Bernanke- young and happy

Source

The Return of the Macroblog

Macroblog

Econ Bloggersphere Next Week

I predict there will be lot of talk about Fed transcripts


Related;
The World Next Week: April 11, 2008

Fed's ammunitions are falling

What Could the Fed Do?

Related;
Distressing Table of the Day

Investment advice from Colbert

Optimal Disaster Insurance

On the Optimal Design of Disaster Insurance in a Federation
by Timothy J. Goodspeed and Andrew F. Haughwout

Abstract: Recent experience with disasters and terrorist attacks in the US indicates that state and local governments rely on the federal sector for support after disasters occur. But these same governments are responsible for investing in infrastructure designed to reduce vulnerability to natural and man-made hazards. This division of responsibilities – regional governments providing protection from disasters and federal government providing insurance against their occurrence – leads to the tension that is at the heart of our analysis. We explore these tensions building on the model of Persson and Tabellini (1996). We show that when the federal government is committed to full insurance against disasters, regions will have incentives to underinvest in costly protective measures. We derive the structure of the optimal second-best insurance system when regional governments choose investment levels non-cooperatively and the central government cannot verify regional investment choices. Surprisingly, second-best transfer levels (and the corresponding regional investment levels) can be greater or less than their first-best counterparts, depending on the relative probability of a disaster. If the probability of a disaster is low, secondbest transfers will be designed to reward regions that succeed in avoiding disasters and punish those that do not, thereby giving regions an incentive to increase investment in protective infrastructure. However, this raises the further question of whether the central government can credibly commit to such a scheme, and we find that ex-post an optimizing central government will decrease transfers if a region provides protective infrastructure that increases its expected future income, generating a soft-budget constraint for regions. This provides an additional incentive for regions to underinvest in protective infrastructure. We discuss these results in light of recent disaster policy outcomes in the US.

Quote of the Day

If the government underwrites all the risks, call it socialism. If it underwrites only the failures, call it foolishness.

- Allan Meltzer

The Fed’s New Alphabet Soup- Vincent Reinhart

First, the mnemonics. On March 14, the Federal Reserve extended access to its discount window to a non-depository, Bear Stearns, for the first time since the 1930s. (The discount window is the Fed’s lending facility, where loans are made at a rate above the federal funds rates and can be secured with a wide variety of collateral.) According to the Federal Reserve Act, lending to such an individual, partnership, or corporation (an IPC) requires the affirmative vote of five of the governors of the Federal Reserve Board. Moreover, the Federal Reserve must attest that there are “unusual and exigent” circumstances and that failure to lend would impair the economy. On March 16, the Fed granted other investment banks access to its lending facility.

On the prior Tuesday, the Fed had introduced a new program called the Term Securities Lending Facility (TSLF), under which it will loan some of the Treasury securities currently on its balance sheet to key financial market participants in return for other securities as collateral. The term of these transactions is 28 days, and the fee paid for the loan of Treasury securities will be set in an auction.

For the past few months, the Fed has been holding regular auctions for depositories of its discount window credit, also for a term of 28 days. This is referred to as the Term Auction Facility (TAF), in which depositories bid for credit. Earlier this month, these auctions were bumped up to total $100 billion per month. To put that sum in perspective, the amount of discount window loans outstanding this month will likely be nine times the previous monthly record from 1919 to the inception of the TAF (see the nearby chart). And if the TAF continues at its recent pace through June of this year, the Federal Reserve will have extended a greater volume of loans over the first eight months of the program than it had cumulatively lent over the prior 90 years.

Last but not least, the Fed also announced that it will loan another $100 billion in the form of 28-day term repurchase (RP) agreements. RPs are the bread-and-butter of a central bank’s open market operations. In the typical RP, the Fed lends money to its dealer counterparties for a fixed term, taking collateral in the form of Treasury securities or the debt and mortgage-backed securities of the government-sponsored lenders, Freddie Mac and Fannie Mae.

If we tally up all these new programs, the Federal Reserve appears willing to commit almost one-half of its balance sheet, around $400 billion, to promote the renewed health of financial markets. Given its open-ended invitation for investment banks to follow the Bear Stearns route and tap the Fed’s discount window, it may wind up committing even more.

-The Fed’s New Alphabet Soup

Three Questions to Bernanke from Carmen Reinhart

From Reinhart's congressional testimony last month;

First, Federal Reserve policy easing in the last five months of last year seemed to be constrained by concerns about inflation. Judging from the longer-term projections included in the minutes of the October 2007 and January 2008 meetings, Federal Reserve policy makers seem to have an informal goal for PCE inflation (excluding food and energy) or something less than 2 percent. Was that goal reining in their response to the weakening of spending in 2007, and will it constrain their actions their actions over the remainder of this year?

