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Whatever It Takes Laurence H. Meyer January 8, 2009 Presentation to the National Economics Club Signature Features of MA Forecast • Recession, transition, and recovery – Deep recession through middle of 2009 – Transition to below trend growth in 2nd half – Robust growth in 2011 • Inflation – Very low, below 1% in 2009, below ½% 2010 – Serious risk of deflation • Policy – Whatever it takes: near zero funds rate + unconventional policy – Fiscal: complement, second and significant stimulus package January 2009 © Macroeconomic Advisers 2 Compared to What? • Early 1990s: Bank capital shortage • Fall 1998: LTCM, etc. • 2001 Recession: Wealth destruction, bursting bubble • 1981-82: Worst postwar recession • Japan in 1990s: ZRP and QE • The Great Depression: debt-deflation • “The aftermath of financial crises” (Reinhart & Rogoff) January 2009 © Macroeconomic Advisers 3 Aftermath of Past Financial Crises Macro Consequences of Financial Crises1 Previous Financial Crises2 Current Episode, US Peak to Trough Number of Years Peak to Trough to Date Including MA Forecast Housing price decline (%) 35.0 6.0 21.0 33.2 Equity prices decline (%) 55.0 3.5 52.7 52.7 Unemployment rate increase (pp) 7.0 4.0 2.3 4.0 Real per capita GDP decline (%) 9.0 2.0 0.4 -3.2 Real Government Debt (%) 86.0 3.03 -- 61.0 1 From Reinhart and Rogoff, "The Aftermath of Financial Crises" prepared for AEA meetings, December 19, 2008 2 The sample of financial crises includes Spain 1977, Norway 1987, Finland 1991, Sweden 1991, Japan 1992, Asian EM economies 1997-1998, Columbia 1998, Argentina 2001, Norway 1899, U.S. 1929 3 For government debt, Reinhart and Rogoff use the increase in government debt in the three years following each crisis January 2009 © Macroeconomic Advisers 4 MA Forecast Summary GDP growth and Unemployment Forecast 10 Inflation Forecast Percent 5.0 H F Percent H F Headline PCE 8 4.0 Unemployment rate 6 3.0 4 FOMC comfort zone 2.0 2 Core PCE 1.0 0 0.0 -2 -1.0 -4 Real GDP growth Q4-2011 Q3-2011 Q2-2011 Q1-2011 Q4-2010 Q3-2010 Q2-2010 Q1-2010 Q4-2009 Q3-2009 Q2-2009 Q1-2009 Q4-2008 Q3-2008 Q2-2008 Q1-2008 Q4-2007 Q3-2007 Q2-2007 Q1-2007 -6 -2.0 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 5 Recession Comparisons Business Cycle Peak April 1960 December 1969 November 1973 January 1980 July 1981 July 1990 March 2001 Trough Duration GDP (Months) (Percent change) Peak Change (Level) 10 11 16 6 16 8 8 -1.6 -0.6 -3.1 -2.2 -2.9 -1.3 -0.4 7.1 6.1 9.0 7.8 10.8 6.8 5.9 2.3 2.6 4.4 1.9 3.6 1.6 2.0 1.6 0.2 2.8 1.6 4.7 1.0 1.1 15 -2.4 8.4 4.0 3.6 11.8 8.0 -2.1 -0.8 8.2 6.4 3.0 1.8 2.2 1.0 February 1961 November 1970 March 1975 July 1980 November 1982 March 1991 November 2001 December 2007 March 2009 Average Average 1960 - 1983 1983 - 2007 Unemployment Rate Unemployment Gap Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 6 The Assumed Fiscal Stimulus Package Assumed Federal Fiscal Stimulus Package Billions of dollars, calendar year 2009 2010 2011 2012 2013 2-yr 5-yr GIA for State & Local Infrastructure Spending 30 70 100 70 30 100 300 Unrestricted GIA for State & Local Gov'ts 50 50 100 100 Increase in Medicaid Matching 20 20 40 40 Extended Unemployment Benefits 10 11 12 11 10 21 54 Individual Income Tax Cut 125 130 134 139 145 255 673 -67 -70 0 -137 153 115 516 1030 Higher-earner Income Tax Increase Total 235 281 246 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 7 Treasury Supply: A Lot in the Pipeline 1600 $ billions Net Treasury Borrowing Federal Debt Held by the Public (4-quarter rolling sum) (% of GDP) 0.60 1400 Projected 2009Q1 1200 0.55 Projected 2010Q4 1000 0.50 800 0.45 600 400 0.40 200 0 0.35 -200 -400 1989 1991 1993 January 2009 1995 1997 1999 2001 2003 2005 2007 2009 0.30 1989 1991 1993 © Macroeconomic Advisers 1995 1997 1999 2001 2003 2005 2007 2009 8 A Synchronized Global Recession 8 Change in Real GDP Global GDP Growth (4-quarter moving average) (4th quarter to4th quarter) Percent H F 2008 7 2009 2010 MA US GDP MA 6 US 5 -0.7 World GDP 0.4 5.2 OE 4 Euro -0.6 -1.1 1.4 Japan -1.8 -1.0 1.0 2 China 7.3 8.1 10.0 1 Brazil 4.6 0.9 4.0 World* 1.0 0.4 3.5 3 0 *At market exchange rates -1 -2 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 Macroeconomic Advisers forecast prepared December 24, 2008. Note: Macroeconomic Advisers forecast for foreign GDP is based on projections by Oxford Economics. January 2009 © Macroeconomic Advisers 9 Deflation: A Serious Threat Deflation Risk Inflation Forecast 5.0 Percent 5.0 H F Headline PCE Percent 4.0 4.0 3.0 3.0 2.0 Headline PCE FOMC comfort zone 2.0 1.0 Core PCE 0.0 1.0 -1.0 0.0 95% confidence band -2.0 -1.0 -3.0 -2.0 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 -4.0 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Confidence band based on historical errors of consensus forecast as computed by Reifschneider and Tulip (2007) and reported in FOMC minutes. Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 10 Deflation: A Serious Threat Baseline Forecast 3.0 Forecast with Deflationary Concerns Percent 3.0 H F Percent H F 2.5 2.5 Core PCE Inflation Inflation Expectations 2.0 2.0 1.5 1.5 Core PCE Inflation 1.0 1.0 Inflation Expectations 0.5 0.5 0.0 2007 2008 2009 2010 0.0 2007 2008 2009 2010 Macroeconomic Advisers forecast prepared November 5, 2008. January 2009 © Macroeconomic Advisers 11 Credit Conditions: The Dominant Forecast Factor 700 Corporate Yield Spread Banks’ Willingness to Lend* (Moody’s Baa less Treasury) (Senior Loan Officer Survey) Basis points 60 Percent of banks 40 600 20 500 0 400 -20 300 -40 200 -60 100 1997 1999 2001 2003 2005 2007 2009 -80 1985 1988 1991 1994 1997 2000 2003 2009 2006 * Share of institutions more (positive) or less (negative) willing to make consumer installment loans. January 2009 © Macroeconomic Advisers 12 Credit Conditions: Gradual Recovery Baa Corporate Yield Spread 7 Conforming Mortgage Spread Percentage points H F 4.5 Percentage points H F 4.0 6 Actual 3.5 5 3.0 4 2.5 Actual Fitted 2.0 3 1.5 2 Fitted 1.0 1 0.5 0 1965 1970 1975 January 2009 1980 1985 1990 1995 2000 2005 2010 0.0 1971 1976 © Macroeconomic Advisers 1981 1986 1991 1996 2001 2006 2011 13 Fed Liquidity Policies: A Summary Cheat Sheet for Fed Liquidity Policies Macroeconomic Advisers Discount Window Primary Dealer Credit Facility (PDCF) Term Repos Term Auction Facility (TAF) Participants Depository institutions Primary dealers Primary dealers Depository institutions Frequency Daily (standing facility) Daily (standing facility) Weekly auctions for 28-day 2 auctions per month RPs Securities Lending Facility Term Securities Lending Facility (TSLF) TSLF Options Program (TOP) Primary dealers Reciprocal Currency Swap BoC, BoE, ECB, BoJ, SNB, Reserve Bank of Austrailia, Danmarks Nationalbank, Norges Bank, Sveriges Riksbank, Bank of New Zealand, Banco Central do Brasil, Banco de Mexico, Bank of Korea, and the Monetary Authority of Singapore Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) Agency Discount Note Purchases Commercial Paper Funding Facility (CPFF) Money Market Investor Funding Facility (MMIFF) Primary dealers Eligible U.S. issuers of commercial paper U.S. money market mutual funds (and over time could include other U.S. money market investors) Unspecified Daily (standing facility) Daily (standing facility) U.S. dollar denominated issues from a U.S. issuer, and rated first-tier securities under Rule Federal agency discount notes 2a-7 Highly-rated, U.S. dollardenominated, three-month Commercial Paper (unsecured and assetbacked) U.S. dollar-denominated CDs and CP issued by highly-rated financial institutions and having remaining maturities of 90 days or less Advances may remain outstanding for the remaining term of the ABCP that is financed, which varies from overnight to 270 days, except Securities have maturities of for depository institutions, where no advance overnight to 360 days under the AMLF may exceed a term of 120 days Borrowers can issue 3month CP to the facility Assets purchased under the program must have maturities from 7 to 90 days Primary credit rate on date loan initiated, to be fixed over term of loan Auction determined rate For unsecured CP, 100 bp over the 3-month OIS plus N/A (outright purchases at a 100-bp securitization fee; amortized cost) for ABCP, 300 bp over 3month OIS Depository institutions Primary dealers Primary dealers Daily (standing facility) Weekly auctions alternating In advance of periods of between two collateral heightened market schedules pressure Daily (standing facility) Daily (standing facility) Same as TSLF Foreign reserves As needed Eligible collateral Broad range of collateral all collateral eligible in triparty repurchase arrangements with the major clearing banks Treasuries, GSE debt, or GSE-guaranteed MBS Broad range of collateral Treasuries Two collateral schedules: 1) only OMO collateral; 2) OMO collateral plus AAA/Aaa-rated privatelabel MBS, CMBS and agency CMOs, and AAA/Aaa-rated ABS Term 90 days Overnight Various terms up to 28 days Alternating auctions of 28 days and 84 days Overnight 28 days Options will be for TSLF loans that have maturities of two weeks or less Rate Primary rate is the federal funds rate plus 25 bps Primary rate from discount Auction determined rate window User pays auctiondetermined penalty for obtaining GC Treasury instead of broader collateral; minimum of 10 bps for schedule 1 and 25 bps for schedule 2 Auction determined price for option to conduct TSLF N/A at a rate of 25 bps Size Limited only by the amount Limited only by the amount of margin-adjusted of margin-adjusted $80b of 28-day RPs collateral posted to the Fed collateral posted to the Fed $600b ($450b 84-day;$150b 28-day) Limited by size of SOMA; dealers can borrow up to 90% of SOMA holdings Announced up to $200b (Schedule 1: $50b; Schedule 2: $150b) ECB, SNB, BoJ,BoE unlimited; BOC $30b; Reserve Bank of Austrailia $30b; Danmarks Nationalbank $15b; Norges Bank $15b; Up to $50 billion in addition Limited by amount of eligible ABCP held by Sveriges Riksbank $30b; Bank of New Zealand to TSLF outstanding money market mutual funds $15b; Banco Central do Brasil $30b; Banco de Mexico $30b; Bank of Korea $30b; and the Monetary Authority of Singapore $30b Limited by outstanding securiites Determined by outstanding amount of CP from January to August 2008; each issuer can borrow Up to $540 billion maximum amount of CP outstanding over that period Duration of program Indefinite Through 4/30/09 Indefinite Will consider making it permanent Indefinite Through 4/30/09 Currently scheduled for year-end; other periods will be considered based on Through 4/30/09 auction results and market conditions Unspecified Through 4/30/09 Recent announcements On 3/16, announced cut in discount penalty to 25 bps and extension of term to 90 days On 3/16, announced establishment of PDCF; on 9/14, broadened eligible collateral; on 12/2, announced extension to 4/30/09 On 7/30, announced the term would alternate auctions between 28 days and 84 On 3/7, announced days; on 9/29, introduced intention to do $100b of 28forward TAF auctions; on day RPs, but program has 10/6, increased both the 84only reached $80b day and 28-day auctions to $150b each, bringing the size of the TAF to $600b On 11/26, announced higher limits on amounts of securities available for borrowing On 5/2, announced an expansion of the collateral that can be pledged in schedule 2; on 12/2, announced extension to 4/30/09 On 12/1, announced auction dates for year-end On 10/13, announced that swaps with the BoE, ECB, and SNB will accommodate whatever quantitiy of U.S. dollar funding is demanded and that the swap arrangements were On 9/19, announced the establishment of the extended to 4/30/09; on 10/14, made similar AMLF; on 12/2, announced extension to announcement for BoJ; on 10/28, established 4/30/09 swaps with New Zealand; on 10/29, established swaps with Brazil, Mexico, Korea, and Singapore On 9/19, annoucned establishment of this program along with the AMLF On 10/21, announced On 10/7, announced the establishment of the establishment of the CPFF MMMIFF Notes Enacted under 13(3); Fed would like to get rid of additional fee to borrowers On 28-day RPs, they any stigma associated with who access the PDCF usually get all MBS borrowing more than 30 days out of collateral 120 days Enacted under 13(3); Fed provides GC Treasuries in exchange for other collateral Options to participate in TSLF operation at the 25 bps rate on a future date; enacted under 13(3) The foreign central banks have to conduct operations to inject the dollars; the swaps are to provide them with the reserves to do so; most foreign central banks do so through term operations January 2009 Swaps specific Treasuries for other Treasuries; user Auction determined rate with pays an auction-determined minimum of 1-month OIS rate penalty (analogous to specialness of borrowed Treasury) Like discount window, only auctioned and less stigma;The two forward TAF Designed to prevent auctions conducted in squeezes in individual November 2008 ($150b each) Treasuries were introduced to cover yearend pressures. © Macroeconomic Advisers Through 4/30/09 Enacted under 13(3); allows money market mutual funds to shed ABCP in order to meet Intention is to help money redemptions; involves lending at primary rate to market mutual funds meet banks who purchase ABS from money market redemptions mutual funds; the loans are non-recourse Through 4/30/09 Enacted under 13(3); Enacted under 13(3); allows money market allows issuers of CP to mutual funds to shed know that they can roll over assets in order to meet their holdings redemptions 14 Improvement in Interbank Funding Market Libor Credit Spread Federal Funds Rate and Libor (Relative to OIS Rate) 6 Percent 400 Basis points 350 5 300 4 250 3-month Libor rate 3 200 150 2 3-month rate 100 1 50 Effective funds rate 1-month rate 0 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 *Effective federal funds rate is a ten-day moving average. The range shown shows the intraday variation, measured as +/- one standard deviation. January 2009 © Macroeconomic Advisers 15 The New Policy Regime Broader use of Fed’s balance sheet to achieve objectives Intention of these policies is to influence financial conditions - Monitor credit conditions to gauge success But no explicit targets Quantitative easing of a different sort - Policies will inject large amounts of reserves But goal is not the level of reserves No single measure to summarize Fed actions - Watch the H.4.1 Makes communications challenging Governance issues - January 2009 All decisions made by FOMC Even though 13(3) programs under authority of Board © Macroeconomic Advisers 16 Whatever It Takes 1. To the (almost) zero bound: why the range? 2. Purchase private assets: offset credit shock – – Attempt to lower risk spreads, increasing credit availability New programs for agency MBS; consumer, small business ABS 3. Purchase longer-term Treasuries – – – Attempt to lower long-term rates (term spreads) Clearly within their authority In combination with greater fiscal expansion 4. Policy commitment language – – Convey staying at low rates for longer than anticipated “Some time” similar to “considerable period” language of 2003 January 2009 © Macroeconomic Advisers 17 Monetary Policy: To the (Almost) Zero Bound MA Call vs. Market Expectations 5.5 Percent H F 5.0 4.5 4.0 3.5 3.0 2.5 2.0 Market expectations 1.5 Current MA forecast 1.0 0.5 0.0 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 