Nominal GDP Targeting: Still a Skeptic

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December 28, 2012

Nominal GDP Targeting: Still a Skeptic

In a few days the clock will run out on another year of disappointing economic growth in the United States and, generally speaking, in the world. It is inevitable and appropriate, then, that the year-end ritual of looking forward by looking backward will include an assessment of whether more or better policy can contribute to a pick-up in growth that failed to materialize in 2012.

To this discussion, Harvard professor Jeff Frankel brings some fresh thinking to the not-quite-fresh notion that the Fed should adopt a nominal gross domestic product (GDP) targeting approach as a replacement for existing central bank practice'described by Frankel and others as policy driven by an inflation-targeting framework. What I particularly like about Frankel's proposal is the fact that he offers up a practical roadmap for using the Fed's current communications tools to transition to an explicit nominal GDP targeting framework. If I were inclined to think such a move would be a good idea, I would view Frankel's proposal with some enthusiasm. Alas, I am not yet so inclined.

As to the case for skepticism on theoretical grounds, I commend to you this excellent post by Mark Thoma at Economist's View. But Professor Frankel suggests a case for nominal GDP targeting on practical grounds by appealing to this counterfactual:

A nominal GDP target for the US Federal Reserve might have avoided the mistake of excessively easy monetary policy during 2004-06, a period when nominal GDP growth exceeded 6 per cent.

Maybe. Average annual real GDP growth over those three years was just over 3 percent, compared to the Congressional Budget Office (CBO) estimates of potential GDP growth of just under 2.5 percent. That's not a big difference, but more importantly the average gap between the level of real GDP and the CBO estimate of potential was just 0.3 percent of average output'essentially zero. The importance of this so-called "output gap" becomes evident if you read the Michael Woodford interview referenced in the aforementioned piece at Economist's View. In that interview, Woodford says, "The idea was to talk about a price level, as opposed to the inflation rate, but a corrected price level target where you add to it some multiple of the real output gap." So for him, something like this measure would be a key element of his proposed monetary policy rule.

What if, rather than some measure of nominal GDP, the 2004'06 Fed had instead been solely focused on the inflation rate? You can't answer that question without operationalizing what it means to be "focused on the inflation rate," but for the sake of argument let's simply consider actual annualized PCE inflation over a two-year horizon. (In his press statement explaining the Federal Open Market Committee's (FOMC) latest decision, Fed Chairman Ben Bernanke suggested using a one- to two-year horizon for inflation forecasting horizon to smooth through purely transitory influences on inflation that the central bank would inclined to "look through.") Here's the record, with the period from 2004 through 2006 highlighted:

If you really do think that there was a policy mistake over the 2004'06 period'and in particular if you believe the FOMC during that should have adopted a more restrictive policy stance'I'm hard-pressed to see what advantage is offered by focusing on nominal GDP rather than inflation alone. In fact, you could argue that that the GDP part of the nominal GDP target would have added just about nothing to the discussion.

I add the observation in the chart above to my earlier comments on an earlier Frankel call for nominal GDP targets. To summarize my concerns, the Achilles' heel of nominal GDP targeting is that it provides a poor nominal anchor in an environment in which there is great uncertainty about the path of potential real GDP. As I noted in my earlier post, there is historical justification for that concern.

Basically, anyone puzzling through how demographics are affecting labor force participation rates, how technology is changing the dynamics of job creation, or how policy might be altering labor supply should feel some humility about where potential GDP is headed. For me, a lack of confidence in the path of real GDP takes a lot of luster out of the idea of a nominal GDP target.

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

 

December 28, 2012 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

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Try, Try Again

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December 21, 2012

Try, Try Again

As a regular, satisfied customer of The Wall Street Journal's "Heard on the Street" feature, I was a bit distressed to read this, from an item titled "Bonds Beware Central Bank Regime Change":

In the U.S., the Federal Reserve has announced that future monetary policy tightening will depend on a hard target for falling unemployment and a softer target for rising inflation expectations. That looks like a tilt toward growth as the priority over inflation.

When The Financial Times and The Wall Street Journal in quick sequence publish articles that seem to misinterpret Fed communications, I have to surmise that the message isn't getting through and bears repeating and further explaning.

Earlier this week, in response to the alluded-to FT article, I addressed the charge of a "tilt toward growth as the priority over inflation," noting that Fed Chairman Ben Bernanke clearly indicated in last week's press conference that there has been no "change in our relative balance, weights towards inflation and unemployment...."

It is true that the Committee's threshold for considering policy action was expressed in terms of a realized value for unemployment and a forecast value for inflation. But that choice, as the Chairman explained in that press conference, was motivated by the nature of the two different statistics:

... the Committee chose to express the inflation threshold in terms of projected inflation between one and two years ahead, rather than in terms of current inflation. The Committee took this approach to make clear that it intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

More importantly, the plan is not to ignore the incoming data and rely solely on internal Committee forecasts:

In making its collective judgment about the underlying inflation trend, the Committee will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation. Also, the Committee will pay close attention to measures of inflation expectations to ensure that those expectations remain well anchored.

Even more important, in my view, this broad approach to assessing price-stability conditions is also the approach the Chairman described in thinking about the allegedly hard target for the unemployment rate:

... the Committee recognizes that no single indicator provides a complete assessment of the state of the labor market and therefore will consider changes in the unemployment rate within the broader context of labor market conditions.

It is fair to point out the difficulties that can arise in implementing this policy strategy in the real time, real messy world. And if you doubt that the Committee is as good as its word, there is probably not much I can say that will convince you otherwise. But we ought to at least take care in being clear what the Committee's word actually is.

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

 

December 21, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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Plain English

« Anticipating Growth despite a Slowdown? Results from the Recent Small Business Survey | Main

December 17, 2012

Plain English

Gavyn Davies writes in The Financial Times (hat tip, Mark Thoma) that he sees a major shift in attitude at the Fed:

In the US, there has been a clear shift in the Fed's policy reaction function, or "Taylor Rule", increasing the weight placed on unemployment and reducing the weight on inflation. The nature and importance of the Fed's policy shift has not yet been fully understood, because it was not really spelled out by Chairman Bernanke in his press conference this week.

I'd score that comment about half accurate. Here's what the Chairman actually said in that press conference:

QUESTION:
Mr. Chairman, what prompted the Committee to make the decision at this particular time to specify targets? And by taking an unemployment rate that is quite low compared to currently, does that shift the balance of priorities in terms of your dual mandate'more in the direction of reducing unemployment rather than inflationary pressures?

BERNANKE:
'It is not a change in our relative balance, weights towards inflation and unemployment, by no means. First of all, with respect to inflation, we remain completely committed to our 2 percent longer- run objective. Moreover, we expect our forecast, as you can see from the summary of economic projections, our forecasts are that inflation will actually remain'despite this threshold of 2.5 [percent]'that inflation will actually remain at or below 2 percent going forward'

I think both sides of the mandate are well-served here. There's no real change in policy. What it is instead is an attempt to clarify the relationship between policy and economic conditions.

That's about as clear a statement about the constancy of the Federal Open Market Committee's (FOMC) objectives as I can imagine. The reason I am giving Davies half credit is his reference to the Taylor rule, and his article's theme that what has changed is the FOMC's "reaction function"'a fancy name for how the Fed will respond to changes in economic conditions in pursuit of its objectives.