Second, policy actions this year suggest that the Federal Reserve has abandoned the practice of gradually responding to economic events that marked the experience of the prior two decades. Will this phase of post-gradualism apply symmetrically later this year if evidence accumulates that inflation expectations are on the rise?

Third, Chairman Bernanke and his predecessors have previously argued that Federal Reserve involvement in the supervision of financial institutions is important in making both the conduct of supervision and monetary policy better. But the past few years apparently witnessed multiple regulatory lapses. Supervisors failed to caution depositories offering potential borrowers unsuitable mortgages. They also acquiesced as complicated structures were booked off the balance sheet, even though, in the event, they were not treated as such by corporate headquarters at the first sign of stress. At the same time, it is hard to read the hesitant easing of late 2007 as evidence that monetary policy makers were receiving useful insights from their supervisory colleagues. Does Chairman Bernanke still view supervision and regulation as an appropriate responsibility of the Federal Reserve?

Related;
Read Rogoff and Reinhart

Challenges for the world’s divided economy

5 Historical Economic Crises and the U.S.
Learning from experience

Third world America

Only the Hawks go to Central Bank Heaven

"Central Bankers- they live and die for price stability"

Laurence Meyer gives an inside look at the workings of FOMC (it starts about 10 minutes into the program, after Greenspan's comments)- it's a bit old lecture, but very informative and useful.

Best book for the layperson on the inner workings of the Fed- yes, better than Greenspan's.
A Term at the Fed: An Insider's View
by Laurence H. Meyer

Inflation Targeting: Lessons from Four Countries

A bit old but useful set of papers on Inflation Targeting experience.

Meet the economist- Timothy F. Geithner

Profile of NY Fed President in FT- a little bit overdone;

Mr Geithner is one of the most powerful economic officials in the world. Yet he still looks more like the gifted young aide of 1997 than an omnipotent central banker. This is partly his youthful appearance - only 46 years old in any event, he looks 10 years younger. But it is also his style, which manages to be casual and driven at the same time.

When he took the stage with Jean-Claude Trichet, president of the European Central Bank, in Davos this year, the visual contrast could not have been greater. Mr Trichet sat bolt upright in a crisp suit, polished shoes and chic tie. Mr Geithner was hunched in his chair, jigging his knee - with a pair of dirty walking boots sticking out of his suit.

People have made the error of mistaking his easy manner for a lack of confidence or steel. In reality, although he is widely described as nice, Mr Geithner can be forceful. "Everyone tends to underestimate him," says a former colleague. "If he was a bigger person physically, people might say he was president material, since he has that aura of power. But because he is slight and he looks young, people underestimate him."

Unusually among senior US officials, Mr Geithner has extensive international experience. He spent much of his childhood in Asia and Africa, where his father was a development expert with the Ford Foundation, completing his high school in Bangkok, Thailand. He studied at Dartmouth and Johns Hopkins before joining Kissinger Associates in 1985 as an Asia expert. He married young to Carole Sonnenfeld, a college sweetheart, and has two children, Elise and Benjamin.

Surprisingly little is known about his private life - Mr Geithner prefers to keep it private - but he is a keen tennis player and an enthusiastic, if inexpert, skier.

Mr Geithner joined the Treasury in 1988 and spent time as assistant attache at the US embassy in Tokyo - witnessing the onset of a decade of stagnation in Japan - before joining Mr Summers's international team under Robert Rubin, Treasury secretary. He rose rapidly, playing a big part in shaping the US response to the Asian crisis.

"He is very bright, independently minded, thoughtful, and has an unusual sense of public service - he is a very easy person to get along with," says Mr Rubin. "He is practical, worldly in the sense that he has a feel for things - for the psychology of markets, the politics of what he is doing - and a good sense of humour." For a high-flying public official, Mr Geithner has remarkably few enemies.

He thinks in probabilistic terms - worrying about "fat tail risks" of adverse possible outcomes even in good times. Long before the credit crisis broke, he led an effort to strengthen the infrastructure underlying the over-the-counter derivative market. But he did not spot how rusty the Fed's liquidity support tools had become, or the vulnerability of the banks to the credit woes, until the crisis erupted, and in the past months has been forced to improvise repeatedly to find ways of pumping cash into frozen parts of the financial system. Recently the Fed has innovated at a remarkable pace. Still, most analysts believe it did too little to contain money market strains in the early months of the crisis.

Peers see Mr Geithner as pragmatic - someone who focuses on what can be achieved and will not let the best be the enemy of the good. Some contrast this with other central bankers, such as Mervyn King, Bank of England governor, who stick more firmly to first principles.

Mr Geithner tends to "smell" his way through situations, a senior central banker says. He attributes this to his background as a Treasury official rather than a high-flying economist or banker - something he shares with Mr Trichet. "The key thing about people such as Trichet or Geithner is that they have come from treasuries - they know how politics and power works," the central banker says.

