There were a few key reports about the economy this week. Economic growth for the Spring was revised down to 1.3% as both consumer and business spending grew more slowly compared to previous periods. After contributing 2.5% to economic growth at the end of 2011, inventories have been a drag on growth in the first two quarters of 2012, which is not bad news. Companies probably found themselves with too much inventory and now are making adjustments to get back in line with consumer spending. Speaking about consumer spending, it has risen by 1.9% over the last year, contributing to the sluggishness of the recovery. Over that same period, inflation as measured by the PCE deflator (average price of consumer goods and services in GDP) rose by 1.6%.
On Friday, there was another report about the state of the consumer (updated for August 2012). Real personal income (real means adjusted for inflation) declined by 0.1% in August while real consumer spending rose by 0.1%. As a result, the savings rate declined to 3.7% (down from 4.1% in July). Consumer spending is on pace to grow by about 2% for the third quarter, slightly faster than the Spring. Meanwhile, consumer prices have risen by 1.5% since August 2011 while core consumer inflation is 1.6%.
Add it up and you still get a sluggish economy with below-average inflation. The next big economic report is this Friday's report on the job market. Currently, the consensus is for just over 100,000 jobs created with little change in the unemployment rate.
Saturday, September 29, 2012
Friday, September 21, 2012
August Employment Report: Florida & Orlando
This morning, the government released the latest report on the job market for Florida and its counties/cities. First, the headlines. The unemployment rate in Florida remained at 8.8% while the state added 23,200 jobs in August (seasonally adjusted). For Metro Orlando, the unemployment rate declined from 9.1% to 8.7% and the metro area added 17,100 jobs (not seasonally adjusted).
The numbers for Florida are OK. Employment growth was more rapid than in previous months, but the leading industries were administrative and waste service (which includes temp jobs), accommodation & food services, and construction. In addition, there was a rebound in private education jobs (remember that the data is seasonally adjusted). The labor force participation rate declined below 60%, falling from 60.7% in August 2011 to 59.9% in August 2012. If the participation rate had remained constant over the last year, the unemployment rate would be 10% instead of 8.8%. Thus, Florida has added jobs in the last year, but most of the decline in the unemployment rate has been due to fewer people participating in the labor force.
Most of the decline in the unemployment rate for metro Orlando is due to seasonal factors, but the seasonally adjust rate will probably show a small decline when reported later this month (the seasonally-adjusted rate was 8.6% in July while the unadjusted rate was 9.1%; the seasonally-adjusted rate will probably be 8.4 or 8.5% in August). The employment gain of 17,100 was the second largest for the month of August since 1988 (the first year that comparable data was available; only exceeded in 2006). The gain moved Orlando from year-over-year employment growth of 1% in July to 2.6% in August (making it the fastest growing metro area in Florida). Of course local government added jobs as public schools reopened (and local data is not seasonally adjusted). The other sector that stands out is professional and business services, which added 6500 jobs and now is the fastest growing sector over the last year, showing a gain of 4.4% since August 2012.
The numbers for Florida are OK. Employment growth was more rapid than in previous months, but the leading industries were administrative and waste service (which includes temp jobs), accommodation & food services, and construction. In addition, there was a rebound in private education jobs (remember that the data is seasonally adjusted). The labor force participation rate declined below 60%, falling from 60.7% in August 2011 to 59.9% in August 2012. If the participation rate had remained constant over the last year, the unemployment rate would be 10% instead of 8.8%. Thus, Florida has added jobs in the last year, but most of the decline in the unemployment rate has been due to fewer people participating in the labor force.
Most of the decline in the unemployment rate for metro Orlando is due to seasonal factors, but the seasonally adjust rate will probably show a small decline when reported later this month (the seasonally-adjusted rate was 8.6% in July while the unadjusted rate was 9.1%; the seasonally-adjusted rate will probably be 8.4 or 8.5% in August). The employment gain of 17,100 was the second largest for the month of August since 1988 (the first year that comparable data was available; only exceeded in 2006). The gain moved Orlando from year-over-year employment growth of 1% in July to 2.6% in August (making it the fastest growing metro area in Florida). Of course local government added jobs as public schools reopened (and local data is not seasonally adjusted). The other sector that stands out is professional and business services, which added 6500 jobs and now is the fastest growing sector over the last year, showing a gain of 4.4% since August 2012.
