The Denouement

Mario Draghi: The Policy Response of the Eurosystem

The President of European Central Bank, Mario Draghi, spoke at the Annual Reception of the Association of German Banks. The following is a selected portion of Mario Draghi's remarks concerning long-term refinancing operations (LTROs) and expected inflation within the eurosystem, Remarks at the Annual Reception of the Association of German Banks:

The policy response of the Eurosystem: 

...As you know, since December last year the Eurosystem has launched two long-term refinancing operations – LTROs – with a maturity of three years. While the total liquidity requested by banks in these operations amounted to around 1 trillion euro, the net liquidity injection by the Eurosystem has been around half a trillion euro because the other half has been shifted over from other operations.

Let me be clear about why we implemented the three-year LTROs. It was not to support sovereign debt markets. It was also not to bolster bank profits.

The LTROs were specifically designed to prevent a credit crunch that could compromise the maintenance of price stability in the euro area. With funding markets closed, banks needed liquidity assurance over the medium term to avoid pre-emptive deleveraging and to continue lending....

...some observers who worry that the liquidity created by the LTRO will lead to inflation or asset price distortions.

Here it is important to distinguish between different concepts of liquidity. We would expect an impact on inflation and asset prices only following a sustained and strong increase in money and credit – not following an increase in central bank liquidity per se. The tentative signs we are seeing of a stabilisation in money and credit growth do not signal increasing inflationary pressures over the medium term.

For example, growth in monetary aggregates remains at low levels, with M3 increasing by 2.5% in January 2012, well below the average growth rate of M3 in monetary union so far, which was 5.9%. The same is true of the counterparts of M3 – loans to the euro area private sector increased by only 1.5% in January, compared with an average of 6.8% since the start of the euro.

Market indicators of inflation expectations overall show no signs of inflation above our medium-term objective. Investors overall assume a break-even inflation rate in five years of around 1.7%. Looking further out at the inflation expectations between five years and ten years also shows that, adjusted for the usual risk premia, market expectations of long-term inflation are fully consistent with our definition of medium-term price stability.

Moreover, the Eurosystem has a range of tools at its disposal to absorb excess liquidity if that is deemed necessary in the future. Available tools include increases in reserve requirements and the conduct of liquidity absorbing operations including not only short-term but also longer-term deposits. Hence, there are tools and the Governing Council can use them as needed. Moreover, our balance sheet has grown and shrunk in the past without creating inflation – for example, this was evident over the course of both 2009 and 2010.

In other words, we are constantly alert to threats to medium-term price stability. Euro area citizens can be certain that our objective is delivering price stability over the medium term – and that we have all the necessary tools to achieve it. The consistent strong anchoring of inflation expectations confirms that our commitment is credible...[Continue] 

 

 

Chairman Bernanke: Recent Developments in the Labor Market

The Chairman of the Federal Reserve, Ben Bernanke, spoke at National Association for Business Economics Annual Conference. The following are selected passages from that speech, Recent Developments in the Labor Market:

The slow labor market recovery can be attributed more to the weakness in aggregate demand than to structural factors: 

...Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand, or of structural changes, such as a worsening mismatch between workers' skills and employers' requirements?  If cyclical factors predominate, then policies that support a broader economic recovery should be effective in addressing long-term unemployment as well; if the causes are structural, then other policy tools will be needed.  I will argue today that, while both cyclical and structural forces have doubtless contributed to the increase in long-term unemployment, the continued weakness in aggregate demand is likely the predominant factor.  Consequently, the Federal Reserve's accommodative monetary policies, by providing support for demand and for the recovery, should help, over time, to reduce long-term unemployment as well...

...To the extent that higher rates of unemployment, especially long-term unemployment, result from structural factors, the scope for countercyclical policies to reduce unemployment would be impaired, and the benefits of a more complete economic recovery for many workers who are unemployed or discouraged would be more limited.

