Lies, Damned Lies, And Pianalto's QE/Deleveraging Lies

We tried to bite our tongue; we ignored some of the sheer hypocrisy of Cleveland Fed's Sandra' oh Sandy' Pianalto (that QE2 was a definitive success in 2010 but now LSAPs require more analysis of costs and benefits); but when she started down the road of praising the US consumer for deleveraging we had enough. In the immortal words of John Travolta: "Sandy, can't you see, we're in misery" as while she notes consumers cutting back on credit card debt (due to forced bankruptcies we note), Consumer debt has only been higher on one month in history! Soaring auto loans and student debt should just be ignored? There is no deleveraging - Total US Consumer debt is 0.23% from its all-time high in mid-2008, and will with all likelihood break the record at the next data point. Meanwhile her speech, so full of careful-not-to-over-commits can be summed up by the world-cloud that shows the six words most prominent: 'Monetary Policy', 'Financial Conditions', and most importantly 'Credit Economy'. Here's the deal: Consumer Debt is Consumer Debt.

Total Consumer Debt - there's your deleveraging!!!


and the simple analysis of her speech this morning:




Full speech can be found here:, but these sections stood out to us:


The Federal Reserve and Monetary Policy


It takes time for our monetary policy actions to affect the economy, so our policy decisions have to be forward-looking. And that is exactly why participants around the FOMC table bring their economic projections to the discussions.


The initial large-scale asset purchase program, which is commonly called quantitative easing, or QE, was announced in the midst of the financial crisis in 2008 and has been extended and expanded several times since then.  As a result of these programs, the Federal Reserve's balance sheet has grown from about $900 billion before the financial crisis to nearly $3 trillion today.

In addition, we have been adjusting the composition of our balance sheet by selling short-term Treasury securities and purchasing an equivalent amount of longer-term Treasury securities. We have also stepped up communications to the public about the future path of interest rates. The FOMC's most recent statement indicates that economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through 2014.

And yet, even with the aggressive and extraordinary actions that the FOMC has taken, we remain in a frustratingly slow economic recovery.  Our economy is still struggling to build momentum almost five years after the Federal Reserve first began to ease monetary conditions..  To understand why our recovery has been so sluggish, one of my Bank's economists has examined economic recoveries in the United States going back to the 1890s.  His work concluded that the deeper the recession, the faster the snap-back, even when the recession was sparked by a financial crisis. However, he found two exceptions to this pattern: the Great Depression and this current period.  His analysis strongly suggests that the collapse of the housing market, which wiped out more than $7 trillion of household net worth, has been a key barrier to a stronger expansion.

Many households had increased their net wealth during the boom period by taking on a lot of debt to finance the purchase of their homes, which increased in value.  When the housing bubble burst, the value of their homes fell, but their debt obligations remained.  Hence, these households were quite suddenly worse off -- literally less wealthy -- than they previously had been on paper.  In response, households have stepped up their saving to rebuild the net worth they lost during the housing market collapse, and in the process, they have scaled back on their spending.



As consumers have adjusted to becoming less wealthy, their attitude toward debt in general has changed.  My Bank's analysis shows that at the beginning of 2011, the average consumer had fewer open credit accounts than at any time in the past dozen years. This trend appears to be driving an overall reduction in the number of bank cards held by the public. Consumers are using fewer credit cards, and they have been paying down the balances on their credit.  More than half of all U.S. consumers now have just one credit card or none at all, and most of that decline reflected consumers closing their bank credit card accounts. In just four years, between 2007 and 2011, the percentage of people with no bank cards increased from about 18 percent to 24 percent.  Moreover, even though lenders have denied credit to some consumers, my Bank’s study indicates that most of the reduction in credit card usage has come as a result of choices made by consumers – not lenders.


While consumers have been cutting back on credit card debt, they have shown a willingness to borrow money to buy cars.  Cars in the U.S. are getting relatively old; indeed, the average age of the auto fleet in our country is at a record high. In addition, lenders increasingly have been willing to extend credit to purchase cars on favorable financing terms.  As a result, the automotive sector is a bright spot in the economic picture.

That said, a stronger economic expansion is going to require significantly more support from consumers and businesses. 



Monetary policy should do what it can to support the recovery, but there are limits to what monetary policy can accomplish...

There are benefits to further monetary policy actions, but we have to be realistic about what those benefits will be, how large those benefits will be, and how other factors will help or hinder the effectiveness of those benefits...

Let me be more specific about the benefits and costs.  By benefits, I mean the ability of our policy actions to move the economy closer to our goals of stable prices and maximum employment. By costs,I mean the potentially adverse effects that our policy actions might impose on financial markets and the economy.  These benefits and costs are not always easy to identify and estimate.  We use economic theory to guide our thinking about the many ways in which our policy actions could affect the economy and financial markets.  We then try to estimate the magnitude of these effects, relying on models based on historical experience.  We are fortunate that we have not experienced many economic hardships as severe as this last recession, but the lack of experience means that we can only generate very rough estimates of the likely costs and benefits of our actions.


So, large-scale asset purchases can be effective. But our experience with these programs is limited, and as a result, they justify more analysis.  For example, as the structure of interest rates has moved lower over time, it is possible that future large-scale asset purchase programs will yield somewhat smaller interest-rate declines than past programs. A related issue to evaluate is whether further reductions in longer-term interest rates would stimulate economic activity to the same degree as they have in the past.

Let me now turn to some of the potential costs. It is conceivable that, at some point, policies designed to promote further declines in rates could interfere with financial stability. Some financial institutions find themselves challenged today by the low-interest-rate environment, and they might take actions to remain profitable that could affect risk in the financial system. One possible response to these conditions is that financial institutions could take on excessive credit risk by "reaching for yield."  At the same time, financial companies could keep prudent credit standards but still suffer significant losses if they were holding too many fixed-rate, low-yield assets when market rates began to rise.

Finally, it is also conceivable that, at some point, the Federal Reserve's presence in certain securities markets would become so large that it would distort market functioning.   It is important to have good estimates of how large the Federal Reserve's participation would have to be to cause a meaningful deterioration in securities market functioning, and to better understand the potential costs of such deterioration for the economy as a whole.

The bottom line is this: I am supportive of actions that provide economic benefits with manageable risks. The FOMC's policy actions to date have been important economic stabilizers and have acted to support the expansion. Yet today, we still find ourselves in a challenging economic environment – one in which we continue to rely on nontraditional policy tools. These new tools come with benefits and with risks…and we must constantly weigh both in our efforts to meet our dual mandate of maximum employment and stable prices.