By Steven K. Beckner

JACKSON HOLE, Wyoming (MNI) – Richmond Federal Reserve Bank
President Jeffrey Lacker and St. Louis Fed President James Bullard cast
doubt Saturday on contentions that further Fed easing can be effective
in reducing unemployment.

Lacker in particular maintained that much of the 8.3% is
“structural” at the Kansas City Fed’s annual symposium and suggested
that the non-accelerating inflation rate of unemployment (NAIRU) is
higher than normal, suggesting less resource slack and hence less Fed
room to ease without inflationary consequences.

Stanford Professor Edward Lazear, a former chairman of President
Bush’s Council of Economic Advisors, presented a paper arguing that most
of the unemployment is “cyclical” and hence amenable to monetary easing.

Lacker said the JOLTs data on job openings in various industries
are of “limited” use for measuring skill “mismatches” in the labor
market that tend to hold up the unemployment rate.

Relying on the JOLTS data is “like looking under the street lamp
and saying well, i haven’t found any mismatches,” he said.

But Lacker said he is seeing ample evidence of such mismatches in
his district, which runs down the East coast from Maryland through the
Carolinas.

“In manufacturing in the Carolinas, we’ve lost a ton of jobs in
textiles, apparel and furniture,” he said, yet there is a “scarcity” of
skilled machinists, aircraft mechanics and other trades.

“So I think the coarseness of the data hide what could be a fair
amount of skills mismatch,” Lacker continued. “I think it’s quite
unhelpful to equate structural and permanent factors.”

“These skill gaps that we see are going to be overcome,” Lacker
went on. “People are working on training programs … . Over time these
gaps will close, but in the meantime these are real costs, real
impediments to clearing labor markets the way we want them to.”

“And it’s not clear monetary policy can obviate these costs in any
meaningful way,” Lacker added.

“I think the useful distinction is between the unemployment rate
that would prevail several years from now in the absence of shocks and
with appropriate monetary policy and the unemployment rate that now
would correspond to maximum employment … . Sept. 1, 2012 maximum
unemployment,” he said. “I think that’s a useful distinction to carry
around. the former is likely to be quite smooth (without shocks) … the
latter I see no economic reason why the natural rate defined that way
isn’t likely to respond to a variety of shocks, isn’t likely to vary
quite substantially,” he said.

Bullard said “it’s the elephant in the room for this conference as
to whether the U.S. economy went through some kind of structural shift
associated with this very large financial crisis and its aftermath. If
you look at the level of real GDP.”

“It sure looks like the economy was on one trend pre-crisis and is
on a very different trend post-crisis, and I think the longer this goes
on, the stronger the statistical evidence will be that we’re on a
different trend,” he continued.

“Now you can posit ideas about why this is, but it does have
startling policy implications,” Bullard said. “It could mean that the
cyclical adjustment that can be attained in a normal business cycle
sense has already happened and that what goes on from here is very
different from the ordinary reaction to a recession that you might
normally be thinking of.”

The comments from two of the more hawkish members of the FOMC came
toward the end of two days of spirited discussion which revolved around
whether the Fed should inject more monetary stimulus and, if it does,
how effective it would be.

Chairman Ben Bernanke set the stage Friday morning in a keynote
address in which he appeared to leave all options open for the FOMC’s
Sept. 12-13 meeting.

Citing unsatisfactory growth and calling high unemployment a “grave
concern,” Bernanke vowed, “”Taking due account of the uncertainties and
limits of its policy tools, the Federal Reserve will provide additional
policy accommodation as needed to promote a stronger economic recovery
and sustained improvement in labor market conditions in a context of
price stability.”

Bernanke said additional asset purchases would have costs that must
be weighed against the benefits, but called them “manageable.” And he
said, “we should not rule out the further use of such policies if
economic conditions warrant.”

Former Fed Vice Chairman Alan Blinder lent his support to further
use of unconventgionmal policy tools Saturday, even pushing his proposal
that the Fed make the rate of interest it pays on exccess reserves
negative, so that banks would have to pay the Fed to hold them, in an
effort to induce banks to lend more.

