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Benjamin Strong and Milton Friedman - Ironically, Something in Common?
by Paul Kasriel of Northern Trust,
Had Milton Friedman not passed away in 2006 and were alive and writing today, he would be arguing forcefully in favor of continued Federal Reserve quantitative easing. Friedman argued that had Benjamin Strong been alive to influence Federal Reserve policy in 1930 and 1931, the recession of 1929 would not have degenerated into the Great Depression. If Milton Friedman were alive today to influence the current Federal Reserve monetary policy debate, the near stagnant economic environment we find ourselves in would not need to persist.
Fed 'Twisting' Will Stimulate Economic Activity for Bond Traders
The consensus view is that after adjourning from its September 20-21 meeting the FOMC will announce a plan to lengthen the maturity structure of its securities portfolio by increasing the proportion of longer-maturity securities in the portfolio.
If Some Dare Call It Treason, Was Milton Friedman a Traitor?
by Paul Kasriel of Northern Trust,
The principal factor accounting for the current exceptionally weak economic recovery is not unusually high uncertainty, too burdensome regulation and taxation, excessive federal government spending and/or debt or a major structural change in the economy, but rather inadequate depository institution credit creation. The reason depository institutions are not creating normal amounts of credit is that they suffered enormous losses after the residential real estate bubble burst and they remain concerned about current and/or future capital adequacy.
Jobs, Jobs, Jobs The Mantra of the Current Season
by Asha Bangalore of Northern Trust,
The unemployment rate in August 2011 stood at 9.1%. The high for the unemployment rate in the post-war period was recorded during the 1981-1982 recession when it touched 10.8% in December 1982. In this business cycle, the recovery commenced in November 1982 and by January 1985 the unemployment rate had dropped to 7.3%. This time around, the high for the unemployment rate is 10.1% (October 2009) and the recovery is 26 months old with a jobless rate, as noted earlier, of 9.1%. Consequently, the level of concern about a persistently high unemployment rate has risen significantly.
The August 9 FOMC Decision - Ineffective at Best, Dangerous at Worst
by Paul Kasriel of Northern Trust,
The FOMCs decision to commit to holding its federal funds target in a range of zero to 25 basis points at least through mid 2013 strikes me as an ineffective way to accomplish one of its goals full employment of the labor force and potentially dangerous with regard to another of its goals stability in an index of goods/services prices. In my view, the Fed should abandon an interest-rate targeting approach to monetary policy. Rather, it should adopt a quantitative-targeting approach targeting the growth in the quantity of combined Federal Reserve and commercial bank credit.
I was sent to Washington to Change the Trajectory of Government Spending
by Paul Kasriel of Northern Trust,
In the 12 months ended Jul 11, cumulative total federal outlays were 2.7% higher than cumulative federal outlays in the 12 months ended Jul 10. The average year-over-year % change in 12-month cumulative outlays from 1956 through today has been 7.6%. And with 12-month cumulative total federal receipts growing at 8.7% the cumulative deficit in the 12 months ended Jul 11 was $1.225 trillion, $36 billion less than the cumulative deficit in the 12 months ended Jul 10. With continued fiscal progress of this nature, S&P will beupgrading U.S. debt faster than the Fed can change its forecast!
S&Ps Downgrade of U.S. Sovereign Debt Some People Actually Pay Them for these Opinions?
by Paul Kasriel of Northern Trust,
S&P stated the obvious after the U.S. markets closed on August 5 - the projected growth in U.S. public debt is on a long-term unsustainable path. Rather than paying S&P for this opinion, all you need to do is look at some past CBO projections and you would have arrived at the same opinion years ago.
U.S. Debt Ceiling If Cooler Heads Do Not Prevail
by Paul Kasriel of Northern Trust,
What would be the immediate economic effect of a sudden balancing of the U.S. federal government budget? The $1.26 trillion decline in federal outlays would represent a negative demand shock to the U.S. economy. Some entities who were expecting payments from the federal government would be disappointed. These disappointed entities might have to cut back on some of their planned spending in order to be able to honor their payment commitments to others. Alternatively, these disappointed entities might have to increase their borrowing in order to honor their payment commitments.
