Macroadvisers

MA's Bomfim Discusses "Who Moves Markets" on CNBC Squawk Box

2012-01-27T06:12:00.000-08:00

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Who Moved Markets in 2011?

2012-01-27T05:44:00.000-08:00

2011 was a remarkable year for FOMC communications with many new initiatives and a more aggressive use of communication as a policy tool.

§ The Chairman hosted the first ever post-meeting press briefing in April.

§ The FOMC adopted a calendar-based funds rate guidance in August.

§ The decisions to implement more unconventional monetary policy tools (calendar-based rate guidance and Operation Twist) led to triple dissents at two meetings. Dissenters used their public speeches heavily to explain their votes.

On net, FOMC speeches put slight upward pressure on the two-year Treasury yield last year.

§ The cumulative effect from FOMC speeches raised the two-year yield by about five basis points, but for the year as a whole, the impact of speeches was more than offset by that of other forms of FOMC communications.

§ In the first half of the year, speeches put some upward pressure on the two-year yield, while the effects of other communications were negligible.

§ During the second half, speeches continued to put upward pressure on yields, but the impact was more than offset by the August FOMC statement.

Relative to 2010, our analysis of Fed communications in 2011 suggests that speeches played a smaller role in influencing the two-year yield. But there are some important distinctions.

§ In 2010, FOMC speeches lowered the two-year Treasury yield by about 40 basis points cumulatively. Last year, the impact was to raise the two-year yield by five basis points.

§ The smaller impact of speeches on yields doesn’t necessarily mean that the market wasn’t paying attention to Fed speeches. Indeed, the Committee appeared to be more divided than in 2010, and hawkish and dovish speeches may have largely offset each other.

§ Lastly, there were fewer speeches last year than in 2010, and we excluded a larger proportion of speeches from our analysis because their timing overlapped with at least one other speech.

The winners of this year’s “Who Moved Markets” awards are…

§ The “I Moved Markets Award” goes to St. Louis Fed President Bullard, who had a larger market impact than any other FOMC member. His speeches and interviews moved the two-year Treasury yield by almost 17 basis points last year.

§ The “Power Player of the Year Award” goes to Philadelphia Fed President Plosser, for having the largest impact per speech.

§ The “Market Neutrality Award” goes to Atlanta Fed President Lockhart, meaning that his speeches were about as likely to move yields higher as lower.

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FOMC Funds Rate Projections: Q&A

2012-01-25T08:05:00.000-08:00

FOMC Funds Rate Projections: Q&A

Many questions apparently remain, even after the FOMC released the templates that it will use tomorrow to summarize participants’ funds rate projections. We address the main questions in this piece.

This is from a commentary that was published on January 24, 2012.

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MA's Meyer Discusses Fed on CNBC Squawk Box

2012-01-25T05:59:00.000-08:00

MA's Monthly GDP Declined 0.8% in November

2012-01-17T06:53:00.000-08:00

Monthly GDP declined 0.8% in November, partially reversing a 1.3% increase in October. The November decline was more than accounted for by inventory investment and net exports; domestic final sales posted a decent gain. The level of monthly GDP averaged over October and November was 3.2% above the third-quarter average at an annual rate. Our latest tracking forecast of 3.0% annualized growth of GDP in the fourth quarter assumes a 0.3% increase in monthly GDP in December.

This is from a commentary that was published on January 17, 2012.

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A More Democratic FOMC

2012-01-17T06:33:00.000-08:00

Even before Bernanke became Chairman, we believed that one of his objectives was to de-personalize monetary policy, that is, to make it less dominated by the Chairman. If that was his objective, he has now achieved it!

This is from a commentary that was published on January 13, 2012.

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Potential Nomination of Jerome Powell and Jeremy Stein to the Fed Board: A+

2011-12-27T11:11:00.000-08:00

The following note was sent to clients on November 15, 2011.

The Wall Street Journal reported that President Obama is considering nominating Jerome (Jay) Powell and Jeremy Stein for the Federal Reserve Board. Both would be outstanding choices, but their eventual appointments would not change monetary policy outcomes.

The nominations have been held up because of the need to have a “package deal,” with one candidate acceptable to Republicans and one to Democrats.
We give the President an A+ for his reported choices. These appointments would materially strengthen deliberations around the FOMC table. They would be active participants and highly respected by their colleagues.
Both potential nominees are well versed in finance and financial markets and would bring to the FOMC expertise in areas that it has rarely had.

Jay Powell has an impressive background in financial markets and macro policy.

He is a visiting scholar at the Bipartisan Policy Center (BPC), where he has focused on state and local fiscal issues. Before working at the BPC, he practiced law and worked both in investment banking and private equity.
He served as Under Secretary of the Treasury for Domestic Finance under President George H.W. Bush.

Jeremy Stein is a distinguished economics professor at Harvard with a worldwide reputation and a record of public service.

He has also taught at MIT and at the Harvard Business School. His specialties include finance, monetary policy, risk management, and banking.
He served earlier in the Obama Administration as a senior advisor to the Treasury Secretary and was on the staff of the National Economic Council.

If nominated and confirmed, how would they change the dynamics of the FOMC?

The FOMC would gain two outstanding people whose areas of expertise would complement those of other Board and FOMC members.
Nonetheless, other than through their interaction with the Chairman, which we shouldn’t discount, Jay Powell and Jeremy Stein would not affect policy outcomes. The Chairman is and will continue to be the dominant force on the Committee.

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Macroprudential Scenarios Service

2011-12-19T12:58:00.000-08:00

Under the Comprehensive Capital Analysis and Review for 2012 (CCAR) and Capital Plan Review (CapPR), banks with assets over $50 billion are required to conduct capital stress tests as outlined by the Federal Reserve to assess whether they would have sufficient capital to continue operations and to lend to households and businesses, even under adverse conditions. The Federal Reserve has published two scenarios; a Supervisory Baseline Scenario and a Supervisory Stress Scenario, which banks are required to use to test their capital adequacy. However, the scenarios published only include a very limited number of economic variables, leaving banks to read between the lines on exactly how these scenarios would affect their portfolios. In addition, banks are required to come up with their own baseline scenario, and their own stressed scenario. These are supposed to represent scenarios which the bank sees as the “most likely” economic scenario and the “most likely” adverse scenario.

Macroeconomic Advisers’ Macroprudential Scenarios Service provides banks with over 400 economic variables that are consistent with the scenarios set forth by the Federal Reserve. In addition, MA provides the same details for the second set of scenarios developed by MA specifically for this purpose. This arms banks with model-based, internally consistent detailed data upon which to base their stress tests. Macroeconomic Advisers is known for its short-term forecasting and commentary on the Fed and markets. But, it is our disciplined, model-based approach which makes us well-equipped to assist clients in analyzing various scenarios that can be used to judge asset adequacy.

Clients will receive four excel files (one for each scenario) with all variables included in our macroeconomic model. They will also receive related documentation, including a brief overview of our proprietary macroeconometric model, used for these scenarios, and brief descriptions of each of the scenarios. Forecasts for these scenarios extend three years. Scenarios are updated in December and June.

For additional information please contact:

Sales:

Lisa Guirl, Director of Product Development
lguirl@macroadvisers.com
314-721-4747

Technical information:

Chris Varvares, Senior Managing Director and Co-Founder
varvares@macroadvisers.com
314-721-4747

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Monthly GDP surged 1.3% higher in October

2011-12-14T08:25:00.000-08:00

Monthly GDP surged 1.3% higher in October, following two months of small declines. The sharp October gain was largely accounted for by a sharp increase in inventory investment, but domestic final sales and net exports posted decent gains, too. The level of GDP in October was 5.0% above the third-quarter average at an annual rate. Our latest tracking forecast of 3.7% GDP growth in the fourth quarter assumes that half of the increase in Monthly GDP in October is reversed in November, with that decline more than accounted for by an assumed decline in inventory investment.

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MA's Meyer Discusses FOMC Meeting on CNBC

2011-12-14T05:14:00.000-08:00

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Toward A More Transparent Policy Regime

2011-12-07T11:06:00.000-08:00

The FOMC is seeking to become more transparent about both its policy objectives and its strategy for achieving those objectives. The Chairman has emphasized that this is an ongoing process.

This is from a commentary that was published on December 5, 2011.

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The ECB and the Euro Crisis

2011-12-05T14:43:00.000-08:00

Today, the most important assumption we have to make in our forecast is about the euro crisis. We tie this to the ECB because we believe it must be a player in any resolution.

This is from a commentary that was published on December 2, 2011.

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FAIL!

2011-11-21T10:46:00.000-08:00

Failure of the “Super Committee” to reach agreement on cutting deficits by at least $1.2 trillion through 2021 now appears all but certain.
Our recent forecasts have assumed agreement on $1.5 trillion of deficit reduction, with two-fifths in revenue increases and three-fifths in spending cuts, and with the fiscal contraction back-loaded.
The Budget Control Act (BCA) requires automatic sequestration to save $1.2 trillion spread equally over 2013-2021. This would imply significantly more drag in 2013 than assumed in our forecast (see chart).
However, there would remain nearly a year to come to some agreement that could alter the path of fiscal contraction and still meet longer-term deficit reduction goals. Thus, we will not alter our fiscal assumptions based on the failure of the Super Committee to satisfy the requirements of the BCA. We already had assumed no extension of the payroll tax holiday or emergency extended unemployment benefits.
The biggest risk to the economy in the near term is posed by the reaction of financial markets. Stock prices are falling sharply as we pen this note. Increased macroeconomic uncertainty from failure of the Super Committee to meet its mandate may yet further roil credit markets, including a possible further downgrade of U.S. debt, and contribute to a weaker near-term outlook.
We continue to believe long-term deficit reduction is absolutely critical for the long-term health of the U.S. economy. However, if it is too front-loaded, coming at a time when the Federal Reserve is unable to effectively cushion the economy from the effects of fiscal contraction, it would do unnecessary harm and slow the decline in what is already a painfully slow fall in the unemployment rate.

The press is reporting that the bi-partisan Congressional “Super Committee” charged with finding a minimum of $1.2 trillion in debt reduction over the next decade today will announce its failure to report a set of recommendations. Apparently neither side was willing to soften their positions on the mix of spending cuts and revenue increases sufficiently to forge an acceptable compromise. On paper, the Committee’s failure will, effective 2013, result in automatic spending cuts (or a “sequester”) totaling $1.2 trillion through 2021. These will be split evenly between “security” and “non-security” outlays and, by our reading of the BCA, be spread evenly over the 9 years.

Our recent forecasts have assumed that the Super Committee succeeds in finding $1.5 trillion in debt reduction—actually more than required by the BCA—but the savings we’ve assumed are back-loaded and divided roughly into two-fifths tax increases, which have a relatively small impact on aggregate demand, and three-fifths spending cuts. Hence, relative to our current forecast a “sequester” implies twice as much fiscal drag in 2013 as shown in our current forecast. The alternative calculations for static fiscal drag are shown in the chart on the next page.

The Committee’s failure has the potential to alter our forecast in two ways. First, the particular paths for spending and tax rates assumed for 2013 and beyond do have a direct bearing on our projections for aggregate demand after next year. If we were certain the sequester will now occur, we would mark down our forecast for 2013 but mark up our forecasts for the subsequent years. However, it is too early to know what really will happen: there is still over a year to go! Some Republicans already are preparing to undo the “automatic” cuts in defense spending. Considering all the possibilities, the result of the Committee’s failure could be more, not less, direct stimulus in 2013 than shown in our current forecast. So, until this situation becomes clearer, we will not change our fiscal assumptions for 2013.

Second, the immediate reaction of financial markets to the failure might lead us to change our forecast even before 2013. As of this writing, stock prices are falling sharply, and at least some of that decline is likely due to the market’s disappointment over the failure of the Super Committee and, by extension, Congress to “govern.” If the slump in stock prices sticks, and to the extent investor, business and consumer confidence slump with the failure in governance, the economy could weaken in the near term. We’ll have to wait to gauge market reactions to the Committee’s failure. Surely, however, some significant probability of the Committee’s failure has been “priced in” all along.

It now seems likely that major progress on the deficit reduction will not occur until after the upcoming presidential election, with both parties viewing the election as a referendum on the mix of taxes and spending. In the meantime, if the automatic spending cuts are undone before 2013, Congress will have revealed the folly of a Balanced Budget Amendment (BBA), which would require cuts far larger than those debated by the Committee and so likely would be somehow circumvented the first time that adhering to the BBA required a painful fiscal contraction.

This is from a commentary that was published on November 21, 2011.

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How Much Room for Additional Treasuries?

2011-11-21T06:34:00.000-08:00

We took a detailed look at the Fed's portfolio to determine the potential scope for additional purchases of Treasury securities, beyond purchases already planned under Operation Twist. We examined the evolution of the portfolio under alternative scenarios for QE3.

This is from a commentary that was published on November 10, 2011.

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Chairman's Press Briefing: No Decision on Communication, But Stay Tuned

2011-11-04T14:16:00.001-07:00

As there was essentially no new information in the prepared remarks, we will jump right into the Q&A. Among other things, the Chairman indicated that there was robust discussion of communication options within the "existing framework" for communicating and thinking about the dual mandate, but no decisions were made at the November FOMC meeting.

This is from a commentary that was published on November 2, 2011.

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FOMC Forecasts: No Policy Implications

2011-11-04T14:12:00.000-07:00

FOMC participants downgraded their growth forecasts appreciably, relative to June, reflecting much gloomier data since then. But the gloomier data were already factored into the August and September decision: Today's forecasts provide no new hints about future policy.

This is from a commentary that was published on November 2, 2011.

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MA's Meyer Discusses FOMC Meeting on CNBC

2011-11-02T08:52:00.000-07:00

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How Good Are Your Communication Skills?

