Whatever It Takes Laurence H. Meyer January 8, 2009 Presentation to the National Economics Club.

Whatever It TakesWhatever It Takes

Laurence H. Meyer

January 8, 2009

Presentation to the National Economics Club

January 2009 © Macroeconomic Advisers 2

Signature Features of MA Forecast

• Recession, transition, and recovery

– Deep recession through middle of 2009

– Transition to below trend growth in 2nd half

– Robust growth in 2011

• Inflation

– Very low, below 1% in 2009, below ½% 2010

– Serious risk of deflation

• Policy

– Whatever it takes: near zero funds rate + unconventional policy

– Fiscal: complement, second and significant stimulus package


Compared to What?

• Early 1990s: Bank capital shortage

• Fall 1998: LTCM, etc.

• 2001 Recession: Wealth destruction, bursting bubble

• 1981-82: Worst postwar recession

• Japan in 1990s: ZRP and QE

• The Great Depression: debt-deflation

• “The aftermath of financial crises” (Reinhart & Rogoff)


Aftermath of Past Financial Crises

Peak to Trough

Number of Years

Peak to Trough to Date

Including MA Forecast

Housing price decline (%) 35.0 6.0 21.0 33.2

Equity prices decline (%) 55.0 3.5 52.7 52.7

Unemployment rate increase (pp) 7.0 4.0 2.3 4.0

Real per capita GDP decline (%) 9.0 2.0 0.4 -3.2

Real Government Debt (%) 86.0 3.03-- 61.0

3 For government debt, Reinhart and Rogoff use the increase in government debt in the three years following each crisis

2 The sample of financial crises includes Spain 1977, Norway 1987, Finland 1991, Sweden 1991, Japan 1992, Asian EM economies 1997-1998, Columbia 1998, Argentina 2001, Norway 1899, U.S. 1929

Macro Consequences of Financial Crises1

Previous Financial Crises2 Current Episode, US

1 From Reinhart and Rogoff, "The Aftermath of Financial Crises" prepared for AEA meetings, December 19, 2008


-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11

Core PCE

Headline PCEH F

FOMC comfort zone

Percent

-6

-4

-2

0

2

4

6

8

10

Q1-

2007

Q2-

2007

Q3-

2007

Q4-

2007

Q1-

2008

Q2-

2008

Q3-

2008

Q4-

2008

Q1-

2009

Q2-

2009

Q3-

2009

Q4-

2009

Q1-

2010

Q2-

2010

Q3-

2010

Q4-

2010

Q1-

2011

Q2-

2011

Q3-

2011

Q4-

2011

H F

MA Forecast Summary

Percent

Real GDP growth

Unemployment rate

GDP growth and Unemployment Forecast

Macroeconomic Advisers forecast prepared December 24, 2008.

Inflation Forecast


Recession Comparisons


Peak Trough (Months) (Percent change) Peak Change (Level)

April 1960 February 1961 10 -1.6 7.1 2.3 1.6

December 1969 November 1970 11 -0.6 6.1 2.6 0.2

November 1973 March 1975 16 -3.1 9.0 4.4 2.8

January 1980 July 1980 6 -2.2 7.8 1.9 1.6

July 1981 November 1982 16 -2.9 10.8 3.6 4.7

July 1990 March 1991 8 -1.3 6.8 1.6 1.0

March 2001 November 2001 8 -0.4 5.9 2.0 1.1

December 2007 March 2009 15 -2.4 8.4 4.0 3.6

Average 1960 - 1983 11.8 -2.1 8.2 3.0 2.2

Average 1983 - 2007 8.0 -0.8 6.4 1.8 1.0

Unemployment GapUnemployment RateBusiness Cycle Duration GDP


The Assumed Fiscal Stimulus Package

2009 2010 2011 2012 2013 2-yr 5-yr

GIA for State & Local Infrastructure Spending 30 70 100 70 30 100 300

Unrestricted GIA for State & Local Gov'ts 50 50 100 100

Increase in Medicaid Matching 20 20 40 40

Extended Unemployment Benefits 10 11 12 11 10 21 54

Individual Income Tax Cut 125 130 134 139 145 255 673

Higher-earner Income Tax Increase -67 -70 0 -137

Total 235 281 246 153 115 516 1030

Assumed Federal Fiscal Stimulus PackageBillions of dollars, calendar year



0.30

0.35

0.40

0.45

0.50

0.55

0.60

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009-400

-200

0

200

400

600

800

1000

1200

1400

1600

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Treasury Supply: A Lot in the Pipeline

