Blogging Intermission

I just wanted to update you all on some changes that have occurred in my life that prevent me from blogging regularly over the near term. Recently, my career path shifted from economic research and forecasting to emerging market fixed income asset management; and as such, I am spending a lot of time learning and a lot less time blogging.

As I derive quite a bit of utility from blogging, I will not be away for too long. Please give me a month or so to sort out the bond markets before I commit myself once again to the "Daily analysis of global economic and financial conditions with a focus on the U.S. TBA."

By the way, I am open to sharing this website with another blogger or two. Eventually, my thoughts are certainly going to shift toward countries other than those of the G7, so an economics focus on the G7 (or any one country) would be perfect.

If you are interested, send me an email with a short proposal (just a paragraph or two) and a link to your work. I am open to new ideas.

Best and thank you for your patience, Rebecca

Read more...

G7 vs. G5 in charts

These are interesting times in global economics, especially from the policy perspective. And although there was a sense of global urgency across the G7 (Canada, France, Germany, Japan, Italy, UK, and US) and the G5 (Brazil, People's Republic of China, India, Mexico, and South Africa) late in 2008 and early in 2009, policy makers now face very different economic circumstances. The global downturn was (mostly) ubiquitous, but the upswing will not be. The G5 are likely to initiate explicit exit strategies before the G7, as growth, domestic demand, and inflation rebound first.

The downturn in the developed world was very severe, as illustrated by the sharp contraction of GDP of the G7 countries. And across the G5, some countries experienced similar declines, however given the nose-dive that was global trade, the economic resilience via expansionary policy in India and China has been rather remarkable.









Domestic demand, underpinned by robust fiscal and monetary policy pushed auto sales forward in the G5 and simply offset some of the decline in retail sales in the G7 (see charts below). I used auto sales in the G5 as a proxy for retail sales, as I could not access a retail sales in India (not even sure they offer the statistic). Impressively, though, retail sales remained strong in the UK. Auto sales in China, Brazil, and India have been hot - the real question here is: what is the underlying demand for goods and services in these countries, especially in China.

Monetary policy - driving down interest rates in order to stimulate consumption via the credit markets - was very successful in the G5, but much less so in the ailing G7.








And finally, inflation has been quite resilient in some countries, notably in the UK and India. As such, the Bank of England has a real trade-off with which to contend: inflation (as measured by the CPI), 1.6% over the year, remains sticky and remarkably close to target, 2.0%. The Reserve Bank of India is seeing food prices drive inflation steadily upward. Some expect India to be one of the first emerging markets to start tightening (The Bank of Israel was the first).








There are a lot of question marks right now - the biggest is when central banks and fiscal authorities start to pull back. Especially in the G7, too early and one risks the feared W, but too late, and inflation becomes an issue.

Across the G7, rate hikes are unlikely to occur until well-into 2010, and maybe even 2011 for some. Across the G5, however, late 2010 is more likely an upper limit, however, some countries like Mexico are seriously struggling and policy will remain loose for some time. (See RGE Monitor Nouriel Roubini's latest, "Thoughts on Where We Are" - unfortunately, a subscription is required.)

Rebecca Wilder

Read more...

The Fed draining reserves?

Prof. Jim Hamilton at Econbrowser (thanks Mark Thoma for the link) addresses one of the Fed’s standard methods of draining liquidity from the banking system: reverse repurchase agreements. Basically, the Fed will transfer some of its assets to the banking system via short-term loans taken out with its Primary Dealers, presumably offering standard (Treasuries) and less standard (MBS or agency bonds) assets as collateral.

Reverse repurchase agreements simply slosh around the assets (MBS, agencies, and Treasuries) between the Fed and the Primary Dealers, rather than removing the assets from the Fed’s balance sheet permanently. Eventually, though, the Fed must sell the securities outright onto the open market – we are far, far from that!

This is all hot air for now. How can the Fed soak up the expansionary liquidity, let alone unwind $1 trillion in assets, when the banking system is still shedding pounds?

The Fed is considering another route, too: conducting the same repurchase agreements with the money-market mutual fund industry in tandem. An excerpt from the FT:

The Federal Reserve is looking to team up with the money-market mutual fund industry as part of its strategy to ensure that its unconventional policies to stimulate the economy do not produce a bout of post-crisis inflation.

The central bank envisages eventually draining liquidity from the financial system by engaging in trades called “reverse repos” with the deep-pocketed money-market funds. In these, the Fed would pledge mortgage-backed securities and Treasuries acquired during the crisis as collateral for short-term loans from the funds.

The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets. By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure from regulators and investors to stick to low-risk liquid investments.

