Bernanke’s Jobs Estimate

Ben Bernanke at Jackson Hole:

If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of large scale asset purchases may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.

Bernanke’s estimate of two million jobs created as a result of his policy appears to be a stitched-together estimate based on two research papers: Fuhrer which estimated a gain of 700,000 jobs from QE1, and Chung et al which estimated 1,800,000 jobs.

The methodology here is interesting, to say the least. From the (unfortunately titled) Fuhrer paper:

Given the range of estimated effects on real spending (GDP), the translation to employment effects is accomplished by use of an Okun’s Law relationship that links GDP growth and changes in the unemployment rate. The typical relationship expressed in quarterly changes is summarized as: Change in unemployment = -0.125 (GDP growth – potential GDP growth).

GDP growth for one-quarter that exceeds potential GDP growth by 1 percentage point results in a one-eighth (0.125) percentage point decline in the unemployment rate. Equivalently, quarterly growth in GDP that exceeds potential growth by 1 percentage point for a year typically lowers the unemployment rate by about one-half percentage point.

Combining this simple Okun’s Law with the estimated effects on GDP discussed in the preceding section implies a decline in the unemployment rate of 30-45 basis points over the 2-year period it takes for the spending rate change to feed through the economy. With the U.S. labor force currently at just over 150 million people, this translates to an increase of about 700,000 jobs, a figure quoted by Boston Fed President Eric Rosengren in his speech of November 17, 2010.

The number of layers of uncertainty is problematic. First we have uncertainty over the level of GDP growth provoked by QE. Second we have uncertainty as to the reliability of the measure and concept of potential GDP growth. And third we have uncertainty as to the extent of the relationship between GDP growth, potential GDP growth and unemployment in this specific case.

Essentially, the equation assumes that because GDP growth has historically resulted in job growth, we should assume it will do so in the future. But this is a very different economy to the one we had fifty years ago. Today it’s possible for the financial sector to generate profits (and thus, GDP) by passing liquidity around the financial sector. And today, any American demand boom will create jobs in China and Mexico (etc), because that’s where the industrial and manufacturing jobs have been shipped to.

So Bernanke’s figure is a guess based on a guess based on a guess based on old data. Maybe 2 million. Maybe, maybe, maybe, maybe.

How do we know that after a big, painful bust that after a short burst of deflationary pain that job growth wouldn’t have come roaring back? After all that happened multiple times in the 19th century.

Hank Paulson might claim that he saved the world from a thousand year nuclear winter by bailing out his former employer Goldman at par on its credit default swaps. You can claim anything about what might have happened otherwise. Maybe, maybe, maybe. Such claims are junk science because they are unfalsifiable.

Yet the reality is very clear — either people have jobs or they don’t. That’s what the regime will be judged on.

The present policy of tripling the monetary base via monetary easing hasn’t solved the jobs problem, because we’re still in the woods. Trillions of easing — which we can say quite confidently has enriched the financial sector far more than any other sector of the economy — and yet we still have a jobs depression (of course, financial sector profits have come roaring back). This is the prime age employment-population ratio:

Quantitative easing hasn’t been about jobs. If this was about jobs or stimulating demand, Bernanke would have aimed the helicopter drops at the wider public, as many economists have suggested. This policy of dropping cash directly to the banks is bailing out a dangerous and morally-hazardous financial sector and too-big-to-fail megabanks that remain dangerously overleveraged and under-capitalised, needing endless new liquidity just to keep past debts serviceable. There has been plenty of cash helicopter-dropped onto Wall Street, but nobody on Wall Street has gone to jail for causing the 2008 crisis. Criminal banksters get the huge liquidity injections they want, and the rest get less than crumbs.

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They Don’t Call Them Real Interest Rates For Nothing

A reader asks:

I had a chat with a wealth management advisor from a well-known financial institution, who was bullish on short duration bond funds due to “the FED’s complete control with regards to suppressing and maintaining short-term interest rates.” I was wondering if you had any articles on what factors (other than the FED, if any) contribute to and continue to suppress short-term interest rates in the US and what potential facts could reverse this trend?

The Fed exerts a great deal of control over nominal interest rates. While the Treasury and Fed maintain the pretensions of an open and transparent market where national and international demand for government securities is generated organically, the reality is that the Fed can monetise anything that the market rejects to achieve any desired nominal interest rate. This applies equally to all securities; though the Fed allows the 10-year and 20-year to float more freely, Operation Twist shows the Fed can control the nominal yield curve if they so wish.

The Fed’s power to control nominal rates is shown quite clearly — as the economy remained in a liquidity trap following 2008, the Fed implemented policies (QE, Twist, ZIRP) to make treasuries expensive ostensibly to discourage hoarding and stimulate aggregate demand (and — so helpfully — keep the Treasury’s interest burden low):

What the Fed cannot really control is the rate of inflation, the other variable that makes the real interest rate, and the key variable in determining whether Treasuries are a winning or losing bet.

Here’s the real rate on the 2-year over the same period:

On computing the graph, my jaw almost hit the floor; real interest rates on the 2-year today are higher than they averaged during the boom years up to 2007. The Negative-Interest-Rate-Policy isn’t so new at all. All the Fed’s accommodative action has been almost meaningless — it has hardly reduced the real interest rate at all from the pre-crisis norm (although the most recent spike into positive real territory is the strongest argument for imminent quantitative easing that I have seen in a long time).

On the other hand, there are clear patterns in real rates over longer periods. Here’s the 2-year, 5-year, 10-year since 1980:


But this doesn’t prove that the Fed can really exert control over real rates. However the graph suggests very strongly that Greenspan took his eye off the ball in terms of real interest rates; as real rates continued to fall, Greenspan wasn’t raising nominal rates, as might be expected of a Fed chairman looking to prevent bubble-formation.

Simply, the idea that short-duration bond funds are a good bet due to “the FED’s complete control with regards to suppressing and maintaining short-term interest rates” is completely wrong on every level; they’ve been a losing investment in real terms for most of the last 5 years, and the Fed is determined to keep it that way. The Fed’s control over nominal interest rates is precisely the reason that I wouldn’t want to invest in treasuries; not only has it continually made bonds into a real losing proposition, the only things that would turn bonds into a winning proposition — rising interest rates, or deflation — are anathema to the Fed, and explicitly opposed by every dimension of current Fed policy.

Why QE Didn’t Cause Hyperinflation

Ben Bernanke, and the Keynesians were right: Quantitative Easing has not caused the kind of inflation that the non-mainstream Austrian economists claimed that it would. The theory was that a soaring monetary base, and the zero-interest-rate-policy would lead to easy money flowing like a tsunami, and creating such a gush that inflation on goods and services — the change in cost from month-to-month and year-to-year — would soar, making daily life impossible for those on fixed incomes, and in a worst-case-scenario — like Zimbabwe, or Weimar Germany — forcing consumers to use an armful or wheelbarrow of cash to purchase a loaf of bread. Let’s look at the monetary base:


That is a huge spike!The monetary base — also known as M0 — is the total amount of coins, paper and bank deposits in the economy. Quantitative easing injects new money into the monetary base, and as we can see above, has great increased it. So why can I still buy bread without a wheelbarrow? That is because the monetary base and the money supply are two different things. In a fractional-reserve banking system, deposits in banks can be lent, re-deposited, and lent again. Government policy determines the number of times that money can be lent — in the United States, total credit cannot exceed lending by more than ten times. The money supply — which accounts for fractional reserve lending — is known as M2. Let’s look at it:


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