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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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June 1, 2021

COVID Lasted Longer Than Expected. What Happened to Retail Space?

In our last post, we observed some deterioration in office market fundamentals in the face of the COVID-19 pandemic. Office market vacancy rates increased notably while asking rents remained relatively unchanged from 2019. Did the retail market respond similarly? Due to mandatory business closures and the increase in e-commerce revenue, one might expect retail market vacancy rates to increase and asking rents to decrease. However, the retail property market overall has been much less affected during the COVID-19 pandemic than the office market. As in our previous post, we explore the retail real estate market vacancy rate and asking rent in the 10 cities with the highest retail space stock square footage (according to CBRE-EA's market ranker).

Unlike the office market, we observe that retail market vacancy rates did not behave nearly as uniformly (see chart 1). The overall retail market vacancy rate was 6.2 percent in the fourth quarter of 2019 (pre-COVID) and increased to 6.6 percent in the fourth quarter of 2020. The Dallas retail market experienced the largest change in the vacancy rate, increasing by 21.31 percent from the fourth quarter of 2019 to the fourth quarter of 2020 (from 6.1 percent to 7.4 percent). Washington, DC exhibited the next largest jump, where the vacancy rate increased by 16.98 percent during the same period (from 5.3 percent to 6.2 percent). While retail markets in Los Angeles, New York City, and Philadelphia saw an 8–10 percent increase in vacancy rates during the pandemic, other markets such as Houston and Phoenix experienced moderate vacancy rate increases—3.03 percent and 2.44 percent, respectively. In more positive scenarios, retail markets in cities such as Atlanta and Chicago saw only a slight increase in vacancy rates during the pandemic, with vacancy rates returning to their pre-COVID level at 5.9 percent and 9.1 percent in the fourth quarter of 2020, respectively.

Chart 1: Vacancy Rates

Chart 2 illustrates that the asking rent in most markets increased during the pandemic. The biggest jump in gross asking rents occurred in Dallas where, perplexingly, vacancy rates also increased the most. Dallas's gross asking rents increased from $13.26 per square foot (psf) to $14.79 psf from the fourth quarter of 2019q4 to the fourth quarter of 2020. New York City also experienced a noticeable increase in gross asking rents, with a 6.3 percent increase from the fourth quarter of 2019 ($33.51 psf) to the fourth quarter of 2020 ($35.62 psf). Other markets experienced moderate increases or mirrored rent rate changes experienced between 2018 and 2019. Atlanta was the only market where gross asking rents decreased. However, Atlanta's downward trend in retail rent rates started in the fourth quarter of 2019, so it is difficult to determine to what extent this trend was preexisting or influenced by the pandemic.

Chart 2: Gross Asking Rent

These observations all beg the question: why did the retail market experience only moderate changes in vacancy rates relative to the office market during the pandemic?

We cannot say for certain why the retail market and office market fundamentals for the top 10 markets followed such different paths. However, just as office-using employment drives demand for office space, we also know that the retail market relies heavily on household consumption. The relatively modest changes in vacancy rates and increased asking rental rates in the retail market could potentially be explained by the rebound in retail sales as shoppers returned to reopened stores (as you can see hereOff-site link). Chart 3 illustrates that retail trade sales temporarily decreased in the early stages of the COVID-19 pandemic (February–April 2020), but they rebounded strongly in May and June 2020, returning the total dollar value of retail trade sales (excluding nonstore retailers) to its pre-COVID level.

Chart 3: Monthly Retail Trade Sales

However, surveys conducted by our Atlanta Fed colleagues (discussed here) show that retail and wholesale firms expressed increased optimism in August 2020 when compared to April 2020. This improved sentiment may have further supported overall retail real estate market performance.

After putting forth these observations, though, one caveat is in order. Although the overall retail market appears to have been much less affected than the office market, the effects could vary by the size and type of business. For example, larger firms often have more financing options. They also tend to have online platforms that can help to offset temporarily sluggish sales at brick-and-mortar locations. The data we reviewed for this post does not discriminate between firm size or type, and we did not explore these dimensions.

We'll continue to monitor market fundamentals and report what we find. Meanwhile, you can track trends in the commercial markets with the Atlanta Fed's Commercial Real Estate Momentum Index.

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 20, 2021

Has the COVID-19 Pandemic Affected Demand for Office Space?

Last July, our Atlanta Fed colleagues concluded that the COVID-19 pandemic would not decrease demand for commercial real estate (here). As the COVID-19 pandemic passes the one-year mark, have expectations on what a "return to the workplace" looks like changed for businesses and their employees? Many firms continue to allow employees to work from home (here and here). Anecdotes suggest that many are reimagining their office culture as they scrutinize empty or underutilized office space in an effort to reduce structural costs. Has this also resulted in a significant shift in demand for office space?