Some Charactersitics of Poverty in 2011: USA, Florida, Orange County
The Census Bureau released a huge amount of data regarding income and poverty this week, including data at the national, state, and local level. There's too much to present in a blog post, but here's some highlights that illustrate some key causes of poverty (the source of the data is provided; you're encouraged to dig deeper if you desire).
Selective
Characteristics of Those in Poverty, 2011
USA
|
Florida
|
Orange County
|
||
Poverty rate
|
Overall
|
15.9%
|
17%
|
18.7%
|
Education
|
Less than HS
|
27.9%
|
28.4%
|
25.9%
|
HS Grad
|
14.2%
|
16.1%
|
17.8%
|
|
Bach. Degree+
|
4.4%
|
5.6%
|
6%
|
|
Work Experience
|
Unemployed
|
32.6%
|
34.9%
|
32.6%
|
Employed
|
7.4%
|
8%
|
10%
|
|
Year-round FT worker
|
2.9%
|
3.3%
|
3.8%
|
|
Marital Status
|
Married
|
5.8%
|
6.9%
|
7.8%
|
Married (year round FT worker)
|
2.1%
|
2.3%
|
2.1%
|
|
Female head of household
|
31.4%
|
28.9%
|
29.5%
|
|
Female head of household (year round FT worker)
|
10.2%
|
9.9%
|
10.9%
|
A few key factors stand out when considering determinants of poverty. Some have stated that having a job doesn't ensure that someone escapes poverty. It doesn't. However, having a year-round, full-time job sure does help! Poverty rates for full-time workers range from 2.9% nationally to 3.8% in Orange County. A similar result occurs for female heads of households: those with full-time employment are much less likely to be in poverty than those without full-time jobs. A related determinant of poverty is education (people with more education are more likely to be employed). Those with college degrees have much lower poverty rates than those with just high school degrees or less.
What's the take away? Poverty is a complex issue that requires a multifaceted approach, but policies that strengthen economic growth resulting in more jobs are vital over the next few years. Improving educational outcomes in general along with efforts to enhance the skills of adults without higher education are critical to reducing poverty over time. Obviously, there are other policies to be considered and debated, but improving economic growth and education/skills is a good place to start.
Thursday, September 20, 2012
Median Household Income by State, 2011
The Census Bureau released its estimates for median household income by state and metropolitan area this week. Which states lead and lag the nation?
1-Maryland $70,004 50-Mississippi $36,919
2-Alaska $67,825 49-West Virginia $38,482
3-New Jersey $67,458 48-Arkansas $38,758
4-Connecticut $65,753 47-Kentucky $41,141
5-Massachusetts $62,859 46-Alabama $41,415
One problem with this data is that it doesn't take into account differences in the cost of living between states. Most people recognize that the cost of living is higher in the northeast and west coast and less expensive elsewhere. However, there isn't official data regarding differences in the costs of living between states (there are some private estimates). The Bureau of Economic Analysis recently released estimates of regional pricing parities for the period 2006-2010; this is experimental data designed to capture cost differences at the state and local level. Note that estimates for 2011 are not available, but 2006-2010 data should still help explain most of the differences in cost of living. Here's the five most and least expensive states in which to live (US=100):
1-Hawaii 116.1 50-South Dakota 87.2
2-New York 114.1 49-North Dakota 88.2
3-New Jersey 111.5 47-Missouri 88.7
4-California 110.7 47-West Virginia 88.7
5-Connecticut 110.5 46-Mississippi 88.9
What happens to median household income by state after adjusting for differences in the cost of living?
1-Alaska $63,925 50-Mississippi $42,529
2-Maryland $63,467 49-West Virginia $43,384
3-New Jersey $60,500 48-Arkansas $43,402
4-Virginia $60,021 47-Florida $44,299
5-Connecticut $59,505 46-New Mexico $44,594
The top three and bottom three remain the same, but the gap between them declines. The Dakotas benefitted the most from the low cost of living, with North Dakota moving from 20th to 9th, once one takes into account its low cost of living. Meanwhile, New York fell from 16th to 32nd. A surprise to some may be Florida having the 4th lowest median household income, after adjusting for cost of living.
