Tag: Federal Reserve

US Mobile Banking Trends Updated

Mobile banking use continued to rise last year as smartphone adoption grew and consumers were increasingly drawn to the convenience of mobile financial services, according to a US Federal Reserve Board report, Consumers and Mobile Financial Services 2016, released on Wednesday.

The report documents consumers’ use of mobile phones–Internet-enabled smartphones as well as more basic phones with limited features–as they bank and carry out financial activities. It is the Board’s fifth annual look at how consumers use mobile phones to access banking services (“mobile banking”), make payments, transfer money, or pay for goods and services (“mobile payments”), and inform financial decisions, as well as their reasons for using these services.

As of November 2015, 43 percent of adults with mobile phones and bank accounts reported using mobile banking–an increase of 4 percentage points from the prior year’s survey. The most common way that consumers use mobile banking is checking their account balances or recent transactions, followed by transferring money between accounts. More than half of mobile banking users received an alert from their financial institution through a text message, push notification, or e-mail–making this the third most common use of mobile banking.

For those who have adopted mobile banking, use of a mobile phone appears to complement their use of other banking channels. Among mobile banking users with smartphones, 54 percent cited the mobile channel as one of the three most important ways they interact with their bank. This share is below those that cited online (65 percent) and ATM (62 percent) as most important, but slightly above the share that cited a teller at a branch (51 percent).

Use of mobile payments continues to be less common than use of mobile banking. Twenty-four percent of all mobile phone users, and 28 percent of smartphone users, made a mobile payment in the 12 months prior to the survey. For smartphone owners who reported making payments with their phones, the most common types of mobile payments were paying bills, purchasing a physical item or digital content remotely, and paying for something in a store.

Use of mobile financial services varies across demographic groups. For particular groups of respondents to the 2015 survey–such as younger adults, Hispanics and non-Hispanic blacks–the shares who reported using mobile banking and mobile payments were higher than the overall survey averages. Smartphone ownership among those with mobile phones is higher for Hispanics than for non-Hispanic whites in this survey.

Consistent with findings from prior years, a majority of consumers using mobile banking and mobile payments cite convenience or getting a smartphone as their main reason for adoption. The main impediments to the adoption of mobile financial services continue to be a stated preference for other methods of banking and making payments, as well as concerns about security.

Concerns about the security and privacy of personal information continue to be expressed by mobile phone users, and the majority of smartphone users reported taking actions that can reduce harm in case of a security incident. The most common actions were installing updates, password-protecting the phone, and customizing privacy settings.

The survey was conducted on behalf of the Board by GfK, an online consumer research firm. The 2015 survey was conducted from November 4-23, 2015. More than 2,500 respondents completed the survey.

Previous surveys have informed the Federal Reserve and other parts of the government on consumer banking and payment behavior and have supported basic research and public discussion.

The 2016 report and a video summarizing the survey’s mobile financial services findings may be found at: http://www.federalreserve.gov/communitydev/mobile_finance.htm.

Fed Says Future Rate Hikes Will Be Gradual

Chair Janet L. Yellen’s speech at the Economic Club of New York “The Outlook, Uncertainty, and Monetary Policy” reinforces the view that only gradual increases in the federal funds rate are likely.

In December, the Federal Open Market Committee (FOMC) raised the target range for the federal funds rate, the Federal Reserve’s main policy rate, by 1/4 percentage point. This small step marked the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery from the worst financial crisis and recession since the Great Depression. The Committee’s action recognized the considerable progress that the U.S. economy had made in restoring the jobs and incomes of millions of Americans hurt by this downturn. It also reflected an expectation that the economy would continue to strengthen and that inflation, while low, would move up to the FOMC’s 2 percent objective as the transitory influences of lower oil prices and a stronger dollar gradually dissipate and as the labor market improves further. In light of this expectation, the Committee stated in December, and reiterated at the two subsequent meetings, that it “expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.”

In my remarks today, I will explain why the Committee anticipates that only gradual increases in the federal funds rate are likely to be warranted in coming years, emphasizing that this guidance should be understood as a forecast for the trajectory of policy rates that the Committee anticipates will prove to be appropriate to achieve its objectives, conditional on the outlook for real economic activity and inflation. Importantly, this forecast is not a plan set in stone that will be carried out regardless of economic developments. Instead, monetary policy will, as always, respond to the economy’s twists and turns so as to promote, as best as we can in an uncertain economic environment, the employment and inflation goals assigned to us by the Congress.

