CBS) – you may have seen it before but I find it very useful when you start teaching monetary policy and interest rates.

Back in 2006 Alan Greenspan vacated the role of chairman of the US Federal Reserve and the two main candidates for the job were Ben Bernanke and Glenn Hubbard. Glen Hubbard was (and still is) the Dean at Columbia Business School and was no doubt disappointed about losing out to Ben Bernanke. His students obviously felt a certain amount of sympathy for him and used the song “Every Breath You Take” by The Police to voice their opinion as to who should have got the job. They have altered the lyrics and the lead singer plays Glenn Hubbard.

Some significant economic words in it are: – interest rates, stagflate, inflate, bps, jobs, growth etc.

WSJ Graphic – Central Bank Interest Rates

August 6, 2012 Leave a comment

If you are teaching monetary policy in any course the graphic below shows a significant expansionary monetary policy. Remember in New Zealand the RBNZ changes interest rates to influence the level of economic activity in order to achieve price stability. Note the following:

• Implementation of monetary policy is one of the roles of the RBNZ
• The Reserve Bank Act established “price stability” as the main objective of the RBNZ. The RBNZ is therefore responsible for achieving “price stability”
• “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (measured by the percentage change in CPI)

In order to stimulate the economy the ECB cut benchmark interest rates to 0.75%. Chinese authorities cut one year yuan lending rate to 6% (still has ammunition left). The Bank of England reduced rates to 0.5%. This is in the hope that businesses will use the cheaper sources of credit to invest in their business and therefore create jobs. Lower rates would also ease the burden of those on floating interest rates.

Central Bank Policy Rates – China cuts for first time since GFC

June 14, 2012 2 comments

The Chinese authorities have cut interest rates for the time since the Global Financial Crisis (GFC). One year lending and deposit rates were cut by 0.25%.

Lending rate – 6.31%
Deposit rate – 3.25%

Although this should encourage spending with an increase in the money velocity in the circular flow some commentators are concerned that the Chinese authorities know something about their economy that the rest of world is in the dark about.

It is interesting to see the reaction of main central banks in the aftermath of the GFC and how aggressive they were in cutting rates – US, EU, UK – relative to the other countries on the graph, namely China, India and Australia. Furthermore notice that some economies seem to have been at a different part of the economic cycle namely Australia, India, and the EU as their central bank rates have risen in order to slow the economy down. This is especially in India as they have had strong contractionary measures in place but have now started to ease off on the cost of borrowing.

Indian growth has slowed to 5.3% this year and although this seems very healthy it is the lowest level in 7 years. A developing nation like this needs higher levels of growth to create the jobs for their vast working age population and without employment there could be a situation not unliike that of Spain where over 50% of those under 25 don’t have a job. The main cause of the slowdown seems to be from a lack of private investment.

Also look how low rates are in the US, UK, and EU. With little growth in these economies the policy instrument of lower interest rates has been ineffective and they are in a liquidity trap. Increases or decreases in the supply of money do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

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