The FED Governor: Ben S. Bernanke
Approach/Strategy:-
1. Constrained Discretion;
2. Inflation-Targeting;
3. PCE As Preferred Measure Of Inflation (Range of 1% to 2% inflation as his "comfort zone");
4. Focused On Inflation Expectations & Resource Utilization To Determine Monetary Policy;
5. Regulation Fair Disclosure or RFD;
6. Relies More On Economic Models And forecasts To guide Views
Challenges 1 (Global Financial Crisis):
1. Forsaking Interest-Rate Targets, The Fed Is Focusing On Cutting Borrowing Costs and Kick-Starting Demand. The Federal Reserve's Increasingly Unconventional Efforts To Mend The Financial Markets and Restore Economic Growth;
2. Maintaining Sustainable Economic Growth & Price Stability
The Fed’s Objective: To Lower A Broad Range Of Interest Rates And Foster Easier Credit Conditions, Even Though The Fed Has Run Out Of Room To Lower Its Target Rate.
The Strategy Comprises Three Sets Of Programs:-
· The first group enhances liquidity via the Fed's traditional role as lender of last resort to banks. These are programs that make loans of cash or Treasury securities in exchange for less-liquid collateral.
· The second set is aimed at supplying liquidity outside the banking system directly to borrowers and investors in key credit markets. These activities include the upcoming program, to be coordinated with the Treasury, to buy up to $200 billion of asset-backed securities, debts backed by car loans, credit cards, and student loans.
· Finally, the Fed has begun to buy longer-term securities, most notably some $600 billion in debt and mortgage-backed paper held by federal agencies. On Jan. 28 2008 it reiterated that it's prepared to buy longer-dated Treasuries.
Fiscal Policy: US$789 Billion Package Of Spending And Tax Cuts
Fed Funds (Overnight Loans Between Banks) Rate as at Oct 2009: Range Of Between Zero & 0.25%
Fed Discount (Direct Loans To Banks From Central Bank) Rate as at Oct 2009: 0.50%
The Outcome as at Oct 2009:-
The Fed's balance sheet has ballooned to $2.1 trillion, reflecting the creation of a spate of lending programs intended to ease the financial crisis. That's more than double before the crisis struck.
As the crisis has eased, so has demand for some of the Fed's lending programs.
Short-term lending, which hit $1.1 trillion at the end of last year (2008), when the crisis was still mounting, has fallen to about $264 billion, a drop of more than 75 percent since the turn of the year (2009). Expecting this trend to continue as markets improve.
Demand for another "commercial paper" program that provides companies with short-term financing needed to pay for salaries and supplies also has declined sharply, from $334 billion at the turn of the year (2009) to less than $50 billion currently (Oct 2009)
Meanwhile, the Fed is on track to wrap up this month (Oct 2009) a $300 billion program to buy government debt. That program aims to lower rates for mortgages and other consumer debt.
The Fed also is buying $1.25 trillion worth of mortgage-backed securities, in another move to force down mortgage rates. Bernanke said both programs appear to be having their "intended effect."
Challenges 2 (Recovery Stage): Fears Of Inflation
The Fed’s Objective: Sop Up The Excess Liquidity Being Pumped Into The Economy.- The “Exit Strategy”
Overall the Federal Reserve has a wide range of tools for tightening monetary policy when the economic outlook requires them to do so. It will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster its dual objectives of maximum employment and price stability.
The Risk: Tightening too soon could short-circuit the recovery. Waiting too long could ignite inflation.
The Exit Strategies:-
1. Besides boosting its key bank lending rate, the Fed can raise the rate it pays banks on reserve balances held at the central bank. That would give banks an incentive to keep their money parked there, rather than having it flow back into the economy, where it can stoke inflationary pressures;
2. The Fed also can set up the equivalent of certificates of deposit for banks at the central bank, another incentive for banks to keep their money at the Fed;
3. The Fed also can drain money from the financial system by selling securities from its portfolio with an agreement to buy them back at a later date. Such large-scale "reverse repurchase agreements" can be done with banks, Fannie Mae and Freddie Mac and other institutions. That might involve transactions with money market mutual funds. Or the Fed can sell a portion of its securities outright.