2011-10-31T14:37:00.000-07:00

We don't expect the announcement of any major initiatives at the end of the November FOMC meeting. Next week will be mostly about exploring ways for the FOMC to communicate better with the public.

This is from a commentary that was published on October 28, 2011.

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On Communication

2011-10-31T10:18:00.000-07:00

We continue to believe that the next easing step, if any, will take the form of communication—e.g., measures designed to signal a longer-than-expected period of “exceptionally low” rates—rather than QE3.

This is from a commentary that was published on October 27, 2011.

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Can Refinancing Reinvigorate the Recovery? Don't Expect Miracles from HARP Modifications

2011-10-25T05:22:00.000-07:00

Today the FHFA announced changes to the HARP program intended to make it easier for borrowers with high loan-to-value (LTV) ratios to refinance their fixed-rate mortgages to take advantage of today's low interest rates. The new regulations, in effect through 2013, eliminate certain risk-based fees for borrowers who refinance into shorter-term mortgages and lower fees for other borrowers, remove the current 125% limit on the LTV ratio for fixed-rate mortgages backed by Fannie Mae and Freddie Mac, in many cases eliminate the need for new property assessments, and do away with certain warranties and representations of lenders.[1] To be eligible, borrowers must be current on their mortgage, with no late payments in the last six months and no more than one late payment within the last year. In addition, the existing mortgage must have been sold to Fannie or Freddie on or before May 31, 2009 and cannot have been previously refinanced under HARP.

The plan announced today shares many similarities with a stylized plan the effects of which were simulated by researchers at MIT and CBO and that we recently argued would have only a modest effect in stimulating the economy.[2] Moreover, a twist in today's announcement is that risk-based fees are entirely eliminated only for those borrowers shortening their fixed-rate mortgages. Consequently, there may be little change in those borrowers' monthly payments even at today's lower interest rate, and so there will not necessarily be much cash flow freed up to be spent on non-housing items.[3] Therefore, we view the new guidelines as aimed more at encouraging borrowers to rebuild balance sheets faster without reducing other expenditures than as a macroeconomic stimulus.

The FHFA suggests that HARP finances might double under the revised guidelines. Given the modest take-up rate on HARP so far, such a doubling could not provide a major stimulus.[4] This does not mean the modifications to the program are not worth pursuing; they are. Just don't expect macroeconomic miracles from them.

This is from a commentary that was published on October 24, 2011.

[1] Federal Housing Finance Agency, “FHFA, Fannie Mae and Freddie Mac Announce HARP Changes to Reach More Borrowers” (FHFA News Release, October 24, 2011).
[2] See “Can Refinancing Reinvigorate the Recovery?” Macroeconomic Advisers’ Macro Focus (Volume 6, Number 13; October 18, 2011).
[3] The FHFA press release underscores this point. “The lower interest rate may provide borrowers the opportunity to shorten the term of their mortgages without much change in their monthly payment and perhaps even a reduction in that payment.”
[4] Through August roughly 900,000 borrowers had refinanced through HARP. Another 900,000 would be only about one-thirtieth of the mortgages owned or guarantee by Fannie and Freddie.

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Man Up: AJ(obs)A vs. J(obs)TGA

2011-10-21T06:07:00.000-07:00

Last week the Republican leadership unveiled the Jobs through Growth Act (JTGA) as a counterpoint to the President’s proposed American Jobs Act (AJA).[1] JTGA includes a Balanced Budget Amendment (BBA), reform of the income tax code, repeal of “Obamacare,” Dodd-Frank, and other regulations, fast-track authority for the President to negotiate new trade agreements, and the easing of restrictions on the exploration for new domestic sources of energy.

Without more detail on the Republican plan, we cannot offer a firm estimate of its economic impact in either the short or long run. However, if what we do know of JTGA were enacted now, we would not materially change our forecasts for either economic growth or employment through 2013.
If actually enforced in fiscal year (FY) 2012, a BBA would quickly destroy millions of jobs while creating enormous economic and social upheaval. However, we believe no responsible policymaker would push the implementation of a BBA when the projected federal deficit is $1 trillion and the Fed is unable to offset much fiscal drag.
A BBA would amplify cyclical swings in the economy. Furthermore, it likely would be abandoned or circumvented with the first recession after ratification, creating confusion and uncertainty over fiscal policy.
The proposed income tax reform is revenue neutral for both households and corporations and so, upon first consideration, implies little near-term impact on either aggregate demand or employment.
However, if the burden of taxes shifts down the income distribution, or if the curtailment of interest deductions and depreciation allowances raise the cost of capital, there could be near-term drag on consumption or investment.
The long-run impact of income tax reform cannot be properly assessed without additional details on the proposal.
The near-term stimulus to employment or investment from repatriating earnings sooner than previously expected is negligible.
The beneficial effects of fast-track trade authority cannot be quantified without knowing what agreements are fast-tracked. Moreover, there is bipartisan support for negotiating trade agreements beneficial to the U.S. economy.
The impact of regulatory and energy proposals in JTGA is difficult to assess, but we are skeptical of claims for large near-term employment effects. Moreover, there is bipartisan support for reducing or delaying the burden of those regulations with adverse near-term impacts on growth and employment.
Previously we reported our estimates that implementation of AJA would boost GDP growth by 1.3 percentage points over 2012 and raise employment 1.3 million by the end of next year.[2]

Demand, Supply, or Both?
In 2009, the Obama Administration released its own estimates of the impact of the American Recovery and Re-Investment Act. This time, it left analysis of AJA to the private sector and challenged Republicans to submit their plan to similar scrutiny. This is asking us to compare apples to oranges. AJA would boost aggregate demand and hence employment in the near term, pushing the economy towards full employment while also adopting programs to reduce “structural” unemployment. JTGA embodies policies more likely to work slowly through the supply side of the economy, not so much reducing current labor market slack as boosting labor productivity in the long run. So, while the enactment of JTGA might not compel us to change our near-term forecasts for growth and employment, it could encourage us to revise up modestly our projections of potential GDP, particularly if eventual details on tax reform imply strong incentives for labor supply and capital investment. In that sense, we view AJA and JTGA as potentially complementary in nature, not competitive.

Balanced Budget Amendment
The Republican call for a Balanced Budget Amendment is maddeningly vague in the operational details that could well doom it. Which definition of the budget? Is it the current deficit, the projected deficit, or even the structural deficit that is to be eliminated? Is balance in the budget required year by year or on average over the business cycle? What’s the enforcement mechanism? Would enforcement require spending cuts, tax increases, or some combination of both? Are there any contingencies (war, natural disasters, recessions, etc) for which the commitment is temporarily set aside? Even if we knew when a BBA might go into effect—and we have no idea, other than never—without these details we could not possibly simulate its impact.

We can, however, say this: the initial impact of a “hard” BBA on jobs would depend on the size of the deficit at the time when the amendment was first enforced. Suppose in 2008, when the deficit seemed manageable, a BBA had been sent by Congress to the states, that it was ratified this fall, and enforced for FY 2012. The effect on the economy would be catastrophic. Our current forecast shows a Unified Budget deficit of about $1 trillion for FY 2012. Suppose this fall the federal government enacted a budget for FY 2012 showing discretionary spending $1 trillion below our forecast, resulting in a “static” projection of a balanced budget for next year. $1 trillion is roughly two-thirds of all discretionary spending, and about 7% of GDP. Our short-run multiplier for discretionary spending is about 2, and let’s assume a simple textbook version of Okun’s law in which the unemployment gap varies inversely with, but by half as much as, the percentage output gap. Then, instead of forecasting real GDP growth of 2% or so for FY 2012, we’d mark that projection down to perhaps -12% and raise our forecast of the unemployment rate from 9% to 16%, or roughly 11 million fewer jobs. With interest rates already close to zero, the Fed would be near powerless to offset this huge fiscal drag.

And that would not be the end of it. Soon it would become obvious that revenues were falling far short of earlier static projections as both taxable income and average tax rates declined cyclically and mandatory spending increased cyclically as well. The induced rise in the deficit could come to $500 billion, requiring an additional $500 billion cut in discretionary outlays that would zero them out. (That’s right, zero them out!) This would cause another 5% decline in GDP and another other 4 million jobs lost, etc.

No model could capture the ensuing chaos and uncertainty, which would make matters far worse. We assume no policymaker faced with this economic reality would advocate implementing such policy. The pall of uncertainty cast over the economy if it appeared a BBA could be ratified and enforced in the middle of recession or when the deficit was still large would have a chilling effect on near-term economic growth. Indeed, the only way to implement a BBA without some fiscal drag is to ratify it when the budget is in balance or surplus. Of course, then we wouldn’t have needed the BBA to achieve balance in the first place.

Suppose the BBA was implemented when the budget already was in balance. There still would be new and powerful uncertainties in play. The economy’s “automatic stabilizers” would be eviscerated, discretionary counter-cyclical fiscal policy would be unconstitutional, and the sole responsibility for macroeconomic stabilization policy would rest with the Fed—perhaps at a time, like today, when the ability of the FOMC to offset fiscal drag is sharply curtailed by the proximity of interest rates to the zero bound. We believe this would change cyclical dynamics. Recessions would be deeper and longer. Furthermore, in our model, critical markers for financial conditions, like private credit spreads and the VIX, have important cyclical components, the magnification of which would further aggravate the business cycle. In all likelihood the effort to legislate fiscal morality with a simple rule would be overturned or suspended with the first big recession following ratification, creating new uncertainty about fiscal policy and the governance that produced the amendment in the first place.

The ultimate goal of a balanced budget amendment is to reduce the federal deficit. As we have written elsewhere, we believe strongly that deficit reduction is necessary both to avoid the slow crowding out of private investment and to avert the eventual sovereign debt crisis implied by current policies. A BBA would not necessarily achieve these goals before being abandoned or circumvented. Furthermore, an interesting and growing literature suggests that uncertainty surrounding fiscal policy retards economic growth.[3] The attempt to enforce a BBA could well end up heightening fiscal uncertainty while magnifying cyclical risks to the economy. It would be far better to achieve a sustainable fiscal policy through considered discretionary actions than under the yoke of a mechanical rule.

Tax Reform
JTGA, like many others current proposals, would reform the income tax code by curtailing or eliminating tax expenditures while lowering marginal tax rates enough to offset the “static” revenue gain of the base-broadening. The main argument for tax reform is that, over time, lower marginal rates will stimulate growth from the supply side of the economy by encouraging extra work, saving, and investment. In addition, a simpler code would cut compliance costs and increase efficiency by reducing tax-induced distortions in the allocation of resources.

JTGA describes the reform as revenue neutral (in static terms) separately for households and corporations. This implies no initial change in either personal disposable income or after-tax corporate profits, and hence no initial effect on aggregate demand. Any immediate impact on consumer spending would depend on distributional particulars not yet spelled out. However, we expect that reducing the top personal marginal rate from the current 36% to the proposed 25% implies some shifting of the personal tax burden from high-income taxpayers towards the middle class. If, as many economists believe, the propensity to consume is higher for the middle class, there could be some initial near-term drag on consumer spending associated with the reform. Distributional considerations also bear on the supply-side outcomes of tax reform. In particular, the effect on the labor force (which determines the long-run effect on “jobs”) depends on the outcome of a tug of war between income and substitution effects—not in the aggregate, but for cohorts differentiated by income, gender, education, and attachment to the labor force. Therefore, we need to know more about the changes in marginal and average tax rates faced by these groups before attempting to assess the effect of tax reform on labor supply and potential output.

On the corporate side, revenue neutrality could imply that lowering the marginal corporate tax rate from the current 35% to the proposed 25% is paid for by limiting current deductions for interest and depreciation. Even without such restrictions the impact on the cost of capital of lowering the corporate tax rate is ambiguous in sign because as the rate declines so does the after-tax value of deductions for interest and depreciation. Our own calculations suggest that if a reduction in the corporate rate is combined with elimination of the corporate deduction for interest and a shift from accelerated to economically neutral depreciation schedules, the cost of capital would rise, not fall. This raises the possibility of a near-term deceleration in fixed investment and calls into question one element of the supply-side rationale for the reform. Indeed, while an objective of tax reform is to encourage more work, saving, and investment with lower marginal rates, a fair question is: relative to what? In particular, tax reform could increase the top marginal rate on dividends and long-term capital gains to 25%, raising the personal marginal tax rate on capital income.

In the mid-1990s, Macroeconomic Advisers participated in a two-year exercise, sponsored by the Joint Committee on Taxation (JCT) that brought together modelers of all stripes in an effort to reach a consensus on the macroeconomic impacts of tax reform. There were lively arguments over the magnitude and direction of short-run demand effects, debates about how to characterize any monetary response, and considerable disagreement over the effects of tax reform on the labor force. Not surprisingly, then, there emerged from the discussion a range of estimates. However, a fair summary is that comprehensive tax reform would increase potential GDP modestly over several decades. There was also agreement that reforming the income tax would have a smaller effect on GDP than, say, replacing the income tax with a consumption tax. Considering all this, we feel comfortable arguing for many of the long-run benefits of reforming the income tax while not expecting much, if any, near-term boost to either GDP or employment. Still, to simulate either the short-run or long-run effects of tax reform more definitively, we need additional details on the proposal, ideally including a full work-up of the static distributional effects.

Repatriation of Profits
JTGA envisions a territorial tax code as part of tax reform. Over time, and in conjunction with the proposed lower corporate income tax rate, this could—provided other countries don’t “retaliate” somehow—encourage businesses to locate in the United States, incent U.S. multinationals to repatriate earnings, and “unlock” for immediate repatriation up to $1.4 trillion.

