President Biden said he would nominate Federal Reserve Chairman Jerome Powell to a second term leading the central bank, opting for continuity in U.S. economic policy despite pushback from some Democrats who wanted someone tougher on bank regulations and climate change.
Mr. Biden said he would also nominate Fed governor Lael Brainard as vice chairwoman of the central bank’s board of governors. Prominent liberals like Sen. Elizabeth Warren (D., Mass.) had warned the president against picking Mr. Powell, and progressive groups mounted a last-ditch campaign to pressure the president to tap Ms. Brainard for the top job.
Our view of the current level of vulnerabilities is as follows:
Asset valuations. Prices of risky assets generally increased since the previous report, and, in some markets, prices are high compared with expected cash flows. House prices have increased rapidly since May, continuing to outstrip increases in rent. Nevertheless, despite rising housing valuations, little evidence exists of deteriorating credit standards or highly leveraged investment activity in the housing market. Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall.
Borrowing by businesses and households. Key measures of vulnerability from business debt, including debt-to-GDP, gross leverage, and interest coverage ratios, have largely returned to pre-pandemic levels. Business balance sheets have benefited from continued earnings growth, low interest rates, and government support. However, the rise of the Delta variant appears to have slowed improvements in the outlook for small businesses. Key measures of household vulnerability have also largely returned to pre-pandemic levels. Household balance sheets have benefited from, among other factors, extensions in borrower relief programs, federal stimulus, and high aggregate personal savings rates. Nonetheless, the expiration of government support programs and uncertainty over the course of the pandemic may still pose significant risks to households.
Leverage in the financial sector. Bank profits have been strong this year, and capital ratios remained well in excess of regulatory requirements. Some challenging conditions remain due to compressed net interest margins and loans in the sectors most affected by the COVID-19 pandemic. Leverage at broker-dealers was low. Leverage continued to be high by historical standards at life insurance companies, and hedge fund leverage remained somewhat above its historical average. Issuance of collateralized loan obligations (CLOs) and asset-backed securities (ABS) has been robust.
Funding risk. Domestic banks relied only modestly on short-term wholesale funding and continued to maintain sizable holdings of high-quality liquid assets (HQLA). By contrast, structural vulnerabilities persist in some types of MMFs and other cash-management vehicles as well as in bond and bank loan mutual funds. There are also funding-risk vulnerabilities in the growing stablecoin sector.
Omarova’s most out-there academic ideas include directing the Federal Reserve to handle consumer deposits, taking that power away from banks. “Having Americans park their money at the Fed would allow the central bank to more directly and efficiently pull the levers of monetary policy by enabling it to credit individual citizens’ accounts when there’s a need to stimulate the economy,” notesPolitico.
Rob Nichols, president of the American Bankers Association, has said such policies would “effectively nationalize America’s community banks,” according to The New YorkTimes. Omarova “wants to eliminate the banks she’s being appointed to regulate,” agrees the Wall Street Journal editorial board. Groups representing both big and small banks, including the American Bankers Association, the Consumer Bankers Association, and the Independent Community Bankers of America, have reached out to more moderate Democrats to lodge their opposition to the pick—a ballsy move, given that she may end up passing down the rules that these associations’ members must later comply with.
Aggregate household debt balances increased by $313 billion in the second quarter of 2021, a 2.1% rise from 2021Q1, and now stand at $14.96 trillion. Balances are $812 billion higher than at the end of 2019 and $691 billion higher than 2020Q2. The 2.1% increase in aggregate balances was the largest seen since 2013Q4 and marked the largest nominal increase in debt balances since 2007Q2.
Total Household Debt Climbs Boosted by Growth in Mortgages and Auto Loans
According to the latest Quarterly Report on Household Debt and Credit, total household debt rose by $313 billion (2.1 percent) to reach $14.96 trillion in the second quarter of 2021. Mortgage balances—the largest component of household debt—rose by $282 billion and auto loans increased by $33 billion. Credit card balances ticked up by $17 billion while student loan debt decreased by $14 billion. Mortgage originations, which include mortgage refinances, reached $1.2 trillion, surpassing the volumes seen in the preceding three quarters. Auto loan originations, which include both loans and leases, reached a record $202 billion.
