Fed Focus

Mismatch Redux

It’s encouraging to see Chairman Bernanke continue his pushback against Minneapolis Fed President Narayana Kocherlakota’s theory of structural unemployment in his speech this week:

Research has found that during and immediately after the serious recessions of 1973 to 1975 and 1981 to 1982, the Beveridge curve also shifted outward, but in both cases it shifted back inward during the recovery.  This temporary outward shift during a deep recession may be the result of a particularly sharp increase in layoffs, which raises unemployment quickly, even as vacancies adjust more slowly.”

That’s a point we’ve been making since Kocherlakota first advanced his jobs mismatch theory back in August 2010. ( For more information, see: Mismatching the Facts http://tlrii.typepad.com/theliscioreport/2010/09/mismatching-the-facts.html )


by Philippa Dunne· · 0 comments · Fed Focus

Without fiscal policy, what’s the Fed to do? Part 1

All evidence suggests to us that when the FOMC finally takes its first long-anticipated step, it will be to take us away from the zero bound, not because they fear the economy is getting too hot, or that there is any real danger of wage inflation, let alone unaggregated healthy wage growth.

In the fall of 2012, current and former Federal Reserve officials, as well as closely affiliated academics, made it clear the central bank is currently “confronted…with a situation that was regarded a few decades ago as merely a theoretical curiosity”: the zero bound.

In one of those papers John Woolford, former member of the New York Fed’s Monetary Policy Advisory Council (and the source of that quote) raised questions about the effectiveness of balance-sheet policies, advocating instead for forward guidance, while acknowledging the danger in central bankers talking too much. Other papers questioned quantitative easing’s ability to do anything about the unemployment rate, noted that the Fed may have fewer options than it suggests, and rang the warning bell on trying to correct macro-economic problems that have historically been addressed through fiscal and monetary policy by monetary policy alone, a bell former Chair Bernanke starting ringing before he left office. Chicago Fed President Charles Evans urged the FOMC to articulate what needs to be done as a first step toward pushing for the fiscal and monetary policies he deemed necessary to get us past the zero bound.

Evans also urged the Fed to adopt a 7/3 policy, where they would maintain their current policy as long as unemployment remained above 7% and inflation below 3%, which he called “an important improvement on current communication policy.”

Better communication policy perhaps, but it would still have left the FOMC in the same position it finds itself in today: we’ve crossed the unemployment rate threshold, but not the inflation bar.

Only the most reckless daredevil would enjoy spending so much time pushed up against the zero bound, but the way out remains the subject of contentious debate and reams of research. The vehemence of the debate, perhaps more of a slugfest, is fueled by the fact that on the other side of the scale, the fiscal side, we have a largely dysfunctional and distrusted government. We’re trying to hash out what should be considered national priorities in a dust-up about fiscal policy.


by Philippa Dunne· · 0 comments · Fed Focus

Distributional effects of ultra-low rates, Part 2

Somewhat humorously, the zero-bound is succeeding where our political system is failing: general discontent has given us some pretty strange bedfellows. The more hawkish voices of course want a more aggressive policy, and are being joined by a growing number of more progressive types who’d like to see corporations making money the hard way—developing new ventures and investing in labor and productivity—instead of through the financial engineering enabled by extremely  low rates.

In a 2013 paper, “QE and ultra-low interest rates: Distributional effects and risks,” McKinsey estimated that in the US, the UK, and the Eurozone governments had garnered about $1.6 trillion while households lost about $630 billion in net interest income by the end of 2012. The authors note that some of those governmental profits fueled the automatic stabilizers, and broke out demographic groups by age, not income. The young were gainers and the old, losers. For households under age 35 who are net borrowers, the gain from lower rates has averaged $1,500 a year; for 35–44, $1,700. But older households with significant interest-bearing assets were losers. Those aged 65–74, -$1,900, and over 75, -$2,700. For the oldest group, that was a hit of 6% of income; for the youngest, a gain of almost 3%. 

They note that non-financial corporations also benefitted, by about $710B, but that had yet to translate into investment, probably because the recession lowered demand expectations. At the time they reckoned the benefit boosted profits by about 5%, one-fourth of the gain since 2007. McKinsey argues that effects of near-zero rates on asset prices were "ambiguous,” but at least in the recent U.S. instance, we’re not really convinced.

As logic would predict, they forecast a reversal of these benefits as interest rates rise. Even with large percentages of fixed-rate mortgages, the authors estimate that in the US household debt service could rise by about 7% for each 100-basis-point increase. The younger net debtors would lose the largest benefit, while the older asset holders gain share. The more capital-intensive industries, utilities, manufacturing, extraction, would take the biggest hit, and this was all before oil prices fell, but companies that “use capital productively,” will be rewarded. What a concept.

 And they forecast an increase in market volatility. No genius points for that, but a nice change.

The Federal Reserve’s most recent Survey of Consumer Finances, for 2013, tells us that increased interest income will be narrowly distributed across households. Although most recent data show that 13.8% of households own stocks directly—which rises to 48% if you include mutual funds and the like—only 1.4% of households own bonds directly. The SCF doesn’t report on bonds owned through mutual funds, but applying the indirect/direct ratio prevailing in stocks to bonds gets us only to 5% of households. About 2% of the middle decile owns bonds (9.2% own stocks), and 6.9% in the top decile. The Fed doesn’t even include a number for bond ownership for the lower decile because it’s very tiny, and the authors note that families in the highest 40% of the income distribution own bonds disproportionately, though much of that is savings bonds. “Ownership of any type of bond other than savings bonds is concentrated among the highest tiers of the income and wealth distributions,” they say.