Mr Geithner is not an intellectual force in the way Mr Summers, Mr Bernanke or Mr King - all professional economists - are. But he understands the issues. "He is incredibly sharp and asks penetrating questions," says Mohamed El-Erian, co-chief executive of Pimco, who got to know him in the Asian crisis. "His approach allows him to identify the key issues quickly and get to the roots of a solution."

For someone who has never worked in the private financial sector, he has a subtle sense of markets' psychology. Yet Mr Summers says labelling him simply a pragmatist sells him short: "I would say he was very much an activist and an internationalist - and these were high principles." Friends say Mr Geithner's experience dealing with crises in emerging markets and Japan, and his coolness under pressure, equip him to handle the current crisis. The US must hope so. As one former colleague points out, there is a big difference between this crisis and those of the 1990s.

"When the crises erupted in Asia there was always the US and the International Monetary Fund there to ride to the rescue," he says. "But this time there is no cavalry." Mr Geithner and his colleagues will have to save themselves.

Explainer of the Day

How the Fed took the money out of monetary policy

Money creation and the Federal Reserve

Creating Money (or Jobs) Out of Thin Air

First and foremost, the Federal Reserve does NOT print new dollar bills. So how is it able to create new money? There are two main forms of money—cash in circulation and checking deposits held in banks. Separate from the money supply are “reserve accounts” that commercial banks are required to have at the Federal Reserve. These reserve accounts hold cash for the commercial banks in case depositors cash-out some of their deposits.

The Federal Reserve can expand the money supply by expanding the amount of deposits held in the U.S. commercial banking system. One way to do so is to purchase U.S. government bonds issued by the U.S. Treasury department. When the Federal Reserve purchases government bonds from commercial banks, it takes bonds out of circulation and electronically credits reserve accounts. U.S. commercial banks armed with more cash reserves will issue new loans which are then deposited back into the banking system. This method effectively increases the dollar amount of checking deposits in the economy, and hence, expands the money supply.

Consequences of Falling

Where is Bernanke taking us?- BusinessWeek cover story podcast
BusinessWeek's John Byrne and Michael Mandel discuss Fed Chairman Bernanke's new mandate, the damage on Wall Street, and the downside of a reeling dollar in Europe.

Volcker doesn't like Inflation targeting

From an interview Volcker gave to Bloomberg in 2006;

Volcker was skeptical that inflation targeting, a device for anchoring inflation expectations embraced by Bernanke, would be helpful.

``That's a little too precise for me,'' he said. ``The inflation rate is bound to go up and down a little bit and it should go up and down a little bit. But I would like to see stability as the target.''

He suggested that Bernanke, who has championed better communication through transparency at the central bank, may be communicating too much.

``It's kind of ironic,'' said Volcker. ``Mr. Bernanke seems to be criticized for a little too much transparency.''

Wizard of Wharton on Inflation Risks

Jeremy Siegel on Bear Stearns, the Rate Cuts and Inflation

The Value of Bernanke's house

Bernanke lives in Washington's Capitol Hill area in a four- bedroom, 2,600-square-foot house he bought new in May 2004 for $839,000. Almost four years later, it may not be worth any more, according to real estate records and local agents....

Real estate records show Bernanke's next-door neighbor's house sold in July 2007 for $880,000, 4.9 percent more than Bernanke's purchase three years earlier. A home four doors down and comparable in size and condition to Bernanke's has been on the market for five weeks at $899,000, after a failed attempt to sell for $988,000 in 2006....

The average sales price in the Washington area dropped to $217,780 in December, a decline of 13 percent from a record of $251,070 in May 2006, S&P/Case-Shiller data show. Washington's home prices had gained an average of 15.9 percent a year in the 10-year period ending in 2005, according to Case-Shiller figures.

-Bernanke's Own Home on Capitol Hill Shows Housing Boom and Bust

Related;
Housing Markets: A Vacant Look

Subprime is not an emerging markets style crisis

I agree with Ajay Shah;

This is undoubtedly a difficult situation. But is it a crisis? One estimate of the size of losses on sub-prime home loans is $400 billion. This is roughly 2.85% of US GDP. In India, with roughly Rs.50 lakh crore of GDP, a comparable scenario would involve home loan losses of Rs.1,43,000 crore. If such a shock hit India, one can only imagine how bad things would be.

In such difficult times, why is the US economy still rolling with the punches? Why has the US economy not collapsed in a mire of failed firms, finger-pointing by government agencies, morchas in the streets, and JPC inquiries? Understanding how this shock is being absorbed, and the equilibriating forces in play, is important in making a call on whether this is a crisis or a mere recession.

