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June 24, 2019
Mapping the Financial Frontier at the Financial Markets Conference
The Atlanta Fed recently hosted its 24th annual Financial Markets Conference, whose theme was Mapping the Financial Frontier: What Does the Next Decade Hold? The conference addressed a variety of issues pertinent to the future of the financial system. Among the sessions touching on macroeconomics was a keynote speech on corporate debt by Federal Reserve Board chair Jerome Powell and another on revitalizing America by Massachusetts Institute of Technology (MIT) professor Simon Johnson. The conference also included a panel discussion of the Fed's plans for implementing monetary policy in the future. This macroblog post reviews these macroeconomic discussions. A companion Notes from the Vault post reviews conference sessions on blockchain technology, data privacy, and postcrisis developments in the markets for mortgage backed securities.
Chair Powell's thoughts on corporate debt levels
Chair Powell's keynote speech focused on the risks posed by increases in corporate debt levels. In his speech, titled "Business Debt and Our Dynamic Financial System" (which you can watch or read), Powell began by observing that business debt levels have increased by a variety of measures including the ratios of debt to gross domestic product as well as the debt to the book value of corporate assets. These higher debt ratios alone don't currently pose a problem because corporate profits are high and interest rates are low. Powell noted some reasons for concern, however, including the reduced average quality of investment-grade bonds, with more corporate debt concentrated in the "lowest rating—a phenomenon known as the 'triple-B cliff'".
Powell noted several differences between the recent increase in corporate debt and the increase in household debt prior to the 2007–09 crisis that offset these risks. These differences include a more moderate rate of increase in corporate debt, the lack of a feedback loop from debt levels to asset prices, reduced leverage in the banking system, and less liquidity risk.
Powell concluded his remarks by saying that although business debt does pose a risk of amplifying a future downturn, it does not appear to pose "notable risks to financial stability." Finally, he noted that the Fed is working toward a more thorough understand of the risks.
Simon Johnson on jumpstarting America
Simon Johnson started his keynote speech by discussing Amazon's search for a second headquarters city. The company received proposals from 238 cities across the country (and Canada). However, in the end, it selected two large metropolitan areas—New York and Washington, DC—that were already among the leaders in creating new tech jobs. Although many places around the country want growth in good jobs, he said the innovation economy is "drawn disproportionately to these few places."
Johnson's remedy for this disproportionate clustering is for the federal government to make a deliberate effort to encourage research and development in various technical areas at a number of research universities around the country. This proposal is based on his book with fellow MIT economist Jonathan Gruber. They argue that the proposal encourages "exactly what the U.S. did in the '40s, '50s, and '60s," which was to help the United States develop new technology to be used in World War II and the Cold War.
Johnson proposed that the funding for new technical projects be allocated through a nationwide competition that intentionally seeks to create new tech hubs. In making his case, Johnson observed that the view that "all the talent is just in six places is fundamentally wrong." Johnson said that he and his coauthor found 102 cities in 36 states that have a substantial proportion of college graduates and relatively low housing prices. Moreover, Johnson observed that existing tech centers' cost of living has become very high, and those cities have substantial political limits on their ability to sustain new population growth. If some of these 102 potential hubs received the funding to start research and provide capital to business, Johnson argued, overall growth in the United States could increase and be more evenly distributed.
Discussing the implementation of monetary policy
The backdrop for the session on monetary policy implementation was postcrisis developments in the Fed's approach to implementing monetary policy. As the Fed's emergency lending programs started to recede after the crisis, it started making large-scale investments in agency mortgage backed securities and U.S. Treasuries. This program, widely (though somewhat misleadingly) called "quantitative easing," or QE, pumped additional liquidity into securities markets and played a role in lowering longer-term interest rates. As economic conditions improved, the Fed first started raising short-term rates and then adopted a plan to shrink its balance sheet starting in 2018. However, earlier this year, the Fed announced plans to stop shrinking the balance sheet in September if the economy performs as it expected.
Julia Coronado, president of MacroPolicy Perspectives, led the discussion of the Fed's plans, and a large fraction of that discussion addressed its plans for the size of the balance sheet. Kevin Warsh, former Federal Reserve governor and currently a visiting fellow at Stanford University's Hoover Institution, provided some background information on the original rationale for QE, when many financial markets were still rather illiquid. However, he argued that those times were extraordinary and that "extraordinary tools are meant for extraordinary circumstances." He further expressed the concern that using QE at other times and for other reasons, such as in response to regulatory policy, would increase the risk of political involvement in monetary policy.
During the discussion, Chicago Fed president Charles Evans argued that QE is likely to remain a necessary part of the Fed's toolkit. He observed that slowing labor force growth, moderate productivity growth, and low inflation are likely to keep equilibrium short-term interest rates low. As a result, the Fed's ability to lower interest rates in a future recession is likely to remain constrained, meaning that balance sheet expansion will remain a necessary tool for economic stimulus.
