Serena Ng and Jonathan H. Wright: Facts and Challenges from the Great Recession for Forecasting and Macroeconomic Modeling: Noted

Serena Ng and Jonathan H. Wright: Facts and Challenges from the Great Recession for Forecasting and Macroeconomic Modeling:

This paper provides a survey of business cycle facts, updated to take account of recent data. Emphasis is given to the Great Recession which was unlike most other post-war recessions in the US in being driven by deleveraging and financial market factors. We document how recessions with financial market origins are different from those driven by supply or monetary policy shocks. This helps explain why economic models and predictors that work well at some times do poorly at other times. We discuss challenges for forecasters and empirical researchers in light of the updated business cycle facts.

Wolfgang Munchau: Do not kid yourself that the eurozone is recovering: Noted

Wolfgang Munchau: Do not kid yourself that the eurozone is recovering:

The main constraint on the resumption of growth is the failure to clean up the banking sector. Europe’s political leaders have seized on the first uptick in European economic indicators as evidence that their policies are working. Who would have thought that? Eurozone gross domestic product expanded 0.3 per cent in the second quarter of this year. It will probably have expanded again in the third quarter….

Comparing the first half of 2007 and the first half of 2013, real GDP contracted by an accumulated 1.3 per cent in the eurozone, 5.3 per cent in Spain and 8.4 per cent in Italy. In the same period investment was down by an accumulated 19 per cent in the eurozone – and 38 per cent in Spain and 27 per cent in Italy. Between the first quarter of 2007 and the first quarter of 2013, employment fell 17 per cent in Spain and 2 per cent in Italy. I would not call the end of the recession until we see a sustained improvement in growth and employment….

Italy is stuck with a combination of an unsustainable high level of public debt and no productivity growth. It has essentially two options to adjust--become like Germany, or leave the eurozone. The country is unable to do the first, and unwilling to do the latter. As the economists Francesco Giavazzi and Alberto Alesina calculated in an article in Corriere della Sera last week, it would cost some €50bn to reduce the tax wedge… to German levels. There is simply no political majority in sight for such radicalism…. The country will be able to muddle through for a while….

Meanwhile, the single largest constraint on the resumption of eurozone growth is not fiscal policy--which is broadly neutral at present across the single currency area--but the continued failure to clean up the banks. The growth rate of loans to the non-financial sector turned negative in 2009…. The economy will teeter on the brink of zero or low growth for the foreseeable future because the financial sector is not supplying the economy with sufficient funds to expand….

The recession that started in 2008 continues, once you ditch the silly obsession with two consecutive quarters. It is not about to end.

The Taper and Its Shadow: Central Bankers Need to Explain the Risks of Further Quantitative Easing


We are live at Project Sydicate:

The central banks of the North Atlantic have promised that they will not raise the short-term safe nominal interest rates they control until the economies under their stewardship show substantial economic recovery.

So far the economies have not done so: they continue to be battered by the destructive fiscal headwinds of austerity, by uncertainty over whether the Republican Party will in fact attempts to crash the credit of the United States, by broken systems of residential finance, and by uncertainty about how the burdens of necessary structural adjustment are to be allocated. With all that, it would seem premature for central banks to even begin to talk about adopting a less stimulative monetary posture.

Yet the central banks of the North Atlantic are doing so.

They are not saying that they will break their promises not to prematurely raise interest rates. But they are saying that their tolerance for continuing to enlarge their balance sheets by purchasing long-term bonds for cash is very limited indeed--the so-called "taper".The problem is that financial markets simply do not believe the central bankers when they say that a present desire to "taper" is completely unconnected with any future desire to raise short-term interest rates. Financial markets think, not unreasonably, the same central bankers who grasp now for excuses to cut off quantitative easing now will also grasp for excuses in the future to say that things have changed and that forward guidance promises should not be kept. And financial markets will continue to think this, unless and until central bankers come up with reasons for believing that further extensions of quantitative easing do in fact run substantial risks.

So let us try to help central bankers explain why the taper now is unconnected with future forward-guidance promise breaking. Let us listen for the reasons that further enlargement of North Atlantic central bank balance sheets carries substantial risks:


OK. Let us set out the reasons: The Federal Reserve spend an extra month buying an extra $85 billion of long-term U.S. Treasury securities for cash, and risks are increased because?