The Fed is solely attempting to assuage inflation angst at this time; it’s still very premature to talk about an exit of expansionary policies when credit markets still crimp the stimulus that the Fed so desperately wants to get into the open market (much of the base, roughly $855 billion on September 23, 2009 and up from $2 billion in August 2008, remains on balance with the Fed in the form of “excess reserves). Just look at the crunch in the consumer credit space (chart to left).

As Prof. Hamilton suggests, the mechanisms of the reverse repos should successfully sterilize the base before it starts to become inflationary (with either the Primary Dealers and/or the Mutual Funds industry). However, one of the programs through which the Fed utilized previously to sterilize its liquidity, and to which Prof. Hamilton refers, – the Supplementary Financing Program – is unlikely to be an avenue for removing liquidity.

In fact, it’s quite the opposite. The Treasury already announced its imminent plan to liquidate the bulk of its $200 billion account with the Fed. There’s another $200 billion in excess reserves with which the Fed must contend (see my previous post here).

It’s easy to get the liquidity into the financial system. But getting it out without collapsing the economy or allowing inflation pressures to build? Well, that’s a different story.

Rebecca Wilder

Read more...

The Fed's moving target: NAIRU

This is the article that I wrote on Angry Bear today.

Neal Soss and Henry Mo at Credit Suisse published a very interesting article, "Where is full employment in a more volatile macroeconomy?", where they argue that the natural (long run) rate of unemployment may be shifting (they do this by showing that the Beveridge curve, which plots the the job vacancy rate against the unemployment rate, is shifting upward). I cannot provide a link, but here are their conclusions pertaining to monetary policy:

In the case of rising NAIRU [RW: this is the rate of unemployment that does not grow inflation, often called the long-run rate] and higher economic volatility, the monetary policy implication is complicated.

On the one hand, a higher NAIRU suggests that it would require a strong and prolonged recovery for the unemployment rate to return to the level attained in the past two decades. This scenario argues for a long period of low interest rates, because the economy’s structure will make it harder to get unemployment back to the low levels of recent business expansions.

On the other hand, a higher NAIRU suggests higher inflation pressure, as the output gap is smaller than otherwise would be the case. In other words, the Fed would have to normalize its policy stance sooner than would have been the case warranted by a stable NAIRU.

The burden of this is likely to be several years of quite low short-term interest rates by any modern standard other than the zero-ish levels of today. Even if the NAIRU is deteriorating, it is likely to be several years before the economy generates enough of a drop in unemployment to get to the new NAIRU, presumably above the levels of the last 20 years but surely below the current 9.7% unemployment rate. Between now and then, high unemployment is likely to remain the focus of policy attention. Labor market policies, such as job retraining for the unemployed, to improve the inflation unemployment trade-off, would make the central bank’s job a lot easier as that longer-run unfolds.

Basically, if the long-run level of unemployment, which the Fed targets implicitly under their dual mandate (maximum sustainable employment and stable prices), is changing then the Fed’s job becomes that much more difficult. Policy is only as good as the model’s calibration: they need to confidently estimate and target a level of employment that may be very much in flux. A simple Taylor Rule estimation illustrates this point.

Note: The Taylor Rule is a policy rule that relates the federal funds target to inflation and the output gap: roughly speaking, as inflation rises relative to the output gap, the Fed should tighten (raise its target); and as the output gap rises relative to inflation, then Fed should ease (lower its target). I estimate the relationship, and you can view my data here, and Wells Fargo's forecast here.

On one hand, the CBO projects that NAIRU is 4.8%. In this case, the Taylor Rule policy drops the fed funds target to -4.6% by the end of the year. Put it this way: the output gap is so big that policy is very, very aggressive but bound by zero.

On the other hand, if NAIRU has shifted to something more like 6% - this is roughly its level in the 1980’s - then the policy prescription is less aggressive. The output gap remains wide, but the implied target rises to -3% rather than almost -5% - still negative, but suggestive of a more benign policy strategy. Inflation pressures would start to build earlier than under the 4.8% case.

This complexity has been documented by the Fed in the minutes of their August 2009 meeting:

Though recent data indicated that the pace at which employment was declining had slowed appreciably, job losses remained sizable. Moreover, long-term unemployment and permanent separations continued to rise, suggesting possible problems of skill loss and a need for labor reallocation that could slow recovery in employment as the economy begins to expand.

Note: this not the same thing as a jobless recovery – the unemployment rate may very well fall with economic growth (no jobless recovery), but then settle at a structurally higher level.

Rebecca Wilder

P.S. I will not be able to respond to comments until tomorrow.

Read more...