However, although structural shifts are no doubt important in the longer term, my reading of the research is that, at most, a modest portion of the recent sharp increase in long-term unemployment is due to persistent structural factors...

...If the recent increase in long-term unemployment were being driven by structural factors rather than, say, the severity of the recession, then the job-finding rates of the long-term unemployed should have fallen sharply relative to those out of work for only a few weeks.  But that's not what we're seeing...the job finding rates of the more recently unemployed and the long-term unemployed all fell over the recession in roughly the same proportion, and they remain low. This pattern is consistent with cyclical factors accounting for the bulk of the recent increase in long-term unemployment.  Similarly, the fact that labor demand appears weak in most industries and locations is suggestive of a general shortfall of aggregate demand rather a worsening mismatch of skills and jobs...[Continue] 

Benoît Cœuré: The Monetary Policy of the European Central Bank

Member of the Excutive Board of the ECB, Benoît Cœuré's presentation at Barclays' European Conference. The following are selected passages and graphs from the presentation, The Monetary Policy of the European Central Bank: 

The overachring principles guiding monetary policy: 

...Knowing that monetary policy does not cure structural economic malaise is one of the overarching principles guiding central banks. Equally important are price stability – as a clear overriding objective – as well as central bank independence and credibility. Let me elaborate on these principles and on how they have supported the ECB’s monetary policy in recent times.

Independence is essential for central banks, particularly in periods of sovereign funding stress. Whenever state finances are unsustainable, the likelihood of governments exerting pressure on central banks to monetise their debts increases. In a monetary union founded on monetary independence and a clear mandate for the central bank, this temptation is ruled out. In such a union, shocks to the "d" factor can even have desirable collateral effects. They can provide incentives to sovereigns to pursue sustainable state finances and to undertake the necessary structural reforms. Switching this mechanism off would weaken incentives to conduct the right economic policies.

Monetary policy committed to price stability and conducted independently and credibly will not only deliver low inflation rates but also contribute to financial stability. I deliberately use the word “contribute” as price stability is a necessary but insufficient condition for financial stability. Financial stability is the joint outcome of:

• sound prudential regulation, supervision and oversight of financial intermediaries, financial markets and financial market infrastructures, and of

• sound macroeconomic policies – comprising monetary policy and fiscal policy.

Nevertheless, its contribution to financial stability can be significant. In particular, a timely exit from non-standard measures and a return to a less accommodative policy stance – once the economic conditions are ripe – are essential for several reasons. First, because monetary policy accommodation for prolonged periods of time might fuel excessive risk-taking, leverage and asset price bubbles. Second, it might discourage banks, companies and governments from strengthening their balance sheets and therefore create a dependence on low rates.

Let me develop here how exit can take place. All the ECB’s crisis-response measures involving liquidity provision over long horizons share an important feature: credit is granted at a low but adjustable rate. We have already been explicit about the fact that the exact interest rate on long-term liquidity will be determined ex post, and be equal to the average policy rate prevailing over the life of the respective open market operation. We have also given banks the option of reversing the long-term repurchase operation in advance, after one year, if the conditions that had warranted the long maturity of central bank credit are no longer in place. In any case, we can withdraw the ample liquidity created as a side effect of the long-term operation whenever the Governing Council deems liquidity conditions are excessive in view of the outlook for price stability. All the tools necessary for large-scale liquidity withdrawal are already in place or will be readily available when needed.

This is consistent with our monetary policy strategy. It emphasises the monitoring of monetary and credit developments, which are linked to both financial imbalances and threats to price stability over longer horizons. It ensures a more symmetric policy with respect to financial misalignments and some “leaning against the wind” if monetary trends signal inflationary pressures over and beyond what standard conjunctural analysis and macroeconomic projects imply...[Continue] 

Graphs from presentation: 

Credit Risk Shocks: 

Bond yield spreads are vis-à-vis the German 10-year government bond, end-of-day data (last value 16 Mar 2012, 17:00 CET).