But Columbia University professor Glenn Hubbard, a top campaign
advisor to Republican Presidential nominee Mitt Romney, told MNI the day
before he does “not think that more asset purchases are going to make a
material difference to the recovery.”

Hubbard, considered a possible successor to Bernanke should Romney
win, added, “I haven’t seen consistent evidence that asset purchases
have had real effects.”

Harvard Professor Martin Feldstein largely shared Lazear’s
conclusion that unemployment is largely cyclical — a view held by
Bernanke and most of his FOMC colleagues — but said that even if that
is true “there are limits to what monetary policy can now do.”

For example, he said the large number of Americans who cannot
qualify to refinance their “under-water” homes at low rates will not be
helped if the Fed pushes mortgage rates even lower. “And the same is
true of other parts of aggregate demand,” he said.

Feldstein, also a former CEA chairman and head of the National
Bureau of Economic Research, told the symposium that quantitative easing
“made an imporatant contribution in 2008, but there are limits, perhaps
compolete limites, to what monetary policy can do now.”

Feldstein said there are non-monetary policies, such as extended
unemployment benefits, that are partially responsible for keeping
unemployment up and limited the efficacy of monetary policy.

Athanasios Orphanides, a former senior Fed staffer and former head
of the Cyprus central bank, also advised caution, disputing Lazear’s
“implied policy prescription” that the Fed should keep pushing money
into economy to reduce unemployment.

Since there is uncertainty about where full employment, or NAIRU,
really lie because of uncertainty about its cyclical and structural
dimensions, Orphanides said “prudence would dictate that we should not
assume” that there is a “new normal” in unemployment.

Orphanides said the Fed is better off aiming at price stability. If
it aims instead for a certain loevbel of unemployment “if it
miscalculates — disaster.”

In other comments in the final day of the symposium, Bank of Japan
Governor Masaaki Shirakawa said that, taking into account the “global
Taylor Rule weighted average policy rate” and the average inflation
rate, worldwide inflation is measuring too low at “below 1%.” He said
that “means the Taylor principle is not satisfied…”

He was referring to the Taylor Rule, named after Stanford professor
John Taylor, which essentially directs the central bank to adjust
short-term interest rates when inflation and unemployment deviate from
specified norms, is considered a model of how to operate monetary
policy.

Shirikawa said the reason why inflation is averaging so low
worldwide is because central banks typically “focus on the core
inflation rate instead of the headline inflation rate…” He said that
is inappropriate “in a world where food and energy prices are determined
globally.”

Shirikawa also said some countries are being forced to expand their
money supplies to counteract the effect of capital inflows that are
causing their currencies to appreciate.

That was a point echoed by Malaysian central bank chief Zeti Akhtar
Aziz. She said expansionary policies by the Fed and other western
central banks are putting upward pressure on Asian currencies and asset
prices, hurting their economies and complicating their policies.

** MNI **

[TOPICS: M$U$$$,MMFUE$,MAUDS$,M$$CR$,M$$BR$,M$J$$$,MI$$$$]

He’s not wrong.

Dutch voters will go to the polls in ten days’ time to elect a new government. And as Harriet Alexander writes, the rise of the Socialist Party – and their decidedly lukewarm stance towards the EU – is threatening to end Holland’s reputation as a dependable, Brussels-friendly member of the beleaguered Eurozone club.

By Steven K. Beckner

JACKSON HOLE, Wyoming (MNI) – Richmond Federal Reserve Bank
President Jeffrey Lacker and St. Louis Fed President James Bullard cast
doubt Saturday on contentions that further Fed easing can be effective
in reducing unemployment.

Lacker in particular maintained that much of the 8.3% is
“structural” at the Kansas City Fed’s annual symposium and suggested
that the non-accelerating inflation rate of unemployment (NAIRU) is
higher than normal, suggesting less resource slack and hence less Fed
room to ease without inflationary consequences.