Ethan Harris, head of global economics research at Bank of America Merrill Lynch, highlighted the potential stress the next downturn would place on the Fed. Harris observed that "other central banks have virtually no ammunition" to fight the next downturn, a reference to the negative policy rates and relatively larger balance sheets of some other major central banks. This dynamic prompted his question, "How is the Fed, on its own, going to fight the next crisis?"
The conference made clear the importance of the links between financial markets and the macroeconomy, and this blog post focused on just three of them. I encourage you to delve into the rest of the conference materials to see these and other important discussions.
February 25, 2019
Tariff Worries and U.S. Business Investment, Take Two
Last summer, we reported that one fifth of firms in the July Survey of Business Uncertainty (SBU) were reassessing capital expenditure plans in light of then-recent tariff hikes and retaliation concerns. Roughly 6 percent had already cut or deferred capital spending as a result of tariff worries.
Since then, tariff hikes and trade policy tensions have continued to mount, as recounted in the Peterson Institute's Trade War Timeline. U.S. stock market volatility also rose sharply in the last four months of 2018, partly in reaction to trade policy concerns. These developments led us to pose another round of questions about trade policy and investment in the January 2019 SBU.
We first asked each firm if tariff hikes and trade policy tensions caused it to alter its capital expenditures in 2018 and, if so, in which direction and by how much. We use the responses to estimate the net impact of tariff hikes and trade policy tensions on U.S. business investment in 2018.
We estimate that tariff hikes and trade policy tensions lowered gross investment in 2018 by 1.2 percent in the U.S. private sector and by 4.2 percent in the manufacturing sector. The larger response for manufacturing makes sense, given its relatively high exposure to international trade. In constructing these estimates, we consider firms that raised and lowered investment due to trade policy, and we weight each firm by its size.
To estimate the dollar impact of trade policy developments, we multiply the percentage amounts by aggregate investment values. The resulting amounts for U.S. business investment in 2018—minus $32.5 billion for the private sector and minus $22 billion for manufacturing—are modest in magnitude, in line with our forward-looking assessment last summer.
In January, we also asked forward-looking questions about the potential impact of trade policy worries on business investment. As reported in Exhibit 2 below, 20 percent of firms said they are reassessing their capital expenditure plans in 2019 because of tariff hikes and trade policy tensions, a share very similar to what we obtained in our forward-looking question last July. As before, manufacturing firms were more likely to reassess their capital spending plans due to trade policy concerns.
Exhibit 3 below speaks to the question of how firms have reassessed their capital expenditure plans. Here, too, results are similar to what we reported last summer, with one important exception. Among firms reassessing, more than half have either postponed or dropped some portion of their capital spending for 2019, compared to just 31 percent in July 2018. Thus, it appears that firms anticipate somewhat larger negative effects of trade policy developments on capital expenditures in 2019 than they did in 2018.
All told, our results continue to suggest that tariff hikes and trade policy tensions have had a rather modest impact on U.S. business investment. Of course, tariffs and other trade barriers affect U.S. and foreign economies through multiple channels. Even if the near-term business investment effects of trade policy developments are modest in magnitude, trade barriers can disrupt supply chains, raise input prices, and lead to higher prices for consumer goods. That's important to keep in mind as the trade policy outlook remains murky.
January 17, 2018
What Businesses Said about Tax Reform
Many folks are wondering what impact the Tax Cuts and Jobs Act—which was introduced in the House on November 2, 2017, and signed into law a few days before Christmas—will have on the U.S. economy. Well, in a recent speech, Atlanta Fed president Raphael Bostic had this to say: "I'm marking in a positive, but modest, boost to my near-term GDP [gross domestic product] growth profile for the coming year."
Why the measured approach? That might be our fault. As part of President Bostic's research team, we've been curious about the potential impact of this legislation for a while now, especially on how firms were responding to expected policy changes. Back in November 2016 (the week of the election, actually), we started asking firms in our Sixth District Business Inflation Expectations (BIE) survey how optimistic they were (on a 0–100 scale) about the prospects for the U.S. economy and their own firm's financial prospects. We've repeated this special question in three subsequent surveys. For a cleaner, apples-to-apples approach, the charts below show only the results for firms that responded in each survey (though the overall picture is very similar).
As the charts show, firms have become more optimistic about the prospects for the U.S. economy since November 2016, but not since February 2017, and we didn't detect much of a difference in December 2017, after the details of the tax plan became clearer. But optimism is a vague concept and may not necessarily translate into actions that firms could take that would boost overall GDP—namely, increasing capital investment and hiring.
