A quarterly business report review virtually

Unlike any of the previous 16 years of QBR’s or the last five years in which we have done a review, this quarter we had to use a virtual delivery to provide the review. We were fortunate to have 73 attendees last Thursday. This gives you an opportunity to see what it is we did.

Video is here.

The slides can be viewed here separately.

And here is the June 2020 Quarterly Business Report.

‘Emergency’ cuts, not all that rare

The FED acted yesterday to make a 50 basis point (0.5%) cut in interest rates to a range of 1-1.25%.  This is unusual but not really rare — in the past 25 years this has been done 9 times including the most recent one.  Bloomberg reports the history.  The vote was unanimous; this isn’t always the case, with two of the three 2008 intermeeting rate cuts running up to the Great Recession facing dissension.  Since 1998 they’ve always been in a downward direction and usually gathered around moments of significant stress in stock markets.

  • October 15, 1998 — the LTCM crisis
  • Jan. 3 and April 18, 2001 — tech bubble pop and ensuing recession
  • Sept. 17, 2001 — after 9/11
  • August 17, 2007 — after failing to act at a meeting 10 days earlier and the market melting down in the middle of the subprime mortgage bank crisis
  • Jan. 22, 2008 — large stock market selloff
  • March 16, 2008 — Bear Stearns (75 bps cut) — 2 dissenting votes
  • October 8, 2008 — coinciding with UK bailout of its banks

At a press conference chair Jay Powell read his opening remarks, which included

The virus and the measures that are being taken to contain it will surely weigh on economic activity, both here and abroad, for some time. We are beginning to see the effects on the tourism and travel industries, and we are hearing concerns from industries that rely on global supply chains. The magnitude and persistence of the overall effects on the economy, however, remain highly uncertain, and the situation remains a fluid one.

Against this background, the Committee judged that the risks to the U.S. outlook have changed materially. In response, we have eased the stance of monetary policy to provide some more support to the economy.

Markets slumped immediately afterwards, leading many to believe there was an expectation of a 75 bp cut; St. Louis Fed president James Bullard threw cold water on that idea today.  “I wouldn’t want to put a tremendous amount of focus on this March meeting. There won’t be a lot of new information there that we don’t have today,” he said.

Much was made over the weekend of the G-7 meeting and statement that was to come out Monday, though it ended up long on words and short on actions.  The ECB has come under fresh pressure to act, though their rates are already negative.

The actions taken, however, have done little to calm markets with the Fed unable to fill all demand for overnight repo borrowing this morning.

Paul Volcker, R.I.P.

Paul Volcker died today at age 92.  A colossus of a man both physically (at 6’7″) and professionally, it sometimes seemed to me his achievements at the Federal Reserve were eclipsed by ‘maestro’ Alan Greenspan who succeeded him in 1987.  A full recounting of his career is impossible, of course, and he did much after leaving the Fed, a job he never asked for but served when asked.

In his biography of Greenspan, The Man Who Knew, Sebastian Mallaby notes that Volcker was deeply influenced by a speech in Belgrade in September 1979, weeks after his appointment.  Arthur Burns gave the speech, a former Fed chair himself, who claimed that the independence of the Fed was over because monetary experts had too many questions to speak with one voice against political pressures.   Mallaby argues that the desire to wring inflation out of the U.S. system, characterized by the Saturday Night Special announcement that Fed policy was being fundamentally changed, was Volcker’s attempt to prove Burns wrong.  (As I was writing this, Mallaby has released a version of this point in his retrospective of Volcker today.) Thus began the long disinflation that was the achievement of Volcker’s career.

fredgraph (11)

Steve Hayward has provided an interesting excerpt from his biography of Reagan about Volcker’s reappointment in 1983.  It’s worth reminding people that conflicts at the FED, so prevalent in today’s debates about economic policy, happened then too.  The battle then, as now, turned partly on exchange rates which the Reagan administration wanted to manage through multilateral agreements including the Plaza Accord (July 1985, to manage a depreciation of the dollar versus the yen) and the Louvre Agreement (February 1987) in which then-Secretary of the Treasury James Baker had tried to push Japan and West Germany to stop the appreciation of their currencies.  He was unsuccessful.

