From ZIRP to NIRP Part II: The Effect of Low Interest Rates on the US Recovery

The Fed’s Monetary Policies in the Post-Recession Era

At the height of the recession in December 2008, the US Federal Reserve adopted historically low interest rates, slashing the federal-funds rate from 1% to between zero and a quarter percentage point. Like the Bank of Japan, the Fed sought to catalyze economic activity and combat deflation by reducing the cost of borrowing for households, businesses, and banks.

A month earlier, it had also started an aggressive quantitative easing program to inject additional liquidity into the economy, buying back bonds and mortgage-backed securities, and adding more than $3.5 trillion to the Fed balance sheet by 2014. Though its easing program tapered off by October 2014, Fed chair Janet Yellen announced that the central bank would reinvest proceeds from the bonds, in effect, providing another stimulus.

The Tepid Global Economic Recovery

Despite these unconventional monetary policies, America’s economic recovery has been tepid and largely unresponsive. According to Yale economist Stephen Roach, “Real GDP growth in the US has averaged only 2.1% in the 28 quarters since the Great Recession ended in the third quarter of 2009 – barely half the 4% average pace in comparable periods of earlier upturns.”

At the outset, the effects of the near-zero interest rate were partially stifled by already high levels of household and business debt, as well as the fact that prospective borrowers with even the slightest level of risk faced high interest rates. And in 2016, with the Fed maintaining historically low interest rates, there is little reason to suggest that a lack of liquidity and credit is ailing creditworthy households and businesses.

The Downsides of Negative Interest Rates

Even so, the persisting concerns about the health of the global economy and the volatility of the financial system have spurred calls for negative interest rates, to be implemented by charging banks for reserve deposits. While this ought to in theory create a similar stimulus effect to the 2008 interest rate cuts, the benefits of such a policy would be limited by the fact that there is a floor on nominal interest rates, in that depositors can always hold onto their cash. The potential downsides to a drastic policy include tarnishing the credibility of the Fed and heightened uncertainty. Moreover, lowering interest rates from their already low levels would constrain the Fed’s ability to vary its monetary policy in the event of a Japanese-style deflationary trend, and force it to turn to even more unconventional policies such as QE.

Persistently low interest rates also encourage excessive risk-taking and higher leverage, posing risks to financial stability. Those seeking higher nominal interest rates are encouraged to turn to more speculative assets. Low interest rates generally incentivize spending and penalize saving, reducing household interest incomes. The St. Louis Fed notes that “Since peaking at $1.33 trillion in the third quarter of 2008, personal interest income has declined by $128 billion, or 9.6 percent.” Some also argue that low interest rates led to the mid-2000s housing boom and a significant spike in household debt.

While a strengthening economic recovery and declining unemployment (down from 10% in October 2009 to 4.9% currently) may prima facie support the view that the Fed’s unconventional monetary policies are working, Roach notes that weak output and the productivity downturn raise worrying questions about the long-term, especially in the context of frothy asset markets.

An emerging consensus holds that the global economy’s current woes are beyond the abilities of creative monetary policy and financial engineering to remedy, and that they may be exacerbated by excessive risk-taking. As such, Notre Dame economist Eric Sims counsels focusing on structural issues such as demographic pressures, declining productivity, and disruptions born of globalization that have hampered economic growth.

References:

http://www.wsj.com/articles/SB122945283457211111

https://www.bloomberg.com/quicktake/federal-reserve-quantitative-easing-tape

http://www.cnbc.com/2016/02/10/the-danger-of-negative-interest-rates-commentary.html

https://www.stlouisfed.org/publications/inside-the-vault/spring-2011/low-interest-rates-have-benefits-and-costs

http://voxeu.org/sites/default/files/file/Geneva17_28sept.pdf

https://www.project-syndicate.org/print/desperate-central-bankers-by-stephen-s–roach-2016-09

Oil Prices Surge Following OPEC Production Cap

Oil prices surged following news that the Organization of Petroleum Exporting Countries had agreed to cut production and cap output. The international oil benchmark Brent crude rose 6% to nearly $49 a barrel on the back of the announcement.

November West Texas Intermediate crude futures jumped 4.7%, or $2.11, to trade at $46.78 a barrel. US stocks also closed higher overall following the surge in oil prices, with the Dow Jones Industrial Average closing up 110.94 points, ExxonMobil Corp. shares jumping 4.40%. Moreover, the S&P 500 index finished up 11.44 points, or 0.5%, at 2,171.37, while the energy sector jumped 4.3%. Oil prices settled up 5.3% at $47.05 on Wednesday.

