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Policy Hub: Macroblog provides concise commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues for a broad audience.

Authors for Policy Hub: Macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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May 27, 2021

The Role of Central Banks in Fostering Economic and Financial Resiliency

The Atlanta Fed recently hosted its 25th annual Financial Markets Conference, with the theme of Fostering a Resilient Economy and Financial System: The Role of Central Banks. The conference addressed both the adequacy of the monetary policy toolkit and the role of the U.S. dollar (USD) in international financial markets. The conference included two keynote talks. The first day featured a keynote speech by Federal Reserve Board vice chair Richard Clarida, followed by a discussion with Atlanta Fed president Raphael Bostic. The second day began with an armchair discussion featuring Harvard professor Larry Summers and Atlanta Fed research director David Altig. A video of the conference is available here video fileOff-site link. This post reviews some of the highlights from the conference.

Keynote talks
Vice chair Clarida's keynote speechOff-site link focused on global factors that help determine the yield curve for sovereign bonds. Clarida observed that studies of domestic and major foreign government markets have found that most of the movements in the term structure of interest rates can be explained by the overall level of the curve and the slope of the curve. He then reviewed work suggesting that a global factor—one that is highly correlated with estimates of the neutral real interest rate—has a great influence on the level of the curve. Given this information, central banks may not have much ability to influence the yield curve's level unless they are willing to unanchor inflation expectations in their domestic market. Clarida then presented evidence that the slope of the U.S. yield curve is highly correlated with its monetary policy, specifically the deviation of the U.S. neutral nominal policy rate from the actual federal funds rate. He acknowledged that correlation does not equal causation but provided some evidence that central bank decisions (by the Fed and major foreign central banks) have a causal relationship with the slope of the yield curve. These observations led Clarida to conclude that "major central banks can be thought of as calibrating and conducting the transmission of policy...primarily through the slopes of their yield curves and much less so via their levels."

Professor Summers raised a variety of concerns about current policy and the risks to the financial system in his chat on the conference's second day. One of these concerns relates to the monetary policy projections, which suggest that inflation will remain sufficiently low so that the Fed's policy rate may not increase for several years. This expectation of low rates may create a "dangerous complacency," according to Summers, that will make it more difficult to raise rates. The result may be that nominal policy rates remain too low, producing higher inflation that leads to even lower real rates and even higher inflation. The result could be not only a "substantial pro-cyclical bias in financial conditions" but also a threat to financial stability if the low nominal rates result in excessive financial leverage.

Monetary policy panel session
The monetary policy toolkit received some scrutiny in a panel titled "Is the Monetary Policy Toolkit Adequate to Meet Future Challenges?" It was moderated by Julia Coronado, president of MacroPolicy Perspectives. Coronado promised a session with some provocative comments, and each of her panelists delivered. Among the problems addressed by the panelists was central banks' limited ability to counteract economic downturns. Historically, central banks have lowered their nominal interest rate target by several percentage points in response to the onset of a recession, or even the elevated risk of one. The continuing decline in nominal rates, however, has reduced central banks' ability to use rate reductions to fight recessions, instead forcing them to rely more on quantitative easing (or more accurately, large-scale asset purchases). Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, and Willem Buiter, a visiting professor at Columbia University, provided two alternative ways of restoring the central bank's ability to lower nominal rates by more than 1 or 2 percentage points.

Gagnon's analysis was based on the Fisher equation, in which the nominal interest rate is approximately equal to the real rate of interest plus the rate of inflation. Gagnon observed that central banks, including the Fed, had set a target inflation rate of 2 percent back when the equilibrium real rate was higher (likely around 2 to 3 percent). Establishing this target rate resulted in equilibrium nominal interest rates around 4 to 5 percent, which gave central banks considerable room to respond to a recession. However, in the period since the inflation targets were set, equilibrium real rates have fallen by 1 to 2 percentage points. This decline greatly reduced central banks' ability to lower rates without taking them negative. Thus, to restore the ability of central banks to respond to higher inflation, Gagnon argued that central banks' inflation target should be increased to 3 to 4 percent.

Buiter implicitly started from the same point: that the decline in the equilibrium real rate had left central banks with too little room to cut interest rates. However, rather than raising the inflation target, Buiter argued that a better solution would be to accept deeply negative nominal interest rates. Several central banks in Europe, as well as the Bank of Japan, have lowered their rates below zero but never as much as 1 percent below zero. Buiter recommended that central banks take the steps necessary to be able to have deeply negative interest rates if that is appropriate for conditions.