Some say risks are increased because financiers will then take that extra cash and invest it abroad, in order to keep such a capital flow from raising the value of their currency foreign central bankers expand their own money supplies and lower their own interest rates, overheating their own economies.

But is this risk the business of the Federal Reserve?

Others say risk is increased because when the Federal Reserve buys Treasuries the financial system responds by extending credit leverage and holding riskier positions in aggregate: a lower price of risk-bearing means, when financiers seek to report positive profits and reach for yield, a larger amount of risk-bearing capacity put to work. But this misses the fact that there is not just a supply of this risk-bearing capacity but a demand for people to accept risks as well. Quantitative easing takes Treasury duration risk off the table, and neutralizes it inside central banks that will hold the securities to maturity. So there is less risk in aggregate for the private sector to hold. Less risk in aggregate means more risk in aggregate? That does not make sense: Who is it that has issued all the risky bonds and taken out all the risky loans to increase the aggregate amount of risk? We simply do not see them. Would that we did, for they would've taken the money and set people to work building assets that they hope would allow them to repay their loans with a healthy profit!

Still others say that risk is increased not for the private sector as a whole, but for systemically-important institutions that are used to having short-term low-interest liabilities and long-term high-interest assets and relying on the law of large numbers to allow them to always hold their long-term bonds to maturity and thus to risklessly profit off the spread--at least in the absence of a financial crisis, in which they would be bailed out anyway. But which are the particular institutions that are creating this systemic risk? If they are commercial banks, then the appropriate policy is to send in the bank examiners to make sure they are not taking undue risks with government-insured deposits, and to ready the FDIC to put them in receivership if necessary. If they are universal banks and the Federal Reserve policymakers do not trust Dodd-Frank to enable proper resolution and receivership, then should not the Federal Reserve be yelling loudly about Dodd-Frank's shortcomings, rather than sending "taper" signals, which raise interest rates and thus break its mandated commitment to aim for high employment?

Federal Reserve, and other central-bank policymakers, who believe that further extension of quantitative-easing policies poses risks need to explain exactly what those risks are and why we need to guard against them now. If not--if the risks impelling the end of quantitative easing are left vague--then central banks will continue to fail to successfully build a firewall between their policies with respect to the size of their balance sheet and their policies with respect to the future path of interest rates.

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Paul Krugman: What’s It All About Then?: Noted

Paul Krugman: What's It All About Then?:

Simon Wren-Lewis writes with feeling about the “austerity deception“; what sets him off is a post that characterizes the whole austerity debate as being about “big-state” versus “small-state” people. Wren-Lewis’s point is that only one side of the debate saw it that way. Opponents of austerity in a depressed economy opposed it because they believed that this would worsen the depression--and they were right. Proponents of austerity, however, were lying about their motives. Strong words, but if you look at their recent reactions it becomes clear that all the claims about expansionary austerity, 90 percent cliffs and all that were just excuses for an agenda of dismantling the welfare state….

One interesting point which Wren-Lewis gets at… is that the austerity side… doesn’t seem to comprehend the notion that other people might actually argue in good faith. No time to do the link right now, but back when we were discussing stimulus many people on the right, economists like Lucas included, simply assumed that people like Christy Romer were making stuff up to serve a political agenda. And now I think we can see why they made this assumption--after all, that’s how they work.

Simon Gilchrist and Egon Zakrajsek: The Impact of the Federal Reserve’s Large-Scale Asset Purchase Programs on Corporate Credit Risk: Noted

Simon Gilchrist and Egon Zakrajsek: The Impact of the Federal Reserve's Large-Scale Asset Purchase Programs on Corporate Credit Risk:

Estimating the effect of Federal Reserve's announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk--as measured by the CDX indexes--for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.

Peter Orszag: Economy Can’t Be All That’s Slowing Health Costs: Noted

Peter Orszag: Economy Can’t Be All That’s Slowing Health Costs:

A new set of projections released last week by Medicare’s actuaries… suggests the deceleration in the growth of health costs we’ve seen over the past few years is ephemeral… [due] to the “lingering effects of the economic downturn and sluggish recovery” and to increases in cost sharing. Both of these explanations have serious shortcomings….

