Bob Gay

The Daily Update - 'Why Do Economic Expansions End?' Part IV

Consider then the implications of short-term rates remaining at or below 3% for an extended period. In the usual recession scenario, the Fed raises its policy rate to the point where bank lending is either unprofitable or unwise. When that happens, banks invariably tighten lending standards, some of the less worthy borrowers struggle to obtain funding, and activity is constrained. To be clear, this ‘cleansing’ of debtors is a prerequisite for the next expansion; procrastination or life support, both of which waste valuable financial resources, simply delay the day of reckoning and make recessions longer and deeper.

Now consider then the implications of short-term rates remaining at or below 3% for an extended period, which is the Fed’s current outlook. Namely, the Fed expects short-term rate instruments, like commercial paper and overnight loans that are the main sources of funding for banks, to remain well below the current prime lending offered to commercial banks’ best customer – now 5-1/2%. Because the Federal Reserve has moved so gradually and predictably in raising short-term rates from very low levels, banks have been able to raise lending rates slowly as well, thereby maintaining ample margins on loans. In fact, loan margins have been at historic highs ever since the Fed lowered its policy rate to zero in the wake of the Global Financial Crisis. Banks tend to follow the Fed in adjusting lending rates to the cost of short-funding, albeit with some delay (i.e. banks mark up prices over costs), except at very low interest rates. This pricing behaviour implies that the Fed uses its policy rate in part as a tool for restoring banks’ balance sheets during times of stress as well as the converse - a means to cool off lending that threatens to overheat the economy.

That cyclical margin on loans is why an inverted yield curve is not necessarily a good predictor of recessions at very low interest rates. The Fed would have to raise the cost of borrowing above 5% to make loans unprofitable, and hence warrant tighter lending standards, whereas FOMC members now project the neutral policy rate at less than 3%. In short, an inversion of the yield curve enough to curtail lending does not seem likely anytime soon. Moreover, the Fed’s gradualism and predictability in recent years also has translated into a very gradual and manageable increase in borrowing costs. Indeed, the notion that Fed policy somehow has been destabilising or damaging to the real economy because interest rates have risen from very low levels is pure foolishness. Normalisation of the Fed’s balance sheet, on the other hand, has become problematic because it is on a collision course with the horrendous US budget deficit.

The Daily Update - 'Why Do Economic Expansions End?' Part III

The Daily Update - 'Why Do Economic Expansions End?' Part III

Western central banks face extraordinary challenges in unwinding their 10-year experiment with unconventional monetary policy that has left them with trillions of dollars of financial assets on their balance sheets and real policy rates still near zero. The Fed, as the first mover, will bear the brunt of these challenges for many reasons.

The Daily Update - China Data + 'Why Do Economic Expansions End?' Part 1

The Daily Update - China Data + 'Why Do Economic Expansions End?' Part 1

This morning China announced its fourth-quarter GDP growth, coming in at 6.4%, matching market expectations, whilst adding the official economic growth for 2018 came in at 6.6%, the slowest pace of growth since 1990 (still a figure that the rest of the world would give their right arm for!). Although the headline figure may have been a little disappointing, there were bright spots included in the data release. These included retail sales, which rose 8.2%…

The Daily Update - PART V: Long-term Implications and Net Foreign Liabilities

The Daily Update - PART V: Long-term Implications and Net Foreign Liabilities

I envision at least three serious long-term consequences of current policy blunders for the US economy. First, at some point, public deficits will crowd out the nascent recovery in private investment – perhaps not this year but by 2019 the burden of financing public debt will begin to interfere with private financing, especially if the private sector is expected to finance public infrastructure projects. Over a longer horizon, the burden of debt will shift to the younger generation whose earnings prospects already are below those of their parents

The Daily Update - Part II: Regime Change: Inflation

Extract from Bob Gay’s piece ‘Regime Change: Inflation’

The longstanding inverse relationship between inflation and economic slack seems to have weakened dramatically.

The Demise of the Phillips Curve.  Almost 60 years ago, an economist named A.W. Phillips published an empirical study that showed periods of low unemployment were associated with rising inflation. The finding was intuitively plausible and meshed nicely with economists’ belief in how competitive markets should work – namely, prices rose when resources including workers were in short supply. By the 1970s, however, that inverse correlation was coming unglued as unemployment ratcheted higher and so did inflation.

The Daily Update - Part III: Regime Change: Inflation

Extract from Bob Gay’s piece ‘Regime Change: Inflation’

One of the most striking yet unsung by-products of globalisation and technology has been the rise of monopolistic industries that has shifted bargaining power from workers to employers. Since the heyday of union power in the early 1970s, which coincided with the coming of age of the postwar baby boom generation, labor’s share has declined from highs around 58% to 53% today. The erosion in workers’ bargaining power has been even more noticeable since the onset of the Great Financial Crisis. Information and communications technology have enabled scale economies that were inconceivable just 25 years ago.

The Daily Update - Part I: Regime change: Inflation

For the next 3 days we feature extracts from our macro-economist Bob Gay’s latest piece ‘Regime Change: Inflation’.

With the nomination of Jerome Powell for Chair of the Federal Reserve Board, we hear much speculation about whether a change in Board members will alter the course and conduct of US monetary policy.  Strong Chairs, including Paul Volcker and Janet Yellen, have managed to guide policy in times of dramatic change in the economic landscape. Mr. Volcker reshaped America’s future by breaking the wage-price nexus of the 1970s. Ms. Yellen will be remembered as the architect of extricating the Fed from the extraordinary policies undertaken in the aftermath of the Global Financial Crisis.

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