Photograph by Daniel Acker/Bloomberg

The Federal Reserve Bank of New York headquarters

Since December, Fed policy makers have said they will hold their benchmark interest rate near zero until the unemployment rate falls to 6.5 percent. Research by a couple of their colleagues implies they should wait until it’s even lower.

The central bank adopted the so-called Evans Rule at the end of last year, pegging any change in its interest-rate target to specific employment and inflation triggers rather than to a particular point in time. Charles Evans, president of the central bank’s Chicago branch, was the first to give voice to the plan.

The only problem has been that while the jobless rate is steadily declining, it’s been dropping for the wrong reason. People have been leaving the labor force in droves, which means they aren’t officially counted as unemployed. Still, an army of idle former workers puts downward pressure on wages, which is certainly not a sign of a vigorous job market.

Now comes a study by Fed Board economists Christopher J. Erceg and Andrew T. Levin, published by the Boston Fed on April 9, that seems to capture exactly what’s been happening.

Their first conclusion is that the drop in the so-called participation rate, or the share of the working-age population in the labor force, is due to frustration over the lack of demand for workers caused by the recession rather than a structural change in the economy, such as the ageing of the baby-boomer generation. This is important because that means that the decline can be addressed by spurring economic growth.

The pair, currently on leave from the central bank and working in the IMF’s research department, then finds that severe recessions cause the participation to break with past patterns. Instead of climbing as an improving economy gives more people the confidence to rejoin the workforce, the rate continues to decline, accounting for more of the gap in employment and leading to less inflation.

That’s exactly what’s been happening — the participation rate fell to a three-decade low of 63.3 percent in March, even as the jobless rate dropped to a more than four-year low of 7.6 percent. The consumer-price index rose just 1.5 percent over the past 12 months, compared with an average 2.4 percent gain over the past two decades.

Then they come to the conclusion that is sure to send a chill through the central bank and also rile its detractors who argue policy makers have already gone too far.

In order to boost participation and wages, the Fed would need to keep stimulating the economy until the jobless rate falls below its long-run potential for an extended period. In other words, run the economy so hot and have employers so clamoring for help that they bid up wages enough to get the disenfranchised to come back into the workforce.

Let’s say the Fed’s long-run employment forecast is about 5.6 percent — in the middle of its 5.2 percent to 6 percent range of estimates. This paper seems to suggest policy makers will need to take joblessness down to something like 5 percent for a long period to get people back into the labor force. This is an extreme oversimplification of the researchers findings, but still provocative.

Original post is Fed’s Employment Trigger Too High? by Political Capital.

Photograph by Patrick Baz/AFP via Getty Images

Cypriots during a protest against an EU bailout deal outside the parliament in Nicosia on March 18, 2013.

More than half a century ago, the Federal Reserve opposed the idea of a tax on bank deposits similar to the one Cyprus has imposed.

It wasn’t the threat of bank runs that was the problem so much as fairness.

In the Federal Reserve Bulletin of November 1941, the central bank wrote that a bank tax “is not in accord with one of the fundamental principles of taxation in a democracy, namely, that taxes should be imposed in accordance with ability to pay.”

A small-businessperson, for example, might be forced to pay more because of large deposits reflecting the volume of his business rather than his profits, the Fed said. His tax might exceed that of a wealthier individual whose deposits were just salary and dividends.

A deposit tax therefore would be “undesirable” and “not consistent with the principle that the well-to-do should contribute a larger share of their incomes than those in less comfortable circumstances.”

Finally, a “technical consideration” was that some people could probably evade the tax by avoiding depositing money.

The full Fed letter is located on the St. Louis Fed’s archive of research, which preserves and gives access to historical economic and banking policy documents.

Original post is Fed Opposed Cyprus-Like Bank Tax — in 1941 by Political Capital.

Photograph by Patrick Fallon/Bloomberg

Richard Fisher, president and chief executive officer of the Federal Reserve Bank of Dallas.

Federal Reserve Bank of Dallas President Richard Fisher, hardly one to resist using a good metaphor to explain the intricacies of central banking, has upgraded his equine assessment of the economy.

He’s also added some classic rock and roll the mix.

“I really do believe my own joke that we’re the best looking horse at the glue factory,” Fisher said today in a CNBC interview, citing the productivity gains of U.S. firms compared with worldwide rivals. “We’re the thoroughbred of the global economy right now.”

As the first of 19 Fed officials to speak publicly after this week’s meeting, Fisher stepped up his game in explaining why he’s wary of the central bank’s Dec. 12 decision to boost their bond buying by adding $45 billion of monthly Treasury purchases to an existing program to buy $40 billion in mortgage debt a month. That puts the Fed’s $2.92 trillion balance sheet on pace to hit almost $4 trillion by the end of next year.

“Since we’re going to have an engorged balance sheet, we may never be able to leave this position,” said Fisher, 63.

“We were at risk of what I call a ‘Hotel California’ monetary policy, going back to the Eagles song which is, you can check out any time you want but you can never leave.”

Fisher made no attempt to tie the band’s 1979 hit, “The Long Run,” to John Maynard Keynes’s famed observation that under such an elongated time-frame “we are all dead.”

Fisher, a former Dallas money manager and U.S. Senate candidate, also noted that Eagles front-man Don Henley comes from the Lone Star State, which also happens to be putting decent growth stats on the board these days.

The reserve bank chief, a California native turned proud Texan, participates in Federal Reserve Board meetings in Washington with Chairman Ben  Bernanke and other policy makers. The district banks rotate in and out of voting positions each year. Dallas gets to vote again in 2014.

Before ending the interview, Fisher said he had to “brag on Texas,” where he expects economic growth of 3.5 percent this year. That’s faster than the 2.2 percent U.S. gross domestic product growth that economists forecast for this year, according to the median of estimates in a Bloomberg survey.

The second-largest state’s 26 million residents can boast a $1.31 trillion economy that’s bigger than Mexico’s — a nation which is about five times more populous. As Fisher might say, Texas has a full tank and its foot on the gas.

Original post is Fisher Warns Fed of Trap: `Hotel California’ by Political Capital.

Photograph by Daniel Acker/Bloomberg

Potential buyers view a new home under construction in South Barrington, Illinois.

One hand washes the other.

The Federal Reserve’s record stimulus is starting to lift the U.S. housing market out of the basement. And the boost in home prices is poised to start giving the broader economy a bigger push, rather than holding it back as it has for years.

Much of the Fed’s unprecedented policy has aimed to cut the cost of home loans, which it’s driven to record lows. The point is to boost the economy, which is what it’ll happen as the rebound in home prices gives people more to spend on other products and services, and that, eventually, will help reduce unemployment.

“Housing is so incredibly important” because it makes the economy “more and more sensitive” to low interest rates, said Torsten Slok, chief international economist at Deutsche Bank AG in New York. “Home prices feed directly into household balance sheets and therefore to consumption, and home prices feed directly into bank balance sheets and therefore banks’ health and their willingness to lend.”

The Fed has attacked the damage from the financial crisis by carrying out quantitative easing, buying more than $2.3 trillion in bonds. Policy makers also have held the main interest rate near zero since December 2008 and pledged to keep it there through mid-2015. Now their efforts are paying off.

See the full story at Bloomberg.com.

With assistance from Shobhana Chandra in New York.

Original post is Fed Boosts Housing, Housing Boosts Fed — Repeat by Political Capital.

Photograph by Stephen Yang/Bloomberg

William "Bill" C. Dudley, president of the Federal Reserve Bank of New York.

Written with Caroline Salas Gage

A Federal Reserve policy maker added to hints that the central bank will continue Treasury purchases into 2013 when officials gather for their last meeting of this year.

Federal Reserve Bank of New York President William C. Dudley said today that “unacceptably high” joblessness is a key consideration as he considers whether to back additional asset purchases known as quantitative easing.

“The Fed will promote maximum employment and price stability to the greatest extent our tools permit, and we will stay the course,” Dudley said in a speech in New York.

Right now, Fed policy makers are buying $40 billion in mortgage debt each month to give the housing market a lift and cut the unemployment rate from its current 7.9 percent. They’re also pledging to keep the main interest rate near zero through mid-2015.

The Fed also has been swapping $45 billion of short-term Treasuries a month for longer-term debt in a program called Operation Twist, which is scheduled to expire at the end of this year. While that doesn’t add to the Fed’s balance sheet, economists expect that policy makers will replace it with a program that does.

When policy makers last met on Oct. 23-24, a “number” of officials said they may need to expand the monthly bond purchases, according to the minutes of the gathering.

Jan Hatzius, chief economist at Goldman Sachs Group Inc., said today he expects the Fed will decide to increase the pace of balance sheet expansion from $40 billion a month now to about $85 billion a month when policy makers meet next month.

The central bank will probably buy about $85 billion in bonds per month starting in early 2013, San Francisco Fed President John Williams said in a Nov. 14 speech. Williams, who votes on policy this year and was one of the first policy makers to back open-ended buying, said monthly purchases may continue well into the second half of the year.

The decision rests with the Federal Open Market Committee, a 12-member panel led by Chairman Ben Bernanke. It also includes the six other Washington-based Fed governors and five of the 12 presidents of the regional reserve banks. The FOMC next meets Dec. 11-12.

As president of the New York Fed, which conducts the open market operations that actually implement the monetary policy made by the FOMC, Dudley always has a vote. The other 11 reserve banks share the four remaining votes in a rotation.

Dudley said today he’ll “focus on the labor market outlook, not just its current state” in determining whether to add to the Fed’s stimulus. “Although the economy continues to expand, we must grow faster if we are to put all of our jobless workers and idle businesses back to work,” he said.

Original post is Fed Hints at More Bond Buying in ’13 by Political Capital.

Photograph by Zhang Jun/Xinhua/Corbis

Federal Reserve Chairman Ben Bernanke testifies before the Joint Economic Committee about the Economic Outlook on Capitol Hill.

A majority of economists believe the Federal Reserve is poised to boost stimulus tomorrow, according to a Bloomberg Survey of 73 economists.

Sixty-four percent say the Fed is going to launch a bond-buying program at the conclusion of its meeting today and tomorrow in Washington. Sixty-eight percent say the Fed will extend its pledge to hold interest rates near zero into 2015 from its current target of late 2014.

Fed Chairman Ben S. Bernanke said in his Aug. 31 speech in Jackson Hole, Wyoming that he believes buying bonds — a strategy known as QE, for quantitative easing — is effective at boosting employment and that the risks are small. The first two rounds helped create 2 million jobs, he said.

Under QE programs, the Fed creates reserves in the banking system and uses them to buy bonds. Economists don’t agree on the form this new program will take.

One option, expected by 44 percent of economists, is for the Fed to announce an open-ended program where it perhaps announces a monthly pace of purchases that will continue until the central bank is happier with the economy.

The other option, expected by 30 percent of economists, is for the Fed to announce a lump-sum of purchases, perhaps $700 billon to be completed by a certain date. This was the format of the Fed’s second QE program, announced in November 2010, to buy $600 billion of Treasuries by the end of 2011.

Most economists agree that either way, the Fed will be buying both Treasuries and mortgage-backed securities.

The Standard & Poor’s 500 Index has risen 4.6 percent since the start of August and is near the highest levels in four years on expectations the Fed will act.

That suggests QE3 may draw the same sort of political reaction as QE2. While markets welcomed the boost QE2 gave to asset prices, the program drew sharp criticism from Republicans as commodity prices climbed and the dollar fell.

Republican Congressional leaders John Boehner of Ohio, Eric Cantor of Virginia, Mitch McConnell of Kentucky and Jon Kyl of Arizona sent Bernanke a letter in November saying that the program “introduces significant uncertainty regarding the future strength of the dollar.” Republican presidential candidate Mitt Romney has said he won’t reappoint Bernanke.

As QE2 ran its course, commodity prices receded, the dollar strengthened in the second half of 2011, and the rate of consumer-price increases tapered off, vindicating Bernanke’s predictions that QE would not lead to lasting inflation or a decline in the dollar.

Yet that doesn’t mean the debate won’t repeat.

Original post is Here Comes QE3 by Political Capital.

Photograph by Joe Raedle/Getty Images

Mitt Romney and Rep. Paul Ryan on stage after accepting the nomination during the final day of the Republican National Convention.

As Mitt Romney accepted his party’s presidential nomination last night, watching his speech from a Wyoming bar were potential candidates to run the Federal Reserve should he win.

Glenn Hubbard, dean of Columbia Business School and an economic adviser to the Republican nominee, left the opening dinner of the Kansas City Fed’s annual monetary policy symposium to catch Romney’s speech from the Blue Heron bar of the Jackson Lake Lodge. He was joined by Harvard University professor Martin Feldstein and Edward Lazear, the former chairman of President George W. Bush’s Council of Economic Advisors.

Hubbard and Feldstein could be on the shortlist to run a Romney Fed after the Republican pick said he wouldn’t reappoint Chairman Ben S. Bernanke, also in Jackson Hole yet not in its watering hole last night. Another potential contender for the Fed helm attending the conference is Stanford University professor John Taylor.

Hubbard drank from a plastic glass of chardonnay during Romney’s speech and at its conclusion clapped and declared it to be “excellent.”

President Barack Obama didn’t go unrepresented. Gene Sperling, director of the National Economic Council, joined the crowd halfway through the speech, shaking his head and throwing a playful punch at Hubbard at one point.

Original post is Wyoming Bar Hosts Possible Romney Fed Picks by Political Capital.

