survey results suggest that further tightening is becoming less widespread

TO BE NOTED: From News N Economics:

"The worst of the credit crisis is likely behind us, say key central banks

Friday, May 1, 2009

Together, global senior loan officer surveys tell the following story: the worst of the credit crunch, at least in commercial banking, is likely behind us. Key central banks - the Bank of Canada (BoC), the Bank of England (BoE), and the European Central Bank (ECB) - report that Q1 2009 credit conditions in their respective banking sectors are generally tightening; however signs of stabilization are emerging: fewer banks are reporting to have tightened. The Bank of Japan (BoJ) reports that credit standards are generally easing somewhat; however, the demand for lending is likely the limiting factor for credit flow in Japan.

The ECB: showing signs of stabilization for household and firm lending

From the ECB's survey report:

The results of the April 2009 bank lending survey show that in the first quarter of 2009 the net percentage of banks reporting a tightening of credit standards on loans and credit lines to enterprises was 43%, which – while still reflecting a pronounced further net tightening – was 21 percentage points lower than in the fourth quarter of 2008. This could point to some stabilisation of the current tightening cycle. For the second quarter of 2009, the banks expect a further reduction of the overall net tightening to 28%.

The BoC: Lending standards still tight, but less widespread

From the BoC's survey report:

Although overall lending conditions continued to tighten, the tightening was somewhat less widespread than in the preceding quarter.

The BoE: Seeing some light, overall standards on corporate lending actually eased...

From the BoE's survey report:

In the three months to mid-March, a net balance of lenders reported that they had reduced the availability of credit to households. Contrary to expectations expressed in the 2008 Q4 survey, a small net balance of lenders reported increased lending to the corporate sector over the past three months. As in previous surveys, concerns about the economic outlook, reduced appetite for risk and falling collateral values had borne down on credit availability.

And the BoJ: Easing somewhat across most loan types

The BoJ's survey report indicates that in the first quarter of 2009 net, lending standards to large firms tightened somewhat, while those to medium-sized firms eased somewhat. Small firm and household lending standards eased somewhat. However, the outlook for small firm and household loans suggests that less easing is on the horizon. Note: the BoJ information can be found in question 7. of the survey.

In Japan, the primary problem in the bank lending space - the limiting factor according to the survey - is not the standards, but the weakening demand for loans (see question 1 of the survey and my previous post).

Overall, banking standards remain tight and are tightening in net across key economies; however, the survey results suggest that further tightening is becoming less widespread. I imagine that the worst of the global credit crunch is now behind us. The Fed's senior loan officer survey report for Q1 2009 will release soon; and I expect it to tell a similar story.

Rebecca Wilder"

The Bank of Canada will be able to scale back its balance sheet when it wants, and at the speed it wants.

TO BE NOTED: From Worthwhile Canadian Initiative:

"The evolution of the Bank of Canada's balance sheet

Jim Hamilton has a couple of recent posts ([1], [2]) at Econbrowser documenting the remarkable changes in the Fed's balance sheet during the financial crisis, so I decided to take take a closer look at the effects of the Bank of Canada's activities on its balance sheet.

The asset side seems straightforward enough, and is indeed pretty dull when compared to the Fed's kaleidoscope of asset types:

When the credit crunch hit, the Bank acted to increase liquidity by putting half of its holdings of T-bills back on the market, and it made available another $30b worth of liquidity by means of resale agreements. Since September, the Bank's balance sheet has increased by about a bit over 50%. (The Fed's has increased by more than 100%).

On to liabilities:

It would have been nice to come up with a Canadian counterpart to Jim Hamilton's striking graph of the jump in the US monetary base, but I couldn't. The reason for this is that Canada doesn't have a monetary base - at least, not the sort of monetary base that you see defined in the old textbooks. In 1994, the requirement that charted banks hold reserves in the form of deposits at the Bank of Canada was abandoned, so the usual definition - currency plus chartered bank reserves - lost its meaning.

As Jim Hamilton notes, most of the expansion of the Fed's balance sheet has been made possible by an increase in reserves. For now, the banks are content to leave those reserves idle, now that the Fed is paying interest on them. But the possibility that they may choose to redeem those reserves at an inopportune moment could complicate matters for the Fed.

But once again, this seems to be another example of a US problem that Canada doesn't have. The Bank's balance sheet expansion was made possible by the federal government's borrowing and then depositing the proceeds in its account at the Bank of Canada. The Bank of Canada will be able to scale back its balance sheet when it wants, and at the speed it wants.

