Interview: Richmond Fed’s Lacker on Libor, ‘soggy’ growth and the limits of monetary policy
There appears to have been a significant slowdown in the second quarter. In particular we saw the pace of job creation slowed to a pace of 75,000 per month in the second quarter down from 226,000 in the first quarter and there are also concerns about slowing growth globally, beyond Europe but also in the emerging world and China, which was highlighted in the minutes (to the June meeting) this week. So, where do you think we’re headed? Are we just going to remain in a soft kind of pace? Are there upside risks to growth? Are there downside risks to growth?
Growth has definitely softened. The data are unmistakably weaker in the second quarter than we had hoped they would be. I think everyone recognized the first quarter and the end of last year were a little bit stronger than we might be able to sustain in the middle of the year but it’s definitely come in softer than I’d expected.
At the beginning of the year, it seemed as if Europe wouldn’t maybe weaken as much as we thought but lately the weakening from Europe has been coming online. In the U.S., I think we’re in a situation where we’re going to fluctuate from between the level where we are now to a level that’s more like we saw six or eight months ago. We’re going to have soggy patches, we’re going to have stronger spurts. If you look back over the last three years that’s the record you see. I don’t see a reason for that to change markedly.
There are some risks to that outlook. I do see downside risks of a more substantial global growth slowing than we’ve seen so far. I also see upside risks over the last twelve months. I think there’s enough potential for us getting past major sources of uncertainty. There’s a risk that resolving that uncertainty unleashes a stronger more positive outlook on the part of businesses and consumers that leads to stronger growth than we’ve seen so far.
And that would be some sort of resolution in Europe?
Excuses, excuses: The problem with ‘structural’ explanations for U.S. unemployment
It’s an arcane economics debate with all-too-real implications for U.S. monetary policy: Is high unemployment primarily the result of “structural” factors like skills mismatches and difficulties relocating, or is it largely due to insufficient consumer demand in a weak economic recovery?
The answer to that question may help determine how much further the Federal Reserve is willing to push its unconventional measures to bring down the jobless rate, currently stuck at 8.2 percent. If unemployment is cyclical, economists say, it would be more likely to respond to looser monetary conditions.
Research from Berkeley professor Jesse Rothstein, published earlier this year and featured recently on the National Bureau of Economic Research’s website, represents one of the most thorough academic efforts to date to discredit the structuralist version of events.
Four years after the beginning of the Great Recession, the labor market remains historically weak. Many observers have concluded that “structural” impediments to recovery bear some of the blame. This paper reviews such structural explanations. I find that there is little evidence supporting these hypotheses, and that the bulk of the evidence is more consistent with the hypothesis that continued poor performance is primarily attributable to shortfalls in the aggregate demand for labor.
Jeffrey Lacker, the Richmond Fed’s hawkish president, is a key proponent of the structural view, arguing this week that the U.S. unemployment rate is about as low as it can be right now without generating undue inflation pressures. In a May speech in Greensboro, North Carolina, Lacker made the case for why monetary policy was powerless to address the ailing jobs market despite the central bank’s dual mandate of maximum sustainable employment and low inflation.
In recent months, many of our business contacts have reported that although demand is beginning to increase, they are unable to respond as quickly as they would like due to an inability to find skilled workers. […]
The rise in long-term unemployment across a wide range of occupational and industry groups provides additional evidence that mismatch is an important factor restraining labor market performance.
Rothstein, however, begs to differ. He says the broad rise in unemployment in a wide array of industries points to a cyclical downturn, since a structural problem might be more confined to crisis-affected sectors like housing and construction.
“… the bulk of the evidence is more consistent with the hypothesis that continued poor performance is primarily attributable to shortfalls in the aggregate demand for labor.”
In other words, no jobs. Tell me something I don’t already know.
Inflation no obstacle to more Fed easing
Another reason the Federal Reserve may have additional room for monetary easing: Inflation expectations fell sharply in May, according to the latest Thomson Reuters/University of Michigan survey of consumer sentiment. Inflation expectations five years out dropped to 2.7 percent in May, the lowest since January. Fed officials often say expectations are a key leading indicator of actual price increases.