Any move of global business to the U.S. would take time, leaving as a candidate for near-term stimulus and job creation only the unlocking of foreign earnings for repatriation. One prominent Republican economist claims a “repatriation holiday” could boost GDP by $360 billion (roughly 2¼%), creating 2.9 million jobs.[4] We view such claims with extreme skepticism. Not surprisingly, following the repatriation holiday in 2004, multinational companies surveyed claimed to have spent large portions of the repatriated funds on hiring and capital investments. If true, this might imply that a repatriation holiday today would have a notable impact on aggregate demand. However, more rigorous empirical research suggests that most of the money repatriated then went towards dividend distributions and share re-purchases, which would have only indirect effects on aggregate demand.[5]

And we believe these effects would be negligible. For example, a “surprise” repatriation holiday might encourage companies to bring funds home sooner than previously planned in order to exploit the temporarily lower tax rate. There would occur an increase in the share price of firms with foreign earnings to repatriate that reflected the present discounted value of both the shifting forward of the repatriation and the temporarily lower rate at which those earnings were taxed. The JCT puts this (undiscounted) gain at between $70 and $80 billion, or less than 0.5% of the value of all corporate equity…not even a day’s variation in today’s volatile stock market.[6] Still, to follow the analysis through: in our model the marginal propensity to consume out of this equity gain would be about 5 cents on the dollar, or less than $4 billion in total spread out over a few years. Not much to talk about.

Furthermore, this is a lump sum payment from government to business predicated upon past economic activity. There would be no change in marginal incentives to hire or invest, and so no compelling reason for companies to use the temporary tax break to expand productive capacity with order books as thin as they are today.[7] Moreover, it is not the case that these multinationals are cash-constrained or lacking access to capital markets.

Regulatory Reform
JTGA would repeal both “Obamacare” and Dodd-Frank while rolling back or limiting many other current or pending regulations, typically by requiring analysis demonstrating the net benefit, often in terms of job creation, of the regulation in question. Republican talking points claim that Obamacare has reduced employment growth 90% by causing a “structural break in job growth” that already has destroyed 800,000 jobs; they also point to a study by the Financial Roundtable concluding that by 2015, Dodd-Frank will have cost 4.6 million jobs. The inference is that some Republicans believe repealing these two pieces of legislation alone will boost employment by more than 5 million in 2015. Add this together with the 2.9 million jobs for repatriation of profits, and you are up to 8 million – enough to reduce our forecast of the unemployment rate in 2015 from over 6% to only slightly more than 1%! Not surprisingly, we view such undocumented claims as, well, talking points.

Regulation does not prevent the economy from achieving full employment. After all, the economy wasn’t that much less regulated in 2007 when the unemployment rate was 4.5%, half of today’s reading. Regulation does require firms to combine labor and capital in a manner that results in less measured output (and higher prices) than otherwise, and that reduction in output can be reflected in lower profits, wage rates, or both. Furthermore, regulation can certainly alter the distribution of employment between industries and regions. There are, however, legitimate reasons for many regulatory requirements, including the discouragement of health and safety hazards and the reduction of systemic financial risk, the costs of which may not be fully reflected in prices posted in an unregulated market. Hence, it is important to recognize that jobs should not be the sole, even the main, criterion for assessing the value of a particular regulation.

Having said that, streamlining regulatory procedures, eliminating duplicative regulations (and regulatory bodies), sun-setting regulations that prove ineffective or have outlived their original purpose, and requiring cost-benefit analyses of proposed new regulations will increase productivity over time, even if the near-term effects on aggregate employment are second-order. It is hard to argue against this. The problem here is the difficulty of quantifying the productivity gain from many of the regulatory proposals included in JTGA. For example, we have no reliable way to measure the effects on national employment or overall productivity of preventing the EPA from tightening its regulation of dust in rural America.

Domestic Energy Promotion
JTGA contains several provisions intended to speed the exploration for and possible eventual production of domestic energy. For example, the talking points claim that, if enacted as part of JTGA, the Jobs and Energy Permitting Act (Senate bill 1226, sponsored by Senator Murkowski of Alaska) will create 50,000 jobs and increase oil production off the Alaskan Outer-Continental Shelf by 1 million barrels per day.[8] No timeline is offered for these increases. In principle, more exploration might spell higher employment in the industry and some eventual reduction in oil prices if exploration uncovers commercially exploitable reserves. However, the magnitude and timing of any such price decline is so speculative that we would not change our forecast of oil prices until the legislation was enacted, and even then only if we saw a notable drop in futures prices for crude oil around that time. Our expectation is that any such decline in price would occur at the back end of the futures curve, with little implication for real personal disposable income, and hence consumer spending, over the next several years. Similarly, it is very hard to assess other claims made in the talking points; for example, that preventing the EPA from regulating greenhouse gases under the Clean Air Act will save 1.4 million jobs by 2014, bringing the total number of jobs created or saved up to almost 9.5 million!

Export Promotion
JTGA would grant the President fast-track authority to negotiate trade agreements to reduce trade barriers and open new markets to American suppliers. The President also favors trade promotion, so there isn’t much here to differentiate the two plans. Furthermore, Congress recently passed three trade-related bills that had been on the docket a considerable period of time. It is not clear what could be negotiated next, or how quickly. We simply cannot quantify the beneficial effects of fast-track authority without knowing more about the trade agreements in question. And, in any event, our interpretation of the relevant empirical literature is that employment gains in domestic industries benefitting from trade agreements usually are modest, develop slowly over time, and may be partially offset by employment losses in other domestic industries that are adversely impacted.

Concluding Remarks: The "Right" Thing to Do?
In closing, we view the main thrust of the Jobs through Growth Act—deficit reduction, tax reform, regulatory relief, free trade, energy exploration—as long-run, supply-side policies the beneficial effects of which are more likely to be reflected in secular productivity gains than in near-term utilization rates for capital and labor. Indeed, there’s a sense here that JTGA is motivated by a belief that the plan is simply the right thing to do, irrespective of short-run effects and distributional consequences—some of which could be negative—and independent of any hard empirical estimates of the long-run benefits. In our judgment and apart from the BBA, the long-run objectives of the plan are not without merit, but it is a reach to argue that quick enactment of JTGA would significantly reduce the unemployment rate over the next year or two because, in our view, the plan does not address the root cause of today’s unemployment—namely, insufficient aggregate demand. In contrast, AJA would boost aggregate demand, but stakes little claim on long-run, supply-side effects. In that sense we view the two plans as more complementary in nature than competitive. If only Democrats and Republicans could see it that way, too!

[1] See http://mccain.senate.gov/public/index.cfm?FuseAction=PressOffice.PressReleases&&ContentRecord_id=feb4d840-c3be-83b1-a1fb-b7f2a039e94d
[2] See “The American Jobs Act: Greater than Expected,” Macroeconomic Advisers’ Macro Focus (Volume 6, Number 12), September 13, 2011.
[3] For example, see Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester, and Juan Rubio-Ramírez, “Fiscal Volatility Shocks and Economic Activity,” (Federal Reserve Bank of Philadelphia, Working Paper 11-32; August 9, 2011).
[4] Douglas Holtz-Eakin, “New $1.4 Trillion U.S. Stimulus is in Sight,” Bloomberg View (October 7, 2011); http://bloom.bg/qEJCrM
[5] An excellent review of past experience with repatriation, including a discussion of the potential stimulus effects, is found in Donald J. Marples and Jane G. Gravelle, “Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis”, The Congressional Research Service (May 27, 2011).
[6] See http://doggett.house.gov/images/pdf/jct_repatriation_score.pdf
[7] Some proposals would require that a significant portion of the repatriated funds be used to hire workers or buy equipment. In all likelihood this would either discourage companies from repatriation or claim the tax break against a hire they would have made anyway.
[8] We are skeptical of the claim that this provision of JTGA would create 50,000 jobs. Phil Verleger, a highly regarded industry expert with whom we consult regularly, estimates the impact on jobs would be between 0 and 1,000, with the most of those positions going to high-skilled people already in the industry, some of whom would be Canadian. At today’s prices, an eventual increase in production of 1 million barrels a day would, other things equal, raise the level of GDP by about 0.2%.

This is from a commentary that was published on October 20, 2011.

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Can Refinancing Reinvigorate the Recovery?

2011-10-19T06:55:00.000-07:00

As part of his plan to stimulate job creation, President Obama “instructed his economic team to work with Fannie Mae and Freddie Mae, their regulator the FHFA, major lenders and industry leaders to remove the barriers that exist in the current refinancing program (HARP) to help more borrowers benefit from today’s historically low interest rates.”[1] One estimate is that if 37 million mortgages owned or guaranteed by government agencies and government-sponsored enterprises (GSEs[2]) were refinanced at today’s interest rates, borrowers would initially save as much as $84 billion per year.[3]

Some argue this money would stimulate the economy like an equal-sized tax cut, but that view is simplistic. A tax cut boosts personal disposable income. Unless the mortgages being refinanced are held by the government, the Federal Reserve, or foreigners, refinancing merely redistributes pre-tax personal income between individual borrowers and lenders, with no effect on personal income.
Therefore, any direct impact on consumer spending would depend importantly on the differential response of borrowers and lenders to the changes in their respective incomes. Empirical estimates suggest this differential is modest.
In addition, recent empirical work suggests the take-up rate on such a program could be small, on the order of just 10%, or roughly 3 million mortgages.
All told, we estimate that, at most, such a plan might boost GDP growth by 0.1 to 0.2 percentage point.
A benefit of the plan might be to help stabilize house prices which, through wealth effects, could support consumption and, by breaking expectations of further price declines, help encourage an earlier turnaround in housing construction.
Such a plan requires support of the Federal Housing Finance Agency (FHFA) or Congressional approval. Neither is assured.

Mortgage rates have plunged to record lows. This should encourage homeowners to refinance their mortgages. However, given tight lending conditions and depressed house prices, many borrowers cannot do so. A proposal to stimulate the economy discussed recently in the press and mentioned by the President in his speech on September 8th is to allow borrowers with GSE-sponsored mortgages to refinance those loans more easily at today’s low rates.

In one version of this plan, proposed a year ago by Glenn Hubbard and Chris Mayer, the GSEs would require mortgage servicers to send streamlined applications for refinancing to eligible homeowners.[4] Servicers’ fees would be wrapped into the new mortgages to reduce costs to taxpayers while allowing borrowers, many of whom are financially distressed, to amortize these fees. The agencies would issue new mortgage-backed securities (MBSs) to retire mortgages in existing MBSs. New mortgages would receive priority over current second liens.

The main argument advanced for such a program is that the reduction in mortgage interest payments will free up cash flow that households will spend. The plan would also help homeowners keep their houses and, by reducing defaults and foreclosures, alleviate downward pressure on house prices while reducing defaults and hence losses incurred by the GSEs and investors in mortgage-backed securities. Investors who have not “priced in” such early refinancing by relatively risky borrowers would suffer losses.[5] Putting aside issues of political practicality, the idea holds some appeal. However, we doubt that it would give a quick and major boost to overall consumer spending.

Spending by Borrowers
Consider this first from the borrowers’ perspective. Some estimates suggest that if all 37 million or so GSE-backed mortgages are refinanced, nominal pre-tax household mortgage interest payments would be reduced by as much as $84 billion per year. Most homeowners claim mortgage interest as an itemized deduction, and we estimate that these deductions are claimed at an effective marginal tax rate of around 20%. Hence, the nominal after-tax saving comes to (1-.20)*84 = $67 billion, or $58 billion in inflation-adjusted terms. If homeowners spent all of this during the ensuing year, it would raise the annual growth of real personal consumption expenditures (PCE) by 0.6 percentage point, and the growth of real GDP by 0.4 percentage point, both before any multiplier effects.

This is substantial—indeed, on a par with our estimates of the stimulus associated with the current payroll tax holiday—but the calculation assumes the take-up rate on the program is 100%, that the mortgages are refinanced immediately at today’s rock-bottom interest rates, that homeowners spend all the after-tax cash-flow relatively quickly, and that investors who suffer losses don’t reduce their spending.

The Take-Up Rate
At least one empirical estimate suggests the take-up rate would be far lower than 100%. Researchers at the Congressional Budget Office and the Massachusetts Institute of Technology recently used a model of the refinancing decision to assess how many mortgages sponsored by Fannie Mae and Freddie Mac would be refinanced if, for one year (2012) and assuming CBO’s economic projections, current restrictions on loan-to-value ratios and credit scores were lifted but no principle forgiven.[6] The model considers the expected costs and benefits to the homeowner of refinancing. The authors projected that 2.9 million mortgages—or just 10% of the total—would be refinanced in the first year, with an interest saving to borrowers of only $7 billion.[7]

Spending by Borrowers
At the aggregate level, a typical estimate of the marginal propensity to consume (MPC) out of disposable income is 0.7. However, if disposable income is decomposed into transfer payments, labor payments, and asset income (which includes “rental income of persons,” the net income derived from home-owning), the MPC on asset income usually is estimated at between 0 and 0.4, consistent with the Life-Cycle Model (LCM) of household behavior; our own estimate is around 0.2. Such estimates imply that not all, or even most, of the mortgage interest saved during a refinancing would be consumed. This also is consistent with survey data suggesting that during previous refinancing booms much of the interest saving was used to pay down mortgages faster—that is, it was saved rather than consumed.

The counterargument is that such low estimates of the aggregate MPC on rental income conceal important differences between consumers. At least some homeowners likely to refinance under the program might have become cash-constrained during the housing collapse and now are so financially strapped as to spend all the interest saving. We believe the truth lies somewhere in a range between the maximum value of 1 and our aggregate estimate of 0.2, but the resolution of this thorny empirical issue, which requires micro or panel data, is beyond the scope of this Focus.[8] Still, even for values at the top end of this range, the effect on aggregate spending would be modest for the estimated take-up rates discussed above (see below).