Posted by Stephen Gordon"

"Perhaps the bubbles in asset prices that were suppressed would only pop up somewhere else"

Nick Rowe weighs in with an idea I just tossed in the bin:

"The Bank of Canada should peg the TSE 300" - revisited

"The Bank of Canada should peg the TSE-300" is the title of a Carleton Economics Department working paper I wrote in 1992. (Sorry, but no web version available; this was in the olden days when all we had was paper, and when the TSX was the TSE.) Given the recent turmoil in financial markets, and the renewed interest in having central banks look at asset prices, I was wondering whether to resurrect this paper, but dithered. Now Roger Farmer has beaten me to it. Mark Thoma posted it on his blog, and Tyler Cowen on his.

The reactions in the comments are mostly either unfavourable, or incredulous. I thought I would write a few words in defence of the idea, and then say why I no longer support it( THANK GOD ).

Many critics are just confused, and think that using monetary policy to peg an index of stock prices is some sort of interventionist policy that prevents markets finding their own equilibrium. But if governments produce money, and they do, then governments have to decide how much money to produce. They have to target something( TRUE ). That something can be the price of gold, or silver, or the exchange rate with another government's money, or the CPI (as in inflation targeting). Or it can be an index of stock prices. In principle, any nominal (measured in dollars) variable can be the target for monetary policy, and the TSX 300 is a nominal variable.

Pegging the TSX 300 is no more interventionist( OK. BUT WHAT IS THE TARGETING FOR? ) than pegging the price of gold, or pegging the CPI (as we do now with inflation targeting). In the long run( BUT CAN IT EFFECT THE SHORT RUN? ), market forces determine the real (inflation-adjusted) value of the TSX 300 even if the Bank of Canada pegs the nominal value; the same is true if the Bank of Canada pegs the price of gold. If this bothers you, just think of the Bank of Canada pegging the value of the Canadian dollar to the TSX 300, rather than vice-versa.

Let me be more precise. My 1992 proposal was that the Bank of Canada should peg the time-path of the total return index of the TSX 300, so it would grow at some fixed rate of (say) 7% per year. The total return index is a better target then the index itself, because it is immune to arbitrary changes in firms' dividend payout ratios.

There is one very curious effect of pegging the total return index to grow at (say) 7% per year. It would mean that a stock index fund would be as safe an investment as Canada Savings Bonds are now, since the holder would be certain of the nominal interest rate (but the real interest rate would be uncertain in both cases). It would be hard to imagine that the equity premium could persist, which could be an important advantage of the policy. All nominal interest rates on government bonds and other safe assets would have to pay the same 7% per year. The TSX 300 would be an ideal investment for widows and orphans.

The main rationale for the policy would be the hope( OK ) that it would tame financial bubbles and crises. Also, if stock prices predict the business cycle, and if this correlation implies causation, taming stock prices might also tame the business cycle.( IT'S A REGULATOR )

It seemed to me a good idea in 1992, but this was before inflation targeting really got off the ground, so I didn't have much to compare it to. A few years ago, when inflation targeting seemed to be performing very well, I changed my mind, and decided it was "very interesting....but stupid". Now I am just uncertain. Here are the main problems.

First, stock prices are very flexible, but a lot of goods prices are very sticky. There is a long-standing principle in macroeconomics that business cyles are caused by sticky prices, and the best macroeconomic policy is to make sure that the prices which don't change quickly don't have to change quickly( A GOOD POINT ). This principle suggests we should target an index of sticky prices (or wages), and the CPI comes a lot closer to this than the TSX 300.

Second, the real fundamental equilibrium value of the TSX 300 can change by a large amount very quickly, due to fundamental changes in profitability, the growth rate of profits, or real discount rates. But if the nominal value of the TSX 300 were pegged, the only way the real value of the TSX 300 could reach its new equilibrium would be for the CPI to adjust. Big fluctuations in the CPI would be undesirable if they did occur, and even more undesirable if they needed to occur but couldn't, because goods prices are sticky. For example, a cut in corporate taxes which would cause a (say) 20% rise in stock prices when the Bank targets the CPI would instead have to cause a 20% decline in the CPI if the Bank targets stock prices.

Finally, the stock market is perhaps a barometer of the state of the economy, but we cannot be sure that pegging the barometer would stabilise the weather. Goodhart's law...(((

Although Goodhart's law has been expressed in a variety of formulations, the essence of the law is that once a social or economic indicator or other surrogate measure is made a target for the purpose of conducting social or economic policy, then it will lose the information content that would qualify it to play such a role. The law was named for its developer, Charles Goodhart (a chief economic advisor to the Bank of England).

The law was first stated in a 1975 paper by Goodhart and gained popularity in the context of the attempt by the United Kingdom government of Margaret Thatcher to conduct monetary policy on the basis of targets for broad and narrow money, but the idea is considerably older. It is implicit in the economic idea of rational expectations. While it originated in the context of market responses the Law has profound implications for the selection of high-level targets in organisations^[1].