Net Treasury Borrowing (4-quarter rolling sum)

Federal Debt Held by the Public (% of GDP)

Projected 2010Q4

$ billions

Projected 2009Q1


-2

-1

0

1

2

3

4

5

6

7

8

1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

A Synchronized Global Recession

Change in Real GDP (4-quarter moving average)

Percent

H F

*At market exchange rates

Global GDP Growth (4th quarter to4th quarter)

Macroeconomic Advisers forecast prepared December 24, 2008. Note: Macroeconomic Advisers forecast for foreign GDP is based on projections by Oxford Economics.

MA US GDP

World GDP

2008 2009 2010

US -0.7 0.4 5.2

Euro -0.6 -1.1 1.4

Japan -1.8 -1.0 1.0

China 7.3 8.1 10.0

Brazil 4.6 0.9 4.0

World* 1.0 0.4 3.5

MA

OE


-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0


-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0


Deflation: A Serious Threat

Inflation Forecast

Confidence band based on historical errors of consensus forecast as computed by Reifschneider and Tulip (2007) and reported in FOMC minutes.

Deflation Risk

Core PCE

Headline PCE

Headline PCE

95% confidence band

H F

FOMC comfort zone

Percent Percent



0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010

Forecast with Deflationary Concerns

PercentPercent

Baseline Forecast

Deflation: A Serious Threat

Core PCE Inflation

H F H F

Macroeconomic Advisers forecast prepared November 5, 2008.

Core PCE InflationInflation Expectations

Inflation Expectations


100

200

300

400

500

600

700

1997 1999 2001 2003 2005 2007 2009

-80

-60

-40

-20

0

20

40

60

1985 1988 1991 1994 1997 2000 2003 2006 2009

Credit Conditions: The Dominant Forecast Factor

Corporate Yield Spread (Moody’s Baa less Treasury)

Basis points Percent of banks

Banks’ Willingness to Lend* (Senior Loan Officer Survey)

* Share of institutions more (positive) or less (negative) willing to make consumer installment loans.


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1971 1976 1981 1986 1991 1996 2001 2006 2011

0

1

2

3

4

5

6

7

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Credit Conditions: Gradual Recovery

Percentage points

ActualFitted

Baa Corporate Yield Spread Conforming Mortgage SpreadPercentage points

Actual

Fitted

H F H F


Fed Liquidity Policies: A Summary

Discount WindowPrimary Dealer Credit

Facility (PDCF)Term Repos Term Auction Facility (TAF)

Securities Lending Facility

Term Securities Lending Facility (TSLF)

TSLF Options Program (TOP)

Reciprocal Currency SwapAsset-Backed Commercial Paper Money

Market Mutual Fund Liquidity Facility (AMLF)

Agency Discount Note Purchases

Commercial Paper Funding Facility (CPFF)

Money Market Investor Funding Facility (MMIFF)

Participants Depository institutions Primary dealers Primary dealers Depository institutions Primary dealers Primary dealers Primary dealers

BoC, BoE, ECB, BoJ, SNB, Reserve Bank of Austrailia, Danmarks Nationalbank, Norges Bank, Sveriges Riksbank, Bank of New Zealand, Banco Central do Brasil, Banco de Mexico, Bank of Korea, and the Monetary Authority of Singapore

Depository institutionsPrimary dealers

Eligible U.S. issuers of commercial paper

U.S. money market mutual funds (and over time could include other U.S. money market investors)