Spending by Lenders
Some argue that a refinancing program would act as a personal tax cut, but this view is simplistic. In the National Accounts, a personal tax cut boosts personal disposable income. A mortgage refinancing might not, because one person’s mortgage interest payment is another person’s interest income. Hence, the refinancing plan could simply shift the composition of pre-tax personal income away from “personal interest income” towards “rental income of persons.” In that case, the net stimulus generated by the refinancing would reflect the difference between how much borrowers raise spending as their rental income rises and how much lenders reduce their spending as their interest income falls. Once could reasonably argue that the MPC of mortgage lenders is lower than the MPC of mortgage borrowers. However, in a typical consumption function the two MPCs usually are constrained to be equal, in part because, at least with aggregate data, it is difficult to reject the hypothesis that they are, in fact, the same. Hence, in such equations, the composition of personal income between interest and rental income does not affect total PCE.

Even so, a differential effect on PCE can arise if the mortgages or mortgage-backed securities are held by foreign investors or if the mortgages are held directly by the federal government, a government agency, or the Federal Reserve—entities not treated as “persons” in the National Accounts. We estimate that roughly 40 percent of the relevant investments fall into these categories. Hence, with every dollar of interest saved through the refinancing program, personal disposable income might rise by 40 cents, reflecting a one-dollar increase in rental income of persons only partially offset by a 60-cent decline in personal interest income. Even if borrowers and lenders share a common MPC, there would be some net stimulus. That stimulus would be greater if, indeed, borrowers responded more strongly than lenders to a shift of income between them.

A Range of Estimates
Simple calculations can establish a reasonable range of estimates for the stimulus to consumption likely to be generated by the refinancing program. At one extreme, suppose that: (a) the take-up rate is 30% with nominal interest saving to borrowers of $21 billion in the first year; (b) borrowers spend all the after-tax cash flow; (c) lenders don’t reduce their spending in response to the decline in their interest income. In that case, real PCE would rise by roughly $15 billion (in 2005 dollars), or 0.2 percent, which would add between 0.1 and 0.2 percentage point to GDP growth before multiplier effects. At the other extreme, assume that: (a) the take-up rate is 10% with nominal interest saving to borrowers of $7 billion in the first year; (b) borrowers spend only 60 percent (or $4.2 billion) of the extra cash flow; (c) personal investors, who see their investment income fall by $4.2 billion (60% of $7 billion), reduce their spending by 20% of that, or $0.8 billion. The net effect would be to boost real PCE by $2.9 billion, which essentially would be lost in the rounding, even with multiplier effects.

Other Benefits
Such calculations leave us skeptical that a refinancing program would quickly jolt consumer spending. However, it could help some homeowners avoid foreclosure, and thereby work gradually to alleviate downward pressure on house prices. Since housing wealth is an important determinant of aggregate consumption, the plan could help backstop consumer spending indirectly through this wealth channel. Furthermore, helping break the expectation of falling house prices could encourage an earlier turnaround in the housing market by lowering the “real” mortgage rate. Complicating that story, however, is that public discussion of the proposal could alert investors in mortgage-backed securities to their potential losses if the plan is enacted. Fear of such losses could encourage capital to leave the sector, pushing nominal mortgage rates higher long before there is any change in the expected rate of change in house prices. Higher mortgage rates now would, of course, work to delay any turnaround in housing activity.

Moot Point?
To implement the plan would require cooperation of the FHFA, the regulatory agency that oversees Fannie Mae and Freddie Mac. To ensure that cooperation, the Acting Director of the FHFA, Edward DeMarco, who was not appointed by President Obama, would have to be convinced that the plan would not lower taxpayers’ return on the assets of the two agencies.[9] Some observers expect such a large-scale refinancing would lead to a significant reduction in revenues on the assets held by Fannie and Freddie. The issue is whether the cost of the lost revenues might be offset through a lower default rate on the newly issued mortgages. Even so, the FHFA could resist the proposal to maintain the agency’s political independence. Without the support of the FHFA, the Administration would have to propose legislation to Congress in order to enact the program, passage of which seems only a remote possibility.

This is from a commentary that was published on October 18, 2011.

[1] “President Obama’s American Jobs Act” (September 8, 2011), p. 17. This set of “talking points” was made available to the press shortly before the President’s speech before Congress.
[2] These are Freddie Mac, Fannie Mae, Ginnie Mae, The Department of Veterans Affairs (loan guarantee program), and the Federal Housing Administration.
[3] Ronald D. Orol and Gregg Robb, “The Regulator Who Could Block Mortgage Refi Plan,” MarketWatch (August 31, 2011).
[4] Glenn Hubbard and Chris Mayer, “How Underwater Mortgages Can Float the Economy,” The New York Times (September 18, 2010).
[5] The failure of pre-payments to rise as would have been expected given the recent decline in yields has resulted in an increase in the value of these securities.
[6] Other proposals would also forgive some principle for underwater mortgagees, with the resulting losses shared by private investors and taxpayers. Given the philosophical and legal issues surrounding such plans, we view them as much less likely to be enacted than plans limited just to refinancing.
[7] Mitchell Remy, Deborah Lucas, and Damien Moore, “An Evaluation of Large-Scale Mortgage Refinancing Programs,” (The Congressional Budget Office, Working Paper 2011-4; September 2011).
[8] And then there is this: at the peak of the housing boom in 2005-06, homeowners’ equity in real estate reached roughly $13 trillion. The rapid pace of refinancing then was accompanied by net mortgage equity withdrawals (MEW) that exceeded $750 billion per year. Our readers know we are not huge fans of the argument that MEW provided a strong independent boost to PCE during that period. However, to the extent it did, it almost certainly won’t be the case this time around. With the sharp drop in house prices since 2006, homeowners’ equity has plunged to only $6 trillion, and measures of MEW have been negative since 2008. We certainly would not expect a “supercharged” (by MEW) effect on spending from the refinancing encouraged by this program.
[9] DeMarco joined the agency in 2006 during the Bush Administration and has served as Acting Director since 2009. The Obama Administration nominated Joseph Smith (banking commissioner of North Carolina), but Smith withdrew his name from consideration in the face of Republican opposition in the Senate.

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MA's Monthly GDP Index Rose 0.4% in August

2011-10-18T07:51:00.000-07:00

Monthly GDP rose 0.4% in August on the heels of a 0.9% increase in July. The two-month increase more than reversed a 1.0% decline over the prior two months (May and June). The increase in August reflected increases in domestic final sales and inventory investment that were partially offset by a decline in net exports. The level of monthly GDP in August was 3.0% above the second-quarter 2.7% annualized growth of GDP in the third quarter assumes a 0.2% increase (not annualized) in September.

This is from a commentary that was published on October 17, 2011.

Technical Note
Macroeconomic Advisers’ index of Monthly GDP (MGDP) is a monthly indicator of real aggregate output that is conceptually consistent with real Gross Domestic Product (GDP) in the NIPA’s. The consistency is derived from two sources. First, MGDP is calculated using much of the same underlying monthly source data that is used in the calculation of GDP. Second, the method of aggregation to arrive at MGDP is similar to that for official GDP. Growth of MGDP at the monthly frequency is determined primarily by movements in the underlying monthly source data, and growth of MGDP at the quarterly frequency is nearly identical to growth of real GDP.

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FOMC Minutes: Let's Communicate Better...

2011-10-14T13:35:00.000-07:00

The staff briefed the FOMC on various easing options. The discussion of communication as a policy tool was consistent with our expectation that communication will likely be the next easing step, if the Committee decides to provide further accommodation.

This is from a commentary that was published on October 12, 2011.

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Antulio Bomfim Discusses Monetary Policy on PBS' Nightly Business Report

2011-10-06T12:02:00.000-07:00

Watch the full episode. See more Nightly Business Report.

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Joel Prakken Discusses ADP Employment Report on CNBC

2011-10-06T11:55:00.000-07:00

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Twist Hangover: Dance Now, Pay Later

2011-09-30T10:37:00.000-07:00

Twist Hangover: Dance Now, Pay Later

We noted in earlier commentaries that Operation Twist is no free lunch for the FOMC. One "cost" of Operation Twist is that it can significantly complicate the exit process.

This is from a commentary that was published on September 28, 2011.

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FOMC Statement Comment: We Like the Way You Dance!

2011-09-23T07:10:00.000-07:00

The Committee announced an aggressive "Operation Twist" and then some, by indicating that it will invest proceeds from agency security paydowns back into the agency MBS market.

On net, the scope of the maturity extension program announced was very close to our expectations.

This is from a commentary that was published on September 20, 2011.

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Larry Meyer Discusses Fed Policy on CNBC

2011-09-21T15:23:00.000-07:00

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FOMC Chatter ahead of the September 2011 Meeting

2011-09-20T11:13:00.000-07:00

The FOMC chatter during the intermeeting period was dominated by Fed officials offering their views on the (conditional) calendar-based forward rate guidance in the August statement. We see a deeply divided Committee, whose members offered a wide range of perspectives on the August decision.

This is from a commentary that was published on September 19, 2011.

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FOMC Briefing: To Twist or Not to Twist, That Is the Question

2011-09-19T14:00:00.000-07:00

A key question in everyone's mind is what the next easing step will be. We expect sterilized large-scale asset purchases (S-LSAPS, duration extension, or "Operation Twist") to be the next "big" easing step, but more likely in November.

This is from a commentary that was published on September 16, 2011.

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MA's Monthly GDP Surged 1.1% in July

2011-09-15T07:44:00.000-07:00

Monthly GDP surged 1.1% in July, essentially reversing declines over the prior two months. The increase in July was accounted for by large contributions from net exports, inventories, and PCE. There were small, offsetting contributions elsewhere. Monthly GDP in July was 1.9% above the Q2 average at an annual rate. Our latest tracking forecast of 1.6% GDP growth in the third quarter assumes essentially a flat trend in monthly GDP over the balance of the third quarter.

Macroeconomic Advisers’ index of Monthly GDP (MGDP) is a monthly indicator of real aggregate output that is conceptually consistent with real Gross Domestic Product (GDP) in the NIPA’s. The consistency is derived from two sources. First, MGDP is calculated using much of the same underlying monthly source data that is used in the calculation of GDP. Second, the method of aggregation to arrive at MGDP is similar to that for official GDP. Growth of MGDP at the monthly frequency is determined primarily by movements in the underlying monthly source data, and growth of MGDP at the quarterly frequency is nearly identical to growth of real GDP.

This is from a commentary that was published on September 9, 2011.

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UPDATED: The American Jobs Act: Greater than Expected Impact

2011-09-13T12:15:00.000-07:00

Last week President Obama unveiled his much-heralded jobs plan, the AmericanJobs Act of 2011 (AJA 2011). It was bigger than expected, with a price tag of $447billion. More than half the total ($245 billion) is in the form of temporary taxrelief, with most of the balance in infrastructure spending. We estimate that ifenacted promptly and assuming no monetary offset, the plan will:

Boost GDP growth roughly 11⁄4 percentage points in 2012 by pulling growthforward, mostly from 2013.
Raise payroll employment 1.3 million by the end 2012, 0.8 million by the end of2013, and progressively smaller amounts thereafter.
These estimates do not reflect jobs that might be created in response to taxincentives for hiring included in the plan. While an argument can be made forsuch effects, we believe them to be modest (more below).
Our simulation does not include the effects of an initiative, under considerationby the Administration, to direct federal housing agencies to facilitate mortgagerefinancing. We will publish a piece on this shortly.
The President will recommend offsetting the cost of AJA 2011 over the comingdecade. The “pay-fors” imply fiscal drag not included in the simulation, but thiswill be modest and most likely occur after 2013 when the economy is strongerand the Federal Reserve is better positioned to accommodate it.
Our published forecast already assumes a one-year extension of the current employeepayroll tax holiday. Hence, if the President’s plan was enacted in its entirety, we wouldrevise up our forecast for GDP growth in 2012 by about a percentage point, not the fullamount shown in this analysis.

THE PLAN
The plan was bigger than expected. Press reports—even those filed shortly before theofficial announcement—speculated that the package would cost between $300 and $400billion. The plan would:

(1) Extend the current employee payroll tax holiday for another year, and increase it from2 percentage points to 3.1 percentage points. Cost: $175 billion.

(2) Introduce a one-year, 3.1 percentage-point employer payroll tax holiday on the first$5 million of a
company’s payroll. In addition, waive for one year the entire 6.2percentage-point employer contribution on incremental increases in payroll of up to $50million. Cost: $65 billion.

(3) Extend 100% business expensing of purchases of equipment and software through2012. Under current law, 50% expensing is allowed in 2012 before depreciationschedules then revert to previous guidelines. Cost: $5 billion.

(4) Allot $35 billion to states for hiring of teachers and first responders. This money,which must be spent during the 2012-13 academic year, is earmarked and so is moretargeted at jobs than would be a block grant.1 However, we do view this money assomewhat fungible. Therefore, we assume that $20 billion of the total will be useddirectly to pay state and local employees, preserving nearly 200,000 jobs in 2012, but thatthe remaining $15 billion is used to prevent cuts in other state and local programs.

(5) Extend unemployment benefits while reforming the unemployment insuranceprogram. Cost: $49 billion. This boosts disposable income, aggregate demand, andhence employment. However, as we have written recently elsewhere, we estimate thatextending benefits also encourages people to remain in the work force to become eligiblefor the benefits, on balance raising the unemployment rate.

(6) Allot $105 billion for infrastructure spending, including monies to modernize publicschools ($30 billion), improve transportation networks ($50 billion), rehabbing orrepurposing vacant properties ($15 billion), and for establishing a new infrastructure bank($10 billion). Most of the funding is targeted at programs with fast spend-outs. Weestimate that 2/5 of this money will be spent by the end of 2012, 2/3 of it by the end of2013, and the rest over the next several years.