I think the intent of recent changes in language is pretty clear, evidenced by comparing this statement following the August FOMC meeting'

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

' with this one, introduced after the September FOMC meeting:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

I added the emphasis above, as in my view it is the key change from previous statements. At least from the point of view of the Atlanta Fed's research staff, there wasn't much of a shift in the economic forecast between August and September (or September and December, for that matter). The change in date from late 2014 to mid-2015 is (I argue) best understood, not in terms of changing economic conditions, but in terms of this explanation, from Mike Woodford's paper presented at the Federal Reserve Bank of Kansas City's 2012 Economic Symposium:

We argue for the desirability of a commitment to conduct policy in a different way than a discretionary central banker would wish to, ex post, and show that (in our New Keynesian model) the optimal commitment involves keeping the policy rate at zero for some time after the point at which a forward-looking inflation-targeting bank (or a bank following a forward-looking "Taylor Rule") would begin to raise interest rates.

This, of course, is exactly the change in reaction function to which Davies refers. But two points need to be emphasized. First, the deviation from the Taylor rule that Woodford describes is an exceptional measure designed to deal with circumstances in which policy rates have fallen to zero and can fall no more. Deploying such measures in the current extraordinary circumstances need not reflect some fundamental change in the approach to policy when things return to conditions that more closely approximate normal.

Second, and more importantly, the Chairman's comments make it abundantly clear that whatever changes may have occurred in how monetary policy is implemented, there is in no way a change in the weight the Committee puts on its price stability mandate. On that there should be no confusion.

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

 

December 17, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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Anticipating Growth despite a Slowdown? Results from the Recent Small Business Survey

« Gazelles, and Why They Matter | Main

December 12, 2012

Anticipating Growth despite a Slowdown? Results from the Recent Small Business Survey

The latest reading on the Wells Fargo/Gallup's Small Business Index indicated business conditions for small firms dropped to the lowest levels since July 2010 (see the chart), and index also said:

Key drivers of this decline include business owner concerns about their future financial situation, cash flow, capital spending, and hiring over the next 12 months.

The latest iteration of the Atlanta Fed's small business survey, which was conducted in October, also noted a decline in 12-month-ahead expectations for sales, hiring, and capital spending (see the chart).

Dissecting this by firm age, the overall decline in expectations stemmed from the firms in our sample that were more than five years old (see the charts).

Over the life of the survey, young firms have tended to be more optimistic about changing business conditions. Are these young firms simply naïve about changing economic conditions, or are they anticipating growth despite expectations for a pullback in the broader economy? We asked the following question this time around in an attempt to capture the business owners' aspirations and job-creating "gazelle" potential:

Five years from now, do you anticipate your business will be:

a) Smaller
b) About the same
c) Somewhat larger
d) Significantly larger

It turns out the group is an optimistic bunch: 30 percent of employer firms said they thought their business would be significantly larger in five years, and firms under six years of age were twice as likely to say so (see the chart). Considering that young firms also tend to have smaller operations than mature firms (the median young firm had from $100,000 to $500,000 in annual revenues and the median mature firm had from $1 million to $7 million), this difference is not shocking.

What was a little surprising was how few of the young firms said they thought they would be smaller in five years. Research suggests that that only about half of businesses make it past five years, and yet only three young firms identified themselves as shrinking. There is always the chance that these young businesses will become fast-growing, job-creating gazelles. After all, a recent study of high-growth firms by the Kauffman Foundation found the average age of the fastest-growing firms in 2010 was only seven years old.

Will they achieve their goals? Only time will tell.

The Atlanta Fed's third quarter small business survey, which asks firms questions about business and financing conditions, is available on our website.

By Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department

 

December 12, 2012 in Small Business | Permalink

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Anticipating Growth despite a Slowdown? Results from the New Small Business Survey

« Gazelles, and Why They Matter | Main

December 12, 2012

Anticipating Growth despite a Slowdown? Results from the New Small Business Survey

The latest reading on the Wells Fargo/Gallup's Small Business Index indicated business conditions for small firms dropped to the lowest levels since July 2010 (see the chart), and index also said:

Key drivers of this decline include business owner concerns about their future financial situation, cash flow, capital spending, and hiring over the next 12 months.

The latest iteration of the Atlanta Fed's small business survey, which was conducted in October, also noted a decline in 12-month-ahead expectations for sales, hiring, and capital spending (see the chart).

Dissecting this by firm age, the overall decline in expectations stemmed from the firms in our sample that were more than five years old (see the charts).

Over the life of the survey, young firms have tended to be more optimistic about changing business conditions. Are these young firms simply naïve about changing economic conditions, or are they anticipating growth despite expectations for a pullback in the broader economy? We asked the following question this time around in an attempt to capture the business owners' aspirations and job-creating "gazelle" potential:

Five years from now, do you anticipate your business will be:

a) Smaller
b) About the same
c) Somewhat larger
d) Significantly larger

It turns out the group is an optimistic bunch: 30 percent of employer firms said they thought their business would be significantly larger in five years, and firms under six years of age were twice as likely to say so (see the chart). Considering that young firms also tend to have smaller operations than mature firms (the median young firm had from $100,000 to $500,000 in annual revenues and the median mature firm had from $1 million to $7 million), this difference is not shocking.

What was a little surprising was how few of the young firms said they thought they would be smaller in five years. Research suggests that that only about half of businesses make it past five years, and yet only three young firms identified themselves as shrinking. There is always the chance that these young businesses will become fast-growing, job-creating gazelles. After all, a recent study of high-growth firms by the Kauffman Foundation found the average age of the fastest-growing firms in 2010 was only seven years old.

Will they achieve their goals? Only time will tell.

The Atlanta Fed's third quarter small business survey, which asks firms questions about business and financing conditions, is available on our website.

By Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department

 

December 12, 2012 in Small Business | Permalink

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Gazelles, and Why They Matter

« Rose-Colored Glasses Make the Future Look Blurry: Sales Uncertainty as Seen by the November BIE | Main

November 29, 2012

Gazelles, and Why They Matter

A gazelle, as you may recall from your favorite wildlife show, is one of those antelope-like animals that run around in herds across the plains and are known for their speed. Sheltered by the herd at birth, their youth is short-lived. In no time flat, gazelles are expected to be up and running or they will be easily devoured by hungry lions.

Probably because of that imagery, the word gazelle is also used in the business literature to represent a young firm that grows very quickly in a relatively short period of time. According to Kauffman Foundation research, the fastest-growing 1 percent of firms typically account for about 40 percent of job creation in the United States. Of that 1 percent, three-quarters are less than six years old. Research also shows that these high-growth young firms are more likely to provide solutions to other businesses than directly to consumers, have some form of intellectual or technological property, and tend to be started by entrepreneurs with business startup experience.

