Brookings: Topics - Business and Finance

Financial Market Confusion and Pessimism Do Not Mean The Fed Is Wrong on Monetary Policy

Douglas J. Elliott — Wed, 19 Jun 2013 15:00:00 -0400

The financial market reactions to today’s Fed announcement about monetary policy are in line with its responses to Fed comments over the last few weeks – a mix of uncertainty and pessimism. But, market uncertainty and some pessimism are not necessarily good reasons to back away from the policy that the Fed is signaling, which is an eventual reduction in monetary stimulus.

Many commentators have been blaming the Fed for the uncertainty, but this seems mostly unfair. First, the Fed itself does not know how the economy will perform over the next year or two and therefore how it may choose to react over the next few months. The Fed never knows for sure what the economy will get up to, but we are in extremely unusual times, particularly in terms of monetary policy. Second, the Fed needs to be cautious about tying itself to specific targets, since no one statistic or pair of statistics will be accurate enough to pinpoint the state of the economy. We want them to make the right decisions based on the full range of data, not lock themselves into a mistaken choice because overly simplistic measures gave a misleading picture. Third, a substantial part of the uncertainty comes from the markets themselves. We do not know how much investors may have been over-relying on the drug of cheap money to goose their investment performances, either out of greed or fear of failing to hit their return targets. Some of the sharp reaction to Bernanke’s May 22^nd testimony may have reflected investors guessing that other investors would realize they were too far out on a limb and would start cutting back on riskier investments.

Some market pessimism is also justified, for this same reason. The Fed has gotten more optimistic about the economy, which means it is likely to reduce the degree to which it stimulates the financial system more quickly than it would have otherwise done. Cheap money tends to push up financial markets, indeed it is one of the main reasons central banks use stimulus, since the increased willingness of investors to take risks increases economic growth by making it easier for businesses and families to finance investments and consumption.

Authors

Douglas J. Elliott

Image Source: © Gary Cameron / Reuters

The SEC Gets Money-Fund Reform Half Right

Robert C. Pozen and Theresa Hamacher — Tue, 18 Jun 2013 11:33:00 -0400

The Securities and Exchange Commission recently proposed two new rules to help prevent sudden redemptions of money-market shares by investors from wreaking havoc on the financial system. The first proposal, requiring a "floating NAV" (net asset value), deserves support because it is limited to the most risky type of money-market funds: those held mainly by fast-moving institutions and invested largely in prime commercial paper.

By contrast, the second proposal would apply to both institutional and retail money-market funds that invest mainly in commercial paper (so-called prime funds). Such funds would generally be required to impose "fees" and "gates" to slow down redemptions once a fund's liquid assets drop below 15% of total assets. This proposal could be counterproductive. To avoid these barriers to redemptions, investors would likely flee en masse as soon as their fund approached the 15% trigger.

Under current rules, money-market funds maintain a constant NAV of $1 per share unless its fair market value drops below 99.5 cents per share. During the financial crisis in 2008, the Reserve Primary Fund—an institutional prime fund—"broke the buck" when its position in the commercial paper of Lehman Brothers went sour. Then some investors, especially large institutions, rushed to redeem shares in other prime money-market funds, leading to distressed sales of commercial paper.

In response, the first SEC proposal would force institutional prime funds to move from a constant NAV of $1 per share to a fluctuating NAV—reflecting the actual market value of its assets every day. Since the fund's NAV per share would gradually reflect any deterioration in the market value of its assets, there would be no dramatic and sudden event of "breaking the buck." Without such an event, institutional investors would be less inclined to flee from a money-market fund to avoid a sharp drop in its NAV from $1 to 99 cents per share.

Sensibly, the SEC's first proposal would not apply to money-market funds holding mainly U.S. government-guaranteed securities. Such securities are effectively immune from default and unlikely to cause a permanent decline in a fund's value. The funds that have broken the buck in the past have invested primarily in commercial paper issued by large corporations. Nor would this proposal apply to retail funds. The money-market fund holdings of any individual retail investor are relatively small and these investors have historically been much slower to redeem than large institutions. Institutional investors follow closely their holdings of money-market funds and make large redemptions as soon as they sniff the possibility of a serious problem.

Unfortunately, the second SEC proposal would apply to prime money-market funds owned mainly by retail investors (although it would not apply to money-market funds that invest primarily in U.S. government-guaranteed securities.) The proposal would generally require funds to impose a 2% charge on all shareholder redemptions once a fund's liquid assets dropped below 15% of total assets. This 2% redemption fee is huge for retail investors in money-market funds, whose total annual returns are often less than 2%.

The second proposal also allows a retail money-market fund to suspend all shareholder redemptions for a period of up to 30 days. The threat of being locked into a money-market fund would terrify most retail investors.

While retail investors have been relatively slow to move in the past, the new rules will require prompt disclosure of the liquidity level of a money-market fund. When a fund's liquid assets dip below 20%, this will be widely noted by the financial press, so retail investors would be put on notice of impending barriers to redemptions.

In response, some retail investors might shift their savings from money-market funds to bank deposits. Such a sharp rise in deposits would be challenging for many banks that are already struggling to meet higher capital standards. More fundamentally, short-term borrowers would receive much less financing from money-market funds.

Other retail investors might keep their savings in a money-market fund, but redeem as soon as it reported liquid assets below 20%. At that point, the risk of redemption fees and suspension would be uncomfortably high, so retail investors would rush to redeem—causing the very "run" that the SEC is trying to prevent.

In short, the SEC should adopt its first proposal to require a floating NAV for institutional prime money-market funds. The agency should rethink its second proposal because it could inadvertently increase—not decrease—redemption waves from retail money-market funds in times of financial stress.