The proviso that policy will evolve as needed is especially pertinent today in light of global economic and financial developments since December, which at times have included significant changes in oil prices, interest rates, and stock values. So far, these developments have not materially altered the Committee’s baseline–or most likely–outlook for economic activity and inflation over the medium term. Specifically, we continue to expect further labor market improvement and a return of inflation to our 2 percent objective over the next two or three years, consistent with data over recent months. But this is not to say that global developments since the turn of the year have been inconsequential. In part, the baseline outlook for real activity and inflation is little changed because investors responded to those developments by marking down their expectations for the future path of the federal funds rate, thereby putting downward pressure on longer-term interest rates and cushioning the adverse effects on economic activity. In addition, global developments have increased the risks associated with that outlook. In light of these considerations, the Committee decided to leave the stance of policy unchanged in both January and March.

I will next describe the Committee’s baseline economic outlook and the risks that cloud that outlook, emphasizing the FOMC’s commitment to adjust monetary policy as needed to achieve our employment and inflation objectives.

FED Holds Rates For Now

Today’s FED release:

Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft. A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. However, global economic and financial developments continue to pose risks. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo. Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.

Key Macroeconomic Uncertainties

FED Vice Chairman Stanley Fischer spoke at the “Policy Challenges in an Interconnected World” Conference. In his speech, “Reflections on Macroeconomics Then and Now“, he highlighted some of the macroeconomic uncertainties which beset the economy.

I would like briefly to take up several topics in more detail. Some of them are issues that have remained central to the macroeconomic agenda over the past 50 years, some have to my regret fallen off the agenda, and others are new to the agenda.