It has been asserted that the stability of the economic recovery that took place in the United Kingdom under John Major's government from late 1992 onwards was a result of Reverse Goodhart's Law: that, if a government's economic credibility is sufficiently damaged, then its targets are seen as irrelevant and the economic indicators regain their reliability as a guide to policy)))

...suggests the opposite. Perhaps the bubbles in asset prices that were suppressed would only pop up somewhere else. Indeed, the classical dichotomy suggests that they would pop up somewhere else( YES ); positive asset price bubbles would pop us as negative CPI bubbles.

I'm not prepared to rule out targeting some weighted average of goods prices and asset prices. But even a broad index of stock prices is a narrow representation of even financial assets, let alone land, houses, and human capital."

I don't like Mechanical Interventions, which this is. It's, in effect, a regulator. I simply don't buy it any more than using interest rates to stop bubbles. It's too blunt an instrument, and I don't believe that it addresses the insurance needed to prevent calling runs. In other words, if it doesn't work, the illusion of safety will lead to another ghastly blowup. By the way, any regulator must be set, which is another reason I don't like it. Economists don't qualify as engineers.

There must be a hundred ways people believe that we can prevent bubbles, and, if we have a Treasury Bubble now which bursts, they won't even be noticing one right in front of their faces. Bagehot's Principles are the ticket. Stop printing up false ones.

"To me, all the policy shift has done is to pay banks not to lend."

Rebecca Wilder on News N Economics does what I like and asks and answers a question that explains something odd to us:

"The Fed’s paying interest on reserve balances has been bugging me lately. I simply don't understand why the Fed would initiate a policy shift desinged to "improve efficiency in the banking sector" when the banking sector is in the middle of a crisis. To me, all the policy shift has done is to pay banks not to lend."

So, the Fed is paying interest on money that is being held in accounts by banks, and not used for loans. In other words, the banks are making money by not lending. Shouldn't the Fed charge for the money it lends or provides?

"Here is what Vice Chairman of the Federal Open Market Committee (FOMC) Donald Kohn had to say about bank lending: “In recent weeks, bank lending appears to have dropped back, consistent with the significant tightening of terms and standards reported by bank loan officers in recent quarters as well as the weakening of economic activity.”

When in fact, what he really meant to say wass this: “In recent weeks, bank lending appears to have dropped back, consistent with the significant tightening of terms and standards reported by bank loan officers in recent quarters, as well as the the weakening of economic activity, and since banks are now earning interest on reserve balances."

Oops. Although I don't doubt that the banks are shell shocked.

"Apparently, the Fed deemed it urgent to pay interest on reserves (IOR) because they fast-tracked the authorization for IOR that was initially set to start in 2011. As part of the Economic Stabilization Act of 2008, the Fed was granted authorization to pay IOR three years early. Theoretically, IOR improves the Fed’s ability to conduce efficient monetary policy in a world where required reserves are falling (see this paper for a nice discussion of monetary policy without reserve requirements). The Bank of Canada, the Bank of England, and the Reserve Bank of New Zealand all conduct monetary policy without reserve requirements, so why not the Fed?"

If reserves are falling, it makes sense to pay people to hold them or to add them.

"The Fed said that the IOR policy would help “eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector”. But why would a central bank try to improve efficiency smack dab in the middle of a banking crisis?"

Are the reserves falling? Does it matter?

"The most likey reason is that the Fed saw the IOR policy as an easy way to keep the effective federal funds rate close to its target as numerous $ billions in liquidity were added to the banking system. Well, that didn’t work. I bet that the Fed did not intend for excess reserve balances to balloon as they have.

The chart illustrates total and excess reserve balances as a share of total bank credit (on the H.4.1 statement). The Fed’s added liquidity (added bank credit) - $1.3 trillion over the last yearpromote bank lending – has ended right back at the Fed’s doorstep in the form excess reserves. Banks are hoarding the funds and getting paid to do it!"

So the Fed did not foresee this happening. They did not see that paying people interest on money in a downturn was going to a major incentive for them. That's hard to believe. I understand Rebecca to be saying that the Fed wanted to offer this incentive to help the balance of inflows and outflows, given that the outflows are currently so large. They wanted to offer an incentive for inflows.

Instead, banks see this as the best deal in town and are taking full advantage of it to the detriment of lending money to people or businesses.

"But don’t worry, the IOR policy can simply disappear. If the Fed cuts to zero, which I believe is a very distinct possibility in January (or even December, who knows), the interest rate paid on reserves will also fall to zero (equal to the FOMC target). Headache gone; then we will see what happens to excess reserve balances.But now that I think of it, the Fed can always change its mind...and the formula used to calculate the IOR rate for the third time."

If the rate were to go to zero, the incentive would be gone, unless they follow the lead of some bond buyers in the news today.

