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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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July 18, 2016

Lockhart Casts a Line into the Murky Waters of Uncertainty

Is uncertainty weighing down business investment? This recent article makes the case.

Uncertainty as an obstacle to business decision making and perhaps even a "propagation mechanism" for business cycles is an idea that that has been generating a lot of support in economic research in recent years. Our friend Nick Bloom has a nice summary of that work here.

Last week, the boss here at the Atlanta Fed gave the trout in the Snake River a break and made some observations on the economy to the Rocky Mountain Economic Summit, casting a line in the direction of economic uncertainties. Among his remarks, he noted that:

The minutes of the June FOMC [Federal Open Market Committee] meeting clearly pointed to uncertainty about employment momentum and the outcome of the vote in Britain as factors in the Committee's decision to keep policy unchanged. I supported that decision and gave weight to those two uncertainties in my thinking.

At the same time, I viewed both the implications of the June jobs report and the outcome of the Brexit vote as uncertainties with some resolution over a short time horizon. We've seen, now, that the vote outcome may be followed by a long tail of uncertainty of quite a different character.

But he followed that with something of a caution…

If uncertainty is a real causative factor in economic slowdowns, it needs to be better understood. Policymaking would be aided by better measurement tools. For example, it would help me as a policymaker if we had a firmer grip on the various channels through which uncertainty affects decision-making of economic actors.

I have been thinking about the different kinds of uncertainty we face. Often we policymakers grapple with uncertainty associated with discrete events. The passage of the event to a great extent resolves the uncertainty. The outcome of the Brexit referendum would be known by June 24. The interpretation of the May employment report would come clear, or clearer, with the arrival of the June employment report on July 8. I would contrast these examples of short-term, self-resolving uncertainty with long-term, persistent, chronic uncertainty such as that brought on by the Brexit referendum outcome.

As President Lockhart indicated in his speech, the Federal Reserve Bank of Atlanta conducts business surveys that attempt to measure the uncertainties that businesses face. From July 4 through July 8, we had a survey in the field with a question on how the Brexit referendum was influencing business decisions.

We asked firms to indicate how the outcome of the Brexit vote affected their sales growth outlook. Respondents could select a range of sentiments from "much more certain" to "much more uncertain."

Responses came from 244 firms representing a broad range of sectors and firm sizes, with roughly one-third indicating their sales growth outlook was "somewhat" or "much" more uncertain as a result of the vote (see the chart). Those noting heightened uncertainty were not concentrated in any one sector or firm-size category but represented a rather diverse group.

Chart: Which of the following best describes how the outcome of the recent referendum in Great Britain (so-called Brexit) has affected your sales growth outlook?

As President Lockhart noted in his speech, "[w]e had a spirited internal discussion of whether one-third is a big number or not-so-big." Ultimately, we decided that uncovering how these firms planned to act in light of their elevated uncertainty was the important focus.

In an open-ended, follow-up question, we then asked those whose sales growth outlook was more uncertain how their plans might change. We found that the most prevalent changes in planning were a reduction in capital spending and hiring. Many firms mentioned these two topics in tandem, as this rather succinct quote illustrates: "Slower hiring and lower capital spending." Our survey data, then, provide some support for the idea that uncertainties associated with Brexit were, in fact, weighing on firm investment and labor decisions.

Elevated measures of financial market and economic policy uncertainty immediately after the Brexit vote have abated somewhat over subsequent days. Once the "waters clear," as our boss would say, perhaps this will be the case for firms as well.




June 16, 2016

Experts Debate Policy Options for China's Transition

After nearly three decades of rapid economic growth, China today faces the challenge of economic rebalancing against the backdrop of slow and uncertain global growth. Although investment and exports have been a motor for growth, China is increasingly experiencing structural issues: widening inequality, overcapacity as a consequence of policy distortions, unsustainable environmental costs, volatile financial markets, and rising systemic risk.

On April 28–29, I attended the First Research Workshop on China's Economy, organized jointly by the International Monetary Fund (IMF) and the Atlanta Fed. The workshop, held at the IMF's headquarters in Washington DC, explored a series of questions that have emerged as China shifts toward a new growth model. Is this the end of the growth miracle? Will the Chinese renminbi one day be as important as the U.S. dollar? Should the rapidly increasing shadow banking activity in China be a source of concern? How worrisome is the rapid rise in China's housing prices?

Panelists shared their views on these and other issues facing the world's second-largest economy (or largest, if measured on a purchasing-power-parity basis). Plans are under way for a second workshop to be held in 2017.

The following is a nice summary of the research discussed at the workshop. It was originally published in the IMF Survey Magazine, and was written by Hui He, IMF Institute for Capacity Development, and Nan Li, IMF Research Department. Thanks to the IMF for allowing me to repost it here.

Is China's economic growth sustainable?
Understanding the source of China's tremendous growth was a recurring theme at the workshop. "China's economy combines enormous dynamism with huge distortions," observed Loren Brandt (University of Toronto). Brandt described his research based on China's firm-level data and emphasized that firm dynamics (entry and exit), especially firm entry, have been the main source of the productivity growth in the manufacturing sector.

