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Sunday, June 24, 2012

The BIS on "The Limits of Monetary Policy"

Each year the Bank for International Settlements (BIS) hosts the world’s central bankers--the BIS shareholders--at their Annual General Meeting in Basel, Switzerland. At the meeting held today, the BIS issued their Annual Report which addresses key monetary policy issues. BIS analyses often contain useful warnings, including their prescient warning in the years around 2003-2005 that monetary policy was too easy, which turned out to be largely correct, as the boom and the subsequent bust made so clear. So the Annual Report is always worth reading.

This is especially true of the Annual Report released today because it devotes a whole chapter to serious concerns about the harmful “side effects” of the current highly accommodative monetary policies “in the major advanced economies” where “policy rates remain very low and central bank balance sheets continue to expand.” Of course these are the policies now conducted at the Fed, the ECB, the Bank of Japan, and the Bank of England. The Report points out several side effects:

  • First, the policies “may delay the return to a self-sustaining recovery.” In other words, rather than stimulating recovery as intended, the policies may be delaying recovery.
  • Second, the policies “may create risks for financial and price stability globally.”
  • Third, the policies create “longer-term risks to [central banks’] credibility and operational independence.”
  • Fourth, the policies “have blurred the line between monetary and fiscal policies” another threat to central bank independence.
  • Fifth, the policies “have been fueling credit and asset price booms in some emerging economies,” thereby raising risks that the unwinding of these booms “would have significant negative repercussions” similar to the preceding crisis, which in turn would feed back to the advanced economies.

The BIS analysis which leads to these concerns is summarized in a series of charts and tables contained in the fascinating chapter “The Limits of Monetary Policy,” which concludes with the warning that “central banks need to beware….”

Tuesday, June 19, 2012

The GDP Impact a U.S. Fiscal Consolidation Strategy

Three and half years ago, in February 2009, John Cogan, Volker Wieland, Tobias Cwik and I estimated what the impact of the 2009 stimulus package (ARRA) would be. Our estimates, obtained by simulating modern macroeconomic models, were much smaller than those of the Administration. Since then our estimates have been verified in research by a group of economists at central banks and international financial institutions who found that our simulations were in mid-range of their models.

Now, Wieland, Cogan and I, joined by Maik Wolters, are simulating modern macroeconomic models to evaluate a fiscal consolidation strategy to reduce the deficit and end the explosion of the debt. We are using two models which incorporate forward looking behavior, one with price and wage rigidities and one with more classical features. We have examined a gradual, credible strategy to reduce federal spending as a share of GDP—relative to current policy as assumed in the CBO alternative fiscal scenario baseline and starting in the first quarter of 2013—as shown in this chart.

Our initial findings, reported here, are that this strategy has a positive impact of GDP, in both the short run and the long run. The positive short run economic effects occur even in the model with price and wage rigidities for several reasons including that the lower spending (as a share of GDP) can reduce expected tax rates and raise permanent after-tax income compared to what would be expected under current policy. This stimulates consumption. The gradual nature of the government spending reduction, which allows time for private spending to adjust, avoids the negative aggregate demand effects that traditional Keynesian models emphasize.

Friday, June 8, 2012

Fed Bought 77% of Federal Debt Increase in 2011: The Data Source

During an interview on CNBC Squawk Box this morning and in my Wall Street Journal oped of last Friday (June 1), I mentioned that the Federal Reserve purchased 77% of the net increase in the debt by the Federal government in 2011. Several people have asked for references for that amazing percentage. The calculation is due to my colleague John Cogan, and is based on data reported in the Federal Budget, FY2013 Historical Tables, Table 7.1: Federal Debt at the End of Year: 1940–2017.

Here is how it is calculated. Table 7.1 shows that federal debt held by the public increased from $9,018,882 million at the end of fiscal year 2010 to $10,128,206 million at the end of fiscal year 2011 for an increase of $1,109,324 million during fiscal year 2011. The same table shows that Federal Reserve holdings of federal debt increased from $811,669 million to $1,664,660 million during the same period for an increase of $852,991 million, which is 77 percent of $1,109,324 million.