Euro Area Corporate Bond Spreads: 

Bonds with maturities of over one year are included in the indices. Benchmark is the EMU AAA government bond index calculated by Merrill Lynch. The last observation is dated 16 March 2012. 

 

 

Chairman Bernanke: The European Economic and Financial Situation

The Chairman of the Federal Reserve, Ben Bernanke, testified before the Committee on Government Oversight and Reform, U.S. House of Representatives. The following are selected passages from his testimony, The European Economic and Financial Situation: 

Developments in Europe: 

...In the past few months, financial stresses in Europe have lessened, which has contributed to an improved tone of financial markets around the world, including in the United States. The improvement reflects, in part, a number of actions taken by European policymakers. First, measures taken by the European Central Bank (ECB), including implementing two longer-term refinancing operations and easing collateral rules and reserve requirements, have allowed European banks to lock in funding for up to three years, thereby alleviating concerns about their near-term prospects. With the benefit of this support, European banks in turn have increased their holdings of sovereign debt, contributing to lower borrowing costs for some countries.

Second, euro-area leaders, the Greek government, and private-sector holders of Greek debt are taking steps to put Greece on a more sustainable fiscal path. Its sovereign debt has been significantly reduced, the Greek authorities are intensifying their efforts to implement fiscal and structural reforms, and the European Union and International Monetary Fund have pledged a considerable amount of new funds as part of a second assistance package. The Greek economy remains in a deep recession, however.

Third and finally, leaders of most of the members of the European Union have approved a new fiscal compact treaty that strengthens fiscal rules and their enforcement. This treaty represents a positive step toward resolving the fundamental tension inherent in having a monetary union without a fiscal union, and thus should help bolster the viability of the euro-area economy in the longer term.

Although progress has been made, more needs to be done. Full resolution of the crisis will require a further strengthening of the European banking system; a significant expansion of financial backstops, or "firewalls," to guard against contagion in sovereign debt markets; and, critically, continued efforts to increase economic growth and competitiveness and to reduce external imbalances in the troubled countries...[Continue] 

 

 

Paul Krugman: Fiscal Policy and Growth in Europe

Paul Krugman - Fiscal Policy and Growth in Europe: 

Chicago Fed President Evans: Monetary Policy Communications Guidance

The following are selected passages from the speech delivered by the President of the Federal Reserve Bank of Chicago, Charles Evans "Monetary Policy Communications Guidance": 

Macroeconomic Enviroment:

...The U.S. is now more than two and a half years into its modest and uneven recovery from the Great Recession. Real gross domestic product growth has averaged just 2-1/2 percent. The unemployment rate is 8-1/4 percent—well above the rate anyone on the FOMC sees as being consistent with our longer-run goal; in my view, this is a substantially higher rate than one might attribute to supply-side factors, such as extended unemployment insurance and a heightened degree of mismatch in labor markets. Realistically, this is a 2-1/4 to 3 percentage point deviation from our current maximum employment objective. Because this occurred with nominal interest rates stuck at the zero lower bound since December 2008, I believe it’s hard to say that we are not in a liquidity trap. Recently, the U.S. data have been more encouraging, with the labor market improving and private demand showing a little more traction. Without a doubt, these are welcome developments. But even the more optimistic forecasts see output increasing only moderately above its potential growth rates; no one has an expectation for a surge in activity that would quickly close resource gaps.

At the same time, the outlook for inflation is subdued, with most FOMC participants’ forecasts for increases in total personal consumption expenditures prices averaging roughly between 1-1/2 and 2 percent over the next three years. Furthermore, private sector long-run inflation expectations are quite well anchored...

An Explicit State-Contingent Policy: 

...Let me outline how this approach might work in practice. The Fed could sharpen its forward guidance by pledging to keep policy rates near zero until one of two events occurs. The first event would be if the unemployment rate moved below a 7 percent threshold. Reductions in the unemployment rate below this level would represent good progress toward the natural rate of unemployment; depending upon the state of inflation expectations, it might be time to lessen policy accommodation.