Authors

Robert C. Pozen
Theresa Hamacher

Image Source: © Jonathan Ernst / Reuters

Dealing with “Too Important to Fail” Banks

Fri, 14 Jun 2013 10:00:00 -0400

Event Information

June 14, 2013
10:00 AM - 11:30 AM EDT

Falk Auditorium

1775 Massachusetts Ave., NW
Washington, DC

Webcast Archive:
Introduction

Full Event

There is a heated debate about how to handle banks that are too big or otherwise too important for governments to allow them to fail in a crisis. Some call for the largest banks to be broken up, or for them to divest all or part of their investment banking operations, in the spirit of the old days of the Glass-Steagall Act. Others suggest forcing banks to be funded with much more shareholder money to try to make failure very unlikely. Still others assert that the Dodd-Frank Wall Street Reform and Consumer Protection Act and global regulatory reforms have reduced the problem so much that major structural reforms such as these are unnecessary.

On June 14, the Economic Studies program at Brookings reviewed and debated the issue of bank size and bank funding. Panelists included FDIC Vice Chairman Thomas Hoenig, banking expert Rodgin Cohen, and Senior Fellow and Director of the Initiative on Business and Public Policy Martin Baily. Douglas Elliott, fellow in Economic Studies, served as moderator.

Join the discussion on Twitter using hashtag #TooBigToFail.

Video

Audio

Dealing with “Too Important to Fail” Banks

Event Materials

14 dealing with too important to fail banks baily presentation

Participants

Panelists

Ted Gayer

Co-Director, Economic Studies
Joseph A. Pechman Senior Fellow

Douglas J. Elliott

Fellow, Economic Studies, Initiative on Business and Public Policy

Martin Neil Baily

Senior Fellow, Economic Studies
Bernard L. Schwartz Chair in Economic Policy Development

H. Rodgin Cohen

Senior Chairman

Thomas Hoenig

Vice Chairman

Fed Policy, Stock Markets and Japan

Douglas J. Elliott — Thu, 13 Jun 2013 08:45:00 -0400

The 6.4% fall in the Japanese stock market overnight, and the general retreat in global stock markets since late May, underline the importance of monetary policy for financial markets. There’s a reason for the old Wall Street saying that you should “never fight the Fed.” Monetary policy is a major determinant of economic activity and therefore of the value of the stocks and bonds of companies, since they are all affected by the level of economic growth. It also affects the cost of funding investment activities; lower interest rates make virtually all investments more attractive. Securities purchases by the Fed and other central banks around the world have a similar effect by bidding up prices. Further, the level of a country’s interest rates has a major impact on currency rates, with money tending to flow to where it can earn the highest interest and away from where it can be borrowed most cheaply. (The so-called “carry trade” focuses specifically on borrowing in currencies with cheap money and investing in currencies with higher interest rates.)

The Japanese are engaged in a massive exercise of monetary loosening in an attempt to increase asset prices and lower exchange rates in the anticipation that both factors will spur economic growth. This has led to sharply higher Japanese stock prices over the last half year, a gain that is being partially unwound as new doubts arise about how fully effective the new policies will be. The big question is whether this is (a) simply an adjustment to a more realistic view of policies that should remain quite supportive of the markets and economic growth or (b) a realization that the policy may be ineffective or ultimately counterproductive. I suspect that the answer is (a), but that the adjustment has further to go, since hopes have been quite inflated and there was insufficient recognition of the dangers and costs of the approach. That said, Japanese stock prices were massively beaten up over the last two decades and it may be that they are responding substantially to a reduction of an excessive and pervasive pessimism.

Markets around the world are also responding to the likelihood that the Fed will begin tightening monetary policy soon. For more on the implications of this, please see my recent presentation at an investor conference.

Authors

Douglas J. Elliott

Image Source: © Toru Hanai / Reuters

Quantitative Easing Withdrawal: How Bad Will it Hurt?

Douglas J. Elliott — Wed, 12 Jun 2013 16:09:00 -0400

The Fed's quantitative easing program and ultra-low interest rates will eventually come to an end, with purchases of new securities by the Fed potentially being reduced as early as this autumn. Financial markets are very focused on how this will occur and what effect it will have on securities of all kinds and on the economy as a whole. Economic Studies fellow Douglas Elliott recently gave a presentation to an investor conference on this issue. These slides are adapted from that presentation.

Downloads

QE Withdrawal: How Bad Will it Hurt?

Authors

Douglas J. Elliott

Image Source: © Brendan McDermid / Reuters

Why Isn’t Disruptive Technology Lifting Us Out of the Recession?

Martin Neil Baily and James M. Manyika — Tue, 11 Jun 2013 13:34:00 -0400

The weakness of the economic recovery in advanced economies raises questions about the ability of new technologies to drive growth. After all, in the years since the global financial crisis, consumers in advanced economies have adopted new technologies such as mobile Internet services, and companies have invested in big data and cloud computing. More than 1 billion smartphones have been sold around the world, making it one of the most rapidly adopted technologies ever. Yet nations such as the United States that lead the world in technology adoption are seeing only middling GDP growth and continue to struggle with high unemployment.

There are many reasons for the restrained expansion, not least of which is the severity of the recession, which wiped out trillions of dollars of wealth and more than 7 million US jobs. Relatively weak consumer demand since the end of the recession in 2009 has restrained hiring and there are also structural issues at play, including a growing mismatch between the increasingly technical needs of employers and the skills available in the labor force. And technology itself plays a role: companies continue to invest in labor-saving technologies that reduce demand for less-skilled workers.

