How big is the output gap?

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July 23, 2012

How big is the output gap?

It's fair to say, I think, that the question posed in the title of this blog post is at the heart of any monetary policy debate.

Here's how the discussion went at the June meeting of the Federal Open Market Committee (FOMC):

"Meeting participants again discussed the extent of slack in labor markets. Some participants judged that the unemployment rate was being substantially boosted by structural factors such as mismatches between the skills of unemployed workers and those required for available jobs....One implication of the view that there is relatively little slack is that providing more monetary stimulus would be likely to raise inflation above the Committee's objective. Some other participants acknowledged that structural factors were contributing to unemployment, but said that, in their view, slack remained high and weak aggregate demand was the major reason that the unemployment rate was still elevated. These participants cited a range of evidence to support their judgment....These arguments imply that slack in labor markets remains considerable and therefore that a reduction in the unemployment rate toward its longer-run normal level would not have much effect on inflation."

If you want more specifics about these contrasting views, you might find recent speeches by some FOMC meeting participants helpful. Jeff Lacker, president of the Federal Reserve Bank of Richmond, is pretty clearly in the "relatively little slack" group:

"It's worth noting...that the effects of unemployment insurance benefits together with the effects of labor market inefficiencies could plausibly account for a quite substantial portion of our elevated unemployment rate. The quantitative estimates of labor market mismatch come from independent methods and datasets and, in principle, measure conceptually distinct inefficiencies. We shouldn't necessarily assume these effects are additive, but combining all three together yields a range of 2.9 to 5.9 percentage points, which is sizable relative to the increase in the total unemployment rate of 5-½ percentage points during the recession."

Vice Chairman Janet Yellen is also pretty clearly on the other side of the debate:

"A critical question for monetary policy is the extent to which these numbers reflect a shortfall from full employment versus a rise in structural unemployment. While the magnitude of structural unemployment is uncertain, I read the evidence as suggesting that the bulk of the rise during the recession was cyclical, not structural in nature.

"Consider...the difference between the actual unemployment rate and the Congressional Budget Office (CBO) estimate of the rate consistent with inflation remaining stable over time...[the] index of the difficulty households perceive in finding jobs...[and the] index of firms' ability to fill jobs....All three measures show similar cyclical movements over the past 20 years, and all now stand at very high levels."

The positions outlined above lay bare why estimates of the output gap command such weight in the discussion of monetary policy'both ends of the FOMC's dual mandate of maximum employment and price stability may run through it. If the output gap is large, that is, if the level of gross domestic product (GDP) is running significantly under potential GDP, the economy is obviously not in a position of maximum employment. And if that is the case, the inflation trend is likely to be headed lower and so the price stability mandate may also be in jeopardy.

Where do I come out in this debate? That isn't important since I don't get a vote. But my boss, Dennis Lockhart does, and he laid out his position in a recent speech to the Mississippi Economic Council.

"I think the output gap'the amount of slack in the economy'is neither as sizeable as the high-end estimates, nor is it zero. If there were no slack at all, 8.2 percent unemployment would represent full employment. If this were so, the economy would have undergone profound structural change over the last five years. As I weigh the findings of research by Federal Reserve economists and others, I do not think a compelling case has yet been made that structural adjustment has played a dominant role in slowing growth and progress against unemployment.

"If, on the other hand, slack in the economy were close to the high estimates, we should have seen more and more persistent downward pressure on prices and wages than has, in fact, been the case. Deciding on the extent of the output gap is not straightforward. I believe the truth is in the gray middle."

To emphasize, this "gray middle" isn't a compromise but a weighing of the available evidence. If the GDP gap really is close to zero, the profound structural change that the economy ought to have experienced hasn't found great support in the data. But if this is just a bigger version of gaps of recessions past, then where is the great disinflationary pressure such slack would ordinarily imply?

You may have another view and, again quoting Lockhart's recent speech, "reasonable people can consider the issues...and come to different conclusions. "And if you're having trouble getting a grasp on GDP, potential GDP, and why the measurement of our national potential isn't an easy task, perhaps we can help. We've recently produced an educational video on the issue. It's not a deep treatment of the issue'in fact, just the opposite. It's a jumping-in point for those who are interested in the policy debate but haven't a clue what a GDP gap is. As always, let us know what you think.