Simon Potter, vice chairman at Millennium Management, noted an international dimension to the Fed's policy setting. Potter observed that many emerging markets had taken on considerably more debt to respond to the ongoing pandemic. He argued that these countries would need fast U.S. growth, and the accompanying increase in exports to the United States to be able to service their debt. Absent such increased debt service capacity, he pointed out that changes in the structure of these countries' debt markets would make rescheduling their debts even more difficult than it had been previously.

These provocative comments did not go unchallenged, however, as the other panelists raised concerns about the feasibility and/or desirability about each of these policy recommendations in the subsequent discussion that Coronado moderated.

Global dollar policy session
A panel on the conference's second day had the provocative title "Is the Financial System's Backbone, the U.S. Dollar, Also a Transmitter of Stress?" The panel's moderator was Federal Reserve Bank of Dallas president Robert Kaplan, who began the discussion by highlighting the importance of the USD in both international trade and international financial markets.

Stanford University Professor Arvind Krishnamurthy's presentation Adobe PDF file format supplied further evidence on the importance of the USD in trade and financial markets. He suggested that the USD's important role resulted in it providing a convenience yield to its users, which resulted in lower USD interest rates for those borrowing USD—both domestic and foreign borrowers. These lower rates, however, came with some financial risks, according to Krishnamurthy. For one, lower rates may induce greater financial leverage in U.S. borrowers. Additionally, foreigners who borrow USD to take advantage of the lower rates may be creating a mismatch between the currency they receive as revenue (especially from sales in their domestic markets) and the USD they need to repay their debt.

Thomas Jordan, chairman of the governing board of the Swiss National Bank, also noted the dominance of the USD in international markets and discussed its implications from the Swiss point of view. He noted two ways in which Switzerland is especially vulnerable to developments regarding USD. First, Swiss banks hold substantial amounts of USD assets and liabilities. Second, the Swiss franc is a safe haven currency that experiences increased demand in times of international financial stress. These result in Switzerland having a strong interest in global financial stability and especially in the stability of USD-funding markets. In this respect, Jordan observed that the Federal Reserve's swap lines with other central banks, including the Swiss National Bank, has been "very crucial." The swap lines provide an important liquidity backstop that recently proved valuable during the COVID-19 crisis.

Michael Howell, the managing director at CrossBorder Capital, focused on the potential for another currency to displace the USD in international markets. In his presentation Adobe PDF file format, he argued we should not be "shortsighted" in dismissing other currencies. In particular, he pointed to China, saying that China sees the USD as a rival and wants to displace it, particularly in Asia. He then went on to discuss some of the steps that China would need to take—and is taking—to displace the USD.

After these remarks by the panelists, Kaplan moderated a question-and-answer session that took a closer look at these and other issues.

May 3, 2021

Is There a Global Factor in U.S. Bond Yields?

The answer to this question seems obvious simply from observing the secular comovement of global nominal yields across some advanced economies plotted in chart 1.

Chart 1: 10-Year Bond Yields, 1992-2021

This observation raises the possibility that domestic bond yields, including those in the large U.S. Treasury market, may be anchored by global economic developments (see, for example, hereOff-site link and hereOff-site link), provision of global liquidity, and international markets arbitrage. The synchronized dynamics in global yields during the last few months serve as a stark reminder of the powerful role that global bond markets play in the transmission of country-specific shocks as well as of monetary and fiscal impulses.

Yet the standard term structure models (see, for example, hereOff-site link), that policymakers and market participants use to form their expectations about the future path of the policy rate, are typically estimated only with information embedded in domestic yields. Global influences enter only via the term premia—that is, the extra returns that investors demand to hold long-term bonds—and are influenced by the flight to safety and arbitrage across international markets. But because the term premia are obtained as a residual component in the model, any misspecification of the factor structure that drives equilibrium interest rates—by omitting a common global factor, for example—may result in erroneously attributing some fundamental movements to the term premia.

Chart 2 illustrates this point, presenting a less-noticed and even overlooked empirical regularity between the term premiaOff-site link on the spread between the 10-year U.S. bond and the 10-year/2-year German bond, which is the benchmark bond for the Eurozone government bond market. This comovement has proved remarkably strong since 2014.1

Chart 2: German Bond Spread and U.S. Term Premia, 2010–21

Take, for example, the pronounced decline in the term premia and the accompanying slide in the German bond spread between 2014 and 2019. Although technical factors might be behind the downward trend in the German bond spread—for example, large Eurozone bond outflows triggered by the euro-area crisis and the introduction of negative interest rates—the slope of the yield curve could also convey important information about the fundamentals of the economy. If the term premia on the 10-year U.S. bond reflect an exogenous "distortion" in the U.S. yield curve due to a flight to safety or an elevated demand for global safe assets, yields are likely to return to normal levels when the uncertainty shock dissipates. In contrast, if investors interpret the yield curve's decline as an endogenous "risk-off" response—that is, a switch to less risky assets—to a deteriorated global environment that can spill over to the U.S. economy, the term structure model would require a "global" factor whose omission may otherwise contaminate an estimate of the term premia.