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Delegates from the state of Maine and supporters of Republican presidential candidate Ron Paul chant 'As Maine goes, so goes the Nation' after they staged a walkout at the Tampa Bay Times Forum.

Ron Paul delegate Betty Jackson didn’t join yesterday’s Republican National Convention walkout by her fellow Paul supporters but “I gave them a thumbs up” because “I do understand their grievances” with the party establishment.

The 100 or so Paul delegates who walked out were protesting the unseating of delegates, including 10 from Maine. The effort to unseat delegates “was rather underhanded,” Jackson said.

Jackson, 57, who hasn’t decided whom she’ll vote for in the November election, said she would “love to hear” Mitt Romney say “we need to audit the Federal Reserve” she said in an interview. “I’d love to hear him say we need to end the Fed and the central banking system” and take the U.S. “back to sound money” yet “I am not anticipating that.”

While Romney has talked about reducing government regulation and spending to give business a freer hand to produce wealth, “I haven’t seen any real plans he’s come up with to do that,” she said. “He has not talked about corporatism: the vicious triangle between corporatists, the lobbyists and the politicians,” said Jackson, who makes upholstery for customer-built furniture.

Jackson said she didn’t listen to Representative Paul Ryan’s speech last night accepting the vice presidential nomination because she was out in the hallway talking to fellow delegates. “I am here to plant and water seeds of liberty and have conversations about why I am a Ron Paul Republican,” she said.

Original post is Paul Delegate: ‘Thumbs Up’ to ‘Underhanded’ Unseating Walk-Out by Political Capital.

Photograph by AP Photo

Meeting with President-elect Richard Nixon are from left standing: Bryce Harlow, assistant to the president; Paul McCracken, Chairman of Economics Advisors, Alan Greenspan, advisor to Nixon, Dr. Arthur Burns, seated left, Nixon, and Rep. Wilbur Mills, chairman of the House Ways and Means Committee in New York City on Dec. 4, 1968.

The Fed is meant to be independent and free from political pressures emanating from Congress or the White House.

That hasn’t always been the case.

For instance, back in the early 70s, Fed Chairman Arthur Burns was pressured by Richard Nixon to manipulate interest rates to suit the political cycle.

Today, the Fed is probably as free as it ever has been from direct political manipulation. However, the November elections could still play a role in monetary policy: the Fed may feel an implicit pressure to maintain the status quo for fear of being used, or abused, by politicians searching for votes.

Given the previous political controversies over quantitative easing, the program to create money and buy bonds, it’s probable the Fed may feel unwilling to embark on a third round, even if it thought that this was necessary. That said, such an outcome looks unlikely at present, particularly in light of minutes from the FOMC’s April 24-25 meeting, published last week, that spoke of a more positive future for the economy. We should assume that more easing isn’t on the agenda.

Perhaps of more relevance is the growing view that it’s time to start tightening monetary policy. European concerns aside, a combination of higher consumer prices, easing conditions in credit markets, and possibly bottoming-out house prices all point in the direction of policy tightening. Sheila Bair, former chair of the FDIC, argued last week in the context of the JPMorgan trading loss that low rates are forcing banks to search for yield, which raises systemic risks in the financial system.

The job of setting monetary policy requires a crystal ball, something that no one has. There’s always a risk that the Fed acts too soon and dampens the recovery. The election, no doubt, will play on policy-setters’ minds. Subconsciously, FOMC members may prefer to avoid raising rates and being brought into the political debate. The result may be higher inflation and higher interest rates in the future.

Original post is The Fed and the Election Cycle by Political Capital.

Photograph by Paul Taggart/Bloomberg

Shipping containers at the Port of New Orleans.

While administration officials are cautious about touting any improvements in the U.S. economy right now, it turns out the Fed is more optimistic than Wall Street.

The Federal Reserve projects 2.4 percent to 2.9 percent growth this year. Bloomberg’s Caroline Salas Gage says the median of 55 estimates from Blue Chip Economic Indicators is 2.3 percent. All but 16 of the predictions were below the bottom of the Fed’s so-called central tendency.

What’s behind the disconnect?

Central bankers are more optimistic about the impact of their stimulus than the analysts. Ben Bernanke’s Fed has kept the benchmark federal funds rate near zero since December 2008 and has undertaken asset purchases totaling $2.3 trillion.

“The connective tissue in the models has just broken down,” Wells Fargo Securities LLC chief economist John Silvia told Bloomberg. “The idea in the old days was you change interest rates and people buy houses.” Now “when the Fed lowers rates, that whole credit-money-multiplier process doesn’t work as well.”

Original post is Fed Forecast Might Not Be as Cautious as You Think by Political Capital.