The energy ministers from the major oil exporting nations struck the deal during talks held in Algeria in order to limit crude production and reduce the oversupply. The formal details of the agreement will be finalized at the OPEC meeting in November.

The deal stipulates a 700,000 barrel reduction of oil output per day overall, though some OPEC nations will cut their production more than others. Iran, for instance, will be allowed to increase its output. Oil production will be limited to a range of 32.5 million to 33 million barrels per day, down from August’s output of 33.2 million barrels.
“Opec made an exceptional decision today,” Iran’s Oil Minister Bijan Zanganeh said, according to the BBC.

Goldman Sachs expressed skepticism that the deal would successfully limit oil production in the long term, in a note that the investment bank circulated to investors. Goldman said that it would not revise its forecasts for WTI at $43 per barrel by the end of this year and $53 a barrel in 2017.

“If this proposed cut is strictly enforced and supports prices, we would expect it to prove self-defeating medium term with a large drilling response around the world,” Goldman’s analysts said.
Goldman also noted that “compliance to quotas is historically poor, especially when oil demand is not weak,” and that other oil exporting nations not beholden to the quota had increased oil production beyond analysts’ expectations.

References:

http://www.cnbc.com/2016/09/28/goldman-sachs-opec-production-cut-deal-doesnt-change-oil-price-forecasts-through-2017.html

http://www.marketwatch.com/story/us-stocks-close-higher-as-oil-jumps-2016-09-28?siteid=bnbh

http://www.marketwatch.com/story/oil-futures-rally-on-report-of-opec-output-cap-agreement-2016-09-28?siteid=bnbh

http://www.bbc.com/news/business-37502538

http://money.cnn.com/2016/09/28/investing/oil-surges-after-opec-informal-meeting/

America’s Birthrate Declines in 2015

Recent data culled by the Centers for Disease Control and Prevention showed an unexpected drop in births in the US in 2015, which fell by 1% from 2014, contrary to the forecasts of demographic analysts. Moreover, the US fertility rate in the first quarter of 2016 fell to 59.8 births per 1,000 women aged 15-44, tying 2013 figures for the lowest fertility rate on record. The figure translates to less than six births for every 100 women, prompting talk that America is currently mired in a baby bust.

America’s current general birth rate is 13.42 births per 1,000 citizens, according to the CIA World Factbook, a figure which is down 10% from 2007.  For comparison, Mexico’s birth rate is 42% higher, or 19.02 births for every 1,000 citizens.

Closer examination of the figures reveals a dramatic change in the ages that women have children today and provide insight into the declining birthrate. There has been a precipitous drop in teenage pregnancies and pregnancies among women in their 20s, both of which have played a large role in driving down the US birthrate. To put it differently, millennials, who have not been having children, are largely responsible for the declining numbers.

A 2015 study by the Urban Institute found that the birth rate for women ages 20-29 fell by 15% between 2007 and 2012. “If these low birth rates to women in their twenties continue, the U.S. might eventually face the type of generational imbalance that currently characterizes Japan and some European countries, but it is too early to predict or worry about that eventuality,” the report noted.

Social changes have pushed women to bear fewer children and put off pregnancy until later in life. Moreover, the economic pressures exerted by the 2008 recession have likely played the biggest role in disincentivizing childbearing among millennial women. While abortion may seem like a likely culprit for this demographic shift, abortion rates have actually declined since the 1980s, according to The Wall Street Journal.

It will soon become apparent whether millennial women will eventually have more children. The most common age in the US is currently 24 or 25, according to The Wall Street Journal, which means there is a sizeable portion of millennials who may decide to become parents in a few short years.

References:

http://blogs.wsj.com/economics/2016/06/07/behind-the-ongoing-u-s-baby-bust-in-5-charts/

http://www.cnbc.com/2015/04/27/baby-bust-millenials-birth-rate-drop-may-signal-historic-shift.html

http://www.cdc.gov/nchs/data/nvsr/nvsr65/nvsr65_03.pdf

http://www.urban.org/research/publication/millennial-childbearing-and-recession

The BIS Warns of Record-High Banking Stress in China

The Bank for International Settlements has recently released a quarterly report warning that China’s “credit to GDP gap” has reached a record 30.1%, indicating that the world’s second-largest economy faces mounting debt and credit pressures. According to the BIS, levels elevated beyond 10% signal high banking strain in an economy. In the United States, for instance, readings surpassed the 10% threshold in the lead-up to the financial recession.