To learn more about the role of gazelles and the challenges they face, the Federal Reserve Bank of Atlanta recently hosted Amy Wilkinson, a senior fellow at Harvard University and a policy scholar at the Woodrow Wilson Center. Wilkinson is a leading entrepreneurship scholar. Her current research focuses on entrepreneurs who scale their company to reach $100 million in revenue in less than five years. (You can see her discussing the topic here.) She has shown that these "founders" tend to drive innovation, and ultimately job creation, in the U.S. economy. These young, high-growth firms are typically driven forward by entrepreneurs with high aspirations, novel ideas, and a strong support system. This support system is analogous to the gazelle's herd'it is a network of financial and human capital providers that help the businesses grow to potential.

To get a perspective on the key drivers and impediments to growth for high-growth-potential firms in the current economic climate, the Atlanta Fed also hosted an entrepreneur roundtable in November. The roundtable included founders of Southeast-based businesses in various stages of development, along with representatives of "the herd."

Many participants indicated that attracting capital in the Southeast has always been challenging, but it has been even more difficult in recent years. Investors in general are more hesitant to take on risk, and the market available for early-stage financing has shrunk. But the biggest impediment to growth in recent years has been the recession and the halting nature of the recovery. The Atlanta Fed's poll of small businesses has noted that business startups today are much more reliant on personal capital versus external capital than was the case for businesses started prior to the recession. The word "uncertainty" was also mentioned a lot, prompting even this group of risk takers to take a bit more conservative stance in their growth expectations.

On the topic of labor, many of these firms cited the importance of having the right talent in place to make a business successful. Participants noted that the person who starts a business is often not the right person to propel the business forward. Recognition of the correct timing of a leadership change and the ability to make hard decisions generally were deciding factors on whether a firm would continue to grow rapidly or plateau. The Kauffman Foundation also cited the important role of talent in its poll of fast-growing firms conducted last year.

Another theme of our recent conversations with entrepreneurs and business experts is the crucial role of the supporting herd in nurturing and enabling a young business to succeed. In building a business from the ground up, a first-time entrepreneur confronts a significant learning curve'from figuring out the tax code to securing financing. The business information and support networks that exist are evolving, but matching ideas to money to people is still not a straightforward process. To complicate things further, "the herd" is not a one-size-fits-all concept; it differs geographically and across industry. As highlighted in a recent Kauffman Foundation study, high-growth firms are more prevalent in some areas of the country, and there are hot spots for certain industries. One group working to make these connections stronger and more efficient is Invest Atlanta, the city of Atlanta's economic development agency. The agency recently launched Start Up Atlanta. The stated aim of Start Up Atlanta is to "'bring together and build Atlanta's entrepreneur ecosystem." Similar efforts are under way across the region.

Considering the significant impact that high-growth firms play in innovation and job creation, researchers at the Atlanta Fed continue to explore the various issues facing young, high-growth potential firms. If you are a small firm and are interested in contributing to this research, we would love for you to sign up for our semiannual poll of small business financing by sending an email to smallbusinessresearch@atl.frb.org.

By Whitney Mancuso and

Ellyn Terry, senior economic analysts in the Atlanta Fed's research department

 

November 29, 2012 in Small Business | Permalink

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Rose-Colored Glasses Make the Future Look Blurry: Sales Uncertainty as Seen by the November BIE

« (Fiscal) Cliff Notes | Main

November 20, 2012

Rose-Colored Glasses Make the Future Look Blurry: Sales Uncertainty as Seen by the November BIE

Uncertainty is widely cited as being a significant contributor to the economy's subpar growth. Reddy and Thurm report in yesterday's Wall Street Journal that "half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next," in large measure because of rising economic uncertainty. But how uncertain is the current economic outlook? A few economists have attempted to measure business uncertainty, often by using the degree of disagreement between various forecasts, the volatility of certain economic indicators, or some combination of the two. (Two such approaches can be found here and here.)

We thought we'd use our Business Inflation Expectations (BIE) survey to see if we could gauge the degree of business uncertainty directly. Last week, we asked our panel to assign probabilities to various sales outcomes for their businesses for the coming year. (This methodology is the same one we have been using to measure inflation uncertainty, except in this case our business panel was asked to reveal their expectations for unit sales growth over the year ahead.)

Specifically, we put to our panel the following statement:

Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to unit sales over the next 12 months.

Panelists were given the following five unit sales outcomes:

1. down (less than '1 percent)
2. about unchanged ('1 percent to 1 percent)
3. up somewhat (1.1 percent to 3 percent)
4. up significantly (3.1 percent to 5 percent)
5. up very significantly (greater than 5 percent)

One hundred and ninety-four businesses responded, and here's what they told us: On average, firms expect unit sales growth of about 1.2 percent in the coming year. That's more pessimistic than the real gross domestic product (GDP) forecast of the consensus of economists for the year (about 2 percent). But the range of possible outcomes seemed, to our eyes a least, to be large and unbalanced.

Consider the chart below, which shows the probabilities the panel, on average, assigned to the various sales outcomes. They assigned a 48 percent chance that their unit sales will grow 1 percent or less in the coming year, balanced against only 23 percent likelihood that unit sales will grow more than 3 percent over the next 12 months. In other words, in the minds of our BIE panel, the range of likely sales outcomes over the year ahead is pretty wide, with a fairly weighty chance that unit sales growth may not move in a positive range at all.

Perhaps we are making a bit too much of the size of the uncertainty businesses are attaching to the outlook. After all, we don't know what uncertainties firms face even in the best of times (since this is the first time we've asked this question). But when we dug into the data a little deeper, we found something else of interest. The degree of economic uncertainty varies widely by firm. Moreover, the greatest uncertainty about the future was held by the panelists who have the most optimistic sales outlook.

Check out the table below. It shows the degree of sales forecast uncertainty on the basis of whether a firm's sales projection is high or low.

Panelists with the most optimistic sales expectations (the 39 firms with the highest sales forecasts) predicted unit sales growth of a little more than 3.5 percent this year, compared with about a 0.5 percent decline in unit sales for the 39 most pessimistic panelists. But also note that those who are relatively optimistic about the coming year have much greater uncertainty about their future than those who are relatively pessimistic'in fact, they're almost twice as uncertain.

What the November BIE survey seems to be saying is that it isn't just that an uncertain business outlook is reining in our growth prospects, but that the outlook is especially uncertain for the firms that think they have the best opportunity for expansion. Apparently, those wearing rose-colored glasses are having trouble seeing through them.

Note: The regular November Business Inflation Expectations report will be released Wednesday morning.

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

 

November 20, 2012 in Inflation, Inflation Expectations | Permalink

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(Fiscal) Cliff Notes

« Getting the Questions Right | Main

November 13, 2012

(Fiscal) Cliff Notes

Since it is indisputably the policy question of the moment, here are a few of my own observations regarding the "fiscal cliff." Throughout, I will rely on the analysis of the Congressional Budget Office (CBO), as reported in the CBO reports titled An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022 and Economic Effects of Policies Contributing to Fiscal Tightening in 2013.

Since the CBO analysis and definitions of the fiscal cliff are familiar to many, I will forgo a rehash of the details. However, in case you haven't been following the conversation closely or are in the mood for a refresher, you can go here first for a quick summary. This "appendix" also includes a description of the CBO's alternative scenario, which amounts to renewing most expiring tax provisions and rescinding the automatic budget cuts to be implemented under the provisions of last year's debt-ceiling extension.

On, then, to a few facts about the fiscal cliff scenario that have caught my attention.