Downward pressure on the natural rate of interest (r∗) is often attributed to an increase in saving. This study uses microeconomic data from the SCF+ to explore the relative importance of demographic shifts versus rising income inequality on the evolution of saving behavior in the United States from 1950 to 2019. The evidence suggests that rising income inequality is the more important factor explaining the decline in r∗. Saving rates are significantly higher for high income households within a given birth cohort relative to middle and low income households in the same birth cohort, and there has been a large rise in income shares for high income households since the 1980s. The result has been a large rise in saving by high income earners since the 1980s, which is the exact same time period during which r∗ has fallen. Differences in saving rates across the working age distribution are smaller, and there has not been a consistent monotonic shift in income toward any given age group. Both findings challenge the view that demographic shifts due to the aging of the baby boom generation explain the decline in r∗. .
While the economic case for reducing inequality isn’t clear, a moral case can be made. One could argue that it’s wrong for the few to have so much while the many have so little. But it’s not the Fed’s job to make moral decisions about the ideal distributions of wealth. This is an inherently political calculation—one that should be addressed through institutions directly accountable to voters. Moreover, the tools at Congress’s disposal—tax rates and control over benefits, for example—are better suited for taking on inequality. And these policies involve costs, too, in terms of growth. Voters should be the ones to decide whether they want to pay them.
The Fed’s role is to balance short- and long-term interests, making the hard choices that may harm the economy now in exchange for long-term stability and expansion. Once politics are involved, however, it becomes difficult if not impossible to make this trade-off. The Fed can do what it does because it has a narrow mandate: reasonable inflation and maximum employment. It needs to stay in its lane.
Former U.S. Treasury Secretary Lawrence Summers said the Federal Reserve’s massive bond-buying program is resulting in a “bizarre” situation in which the government’s funding structure is overly focused on the short-term.
Under its quantitative easing program, the Fed purchases longer-term Treasuries and the money it creates to buy them ends up in the accounts that banks hold with the central bank, in the form of overnight reserves.
These reserves earn a rate of interest that’s linked to changeable overnight benchmarks — currently 0.15% per year. That, in effect is the rate the government, through the Fed, is paying to borrow this money.
At the same time, any payments the government makes on Treasury bonds to the Fed is ultimately a flow from one part of the government to another and, arguably, cancels itself out in the end. So the upshot is the government owes, in real terms, less longer-term fixed-rate debt and more shorter-term floating-rate debt.
The Fed cut its benchmark interest rate to near zero in March 2020 and has been purchasing at least $120 billion a month in Treasurys and mortgage bonds to provide extra stimulus to the economy. Officials since the end of last year said those purchases would continue until they see “substantial further progress” toward their goals of low unemployment and stable inflation.
Officials said in a statement Wednesday, at the conclusion of their two-day meeting, “the economy has made progress toward these goals” this year and indicated they would “assess progress in coming meetings.”
That is a clue the Fed could outline plans to start reducing, or tapering, the purchases, later this year. The central bank’s next meetings are scheduled for Sept. 21-22 and Nov. 2-3.
Fed Chairman Jerome Powell said at a virtual news conference Wednesday that the central bank was nowhere near considering plans to raise interest rates.
It is becoming increasingly accepted that lowering interest rates might at some point prove contractionary (the “reversal interest rate”) if lower lending margins cut the supply of bank loans. This paper argues that there are many other reasons to question reliance on monetary policy to provide economic stimulus, particularly over successive financial cycles. By encouraging the issue of debt, often for unproductive purposes, monetary stimulus becomes increasingly ineffective over time. Moreover, it threatens financial stability in a variety of ways, it leads to real resource misallocations that lower potential growth, and it finally produces a policy “debt trap” that cannot be escaped without significant economic costs. Debt-deflation and high inflation are both plausible outcomes.
Author(s): William White
Publication Date: 5 March 2021
Publication Site: Institute for New Economic Thinking