To understand how office market performance fundamentals have changed since the COVID-19 pandemic began, we examine office-using employment, vacancy rate, and rental rate trends across the 10 cities with the highest office space square footage stock. We hypothesize that markets with higher office space inventories likely have more office workers and may experience larger, longer-lasting effects resulting from massive shifts to remote work arrangements.

The United States experienced significant declines in employment due to COVID-19, but what was the effect on the office-based workforce? Using the Bureau of Labor Statistics' office-using employment series at the metropolitan statistical area (MSA) level, we observe in chart 1 that the number of employees using commercial office space has declined significantly in the pandemic. The graph on the right illustrates the monthly change in the number of employees using offices, which decreased by 6 percent on average from March 2020 to April 2020. The decline was most severe (11 percent) in the Los Angeles-Long Beach-Anaheim, CA MSA and mildest (2 percent) in the Washington-Arlington-Alexandra, DC-VA-MD-WV MSA. Although most markets saw a positive change in May 2020, the graph on the left shows that the number of employees using physical office space is still lower than it was before the start of the COVID-19 pandemic.

Chart 1 of 3: Office Using Equipment

The survey conducted by our colleagues in June 2020 (here) indicated that roughly 80 percent of respondents had no plans to change their current floor space needs. It seems reasonable, however, that the significant decline in office-using employment across metro areas with the largest office stock might translate to higher vacancy rates. Recent office market data from the CBRE Economic Advisors (CBRE-EA)1 indicate that office market vacancy rates increased significantly in 2020. Chart 2 illustrates stable vacancy rates before the COVID outbreak. Following the outbreak, in the second quarter of 2020, vacancy rates moved up. The overall office market vacancy rate was 12.2 percent in the fourth quarter of 2019 and 12.3 percent in the first quarter of 2020, then steadily increased through the year to 15 percent in the fourth quarter of 2020. All markets experienced vacancy rate increases for office space, with markedly different changes. Changes for the Denver and New York office market vacancy rates, for example, were larger than for most other cities. Denver's increased by 30.89 percent from the first quarter of 2020 to the fourth quarter (from 12.3 percent to 16.1 percent) while New York saw the largest jump (36.78 percent, from 8.7 percent to 11.9 percent). Interestingly, although Denver experienced the second highest jump in vacancy rates in 2020, the Denver and Houston MSAs did not experience a dramatic change in the number of employees using office space in 2020.

Chart 2 of 3: Office Market Vacancy Rate

Observing that office space vacancy rates increased significantly during the pandemic, we wondered if landlords renegotiated rent rates, so we explored the trend in gross asking rent. This is the estimated rent rate for a gross lease type where a landlord is responsible for expenses such as utilities and property taxes. Chart 3 illustrates trends of gross asking rent per square foot from the first quarter of 2016 to the fourth quarter of 2020. The data indicate that the asking rent rate did not change significantly during the pandemic compared to the previous period. While gross asking rent in the Dallas market increased slightly from the third quarter of 2020 to the fourth quarter, it was a relatively minor change. With such a high level of uncertainty, it's possible that real estate firms and investors were not convinced they needed to adjust asking prices. Another possibility is that tenants received longer periods of free rent in exchange for not adjusting rent prices downward. This second scenario effectively makes rents cheaper, although contract rates appear to be the same. We are unable to investigate further due to the unavailability of prerequisite data.

Chart 3 of 3: Office Market Asking Rent


We explored office market fundamentals since the onset of the COVID-19 pandemic and found that office-using employment declined while vacancy rates for office space increased significantly. How office property asking rent rates have responded to the pandemic remains unclear. Due to the long terms required for commercial leases, landlords appeared unwilling to lower rents because they expected that market conditions would soon improve.

Since firms remain uncertain as to when employees will return to the office, policymakers and investors should monitor current office market vacancy rates to best prepare to operate in an environment with sustained high vacancy rates. Will some firms have to reimagine their space and convert assets into different property types? We'll continue to monitor these market fundamentals, including property conversions, and report back. Meanwhile, you can track trends in market fundamentals with the Atlanta Fed's Commercial Real Estate Momentum Index.

1 [go back] CBRE- Econometric Advisors (EA) release quarterly data on the commercial real estate markets.

May 6, 2021

How Has GDPNow Performed during the Pandemic?

According to the U.S. Bureau of Economic Analysis (BEA), real gross domestic product (GDP) grew at an annualized rate of 6.4 percent in the first quarter of 2021, 1.5 percentage points below our final GDPNow model forecast. The size of this forecast error is large relative to GDPNow's prepandemic history but much smaller than the extremely large errors recorded last year. In short, the GDPNow model has struggled to accurately capture the unusual sources of variation in GDP caused by the COVID-19 pandemic and the various policy responses. The colored dashed lines in chart 1 show the evolution of GDPNow's forecast errors for each of the last five quarters. Unlike any of the four quarters of 2020, GDPNow's forecasts of real GDP growth last quarter was always within 5 percentage points of the BEA's first published estimate. Nevertheless, we can see that the GDPNow forecasts for GDP growth last quarter were still less accurate than before the pandemic.

