Thursday, September 17, 2009

Flow of funds: not a shock, but interesting nevertheless

I always get excited when the Federal Reserve releases its quarterly Flow of Funds Tables. I will keep this short, as it is 9:30pm and my husband is about to scream.

First things first: household net worth is stable. A very good representation of the "wealth effect" is seen in the ratio of household net worth to personal disposable income (income net of taxes). This ratio is negatively correlated with the saving rate: as consumer wealth rises relative to income, the incentive to save (spend more now) falls.

As the chart illustrates, the ratio of net worth to disposable income rested quietly between 4 and a little over 5 spanning much of the measured series (1951, not shown, to about 1996); it now sits inside that band, 4.87 in Q2 2009. According to this relationship, spending and saving should stabilize, with households paying down debt and increasing consumption accordingly with income generation.

The point of income generation is not the topic here. But since wage growth is down to record lows (see Mark Thoma's post here), it seems that there is no way to go but up once the labor market turns around.

Households are taking a beating in credit markets, finding return only in the riskier equity markets.


And finally, the federal government owned nearly 15% of all securities in the GSE-backed MBS market. The Fed accumulated 11% of that!

It's going to take a much healthier economy than this one to withstand an unwinding of the Fed's balance sheet. Like I said, not surprising but interesting nevertheless.

Rebecca Wilder

7 comments:

  1. this graph explains how the economy can regain the necessary health.

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  2. Rebecca,

    The Fed's exit strategy is not only a topic of interest on my blog, but all over the web and other economic circles. You say "It's going to take a much healthier economy than this one to withstand an unwinding of the Fed's balance sheet"...how healthy will the economy have to be?

    Obviously the economy has a long way to go before it fully recovers, but many people are eagerly awaiting (even demanding) that this exit strategy or "unwinding of the Fed' balance sheet" happen sooner rather than later. Will the Fed unwind too soon? It seems as though we should we be careful how quickly we demand their exit from the marketplace...Thoughts?

    Thanks,
    Tim

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  3. "According to this relationship, spending and saving should stabilize, with households paying down debt and increasing consumption accordingly with income generation."

    Make that [wage] income generation. I think you are assuming real earnings growth, which I believe has NOT been happening for a while. That leads me to ...

    And, "The point of income generation is not the topic here. But since wage growth is down to record lows (see Mark Thoma's post here), it seems that there is no way to go but up once the labor market turns around."

    Why do you assume the labor market will turn around when it is probably oversupplied globally? There are about 6 billion people. Say 4 billion want jobs, and there are only 3 billion jobs. What happens? Maybe the post World War II period is an anomaly in history for the USA?

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  4. @anonymous: there's a huge amount of unused capacity, and no inflationary pressure besides fuel shocks. If the public sector would get its act together and decide we need as many wind turbines and plug-in hybrids as we do to keep flood insurance from collapsing commercial real estate asset prices, labor markets would be golden.

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  5. Rebecca,
    I came across your blog from "The Financial Ninja" and checked it out. While I would say we are about as far apart on economic theory as possible, I wanted to give a shout out to a fellow Bostonian! I grew up north of Boston and currenty work in Cambridge in Biotechnology. I am always glad to have a fellow Boston based blogger running a quality site. Keep up the great work!

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  6. Hello getyourselfconnected!

    Thank you for the shout-out. Weather's nice today, isn't it? I am new to Boston - living here for just about 3 years. I work in one of the office buildings off of the Pru. I guess that you are close to Kendall.

    Well, see you soon - and keep up with your blog! Good job.

    R

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