The President has instructed his economic team to work with Fannie Mae, Freddie Mac,and the FHFA to devise a strategy for removing barriers that prevent strappedhomeowners from re-financing at today’s rock-bottom interest rates. Refinancing couldfree up cash flow for consumers to spend, providing an additional modest boost to theeconomy. Such a plan is not included in our simulation here, but we will publish a pieceon this initiative shortly.

Finally, the President will present to the Joint Select Committee (JSC) on deficitreduction, established under the Budget Control Act (BCA) of 2011, hisrecommendations on how to pay for AJA 2011 over the coming decade. We expect thispayback will build only gradually and not begin until 2014, so as not to offset thestimulus in 2012 or to reinforce the payback in 2013.

SIMULATION RESULTS

We used our macro model to simulate the effects of AJA 2011 through 2015 against abaseline that assumes none of the provisions of the plan. When constructing thesimulation we assumed no offsetting change in monetary policy since, in the near term,we believe the Federal Open Market Committee (FOMC) would welcome faster growthwhile, in the intermediate, term there is no lasting impact on either the unemploymentrate or inflation from the temporary stimulus. In addition, we did not include any “pay-fors” that the President might recommend. These would produce modest fiscal drag,probably after 2013. However, we believe the FOMC could offset relatively easily byengineering a slight decline in interest rates relative to the baseline.3

Our results are summarized in the two nearby charts. Theplan boosts real GDP growth (measured 4th quarter over 4thquarter) by 1.3 percentage points in 2012, but lowers it byalmost the same amount in 2013, leaving the level of GDPafter 2013 slightly above the baseline — a reflection of boththe “tail” on infrastructure spending and the fact that theprivate capital stock remains higher even through 2015.Payroll employment is boosted 1.3 million by the end of2012, 0.8 million by the end of 2013 and by diminishingamounts thereafter. The gradual decline in employmenttowards the baseline reflects lags in the response of labordemand to output. The unemployment rate is reduced by anaverage of 0.3 percentage point over the period 2012-2105.That the decline in unemployment is so modest in 2012reflects an increase in labor force participation encouragedby the extension of emergency unemployment benefits. Theimpact on inflation (not shown) was negligible.

MORE ON THE JOBS TAX CREDIT
The incremental tax credit could temporarily boostemployment in two ways. First, it could encourageemployers to hire workers in 2012 rather than later if thevalue of the tax credit exceeds the expected benefit ofdelaying the hires. Second, by lowering the relative price oflabor the credit could encourage substitution of labor forcapital. An example might be a firm that, instead of buyingnew computers, takes advantage of the credit to hire ITpersonnel to maintain or upgrade existing systems. Ourmodel does not allow such ex post substitution (capital /labor proportions are assumed to be variable before thecapital is in place, but fixed after) so we could not directlysimulate this possibility. However, there is some evidence inthe academic literature on labor demand suggesting a smallshort-run substitution elasticity that could imply a jobs effectfrom the incremental credit.

For example, the incremental tax credit reduces the marginal after-tax wage rate by 6.2%.Since, on average, wages constitute 80% of compensation, the credit might reducemarginal after-tax compensation by 0.8*6.2% = 4.9%. Note, however, the President’splan extends 100% expensing through 2012, and we estimate that this reduces themarginal after-tax cost of capital by 2.3%, so that the relative price of labor declines byonly 2.6%. If the short-run substitution elasticity is 0.1, the resulting increase in labordemand is 0.26%. This could be met either by increasing the workweek or by hiringextra workers.4 Suppose 3⁄4 of the increase in demand, or 0.18%, is met with new hires.Private payrolls (governments do not claim the credit and hence do not respond to it) are about 109 million. So, 0.18 % of 109 million is roughly 200 thousand. Yet we view eventhis modest number with suspicion, given the announced temporary nature of theincentive and that currently lack of aggregate demand is the principal constraint oncurrent hiring. It seems unlikely to us that in today’s weak economy, the credit wouldcompel firms to incur the fixed costs of first increasing and then decreasing their labor /capital ratio all within a year.

CONCLUDING COMMENTS
The package is intended to deliver stimulus that is timely, temporary, and targeted toareas of immediate need, while promising to pay for stimulus when the economy isstronger and the FOMC better poised to offset any drag associated with the payback.On these grounds the plan seems reasonable to us. It is not, however, a panacea that willput the unemployment rate on a notably steeper descent towards full employment.Rather, it shifts growth from the future, when we hope the economy will be stronger, totoday when we know it remains mired in a sub-par expansion.

______
1 See “Granting Jobs to States”, Macroeconomic Advisers’ Macro Musing (Volume 4, Number 17;August 26, 2011).
2 See “Extended UI Benefits Cloud Interpretation of Labor-Market Data”, MacroeconomicAdvisers’ Macro Focus (Volume 6, Number 11; September 7, 2011).
3 Our baseline assumes—perhaps optimistically—that the JSC achieves an extra $1.5 trillion indeficit reduction by 2021 beyond the spending caps enacted as part of BCA 2011. However, any savings the JSC achieves over $1.2 trillion will prevent automatic spending cuts of that amount.Hence, one could even argue that our simulation already reflects most of the “pay-fors” requiredto offset the cost of AJA 2011.
4 The credit is for incremental increases in payroll, not employees.

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Low Expectations

2011-09-12T12:46:00.000-07:00

We expect additional monetary policy easing just ahead, but we have low expectations about the Fed's ability to provide further substantial stimulus.

It's not that the Fed is powerless to address the most recent bout of economic weakness. It's just that its remaining options have either limited potential to provide further stimulus or high perceived costs (or both).

This is from a commentary that was published on September 9, 2011.

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MA's Prakken Discusses Obama's Plan on CNBC

2011-09-09T12:15:00.000-07:00

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American Jobs Act: A Significant Boost to GDP and Employment

2011-09-08T22:26:00.000-07:00

We estimate that the American Jobs Act (AJA), if enacted, would give a significant boost to GDP and employment over the near-term.

The various tax cuts aimed at raising workers’ after-tax income and encouraging hiring and investing, combined with the spending increases aimed at maintaining state & local employment and funding infrastructure modernization, would:

Boost the level of GDP by 1.3% by the end of 2012, and by 0.2% by the end of 2013.
Raise nonfarm establishment employment by 1.3 million by the end of 2012 and 0.8 million by the end of 2013, relative to the baseline.

The program works directly to raise employment through tax incentives and support to state & local governments for increasing hiring; it works indirectly through the positive boost to aggregate demand (and hence hiring) stimulated by the direct spending and the increase in household income resulting from lower employee payroll taxes and increased employment.

Because the package is some $100-$150 billion larger than the proposal widely reported in the press and that we wrote about two weeks ago, these effects are expected to be significantly larger than previously expected.

This simulation did not incorporate potential incentive effects on employment from the payroll tax credit for new hires.

Studies have found that such credits do incent increased hiring.
However, it is difficult to know the employment base of the firms eligible to receive the credit, hence we could not form an estimate of the aggregate employment gain
That we did not allow for these effects suggests some upside risks to these employment estimates presented here.

Because these initiatives are planned to expire by the end of 2012 — except for the infrastructure spending, which has a longer tail — the GDP and employment effects are expected to be temporary.

That is, these proposals will pull forward increases in GDP and employment, not permanently raise their level.
Nevertheless, there may be good reasons to want to implement such programs today, if the government can follow through on the commitment to trim deficits later:

There remains considerable slack in the economy and nearly all forecasts anticipate only a gradual decline in the unemployment rate over the next couple of years.
Given the elevated risk of recession the U.S. faces today, additional near-term stimulus reduces that risk.
Given the deleterious effects of long-term unemployment on an individual’s skills and long-term employment prospects, speeding a return to employment is both individually and socially beneficial.
With monetary policy’s limited room to lower rates and stimulate demand, there is a role for counter-cyclical fiscal policy.

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Is the Fed Too Obsessed with Inflation? A Proposal for a New FOMC Regime

2011-09-08T15:44:00.000-07:00

When the Chairman discusses the FOMC's medium-term inflation objective, we suspect that many in the market interpret him as saying that the inflation goal is also a near-term objective. This interpretation undermines the FOMC's ability to ease under current circumstances.

If the "2% or slightly below" inflation objective were also a short-term goal, the FOMC would respond to even short-term deviations of core inflation from its target.
It appears that the fact that year-to-date core inflation is running slightly above 2% is a constraint on whether, how, and how aggressively the FOMC is prepared to ease.
Our interpretation is that the FOMC is not actually so set on hitting the 2% inflation objective over the near term, but market perceptions do matter, especially when those perceptions are a risk to the stability of longer-term inflation expectations.

A key issue is providing clarity on how tolerant the FOMC is, or should be, about short-run departures of core inflation from 2%. We propose a new policy regime, called monitoring-range inflation targeting (MRIT, pronounced "merit") that provides such clarity.

Under MRIT, the FOMC announces an explicit medium-term headline inflation target-e.g., 2%-together with a short-term monitoring range for expected core inflation-e.g., 1.5% to 2.5% on a 12-month change basis.
Under MRIT, if the labor market did not improve significantly, the FOMC would keep the funds rate "exceptionally low" as long as near-term core inflation was projected to stay within the monitoring range, provided, of course, longer-term inflation expectations remained consistent with the medium-term inflation target.
We don't know whether the FOMC is or will be considering MRIT. We strongly believe that it should! Indeed, we believe it so strongly that we anticipate something akin to MRIT being announced, perhaps early next year.

With core PCE inflation not expected to move above 2.5% for a very long time, MRIT would signal that the FOMC expects to stay exceptionally accommodative well beyond 2013.

An advantage of MRIT over other easing options is that it doesn't involve an expansion of the balance sheet-as required by QE3-or a temporary increase in the effective inflation target-as would be the case under price level targeting.
Like pure inflation targeting, MRIT would reinforce the medium-term commitment to price stability, but it would preserve the FOMC's flexibility in the short run.
Like price level targeting, MRIT would signal a greater tolerance for higher inflation in the near term, but with lower risks to the stability of long-term inflation expectations.

An Inflation Targeting Regime with a Short-Run Monitoring Range
We propose that the FOMC announce an explicit medium-term target for headline inflation and a shorter-term monitoring range for expected core inflation.[1] We refer to this as a "Monitoring-Range Inflation Targeting" regime," or MRIT.[2] For instance, the FOMC could announce a 2% medium-term target for headline inflation and a 1.5%-to-2.5% monitoring range for expected core inflation over the short term.

We strongly believe that the medium-term objective should be a point rather than a range, and that it should be expressed in terms of headline inflation. The emphasis on headline inflation would indicate that the Committee is focused on all prices, i.e., that it does realize that the public buys all goods and services, including gas and groceries! Setting the medium-term target as a point would help bring clarity to the Committee's ultimate goal and, importantly, distinguish it from the monitoring range.

The monitoring range would bracket the medium-term point objective. Setting the monitoring range for expected core inflation over the short term, rather than headline inflation, would reflect the Committee's long-standing view that core inflation is a better predictor of trends in headline inflation than is today's headline inflation. Headline inflation is just too volatile over the short run to be a reliable indicator of its trend.

Our proposal reflects our view that current circumstances should, and may, lead the FOMC to rethink the weight it places on achieving a strict inflation objective in the short run, relative to promoting full employment. In particular, given how far the FOMC is from its full-employment objective these days, the Committee should be able to put in place policies that are likely to lead to some short-term overshooting of its medium-term inflation objective.[3] But our proposal goes beyond addressing the current weakness in economic conditions. We view MRIT as a permanent new operating regime for the FOMC, one that would reinforce its commitment to price stability without jeopardizing its ability to address the other side of its dual mandate.

Why Do We Consider MRIT to be "Above the Line?" [4]
In a recent commentary we discussed various options that we consider to be "above the line," i.e., options that would be in consideration under current circumstances. MRIT was not included in that commentary (because we hadn't thought of it at that time) but we consider it to be essentially a combination of two options that we included in that list: announcing an explicit inflation target and price-level targeting. Better still, we consider MRIT to have some of the key benefits of each of these two options but, potentially, without their drawbacks.

Similar to pure inflation targeting, MRIT has the advantage that it helps reinforce the stability of longer-term inflation expectations. Nonetheless, unlike pure inflation targeting, we believe that MRIT would not limit the FOMC's ability to provide further support to the faltering recovery (the other part of the dual mandate), even if current readings on core inflation are at or slightly above the mandate-consistent medium-term inflation target.

MRIT is similar to price level targeting in that it allows the Committee to temporarily tolerate a rise in inflation beyond the medium-term target. But under price level targeting, the extra tolerance for above-target inflation could lead longer-term inflation expectations to become unmoored, given that the public would not know how much of an overshoot would be tolerated by the Committee in the future.[5] In contrast, the Committee's tolerance of above-target inflation under MRIT is well defined and pre-announced (in the form of the short-term monitoring range).

Another advantage of MRIT over other easing options is that it doesn't involve an expansion of the Fed's balance sheet-as required by QE3-or a temporary increase in the inflation target, which has been advocated by some, but which, in our opinion, could lead to a significant un-anchoring of longer-term inflation expectations. Indeed, we don't even consider a temporary increase in the inflation target to be an above-the-line option.

The Benefits of MRIT Today
To illustrate why the notion of a short-run monitoring range matters, consider the fact that year-to-date core inflation is running at slightly above 2% appears to be a constraint on whether, how, and how aggressively the FOMC should ease in response to the faltering recovery. The Chairman has pretty much said as much.[6] If, instead, the Committee had a short-term monitoring range along the lines discussed above, 2% core inflation would be no impediment for further easing, provided longer-term inflation expectations are still consistent with the Committee's medium-term inflation objective, as they are today.

MRIT would be especially helpful today when the FOMC is at the zero bound, GDP growth and unemployment rate projections call for more easing, and some, including many on the Committee, either expect or worry that inflation will move to 2% or modestly above. MRIT would signal that the Committee today is prepared to tolerate somewhat higher inflation in the short-run, compared to its 2% medium-term objective.