Washington Had a Spending Problem
by Paul Kasriel of Northern Trust,
Although Washington does not seem to have a current spending problem, what about a spending problem going forward? Specifically, if the programs specified in President Obamas February 2011 budget proposal were implemented, how would growth in federal total outlays in an eight-year Obama presidential tenure compare with growth in federal total outlays of other presidents tenures? To answer this question, I have relied on projections of total federal outlays by the Congressional Budget Office (CBO), the nonpartisan scorekeeper of all things fiscal.
U.S. Businesses Appear to Have Selective Uncertainty
by Paul Kasriel of Northern Trust,
Business hiring remains weak and business capital spending is robust. The capital spending part is illustrated in the chart below showing the 8-quarter annualized growth in shipments of nondefense capital goods deflated by the PPI for capital goods. I would think that if abnormally-high business uncertainty prevailed today, there would have been considerably slower growth in price-adjusted purchases of nondefense capital goods than what has occurred.
Will China?s Real Estate Market Become the World?s Problem?
by James Pressler of Northern Trust,
There are significant imbalances in the Chinese real estate market and that this constitutes a large asset bubble that is reaching the end of its run. While there may not be one defining event that marks its collapse, over the next twelve months we expect a marked rise in NPLs within the smaller provincial and regional banks, and some high-profile defaults. And while this will not necessarily mark the end of the Chinese miracle, it will provide a substantial shock to development policies and perhaps a renewed drive toward a more sustainable, domestically-driven economy.
Continued Sluggish Economic Growth Expected Through 2012
by Asha Bangalore of Northern Trust,
Bernanke indicated that the FOMC would be prepared to make monetary policy more accommodative if things do not improve. He emphasized the importance of the employment situation improving. Our forecast does not call for an acceleration in real GDP growth in the second half of 2011 nor does it call for a decline in the unemployment rate. Rather, we see the unemployment inching higher. Although we do not envision a meaningful risk of a contraction in indexes of consumer prices for goods and services in the next 12 months, we do envision continued declines in house prices.
Poor People or Old People - Who Do We Want to Help?
by Paul Kasriel of Northern Trust,
Milton Friedman used to talk about the "tyranny of the status quo." By that, he meant that it is difficult to change public policy because of entrenched interest groups allied with policies that have been in effect for decades. I would argue that opposition to changes in our current Social Security and Medicare programs is an example of tyranny of the status quo. The original intent of both was to provide an income support floor for our retired senior citizens. So, why do these programs supplement the income directly through Social Security and indirectly through Medicare to wealthy seniors?
Do We Have a Medicare Budgetary Problem or an Aging Population Problem?
by Paul Kasriel of Northern Trust,
If it makes sense for corporations to borrow to fund capital expenditures, why does it not make sense for the federal government to do so as well? By the gov making investments in physical capital (infrastructure) and human capital (education), the economy's future growth rate would be expected to be enhanced. This would imply higher future tax revenues (without higher tax rates) to pay the interest and principal on the debt issued to fund capital expenditures. So, rather than trying to balance the overall budget, would it not make more sense to bring into balance the operating expenses?
U.S. Monetary Policy: A Case of Self-Induced Paralysis?
by Paul Kasriel of Northern Trust,
Part of the decreased real GDP growth/increased unemployment rate central-tendency forecasts for June vs. April can be attributed to supply interruptions from Japan and higher energy prices. But given the FOMC's assumption that the supply interruptions are dissipating and that energy prices are declining, this explanation does not apply to the reduced real GDP growth and unemployment rate central-tendency forecasts for 2012. I think the central-tendency forecasts for real GDP growth and the unemployment rate are optimistic for 2011 and 2012 in the absence of continued quantitative easing.
Economy Brakes Even Before Fed Takes Its Foot Off the Accelerator
Although quantitative easing might not help stimulate domestic spending on goods, services and assets, in the words of our grandmothers-it couldn't hurt. All else the same, if the Fed purchases securities in the open market, the seller of these securities can do one or a combination of three things with them - spend them, lend them or just hold them. If sales proceeds are spent or lent, then there is a net increase in spending on something in the economy. Only if the sales proceeds are just held would quantitative easing not lead to a net increase in spending in the economy.
Is There a Guide for What May Trigger QE3?
by Asha Bangalore of Northern Trust,
The 'hurdle for QE3' is high. Discussion of the current U.S economy almost always includes mention of the Feds view that justification for QE3 is more stringent than QE2. We have been mulling this thought around for a few days and here is the checklist for what may trigger QE3. First, labor market conditions need to show a consistent improvement which suggests that the turnaround is durable. The requirements pertaining to the labor market could be summed up as: back-to-back declines in the unemployment rate, strong gains in payroll employment, and a declining trend of initial jobless claims.
The Fed Terminates QE, We Lower our GDP Forecast
by Asha Bangalore of Northern Trust,
We have been putting a lot of emphasis on monetary financial institution (MFI) credit as a cyclical determinant of domestic demand for goods and services. We define MFI credit as the sum of the credit extended by the Fed, the commercial banking system, loan system and the credit union system. MFI credit is credit figuratively created ?out of thin air.? There is a distinction between created credit and transfer credit. In the latter is transferred from the grantor of this credit to the recipient of credit. Transfer credit, then, is funded by the grantor by postponing some spending.
Standard & Poor?s Downgrade Outlook on US Sovereign Debt ? Initial Reflections
by Asha Bangalore of Northern Trust,
S&Ps changed in its outlook on US debt to negative but reaffirmed the AAA rating of the nation's debt. Todays market response to this action includes equity prices viewing this in negative light. The markets response is not entirely consistent with a downgrading of sovereign debt because the decline in rating implies that the financial situation of the federal government is less secure and there are doubts creeping in about the federal governments ability to meet its debt obligations. If this was the case, the dollar should have declined and Treasury security yields should have risen.
Why the Doves of the FOMC Have an Advantage at the April FOMC Meeting
by Asha Bangalore of Northern Trust,
There are differences of opinion among members of the FOMC that have emerged in speeches of several Fed officials in recent weeks. A line is being drawn between those who favor the Fed's current accommodative monetary policy and those who are supportive of policy actions to curb demand and contain future inflationary pressures. Based on evidence present here, the doves appear to have a strong advantage at the April 26-27 FOMC meeting to stay the course and complete the $600 billion asset purchase and watch the evolution of economic conditions.
One Man?s Fiscal Austerity is Another?s Prosperity?
by Paul Kasriel of Northern Trust,
Fiscal austerity is the rage in the developed economies. The proponents of fiscal austerity argue that it will lead to economic prosperity. The opponents of fiscal austerity argue that it will lead to poverty. If the government decides to spend less, then, it will need less funding. This, in turn, implies that the government will either cut back on its current taxation or cut back on its current borrowing. The former recipients of the cut-back government expenditures will indeed experience a decline in their spendable funds. However, taxpayers will find themselves with extra spendable funds.
Near-term Outlook For A Troubled World
Although 2011 is only three months old, the world has changed dramatically. Along with the evolving European debt crisis, seemingly -isolated Tunisian protests grew to varying levels of upheaval throughout the Arab world, and an historic earthquake and subsequent tsunami have left Japan?s outlook under a cloud of uncertainty. Each of these situations is significant in its scope and magnitude, but by focusing on just the key elements, the main risks can be appreciated.
To QE or Not to QE? That is the Question
Historically, % changes in MFI credit "explain" a large proportion changes in nominal GDP. Commercial bank credit accounts for the largest component of private MFI credit. Since the FOMC commenced its second round of easing in early November 2010, the increase in Federal Reserve and commercial bank credit has been dominated by the increases in Federal Reserve credit. If the FOMC terminates its easing policy in June and private MFI credit creation does not pick up, total MFI credit growth will slow. All else the same, this would augur poorly for nominal GDP growth in the second half of 2011.
Key Market Trends between QE1 and QE2
by Asha Bangalore of Northern Trust,
QE1 provided support to the U.S. economy and revived economic activity. In the months before QE2 was put in place, a turnaround of the U.S. economy from a severe recession was a vote of confidence which lifted equity prices. If economic reports in the months ahead plant seeds of doubt about the durability of economic growth, equity prices are most likely to post declines and a drop in interest rates is possible, irrespective of whether QE2 has expired.
Fisher Could Dissent if Oil Prices Maintain Upward Trend
by Asha Bangalore of Northern Trust,
Dallas Fed President Fisher indicated yesterday that he would vote to scale back/discontinue the Fed's Treasury securities buying program of $600 billion at the March 15 FOMC meeting. Last week, Chairman Bernanke indicated that only under conditions of sustained growth, expanding payrolls, and inflation readings that are consistent with price stability would the Fed consider terminating the program. Economic data indicate that the Fed is not close to meeting these. In his opinion, the Fed's job "is done" and continued purchases of Treasuries may result in raising inflation expectations
Equity Markets and Oil Prices
by Asha Bangalore of Northern Trust,
The turmoil in the Middle East and North Africa has led to higher oil prices. Brent crude oil was trading at $116.99 ($113.07 on 3/1/2011) as of this writing and West Texas Crude was quoted at $101.68 ($99.63 on 3/1/2011). The Libyan crisis has raised oil prices significantly in the last three trading days. The crisis in the region commenced the day after a Tunisian man set fire to himself on January 21, 2011.
Musings on Proposed Government Spending Cuts and Current Energy Price Increases
by Paul Kasriel of Northern Trust,
Just as labor is an important input in the production of goods and services, so is energy(E). An increase in the price of E reflects a relative shortage of E from what was the case. Just as the price of labor can increase from an increase in demand or a decrease in supply, so, too, can the price of E. Assume that before an increase in the price of E, the economy was set to go from 3% growth to 4% growth. Assume that the increase in the price of E has resulted from an increase in the demand for E. At the higher price of E due to demand, the economy will not be able to rise from 3% to 4%.
Don?t Know Much about Geography, Don?t Know Much Trigonometry, But Sarah Palin Does Know Her ...
by Paul Kasriel of Northern Trust,
On November 8, 2010, Sarah Palin commented that the Fed?s quantitative easing monetary policy was tantamount to printing money out of thin air. Sarah Palin may not know much about geography, but she does know her Fed policy. I would phrase quantitative easing a little differently. It is the Federal Reserve creating a specific amount of credit figuratively out of thin air. Theoretically, the Federal Reserve can create an unlimited amount of credit out of thin air. Of course, there would be dire economic consequences if the Fed were to create an unlimited amount of credit out of thin air.
Changing Perception of the Economy - Food for Thought
by Asha Bangalore of Northern Trust,
The bond market essentially signals the U.S. economy is turning around and is most likely to establish sustained growth in 2011. A part of the bullish sentiment commenced after Bernanke's speech in the last week of August 2010 when the Fed signaled that a second round of support was on its way. Inflation expectations have moved up (see Chart 3) from lows in the summer of 2010. But, they are yet to surpass the levels seen prior to the onset of the crisis. Actual inflation measures also do not represent a threat.
January Employment Report ? Pace of Job Growth Inadequate for Fed to Change Current Stance
by Asha Bangalore of Northern Trust,
The number of jobs created since the recovery commenced in June 2009 is troubling and raises the level of concern for policymakers. The level of employment, irrespective of how it is measured, is still significantly below the prior peak even after 19 months of economic growth. Job creation is proceeding in the desirable direction but at a tepid pace such that it is does not offer sufficient justification for the Fed to end the $600 billion purchase of Treasury securities (also known as QE2) before the planned expiration date of June 2011.
U.S. Real GDP vs. Potential GDP ? Time to Assess this Yardstick
by Asha Bangalore of Northern Trust,
The U.S. economy has registered six quarters of economic growth, inclusive of the projected increase in real GDP during the fourth quarter of 2010. There is enormous room for growth before inflation becomes a concern. The recovery phase ended in 2010 and expansionary phase of the current business cycle should commence in 2011. Cognizant of this information, markets will evaluate the performance of the economy in a different light going forward.
The 2011 Economic Outlook ? Credit Given Where Credit Is Due
by Paul Kasriel of Northern Trust,
With regard to 2011 real GDP growth, we now expect Q4/Q4 growth of 3.3% vs. 3.0%. An upward revision of 2011 Q4/Q4 real consumption growth to 2.9% from 2.5% in November is the primary factor accounting for the upward revision to the real GDP growth forecast. We are more optimistic about 2011 real GDP growth primarily because QE2 implies that the Fed will be purchasing all of the additional Treasury debt issued in conjunction with the Obama-McConnell tax and unemployment insurance compromise. We currently see more upside risk to our 2011 real GDP growth forecast than downside risk.
