Why did the Fed raise the Federal Funds Rate?

It appears they believe the economy has recovered to the point where it is warranted. There is political debate about whether this is correct, but the Fed issued a statements explaining their reasoning. There appears to be a concern that the current trajectory of the economy might lead to inflation - over 2% - down the road. The increase is an early adjustment to ensure that does not occur.

- Click here for the statement.

Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

For commentary:

- CNBC: FED RAISES RATES BY 25 BASIS POINTS, FIRST SINCE 2006.
- Market Watch: OK, the Fed’s raised interest rates — now what?
- Nerd Wallet: Federal Funds Rate: What Rising Interest Rates Mean for You.
- Wall Street Journal: Fed Plans to Signal Gradual, Cautious Path on Rate Hikes.

From the Atlantic: The Zombie Numbers That Rule the U.S. Economy

In 2305 we looked briefly at the budgeting process and will also look at economic policy making soon enough. Both make use of numbers that purport to tell us how the economy is doing - but here's a suggestion that those numbers are misleading.

- Click here for the article:

We act as if they are markers from time immemorial, but in fact they were invented for modern industrial nations after the Depression and World War II and are now seriously outdated.

Take gross domestic product. Derived from formulas set down by the economist Simon Kuznets and others in the 1930s, its limitations have long been recognized, none more eloquently than by Robert F. Kennedy in a famous speech in 1968 when he declared that it measured everything except that which is worth measuring.

GDP treats all output as a positive. When you buy LED lights that obviate the need to spend on incandescent bulbs and reduce energy consumption, GDP goes down and what should be an unmitigated good becomes a statistical negative. If a coal company pollutes a river, the cleanup costs are positive for GDP, as are any health care costs for those harmed.

What’s more, we have also come to assume that with output comes more spending and employment, but factories today are powered by robotics and software, and robots don’t buy more lattes and shoes.

GDP is a good number for a nation that produces lots of stuff made by lots of workers, but for an information economy grounded in services and intellectual property and awash in apps that cost nothing yet enable commerce, it is not up to the task. Nor are many of our indicators. Our trade figures treat an iPhone made—more accurately, assembled—in China with no reference to the intellectual property created by Apple in California.

From Bloomberg: Five Reasons to Fear the Debt Ceiling

A quick primer:

1. Global markets will see the U.S. government as grossly and dangerously incompetent.2. Forced spending cuts will kill the economic recovery.3. The U.S. government might actually default on its debts.4. A default could trigger a global crash.5. The government’s fiscal problems will only get worse.

Many House Republicans doubt default will result in economic crisis.

From the NYT:

As President Obama steps up his declarations about the dire consequences of not raising the debt limit, increasing numbers of Congressional Republicans are disputing that forecast, as well as the timing of when the Treasury might run out of money and the implications of a default, further complicating the negotiating situation for both Mr. Obama and Speaker John A. Boehner, who must find a way out of the impasse.

Both men were counting on the prospect of a global economic meltdown to help pull restive Republicans into line. On Wall Street, among business leaders and in a vast majority of university economics departments, the threat of significant instability resulting from a debt default is not in question. But a lot of Republicans simply do not believe it.

A surprisingly broad section of the Republican Party is convinced that a threat once taken as economic fact may not exist — or at least may not be so serious. Some question the Treasury’s drop-dead deadline of Oct. 17. Some government services might have to be curtailed, they concede. “But I think the real date, candidly, the date that’s highly problematic for our nation, is Nov. 1,” said Senator Bob Corker, Republican of Tennessee.

Others say there is no deadline at all — that daily tax receipts would be more than enough to pay off Treasury bonds as they come due.

One critics calls them debt ceiling truthers.

Has austerity hampered economic growth?

Here is an argument that it has.

In recent recessions, government spending has increased. Not in the current recession. Here's one factoid. Government jobs have been cut, which keeps the unemployment rate high. In previous recessions they increased.



A CBO report argues that austerity has cut GDP growth by .8 percent.

Two theories about what's ailing the US economy

Both look at factors that retard the ability of people to spend, whcih is critical in a consumer based economy like ours.

