M1, Monetary Base and Money Multiplier

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,000

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

$ B

illio

n

0

1

2

3

4

Mon

ey M

ultip

lier

MB Multiplier M1

Excess Reserves, Deposits& Excess Reserve Ratio

0100200300400500600700800900

1,0001,1001,2001,3001,4001,5001,6001,7001,800

05 06 07 08 09 10 11 12 13 14

$ B

illio

n

0.000.100.200.300.400.500.600.700.800.901.001.101.201.301.401.501.601.701.80

Exc

ess

Res

erve

Rat

io

Excess Reserves

Demand Deposits

Other Checkable Deposits

Excess Reserve Ratio

TRANSMISSION MECHANISMS OF MONETARY POLICY(10 channels through which monetary policy affects economic output)

 2 Interest Rate Channels1. Traditional Interest RateExpansionary monetary policy => falling real interest rates => lower cost of capital => rising investment => rising output

2. Inflation RateExpansionary monetary policy => rising expected inflation => falling real interest rates => lower cost of capital =>

rising investment => rising output

3 Asset Price Channels 3. Exchange RateExpansionary monetary policy => falling real interest rates => U.S deposits become relatively less attractive than foreign

deposits => depreciating dollar => increasing net exports => rising output

 

4. Tobin’s qExpansionary monetary policy => falling interest rates => falling demand for bonds => higher demand for stocks =>

higher stock prices => lower equity cost of financing investment=>

market value of firm > replacement cost of capital => rising investment => rising output

5. Wealth EffectExpansionary monetary policy => falling interest rates => falling demand for bonds => higher demand for stocks =>

higher stock prices => increasing financial wealth =>increasing consumption => rising output

5 Credit Channels 

6. Bank LendingExpansionary monetary policy => increasing bank deposits => rising bank loans => rising business investment and

consumer spending => rising output

 

7. Balance SheetExpansionary monetary policy => higher stock prices =>higher firm net worth => lower adverse selection and moral hazard

=> higher business lending => greater investment => rising output adverse selection = potential bad credit risks are the ones who most actively seek out loans

moral hazard = the lender runs the risk that the borrower will engage in risky activities that make it less likely that the loan will be paid back

 

8. Cash FlowExpansionary monetary policy => lower nominal interest rates =>higher cash flows => higher liquidity => improved

balance sheet => lower adverse selection and moral hazard => higher business lending => greater investment => rising output

9. Unanticipated Price LevelExpansionary monetary policy => unanticipated increase in prices => reduces real value of firm’s liabilities => higher real

net worth => lower adverse selection and moral hazard => higher business lending => greater investment => rising output

 

10. Household LiquidityExpansionary monetary policy => higher stock prices => increasing financial assets => higher net worth =>

lower likelihood of financial distress => higher consumer durable and housing expenditures => rising output

Real Fed Funds (fed funds - core CPI)

-8

-6

-4

-2

0

2

4

6

8

10

12

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

4% = Recession causing level

Business Fixed Investment(Nonresidential Structures)

8

1816

2

-11

1 2

-33

-20-20-17

-6-4

13

-1-2-2

5 4

0

7

-2

-8

2

1922

10

1

11

28

24

8

1

9

-4

-10

-31-31

-27-29

-23

13

-2

9

-28

35

21

1113

10

17

0

-50

-40

-30

-20

-10

0

10

20

30

40

00Q1 01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1

-50

-40

-30

-20

-10

0

10

20

30

40

Annualized Quarter Growth Rate

% Change From Quarter One Year Ago

Deflation can lead to:Falling goods & services pricesFalling home pricesFalling stock pricesFalling wages

Deflation leads to:•Households postpone spending•Rising real interest rates•Rising debt burdens

Hoarding money => deflationAusterity => stagnation/deflationDeflation => rising purchase power of dollarDeflation => lower wages => rising debt burden

Inflation (CPI)(year over year % growth)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

HeadlineCore (excludes food and energy)

U.S. Dollar Exchange Rate Major Currency Index

Nominal & Real (1973 = 100)

60

70

80

90

100

110

120

130

140

150

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 1460

70

80

90

100

110

120

130

140

150

Nominal RealSource: FRB: Exchange Rates G.5 (405)

Trade BalanceGoods Exports minus Goods Imports

Service Exports minus Service Imports

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

$ B

illi

on

s

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

$ B

illi

on

s

Recession

Services

Goods

S&P 500 Stock Index(monthly average)