The second event that would commit us to raise rates would be if inflation rises above a particular threshold that is clearly unacceptable. This trigger would be a safeguard against the possibility that our assessments of economic conditions and resource slack are wrong and the natural rate of unemployment is higher than 7 percent. If this were so, our experience from the 1970s suggests that a continuation of the low-rate policy would generate a further unexpected increase in inflation; by adjusting policy according to this trigger, the Fed would begin exiting from what would now evidently be excessive policy accommodation. We would not have the desired reductions in unemployment, but then again, there wouldn’t be anything that monetary policy could do about it.

I would argue that this inflation-safeguard threshold needs to be well above our current 2 percent inflation objective. This is consistent with the theoretical work showing that extraction from a liquidity trap requires the central bank, if necessary, to allow inflation to run higher than its target over the medium term. My preferred inflation threshold is a forecast of 3 percent over the medium term. For a central bank like the Federal Reserve that has a statutory dual mandate, this seems like a risk that we should be willing to accept. We would suffer some net policy loss if the gains in employment did not occur. But we certainly have experienced inflation rates near 3 percent in the recent past and have weathered them well. Such an experience would not be anything close to the debilitating higher inflation rates we saw in the 1970s or 1980s. And 3 percent isn’t high enough to unhinge long-run inflation expectations. Indeed, I think our new framework commitment to a 2 percent long-run inflation goal would help anchor inflation expectations if we undertook this policy strategy.

Let me also emphasize that under this policy proposal, inflation reaching 3 percent is only a risk—and not a certainty. Indeed, simulations of standard models suggest that inflation is likely to remain below 3 percent even under a policy of extended monetary accommodation....[Continue] 

 

Consumer Price Index - February 2012

"The energy index rose 3.2 percent in February after a 0.2 percent increase in January. The gasoline index rose 6.0 percent, its largest increase since December 2010." 

Consumer Price Index Summary: The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.9 percent before seasonal adjustment.

The gasoline index rose sharply in February, accounting for over 80 percent of the change in the all items index. the gasoline increase led to a 3.2 percent rise in the energy index despite a decline in the index for natural gas. The food index was unchanged in February, with the food at home index unchanged for the second month in a row as major grocery store food indexes were mixed....[Continue] 

Rebecca Wilder: Does the US Corporate Saving Rate Portend a Lower Unemployment Rate?

Rebecca Wilder: 

Does the US Corporate Saving Rate Portend a Lower Unemployment Rate?: An interesting thing happened in Q4 2011: the corporate saving rate declined following two quarters of gains. Nominal net saving by the domestic business sector fell 3%, while nominal gross fixed investment and inventories surged 6% – the two pushed the saving rate down nearly 40 bps to 2.94% of GDP. The corporate saving rate (gross saving less gross investment) has been on a downward trend since the end of 2009, a welcomed trend by the labor market.

...The point here is that the trend in corporate saving has fallen sufficiently to portend some material declines in the unemployment rate in coming quarters….ALL ELSE EQUAL. For example, a simple bivariate regression would forecast a 7.5% unemployment rate if the corporate saving rate falls another 30 bps to 2.6%...[Continue] 

Mario Draghi: Competitiveness of the euro area and within the euro area

The following are selected passages from the speech delivered by the President of the ECB, Mario Draghi, "Competitiveness of the euro area and within the euro area": 

Mario Draghi on the state of the euro economy and monetary policy: 

Overall, we see continued signs of stabilisation in the euro area economy, albeit still at a low level. The situation in financial markets has clearly improved in response to the ECB’s measures. The improvement is also due to the progress made by euro area governments towards accepting more binding common fiscal rules and by the progress on fiscal consolidation and economic reform in many countries...