Chart 1: Accuracy of GDPNow Forecasts

Despite the recent deterioration in GDPNow's accuracy, its forecasts over the past 15 months share some broad similarities with professional forecasts, as chart 2 shows. From mid-March to mid-May 2020, both GDPNow and the consensus Wall Street Journal Economic Forecasting SurveyOff-site link (WSJ) forecasts of real GDP growth declined sharply. As described here, GDPNow did not anticipate the extent of the plunge in services consumption last March and the resulting impact on GDP growth for the first quarter of last year. The nosedive and rebound in economic activity last year were evident in GDPNow's forecasts for GDP growth in the second quarter of 2020. Forecasts for third-quarter GDP growth strengthened during much of the summer and early fall, and GDPNow performed as well or better than the consensus forecast over much of that period. However, for the last two quarters, GDPNow forecasts were more erratic, and generally less accurate, than the consensus.

Chart 2: Forecasts and initial BEA estimates of quarterly real GDP growth

It's not surprising that GDPNow's accuracy has deteriorated relative to the consensus of professional forecasts. Unlike GDPNow, professional forecasters have been able to use data on personal mobility and government mitigation measures (such as hereOff-site link, hereOff-site link, hereOff-site link, and hereOff-site link), and a number of studies have shown that these measures relate to cross-country differences in GDP growth observed in 2020 (for example, hereOff-site link and hereOff-site link). Transportation services and leisure and hospitality accounted for half the decline in consumer spending in the first two quarters of 2020, and a number of high-frequency measures of activity in these sectors (such as hereOff-site link, hereOff-site link, hereOff-site link, and hereOff-site link) are available before official spending dataOff-site link are. Finally, spikes in consumer spending following the distribution of stimulus payments included in the December and March fiscal packages were evident in some high-frequency measures of consumer spending (available hereOff-site link and hereOff-site link) before they were evident in the retail salesOff-site link and personal income and outlaysOff-site link releases. In contrast, GDPNow uses a fixed methodology and source data for estimating GDP, making it much less adaptable to unusual circumstances.

Nevertheless, GDP forecasting during the pandemic has been challenging even for professional forecasters. Chart 3 shows the distributions of GDPNow and WSJ survey panelist forecast errors of real GDP growth for projections made about 20 days before the BEA's release of its initial GDP estimate. The gray cross marks represent individual WSJ panelist errors, and the blue rectangles represent interquartile ranges (IQRs), or middle halves, of the distribution of their forecast errors. The IQRs widened during the pandemic, and a number of panelists had errors in the middle two quarters of last year that were dramatically larger than usual.

Chart 3: Forecast errors of real GDP growth about 20 days before GDP release

Still, it is plausible that the extreme fluctuations in the data used by the GDPNow model have embedded some inaccuracies into the GDPNow forecasts. To examine this question, let's consider GDPNow's final projections of the main subcomponent contributions to overall real GDP growth since the model was released to the public in 2014. Chart 4 shows the stacked forecast errors of these projections. By construction, the sum of the bars in any quarter is approximately equal to the black dot showing the difference between the first official estimate of real GDP growth and that quarter's final GDPNow forecast. The bars have become much larger since the pandemic, but especially for services consumption and state and local government expenditures (S&L). In this post, I've noted issues related to services consumption, but most of the huge third-quarter S&L error fell into a category referred to as "sales to other sectors Adobe PDF file formatOff-site link." GDPNow expected these sales—which are largely health, hospital, tuition, and other educational charges and fees—to continue plummeting in the third quarter instead of rebounding strongly, as they did. (The S&L contribution error is negative because the BEA subtracts these sales from the S&L subcomponent, and from GDP, to avoid double-counting). The S&L contribution errors in the last two quarters were still quite large, and mostly the result of the GDPNow model incorrectly continuing to forecast declines of these "sales to other sectors."

Chart 4: Errors of final GDPNow forecast of subcomponent contributions to real GDP growth

In the coming months, we plan to tweak the architecture behind GDPNow in hope of mitigating these sorts of errors. For instance, the day before the most recent GDP release, a modified version of the GDPNow model (one that reduces the influence of the pandemic on some of its forecasting equations) predicted first-quarter real GDP growth of 5.5 percent. More than half of the difference between this forecast and the official final GDPNow forecast of 7.9 percent growth was the result of a lower forecast for growth in the S&L subcomponent (1.3 percent), a number much closer to the BEA's S&L growth estimate (1.7 percent) than the final GDPNow forecast (14.6 percent). Such enhancements might help improve GDPNow's forecasting accuracy down the line. But GDPNow will remain susceptible to forecast inaccuracies whenever unusual events (such as the COVID-19 pandemic) hit the economy and dramatically shift spending patterns.