By Mike Bryan, vice president and senior economist in the research department at the Atlanta Fed

July 23, 2012 in GDP | Permalink

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well, the size of the output gap is mostly beside the point: we *never*, never know the size of the output gap. We didn't in 2007. We didn't in 1998, nor did we know it 1976. Pick a year, we didn't know it that year either.

So whether we know the size of the gap or not should not be relevant, since we've never actually known it. Nor do we know the lags or leads with which monetary policy affects the economy (i say leads, because we know planners set expectations so policy acts with a lead).

The name of the game is not to pick a policy target that corresponds to the size of the output gap, an unknown. The name of the game is to pick a policy that we know will have desirable outcomes *regardless* of the size of the output gap.

Another fact we know is that most people learn on the job. Back in the 90s during the IT boom, most people entering IT did had other backgrounds. Employers in the US generally train employees (even if they have a grad degree). When demand for labor is high enough, employers cant be as picky as they are now. There is no such thing as "structural unemployment" only low demand for labor.

Third, we know that the Federal Reserve cannot target import prices without raising unemployment. 80% of the gap between PCE and GDP deflator is correlated with *oil prices.* You know, the housing market was well into recession in 2008, when the fed left rates at 2% in sept 2008, because it was overly focused on an inflation measure highly influenced by oil prices.

When you add all this up: unknown potential output, weak aggregate demand, and inappropriate measures of domestic inflation, it all adds up to failed policy.

A far better policy over the last 5 years would have been simple nominal income targeting. Had the Fed simply targeted a 4.5% growth path and agreed to steer the nominal economy along that path, we would be in far better shape regardless of the size of the output gap. So-called deleveraging would be proceeding as a far more rapid pace.

Posted by: dwb | July 24, 2012 at 08:28 AM

What's to be done?

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July 13, 2012

What's to be done?

It's always hard to please everyone. Sometimes it's hard to please anyone. You probably don't need a lot of convincing on this point, but if you desire one more case study look no further than the past week's commentary on monetary policy, starting with Wonkblog's rather negative performance review (post by Brad Plumer) of the Fed's recent policy decisions:

"Right now, unemployment is falling more slowly than the Fed expected when it issued its forecasts back in April' When the Fed published its forecasts, it expected more jobs reports like April's, which initially showed the economy adding 115,000 jobs new jobs. But that hasn't happened' Which means the Fed's own numbers prove the Fed is failing to meet its dual mandate of keeping unemployment and inflation low. (Inflation is below the central bank's target right now; unemployment is not.)"

Plumer favorably references an earlier item from the Peterson Institute's Joe Gagnon, bearing the damning title "The Fed Shirks Its Duty":

"On June 20, 2012, the Federal Reserve System's Federal Open Market Committee extinguished the last shred of doubt as to whether it intends to achieve its mandated objectives."

Carnegie Mellon's Alan Meltzer similarly wonders "What's Wrong With the Federal Reserve?" But his lament, published earlier this week in the op-ed pages of the Wall Street Journal, doesn't exactly mesh with the Gagnon-Plumer school of thought.

"One of the Fed's big mistakes is excessive attention to the short term, over which it has little influence'

"The problem with the short term is that data reported today are subject to revision, or reflect only transitory changes. The better economic data last winter are one of many examples. Would the reported improvement in the economy persist? We didn't learn the answer until weaker data reported this spring. Is the slowdown persistent or temporary? We can only guess.

"Executing monetary-policy changes in response to transitory data is a mistake'

"Today's economic problems are serious, but the Fed can't do much about them if these problems are not monetary. Very expansive monetary policies did help during the crisis of 2008'09, but they're not what is needed now'"

I don't see a dispute here about the fact in the first half of the year the U.S. economy has grown considerably slower than most people'including those in the Fed'thought it would. As usual, the dispute comes down to how to interpret those facts and what to do about them.

