The Federal Reserve staff on the evolution of US household net worth and related financial flows during the last decade

The Federal Reserve released an informative discussion paper this week that presents background on the Integrated Macroeconomics Accounts (IMAs) of the US.  The IMAs is a long-term interagency project between the Fed and the Bureau of Economic Analysis aimed at linking saving, capital accumulation, investment in financial assets and balance sheet data within an integrated framework using consistent definitions, classifications, and accounting conventions.

In the IMAs, each of the sectors of the economy is depicted according to a consistent set of statistical accounts: the current account (production and distribution of income accounts), and the accumulation accounts (capital, financial, other volume changes, and revaluation accounts).  These accounts allow one to trace the factors leading to changes in the net worth position on the balance sheet of each sector.

The paper contains lots of useful information for those interested in the analysis of national income and flow of funds accounts.

As a way to help demonstrate the usefulness of the IMAs, the authors of the paper have included a section describing the evolution of household net worth and its components during the last decade, thus enabling the reader to understand some of the underlying causes and subsequent effects of the recent financial crisis. 

As you read the excerpt below, keep in mind the following basic rule of thumb: a key indicator of the demand generated by any sector of the economy is its net borrowing (i.e., the difference between its total spending and income).

Uses of the IMAs

The recent financial crisis has vividly shown that analyzing the change in net worth and its composition is critical to understanding the health, risks, and prospects of an economic sector.  Net worth is a broad measure of the wealth of a sector, often used in conjunction with other variables, such as income and interest rates, to study variables such as consumption and saving.

The IMAs enable one to analyze net worth and its composition, clarifying how the current balance sheet position came about by distinguishing between saving, borrowing, holding gains or losses, and other changes in volume.  As an example, we can look at the IMAs for the household and [Non-Profit Institutions Serving Households] sector.  In the first half of the last decade, the household sector shifted from being a major lending sector to a major borrowing sector, rivaled only as a borrower by the federal government sector. It was at this same time that the rest of the world sector became the predominant lending sector.

At the same time, household net worth surged rapidly and the ratio of household net worth to disposable personal income reached record levels (chart 1 -- click on chart to expand).  This surge was caused not by elevated savings, but by sizable capital gains both on housing wealth and on stock-market wealth (chart 2).

Chart 1

Chart 2

Indeed, the ratio of both housing wealth and stock market wealth to disposable personal income surged to historically unprecedented levels (chart 3).  Not surprisingly, household debt also ballooned.  The ratio of household debt to disposable personal income surged from around 90 percent at the beginning of the decade to an all-time high of around 130 percent in the middle of 2007 (chart 4).

Chart 3

Chart 4

This ratio dropped to 111 percent by the end of 2011 as consumers borrowed less and as a significant amount of mortgage debt was written off. [...] [T]he household sector shifted back to being a major net lender in 2008.

Net borrowing by the federal government, on the other hand, ballooned to over $1.3 trillion in both 2009 and 2010. In 2009, the rest of the world sector was a significant lender, along with the financial business sector. The nonfinancial corporate business sector, traditionally a net borrower, became a net lender in 2009, as capital expenditures remained relatively low and retained earnings elevated (Cagetti et al, 2012:6-8).

Reference

Cagetti, M., Elizabeth Ball Holmquist, Lisa Lynn, Susan Hume, McIntosh and David Wasshausen, The Integrated Macroeconomic Accounts of the United States, 2012-81, Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C.

Bernanke on the Fed's policy of paying interest on reserves

Chairman Bernanke gave a good speech yesterday in which he indicated being encouraged by recent improvements in the US housing sector. Specifically, Bernanke explained that residential investment "will be a source of economic growth and new jobs during the next couple of years". However, he expressed concern regarding both the fiscal drag that will result from the phasing out of some federal stimulus spending and the risks that the situation in Europe pose to the US economy.