The elevated credit to GDP gap suggests excessive credit growth in China and the possibility of a financial implosion. Should such an event occur, the repercussions would greatly damage the global economy. According to the Telegraph, “outstanding loans have reached $28 trillion, as much as the commercial banking systems of the US and Japan combined. The scale is enough to threaten a worldwide shock if China ever loses control.”

China’s total debt has reached 255% of GDP, having ballooned by 107% in the past eight years, and continues to grow, while corporate debt alone has hit 171% of GDP. Though China’s leadership has promised to limit debt growth, it has been hardpressed to follow through on its pledge given that debt has sustained the nation’s economic growth. Government spending on infrastructure and real estate has also proven to be less productive and failed to contribute meaningfully to GDP.

Some analysts have taken to prescribing bank recapitalization and reducing reflexive stimulus spending to artificially sustain growth on the part of the Chinese government. China’s central bank issued a statement earlier this year averring that investors would be able to maintain reasonably high levels of capital in the event of a serious banking shock. The fear, according to the Telegraph, is that a surge in capital outflows may force the central bank to sell off foreign currency to bolster the yuan, “automatically tightening monetary policy” and sparking a vicious cycle.

Significant doubts remain as to whether the government can extricate the nation from its precarious situation, though state control of the financial system may conversely prove to partly mitigate the risk of a banking crisis.

References:

http://www.mauldineconomics.com/outsidethebox/does-it-matter-if-china-cleans-up-its-banks

http://www.bloomberg.com/news/articles/2016-09-18/bis-warning-indicator-for-china-banking-stress-climbs-to-record

http://www.telegraph.co.uk/business/2016/09/18/bis-flashes-red-alert-for-a-banking-crisis-in-china/

http://www.businessinsider.com.au/this-early-warning-indicator-of-looming-financial-risks-is-flashing-red-for-china-2016-9

U.S. Median Household Income Grew by 5.2% in 2015

According to the Census Bureau, household median income in the US was $56,516 in 2015 whereas the highest recorded level of household median income was $57,909 in 1999, a sum that has been adjusted for inflation.The latest numbers were derived from an annual Census Bureau survey of 95,000 households.

However, the Census Bureau also reported that in 2015, the middle and lower classes of America enjoyed the best year of economic growth in decades, though this did not completely erase the losses of the 2008 recession.. Real median household income grew by 5.2%, from $53,700 in 2014 to $56,516 in 2015– the largest such increase ever recorded by the bureau. Median household income outpaced average income, which grew by 4.5% to $79,263.

Furthermore, the poverty rate decreased by 1.2% in 2015, the steepest such decline since 1968, with 3.5 million fewer impoverished Americans than in 2014. Lower income homes disproportionately large income gains, with households in the 10th and 20th percentiles, respectively, seeing 7.9% and 6.3% increases. Households in the 90th percentile, conversely, saw 2.9% income growth. The expansion of health insurance coverage also continued, with the percentage of uncovered Americans falling by 1.3 points to 9.1%.

The gains can be attributed to a stronger labor market, reduced inflation, and rising wages (particularly with regard to minimum wages). Employers added 3 million more jobs while the unemployment rate fell to 5%. The improvements also suggest that America’s economic recovery following the 2008 recession is beginning to spread more broadly, which is a major bone of contention in the current presidential election.

Incomes did indeed increase across gender, racial, and ethnic groups. However, they did not change significantly in rural areas, while cities saw a 7.3% jump in income levels, and the South enjoyed weaker growth than the West.

Median household incomes are still 1.6% lower than they were in 2007, adjusting for inflation, and 2.4% lower than the peak reached in 1999.

References:

http://www.nytimes.com/2016/09/14/business/economy/us-census-household-income-poverty-wealth-2015.html

https://www.washingtonpost.com/news/wonk/wp/2016/09/13/the-middle-class-and-the-poor-just-had-the-best-year-since-the-end-of-the-great-recession/

http://blogs.wsj.com/washwire/2016/09/14/takeaways-from-the-5-2-gain-in-u-s-median-household-income/

http://seekingalpha.com/article/4007202-household-incomes-decline-middle-class