Estimates of poverty at the state and local level are also distorted by cost of living differences (i.e., it's hard to use a national standard when the cost of living differs significantly between states, but that's the approach used when determing official estimates of poverty). That's a story for another day...
1-Maryland $70,004 50-Mississippi $36,919
2-Alaska $67,825 49-West Virginia $38,482
3-New Jersey $67,458 48-Arkansas $38,758
4-Connecticut $65,753 47-Kentucky $41,141
5-Massachusetts $62,859 46-Alabama $41,415
One problem with this data is that it doesn't take into account differences in the cost of living between states. Most people recognize that the cost of living is higher in the northeast and west coast and less expensive elsewhere. However, there isn't official data regarding differences in the costs of living between states (there are some private estimates). The Bureau of Economic Analysis recently released estimates of regional pricing parities for the period 2006-2010; this is experimental data designed to capture cost differences at the state and local level. Note that estimates for 2011 are not available, but 2006-2010 data should still help explain most of the differences in cost of living. Here's the five most and least expensive states in which to live (US=100):
1-Hawaii 116.1 50-South Dakota 87.2
2-New York 114.1 49-North Dakota 88.2
3-New Jersey 111.5 47-Missouri 88.7
4-California 110.7 47-West Virginia 88.7
5-Connecticut 110.5 46-Mississippi 88.9
What happens to median household income by state after adjusting for differences in the cost of living?
1-Alaska $63,925 50-Mississippi $42,529
2-Maryland $63,467 49-West Virginia $43,384
3-New Jersey $60,500 48-Arkansas $43,402
4-Virginia $60,021 47-Florida $44,299
5-Connecticut $59,505 46-New Mexico $44,594
The top three and bottom three remain the same, but the gap between them declines. The Dakotas benefitted the most from the low cost of living, with North Dakota moving from 20th to 9th, once one takes into account its low cost of living. Meanwhile, New York fell from 16th to 32nd. A surprise to some may be Florida having the 4th lowest median household income, after adjusting for cost of living.
Estimates of poverty at the state and local level are also distorted by cost of living differences (i.e., it's hard to use a national standard when the cost of living differs significantly between states, but that's the approach used when determing official estimates of poverty). That's a story for another day...
Friday, September 14, 2012
The Case Against QE3
I made a case in favor of QE3, so now it's time to make the case against QE3. As with any policy, there are costs as well as benefits. The arguments in favor of QE3 emphasize the potential long-term damage that could result from a permanent increase in unemployment. However, there is reason to doubt about how much QE3 will reduce unemployment. Interest rates in general and mortgage rates in particular are at historic lows. How much lower will they go as a result of QE3? We'll see. But rates will have to decline significantly to have a noticeable impact on the housing market. A decline of 0.25% or less is unlikely to have a significant impact. The already low interest rates have helped corporations and many mortgage holders to refinance, helping to strengthen their balance sheets. Another small decline in mortgage rates is unlikely to have much of an impact.
In addition, the Fed has tried to limit its purchases of securities to short-term Treasuries to avoid introducing distortions to financial markets. In other words, buying mortgage-backed securities will artificially reduce mortgage rates until the Fed withdraws the stimulus sometime in the future (2015?). When that occurs, there's likely to be a higher than normal increase in interest rates (including mortgage rates) as rates rise from artificially low levels (in addition to increasing due to economic strenghening). At that point, lenders will have a considerable amount of mortgages with low interest rates locked in while they'll need to start paying higher rates on deposits. In addition, people with low mortgage rates will be somewhat reluctant to move, knowing that they'll have to pay a higher interest rate when buying a new house (of course many people will have to move for a new job, etc., but this will reduce the amount of "voluntary" moves).
Though lower interest rates increases the demand for loans, they may discourage lenders from making loans if it reduces the spread (lenders earn profits based on the difference between what they earn on loans and what they pay for funds). Smaller spreads may encourage lenders to focus on prime customers.