The only thing that might also have been a factor was the hope of helping the capital reserves and general health of the banks by paying them this extra money. But how many ways do we have to give them money not to lend? This was a poorly designed move.

"But the GSEs have been nationalized. Their obligations are already U.S. government debt. What’s going on here?"

John Hempton of Bronte Capital with comments on a Krugman post that I also commented on:

"I used to think that if the government only made the GSE obligations full faith and credit (FFC) obligations the remaining problems in the conventional mortgage market would go away. Paul Krugman still thinks it:

The Fed is confusing me

OK, so the Fed is planning to buy obligations of the GSEs — as well as securities guaranteed by the GSEs. This is in an effort to lower spreads. The Fed will in effect pay for these purchases by having the Treasury issue U.S. government debt.

But the GSEs have been nationalized. Their obligations are already U.S. government debt. What’s going on here?
It’s true, as the Fed’s statement says, that Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. But that’s presumably because the Bush administration, weirdly, has refused to declare that GSE debt is backed by the full faith and credit of the US government. Why not just make that declaration, turning GSE debt into Treasury obligations, rather than stuff the obligations onto the balance sheet of the Federal Reserve?

Is this some kind of strange political game? Is there something else going on here? Inquiring minds want to know.

He is of course wrong. The Goldman Sachs obligation is full faith and credit of the US Treasury - and trades at an irrationally wide spread. Nobody has given a plausible explanation (except lack of trust in the government) as to why the spread on FDIC paper issued by Goldies but backed by the full faith and credit of the US Treasury is 200 bps.

For once the world is even stranger than Paul Krugman thought and stranger than his models.

Now there is an implication here - which is if the market will not believe that something is full faith and credit of the US Government then the government should buy it, issue treasuries and make an arbitrage profit. There is a free lunch here. Of course this mucks government accounting around (the debts wind up on balance sheet of the government rather than just contingent). However it does not change the economics from the government perspective.

And in the process we go from the government buying the troubled assets of financial institutions to the government buying the guaranteed liabilities of financial institutions.

John Hempton

Very interesting points by Hempton as per usual. I love the idea of Government Arbitrage Profit on distrust of the Government. Here is my comment:

Let me make the announcement for them:

Implicit Government Guarantees are actually Explicit. Watch what we do, not what we say. Otherwise, our words and actions will not make sense to you.

Oddly, it amuses us to see you perplexed.

— Don the libertarian Democrat

Now, of course, there's the question of why not come out and say it? Apparently, there are some tax reasons, etc. But that doesn't negate the fact that the government is on the hook. Presumably, the idea is that this debt is held to be less guaranteed than other debt. I don't believe it. I believe that it is implicitly guaranteed, which, by now, should be clear means explicitly guaranteed. I do agree that they see some advantage to leaving the door open that these debts are less secure than other government debts, but I don't believe that it lies in the FDIC Prospectus.

In that sense, I think that Nick Rowe might be both and right and wrong in his comment on Buiter, who might be accepting the demarcation the Fed is maintaining:

"One small point of disagreement:

“By continuing to accept instruments issued or guaranteed by Fannie and Freddie as collateral, the Fed clearly does not accept assets that were safe from the perspective of the US tax payer, because what safety there is comes from that tax payer’s own guarantee.”

But since the taxpayer owns the Fed, there is no extra risk for the taxpayer if the Fed buys these securities. (Note the parallel to the Bank of Canada buying CMHC-insured mortgages, where CMHC is clearly owned by the government.)

Posted by: Nick Rowe | November 29th, 2008 at 10:15 pm "

I think that this is like a shell game with three peas. The shells are The Fed, F & F, and Congress. The peas say that the taxpayers pay. Now, the point isn't to convince us that we can win, since, lucky for us, we win each time. Rather, it to create the illusion that we might lose, which, unfortunately, we cannot. The Fed wants to have it both ways. Convince everyone that these debts are less than FF Guaranteed, and yet imply that they are. The point is that the taxpayers need to actually know which it is.

McTeer On A Rate Cut

Bob McTeer comes out for a rate cut, which is a change in his thinking:

"However, given the recent worsening in the credit freeze and its spread to Europe, I have changed my mind. The European Central Bank has been in denial, in my opinion, even given its single inflation mandate. ECB easing is overdue and a coordinated rate cut with the Fed, the Bank of England, the Bank of Canada and perhaps others participating would likely have a major impact, albeit primarily psychological.

If the Fed initiates a coordinated rate cut of 50 basis points, it will give the ECB cover to do what it should have done already. It would also give the Fed's cut more bang for the buck. After all, given the way things are going in the markets, what do we have to lose?"

Add McTeer and Gross, and you've got two intelligent people calling for a cut, although they seem to differ on the amount.