1. Going over the cliff would put the federal budget on the path to sustainability.

If reducing the level of federal debt relative to gross domestic (GDP) is your goal, the fiscal cliff would indeed do the trick. According to the CBO:

Budget deficits are projected to continue to shrink for several years'to 2.4 percent of GDP in 2014 and 0.4 percent by 2018'before rising again to 0.9 percent by 2022. With deficits small relative to the size of the economy, debt held by the public is also projected to drop relative to GDP'from about 77 percent in 2014 to about 58 percent in 2022. Even with that decline, however, debt would represent a larger share of GDP in 2022 than in any year between 1955 and 2009.

Such would not be the case should the status quo of the CBO's alternative scenario prevail. Under (more or less) status quo policy, the debt-to-GDP ratio would rise to a hair under 90 percent by 2022:

The current debt-to-GDP ratio of 67 percent is already nearly double the 2007 level, which checked in at about 36 percent. However, though the increase in the debt-to-GDP ratio over the past five years is smaller in percentage terms, a jump to 90 percent from where we are today may be more problematic. There is some evidence of "threshold effects" that associate negative effects on growth with debt levels that exceed a critical upper bound relative to the size of the economy. At the Federal Reserve Bank of Kansas City's 2011 Economic Symposium, Steve Cecchetti offered the following observation, based on his research with M.S. Mohanty and Fabrizio Zampolli:

Using a new dataset on debt levels in 18 Organisation for Economic Co-operation and Development (OECD) countries from 1980 to 2010 (based primarily on flow of funds data), we examine the impact of debt on economic growth....

Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the number is about 85 percent of GDP.

Of course, causation is always a tricky thing to establish, and Cecchetti et al. are clear that their estimates are subject to considerable uncertainty. Still, it is clear that the fiscal cliff moves the level of debt in the right direction. The status quo does not.

2. The fiscal cliff moves in the direction of budget balance really fast.

By the CBO's estimates, over the next three years the fiscal cliff would reduce deficits relative to GDP by about 6 percentage points, from the current ratio of 7.3 percent to the projected 2015 level of 1.2 percent.

Deficit reduction of this magnitude is not unprecedented. A comparable decline occurred in the 1990s, when the federal budget moved from deficits that were 4.7 percent of GDP to a surplus equal to 1.4 percent of GDP. However, that 6 percentage point change in deficits relative to GDP happened over an eight-year span, from 1992 to 1999.

It is probably also worth noting that the average annual rate of GDP growth over the 1993'99 period was 4 percent. The CBO projects real growth rates over the next three years at 2.7 percent, which incorporates two years of growth in excess of 4 percent following negative growth in 2013.

The upshot is that, though the fiscal cliff would move the federal budget in the right direction vis à vis sustainability, it does so at an extremely rapid pace. I'm not sure speed kills in this case, but it sounds pretty risky.

3. The fiscal cliff heavily weights deficit reduction in the direction of higher taxation.

Over the first five years off the cliff, almost three-quarters of the deficit reduction relative to the CBO's no-cliff alternative would be accounted for by revenue increases. Only 28 percent would be a result of lower outlays:

The balance shifts only slightly over the full 10-year horizon of the CBO projections, with outlays increasing to 34 percent of the total and revenues falling to 66 percent.

Particularly for the nearer-term horizon, there is at least some evidence that this revenue/outlay mix may not be optimal. A few months back, Greg Mankiw highlighted this, from new research by Alberto Alesina, Carlo Favero, and Francesco Giavazzi:

This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions.

Of course, that in the end is a relatively short-run impact. It does not directly confront the growth aspects of the policy mix associated with fiscal reform. Controversy on the growth-maximizing size of government and the best growth-supporting mix of spending and tax policies is longstanding. The dustup on a Congressional Research Services report questioning the relationship between top marginal tax rates and growth is but a recent installment of this debate.

Here's what I think we know, in theory anyway: Government spending can be growth-enhancing. Tax increases can be growth-retarding. It's all about the tradeoffs, the details matter, and unqualified statements about the "right" thing to do should be treated with suspicion. (If you are an advanced student of economics or otherwise tolerant of a bit of a math slog, you can find an excellent summary the whole issue here.)

In other words, there are lots of decisions to be made'and it would probably be better if those decisions are not made by default.

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

 

November 13, 2012 in Federal Debt and Deficits, Fiscal Policy, Taxes | Permalink

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Getting the Questions Right

« Reading Labor Markets | Main

November 09, 2012

Getting the Questions Right

Among the plethora of post-election exit-poll results, the CNBC website highlights a particularly interesting response, linked from the mega-blog Instapundit with the title "Voters Worry More About Inflation Than You Think." The CNBC article itself, written by Allison Linn, describes the poll results in more detail:

It's no surprise that voters in Tuesday's presidential election identified the economy as the No. 1 issue in the campaign, far ahead of health care and the federal budget deficit.
But it was a surprise that so many voters identified rising prices as the biggest economic problem they face.

Linn notes something of a disconnect between this view and the facts on the ground:

...inflation has generally been running well under 2 percent, and Federal Reserve bankers repeatedly have said they feel comfortable that low inflation allows them to keep interest rates at rock-bottom levels.

Yet in an exit poll of more than 25,000 voters conducted by NBC News, 37 percent identified rising prices as the biggest problem facing people like them.

Unemployment was cited by 38 percent, only slightly more than the number who said inflation was their top economic concern. Taxes were named by 14 percent and the housing market was the top concern of 8 percent.

The policy stakes on understanding these responses are pretty high. In the end, the cost of inflation comes in the form of how it may distort behavior and the allocation of resources. So the expectation or perception of significant inflation is at least as pernicious as the measurement itself.

But what, exactly, does this concern about "inflation" actually reflect? Probably not what we think. Some time ago, my colleagues Mike Bryan and Guhan Venkatu (from the Cleveland Fed) made note of "The Curiously Different Inflation Perspectives of Men and Women." Their findings are pretty informative:

Over the past few years, the Federal Reserve Bank of Cleveland, with assistance from the Ohio State University, has studied household inflation perceptions and expectations using a monthly survey of approximately 500 Ohioans (the FRBC/OSU Inflation Psychology Survey). This survey, which records respondents' perceptions of price changes over the past 12 months as well as their expectations for price changes over the next 12 months, has uncovered a surprising result. The data indicate that the public's estimates and predictions of inflation are significantly and systematically related to the demographic characteristics of the respondents. People with high incomes perceive and anticipate much less inflation than people with low incomes, married people less than singles, whites less than nonwhites, and middle-aged people less than young people. This Commentary describes what is perhaps the most curious observation of all: Even after we hold constant income, age, education, race, and marital status, men and women hold very different views on the rate at which prices are changing.

...[S]tatistical tests reveal that even after we adjust for the respondents' age, race, education, and income, women in our survey tended to think inflation was 1.9 percentage points higher than men. A similar examination of respondents' predictions of future inflation yields the same basic result: After we account for other major demographic factors, on average, women expected prices to rise 2.1 percentage points more than men.

It is important to note that this result was not unique to the Cleveland Fed study:

An examination of survey data collected by the University of Michigan (which has recorded the inflation forecasts of U.S. households on a monthly basis since 1978) reveals that women consistently hold higher inflation expectations than men, even after we hold constant other important demographic characteristics of the respondent.