Material differences of opinion about how to interpret the current economic environment was the focal point of a speech given today by Atlanta Fed President Dennis Lockhart, in Jackson, Mississippi. Acknowledging the divergent views represented by the Plumer, Gagnon, and Meltzer views, President Lockhart offers his own:

"The question that the members of the FOMC confront is whether there is more that can be done to address the related challenges of slower GDP growth and tepid job creation. So, to wind up, let me give you my take on the key questions underlying a decision to bring on more monetary stimulus.

"I think the output gap'the amount of slack in the economy'is neither as sizeable as the high-end estimates, nor is it zero. If there were no slack at all, 8.2 percent unemployment would represent full employment. If this were so, the economy would have undergone profound structural change over the last five years. As I weigh the findings of research by Federal Reserve economists and others, I do not think a compelling case has yet been made that structural adjustment has played a dominant role in slowing growth and progress against unemployment.

"If, on the other hand, slack in the economy were close to the high estimates, we should have seen more and more persistent downward pressure on prices and wages than has, in fact, been the case. Deciding on the extent of the output gap is not straightforward. I believe the truth is in the gray middle.

"On the risk associated with the balance sheet: in my judgment, some further use of the balance sheet to promote continued recovery and/or financial stability brings with it manageable risks. I think reversal of the cumulative balance sheet scale and maturity structure can be accomplished in an orderly manner. But the step of additional balance sheet expansion should be undertaken very judiciously. Such a step would take us further into uncharted territory.

"On the likely effectiveness of further monetary stimulus'a policy that would necessarily be brought to bear at least in part through credit channels'I think we should have modest expectations about what further action can accomplish. I do not think this means monetary policy is impotent or has reached its limit. But I don't see more quantitative easing or similar policy action as a miracle cure, especially absent fixes in policy areas outside the central bank's purview."

And to the dimming forecasts:

"So, as one policymaker, here's my situation: my support for the current stance of policy rests on a forecast that sees a step-up of output and employment growth by year-end and into 2013. If the economy continues on the track indicated by the most recent incoming data and information, that forecast will become untenable, as will the policy premises underlying it."

Plumer and Gagnon argue we are already at that point. Meltzer believes otherwise. Lockhart is weighing both possibilities. That approach pleases neither camp, but it's the right thing to do.

By Dave Altig, executive vice president and research director at the Atlanta Fed

July 13, 2012 in Federal Reserve and Monetary Policy, Forecasts, Monetary Policy | Permalink

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Young versus mature small firms seeking credit

« Do falling commodity prices imply disinflation ahead? | Main

June 28, 2012

Young versus mature small firms seeking credit

The ongoing tug of war between credit supply and demand issues facing small businesses is captured in this piece in the American Prospect by Merrill Goozner. Goozner asks whether small businesses are facing a tougher borrowing environment than is warranted by current economic conditions. One of the potential factors identified in the article is the relative decline in the number of community banks'down some 1,124 (or 13 percent of all banks from 2007). Community banks have traditionally been viewed as an important source of local financing for businesses and are often thought to be better able to serve the needs of small businesses than large national banks because of their more intimate knowledge of the business and the local community.

The Atlanta Fed's poll of small business can shed some light on this issue. In April we reached out to small businesses across the Sixth Federal Reserve District to ask about financing applications, how satisfied firms were that their financing needs were being met, and general business conditions. About one third of the 419 survey participants applied for credit in the first quarter of 2012, submitting between two and three applications for credit on average. As we've seen in past surveys (the last survey was in October 2011), the most common place to apply for credit was at a bank.

For the April 2012 survey, the table below shows the average success of firms applying to various financing sources (on a scale of 1 to 4, with 1 meaning none of the amount requested in the application was obtained, and 4 meaning that the firm received the full amount applied for). The table also shows the median age of businesses applying for each type of financing.

The results in the table show that for credit applications, Small Business Administration loan requests and applications for loans/lines of credit from large national banks tended to be the least successful, whereas applications for vendor trade credit and commercial loans/line-of-credit from community banks had the highest average success rating.

Notably, firms applying for credit at large national banks were typically much younger than firms applying at regional or community banks. If younger firms generally have more difficulty in getting credit regardless of where they apply, it could explain why we saw less success, on average, among firms applying at larger banks.