So how sensitive is the estimate of the future path of policy rate to model specification? I next illustrate this sensitivity by augmenting the factor space in a standard (five-factor) term structure model with incremental information from an additional global factor, not contained in the other factors. Given the reasonably tight correlation between the term premia for the 10-year U.S. bond and the 10-year/2-year German bond spread, it seems natural to use the latter as an observed proxy for a global factor, although other statistical approaches for extracting one or more common global factors are certainly possible.

To quantify the potential effect of the global factor, I focus on yield curve dynamics seen in 2019, a period characterized by elevated economic, trade, and geopolitical uncertainty that led to a material decline in observed yields. But did a fundamental shift in the expected path of policy rate, or lower term premia, drive this decline? In the left panel of chart 3, I plot the expected policy rate paths for the second quarter (or midpoint) of 2019, obtained from models with and without a global factor. (Recall that in the second quarter of 2019, the target range for the federal funds rate was 2.25 percent to 2.50 percent.)

Chart 3: Model-Implied Paths of Policy Rate

The difference in the shape of the expected policy rate paths implied by the two models is striking. (The models' estimates use unsmoothed yield data at quarterly frequency, with continuous bond maturities from one to 80 quarters.) Although the expected policy rate path for the standard model is fairly flat, the rate path for the model with a global factor is deeply inverted up to five-year maturities, suggesting that over this horizon one could have expected rate cuts of almost 100 basis points. These expectations occurred against the backdrop of stable growth and inflation outlook in the United States but deteriorating global economic and trade conditions. The right panel of chart 3 displays the evolution of the expected rate path, estimated from the global factor model, for the two quarters before and the two quarters after the second quarter of 2019, as the Federal Reserve started to adjust its policy rate lower. It is worth noting that the strong effect of the German 10-year/2-year spread in the term structure model with global factor is a relatively recent phenomenon. (Additional results suggest that this factor has only a muted impact on the model estimates prior to 2014.)

The policy implications of these findings warrant several remarks. One direct implication is that the common global determinants of the neutral rate of interest, as well as inflationary dynamics, could constrain the potency of domestic monetary policy. A prime example of these constraints was the policy rate normalization phase undertaken by the Fed during the 2016–18 period, which was characterized by global disinflationary pressures, underwhelming economic performance in Europe and Japan, slowing economic growth in China, and escalating trade tensions. These forces were potentially counteracting the Fed's policy efforts and exerting downward pressure on the global neutral rate of interest. The recent economic and financial developments resulting from the COVID-19 pandemic (such as the global nature of the shock, synchronized monetary and fiscal response across countries, and international financial market comovements) and the ongoing recovery appear to only strengthen the case for the importance of incorporating global information in bond-pricing models.




1 [go back] I should note that the correlation between the two series increased from 52.9 percent before 2014 to 76.2 percent after 2014. Interestingly, the beginning of 2014 marks another important shift in financial markets: a sharp and persistent compression in the breakeven inflation forward curve, as a Liberty Street Economics blog postOff-site link recently discussed. A similar flattening is present in the forward term premia of nominal bonds. This is consistent with the interpretation that such flattening—starting in 2014—is likely the result of a new regime, characterized by the compression of inflation risk across maturities.

May 18, 2020

A Couple of Insights from the April Current Population Survey

The latest reading of the Atlanta Fed’s Wage Growth Tracker indicates that wage growth is slowing. It came in at 3.3 percent for April, down from 3.5 percent in March and 3.7 percent in February. This slowing primarily reflects the relatively large decline in the employment of those who typically experience the fastest wage growth: young workers. In February, those aged 16–24 accounted for about 12 percent of employment. By April, that share had dropped to under 10 percent. This change has significant bearing on the Wage Growth Tracker because those aged 16–24 had median wage growth of around 7.8 percent on average over the last year, versus 3.6 percent for all workers. So their decreased share of employment has helped pull overall median wage growth lower (see here for more discussion).

