Showing papers in "FRBSF Economic Letter in 2012"

Why Has Wage Growth Stayed Strong

Abstract: Despite a severe recession and modest recovery, real wage growth has stayed relatively solid. A key reason seems to be downward nominal wage rigidities, that is, the tendency of employers to avoid cutting the dollar value of wages. This phenomenon means that, in nominal terms, wages tend not to adjust downward when economic conditions are poor. With inflation relatively low in recent years, these rigidities have limited reductions in the real wages of a large fraction of U.S. workers.

Uncertainty, Unemployment, and Inflation

Abstract: In this Economic Letter, we examine the economic effects of uncertainty using a statistical approach. We provide evidence that uncertainty harms economic activity, with effects similar to a decline in aggregate demand. The private sector responds to rising uncertainty by cutting back spending, leading to a rise in unemployment and reductions in both output and inflation. We also show that monetary policymakers typically try to mitigate uncertainty’s adverse effects the same way they respond to a fall in aggregate demand, by lowering nominal short-term interest rates. Our statistical model suggests that uncertainty has pushed the unemployment rate up at least one percentage point in the past three years. By contrast, uncertainty was not an important factor in the unemployment surge during the deep downturn of 1981–82. One possible reason why uncertainty has weighed more heavily on the economy in the recent recession and recovery is that monetary policy has been limited by the zero lower bound on nominal interest rates. Because nominal rates cannot go significantly lower than their current near-zero level, policy is less able to counteract uncertainty’s negative economic effects.

Liquidity Risk and Credit in the Financial Crisis

Abstract: The 2007–08 financial crisis was the biggest shock to the banking system since the 1930s, raising fundamental questions about liquidity risk The global financial system experienced urgent demands for cash from various sources, including counterparties, short-term creditors, and, especially, existing borrowers Credit fell, with banks hit hardest by liquidity pressures cutting back most sharply Central bank emergency lending programs probably mitigated the decline Ongoing efforts to regulate bank liquidity may strengthen the financial system and make credit less vulnerable to liquidity shocks

The Federal Reserve's unconventional policies

Abstract: After the federal funds rate target was lowered to near zero in 2008, the Federal Reserve has used two types of unconventional monetary policies to stimulate the U.S. economy: forward policy guidance and large-scale asset purchases. These tools have been effective in pushing down longer-term Treasury yields and boosting other asset prices, thereby lifting spending and the economy. This Letter is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco at the University of California, Irvine, on November 5, 2012.

Monetary policy and interest rate uncertainty

Abstract: Market expectations about the Federal Reserve’s policy rate involve both the future path of that rate and the uncertainty surrounding that path. Fed policy actions have historically been preceded by high levels of uncertainty, which decline after the policy is made public. Recently, measures of near-term interest rate uncertainty have fallen to historical lows, due partly to a Fed policy rate near zero. Unconventional monetary policies have substantially lowered both expectations and uncertainty about the future path of the Fed’s policy rate.

Is China due for a slowdown

Abstract: Many analysts have predicted that a Chinese economic slowdown is inevitable because the country is approaching the per capita income at which growth in other countries began to decelerate. However, China may escape such a slowdown because of its uneven development. An analysis based on episodes of rapid expansion in four other Asian countries suggests that growth in China’s more developed provinces may slow to 5.5% by the close of the decade. But growth in the country’s less-developed provinces is expected to run at a robust 7.5% pace.

Housing bubbles and homeownership returns

Abstract: In the aftermath of the global financial crisis and the Great Recession, research has sought to understand the behavior of house prices. A feature of all bubbles is the emergence of seemingly plausible fundamental arguments that attempt to justify the dramatic run-up in prices. Comparing the U.S. housing boom of the mid-2000s with ongoing Norwegian housing market trends again poses the question of whether a bubble can be distinguished from a rational response to fundamentals. Survey evidence on expectations about house prices can be useful for diagnosing a bubble.

U.S. and Euro-Area Monetary Policy by Regions

Abstract: A recent Economic Letter applied the well-known Taylor rule for determining the monetary policy interest rate to illustrate the economic divergence between core and peripheral European countries (Nechio 2011). The letter demonstrated that the European Central Bank’s (ECB) target rate closely resembled the policy rate predicted by the Taylor rule for the euro area as a whole. At the same time though, the Taylor rule indicated that substantially different rates were appropriate for core and peripheral European economies. That difference reflected large economic disparities among euro-area countries.

Will the jobless rate drop take a break

Abstract: In January, the US Bureau of Labor Statistics significantly reduced its projections for medium-term labor force participation The revision implies that recent participation declines have largely been due to long-term trends rather than business-cycle effects However, as the economy recovers, some discouraged workers may return to the labor force, boosting participation beyond the Bureau’s forecast Given current job creation rates, if workers who want a job but are not actively looking join the labor force, the unemployment rate could stop falling in the short term>

Why is unemployment duration so long

Abstract: During the recent recession, unemployment duration reached levels well above those of past downturns. Duration has continued to rise during the uneven economic recovery that began in mid-2009. Elevated duration reflects such factors as changes in survey measurement, the demographic characteristics of the unemployed, and the availability of extended unemployment benefits. But the key explanation is the severe and persistent weakness in aggregate demand for labor.

Do Fed TIPS purchases affect market liquidity

Abstract: The second round of Federal Reserve large-scale asset purchases, from November 2010 to June 2011, included regular purchases of Treasury inflation-protected securities, or TIPS. An analysis of liquidity premiums indicates that the functioning of the TIPS market and the related inflation swap market improved both on the days the Fed purchased TIPS and over the course of the LSAP program. Thus, TIPS purchases had liquidity benefits beyond the effect they may have had in reducing Treasury yields.

U.S. Fiscal Policy: Headwind or Tailwind?

Abstract: Aggregate state, local, and federal fiscal policy was expansionary during the Great Recession and the initial stages of recovery, providing a tailwind to economic growth. Federal fiscal policy in particular was more expansionary than usual, according to a historical analysis, even when the weakness of the economy is taken into account. However, during the past year, aggregate government budgetary policy has reversed course. Over the next few years, as federal fiscal policy shifts toward austerity, it is likely to be a headwind against economic growth. State, local, and federal fiscal policy in the United States has historically been countercyclical. Government spending as a share of gross domestic product generally rises during economic downturns and falls during expansions, while tax revenue does the opposite. Thus, the difference between government spending and revenue—the combined state, local, and federal deficit—tends to lean against business cycle fluctuations. This countercyclical feature of government fiscal policy arises in part through automatic stabilizers, that is, previously enacted programs that are designed to increase outlays during downturns and contract in expansions without explicit policy changes. For example, when the economy enters a downturn, government spending on safety net programs, such as Medicaid and unemployment insurance, increases because more Americans need financial assistance. At the same time, tax revenue falls as incomes, sales, and property values decline.

Fed Asset Buying and Private Borrowing Rates

Abstract: With the federal funds rate, the traditional policy tool of the Federal Reserve, effectively reaching zero in late 2008, policymakers have turned to unconventional policy tools to further ease the stance of monetary policy (Williams 2011). These tools are aimed at lowering longer-term interest rates to stimulate economic activity and reduce unemployment. They can be grouped into two categories: communication and balance sheet policies. The Federal Open Market Committee (FOMC) has taken new communication initiatives by providing forward guidance about future policy. In August 2011, it started to explicitly lay out its expectations for the future path of the federal funds rate. The Fed’s unconventional balance sheet policies began in 2009 with a program of large-scale asset purchases (LSAPs) of Treasury and mortgage-backed securities, followed by further purchase programs. These purchases have been designed to put downward pressure on longer-term interest rates. Unconventional monetary policy actions can only be successful in stimulating the economy if they lower the interest rates that matter most for businesses and households, that is, the private borrowing rates that determine the cost of funds for the private sector. This Economic Letter reviews the Fed’s balance sheet programs, providing evidence about their impact on private borrowing rates, such as corporate bond yields and mortgage rates. To help understand the financial-market effects of these programs, the Letter examines the channels through which they likely have affected longer-term interest rates. It also looks at mortgage spreads, which capture the difference between the return to investors on mortgage bonds and mortgage costs to homeowners, focusing on factors that may limit pass-through to primary mortgage rates. Three rounds of asset purchases

Highway grants: roads to prosperity?

Abstract: Federal highway grants to states appear to boost economic activity in the short and medium term. The short-term effects appear to be due largely to increases in aggregate demand. Medium-term effects apparently reflect the increased productive capacity brought by improved roads. Overall, each dollar of federal highway grants received by a state raises that state’s annual economic output by at least two dollars, a relatively large multiplier.

Government Spending: An Economic Boost?

Abstract: Over the past three years, there has been a resurgence in economic research on the impacts of fiscal policy, as implemented through direct government spending and tax rates. This resurgence is due in large part to the severe global economic downturn and the massive fiscal stimulus programs put in place in many countries as a response. Now, as many countries pivot from stimulus to austerity despite uncertain recovery, the question of the economic effects of higher taxes and reductions in government spending takes on a new importance. This Economic Letter reviews recent research on the economic effects of fiscal policy. This research makes clear that many factors can affect the size and direction of fiscal effects, suggesting that policymakers must carefully consider the specific context of fiscal policy to understand the probable effects of new spending and tax initiatives.

