macroblog

Did the Stimulus Package Actually Stimulate?

One of the big questions of the policy season is surely “Did the $100 billion of tax rebates distributed to households in May, June, and July actually work?” “Work” in this case means “stimulate consumer spending.” You may want to sit down before I tell you this, but so far economists disagree. In one corner you have Christian Broda at the University of Chicago and Jonathan Parker at Northwestern University:

The Economic Stimulus Act of 2008 was aimed at increasing disposable income temporarily through tax rebates in the hope this would stimulate spending and end or at least mitigate the severity of a U.S. economic slowdown. We find that to a significant extent they succeeded. The stimulus payments are initially being spent at significant rates. These rates are slightly higher than those observed in 2001 when fiscal policy has been credited with helping end the 2001 recession.

In the other you have Martin Feldstein:

Although press stories emphasizing that the rebates induced additional consumer spending were technically correct, they missed the important point that the spending rise was very small in comparison to the size of the tax rebates.

A recent, widely reported academic study by Christian Broda and Jonathan Parker showing that the rebates led to increased spending on nondurable items (like food and drugs) does not contradict the implication of the more comprehensive data—on national retail sales and total consumer spending—that the induced rise in consumer outlays was small relative to the size of the rebate.

Oh boy. Let’s back up a step. Before the fact, here is what people said they were planning to do with their rebates (by at least one report):

So what did the people receiving the rebates do with them? Well, if we could answer that one, it would be easy to resolve the Feldstein vs. Broda-Parker dispute. It does seem undeniable that a pretty good piece of those rebates was saved, at least in the first two months.

Can those elevated saving rates recorded in May and June reflect an outbreak of thriftiness? The real answer is “who knows?” but we can do a little back-of-the-envelope arithmetic to put things in perspective. Ignoring the Katrina-related dip in August 2005, the average saving rate from the beginning of 2005 through this past April was about 0.61 percent.

So, here’s the question: Assuming that consumers saved out of nonrebate income at the rate of 0.61 percent, how much would they have had to save out of the sums distributed in May and June to raise the overall saving rates to the observed values of 4.9 and 2.5 percent?

If you do the annualized calculation for the $43 billion of rebates in May and $28 billion in June you get some pretty striking numbers: An implied saving rate out of the rebates of somewhere in the neighborhood of 83 percent in May and 63 percent in June.

You can argue that there is a sense in which even these figures are understated. Durable goods purchases, for example, are theoretically a form of household saving, and the Broda-Parker survey respondents did indicate that about 20 percent of their rebates went toward the purchase of durables. However, if that is so durable expenditures without the tax rebates would have been really low. Though expenditures on durables grew at an annualized rate of 5.8 percent in May—not bad—they shrank by 17.4 percent in June.

These back-of-the-envelope calculations are pretty rough, of course, but they are broadly consistent with evidence from the 2001 tax rebates. That evidence also suggests that about one-third of the rebates were spent in the quarter following their disbursement, so the spending effects of this year’s model may yet have legs.

On the other hand, even if the rebates do prop up consumer spending in the short run, that would hardly settle the debate about whether they were the best way to spend $100 billion. But that’s a different debate for a different time.

What the Fed did during macroblog's vacation

To state the very obvious, it has been quite an eventful twelve months since I last committed fingers to laptop. I might well have titled this post "Four Fed programs that did not exist one year ago." Over the four months from December to March, the Federal Reserve Board of Governors and the Federal Open Market Committee, or FOMC, introduced an alphabet soup of new lending programs to address acute stress in financial markets, some of which required the invocation of emergency powers based on "unusual and exigent circumstances."

I know that in some quarters—maybe the one where you reside—all this activity had a certain frenetic, whack-a-mole feel to it. But I think it appropriate to view the Fed's actions over this period as what I believe them to be: A measured and logical sequence of steps to address very specific liquidity distress in financial markets.

If I had to choose one picture to describe the crux of the "liquidity" problems to which I am referring it would be this one:

In effect, the OIS (overnight index swap) yield is a measure of the rate that banks charge one another for overnight loans and the LIBOR (London Inter Bank Offered Rate) yields represent the rate charged for slightly longer-term (30- and 90-day) lending. The explosion in this spread in August 2007 was the marker for the emergence of a severe disruption in the means by which lending institutions typically finance their ongoing operations.