From a policy standpoint, another interesting statement by Bernanke came during the Q&As that followed his speech when Bernanke indicated that reducing the rate of interest paid on reserves by the Fed would have little stimulative effect on bank lending. (For more details, see Joe Weisenthal of Business Insider)

In the Q&A he hit on other interesting points, such as the issue of the Fed paying interest on excess reserves (IOER), a payment that's commonly said to be an inducement for the banks to do nothing, and just leave money at the bank. Bernanke's angle is that eliminating IOER to zero would barely stimulate any lending, but that having zero rates could cause mechanical issues in the market, and that keeping IOER allows for an easily tool to tighten policy in the future, simply by raising it.

Read more: http://www.businessinsider.com/ben-bernanke-the-economic-recovery-and-economic-policy-2012-11#ixzz2CzcOFAUA

Bernanke's angle is that eliminating IOER to zero would barely stimulate any lending, but that having zero rates could cause mechanical issues in the market, and that keeping IOER allows for an easily tool to tighten policy in the future, simply by raising it.

Read more: http://www.businessinsider.com/ben-bernanke-the-economic-recovery-and-economic-policy-2012-11#ixzz2CzciBTjO

This is actually significant seeing as Bernanke suggested in the past that one of the options that the Fed has to entice banks to lend is to reduce the rate of interest paid on reserves. Here is an excerpt from his testimony before Congress in July of last year:

...we have a number of ways in which we could act to ease financial conditions further. [...] The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally.

Recall that since December 2008 when the Fed started paying interest on reserves, the Fed's instrument has been effectively its asset portfolio. The policy of paying interest on reserves is a policy tool used to support the active use of this instrument. 

Read more: http://www.businessinsider.com/ben-bernanke-the-economic-recovery-and-economic-policy-2012-11#ixzz2Cuiiae2u

next year the drag from federal fiscal policy on GDP growth will outweigh the positive effects on growth from fiscal expansion at the state and local level.

Read more: http://www.businessinsider.com/ben-bernanke-the-economic-recovery-and-economic-policy-2012-11#ixzz2Cuiiae2u

next year the drag from federal fiscal policy on GDP growth will outweigh the positive effects on growth from fiscal expansion at the state and local level.

Read more: http://www.businessinsider.com/ben-bernanke-the-economic-recovery-and-economic-policy-2012-11#ixzz2Cuiiae2u

Bill Vickrey and Alan Blinder on the burden of the national debt

A colleague asked me today if I thought the national debt was a burden imposed on future generations.  No doubt my colleague has been following the debate of late on that issue. Anyway, in my opinion, anyone who argues that the national debt is a burden on future generations has to take into consideration the views put forth by the late economist and Bank of Sweden Nobel laureate Bill Vickrey.  According to Prof. Vickrey, the notion that government debt is a burden imposed on future generations is a false worry.  In Prof. Vickrey's own words:

...[I]n generational terms, the debt is the means whereby the present working cohorts are enabled to earn more by fuller employment and invest in the increased supply of assets, of which the debt is a part, so as to provide for their own old age. In this way the children and grandchildren are relieved of the burden of providing for the retirement of the preceding generations, whether on a personal basis or through government programs.

This fallacy is another example of zero-sum thinking that ignores the possibility of increased employment and expanded output. While it is still true that the goods consumed by retirees will have to be produced by the contemporary working population, the increased government debt will enable more of these goods to be exchanged for assets rather than transferred through the tax-benefit mechanism.

Also, in regard to the notion that deficits represent "sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital", Prof. Vickrey considered such an idea a fallacy stemming from a false analogy to borrowing by individuals.  Again, according to Prof. Vickrey,

[c]urrent reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges. This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future. This is in addition to whatever public investment takes place in infrastructure, education, research, and the like. Larger deficits, sufficient to recycle savings out of a growing gross domestic product in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity. Deficits in excess of a gap growing as a result of the maximum feasible growth in real output might indeed cause problems, but we are nowhere near that level.

Finally, it's also important to mention that, as economist Alan Blinder has pointed out in the past, the majority of government bonds in the US have a maturity period of about a decade:

...in my view, most of the debate is beside the point because, in the real world, the bonds that will be issued to cover deficits will almost always mature in less than 10 years, a time frame within which most of today's taxpayers will still be around to pay the bills.  So intergenerational aspects of present-value budget constraints are mostly irrelevant. (2004:19) (emphasis added)

References

Blinder, Alan."The Case Against the Case Against Discretionary Fiscal Policy" CEPS Working Paper No. 100, June 2004.

Vickrey, William. "Fifteen fallacies of financial fundamentalism: A disquisition on demand-side economies", Proceedings of the National Academy of Sciences of the United States of America, Vol. 95, No. 3, February 1998, pp. 1340-1347.

Hyperinflation in Weimar Germany: New Perspective on the “German View” using a Post-Keynesian Flow of Funds Framework

By Joseph Laliberté

Some of this material will be used for a future publication. Comments most welcome.

The “quantity theory explanation” and the “German view” are two schools of thought found in the literature to explain hyperinflation in Weimar Germany.

The quantity theory explanation emphasizes the role of fiscal deficits as the root cause of hyperinflation episode (Câmara and Vernengo, p. 1):

According to the quantity theory of money the origins of any inflationary process are to be found in irresponsible fiscal policies of governments. Budget deficits lead to the rise of a supply in money, and consequently higher prices. The solution to an inflationary process is to restore the principles of sound money either by reducing expenditure or raising revenues.

Or in the words of Kiguel (1989):

Hyperinflation, understood in this paper as a process of accelerating inflation, in fact occurs because governments have unsustainably large budget deficits...A correction of the fiscal imbalance has been crucial for stopping hyperinflation. This factor is well documented in the works of Yeager (1981), Sargent (1982), and Webb (1986) on the hyperinflation episodes in the central European countries during the 1920s and by Sachs (1987) on the more recent Bolivian episode.

There are many variants within the school of thought known as the Quantity Theory of Money. One major irritant from a post Keynesian standpoint is the notion that the money supply is exogenous and determined by the central bank. In general, proponents of the quantity theory explanation contend that although the government deficit may be the starting point of hyperinflationary episode, the key triggering factor of elevated inflation is to be found in the monetisation of this deficit by monetary authority. We will leave this last point aside for the purpose of this analysis and simply note the quantity theory focus on very large fiscal deficit as a key factor in accelerating inflation.

In opposition to the quantity theory explanation, German economists in the Republic of Weimar long contended that the imbalance created by the Treaty of Versailles in Germany's current account was the chief cause of hyperinflation. The balance of payment explanation, also called the “German view” in the literature, was in fact so prevalent in Weimar Germany, particularly at the Reichbank itself, that it was considered an official position (Laidler and Stadler, 1998, footnote 4). The lead proponent of the balance of payment explanation was Karl Helfferich, a German politician and economist, who was successively Secretary for the Treasury and Secretary of the Interior of the German Empire during WWI, and who wrote a book on money in 1927 (taken from Laidler and Stadler, 1998, p. 820):

First came the depreciation of the German currency by the overburdening of Germany with international liabilities and by the French policy of violence. Thence followed a rise in prices of all imported commodities. This led to a general rise in prices and wages, which in turn lead to a greater demand for currency by the public and by the financial authorities of the Reich; and finally, the greater calls upon the Reichbank from the public and the financial administration of the Reich led to an increase in the note issue.

Economists from other western nations have perhaps always looked with high suspicion to the “German view” because of its perceived political motive. Indeed, it was highly convenient for the German political class to blame hyperinflation on the Treaty of Versailles. Further, it did not help that Karl Helfferich himself was a German hawk during WWI and was responsible for a financial policy that contends that the cost of the war should be financed by borrowing rather than by fresh taxation (in other words, he was an interested party). These factors may explain why the balance of payment explanation as the root cause of hyperinflation has never been particularly popular among academics outside of Germany.

The objective of this analysis is to demonstrate using a post-Keynesian flow of funds analytical framework that, in conformity with the “Germany view”, the terms of reparations included in the Treaty of Versailles set the conditions for hyperinflation in Weimar Germany. Also, it seeks to show that hyperinflation in Weimar Germany is fully consistent with the existence of significant and on-going imbalances in both the current account and the fiscal situation.

After WWI, Germany was off the gold standard and on a floating exchange rate vis-à-vis other currencies such as the gold-pegged U.S. dollar. The Treaty of Versaille imposed heavy penalty on Germany relative to the size of its economy; by some estimates, reparations represented 20 times the total average German coal yearly output before the War, or nearly four times the average value of U.S., English or German annual exports before the war.

The Treaty of Versailles imposed two types of reparations on Germany: reparations payable in gold and reparations payable in real goods. It should be noted that the two types of reparations amount to the same thing: Germany was out of gold-denominated securities at end of WWI (due chiefly to its chronic current account deficit during the war itself, see here, p. 698), therefore the only way for Germany to obtain gold-pegged foreign currencies was through the exports of goods via the current account (or sales of assets abroad via the capital account).  We will assume therefore for the purpose of this analysis that all reparation was payable in real goods ("in kind" reparations). We have for Weimar Germany, the following standard flow of funds equation before reparations in period 0: 

1)      (G₀ - T₀) - (S₀ - I₀) = (M₀ - X₀)

Assuming the economy is at full capacity at a given price level P, and that E₀ is the equilibrium exchange between the German mark and the US gold-pegged dollar at which X₀=M₀, we have in period 0 (assuming the exchange rate is at E₀): [i]

2)      (G₀ - T₀) - (S₀ - I₀) = 0

The State was responsible for reparations, and paid for it using German marks. Therefore, reparations without a corresponding amount of new taxes directly increase Weimar Germany’s fiscal deficit. It should be noted that the price the German governments had to pay to entice German exporters to sell to the German government for German marks rather than export to foreign countries for U.S. gold-pegged dollars is a direct function of the prevailing exchange rate.  Denoting by Q the quantity of reparations in kind, we can define V₀ as the nominal value of reparations under Versailles denominated in German mark in year 0:

3)      V₀ = E₀*P*Q

The increase in budget deficit in year 0 therefore corresponds to V₀.  Substituting in the flow of funds of equation, we have:

4)      ((G₀ + V₀) - T₀) - (S₀ - I₀) = (M₀ - (X₀ - V₀))

Since M₀ = X₀, we now have the current account in a deficit by the amount of nominal reparations V₀.  So equation 4 could be simplified to:

5)      ((G₀ + V₀) - T₀) - (S₀ - I₀) = V₀

The current account, now in deficit, causes a reduction in the exchange.  Note: ΔE₁ is the change in the exchange rate.  It is to be interpreted as "the increase in % in the number of German mark you obtain from 1 US gold-pegged dollar". 

Thus we have the change in the exchange rate in period 1 which is a function of the nominal value of reparations denominated in German mark in period 0:

6)      ΔE₁ = f (V₀)

We also have:

7)      E₁ = (1 + ΔE₁)*E₀

Using equation 7, we can derive the following equation: 

8)      V₁ = (1 + ΔE₁)*E₀*P*Q

Combining equations 8 and 3, we obtain:

9)      (V₁ / V₀) - 1 = ΔE₁

Equation 9 says that the increase in nominal reparations denominated in German mark in period 1 relative to period 0 corresponds exactly to the depreciation of the exchange rate, itself caused by the current account deficit resulting from reparations payments in period 0 as shown above.  Re-arranging equation 9:

10)      V₁ = V₀*(1 + ΔE₁)

Pursuing with the same logic, nominal reparations denominated in German Mark in period 2 will be:

11)       V₂ = V₀*(1 + ΔE₁)*(ΔE₂ + 1)  

In period n, we will have:

12)       V_n = V₀*(1 + ΔE₁)*(1 + ΔE₂)*(1 + ΔE₃)* ... *(1 + ΔE_n) 

And so on and so forth.  Assuming a constant impact in percentage on the exchange rate (constant elasticity), we can simplify the above equation to:

13)       V_n  = V₀ (1 + ΔE)ⁿ

Substituting this equation in period n flow of funds equation, we have

14)       ((G_n+ (V₀ (1 + ΔE)ⁿ)) - T_n) - (S_n - I_n) = (V₀ (1 + ΔE)ⁿ)

Assuming n tends toward infinity, we are left with (denominated in German mark) an infinite nominal amount of reparations, as well as an infinite budget deficit coupled with an infinite current account deficit. Moreover, the value of the German mark relative to other currencies will tend toward zero. Reparations therefore had the effects of triggering a vicious cycle of ever-increasing current account deficit and ever-increasing fiscal deficit in Weimar Germany.

The very tendency to approach equilibrium in the current account through a decrease in the exchange rate was undermined by the ever-increasing nominal value of reparations denominated in German marks, which was itself caused by the decrease in exchange rate. In all likelihood, a country caught in this kind of cycle will eventually face a vicious inflation spiral unless it can afford politically to impose new taxes on its population in order to “confiscate” domestic consumption to pay for reparations. [ii]

Therefore, based on this analysis, the root cause of hyperinflation in Weimar Germany are to be found in the conditions as set out in the Treaty of Versailles regarding reparations.  Seen from a flow of funds perspective, the “German View” is therefore fully consistent with the existence of significant imbalance in both the current account and the fiscal situation.  

[i] These assumptions are made for simplification purpose. Altering them would not ultimately change the result of the analysis.

[ii] Clearly, the Weimar government could not afford politically to impose new taxes on its population. For example, Ladislaus Bortkiewicz, an economist in Weimar Germany, contended that the extreme fragility of Germany’s socio-political situation after WWI may have made inflation the most appropriate policy response (Laidler and Stadler, 1998, p.828).

References

Alcino Câmara and Matias Vernengo, The German Balance of Payment School and the Latin American Neostructuralists,  http://acd.ufrj.br/~coopegrid/pdfs/german%20balance%20of%20payment%20school.pdf

David E. Laidler and George W. Stadler, "Explanations of the the Weimar Republic’s Hyperinflation: Some Neglected Contributions in Contemporary German Literature", Journal of Money, Credit and Banking (Nov. 1998), pp. 816-831. http://www.jstor.org/stable/2601130

Miguel A. Kiguel, "Budget Deficits, Stability, and the Monetary Dynamics of Hyperinflation", Journal of Money, Credit and Banking, Vol. 21, No. 2 (May, 1989), pp. 148-157
http://www.jstor.org/stable/1992365

Federal Reserve Bulletin, ISSUED BY THE FEDERAL RESERVE BOARD AT WASHINGTON, various years, see for example: http://fraser.stlouisfed.org/docs/publications/FRB/1920s/frb_061923.pdf

Mythologies: Money and hyperinflation, http://rabble.ca/blogs/bloggers/progressive-economics-forum/2011/08/mythologies-money-and-hyperinflation

Thomas J. Sargent, "The Ends of Four Big Inflations", in: Inflation: Causes and Effects, University of Chicago Press (1982) http://www.nber.org/chapters/c11452.pdf

Thoughts on endogenous money

The author of Unlearning Economics has written two good posts on the endogenous nature of money (i.e., the notion that the money supply adjusts to the demand for money). I agree with the author's assertion that recognizing the endogenous nature of money is important in order for policymakers to properly address issues relating to financial instability.

Just to add to this discussion, the key aspect about the endogenous nature of money is its ambivalent effects on the working of the economic system. On the one hand, as stressed by many post-Keynesian monetary economists (especially circuitistes and modern monetary theorists), the endogeneity of money enables both the level of investment and growth to surpass what it would otherwise be in a context of self-financing.

According to this view, a recognition of the endogeneity of money frees us from the "fictitious" constraint of a fixed money stock and, as such, opens up new possibilities (from a economic policy standpoint) for achieving full employment and improved living standards (e.g., via public investment financed by government deficit financing and money creation). Also, it forces us to look for a better explanation in regard to the causes of inflation and to reconsider the popular view that inflation occurs solely as the result of an excessive rate of growth in the money supply or as a consequence of government deficit spending. In a context of endogenous money, the causality between increases in prices and the money supply can also be considered as flowing from prices and output to money rather than uniquely the other way around, as is most often believed.

On the other hand, as recently emphasized by the staff economist of the Bank for International Settlements (BIS), the endogenous nature of money, by allowing investment to surpass the capacity of self-financing, also acts to intensify the inherent risks and instability of the modern economy (in which finance plays a critical role) by creating the conditions that lead to unsustainable booms in credit and asset prices that "can eventually lead to serious financial strains and derail the world economy" (Borio and Disyatat, 2011:27).

Now, let me be clear: I'm not saying that these approaches are irreconcilable, or that they exclude each other's views on the issue. On the contrary, one has to look very closely to uncover the difference between the views on the monetary system of post-Keynesian monetary economists and those of BIS economists. They are quite similar in many respects, as recently highlighted by economist Bill Mitchell. For instance, recall that the late Hy Minsky, a post-Keynesian economist, emphasized long ago the destabilizing effect of the modern financial system, a notion that is closely aligned with the views of the BIS economists today. So, in this sense, all I mean to suggest is that the focus of these two groups of economists tends to be different, not that both views are necessarily different in scope.* (For instance, modern monetary economists have been doing some excellent work to address the financial stability issue. See, for instance, Randall Wray and Eric Tymoigne.)

Finally, I will just conclude by saying that, in Canada (where I reside), empirical evidence pointing to the endogeneity of money (i.e., that money supplied by the central bank is demand-led) has been around for a while. Consider this excerpt from Bank of Canada Technical Report 16: Monetary Base and Money Stock in Canada by economists Kevin Clinton and Kevin Lynch arguing against the notion of an exogenous money supply:

...the findings contrary to the monetarist position are strongly enhanced by evidence that emphatically demonstrates causality running from money to the base. The historical association observed between the two arises primarily from the influence of deposits on bank reserves, not vice versa, so that the existing correlation, weak though it may be, could give an exaggerated impression of how well the money supply could be controlled via the base. [...] The empirical tests reject the notion that there is "direct" link between bank reserves and bank deposits and that changes in bank reserves cause changes in bank deposits. (4,40)

This technical report was published in 1979. I know of no convincing evidence that refutes these findings (keeping in mind that Canada no longer requires banks to hold reserves).


* The difference between the two approaches lies mainly in their views regarding the existence of the Wicksellian notion of natural rate of interest. Although this is not an insignificant issue, for the purpose of this post there is no need to elaborate further on this point.

References

Borio, C., and P. Disyatat, Global imbalances and the financial crisis: Link or no link? Bank for International Settlements Working Paper No. 346, May 2011.

Clinton, K. and K. Lynch, Bank of Canada Technical Report 16: Monetary Base and Money Stock in Canada, Bank of Canada, 1979

Marvin Goodfriend on QE3: "This is a game changer for the Fed"

From a Bloomberg interview on QE3 with Marvin Goodfriend (click on "OK"):

I think this is a game changer for the Fed. I think it's a return to what we called a few decades ago "go and stop" monetary policy, which is to say, go all-in on a low unemployment target until the actual inflation rate rises enough to alarm the public.

