MacroScope

Fiscal tightening + monetary stimulus = ‘borderline insanity’?

It’s a curious pattern being repeated around the industrialized world. Governments are trying frantically to tighten their belts even as the monetary authorities loosen their purse strings. This week in the United States is a perfect example: the Fed looks set to extend its bond purchase program even as Washington fails to reach an agreement to avoid the dreaded “fiscal cliff.”

It’s the sort of dissonant policy that is unlikely to yield very constructive results at a time when the U.S. economy is struggling to achieve a meager 2 percent growth rate.

Thomas Lam, group chief economist at OSK-DMG inSingapore:

The current one-sided policy mix of fiscal tightening and monetary easing is problematic (for example, the UK experimented with this approach –  fiscal consolidation and monetary accommodation – and it clearly failed to generate a sustained recovery).  In some cases, it’s borderline insanity –  it’s like you’re trying the same or broadly similar approach but hoping for a different outcome every single time.

Lam says some countries have the room to stimulate growth in the short-term, and should not miss the opportunity to do so.

A one-size-fits-all fiscal policy approach (in the current context, fiscal tightening is the norm) is not only misguided but extremely dangerous for the global economy as it remains more-or-less stuck in the mud. Policymakers, especially in economies with subdued sovereign risk premiums (like in UK, US, Germany and Japan for instance), need to consider the notion of fiscal flexibility – a combination of near-term, though temporary, fiscal boost coupled with the commitment of longer-term fiscal tightening.

Jobs, triggers and the Fed

As Federal Reserve officials debate whether to use thresholds for inflation and joblessness to guide monetary policy, Friday’s jobs report may be a cautionary tale.  The idea of thresholds is to pick markers for potential policy change – an unemployment rate of 6.5 percent, for instance, as a guidepost for when the central bank might begin to raise rates – so that the market has a better idea of where Fed policy is headed. As the unemployment rate nears that level, the theory goes, investors will gradually start to price in tightening; if the unemployment rate rises again, they’ll price it out.

But some Fed officials, notably the hawkish heads of the Richmond, Philadelphia and Dallas regional Fed banks, oppose the idea. One reason: the unemployment rate alone cannot capture the state of the labor market. Friday’s report show why.

Unemployment in November fell to 7.7 percent, the lowest in nearly four years. But the decline was not a sign of labor market strength – far from it. People were giving up looking for jobs, signaling hopelessness, not hope.

America is not Greece: Low funding costs give U.S. government room to borrow

Is the U.S.on the road to Greece, as some politicians have proclaimed?

Most economists say the comparison is nonsense. At a towering $15 trillion, the U.S. economy is not only the world’s largest, it is also more than 50 times the size of Greece’s. This gap makes any type of comparison difficult – it would be like analyzing trends in Maryland in relation to the entire euro zone.

Another key difference: Unlike Greece, the U.S. actually controls its own currency. That means a debt default is effectively impossible. This reality, coupled with strong monetary stimulus from the Federal Reserve, helps explain why U.S. bond yields remain near historic lows despite larger deficits.

Mark Weisbrot, co-director of the progressive Center for Economic and Policy Research in Washington, says a country’s interest burden is far more important than its total debt levels in determining the government’s ability to service it. He argued in a recent editorial:

Hey, at least it beats the Mayan outlook

A panel of economic luminaries took the stage in Chicago this afternoon to join in a tradition repeated this time of the year in cities across the country, opining on the outlook for the coming year.

Raghuram Rajan, a finance professor at University of Chicago’s Booth School of Business, began with a joke involving 973 sheep and a dog, the butt of which was the intellectual capacity of economic forecasters. He went on to predict slow world growth ahead, highlighting the geopolitical risks from conflict in the Middle East and Asia, and the limits of fiscal and monetary policy to turn things around.

Carl Tannenbaum, Northern Trust’s chief economist, focused on the still-troubled housing market and risks posed by the failure of European political leaders to resolve their financial crisis (he observed that Americans frustrated by the deadlock in Washington over resolving the U.S. fiscal cliff have only to look across the Atlantic for comfort that things, certainly, could be worse).

Geithner’s gauntlet: Social Security is a “separate process” from fiscal cliff talks

Social Security should not be part of the current negotiations over the U.S. budget – that was the message from outgoing Treasury Secretary Timothy Geithner over the weekend. During a veritable tour of Sunday shows aimed at addressing negotiations surrounding the “fiscal cliff” of expiring tax cuts and spending reductions, Geithner told ABC News’ “This Week”:

What the president is willing to do is to work with Democrats and Republicans to strengthen Social Security for future generations so Americans can approach retirement with dignity and with the confidence they can retire with a modest guaranteed benefit.

But we think you have to do that in a separate process so that our seniors aren’t – don’t face the concern that we’re somehow going to find savings in Social Security benefits to help reduce the other deficit.

At the Fed, there’s a way to raise rates — but is there a will?

The Federal Reserve has kept its key federal funds rate at near-zero for four straight years, and it expects to keep it there for at least two more. But with each trip around the sun, outsiders wonder whether central bank policymakers will act without hesitation when the time finally comes to tighten monetary policy?

This week, the official with his hand on the Fed’s interest-rate lever, so to speak, asked that same question. Simon Potter, head of the Federal Reserve Bank of New York’s open market operations, was at NYU‘s Stern School of Business discussing the various ways the central bank can tighten policy: the federal funds rate; the interest rate on excess bank reserves; reverse repurchase agreements. Potter runs the unit that carries out Fed policy in the market, and sits in on most policy-setting meetings in Washington. Asked by a student about the inflationary or deflationary risks associated with tightening policy in the future, he had this to say:

The real heart of that question is a willingness one. I’m pretty confident we have the technical ability to raise rates. The hard part will be the willingness in some people’s minds. What I’ve seen among most people in financial markets is they’re pretty sure that the Fed will raise rates when it’s appropriate to do it… Definitely compared to 2009-2010, the type of hedge funds and people who took large bets thinking this would lead to high inflation have given up on that bet.

Could the private sector stage a stimulus plan?

Since the financial crisis, the federal government has implemented a fiscal stimulus plan and the Federal Reserve took to the road of monetary stimulus, actively seeking new routes to revive the U.S. economy.

The private sector, however, has been laggard in adding its muscle to the revival efforts. Private firms have added employees, but very cautiously, and wages are stagnant. Meanwhile, a huge amount of cash sits idle on corporate balance sheets.

“Capital expenditure plans are being retrenched,” notes Dan Heckman, senior fixed income strategist and senior portfolio manager at Minneapolis, Minnesota-based US Bank, with $80 billion in assets under management. “Most major corporations are sitting on tons of cash. They have no appetite for borrowing and credit line utilization is at all-time lows.”

The trouble with the Fed’s calendar guidance on rates

Sometimes, communication can be the art of what not to say. Federal Reserve Chairman Ben Bernanke took pains this week to make clear that the central bank’s indication that it will likely keep rates low until mid-2015 does not mean it expects growth to remain weak for that long.

By pushing the expected period of low rates further into the future, we are not saying that we expect the economy to remain weak until mid-2015; rather, we expect – as we indicated in our September statement – that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

The comments speak to a key problem with the notion of calendar-based forward guidance, first adopted by the Fed in August of 2011: each time officials push the date further into the future, they risk dampening financial market sentiment, thereby having the opposite effect to the stimulus it intended.

NY Fed’s Dudley: “Blunter approach may yet prove necessary” for too-big-to-fail banks

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It was kind of a big deal coming from the Federal Reserve Bank of New York’s influential president William Dudley. The former Goldman Sachs partner and chief economist has offered a fig leaf to those who say the problem of banks considered too-big-to-fail must be dealt with more aggressively. Some regional Fed presidents have advocated breaking up these institutions. But Dudley and other powerful figures at the central bank have maintained recent financial reforms have already laid the groundwork for resolving the issue.

At a gathering of financial executives in New York last week, Dudley said he prefers the existing approach of making it costlier for firms to become big in the first place. Still, he left open the possibility of tackling the mega-bank problem more directly:

Should society tolerate a financial system in which certain financial institutions are deemed to be too big to fail? And, if not, then what should we do about it?

How big will the Fed’s QE3 end up being?

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Polling data courtesy of Chris Reese

We’ll know it when we see it. That’s essentially been the Federal Reserve’s message since it launched an open-ended bond-buying stimulus plan that it says will remain in place for as long “the outlook for the labor market does not improve substantially.” Which begs the question: how much larger is the central bank’s $2.9 trillion balance sheet likely to get?

Minutes from the Federal Reserve’s October meeting point to solid support within the central bank for ongoing monetary easing via asset purchases well into 2013.

A number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program in order to achieve a substantial improvement in the labor market.