Most intriguing of all, the systematic overstatement of inflation by all consumers, relative to official statistics, and the difference in responses between men and women are not a result of ignorance about the facts, according to those official statistics:

In the August 2001 FRBC/OSU survey, we sought an answer to this question by asking, "Have you heard of the Consumer Price Index (CPI) before?" and "By about what percentage do you think the CPI went up (or down), on average, over the last 12 months?"

A significantly higher proportion of men had heard of the CPI compared to women (75 percent versus 61 percent, respectively). For those who had heard of the CPI, the average perception about how much it had risen over the past 12 months was surprisingly accurate'a perceived increase of 2.9 percent compared to an actual increase of 2.7 percent. It is also very interesting that men and women perceived the CPI's growth rate nearly identically (2.8 percent versus 3.1 percent, respectively.) However, of those who knew of the CPI, the average perception of price increases was 6.7 percent. And even within the subgroup of respondents who knew of the CPI, men had a significantly lower perception of price increases than did women (6.0 percent vs. 7.4 percent). In other words, the public believes that prices are rising more than the CPI reports, and women more so than men.

There are a couple of hypotheses that could be advanced to explain results like this. One is that the conspiracy crowd is correct and the official statistics are rigged and vastly understate true inflation. But that wouldn't get us anywhere near an understanding of why survey responses about inflation would be systematically different across men and women, higher- and low- income individuals, and just about any other demographic cuts we might make.

A second possibility it is that individuals' responses reflect price changes in their own personal market basket, which may differ from that of the average urban wage earner whose habits are reflected in the Consumer Price Index (CPI).That might explain why any demographic sub group could arrive at different inflation perceptions, but it doesn't explain why respondents as a whole systematically overstate inflation relative to the CPI.

I think the most likely explanation is that the survey respondents are expressing a much different concern than whether they believe food, gas, autos, banking services, or whatever are increasing or are likely to increase faster than the official statistics indicate. My guess is that they are telling us that they are concerned that their real'or inflation-adjusted'incomes are not rising fast enough to comfortably sustain their desired spending:

As I noted, the policy stakes are high. In the current environment, the policy prescription for fighting an incipient rise in inflation expectations would be much different than one deployed to address the reality of the chart above. All the more reason to make sure we understand the questions we are asking and the responses we get back.

Just to be sure, we monitor inflation trends and inflation expectations from a number of perspectives: Treasury Inflation Protected Securities (TIPS), forecasts, and the Business Inflation Expectations (BIE) survey, to name just three. And all are available on the Atlanta Fed's Inflation Project for the terminally curious to monitor with us.

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

 

November 9, 2012 in Inflation | Permalink

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The question of inflation perceptions is indeed the right question, and some recent work has been done on this. See "'Real-Feel' Inflation: Quantitative Estimation of Inflation Perceptions," Business Economics, Vol. 47, No. 1, National Association for Business Economics, pp. 14-26, which tries to quantify some of the known cognitive biases that operate on inflation perceptions (or at least, to provide the first pieces of a model to do so, were it calibrated properly).

You can find a copy of the paper, although not the BE version, here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1661941

Posted by: Michael Ashton | November 09, 2012 at 11:42 AM

You are looking at the personal income data that because of the massive inequality in the US significantly overstates the income of the bulk of the population.

If you look at the average hourly and weekly earnings published by the BLS you get a very different picture of real income growth.

Average hourly earnings growth is at the record low of 0.8% and with 2% that leaves real income growth much, much weaker than your chart implies. Moreover, the higher inflation stems from food and oil that is a necessity for
the 80% of the population this measure covers.

Posted by: Spencer | November 09, 2012 at 12:24 PM

Reading Labor Markets

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November 05, 2012

Reading Labor Markets

When the September employment report was released on October 5, the top-line payroll employment gain for the month, as reported in the U.S. Bureau of Labor Statistics' (BLS) establishment survey, logged in at 114,000. Under standard assumptions, a number of this magnitude would be barely enough to absorb the growth of the labor force and keep the unemployment rate constant. In contrast, in that same October 5 report we learned from the BLS household survey that the measured unemployment rate fell from 8.1 percent in August to 7.8 percent in September.

According to Friday's BLS report on the employment situation for October, the top-line payroll employment gain for the month from the establishment survey was 171,000. At that pace'which is also the current average gain for the past three months'the Atlanta Fed jobs calculator suggests the unemployment rate should fall another one-half of a percentage point over the next year. At the same time, according to the BLS household survey, the unemployment rate rose from 7.8 percent in September to 7.9 percent in October.

This is as good an illustration as any to explain why, on November 1, Atlanta Fed President Dennis Lockhart said the following in a speech to the Chattanooga Tennessee Downtown Rotary Club:

In its post-meeting statement on September 13, the FOMC said, "If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability."...

For policy purposes, I think it's appropriate to be cautious about relying on a single indicator of labor market trends'for example, the unemployment rate'to determine whether the condition of "substantial improvement" has been met.

As the FOMC went into its September meeting, the official BLS statistics indicated that net U.S. job creation in August was a mere 92,000. That number is below the 'all else equal' threshold of about 100,000 jobs required to keep the unemployment rate from rising, and that information is what Fed policymakers had in hand when they met on September 12'13 and decided on the policy action described by President Lockhart.

On Friday, after two revisions, the BLS told us jobs expanded by 192,000 in August, well above the average for the jobs recovery that started in early 2010, 100,000 jobs (more than double) above the initial estimate.

Looking through month-to-month variations is not a lot of help in real-time tea-leaf reading. Here is the 12-month moving average of employment gains, the blue line indicating the way things looked in September, the red line showing the way they look today:

Over time, it remains the case that monthly employment gains are pretty consistently coming in at 150,000 to 160,000 jobs created per month, and that rate has been enough to generate relatively steady declines in the unemployment rate:

That could change, of course, and the last four months of data have generally shown an acceleration in the job-growth trend. But the data definitely were not indicating that trend as it was happening, an unfortunate reality that isn't likely to change. One way to soften the blow of that problem, emphasized in the Lockhart speech, is to keep an eye on as a broad a set of signals as possible:

... let me share a qualitative framework for defining "substantial improvement."

The starting point certainly should be the headline unemployment rate and the payroll jobs number. The interpretation of movements in these two statistics would be enriched and reinforced by a review of additional data elements.

I added the emphasis there, as I think the point bears highlighting. President Lockhart goes on to give examples of what he would look for in determining whether the substantial improvement threshold has been met. Things like reductions in the numbers of marginally attached and discouraged workers, growing labor force participation rates, declining numbers of people who want full-time work but have to settle for part-time, and positive forward indicators like falling initial claims for unemployment insurance.

The Calculated Risk blog continues to be a one-stop shop for a lot of this information'here and here, for example'and overall nothing much overturns the picture of steady, but slow, progress. That would suggest the acceleration of the past several months is probably not a new trend, but a continuation of the same-old same-old. But then again, the track record painfully demonstrates how hard that is to know in real time.

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

 

November 5, 2012 in Employment, Labor Markets | Permalink

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Has Fed Behavior Changed?

