First Glance 12L provides a first look at banking and economic conditions within the 12th District. The report, “Interest Rate Shift Helped Housing but Hurt Bank Net Interest Margins,” [Archived PDF] notes that District banks’ average quarterly net interest margin slipped as lower interest rates and loan-to-asset ratios weighed on asset yields. The shifting asset mix contributed to margin compression but benefitted average liquidity and risk-based capital ratios. Districtwide loan and job growth cooled but remained above average, and lower interest rates boosted home prices, affordability, and homebuilding. In addition to supervisory hot topics, the report covers wildfire-related risks in California.
Since the 1980s, computers have reshaped the job market, replacing workers in jobs that rely on routine tasks, from bank tellers to auto workers.
In response, workers moved to two types of non-routine jobs beyond the reach of computers: cognitive (e.g., analysts) and physical (e.g., food servers).
Older workers have fared like all other workers because, overall, they were just as likely to be in the routine jobs that were disrupted.
They also moved into non-routine jobs at similar rates, as the abilities needed for these jobs, such as a college degree or people skills, did not vary much by age.
A subsequent study will explore whether, over the next two decades, increasingly capable computers might favor jobs that do rely on skills that vary by age.
“The wealthy countries must begin providing public climate finance at the scale necessary to support not only adaptation but loss and damage as well, and they must do so in accordance with their responsibility and capacity to act.” This is the main message of a technical report titled “Can Climate Change-Fueled Loss and Damage Ever Be Fair?” launched on the eve of the UN Climate Change Conference (COP25) to be held in Madrid from 2 to 13 December.
The U.S. and the EU owe more than half the cost of repairing future damage says the report, authored by Civil Society Review, an independent group that produces figures on what a “fair share” among countries of the global effort to tackle climate change should look like.
“The poorer countries are bearing the overwhelming majority of the human and social costs of climate change. Consider only one tragic incident—the Cyclones Idai and Kenneth—which caused more than $3 billion in economic damages in Mozambique alone, roughly 20% of its GDP, with lasting implications, not to mention the loss of lives and livelihoods” argues the report. “Given ongoing and deepening climate impacts, to ensure justice and fairness, COP25 must as an urgent matter operationalize loss and damage financing via a facility designed to receive and disburse resources at scale to developing countries.”
The UN Framework Convention on Climate Change (UNFCCC) has defined loss and damage to include harms resulting from sudden-onset events (climate disasters, such as cyclones) as well as slow-onset processes (such as sea level rise). Loss and damage can occur in human systems (such as livelihoods) as well as natural systems (such as biodiversity).
Eight weeks after Hurricane Dorian—the most intense tropical cyclone to ever strike the Bahamas—Prime Minister of Barbados, Mia Amor Mottley, spoke at the United Nations Secretary General’s Climate Action Summit. She said: “For us, our best practice traditionally was to share the risk before disaster strikes, and just over a decade ago we established the Caribbean Catastrophic Risk Insurance Facility. But, the devastation of Hurricane Dorian marks a new chapter for us. Because, as the international community will find out, the CCRIF will not meet the needs of climate refugees or, indeed, will it be sufficient to meet the needs of rebuilding. No longer can we, therefore, consider this as an appropriate mechanism…There will be a growing crisis of affordability of insurance.”
An April 2019 report from ActionAid revealed the insurance and other market based mechanisms fail to meet human rights criteria for responding to loss and damage associated with climate change. The impact of extreme natural disasters is equivalent to an annual global USD$520 billion loss, and forces approximately 26 million people into poverty each year.
Michelle Bachelet, UN High Commissioner for Human Rights, recently warned that the climate crisis is the greatest ever threat to human rights. It threatens the rights to life, health, housing and a clean and safe environment. The UN Human Rights Council has recognized that climate change “poses an immediate and far reaching threat to people and communities around the world and has implications for the full enjoyment of human rights.” In the Paris Agreement, parties to the UN Framework Convention on Climate Change (UNFCCC) acknowledged that they should—when taking action to address climate change—respect, promote and consider their respective obligations with regard to human rights. This includes the right to health, the rights of indigenous peoples, local communities, migrants, children, persons with disabilities and people in vulnerable situations and the right to development, as well as gender equality, the empowerment of women and intergenerational equity. Tackling loss and damage will require a human-rights centered approach that promotes justice and equity.
Across and within countries, the highest per capita carbon emissions are attributable to the wealthiest people, this because individual emissions generally parallel disparities of income and wealth. While the world’s richest 10% cause 50% of emissions, they also claim 52% of the world’s wealth. The world’s poorest 50% contribute approximately 10% of global emissions and receive about 8% of global income. Wealth increases adaptive capacity. All this means that those most responsible for climate change are relatively insulated from its impacts.
Between 1850 and 2002, countries in the Global North emitted three times as many greenhouse gas (GHG) emissions as did the countries in the Global South, where approximately 85% of the global population resides. The average CO2 emissions (metric tons per capita) of citizens in countries most vulnerable to climate change impacts, for example, Mozambique (0.3), Malawi, (0.1), and Zimbabwe (0.9), pale in comparison to the average emissions of a person in the U.S. (15.5), Canada (15.3), Australia (15.8), or UK (6).
In the 1980s, oil companies like Exxon and Shell carried out internal assessments of the carbon dioxide released by fossil fuels, and forecast the planetary consequences of these emissions, including the inundation of entire low-lying countries, the disappearance of specific ecosystems or habitat destruction, destructive floods, the inundation of low-lying farmland, and widespread water stress.
Nevertheless, the same companies and countries have pursued high reliance on GHG emissions, often at the expense of communities where fossil fuels are found (where oil spills, pollution, land grabs, and displacement is widespread) and certainly at the expense of public understanding, even as climate change harms and risks increased. Chevron, Exxon, BP and Shell together are behind more than 10% of the world’s carbon emissions since 1966. They originated in the Global North and its governments continue to provide them with financial subsidies and tax breaks.
Responsibility for, and capacity to act on, mitigation, adaptation and loss and damage varies tremendously across nations and among classes. It must also be recognized that the Nationally Determined Contributions (climate action plans or NDCs) that have thus far been proposed by the world’s nations are not even close to being sufficient, putting us on track for approximately 4°C of warming. They are also altogether out of proportion to national capacity and responsibility, with the developing countries generally proposing to do their fair shares, and developed countries proposed far too little.