So are we witnessing a failure of technology? Our answer is "no." Over the longer term, in fact, we see that technology continues to drive productivity and growth, a pattern that has been evident since the Industrial Revolution; steam power, mass-produced steel, and electricity drove successive waves of growth, which has continued into the 21st century with semiconductors and the Internet. Today, we see a dozen rapidly-evolving technology areas that have the potential for economic disruption as well in the next decade. They fall into four groups: IT and how we use it; machines that work for us; energy; and the building blocks of everything (next-gen genomics and synthetic biology).

Wide ranging impacts

These disruptive technologies not only have potential for economic impact—hundreds of billions per year and even trillions for the applications we have sized—but also are broad-based (affecting many people and industries) and have transformative effects: they can alter the status quo and create opportunities for new competitors.

While these technologies will contribute to productivity and growth, we must look at economic impact in a broader sense, which includes measures of surplus created and value shifted (for instance from producers to consumers, which has been a common result of Internet adoption). The greatest benefit we measured for autonomous vehicles—cars and trucks that can proceed from point A to point B with little or no human intervention. The largest economic impact we sized for autonomous vehicles is the enormous benefit to consumers that may be possible by reducing accidents caused by human error by 70 to 90 percent. That could translate into hundreds of billions a year in economic value by 2025.

Predicting how quickly even the most disruptive technologies will affect productivity is difficult. When the first commercial microprocessor appeared there was no such thing as a microcomputer—marketers at Intel thought traffic signal controllers might be a leading application for their chip. Today we see that social technologies, which have changed how people interact with friends and family and have provided new ways for marketers to connect with consumers, may have a much larger impact as a way to raise productivity in organizations by improving communication, knowledge-sharing, and collaboration.

There are also lags and displacements as new technologies are adopted and their effects on productivity are felt. Over the next decade, advances in robotics may make it possible to automate assembly jobs that require more dexterity than machines have provided or are assumed to be more economical to carry out with low-cost labor. Advances in artificial intelligence, big data, and user interfaces (e.g., computers that can interpret ordinary speech) make it possible to automate many knowledge worker tasks.

More good than bad

There are clearly challenges for societies and economies as disruptive technologies take hold, but the long-term effects, we believe, will continue to be higher productivity and growth across sectors and nations. In earlier work, for example, we looked at the relationship between productivity and employment, which are generally believed to be in conflict (i.e., when productivity rises, employment falls). And clearly, in the short term this can happen as employers find that they can substitute machinery for labor—especially if other innovations in the economy do not create demand for labor in other areas. However, if you look at the data for productivity and employment for longer periods—over decades, for example—you see that productivity and job growth do rise in tandem.

This does not mean that labor-saving technologies do not cause dislocations, but they also eventually create new opportunities. For example, the development of highly flexible and adaptable robots will require skilled workers on the shop floor who can program these machines and work out new routines as requirements change. And the same types of tools that can be used to automate knowledge worker tasks such as finding information can also be used to augment the powers of knowledge workers, potentially creating new types of jobs.

Over the next decade it will become clearer how these technologies will be used to raise productivity and growth. There will be surprises along the way—when mass-produced steel became practical in the 19th century nobody could predict how it would enable the automobile industry in the 20th. And there will be societal challenges that policy makers will need to address, for example by making sure that educational systems keep up with the demands of the new technologies.

For business leaders the emergence of disruptive technologies can open up great new possibilities and can also lead to new threats—disruptive technologies have a habit of creating new competitors and undermining old business models. Incumbents will want to ensure their organizations continue to look forward and think long-term. Leaders themselves will need to know how technologies work and see to it that tech- and IT-savvy employees are included in every function and every team. Businesses and other institutions will need new skill sets and cannot assume that the talent they need will be available in the labor market.

Authors

Publication: Yahoo! Finance

Image Source: © Yves Herman / Reuters

Another Funeral for the Midsize Airline Hub

Adie Tomer — Fri, 07 Jun 2013 13:00:00 -0400

For the midsize airline hub, there’s been another death in the family. Just this week, news broke that Delta would shutter its hub operations in Memphis, Tenn. This marks the third time since 2000 that a metropolitan area smaller than 5 million people lost its official hub declaration, while other similar-sized hubs are barely hanging onto their status.

This is the new reality of commercial aviation in America—fewer hubs and fewer airlines, resulting in more concentrated operations across the country. In response, consumers need to understand the consequences of these business and logistical shifts.

The typical origin story for these lost hubs is upheaval in the airline industry. At the turn of the century, American boasted 10 major commercial airlines. But following a wave of bankruptcies and mergers, the number of major domestic carriers will drop to just four following the proposed American/US Airways merger. The theory goes that when two airlines merge, economies of scale allow the new single entity to cut hubs out of its network.

In many ways, Memphis fits this narrative perfectly. Originally the southern hub for Minneapolis-based Northwest Airlines, Memphis knew it was in a tough spot when Northwest and Delta merged in 2008. Delta’s hub in Atlanta was only about 350 miles away, making two southern hubs an unneeded luxury. So while this week’s announcement makes it official, the airport already lost roughly one-third of its departures between 2010 and 2012. The writing was on the wall.

Unfortunately, that origin story is a little too simple. The real impetus for these operational shifts is a more traditional market story: supply and demand.

Based on Brookings analysis of FAA data, domestic travel demand has hit the skids. Between 2005 and 2012, the number of domestic passengers actually dropped by 15 million passengers while international passengers jumped by 27 million. Domestic growth slows even further if you subtract the domestic legs of international journeys.

At the same time as demand stalled, airlines also reduced flights. To increase what the industry calls load factors—essentially the average share of seats filled on each flight—airlines reduced domestic flight levels by 10 percent between 2005 and 2012. This left travelers with fewer departure options, but it helped increase domestic load factors from 78.6 percent to 84.3 percent over the same period.