The Risks In The Global Economy:-
1. High Oil Price with a sustained supply shock resulting from a major interruption in the supply -> Inflation Pressures -> Higher Interest Rate -> Bizs Cut Capital Spending & Hiring -> Cut In Consumer Spending -> Raising Inflation And A Flagging Economy!;
2. A Global Credit & Liquidity Crunch Originate From US Subprime Loans Crisis (Stabilizing );
3. A Global Deflationary Threat -> Hints of Global Recovery And Fears of Inflation;
4. A US Dollar (Depreciating) Crisis & High Commodity Prices (Rising)
By Ben Bernanke … Oct 2009
Federal Reserve Chairman Ben Bernanke sent a fresh signal on Oct 2009 that he's in no rush to reverse course and start boosting interest rates.
The Fed's key bank lending rate is now (Early Oct 2009) at a record low near zero and will probably stay there for an "extended period. That echoed the pledge he and his colleagues made at their meeting in late September 2009.
The goal: super-low rates will entice people and businesses to spend more, nurturing the budding recovery.
Although Bernanke has previously said the United States is likely out of recession, he has warned that the recovery won't be robust enough to prevent the unemployment rate - now (Oct 2009) at a 26-year high of 9.8 percent - from rising.
It is expected to top 10 percent this year (2009), and rise as high as around 10.5 percent in the middle of next year (2010) before slowly drifting downward.
Still, Bernanke made clear on Oct 2009 that when the time is right the Fed will have the tools and the political will to reel in the unprecedented amount of money it has pumped into the economy to avoid unleashing inflation.
At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road.
The Fed chief laid out some more details about how the central bank would sop up the money.
By Former Federal Reserve Chairman Alan Greenspan … Oct 2009
He predicted that the jobless rate will pass 10 percent and stay there for a while, and a second stimulus plan is not needed now (Oct 2009).
He spoke favorably of extending unemployment benefits and tax credits for health insurance, options the Obama administration is considering for helping people laid off during the recession.
With more than 15 million people out of work, unemployment reached 9.8 percent in September 2009, the highest rate in 26 years. This is an extraordinary period and temporary actions must be taken, especially to assuage the angst of a very substantial part of its population.
“I don't actually consider those types of actions stimulus programs. I think that they are essentially programs which support people - essentially their living standards in part. I grant you it has a stimulus effect, but that would be my primary focus”.
Calling the jobs (Sept 2009) report "pretty awful," Greenspan said he is particularly concerned with statistics showing the number of people out of work for six months or more has reached 5 million after going up sharply last month (Sept 2009).
People who are out of work for very protracted periods of time lose their skills eventually. What makes an economy great is a combination of the capital assets of the economy and the people who run it. And if you erode the human skills that are involved there, there is a real and, in one sense, an irretrievable loss.
Looking ahead on the unemployment picture, his "own suspicion is that we're going to penetrate the 10 percent barrier and stay there for a while before we start down."
He would recommend that President Barack Obama focus on trying to get the economy going but without doing so much that the government's actions are counterproductive.
With growth for the third quarter 2009 appearing to reach or surpass 3 percent, Greenspan said he would not propose a second stimulus package. In my judgment it's far better to wait and see how this momentum that has already begun to develop in the economy carries forward.
Greenspan again expressed his concern over the growing size of the federal deficit and the federal debt.
Monetary Policy …
Why Inflation Fears Are Unfounded: The Fed will have plenty of time to reverse its huge stimulus, as unused labor and production capacity prevent price pressures from building
Given all the monetary fuel sloshing around the economy right now (Aug 2009), it's easy for investors to feel a little edgy about future inflation. So policymakers at the Federal Reserve have gone to great lengths to convince people the Fed has the tools to sop up the excess funds before they ignite an explosion in prices. However, market professionals have never doubted the Fed's ample assortment of tools.
The question has always been about timing. Too little policy tightening too late could kindle inflation, forcing more stringent measures to tamp it down later on.
Following their Aug. 11-12 2009 meeting, Fed policymakers sounded a pinch more optimistic than they did after their June 2009 meeting. Indeed, fresh news from the July 2009 labor markets amid other favorable signs suggests the recession is all but over. Still, the central bankers said they will keep interest rates exceptionally low for a long time.
Inflation? Not to worry, they say.