Unfortunately, as Kevin Anderson (Professor of Energy and Climate Change at the University of Manchester and a former Director of the Tyndall Centre for Climate Change Research) has said: “a 4°C future is incompatible with an organized global community, is likely to be beyond ‘adaptation,’ is devastating to the majority of ecosystems, and has a high probability of not being stable.”
Equity analysis
The report assess countries’ NDCs against the demands of a 1.5°C pathway using two ‘fair share’ benchmarks, as in the previous reports of the Civil Society Equity Review coalition. These ‘fair share’ benchmarks are grounded in the principle-based claims that countries should act in accordance with their responsibility for causing the climate problem and their capacity to help solve it. These principles are both well-established within the climate negotiations and built into both the UNFCCC and the Paris Agreement.
To be consistent with the UNFCCC’s equity principles—the wealthier countries must urgently and dramatically deepen their own emissions reduction efforts, contribute to mitigation, adaptation and addressing loss and damage initiatives in developing countries; and support additional sustainable actions outside their own borders that enable climate-compatible sustainable development in developing countries.
For example, consider the European Union, whose fair share of the global emission reduction effort in 2030 is roughly about 22% of the global total, or about 8 Gigatons of CO2 equivalent (GtCO2eq). Since its total emissions are less than 5 GtCO2eq, the EU would have to reduce its emissions by approximately 160% per cent below 1990 levels by 2030 if it were to meet its fair share entirely through domestic reductions. It is not physically possible to reduce emissions by more than 100% domestically. So, the only way in which the EU can meet its fair share is by funding mitigation, adaptation and loss and damage efforts in developing countries.
Today’s mitigation commitments are insufficient to prevent unmanageable climate change, and—coming on top of historic emissions—they are setting in motion devastating changes to our climate and natural environment. These impacts are already prevalent, even with our current global average surface temperature rise of about 1°C. Impacts include droughts, firestorms, shifting seasons, sea-level rise, salt-water intrusion, glacial retreat, the spread of vector borne diseases, and devastation from cyclones and other extreme weather events. Some of these impacts can be minimized through adaptation measures designed to increase resilience to inevitable impacts.
These measures include, for example, renewing mangroves to prevent erosion and reduce flooding caused by storms, regulating new construction so that buildings can withstand tomorrow’s severe weather, using scarce water resources efficiently, building flood defenses, and setting aside land corridors to help species migrate. It is also crucial with such solutions that forest dwelling and indigenous peoples be given enforceable land rights, for not only are such rights matters of basic justice, they are also pragmatic recognitions of the fact that indigenous peoples have successfully protected key ecosystems.
Tackling underlying social injustices and inequalities—including through technological and financial transfers, as well as though capacity building—would also contribute to increasing resilience. Other climate impacts, however, are unavoidable, unmanageable or unpredictable, leading to a huge degree of loss and damage. Experts estimate the financial damage also will reach at least USD$300-700 billion by 2030, but the loss of locally sustained livelihoods, relationships and connections to ancestral lands are incalculable.
Failure to reduce GHG emissions now—through energy efficiency, waste reduction, renewable energy generation, reduced consumption, sustainable agriculture and transport—will only deepen impacts in the future. Avoidable impacts require urgent adaptation measures. At the same time, unavoidable and unmanageable change impacts—such as loss of homes, livelihoods, crops, heat and water stress, displacement, and infrastructure damage—need adequate responses through well-resourced disaster response plans and social protection policies.
For loss and damage financing, developed countries have a considerable responsibility and capacity to pay for harms that are already occurring. Of course, many harms will be irreparable in financial terms. However, where monetary contributions can help restore the livelihoods or homes of individuals exposed to climate change impacts, they must be paid. Just as the EU’s fair share of the global mitigation effort is approximately 22% in 2030, it could be held accountable for that same share of the financial support for such incidents of loss and damage in that year.
The table below provides an illustrative quantification of this simple application of fair shares to loss and damage estimates, and how they change if we compute the contribution to global climate change from the start of the industrial revolution in 1850 or from 1950.
Table 1: Countries’ Share of Global Responsibility and Capacity in 2019, the time of Cyclones Idai and Kenneth, as illustrative application of a fair share approach to Loss and Damage funding requirements.
The advantage of setting out responsibility and capacity to act in such numerical terms is to drive equitable and robust action today. Responsible and capable countries must—of course—ensure that those most able to pay towards loss and damage repairs are called upon to do so through domestic legislation that ensures correlated progressive responsibility. However, it should also motivate mitigation action to ensure that harms are not deepened in the future.
In the Equity analysis used here, capacity—a nation’s financial ability to contribute to solving the climate problem—can be captured by a quantitative benchmark defined in a more or less progressive way, making the definition of national capacity dependent on national income distribution. This means a country’s capacity is calculated in a manner that can explicitly account for the income of the wealthy more strongly than that of the poor, and can exclude the incomes of the poorest altogether. Similarly, responsibility—a nation’s contribution to the planetary GHG burden—can be based on cumulative GHG emissions since a range of historical start years, and can consider the emissions arising from luxury consumption more strongly than emissions from the fulfillment of basic needs, and can altogether exclude the survival emissions of the poorest. Of course, the ‘right’ level of progressivity, like the ‘right’ start year, are matters for deliberation and debate.1
The report acknowledges “the difficulties in estimating financial loss and damage and the limited data we currently have,” but it recommends nevertheless “a minimal goal of providing at least USD$300 billion per year by 2030 of financing for loss and damage through the UNFCCC’s Warsaw International Mechanism for Loss and Damage (WIM).” Given that this corresponds to a conservative estimate of damage costs, the report further recommends “the formalization of a global obligation to revise this figure upward as observed and forecast damages increase.”
The new finance facility should provide “public climate financing and new and innovative sources of financing, in addition to budget contributions from rich countries, that can truly generate additional resources (such as air and maritime levies, Climate Damages Tax on oil, gas and coal extraction, a Financial Transaction Tax) at a progressive scale to reach at least USD$300 billion by 2030.” This means aiming for at least USD$150 billion by 2025 and ratcheting up commitments on an annual basis. Ambition targets should be revised based on the level of quantified and quantifiable harms experienced.