Such supply and demand shifts couldn’t exist in a locational vacuum. In an effort to consolidate domestic operations, airlines had to locate metro area airports with insufficient seat demand where they also oversupplied flights.

The midsize hubs answered this question a little too perfectly. Their economic and demographic bases were often too small to fill the higher-capacity planes on ocean-crossing journeys, meaning they were unfit to operate as international hubs, especially in comparison to metro areas like New York and Miami. The midsize hubs were also too small to support multiple flights between many of their domestic peers. For example, transfer passengers represented 63 percent of Cincinnati’s total volumes in 2003; take away all those forced transfers and there simply isn’t enough business left.

These market realities meant hubs located in metros with populations under 5 million people often experienced dramatic changes. As mentioned, Memphis will join the ranks of St. Louis, Pittsburgh, and Las Vegas as locations losing airline-assigned hub status since 2000. Other official hubs like Detroit, Minneapolis, Cleveland, Cincinnati, and Salt Lake City have all seen their total flights drop faster than the national average. These last five markets haven’t lost hub status—but that hasn’t insulated them from market forces beyond their control.

There is no question that these business shifts can dramatically inconvenience passengers, both in and outside of the former midsize hubs. Stories like this in the New York Times, where 700-mile travel takes all day, are becoming all too common.

But this kind of qualitative reporting doesn’t address a quantitative reality: How many people actually wanted to make the same trip? If the numbers aren’t enough to cover a flight’s operating costs, then airlines have no incentive to offer the trip.

Unless those travel demand numbers change, flyers will need to adjust. Traveling between midsize and smaller markets will often mean few direct connections. Itineraries may last longer as connections add unnecessary flight mileage. Effective prices—tickets plus fees—may rise due to industry consolidation and serious restrictions on international competition. Forced flight connections via regulation isn’t coming either—the country already tried that once and it meant even higher prices than today.

These are the cold realities of travel in America. So as markets like Cleveland, Cincinnati, and Salt Lake City look around the room at another demise, we should genuinely ask: Who’s next?

Authors

Adie Tomer

Image Source: © Jeff Haynes / Reuters

Can Smartphones Help Improve Access To Medications?

Gregory W. Daniel — Fri, 07 Jun 2013 14:00:00 -0400

Undertreatment of common diseases and conditions contributes to critical gaps in the public health of the United States. While undertreatment is a complex problem that can result from a range of failures along the healthcare continuum, lack of access to and low usage of health services is widely recognized as a critical barrier. Addressing the undertreatment of common diseases and conditions will require innovative thinking about existing healthcare practices, medical technologies, and a commitment to testing promising solutions by all healthcare stakeholders, including providers, payers, manufacturers, patients, and regulators.

Advances in technology have brought about promising solutions for consumer self-care. In recent years, medical technologies have been utilized in many healthcare delivery settings and have demonstrated the potential to improve outcomes and decrease costs. Applications developed for smartphones, electronic devices, and the internet can assist patients in making complex health care decisions. Portable and wireless diagnostic technologies can collect valuable health information such as cholesterol levels, blood pressure, and measures of blood glucose control and transmit the data back to the consumer or to providers via direct input into electronic health records (EHRs) to inform and optimize treatment. As these consumer-oriented medical technologies continue to evolve, patients will have better tools to facilitate the safe and effective use of medications.

In addition, an increasing number of alternative and innovative practice settings have expanded the role of many health care providers. Acute care centers and retail medical clinics (e.g., CVS MinuteClinic) provide consumers with greater access to and options for medical care, typically through the use of nurse practitioners, physician assistants, and pharmacists. Collaborative practice agreements and medication therapy management programs have also enhanced communication and clinical care between healthcare providers.

Recognizing these emerging trends and opportunities, the U.S. Food and Drug Administration (FDA) is exploring how health care providers and innovative technologies might enable a broader range of medications to be made available in the nonprescription setting. This initiative, know as Nonprescription Safe Use Regulatory Expansion (NSURE), was launched by FDA to address one issue that may contribute to the problem of medical undertreatment: lack of access to appropriate medications. Through an expansion of the nonprescription drug class, FDA may support increased access to medications for undertreated diseases and conditions, particularly for underserved populations without regular access to a physician.

Establishing creative ways to utilize technologies and health professional expertise may help to overcome existing barriers in consumer self-care. In-store kiosks, mobile applications, and other technologies may help to guide consumers to the appropriate self-selection and self-treatment of medications. Similarly, pharmacists and other healthcare providers may provide consultation services to ensure the continued safe use. These mechanisms may permit certain prescription medications to be switched to nonprescription status for increased access.

In launching the NSURE initiative, FDA has begun to address one component of undertreatment of common diseases and conditions. Further development of the NSURE initiative will require a greater understanding of the health, economic, behavioral, and technological factors involved. In an effort to explore these key considerations, the Engelberg Center for Health Care Reform has initiated a series of expert workshops which address major factors in the NSURE initiative. These meetings have served to inform the NSURE initiative through broad stakeholder input on issues related to the role of health care providers, the innovative application of technology, and integration within the existing health care delivery systems. Additional topics to be explored in upcoming workshops include issues related to cost-shifting, third-party reimbursement, and economic considerations.

Ultimately, the NSURE initiative may promote the use of essential medications, and could serve as an important mechanism to bring undertreated patients into the healthcare system. For more information on these issues, including a description of the latest expert workshop, please visit the Brookings event page “Innovative Technologies and Nonprescription Medications: Addressing Undertreated Diseases and Conditions through Technology Enabled Self-Care”.