1 - It's high student debt:

Nowadays, younger Americans are becoming less likely to take out loans to buy a house or a car. One possible reason? They’re too overloaded with student debt.

. . . student debt has grown dramatically over the last decade — some 43 percent of Americans under the age of 25 had student debt in 2012, with the average debt burden now $20,326. By contrast, back in 2003, just 25 percent of younger Americans had debt, and the average burden was $10,649.

What’s particularly notable is that these student loans appear to be crowding out other types of borrowing. For a long time, younger Americans with student debt were more likely to own homes than those without — largely because college grads are likelier to have higher earnings. But that trend has reversed . . .

2 - It's underwater mortgages:

It is widely recognized that the fall in housing prices had a “wealth effect” that led homeowners across the country to cut back on spending. In the updated paper, Mian, Sufi and Rao measured how much more underwater borrowers probably cut back on spending compared to borrowers without an overhang of mortgage debt. (More precisely, they measured how much homeowners cut back on auto spending for each dollar loss of housing wealth. But that’s important; the decline in auto sales was a significant part of the economic contraction.)

The authors found that being underwater makes a big difference. . . Zip codes with fewer than 15 percent of homeowners only cut back only a little – spending only half a cent less for every dollar their home fell in value. But in Zip codes where more than 50 percent of homeowners were underwater, borrowers cut back five times as much – spending 2.5 cents less on car purchases for each dollar of reduced housing wealth.

Is there a reason for businesses to hire workers?

Maybe not. This graph shows that since the end of the recession, productivity (the blue line) has increased despite the fact that employment (the red line) has barely budged. In fact this seems part of a trend that dates back to the 70s. Maybe more indication of the impact of technology on employment.

From Wonkblog: The incredible shrinking labor force, in one chart

Here's a positive observation: The U.S. labor force is shrinking. Back in 2007, 66 percent of Americans had a job or were actively seeking work. Today, that number is at 63 percent and falling.

Here's what this looks like by age group:




The labor force is shrinking for the young but increasing for the old. These might be related. Fewer retirees means fewer job openings.

March unemployment report is out: 88,000 jobs created, labor force shrinks, 7.6% unemployment rate

The Dish runs through the commentary. The numbers are actually below what is necessary to keep up with population growth. Almost half a million people dropped out of the labor force, and fewer people are actually working now than a month ago.

Many point out that this is the first report out since both the sequester and the increase in the payroll tax. Government jobs - in addition to private sector jobs based on government contracts are being shred, and this is just the beginning of the process, so some fear the numbers might get worse.

David Stockman thinks the economy is doomed, but not everyone is convinced

Stockman was once Ronald Reagan's head of the Office of Management and Budget and became a firece critic of the administration - along with most others - after he left office.

He recently wrote an opinion piece in the NYT where he lays out his multiple issues with the US's economic history since the early 1930s. He thinks the current - limited - recovery will end in a crash, and this time there will be little we can do to dig ourselves out of it.

There's been quite the backlash against it however, which allows us a preliminary look at debate over the state of the economy - and our economic policies in general - prior to digging into it later this semester.

Some of the commentary:

- 'David Stockman Goes Way, Way Over the Top'

- The nihilism of David Stockman.
- David Stockman's Delusions:
- It Wasn't David Stockman Who Wrecked the Economy

Did a reduction in Defense Spending lead to a contraction in the economy?

This might end up being a lesson in the danger of quickly cutting spending. It sounds nice, but it has consequences. By the way - most, ok all, of this was stolen from Wonkblog.

The GDP shrank 0.1 % in the last quarter of 2012 even though the private sector grew.

Here's the breakdown in chart form:



And some commentary:

- Yikes! Economy shrank in fourth quarter for the first time since ’09.
- Economy shrinks as federal spending cuts trump private sector’s growth.
- Government is hurting the economy — by spending too little
- GDP Report Is Less Negative Than It Looks

And one more chart that compares the private and public components of ther economy.

From the Congressional Research Service: Taxes and the Economy: An Economic

The Congressional Resrach Service issued a report analyzing tax rates and job growth over the past 60 years and finds no evidence that tax cuts are related to job growth.

Read the report here.

