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Federal Reserve ChallengeDecember 10 2008
Damian Gray
Ben Blieden
Scot Weisman
Adam Nichols
Robert Searle
Monetary Policy Recommendations
Maintain Fed Funds Rate at 1%
Lower Cost of Capital
Purchase Long term Debt
Create Innovative Lending Facilities
2004
Q3
2004
Q4
2005
Q1
2005
Q2
2005
Q3
2005
Q4
2006
Q1
2006
Q2
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
-1
0
1
2
3
4
5
6Percentage Change GDP
Source: BEA
3rd Quarter GDP -.5%
• Personal consumption 3.7%• Government consumption 5.4%• Business Investment .4%• Exports 3.4%• Imports 3.2%
Source: BEA
GDP = C+I+G+(X-M)
GDP forecasts
• Goldman Sachs predicts 4th quarter GDP will go down 5%
• Personal consumption will continue to decrease in 2009
• Barack Obama’s plans will boost government consumption in 2009
Source: CNN
Loss of Jobs
Jan-
07
Mar
-07
May
-07
Jul-0
7
Sep-0
7
Nov-0
7
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep-0
8
Nov-0
8
-600
-500
-400
-300
-200
-100
0
100
200
300
Nov. 8: 533,000
Total Year to Date:Nearly 2 Million
Source: BLS
Unemployment Rising
0
1
2
3
4
5
6
7
8
January 2008: 4.9%
November 2008: 6.7%
Source: BLS
Other employment problems
• Unemployment – lagging indicator• Increase in underemployment
– The number of workers who are working part time for economic reasons has increased by 2.8 million in the past year
• Increase in discouraged workers– In the past year discouraged workers have gone up
from 259,000 to 608,000
Source: BLS
Unemployment Forecasts
• Unemployment will continue to rise throughout 2009 and by December it may reach 9-10%
• Obama is planning to create millions of jobs through extensive government spending
Source: CNN Money
Inflation vs. Core Inflation
Jan-
07
Mar
-07
May
-07
Jul-0
7
Sep-0
7
Nov-0
7
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep-0
8
-1.5
-1
-0.5
0
0.5
1
1.5
InflationCore Inflation Source: BLS
Deflation and Collateral
Deflation can lead to significant declines in the value of collateral owned by households and firms, making it more difficult to borrow
Falling collateral values on outstanding loans, reduces manufacturing and lowers consumption
Inflation Targeting
Making the Fed's inflation goals more explicit could reduce uncertainty and assist business and financial market planning
Housing Bubble• Irresponsible Lending/Borrowing
– Fannie and Freddie mortgages rose 600% during the 90s surpassing $5T
– Housing prices jumped 80% in 8 years
• Lack of regulation & oversight• Credit regulators not understanding how to rate
collateralized debt obligations (CDOs) and commercial mortgage-backed securities (MBSS)
Source: CNBC
Inflated home Prices
Rise in Mortgage Rates
Janu
ary
2004
Mar
ch 2
004
May
200
4
July
2004
Septe
mbe
r ...
Novem
ber .
..
Janu
ary
2005
Mar
ch 2
005
May
200
5
July
2005
Septe
mbe
r ...
Novem
ber .
..
Janu
ary
2006
Mar
ch 2
006
May
200
6
July
2006
Septe
mbe
r ...
Novem
ber .
..
Janu
ary
2007
Mar
ch 2
007
May
200
7
July
2007
Septe
mbe
r ...
Novem
ber .
..
Janu
ary
2008
Mar
ch 2
008
May
200
8
July
2008
Septe
mbe
r ...
Novem
ber .
..0
1
2
3
4
5
6
7
8
30 Year Fixed 1 Year ARM
Source: Bloomberg
Rising Energy Costs(CPI) Energy
Fall in Home prices andNon-Farm Payrolls
Rise in Foreclosures
Failures
• Bear Stearns -> JPMorgan Chase• Lehman Brothers ($1.35B) -> Barclays• Wachovia ($15.1B) -> Wells Fargo• Washington Mutual -> JPMorgan Chase• Countrywide -> Bank of America• Merrill Lynch -> Bank of America
Multiplier Effect
The decrease in the velocity of money has a multiplier effect because money being introduced by the Fed is not being multiplied
Instead creating a contraction - The slowing velocity leads to a negative multiplier effect
Money Supply Increasing
M1 Multiplier Decreasing
-5
-4
-3
-2
-1
0
1
2
3
4
5Personal Consumption (Percent Change)
-3.7%
1.2%
Source: BLS
Consumer Confidence Falls
Jan-05Jan-91Jan-77Jan-63Jan-49Jan-35Jan-21Jan-07Jan-93Jan-79Jan-65Jan-510
20
40
60
80
100
120
Source: Conference Board Consumer Resource Center
Why Consumer Confidence is Falling
• Tight credit conditions• Job losses• Falling incomes• Uncertainty of the future
Consumer Saving
Falloff in Retail Sales
Jan-05Jan-03Jan-01Jan-99Jan-97Jan-95Jan-93Jan-91Jan-89Jan-87Jan-85290000
300000
310000
320000
330000
340000
350000
Retail Sales (excluding food) per month
Mil
lio
ns
of
Do
llar
s
Source: www.economicindicators.gov
Troubled Asset Relief Program
• Treasury’s Capital Purchase Program
– Recapitalize bank balance sheets
National Debt
• Greater Than $11trillion, October 1st, 2008
• Over 73% of GDP
• Largest ever during WWII at 122%
Source: IOUSA
Debt as a % of GDP
Who Owns the Debt ?
• Government Accounts (Trust Funds)– Largest is Social Security – Medicare, Medicaid problems as population ages
• Publicly-held: $6.302 trillion– $2.74 trillion foreign-owned– Japan $585.9 billion & China $541 billion
• Congress has approved 6 increases of the debt limit since 2002, totaling $4.915 trillion– Most recently Oct. 3, 2008 - $700 billion
Concord Coalition
Budget FY 2008• $2.5 trillion in revenue• $2.9 trillion in spending
Personal Income Tax41%
Payroll FICA31%
Corporate Income Tax12%
Other2%
Deficit14%
Source: IOUSA
$400 billion deficit in the FY 2008 budget
Cost to Economy of Big Three Auto Makers Failure
239,341 Direct job losses973,969 Supplier job losses 1,738,034 Related industry jobs $150.7 billion Personal income$14.3 billion Increased transfer payments
(unemployment)$21.1 billion Social Security payroll taxes $24.7 billion Personal income taxes
Source: CNN Money
Annual Auto Industry Jobs Loss
Source: BLS
Unfunded Promises
Liabilities11
21%
Social Security7
13%
Medicare (A,B)26
49%
Medicare (D)8
15%
Misc1
2%
$53 trillion in promises
Chart shownin trillions Source: IOUSA
Negative Effects
• With Rising Unemployment– Tax Revenue drops– Increasing the deficit– Decreasing our solvency
• Unfunded promises rising on top of debt
• Example set for over leveraging consumers
0
500000
1000000
1500000
2000000
2500000
3000000
19
43-0
1
19
45-1
0
19
48-0
7
19
51-0
4
19
54-0
1
19
56-1
0
19
59-0
7
19
62-0
4
19
65-0
1
19
67-1
0
19
70-0
7
19
73-0
4
19
76-0
1
19
78-1
0
19
81-0
7
19
84-0
4
19
87-0
1
19
89-1
0
19
92-0
7
19
95-0
4
19
98-0
1
20
00-1
0
20
03-0
7
20
06-0
4
Do
llars
($
)
Year
Consumer Debt
Seasonally Adjusted
Rising American Consumer Debt
Source: BLS
1977 Amendment to the Federal Reserve Act
1.to promote "maximum" sustainable output and employment
2.to promote "stable" prices
Monetary Policy Focus
Encourage business investment and consumer spending by:
–lowering the cost of capital–increasing the availability of credit
Declining Commercial and Industrial Loans
Falling Gross Private Domestic Investment
Effective Rate vs. Target Rate
Quantitative Easing
• Current lending facilities– Term Auction Facility (TAF)– Term Securities Lending Facility (TSLF)– Primary Dealer Credit Facility (PDCF)– Commercial Paper Funding Facility (CPFF)– Term Asset-Backed Securities Lending Facility
(TALF)– Interest on Reserve Balances
Expanding Reserve Bank Credit
Interest on Reserves
• Nov 5th action to set remuneration rate equal to target enables better control of effective rate
• Encourages banks to hold reserve deposits at Fed - further expansion of consumer and business credit facilities
The Rising Effective Fed Funds Rate Since November
Growth of Reserve Balances at Federal Reserve Banks
Term Asset-Backed Securities Facility (TALF)
• For growth to occur there must be consumer spending and business investment
• TALF aids credit markets for consumers and small businesses by incentivizing lending for banks
FRBNY
Consumer and Small Business
Bank
Non-Recourse Loan
Loan$$$
Asset-Backed Security
ABS Collateral
Small Business
• Employs more than half of private sector workers
• Generate half of new net jobs annually over past decade
• Account for more than1/2 of nonfarm GDP
• Small firms cannot offer innovative new products or services without competitive credit.
