Richmond Fed President Jeffery Lacker on our Economy

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In his May address on economic outlook, President Jeffrey Lacker had much to say. He claims that we can expect a growth rate around 2% for the foreseeable future. This is a positive testament to our resilience considering the nature of our most recent recession, he says. This doesn’t seem terrible. Slow progress is progress nonetheless. Dr. Lacker mentioned a few key figures and points I’d like to share, and then a crucial statement that warrants quotation.

Two significant components to growth are productivity per worker and inputs. He notes that from 1950-2000 worker productivity was about 1.8%, yet in the recovery is has only been 1% (despite a sugar rally in ’09). Productivity is influenced by research and development, entrepreneurship and innovation, labor skills, and public infrastructure – Dr. Lacker is quick to mention that monetary policy is not on that list. I will discuss this later.

Inputs had a similar rate of 1.7% 1950-2000, and 1.1% post-recovery. Inputs include employment, so this is a key figure to monitor when examining our outlook. If businesses are not able to add more inputs, it stands to reason that less people will be put to work. Let’s parse the issue of employment.

Unemployment has fallen at around .7% per year since the recession, and that is faster than the past two cycles, he says. A more stark statistic Dr. Lacker points out, however, is a rapidly shrinking labor force participation rate. It has fallen from 67% to 63.3%, much ado to people that have given up looking for jobs. This is a structural issue that is not easily influenced by monetary easing. With the aforementioned low productivity, the lower participation rate significantly hinders our growth outlook. That means workers producing less on top of there being less workers.

There are some positive figures that he shares. Housing activity, although not a heavy mover of overall GDP, is rapidly picking up. Consumer expenditures make up a much larger portion of output, and needs to be a leader in raising our growth rate, Dr. Lacker argues. Businesses are also starting to spend more, which is a figure he likes. It rose 5.5% in 2012, and he expects even more this year. I would argue that if we want consumers to spend more, we need to be making more things that maximize their utility. This would go full circle to the lower productivity.

The government is not helping matters, he says. The massive debt and deficits, as well as no consensus in sight on where to tax or cut spending, he claims, are feeding into a populous already extra-cautious from recessionary income shocks. There is also a Euro-zone crisis that Dr. Lacker thinks is hurting our exporting opportunities.

This was his overall statement on our economic outlook. All things considered, 2% is not a bad accomplishment given the factors that are hurting output. If we could pursue such a figure, there could be a semblance of relative normalcy from the sluggish drudgery that has been our economy.

With that in mind, I’d like to shift gears to recent monetary policy. Given the structural issues that we are facing it would seem that easing would not be a way to help the issue. Dr. Lacker agrees,and says that,

“In this situation, to me, the benefit-cost tradeoff associated with further monetary stimulus does not look promising. The Fed seems unable to improve real growth despite striving mightily over the last few years, and further increases in the size of the balance sheet raise the risks associated with the exit process that’s going to accompany withdrawing stimulus when the time comes to withdraw stimulus. That’s why I do not support the current asset purchasing program.”

Stimulus cannot impact the real factors influencing our growth, so it seems to be moot. Instead, the Fed would be better off merely fostering a monetary climate that cultivates certainty and enables optimal transactions. As mentioned in an earlier post, this would be most effectively accomplished through interest rate targeting. 

These asset purchases are only exacerbating the structural problems that are hurting output and growth.  Perhaps this is slowly being realized by policymakers who in a recent statement hinted at the possibility of reducing the amount they are buying. But what does $85 Billion a month really matter when you have no limit, right?

In the opening lecture to my undergrad Money and Banking course, the professor opened with the Chinese curse, “May you live in interesting times.”

We are living in interesting times.

We need a bigger boat!

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The graph below is telling us an interesting story. Despite many rounds of easing, and many months of the Fed buying mass amounts of Mortgage Backed Securities and treasury bonds, the economy does not seem to be taking well to the medicine. No matter how much the Fed flexes its muscles growth has been sluggish. Let’s look at some indicators to get an idea of our monetary climate.

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The amount of cash available to businesses and investors (blue line) is exceedingly high. This should be great news considering how low interest rates are. We should be seeing investment skyrocketing!

This is not the case, however. Investment is only slightly picking up (green line). Clearly there is an unforeseen component to loanable funds that low interest rates are not accounting for. As we know, prices are information. The low rate is below its true price because it does not encompass as much information, which could be excess rick, uncertainty, etc.

Making things even more confusing is velocity being on a downward spiral (red line). All conventional monetary policy wisdom  is not applicable here. Usually if money is made available, people are putting it to productive use. We are seeing the complete opposite case though.

So what does this all mean? It would seem like the economy is worried about the discretionary nature of the Fed’s policies. Just as the Fed gives, they can take away. Nobody knows what will happen once the Fed moves to sell back all that it is buying up, so it would seem that they would rather wait it out than be a bigger victim of inflation or rate increases.

Perhaps the Fed would see more impressive results if it were to constrain its discretionary powers with something like the Taylor Rule. This is highly unlikely, but it would help instill the type of security that investors seem to be wanting. Velocity would stop plummeting and businesses would be willing to finance more projects and take better risks. Interest rates would reflect their true price. From there, growth will follow.

What are your thoughts on this graph? Do you think the Fed needs to produce more stimulus, or does it need to change its approach?

Recommended Reads?

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Seeing as how I’m new to blogging, I have been trying to be more of a listener than a writer. I’m trying to get a feel for what you economists are talking about and working on. There is clearly much going on in our world. Between the Fed, Congress, and Thomas Herndon, we have enough fodder to keep out minds turning and fingers churning out material.

Who are some econ bloggers that you like to interact with? Who do you read to challenge and expand your knowledge? I’d like to hear your input.

Getting things started

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Hi, I’m Keaton, an econ student at Western Kentucky University. I go to class through the day, work through the night, and write while I eat. When I’m not running regressions, I’m riding my bike.

This blog is meant to be a think tank where ideas can be shared, discussed, and formed. There will be much talk about what’s going on in the world of economics, as well as models that impact our daily lives.

It is said that in a room full of ten economists, there are eleven opinions. The last thing there needs to be is another economist on a soapbox. This blog isn’t about what I think, it is about thorough analysis.

I will focus on real data and real results; I will examine policies, as Thomas Sowell says, “by the incentives they create, not by the hopes that inspire them.”

Feel free to join the conversation. This is a collaboration, a group effort. I’m excited to see where we go.