Fed officials seem confident that economic conditions will offer an unusually wide time frame to begin tightening policy before price pressures can build. The reason is the enormous slack, or unused labor and production capacity, created by the deepest recession since the 1930s, and the long time that will be needed to absorb the excess. U.S. industry was operating at only 68% of its capacity in June 2009, a record low. History, and basic economics, show inflation cannot take hold until resources start to get stretched.
The most compelling anti-inflation story comes from the labor markets. Any broad and sustained speedup in prices would require a reacceleration in wage growth, the classic wage-price spiral. However, despite the encouraging news from the July 2009 job data, including a smaller-than-expected 247,000 drop in payrolls and a dip in the jobless rate to 9.4% from 9.5% in June 2009, it will be a long time before the job markets are strong enough to push up hourly wages.
Right now (Aug 2009), the spiral for both wage and price inflation is downward, and the rates for both are set to fall further. Hourly wages of production workers last month (July 2009) rose only 2.5% from a year ago (2008), down from a 4.2% pace before the recession began. The comparable annual rate in recent months (Before July 2009) has been even weaker.
At the same time, core inflation, which excludes the short-term ups and downs in energy and food, has fallen more than a percentage point over the past year (2008), to 1.5% in June 2009. Many economists believe the rate will head toward zero in coming months (Aug 2009 & Beyond), a pace below the Fed's comfort zone and dangerously close to deflation, or falling prices.
Wage growth is sure to slow further, since few economists believe the jobless rate has topped out. That won't happen until the economy is strong enough to create the 100,000 or so jobs per month that are necessary to keep the jobless rate from rising. Even after unemployment peaks, it will be far above 5%, thought to be about "full employment." That's the level where price pressures intensify—a mark unlikely to be reached during 2010.
In addition, businesses will be hesitant to rehire laid-off workers until they absolutely have to do so. Companies are enjoying the cost advantages of their slimmed-down workforces. Productivity, or output per hour worked, surged at a 6.4% annual rate in the second quarter 2009. With real gross domestic product widely expected to grow 2% to 3% in the current quarter (3Q2009) as hours worked continue to fall, productivity is set to post another solid advance this quarter (3Q2009).
Big productivity gains, along with weakening wage growth, mean unit labor costs, or pay adjusted for productivity, are plummeting. These costs, which are closely aligned with the pressure to raise prices, fell at an eye-popping 5.8% annual rate in the second quarter 2009 after dropping 2.7% in the first quarter, and they most likely will fall again in the current quarter (3Q2009).
The Fed will be especially vigilant to ensure that its flood of funds does not lift expectations of inflation that could influence price markups and wage setting. But until labor markets improve significantly, any such expectations are highly unlikely to take hold.
2H2009 GDP Growth …
A growing consensus predicts a weak rebound from the recession, but that would go against both the latest data and a trend dating back nine business cycles
There's an old saying in economic forecasting: The consensus is always wrong. But which way? The average forecast of the 52 economists surveyed by Blue Chip Economic Indicators calls for growth in real gross domestic product of 2.7% over the next four quarters (4Q2009 – 4Q2010), with the annual rate in any single quarter no greater than 3%. This early in the recovery, it's tough to argue that the consensus is either too pessimistic or too optimistic, but one thing is clear. The herd does not think the past tendency of strong recoveries to follow deep recessions will hold true this time. For example, in the first year after the severe slumps in 1973-75 and 1981-82, real GDP grew 6.2% and 7.7%, respectively.
The correlation between the depth of recessions and the strength of recoveries over the last nine business cycles is unmistakable. It relates to the extent of the cuts businesses make in output, payrolls, and inventories. It also reflects the amount of pent-up demand created as consumers and businesses postpone spending. Like a rubber band, the economy snaps back in proportion to how far it was pulled down, as consumers finally upgrade old laptops and buy new clothes, and businesses replace inventories and worn-out equipment.
If the consensus is right, the economy's departure from past experience would be striking. After each of the past nine recessions, deep or shallow, real GDP has never required more than three quarters to regain its peak level prior to the downturn. If GDP staged a full recovery over the next three quarters, the economy would grow at a 5.4% annual rate. Even stretched over four quarters, the pace would still be 4.1%.
The common argument is that the usual rebound effect will be limited by the aftershock of the financial crisis: Credit growth is plunging, because households need to unload debt and save more amid lost wealth and tight credit, limiting the business sector's response. However, that's no sure thing. Data on credit flows are not particularly useful for predicting the strength of a recovery. They note that in the strong upturns of the 1970s and 1980s, consumer spending accelerated well before the upturn in consumer credit.