Debts are more equally distributed. Half—52%—of the bottom 20% is in debt; 84% of the top decile. But the top has a leverage ratio (debt/income) of 8%, compared with 19% at the bottom. Leverage ratios are highest in the middle of the distribution.

Really, what jumps out at you putting this stuff together are the details, like the fact that the fraction of young families with education debt increased from 22.4% to 38.8% between 2001 and 2013, and the fraction of middle-income families who  saved fell significantly.

by Philippa Dunne· · 0 comments · Fed Focus

Thinking about the Fed, Wages, Part 3

 Those urging the Federal Reserve to delay include those who believe the economy is too fragile to withstand any increase in rates, and that our more vulnerable workers will take the hit, and those who believe the stock-market will be in for a fall. 

 We’ve argued the weak wage case repeatedly, and will spare you a recap. Some of our most respected analysts argue that wage increases are a late-cycle rear-view mirror phenomenon in an ordinary cycle, and we agree. But our own analysis of the current recovery suggests that the labor market will take a while more to follow historical metrics. We will cite, however, a recent paper by former Bank of England advisor and Dartmouth professor (among other things) David Blanchflower and Andrew Levin, currently at the IMF but moving to Dartmouth in the fall, in which they publish some new results on underemployment and wages drawn from state-level data. In a nutshell, they find that a decrease in broadly measured labor-market slack does not increase wage pressure if the level of slack remains high, and assert that starting the tightening process would be premature, and should be held off until labor market slack decreases significantly and inflation comes closer to the FOMC’s goal of 2 percent.

Considering its recent performance (see below), if the stock market can’t withstand up to a 1% increase in the policy rate, we’d better find that out. 

The environment of super-low rates and high liquidity has encouraged all kinds of financial machinations. The withdrawal of that indulgence, we hope, will encourage economic actors to focus  on more productive long-term activity. We suspect that a move from abnormally low rates to still very low rates won't derail the welcome increase in capital spending we have seen recently. 

We support concern about the effect the first move may have on the improving job market–it still has a way to go. A recent SF Fed piece suggests a few more years to true health.  That makes it a real shame that there's little possibility of a productive fiscal compromise: a focused business and low-inflation friendly infrastructure/retrofitting project that could offset the potential pressure on our workforce as rate increases turn the corner. Not to mention some relief from the ever increasing flat tire rate caused by old degraded roadways.

by Philippa Dunne· · 0 comments · Fed Focus

Bad News from the SF Fed

The last thing we want right now is a study from a regional federal reserve bank with the headline, "Jobless Recovery Redux?" and a subhead, "Reasons for pessimism," but that's what we have from the SF Fed, and it's hard to argue with their logic.

Researchers Mary Daly, Bart Hobjin, and Joyce Kwok consider three labor market indicators–flows in and out of unemployment, involuntary part-time employment, and temporary layoffs–to project how the unemployment rate may behave when the anticipated recovery begins.

They point out that before the 1991 recession, increases in the inflow rate, the speed at which workers move into unemployment, and decreases in the outflow rate, the pace at which they find jobs, were nearly equivalent in relative terms during recessions. The resultant sharp increases in the unemployment rate were followed by rapid recoveries as firms hired back workers in improved conditions.

Increases in the unemployment rate in the 1991 and 2001 recessions, however, were driven by disproportionate declines in the outflow rate, making lack of hiring the primary culprit.  And recoveries diverged from the established pattern as well: outflow rates recovered much more slowly than they had in pre-1990 recoveries.  In fact, the authors cite several studies showing that current business-cycle fluctuations in the unemployment rate are driven primarily by the outflow rate.

The current recession is particularly nasty because the outflow rate is at an historic low and the inflow rate is rising in line with the recessions of the 1970s and 1980s-actually, it's shooting straight up at present-both  contributing to an extremely weak labor market.

The authors evaluate several possibilities for the future. Their benchmark, no change in the outflow/inflow rates, would bring us to 10% unemployment by 2010. The "Blue Chip" consensus included in the paper posits an employment recovery slightly weaker than that of 1983 and a bit stronger than that of 1992, bringing the unemployment rate to 10% in early 2010, from where it would begin to decline.  But if inflow/outflow rates behave as they did in 1992, unemployment would peak around 11% by summer of 2010, and remain above 9% through 2011.

And that's where temporary layoffs and involuntary part-time work come in. In the current recession those working part-time for economic reasons has risen dramatically and to an historical high, from 3.0% in December 2007 to 5.8% in April 2009, with significant reductions in hours across broad sectors. At the same time the share of workers on temporary-as opposed to permanent-layoff is very low. In fact it actually fell from 12.9% in Dec-07 to 11.9% in April-09. (Generally the share of workers on temporary layoffs rises during recessions: it increased from 16.1% to 20.7% between July 1981 and November 1982.)  So with few workers on temporary lay-off waiting in the wings, and a large number working part-time against their wills, it seems logical that employers will expand the hours of partially-idled workers instead of taking on new employees. The authors formulate their forecast for the unemployment rate by adding the linear relationship between part-time employment and the unemployment rate between Dec-07 and April-09 to the Blue Chip consensus. This suggests labor market slack will be higher by the end of the year than at any time since WWII, the outflow rate will be historically low, and the unemployment rate will be sticky. In other words, Jobless Recovery III.

Full report here: 
by Philippa Dunne· · 0 comments · Fed Focus