Daniel Silver, economist at JP Morgan:
This level of longer-term inflation expectations is towards the bottom of the range that has been reported in recent years – 2.7% has been hit on several occasions (most recently between October 2011 and January 2012) and 2.6% was only reached back in December 2008 and March 2009, early on in the crisis period. Most other inflation measures that the Fed watches (including core PCE inflation and the 5yr-5yr breakeven inflation rate) have signaled that inflation expectations are still anchored and underlying inflation pressure is modest.
The downshift comes in the wake of inflation figures for April that also pointed to a tame price environment. This is why Eric Green at TD Securities argues “U.S. inflation favors the doves.”:
In many ways the release today is emblematic of what we expect to see on the inflation front over the next six months. That is, steady disinflation on headline prices (driven by roll over and seasonal effects from energy prices) and stable core prices. Headline inflation will fall through core next month as energy prices alone virtually ensure a gain of no more than 0.1%, probably less. As headline inflation drifts to 2.0% y/y next month (from 2.3% y/y April) and 1.8% y/y by August, the inflation metric will work in favor of the more dovish contingent on the FOMC.
Still, deflation fears, a key underpinning of the Fed’s second round of quantitative easing, are not likely to make a comback, says Green:
That does not mean we are in a period of disinflation akin to the pre-QE2 period. Inflation will not be the cause célèbre of more accommodation, it will merely be removed as a potential obstacle among those favoring stronger growth, and truth be told, higher inflation.
Jobs or inflation — Is the Fed distracted?
The Federal Reserve doesn’t get much love from Washington these days but it did receive a rare bit of political backing on Wednesday as Democrats defended its role in promoting full employment as well as stable prices.
The U.S. central bank has been the target of criticism from members of both political parties as a result of bank bailouts and hands-off rule-enforcement that let predatory and unsound lending practices go unchecked, among other shortfalls.
But discussing legislation narrowing the Fed’s mandate to a single-minded focus on price stability, Democrats questioned the need to drop the full employment side of the dual mandate.
“Is it a problem?” asked Minnesotan Keith Ellison. “To the degree that we have problems with monetary policy, is the dual mandate the cause?”
Ellison said that far from distracting the Fed, the lofty 8.1 percent unemployment rate should get greater attention. “This is a national disgrace,” he said.
Ron Paul, a presidential candidate who chairs a subcommittee on domestic monetary policy, held a hearing to discuss several pieces of legislation changing the Fed’s mandate. Two of these would limit the Fed’s focus to price stability.
With partisan divisions and other priorities, Congress is unlikely to make any changes to the Fed’s mandate this year. But the effort could gain momentum if Republicans control both houses of Congress after November.
The Feds don’t control credit unions, that’s why I moved my money. That and the fact that they actually pay you interest on your savings!
Bernanke: U.S. is not Japan, and I have not changed my mind
Of all the questions Federal Reserve Chairman Ben Bernanke was asked during his press conference on Wednesday, one appeared to pique his interest in particular: Was he being less aggressive as central bank chairman than the advice he dished out to Japan as an academic in the 1990s would prescribe?
It was the second half of the question asked by Binyamin Applebaum and yet the chairman was eager to get right to it: “Let me tackle that second part first,” he began.
Applebaum may have been channeling the Nobel-winning economist Paul Krugman, a Princeton colleague of Bernanke’s and critic of Fed policy, who recently argued the Fed chief was being inconsistent and overly cautious.
Bernanke argued that the Fed has done a lot already to support growth and bring down unemployment. Actively aiming for higher inflation with additional use of unconventional tools would risk the central bank’s long-term credibility. Here is his answer in full:
So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.
I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation – that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer – are not exhausted. There are still other things that the central bank can do to create additional accommodation.
Now, looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy.
So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And, clearly, when you’re in deflation, and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.
Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal. The policy is extraordinarily accommodative. We – and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction – a slightly increased pace of reduction in the unemployment rate?
The view of the committee is that that would be very reckless. We have – we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.
Resolving Shirakawa’s conundrum
The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:
It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.
Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:
At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.
Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.
Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:
Who’d be a central banker?
The focus is already on the euro zone finance ministers meeting in Copenhagen, starting on Friday, which is likely to agree to some form of extra funds for the currency bloc’s future bailout fund. What they come up with will go a long way to determining whether markets scent any faltering commitment on the part of Europe’s leaders.