In the idealised world of securitisation, a parcel of home loans is converted into securities, which are then sold into the broad market. The ownership of these securities is dispersed amidst international hedge funds, pension funds, etc. The originator of the home loan is largely immune to the outcome : if a default takes place, the losses are borne by the owners of the securities.

Many critics of securitisation have pointed out that this theory has not quite panned out as expected. However, at the same time, there is no doubting the fact that securitisation has given a substantial dispersion of the $400 billion loss. For this reason, the impact of the massive loss on the US financial system is not as large as it might otherwise have been.

The second equilibriating channel lies in monetary policy. Unlike many other countries which have experienced crises, the US has well functioning institutions for conducting monetary policy. The US Fed has cut rates dramatically in response to difficulties in the economy. On 14th March, the 90-day treasury rate in the US had dropped to 1.16%. The impact of lowered interest rates on the economy is not as strong as it used to be, owing to difficulties in finance. However, a certain impact is surely there. Low interest rates are helping strengthen demand, and help attract smart speculators to buy assets at fire sale prices.

Difficulties in finance inflict damage on the economy when they trip up the debt financing of firms. However, US corporations are unusually under-leveraged and cash-rich. Hence, this recession-inducing channel from credit market distress to the real economy is absent. The health of US corporations today is very different from the health of Japanese firms in Japan's lost decades.

Low interest rates are doing their job in one critical respect: the decline of the dollar. Unlike other countries which have experienced crisis, the US has a floating exchange rate and an open capital account. The exchange rate pegging with capital controls, which has brought down so many emerging markets, is absent. When interest rates dropped, the dollar fell - exactly as it should. The weak dollar is bolstering net exports and helping the economy.

These effects are large. The Q4-2005 current account deficit was 7% of GDP; this has shrunk to 4.9% of GDP in Q4-2007. In other words, over these two years, the decline in the dollar contributed roughly 2% of higher demand for goods and services produced in the US.

A second remarkable feature of the decline in the dollar is the funding channel for the US through Asian central banks and governments in the middle east. For each $1 trillion of reserves held in USD assets, a 10% decline in the dollar constitutes a transfer of $100 billion to the issuer of liabilities in the US. Every Asian country should be asking whether this deal makes any sense for them, but in understanding the present situation, it's useful to note that no other country facing a crisis in the past has had such a good deal, which produces fiscal transfers in the time of need.

Unlike many countries which have experienced crises, monetary policy in the US is manned by brilliant intellectuals like Ben Bernanke and Fred Mishkin. Few people in the world understand the interplay between monetary policy and financial sector difficulties as well as them.

The Fed cut rates, but the monetary transmission was not quite working owing to difficulties in finance, so the rate cuts were not doing their job. Hence, the Fed has been innovating with new ways to get back into the game. These innovations include changing rules on collateral, reaching out to financing non-banks, etc. These strategies are on the right track and will help.

Some hedge funds and private equity funds have failed. From the viewpoint of public policy, this reiterates the case for having hedge funds and private equity funds as major players, since these failures have no repercussions. The failure of Carlyle is very different from the failure of financial firms like banks or insurance companies which have assured returns obligations to the general public. It is an excellent risk management strategy for society to have hedge funds where rich people place their money, which can blow up when times go bad inflicting losses on rich people.

In the failure of Bear Stearns, there was no bailout. Senior managers will be sacked, and the shareholders were expropriated. In this fashion, bit by bit, the losses on the housing market are being absorbed by various portfolios.

Conditions in the US are undoubtedly difficult. However, it is important to also understand the institutional depth of economic policy making, and the equilibriating responses which are in play. This may well be a recession, but it is not an emerging markets style crisis.

Confused about 'Syntax Destruction'

"I know you believe you understand what you think I said, but I am not sure you realize that what you heard is not what I meant,"- Greenspan

Imperfect Central Bank Communication - Information versus Distraction

Summary: Much of the information communicated by central banks is noisy or imperfect. This paper considers the potential benefits and limitations of central bank communications in a model of imperfect knowledge and learning. It is shown that the value of communicating imperfect information is ambiguous. There is a risk that the central bank can distract the public; this means that the central bank may prefer to focus its communication policies on the information it knows most about. Indeed, conveying more certain information may improve the public's understanding to the extent that it "crowds out" a role for communicating imperfect information.

Under-appreciated Economists

In his best-selling memoir, The Age of Turbulence (Penguin Press, 2007), Alan Greenspan singled out David J. Stockton, head researcher at the Fed since 2000. “He never sought nor received the press that Fed governors get, but when the governors gave speeches, it was his forecast of the U.S. economy that Fed watchers were getting. We governors learned to see him as the indispensable, behind-the-scenes staffer”(p. 250).

via Teaching Economist