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November 02, 2012

Has Fed Behavior Changed?

To the titular question, Steve Williamson thinks the answer is "yes":

' the behavior of the FOMC has changed. Either it cares about some things it did not care about before (and in a particular way), or it cares about the same things in different ways'in particular it is less concerned about its price stability mandate.

Part of the Williamson case relies on an earlier post, where Williamson illustrates deviations of the actual path of the federal funds rate paths from his own estimated version of the Taylor rule:

New Keynesians like to think about monetary policy in terms of a Taylor rule, which specifies a target for the federal funds rate as a function of the "output gap" and the deviation of the actual inflation rate from its target value. According to standard Taylor rules, the fed funds target should go down when the output gap rises and up when the inflation rate rises. You can even fit Taylor rules to the data. I fit one to quarterly data for 1987-2007, and obtained the following:

R = 2.02 - 1.48(U-U*) + 1.17P,

where R is the fed funds rate, U is the unemployment rate, U* is the CBO natural rate of unemployment (so U-U* is my measure of the output gap) and P is the year-over-year percentage increase in the PCE deflator. You can see how it fits the historical data in the next chart.

(enlarge)

So that's how the Fed behaved in the past. If it were behaving in the same way today, what would it be doing? Given that U = 7.8, U* = 6.0, and P = 1.5, my Taylor rule predicts R = 1.1%....

So, the Fed's behavior seems to have changed.

An obvious point: It is clear from Williamson's chart above that the predictive power of his version of the Taylor rule is far from perfect. In fact, through 2007 the standard deviation of the estimated rule's prediction error is 1.3 percentage points. From that perspective, the difference between a Williamson-Taylor rule funds-rate prediction of 1.1 percent and the actual current value of 0.14 percent doesn't seem so dramatic. I don't really see an obvious deviation from previous behavior.

More to the point, unless the metric is an absolutely slavish devotion to a particular form of the Taylor rule, I'm not exactly sure what evidence supports a conclusion that the Federal Open Market Committee (FOMC) is now "less concerned about its price stability mandate." As I argued a few weeks back, I think it is not too much of a stretch to construct a justification of post-crisis Fed actions up to the September decision entirely in terms of support for the FOMC's price stability mandate.

I don't take any great exception to Williamson's claim that, with respect to the FOMC's stated inflation objective, things look pretty much on target:

If we look at a longer horizon, as I did here, from the beginning of 2007 or the beginning of 2009, you'll get something a little higher than 2.0% (I didn't have the most recent observation in the chart in the previous post). Too low? I don't think so.

Furthermore, in my previous post I noted that while there is a plausible case that previous asset purchase programs were required to maintain this salutary record on the inflation front, the case is arguably less plausible for "QE3." But, to my mind, that just isn't enough evidence to conclude that the FOMC has downgraded its price stability goals.

Consider a homeowner with the dual mandate of keeping both the roof of the house and the driveway in good repair. If the roof isn't leaking but there are cracks in the driveway, I think you would expect to see the owner out on the weekend patching the concrete. I don't think you would conclude as a result that he or she had ceased caring as much about the condition of the roof. I do think you would conclude that attention is being focused where the problem exists.

I suppose the argument is that the Fed is raining so much liquidity down on the world that the roof is, sooner or later, bound to leak. The FOMC has expressed confidence that, if this happens, it has the tools to patch things up and will deploy those tools as aggressively as required to meet its mandate. I guess Steve Williamson feels differently. But that, then, is a difference of opinion about things to come, not about the facts on the ground.

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

November 2, 2012 in Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

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Investor Participation in the Home-Buying Market

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October 19, 2012

Investor Participation in the Home-Buying Market

What is the investor share of the home-buying market, and in what direction is the trend moving? We have been asking ourselves this question for the past few months, because the answer can help to inform what type of housing recovery we are seeing. Is it being driven by owner occupants or investors?

If it is being driven by investors, does this signal an emerging aversion to homeownership? Or, instead, does this simply signal that owner occupants are unable access mortgage finance and that, for now, owner occupants will be unable to maintain the share of market they once held? If we see that the owner occupant share is increasing, this observation could offer some support that the housing recovery has legs. The conclusion that the investor share is increasing, then, may suggest that we will see home sales activity fall off once prices rise to the point that it no longer makes sense for investors to continue buying.

To help us pinpoint the share and trend in the investor participation in the home-buying market, we polled our real estate business contacts to get a better sense for our regional portrait of investor market share. When asked to describe the distribution of home buyers in their market, our business contacts from the Southeast (excluding Florida) noted that one-fifth of home sales, on average, were to investors. Once we added Florida into our tally of Southeast contacts, just over one-fourth of sales, on average, were to investors.

Since this was the first time we posed this question to our business contacts, we lacked information on the directional trend. To address this information gap, we asked our business contacts how sales to investors had changed between the second and third quarters of 2012. More than half reported no change or a slight decline in home sales to investors, unless you include the Florida observations. A closer look at Florida reveals that nearly two-thirds of our business contacts reported that sales to investors in Florida have increased over the past quarter. The investor dynamic in Florida all seems to add up, especially given the strong demand from international buyers and cash investors in South Florida. This dynamic was discussed in the latest issue of EconSouth.

We thought it would also be informative to ask our business contacts about their expectations for future investor home buying activity. For the Southeast less Florida, more than half of our business contacts indicated that they did not expect there to be much change in investor market share over the next year. For Florida, more than half of the business contacts continued to indicate that they expected share of sales to investors to increase.

While the intelligence gathered from our business contacts aligns nicely with external data sources, we still had a few concerns that made us question the directional trend of these data.

The first source of concern is two-fold. First, brokers serve as a key input to our business contact poll and others like it. In and of itself, this is not a big deal because brokers are valued business contacts that provide us with a frequent and timely pulse on changing conditions in local real estate markets. What is slightly problematic is that brokers often rely heavily on the Multiple Listing Service (MLS), which brings me to my second point. We have also been hearing through business contacts (and this is echoed in the media here) that the composition of the investor pool has shifted from primarily smaller mom/pop-type investors to larger institutional investors that, more often than not, purchase properties at auction or directly from banks. Often, these sales take place before the properties get listed on MLS.

So, how involved are brokers in transactions that take place before MLS? Is this particular slice of investment activity being picked up by our sources? If not, how much do we really know about the share and directional trend of investor participation in the home buyer market?

Media coverage (here, for example) of these institutional investors often describes scenes at local auction in which institutional investors outbid smaller investors and have gone so far as to expand their presence and show up at auctions where properties at the fringe (in less desirable locations) are being sold. This piece of information, alone, leads me to believe that these larger investors have displaced smaller investors. Therefore, it would not necessarily be correct to think of properties acquired by institutional investors as something in addition to the properties purchased by smaller mom/pop investors. Instead, many of the mom/pop investors have been priced out of the market and replaced by institutional investors.

Another related concern involves the timing and strategy of these institutional investors. Why would institutional investors flood local real estate markets at the same time that inventory is tightening and home prices are beginning to stabilize and modestly increase in many markets? Wouldn't this squeeze their yields and make it less desirable for them to continue to ramp up their efforts?