Under MRIT, if the labor market does not improve significantly, the FOMC would keep the funds rate "exceptionally low" as long as near-term core inflation is projected to stay within the monitoring range, provided, of course, longer-term inflation expectations remain consistent with the medium-term target. For instance, with core PCE inflation currently running at 1.6% (based on the 12-month change) and not expected to move above 2.5% for a very long time, MRIT would signal that the Committee won't start removing policy accommodation until well beyond 2013.

The Benefits of MRIT as a New Policy Regime
We propose MRIT not as a temporary, emergency measure, but as a new, permanent regime. This would show a high degree of confidence that the Committee now believes that MRIT is "best-practice" monetary policy.[7]

A key benefit of MRIT is that it more fully addresses the Committee's dual mandate than would a pure inflation targeting regime. For instance, the medium-term inflation target component of MRIT fully incorporates the Committee's price stability objective, whereas the notion of a short-term monitoring range, which allows inflation to deviate from the medium-term objective over the short-run, would give the Committee the flexibility it needs to address the full-employment portion of its congressionally-mandated objective.

What about Long-Term Inflation Expectations?
Could the FOMC really signal greater tolerance for moderately above-target inflation over the short run without upsetting long-term inflation expectations? We believe that confidence that the Committee can keep long-term inflation expectations anchored is the absolute precondition for proceeding with MRIT. Maintaining stable long-term inflation expectations is especially important, and perhaps challenging, if core inflation moves toward the upper end of the monitoring range over the next year or two.

How could the FOMC meet this challenge? The answer, of course, is effective communication. The Committee would have to be extremely clear about its intent and the short- and medium-term implications of the new policy regime for the conduct of monetary policy. An essential part of this communication must be to emphasize and hammer home that the FOMC is as committed as ever to achieving price stability (its medium-term inflation objective). The practical question here is whether Chairman Bernanke could get the job done. We think he can!

Blowing in the Wind?
We have set out a proposal here that we think makes sense, that would be very effective today, and that dominates, perhaps by a wide margin, any other option the FOMC has available, especially QE3. We have not heard anyone, inside or outside the Committee, even mention this option.[8] So are we blowing in the wind, or is MRIT possibly an above-the-line option that might be discussed (though not implemented) as early as this month? We don't really know.

We admit that a motivation for offering this proposal is to increase the odds that the Committee will carefully look at it, sooner rather than later. We are being more speculative than normal here, but we can imagine something akin to MRIT being announced as early as January. But then again, maybe we're just too enamored with our own proposal!

The Bottom Line
We proposed a new regime for the FOMC, which we called monitoring-range inflation targeting (MRIT). Under MRIT, the FOMC would announce an explicit medium-term target for headline inflation and a short-term monitoring range for expected core inflation. A key benefit of MRIT is that it would reinforce the FOMC's commitment to price stability over the medium term while also giving the Committee some room to provide additional stimulus over the short run. We believe that MRIT dominates other easing options that are currently under consideration. In addition, MRIT could easily become a permanent new regime for the Committee and not just another emergency action taken to address the aftermath of the Great Recession. A main challenge with adopting MRIT is the risk that it might unsettle longer-term inflation expectations. This is a communication challenge that, we believe, could be handled by Chairman Bernanke. At any rate, other potentially effective easing actions currently on the table would present even greater communication challenges.

[1] We are not saying that the FOMC should ask Congress to change the Federal Reserve Act to set price stability as its single objective. As the Chairman has commented in the past, the Committee could put it in terms of a mandate-consistent inflation rate.
[2] The Bank of Canada's (BoC) inflation targeting regime comes the closest to our proposal. The BoC sets its inflation objective (called the "inflation-control target") as a range of 1% to 3% for headline inflation but indicates that it is aiming for 2% in the medium term. As a result, we view the BoC regime more as having a point target than a range target. The BoC also sets a shorter-term guideline for core inflation, called the "operational guide." This range, however, has no official status, and it was not mentioned in the "Joint Statement of the Government of Canada and the Bank of Canada on the Renewal of the Inflation-Control Target," November 23, 2006.
[3] Our proposal has some of the spirit of the risk management approach practiced under Greenspan. For instance, that approach held that, when there is a risk of deflation but no deflation in the forecast, the FOMC should put in place a policy so stimulative that it might overshoot its medium-term inflation objective if its forecast turns out to be correct.
[4] Please see our Policy Focus commentary, "Above the Line and Below the Line: A Peek into the FOMC's Easing Toolkit," August 25, 2011.
[5] In a price level targeting regime, the Committee operates as if it had a time-varying effective inflation target. In particular, such a regime can be thought of as one where the Committee targets an average inflation rate over a given horizon. For instance, if the averaging period were four years, and inflation were averaging a full percentage point below its target over the preceding two years, the Committee would then have to aim for approximately a full percentage point overshoot, on average, over the subsequent two years. If this sounds complicated, you're not alone. Explaining a price level targeting regime to the public would itself be a challenge, much less implementing it!
[6] Please see Chairman Bernanke's testimony on the semiannual Monetary Policy Report to the Congress on July 13 and July 14, 2011. Please also see his press conference on June 22, 2011.
[7] From a modeling perspective, MRIT would involve a non-linear policy function, whereby the FOMC doesn't respond to fluctuations in core inflation that still leave it within the monitoring range but reacts strongly when core inflation falls outside the range. Of course, the FOMC would respond vigorously to deviations of longer-term inflation expectations from the medium-term inflation target, as well as to conditions in the labor market.
[8] President Evans, to be sure, got close to it in a recent speech, though his thinking seems closer to price level targeting than to MRIT. Please see Evans, Charles, 2011. "The Fed's Dual Mandate Responsibilities and Challenges Facing U.S. Monetary Policy." Remarks delivered at the European Economics and Financial Centre in London, United Kingdom on September 7, 2011.

This is from a commentary that was published on September 7, 2011.

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Is the Fed Too Obsessed with Inflation? A Proposal for a New FOMC Regime

2011-09-08T14:02:00.000-07:00

A key issue for monetary policy these days is providing clarity on how tolerant the FOMC is, or should be, about short-run departures of core inflation from 2%. We propose a new policy regime, called monitoring-range inflation targeting (MRIT, pronounced "merit") that provides such clarity. As its name suggests, MRIT combines an explicit medium-term target for headline inflation with a short-run monitoring range for core inflation.

This is from a commentary that was published on September 7, 2011.

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Extended Unemployment Benefits Cloud Interpretation of Labor-Market Data

2011-09-07T14:47:00.000-07:00

Extended unemployment insurance (UI) benefits provide a safety net to job-losers, raise income and stimulate aggregate demand and employment, and alter the incentives to search for work and to be counted in the labor force as unemployed.

These first two effects are widely appreciated and not the main subject of this report.
The third type of effects — what we label as the “behavioral” channels — have consequences for the interpretation of data on unemployment and the level of resource utilization that are perhaps less well understood.
Stimulus effects are currently adding a couple-hundred thousand to employment and lowering the unemployment rate by one- to two-tenths, but behavioral channels are raising the unemployment rate by considerably more. The net effect is to raise the reported unemployment rate by about 1⁄2 percentage point and the NAIRU by about 2⁄3 of a percentage point.

The presence of extended UI benefits alters the incentives to search for work and to be counted in the labor force as unemployed.

UI benefits lower the net benefit to accepting employment and raise the incentive to continue to search for work and to decline employment offers that are less than ideal. This leads to longer durations of unemployment, but may allow for more productive “matches” between employers and employees.
Recipients of UI benefits may be counted in the labor force as unemployed and looking for work even if they do not currently intend to accept a job offer.
The combined effect of these two behavioral channels is to raise the reported labor force and the reported unemployment rate, with little effect on employment, in contrast with stimulus effects, which raise employment and lower unemployment.

The increase in unemployment from behavioral channels raises the NAIRU by an equivalent amount and has no direct impact on the unemployment gap — the difference between the unemployment rate and the NAIRU.

Failure to recognize the effect on the NAIRU would lead one to over-estimate the unemployment gap and to expect less inflation (via a Phillips Curve model).
Correctly gauging the degree of labor-market slack is critical for monetary policy.

We estimate that the behavioral channels are currently boosting the reported labor force by roughly 1 million, and the reported unemployment rate (and the NAIRU) by about 2⁄3 of a percentage point.

At the peak in 2010, when there were some 6 million recipients, the impacts on the labor force and the unemployment rate (also NAIRU) of the behavioral channels were approximately 11⁄2 million and 1 percentage point, respectively.
The expiration of extended UI benefits in 2012 will lower the NAIRU and contribute negatively to employment, unemployment, and the labor force.
Conversely, we would revise up our forecasts for employment, the unemployment rate, and the labor force, if extended UI benefits are renewed.

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MA Analysis of the President's Job Proposals

2011-09-07T09:56:00.000-07:00

In anticipation of the President's upcoming jobs speech, published two commentaries in the past couple of weeks:
A Jobs Bill (Not So) Great Expectations
Impact on Employment of Federal Grants to States

We will be publishing our analysis of the President's plan to the MA blog as soon as it is available on Thursday.

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FOMC Minutes: Bold is "Measured"

2011-09-01T12:38:00.000-07:00

The minutes suggest that the discussion around the FOMC table in August wasn't about whether to ease, but how to ease and how aggressively to ease.

This is from a commentary that was published on August 30, 2011.

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ADP Report (+91K): Tepid, Disappointing, but not Unexpected (Joel Prakken on CNBC)

2011-08-31T09:47:00.000-07:00

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$50b in federal grants to states could save more jobs than $60b in unemployment benefit extensions

2011-08-30T13:27:00.000-07:00

When tax revenues fall in a recession, state and local governments respond by cutting employment. Federal grants to states could avoid these layoffs by offsetting the budget shortfalls until the states’ revenues recover. We estimate that $50 billion in federal grants to state and local governments would directly raise state and local employment in 2012 by about 150,000.

In a recent Macro Focus we described our modest expectations for the effectiveness of provisions that might be included in a jobs bill the President will unveil after Labor Day. One possibility not discussed in that piece but finding some play in the press is extending federal grants-in-aid to states. Nearly all state governments face a balanced-budget mandate. Hence, when revenues fall during a recession, states respond with some combination of tax hikes and spending cuts. One way for states to cut spending is to lay off workers. Federal grants could forestall these layoffs.

Using yearly average data since 1962, we ran a simple regression of the logarithmic change in S&L employment per capita on S&L deficits (NIPA definition, and expressed relative to S&L outlays) in the previous year.

Our analysis shows that if this year, the federal government grants an additional $50 billion to S&L governments—roughly enough to eliminate the S&L deficits we project for next year—S&L employment will be boosted directly by 0.8% in 2012, or approximately 150,000 jobs. This implies that roughly $9 billion of the grants would be used to defend S&L jobs. The rest would be used to prevent other spending cuts or tax hikes at the state and local level. Hence, the remaining $41 billion would also boost employment indirectly by stimulating aggregate demand.

That nearly 20% of the grants would go directly to jobs raises the relative power of grants as a jobs measure. For example, if states use the remaining $41 billion to prevent an increase in state personal taxes, the total impact on jobs in 2012 rises to around 290,000. This compares favorably to the 200,000 jobs we estimated would result in 2012 from extending unemployment benefits for another year at a greater cost of $60 billion.

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Go Take a Hike; Let’s Talk Again in September

2011-08-29T12:46:00.000-07:00

As we expected, there was no major news in Chairman Bernanke's remarks at Jackson Hole. In effect, the Chairman told symposium participants to enjoy the program, relax, and go hiking.

He announced no new easing initiatives but signaled that the Committee has an easing bias.

This is from a commentary that was published on August 26, 2011.

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Above the Line and Below the Line: A Peek into the FOMC’s Easing Toolkit

2011-08-29T12:42:00.000-07:00

We categorize the FOMC’s easing tools as either above the line (on the table, likely under consideration now) or below the line (off the table, at least for now).

The dividing line between on-the-table and off-the-table options can shift depending on how the macro outlook evolves.

This is from a commentary that was published on August 25, 2011.

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The Chairman at Jackson Hole: Déjà Vu

2011-08-25T12:22:00.000-07:00

It may seem like there is an echo in the room. Recent changes in the growth outlook and stance of monetary policy are eerily similar to the circumstances surrounding last year's gathering at Jackson Hole. The Chairman's remarks may also be similar to last year's.

This is from a commentary that was published on August 22, 2011.

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Duration-Extension Trades at the Fed: The Power (and Limits) of Sterilized LSAPs

2011-08-25T12:20:00.000-07:00

In principle, there is enough room in the Fed's portfolio for duration-extension strategies to provide significant additional monetary stimulus. But such strategies face a high threshold, though not as high as that for conventional large-scale asset purchases (LSAPs).

This is from a commentary that was published on August 22, 2011.

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A Jobs Bill: (Not so) Great Expectations

2011-08-25T08:20:00.000-07:00

President Obama will unveil a new jobs plan shortly after Labor Day. Unofficial reports suggest it will include a combination of initiatives to increase hiring indirectly by stimulating aggregate demand, while simultaneously encouraging hiring with tax credits and training programs. These initiatives may include:

An extension of federal funding for emergency unemployment benefits
An extension of the payroll tax holiday, possibly expanded to include the employers' portion of Social Security taxes
An extension of temporary businesses "expensing" of capital investments
A new tax credit for businesses that increase the size of their workforce
Infrastructure spending, perhaps including renovation of public schools
A job-training program targeting the long-term unemployed, possibly modeled after a program in Georgia
To pay for these short-run initiatives, the President may seek more long-term deficit reduction than called for under the recent debt ceiling deal

We estimate that extending through 2012 the employee payroll tax holiday, emergency unemployment benefits, and business expensing provisions would boost employment roughly 600,000 by the end of next year, with the effect quickly dissipating over the following two years. A temporary reduction in the employer payroll tax in 2012 may pull some employment forward from later years, as might a temporary tax credit for hiring, but we expect these effects to be negligible in such a weak economy. Infrastructure spending can make good economic sense in both the short-run and long-term, particularly at today's low interest rates, but takes time to ramp up and will be limited in scope by current political realities. Training programs could result in the faster re-employment of some workers, reducing structural unemployment. However, because none of these ideas address the main impediment to hiring-persistently insufficient final demand-our expectations for the success of a jobs bill are, well, not so great.

EXTENDING UNEMPLOYMENT BENEFITS
Roughly speaking, extending unemployment benefits through 2012 would cost $60 billion, boost real GDP growth 1/4 percentage point over the year, and raise employment 200,000 by the fourth quarter. Of course, these effects would reverse after 2012 following the expiration of the benefits. The hope, then, is that the economy gains enough momentum in 2012 to keep growing strongly in 2013 when the benefits expire. Otherwise, the issue of yet another extension of unemployment benefits surely will be re-visited.

Furthermore, there is a strong irony here. Recent research suggests that emergency unemployment benefits have increased the unemployment rate by raising the labor force and perhaps by reducing the intensity of job search. Our own estimate is that these benefits currently boost the labor force enough to raise the unemployment rate 0.6 percentage point. Hence, extending unemployment benefits for another year will raise GDP growth and employment modestly, but also prevent an even larger decline in the labor force and hence a decline in the unemployment rate.[1]

EXTENDING THE PAYROLL TAX HOLIDAY
Extending the current holiday on the employee share of Social Security taxes through 2012 would, roughly speaking, cost $120 billion, boost real GDP growth 1/2 percentage point over the year, and raise employment 400,000 by the fourth quarter, assuming (as we do) that employers don't use the holiday as an opportunity to limit raises and or bonuses. Expanding the holiday to include the employer share of Social Security taxes would double the cost but not the stimulus, unless employers passed their tax savings on to workers. In our modeling, a cut in the employer share of payroll taxes goes almost entirely into profits with little effect on either GDP or employment. Hence, we rate expanding the payroll tax holiday to include the employer share of Social Security taxes as an ineffective way to stimulate aggregate demand and hence to boost employment.

Some argue that reducing payroll taxes will encourage hiring independent of any impact on employment through aggregate demand. At full employment a permanent reduction in payroll taxes could coax forth additional labor supply while inducing a substitution of labor for capital (which, incidentally, would tend to reduce capital expenditures-an important component of aggregate demand). However, with employment constrained by a lack of aggregate demand, the principal effect on hiring of a temporary reduction in payroll taxes would be to convince employers to pull hiring forward from 2013 (or beyond) because the certain tax benefits of hiring in 2012 exceed the expected benefits of delaying the hire until 2013 or later. It is next to impossible to assess for how many employers this calculus favors hiring sooner than later. However, with the consensus forecast now showing little cyclical improvement in the economy over the coming year, and with little risk of a labor shortage anytime soon, we expect most employers to conclude that it remains a bad time to hire, even with the tax benefit.

A JOBS TAX CREDIT
The President reportedly is considering a tax credit based on the net change of a firm's workforce over a year. Such a credit would have to be carefully designed to prevent firms from "gaming" it. In addition, to have maximum immediate impact, the credit would have to be temporary. Ironically, if maintained long enough, such a credit would, by reducing the relative cost of hiring workers from a growing labor force, encourage firms to substitute labor for capital, thereby reducing labor productivity and hence real wages-probably not the intent! As a temporary measure a jobs tax credit could, like the payroll tax holiday just discussed, encourage firms to pull forward hiring forward from 2013 (or beyond) if the certain tax benefits of hiring now exceed the expected benefits of hiring later. Hence, we have the same guarded assessment of the jobs tax credit as we do of the payroll tax holiday.

EXTENDING EXPENSING
Special expensing provisions for businesses are slated to expire at the end of this year. Extending these provisions would lower the cost of capital, stimulate investment spending and hence aggregate demand and employment, but also induce a largely offsetting substitution away from labor towards capital. The net effect is a relatively small boost to employment. We estimate that extending the expensing provisions through 2012 would boost real GDP growth by about 0.1 percentage point, with a change in employment that, by the end of next year, is lost in the rounding.

INFRASTRUCTURE SPENDING
Reports suggest that the President may propose spending tens of billions of dollars to renovate the nation's public schools. Whatever the project, infrastructure spending certainly stimulates aggregate demand and employment, and also has a relatively high short-run multiplier. Furthermore, especially at the current cost of federal debt, there surely are infrastructure projects with a positive net return to society in the long run. However, as we think was learned following the enactment of the 2009 stimulus bill, there are fewer "shovel-ready" projects than once argued. Given delays arising from environmental issues and local battles over eminent domain, as well as lengthy construction timetables, the spend-out schedules for new infrastructure programs can span the better part of a decade.

For example, suppose Congress appropriates for public construction $50 billion - a lot in today's partisan political climate, and more than appropriated under the 2009 stimulus bill. Spend-out schedules shown by the Congressional Budget Office for infrastructure spending suggest that in the first full year following the appropriation of funds, perhaps no more than 15% of the total (or $7.5 billion) would actually be spent. Assuming a multiplier of 2, this would raise real GDP by less than 0.1% at the end of one year. Through a typical Okun's law, this would raise employment by roughly 75,000. The peak employment effect would occur in the second and third years, but would still reach only about 125,000. This is just one month's growth of employment, even in today's weak economy.

If public works projects are worthwhile as long-run investments, now is certainly an opportune time to start them. However, infrastructure spending cannot jump-start near-term hiring unless ramped up at a pace and on a scale that, outside of wartime, would be unprecedented. Some economists, like Princeton's Paul Krugman, advocate exactly this policy, but in today's political climate it simply won't happen.

JOB TRAINING PROGRAM
Press reports also suggest that the President's plan will target the long-term unemployed, and he has lauded a program in Georgia, called Georgia Works, under which participating companies, at no cost to themselves, train workers for eight weeks at the end of which companies can offer trainees jobs or not. During the training, workers can receive unemployment benefits as well as a modest stipend to cover transportation and other out-of-pocket expenses. Since 2003, about 1/4 of participating workers eventually were hired by the companies that trained them, and 60% quickly found gainful employment somewhere.

Long stints of unemployment erode workers' skills, earnings, and morale, so a program that improves the match of skills supplied and demanded in labor markets seems appealing. It could help reduce structural unemployment. Still, it is unrealistic to think that Georgia Works could be quickly replicated nationwide; it certainly would be expensive to fund and administer. There also are legitimate concerns regarding design and effectiveness. Any such program must prevent firms from repeatedly exploiting what amounts to free labor. Labor economists have not studied Georgia Works sufficiently to know whether participating workers would have found jobs anyway. With unemployment currently so high, a ready supply of qualified job applicants might undermine the perceived value to employers of the free training. Furthermore, training does not address the issue of insufficient final demand. The take-up rate on such a program could be disappointingly low if, in this weak economy, firms aren't looking to hire even a well-trained worker.

LINKING SHORT RUN AND LONG RUN
The President would be correct to link short-term stimulus with credible long-run deficit reduction. Without the latter, the former cannot be enacted. And, financial markets (not to mention S&P!) could react badly to the cost of a short-term jobs bill not matched by a convincing willingness to pay for it later. The more near-term stimulus the President requests, the more long-term deficit reduction he must seek and, hence, the more likely the long-term deficit reduction must include tax hikes opposed by Republicans and entitlement cuts opposed by Democrats. Therefore, a dilemma for the President is that the more stimulus he requests the greater the chance of a political deadlock that precludes any jobs bill at all.

SUMMING UP
Temporarily extending the current payroll tax holiday, emergency unemployment benefit, and business tax breaks will temporarily boost GDP and hence employment, albeit modestly. For temporary training programs and hiring incentives to have much impact now, firms must be confident that when the temporary programs and incentives expire, economic conditions will validate the decision to hire earlier rather than later. In today's economy, there's certainly no guarantee this will occur. For infrastructure spending to make a big dent in the unemployment rate, it would have to be done rapidly and on a scale that is impossible in today's political climate. In sum, and disappointing as it may be to unemployed Americans, there simply are limits to what a jobs bill can achieve today.

[1] See Macroeconomic Advisers' Macro Focus, "Allowing Extended UI Benefits to Expire in 2012 Could Lower NAIRU by 2/3 of a Percentage Point & Other Effects on Unemployment and the Labor Force" (Forthcoming). Our current forecast, which assumes unemployment benefits are not extended, incorporates a related decline in the unemployment rate over 2012. This explain why our forecast shows declining unemployment even in the face of very sluggish GDP growth.

This is from a commentary that was published on August 24, 2011.

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Larry Meyer Discusses the Economy and Fed on CNBC's Kudlow Report

2011-08-21T20:40:00.000-07:00

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Larry Meyer discusses today's market sell-off on CNBC

2011-08-18T10:44:00.000-07:00

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Meyer: FOMC would be strengthened significantly by addition of Clarida and Stein

2011-08-12T16:40:00.000-07:00

The Wall Street Journal reported today that, according to “several people familiar with administration deliberations,” the President will nominate Richard Clarida and Jeremy Stein to the Federal Reserve Board.

Congratulations to the nominees and kudos to the President, the team advising him, and the Republicans, to the extent that this is the outcome of a “deal.”
Both are first-rate economists and bring expertise ensuring that they would make valuable contributions at the Board and at the FOMC.
It was irresponsible to leave the Board so understaffed for so long, but we appreciate the challenge of getting anyone confirmed for anything in today’s political climate.
These are superb appointments. It’s hard to think of better choices! It was worth the wait!

If confirmed, Richard Clarida and Jeremy Stein will bring substantial economics and finance expertise, market savvy, and international perspective to the Board.

Jeremy Stein is a professor of economics at Harvard University. He served earlier in the Obama Administration as a senior advisor to the Treasury Secretary and was on the staff of the National Economic Council. His specialties include finance, monetary policy, risk management, and banking. He brings a set of skills and background that the FOMC has not always, indeed rarely, had.
Richard Clarida is a professor of economics at the School of International and Public Affairs at Columbia University and, since 2006, an executive vice president at PIMCO. He was the Assistant Treasury Secretary for Economic Policy in the George W. Bush administration. His focus has been on economic policy, the global and U.S. economic outlook, international capital flows, and the maturity structure of U.S. debt. The last would be especially useful at the FOMC today!

One is a Republican; the other is a Democrat. Who cares (other than the Democrats and Republicans, of course)?

We hope that this “bipartisan” approach will facilitate confirmation by the Senate.
Political affiliation may well have been part of the nomination calculus, but, in this case, the politics stops at the door of the Eccles building.
We have been saying that the Chairman and Vice Chair deserve some playmates. Hopefully, they just got two!

Does this strengthen the position of the Chairman, especially after the three dissents by bank presidents at the August FOMC meeting?

We don’t think so. As we have said in the past, the Chairman is the decider. That has been the case, and that will continue to be the case if Jeremy Stein and Richard Clarida are nominated and confirmed.
While one of Meyer’s Laws of Voting (#3: There shall not be more than two dissents) took a hit with the three dissents, we still stand by #1: Board members shall not dissent!2
If confirmed, the two new members will be excellent team players and follow the FOMC tradition of consensus voting. They will bring much to the table and surely help the Chairman make better decisions.

The bottom line is: The Board and FOMC would be significantly strengthened by the two nominees.

The addition of Richard Clarida and Jeremy Stein to the Board would make this one of the strongest Boards in the recent history of the FOMC.
As strong as the Board was when Larry was there, this one might become even stronger given Clarida’s and Stein’s unquestioned expertise in financial markets, monetary policy, and economic matters.

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FOMC Statement Comment: Unprecedented and Very Effective

2011-08-11T10:57:00.000-07:00

Consistent with our expectations, the FOMC started easing through communication, though much more forcefully than we had anticipated.

This is from a commentary that was published on August 9, 2011.

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Turning up the Rhetoric in Tomorrow’s FOMC Statement

2011-08-11T10:56:00.000-07:00

Given the continuing sharp deterioration in global financial markets in recent days—and the growing danger that it poses to U.S. economic prospects—we expect the FOMC to be even more forceful in its description of the macro context and outlook than suggested by the FOMC Briefing commentary that we published last week.

This is from a commentary that was published on August 8, 2011.

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FOMC Chatter ahead of the August 2011 Meeting

2011-08-11T10:54:00.000-07:00

The discussion over this intermeeting period focused on the slowdown in the first half, the uncertainties surrounding the outlook for the second half and next year, and the prospect for monetary policy in the near term.

This is from a commentary that was published on August 8, 2011.

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The Power (and Limits) of Communication: FOMC Rates Guidance and the Yield Curve

2011-08-11T10:52:00.000-07:00

In principle, FOMC communications can be very powerful. If the FOMC could encourage the market to shift out its expectation of the time of the first rate hike by six months, the impact on the ten-year Treasury yield would be comparable to that of $760 billion of QE! Our analysis suggests that a six-month shift in the expected time of the first rate hike would have a significant impact on the yield curve.

This is from a commentary that was published on August 8, 2011.

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FOMC Briefing: Tilting Toward Easing

2011-08-11T10:48:00.000-07:00

We don’t expect the FOMC to take any significant easing action next week, though the tone of the meeting will very much reflect a Committee that is tilting toward easing.

This is from a commentary that was published on August 5, 2011.