Further, developing countries who face climate emergencies should benefit from immediate debt relief–in the form of an interest-free moratorium on debt payments. This would open up resources currently earmarked for debt repayments to immediate emergency relief and reconstruction.
Finally, a financial architecture needs to be set up that ensures funding reaches the marginalized communities in developing countries, and that such communities have decision making say over reconstruction plans. Funds should reach communities in an efficient and effective manner, taking into account existing institutions as appropriate.
Currently, the Paris Rulebook allows countries to count non-grant instruments as climate finance, including commercial loans, equity, guarantees and insurance. Under these rules, the United States could give a USD$50 million commercial loan to Malawi for a climate mitigation project. This loan would have to be repaid at marketinterest rates—a net profit for the U.S.—so its grant-equivalence is $0. But under the Paris Rulebook, the U.S. could report the loan’s face value ($50 million) as climate finance. This is not acceptable. COP25 must ensure that the WIM has robust outcomes and sufficient authority to deliver a fair and ambitious outcome for the poorest and most vulnerable in relation to loss & damage.
Note
For more details, including how progressivity is calculated and a description of the standard data sets upon which those calculations are based, see the referenceproject page. For an interactive experience and a finer set of controls, see the Climate Equity Reference Calculator. (return to text)
(Speech by Governor Lael Brainard, at the Presentation of the 2019 William F. Butler Award New York Association for Business Economics, New York, New York)
It is a pleasure to be here with you. It is an honor to join the 45 outstanding economic researchers and practitioners who are past recipients of the William F. Butler Award. I want to express my deep appreciation to the New York Association for Business Economics (NYABE) and NYABE President Julia Coronado.
I will offer my preliminary views on the Federal Reserve’s review of its monetary policy strategy, tools, and communications after first touching briefly on the economic outlook. These remarks represent my own views. The framework review is ongoing and will extend into 2020, and no conclusions have been reached at this time.1
Outlook and Policy
There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market, despite persistent uncertainty about trade conflict and disappointing foreign growth. Recent data provide some reassurance that consumerspending continues to expand at a healthy pace despite some slowing in retail sales. Consumer sentiment remains solid, and the employment picture is positive. Housing seems to have turned a corner and is poised for growth following several weak quarters.
Employment remains strong. The employment-to-population ratio for prime-age adults has moved up to its pre-recession peak, and the three-month moving average of the unemployment rate is near a 50-year low.2 Monthly job gains remain above the pace needed to absorb new entrants into the labor force despite some slowing since last year. And initial claims for unemployment insurance—a useful real-time indicator historically—remain very low despite some modest increases.
Foreign growth remains subdued. While there are signs that the decline in euro-area manufacturing is stabilizing, the latest indicators on economic activity in China remain sluggish, and the news in Japan and in many emerging markets has been disappointing. Overall, it appears third-quarter foreign growth was weak, and the latest indicators point to little improvement in the fourth quarter.
More broadly, the balance of risks remains to the downside, although there has been some improvement in risk sentiment in recent weeks. The risk of a disorderly Brexit in the near future has declined significantly, and there is some hope that a U.S.–Chinatrade truce could avert additional tariffs. While risks remain, financial market indicators suggest market participants see a diminution in such risks, and probabilities of recessions from models using market data have declined.
The baseline is for continued moderate expansion, a strong labor market, and inflation moving gradually to our symmetric 2 percent objective. The Federal Open Market Committee (FOMC) has taken significant action to provide insurance against the risks associated with trade conflict and weak foreign growth against a backdrop of muted inflation. Since July, the Committee has lowered the target range for the federal funds rate by ¾ percentage point, to the current range of 1½ to 1¾ percent. It will take some time for the full effect of this accommodation to work its way through economic activity, the labor market, and inflation. I will be watching the data carefully for signs of a material change to the outlook that could prompt me to reassess the appropriate path of policy.
Review
The Federal Reserve is conducting a review of our monetary policy strategy, tools, and communications to make sure we are well positioned to advance our statutory goals of maximum employment and price stability.3 Three key features of today’s new normal call for a reassessment of our monetary policy strategy: the neutral rate is very low here and abroad, trend inflation is running below target, and the sensitivity of price inflation to resource utilization is very low.4
First, trend inflation is below target.5 Underlying trend inflation appears to be running a few tenths below the Committee’s symmetric 2 percent objective, according to various statistical filters. This raises the risk that households and businesses could come to expect inflation to run persistently below our target and change their behavior in a way that reinforces that expectation. Indeed, with inflation having fallen short of 2 percent for most of the past seven years, inflation expectations may have declined, as suggested by some survey-based measures of long-run inflation expectations and by market-based measures of inflation compensation.
Second, the sensitivity of price inflation to resource utilization is very low. This is what economists mean when they say that the Phillips curve is flat. A flat Phillips curve has the important advantage of allowing employment to continue expanding for longer without generating inflationary pressures, thereby providing greater opportunities to more people. But it also makes it harder to achieve our 2 percent inflation objective on a sustained basis when inflation expectations have drifted below 2 percent.
Third, the long-run neutral rate of interest is very low, which means that we are likely to see more frequent and prolonged episodes when the federal funds rate is stuck at its effective lower bound (ELB).6The neutral rate is the level of the federal funds rate that would keep the economy at full employment and 2 percent inflation if no tailwinds or headwinds were buffeting the economy. A variety of forces have likely contributed to a decline in the neutral rate, including demographic trends in many large economies, some slowing in the rate of productivity growth, and increases in the demand for safe assets. When looking at the Federal Reserve’s Summary of Economic Projections (SEP), it is striking that the Committee’s median projection of the longer-run federal funds rate has moved down from 4¼ percent to 2½ percent over the past seven years.7 A similar decline can be seen among private forecasts.8 This decline means the conventional policy buffer is likely to be only about half of the 4½ to 5 percentage points by which the FOMC has typically cut the federal funds rate to counter recessionary pressures over the past five decades.
This large loss of policy space will tend to increase the frequency or length of periods when the policy rate is pinned at the ELB, unemployment is elevated, and inflation is below target.9 In turn, the experience of frequent or extended periods of low inflation at the ELB risks eroding inflation expectations and further compressing the conventional policy space. The risk is a downward spiral where conventional policy space gets compressed even further, the ELB binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. While consumers and businesses might see very low inflation as having benefits at the individual level, at the aggregate level, inflation that is too low can make it very challenging for monetary policy to cut the short-term nominal interest rate sufficiently to cushion the economy effectively.10
The experience of Japan and of the euro area more recently suggests that this risk is real. Indeed, the fact that Japan and the euro area are struggling with this challenging triad further complicates our task, because there are important potential spillovers from monetary policy in other major economies to our own economy through exchange rate and yield curve channels.11
In light of the likelihood of more frequent episodes at the ELB, our monetary policy review should advance two goals. First, monetary policy should achieve average inflation outcomes of 2 percent over time to re-anchor inflation expectations at our target. Second, we need to expand policy space to buffer the economy from adverse developments at the ELB.
Achieving the Inflation Target
The apparent slippage in trend inflation below our target calls for some adjustments to our monetary policy strategy and communications. In this context and as part of our review, my colleagues and I have been discussing how to better anchor inflation expectations firmly at our objective. In particular, it may be helpful to specify that policy aims to achieve inflation outcomes that average 2 percent over time or over the cycle. Given the persistent shortfall of inflation from its target over recent years, this would imply supporting inflation a bit above 2 percent for some time to compensate for the period of underperformance.
One class of strategies that has been proposed to address this issue are formal “makeup” rules that seek to compensate for past inflation deviations from target. For instance, under price-level targeting, policy seeks to stabilize the price level around a constant growth path that is consistent with the inflation objective.12 Under average inflation targeting, policy seeks to return the average of inflation to the target over some specified period.13
To be successful, formal makeup strategies require that financial market participants, households, and businesses understand in advance and believe, to some degree, that policy will compensate for past misses. I suspect policymakers would find communications to be quite challenging with rigid forms of makeup strategies, because of what have been called time-inconsistency problems. For example, if inflation has been running well below—or above—target for a sustained period, when the time arrives to maintain inflation commensurately above—or below—2 percent for the same amount of time, economic conditions will typically be inconsistent with implementing the promised action. Analysis also suggests it could take many years with a formal average inflation targeting framework to return inflation to target following an ELB episode, although this depends on difficult-to-assess modeling assumptions and the particulars of the strategy.14
Thus, while formal average inflation targeting rules have some attractive properties in theory, they could be challenging to implement in practice. I prefer a more flexible approach that would anchor inflation expectations at 2 percent by achieving inflation outcomes that average 2 percent over time or over the cycle. For instance, following five years when the public has observed inflation outcomes in the range of 1½ to 2 percent, to avoid a decline in expectations, the Committee would target inflation outcomes in a range of, say, 2 to 2½ percent for the subsequent five years to achieve inflation outcomes of 2 percent on average overall. Flexible inflation averaging could bring some of the benefits of a formal average inflation targeting rule, but it would be simpler to communicate. By committing to achieve inflation outcomes that average 2 percent over time, the Committee would make clear in advance that it would accommodate rather than offset modest upward pressures to inflation in what could be described as a process of opportunistic reflation.15
Policy at the ELB
Second, the Committee is examining what monetary policy tools are likely to be effective in providing accommodation when the federal funds rate is at the ELB.16 In my view, the review should make clear that the Committee will actively employ its full toolkit so that the ELB is not an impediment to providing accommodation in the face of significant economic disruptions.
The importance and challenge of providing accommodation when the policy rate reaches the ELB should not be understated. In my own experience on the international response to the financial crisis, I was struck that the ELB proved to be a severe impediment to the provision of policy accommodation initially. Once conventional policy reached the ELB, the long delays necessitated for policymakers in nearly every jurisdiction to develop consensus and take action on unconventional policy sapped confidence, tightened financial conditions, and weakened recovery. Economic conditions in the euro area and elsewhere suffered for longer than necessary in part because of the lengthy process of building agreement to act decisively with a broader set of tools.
Despite delays and uncertainties, the balance of evidence suggests forward guidance and balance sheet policies were effective in easing financial conditions and providing accommodation following the global financial crisis.17 Accordingly, these tools should remain part of the Committee’s toolkit. However, the quantitative asset purchase policies that were used following the crisis proved to be lumpy both to initiate at the ELB and to calibrate over the course of the recovery. This lumpiness tends to create discontinuities in the provision of accommodation that can be costly. To the extent that the public is uncertain about the conditions that might trigger asset purchases and how long the purchases would be sustained, it undercuts the efficacy of the policy. Similarly, significant frictions associated with the normalization process can arise as the end of the asset purchase program approaches.
For these reasons, I have been interested in exploring approaches that expand the space for targeting interest rates in a more continuous fashion as an extension of our conventional policy space and in a way that reinforces forward guidance on the policy rate.18 In particular, there may be advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum—yield curve caps—in tandem with forward guidance that conditions liftoff from the ELB on employment and inflation outcomes.
To be specific, once the policy rate declines to the ELB, this approach would smoothly move to capping interest rates on the short-to-medium segment of the yield curve. The yield curve ceilings would transmit additional accommodation through the longer rates that are relevant for households and businesses in a manner that is more continuous than quantitative asset purchases. Moreover, if the horizon on the interest rate caps is set so as to reinforce forward guidance on the policy rate, doing so would augment the credibility of the yield curve caps and thereby diminish concerns about an open-ended balance sheet commitment. In addition, once the targeted outcome is achieved, and the caps expire, any securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably. This is important, as it could potentially avoid some of the tantrum dynamics that have led to premature steepening at the long end of the yield curve in several jurisdictions.
Forward guidance on the policy rate will also be important in providing accommodation at the ELB. As we saw in the United States at the end of 2015 and again toward the second half of 2016, there tends to be strong pressure to “normalize” or lift off from the ELB preemptively based on historical relationships between inflation and employment. A better alternative would have been to delay liftoff until we had achieved our targets. Indeed, recent research suggests that forward guidance that commits to delay the liftoff from the ELB until full employment and 2 percent inflation have been achieved on a sustained basis—say over the course of a year—could improve performance on our dual-mandate goals.19
To reinforce this commitment, the forward guidance on the policy rate could be implemented in tandem with yield curve caps. For example, as the federal funds rate approaches the ELB, the Committee could commit to refrain from lifting off the ELB until full employment and 2 percent inflation are sustained for a year. Based on its assessment of how long this is likely take, the Committee would then commit to capping rates out the yield curve for a period consistent with the expected horizon of the outcome-based forward guidance. If the outlook shifts materially, the Committee could reassess how long it will take to get inflation back to 2 percent and adjust policy accordingly. One benefit of this approach is that the forward guidance and the yield curve ceilings would reinforce each other.
The combination of a commitment to condition liftoff on the sustained achievement of our employment and inflation objectives with yield curve caps targeted at the same horizon has the potential to work well in many circumstances. For very severe recessions, such as the financial crisis, such an approach could be augmented with purchases of 10-year Treasury securities to provide further accommodation at the long end of the yield curve. Presumably, the requisite scale of such purchases—when combined with medium-term yield curve ceilings and forward guidance on the policy rate—would be relatively smaller than if the longer-term asset purchases were used alone.
Monetary Policy and Financial Stability
Before closing, it is important to recall another important lesson of the financial crisis: The stability of the financial system is important to the achievement of the statutory goals of full employment and 2 percent inflation. In that regard, the changes in the macroeconomic environment that underlie our monetary policy review may have some implications for financial stability. Historically, when the Phillips curve was steeper, inflation tended to rise as the economy heated up, which prompted the Federal Reserve to raise interest rates. In turn, the interest rate increases would have the effect of tightening financial conditions more broadly. With a flat Phillips curve, inflation does not rise as much as resource utilization tightens, and interest rates are less likely to rise to restrictive levels. The resulting lower-for-longer interest rates, along with sustained high rates of resource utilization, are conducive to increasing risk appetite, which could prompt reach-for-yield behavior and incentives to take on additional debt, leading to financial imbalances as an expansion extends.
To the extent that the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation may lead financial stability risks to become more tightly linked to the business cycle, it would be preferable to use tools other than tightening monetary policy to temper the financial cycle. In particular, active use of macroprudential tools such as the countercyclical buffer is vital to enable monetary policy to stay focused on achieving maximum employment and average inflation of 2 percent on a sustained basis.
Conclusion
The Federal Reserve’s commitment to adapt our monetary policy strategy to changing circumstances has enabled us to support the U.S. economy throughout the expansion, which is now in its 11th year. In light of the decline in the neutral rate, low trend inflation, and low sensitivity of inflation to slack as well as the consequent greater frequency of the policy rate being at the effective lower bound, this is an important time to review our monetary policy strategy, tools, and communications in order to improve the achievement of our statutory goals. I have offered some preliminary thoughts on how we could bolster inflation expectations by achieving inflation outcomes of 2 percent on average over time and, when policy is constrained by the ELB, how we could combine forward guidance on the policy rate with caps on the short-to-medium segment of the yield curve to buffer the economy against adverse developments.
For example, the Blue Chip Consensus long-run projection for the three-month Treasury bill has declined from 3.6 percent in October 2012 to 2.4 percent in October 2019. See Wolters Kluwer (2019), Blue Chip Economic Indicators, vol. 44 (October 10); and Wolters Kluwer (2012), Blue Chip Economic Indicators, vol. 37 (October 10). (return to text)
The important observation that some consumers and businesses see low inflation as having benefits emerged from listening to a diverse range of perspectives, including representatives of consumer, labor, business, community, and other groups during the Fed Listens events; for details, see this page. (return to text)
For details on purchases of securities by the Federal Reserve, see this page. For a discussion of forward guidance, see this page. See, for example, Simon Gilchrist and Egon Zakrajšek (2013), “The Impact of the Federal Reserve’s Large-Scale Asset Purchase Programs on Corporate Credit Risk,” Journal of Money, Credit and Banking, vol. 45, (s2, December), pp. 29–57; Simon Gilchrist, David López-Salido, and Egon Zakrajšek (2015), “Monetary Policy and Real Borrowing Costs at the Zero Lower Bound,” American Economic Journal: Macroeconomics, vol. 7 (January), pp. 77–109; Jing Cynthia Wu and Fan Dora Xia (2016), “Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound,” Journal of Money, Credit and Banking, vol. 48 (March–April), pp. 253–91; and Stefania D’Amico and Iryna Kaminska (2019), “Credit Easing versus Quantitative Easing: Evidence from Corporate and Government Bond Purchase Programs” [archived PDF], Bank of England Staff Working Paper Series 825 (London: Bank of England, September). (return to text)
Involuntary part-timeemployment reached unusually high levels during the last recession and declined only slowly afterward. The speed of the decline was limited because of a combination of two factors: the number of people working part-time due to slack business conditions was declining, and the number of those who could find only part-time work continued to increase until 2013. Involuntary part-timeemployment recently returned to its pre-recession level but remains slightly elevated relative to historically low unemployment, likely due to structural factors.
They find that most states ended the year with surpluses. Yet states worry that the stimulus effect of the Trump tax cut is disappearing, forecasting weaker growth in income tax revenues for the fiscal year 2020.
These analyses are based on data gathered directly from individual states. This collection is the only timely and accurate data source covering state tax revenue and fiscal performance for baselines and comparisons.
Abstract
State government tax revenues rebounded in the first quarter of 2019 after declines in the fourth quarter of 2018. However, year-over-year growth was substantially weaker in the first quarter of 2019 than in the final quarter of 2017 and the first three quarters of 2018. Most of the recent weakness was attributable to personal income tax declines.
State personal income taxes declined for the second consecutive quarter, reflecting a spike in state income tax payments in December 2017 and January 2018 in response to changes made in the TCJA. However, preliminary data for the second quarter of 2019 indicate double-digit growth in state personal income tax revenues, mostly because of higher final payments and delayed estimated payments filed in April. The surge in personal income tax revenues made up for earlier shortfalls in most states and put the revenues back on track for the states to close the budget books for fiscal year 2019 without shortfalls.