The slow recovery: it’s not just housing

Abstract: States that were hit hard by the housing bust performed worse economically during the recession of 2007-09. However, the close relationship between the fall in home prices and state economic activity has largely disappeared during the recovery. High unemployment, restrained demand, and idle production capacity are national in scope. These are just the sorts of problems monetary policy can address. ; This Letter was adapted from a speech by the president and CEO of the Federal Reserve Bank of San Francisco at the University of San Diego on April 3, 2012.

The economic outlook and Federal Reserve policy

Abstract: Progress reducing unemployment has nearly stalled, while annual inflation has fallen below the Federal Reserve’s 2% target. To move toward maximum employment and price stability, the Fed recently announced plans to purchase more mortgage-backed securities and extend its commitment to keep its benchmark interest rate exceptionally low through mid-2015. Thanks partly to these actions, the recovery should gain momentum. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco at the City Club of San Francisco on September 24, 2012.

Consumer Debt and the Economic Recovery

Abstract: A key ingredient of an economic recovery is a pickup in household spending supported by increased consumer debt. As the current economic recovery has struggled to take hold, household debt levels have grown little. Some evidence indicates that households adjusted debt in line with house price movements in their local markets. However, the data show that consumer debt cutbacks were largest among households that defaulted on mortgages or had lower credit scores, suggesting that household borrowing also was restricted by tight aggregate credit supply.

Did the Housing Boom Affect Mortgage Choices

Abstract: Rapid house price appreciation during the housing boom significantly influenced homebuyer selection of adjustable-rate mortgages over fixed-rate mortgages. In markets with high house price appreciation, house price gains directly influenced mortgage choice. But in markets with less appreciation, price gains did not influence borrower choices between adjustable or fixedrate mortgages. In addition, the influence of fundamental drivers of mortgage choice, such as mortgage interest rate margins, tended to be muted in markets with high price appreciation. The collapse of the housing market and the high default rates on residential mortgages in recent years suggest that bubble conditions distorted borrower decisions about mortgage financing. This Economic Letter examines the relationship of housing market conditions during the boom to buyer choices between fixed-rate and adjustable-rate mortgages. Our analysis indicates that the pace of house price appreciation had a significant impact on mortgage choice in high-appreciation markets compared with other markets. In high-appreciation markets, the pace of house price gains was strongly linked to the popularity of adjustable-rate mortgages. But, in other markets, changes in house prices had no effect on mortgage choice. These results are consistent with research showing that higher house price appreciation leads to terms on adjustable-rate mortgages that can be relatively attractive to some borrowers and that financially constrained borrowers tend to prefer such loans. Margins on mortgage interest rates and general financial market conditions have traditionally been important determinants of mortgage financing choice. However, we find that the effects of some of these fundamental factors were muted in markets with high house price appreciation compared with other markets. These findings may partly reflect that homebuyers in high-appreciation markets expected to hold their loans only briefly before refinancing. Still, they also provide some evidence that bubble-like conditions can dilute the impact of fundamentals on economic choices. Mortgage instruments

Credit Access Following a Mortgage Default

Abstract: Borrowers who default on mortgages return to the mortgage market at extremely slow rates. Only about 10% of borrowers with a prior serious delinquency regain access to the mortgage market within 10 years of their default. Borrowers who terminate mortgages for reasons other than default return to the market about two-and-a-half times faster than those who default. Renewed access to credit takes even longer for subprime borrowers with a serious delinquency on their record. Historically, the U.S. mortgage default rate has varied in the range of 0–2% over the economic cycle. However, default rates broke dramatically from this historical pattern in 2006. At the peak of the housing downturn, the aggregate default rate climbed to about 10% of mortgages. In certain geographical markets and for certain types of mortgages, such as loans to subprime borrowers, the rate exceeded 25%.

Asia’s role in the post-crisis global economy

Abstract: In the wake of the global financial crisis of 2007–08, Asia has emerged as a pillar of financial stability and economic growth. A recent San Francisco Federal Reserve Bank conference focused on Asia’s changing role in the global economy. Asia’s relative strength is allowing it to play an expanded part in multilateral responses to the European sovereign debt crisis. And the reforms put in place following the 1997 Asian financial crisis offer models for countries currently trying to stabilize their economies.