What about inflation? Prior to Ben Bernake's speech at the Jackson Hole conference on August 31, break-even inflation using 5-year TIPS was 1.92%. On Wednesday, September 12, it was 2.12% (Friday evening update: it rose to 2.39% on Friday; the highest since the summer of 2008; the break-even inflation rate using 10-year TIPS is 2.64%, the highest since 2006). Thus, in anticipation of QE3, expected inflation has risen somewhat (highest since May 2011). CPI inflation is running at 1.7% over the last 12 months while core CPI inflation is 1.9%, as close as you can get to the Fed's target of 2%. So unlike prior to QE1 and QE2, neither inflation nor break-even inflation is considerably below the 2% target (click here for details).
Is QE3 responsible for high oil prices? Not yet. Here's a chart showing the behavior of oil prices since June 2012:
As can be seen, most of the recent increase occurred prior to Bernanke's speech in Jackson Hole. Prior to the speech, oil sold for about $94.60 per barrel; as of Friday morning, September 14, it's $99.50 per barrel. Some of the increase can be attributed to turmoil in the Middle East while some is due to increased speculation due in part to QE3.
Clearly, there's a lot to be considered, but I'll address one last topic - the Fed's exit strategy. This was a hot topic about a year ago (the Fed even began to test methods that could be used to remove reserves in the future). Given the extraordinary size of the Fed's balance sheet, making it even large increases the complexity of any exit strategy. In other words, removing $3 trillion of excess reserves is more difficult than removing $2 trillion of excess reserves. Removal of excess liquidity needs to be done with care - not too soon (hurting the recovery) but not too late (increasing inflation). As mentioned earlier, distortions in financial markets resulting in artificially low rates will disappear when the Fed implements its exit strategy. The more the distortion, the harder the adjustment back to normal conditions (and the Fed is hoping for significant distortion in order for the policy to be effective).
Add it up and I think the costs exceed the benefits. If financial markets locked up again due to a European implosion or if fears of deflation started to take hold, additional QE would be justified. However, given sluggish growth (which is still growth), inflation close to its target, and the limited impact, I would not have voted for QE3.
In addition, the Fed has tried to limit its purchases of securities to short-term Treasuries to avoid introducing distortions to financial markets. In other words, buying mortgage-backed securities will artificially reduce mortgage rates until the Fed withdraws the stimulus sometime in the future (2015?). When that occurs, there's likely to be a higher than normal increase in interest rates (including mortgage rates) as rates rise from artificially low levels (in addition to increasing due to economic strenghening). At that point, lenders will have a considerable amount of mortgages with low interest rates locked in while they'll need to start paying higher rates on deposits. In addition, people with low mortgage rates will be somewhat reluctant to move, knowing that they'll have to pay a higher interest rate when buying a new house (of course many people will have to move for a new job, etc., but this will reduce the amount of "voluntary" moves).
Though lower interest rates increases the demand for loans, they may discourage lenders from making loans if it reduces the spread (lenders earn profits based on the difference between what they earn on loans and what they pay for funds). Smaller spreads may encourage lenders to focus on prime customers.
What about inflation? Prior to Ben Bernake's speech at the Jackson Hole conference on August 31, break-even inflation using 5-year TIPS was 1.92%. On Wednesday, September 12, it was 2.12% (Friday evening update: it rose to 2.39% on Friday; the highest since the summer of 2008; the break-even inflation rate using 10-year TIPS is 2.64%, the highest since 2006). Thus, in anticipation of QE3, expected inflation has risen somewhat (highest since May 2011). CPI inflation is running at 1.7% over the last 12 months while core CPI inflation is 1.9%, as close as you can get to the Fed's target of 2%. So unlike prior to QE1 and QE2, neither inflation nor break-even inflation is considerably below the 2% target (click here for details).
Is QE3 responsible for high oil prices? Not yet. Here's a chart showing the behavior of oil prices since June 2012:
As can be seen, most of the recent increase occurred prior to Bernanke's speech in Jackson Hole. Prior to the speech, oil sold for about $94.60 per barrel; as of Friday morning, September 14, it's $99.50 per barrel. Some of the increase can be attributed to turmoil in the Middle East while some is due to increased speculation due in part to QE3.
