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Tobias Adrian, Richard Crump, Peter Diamond, and Rui Yu
Expectations about the path of interest rates matter for many economic decisions. Three sources for obtaining information about such expectations are available. The first is extrapolation from historical data. The second consists of surveys of expectations. The third are expectations drawn from financial market prices, often referred to as market expectations. The last are usually considered to be model-based expectations, because, generally, a model is needed to reliably extract expectations from current prices. In this post, we explain the need for and usage of term structure models for extracting far in the future interest rate expectations from market rates, which can be used to discount the long run. We will illustrate our arguments by discussing the measurement of long-run discount rates for Social Security.
Each year, the manager of the Federal Reserve’s System Open Market Account (SOMA) submits an accounting of open market operations and other developments influencing the composition and performance of the Fed’s balance sheet to the Federal Open Market Committee (FOMC).
On Tuesday, April 14, the Federal Reserve Bank of New York hosted an all-day workshop entitled Chapter 9 and Alternatives for Distressed Municipalities and States. The workshop was jointly organized and sponsored by the Volcker Alliance and George Mason University’s State and Local Government Leadership Center. The event brought together key experts, practitioners, and researchers on the subject of fiscal distress at the state and local level. The aim of the session was to foster discussion on the role of Chapter 9 of the U.S. Bankruptcy Code, alternatives for distressed governments, and strategies to avoid stress and achieve good fiscal outcomes.
The monetary base in the United States, defined as currency plus bank reserves, grew from about $800 billion in 2008 to $2 trillion in 2012, and to roughly $4 trillion at the end of 2014 (see chart below). Some commentators have viewed this increase in the monetary base as a sure harbinger of inflation. For example, one economist wrote that this “unprecedented expansion of the money supply could make the '70s look benign.” These predictions of inflation rest on the monetarist argument that nominal income is proportional to the money supply. The fact that the money supply has expanded rapidly while real income has grown very modestly means that sooner or later prices will have to catch up. Most academic economists (from Cochrane to Krugman and Mankiw) disagree. The monetarist argument arguably applies only to non-interest-bearing central bank liabilities, but since October 2008 a large fraction of the monetary base has consisted of reserves that pay interest (the so-called IOER, or interest on excess reserves) and one linchpin of the Fed’s “policy normalization principles” consists precisely in raising the IOER along with the federal funds rate. Since reserves pay close to market interest rates, they are close substitutes for other short-term assets such as Treasury bills from a bank’s perspective. As long as the central bank can affect the return on these short-term assets by adjusting the IOER, controlling inflation with a large balance sheet seems no different than it was before the Great Recession.
Marco Del Negro, Marc Giannoni, Raiden Hasegawa, and Frank Schorfheide
GDP contracted 4 percent from 2008:Q2 to 2009:Q2, and the unemployment rate peaked at 10 percent in October 2010. Traditional backward-looking Phillips curve models of inflation, which relate inflation to measures of “slack” in activity and past measures of inflation, would have predicted a substantial drop in inflation. However, core inflation declined by only one percentage point, from 2.2 percent in 2007 to 1.2 percent in 2009, giving rise to the “missing deflation” puzzle. Based on this evidence, some authors have argued that slack must have been smaller than suggested by indicators such as the unemployment rate or deviations of GDP from its long-run trend. On the contrary, in Monday’s post, we showed that a New Keynesian DSGE model can explain the behavior of inflation in the aftermath of the Great Recession, despite large and persistent output gaps. An implication of this model is that information about the future stance of monetary policy is very important in determining current inflation, in contrast to backward-looking Phillips curve models where all that matters is the current and past stance of policy.
Even the most casual observer of American politics knows that today’s Republican and Democratic parties seem to disagree with one another on just about every issue under the sun. Some assume that this divide is merely an inevitable feature of a two-party system, while others reminisce about a golden era of bipartisan cooperation and hold out hope that a spirit of compromise might one day return to Washington. In this post, we present evidence that political polarization—or the trend toward more ideologically distinct and internally homogeneous parties—is not a recent development in the United States, although it has reached unprecedented levels in the last several years. We also show that polarization is strongly correlated with the extent of income inequality, but only weakly associated with the rate of economic growth. We offer several tentative explanations for these relationships, and discuss whether all forms of polarization are created equal.
