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January 23, 2008

Economist's View - 5 new articles

Economic and Social Differences by State and Party ID

From The Monkey Cage:

Economic and Social Differences by State and Party ID, by David Park: ...Here's a graph from the 2000 National Annenberg Election Studies. Each state represents the mean economic and social estimates (red states indicate self-reported Republicans and blue self-reported Democrats). Positive is more Conservative and Negative more Liberal.


There is no overlap between Democrats and Republicans on the economic dimension but some overlap on the social dimension. Democrats appear to be more economically cohesive than Republicans. Socially, WV Democrats are more conservative than Republican VT, NY, MA, CT and RI. ...

Emergency Rate Cut

I can't say I expected this to happen today. So far so good, stock markets are recovering, at least for the moment, but the 75 basis point cut is aggressive and makes me wonder if there are things the Fed knows that we don't. In that sense, I hope this move calms markets rather than reinforcing their worries. First, the statement from the FOMC:

FOMC Statement: The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Eric S. Rosengren; and Kevin M. Warsh. Voting against was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Absent and not voting was Frederic S. Mishkin. In a related action, the Board of Governors approved a 75-basis-point decrease in the discount rate to 4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Chicago and Minneapolis.

Here's Greg Ip of the Wall Street Journal:

Fed Cuts Key Interest Rate As Recession Fears Well Up, by Greg Ip, WSJ: Federal Reserve Chairman Ben Bernanke, putting caution aside, orchestrated a steep cut in interest rates just a week before a scheduled policy meeting in an effort to short-circuit a downward spiral of investor confidence and tightening credit.

The three-quarters of a percentage point cut in the Fed's short-term interest rate target -- to 3.5% -- could help restore confidence to investors and counter the threat of recession. But the reduction risks making the Fed look like it panicked in response to market developments.

The move is unlikely to be the last cut, the Fed indicated. "Appreciable downside risks to growth remain," it said, vowing to "act in a timely manner as needed to address those risks." ...

The immediate market response was positive. The Dow Jones Industrial Average, down as much as 464 points early in the morning, recovered much of those losses by midday. European markets, which were falling steeply, reversed course and closed higher on the Fed's action.

The Fed said it acted because of "weakening of the economic outlook and increasing downside risks to growth. Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."

The Fed statement suggested a downshift in its worries about inflation. It said it expects "inflation to moderate in coming quarters" though it will "monitor inflation developments carefully."

The move would be "pointless" if it merely shifted a scheduled rate cut ahead by a week, said former Fed governor Laurence Meyer, now vice-chairman of consultants Macroeconomic Advisers LLC. "Instead, today's move was driven by a desire to get a larger cumulative change in the federal funds rate by the end of the month." He predicted a half-point cut next week. ...

The move was the first rate cut between scheduled meetings of Fed policymakers since the immediate aftermath of the Sept. 11, 2001 terrorist attacks...

The Fed last cut the target for the federal-funds rate, charged on overnight loans between banks, by as much in 1982, when it was lowered a full point. Prior to 1994, however, fed funds rate cuts weren't announced, and the Fed relied on the less-important discount rate, charged on direct Fed loans to banks, to signal its actions. It cut that rate a full percentage point in 1991. ...

The rate cut follows five months of gradualism in which the Fed has seen each of its last three rate cuts rapidly overtaken by events, as the credit crunch and housing collapse deepened. Mr. Bernanke had been balancing those risk against still-high inflation. But he signaled on Jan. 10 that he had shifted his focus principally to supporting growth as employment, retail sales and manufacturing activity all weakened sharply. While some Fed officials mulled the merit of an intermeeting cut then, Mr. Bernanke figured the speech would serve to recalibrate market expectations enough that he could wait until next week's meeting.

That game plan changed Monday in response to a double dose of bad market news: first, that several major bond insurers could lose their triple-A credit ratings, which would shift the risk of default on an additional billions of dollars of debt back onto banks, further constraining their lending; and then, on Monday, the global stock market rout, which cast into doubt the rest of the world's ability to ride out a U.S. recession. ...

And, Brad DeLong points to Rex Nutting:

Fed cuts rates 75 basis points in emergency move - MarketWatch: WASHINGTON (MarketWatch) -- Hoping to halt a market meltdown and prevent a recession, the Federal Reserve lowered its overnight lending rate by three quarters of a percentage point to 3.50% on Tuesday in a rare move between formal meetings.

The 75 basis-point surprise cut came after global financial markets sold off in dramatic fashion on Monday on fears that bad bets in credit markets could spread further and drive the U.S. economy into recession. See full story on London markets.