Stanford Professor Edward Lazear, a former chairman of President
Bush’s Council of Economic Advisors, presented a paper arguing that most
of the unemployment is “cyclical” and hence amenable to monetary easing.

Lacker said the JOLTs data on job openings in various industries
are of “limited” use for measuring skill “mismatches” in the labor
market that tend to hold up the unemployment rate.

Relying on the JOLTS data is “like looking under the street lamp
and saying well, i haven’t found any mismatches,” he said.

But Lacker said he is seeing ample evidence of such mismatches in
his district, which runs down the East coast from Maryland through the
Carolinas.

“In manufacturing in the Carolinas, we’ve lost a ton of jobs in
textiles, apparel and furniture,” he said, yet there is a “scarcity” of
skilled machinists, aircraft mechanics and other trades.

“So I think the coarseness of the data hide what could be a fair
amount of skills mismatch,” Lacker continued. “I think it’s quite
unhelpful to equate structural and permanent factors.”

“These skill gaps that we see are going to be overcome,” Lacker
went on. “People are working on training programs … . Over time these
gaps will close, but in the meantime these are real costs, real
impediments to clearing labor markets the way we want them to.”

“And it’s not clear monetary policy can obviate these costs in any
meaningful way,” Lacker added.

“I think the useful distinction is between the unemployment rate
that would prevail several years from now in the absence of shocks and
with appropriate monetary policy and the unemployment rate that now
would correspond to maximum employment … . Sept. 1, 2012 maximum
unemployment,” he said. “I think that’s a useful distinction to carry
around. the former is likely to be quite smooth (without shocks) … the
latter I see no economic reason why the natural rate defined that way
isn’t likely to respond to a variety of shocks, isn’t likely to vary
quite substantially,” he said.

Bullard said “it’s the elephant in the room for this conference as
to whether the U.S. economy went through some kind of structural shift
associated with this very large financial crisis and its aftermath. If
you look at the level of real GDP.”

“It sure looks like the economy was on one trend pre-crisis and is
on a very different trend post-crisis, and I think the longer this goes
on, the stronger the statistical evidence will be that we’re on a
different trend,” he continued.

“Now you can posit ideas about why this is, but it does have
startling policy implications,” Bullard said. “It could mean that the
cyclical adjustment that can be attained in a normal business cycle
sense has already happened and that what goes on from here is very
different from the ordinary reaction to a recession that you might
normally be thinking of.”

** MNI **

[TOPICS: M$U$$$,MMFUE$,MAUDS$,M$$CR$,M$$BR$]

By Steven K. Beckner

Continued:

There’s no denying that unemployment has been driven up and kept
high more than three years after the declared end of the recession by
structural factors, said one participant, Bank of America chief
economist Mickey Levy.

As proof that mismatches are important, Levy noted that even
though recent Fed beige book surveys have shown weak labor market
conditions, they have also shown that firms are having “a hard time
finding the right, skilled people” in a majority of the 12 Fed
districts.

Levy also said government work disincentives are preventing
reductions in unemployment. He cited extended unemployment benefits,
“the unprecedented dramatic increase in disability insurance,” the
dramatic growth in the number of food stamp recipients and the
weakening of work requirements for receiving welfare benefits.

“All those factors inhibit growth and employment despite
unprecedented monetary stimulus,” Levy said.

Levy suggested that the structural-cyclical controversy presents
a false dichotomy.

“If something is not specifically structural, like extended
unemployment compensation, and doesn’t affect long-run potential growth
but takes five to seven years to return to normal, do you consider that
cyclical?” he asked.

Work disincentives and skill mismatches are suppressing short-term
growth and unemployment reductions without necessarily affecting
long-term trend growth, said Levy. “Why else would we have upward
pressure on real wages and not deflation. We have U-6 unemployment of
16%, but core inflation is 2%.”

(2 of 2)

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

Continued:

By Steven K. Beckner

Among the dangers, they warn, is that “the central bank can be
‘cornered’ by 1) fiscal authorities and 2) systemically important
economic agents.”