To investigate this issue, we compared the average application success among young firms (less than six years old) that applied at both regional or community banks and at large national banks, pooling the responses from the last few years of our survey. The credit quality of borrowers is controlled for by looking only at firms that applied at both types of institutions. What we found was no significant difference in the average borrowing success of young firms applying for credit across bank type'it just does seem to be tougher to get your credit needs met at a bank if you're running a young business. Interestingly, we also found that more mature firms were significantly more successful when applying at regional or community banks than at large national banks'it seems to be relatively easier for an established small business to obtain requested credit from a small bank.

While this analysis did not control for other factors that could also affect the likelihood of borrowing success, the results do suggest that Goozner's question about the impact of declining community bank numbers on small business lending is relevant. If small businesses are generally more successful when seeking credit from a small bank, will an ongoing reduction in the number of community banks substantially affect the ability of (mature) small businesses to get credit? More detailed insights from the April 2012 Small Business Credit Survey will be available soon on our Small Business Focus website, and we will provide an update when they are posted.

By John Robertson, vice president and senior economist,

 

and

Ellyn Terry, senior economic research analyst, both of the Atlanta Fed's research department

June 28, 2012 in Banking, Economic Growth and Development, Saving, Capital, and Investment | Permalink

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Do falling commodity prices imply disinflation ahead?

« Employment growth and the FOMC Summary of Economic Projections | Main

June 25, 2012

Do falling commodity prices imply disinflation ahead?

Cost pressures at the manufacturing level appear to be easing'at least, so say the manufacturers in our Business Inflation Expectations survey. In June, manufacturers reported that unit costs were up only 1.3 percent over the last 12 months, a full percentage point below their assessment at the end of last year. Retailers, on the other hand, report unit cost increases of 2.1 percent, down a bit from May, but 0.3 percentage points higher than in December.

We put a special question to our panel in June that may shed a little light on these patterns. When we asked firms to tell us what has been driving their unit costs over the past 12 months, manufacturers saw considerably less pressure coming from their cost of materials compared with other firms. Perhaps this discovery isn't very surprising. After all, commodity prices have been falling pretty sharply of late, and these costs are especially influential to manufacturers' assessment of the cost environment. (Indeed, in response to a special question we asked our panel in March, manufacturers ranked materials costs as the number-one influence on their pricing decisions.)

Does the fall in commodity prices mean we can expect a pass-through of these lower costs to consumers?

Perhaps. There's certainly a strong intuitive appeal to the "pipeline" theory of inflation. Here's the idea as described by the Bank of England (BOE):

"Consumer prices'can be thought of as the end of a 'pipeline' of costs and prices. The final price will be made up of many different components of cost as well as the retailer's profit or margin' Prices at one stage of the pipeline become costs for the next stage'"

But economists who have looked down the inflation pipeline haven't found flows, but rather trickles. Years ago, Todd Clark of the Cleveland Fed put it this way while he was at the Kansas City Fed: "the empirical evidence' shows the production chain only weakly links consumer prices to producer prices."

So the "inflation pipeline" theory isn't that simple, as the BOE goes on to explain:

"The [pipeline] idea is a simplification' Prices are determined by the interaction of supply and demand. If the cost of raw materials rises, for example, producers or retailers might accept lower profit margins rather than raise their prices. They are more likely to do this if demand is weak or because of competition. The degree of competition in markets can affect how much cost increases are passed on to consumers."

Investigations into what might be obstructing the flows through the inflation pipeline have taken several approaches, including the one suggested by the BOE above: Firms may vary their markups (or margins) to damp the influence of costs on prices as they pass from one stage of production to the next. This idea has become a cause célèbre in macroeconomics and a key element of something called the New Keynesian Phillips Curve.

And so we've been keeping our eyes on how our panel assesses their margins, and we note something pretty striking. That is, margins are rising, but primarily for retailers. Indeed, as our panel sees it, retail margins are getting pretty close to returning to normal. Manufacturers, however, still see their margins as well below normal.