The financial crisis and inflation expectations

Abstract: One measure of a successful monetary policy is its ability to anchor expectations about future inflation rates. Financial crises, such as that of 2008–09, can be considered natural experiments that test this anchoring. The effects of the crisis on inflation expectations were largely temporary in the United States, but longer-lasting in the United Kingdom. That is surprising because the United Kingdom had a formal inflation target during this period. Expectations may have been affected more because inflation stayed above the central bank’s target for extended periods following the crisis.

Emerging Asia: two paths through the storm

Abstract: The overall effect of the global financial crisis on emerging Asia was limited and short-lived. However, the crisis affected some countries in the region more than others. Two main crisis transmission channels, exposure to U.S. financial markets and reliance on manufacturing exports, determined how severely countries in the region were affected. Countries that were relatively less connected to global financial markets and relied less on trade fared better and recovered more quickly than countries that were more dependent on global financial and trade markets.

Small business loans and small bank health

Abstract: Total business loans under $1 million held by small U.S. banks continue to dwindle. Disproportionate negative growth at financially weak small banks has been an important factor in this decline. Loan volumes at strong small banks actually grew in 2011. The finding supports the view that supply conditions, not just tepid demand for credit, have affected bank lending to small businesses.

Worker Skills and Job Quality

Abstract: Some observers have argued that the nation’s high unemployment rate during the current recovery stems partly from widespread mismatches between the skills of jobseekers and the needs of employers. A recent San Francisco Federal Reserve Bank conference on workforce skills considered evidence that employers have had difficulties finding workers with appropriate skills in recent years. However, these mismatches do not appear to be much more severe than in the past. Overall, the conference proceedings suggested the U.S. economy can still produce good jobs for workers at a variety of skill levels.

External Shocks and China's Monetary Policy

Abstract: China prohibits its private sector from freely trading foreign assets and tightly manages currency exchange rates. In the wake of the recent global financial crisis, interest rates on China’s foreign assets fell sharply, while yields on Chinese domestic assets remained relatively high, posing a challenge for China’s monetary policy. Opening the capital account would improve China’s capacity to weather external shocks, such as sudden declines in foreign interest rates. However, allowing the exchange rate to float without removing capital controls is less effective.

Are U.S. Corporate Bonds Exposed to Europe

Abstract: The European sovereign debt crisis has created tensions in the global corporate debt market. Investors increasingly hold international assets and companies issue bonds in many countries. Thus, shocks to the European corporate bond market are readily transmitted to the U.S. corporate bond market. However, the rate of transmission is less than one-to-one. Moreover, different segments of the U.S. market vary in the magnitude of their response to European shocks. In particular, higher-rated nonfinancial borrowers and lower-rated financial borrowers are less affected on average.

Mortgage Prepayment: An Avenue Foreclosed?

Abstract: When the housing boom of the past decade turned into a bust, falling house prices played a primary role in driving up delinquency and foreclosure rates. As housing values fell, distressed borrowers lost equity, which hindered their ability to escape delinquency by prepaying their mortgages by refinancing or selling their homes. Falling house prices may have especially impinged on subprime and adjustable-rate borrowers. These homeowners may have counted on being able eventually to refinance into loans with terms more affordable than those of their original mortgages.

Commodity prices and PCE inflation

Abstract: Commodity prices have soared several times in recent years, raising concerns that overall inflation could rise substantially. However, crops, oil, and natural gas make up only about 5% of the cost of U.S. consumer goods and services. Thus, about one percentage point of the 10% cumulative inflation since 2007 reflects price rises in these important commodity categories. When the contribution of these commodities is subtracted from overall inflation, the resulting pattern is remarkably similar to that of core inflation, which excludes food and energy prices.

Job Creation Policies and the Great Recession

Abstract: The adverse labor market effects of the Great Recession have intensified interest in policy efforts to spur job creation. The two most direct job creation policies are subsidies that go to workers and hiring credits that go to employers. Evidence indicates that worker subsidies are generally more effective at creating jobs. However, the unique circumstances of recovery from the Great Recession, especially the weak demand for labor, make hiring credits more effective in the short term. The slow recovery of employment in the aftermath of the Great Recession has sharpened debate over policies to spur job creation. Policies for directly creating jobs include hiring credits, which are subsidies for employers to hire workers, and worker subsidies, which subsidize individuals to enter the labor market. Hiring credits effectively subsidize wages when employers hire. They increase demand for labor by lowering the cost of labor to employers. Worker subsidies raise worker earnings, thereby encouraging people to work. Although economic theory predicts that both policies should lead to higher employment, evidence suggests that worker subsidies are more effective. However, drawing on Neumark (2011), this