"The committee took this action in view of a weakening economic outlook and increasing downside risks to growth," the Federal Open Market Committee said in a statement. The Fed also lowered its discount rate by 75 basis points to 4%. It was the largest cut in the federal funds rate since 1982, after the FOMC had driven rates to 20% to kill inflation.

U.S. stocks opened with huge losses. The Dow Jones Industrial Average was down more than 450 points, or more than 3%. Treasurys rallied. "This move is not an instant fix," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics. "The economy is still staring recession in the face, but at least the Fed now gets it." With the move coming just eight days before the next scheduled meeting, "there can be no doubt that the timing of this morning's move is aimed at supporting global financial markets after yesterday's global equity meltdown," wrote Joshua Shapiro, economist for MFR Inc. Some traders said the Fed's move sniffed of panic. "I think that there's an element of thinking that, if the Fed is so worried that it is cutting rates, then that is feeding into fears that the U.S. economy is in really bad shape," said David Page, a strategist at Investec Securities in London.

After a conference call Monday evening among the 10 voting members of the Federal Open Market Committee, the FOMC released a statement early Tuesday saying downside risks to growth remain. One member of the committee, William Poole, president of the St. Louis Fed, voted against the move. One other, Fed Gov. Frederic Mishkin, was absent. "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households," the FOMC said. "Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets." "Appreciable downside risks to growth remain," the statement said. "The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks." The statement barely mentioned inflation, only saying that the FOMC expects inflation to moderate and will monitor inflation carefully...

I teach most of today and can't so much on this, so here's more from: Jim Hamilton, Paul Krugman, Andrew Samwick, WSJ Economics Blog (here and here too), Bloomberg, Financial Times, Felix Salmon, Wilhelm Buiter, and Barry Ritholtz.

"Every Major U.S. Bank Was Profitable Last Year"

John Berry says we shouldn't feel too sorry for banks, or worry that credit is about to dry up and ruin the economy [Update: After today's events, I'll be curious to see if John Berry, who has been more bullish (or at least less bearish) than many other commentators, changes his tune at all.]:

Every Major U.S. Bank Was Profitable Last Year, by John M. Berry, Bloomberg: With all the large writedowns and losses announced for the fourth quarter, hardly any attention is being paid to just how profitable U.S. banks really are.

That inattention has raised unnecessary concerns that the banks may be so crippled by losses that they will cut lending to the point it might undermine the U.S. economy.

Some commentators have said the banks are in the worst shape since the Great Depression. That isn't close to being correct.

Other analysts have raised the specter of the stagnant Japanese economy of the 1990s, when banks there were crippled by huge losses when a real estate price bubble burst... This comparison also is off base.

Even Citigroup Inc., by far the hardest hit of the big U.S. banks by subprime-related problems, earned $3.62 billion last year. That was with a $9.83 billion fourth-quarter net loss and more than $22 billion in writedowns and additions to loan-loss reserves.

For JPMorgan Chase & Co., the third-biggest U.S. bank, the focus was on the 34 percent drop in fourth-quarter profits from a year earlier. Its full-year $15.4 billion profit, a record, was largely ignored. ...

Economist Robert E. Litan, a senior fellow at the Brookings Institution who has done numerous studies of the U.S. financial system, said the banks are in far better shape than the dire assessments suggest.

''Strip out the losses and Citi could make close to $10 billion a quarter,'' Litan said. Noting how quickly the bank has been able ... to replace the capital depleted by losses, he added, ''Why would anybody buy stock if they thought Citi was going down the tubes?''

''And this is nothing like the Japanese situation,'' Litan said. ... The story is largely the same at Merrill Lynch & Co., the world's largest brokerage, though the losses are greater relative to its size. ...

Credit isn't as readily available as it was for several reasons, including a less favorable economic outlook, tighter lending standards, particularly for mortgages, and a lack of a secondary market for some types of loans such as jumbo mortgages.

On the other hand, the interest rates many borrowers are paying have dropped. The bank prime rate, to which many loans are linked, is 7.25 percent, the lowest since January 2006.

As of Jan. 17, the average interest rate on 30-year fixed- rate mortgages dropped to 5.69 percent, the lowest level since June 2005.

In the two weeks ended Jan. 18, corporate borrowers sold $50 billion worth of investment-grade bonds at the lowest interest rates since April 2007.