“Fiscal authorities will try to force the central bank to monetize
government debt in order to avoid politically unpopular austerity
measures,” they continue. “Brinksmanship between proponents of monetary
dominance and proponents of fiscal dominance leads to uncertainty in the
economy.”

“The aim of any central bank should be to monitor the fiscal
situation in order to avoid battles between fiscal and monetary
authorities,” they recommend.

“Unsustainable fiscal debt levels can … undermine the
credibility of monetary policy rules,” they conclude. “In the fiscal
dominance regime, the central bank is forced to choose between inflation
and government default. A possible government default has adverse
knock-on effects on the financial system and its stability. The diabolic
loop between sovereign risk and banking risk amplifies the initial
effect.”

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

By Steven K. Beckner

JACKSON HOLE, Wyo. (MNI) – An unsustainable fiscal policy can
undermine sound monetary policy, participants in the Kansas City Federal
Reserve Bank’s annual symposium were told Saturday.

Ideally, monetary, fiscal and regulatory policies should be in
synch with each other and not work at cross purposes, according to a
paper on “Redistributive Monetary Policy” prepared for presentation to
top central bankers from around the world.

Although monetary policy can be used to redistribute wealth, it
should be used sparingly and with an eye to potential negative
consequences.

The Fed has been holding both short- and long-term interest rates
very low for several years to support economic recovery, and one effect
has been to greatly reduce the federal government’s borrowing costs as
it runs record annual budget deficits.

This has led some, including Richmond Fed President Richard Fisher
in a recent MNI interview, to say that the Fed is inadvertently enabling
the federal government to delay reining in deficit spending.

The paper, written by Princeton University professors Markus
Brunnermeier and Yuliy Sannikov, does not directly address that issue
but does have implications for the relationship between monetary and
fiscal policy in the United States and other nations.

Although the Fed considers itself an “independent” central bank,
the reality is that monetary policy cannot operate completely
independently from fiscal policy, they imply.

“Carefully designed policy can reduce the frequency of financial
recessions and minimize inefficiencies once they happen,” Brunnermeir
and Sannikov write, but they add, “Our analysis suggests that some
seemingly natural policy responses can actually be counterproductive.”

“Importantly, contrary to predominant view, the three objectives of
price stability — financial stability, and fiscal government debt
sustainability — cannot be treated independently from each other and
assigned separately to monetary, regulatory, and fiscal authorities,
respectively,” they continue. “They are all closely interlinked.”

Among the “moral hazards” of anti-recessionary policies, they warn
that the central bank can get “cornered” by the fiscal authorities and
forced into imprudent monetary policies.

But first they explore the tools which central banks can use to
counter financial crises and recessions: 1) short-term interest rate
policies, 2) “helicopter drops” of money, 3) asset purchase programs,
and 4) collateral policies for lending programs.

These tools can be used to counter “adverse shocks” when liquidity
can dry up, lead to “fire sales” of assets and cause the “money
multiplier” to shrink as banks cut backs on their lending. The result
can be deflationary pressures.

In addition to stimulating spending and investment via low interest
rates and boosting net exports through exchange rate changes,
Brunnermeir and Sannikov postulate a new “redistributional channel of
monetary policy.”

“Monetary policy leads to changes in various asset prices and the
values of debt/mortgage contracts,” they explain. “This monetary
transmission channel works primarily through capital gains … . Lower
interest rates can also increase the risk-]taking behavior of investors
and asset price distortions.”

The Princeton economists emphasize that, since asset holdings vary,
“hence monetary policy affects different economic agents differently. As
a consequence, monetary policy redistributes wealth.”

They say “this redistributive effect can mitigate distortions, such
as debt overhang problems that arise from amplification
mechanisms … . These mitigating effects can spur growth and lead to an
overall higher wealth level in the economy.”

One example of the “redistributive” effects of monetary policy is
that lower interest rates reduce banks’ funding costs, thereby
increasing their profits and enabling them to more easily recapitalize.
Also low interest rates increase the value of banks’ bond holdings.

