CFS Monetary Measures for September 2017

Today we release CFS monetary and financial measures for September 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.8% in September 2017 on a year-over-year basis versus 4.1% in August.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Sep17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

From China / Market Implications from Unconventional Monetary Policies…

The Shanghai Development Research Foundation (SDRF) recently hosted a superb dialog on issues stretching from China, the international monetary system, re-thinking the nature of money, among others.  I had the pleasure of presenting on “Market Implications from Unconventional Monetary Policies.”

My remarks centered on:

The need to assess the normalization of monetary policies through the lens of major macro shifts over the last 10 years.

Specifically, three “never befores” need to be resolved.  For instance, “never before” has there been such 1) large scale intervention by central banks and governments; 2) growth in the financial regulatory apparatus and labyrinth of rules governing markets; and 3) distortions across a wide range of financial markets.

Here, CFS monetary and financial data illustrate why goods price inflation has remained subdued and – in contrast – asset price inflation has not.

Evaluation of long-term stock and bond market valuations reveal market distortions.

Speculative positioning has been actively influenced by the patterns of rise and restraint in balance sheet operations in recent years.

Going forward, officials would benefit by seeking balance among these three “never before” forces.

For slides accompanying the presentation:  http://www.centerforfinancialstability.org/speeches/ShanghaiDRF_090517.pdf

On a parenthetical note, I left China excited with advances in mobile pay.  It will redefine the nature of money.

CFS Monetary Measures for August 2017

Today we release CFS monetary and financial measures for August 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.1% in August 2017 on a year-over-year basis, maintaining the same growth rate as in July.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Aug17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

 

Sargen: The Fed Begins to Shrink Its Balance Sheet

Highlights

  • The Federal Reserve is expected to announce it will begin to shrink its balance sheet over the next few years at this month’s FOMC meeting.  Investors are pondering how smoothly the process will go.
  • Opinions on this matter are divided.  Some observers are concerned it could disrupt financial markets, but the prevailing view is it will not.
  • Another issue is whether monetary policy will ever be as it was before the 2008 Global Financial Crisis (GFC).  Our take is it has been permanently altered, because the transmission mechanism increasingly works through capital markets.
  • We believe the Fed will aim for the funds rate to reach 2% and will then pause.  The changing composition of the Board of Governors, however, adds an element of uncertainty in 2018.

The Controversy Surrounding Quantitative Easing

During the GFC the Federal Reserve engaged in unorthodox policies that were intended to stabilize the financial system and to encourage investors to add to holdings of risk assets.  The Fed did so by purchasing massive amounts of government securities and residential mortgage-backed securities (RMBS) that increased its balance sheet four-fold (Figure 1).  The initial round of quantitative easing (QE) is widely credited by economists as having stabilized the financial system and thereby averted an even worse outcome.  However, subsequent rounds were viewed more skeptically, as they occurred when the economy and markets had stabilized.

Figure 1:  Assets of the Federal Reserve ($ billions)


Source: Bloomberg and Federal Reserve.

The Fed’s intent was to encourage investors to add to risk assets such as corporate stocks and bonds, which would bolster the economy by creating a positive wealth effect and ease borrowing conditions for consumers and corporations.  From the Fed’s perspective, it was worth doing so in order to reduce the unemployment rate, which fell from a peak of 10% to below 4.5% recently.  One of the main criticisms, however, is that its actions also distorted capital market prices and thereby may contribute to another asset bubble.  Previously, the Fed primarily influenced short-term interest rates rather than the entire term structure and risk assets, so it would not distort capital markets.


Normalizing Monetary Policy

The ultimate test of the QE experiment is the Fed’s ability to develop a successful exit strategy.  The Fed’s staff has been working on a game-plan since the early part of this decade.  One of the first actions was the decision to pay interest on bank reserves.  By doing so, the Fed created an additional means to control bank reserves and thereby lessen the risk that the money supply would expand unduly once bank lending expanded materially.  Officials were also cognizant of mistakes their predecessors made during the Great Depression, when the Fed doubled reserve requirements and banks responded by reducing loans outstanding considerably.

One of the key differences today is that monetary policy works through capital markets, as well as through the banking system.  Therefore, the Fed ultimately must influence investors’ expectations by communicating its intentions clearly.  Policymakers learned this lesson all too well during the so-called “taper tantrum” in mid-2013, when Ben Bernanke mentioned in Congressional testimony that the Fed was considering winding down its purchases of securities in 2014.  Much to the Fed’s chagrin, bond yield surged by a full percentage point during the remainder of 2013 as investors believed the Fed was about to tighten monetary policy.

In light of this experience, some observers are concerned that a similar outcome could occur as the Fed pares its holdings of securities.  The prevailing view, however, is that this news already is priced into markets, and a spike in rates is only likely if there are surprise developments. Recognizing this, Fed officials have gone out of their way to reassure investors that it will shrink its balance sheet very gradually: It has stated that it will not sell securities outright, but will allow a portion to roll off its books as bonds mature.