The credit well hasn't run dry and it's not about to. And the nation's banks will be supplying a large share of it.

links for 2008-01-22

Tim Duy: Adding to the Fiscal Stimulus Discussion

While Tim was in central Oregon this weekend teaching the next generation of Fed Watchers where to go and hide after a bad call, he thought a bit about fiscal policy:

Adding to the Fiscal Stimulus Discussion, by Tim Duy: I rarely comment on fiscal policy. But tonight I feel somewhat adventurous, comfortably ensconced this holiday weekday in the snowy Central Cascades, watching the temperature dip toward zero. I was happy that I brought with me the print edition of the weekend Wall Street Journal, if nothing else for Bruce Bartlett's op-ed piece and the cover story on fiscal policy. It, as well as Mark's comments, prompted me to think about potential benefits offered by the proposed stimulus, concluding that there is an important international aspect to the stimulus that is often overlooked.

My initial read of Barlett's piece was as an argument against temporary tax cuts, not for permanent cuts. And by in large, I agreed with Barlett. To be sure, there will be persons who do in fact spend virtually all of their tax rebate immediately, and those whose liquidity constraints are temporarily relieved. But, when all is said and done, the dollars being talked about are small relative to the size of the economy and temporary. We will see a flurry of press stories detailing the issuance of the checks, the ensuing stories of a spike in consumer spending, complete with the personal accounts of households and retailer. The personal income report will pop, and the GDP report will gain one percentage point over what it would have been otherwise, perhaps staving off a technical recession. Economists will have another data point to beat to death with econometrics, conclusively reaching multiple conclusions.

Reporters could write their stories now, fill in the details later. I have been here before, and will be here again.

This is not meant to imply that I am opposed to a stimulus package – if we can afford to spend $100+ billion in Iraq, we can afford to do it here. And if you want to get cash in the hands of spenders fast, putting checks in the mail is the way to do it. While I am very sympathetic to calls for infrastructure spending, we all know the money will trickle out over time, and thus have a fraction of the impact of $100 billion spent today. I would prefer rebates limited to those households earning less than $85,000, and expansions to a mix of temporary adjustment programs (unemployment insurance, etc.). I am wary of additional support for homeowners, but only because I am appalled that we as a society have created conditions such that households feel compelled to spend upwards of 50% of their income on housing.

Moreover, there is an additional mechanism by which the stimulus could be effective, even if the impacts on domestic consumption are relatively small and temporary – the stimulus may reduce the probability of a disorderly adjustment of the external accounts.

I generally do not view the current situation in a typical closed-economy Keynesian fashion. Keynes focused on situations where domestic consumption fell short of productive capacity due to an unwillingness to spend (excessive saving met with hesitant investment). Government spending – sustained, long term capital investment – could alleviate the imbalance by releasing the unused resources via issuance of debt.

In contrast, the US faces a resource constraint, not an unwillingness to spend. The existence of our sizable trade imbalance is evidence of that constraint. We have no problem spending money – we consume more than we produce in this country. Period. We rely on foreign savings and production (depending on what side of the international accounts you focus on) to support that consumption. Which is why I found this comment to be particularly prescient:

Foreign savers will no longer lend to citizens for consumption (by buying securitized mortgages and such), so the gov will temporarily borrow the money from foreign savers and give it to citizens to spend.

Correct – US consumers lost access to an important source of financing, and market participants are in a "run and hide" mood as they sort out the long term implications. What financial markets remain willing to absorb is US government debt. The fiscal stimulus we enact today can be viewed as an attempt to stabilize markets enough to lure foreign savers, or governments, back into supporting US domestic demand in excess of production capabilities without the US government as an intermediary. Note the desperate attempt of the financial community to recapitalize via foreign savings. And see Brad Setser.

Suppose that the transition away from foreign savings/production is underway – as suggested by the stabilization of the US current account deficit. There is a risk that this becomes disorderly, and the US government can smooth the transition by borrowing funds from abroad to offset a drop in capital inflows to private assets. The temporary stimulus has its impact not by "jump starting" the economy, but instead by preventing a disorderly adjustment as we transition to a new growth path. Then the stimulus was effective, even is "temporary."

But the other side of the adjustment will not be days of wine and roses. Quite the contrary. Lessening our reliance on external production implies reduced rates of domestic demand growth on the other side of this downturn. It comes as little surprise to me that the Fed's long term outlook appears looks consistent with potential growth near 2.5%.

Longer term, the potential downsides of stabilization policy emerge if we are not happy with the transition toward lower domestic demand growth rates. Then we will be increasingly using monetary and fiscal policy to foster a growth path that I suspect the rest of the world will be increasingly unwilling to support. As incomes rise across the globe, citizens of other nations will be increasing interested in producing for their own consumption, not ours. At that point, continued reliance on the rest of the world will prove difficult to maintain.

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