Expanding margins, then, may slow the flow of falling commodity prices through the inflation pipeline. Manufacturers may take the fall in commodity prices as an opportunity to improve their woeful margins. And if they do pass these cost savings on down the production chain, it still might not hit consumers' wallets if retailers continue to increase their margins. (Based on our survey, that's what seems to have been going on lately, anyhow.)

For other insights from the June Business Inflation Expectation survey, see the Inflation Project on our website.

By Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

Nicholas Parker, economic research analyst, all with the Atlanta Fed

June 25, 2012 in Inflation, Pricing | Permalink

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Employment growth and the FOMC Summary of Economic Projections

« The armchair Fed historian | Main

June 22, 2012

Employment growth and the FOMC Summary of Economic Projections

Here at macroblog we are always keen for an excuse to play with the Atlanta Fed's Jobs Calculator, and Wednesday's release of the Summary of Economic Projections (SEP) from the most recent meeting of the Federal Open Market Committee (FOMC) provides the perfect opportunity. The SEP, as you know, offers up three-year (and longer-run) projections of growth in gross domestic product (GDP), inflation measured by the personal consumption expenditure index (both headline and core), and the unemployment rate.

The SEP does not directly provide information on employment growth, and each of the 19 FOMC participants among the seven governors and 12 Federal Reserve Bank presidents will have their own views about how all the dots connect between GDP growth, unemployment, and job creation. I don't presume to speak for any of them, but with a few assumptions we can get a ballpark sense of how the range of unemployment rate projections might map into payroll job changes.

Assume, for example, that the labor force participation rate'the share of the working population that is either employed or actively seeking work'remains at its May level of 63.8 percent through 2014. In this case, the "central tendency" range of unemployment rate projections implies the following:

As a frame of reference, here is the recent employment record in the United States:

Overall, the hypothetical job growth based on SEP projections looks reasonably consistent with the employment experience of the last year and a half or so. If you yourself are inclined to think that the 2011 experience or the 12-month trend represent the most likely pace for the job growth going forward, you would probably find yourself in agreement with the lower unemployment numbers in the SEP. If you are convinced that the past three months represent a persistent downshift in the pace of job creation, you probably align with the higher end of the projections.

All of these calculations depend on my assumption about the labor force participation rate, and we along with many others have been warning that a constant participation rate may not be in the cards. Interested readers can go to the calculator and plug in their own participation rate assumptions and see how the resulting jobs numbers change. Our sense is that the participation rate is most likely to rise, which would count as a risk that the calculations above understate the job growth needed to hit the indicated ranges for the unemployment rate. On the other hand, some have argued that the expiration of extended unemployment benefits will actually lower the participation rate, as some people will simply drop out of the labor force. Declines in the participation rate would lower the job creation needed to support the unemployment rate projections in the SEP.

We'll see, but barring the participation complication, the unemployment rate projections on their face look pretty consistent with the same sort of progress on the job creation front that we have seen over the past couple of years. For better and worse.

By Dave Altig, executive vice president and research director at the Atlanta Fed

June 22, 2012 in Employment | Permalink

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The armchair Fed historian

« Fed purchases of government debt: Flow-share versus stock-share | Main

June 13, 2012

The armchair Fed historian

I enjoy researching economic history'some of my work with Steve Quinn on early central banking is here, here, and here.

The only problem with historical research, though, is that it tends to involve some real work'long hours spent with dusty archival volumes, consumption of lots of coffee and antihistamines, and a steady hand on the digital camera.

Just recently'and somewhat belatedly'I became aware of a Google application (thanks to Benjamin Guilbert's blog) that lets would-be economic historians breeze over the rough stuff and do some interesting research from their own computer keyboards. The application is called Ngrams, and here's how it works.

Basically, Ngrams counts occurrences of words in books that have been scanned by Google into its Google Books database. It then plots out the frequencies of these words as annual time series. These plots can then be used to measure how interest in a topic varies over time'to construct "cultural histories."

There are some limitations to this technique, mostly related to unavoidable issues in Google's database. For example, the dataset I chose to work with covers only English-language publications and stops in mid-2009. (See the Ngrams website for more detailed information.)

The six charts below represent a first attempt to use Ngrams to delve into the cultural history of the Federal Reserve.

