Wednesday, February 18, 2009

Bernanke: His Words of Encouragement?

Ben Bernanke spoke today at the Nation Press Club luncheon in Washington, D. C. (His speech is found at His pledge to us is that the Fed will do “everything possible within the limits of its authority” to restore stable markets and get the U. S. out of recession.

If the past six months is any indication, we can believe him when he says this. For one thing, we have seen the Federal Reserve increase the “Factors Supplying Reserve Funds” from about $939 billion on September 3, 2008 to a peak of around $2.347 trillion on December 17, 2008 before falling to about $1.879 trillion on February 11, 2009. So from September 3, 2008 to February 11, 2009, “Factors Supplying Reserve Funds” to the banking system doubled…that is in a period of 23 weeks or less than one-half of a year.

Yes, I think we can believe what the Chairman of the Fed has said.

The effort is to “restore stable markets and get the U. S. out of recession.”

One can argue that the financial markets have stabilized somewhat and there have not been the major financial bailouts or nationalizations (AIG) or failures (Lehman Brothers) that we saw in September 2008. If this is restoring stability to the markets then there has been some success. However, with the lending pipeline seemingly paralyzed and the stock market at near-term lows, there is still a long way to go before we can conclusively say that the markets have become stabilized.

Let’s look a little deeper at what has happened in the financial system over the past several months.

First, let’s look at the total reserves in the banking system. Here we see, first hand, the impact of Federal Reserve actions on the banking system. Total reserves at depository institutions (not seasonally adjusted) were around $44.1 billion in January 2008 and were still around $44.1 billion in August 2008. Since August, however, total reserves have increased by approximated $809 billion to $1.853 trillion. Year-over-year (January 2008 to January 2009) this represent an annual rate of increase of 1853%...not bad. (Don’t annualize the rate of increase from the August figure…the figure is kind of silly!)

The next thing we can look at is what Bernanke calls “the narrowest definition of the money supply, the monetary base”. The monetary base is defined as all items that are bank reserves or could become bank reserves (cash held outside of depository institutions). In January 2008, the monetary base (not seasonally adjusted) was at about $831 billion. In August 2008 it had only increased to around $847 billion. But, in January 2009, the monetary base totaled about $1.710 trillion. Obviously, the year-over-year rate of increase in the monetary base was slightly over 100%...a pretty sizeable annual rate of increase…again, most of the increase coming from September 2008 to the present.

This, we are told is where the problem with the financial system is…”banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed.” That’s what financial institutions do when they are scared silly…because they don’t know the value of their assets and might be insolvent…or because they don’t know how good the credit is of people who want to borrow…if there are any that do want to borrow. That is, there is constipation in the lending system.

The increases in total reserves and the monetary base is having an impact on the growth of the two broader measures of the money stock but this increase is coming primarily in cash held outside of banks. That is, people and businesses are holding onto cash rather than spending it. This is consistent with the effort of people to either save or to pay down debt…exactly what one would expect at a time like this. People have too much debt, are risk averse about the future, and so are holding onto things…if they can.

The money stock measures have increased through the end of the year showing some effect of the Federal Reserve action. The year-over-year rate of growth of the M1 measure of the money stock (not seasonally adjusted) is around 13%, up from about 2% in August and a negative number through the first half of 2008. The broader measure of the money stock, M2, is running at an 11% year-over-year rate of increase (on a not seasonally adjusted basis), which is up from about 5.5% in August and around 6.5%for the first half of 2008. Both of these measures are growing at rates that are historically very high, but, again, a lot of this increase is in the cash component of the money stock and is not being spent!

What about lending in the banking system? Loans and leases at commercial banks in the United States have increased since the last week in August 2008 from about $6.9 trillion to around $7.1 trillion in the first week of February 2009…an increase of about $200 billion. Commercial and industrial loans have risen by about $50 billion and real estate loans have risen by around $144 billion. Residential real estate loans have risen by about $32 billion and commercial real estate loans have increase by around $47 billion. Consumer credit has grown by $55 billion, primarily with an increase in credit card debt.

Some increase in credit is occurring…but not a whole bunch…and a lot of this is to help businesses and others keep things going as their cash flows have slowed down. Lending is NOT robust, by any measure.

So, we have words of encouragement being spoken…but we are a long way from getting through this thing. And, the Federal Reserve owns up to this in the projections it released after Bernanke spoke. These projections are a part of the information reviewed by the Federal Open Market Committee at its meeting on January 27-28 2009. The release of these projections is a part of the Fed’s attempt to be open to the world by supplying the forecasts it is basing its decisions upon.

And the forecasts…gross domestic product may contract by up to 1.3% in 2009, although it is expected to increase nicely in 2010 and 2011. Unemployment might rise to a high of 8.8% this year, although it is projected to drop substantially in 2010 and 2011. And, what about inflation, we are told that the Fed is projecting core inflation to be between 0.9% and 1.1% this year and only modestly higher in 2010/2011.

The basic interpretation is that the economy will continue to be in recession throughout 2009 but will be getting better by the end of the year. Then things will get continually better in the following two years.

Inflation…well don’t worry about inflation…even though the Fed has pumped all these reserves into the banking system and the Federal Government is looking at deficits in the trillions of dollars for several years down the road. The Fed’s balance sheet “can be unwound ‘relatively quickly’ given the short-term nature of the assets the Fed holds.” Bernanke assures us that “The principal factor determining the timing and pace of that process will be the Federal Reserve’s assessment of the condition of credit markets and the prospects for the economy.” Okay...

I think I am missing something, however. First, when is credit going to start to flow again, given all the bad assets that are being held by banks? Doesn’t this have to happen before we start to get a smooth acceleration in economic growth? Second, who is going to finance all of the government debt that is going to be issued? Is the Federal Reserve going to print money to take care of the deficits we are facing? Somehow, I am missing some in the encouragement I am being given!

1 comment:

kylesch said...

I agree, that there are a lot of questions left to be answered here. The risk of rapid inflation once the narrow money supply 'widens out' are real.

That said, by chance, I happened to catch Bernanke's speech and following Q&A and the latter I found quite enlightening. I truly felt like a switch had been turned on and Bernenake "got it" that the public wants to know how the Fed is making their decisions.

It's clear that they are aware of all the same issues we worry about, but unfortunately now it just seems like they weight the issues with different scales of importance.

We'll see how far this whole transparency spiel goes. So far it has left us with [now gone] [where policy goals are inconsistent] [coming soon]. I believe in the idea ... let's just see how the implementation turns out.