The Federal Reserve increases the Federal Funds Rate

2305 students will be looking at the executive branch and at economic policy making - especially monetary policy - over the course of the semester. This story regarding the Fed touches on both. Let's look at some basic facts before digging into why the Fed did what it did. In a sense, this marks the end of the policies related to addressing the problems stemming from the Great Recession.




Three background questions

So, what is the Federal Funds Rate?

The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation. The Federal Open Market Committee (FOMC), which is the Federal Reserve’s primary monetary policymaking body, telegraphs its desired target for the federal funds rate through open market operations. Also known as the “fed funds rate".

While we are at it, what is the Federal Reserve?

The central bank of the United States. The Fed, as it is commonly called, regulates the U.S. monetary and financial system. The Federal Reserve System is composed of a central governmental agency in Washington, D.C. (the Board of Governors) and twelve regional Federal Reserve Banks in major cities throughout the United States.

So what does the Federal Reserve Do?

Current functions of the Federal Reserve System include:

- To address the problem of banking panics

- To serve as the central bank for the United States

- To strike a balance between private interests of banks and the centralized responsibility of government

- To supervise and regulate banking institutions

- To protect the credit rights of consumers

- To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of

- - maximum employment

- - stable prices, including prevention of either inflation or deflation

- - moderate long-term interest rates

- To maintain the stability of the financial system and contain systemic risk in financial markets

- To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system

- To facilitate the exchange of payments among regions

- To respond to local liquidity needs

- To strengthen U.S. standing in the world economy

Learning from mistakes in Houston

The Atlantic tries to figure out what drives job growth in Houston - which is by far the largest than in any other city as you can tell from this graph:


Its link to the energy play a big role, but they highlight Houston's ability to learn from past mistakes. This is especially true of its ability to not repeat what lead to the recession Houston suffered from 1982 to 1987.

First, oil companies did not lay off too many workers after the 2008 crash.

Houston's energy sector is remarkably old -- the average age is over 50 -- and companies were nervous about laying off too many veteran workers before they had time to pass their skills down to the younger generation. Houston's energy demographics "helped to moderate energy industry job losses," leading to fewer job losses overall.

Second, policies were put in place to ensure that a housing bubble would not develop.

The 1980s also taught Houston a lesson about real estate. Between 1982 and 1987, Houston suffered "one of the worst regional recessions in U.S. history," Jankowski said. The metro area lost more than 220,000 jobs -- one in seven in the region -- but added nearly 188,000 housing units, as developers ignored the signs that demand had plummeted. The results were disastrous and scarring for the real estate industry.

Houston avoided over-building problems in this recession by tightening lending and home construction in the early years of the crisis. Houston didn't really have a housing bubble in the 2000s. The ratio between its median house prices and median household incomes peaked at 2.7 in 2006. By comparison, a typical Miami family would have to spend five-and-a-half years of their total income to afford an average home in the city by 2006. In Riverside, it would take nearly seven years. So as housing values cascading all across along the Sun Belt -- by 40 percent percent in Miami and 44 percent in Riverside -- they merely dipped about 2 percent in Houston.

Is federal spending really out of control?

Ex Reagan and HW Bush official Bruce Bartlett says no. Except for interest payment on the debt, federal spending is stable if it is looked at as a percentage of GDP, which tends to grow despite the recent setback.

Click to the story here. He offers this chart, with data based on a report linked to in his article:



And this commentary:

. . . we see that spending for every single government program going forward is remarkably stable as a percentage of GDP. Those who complain loudest about spending and deficits nearly always base their concerns on projections of nominal spending that are unadjusted for inflation, growth of the population or growth of the economy. This is intellectually dishonest.

In fact, virtually all the growth in projected spending comes not from entitlements or giveaways to the poor and lazy, as Republicans would have us believe, but rather from interest on the debt. This is a problem, but not nearly to the extent that it appears.

The reason is that interest on the debt is what economists call a pure transfer. Economically, it is little different from taking money out of your right pocket and putting it into your left pocket. That is because the vast bulk of interest goes to people and institutions who simply use it to buy more Treasury securities.

Not that it's all paid for of course, or that someone might raise a stink about what the programs do, but his point is simply that spending as projected now is stable when compared to GDP - a point that is quite often made. Data can be presented in different ways to try to make different points.

Since we cannot project events like terrorist attacks and recessions, we don't know what will actually occur. Notice that the lines are far more volatile prior to 2012 than after it. The peaks and valleys are the result of changes in the economy, but they do seem to vary in a manner that averages out to the base line he draws going forward. The spike just before 2010 is the spending related to the Great Recession. This points out the need to be mindful of policies that lead to the creation of bubbles.

- The Dish comments here.

Meet California City, California

One of the Fiscal Times' top 9 recession ghost towns:

The Federal Reserve to Hold Interest Rates Down Until the Unemployment Rate Goes below 6.5%

Story in the NYT and Washington Post.

