Is the Fed Behind the Curve?

Imagine Fed Governor Rip van Winkle started his nap at the beginning of 2007 and just woke up to find that inflation is close to the Fed’s objective and the unemployment rate is at its 30-year average. You could forgive him for expecting the federal funds rate to be close to its long-run norm of about 4%, and for his surprise upon learning that the funds rate is at 0.1% and Fed assets are five times where they were when his snooze began.

Is the Fed already behind the curve? Why do policymakers emphasize their expectation that rates will stay low “for a considerable time” beyond October (when asset purchases are expected to halt)? What risks are they seeking to balance?

Monetary Policy and Financial Stability: Never Say Never

Last week, in her most important speech since becoming Fed Chair in February, Janet Yellen articulated the emerging policy consensus about the relationship between monetary policy and financial stability. What is that consensus? How confident should we be about its precepts? How will it influence Fed monetary policy over the medium term?

GDP: Seasons and revisions

Growth from the fourth quarter of 2013 to the first quarter of 2014, originally thought to have been about +0.1% in April, was revised last week to –2.9%. That’s at a seasonally-adjusted, annualized rate (SAAR) – the way the U.S. Bureau of Economic Analysis (BEA) usually reports real GDP growth. News reports varied between shock and concern. Was the anemic recovery over?Or, was it just that this winter was especially harsh?

In reality, these headline growth numbers simply don’t contain all that much information for real-time business cycle analysis...

How securitization really works

In the winter of 1997, musician David Bowie issued $55 million worth of bonds backed by royalty revenue from 287 songs he had written and recorded before 1990. The bonds had a 10-year maturity, a Moody’s A3 rating, and a 7.9% interest rate (at the time, the 10-year Treasury yield was around 6.5%, so the spread was relatively modest). “Bowie bonds” were no accident: by the late 1990s, the U.S. financial system had evolved to the point where virtually any payment stream could be securitized.

The success of U.S. securitization – as an alternative to bank finance – is a key factor behind the current push of euro-area authorities to increase securitization...

Reverse Repo Risks

Since the collapse of Lehman Brothers in September 2008, the Federal Reserve has stabilized the financial system and put the economy back on a path to sustainable growth. This task involved creating a colossal balance sheet, which now stands at $4.37 trillion, more than four times the pre-Lehman level ($940 billion). As textbooks (like ours) teach, along with this increase in Fed assets has come an increase in reserve liabilities (which represent deposits by banks at the Fed). Today, banks’ excess reserves (that is, the extra reserves beyond those that banks must hold at the Fed) are at $2.56 trillion, compared to virtually zero prior to the crisis.

Getting the money and banking system back to normal requires doing something to manage these excess reserves ...

Growth and dynamism: troubling facts

When the U.S. economy was booming in the 1990s, new firms flourished and willing workers found jobs quickly. In the current decade, these patterns faded. Startup and job finding rates have slowed so that employment has only just surpassed its 2007 peak. While part of current U.S. frailty remains cyclical, these trends suggest a worrying loss of economic dynamism...

Monetary policy target regimes: inflation, price level, nominal GDP, etc.

Should central banks target inflation, the price level or nominal GDP? The question of the appropriate policy target has been a subject of analysis at least since the 1980s and has become a matter of intense debate (see here and here) for the past several years. Many proponents of price-level or nominal GDP targeting share the idea that – by credibly committing to make up the shortfalls in the price level or in nominal GDP relative to the pre-crisis trend – policymakers could drive down the current real interest rate and accelerate the economic recovery.

Looking at where we are today, what would this mean?

Time-varying Capital Requirements: Rules vs. Discretion (again)

Among its numerous, innovations Basel III proposes that national authorities use countercyclical capital buffers to temper booms in credit growth and asset prices. [...]

Will it work? Is such a system either practical or desirable? Our view is that regardless of how theoretically attractive, making such time-varying capital regulation discretionary is unlikely to work in practice. Rules would serve us all much better.

Update on Target2 Balances: Limited progress

Observers of the euro-area financial crisis typically focus on the yield spreads on peripheral government long-term bonds (compared to German yields) as the “fever thermometer” of the crisis. On that basis (see chart below), the crisis looks like it is over: after peaking in 2012, spreads rapidly receded following European Central Bank (ECB) President Mario Draghi’s promise to do “whatever it takes” to save the euro. Indeed, in Ireland, Italy, and Spain, yields themselves have now sunk to the lowest levels since the euro was created in 1999...

Bubble, Bubble, Toil and Trouble: What's a policymaker to do?

With key central bank policy rates stuck at the zero bound (or below!), investors in Europe, Japan, and the United States are searching for yield under every rock (see, for example, the charts below on S&P500 prices and earnings). That is, they are willing to accept small gains on their investments because they see little risk that their cost of funding will rise significantly for a long time...

Commentary

Money, Banking, and Financial Markets