Early in recoveries, the growth of household income is a more important impetus to spending than credit. As job losses fade, pay from wages and salaries, about 60% of aftertax income, will turn up, as it did in July 2009 for the first time in nine months. Also, a lot of spending is done by households and businesses that either don't need to borrow or have good credit quality.
The recovery's oomph will also turn on how much income households feel they need to put away to eliminate debt and restore nest eggs. A rising saving rate weighs heavily on the growth of consumer spending. However, with savings in the second quarter 2009 already at 5% of aftertax income, up from 1.2% in early 2008, the saving rate may be about as high as it needs to go to give households the cushion they want.
Historically, saving behavior loosely tracks the ratio of household income to wealth. As that ratio rises, in this case because of plunging stock prices and home values, so does the savings rate. By the second quarter 2009 the ratio had risen to the levels of the early 1990s, when the saving rate was about 6%, close to where it is now (Oct 2009). Moreover, households in the second quarter 2009 recovered $2 trillion of the $14 trillion in net worth lost during the recession, and rising stock and home prices imply another gain of about $2 trillion this quarter (3Q2009).
So far, the raft of surprisingly positive data in recent weeks (Sept 2009) supports the more upbeat recovery scenario. In particular, the index of leading indicators, a composite of 10 gauges that tends to foreshadow recessions and recoveries, has turned up sharply. Since March the index has grown at an 11.7% annual rate, the fastest five-month pace since the 1981-82 recession.
For now (Oct 2009), none of this will change the minds of the more pessimistic forecasters. However, the historical pattern is on the side of the optimists.
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Greater Expectations for Second-Half 2009 GDP Growth: Economists are raising their second-half 2009 forecasts to 2% to 3%, a pace that would increase the chances for a sustainable economic recovery
Don't look now (Aug 2009), but at least a smidgen of optimism is brightening the economic outlook. After news that real gross domestic product contracted at a mere 1%annual rate last quarter (2Q2009), following three much steeper declines, many economists are nudging up their forecasts for second-half 2009 growth into the 2%-to-3% range. That pace would be twice the general expectation only a few months ago (Before Aug 2009), and it would heighten the chances for a sustainable recovery.
Economists agree that a lasting turnaround depends on consumers, and without a stronger labor market, the upturn could fall flat. All that is true, but recoveries don't start with more jobs. In each of the past four rebounds, overall output, measured by real GDP, picked up first, and jobs afterward. Payrolls turned up one quarter after the 1973-75 recession hit bottom, three quarters following the 1981-82 and 1990-91 downturns, and seven quarters after the 2001 slump.
The same trend is shaping up this time, and second-quarter GDP data show why. Businesses liquidated inventories at a record annual rate of $141 billion last quarter (2Q2009) after a decline of $114 billion in the first quarter 2009. That's the largest two-quarter shrinkage since quarterly records began in 1947. Coming at a time when overall demand shows every sign of stabilizing, that has pushed down stockpiles too far, and businesses now (Aug 2009) have to ramp up production as customers reorder. It's a classic business cycle pattern.
The surprising depth of the inventory liquidation is a chief reason—along with firmer housing activity and consumers' enthusiastic response to the cash-for-clunkers program—forecasters are boosting second-half 2009 expectations. The jump in the Institute for Supply Management's July 2009 index of industrial activity, which showed big gains in orders and production, strongly supports the more upbeat view.
If the economists are right, growth of 2% to 3% will be sufficient to generate at least modest job gains that will prop up consumer spending. It will also add to top-line revenues and help to revive bottom-line profits.
American businesses already are backing away from the cost-cutting frenzy that had exerted such a heavy drag on growth. The downtrend in new jobless claims through July 2009 means a diminishing pace of payroll reductions, and companies have greatly slowed the rate of their cutbacks in capital spending. After record declines of 19% and 39% in the fourth 2008 and first quarters 2009, outlays for equipment and construction shrank only 9% last quarter (2Q2009).
More important, past cost-cutting will benefit profits for some time, and higher earnings will drive companies to expand their operations. With 337 of the companies in Standard & Poor's 500-stock index having reported, second-quarter 2009 earnings are on a track to decline 30% from a year ago (2008).