Question 1: How popular is the Federal Reserve as a discussion topic compared with other central banks?

• Search terms: Bank of England, Federal Reserve, Reichsbank, Bundesbank, Bank of Japan
• Time period: 1900'2008

• My interpretation: almost from its beginning in 1913, the Federal Reserve has been the primary focus of English-language writing on central banks.

Question: 2 The Fed was founded as a means to counteract banking panics. What has been the impact of the Fed on the discussion of panics?

• Search term: bank panic
• Time period: 1866'2008

• My interpretation: that bank panics were widely discussed in the wake of three National Banking Era panics in 1873, 1893, and 1907, no surprise. Interest in bank panics peaked following the widespread bank failures of the early 1930s. This topic became less popular after World War II, but interest reawakened with the numerous savings and loan failures of the 1980s and early 1990s.

Question 3: One of the early policy goals of the Fed was to improve the efficiency of the check payment system. When did use of checks become the norm for ordinary Americans?

• Search terms: pay envelope, pay check, paycheck
• Time period: 1900'2008

• My interpretation: in 1920, most people did not have checking accounts and were paid in envelopes stuffed with cash. By 1960, most households had checking accounts and were paid by "pay check," later contracted to "paycheck."

Question 4. What has been the impact of the Fed on people's concerns about inflation and unemployment?

• Search terms: unemployment, inflation
• Time period: 1900'2008

• My interpretation: interest in unemployment shot up during the Great Depression, fell back in the postwar years, but resurged in the 1970s. Discussion of unemployment then falls steadily to the end of the sample in 2008. Inflation was rarely discussed until the United States left the gold standard in 1933. Interest in inflation remained below unemployment until inflation began to accelerate in the 1970s. Since about 1980, interest in these two topics has been almost identical.

Question 5: In the mind of the public, which policy goal should the Fed be most concerned with: price stability, financial stability, or employment?

• Search terms: price stability, financial stability, Phillips curve (as an imperfect proxy for "employment"; note that the original article by William Phillips appeared in 1958)
• Time period: 1900'2008

• My interpretation: financial stability was paramount until after the 1951 Treasury-Fed Accord. Price stability then takes center stage until the turn of the 21st century but by 2008 had converged with financial stability. Interest in the Phillips curve seems to have peaked in the early 1980s.

Question 6: What has been the impact of two "big ideas" on monetary policy, proposed by Robert E. Lucas (1976) and John B. Taylor (1993)?

• Search terms: Lucas critique, Taylor rule
• Time period: 1970'2008

• My interpretation: in his 1976 paper, Lucas argued that there were limits on the usefulness of statistical relationships (the Phillips curve in particular) in monetary policymaking. Partly in response to the Lucas critique, Taylor in 1993 proposed that central banks follow a simple rule in setting short-term interest rates. Interestingly, discussion of the Lucas critique peaked around the time of the publication of Taylor's paper. Interest in the Taylor rule was still growing at the end of the sample in 2008.

You may or may not agree with the choice of search terms or the interpretations of the search results, but you are welcome to conduct your own historical research with the same application'all from the comfort of your armchair, no digital camera required. We'll have more of these cultural histories to share in later posts.

By Will Roberds, research economist and senior policy adviser at the Atlanta Fed

June 13, 2012 in Employment, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

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Fed purchases of government debt: Flow-share versus stock-share

« The skills gap: Still trying to separate myth from fact | Main

June 11, 2012

Fed purchases of government debt: Flow-share versus stock-share

In last Friday's entry to his Economics One blog, Stanford Professor John Taylor reiterated an observation he made a week earlier in a June 1 Wall Street Journal op-ed: In fiscal year 2011, the Federal Reserve, largely as a result if its second large scale asset purchase program (or "QE2"), purchased a quantity of Treasury debt equivalent to 77 percent of all the debt issued to the public by the federal government. In his blog post Taylor refers to this as an "amazing percentage" and in the Wall Street Journal piece lumps it in with a collection of other policies that he views as problematic:

"... the discretionary stimulus packages and exploding debt, the regulatory unpredictability associated with ObamaCare and Dodd-Frank, which includes hundreds of rules still waiting to be written, and the unprecedented quantitative easing through which the Federal Reserve bought 77% of new federal debt in 2011."