Clearly, there's a lot to be considered, but I'll address one last topic - the Fed's exit strategy. This was a hot topic about a year ago (the Fed even began to test methods that could be used to remove reserves in the future). Given the extraordinary size of the Fed's balance sheet, making it even large increases the complexity of any exit strategy. In other words, removing $3 trillion of excess reserves is more difficult than removing $2 trillion of excess reserves. Removal of excess liquidity needs to be done with care - not too soon (hurting the recovery) but not too late (increasing inflation). As mentioned earlier, distortions in financial markets resulting in artificially low rates will disappear when the Fed implements its exit strategy. The more the distortion, the harder the adjustment back to normal conditions (and the Fed is hoping for significant distortion in order for the policy to be effective).
Add it up and I think the costs exceed the benefits. If financial markets locked up again due to a European implosion or if fears of deflation started to take hold, additional QE would be justified. However, given sluggish growth (which is still growth), inflation close to its target, and the limited impact, I would not have voted for QE3.
The Case for QE3
Let me begin by repeating that I would have voted against QE3. That said, Ben Bernanke is a very good economist with honorable intentions, so there's some good reasons for it. Here's the case for QE3.
The key aspect of QE3 involve the intent to purchase $40 billion worth of mortgage-backed securities as long as the unemployment rate remains high and even as the economy begins to strengthen. That tells us a few points behind the rationale. Of course the weakness of the recovery is reason for further stimulus, but the design of QE3 suggests a significant concern about the long-run behavior of the labor market. Ben Bernanke and others on the Fed fear hysteresis. What's that? It occurs when a significant number of the unemployed remain out of work for an extended period of time, rendering them unemployable. Thus, short-term unemployment resulting from a recession results in long-term unemployment which becomes a permanent fixture of the economy. That could mean they leave the labor force and don't come back (witness the significant decline in the labor force paritcipation rate in recent years) or they remain in the labor force and become structurally unemployed (want a job but aren't qualified for the jobs that are available). As a resuslt, the "normal" unemployment rate (what economists call the natural rate or NAIRU) rises. A consensus seems to be developing that the "normal" unemployment rate has risen from just below 5% to 6% (still some diagreement with some thinking it could be as high as 7% while others think it is somewhat lower; hard to be sure given it's still changing). What's the big deal about an increase of about one percentage point? One percent translates to about 1.5 million people (given the current labor force of about 155 milion). So the human cost is quite high. In addition, with 1.5 million fewer workers employed during normal times, the economy won't be able to produce as much, reducing potential GDP. For now, let's assume that these permanently unemployed workers that remain in the labor force are half as productive as the average worker. Taking GDP divided by the total number of people employed gives the average output per worker ($109,000). Divide that in half to estimate output per worker becoming permanently unemploed. Multiply that by 1.5 million and it's over $80 billion per year (not including those that permanently drop out of the labor force). In order to reduce the likelihood of this permanent increase in unemployment and loss of output, the Fed thinks it's worth doing it all can to reduce unemployment and thus reduce the likelihood of hysteresis.
Why mortgage-backed securities instead of US Treasuries? One reason for the very weak recovery is that residential investment is not rebounding like in previous recoveries. Following the 1973-75 and 1982 recessions, residential investment contributed an average of about one percentage point to economic growth for the first two years of recovery. What about this time? In 2010 and 2011, residential investment's contribution was slightly negative. Also, some of the highest unemployment rates are in occupations related to construction, so targeting mortgages instead of interest rates in general can have a more significant effect on unemployment. In addition, when people buy houses, they also tend to also buy furniture as well as other purchases, so some may say that spurring the housing market could help with sales of furniture and other durable household equipment (the government's term, not mine). In the recoveries of the mid-1970s and early-1980s, this category contrubuted about 0.2% to economic growth for the first two years compared to about 0.1% this time (not much of a difference).
One other change was the statement that the Fed would continue to engage in QE3 even after signs of economic strengthening. Previously, it was thought that the Fed would back off when positive economic data started to take hold. Michael Woodford, an economist with the St. Louis Fed, presented a paper at a central bank meeting in Jackson Hole critical of this policy. He made the case that this sends the signal that the Fed was implying that it was going to provide stimulus because the economy was quite weak, which may reduce consumer and business confidence. By stating that it would continue to provide stimulus even after there are signs of economic strengthening, it may be able to provide stimulus without damaging confidence, resulting in a more powerful effect.