Deciphering Debt
2011 is likely to raise more issues about debt, with periodic market panics about debt sustainability and bailouts. We offer this primer on the issue of debt ? specifically the various measures and the roles they play in determining a country?s risk of facing some form of debt-related crisis. Metrics to assess indebtedness of nations are classified as solvency and liquidity measures. Each are discussed, as is the special topic of the banking sector and its relation to public debt. We give our view of global public-debt-related challenges in 2011.
Treasury Market's Perception of Recovery Path is Strongly Bullish, But Mind the Hurdles
by Asha Bangalore of Northern Trust,
The 10-year Treasury note yield has climbed from a recent low of 2.41% (October 6-8, 2010) to 3.27% as of this writing. The 86 bps increase in yield in a short span reflects the market's assessment of likely improvements in economic conditions during the months ahead and the impact of a projected increase in supply of Treasury debt as a result of the compromise tax deal President Obama announced yesterday.
Corporations, Give Thanks - With 'Enemies' Like This, Who Needs Friends?
by Paul Kasriel of Northern Trust,
On November 23, the Bureau of Economic Analysis updated its analysis of U.S. corporate profits. After-tax corporate profits from current operations hit their highest level, $1.221 trillion, since the beginning of this data series, 1947:Q1. Paul Kasriel gives further analysis.
Commodity Prices: What is Likely Impact in the United States?
by Asha Bangalore of Northern Trust,
The S&P GSCI commodity index has moved up 11.3% from a year ago on November 19, 2010 (see Chart 1). The trade weighted dollar declined 1.2% from a year ago as of November 12, 2010. The immediate inference is that the extent of gains in the commodity price index is larger than the decline of the dollar. By implication, commodity price gains reflect more than the depreciation of the greenback.
Is Inflation Lurking Around the Corner?
by Asha Bangalore of Northern Trust,
An inflationary threat is not lurking and nor are the current readings of inflation at levels the Fed needs to fret about in the near term. The Fed has traditional tools (raise reserve requirements, raise the federal funds rate or undertake open market sales of securities) and a new instrument, raising the rate paid on excess reserves. The probability of delayed action to address rising prices is small and will occur only if unemployment continues at an unacceptably high level. Inflation hawks cannot support their contention that QE2 is tinder for future inflation.
I Wonder What Milton Friedman and Karl Drunner Would Say About Allan Meltzer
by Paul Kasriel of Northern Trust,
On November 9, I wrote a commentary entitled ''Quantitative Easing in the mid 1930s Appeared to be Successful''. In my commentary, I did not mention what happened to the U.S. unemployment rate as a variation on quantitative easing was taking place. So, let?s do this now.
I Am Shocked, Shocked that the QE2 is Akin to Printing Money and Public Debt Monetization!
by Paul Kasriel of Northern Trust,
Whenever the sum of Federal Reserve and commercial banking system credit increases, credit is being created out of thin air and debt is being monetized. The magnitude of the credit creation being contemplated by the Fed is not extraordinary in an historical context. It is not an extraordinary increase in credit creation given the current amount of resource underutilization in the U.S. economy. Being shocked by the implications of QE2 with respect to ?printing money? and the ?monetization of debt? would appear to be either nave or hypocritical.
They Just Don't Get It
by Paul Kasriel of Northern Trust,
Had the Fed said that QE2 would involve the purchase of $600 billion of Treasury bills rather than Treasury coupon securities, we could have avoided this phase of uninformed criticism of the policy. Of course, the chorus of critics would have complained that by the Fed purchasing bills rather than coupons it was not affecting the ?important? part of the yield curve.
The Quantitative Easing in the mid 1930s Appeared to have been Successful
by Paul Kasriel of Northern Trust,
There is much skepticism as to whether the Fed?s second round of quantitative easing, QE2, will be effective in stimulating the nominal demand for goods and services in the U.S. economy. Keying off Mark Twain?s aphorism that although history may not repeat, it often rhymes, perhaps we can get some guidance as to whether QE2 will be successful from the results of the quantitative easing that was initiated in the second half of 1933.