The 2011 figures cited by Taylor do reflect, in dollar terms, a large increase in the Fed's Treasury purchases. As he notes, the 77 percent represents an increase of $853 billion in Fed holdings over a $1,109 billion expansion in publicly held government debt. Prior to last year, the largest dollar increase in Federal Reserve holdings of Treasury securities over a single year was $278 billion, in fiscal year 2009 (equivalent to 16 percent of the record increase in publicly held debt of $1,741 billion). The next three largest increases were $70 billion (32 percent), $52 billion (14 percent), and $44 billion (12 percent) in fiscal years 2002'04 (in that order).

So, in historical terms and absolute dollar terms, the 2011 share of the debt flow was quite large. But does it represent a significant change in economic terms? In their review of the evidence regarding the effects of earlier central bank asset purchase programs in the United States and elsewhere, Sharon Kozicki and her Bank of Canada colleagues make this observation (emphasis added):

"The effectiveness of unconventional monetary policy measures depends on several factors. Measures appear to have been effective (i) when targeted to address a specific market failure, focusing on market segments that were important to the overall economy; (ii) when they were large in terms of total stock purchased relative to the size of the target market; and (iii) when enhanced by clear communication regarding the objectives of the facility."

Professor Taylor's calculation focuses on the flow of debt issuance and who purchased it, and we wouldn't completely discount the proposition that flows of purchases can be important. But the accumulated evidence suggests to us that we should be really thinking in terms of something like the stock or accumulated total of Fed purchases relative to the size of publicly held Treasury debt, as the passage from Kozicki and coauthors indicates. That calculation produces a Federal Reserve share of about 16 percent of publicly held Treasury securities for fiscal year 2011, which is up sharply from the 8'10 percent levels seen during the 2008'10 period but very similar to the share of Treasury securities held by the Federal Reserve during the years 2000 through 2007.

We obviously would not conclude from this that monetary policy was less accommodative in the past several years than it was prior to the crisis. In 2009 and 2010 asset purchases were dominated by the accumulation of agency-issued mortgage-backed securities. We would want to measure the stance of monetary policy with reference to the Fed's share of a broader set of assets, an idea that was introduced in a previous macroblog post.

But whether one prefers to think in terms of stock-share or flow-share, thinking in terms of ratios does highlight an important part of the policy environment of the moment. Harvard professor and former Treasury Secretary Lawrence Summers has, for example, suggested that the federal government issue more longer-term debt in order to support government spending at a low cost. Because both QE2 and the more recent maturity extension program were targeted at reducing the holdings of longer-dated Treasury securities that would otherwise be held by private investors, the effectiveness of the Fed's actions is sensitive to the type of debt management actions advocated by Summers (as this paper nicely explains).

More generally, if the Fed's share of publicly held debt is a key element in determining the degree of monetary policy accommodation, changes in the level and composition of outstanding government (or agency) debt may amplify or mitigate the effects of central bank asset purchases. In normal times we wouldn't think too much about this impact because explicit changes in the funds rate would swamp any effects of asset share, which in any event would only evolve gradually. But with the funds rate at the zero bound, asset share and composition take on more importance.

In the shorter term, changes in the magnitude of federal government may not have too large of an independent impact on the stance of monetary policy, although it is noteworthy that current projections indicate the Treasury will sell about $1,450 billion of debt to the public in fiscal year 2012, and $1,060 billion in 2013. In addition there is this, from today's edition of The Wall Street Journal's Real Time Economics:

"The U.S. Treasury intends to continue to gradually extend the average maturity of the securities it issues'a tactic that locks in borrowing costs but potentially dilutes the impact of a Federal Reserve policy intended to boost the economy."

In such an environment, it is probably good to remember that standing pat with central bank asset purchases does not necessarily mean standing still with monetary policy.

By Dave Altig, executive vice president and research director at the Atlanta Fed, and

John Robertson, vice president and senior economist in the Atlanta Fed's research department

June 11, 2012 in Federal Reserve and Monetary Policy | Permalink

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