...As far as monetary policy is concerned, growth will be supported by the very low short-term interest rates and by all the measures adopted by the ECB to foster the proper functioning of the euro area’s financial sector.

Taking the context of deeply malfunctioning credit markets, our recent decision on medium-term liquidity has been central in banks returning to play their vital role in the real economy. Banks account for over two thirds of external financing of firms in the euro area. Banks are especially important for small and medium-sized enterprises, which account for nearly three quarters of employment in the private sector.

As many as 800 banks participated in our last operation. They cover virtually the entire euro area. Many of the banks are small, regional institutions. I cannot even mention their location, the towns, the villages where these banks are, because often they would be the only bank in town so they could be identified. This tells us one thing – that the money is now closer to households and the small and medium-sized enterprises than it was before.

We are continuously alert to the risk of inflation, but this risk is not materialising at the present time. Moreover, inflation expectations remain firmly anchored in line with price stability. All the necessary tools to address potential upside risks to medium-term price stability are fully available.

Over the past 13 years, the ECB has achieved one of the best records of price stability in European history. We are committed to maintaining that record.

The recent signs of stabilisation allow us all to face the medium-term challenges for the euro area with a degree of confidence. All policy-makers should take advantage of this position to continue their reforms with confidence...

Mario Draghi on competitiveness within the euro: 

...Overall, looking at competitiveness within the euro area, there have been substantial differences across countries.

Indeed, the strains in some sovereign debt markets have been compounded by the severe competitiveness differentials that have emerged within the euro area.

A convenient way to identify competitiveness differentials is simply to look at the current account balances of each country.

Current account imbalances could be justified for any country, including those participating in a monetary union, and they do not necessarily reflect a loss of competitiveness. But increasingly, larger current account deficits have resulted from significant losses of national competitiveness, signalling domestic macroeconomic imbalances and deeper structural problems. These losses of competitiveness limit the country’s growth potential and hinder its participation in the global trade integration.

Against this background, rather than financing productive investment in the tradable sector and fostering export performance, capital inflows in some countries with excessive current account deficits have fuelled asset price rises and private indebtedness. Hence, current account imbalances within the euro area should be a source of concern for policy-makers when they relate to losses of competitiveness....

Mario Draghi on the policy challenges to increase competitiveness: 

...Within the euro area, a number of countries need to repair and strengthen their competitiveness for the sake of their own continued prosperity and the overall stability of our economic and monetary union. This process requires going to the root of the loss of competitiveness, tackling its sources and enhancing the opportunities for growth.

The time frame of this correction will differ according to the degree of the imbalances and countries’ overall economic conditions. But in times of severe financial constraints, there is no other choice than to address the structural losses in competitiveness in an urgent and decisive manner.

What monetary policy can do for competitiveness is to ensure price stability in the euro area, reducing risk premia and making sure that all the transmission channels of the monetary impulse do work.

I would add that the markets clearly understand that. Thus, continued price stability, unencumbered credit markets, fiscal consolidation and structural reforms that decisively address the issue of insufficient growth stemming from loss of competitiveness would bring about an increase in confidence. And, as I am sure we all understand, increased confidence will further contribute to Europe’s recovery and to our longer-term potential for growth, jobs and continued prosperity.

 

FOMC Statement March 13, 2012

The FOMC announced their decision to keep the target range for the federal funds rate at 0 - 1/4. The statement revealed the FOMC intends to keep the rate low:  "conditions are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014." Notable commentary : Will the Fed Cage the Hawks? - Mark Thoma

FOMC Statement: Information received since the Federal Open Market Committee met in January suggests that the economy has been expanding moderately. Labor market conditions have improved further; the unemployment rate has declined notably in recent months but remains elevated. Household spending and business fixed investment have continued to advance. The housing sector remains depressed. Inflation has been subdued in recent months, although prices of crude oil and gasoline have increased lately. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook. The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who does not anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014.

Effective Federal Funds Rate: