R. DHAWAN Jan 1411

Is Federal Reserve Bank Policy Working in the US? DR. RAJEEV DHAWAN Director, Economic Forecasting Center Georgia State University Presented at the Global Interdependence Center’s Meeting at the Central Bank of Chile in Santiago • January 17, 2011

AGENDA 1. Define the latest Federal Reserve Bank policy aka Quantitative Easing 2. Effectiveness metrics 3. Impediments to boosting aggregate demand; what creates job growth?

4. Ability and willingness of commercial banks to make loans to businesses (especially to small firms) 5. Concluding remarks

Quantitative Easing:The Second Round (QE2) • Quantitative Easing refers to changes in the composition and/or size of a central bank’s balance sheet that are designed to ease liquidity and/or credit constraints (Blinder 2010) • The central bank hopes that by reducing interest rate spreads/risk premiums the central bank can boost aggregate demand even at the zero lower bound for the policy interest rate

Jim Bullard’s Fear and Solution

The FOMC’s “extended period” language may be increasing the probability of a Japanese-style outcome for the United States.

…on balance, the U.S. quantitative easing program offers the best tool to avoid such an outcome.

Source : James Bullard, “Seven Faces of “the Peril”, September/October 2010

U.S. Inflation Compared to Japan 4.0

(%, PCHYA)

3.0 2.0

US Deflator (starting in 2000)

1.0 0.0 -1.0 -2.0

Japan Deflator (starting in 1990)

-3.0 -4.0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82

FOMC’s December Statement To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate…. The Committee…. intends to purchase a further $600 billion of longerterm Treasury securities by the end of the second quarter of 2011.

Source: FOMC statement & FRB of NY, November 3, 2010

QE2’s Effectiveness: Inflation, Spreads & Side Effects

Risk Premium in Investment Grade Bonds

Expected vs. Actual Inflation

BB+ Corpora t e v s. 1 0-Yea r T-Bon d

(%) 4

(%) 12

3

10

2

8

1

6

0

4

2

-1

JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN 2006 2007 2008 2009 2010 2011

0

10-Y Bon d Ra t e Less T IPS Ra t e Cor e In fl a t ion (3-m on t h A n n . Gr owt h )

OCT 2006

MAR 2007

AUG

JAN 2008

JUN

Stock Market and Gold ($/T roy ounce ) 1450

12000

1400

11500

1350 11000 1300 10500 1250 10000

9500

1200

AUG 2010

SEP

DOW30 (Lef t )

OCT

NOV

Gol d (Ri gh t )

DEC

JAN 2011

1150

Instead of Flattening the Yield Curve has steepened

NOV

APR 2009

SEP

FEB 2010

JUL

DEC

Long-Term Rates: Germany vs. Japan vs. US vs. UK (%) 1.50 1.40 1.30 1.20 1.10 1.00 0.90

NOV 2010

Germa n 1 0-Y Bon d US 1 0-Y Bon d

DEC

UK 1 0-Y Bon d Ja pa n ese 1 0-Y Bon d

JAN 2011

10-Year Bond Rate and Trade Deficit 10-Year Bond Regression

Source: May 2005, Forecast of the Nation, EFC@GSU Trade Balance ($ bil.)

-20 -25 -30 -35 -40 -45 -50 -55

JAN 2009

MAR

MAY

JUL

SEP

NOV

JAN 2010

MAR

MAY

JUL

SEP

NOV

US Trade Weighted Currency Index (I ndex 2000 = 100) 120

Emerging Currencies 110

100

90

Major Currencies

80

70

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Impediments to Boosting Aggregate Demand

Hom e Prices: Case-Shiller National Av erage

Consumer Confidence and Stock Market Wealth (I ndex 1966 = 100) 120

200

16000 180

100

14000 160

80

12000 140

60

10000 120

40

8000 100

20

APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC 2006 2007 2008 2009 2010

Con su m er Con fiden ce (Left )

6000 80

1997

1998

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Wil sh ir e 5000 (Righ t )

Home Price Expectations Survey High

EFC Median

Low

Source: MaroMarkets Home Price Expectations Survey, December 2010

Employment Recovery

So What Creates Jobs?

Investment in Tech Equipment and Software as a % of GDP (%) 5.0

4.5

Golden 90’s Job Growth: 240K/Month

2003-2007 Job Growth: 132K/Month

12%

6% 4.0

3.5

3.0

2008-2009 Job Loss: 400K/Month

-15%

+19% 2010 YTD: 87K/Month

2.5

2.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Job Growth and Tech Investment Rajeev Dhawan Professor & Director Economic Forecasting Center Georgia State University

ORDERS: 1% ORDERS  0.45%  TECH

CEO: 1% CEO  0.034%  TECH 1% CEO  0.11%  ORDERS

Employment growth (Job additions)

TECH: 1% TECH  0.059%  EMP:

Harold Vasquez Research Specialist Economic Forecasting Center Georgia State University

 The improvements in CEO’s perceptions about the future increases TECH investment spending.  TECH investment significantly increases employment growth via durable goods ORDERS channel.

Source: “U.S. Employment Growth and Tech Investment: A New Link” By Rajeev Dhawan & Harold Vasquez, 2010

Chief Executive Confidence & Durable Goods Orders Ex pect a t i on s of Bu si n ess Con di t i on s i n Own In du st ry 6 Mon t h s Ah ea d (%, Y -O-Y ) 20

70

10 60 0 50

-10 -20

40 -30 30

II IV II IV II IV II IV II IV II IV II IV II IV II IV II IV II IV II IV 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

CEO Con f i den ce (Lef t )

Du ra bl e Goods Orders Growt h (Ri gh t )

-40

Dow30 Revenue Growth and Job Gains (%, Y-O-Y)

(‘000 Jobs)

20%

2500 2000

15%

1500 10% 1000 5%

500

0%

0 -500

-5%

-1000 -10% -1500

-15%

-2000

-20%

-2500 2001 2002 2003 2004 2005 2006 2007 2008 09q1 09q2 09q3 09q4 10q1 10q2 10q3

DOW 30 (Left)

Private Job Gains (Right)

CISCO vs. WALMART Revenue Growth 30% 25% 20% 15% 10%

CISCO

5%

Walmart

0%

-5% -10% -15% -20% 2006q1 2006q3 2007q1 2007q3 2008q1 2008q3 2009q1 2009q3 2010q1 2010q3

WALMART CEO Mike Duke

Three issues that we often talk about: tax, trade, and health care.

Source: Bloomberg Businessweek, December 6, 2010

But What About the Ability/Willingness of Banks to Lend?

Source : The Wall Street Journal, September 27, 2010

Excess Reserves of Depository Institutions ($ Bil.) 1200 1000 800 600 400 200 0 -200

AUG OCT DEC FEB APR JUN AUG OCT DEC FEB APR JUN AUG OCT DEC 2008 2009 2010

Fear of Fire Sales and the Credit Freeze Douglas Diamond Professor of Finance University of Chicago

Raghuram Rajan Professor of Finance University of Chicago

“overhang� of impaired banks

an that may be forced to sell soon can reduce the current price of illiquid securities sufficiently that banks have no interest in selling. This

creates high expected returns to holding cash for potential buyers and an aversion to making term loans.

Source: NBER working paper #14925, April 2009

Food-For-Thought • Job growth is a function of “tech” investment that in turn is dependent upon confidence levels (CEO’s and consumers) • Can a central bank do anything here?

• Not directly, but by easing the flow of credit it can help small firms that are primarily bank finance dependent • How to do it?

• Clean up the toxic debt by using the QE power (Explore setting up a Resolution Trust Corporation as in early 90’s? Reviving Treasury’s PPIP?)

Special Thanks to the Center’s Executive Sponsors Carl R. Zwerner Chair of Family Owned Businesses

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