This week-long series examined the evolution of the Federal Reserve’s securities portfolio and its performance over time. While the intent has been to enhance understanding of the Fed’s activities, the Federal Reserve has long maintained a commitment to transparency and accountability. The
historical information presented in these posts represents the work of New York
Fed staff to collect portfolio-related information from annual statements and reports, most of which
are public. To enhance public access, the
resulting time series we compiled are being provided in downloadable Excel files
accompanying each post. In this last post of the series,
we review sources of information on the Fed’s operations, income, and balance
Marco Del Negro,
Jamie McAndrews, and Julie Remache
In 2012, the Fed’s remittances
to the U.S. Treasury amounted to $88.4 billion. The vast majority of these
remittances originated as income from the SOMA portfolio (see the second post in this series for an account of the history of SOMA income). While
net income has been high in recent years because of the Fed’s large balance
sheet, it is likely to drop in the future as the Fed normalizes interest rates.
This is because the Fed will likely face increased interest expense on its
reserve balances and possibly realize losses in the case of asset sales. A
recent paper by economists at the Board of Governors of the Federal Reserve
System (Carpenter et al.) shows that under some scenarios the Fed
may be forced to decrease its remittances to zero for a few years (see also the
related work by Hall
and Reis and by Greenlaw,
Hamilton, Hooper, and Mishkin). The fact that remittances may vary more
over the next few years than they have in the past has highlighted the fact
that monetary policy has fiscal implications.
Fleming, Deborah Leonard, Grant Long, and Julie Remache
Federal Open Market Committee (FOMC) has actively used changes in the size and
composition of the System Open Market Account (SOMA) portfolio to implement monetary
policy in recent years. These actions have been intended to promote the Committee’s
mandate to foster maximum employment and price stability but, as discussed in a
prior post, have also generated high levels of portfolio
income, contributing in turn to elevated remittances to the U.S. Treasury. In
the future, as the accommodative stance of monetary policy is eventually
normalized, net portfolio income is likely to decline from these high levels
and may dip below pre-crisis averages for a time, potentially contributing to a
suspension in remittances (Carpenter
et al. 2013). But what would the path of the
portfolio and income look like had these unconventional balance sheet actions not
been taken? In this post, we conduct a counterfactual exercise to explore such
Meryam Bukhari, Alyssa Cambron, Marco Del Negro, and Julie Remache
Note: On August 15, 2013, the data files associated with this post and with the post “The SOMA Portfolio through Time” were expanded to include historical data in nominal dollars. In addition, the estimated value for 1996 in the chart “Total Portfolio Unrealized Gains and Losses” was revised and the associated data file was updated.
Historically, the Federal Reserve has held mostly
interest-bearing securities on the asset side of its balance sheet and, up
until 2008, mostly currency on its liability side, on which it pays no
interest. Such a balance sheet naturally generates income, which is almost entirely remitted to the U.S. Treasury once operating expenses and statutory dividends on capital are paid and sufficient earnings are retained to equate surplus capital to capital paid in. The financial crisis that began in late 2007
prompted a number of changes to the balance sheet. First, the asset side of the balance sheet increased dramatically, a result of both the various liquidity facilities and the Large-Scale Asset Purchase programs (LSAPs) (see yesterday's post on the history of the Fed’s balance sheet). Second, this expansion of the balance sheet was financed in large part by issuing interest-bearing reserves instead of additional noninterest-bearing currency. As a consequence of these changes, future net income from the Fed’s portfolio will
depend on a wider range of factors and may be more variable for a period of
time—a topic that has generated increased discussion (see papers by Carpenter
et al., Hall and Reis,
Hamilton, Hooper, and Mishkin).
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