Summing up, inflatio is under control (below 2%), unemployment remains stubbornly high with signs of a permanent increase in the normal rate of unemployment, resulting in singificant human costs and permanent loss of output. Extraordinary efforts to reduce unemployment can thus provide long-term benefits to the economy.
The key aspect of QE3 involve the intent to purchase $40 billion worth of mortgage-backed securities as long as the unemployment rate remains high and even as the economy begins to strengthen. That tells us a few points behind the rationale. Of course the weakness of the recovery is reason for further stimulus, but the design of QE3 suggests a significant concern about the long-run behavior of the labor market. Ben Bernanke and others on the Fed fear hysteresis. What's that? It occurs when a significant number of the unemployed remain out of work for an extended period of time, rendering them unemployable. Thus, short-term unemployment resulting from a recession results in long-term unemployment which becomes a permanent fixture of the economy. That could mean they leave the labor force and don't come back (witness the significant decline in the labor force paritcipation rate in recent years) or they remain in the labor force and become structurally unemployed (want a job but aren't qualified for the jobs that are available). As a resuslt, the "normal" unemployment rate (what economists call the natural rate or NAIRU) rises. A consensus seems to be developing that the "normal" unemployment rate has risen from just below 5% to 6% (still some diagreement with some thinking it could be as high as 7% while others think it is somewhat lower; hard to be sure given it's still changing). What's the big deal about an increase of about one percentage point? One percent translates to about 1.5 million people (given the current labor force of about 155 milion). So the human cost is quite high. In addition, with 1.5 million fewer workers employed during normal times, the economy won't be able to produce as much, reducing potential GDP. For now, let's assume that these permanently unemployed workers that remain in the labor force are half as productive as the average worker. Taking GDP divided by the total number of people employed gives the average output per worker ($109,000). Divide that in half to estimate output per worker becoming permanently unemploed. Multiply that by 1.5 million and it's over $80 billion per year (not including those that permanently drop out of the labor force). In order to reduce the likelihood of this permanent increase in unemployment and loss of output, the Fed thinks it's worth doing it all can to reduce unemployment and thus reduce the likelihood of hysteresis.
Why mortgage-backed securities instead of US Treasuries? One reason for the very weak recovery is that residential investment is not rebounding like in previous recoveries. Following the 1973-75 and 1982 recessions, residential investment contributed an average of about one percentage point to economic growth for the first two years of recovery. What about this time? In 2010 and 2011, residential investment's contribution was slightly negative. Also, some of the highest unemployment rates are in occupations related to construction, so targeting mortgages instead of interest rates in general can have a more significant effect on unemployment. In addition, when people buy houses, they also tend to also buy furniture as well as other purchases, so some may say that spurring the housing market could help with sales of furniture and other durable household equipment (the government's term, not mine). In the recoveries of the mid-1970s and early-1980s, this category contrubuted about 0.2% to economic growth for the first two years compared to about 0.1% this time (not much of a difference).
One other change was the statement that the Fed would continue to engage in QE3 even after signs of economic strengthening. Previously, it was thought that the Fed would back off when positive economic data started to take hold. Michael Woodford, an economist with the St. Louis Fed, presented a paper at a central bank meeting in Jackson Hole critical of this policy. He made the case that this sends the signal that the Fed was implying that it was going to provide stimulus because the economy was quite weak, which may reduce consumer and business confidence. By stating that it would continue to provide stimulus even after there are signs of economic strengthening, it may be able to provide stimulus without damaging confidence, resulting in a more powerful effect.
Summing up, inflatio is under control (below 2%), unemployment remains stubbornly high with signs of a permanent increase in the normal rate of unemployment, resulting in singificant human costs and permanent loss of output. Extraordinary efforts to reduce unemployment can thus provide long-term benefits to the economy.
Thursday, September 13, 2012
QE3!
The Fed has just announced a new round of quantitative easing (QE3). Specifically, the Fed announced that it will start buying $40 billion worth of mortgage-backed securities per month (conditional on the performance of the labor market) and continue Operation Twist for the remainder of the year (sell short-term securities, buy long-term securities, $45b/month). Also, it indicated that it anticipates maintaining low interest rates through mid-2015. The goal is to reduce long-term interest rates, particularly mortgage rates, with the hope of increasing borrowing and spending in general and providing support to the housing market in particular.