In November, we had two surveys in the field—our BIE survey (undertaken at the beginning of the month) and a national survey conducted jointly by the Atlanta Fed, Nick Bloom of Stanford University, and Steven Davis of the University of Chicago. (That survey was in the field November 13–24.) In both of these surveys, we asked firms how the pending legislation would affect their capital expenditure plans for 2018. In the BIE survey, we also asked how tax reform would affect hiring plans.
The upshot? The typical firm isn't planning on a whole lot of additional capital spending or hiring.
In our national survey, roughly two-thirds of respondents indicated that the tax reform hasn't enticed them into changing their investment plans for 2018, as the following chart shows.
The chart below also makes apparent that small firms (fewer than 100 employees) are more likely to significantly ramp up capital investment in 2018 than midsize and larger firms.
For our regional BIE survey, the capital investment results were similar (you can see them here). And as for hiring, the typical firm doesn't appear to be changing its plans. Interestingly, here too, smaller firms were more likely to say they'd ramp up hiring. Among larger firms (more than 100 employees), nearly 70 percent indicated that they'd leave their hiring plans unchanged.
One interpretation of these survey results is that the potential for a sharp acceleration in GDP growth is limited. And that's also how President Bostic described things in his January 8 speech: "For now, I am treating a more substantial breakout of tax-reform-related growth as an upside risk to my outlook."
November 6, 2017
Building a Better Model: Introducing Changes to GDPNow
Among the frequently asked questions on GDPNow's web page is this one:
Is any judgment used to adjust the forecasts? Our answer:
No. Once the GDPNow model begins forecasting GDP growth for a particular quarter, the code will not be adjusted until after the "advance" estimate. If we improve the model over time, we will roll out changes right after the "advance" estimate so that forecasts for the subsequent quarter use a fixed methodology for their entire evolution.
This macroblog post enumerates a number of minor changes to GDPNow that were implemented on October 30, when it began forecasting fourth-quarter real gross domestic product (GDP) growth. Here is a summary of the changes, intended to improve the accuracy of the GDP subcomponent forecasts:
- Services personal consumption expenditures (PCE). Use industrial production of electric and gas utilities to nowcast real PCE on electricity and natural gas. Use international trade data on travel services to forecast revisions to related PCE travel data.
- Real business equipment investment. Use/forecast data from the advance U.S. Census Bureau reports on durable manufacturing and international trade in goods that, previously, hadn't been utilized until the full reports on manufacturing and/or international trade .
- Real nonresidential structures investment. Replace a discontinued seasonally adjusted producer price index for "Steel mill products: Steel pipe and tube" with a nonseasonally adjusted version. The index is used to construct a price deflator for private monthly nonresidential construction spending.
- Real residential investment. Use employment data for production and nonsupervisory employees of residential remodelers to help forecast real investment in residential improvements.
- Real change in private inventories. Use published monthly inventory levels in the U.S. Bureau of Economic Analysis's underlying detail tables 1BU and 1BUC after the third-release GDP estimate from the prior quarter to estimate inventory levels for a number of industries in the first month of the quarter forecasted by GDPNow.
- Federal, state, and local government spending. Forecast investment in intellectual property products for these subcomponents using autoregression models.
The first three columns of the following table decompose the official estimate of the third-quarter real GDP growth rate, and forecasts of the growth rate from the discontinued and modified versions of GDPNow, into percentage point contributions from the subcomponents of GDP.
As the table shows, the methodological changes did not have much of an impact on the final third-quarter subcomponent forecasts—apart from inventory investment, where the modifications lowered the contribution to growth from 0.80 percentage points to 0.60 percentage points—or on their accuracy. Nevertheless, the topline GDP forecast of the modified model (2.3 percent) was less accurate than the previous version (2.5 percent). In the discontinued version of GDPNow, an overestimate of the inventory investment contribution to growth partly canceled out underestimated contributions from each of net exports, government spending, and nonresidential fixed investment.
In the modified version, the inventory contribution was also underestimated and did not cancel out these other errors. The last two columns of the table show that all of the subcomponent errors of the modified model were at least as small as their historical average for the discontinued version. However, the topline GDP forecast was less accurate than average because of less cancellation of the subcomponent errors than usual. We hope that the cancellation of subcomponent errors in the modified model will be more similar to the historical average in the discontinued version in the future.
Although the methodological changes could have more of an impact than the table suggests, we do not expect them to have a substantial impact in general. For example, on October 30, the discontinued version of GDPNow projected 3.0 percent GDP growth in the fourth quarter, which was little different from the modified model forecast of 2.9 percent growth. We provide a more detailed explanation of the changes to GDPNow here . Going forward, this same document will document any further changes to the model and when we made them.
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