To help provide some insight into the institutional investor, I created a table of information to provide a profile on a few institutional investors often cited by the press. It is important to mention that this table was not intended to be all-encompassing and that the source of information is entirely secondary.

What this table implies is that institutional investors ramped up activity earlier this year and have indeed concentrated their investment activity within a handful of markets that were hit hard by the housing downturn. Acquisition strategies for these larger investors focus on mostly low-priced, distressed properties.

This makes sense. The markets hit hardest by the housing downturn are also the markets where distressed properties make up a significant portion of the available homes for sale. However, data from CoreLogic indicates that the share of distressed sales is steadily declining over time. As the distressed sales share continues to shrink and home prices continue to rise, it stands to reason that investment activity will shrink (or continue to shrink).

It was recently noted that Och-Ziff Capital Management Group LLC, a large institutional investor (not outlined in the table above), announced that it intends to exit this line of business. Perhaps it is just a matter of time before other large investors follow suit.

By Jessica Dill, a senior analyst in the Atlanta Fed's Center for Real Estate Analytics

 

October 19, 2012 in Housing, Real Estate | Permalink

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The (Maybe Not So) Simple Arithmetic of Unemployment and Labor Force Participation

« Divergent Jobs Reports: Will the Real State of the Labor Market Please Stand Up? | Main

October 12, 2012

The (Maybe Not So) Simple Arithmetic of Unemployment and Labor Force Participation

I have precisely zero interest in jumping into any fray from the before and after of Wednesday's Wall Street Journal opinion piece by Jack Welch, wherein he defends his previous comments on the reliability of reported unemployment statistics. But there is one particular statement in that editorial that offers up what is sometimes called a teachable moment, to wit,

By definition, fewer people in the workforce leads to better unemployment numbers.

By definition, that's not really correct. Consider a really simple example. Suppose:

Population = 200

Number of Employed People = 92

Number of Unemployed People = 8

Labor Force (Employed + Unemployed) = 100

In this example the labor force participation rate is 0.50 (the labor force divided by the population) and the unemployment rate 0.08, or 8 percent (the number of unemployed divided by the labor force).

Now suppose that five people drop out of the labor force (which would mean that labor force participation would decline from 0.5 to 0.475). What happens to the unemployment rate? Well, it depends what those 5 people were doing before they left the labor force. If they were unemployed, then unemployment falls to 3, the labor force falls to 95, and the unemployment rate is about 3.2 percent (or 0.0316 times 100). But if the 5 people who dropped out the labor force had been previously employed, the unemployment rate would actually rise to about 8.4 percent (because the number of unemployed would still be 8, but it would now be divided by 95 instead of 100).

Hope that clears it up.

Note: You can take a look some actual data on flows into and out of employment, unemployment, and not in the labor force here.

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

October 12, 2012 | Permalink

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Divergent Jobs Reports: Will the Real State of the Labor Market Please Stand Up?

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October 10, 2012

Divergent Jobs Reports: Will the Real State of the Labor Market Please Stand Up?

The September employment report from the U.S. Bureau of Labor Statistics (BLS) was predestined to create a significant amount of buzz. But the confluence of headline jobs growth at a modest clip of 114,000 and a surprisingly large 0.3 percentage point reduction in the unemployment rate has made the report more buzz-worthy than we (here at macroblog) expected. Although some of the commentary has been more heat than light, there have been some particularly good reminders of the difference between the establishment survey data, from which the headline jobs figure is derived, and the household survey data, from which come the unemployment statistics. The discussions on Greg Mankiw's blog and by Catherine Rampell (at The New York Times's Economix blog) are especially useful. Or, perhaps even better, you can go to the source at the BLS.

It's important to remember that both surveys are subject to error and, because of its much smaller sample size, the household survey can be subject to particularly sizeable swings. Specifically, the standard error of the household survey's monthly change in employment is 436,000(!). Based on the most extreme assumptions about flows in and out of unemployment and in and out of the labor force, understating or overstating actual employment by 436,000 would imply a measured unemployment rate ranging from 7.5 percent to 8.1 percent. (The BLS estimate of the standard error for unemployment puts a range on September's number of 7.6 percent to 8 percent.)

In his post, Greg Mankiw makes reference to a Brookings Institution paper by George Perry from a few years back that offers what is probably good advice: since both the payroll and household surveys are subject to error, and since the errors in each are likely unrelated to one another, the clearest picture about what is happening to employment in real time can be gleaned by combining information from both.

In fact, in a directional sense, both the household and payroll surveys are giving the same signals. In the table below, we compare the recent trends in monthly job gains measured in both surveys. The coverage in the two reports is slightly different. Unlike the payroll count, the household survey includes the self-employed and counts multiple jobs held by a single person as a single instance of employment. Because of this, the BLS also reports an adjusted version of the household survey, called the payroll concept adjusted employment measure. This payroll-consistent measure is designed to control for definitional differences across the household and establishment reports and also makes statistical adjustments for changes to the population controls in various years. So we include the data from this measure in the last column of the table.

Overall, all three measures suggest a weaker trend over the last six months than over the last nine months. All three measures also indicate that things were somewhat stronger on average in the last three months than in the prior three months. The bottom line in our view is that, though the employment levels can be quite different across the three measures, all suggest that the jobs picture has improved somewhat in the past three months.

The suggestion in George Perry's Brookings paper'combining the household and establishment data'can be implemented by constructing a weighted average of the two surveys. In our variation we put weights in proportion to the inverse of the sampling variability of the payroll and household surveys, which would roughly imply an 80 percent weight on the establishment measure and 20 percent on the payroll-consistent household measure. The estimates using these weights are reported in the last column of the table above. Because the component employment measures display directionally similar trends in recent months, the weighted average does as well. 

In a speech given a few weeks ago, Atlanta Fed President Dennis Lockhart, our boss here, offered the opinion that

Taking a two-year view, the trend rate of gains in employment has been roughly 150,000 per month. This pace would be sufficient, at current levels of participation in the workforce, to sustain a steady, gradual reduction of the unemployment rate.

As the September employment reports show, predicting the unemployment rate month to month can be tricky business, and there may be better ways than just extrapolating from the jobs data. But thus far we are inclined to think that slow but steady progress on the jobs front is still the best story.

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

October 10, 2012 in Employment, Labor Markets | Permalink

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Supporting Price Stability

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October 09, 2012

Supporting Price Stability

All of the five questions that Chairman Ben Bernanke addressed in his October 1 speech to the Economic Club of Indiana rank high on the list of most frequently asked questions I encounter in my own travels about the Southeast. But if I had to choose a number one question, on the scale of intensity if not frequency, it would probably be this one: "What is the risk that the Fed's accommodative monetary policy will lead to inflation?"

The Chairman gave a fine answer, of course, and I hope it is especially noted that Mr. Bernanke was not dismissive that risks do exist:

"I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. ...

"Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to 'take away the punch bowl' is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions."

While the world waits for "take away the punch bowl" time to arrive, here is another question that I think worthy of consideration: "Looking back over the past several years, what is the risk that the Fed's price stability mandate would have been compromised absent accommodative monetary policy?"

As the Chairman noted in his speech, it isn't easy to take the evidence at hand and argue any inconsistency between the Federal Open Market Committee's (FOMC) policy actions and its price stability mandate:

"I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years."