The Fed also indicated at the June FOMC meeting that its balance sheet would eventually decline by $50 billion on a monthly basis ($600 billion annually) until it chooses to halt or reverse the process.  At this pace, the monetary base would revert to its pre-crisis growth trend by 2021. However, Fed watchers do not expect it to get there: Estimates vary, but the general consensus is the terminal size of the balance sheet the Fed range is around $2.5 trillion, or roughly one half of the current level.  The Fed has indicated that the balance sheet will be no larger than necessary to manage monetary policy in the current framework, which requires more reserves than pre-crisis policy.


Challenges Confronting Policymakers

It remains to be seen how well the transition to policy normalization will go.  Although the initial process has been smooth, the Fed nonetheless faces formidable challenges ahead.  One is to ascertain the natural rate of unemployment, commonly referred to as NAIRU, below which inflation rises.  This is important because the Fed utilizes econometric models that assume the Phillips curve relationship between wage increases and unemployment holds.  The relationship, however, is far from stable: Previously, wage pressures would typically be evident when the unemployment rate is below 5%, but this has not happened currently.  The reason is unclear to policymakers and market participants, but one reason may be is that there is a large pool of workers who are currently working part time that are seeking full time jobs.

Meanwhile, the core rate of inflation has drifted below the Fed’s 2% target.  This has increased uncertainty about whether it will raise the funds rate at the end of this year, as it did in 2015 and 2016.  Nonetheless, while the timing of rate increases is uncertain, we believe the Fed is aiming for a funds rate of 2.0% and will then pause.  This is well below the average rate of 4%, which is typical for an economy growing at 2% and inflation close to that pace.


Will Monetary Policy Ever Return to Normal?

This begs the question of whether monetary policy will eventually revert to the way it was conducted before the GFC, when it mainly influenced the volume of bank reserves by purchasing or selling treasuries to influence the funds rate.

Our assessment is that the conduct of monetary policy has been altered permanently, as the transmission mechanism increasingly occurs through capital markets.  If so, investors need a guide to assess whether policy conditions are becoming easier or tighter.  The standard procedure today is to look at a variety of financial market indicators — such as short term and long term treasury yields, credit spreads, the stock market, and the trade weighted dollar – to compute a financial conditions index.  Thus, based on the latest readings, financial conditions have actually eased despite the increases in the funds rate, because equities have risen while credit spreads and the trade-weighted dollar have declined (Figure 2).

Figure 2: Financial Conditions Have Eased Recently

Source: Bloomberg and Goldman Sachs.

Finally, it remains to be seen how monetary policy may shift as the composition of the Board of Governors changes.  By next year, for example, there could be a new Fed Chair, along with a new Vice Chair and three new governors.  It is too early to speculate about what is in store. Nonetheless, investors will be keen to assess whether monetary policy will remain highly discretionary and consensual, as it was during the Bernanke-Yellen era, or whether it will become more rules based, as some Fed critics have argued.  In this respect, the changing of the guard will become a focus for market participants in the coming year.

CFS Monetary Measures for July 2017

Today we release CFS monetary and financial measures for July 2017.  CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.1% in July 2017 on a year-over-year basis versus 3.7% in June.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jul17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

CFS Monetary Measures for June 2017

Today we release CFS monetary and financial measures for June 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 3.7% in June 2017 on a year-over-year basis versus 4.4% in May.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jun17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

CFS Monetary Measures for May 2017

Today we release CFS monetary and financial measures for May 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.4% in May 2017 on a year-over-year basis, maintaining the same growth rate as in April.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_May17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

CFS Monetary Measures for April 2017

Today we release CFS monetary and financial measures for April 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.4% in April 2017 on a year-over-year basis versus 3.9% in March.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Apr17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

Sargen on Corporate Tax Cuts versus Tax Reform Revisited

Highlights

  • As part of “the largest tax cut in history” the Trump Administration is proposing to lower the corporate tax rate to 15% while shifting to a territorial system in which U.S. companies no longer would be disadvantaged on taxation of overseas profits.  The stated goal is to boost long-term economic growth through increased business capital spending.
  • The one page proposal, however, is really a wish list of tax cuts for corporations and individuals, rather than a plan to reform the tax code.  That is the goal of the bill Paul Ryan and House Republicans drafted last summer; however, prospects for its passage have been hurt by failure to repeal Obamacare.
  • While equity investors are banking on corporate tax cuts to be enacted later this year, the unanswered question is how they will be paid. The President and his supporters contend the proposal pays for itself with stronger growth.  However, the risk is the federal deficit will blow out from already high levels.