How did financial markets react? I'm writing this at 12:45pm (15 minutes after the announcement). The initial reaction is a 0.5% increase in stock prices as well as some increase in gold & silver. However, oil and gas prices have not risen. What about long-term interest rates? Yields on ten-year Treasury bonds have risen significantly, from 1.72% prior to the announcement to 1.82% as of 12:50pm. Why would the yield on Treasuries increase? Some possible reasons include the fact that the Fed is going to purchases mortgage-backed securities instead of Treasuries and concerns about higher inflation.
Was it the right move? Argument in favor of it includes the weakness of the economic recovery (economic growth below 2% in the first half of 2012 & unemployment above 8% accompanied by subpar job growth). Also, inflation is running below 2% (the Fed's target). The hope is that lower long-term interest rates will spur growth providing some support to the recovery. That said, Ben Bernanke and other members of the Fed know and hae stated that there are limits to any benefits.
Arguments against include that this will probably have a very limited effect on economic growth. Interest rates are already near historic lows. Also, though overall inflation is below 2%, core inflation is close to 2%. Energy prices are already rebounding from recent declines, so overall inflation will rise in the coming months (beginning with tomorrow's inflation report). Also, as mentioned in a previous post, expected inflation as measured in the market for TIPS (treasury-inflation-protected securities) is not that low (break-even inflation over the next five years is about 2.1% and rising somewhat in recent weeks compared to significant declines prior to QE1 and QE2). Also, this will complicate the Fed's exit strategy.
What's the take away? Though the Fed has discussed the limits to another round of QE3, it chose to implement a new round of quantitative easing. It did make it contingent on the performance of the economy, so if the economy strengthens, it could choose to stop QE3 after a few months. More likely, it will continue well into 2013. Also, it can't be accused of trying to finance the budget deficit since it chose to purchases mortgage-backed securities instead of government bonds. What's my initial take? I would have voted no. I don't anticipate significant benefits and I think it introduces more distortions to financial markets that may be hard to unwind. Do I think it will lead to rapid inflation? Not anytime soon. I wouldn't be surprised if there are more posts on this topics in the coming days.
How did financial markets react? I'm writing this at 12:45pm (15 minutes after the announcement). The initial reaction is a 0.5% increase in stock prices as well as some increase in gold & silver. However, oil and gas prices have not risen. What about long-term interest rates? Yields on ten-year Treasury bonds have risen significantly, from 1.72% prior to the announcement to 1.82% as of 12:50pm. Why would the yield on Treasuries increase? Some possible reasons include the fact that the Fed is going to purchases mortgage-backed securities instead of Treasuries and concerns about higher inflation.
Was it the right move? Argument in favor of it includes the weakness of the economic recovery (economic growth below 2% in the first half of 2012 & unemployment above 8% accompanied by subpar job growth). Also, inflation is running below 2% (the Fed's target). The hope is that lower long-term interest rates will spur growth providing some support to the recovery. That said, Ben Bernanke and other members of the Fed know and hae stated that there are limits to any benefits.
Arguments against include that this will probably have a very limited effect on economic growth. Interest rates are already near historic lows. Also, though overall inflation is below 2%, core inflation is close to 2%. Energy prices are already rebounding from recent declines, so overall inflation will rise in the coming months (beginning with tomorrow's inflation report). Also, as mentioned in a previous post, expected inflation as measured in the market for TIPS (treasury-inflation-protected securities) is not that low (break-even inflation over the next five years is about 2.1% and rising somewhat in recent weeks compared to significant declines prior to QE1 and QE2). Also, this will complicate the Fed's exit strategy.
What's the take away? Though the Fed has discussed the limits to another round of QE3, it chose to implement a new round of quantitative easing. It did make it contingent on the performance of the economy, so if the economy strengthens, it could choose to stop QE3 after a few months. More likely, it will continue well into 2013. Also, it can't be accused of trying to finance the budget deficit since it chose to purchases mortgage-backed securities instead of government bonds. What's my initial take? I would have voted no. I don't anticipate significant benefits and I think it introduces more distortions to financial markets that may be hard to unwind. Do I think it will lead to rapid inflation? Not anytime soon. I wouldn't be surprised if there are more posts on this topics in the coming days.
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