  1. Inflation and unemployment: Estimated Phillips curves appear to be flatter than they were estimated to be many years ago–in terms of the textbooks, Phillips curves appear to be closer to what used to be called the Keynesian case (flat Phillips curve) than to the classical case (vertical Phillips curve). Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don’t believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate–something that we would like to happen.
  2. Productivity and growth: The rate of productivity growth in the United States and in much of the world has fallen dramatically in the past 20 years. The table shows calculated rates of annual productivity growth for the United States over three periods: 1952 to 1973; 1974 to 2007; and the most recent period, 2008 to 2015. After having been 3 percent and 2.1 percent in the first two periods, the annual rate of productivity growth has fallen to 1.2 percent in the period since the start of the global financial crisis.The right guide to thinking in this case is given by a famous Herbert Stein line: “The difference between a growth rate of 1 percent and 2 percent is 100 percent.” Why? Productivity growth is a major determinant of long-term growth. At a 1 percent growth rate, it takes income 70 years to double. At a 2 percent growth rate, it takes 35 years to double. That is to say, that with a growth rate of 1 percent per capita, it takes two generations for per capita income to double; at a 2 percent per capita growth rate, it takes one generation for per capita income to double. That is a massive difference, one that would very likely have severe consequences for the national mood, and possibly for economic policy. That is to say, there are few issues more important for the future of our economy, and those of every other country, than the rate of productivity growth.At this stage, we simply do not know what will happen to productivity growth.Robert Gordon of Northwestern University has just published an extremely interesting and pessimistic book that argues we will have to accept the fact that productivity will not grow in future at anything like the rates of the period before 1973. Others look around and see impressive changes in technology and cannot believe that productivity growth will not move back closer to the higher levels of yesteryear.7 A great deal of work is taking place to evaluate the data, but so far there is little evidence that data difficulties account for a significant part of the decline in productivity growth as calculated by the Bureau of Labor Statistics.
  3. The ZLB and the effectiveness of monetary policy: From December 2008 to December 2015, the federal funds rate target set by the Fed was a range of 0 to 1/4 percent, a range of rates that was described as the ZLB (zero lower bound).9 Between December 2008 and December 2014, the Fed engaged in QE–quantitative easing–through a variety of programs. Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.Critics have argued that QE has gradually become less effective over the years, and should no longer be used.It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.
  4. The monetary-fiscal policy mix: There was once a great deal of work on the optimal monetary-fiscal policy mix. The topic was interesting and the analysis persuasive. Nonetheless the subject seems to be disappearing from the public dialogue; perhaps in ascendance is the notion that–except in extremis, as in 2009–activist fiscal policy should not be used at all. Certainly, it is easier for a central bank to change its policies than for a Treasury or Finance Ministry to do so, but it remains a pity that the fiscal lever seems to have been disabled.
  5. The financial sector: Carmen Reinhart and Ken Rogoff’s book, This Time Is Different, must have been written largely before the start of the great financial crisis. I find their evidence that a recession accompanied by a financial crisis is likely to be much more serious than an ordinary recession persuasive, but the point remains contentious. Even in the case of the Great Recession, it is possible that the U.S. recession got a second wind when the euro-zone crisis worsened in 2011. But no one should forget the immensity of the financial crisis that the U.S. economy and the world went through following the bankruptcy of Lehman Brothers–and no one should forget that such things could happen again.The subsequent tightening of the financial regulatory system under the Dodd-Frank Act was essential, and the complaints about excessive regulation and excessive demands for banks to hold capital betray at best a very short memory.We, the official sector and particularly the regulatory authorities, do have an obligation to try to minimize the regulatory and other burdens placed on the private sector by the official sector–but we have a no less important obligation to try to prevent another financial crisis. And we should also remember that the shadow banking system played an important role in the propagation of the financial crisis, and endeavor to reduce the riskiness of that system.
  6. The economy and the price of oil: For some time, at least since the United States became an oil importer, it has been believed that a low price of oil is good for the economy. So when the price of oil began its descent below $100 a barrel, we kept looking for an oil-price-cut dividend. But that dividend has been hard to discern in the macroeconomic data. Part of the reason is that as a result of the rapid expansion of the production of oil from shale, total U.S. oil production had risen rapidly, and so a larger part of the economy was adversely affected by the decline in the price of oil. Another part is that investment in the equipment and structures needed for shale oil production had become an important component of aggregate U.S. investment, and that component began a rapid decline. For these reasons, although the United States has remained an oil importer, the decrease in the world price of oil had a mixed effect on U.S. gross domestic product. There is reason to believe that when the price of oil stabilizes, and U.S. shale oil production reaches its new equilibrium, the overall effect of the decline in the price of oil will be seen to have had a positive effect on aggregate demand in the United States, since lower energy prices are providing a noticeable boost to the real incomes of households.
  7. Secular stagnation: During World War II in the United States, many economists feared that at the end of the war, the economy would return to high pre-war levels of unemployment–because with the end of the war, demobilization, and the massive reduction that would take place in the defense budget, there would not be enough demand to maintain full employment.Thus was born or renewed the concept of secular stagnation–the view that the economy could find itself permanently in a situation of low demand, less than full employment, and low growth.10 That is not what happened after World War II, and the thought of secular stagnation was correspondingly laid aside, in part because of the growing confidence that intelligent economic policies–fiscal and monetary–could be relied on to help keep the economy at full employment with a reasonable growth rate.Recently, Larry Summers has forcefully restated the secular stagnation hypothesis, and argued that it accounts for the current slowness of economic growth in the United States and the rest of the industrialized world. The theoretical case for secular stagnation in the sense of a shortage of demand is tied to the question of the level of the interest rate that would be needed to generate a situation of full employment. If the equilibrium interest rate is negative, or very small, the economy is likely to find itself growing slowly, and frequently encountering the zero lower bound on the interest rate.

    Research has shown a declining trend in estimates of the equilibrium interest rate. That finding has become more firmly established since the start of the Great Recession and the global financial crisis. Moreover, the level of the equilibrium interest rate seems likely to rise only gradually to a longer-run level that would still be quite low by historical standards.

    What factors determine the equilibrium interest rate? Fundamentally, the balance of saving and investment demands. Several trends have been cited as possible factors contributing to a decline in the long-run equilibrium real rate. One likely factor is persistent weakness in aggregate demand. Among the many reasons for that, as Larry Summers has noted, is that the amount of physical capital that the revolutionary information technology firms with high stock market valuations have needed is remarkably small. The slowdown of productivity growth, which as already mentioned has been a prominent and deeply concerning feature of the past six years, is another important factor.12 Others have pointed to demographic trends resulting in there being a larger share of the population in age cohorts with high saving rates.13 Some have also pointed to high saving rates in many emerging market countries, coupled with a lack of suitable domestic investment opportunities in those countries, as putting downward pressure on rates in advanced economies–the global savings glut hypothesis advanced by Ben Bernanke and others at the Fed about a decade ago.