Note that while the tracker reflects the compositional change in who is employed, it didn’t show a spike in wage growth suggested by the average hourly earnings data from the Bureau of Labor Statistics' Payroll Survey. This is because the average hourly earnings data are a snapshot of the average earnings of all workers, hence last year's average will include people who are not employed today (and vice versa). As a result, the spike in average earnings was for an awful reason: a lot of low-wage workers lost their jobs. In contrast, the tracker compares the wages of the fortunate people who were employed both today and a year earlier.

Another wage development to keep an eye on are wage freezes. During the Great Recession, there was a large and persistent increase in the fraction of workers who said their wage was unchanged from a year earlier. We will be examining the Wage Growth Tracker data for evidence of an increased incidence of wage freezes or even wage cuts. The fraction of people reporting no change in their wage has increased from 13.7 percent in February to 14.1 percent in April. In contrast, the cyclical low for this series was 12.7 percent in November of 2019.

The April data also revealed a sharp increase in the number of people who are employed but on unpaid absence from work for "other reasons." As described in this recent macroblog post, these are most likely people whose employers furloughed them. March saw an estimated 1.5 million such workers. In April, that number swelled to 6.2 million. If those people had been counted as unemployed instead of employed, the unemployment rate would have been 18.7 percent in April instead of the official number of 14.7 percent. Going forward, a gauge of the strength of the labor market recovery will be how many of these furloughed workers eventually return to work versus become unemployed—or even leave the labor force. Stay tuned.

John Robertson, a senior policy adviser in the Atlanta Fed's research department

May 15, 2020

Introducing the CFO Survey

For almost 25 years, the Duke CFO Global Business Outlook has provided policymakers, academics, and the public with an understanding of how financial executives view the economy and prospects for their business. Today, three partners—Duke University's Fuqua School of Business, the Federal Reserve Bank of Richmond, and the Federal Reserve Bank of Atlanta—announce an enhanced iteration of this survey, now called theCFO Survey. Starting with the second-quarter data release on July 8, 2020, the CFO Survey will offer the same crucial information about the economic outlook and, through some methodological updates, an enhanced look at how U.S. companies perceive and react to the current economic environment.

This partnership comes at an opportune time. As the country faces considerable economic and political uncertainty, the on-the-ground information policymakers receive from businesses has never been more important. In the longer run, the information collected through the CFO Survey will help economists and researchers understand how firms reacted amid the COVID-19 pandemic and its economic consequences. It will therefore provide a key input into our understanding of the role that sentiment and uncertainty play in corporate decision-making processes.

What will change?

Much of the Duke survey will remain the same. One change is a discontinuation of the international portion. The CFO Survey will initially survey only U.S. firms, to fully establish the U.S. panel. (After we've reached our domestic panel-composition goals, we hope to eventually engage our global partners again.) Another change is that the sampling design has moved from a repeated cross-section to a panel-data format, meaning that the same pool of business leaders will participate each quarter. Finally, the team engaged in a thorough methodological review, and the survey questions will be streamlined and the survey process made more efficient for participants. More details on changes to existing questions will be available over the course of the next few weeks, and the first set of data generated using the updated questionnaire design will be available on July 8 on the new CFO Survey website: www.cfosurvey.org.

What will stay the same?

The survey will continue to track business sentiment over time and ask questions pertaining to business leaders' most pressing concerns, their expectations for their own firms' performance, and their expectations for the performance of the U.S. economy over the year ahead. Because Duke has conducted this survey since 1996, the rich historical data will allow for contextual insights on key indicators including revenue, capital expenditures, and employment as well as illuminating trends and shifts in business sentiment. The headline CFO Optimism Index will remain unchanged—that index measures business leaders' optimism about the U.S. economy and their own firm's financial prospects.

The objectives of the survey will not change, nor will the target participants. In addition to chief financial officers, the CFO Survey panel includes treasurers, vice presidents, and directors of finance, owner-operators, accountants, controllers, and others with financial decision-making roles in their organizations. To get the broadest view possible, the CFO Survey panel includes representatives from firms that range in size from owner-operators to Fortune 500 companies and covers all major industries. Finally, the survey will remain quarterly, and aggregated survey results and analysis will be publicly available via the new CFO Survey website.

We are excited to continue to provide this valuable complement to the array of existing data available to policymakers, business decision-makers, academic researchers, and the public. For more information and for the new quarterly results, check www.cfosurvey.org on July 8, 2020. Of course, we'll also alert you here when the time comes!

John Graham, the D. Richard Mead Jr. Family Professor of Finance at Duke University's Fuqua School of Business,

Brent Meyer, a policy adviser and economist in the Atlanta Fed's Research Department,

Nicholas Parker, the Atlanta Fed's director of surveys, and

Sonya Ravindranath Waddell, a vice president and economist at the Federal Reserve Bank of Richmond