18 Prescribed Funds Rate: Taylor Rule Perspective 12 Backward-looking Policy Rule Forward-looking Policy Rule (Based on macroeconomic outcomes) (Based on FOMC & MA forecasts) Percent 10 H F Percent H F Policy Rule Prescription 10 8 Actual and Predicted Funds Rate 8 6 6 4 4 2 2 0 0 -2 Prescription from MA Forecast -2 -4 -6 1987 1990 1993 1996 1999 2002 2005 2008 2011 Prescription from FOMC forecasts Actual and Predicted Funds Rate -4 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 19 Fed Balance Sheet: Massive and Growing Current Announced August 1 2007 ($ bil) ($ bil) ($ bil) Lending Facilities (Focused on Term Credit) 28-day RPs Term Auction Facility (TAF) FX Swaps Asset-backed CP Liquidity Facility (ALMF) Purchases of agency discount notes Commercial Paper Funding Facility (CPFF) Money Market Investor Funding Facility (MMIFF) Discount Window PDCF 80 450 622 24 15 334 0 94 37 100 600 Unlimited Unlimited* Unlimited* Unlimited* 540 Unlimited* Unlimited* 0 0 0 0 0 0 0 2 0 Rescue Operations (Focused on Individual Institutions) Maiden Lane I (Bear Stearns) Maiden Lane II (AIG RMBS holdings) Maiden Lane III (AIG-backed CDOs) Credit to AIG Non-recourse credit to Citigroup 27 20 27 39 0 Operations Focused on Asset Prices Term Asset-Backed Securities Loan Facility (TALF) Outright holdings of agency debt Outright holdings of agency MBS 0 5 0 200 100 500 0 0 0 496 n/a 791 "Normal" Portfolio Outright holdings of Treasuries 1,774 29 22.5 30 60 Up to 262 3,788 0 0 0 0 0 2 TSLF operations do not add reserves but do use the Fed's holdings of Treasuries. *Amounts of AMLF, discount note purchases, CPFF, discount window, and PDCF are limited by amount of outstanding eligible securities. January 2009 © Macroeconomic Advisers 20 Reserves: More than Needed Total Amount of Reserves 900 Composition of Reserves $ billions 1200 800 1000 700 800 $ billions Reserves through lending programs 600 600 Excess reserves 500 400 Total reserves 400 200 300 0 200 -200 100 -400 Other reserves Required reserves 0 Jan-06 Jun-06 Nov-06 January 2009 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 -600 Jan-06 Jun-06 © Macroeconomic Advisers Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 21 Treasury Yields: Historic Lows Yield Curve Slope Treasury Yields (10 year-2 year spread) 6 3.0 Actual 2.5 5 2.0 Ten-year Treasury yield Fitted 4 1.5 1.0 3 0.5 2 0.0 Two-year Treasury yield -0.5 Residual 1 -1.0 0 May-07 Aug-07 January 2009 Nov-07 Feb-08 May-08 Aug-08 Nov-08 -1.5 1984 1987 © Macroeconomic Advisers 1990 1993 1996 1999 2002 2005 2008 22 Keys to an Eventual Rebound 1. Drags do not continue at current pace - Credit conditions begin gradual improvement - Equity prices rebound - Housing activity stabilizes - Home prices fall at slower pace 2. Overwhelming policy response January 2009 – Very large fiscal stimulus package – Monetary policy and balance sheet policy © Macroeconomic Advisers 23 Housing Construction: In Search of a Bottom House Price Indexes Housing Activity (4-quarter percent change) 2350 Pp Thous. units Housing starts (left) H F 2.0 2100 1.5 1850 1.0 1600 0.5 1350 0.0 1100 -0.5 25 Percent H F 20 15 10 5 FHFA purchase-only index 0 -5 850 -1.0 Contribution of residential investment to GDP (right) -10 Case-Shiller index 600 -1.5 -15 350 2000 2002 2004 2006 2008 2010 -2.0 -20 2001 2003 2005 2007 2009 Case-Shiller cumulative decline -33.2 OFHEO cumulative decline -12.9 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 24 Equity Prices: Sharp Decline, then Rebound Next Year Household Net Worth S&P 500 Index 2500 (4-quarter change) Index H F 20 Trillions $ H F 15 2000 10 Long-term fair value range 5 1500 0 1000 -5 -10 500 -15 0 1985 1989 1993 1997 2001 2005 2009 -20 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Macroeconomic Advisers forecast prepared December 24, 2008. January 2009 © Macroeconomic Advisers 25