Bernanke’s JEC Testimony
May 20 – May 24, 2013
On Wednesday, May 22, Federal Reserve Chairman Ben Bernanke will testify on “The Economic Outlook.” The next monetary policy meeting is four weeks away, but Bernanke is likely to provide a preview of what will be discussed at that time – specifically, on the issue of when to begin reducing the rate of asset purchases. The short answer may be “it depends.”
Recent data reports suggest a mixed bag in the current quarter. Retail sales were not as bad as feared in April, but were far from what one would consider to be “strong.” Manufacturing data has been relatively soft. The labor market remains a key focus for Fed policymakers, and is an important indicator of the amount of slack in the economy. While the unemployment rate has trended lower over the last few years, a lot of that decline has been due to a drop in labor force participation (with about a quarter of that due to demographics). The employment/population ratio has continued to trend at a low level. Long-term unemployment remains elevated.
Inflation has been trending lower. Some of that reflects the decline in gasoline prices (which has been amplified more recently by the seasonal adjustment, which looks for large seasonal increases in the spring). However, core inflation is also trending down. Commodity prices are soft, reflecting weakness in the global economy. Prices of imported raw materials and finished goods show no inflation pressure. Capacity utilization in manufacturing remains low, suggesting no inflation pressure for production constraints. The slack in the labor market will limit wage pressures. Inflation expectations remain well anchored. In the last few years, many market participants have feared that fiscal and monetary policies would lead to sharply higher inflation. We’ve maintained that such a surge would be very unlikely given the amount of slack in the economy. In their projections of late April, Federal Reserve officials expect inflation (as measured by the PCE Price Index) to trend at or below the 2% target both this year and next.
Recall that the Fed is undertaking two extraordinary policies: the forward guidance on the overnight lending rate (the conditional commitment to keep short-term interest rates exceptionally low) and the Large-Scale Asset Purchase program (what most people call “QE3”). The Fed has quantitative thresholds on the forward guidance (unemployment above 6.5%, an inflation outlook of not more than 2.5%, stable inflation expectations), but these are guideposts, not targets. Importantly, the Fed has indicated that it will keep short-term interest rates low for some time after the recovery picks up steam. The LSAP has a qualitative threshold (“substantial improvement” in the labor market), which makes it a judgment call. Nobody at the Fed is happy that they are purchasing assets, but the majority feels that it’s the right thing to do. The Fed has spent a lot of effort working out its exit strategies, which include an eventual reduction in the rate of asset purchases, but that doesn’t mean that we’ll see a change anytime soon. Clearly, a lot will depend on the job market data.
In the April policy statement, the FOMC indicated that the pace of asset purchases could be raised or lowered depending on how the economic outlook evolved. That seemed to soften concerns that asset purchases would end sooner rather than later. However, even with the mixed economic data of the last few weeks, the debate has shifted back to when to end QE3. Why was the possibility of increasing the pace of asset purchases included in the April policy statement? One concern is that inflation could prove to be too low. It’s real (inflation-adjusted) interest rates that matter for the economy. So lower inflation would, all else equal, imply higher real rates. The majority is clearly far away from raising the pace of asset purchases, but the issue was likely on the table at the April FOMC meeting. Let’s see if Bernanke brings it up this week.
The Budget Deficit
May 13 – May 17, 2013
The Monthly Treasury Statement showed a large budget surplus for April. Some of that may prove to be temporary. Income was pulled forward into 2012 ahead of expected tax increases in 2013 and that was reflected in higher tax payments in April. Some of it is payback from the bailouts of a few years ago (for example, earnings from Fannie Mae and Freddie Mac). However, much of the improvement reflects a rebound from a severe recession. Tax revenues are recovering and recession-related expenses are trending lower. The near-term reduction in the deficit may limit efforts to address the long-term problem.
For the first seven months of the fiscal year, tax receipts were up 15.9% from the same period last year – individual tax receipts rose 20.0% y/y, corporate tax receipts rose 21.4% y/y, and payroll taxes rose 10.6% y/y.
Outlays are down 0.6% from the first seven months of FY12. Spending for the current fiscal year is likely to be below where it was projected to be back in the summer of 2008. Federal employment is now lower than it was when Obama took office.
The deficit should continue to improve as the economy recovers from the recession. However, short-term efforts to reduce the deficit (the payroll tax increase and sequester cuts) will restrain the pace of the recovery (GDP growth is expected to be about 1.5 percentage point lower this year). We may still see growth in the 2.0% to 2.5% range, but it would have been much stronger (3.5% to 4.0%) without the fiscal restraint.
The fiscal cliff deal at the start of the year limited the self-imposed fiscal contraction in 2013, but did not resolve the debt ceiling issue. Recall that the debt ceiling was breached on December 31, but Congress waved the limit through February 15, then later extended that deadline to May 19. A grand bargain on fiscal policy is unlikely, but there could be some legislative changes in a deal to raise the debt ceiling this week. Lawmakers are well aware that “governance by crisis” is unpopular with the American people. A government shutdown is very unlikely. Remember, the debt ceiling does not authorize spending (that comes from Congress through budget authorizations or Continuing Resolutions). It merely allows for the government to make good on obligations that it has already made.
By now, readers should be well aware of the problems with the Rogoff and Reinhart study that purported to show a 90% debt-to-GDP threshold (beyond which the economy slows). There is no such threshold!
The deficit has been falling and is likely nearing a level that would leave the debt-to-GDP ratio stable or declining. That’s presuming that the economic recovery continues at a moderate pace. If the pace of growth improves more substantially, as would happen as the level of GDP moves towards its potential and slack is taken up, the near-term budget outlook will improve even more dramatically. However, the problem with the deficit has not been the short-term outlook. Rather, the problem is the long-term strains from Medicare as the baby-boom generation retires. Congress continues to focus on unhelpful short-term fixes and is largely ignoring the long-term problem.
All’s Well That Ends Well
May 6 – May 10, 2013
The economic data reports were decidedly mixed last week. However, the April Employment Report exceeded expectations, which provided a good excuse for share prices to move higher. Bonds were whipsawed, encouraged by the view that the Fed was less likely to taper its asset purchases, but then hit hard by the better-than-expected payroll figures.
Nonfarm payrolls rose more than expected in April, while figures for February and March were revised higher. Results were mixed across sectors, suggesting that manufacturing has softened, but the consumer appears to be in relatively good shape. Temp-help employment rose, an encouraging sign, but average weekly hours fell, suggesting less of a need to increase hiring. Prior to seasonal adjustment, we added 932,000 payrolls in April. Unadjusted payrolls are trending about where they were in 2006. We still have a long way to go for a full recovery.
State and local tax receipts have improved. Job losses at the state and local levels of government appear to be bottoming. They may not increase much from here, but it’s good if they’ve stopped falling. Federal government payrolls are trending down, now down 3,000 since December 2008 (so much for the “massive” increase in government that we keep hearing about). Some of this reflects the contraction in the U.S. Postal Service, but there appear to be some sequester effects. Sequester cuts don’t happen all at once. In fact, some government agencies had trimmed payrolls in anticipation of the cutbacks. Other job cuts are likely to show up in the months ahead.
Consumer spending was stronger than expected in March, but that reflects an impact of colder weather, which boosted the consumption of household energy, and is unlikely to be repeated. Unit motor vehicle sales were up significantly year-over-year in April, but the seasonally adjusted pace appears to have slowed. That may reflect a lagged impact from the payroll tax hike. On the other hand, wealth gains in housing and equities are likely providing support to consumer spending at the upper end of the income scale.
The manufacturing data have been generally weak. Average weekly hours in manufacturing fell further in April and overtime hours declined. Factory orders fell. March trade figures continued to show a softening trend in imports and exports. The U.S. economy is not getting any help from the rest of the world.
The Federal Open Market Committee left monetary policy unchanged last week. The policy statement was a near photocopy of the previous one (from March 20). However, there were two notable changes. The first was that the Fed indicated more emphatically that tighter fiscal policy is restraining growth. The second was an added statement on the Large-Scale Asset Purchases (QE3). Much of the recent Fed debate has been about when to begin tapering the rate of asset purchases. Instead, the FOMC suggested that the pace could be increased as well as lowered, depending on what happens with inflation and the labor market. The PCE Price Index, the Fed’s chief inflation gauge, rose just 1.0% in the 12 months ending in March and lower gasoline prices should push the y/y increase below 1% in April. That’s against a Fed target rate of 2.0%. Deflation (a general decline in the price level) is still unlikely, but Fed officials fear it more than anything else. It’s a small chance of a big problem, one the Fed takes very seriously. The Fed is justified in keeping an increase in the rate of asset purchases on the table. However, the employment figures are consistent with a tapering in Fed asset purchases late this year.
In short, the economy remains firmly on the recovery path, although growth is likely to remain uneven over time and across sectors. We still have a difference in the economic outlooks between the stock market and the bond market, but this should clear up somewhat when the data roll in mid-May.
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