Frequency Daily (standing facility) Daily (standing facility)Weekly auctions for 28-day RPs

2 auctions per month Daily (standing facility)Weekly auctions alternating between two collateral schedules

In advance of periods of heightened market pressure

Daily (standing facility) Daily (standing facility) Unspecified Daily (standing facility) Daily (standing facility)

Eligible collateral Broad range of collateral

all collateral eligible in tri-party repurchase arrangements with the major clearing banks

Treasuries, GSE debt, or GSE-guaranteed MBS

Broad range of collateral Treasuries

Two collateral schedules: 1) only OMO collateral; 2) OMO collateral plus AAA/Aaa-rated private-label MBS, CMBS and agency CMOs, and AAA/Aaa-rated ABS

Same as TSLF Foreign reservesU.S. dollar denominated issues from a U.S. issuer, and rated first-tier securities under Rule 2a-7

Federal agency discount notes

Highly-rated, U.S. dollar-denominated, three-month Commercial Paper (unsecured and asset-backed)

U.S. dollar-denominated CDs and CP issued by highly-rated financial institutions and having remaining maturities of 90 days or less

Term 90 days OvernightVarious terms up to 28 days

Alternating auctions of 28 days and 84 days

Overnight 28 daysOptions will be for TSLF loans that have maturities of two weeks or less

As needed

Advances may remain outstanding for the remaining term of the ABCP that is financed, which varies from overnight to 270 days, except for depository institutions, where no advance under the AMLF may exceed a term of 120 days

Securities have maturities of overnight to 360 days

Borrowers can issue 3-month CP to the facility

Assets purchased under the program must have maturities from 7 to 90 days

RatePrimary rate is the federal funds rate plus 25 bps

Primary rate from discount window

Auction determined rateAuction determined rate with minimum of 1-month OIS rate

Swaps specific Treasuries for other Treasuries; user pays an auction-determined penalty (analogous to specialness of borrowed Treasury)

User pays auction-determined penalty for obtaining GC Treasury instead of broader collateral; minimum of 10 bps for schedule 1 and 25 bps for schedule 2

Auction determined price for option to conduct TSLF at a rate of 25 bps

N/APrimary credit rate on date loan initiated, to be fixed over term of loan

Auction determined rate

For unsecured CP, 100 bp over the 3-month OIS plus a 100-bp securitization fee; for ABCP, 300 bp over 3-month OIS

N/A (outright purchases at amortized cost)

SizeLimited only by the amount of margin-adjusted collateral posted to the Fed

Limited only by the amount of margin-adjusted collateral posted to the Fed

$80b of 28-day RPs$600b ($450b 84-day;$150b 28-day)

Limited by size of SOMA; dealers can borrow up to 90% of SOMA holdings

Announced up to $200b (Schedule 1: $50b; Schedule 2: $150b)

Up to $50 billion in addition to TSLF outstanding

ECB, SNB, BoJ,BoE unlimited; BOC $30b; Reserve Bank of Austrailia $30b; Danmarks Nationalbank $15b; Norges Bank $15b; Sveriges Riksbank $30b; Bank of New Zealand $15b; Banco Central do Brasil $30b; Banco de Mexico $30b; Bank of Korea $30b; and the Monetary Authority of Singapore $30b

Limited by amount of eligible ABCP held by money market mutual funds

Limited by outstanding securiites

Determined by outstanding amount of CP from January to August 2008; each issuer can borrow maximum amount of CP outstanding over that period

Up to $540 billion

Duration of program Indefinite Through 4/30/09 IndefiniteWill consider making it permanent

Indefinite Through 4/30/09

Currently scheduled for year-end; other periods will be considered based on auction results and market conditions

Through 4/30/09 Through 4/30/09 Unspecified Through 4/30/09 Through 4/30/09

Recent announcements

On 3/16, announced cut in discount penalty to 25 bps and extension of term to 90 days

On 3/16, announced establishment of PDCF; on 9/14, broadened eligible collateral; on 12/2, announced extension to 4/30/09