Authors

Gregory W. Daniel

Image Source: © Steve Marcus / Reuters

Time to Start Experimenting with Macroprudential Regulatory Policy

Douglas J. Elliott — Tue, 04 Jun 2013 10:36:00 -0400

I firmly believe that the U.S. needs to use macroprudential tools as a way of reducing the harm from cycles in the financial system. The traditional options—monetary policy and standard safety and soundness regulation—have real weaknesses. Monetary policy is generally too blunt a tool, since forcing interest rates up or down for the whole economy is an inefficient way to deal with issues specific to the financial system. On the other hand, traditional financial regulation is so focused on each individual financial institution that it often misses larger trends in the system as a whole. Macroprudential tools have the corresponding advantages of operating on the financial system as a whole, but without doing unnecessary collateral damage to the rest of the economy.

The recent study that I did with Greg Feldberg and Andreas Lehnert solidifies my view that macroprudential policy is valuable, but that we also must be aware of its limits and of the need to develop a better framework for understanding the tools and how best to use them. Our comprehensive review strongly suggests that the macroprudential actions of American authorities over many decades achieved their purposes, at least in part. To be fair, the analysis shows a relatively weak effect and the results are not always statistically significant. However, this is the first study to provide such a comprehensive analysis and it is very likely that more refined approaches to analysing the data will find clearer results. We see promising ways to improve the analysis and doubtless other researchers will find even more. Our collective understanding of macroprudential theory is also much better now than it was a few decades ago, which should allow us to optimise our actions in ways that we did not do in the past.

While I’m confident that macroprudential policy is useful, it is critical not to overstate what it can achieve or the ease with which it can be implemented effectively. We are in the early days of macroprudential policy, akin perhaps to where monetary policy stood in the 1950s. We need more refined theory, better statistics, and, unfortunately, we will also need to learn by experimentation. The good news is that any moderately intelligent macroprudential policy is likely to be better than our de facto policy of recent decades, which was never to use these tools, effectively leaving their setting at “off” even in the midst of the biggest credit bubble in history.

Macroprudential policy may be particularly helpful in the next decade or two, because the other choice is likely to be the blunt application of monetary policy. Non-intervention will not be politically viable in the wake of the financial crisis. Some may argue that the quantitative easing belies this, with authorities deliberately creating a bubble, or at least risking one. Whatever one’s views of the value of QE, the current situation is a transitional one and there will be a need to counteract any credit boom, or to prepare for the consequences of its eventual reversal, whether that boom is in process now or is a future contingency.

American policymakers generally view macroprudential policy favorably, but we do not have a good governance structure for it and the resources being put into considering it are far less than those devoted to implementing Dodd-Frank, for understandable reasons. We do not need to instantly get the macroprudential policy framework right, but we should be shifting our attention increasingly to that topic. It may not be all that long before we have to choose whether and how to use macroprudential tools. The tools to be considered should include the core tools of counter-cyclical capital buffers, counter-cyclical liquidity buffers (after we settle on the base liquidity rules and have some experience of them), and limits on loan-to-value (LTV) ratios for mortgages or capital requirements that vary with LTV ratios. We may also wish to consider setting minimum collateral requirements or haircuts for transactions involving the repurchase agreements and securities lending.

Authors

Douglas J. Elliott

Publication: The Economist

Image Source: © Brendan McDermid / Reuters

The Fed Will Soon Be Regulating Some Major Life Insurers

Douglas J. Elliott — Tue, 04 Jun 2013 11:58:00 -0400

The Federal Reserve will soon be an important regulator of the largest insurers, which will be a major change in regulatory regime that could have real effects on how these insurers operate, including what products they offer and how much they charge.

The Financial Stability Oversight Council has announced a preliminary determination to designate several major financial institutions as systemically important. The specific names were not announced, since the firms have 30 days to appeal the designation, though two major insurers were apparently included (AIG and Prudential) and MetLife is likely to follow soon. Designation as a SIFI (Systemically Important Financial Institution) could carry with it a considerably greater regulatory burden, as the Fed will have quite wide powers over all SIFIs. The Fed automatically has these same regulatory powers over medium-sized and larger banks, so the real issue has been which non-bank financial institutions would be designated.

The big question now is how the Fed will choose to regulate these insurers. They have given little clue so far and, frankly, their thinking is probably not yet very advanced. They focused on the designation process first and they are already overwhelmed with concrete deadlines imposed by other parts of the Dodd-Frank Act. However, the act of designation will start to concentrate their mind on some important choices to be made.

For those who want to know more, please read my recent paper providing a detailed overview on how life insurance SIFIs ought to be regulated.

Authors

Douglas J. Elliott

Image Source: © Brendan McDermid / Reuters

Why I'm A Long-Run U.S. Economy Optimist

George L. Perry — Mon, 03 Jun 2013 17:37:00 -0400

There is a lot of disagreement about the economy today. Some analysts focus on signs the recovery is quickening while others see new problems stemming from the end of a bond market bubble. My own view is that of a long-run optimist and I get there by remembering the history of postwar business cycles.

It is widely agreed that the present recovery has been disappointingly slow, in part because of the hangover from past excesses in home-building, banking and consumer borrowing. Initially, policy stimulus offset these headwinds, but when that ended the recovery slowed again.

What is less widely appreciated is that the recoveries from the last three recessions have all started slowly. In the first 8 postwar business cycles, spanning a period of 40 years, employment started rising right after the cyclical trough. Not so in the last three cycles. Employment continued to decline even after output began a gradual rise. It only got back to its trough level after 20 months in this recovery, and only after 27 months and 18 months in the two previous cycles.