    Whatever the cause, other things being equal, a lower level of the long-run equilibrium real rate suggests that the frequency and duration of future episodes in which monetary policy is constrained by the ZLB will be higher than in the past. Prior to the crisis, some research suggested that such episodes were likely to be relatively infrequent and generally short lived.15 The past several years certainly require us to reconsider that basic assumption. Moreover, recent experience in the United States and other countries has taught us that conducting monetary policy at the effective lower bound is challenging.16 And while unconventional policy tools such as forward guidance and asset purchases have been extremely helpful and effective, all central banks would prefer a situation with positive interest rates, restoring their ability to use the more traditional interest rate tool of monetary policy.

    The answer to the question “Will the equilibrium interest rate remain at today’s low levels permanently?” is also that we do not know. Many of the factors that determine the equilibrium interest rate, particularly productivity growth, are extremely difficult to forecast. At present, it looks likely that the equilibrium interest rate will remain low for the policy-relevant future, but there have in the past been both long swings and short-term changes in what can be thought of as equilibrium real rates.

    Eventually, history will give us the answer. But it is critical to emphasize that history’s answer will depend also on future policies, monetary and other, notably including fiscal policy.

Federal Reserve Board proposes rule to address risk associated with excessive credit exposures of large banking organizations to a single counterparty

The Federal Reserve Board on Friday proposed a rule to address the risk associated with excessive credit exposures of large banking organizations to a single counterparty. As demonstrated during the financial crisis, large credit exposures, particularly between financial institutions, can spread financial distress and undermine financial stability.

The proposal would apply single-counterparty credit limits to bank holding companies with total consolidated assets of $50 billion or more. The proposed limits are tailored to increase in stringency as the systemic footprint of a firm increases:

  • A global systemically important bank, or G-SIB, would be restricted to a credit exposure of no more than 15 percent of the bank’s tier 1 capital to another systemically important financial firm, and up to 25 percent of the bank’s tier 1 capital to another counterparty;
  • A bank holding company with $250 billion or more in total consolidated assets, or $10 billion or more in on-balance-sheet foreign exposure, would be restricted to a credit exposure of no more than 25 percent of the bank’s tier 1 capital to a counterparty;
  • A bank holding company with $50 billion or more in total consolidated assets would be restricted to a credit exposure of no more than 25 percent of the bank’s total regulatory capital to another counterparty;
  • And bank holding companies with less than $50 billion in total consolidated assets, including community banks, would not be subject to the proposal.

“We are determined to do as much as we can to reduce or eliminate the threat that trouble at one big bank will bring down other big banks,” said Federal Reserve Board Chair Janet L. Yellen.

Similarly tailored requirements would also be established for foreign banks operating in the United States.

“This regulation would complement overall capital requirements, which are generally based on the size and nature of a bank’s assets, but do not address the concentration of risk in specific borrowers or counterparties,” Governor Daniel K. Tarullo said.

The proposed rule implements part of the Dodd-Frank Act and builds on earlier proposals released by the Board in 2011 and 2012, and includes some modifications based on comments received. Additionally, the proposal seeks to promote global consistency by generally following the international large exposures framework released by the Basel Committee on Banking Supervision in 2014.

The Board on Friday also released a white paper explaining the analytical and quantitative reasoning for the proposed rule’s tighter 15 percent limit for credit exposures between systemically important financial institutions. Because systemically important financial institutions are generally engaged in similar activities and exposed to similar risks, the paper discusses why systemically important firms are more likely to come under stress at the same time and, as a result, generally incur more risk when exposed to other systemically important firms compared to non-systemically important counterparties.

Comments on the proposed rule are invited until June 3, 2016.

What Happened to the Great Divergence?

Governor Lael Brainard, spoke at the 2016 U.S. Monetary Policy Forum, New York, New York. The speech highlighted that whilst there was a phase when different economic centres were diverging, now there are more common elements, including low growth, low interest rates and low inflation. Global shocks are being transmitted via the financial system, creating volatility and spillover effects.

To the extent that we are observing limited divergence in inflation outcomes and less divergence in realized policy paths than many anticipated, this could be attributable to common shocks or trends that cause economic conditions to be synchronized across economies. The sharp repeated declines in the price of oil have been a major common factor depressing headline inflation and are also likely feeding into low core inflation, although to a lesser extent. As noted previously, these price declines have led headline inflation across the globe to behave quite similarly over this time period. Even so, most observers expect this source of convergence in inflationary outcomes to eventually fade and thereafter not affect monetary policy paths over the medium term.