QE2 Is Likely to Be More Successful than QE1
by Paul Kasriel of Northern Trust,
The theory behind quantitative easing is that an increase in the quantity of combined central and commercial bank credit will lead to an increase in nominal aggregate spending on goods, services and assets. Indeed, the correlation coefficient between percentage changes in the annual average of combined Federal Reserve and commercial banking system credit and the percentage changes in nominal U.S. GDP from 1960 through 2006 is relatively high, at 0.62. This correlation coefficient is reduced to 0.49, however, when the period is extended through 2009. Northern Trust explains why.
A Refresher Before Fed's Announcement of Second Round of Quantitative Easing
by Asha Bangalore of Northern Trust,
The Federal Reserve is widely expected to announce the second round of quantitative easing after the Federal Open Market Committee meeting on November 4. The goal of QE2 will be to bring about an increase in real GDP above the tepid 2.0 percent pace reported for the third quarter, as well as bring down the 9.6 percent unemployment rate. The reputation of the Bernanke Fed largely rests on the success of this new policy. Northern Trust present charts of Treasury bond yields since 2007, with markers for major monetary policy events.
Employment is Main Focus of Fed Policy
by Asha Bangalore of Northern Trust,
The Fed is widely expected to announce the details of the second round of quantitative easing following its two-day meeting ending November 3. Advocates of QE2 expect lower interest rates to lift all interest-sensitive expenditures, including home purchases, mortgage refinances and business expenditures. In addition, bankers could be more likely to lend given paltry earnings from excess reserves and Treasury securities. Finally, the benefit of increased exports from a depreciation of the dollar may reflect in headline GDP.
The Effectiveness of QE2 Depends on Quantities, Not Interest Rates or Exchange Rates
by Paul Kasriel of Northern Trust,
The level of U.S Treasury security interest rates or the level of the U.S. dollar foreign-exchange rate are not the correct way to think about the prospective effectiveness of QE2. What transpires with respect to commercial bank credit will determine the effectiveness of QE2 in increasing aggregate demand for U.S. goods and services.
The Real Economic Cost of Government Is Spending - So, What Do You Want to Cut?
by Paul Kasriel of Northern Trust,
Because the private sector generally uses productive resources more efficiently than the government does due to competitive pressures, the economy's long-run potential real economic growth rate is hurt by increases in federal spending. The largest projected increase in spending by an order of magnitude over the next decade is for entitlement programs - Social Security, Medicare and Medicaid. Millions of baby boomers will become eligible for Social Security and Medicare benefits over the next 10 years. Northern Trust also discusses home sales, employment and leading economic indicators.
Ten Questions: USA vs. Japan
The combination of lackluster growth and disinflation in the U.S. has led to comparisons with Japan's dire experience following the collapse of asset prices in the 1990s. A frequent question is whether Japan's 'lost decade' will play out in the United States. The Q&A included in this commentary identifies similarities and differences between the experiences of the two countries, with an emphasis on the recovery path. It appears that the U.S. is unlikely to mimic the economic path of Japan in the 1990s.
Michael Boskin?s Summer of Economic History Amnesia
by Paul Kasriel of Northern Trust,
Michael Boskin, former chairman of the President?s Council of Economic Advisers under George H.W. Bush, argues in a recent editorial for the Wall Street Journal that the current economic recovery is so feeble because of economic policies pursued by the current presidential administration. There is another reason for the relative weakness in the first year of this current recovery, however: the unprecedented contraction in nominal and real bank credit in the post-WWII era.
I Renounce Monetarism (with apologies to Mr. Lippman of Pendant Publishing)
by Paul Kasriel of Northern Trust,
Monetarists such as Milton Friedman hold that the M2 money supply is a leading indicator of aggregate demand. Indeed, from 1960 through 1989, the price-adjusted M2 money supply had a relatively high correlation with real aggregate demand for goods and services. As charts presented in this commentary illustrate, however, from 1990 through the second quarter of 2010 the correlation between real M2 and real final sales of domestic product deteriorated dramatically.
Nitty Gritty Details of the Labor Market Make Headlines
by Asha Bangalore of Northern Trust,
The elevated 9.5 percent official unemployment rate and the broader 16.5 percent jobless rate highlight the dire status of the labor market even after four quarters of economic growth. Financial markets have yet to follow closely the report on job openings, however, which contains information each month about the total number of job openings, the pace of hiring and separations in the economy. Harvard economics professor Robert Barro discusses the implications of the job openings report in a recent article for the Wall Street Journal.
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