Echoing Brandt's message, Kjetil Storesletten (University of Oslo) discussed regional growth disparities and showed that barriers preventing firms from entering an industry account for most of the disparities. Such barriers are more severe for privately owned firms in regions in which state-owned enterprises (SOE) dominate, he said.

In his keynote speech, Nicholas Lardy (Peterson Institute for International Economics) offered an upbeat view on China's transition to a new growth model, one in which the service sector plays a larger role than manufacturing. The bright side of the service sector, he noted, is its continued strong productivity growth. The development of financial deepening and the stronger social safety net are contributing to increased consumption, which helps to rebalance the economy.

However, he emphasized, SOE reforms remain critical as the service sector cannot provide a silver bullet for a successful transition.

Central bank's policy decisions
Several participants tried to discern how the People's Bank of China (PBC) conducts monetary policy. Tao Zha (of the Atlanta Fed's Center for Quantitative Economic Research and Emory University) found that the PBC reacts sharply when the gross domestic product's growth rate falls below its target, increasing the money supply by 11.5 percentage points for every 1 percentage point shortfall.

Mark Spiegel (Center for Pacific Basin Studies) discussed the trade-offs involved in Chinese monetary policy—for example, controlling the exchange rate versus maintaining inflation stability. He also argued that the heavy use of reserve requirements on banks as a monetary policy tool might have an unintentional consequence to reallocate capital from SOEs to more efficient privately owned firms and could therefore offset the resource misallocation caused by the easy credit to SOEs that banks granted in the high growth years.

Renminbi versus the dollar
Eswar Prasad (Cornell University and Brookings Institution) argued that China's capital account will become more open and the renminbi will be used more widely to denominate and settle cross-border transactions. But he also noted that legal and institutional constraints in China were likely to prevent the renminbi from serving as a safe-haven currency as the U.S. dollar does today.

Moreover, he said, the current sequencing of liberalization initiatives—that is, removal of capital account restrictions before appropriate financial market supervision and regulation and exchange rate reform—poses financial stability risks.

Shadow banking and the housing market
Recently, volatile Chinese financial markets and continued housing price appreciation have raised serious financial stability concerns.

Michael Song (Chinese University of Hong Kong) argued that rapidly rising shadow banking activity is an unintended consequence of financial regulation. Restrictions on deposit rates and loan-to-deposit ratios have led to the issuance by banks of "wealth management products" to attract savers with higher returns. Because these restrictions had a greater impact on small banks, the big state banks had more room to undercut the smaller banks by offering wealth management products with higher returns and then restricting liquidity to them in interbank markets, ultimately making the banking system more prone to liquidity distress and runs.

Hanming Fang (University of Pennsylvania) found that, except in big cities such as Beijing and Shanghai, housing prices in China's urban areas between 2003 and 2013 more or less tracked rising household incomes. In his view, the Chinese housing boom is thus unlikely to trigger an imminent financial crisis. He warned, however, that housing prices may fall rapidly if economic growth slows dramatically, and that such a development could, in turn, amplify the economic downturn.

Rising wage inequality
China's rapid growth over the past two decades has been accompanied by rising wage inequality, an issue highlighted by two conference participants. Dennis Yang (University of Virginia) explored the distributional effects of trade openness in China and found a significant impact on wage inequality of China's accession to the World Trade Organization in 2001.

Chong-En Bai (Tsinghua University) argued that the decline after 2008 of the skill premium—that is, the ratio of the skilled labor wage to the unskilled labor wage—can be explained by the Chinese government's targeted credit extension to unskilled labor-intensive infrastructure sector (as part of the fiscal stimulus following the global financial crisis). Such distortionary policies might have short-run growth benefits but could lead to long-run welfare losses, he said, especially when rural-to-urban migration has run its course.

July 1, 2015

Far Away Yet Close to Home: Discussing the Global Economy's Effects

In case you needed any motivation to take interest in the outcome of ongoing negotiations between the Greek government and its international creditors, this excerpt from the Wall Street Journal ought to do it:

Global growth is really important. We are all connected through the financial markets, through foreign-exchange markets," Fed governor Jerome Powell said last week in an interview with The Wall Street Journal. "If global growth weakens, or remains weak, and we get into a trend of that, then yes, that will be a big headwind for the United States economy."

Last week, I participated in the latest edition of our webcast, ECONversations, devoted to the theme "what to make of the first quarter?" (The webcast can be found here). The conversation revolved around the Atlanta Fed staff's view of why 2015 began with such a whimper and ideas on prospects for improvement through the balance of the year.

Not surprisingly, the international context loomed large. Between June 2014 and March 2015, the U.S. dollar appreciated by about 14 percent against a broad basket of currencies, and by about 20 percent against major currencies. The dollar has roughly remained in those neighborhoods since. As to the gross domestic product (GDP) side of the story, arithmetically net exports subtracted almost 2 percentage points off first quarter growth.

A key assumption of our current outlook is that the international environment (including the exchange rate) will stabilize, and smoother sailing without the "big headwind" referenced by Governor Powell is ahead.

