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

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

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

3. 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)

4. Aftermath of Past Financial Crises

5. MA Forecast Summary GDP growth and Unemployment Forecast Inflation Forecast Percent Percent H F H F Headline PCE Unemployment rate FOMC comfort zone Core PCE Real GDP growth Macroeconomic Advisers forecast prepared December 24, 2008.

6. Recession Comparisons Macroeconomic Advisers forecast prepared December 24, 2008.

7. The Assumed Fiscal Stimulus Package Macroeconomic Advisers forecast prepared December 24, 2008.

8. Treasury Supply: A Lot in the Pipeline Net Treasury Borrowing (4-quarter rolling sum) Federal Debt Held by the Public (% of GDP) $ billions Projected 2009Q1 Projected 2010Q4

9. A Synchronized Global Recession Change in Real GDP (4-quarter moving average) Global GDP Growth (4th quarter to4th quarter) Percent H F MA US GDP World GDP *At market exchange rates Macroeconomic Advisers forecast prepared December 24, 2008. Note: Macroeconomic Advisers forecast for foreign GDP is based on projections by Oxford Economics.

10. Deflation: A Serious Threat Deflation Risk Inflation Forecast Percent Percent H F Headline PCE Headline PCE FOMC comfort zone Core PCE 95% confidence band Confidence band based on historical errors of consensus forecast as computed by Reifschneider and Tulip (2007) and reported in FOMC minutes. Macroeconomic Advisers forecast prepared December 24, 2008.

11. Deflation: A Serious Threat Baseline Forecast Forecast with Deflationary Concerns Percent Percent H F H F Core PCE Inflation Inflation Expectations Core PCE Inflation Inflation Expectations Macroeconomic Advisers forecast prepared November 5, 2008.

12. Credit Conditions: The Dominant Forecast Factor Corporate Yield Spread (Moody’s Baa less Treasury) Banks’ Willingness to Lend* (Senior Loan Officer Survey) Basis points Percent of banks * Share of institutions more (positive) or less (negative) willing to make consumer installment loans.

13. Credit Conditions: Gradual Recovery Baa Corporate Yield Spread Conforming Mortgage Spread Percentage points Percentage points H F H F Actual Actual Fitted Fitted

14. Fed Liquidity Policies: A Summary

15. Improvement in Interbank Funding Market Libor Credit Spread (Relative to OIS Rate) Federal Funds Rate and Libor Percent Basis points 3-month Libor rate 3-month rate Effective funds rate 1-month rate *Effective federal funds rate is a ten-day moving average. The range shown shows the intraday variation, measured as +/- one standard deviation.

16. 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

17. Whatever It Takes • To the (almost) zero bound: why the range? • Purchase private assets: offset credit shock • Attempt to lower risk spreads, increasing credit availability • New programs for agency MBS; consumer, small business ABS • Purchase longer-term Treasuries • Attempt to lower long-term rates (term spreads) • Clearly within their authority • In combination with greater fiscal expansion • Policy commitment language • Convey staying at low rates for longer than anticipated • “Some time” similar to “considerable period” language of 2003

18. Monetary Policy: To the (Almost) Zero Bound MA Call vs. Market Expectations Percent H F Market expectations Current MA forecast Macroeconomic Advisers forecast prepared December 24, 2008.

19. Prescribed Funds Rate: Taylor Rule Perspective Backward-looking Policy Rule (Based on macroeconomic outcomes) Forward-looking Policy Rule (Based on FOMC & MA forecasts) Percent Percent H F H F Macroeconomic Advisers forecast prepared December 24, 2008.

20. Fed Balance Sheet: Massive and Growing 1,774 3,788 2

21. Reserves: More than Needed Total Amount of Reserves Composition of Reserves $ billions $ billions Reserves through lending programs Excess reserves Total reserves Other reserves Required reserves

22. Treasury Yields: Historic Lows Yield Curve Slope (10 year-2 year spread) Treasury Yields Actual Ten-year Treasury yield Fitted Two-year Treasury yield Residual

23. Keys to an Eventual Rebound • Drags do not continue at current pace • Credit conditions begin gradual improvement • Equity prices rebound • Housing activity stabilizes • Home prices fall at slower pace • Overwhelming policy response • Very large fiscal stimulus package • Monetary policy and balance sheet policy

24. Housing Construction: In Search of a Bottom House Price Indexes (4-quarter percent change) Housing Activity Pp Thous. units Percent H F H F Housing starts (left) FHFA purchase-only index Contribution of residential investment to GDP (right) Case-Shiller index Case-Shiller cumulative decline -33.2 OFHEO cumulative decline -12.9 Macroeconomic Advisers forecast prepared December 24, 2008.

25. Equity Prices: Sharp Decline, then Rebound Next Year S&P 500 Index Household Net Worth (4-quarter change) Index Trillions $ H F H F Long-term fair value range Macroeconomic Advisers forecast prepared December 24, 2008.