The provision of financial services and products is undergoing rapid transformation, including through the development of stablecoins, which seek to stabilize the price of a digital currency by linking its value to that of a pool of assets. Stablecoins can potentially serve as a means of payment and store of value, and may contribute to the development of global payment arrangements that are faster, cheaper, and more inclusive. Yet these potential benefits can only be realized if significant risks are addressed. Stablecoin initiatives built on an existing big tech platform with a global customer base may have the potential to scale rapidly, and could pose regulatory and oversight challenges and risks related to consumer protection, fair competition, and the combating of money laundering and terrorism financing, among others, as well as have a significant impact on public policy goals such as financial stability and monetary policy transmission. This paper, written jointly by G7 members, the BIS, and the IMF, including RESMF staff, scopes the causes and implications of the adoption of global stablecoins, and the potential policy efforts to rein in the risks they can bring about.
We study the optimal design of a central bank digital currency (CBDC) in an environment where agents sort into cash, CBDC and bank deposits according to their preferences over anonymity and security; and where network effects make the convenience of payment instruments dependent on the number of their users. CBDC can be designed with attributes similar to cash or deposits, and can be interest-bearing: a CBDC that closely competes with deposits depresses bankcredit and output, while a cash-like CBDC may lead to the disappearance of cash. Then, the optimal CBDC design trades off bank intermediation against the social value of maintaining diverse payment instruments. When network effects matter, an interest-bearing CBDC alleviates the central bank’s tradeoff.
We estimate world cycles using a new quarterly dataset of output, credit and assetprices assembled using IMF archives and covering a large set of advanced and emerging economies since 1950. World cycles, both real and financial, exist and are generally driven by US shocks. But their impact is modest for most countries. The global financial cycle is also much weaker when looking at credit rather than assetprices. We also challenge the view that synchronization has increased over time. Although this is true for prices (goods and assets), this not true for quantities (output and credit). The world business and credit cycles were as strong during Bretton Woods (1950–1972) as during the Globalization period (1984-2006). For most countries, the way their output co-moves with the rest of the world has changed little over the last 70 years. We discuss the reasons behind these new findings and their policy implications for small open economies.
by Nina Biljanovska, Lucyna Gornicka & Alexandros Vardoulakis
An asset bubble relaxes collateral constraints and increases borrowing by credit-constrained agents. At the same time, as the bubble deflates when constraints start binding, it amplifies downturns. We show analytically and quantitatively that the macroprudential policy should optimally respond to building asset price bubbles non-monotonically depending on the underlying level of indebtedness. If the level of debt is moderate, policy should accommodate the bubble to reduce the incidence of a binding collateral constraint. If debt is elevated, policy should lean against the bubble more aggressively to mitigate the pecuniary externalities from a deflating bubble when constraints bind.
by Senay Agca, Deniz O Igan, Fuhong Li & Prachi Mishra
Why do firms lobby? This paper exploits the unanticipated sequestration of federal budget accounts in March 2013 that reduced the availability of government funds disbursed through procurement contracts to shed light on this question. Following this event, firms with little or no prior exposure to the federal accounts that experienced cuts reduced their lobbying spending. In contrast, firms with a high degree of exposure to the cuts maintained and even increased their lobbying spending. This suggests that, when the same number of contractors competed for a piece of a reduced pie, the more affected firms likely intensified their lobbying efforts to distinguish themselves from the others and improve their chances of procuring a larger share of the smaller overall. These findings are stronger in government-dependent sectors and when there is intense competition. The evidence is more consistent with a rent-seeking explanation for lobbying.
by Deniz O Igan, Hala Moussawi, Alexander F. Tieman, Aleksandra Zdzienicka, Giovanni Dell’Ariccia, Paolo Mauro
We track direct public interventions and public holdings in 1,114 financial institutions over the period 2007–17 in 37 countries based on publicly available information. We use aggregate official data to validate this new dataset and estimate the fiscal impact of interventions, including the value of asset holdings remaining in state hands at end-2017. Direct public support to financial institutions amounted to $1.6 trillion ($3.5 trillion including guarantees), with larger amounts allocated to lower capitalized and less profitable banks. As of end-2017, only a few countries had fully divested the initial support they provided during the crisis. Public holdings were divested faster in better capitalized, more profitable, and more liquid banks, and in countries where the economy recovered faster. In countries where the government stake remained high relative to the initial intervention, private investment and credit growth were slower, financial access, depth, efficiency, and competition were worse, and financial stability improved less.
Over the past three decades, the price of machinery and equipment fell dramatically relative to other prices in advanced and emerging market and developing economies. Using cross-country and sectoral data, we show that the decline in the relative price of tangible tradablecapital goods provided a significant impetus to the capital deepening that took place during the same time period. The broad-based decline in the relative price of machinery and equipment, in turn, was driven by the faster productivity growth in the capital goods producing sectors relative to the rest of the economy, and deeper trade integration, which induced domestic producers to lower prices and increase their efficiency. Our findings suggest an additional channel through which rising trade tensions and sluggish productivity could threaten real investment growth going forward.
We study the impact of bankcredit on firm productivity. We exploit a matched firm-bank database covering all the credit relationships of Italiancorporations, together with a natural experiment, to measure idiosyncratic supply-side shocks to credit availability and to estimate a production model augmented with financial frictions. We find that a contraction in credit supply causes a reduction of firm TFP growth and also harms IT-adoption, innovation, exporting, and adoption of superior management practices, while a credit expansion has limited impact. Quantitatively, the credit contraction between 2007 and 2009 accounts for about a quarter of observed the decline in TFP.
by Antonio Fatás, Atish R. Ghosh, Ugo Panizza & Andrea F Presbitero
Governments issue debt for good and bad reasons. While the good reasons—intertemporal tax-smoothing, fiscal stimulus, and asset management—can explain some of the increases in public debt in recent years, they cannot account for all of the observed changes. Bad reasons for borrowing are driven by political failures associated with intergenerational transfers, strategic manipulation, and common pool problems. These political failures are a major cause of overborrowing though budgetary institutions and fiscal rules can play a role in mitigating governments’ tendencies to overborrow. While it is difficult to establish a clear causal link from high public debt to low output growth, it is likely that some countries pay a price—in terms of lower growth and greater output volatility—for excessive debt accumulation.
by Harald Hau, Peter Hoffmann, Sam Langfield & Yannick Timmer
New regulatory data reveal extensive price discrimination against non-financial clients in the FX derivatives market. The client at the 90th percentile pays an effective spread of 0.5%, while the bottom quarter incur transaction costs of less than 0.02%. Consistent with models of search frictions in over-the-counter markets, dealers charge higher spreads to less sophisticated clients. However, price discrimination is eliminated when clients trade through multi-dealer request-for-quote platforms. We also document that dealers extract rents from captive clients and market opacity, but only for contracts negotiated bilaterally with unsophisticated clients.