On 3/7, announced intention to do $100b of 28-day RPs, but program has only reached $80b

On 7/30, announced the term would alternate auctions between 28 days and 84 days; on 9/29, introduced forward TAF auctions; on 10/6, increased both the 84-day and 28-day auctions to $150b each, bringing the size of the TAF to $600b

On 11/26, announced higher limits on amounts of securities available for borrowing

On 5/2, announced an expansion of the collateral that can be pledged in schedule 2; on 12/2, announced extension to 4/30/09

On 12/1, announced auction dates for year-end

On 10/13, announced that swaps with the BoE, ECB, and SNB will accommodate whatever quantitiy of U.S. dollar funding is demanded and that the swap arrangements were extended to 4/30/09; on 10/14, made similar announcement for BoJ; on 10/28, established swaps with New Zealand; on 10/29, established swaps with Brazil, Mexico, Korea, and Singapore

On 9/19, announced the establishment of the AMLF; on 12/2, announced extension to 4/30/09

On 9/19, annoucned establishment of this program along with the AMLF

On 10/7, announced the establishment of the CPFF

On 10/21, announced establishment of the MMMIFF

NotesFed would like to get rid of any stigma associated with borrowing

Enacted under 13(3); additional fee to borrowers who access the PDCF more than 30 days out of 120 days

On 28-day RPs, they usually get all MBS collateral

Like discount window, only auctioned and less stigma;The two forward TAF auctions conducted in November 2008 ($150b each) were introduced to cover year-end pressures.

Designed to prevent squeezes in individual Treasuries

Enacted under 13(3); Fed provides GC Treasuries in exchange for other collateral

Options to participate in TSLF operation at the 25 bps rate on a future date; enacted under 13(3)

The foreign central banks have to conduct operations to inject the dollars; the swaps are to provide them with the reserves to do so; most foreign central banks do so through term operations

Enacted under 13(3); allows money market mutual funds to shed ABCP in order to meet redemptions; involves lending at primary rate to banks who purchase ABS from money market mutual funds; the loans are non-recourse

Intention is to help money market mutual funds meet redemptions

Enacted under 13(3); allows issuers of CP to know that they can roll over their holdings

Enacted under 13(3); allows money market mutual funds to shed assets in order to meet redemptions

Cheat Sheet for Fed Liquidity PoliciesMacroeconomic Advisers


0

1

2

3

4

5

6

Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08

0

50

100

150

200

250

300

350

400

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09

Improvement in Interbank Funding Market

Libor Credit Spread (Relative to OIS Rate)

Basis points

3-month rate

1-month rate

Percent

Effective funds rate

3-month Libor rate

Federal Funds Rate and Libor

*Effective federal funds rate is a ten-day moving average. The range shown shows the intraday variation, measured as +/- one standard deviation.


The New Policy Regime

Broader use of Fed’s balance sheet to achieve objectives

Intention of these policies is to influence financial conditions- Monitor credit conditions to gauge success- But no explicit targets

Quantitative easing of a different sort- Policies will inject large amounts of reserves- But goal is not the level of reserves

No single measure to summarize Fed actions- Watch the H.4.1- Makes communications challenging

Governance issues- All decisions made by FOMC- Even though 13(3) programs under authority of Board


Whatever It Takes

1. To the (almost) zero bound: why the range?

2. Purchase private assets: offset credit shock– Attempt to lower risk spreads, increasing credit availability– New programs for agency MBS; consumer, small business ABS

3. Purchase longer-term Treasuries– Attempt to lower long-term rates (term spreads)– Clearly within their authority– In combination with greater fiscal expansion

4. Policy commitment language– Convey staying at low rates for longer than anticipated– “Some time” similar to “considerable period” language of 2003


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09

Monetary Policy: To the (Almost) Zero Bound

Current MA forecast

Market expectations

H F

MA Call vs. Market ExpectationsPercent



-4

-2

0

2

4

6

8

10

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Prescription from MA Forecast