In contrast, a more persistent source of convergence may be found in an apparent decline in the neutral rate of interest. The neutral rate of interest–or the rate of interest consistent with the economy remaining at its potential rate of output and inflation remaining at target level–appears to have declined over the past 30 years in the United States and is now at historically low levels. Similarly, longer-run interest rates appear also to have fallen across a broad group of advanced and emerging market economies, suggesting that neutral rates are at historically low levels in many countries around the world and near or below zero in the major advanced foreign economies. Although the reasons for the declines in neutral rates are not perfectly understood and may differ across countries, there are some common drivers, such as slower productivity and labor force growth and a heightened sensitivity to risk.

The very low levels of the shorter run neutral rate reflect in part headwinds from the crisis that are likely to dissipate over time. However, if many of the common forces holding down neutral rates prove persistent, then neutral rates may remain low through the medium term, implying a shallower path for policy trajectories.

The global economy is also experiencing a downshift in emerging market growth momentum led by China, which may prove somewhat persistent. Whereas earlier in the recovery there was a striking divergence between the relatively buoyant growth in major emerging economies and depressed growth in advanced economies, lately the extent of divergence has diminished noticeably. China is undergoing a challenging set of economic transitions. Trend growth has slowed substantially and is expected to slow further, and the composition of growth is shifting away from resource-intensive manufacturing and exports toward a greater share for consumption and services. China’s investment has slowed sharply recently after accounting for nearly one-third of global investment over the past three years and about one-half of global consumption in certain metals such as iron ore, aluminum, copper, and nickel. Commodity exporters and close trading partners in Asia will be most affected, but the changes in the composition and rate of growth in a country that has accounted for about one-third of the growth in world output and trade will likely ripple through the global economy much more generally.

Amplified Spillovers
Of course, policy divergence among major economies could be limited by rapid and strong transmission of foreign shocks across borders. In particular, although the U.S. real economy has traditionally been seen as more insulated from foreign trade shocks than many smaller economies, the combination of the highly global role of the dollar and U.S. financial markets and the proximity to the zero lower bound may be amplifying spillovers from foreign financial conditions. By one rough estimate, accounting for the net effect of exchange rate appreciation and changes in equity valuations and long term yields, over the past year and a half, the United States has experienced a tightening of financial conditions that is the equivalent of an additional increase of over 75 basis points in the federal funds rate.10

The transmission of divergent economic conditions across borders typically occurs though a couple of different channels. First, a decline in demand in one country reduces its demand for imports from other countries. Second, the fall in economic activity would be expected to trigger a more accommodative monetary policy, which helps offset the effect of the shock by both supporting domestic demand and weakening the exchange rate. The weaker exchange rate in turn leads domestic consumers to switch their expenditures away from more expensive foreign imports to cheaper domestic products while increasing the competitiveness of exports. The extent to which monetary policy offsets the shock by dispersing it to trade partners as opposed to strengthening domestic demand depends on the responsiveness of domestic demand relative to the exchange rate. The exchange rate channel, by raising the price of imports in domestic currency, also pushes up domestic inflation and exerts downward pressure on foreign inflation.

The strength of spillovers across countries and the extent to which that affects policy divergence across countries depend on a foreign economy’s openness to these different channels. The recent experience of Sweden suggests that for highly open economies, the effect of foreign shocks can be extremely powerful. Sweden’s economic growth has been relatively rapid recently, reaching nearly 4 percent over the most recent four quarters. Moreover, the employment gap is estimated to be nearly closed, and there are signs of financial excess in the housing market. In ordinary times, these conditions would be consistent with relatively tight monetary policy. However, inflation has run persistently well below the central bank’s 2 percent inflation target. Given the relative openness of Sweden’s economy, moving the inflation rate back up to target has been greatly complicated by the sensitivity of Sweden’s exchange rate and financial conditions to developments in the euro area, where domestic economic conditions are consistent with much more accommodative policy. As a result, the Riksbank has been pursuing extremely accommodative monetary policy, most recently lowering the interest rate on deposits to minus 0.5 percent and authorizing the Governor and Deputy Governor to intervene in foreign currency markets.