One main reason for this is that the economy used to be more inflation prone in the earlier periods and recessions were generally the result of the Fed fighting inflation. As it pursued its dual mandate to maximize employment and fight inflation, the Fed raised interest rates when the economy boomed and lowered them when it slumped. Interest-sensitive demands, which had been suppressed in the tight money period, recovered promptly when the Fed eased again. In the recent cycles, while interest rates still moved countercyclically, they were not the main cause of the recessions.

A second reason is the declining importance of manufacturing, which is inherently more cyclical than many sectors because demands are relatively postponable as well as interest sensitive. In the late 1960s, 32 percent of private sector jobs were in manufacturing industries. By 2006, it was only 12 percent.

The present resembles these recent decades more than earlier ones, and that tells us a lot about economic prospects for economic expansion. What happens from here will depend on how much room there is for further expansion. Because the inflation problems of the early postwar decades are not on the horizon, and because we know the Fed wants to keep it that way, the prospects for expansion will be shaped importantly by how far the economy is from its potential.

In 1992, the unemployment rate averaged 7.5 percent. There followed an 8-year expansion that reduced unemployment to 4.0 percent. In 2003 the unemployment rate averaged 6.0 percent. That expansion ended 4 years later when unemployment averaged 4.6 percent. Neither of these expansions ended because inflation had become a problem. And there is no reason to believe the economy cannot safely operate at such unemployment rates again.

Today, after four years of slow recovery, unemployment is at 7.5 percent, still well above where the 2003 expansion started, and just where unemployment was at the start of the long expansion of the 1990s. We have to hope that Europe's problems are not too big a drag on the rest of the world, and that policy paralysis does not tighten fiscal policy too much, too soon. But there is nothing on the horizon of normal U.S. economic prospects that indicates we cannot today be starting an expansion like that of the 1990s today.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: © Brendan McDermid / Reuters

The Coming Wave

G. Andrew Karolyi, David Ng and Eswar Prasad — Fri, 31 May 2013 11:13:00 -0400

Editor's Note: This piece is part of the June issue of Finance & Development.

As emerging market economies become increasingly important players in the global economy, their share of the global cross-border flows of financial assets is also rising. Because of their strong growth prospects, emerging market economies have attracted foreign investors in search of higher returns, especially at a time of very low interest rates in advanced economies. And flows have also gone in the other direction, as the governments of emerging market economies have built up their foreign exchange reserves by investing heavily in advanced economies.

Recently, another phenomenon has gradually gained momentum: the outflow of private capital from emerging market economies as their investors seek overseas opportunities.

Understanding the volumes and patterns of the various outflows—sovereign and private—and analyzing what influences them will shed light on how the landscape of international capital flows is likely to change as emerging market economies become more integrated into global financial markets. We look at the types of capital outflows from emerging markets and describe some preliminary results from our ongoing research, which shows that the direction of portfolio outflows—relatively small now, but with a large potential to expand—is heavily influenced by proximity and familiarity.

Exporting capital

Led by China, emerging markets added about $6 trillion to their foreign exchange reserves between 2000 and 2012—with nearly all of it invested in securities issued by the major reserve currency economies, mainly the United States. It is likely that these emerging market economies will accumulate foreign exchange reserves at a much slower pace in coming years because most have put away sufficient stocks of foreign reserves to help buffer any future capital flow volatility.

Read the full piece on Finance & Development »

Authors

G. Andrew Karolyi
David Ng
Eswar Prasad

Publication: Finance and Development

Rethinking Responsibility in Innovation

Thu, 30 May 2013 10:00:00 -0400

Event Information

May 30, 2013
10:00 AM - 11:30 AM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

While emerging technologies—like nanotechnology, synthetic biology and advanced manufacturing—bear the promise of great benefits to society, they also pose significant risks. New sciences and technologies substantially affect society and yet it is nearly impossible to anticipate every major consequence of their advancement, development and commercialization. Who is responsible for those consequences? How is responsibility distributed among the various actors who influence and regulate innovation such as private enterprises, the government, inventors and the general public?

On May 30, the Center for Technology Innovation at Brookings hosted a public forum to discuss the role of social responsibility in each stage of the innovation process. A panel of experts discussed the kinds of institutions and incentives that govern innovation and how they shape the behavior of researchers, high-tech firms, capital investment firms, and regulatory agencies.

Audio

Rethinking Responsibility in Innovation

China’s Foreign Reserves and Overseas Investment

Thu, 30 May 2013 03:00:00 -0400

Event Information

May 30, 2013
3:00 PM - 4:30 PM CST

School of Public Policy and Management Auditorium
Brookings-Tsinghua Center

Beijing, China

An outstanding feature of the current world economy is the internal imbalance of the economic structure in the developed entities, which is persisted and expanded due to the global trade imbalance. After the global financial crisis, China’s foreign exchange reserves accounted for 1/3 of world’s total, and 1/2 of China’s GDP. Huge risk exists, when such amount of foreign reserves is exposed to turbulent international financial market.

On May 30th, 2013, the Brookings-Tsinghua Center for Public policy hosted a public event, featuring Dr. Yu Qiao, nonresident senior fellow of the Brookings-Tsinghua Center, to address the aforementioned issues of China’s foreign currency reserves and its overseas investment. To mitigate the huge risk, as Yu Qiao suggested, a diversified investment portfolio is needed, and the investment demand of China’s aging population should be taken into serious consideration. Dr. Yu’s monograph A Study on the External Environment of Chinese Investments in the United States and his newly-released book China’s Foreign Reserves and Overseas Investment were also presented at the event.

After the talk, Jing Xuecheng, director of China International Economic Relations Association, and Chen Xiaowen, deputy editor-in-chief of the Commercial Press made comments to Yu Qiao’s presentation and book.