As previously mentioned, I'm not sold on the idea that a new round of quantitative easing (QE) by the Fed will have much impact on the US economy. So, in a way, I don't reject Goodfriend's view that QE could involve diminishing returns down the road. However, I disagree with Goodfriend in regard to the inflationary risks that QE poses in future. Here, it may be worth highlighting an important point advanced by Oscar Jorda, Moritz Schularick and Alan Taylor in their paper "When Credit Bites Back: Leverage, Business Cycles and Crises" (2011), which discusses the after-effects of financial crises from a historical perspective:

...[O]ur results speak more directly to the question of whether policy-makers risk unleashing inflationary pressures by keeping interest rates low. Looking back at business cycles in the past 140 years, we show that policy-makers have little to worry about. In the aftermath of credit-fueled expansions that end in a systemic financial crisis, downward pressures on inflation are pronounced and long-lasting. If policy-makers are aware of this typical after-effect of leverage busts, they can set policy without worrying about a phantom inflationary menace. (2011:6)

That said, the interview nonetheless contains a lot of valuable insight on the policy implications of QE3 moving forward, as well as the reasons that may have prompted FOMC members to go ahead with another round of QE right now.

Finally, I also think Goodfriend makes a valid point when he suggests that the Fed is not providing sufficient information to the public about both the specific unemployment (or any other labor market indicator) target for QE3 and the evidence to justify additional QE at this time. That Goodfriend focuses on this last point is not surprising given that he's been a longtime advocate of central bank transparency, a principle that I too find important, although for different reasons. While Goodfriend views transparency as necessary for policy effectiveness, I believe it is a commendable principle for government organizations to follow for reasons of public accountability.

References

Jorda, O., M. Schularick and A. Taylor, When Credit Bites Back: Leverage, Business Cycles and Crises, Federal Reserve Bank of San Francisco, Working Paper, November 2011.

Another round of QE: More of the same?

I once had a boss who always asked for briefing material of "no more than 100 words". He'd also say "Give me charts, please. Charts!" Here's a snapshot of what he would get if I was asked to update him on the effect of the Fed's quantitative easing (QE) strategy.

Recall that the Fed implements QE by buying financial assets from banks and other private institutions in the aim of putting downward pressure on yields and thus reducing interest rates. QE as a policy measure is easily identifiable in charts since it increases massively the amount of excess reserves in the banking system.

Given that Chairman Bernanke announced a new round of QE last week, I thought these charts might be of interest.* Not all of these indicators are related to QE's stated objectives. Still, given the centrality of QE in the Fed's overall strategy, I think it's useful to include them.

So, to summarize, since the start of QE, bank lending standards have returned to normal...

 

...business loans have rebounded, though not at pre-QE levels...

...the rate of increase in manufacturers' new orders has normalized...

...corporate profits have continued to rise well beyond pre-QE levels...

...the cost of borrowing for businesses (as reflected in the rate of 10-year inflation protected securities) has come down...

...as did the 30-year conventional mortgage rate...

... and stocks have recovered.
 

On the other hand, home prices have remained depressed...

...the employment-population ratio has flattened...

...and, finally, the rate of unemployment is still stubbornly high.

In a speech earlier this year, the President of the San Francisco Fed, John Williams, called the level of unemployment in the US a "national calamity that demands our attention". From the charts above, it's clear that another round of QE is unlikely to do much to help create more jobs moving forward.

* All charts and data are from the St. Louis Fed, FRED.

Joseph Stiglitz on low interest rates as the cause of the crisis

Joseph Stiglitz takes on the argument that low interest rates caused the subprime crisis. It appears to be an old clip but I'm adding it to the file.

And, as I've noted previously, Robert Shiller agrees with Stiglitz on this.

Similarly, Barry Eichengreen also makes a great point when he argues that it's not only borrowers' frenzy for easy credit that's to blame for these types of problems. This is what Eichengreen has to say about who's at fault for the current European mess:

I’m not too big on the language of culpability. But it takes two to tango. For every reckless borrower there is a reckless lender. The Greeks may have borrowed too much, but someone lent them all that money. German banks and those who regulated them clearly played some role in the crisis.

See here for a more detailed analysis on the role of low interest rates during the lead up to the US subprime crisis.