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Meyer Discusses Fed Policy on CNBC

2011-08-09T07:30:00.000-07:00

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Debt Ceiling Deal: Little Fiscal Drag in '12, Big Risk in '13

2011-08-01T16:58:00.000-07:00

The Debt Ceiling Deal:

Little Fiscal Drag in 2012, Big Fiscal Risk in 2013

Fiscal drag from the debt ceiling deal reached in Washington over the weekend would be modest and likely spread fairly evenly over the coming decade unless automatic spending cuts described in the legislation are triggered.

If the deal is enacted as planned — $917 billion of initial cuts followed by $1.5 trillion of additional cuts to be recommended by a Joint Select Committee (JSC) of Congress — the average impact on annual GDP growth over the next decade would be roughly 0.1 percentage point before multiplier effects, with the peak effect probably never more than 1⁄4 percentage point.
However, if the JSC recommendations are not enacted, automatic spending cuts could subtract as much as 0.7 percentage point of GDP growth from FY 2013, again before multiplier effects.
This would be bitter medicine for an economy likely still to be mired in a sub-par recovery at a time when the Federal Open Market Committee (FOMC) is badly positioned to offset any fiscal drag.

There would be somewhat less fiscal drag next year under the terms of this deal than we assumed in recent forecast, but a lot of risk surrounding any fiscal assumptions for 2013.

Our most recent forecast assumes that federal spending in FY 2012 is cut $36 billion below the March CBO baseline. The debt ceiling deal shows cuts of only $22 billion, suggesting a slight upward revision to our GDP forecast, all else equal.
Our most recent forecast assumes that spending in FY 2013 is cut $72 billion below the CBO baseline. This could be way too little or too much, depending on the JSC recommendations and whether or not they are enacted.

The Budget Control Act of 2011 (BCA) would cut spending through FY 2021 by $917 billion ($763 billion excluding interest) with caps on discretionary budget authority. It would also create the JCS to recommend by year’s end an additional $1.5 trillion in deficit reduction over 10 years. Failure to enact the JCS recommendations would trigger automatic spending cuts of $1.2 (with an allowance for savings on debt service) to be spread evenly across FY 2013 through FY 2021.

CBO has scored the provisions of BCA relative to its March adjusted baseline (see table) but, regarding provisions related to the special committee JSC, that scoring shows only the $1.2 trillion of cuts through FY 2021 that could be triggered automatically if the recommendations of the JSC are not enacted. We estimate that if the automatic spending cuts are triggered, primary spending would be cut by $113 billion per year starting immediately in FY 2013. These cuts would cumulate to a little over $1 trillion by FY 2021, with associated savings on debt service that we put at about $180 billion. (Our yearly estimates, which cumulate to the $1.2 trillion, are also shown in the bottom panel of the table).

The failure of the JSC to recommend additional budget savings, or failure to enact the Committee’s recommendations, would have considerable near-term consequences for the economy. The static fiscal drag from just the spending caps is relatively modest. The drag from the action or inaction of the Joint Select Committee is another matter. While the JSC has a stated goal of achieving at least $1.5 trillion of extra deficit reduction over 10 years, it could recommend deficit reduction that is back-loaded and that includes tax increases which would have less impact on aggregate demand than spending cuts. Hence, fiscal drag associated with the JSC recommendations might be relatively muted and build over time. However, if the automatic procedures are triggered, the extra deficit reduction is all in spending cuts and the associated fiscal drag is completely front-loaded into FY 2013, just as the Bush tax cuts are set to expire. While this will undoubtedly pressure the JSC to make recommendations that the Congress will approve and the President enact, it does highlight the possibility of a major fiscal shock in FY 2013.

The chart shows our estimates of the static fiscal drag arising from the BCA. Shown in blue is the drag from the initial round of cuts in spending forced by the caps on discretionary outlays. This averages a modest 0.1 percentage point of GDP growth in FY 2012 and FY 2013, and lesser amounts in the years thereafter. The additional drag from the automatic spending cuts is shown in red. In FY 2013 this is a quite sizable extra 0.7 percentage point, bringing the total drag to around 0.8 percentage point, but is zero thereafter. If, instead, the JSC’s recommendations are enacted, that extra 0.7 percentage point likely would be dispersed more evenly over the next 10 years so that in total, the drag would probably never exceed 1⁄4 percentage point in any particular year.

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Boehner v2 fiscal drag on GDP: 0.1 pp/year over 4 years

2011-07-28T08:01:00.000-07:00

House Speaker Boehner has proposed an amended version of his original plan to cut spending as a way to break the deadlock over raising the debt ceiling.

Like the first plan, the “Boehner Plan #2” initially limits spending through fiscal year (FY) 2021 with caps on discretionary budget authority while promising to convene a commission to identify more savings later.

CBO has scored this new plan relative to its March baseline. The score does not include savings that might come out of the promised commissions, since these are speculations now.

In the revised plan, cuts in primary spending (that is, excluding interest payments) cumulate to $762 billion ($916 billion including interest) compared to $715 billion in the original plan.
The cuts are now more front-loaded.
The chart shows our estimate of the static fiscal drag (that is, before any multiplier effects or financial offsets) associated with the Senate or “Reid Plan” and the two House or “Boehner Plans” by fiscal year.
We estimate that the new Boehner plan would still slow GDP growth by an average of 0.1 percentage point from FY 2012 through FY 2015.
Now, however, the peak effect is a little more than 0.1 percentage point in FY 2012 rather than a little more than 0.2 percentage point in FY 2014.

Our current forecast shows more fiscal drag from discretionary spending in FY 2012 than any of these plans, and more drag in FY 2013 than both Boehner plans.

The Reid plan does show more drag in FY 2013 than our forecast assumes, but we doubt that war spending could be curbed as sharply or as quickly as the Reid plan contemplates. Furthermore, such cuts would surely meet stiff Republican opposition.

Consequently, if a compromise is reached somewhere between the Reid plan and the Boehner Plan #2, we likely will raise our forecast line for discretionary spending modestly, at least through FY 2013.

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Dueling Debt Proposals: How Much Fiscal Drag?

2011-07-27T13:59:00.000-07:00

The House and the Senate have advanced separate but dueling plans to cut federal spending as a way to break the current impasse over raising the debt ceiling.

Both plans would initially limit spending through 2021 with caps on discretionary budget authority while promising to convene commissions to identify more savings later. The Senate plan has a separate cap for spending on the wars in Iraq and Afghanistan.

CBO has now scored both of these plans relative to its March adjusted baseline. The scores do not include savings that might come out of the promised commissions, since such savings are merely speculative now. The plans are summarized in the table below.

The cuts in primary spending (that is, excluding interest payments) in the House (or Boehner) plan cumulate to just $715 billion ($851 billion including interest).
The cuts in primary spending in the Senate (or Reid) plan cumulate to $1.8 trillion ($2.2 trillion including interest).
The cuts in the Senate plan are so much larger because that plan quickly cuts budget authority for the wars in Iraq and Afghanistan by well over $100 billion relative to the CBO baseline.
The chart shows our estimate of the static fiscal drag (that is, before any multiplier effects or financial offsets) associated with each plan by fiscal year.
We estimate that the Reid plan would slow GDP growth (again, statically) by about ¼ percentage point on average from fiscal year (FY) 2012 through FY 2015, with the peak effect being almost ½ percentage point in FY 2013.
We estimate that the Boehner plan would slow GDP growth by only about 0.1 percentage point on average over the same period, with the peak effect being a little over 0.2 percentage point in FY 2014.

Our current forecast shows more fiscal drag from discretionary spending in FY 2012 than either of these plans, and more drag in FY 2013 than the Boehner plan. The Reid plan does show more drag in FY 2013 than our forecast assumes, but we seriously doubt that the war effort could be scaled back as sharply or quickly as the Reid plan apparently contemplates. Furthermore, such near-term cuts would surely encounter stiff Republican opposition.

Consequently, if a compromise is reached on spending cuts somewhere between the two plans under consideration, we likely will raise our forecast line for discretionary spending — at least through FY 2013, while we await recommendations of the commissions regarding additional fiscal restraint.

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Treasury Yields: Up or Down if the Debt Ceiling is not Raised Soon?

2011-07-25T05:59:00.000-07:00

Based on conversations with a number of our clients, we detected an extremely wide range of views regarding the market impact of a delay in raising the debt ceiling. In particular, there was even disagreement about the direction of the effect on the ten-year Treasury yield! However, no one expected a calamity as a result of a brief delay in raising the ceiling, even if it was accompanied by a Treasury debt downgrade.

In this commentary we discuss the different factors that are likely to influence Treasury yields and the curve if the debt ceiling is not raised by early August. We then offer our own views on how the curve might behave if there is, say, on one-month delay in raising the debt ceiling and a downgrade of U.S. Treasury debt. We also discuss the likely behavior of risk assets.

[This is a brief excerpt from a longer commentary.]

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Debt Ceiling: Delay Equals Growth Recession

2011-07-22T16:53:00.000-07:00

The probability that Congress and the Administration fail to raise the debt ceiling before the Treasury runs out of cash has risen substantially. Our initial estimates are that if such action is delayed one month while a modest deficit-reduction plan is negotiated, Treasury debt will be downgraded, interest rates will rise modestly, and the economy will enter a brief growth recession. In particular:

Relative to the baseline, GDP growth would be slowed by 0.6 percentage point during the second half of 2011, but boosted by 0.2 percentage point during 2012.The unemployment rate would rise to 9.6% by the end of the year compared to 9.2% in the baseline, and still exceed 8% by the end of next year.
During the third quarter, long-dated Treasury yields would rise by 20 basis points relative to the baseline and by 10 basis points thereafter.
Private credit spreads for long-dated yields would widen by 20 basis points in the third quarter, but then quickly return to the baseline value. Stock prices would temporarily decline roughly 5%.

That these effects are relatively benign depends critically on the assumption that the political impasse over the debt ceiling is resolved fairly promptly and with at least some progress towards long-run deficit reduction. The economy would deteriorate quickly and much more dramatically if expectations were for a long impasse with an uncertain outcome. Of course, even worse — although very unlikely — would be an outright sovereign default, a scenario that is practically impossible to size.

More benign scenarios also are possible. The debt ceiling could be raised before the Treasury runs out of cash but Treasury debt downgraded nevertheless. We believe this would have minimal effects on financial markets or the economy. Another possibility, and one that looks increasingly likely, is a deal under which the President can raise the debt ceiling up to three times before the next Presidential election in exchange for progress on deficit reduction. This, too, we believe would be less pernicious than the scenario developed here.

...

[For the complete analysis, contact MA]

...

Compared to our baseline forecast, this fiscally induced “shock” creates a growth recession. Its later effects could be partially offset by an expected monetary easing but it would almost certainly be too late now for the Fed to prevent an initial slowing of growth and rise in the unemployment rate. It seems the height of policy folly for elected officials, intent on a game of budgetary chicken, to chance this downside risk during an economic recovery that was sub-par to begin with and lately seems to have faltered further. Sometimes in a game of chicken, people get injured—seriously.

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MA's Monthly GDP Declined 0.4% in May

2011-07-15T06:39:00.000-07:00

Monthly GDP declined 0.4% in May following no change in April, which was revised up from a 0.2% decline. While soft, the May reading is still in line with a rising trend. The May decline primarily reflected declines in net exports and the portion of monthly GDP not covered by the monthly source data. Domestic final sales posted a small decline, while inventory investment posted a solid increase. Averaged over April and May, monthly GDP was 1.8% above the first-quarter average at an annual rate. Our latest tracking estimate of 1.5% GDP growth in the second quarter assumes no change in monthly GDP in June.

This is from a commentary that was published on July 15, 2011.

Technical Note:

Macroeconomic Advisers’ index of Monthly GDP (MGDP) is a monthly indicator of real aggregate output that is conceptually consistent with real Gross Domestic Product (GDP) in the NIPA’s. The consistency is derived from two sources. First, MGDP is calculated using much of the same underlying monthly source data that is used in the calculation of GDP. Second, the method of aggregation to arrive at MGDP is similar to that for official GDP. Growth of MGDP at the monthly frequency is determined primarily by movements in the underlying monthly source data, and growth of MGDP at the quarterly frequency is nearly identical to growth of real GDP.

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Monetary Policy Testimony: Fiscal Policy Testimony?

2011-07-14T14:00:00.000-07:00

There was no new information in the Chairman's prepared remarks, which followed very closely portions of the minutes of the June meeting, released yesterday, as well as the tone of the discussion at his June press conference and, of course, our Preview. The most interesting part of the discussion was on fiscal policy, during the Q&A.

This is from a commentary that was published on July 13, 2011.

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FOMC Minutes: Preparing, Debating, and Waiting

2011-07-14T06:17:00.000-07:00

Preparing, Debating, and Waiting

We read the minutes of the June meeting as consistent with our Fed views. We had noted that we see the Committee in a wait-and-see mode, watching the incoming data carefully in an environment of unusual uncertainty about the outlook.

This is from a commentary that was published on July 12, 2011.

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MA's Meyer Guest Hosts CNBC's Employment Report Squawk Box

2011-07-08T08:20:00.000-07:00

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June Employment a Bust

2011-07-08T01:20:00.000-07:00

The employment report for June was an utter disappointment. Payroll employment barely rose, the unemployment rate rose one-tenth to 9.2%, the workweek and hours worked declined, and average hourly earnings were essentially flat. All of this spells bad momentum for hours and income heading into the third quarter. In addition, while chain-store sales rose in June, they did not rise by enough to rationalize our previous assumption for a solid increase in real PCE in June. This further undercuts momentum for consumer spending heading into the third quarter. On top of this, wholesale inventories were reported to be very strong through May … good news for Q2, but bad news for the second half, as some of the unexpected strength in Q2 inventory building was likely robbed from Q3 and beyond.

This leaves us thinking hard about the second half...

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MA's Prakken Discusses June ADP Employment Report on CNBC

2011-07-07T07:00:00.000-07:00

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