0

100

200

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

1500

1600

1700

1800

1900

2000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 140

1

2

3

4

5

6

7

8

9

10

Nominal Index Recession

Fed Funds Rate (RHS) Real Index

Real Personal Consumption Expenditures

(Durable Goods)

24.5

-7.0

7.1

3.0

7.0

-0.2

4.9

38.1

-4.5

4.2

12.3

-5.2

1.2

17.617.9

3.85.7

2.6

8.17.3

4.3

12.1

5.8

-9.8

16.5

0.3

6.15.65.15.75.2

2.3

-9.6

-2.9

-12.3

-25.4

1.3

-2.0

20.9

-6.1

5.5

10.5

7.2

15.3

7.3

-2.3

5.4

13.911.5

-0.2

8.9

13.6

8.1

-30

-20

-10

0

10

20

30

40

50

00Q1 01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1

-30

-20

-10

0

10

20

30

40

50Annualized Quarter Growth Rate

% Change From Quarter One Year Ago

Weak fundamentals are restricting sales:Few new jobs, low income growth, high unemployment, low and volatile wealth, limited access to credit, deleveraging and low confidence consistent with a deep recession.Factors supporting consumer spending:Private sector job growth, consumer are fixing their budgets, falling debt payments through debt reduction and refinancing, consumers who have stopped making mortgage payments but not yet defaulted have extra cash.

12

Demand side factors:1.Affordability is high2.Large pent up demand for homes3.Low mortgage interest rates, but tight credit and some households suffer from inpaired credit4.Rising investor and consumer confidence5.Modest job and income growth

Supply-side factors:1.Falling inventory of homes (“underwater” households are reticent to list home)2.Falling distressed homes available for sale3.Lack of new home inventory

Residential Investment

3.2

-2.7

-6.9

0.31.8

5.7

2.2

-3.4

11.110.2

2.3

6.33.9

9.4

22.0

11.3

3.7

15.9

4.13.2

7.59.6

4.1

0.1

-4.2

-17.0

-21.2-19.6

-16.4

-12.0

-24.1

-29.3-28.5

-14.5

-19.9

-33.2-35.1

-22.2

17.2

-4.8

-11.5

23.2

-28.6

1.4

-1.4

4.21.4

12.0

20.6

8.4

13.6

17.6

12.6

-50

-40

-30

-20

-10

0

10

20

30

40

00Q1 01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1 13Q1

-50

-40

-30

-20

-10

0

10

20

30

40

Annualized Quarter Growth Rate

% Change From Quarter One Year Ago

Consumer Credit Outstanding(monthly change & annual growth rate)

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

00 01 02 03 04 05 06 07 08 09 10 11 12 13

Percen

t

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

$ b

il (

SA

)

Recession

Consumer Credit Monthly Change (RHS)

Year-over-Year Growth (LHS)

January monthly change = $ 16.2 billionJanuary Y-O-Y growth rate = 5.8%

•Surging non-revolving credit (financing for big ticket items)•Rising auto loans due to strong auto sales•Rising government-backed student loans ($500 billion, 1/5 of total consumer credit).• debt => spending => Y/Y•Stagnant revolving credit (credit card) due to relatively high borrowing rates, but credit standards are looser.

Supply Side of Credit•Cheaper financing and better access to credit has released pent-up demand.

Demand Side of Credit•Better labor market => improving financial positions (ability) => rising consumer confidence (willingness) => credit financed consumption

Deleveraging = 1/3Charge-off = 2/3

Household Debt Service &Financial Obligations Ratios

10%

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 1310%

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

Recession

Debt Service Ratio

Financial Obligations Ratio

Source: Federal Reserve.

The household debt service ratio is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt.

The debt service ratio fell to 10.61% in the third quarter of 2012, the lowest level since Q3 of 1994. Falling interest rates and debt levels both caused the decline.Low debt payments are freeing up disposable income for additional consumption or savings.

The financial obligations ratio adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.

The financial obligation ratio fell to 15.74% in the third quarter of 2012, down from 18.9% in Q3 of 2007.

Lessons for Monetary Policy

1. Dangerous to associate easing or tightening with fall or rise in nominal interest rates.

2. Other asset prices besides short-term debt have information about stance of monetary policy.

3. Monetary policy effective in reviving economy even if short-term interest rates near zero.

4. Avoiding unanticipated fluctuations in price level important: rationale for price stability objective.