The earnings surprises reflect companies' efforts to maintain productivity, which is crucial to protecting profit margins. Since the recession began in late 2007, profits per dollar of output among nonfinancial corporations have fallen from 11.8 cents to 10 cents in the first quarter of 2009. That broad measure of margins dropped to 6.3 cents at the low point of the mild 2001 recession.
The Commerce Dept.'s revisions to GDP suggest productivity, or output per hour worked, grew more slowly last year (2008) than current (Aug 2009) data show. But productivity typically falls outright in a recession, and for it to continue to grow at all in a downturn as severe as this one is highly unusual. Given that GDP fell only 1% last quarter while hours worked dropped 8.9%, productivity in the second quarter surged, holding down labor costs and adding further support to margins.
Unfortunately, defending profits in this recession has cost the economy 6.5 million jobs through June. But as companies boost their ordering and production in the second half, they will need to lift payrolls, too.
Corporate Spending …
Business Is Lean, Fit, and Ready to Grow: Outside of finance, corporate balance sheets are rock-solid, and companies will be able to respond quickly as business conditions improve in the second half 2009
The debate over the strength and durability of the recovery remains intense. Even if the current upturn mimics past norms, in which strong recoveries follow severe recessions, many analysts still believe a surprisingly solid second half 2009 won't prevent the economy from faltering in 2010. The big worry, of course, is consumers and the lack of income needed to repair their ragged finances.
What gets overlooked, however, is the totally opposite state of affairs in the business sector, which may be more important to the recovery's trajectory than household balance sheets. American corporations have rarely if ever emerged from a recession so lean, financially fit, and ready to respond to growth. That's important, because companies do the hiring, and their ability and willingness to expand is a crucial gear in the economy's growth machine.
Businesses were already trim heading into the recession: After the 2001 downturn, both payrolls and capital spending grew at the slowest pace in any post-recession period. Then came the cost-cutting frenzy of the past year (2008), allowing profits to turn up strongly in the second quarter 2009, based on Commerce Dept. data, even as overall domestic demand fell. With demand set to grow at least modestly in the second half 2009, the upturn in profits will continue. A decisive return to profitability was a key feature of the recoveries from the severe recessions of the 1970s and 1980s.
Outside the finance sector, the rock-solid condition of corporate balance sheets was clear from the Federal Reserve's latest data. One standout factoid: Nonfinancial companies in the second quarter 2009 had a $156 billion surplus of cash flow relative to their capital spending, a surfeit that allows companies to finance all of their current outlays for equipment and construction without borrowing. Except for 2005, when companies were allowed a one-time repatriation of foreign earnings at a reduced tax rate, that is the largest surplus on record.
Many businesses are already investing some of that cash in new equipment as they ramp up output in response to firmer demand and skimpy inventories. Both orders and production of business equipment have turned up in recent months. Outlays for new construction are sure to remain depressed, but spending for equipment appears to be rebounding faster than in past recoveries. Historically, growth in capital spending and hiring have been tightly correlated.
Through the second quarter 2009, much of the more than adequate cash flow of nonfinancial corporations went to beefing up their holdings of financial assets. Since the end of last year (2008), the ability of liquid assets to cover short-term liabilities has increased back to the record levels that existed prior to the recession.
Companies also have taken advantage of the rallies in the stock and bond markets. They have eliminated a lot of short-term debt, replacing it with more predictable long-term obligations at a low fixed rate. The annual rate of corproate bond issuance averaged $488 billion in the first half, 2009 up significantly from $141 billion in the second half of last year (2008). Plus, corporations became net issuers of stock in the second quarter 2009 for the first time in seven years, eliminating the drain on cash flow from stock buybacks over that period.
Of course, none of this matters for hiring unless businesses can count on stronger revenues. However, recent data suggest demand, especially by consumers, looks stronger than expected. August 2009 retail sales jumped 2.7%, and the surprise was the breadth of the gains outside of the cash-for-clunkers boost. Rising housing starts suggest homebuilding will contribute positively to growth for the first time in 31/2 years. Exports are rising, and government outlays certainly will increase.
As business conditions improve, with companies able to respond quickly, more hiring will not be far behind. Income is always the chief driver of consumer spending, and once jobs begin to turn up, consumers will not likely cause the recovery to falter.