Even in the much larger United States economy, with imports accounting for a little over 15 percent of gross domestic product (GDP), spillovers can be quite strong, in part reflecting the international role of U.S. financial markets and the dollar. Since the middle of 2014, with a reassessment of demand growth in the euro area and subsequently in emerging markets and other commodity exporters, the real trade-weighted value of the dollar has increased nearly 20 percent. As a result, in 2014 and 2015, net exports subtracted a little over 1/2 percentage point from GDP growth each year, and econometric models point to a subtraction of a further 1 percentage point this year.12 In addition, the dollar’s appreciation is estimated to have put significant downward pressure on inflation: Non-oil import prices fell 3-1/2 percent in 2015, subtracting an estimated 1/2 percentage point from core PCE inflation.

Financial channels can powerfully propagate negative shocks in one market by catalyzing a broader reassessment of risks and increases in risk spreads across many financial markets. Since the beginning of the year, U.S. financial markets have reacted strongly to adverse news on emerging market growth, even though the news on the U.S. labor market has remained positive. In this regard, although China’s direct imports from the United States are modest, uncertainty about changes to its exchange rate system and financial imbalances, together with changes in the composition of its growth, have had broader global spillovers that may pose risks to the U.S. outlook.

Recent events suggest the transmission of foreign shocks can take place extremely quickly such that financial markets anticipate and indeed may thereby front-run the expected monetary policy reactions to these developments. It also appears that the exchange rate channel may have played a particularly important role recently in transmitting economic and financial developments across national borders. Indeed, recent research suggests that financial transmission is likely to be amplified in economies with near-zero interest rates, such that anticipated monetary policy adjustments in one economy may contribute more to a shifting of demand across borders than a boost to overall demand. This finding could explain why the sensitivity of exchange rate movements to economic news and to changes in foreign monetary policy appear to have been relatively elevated recently.

Financial tightening associated with cross-border spillovers may be limiting the extent to which U.S. policy diverges from major economies. As policy adjusts to the evolution of the data, the combination of heightened spillovers from weaker foreign economies, along with a lower neutral rate, could result in a lower policy path in the United States relative to what many had predicted.

Policy
In circumstances where many economies face common negative shocks or where negative shocks in one country are quickly transmitted across borders, it is natural to consider whether coordination can improve outcomes. Under certain conditions–such as flexible exchange rates, deep and well-regulated financial markets, and flexible product and labor markets–policies designed for the domestic economy can readily offset any spillovers from economic conditions abroad, and policies designed to address domestic conditions can achieve desirable outcomes both within the national economy and more broadly.

In some circumstances, however, cooperation can be quite helpful. If, for example, economies face a common challenge, coordination can communicate to markets that policymakers recognize the challenge and will work to address it. Reducing uncertainty about the direction of policy and addressing concerns about policies working at cross-purposes can boost the confidence of businesses and households. With intensified transmission effects in the vicinity of the zero lower bound, there is a risk that uncoordinated policy on its own could have the effect of shifting demand across borders rather than addressing the underlying weakness in global demand. The difficult start to the year should be a prompt for greater policy coherence and clarity. This might be a good time for policymakers to reaffirm their commitment to work toward the common goal of strengthening global demand.

Similarly, with anemic global demand and interest rates near zero, in some economies there is scope for monetary policy to be more effective with fiscal policy working in the same direction. With potential growth and nominal borrowing rates both low, public investment that increases potential in the longer run and demand in the shorter run could make an important contribution. A joint determination by policymakers across major economies to better deploy policy tools to provide support for global demand could be beneficial.

The Dynamics of US Mortgage Debt in Default

Research from the USA highlights the fact that when house prices fall, and household debt is high, the rise in defaults is more correlated to  the number of households falling behind in their mortgage payments that the debts of those already in default.

From St. Louis Fed Research

The large decrease in US house prices between 2006 and 2011 led to a dramatic increase in mortgage debt defaults. Since then, the share of mortgage debt in default has decreased significantly and is now close to the pre-2006 level. In this essay, we argue that these fluctuations are predominantly the consequence of changes in the number of households falling behind in their mortgage payments (the extensive margin) and not changes in the amount of debt of those in default (the intensive margin). On average, the extensive margin accounts for 78 percent of the increase in the 2006-09 period and 93 percent of the decrease in the 2011-15 period. This information may be useful in designing prudential policies to mitigate mortgage default.