A macroeconomic explanation is difficult to reconcile with the slowdown in Medicare, because there is no reason to expect Medicare--a subsidy that goes mainly to retired people--to be much affected by the economy. What’s more, the econometric methodology itself, which I have long disliked, was debunked in another paper released last week. Amitabh Chandra and Jonathan Holmes of Harvard University and Jonathan Skinner of Dartmouth… when they made even modest changes in this type of model, the results changed drastically… econometric results are untrustworthy if small specification changes… substantially alter the results….

I’m willing to put some pride, if not money, on the table. The actuaries project that, in 2014, Medicare will grow by more than 5 percent. I bet it will be less than that…. It is also encouraging that the growth in total compensation in the health sector has fallen to between 2 percent to 4 percent annually over the past three years, from 5 percent to 8 percent a decade ago…. Doug Elmendorf, the director of the Congressional Budget Office, summarized the situation trenchantly last week. In comments on the Chandra paper, he noted, “The slowdown in health care cost growth has been sufficiently broad and persistent to persuade us to make significant downward revisions to our projections of federal health care spending.”… The past several years have been encouraging. But we should push for further steps--especially, moving Medicare away from fee-for-service payments--to keep costs decelerating.

Bill Clinton: Summers slandered : Noted

Bill Clinton: Summers slandered:

Bill Clinton says Lawrence Summers, his former Treasury secretary, did not deserve the criticism he received when he was under consideration to be the next chairman of the Federal Reserve. "I think there's this kind of cartoon image that's been developed that somehow Larry Summers was a one-note Johnny, just trying to let big financial titans ravage the land," the former president said in an interview aired Sunday on CNN's "Fareed Zakaria Live." "And it's just ludicrous." Clinton said Summers, who came under criticism from liberals for being too close to Wall Street's largest financial institutions, had accomplished much. Summers has also served as director of the National Economic Council, chief economist of the World Bank and president of Harvard.

"He played a central role in helping President Obama use the power of the government to try to bring the economy back when we were on the brink of just sliding into depression when he took office," Clinton said. "When he worked for me, he played a central role in implementing much more balanced policies than had been let on, where we had more private sector growth, but we also had good, sensible regulatory oversight."

Jon Hilsenrath: Yellen Would Bring Tougher Tone to Fed: Noted

Jon Hilsenrath: Yellen Would Bring Tougher Tone to Fed:

Dick Anderson, who served a brief stint as the chief operating officer of the Fed's Washington board, ending in December 2012, said, "Yellen's abrasive, intimidating style is probably more suited for a 'Mad Men' era as opposed to a modern office environment." Mr. Anderson and Ms. Yellen clashed over a plan he proposed to cut spending by regional Fed banks, which she thought reached beyond his job description and resisted, according to people familiar with the matter. Her style, Mr. Anderson said, sharply contrasted with Mr. Bernanke's style and wouldn't serve the Fed well….

Ms. Yellen has had tense relations at times with Fed Governor Daniel Tarullo, the Fed's point person on bank regulatory issues, according to people who know them. But Ms. Yellen seemed to signal they were on common ground in a speech in San Diego earlier this year when she endorsed his views on regulation….

Ms. Yellen has been a polarizing figure among some Fed staff members in Washington, according to several current and former staff members. An armada of more than 300 Fed staff economists plays a central role in examining the banking system, analyzing the economy and formulating policies. Ms. Yellen led reviews of the Fed's research divisions after becoming vice chairwoman. In the process, several people said, Ms. Yellen ruffled feathers in the Fed's important monetary-affairs group, which was exhausted and depleted by the financial crisis. This group does most of the ground work formulating the Fed's interest-rate decisions.

Kevin Roose: The Fed Decides the Economy Still Sucks: Noted

Kevin Roose: The Fed Decides the Economy Still Sucks:

In a widely unexpected move, the Federal Reserve has decided not to "taper" its bond-buying…. The no-taper decision is sending stocks to all-time highs…. Another Fed, itching to stop abnormal stimulus and shrink the balance sheet, might have plugged its ears…. But this Fed listened…. Part of the reason today's move shocked Wall Street is that this is a much different Fed from the one most traders are used to dealing with. It's a more compassionate Fed, a more holistic Fed, and a Fed that sees its role… filling the gaps where legislators are failing…. The Fed, with few exceptions, is all Yellens now. 

What Are the Risks of Quantitative Easing, Really?


In the financial market there is a demand for risk-bearing capacity by firms and others who want to borrow but who cannot guarantee that they will be able to repay. The higher is the price of risk--the greater the risk premium interest rate spread over short-term Treasuries they must pay--the less they will borrow.