This marks a significant shift for the Fed. It will no longer focus strictly on inflation. It will also now take unemployment into account. This was part of its original mandate.

From the Atlantic: The U.S. Recovery Has Been Spectacular*

This builds on the point made in a post below. The caveat here is that the US recovery only looks good compared to the recovery of other nations.

American policymakers have simply done less harm than their counterparts abroad. Not that our policy has been perfect. Austerity at the state and local level and not aggressive enough monetary policy have put too low a speed limit on our recovery. But at least we've avoided British-style austerity and Japanese-style tight money -- or both, like Europe.

If you want to feel even better about our subpar recovery, just look at how it compares to other recoveries from financial recoveries. As Ken Rogoff and Carmen Reinhart have famously demonstrated with eight centuries of data, these recoveries are almost always frustratingly slow. The chart below, from my colleague Derek Thompson, shows just how much better we're doing this time around compared to the other big crises of the past century.

The Recovery in the US beats that in Europe.

The Dish and Paul Krugman point out that the economy in the US has outpaced Europe's since the recession. They use this to argue against austerity. They offer some graphs to back up their points. Unemployment and GDP are better in the US than elsewhere:

The June Jobs Report

This is a few days late.

- The news release from the Department of Labor.
- Related story in the NYT.
- A compilation of reactions from Andrew Sullivan.

Since this is election season, there's no guarantee that Congress will do anything to remedy this - but the Federal Reserve - unaffected by elections - can.

Ezra Klein:

The question now is whether these numbers will change our economic policy. In Congress, the answer is almost certainly not. So, much as the data makes an overwhelming case for, say, hiring hundreds of thousands of workers to rebuild the nation’s infrastructure, or passing a large employer-side payroll tax cut to goose hiring, there’s little chance House Republicans will greenlight either policy response.

But with Congress largely on the sidelines, inflation low, and the labor market recovering, there’s a stronger and stronger case for the Federal Reserve to step in more aggressively. “The big question is whether this is a weak enough report to get the Fed to move,” writes economist Justin Wolfers. “I think it is, and they will.”

Absolute poverty in the US is getting worse.

Something to tack onto 2302s look at social welfare policy. Via Andrew Sullivan.

- The Recession and Extreme Poverty.
- Poor and Getting Poorer.

Recessions, in fact, appear to affect disproportionately the extreme poor, rather than those closer to the federal poverty threshold or the "near poor," those whose income is less than twice the federal poverty threshold.

Consider this: in 2010, 6.7 percent of Americans were among the extreme poor, as compared to 5.2 percent in 2007 and 4.5 percent in 2000. That's a 50 percent increase in the fraction of extremely poor individuals -- the greatest increase, by far, of any income group relative to the poverty threshold.
The comments are worth perusing.

Fed to extend Operation Twist

From the Washington Post:

The Federal Reserve on Wednesday renewed a program designed to provide a push to economic growth amid a warning that hiring is slowing.

The Fed said it would extend “Operation Twist,” a program that seeks to reduce long-term interest rates, through the end of the year. The decision was a sign that the Fed is not pulling back from its years-long campaign to support the U.S. economy.

In its policymaking statement, the Fed said “growth in employment has slowed in recent months” and made clear it is “prepared to take further action” in the future.

The Fed “anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate,” the statement said. “Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”
- Definition: Operation Twist

The Fed unlikley to act on the economy when it meets this week.

The story is in the Fiscal Times. Last week - in 2302 - we discussed monetary policy and the role of the Fed in regulating the macro economy. We especially noted that since it is an executive institution that already has a mandate to act by Congress, it is free from the political constraints common in Congress. That doesn't mean it will always act however.

Here's proof:

Even though the jobless rate is far above that mark, don’t expect any bold new steps this week. Here are the three main reasons why the Fed won’t act:

1. The Slow-Boil Euro Crisis
2. Growth has Slowed, not Stopped
3. The Fiscal Cliff Ahead.

We should discuss in class. This adds to our query about whether government can actually work.

Federal Reserve Study Reveals that U.S. Wealth Fell 38.8% in 2007-2010 on Housing

The information comes from a report issued by the Federal Reserve. Bloomberg outlines it here. This complicates recovery since less wealth means less purchasing power and less demand for goods and services.

Halftime?

Another depressing read. Some economists have argued that the 2007-2009 recession was a financial in nature, and these tend to be especially nasty. The last was the Great Depression and that took over a decade and the massive federal spending necessary to fight WW2. Japan is still digging out of its financial crash 20 years ago. We might only be in the middle of ours.

But according to the author, there are other factors at play which will delay recovery. These include an aging population, debt, and the economy's ongoing transition to a digital environment.

This should help guide us we approach discussions of public policy. What types of polices can alleviate this? Assuming any can, and we just have to wait it out.

Are we looking at the wrong depression when we try to figure out how to deal with economy?

Economist Stephen Davies suggests that we are, and that the current recession - or whatever it is - look more like the Long Depression of 1873 - 1879, than the Great Depression of the 1930s. This matters because our policy responses as of yet has assumed that the factors driving the current economy are similar to those of the 1930, but these responses might be the wrong ones.

