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The United States has been borrowing from the rest of the world since the mid-1980s. From 2000 to 2008, this borrowing averaged over $600 billion per year, which translates into U.S. spending exceeding income by almost 5.0 percent of GDP. Borrowing fell during the recent recession, as would be expected, and then rebounded with the recovery. Since 2011, however, borrowing has trended down and fell to 2.4 percent of GDP in 2013, the smallest amount as a share of GDP since 1997. A reduced dependency on foreign funds can be viewed as a favorable development to the extent that it reflects an improvement in the fiscal balance to a more easily sustainable level. However, it also reflects the lackluster recovery in residential investment, which is one reason the economy has yet to get back to its full operating potential.
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.
Marco Del Negro, Marc Giannoni, Raiden Hasegawa, and Frank Schorfheide
Since the financial crisis of 2007-08 and the Great Recession, many commentators have been baffled by the “missing deflation” in the face of a large and persistent amount of slack in the economy. Some prominent academics have argued that existing models cannot properly account for the evolution of inflation during and following the crisis. For example, in his American Economic Association presidential address, Robert E. Hall called for a fundamental reconsideration of Phillips curve models and their modern incarnation—so-called dynamic stochastic general equilibrium (DSGE) models—in which inflation depends on a measure of slack in economic activity. The argument is that such theories should have predicted more and more disinflation as long as the unemployment rate remained above a natural rate of, say, 6 percent. Since inflation declined somewhat in 2009, and then remained positive, Hall concludes that such theories based on a concept of slack must be wrong.
One contributor to the subdued pace of economic growth in this expansion has been consumer spending. Even though consumption growth has been somewhat stronger in the past couple of quarters, it has still been weak in this expansion relative to previous expansions. This post concentrates on consumer spending on discretionary and nondiscretionary services, which has been a subject of earlier posts in this blog. (See this post for the definition of discretionary versus nondiscretionary services expenditures and this post for a subsequent update.) Discretionary expenditures have picked up noticeably over recent quarters but, unlike spending on nondiscretionary services, they remain well below their pre-recession peak. Even so, the pace of recovery for both discretionary and nondiscretionary services in this expansion is well below that of previous cycles. One explanation is that weak income expectations continue to constrain household spending.
In a recently released New York Fed staff report, we present a forward-looking monitoring program to identify and track time-varying sources of systemic risk. Our program distinguishes between shocks, which are difficult to prevent, and the vulnerabilities that amplify shocks, which can be addressed. Drawing on a substantial body of research, we identify leverage, maturity transformation, interconnectedness, complexity, and the pricing of risk as the primary vulnerabilities in the financial system. The monitoring program tracks these vulnerabilities in four sectors of the economy: asset markets, the banking sector, shadow banking, and the nonfinancial sector. The framework also highlights the policy trade-off between reducing systemic risk and raising the cost of financial intermediation by taking pre-emptive actions to reduce vulnerabilities.
One way to assess the stance of monetary policy is to assert that there is a natural interest rate (NIR), defined as the rate consistent with output being at its potential. Broadly speaking, monetary policy can be seen as expansionary if the policy rate is below the NIR with the gap between the rates measuring the extent of the policy stimulus. Of course, there are many challenges in defining and measuring the NIR, with various factors driving its value over time. A key factor that needs to be considered is the effect of uncertainty and risk aversion on households’ savings decisions. Households’ tolerance for risk tends to be lower during downturns, putting upward pressure on precautionary savings, and thereby downward pressure on the natural interest rate. In addition, uncertainty dictates how much precautionary savings responds to changes in risk aversion. So policymakers need to be aware that rate moves to offset adverse economic conditions that are appropriate in tranquil times may not be sufficient in times of high uncertainty.
inflation as dependent on inflation expectations and the level of economic slack, with changes in expectations or slack leading to changes in the inflation rate. The global slowdown and the subsequent sovereign debt crisis caused the greatest divergence in unemployment rates among euro area member countries since the monetary union was founded in 1999. The pronounced differences in economic performances of euro area countries since 2008 should have led to significant differences in price behavior. That turned out to be the case, with a strong correlation evident between disinflation and labor market deterioration in euro area countries.
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.
Today, the Federal Reserve Bank of New York (FRBNY) is hosting the spring meeting of its Economic Advisory Panel (EAP). At this meeting, FRBNY staff are presenting their forecast for U.S. growth, inflation, and unemployment through the end of 2015. Following the presentation, members of the EAP, all of whom are leading economists in academia and the private sector, are asked to critique the staff forecast. Such feedback helps the staff evaluate the assumptions and reasoning underlying their forecast and the key risks to it. Subjecting the staff forecast to periodic evaluation is an important part of the forecasting process; this review informs the staff’s discussions with New York Fed President William Dudley about economic conditions. In the same spirit of inviting feedback, we are sharing a short summary of the staff forecast in this post; for more detail, see the material from the EAP meeting on our website.
The European Central Bank (ECB) released its 2014:Q1 Survey of Professional Forecasters (SPF) on February 13. The release comes at a time of growing concern about low Euro-zone inflation: consumer prices were up only 0.7 percent over the year in January, the fourth consecutive monthly reading of less than 1 percent and well below the ECB’s target of just below 2 percent. Some commentators have argued that falling inflation after five years of recession or very slow growth has raised the threat of deflation.
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