The Trump Administration’s Wish List

Throughout the 2016 campaign, Donald Trump advocated lower taxes for businesses and individuals as a way to bolster economic growth, and he called for the corporate tax rate to be lowered to 15% from the current rate of 35%.  Because there were few details to back this proposal, however, investors focused on the tax bill drafted by Speaker Ryan and the Republican House leadership, as it had broad support among the Republican rank and file.  It contained four key provisions: (i) reduce the corporate tax rate to 20%; (ii) allow immediate expensing of capital outlays, but exclude interest deductions; (iii) incent businesses to repatriate profits earned abroad; and (iv) implement a border-adjustment-tax (BAT) that would effectively subsidize exports and tax imports.

The intent of the Republican bill was to streamline the tax code and facilitate passage by making it deficit neutral.  With the first three provisions generally consistent with the President’s agenda, market participants focused on the BAT provision that is controversial because of the adverse consequences for firms that rely on imports.

In the wake of the health care fiasco, the prospects for a tax bill that is deficit neutral were dealt two major blows: (1) The failure to replace Obamacare meant the Republican leadership could not garner the projected savings in revenues of more than one trillion dollars over ten years that would have occurred if Medicaid expansion had been halted.  (2) The wrangling over health care made it less likely that the BAT provision would clear the tax bill, because it is too complex and too controversial.

As these developments unfolded, I envisioned a situation in which Speaker Ryan would tell the President that he could no longer support a 20% corporate tax rate unless additional revenues were forthcoming.  Instead, the President upped the ante on Speaker Ryan and the Republican leaders in Congress this past week by stating he favored a 15% corporate tax rate and that he was not concerned about the budgetary consequences. (According to the Urban-Brookings Tax Center, lowering the corporate tax rate to 15% could entail a revenue loss of $2.4 trillion over 10 years, or $600 billion more with a 20% tax rate.)  In addition, the Administration’s proposal appears to drop the BAT provision, which is estimated to generate more than $1 trillion in revenues over the next ten years, and is silent on the issue of deductibility of interest expense.

In the Trump Administration’s view, a lower tax rate would spur stronger economic growth, which would boost tax revenues.  The problem, however, is that tax cuts may provide a boost to the economy by increasing aggregate demand, but the effects are likely to be only temporary if they blow out the budget.


Do Budget Deficits Matter?

This issue loomed large during the 1980s when the Reagan Administration achieved significant tax cuts for businesses and individuals that helped boost the economy.  Although they were accompanied by a significant expansion in the budget deficit, interest rates plummeted from record levels, mainly because the Federal Reserve succeeded in reining in inflation and inflation expectations.  Accordingly, many people at the time concluded budget deficits did not matter for the economy or financial markets.

One needs to be careful about drawing this inference today, however, because the economic environment is very different.  First, inflation and interest rates are near record low levels, and they are likely headed higher as the economy improves and the Fed normalizes interest rates.  Second, the trend rate of economic growth has fallen from more than 3% per annum to about 2% p.a. in the past decade. The challenge the Administration and Congress face is that it is not easy to boost productivity growth and increase labor force participation.

According to the Congressional Budget Office (CBO) projections based on recent trend growth, the budgetary picture is about to worsen in the absence of any policy changes: The federal deficit is projected to grow from less than 3% of GDP to more than 5% by 2027.  This is mainly due to increased outlays for entitlement programs such as Social Security, Medicare and Medicaid owing to the aging of the population and medical costs that have outstripped the pace of inflation.  Stated another way, ten years from now all federal revenues would go to pay for entitlements and debt servicing costs, meaning that all discretionary programs would have to be covered out of deficit financing.

Supporters of lower tax rates counter the picture is far less bleak if trend growth of 3% is restored. (See the commentary by Stephen Moore “Growth Can Solve the Debt Problem” in the Wall Street Journal dated April 26.)  This line of reasoning, however, is risky, because one can always assume the problem away via optimistic growth rate assumptions.  (See the commentary by former CBO Director, Douglas Holtz-Eakin, “Trump’s Tax Plan is Built on a Fairy Tale” in the Washington Post dated April 26.)

So far, at least, financial markets have adopted a “wait and see” posture.  Equity investors are banking on a boost to the economy and corporate profits from tax cuts being enacted, while the bond market is dubious, but supported by lower interest rates abroad.

Speaker Ryan and Republican leaders in Congress, however, are more concerned about prospects for the budget. They are likely to push back on the President’s tax initiatives, especially when he is also supporting increased spending on defense and infrastructure and no checks on the growth of entitlement programs.  It remains to be seen, therefore, how the political process will play out, and whether the President’s tax proposal or the Congressional Republicans’ will prevail. Meanwhile the process is expected to drag on for a long time and possibly into next year.

CFS Monetary Measures for March 2017

Today we release CFS monetary and financial measures for March 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.0% in March 2017 on a year-over-year basis versus 4.1% in February.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Mar17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’