That assumption generated some discussion (in the Q&A part of the webcast, and via online questions). With some paraphrasing, here are a few of the comments and questions we received, and my best attempt to respond:

Q: You associate the prior appreciation in the dollar with a several percentage point subtraction from growth in the first quarter. This seems quite large in context of available research on the elasticity of the trade balance to movements in the foreign exchange value of the dollar.

A: In the webcast, I did loosely refer to the trade effect on first quarter GDP as a "dollar effect." But the questioner—Barclay's head of U.S. economics research, Michael Gapen— is completely correct in asserting that standard estimates wouldn't support exchange-rate appreciation as an all-encompassing explanation for the big first quarter trade deficit. Our own estimates imply that four quarters after an exchange rate shock that raises the real broad-dollar index by 10 percentage points, real GDP is about one-half a percentage point lower than it would have been without the shock. This impact is roughly the same as most standard estimates (including Barclay's).

Some analyses might imply a larger GDP impact for the pure dollar effect, but any reasonable estimate would leave a fair amount of the first quarter net export decline unexplained. In any event, exchange-rate movements are both cause and effect, which brings us to:

Q: I have a question regarding the impact of the U.S. dollar (USD) in the economy. We often learn that changes in the real exchange rate affect the economy with a lag. Take Japan, for instance. It had a substantial depreciation in Japanese yen (JPY) real exchange rate but with very minimal impact on Japan's trade performance so far. What makes you so confident that the strong USD has had a strong impact in the U.S. economy in such a short period of time? Wouldn't the negative contribution from net exports more likely be linked to delays in West Coast ports and the sharp slowdown in Asian economies (China, in particular)?

A: Yes, in our analysis (and most we know of), the effects of exchange rates occur with a lag. And, as noted above, only a fraction of the decline in net exports by the end of 2014 and into the beginning of this year can be plausibly attributed to dollar appreciation. But we do think those effects are there, and they are continuing (to a lesser extent) in the current quarter.

Of course, changes in the value of the currency are an effect of other developments as well as a cause of changes in exports, GDP, and the like. All else is not typically equal, which often makes simple correlations (or, in the Japanese case, the lack thereof) difficult to interpret.

One of those "not equal" things could well have been the port delays. We don't have a firm estimate of how the backlogs might have affected the first quarter GDP statistic. If the impact was indeed material, we should see some reversal in the second and third quarters now that things are apparently getting back to normal. We'll count that as an upside risk.

And looking forward?

Q: Shouldn't the economic crisis in Greece dampen the demand for American exports and decrease growth well into the fourth quarter?

A: The good news is that current forecasts suggest 2015 euro-area growth will exceed its 2014 pace (according to the World Bank). In fact, the 2015 forecast strengthened over the course of this year despite the ongoing uncertainty associated with the Greek crisis. By most accounts, Canadian economic activity this year is expected to follow a trajectory similar to the United States (in like a lamb, out like something less lambish).

Mexico, as well, is expected to show more growth this year than last, despite some softening of the outlook since the beginning of the year. Put those three together (expanding the euro area to the entire European Union), and you have the anticipation of some improvement in countries accounting for somewhere in the neighborhood of 55 percent of our export markets.

The bad news is the ongoing uncertainty associated with the Greek crisis. Further, the outlook in emerging economies is growing more downbeat. These realities—a continuing impact of prior dollar appreciation and the fact that better foreign growth still does not equate to great growth—has us reluctant to think that net exports will be a big positive number in this year's GDP calculations. That reluctance notwithstanding, for now we are writing in a smaller trade deficit over the course of the year than what we saw in the first quarter.

If you want to go into the July 4 holiday on a somewhat optimistic note, I'll note that our GDPNow estimates for the second quarter have strengthened substantially with the arrival of more recent data—notably including signals of a much lower trade deficit effect than in the first quarter and today's positive news on manufacturing and nonresidential construction. Those data may not be enough to generate full confidence in our forecast for a much better second half of 2015, but they are moving in the right direction.


April 17, 2015

Déjà,À Vu All Over Again

In a recent interview, Fed Vice Chairman Stanley Fischer said, “The first quarter was poor. That seems to be a new seasonal pattern. It's been that way for about four of the last five years.”

The picture below illustrates the vice chair's sentiment. Output in the first quarter has grown at a paltry 0.6 percent during the past five years, compared to a 2.9 percent average during the remaining three quarters of the year.

Real Gross Domestic Product Growth by Quarter

What's causing this pattern? Well, it could be we just get really unlucky at the same time every year. Or, it could be a more technical problem with seasonal adjustment after the Great Recession (this paper by Jonathan Wright covers the topic using payroll data). It also seems likely that we can just blame the weather (see this Wall Street Journal blog post).

Whatever the reason for the first-quarter weakness, it appears to be happening again. Our current quarterly tracking estimate—GDPNow—has first-quarter growth hovering just above zero. As for the rest of the year, we'll have to wait and see. We of course hope it follows the postrecession pattern.