In the financial market there is also a supply of risk-bearing capacity by savers and financial intermediaries who want to lend, and are willing to accept and bear some risk in return from getting more than the short-term Treasury rate. The higher is the price of risk----the greater the risk premium interest rate spread over short-term Treasuries they must pay--the more they will be willing to lend.

When the Federal Reserve undertakes quantitative easing, it enters the market and takes some risk off the table, buying up some of the risky assets issued by the U.S. government and its tame mortgage GSEs and selling safe assets in exchange. The demand curve for risk-bearing capacity seen by the private market thus shifts inward, to the left: a bunch of risky Treasuries and GSEs are no longer out there, as the government is no longer in the business of soaking-up as much of the private-sector's risk-bearing capacity:


And this leftward shift in the net demand to the rest of the market for risk-bearing capacity causes the price of risk to fall, and the quantity of risk-bearing capacity supplied to fall as well. Yes, financial intermediaries that had held Treasuries and thus carried duration risk take some of the cash they received by selling their risky long-term Treasuries to the Fed and go out and buy other risky stuff. But the net effect of quantitative easing is to leave investors and financial intermediaries holding less risky portfolios because they are supplying less risk-bearing capacity.

How do we know that they are holding not more but less risky portfolios? We know because we know that supply curves slope up, and if they were holding more risky portfolios in total--supplying more risk-bearing capacity to the market--the price of risk would have not fallen but risen, and interest rate risk spreads would be not lower but higher, wouldn't they?

So when the intelligent and thoughtful Mark Dow tweets:

I, too, think risks [of QE] overstated, but they're non-zero. Main ones r credit leverage buildup…

I am at a loss. As long as supply curves slope up, QE does not increase but reduces the leverage of private-sector financial asset holders.

And when the intelligent and thoughtful Mark Dow tweets:

I, too, think risks overstated, but they're non-zero. Main ones r… outsized int'l capital flows

I am again at a loss. Yes, the Federal Reserve has taken some domestic risky assets off the table. Yes, U.S. financial intermediaries and savers will respond by buying foreign assets to so deploy some of their now-undeployed risk bearing capacity. Yes, they will now bear some exchange-rate risk. But, once again, the fact that QE pushes interest rate spreads down is very powerful evidence that these capital flows are not "outsized"--that the extra exchange-rate risk U.S. financial intermediaries have now taken onto their books is less than the duration risk that QE took off of their books.

At least, that is the case as long as the supply curve for risk-bearing capacity slopes up, like a good supply curve should.

Perhaps those who claim that there are big risks to quantitative easing regroup. Perhaps they claim that financial intermediaries are perverted, and that the lower is the price of risk the greater is the amount of risk-bearing capacity they supply to the market because they lose their jobs if they don't make at least three cents on every dollar of assets in a normal year in which risk chickens come home to roost.

In that counterfactual world, the supply-and-demand graph would look like this:


And in that counterfactual world, the Federal Reserve's adoption of quantitative easing policies triggered an enormous expansion of the quantity of risk-bearing capacity demanded by firms and households and a huge private-sector lending boom as firms issued enormous tranches of risky bonds and as firms and households took out risky loans. In that counterfactual world, employment in bond underwriting tripled as $85 billion a month in QE was more-than-offset by an extra $120 billion a month in private-sector bond issues. In that counterfactual world, we saw a rapid recovery of housing construction and a thorough equipment investment boom as far across the U.S. as they eye could see.

That didn't happen.

So what are the risks of QE?

It really seems to be this:

  • Commercial banks traditionally accept deposits, put the deposits in long-term Treasuries, rely on the law of large numbers and on deposit insurance to allow them to always hold their long-term Treasuries to maturity, and so have a riskless and profitable business model.
  • When commercial banks cannot do this, they find some way to gamble with government-insured deposits.
  • ????
  • LOSS!!

But this is not a source of systemic risk: because the deposits they may be gambling with are government insured by the FDIC, no run on the banking system or the shadow banking system occurs when risks come due. It would be embarrassing, yes. And the proper response to thinking that commercial banks are running undue risks with government-insured money is to send in the bank examiners--not to undertake policies that raise unemployment.

So put me with Ryan Avent, who tweets:

[The] risk [is that] of not being considered a [very] serious person by peers [unless you claim to greatly fear the risks of quantitative easing]

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