Here's his rationale: What we are going through is a prolonged global contraction driven by the disruptions caused by ongoing consequences of shifts in technology, not a sharp decline in economic activity driven by a lack of liquidity (capital). The same shifts were occurring in the late 19th Century. New technologies replaced the old and the disruptions caused very real pain on those not able to adjust, but ultimately benefited those who could, as well as the country as a whole:

. . . the 30 to 40 years after 1870 saw the advent of technologies that would define modern life, including electricity, the internal-combustion engine, the telephone, the diesel engine, and the modern petroleum industry.

As a result, the official figures are seriously misleading. While nominal wages stagnated or declined, real living standards increased because of the falling cost of products. Output increased, but this is not captured unless one applies a GDP inflator to account for the increasing value of money. So the Long Depression of the 1870s and 1880s was not a simple story of economic standstill.

So what happened? Essentially a set of innovations in technology and business organization made in the later eighteenth and early nineteenth centuries had exhausted their potential to raise productivity and growth by the 1860s. This, combined with mistaken policies, had led to malinvestment and a significant buildup of debt by the early 1870s in both Europe and the United States.

What followed, Irving Fisher argued, was a crisis brought about by the realization that many investments were not going to pay enough and the consequent need for sustained “deleveraging” (paying back or writing off of debt). At the same time there was a burst of technological and organizational innovation. This increased productivity and created many new products but also led to large adjustments as older industries and forms of employment shrank, prompting a large movement of labor. This took some time, so the costs of the transition in human terms were significant.

Is democracy being theatened in Europe?

Paul Krugman thinks so:

Last month the European Bank for Reconstruction and Development documented a sharp drop in public support for democracy in the “new E.U.” countries, the nations that joined the European Union after the fall of the Berlin Wall. Not surprisingly, the loss of faith in democracy has been greatest in the countries that suffered the deepest economic slumps.

And in at least one nation, Hungary, democratic institutions are being undermined as we speak.

One of Hungary’s major parties, Jobbik, is a nightmare out of the 1930s: it’s anti-Roma (Gypsy), it’s anti-Semitic, and it even had a paramilitary arm. But the immediate threat comes from Fidesz, the governing center-right party.

Fidesz won an overwhelming Parliamentary majority last year, at least partly for economic reasons; Hungary isn’t on the euro, but it suffered severely because of large-scale borrowing in foreign currencies and also, to be frank, thanks to mismanagement and corruption on the part of the then-governing left-liberal parties. Now Fidesz, which rammed through a new Constitution last spring on a party-line vote, seems bent on establishing a permanent hold on power.

He presents a textbook case in how to establish a tyrannical totalitarian government:

Fidesz [the new ruling party in Hungary] is relying on overlapping measures to suppress opposition. A proposed election law creates gerrymandered districts designed to make it almost impossible for other parties to form a government; judicial independence has been compromised, and the courts packed with party loyalists; state-run media have been converted into party organs, and there’s a crackdown on independent media; and a proposed constitutional addendum would effectively criminalize the leading leftist party. Taken together, all this amounts to the re-establishment of authoritarian rule, under a paper-thin veneer of democracy, in the heart of Europe.

It sucks to be a millennial

From the Atlantic, an article detailing the impact the current recession is having on the Millennial Generation.

Does consumer spending drive the economy, not private investment?

Here's an argument that it does - and it goes against recent economic theory (but one of the consequences of economic events like the Great Recession is a rethinking of economic theory):

AS an economic historian who has been studying American capitalism for 35 years, I’m going to let you in on the best-kept secret of the last century: private investment — that is, using business profits to increase productivity and output — doesn’t actually drive economic growth. Consumer debt and government spending do. Private investment isn’t even necessary to promote growth.

This is, to put it mildly, a controversial claim. Economists will tell you that private business investment causes growth because it pays for the new plant or equipment that creates jobs, improves labor productivity and increases workers’ incomes. As a result, you’ll hear politicians insisting that more incentives for private investors — lower taxes on corporate profits — will lead to faster and better-balanced growth.

The general public seems to agree. According to a New York Times/CBS News poll in May, a majority of Americans believe that increased corporate taxes “would discourage American companies from creating jobs.”

But history shows that this is wrong.
Read on, we will discuss this in 2302.

No Double Dip?

The economy grew 2.5% in the third quarter. This is not enough to regain lost jobs, but its positive territory.

Andrew Sullivan links to useful commentary.

Recession impact revised, it was worse than thought

From the NYT:

Data revisions going back to 2003 . . . showed that the 2007-2009 recession was deeper, and the recovery to date weaker, than originally estimated. Indeed, the latest figures show that the nation’s economy is still smaller than it was in 2007, when the Great Recession officially began.

Adapt or Die—Some Jobs Are Never Coming Back

Adapt or Die—Some Jobs Are Never Coming Back.

And those that are, do not pay well.