As late as 2006, average emissions for new passenger vehicles registered in the EU were around 161 g/km. As cars became smaller and lighter, that figure fell to 118 g/km in 2016. But this average crept back up, owing to an increase in the market share of gasoline engines, which emit more CO2 than diesel engines do. By 2018, the average emissions of newly registered cars had once again climbed to slightly above 120 g/km, which is twice what will be permitted in the long term.
Even the most gifted engineers will not be able to build internal combustion engines (ICEs) that meet the EU’s prescribed standards (unless they force their customers into soapbox cars). But, apparently, that is precisely the point. The EU wants to reduce fleet emissions by forcing a shift to electric vehicles. After all, in its legally binding formula for calculating fleet emissions, it simply assumes that EVs do not emit any CO2 whatsoever.
The implication is that if an auto company’s production is split evenly between EVs and ICE vehicles that conform to the present average, the 59 g/km target will be just within reach. If a company cannot produce EVs and remains at the current average emissions level, it will have to pay a fine of around €6,000 ($6,600) per car, or otherwise merge with a competitor that can build EVs.
But the EU’s formula is nothing but a huge scam. EVs also emit substantial amounts of CO2, the only difference being that the exhaust is released at a remove—that is, at the power plant. As long as coal– or gas-firedpower plants are needed to ensure energy supply during the “dark doldrums” when the wind is not blowing and the sun is not shining, EVs, like ICE vehicles, run partly on hydrocarbons. And even when they are charged with solar– or wind-generated energy, enormous amounts of fossil fuels are used to produce EV batteries in China and elsewhere, offsetting the supposed emissions reduction. As such, the EU’s intervention is not much better than a cut-off device for an emissions control system.
Adding further evidence, the Austrian think tank Joanneum Research has just published a large-scale study [PDF, in German] commissioned by the Austrian automobile association, ÖAMTC, and its German counterpart, ADAC, that also confirms those findings. According to this study, a mid-sized electric passenger car in Germany must drive 219,000 kilometers before it starts outperforming the corresponding dieselcar in terms of CO2 emissions. The problem, of course, is that passenger cars in Europe last for only 180,000 kilometers, on average. Worse, according to Joanneum, EV batteries don’t last long enough to achieve that distance in the first place. Unfortunately, drivers’ anxiety about the cars’ range prompts them to recharge their batteries too often, at every opportunity, and at a high speed, which is bad for durability.
As for EU lawmakers, there are now only two explanations for what is going on: either they didn’t know what they were doing, or they deliberately took Europeans for a ride. Both scenarios suggest that the EU should reverse its interventionist industrial policy, and instead rely on market-based instruments such as a comprehensive emissions trading system.
With Germany’s energy mix, the EU’s regulation on fleet fuel consumption will not do anything to protect the climate. It will, however, destroy jobs, sap growth, and increase the public’s distrust in the EU’s increasingly opaque bureaucracy.
from M. Ayhan Kose, Director, Prospects Group, World Bank Group:
Dear Colleagues.
This year marks the tenth anniversary of the 2009 global recession. Most emerging market and developing economies (EMDEs) weathered the global recession relatively well, in part by using the sizeable fiscal and monetary policy buffers accumulated during the prior years of strong growth. However, a short-lived rebound in activity has been followed by a decade of protracted weakness in EMDEs amid bouts of financial market stress, falling commodity prices, and subdued trade and investment.
Are EMDEs ready to face a deeper global downturn, if it materializes? Our new study A Decade After the Global Recession: Lessons and Challenges for Emerging and Developing Economies [PDF] takes on this question. It examines developments of the past decade, draws lessons for these economies, and discusses policy options. The study is the first comprehensive analysis on the topic with a truly EMDE focus. It offers three main conclusions. First, perhaps for the first time, many EMDEs were able to implement large-scale countercyclical fiscal and monetary policy stimulus during the last global recession. Second, looking ahead, policymakers in many EMDEs are now equipped with stronger policy frameworks than in earlier global downturns or financial crises. Third, EMDEs have now less policy room to face a global downturn than they had before the 2009 global recession. Irrespective of the timing of the next global downturn, the big lesson of the past decade for EMDEs is clear: since they are less well prepared today than prior to the 2009 episode, they urgently need to undertake cyclical and structural policy measures to be able to effectively confront the next downturn when it happens.
You can download the book here [PDF]. Its table of contents is below (each chapter individually downloadable). All charts featured in the book (with underlying data series) are also available below.
This post reviews many of the papers and presentations from the workshop dealing with both financial regulation and innovations in financial technology. It also reviews one of the keynote speeches on the important topic of corporate governance. A companion macroblog post summarizes the workshop’s discussion of digital currencies.
Post-crisis changes in regulation
Some banks had difficulty obtaining adequate funding from private financial markets during the crisis of 2007–08, despite being well capitalized by that period’s capital standards. In part, these funding difficulties were a result of bank depositors fearing that banks had not adequately provisioned for their credit losses.
A paper by University of Michigan professors Thomas Flanagan and Amiyatosh Purnanandam examines the question “Why Do Banks Hide Losses?” [PDF] with a particular focus on the role of shareholder monitoring and management incentives. One problem in conducting such a study is that of separating bad investment decisions from deceptive accounting. This paper exploits an unexpected change in regulation in India to help provide such separation. This regulatory change forced all of the banks in that country to detail the extent of their underreporting of loan losses in 2015. The paper finds that weaker shareholder monitoring and higher-power executive compensation contracts are associated with more underreporting of loan losses.1 This paper helps us to understand how banks exploit accounting discretion over loan losses and reinforces the importance of supervisory oversight.