Prescription from FOMC forecasts

Actual and Predicted Funds Rate-6

-4

-2

0

2

4

6

8

10

12

1987 1990 1993 1996 1999 2002 2005 2008 2011

Policy Rule Prescription

Actual and Predicted Funds Rate

Prescribed Funds Rate: Taylor Rule Perspective

Backward-looking Policy Rule (Based on macroeconomic outcomes)

Percent Percent

Forward-looking Policy Rule (Based on FOMC & MA forecasts)

H F H F



Current Announced August 1 2007($ bil) ($ bil) ($ bil)

Lending Facilities (Focused on Term Credit)28-day RPs 80 100 0Term Auction Facility (TAF) 450 600 0FX Swaps 622 Unlimited 0Asset-backed CP Liquidity Facility (ALMF) 24 Unlimited* 0Purchases of agency discount notes 15 Unlimited* 0Commercial Paper Funding Facility (CPFF) 334 Unlimited* 0Money Market Investor Funding Facility (MMIFF) 0 540 0Discount Window 94 Unlimited* 2PDCF 37 Unlimited* 0

Rescue Operations (Focused on Individual Institutions)Maiden Lane I (Bear Stearns) 27 29 0Maiden Lane II (AIG RMBS holdings) 20 22.5 0Maiden Lane III (AIG-backed CDOs) 27 30 0Credit to AIG 39 60 0Non-recourse credit to Citigroup 0 Up to 262 0

Operations Focused on Asset PricesTerm Asset-Backed Securities Loan Facility (TALF) 0 200 0Outright holdings of agency debt 5 100 0Outright holdings of agency MBS 0 500 0

"Normal" PortfolioOutright holdings of Treasuries 496 n/a 791

*Amounts of AMLF, discount note purchases, CPFF, discount window, and PDCF are limited by amount of outstanding eligible securities.

TSLF operations do not add reserves but do use the Fed's holdings of Treasuries.

Fed Balance Sheet: Massive and Growing

1,774 3,788 2


-600

-400

-200

0

200

400

600

800

1000

1200

Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08

0

100

200

300

400

500

600

700

800

900

Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08

Reserves: More than Needed

Composition of ReservesTotal Amount of Reserves

$ billions

Total reserves

Other reserves

Reserves through lending programs

$ billions

Required reserves

Excess reserves


0

1

2

3

4

5

6

May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1984 1987 1990 1993 1996 1999 2002 2005 2008

Treasury Yields: Historic Lows

Treasury Yields Yield Curve Slope (10 year-2 year spread)

Ten-year Treasury yield

Two-year Treasury yield

Actual

Residual

Fitted


Keys to an Eventual Rebound

1. Drags do not continue at current pace- Credit conditions begin gradual improvement

- Equity prices rebound

- Housing activity stabilizes

- Home prices fall at slower pace

2. Overwhelming policy response– Very large fiscal stimulus package

– Monetary policy and balance sheet policy


-20

-15

-10

-5

0

5

10

15

20

25

2001 2003 2005 2007 2009

350

600

850

1100

1350

1600

1850

2100

2350

2000 2002 2004 2006 2008 2010

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Housing Construction: In Search of a Bottom

Housing Activity

Thous. units

H F

Pp

Contribution of residential investment to GDP (right)

Housing starts (left)

House Price Indexes (4-quarter percent change)

Percent

FHFA purchase-only index

Case-Shiller index

H F

Case-Shiller cumulative decline -33.2

OFHEO cumulative decline -12.9



0

500

1000

1500

2000

2500

1985 1989 1993 1997 2001 2005 2009

-20

-15

-10

-5

0

5

10

15

20

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Trillions $

H F

Household Net Worth (4-quarter change)

Equity Prices: Sharp Decline, then Rebound Next Year

S&P 500 Index

IndexH F

Long-term fair value range


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Whatever It Takes Laurence H. Meyer January 8, 2009 Presentation to the National Economics Club.

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