Commentary from the Atlantic, plus some handy graphics:

The unemployment rate since 1945:

The top end tax rate since 1945:

From Jeffery Sachs: Economic Policy Beyond Gimmicks

A noted economist takes the president and Congress to task for pursuing short terms fixes to the economy when the problems we face - in his mind - are structural. Part of his criticism should sound familiar to students who just finished reading Fed 10. Interests who are now benefiting from existing policies are resistant to any change that might undermine those benefits. This is what Jonathan Rauch referred to as Demosclerosis. He calls for policies that focus on investments, not temporary boosts to consumer spending:

The big mistake of Obama and his economic team from the start was to treat the downturn as a temporary recession, albeit a very big one. A temporary recession requires a temporary fix. A structural crisis requires long-term strategies. Here we are in 2012 without any long-term strategies except to wait out the crisis.

Real solutions require fresh strategies to break free of vested interests in energy, healthcare, education, and infrastructure. In other words, in today's political environment, real solutions won't happen any time soon. We are stuck.

.... The question for America is how we are going to break free of this low-level trap. First, we will need a government that is not subservient to the status-quo corporate interests blocking innovation in key sectors such as health, transport, and energy. Second, we need a government that can strategize, not just improvise. Third, we need to end the nonsensical bluster against government. Our specialist scientific agencies are still doing amazing things right before our eyes this year: exploring Mars and unlocking the complex mysteries of the human genome. We could be doing a lot more to solve our social and economic problems and to re-establish our prosperity if we put our confidence back into science, technology, advanced training, and public-private partnerships.

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.

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.

Keynes vs. Hayek

Click here for a review in Reason Magazine of a recent book detailing the conflict between John Maynard Keynes and Frederick Hayek over what, if any, measures should have been made by government to intervene in the Great Depression. The reviewer argues that the book falls short of outlining the dispute adequately, but fill in the gaps for us.

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.

Deleveraging

Despite the fact that overwhelming debt is held across the board and paying it down - deleveraging - seems to be necessary, doing so quickly can create problems (like further stalling a recovering economy) since it involves not spending the money needed to keep the economy afloat.

Here's back and forth on the subject:

- Is Focusing on Deleveraging a Useless Distraction?
- Deleveraging and monetary policy.
- Delevering.
- Three Ways of Looking as Deleveraging and Monetary Policy.
- You ain't seen nothing yet.

Are Workers Too Productive? - The Atlantic

Are Workers Too Productive? - The Atlantic.

This article stuck out to me. It hits one of the reasons why forces of technology may be impacting unemployment as much as anything else. Workers are more and more productive due to technological developments meaning that fewer and fewer are necessary to make products. Businesses, as a result, do not have to hire more workers.

From the Hill: Frustrated lawmakers have few options with Europe debt crisis

The state of America's economy seems to depend on the state of Europe's. There seems little Congress can do to change that, even if they want to:

“One of the frustrations is that we don’t have any control over Europe’s decisions,” said Rep. John Campbell (R-Calif.), voicing a typical complaint. “Is our financial system sufficiently protected?”

Lawmakers seem to be stymied in coming up with a way for a domestic legislative body to address a foreign crisis, even as it adversely impacts America’s economy.

No major bills have been introduced this Congress with the intent of addressing Europe’s debt crisis and its impact in America.

. . . Bernanke told frustrated lawmakers there’s not much the U.S. can do.

“Unfortunately…we’re kind of innocent bystanders here,” he said. “I don’t have any good suggestions other than to support [Europe’s] efforts and to continue to push them.”

Treasury Secretary Timothy Geithner was probed by lawmakers Thursday for possible ways they could act. Senate Banking Committee Chairman Tim Johnson (D-S.D.) asked Geithner what policies Congress could pursue to limit Europe’s impact on America’s economy.

But again, direct solutions were hard to come by.

“We can’t want it more than they do. We can’t compel them to act,” said Geithner.

He echoed Bernanke in saying regulators were keeping a close eye on how financial institutions back home might be exposed to Europe. But other than that, the main thing Congress can do to avoid Europe’s economic problems is address its own, Geithner said.

“That’s our best protection, as always,” he said