The analysis is performed using data from the Federal Reserve Bank of New York Consumer Credit Panel/Equifax. In our measure of default, we consider all households with mortgage payments 120 or more days late. Figure 1 shows the share of mortgage debt in default, which fluctuated between 0.7 percent and 1 percent in the 1999-2006 period and then jumped to 7.5 percent in 2009. The figure also shows the evolution of house prices, whose collapse coincided with increasing mortgage defaults. In a recent article, Hatchondo, Martinez, and Sánchez (2015) show how these two series are related: A rapid decrease in house prices causes a sharp increase in mortgage defaults because more households find themselves with negative home equity (“under water”), and some of these households find it beneficial to default after a negative shock to income (i.e., unemployment).

We decompose the changes in the share of debt in default into changes in four different components: average debt in default, number of households in default, average debt, and number of households with debt. Basically, since

we can compute the percentage change (%∆) in the share of debt in default as follows:

Figure 2 shows the results of the decomposition by year; the four colors in each column represent the changes in the four components. The percentage value (shown on the left vertical axis) illustrates the change in the share of debt in default generated by the changes in a particular component. According to the previous equations, the summation of changes in the four components equals the changes in the share of debt in default (represented by the values for the black dots as shown on the right axis). For example, the black dot for 2006-07 has a value of 92, which indicates that the share of debt in default increased by 92 percent in that time period.

There are three interesting findings. First, and most importantly, we find that fluctuations in the number of households in default accounted for most of the fluctuations in the share of debt in default (shown by the size of the orange part of the bars in Figure 2). The share of households in default was very large not only for the years when defaults were increasing (2006 to 2009), but also for the subsequent years when the share of debt in default decreased slowly but steadily. The changes in the number of households in default confirm our earlier claim that the drastic decline in house prices between 2006 and 2009 caused negative home equity for more households. For some of these households a negative income shock triggered default, thus leading to the sharp increase in mortgage debt default. Another reason for this pattern is the delay in foreclosure proceedings that started during the Great Recession. Chan et al. (2015) show that borrowers’ knowledge of a possible long delay between the formal notice of foreclosure and the actual foreclosure sale date affects the likelihood of default: Borrowers who anticipate a longer period of “free rent” have a greater incentive to default on their mortgages.

Second, our results indicate that from 2003 to 2007 the average amount of debt (the gray part of the bars in Figure 2) exerted downward pressure on the share of debt in default. That is, since the average amount of debt was increasing, if the other three components had not increased, the share of debt in default would have decreased.

Finally, we find that the average amount of debt in default (the yellow part of the bars in Figure 2) was important in the 2006-08 period. This finding indicates that part of the increase in the share of debt in default during that period was actually due to an increase in the amount of the debt of households in default. This increase is in line with the fact that the decline in house prices affected households with larger debt (not necessarily subprime loans) that were not falling into default before 2006. When house prices plummeted in 2006, more households from this group defaulted. Later in the recession, the importance of the average amount of debt was overtaken by the number of households in default as more and more households with similar characteristics chose to default.

To summarize, the rapid increases in mortgage debt in default between 2006 and 2011 captured the attention of the public, policymakers, and researchers. It is important to understand the main forces driving the default increase, especially in designing prudential policies that minimize mortgage default such as those analyzed by Hatchondo, Martinez, and Sánchez (2015). The decomposition exercise in this essay suggests that the evolution of the share of mortgage debt in default can be accounted for mostly by changes in the number of households in default rather than changes in the overall amount of mortgage debt and the number of households with mortgages. Changes in the amount of debt in default also played a nonnegligible role, especially during the pre-crisis to early crisis periods.

Federal Reserve Board announced a $131m penalty against HSBC North America

The Federal Reserve Board on Friday announced a $131 million penalty against HSBC North America Holdings, Inc. and HSBC Finance Corporation for deficiencies in residential mortgage loan servicing and foreclosure processing. The penalty is being assessed in conjunction with an agreement involving similar deficiencies that HSBC announced Friday with the U.S. Department of Justice, other federal agencies, and the state attorneys general.

The penalty assessed by the Board is the maximum amount allowed under the law, taking into account the circumstances of HSBC’s unsafe and unsound practices and foreclosure activities. The penalty may be satisfied by providing borrower assistance or remediation in conjunction with the Department of Justice settlement, or by providing funding for nonprofit housing counseling organizations. If HSBC does not satisfy the full penalty amount within two years, the remaining amount must be paid to the U.S. Department of Treasury. The Board will closely monitor compliance by HSBC with the requirements of the order.