In the meantime, top billing goes to Bundesbank chief Jens Weidmann speaking in London later. He is heading an increasingly vocal group within the European Central bank who are fretting about the future inflationary and other consequences of the creation of more than a trillion euros of three-year money. There is no chance of the ECB hitting the policy reverse button yet but the debate looks set to intensify. A combination of German inflation and euro zone money supply numbers today (which include a breakdown on bank lending) will give some guide to the pressures on the ECB.
Central bankers face a very mixed picture with U.S. recovery and high oil vying with the unresolved euro zone debt crisis and signs of slowdown in China.
Bank of England Governor Mervyn King was sitting firmly on the fence yesterday, saying he did not know whether more QE would be required in Britain or not. Tellingly, he also did not know whether euro zone policymakers will take advantage of the window of opportunity offered them by the ECB or not. King illuminated a common theme coming from central bankers, saying the onus was firmly on the politicians now, while his colleague Adam Posen noted that the reason Britain’s recovery has lagged America’s is because of the former’s tough austerity measures. That’s another debate that is echoing around the euro zone. In the States, Bernanke said it is too soon to declare victory in the U.S. economic recovery.
Back to the euro zone and Spanish media was alive with reports that the EU was pressing Madrid to take a bailout to recapitalize its wobbly banks. The denials from both centres were so emphatic that it seems not to be true. It seems EU Competition Commissioner Joaquin Almunia spelled out three options to clean up Spain’s banking sector: using Spanish public funds, finding private investment or applying for European aid. Journalists present leapt on the latter. That may well become true in the end … but not yet.
Spain faces a general strike on Thursday while Prime Minister Mariano Rajoy is promising Friday’s 2012 budget will deliver eye-watering austerity for a country already sinking back into recession.
Europe’s triple threat: bad banks, big debts, slow growth
The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.
These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:
It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth. Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.
All these steps, especially if taken together in an attempt to treat the three crises holistically could substantially improve outcomes. At the same time, institutional reforms to create a true financial union and a common risk free asset could help both solve the current problems and reduce the connections of these crises in the future. Of course, politics, ideology, or additional economic shocks could all hinder improvement. The euro area is highly vulnerable and without deft policy may continue in crisis for a considerable amount of time.
Reading the ECB runes, March edition
Economists seeking insight into the kind of analysis the European Central Bank is using to support its policy decisions can get hints from its monthly bulletin. Not for everyone, but here’s what is in March’s edition:
* The effective exchange rates of the euro – revised trade weights in the light of global economic integration
* Recent developments in the financial account of the euro area balance of payments
* Impact of the two three-year longer-term refinancing operations
* Liquidity conditions and monetary policy operations in the period from 9 November 2011 to 14 February 2012
* Developments in the issuance and yield spreads of euro area government debt securities
* The impact of recent changes in indirect taxes on the HICP
A recovery in Europe? Really?
There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.
At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.
But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.
Joblessness is reaching shameful levels in southern Europe. In Greece, unemployment rose to a new record high of 21 percent in December and to 23 percent in Spain in January. Even in wealthy, northern Europe, the number of people out of work has started to rise in France, the Netherlands and Germany.
Just over half of the euro zone‘s economic output is generated by domestic consumer spending, but demand for goods looks chronically weak and fiscal austerity is aggravating the situation. Euro zone governments, desperate to distinguish themselves from debt-stricken Greece, are completely unwilling to step in and spend. The European Commission, persuaded mainly by Germany that fiscal discipline will lift economic growth, is on their backs to get their deficits within the 3 percent level of GDP by the end of 2013.
“The case against Europe’s growth strategy is that it is all supply and no demand,” said Philip Whyte, a senior research fellow at the Centre for European Reform. “Fiscal policy is being tightened too rapidly. The more certain EU countries do to balance their budgets, the more output contracts,” he said in a recent paper.
So where will growth come from? The ECB’s Draghi said this week he is counting on foreign demand. Emerging Asia and a stronger recovery in the United States might help pull the euro zone out of its slump. But with Germany responsible for almost 40 percent of the euro zone’s exports, a wider tide of prosperity across the currency area looks unlikely.