The funding problems encountered by U.S. banks led to runs and ultimately the collapse of a few banks, but these problems had a significant effect on the operations of some banks that survived. One measure of the vulnerability of a bank to a funding shock was its reliance on uninsured, wholesale deposits from large institutions. Professors Sudheer Chava of Georgia Institute of Technology, Rohan Ganduri of Emory University, Linghang Zeng of Babson College, and graduate student Nikhil Paradkar of Georgia Tech examine one effect of these shocks in their paper “Shocked by Bank Funding Shocks: Evidence from 500 Million Consumer Credit Cards” [PDF]. The paper finds that banks that were more exposed to wholesale funding shocks made larger cuts in consumercredit lines than other banks. The authors further find that these cutbacks were made to the most credit-constrained customers (those with lower credit scores and higher utilization of their credit line). The results also suggest that these credit-constrained consumers responded by cutting back their consumption. Overall, these results provide additional support for regulatory policies intended to strengthen banks so that they can continue lending through future crises.
The Federal Reserve was created in 1913 in large part to provide a source of liquidity during periods of stress in bank lending markets. Yet banks proved surprisingly resistant to borrowing from the Fed’s discount window at the start of the funding problems in the fall of 2007. In an attempt to overcome this reluctance to borrow, the Fed created the Term Auction Facility (TAF) in December 2007. A paper by professors Yunzhi Hu of the University of North Carolina at Chapel Hill and Hanzhe Zhang from Michigan State University examines the TAF in a paper titled “Overcoming Borrowing Stigma: The Design of Lending-of-Last-Resort Policies” [PDF]. This paper develops a simple model in which TAF funding is preferred by stronger banks because the funds are only available with a delay (that is, the funds will not help a bank facing an immediate run) and because TAF gives stronger banks the potential to borrow at lower costs. The paper also provides evidence that when both the discount window and TAF were available, the weakest banks borrowed from the discount window and the relatively stronger banks bid for TAF funds. The results of this study may help to inform the Fed’s policies on the provision of emergency liquidity in the future.
Issues related to bankcapital have been the subject of ongoing discussion among academics, bankers, and regulators since the crisis. Bank of Finlandeconomists Gene Ambrocio and Esa Jokivuolle, along with professors Iftekhar Hasan from Fordham University and Kim Ristolainen from the University of Turku, surveyed the views of banking and finance academics and reported the results in the paper “Are Bank Capital Requirements Optimally Set? Evidence from Researchers’ Views” [PDF] (slide deck [PDF]). The survey obtained results from 149 leading academic researchers. It found that most respondents believe that higher capital ratios would reduce the likelihood of a crisis and the social costs associated with a crisis. Most respondents thought an increase of 5 percentage points in capital would increase the average cost of capital and reduce banklending. However, a majority said that this reduction in lending would result in “minimal to no change” in economic activity.
Fintech lending
Banks have historically been important suppliers of credit to consumers and small businesses. However, since the crisis, lending by some fintech firms to these borrowers has grown rapidly. The conference addressed a variety of questions such as the sources of competitive advantage to fintechlenders; competition between fintech lenders, small banks, and large banks; and the impact of fintechlending on consumers. Additionally, the conference looked at post-crisis changes in banksecuritization rules, which may have some relevance to fintech lenders’ efforts to fund their loans.
Many large banks retreated from some types of retail and small business lending. In part, this pullback was likely to due to a combination of the increased riskiness of these loans and the tightening of bank capital requirements. However, fintechlenders have been expanding into some of the same spaces, raising the question of whether the reduced lending by big banks was due in part to competitive pressure from fintech firms. It also raises the question of whether smaller banks were also retreating due to increased competition or expanding to help fill the void left by the larger banks. Two papers examine the rise of fintechs in two different lending markets and analyze what developments in these markets tell us about big versus small banks.
An important issue for any type of lender is its access to funding. Banks fund their loans with a combination: (a) their own liabilities in the form of deposits and other market borrowings and (b) loan sales to investors. The risk with on-balance-sheet lending is that too many loans will turn bad, the bank will suffer large loan losses, and depositors will flee the bank. Although some fintech firms fund loans with their own liabilities, most of their loans are funded by sales to investors. The advantage to the loan originator of selling loans is that, if the loan goes bad, the buyers of the loan bear the credit losses. However, such sales can lead to concerns that the bank or fintech originating a loan will not be as careful in underwriting and monitoring as they would be with the loans they retain on their own books. The result can be similar to that discussed in the Chava et al. paper, where originators have to reduce their lending volume.
Spatt observed that the importance of proxy advisory firms is easy to understand. All shareholders in a firm face the same questions, and there is similarity in questions across firms. However, any one shareholder obtains only a small fraction of the gains from better governance while potentially paying all of the costs of analysis. In this setting, proxy advisory firms are a predictable market solution to a potential free-riding problem. The increasing returns to scale that arise in this setting also naturally lends itself to the development of a monopoly—or in this case, a duopoly. The result can be reduced incentives for the two proxy advisory firms to avoid factual mistakes and increased power for the advisers to impose their philosophy on firms. Spatt discussed a variety of steps the Securities and Exchange Commission has taken and further actions that could mitigate these concerns. However, the problem of what to do about the role of institutions and proxy advisers in corporate governance is one that may not be totally solvable, but rather requires careful management over time.
Conclusion
The post-crisis period has seen dramatic changes in both information technology and government regulation. The papers presented recently at a workshop at the Atlanta Fed analyzed a number of these changes and contribute to our understanding of how the financial system is likely to evolve in the future.
Larry D. Wall is executive director of the Center for Financial Innovation and Stability at the Atlanta Fed. The author thanks Brian Robertson for helpful comments. The view expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. If you wish to comment on this post, please email atl.nftv.mailbox@atl.frb.org.
1 For further discussion on banks’ reporting of loan losses, see Larry’s recent post on changes to U.S. accounting rules.