Transcript

Chinese Event Transcript (.pdf)

Event Materials

China overseas investment Yu Qiao Chinese transcript edited

Participants

Panelists

Feng Wang

Director, Brookings-Tsinghua Center
Senior Fellow, Foreign Policy, Global Economy and Development, John L. Thornton China Center

Qiao Yu

Nonresident Senior Fellow, Brookings-Tsinghua Center

JING Xuecheng

Director

CHEN Xiaowen

Deputy Editor-in-Chief

A New Chance for European Politics

Javier Solana — Wed, 29 May 2013 00:00:00 -0400

Most political leaders in Europe want the European Union to emerge from its current crisis stronger and more united. But the economic policies that have been implemented in most EU countries since the crisis began have given rise to an unprecedented threat to deeper integration – and, indeed, to what already has been achieved.

After five years of financial and economic crisis, anti-European politics has come resoundingly to the fore in many EU countries – France, the United Kingdom, Italy, Austria, Holland, Finland, Greece, Portugal, and even Germany. Growing institutional disaffection has become a corrosive reality almost everywhere in Europe. The only way to overcome Europe’s existential crisis, and to respond to citizens’ demands for change, is to confront Europe’s domestic opponents head-on: politics without palliatives.

Europe needs, first and foremost, to break the vicious circle of recession, unemployment, and austerity that now has it in its grip. That means, first of all, refocusing economic policy on growth, employment, and institutional innovation. It is impossible to advance toward political union while seeming to abandon Europe’s citizens along the way, which is the impression that unremitting austerity has created. Sacrifice, too many Europeans believe, is not laying the groundwork for a better, more prosperous Europe, but is dragging them into a fatal tailspin.

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Authors

Javier Solana

Publication: Project Syndicate

Act of Congress: How America's Essential Institution Works, and How It Doesn't

Tue, 28 May 2013 14:00:00 -0400

Event Information

May 28, 2013
2:00 PM - 3:30 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

This event was streamed live by C-SPAN2 Book TV.

In his new book, Act of Congress: How America's Essential Institution Works, and How It Doesn't (Knopf, 2013), author Robert G. Kaiser chronicles the dramatic story of Congress’ struggle to pass financial reform overhaul in the wake of the financial collapse in 2008. As a reporter with the Washington Post, Kaiser was a first-hand observer of the legislative process that resulted in The Dodd–Frank Wall Street Reform and Consumer Protection Act, one of the most significant pieces of legislation regulating Wall Street in recent memory. In this book, Kaiser pulls back the curtain and shows us the inner machinery—the politics and players, the successes and the failures—of the U.S. Congress.

On May 28, as part of the Management and Leadership Initiative, Governance Studies at Brookings hosted a book event for Act of Congress, which discusses lessons from the process of passing Dodd-Frank and the impact of partisanship, lobbyists, and staffers on the legislative and policymaking process. Moderated by Senior Fellow E.J. Dionne, author Robert G. Kaiser presented his findings, followed by the reflections of Senator Chris Dodd, one of the two legislators who worked to move these reforms through Congress, and for whom the act is named, and Brookings scholar Tom Mann.

Video

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Act of Congress: How America's Essential Institution Works, and How It Doesn't

Strengthening the Federal/State Partnership on Passenger Rail

Robert Puentes — Tue, 21 May 2013 00:00:00 -0400

Robert Puentes presented this testimony before the House of Representatives Subcommittee on Railroads, Pipelines, and Hazardous Materials and the Committee on Transportation and Infrastructure in advance of the expiration of the Passenger Rail Investment and Improvement Act, which emphasized better rail performance and demanded a commitment from Amtrak's state partners. He discussed Amtrak's performance and the partnerships between the federal government, Amtrak, and the states, highlighting the ways in which states have provided lessons the nation should build on going forward.

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Authors

Robert Puentes

Why Investors Should Brush Up on Their Political Science and Economics

Douglas J. Elliott — Fri, 17 May 2013 16:38:00 -0400

Newspapers have been reporting the possible misuse by hedge funds of confidential information about proposed government actions. Whatever the truth of these particular allegations, it is a sign of the intense interest that much of the “smart money” displays in the specifics of government policy.

This runs counter to the misconception, still held by many investors, that we will eventually return to the “good old days” when they can focus again on businesses and ignore governments. They believe that the current need to actively scrutinize the likely actions of the U.S. and other governments is a fluke resulting from the financial crisis and the ensuing severe recession. This seems very unlikely. Governments should always matter a great deal to investors: they establish the framework of laws and regulations that rule business transactions, set taxes, establish monetary policies, decide government spending levels, choose among infrastructure projects, etc.

A return to the norm

The truth is that the 20 or so years preceding the financial crisis was the aberration and we are returning to more normal conditions. In the U.S., we went through a couple of decades in which governments were relatively laissez faire, intervening less than usual in business operations and continuing a trend of deregulation.

Further, the Fed, in line with central banks in other advanced economies, began to believe that a “Great Moderation” had occurred in business cycle conditions as a result of better central bank operations based on an accumulation of understanding of monetary policy over the years. Financial markets operated fairly freely, as the government held the reins with a light hand.

Do not expect these conditions to recur anytime soon. In the short to medium term, the memory of the terrible economic and political damage from the financial crisis will certainly keep the level of government intervention in the U.S. at high levels. Further, the need to resolve our fiscal problems will involve major decisions about what the government does and how it pays for it. This will have knock-on effects throughout the economy, both by affecting general conditions and by hitting particular industries, such as defense contractors or hospitals. This will come on top of activist monetary policies at the Fed that will bring years of critical decisions about the level of purchases of bonds by the Fed, their eventual disposition as the inventories are worked down, and, of course, an eventual rise in interest rates that will need to be carefully managed.