http://www.federalreserve.gov/newsevents/testimony/mishkin20080416a.htm
Long Term Debt
• Purchase long term Treasury and agency (Fannie, Freddie, etc.) debt to influence yields
Purchases on the open market:
• Drive down yields • Influence other long term interest
rates across the financial markets
30 Year Bond Yields Falling
10 Year Treasury Notes Falling
National 20 & 30 yr Fixed Mortgage Rates Falling (bankrate.com)
Fiscal Recommendations
• Complement Fiscal PolicyNew lending facilities
• Infrastructure Development• Green Technology
Increase Consumer Confidence• Create Jobs through incentives (green)• Housing opportunities and retention• Fed & Treasury work to make FDIC Insurance
permanent
Obama’s Short Term Emergency Plan
• A thousand dollar ($1,000) emergency energy rebate
• Fifty billion dollars to jumpstart the economy and save 1 million Americans from losing their jobs
• $ 25 Billion Stake Growth Fund
• $ 25 Billion Jobs and Growth Fund
Source: Barackobama.com
Obama’s Plan for Business• Create 5 million new jobs through Green, Clean Energy,
and Alternative Fuel Initiatives
– $150 billion over 10 years• Biofuels and fuel infrastructure• Commercial scale renewable energy
• Double Funding for Manufacturing Extension Partnerships
• Boost Renewable Energy Sector– 25% of American electricity from renewable resources by 2025
Source: www.barackobama.com
Infrastructure Investment
• Create National Infrastructure Reinvestment Bank
• Transportation Infrastructure Projects across USA
• Create up to 2,000,000 jobs
• Stimulate new business activity
Source: www.barackobama.com
INFRASTRUCTURE Complement Fiscal Policy Initiatives
• Create New Lending Facilities SPECIFICALLY for Infrastructure Improvements
• Low Cost Financing will promote Business Opportunity and Expansion
• Jobs Created
GDP = C+I+G+(X-M):
G will lead to I, which will also promote C
Historical Perspective – Lessons Learned
Prosperity of the 1990’s was due to:• Advance of the Internet – new opportunities• Moore’s Law – every 18 months technology was
predictably smaller, faster, cheaper to produce• New companies with new products • Ability to use, process INFORMATION
• New Technologies• New Companies• New Jobs• Higher Wages• Better , Cheaper Technology and Efficiency keeps Inflation in check
Dependence on Oil –The Cost Push Problem
Cost Push Inflation – where resource or input prices cause finished goods prices to rise, would still be a problem (like OIL prices)
Recommendation
The Fed funds alternative technologies through new lending facilities to reduce our dependence on foreign oil
Get Back to Innovating• Get back to Innovating, Producing new
Alternative Energy Products• Reduce our dependence on foreign oil• Lowering Imports, Export New Innovations• New Green Technologies will spur new
Opportunities
Creating New Lending Facilities SPECIFICALLY for New Technologies:
New Products, New Companies, New Jobs
GDP = C+I+G+(X-M):
I will lead to C, and will also help promote (X-M)
M3 Growth in 90’s
Private Asset Exchange Lending Program
• Provides needed liquidity to larger businesses, both financial and non-financial
• Provides profitable situation for Treasury and taxpayers that can assist in new fiscal policy expenditures
TreasuryFederal Reserve
Business
CommercialBanks
Private Asset Exchange Lending Program
Treasurie
s
$$$$$
Loan $$$Private Assets
Treasuries
PrivateAssets
Maintain Target Rate at 1%
• Concentrating on Long Term Rates strategy, with Fed Communication:
**Remarks by Governor Ben S. Bernanke At the Annual Washington Policy Conference of the National Association of Business Economists, Washington, D.C. March 25, 2003
As with fiscal policy, public beliefs about how monetary policy will perform in the long run affect the effectiveness of monetary policy in the short run. **
Avoid Liquidity Trap
• Avoid nominal rate dropping to 0%• Reserve this option for Q1 2009 in case
the economy does not respond to Fiscal initiatives
Money Market Squeeze
Lowering FFR below 1% will squeeze Money Markets:
• Money Market Expense Ratios make it difficult to manage money funds for banks
• Losses in U.S. money market mutual funds will cause investors to stay away from short-term markets
Fed Recommendations
• Maintain Fed Funds rate at 1% at this time• Continue “Quantitative Easing”• Continue paying Interest on Reserves• Maintain lending facilities• Purchase long-term debt• Create new “Private Asset Exchange Lending”
program
Effects on GDP
These Recommendations should:• Increase Confidence between Banks (encouraging
lending)• Loosen tight consumer credit (encouraging
consumption)• Support Manufacturing (increasing employment) • Promote innovation (get us off oil, increase investment)• Increase Consumer Confidence (promoting spending)• Reverse the GDP downward Trend (C+I+G+(X-M))
Questions
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