The Board of Governors was by this time fully appointed by Reagan and had in early 1986 actually voted 4-3 to cut rates with Volcker in the minority.  Volcker was forced to go to Japan and Germany to get rate cuts there to coordinate, which weakened his position.  It is quite clear to me that this was probably the end of any chance that Volcker would stay for a third term.

As Allan Meltzer notes in his magisterial History of the Federal Reserve,

[Baker] may not have understood that a central bank that targets an exchange rate cannot control money stock growth or domestic interest rates, but Volcker did.  Volcker was reluctant to relinquish central bank independence that he had worked so diligently to restore. (p. 1191)

And it was important that this link be broken because a scant 19 months later, in October 1987, stock markets fell after interest rate increases had caused revaluation of asset prices.  Exchange rates finally relented (the deutschemark fell to 1.63 from 1.80 in the last quarter that year.)  As Meltzer recounts, this gave the FED the ability to do what it does best:  act as lender of last resort.

Markets did not function smoothly in the aftermath of the stock market decline.  There was a scramble for liquid assets.  The Federal Reserve satisfied the demand, helped markets to settle transactions, and prevented the devastating secondary effects of the 1929 stock market drop.  Economic growth resumed after a brief pause. (p. 1193)

That period was the beginning of the Greenspan Fed, but the keys had been handed to him by Volcker.  When in May 1988 candidate George H.W. Bush had declare that “there is more room for the economy to growth without unacceptable increases in inflation,” Greenspan was determined to not let Volcker’s work be undone.  They raised interest rates three months later, largely to the approval of the press and Wall Street.   It would be two more years before a mild recession largely caused by a supply shock from the Middle East, and through it all Greenspan protected the legacy of the Volcker disinflation.

A change in policy draws two dissents

The FED acted as we expected today.  It lowered the Fed funds rate target range to 2-2.25% from its previous 2.25-2.5%.  This was the first cut since the middle of the Great Recession in 2008-09.  It also announced (perhaps a bit less expected) that it would end quantitative tightening two months earlier than it had previously said, moving the end date to August from October 2019.

(It’s worth noting that the end of QT is considered by some another round of easing, on top of the 25 basis point cut.  However, I believe the evidence on both QE and QT are weak in causing changes in interest rates, so if there is an effect here it will be on market sentiment.  I have nothing further to add about that change at this point.)

It is noteworthy that two FOMC members dissented, preferring to wait for more data before moving towards tightening.  Esther George of the Kansas City Fed had already indicated that the deviations in inflation from its 2% target were OK with her if they were in a range +/- 0.5%.  (There was an Italian report that she was more comfortable with a rate cut this week but it appears the report was mistaken.)  President George is considered the anchor on the hawkish end of the FOMC policy spectrum and her dissent should not come as a surprise.

The other dissent — which on reflection should not have been a surprise — was Eric Rosengren of the Boston Fed.  In a recent speech he emphasized central bank independence (a topic near and dear to my heart.)  The speech emphasized the need for the Fed not to succumb to partisan pressures.  Thus I am willing to argue Rosengren tipped his hand that he was not to be forced by Washington to lower rates.

But Washington probably had little to do with it.  In a world with more and more bonds yielding negative returns (you are paying government to hold your money), the U.S. rate was drawing in huge amounts of liquidity from abroad and pushing the dollar higher.  This effect was called out by the FOMC statement in changing its statement from June to mention “the implications of global developments for the economic outlook” while saying inflation was still muted — it is as if the latter gives them permission to look at the former.  Greg Ip at the Wall Street Journal called this correctly earlier today:

The outside world has always influenced the Fed, because a foreign recession or crisis can hit U.S. exports and financial markets. Fed Chairman Jerome Powell has cited weak global growth as a reason the Fed will probably reduce rates. The new wrinkle is that the central bank is factoring not just foreign economic developments but also foreign interest rates into where U.S. rates ought to be.

“U.S. rates can diverge to some extent from global rates but there’s a limit to how far that process can go, because of integrated capital markets,” Fed Vice Chairman Richard Clarida said recently on Fox Business Network.

We are accustomed to looking at yield curves in the US, but increasing attention will need to be paid to the implications of exchange rate movements as we move into 2020.  This being a relatively uncharted part of U.S. monetary policy, we can expect more statements from FOMC members in the next few weeks as they explain the relevance of exchange rates in their decisions.  Clearly, at least two members of the committee were not convinced.