The terms of the monetary assessment against HSBC are similar to those that were part of the penalties issued by the Board in February 2012 and July 2014 against six other mortgage servicing organizations that reached similar agreements with the U.S. Department of Justice and the state attorneys general.

The Board previously issued an enforcement action in April 2011 requiring HSBC to correct its servicing and foreclosure-related deficiencies. That action was among 14 corrective actions issued against Board-supervised mortgage servicers or their parent holding companies for unsafe and unsound practices in residential mortgage loan servicing and foreclosure processing.

Fed Holds Rate

The latest release from the Fed highlights that any further lift in rates will be slow.

Information received since the Federal Open Market Committee met in December suggests that labor market conditions improved further even as economic growth slowed late last year. Household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed. A range of recent labor market indicators, including strong job gains, points to some additional decline in underutilization of labor resources. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined further; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.

Given the economic outlook, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

The US Market fell 1.5% in response.

Fed December Minutes Signal Further Rate Rises … Later

The minutes of the December 2015 Federal Open Market Committee have been published, and outlines the discussions which underpinned the decision to lift the US federal funds rate. Here is an extract:

Regarding the medium-term outlook, inflation was projected to increase gradually as energy prices and prices of non-energy imports stabilized and the labor market strengthened. Overall, taking into account economic developments and the outlook for economic activity and the labor market, the Committee was now reasonably confident in its expectation that inflation would rise, over the medium term, to its 2 percent objective. However, for some members, the risks attending their inflation forecasts remained considerable. Among those risks was the possibility that additional downward shocks to prices of oil and other commodities or a sustained rise in the exchange value of the dollar could delay or diminish the expected upturn in inflation. A couple also worried that a further strengthening of the labor market might not prove sufficient to offset the downward pressures from global disinflationary forces. And several expressed unease with indications that inflation expectations may have moved down slightly. In view of these risks and the shortfall of inflation from 2 percent, members expressed their intention to carefully monitor actual and expected progress toward the Committee’s inflation goal.

After assessing the outlook for economic activity, the labor market, and inflation and weighing the uncertainties associated with the outlook, members agreed to raise the target range for the federal funds rate to ¼ to ½ percent at this meeting. A number of members commented that it was appropriate to begin policy normalization in response to the substantial progress in the labor market toward achieving the Committee’s objective of maximum employment and their reasonable confidence that inflation would move to 2 percent over the medium term. Members agreed that the post meeting statement should report that the Committee’s decision reflected both the economic outlook and the time it takes for policy actions to affect future economic outcomes. If the Committee waited to begin removing accommodation until it was closer to achieving its dual-mandate objectives, it might need to tighten policy abruptly, which could risk disrupting economic activity. Members observed that after this initial increase in the federal funds rate, the stance of monetary policy would remain accommodative.

However, some members said that their decision to raise the target range was a close call, particularly given the uncertainty about inflation dynamics, and emphasized the need to monitor the progress of inflation closely.

Members also discussed their expectations for the size and timing of adjustments in the target range for the federal funds rate going forward. Based on their current forecasts for economic activity, the labor market, and inflation, as well as their expectation that the neutral shortterm real interest rate will rise slowly over the next few years, members expected economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate. However, they also recognized that the appropriate path for the federal funds rate would depend on the economic outlook as informed by incoming data. Members stressed the potential need to accelerate or slow the pace of normalization as the economic outlook evolved. In the current situation, because of their significant concern about still-low readings on actual inflation and the uncertainty and risks present in the inflation outlook, they agreed to indicate that the Committee would carefully monitor actual and expected progress toward its inflation goal. In determining the size and timing of further adjustments to monetary policy, some members emphasized the importance of confirming that inflation would rise as projected and of maintaining the credibility of the Committee’s inflation objective. Based on their current economic outlook, they continued to anticipate that the federal funds rate was likely to remain, for some time, below levels that the
Committee expected to prevail in the longer run.

The Committee also maintained its policy of reinvesting principal payments from agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. In view of members’ outlook for moderate growth in economic activity, inflation moving toward its target only gradually, and the asymmetric risks posed by the continued proximity of short-term interest rates to their effective lower bound, the Committee anticipated retaining this policy until normalization of the level of the federal funds rate was well under way. This policy, by keeping the Committee’s holdings of longer term securities at sizable levels, should help maintain accommodative
financial conditions.