World markets increasingly important

Beyond our shores, the global economy is increasingly influenced by emerging market countries that believe in much more active government policies and even state ownership of major businesses. These nations will also make key decisions about where to invest public funds, and where to encourage the investment of private money, as they continue to develop rapidly. The choices of their governments, and the reactions of our own, will have a major impact on U.S.-based companies and on our own stock markets and interest rates, as well as the value of the dollar in foreign currencies, and therefore our trade balances.

Europe, for its part, is going through a prolonged set of inter-related political crises that aggravate economic problems, in turn worsening the political difficulties. The impacts on businesses and the overall economy have had, and will have, substantial effects on America and the rest of the world. Europe is likely to remain in political turmoil for years, even if the potential short-term disasters are overcome. If things work out on the positive side, reshaping their joint political institutions will still take years and will have major effects on their economies and therefore ours.

Government actions matter

This pattern, where government decisions have determining effects on business choices and investor returns, is typical of preceding decades and even centuries. Sometimes this has been vividly demonstrated by decisions about war or the trade equivalent -- trade wars or competitive devaluations of exchange rates. Other times, the big impacts have come from tax and regulatory policies that differ greatly from that of neighbors and trading partners. Other times it has been massive infrastructure projects such as the creation of the transcontinental railroads and the federal give-aways of free land to homesteaders. Even the abolition of slavery had massive economic impacts. Government actions going forward may be less dramatic than these examples, but there is no doubt that what happens here and abroad will be profoundly influenced by political decisions and the implementation of these decisions by bureaucracies.

So, pay attention to politics here and around the world and the intersection of those politics with underlying economic issues. Government decisions may sometimes prove to be more important than the intricacies of business strategies in determining the fate of investments.

Authors

Douglas J. Elliott

Publication: Yahoo! Finance

A Theoretical Framework for Kenya's Central Bank Macroeconometric Model

Maureen Were, Anne W. Kamau, Moses M. Sichei and Moses Kiptui — Fri, 17 May 2013 10:29:00 -0400

INTRODUCTION

This paper presents the theoretical framework for the Central Bank of Kenya (CBK) macroeconometric model. In addition, it highlights the theoretical base for the model’s main behavioral equations. The justification for the model relates to its usefulness in aiding the policymaking process at the CBK. It is expected that the model will support the Monetary Policy Committee (MPC) and Research Department in further understanding how the economy works through the complex interactions of various economic agents. The conduct of monetary policy requires fairly accurate analyses and forecasts backed up by sound economic theory and a rationale ensuring that effective monetary policy is formulated and implemented. In this regard, the model will provide consistent short-term forecasts of key macroeconomic variables such as economic growth and inflation. In addition, the model will be helpful in evaluating the impact of various shocks and policies on the economy. The MPC may also use the model as an instrument to help in structuring its communication with the public on the rationale behind its decisions.

This paper is organized as follows. The rest of Section 1 discusses the type of macro model developed, Section 2 presents the model’s logical and theoretical framework and illustrates the linkages between the monetary submodel and the other blocks of the model, Section 3 discusses the theoretical foundations of the model’s behavioral equations, and Section 4 concludes.

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Authors

Maureen Were
Anne W. Kamau
Moses M. Sichei
Moses Kiptui

Alleviating Poverty: Mobile Communications, Microfinance and Small Business Development Around the World

Darrell M. West — Thu, 16 May 2013 12:00:00 -0400

Editor’s Note: The Center for Technology Innovation at Brookings releases this paper in conjunction with the May 16 forum at Brookings, “Mobile Technology’s Role in Combating Global Poverty and Enabling Entrepreneurship.” Both are part of the wider Mobile Economy Project which examines how the rapid expansion of mobile technology around the world is transforming economic opportunity for millions.

Poverty is one of the most pressing problems around the world. According to statistics from the World Bank, nearly one-quarter of the global population lives at or below the poverty line of $1.25 per day.[i] With so many people struggling for basic subsistence, it is hard for those affected to get out of poverty, gain access to capital, or develop small firms or businesses that help them build a better life.

Yet with the growth of mobile technology, there are new opportunities for individuals and small businesses to lift themselves up. People can use handheld devices to make monetary transfers, arrange for microfinance loans, establish small enterprises, and improve their economic circumstances. This helps them alleviate poverty and create a better situation for themselves and their families.

Jeffrey Sachs, director of Columbia University's Earth Institute, said that wireless communication is a breakthrough technology that helps to solve the worst problems associated with health care, poverty, and educational access. "Now in every village where I go, someone's got a cell phone, somebody can make an emergency call, someone can find out the price on the market, someone can start a business empowered by the fact that they can reach a customer or a supplier, someone can drive a taxi or a truck for that reason as well. Everything is changing," said Sachs.[ii]

In this Mobile Economy Project report, Darrell West looks at the growth of handheld devices and investigates the barriers to doing business in the developing world. In particular, West explores how mobile devices enable individual entrepreneurship and small business development. Despite the presence of barriers such as corruption, lack of transparency and capital, and poor infrastructure in many parts of the developing world, there are successful ventures enabled by mobile technology.

The report details some of the cases which illustrate emerging possibilities for alleviating poverty in different countries including:

The growth of mobile devices
Mobile money transfer services
Mobile tools for small businesses
Microfinance applications

[i] World Bank data is found at http://povertydata.worldbank.org/poverty/home/.

[ii] Kyla Yeoman, “Can Mobile Phones End Extreme Poverty?”, Global Envision, March 16, 2012.

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Authors

Darrell M. West