A brief chronology, then:

August 17, 2007: The Board of Governors cuts the primary credit rate (or discount rate), the interest rate Federal Reserve Banks charge on direct loans made to banks.

September 18, 2007: The FOMC cuts its target for the federal funds rate, the first in a string of seven consecutive rate reductions.

December 12, 2007: The Board of Governors introduces the Term Auction Facility (or TAF), initially a mechanism for providing loans to banks for a period of 28 days (as opposed to the typical overnight maturity associated with standard primary credit loans). Last week, the Board announced the program would be extended to make loans available for a term of 84 days.

March 7, 2007: The FOMC authorizes the New York Fed to conduct open market operations using Term Repurchase Agreements. Like the TAF, the term repo program allowed the Fed the flexibility to conduct operations over periods of about a month rather than the overnight basis that is typical in more normal environments.

March 11, 2008: The FOMC approves the creation of the Term Security Lending Facility (TSLF), which authorized swapping Treasury Securities (over a period of 28 days) for "other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS."

March 16: The Board of Governors creates the Primary Dealer Credit Facility (PDCF), authorizing direct loans to broker dealers who are authorized to engage in securities transactions with the Federal Reserve.

What do I want you to see? As I noted above, I see a progression of logically consistent steps that neither lurched to extreme solutions nor ignored the imperatives of the problem at hand:

• The first step was to invoke the usual tools of monetary policy (in the form of discount window lending and federal funds rate adjustments).

• Then it became obvious that injecting liquidity into overnight markets alone was not solving the problem of funding being unavailable for periods of time even as short as one to three months. The next step, then, was to lengthen the maturity of loans and asset exchanges in policy operations (in the form of the TAF and Term Repurchase Agreements). (An additional salutary effect of the TAF was apparently the lack of "stigma" that is thought to be attached to borrowing from the discount window.)

• From there, it became clear that Treasury securities were rapidly emerging as the only widely accepted form of collateral to support short-term borrowing and lending, a function that securities backed by real estate assets were simply unable to perform. Some relief to this problem was already inherent in the form of the broader-than-Treasuries collateral options in the TAF. Further relief was provided by the TSLF, which in effect implemented a swap of in-demand Treasury securities from the Federal Reserve's balance sheet for less liquid mortgage-backed assets.

• Finally, the potential systemic consequences of acute stress in the primary dealer network led us to the PDCF, in effect broadening the class of institutions to which the central bank would stand ready to infuse short-term liquidity.

Once again, in my view there is a methodical progression to the whole process that is too commonly overlooked: Start with the standard tools (the discount rate and federal funds rate), move on to a lengthening of the maturity in the term of those standard tools (TAF and Term Repurchase Agreements), on to a broadening of the collateral used to support monetary policy operations (TSLF), and finally expanding the class of institutions to which the Federal Reserve will lend (PDCF).

It is not entirely obvious that the new long-run level of the OIS-Libor spreads pictured above will once again converge to the values that prevailed prior to August 2007, but I would argue that the still-elevated levels of these spreads implies we have a ways to go before financial markets are again fully functional. Though the lending programs put in place in the past year have not been, and could not be, a magic elixir for solving all financial market woes, I would take the bet that they are least providing enough stability for the market to continue the painful process of healing itself. Getting to this point has not always been pretty in real time, and there is plenty of room for debate about the long-run costs and benefits of each step along the way. But given a little time for perspective I believe we will find a certain beauty to it all.

macroblog returns

With this posting, I’m pleased to announce the return of macroblog, which has been on hiatus since I came to the Federal Reserve Bank of Atlanta as its research director in August of last year.

I originally launched macroblog in 2004 as an independent blog, but it will now be run through the Atlanta Fed on our Web site. Macroblog will feature commentary by me as well as other members of the Bank’s research department. The purpose of the blog is to help inform readers with commentary and observations on a variety of current economic topics, including monetary policy, macroeconomic developments, financial issues, and Southeast regional trends. I do need to emphasize that the views expressed in macroblog will not necessarily be those of the Atlanta Fed or the Federal Reserve System – feel free to quote me on that.

A few logistics: Postings to macroblog will be made on Tuesdays and Thursdays. Though we will continue to post articles during the Federal Open Market Committee (FOMC) blackout period (which runs from the week before the FOMC meeting until the Friday after), we will not be commenting on monetary policy during that period. In addition, I will not personally post content during the blackout period.

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