To the question I posed earlier, I am tempted to take those observations one step further. Without the policy steps taken by the FOMC over the past several years, the "excellent" price stability record would indeed have been compromised.

Consider the so-called five-year/five-year-forward breakeven inflation rate, a closely monitored market-based measure of longer-term inflation expectations. If you are not completely familiar with this statistic'and you can skip this paragraph if you are'think about buying a Treasury security five years from now that will mature five years after you buy it. When you make such a purchase, you are going to care about the rate of inflation that prevails between a period that spans from five years from today (when you buy the security) through 10 years from today (when the asset matures and pays off). By comparing the difference between the yield on a Treasury security that provides some insurance against inflation and one that does not, we can estimate what the people buying these securities believe about future inflation. The reason is that, if the two securities are otherwise similar, you would only buy the security that does not provide inflation insurance if the interest rate you get is high enough relative to inflation-protected security to compensate you for the inflation that you expect over the five years that you hold the asset. In other words, the difference in the interest rates across an inflation-protected Treasury and a plain-vanilla Treasury that does not provide protection should mainly reflect the market's expected rate of inflation.

When you look at a chart of these market-based inflation expectations along with the general timing of the FOMC's policy actions, from the first large-scale asset purchase in 2008'2009 (QE1) to the second asset purchase program (QE2) in 2010 to the maturity extension program (Operation Twist) in 2011, the relationship between monetary policy and inflation expectations is pretty clear:

In each case, policy actions were generally taken in periods when the momentum of inflation expectations was discernibly downward. A simple-minded conclusion is that FOMC actions have been consistent with holding the bottom on inflation expectations. A bolder conclusion would be that as inflation expectations go, so eventually goes inflation and, had these monetary policy actions not been taken, the Fed's price stability objectives would have been jeopardized.

Statements like this do not come without caveats. A perfectly clean measure of inflation expectations requires that Treasuries that do and do not carry inflation protection really are otherwise identical. If that is not the case, differences in rates on the two types of assets can be driven by changes in things like market liquidity, and not changes in inflation expectations. Calculations of five-year/five-year-forward breakeven rates attempt to control for some of these non-inflation differences, but certainly only do so imperfectly.

Perhaps more pertinent to the current policy discussion, inflation expectations have, in fact, moved up following the latest policy action'which I guess people are destined to call QE3. But unlike the periods around QE1, QE2, and Twist, QE3 was not preceded by a period of generally falling longer-term breakeven inflation rates. So this time around there will be another, and perhaps more challenging, chance to test the proposition that monetary accommodation is consistent with price stability. As for previous actions, however, I'm pretty comfortable arguing the case that the price stability mandate was not only consistent with accommodation, it actually required it.

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

 

October 9, 2012 in Monetary Policy | Permalink

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Trends in Small Business Lending

« How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey | Main

October 03, 2012

Trends in Small Business Lending

The Atlanta Fed's latest semiannual Small Business Survey is active through October 22, 2012. If you own a small business and would like to participate, send an e-mail to SmallBusinessResearch@atl.frb.org.

In our previous survey conducted in April 2012, we found that firms applying for credit at large national banks had notably less success than firms that applied to small banks.

We also found that the firms applying to large banks tended to be much younger than the firms that applied to small banks. We speculated that this "age factor" could be contributing to the lower overall success rates at large banks.

A difference between small businesses' success at large and small banks has also been documented by the online credit facilitator Biz2Credit. Biz2Credit works a bit like an online dating service'after answering a series of questions (and providing the typical financial documents required by lenders), small businesses are presented with five potential "matches." To determine the best five matches, Biz2Credit identifies what lenders are looking for'usually a certain credit score, a minimum number of years in business, an established banking relationship, and targeted industries.

The resulting credit applications are the basis for the Biz2Credit Small Business Lending Index. Biz2Credit also reports approval rates from the matching process for large banks, small banks, credit unions, and alternative lenders. These approval rates are plotted on the chart below.

Much like we saw in the Small Business Survey, Biz2Credit reports that small firms have had consistently less success in obtaining credit at large banks.
Confirming our results encourages us that our April observation was a good one. But confirmation isn't explanation'what accounts for the different experiences small businesses have in securing credit from small banks versus big banks? And so, we dig deeper.

Note: According to Biz2Credit, its index is based on 1,000 of the 10,000-plus applications submitted each month. To be included, the business has to have at least a 680 credit score, be at least two years old, and have an established relationship with the bank to which it is applying. Selection methods are also applied to provide for national representation.

By Ellyn Terry, senior economic research analyst at the Atlanta Fed

October 3, 2012 in Banking, Small Business | Permalink

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How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

« Scientists? Engineers? How about Gardeners? | Main

September 27, 2012

How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

Opinions vary widely about how much slack there is in the economy these days. Some say a lot'some say not so much.

Last month, we reached out to members of our Business Inflation Expectations (BIE) panel for their take on the issue. The panel indicated they had more pricing power in August than they did last October. OK, that doesn't exactly gauge the amount of slack businesses think they have, but it does suggest that, however much slack there is, it's been shrinking.

Another detail revealed by our August inquiry was that retailers think they have more pricing power compared with manufacturers'a pretty good sign the latter is experiencing more slack than the former.

In this month's BIE survey we went fishing in the same murky waters, but this time we took a more direct approach. We asked our panel to provide a percentage estimate of how far their sales levels are above/below "normal." Here's what we found: On a gross domestic product (GDP)'weighted basis, the panel estimates that current sales are about 7.5 percent below normal. That's more slack than the conventional estimates, like the Congressional Budget Office's (CBO) measure of the GDP gap, which puts the economy about 6 percent under its potential.

But perhaps a more interesting observation from our September survey is how widely current performance varies by sector and size within our panel. Retailers, for example, say their current sales are a little less than 2 percent below normal. And firms in the leisure/hospitality and the transportation/warehousing sectors'sectors where growth has been particularly robust in recent years'say they are operating at, or just a shade above, normal levels.

Compare these estimates with those from durable goods manufacturers, which report that their current sales levels are nearly 12 percent below normal, and finance and insurance companies, which say they are almost 17 percent below normal. And construction firms? Well, best not even ask them.

And the amount of slack firms are reporting isn't just a reflection of their sector of the economy'size also matters. Firms with more than 500 employees say their current sales levels are a little less than 5 percent below normal'half as much as the amount of slack being reported by small firms.

So we're led back to the question that kicked this blog post off. How big is the output gap? Some say a lot'some say not so much. And this difference in perspective is not just among policymakers. Within the economy, experience varies at least as widely; some firms' sales are still well below normal, while others are telling us that they are very nearly back to normal, and some are already there.

But here's the rub. If the economy represents a constellation of firms operating at widely varying levels of capacity, from what viewpoint should we consider the economy relative to its potential? Are aggregate measures, like the one provided by the CBO or by our "GDP-weighted" approach, appropriate perspectives? Indeed, given widely varying measures of economic performance across firms and industries, how meaningful is an aggregate assessment of economic slack?

Ah, we'll leave these questions for the November survey.

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

 

September 27, 2012 in Inflation, Inflation Expectations | Permalink

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