 

Presidents never like interest rate hikes, or, the old jawbone

President Trump, in his usual way of speaking, told Joe Kernan of CNBC that he doesn’t necessarily agree with the Federal Reserve’s raising of interest rates. This act, known alternatively as ‘moral suasion’ or ‘jawboning’, has actually been happening for a while. Economic adviser Larry Kudlow did almost the same thing on Fox News three weeks ago.

Criticism has been coming in from many quarters, not all from the usual sources. Keith Hennessey, formerly of the Bush43 White House, “disagree[s] with President Trump on every aspect of this.” Most of the claims are that this breaks from a long-standing tradition. But for how long? Pres. George H.W. Bush blamed Fed chair Alan Greenspan for his electoral loss in 1992, a theme that his administration began as early as 1989. Pres. Ronald Reagan in 1981 told a group of supporters, “The Fed is independent, but they’re hurting us.” Perhaps the most famous act, done more privately, was when LBJ shoved then Fed chair William McChesney Martin around a room, shouting at him, “Martin, my boys are dying in Vietnam, and you won’t print the money I need.”

This reticence of presidents to talk about the Fed, then, is fairly recent history, started by Bill Clinton’s Treasury secretaries Robert Rubin and Larry Summers. Greenspan having enough credibility to be called a maestro probably stayed the hand of Bush43’s staff (you might argue they needed to jawbone rates higher) and the Obama White House used breakfasts to persuade Bernanke and Yellen in private more than with public statements.

Hennessey’s article does make a very strong point though, and is the reason why we should find Trump’s statement unsurprising. Elected officials like economic expansions because incumbents are rewarded for a good economy (even if they’ve done nothing to cause it) and so rising interest rates tend to be characterized as “taking away the punch bowl just as the party gets started.” That is, elected officials always have an inflationary bias, regardless of party. Since the Fed typically has leaders with less of an inflationary bias, with more frequent spikes. (To give my bona fides and perhaps my biases, I have been writing on this topic professionally for 35 years.)

We could have a fine argument about whether the Fed is going too fast or too slow, but that’s not my point. It’s only that jawboning the Fed is an old tool in the economic policy toolbox and those acting like this is taboo have forgotten their history.

Who is in the middle class?

A friend asked me this question, here is what I mailed him.

There is no way to say for sure “who is in the middle class.” Here are a couple of answers I give when I am asked this question, largely from a set of studies done by the Pew Research Center.

  1. If you mean middle class by income, the middle fifth of the income distribution — those within 10% of median income of $56,516 when ranking families from lowest to highest — is approximately between $43,000 and $72,000. If you were to take the group of people living between 2/3rds of the median income to about twice the median income, that share of the population has fallen from 61% in 1971 to 50% today. Both the upper and lower tiers have grown. 
  2. A recent Pew Survey, says most Americans feel you need to have a job and be able to save money to be part of the middle class. But another survey says 47% of Americans say that, if they were confronted with an unexpected expense of $400, they would either have to borrow the money or sell something to pay for it. That is, they didn’t have $400 in readily available savings. Does this mean those 47% are not part of the middle class? That would have to include some portion of the 50% I mentioned in the first point. The Pew survey also said that less than half of Americans think you need a college education or to own your own home, or to be able to afford a vacation. It really does seem people look at this as an income measure.

First blog post

I used to blog, a lot.  When I ran for public office people told me I should get rid of the blog because I had written too much and couldn’t possibly remember and defend every word.  I did so; I wish I hadn’t.  I had some good things there.  What started off as a blog for a group of faculty concerned about higher education became a house for one, and eventually discussion turned back to economics.  I’m sure that stuff is around some internet archive somewhere if you really want to look for it.  I’m thinking instead of a new place.  Besides, I always wanted to design a WordPress blog.  (This thing will change shape frequently over the next few months until it gets to what I like, but there’s no reason not to put it in play right away.)

Nowadays most of what I think gets talked about on radio every Saturday.  It someone serves as an outlet for my classroom habits.  I am saving this blog for both my longer writings (I tried Tumblr, doesn’t work for me)  and to feature slides that I use in my presentations.  The goal is to get you interested in my writing and speaking, and hopefully engage in some dialogue.  Welcome, and please click around as you wish!