In passing, Brunnermeir and Sannikov lend support to the Fed’s use
of “forward guidance” to advertise their intention to keep the federal
funds rate very low “at least through late 2014.”

“For conventional monetary policy to control the long-term yield,
i.e., to achieve a shift in the long-]term bond price, it is necessary
that the central bank credibly commit to a low interest rate until the
economy strengthens again,” they write.

Unconventional monetary policy, including asset purchases and
subsidized lending programs, can also help counter a shock by boosting
asset prices, though some parties benefit more than others.

“When is monetary policy most welfare enhancing?” they ask.
“Absent any monetary intervention, an adverse shock leads to fire
sales of physical capital from productive to less productive agents and,
in addition, to deflationary pressure. Monetary policy that is
accommodating in these states of the economy provides support for the
price of capital and other assets.”

Without central bank support, asset sales can not only destroy
wealth, but worsen “liquidity and deflationary spirals,” they warn.

The economists say the ability of the central bank to respond
“depends on the quantity and maturity of outstanding government debt and
other long-dated assets, as well as on whether mortgage interest rates
are primarily fixed or floating. For example, if the ailing sector holds
more long-dated assets, then a smaller interest rate cut might suffice
to generate the same capital gains effect.”

“Surprisingly, interest rate derivatives that insulate banks from
interest rate risk make monetary policy less effective,” they note.

When a shock leads to large and unsustainable budget deficits, a
“diabolic loop” can arise, warn Brunnermeir and Sannikov.

If monetary easing is not offset by fiscal spending cuts — what
they call a regime of “fiscal dominance” — then “it has a large impact
on inflation, and the monetary authority is de facto not in full control
of inflation.”

Another possible scenario is default on government debt, the
spectre of which has been haunting Europe for two years or more.

“If the market expects that 1) the government will not restrain its
fiscal spending and 2) the central bank will not monetize the
unsustainable part of future government expenditures, then long-term
bonds are subject to default and the difference between sovereign and
private debt claims vanishes,” they write. “In other words, government
bonds lose their ‘moneyness’ as their role as a store of value is
compromised.”

The result is the kind of “flight to safety” witnessed recently as
investors flee Greece, Spain and other nations’ sovereign debt into U.S.
Treasuries, gold and so forth.

Without specifically mentioning the plight of European debtor
nations, the Princeton pair describe some of the problems they and their
creditors have been facing.

“If the financial sector holds a lot of government debt, the
diabolic loop between sovereign debt and banking debt can exacerbate the
situation,” they write. “As the real value of long-term bonds drops,
the financial sector contracts its balance sheet. The resulting credit
crunch stifles real economic growth. Lower economic growth lowers the
tax revenue for the sovereign, making a default or monetization of
government debt more likely.”

“At the same time, the financial sector might need to be
recapitalized by the government,” they continue. “The increased
probability of a bailout makes it less likely that the government will
be able to honor its old debt.”

“In addition, deflationary and inflationary pressures are at work,”
they go on. “A negative shock on sustainability of government debt can
trigger both deflationary and inflationary forces.”

Brunnermeir and Sannikov say “balancing these forces to target
price stability is especially challenging. The system is not very
forgiving: Small policy mistakes can lead the economy to drift onto an
inflationary or deflationary path.”

Because of “moral hazard” — the tendency for a policy to cause
excessive risk-taking and other undesired behavior — they caution that
“redistributive monetary policy should be strictly limited.”

“Hence, ex ante, the central bank wants to commit itself to limit
the redistributive aspects of monetary policy,” they write. “Ex post, it
would like to redistribute wealth to stimulate the economy, but this
undermines the credibility of the rule.”

-more- (1 of 2)

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]

See what happens when you vote for a Socialist government 

‘Representatives of the three parties in the coalition government are to continue talks over the weekend in a bid to overcome differences on 11.5 billion euros’ worth of painful austerity measures’

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WSJ article

Reuters Breakingviews

Zerohedge

Oh dear