Is it possible for the sitting president who is up for reelection to manipulate economic figures in order to create a falsely favorable (to him) improvement, or must he rely on promoting a complementary interpretation with stated numbers for a better public image?

He and his surrogates will put the most favorable spin on the numbers, but I doubt overt manipulation. The Civil Servants who create the numbers are very smart people dedicated to producing the most accurate numbers possible and would make a major stink if someone tried to bias that process. The risks and consequences of doing so would not be worth it.

How does the Fed lower its balance sheet?

The Fed shrinks its balance sheet when it sells assets, allows them to mature without replacing them, has loans repaid.

The total assets on the Fed’s balance sheet grew from roughly $800 billion just prior to the financial crisis to just under $3 trillion. The growth was larger than it might have been because the traumatized banking system held onto the reserves created by the Fed rather than making maximum use of them in making loans and investments which create deposit money. The economy and financial system has adjusted to the Fed’s current balance sheet. It won’t be advisable to shrink it until more vigorous lending by the banking system threatens to be inflationary. At that point the expansion of the “money multiplier” will need to be partially offset by the Fed draining reserves, i.e. shrinking its balance sheet.

How much control does the Fed have on interest rates.

It has pretty close control over the Federal funds rate and other very short-term rates. It’s influence (rather than control) over longer term rates depends on market sentiment, which, in turn, is based on economic conditions. Lately, economic circumstances and the credibility of the Fed have given it pretty much influence over longer term rates. That is the point of Mr. Bernanke promising low rates for an extended period of time. If that is believed, longer term rates stay low, as in a 2 percent rate on a 10 year bond. If growth and/or inflation pick up substantially, that rate will rise (and longer rates will rise more) whether the Fed likes it are not.

Recently, Bernanke made some very dovish comments which seems to favor the current political party . . . is the Fed chief politically inclined.

The Fed chief always wants the best economy possible and sustainable; so one might say that it favors incumbents. But, remember that while Mr. Bernanke was reappointed by the Democratic President, he was originally appointed as a governor and later as Chairman (and to the Council of Economic Advisors in between) by a Republican president. He wants the best legacy possible for himself regardless of which party might share the credit.

What was the most interesting/unusual experience you had as a FOMC/Bank President?

On a recurring basis, the most interesting aspect of the job was the FOMC meetings about every six weeks and the preparations with my economists leading up to those meetings. Budgets, other meetings, personnel issues, operation issues were all less fun. I enjoyed particularly some of the creativity we brought to our annual reports. For example, one year I included a picture of myself visiting three graves: Buddy Holly, Adam Smith, and Sam Houston.  There wasn’t room for Evita.

How will the EU troubles, specifically Spain’s, potentially manifest themselves in our economy? What is the best fix? What correlations are there between our own fiscal policy/economic conditions and those of Spain, Greece, and Portugal?

Countries are tied together through both trade (imports and exports) and financial transactions such as bank loans security holdings and the like. As southern Europe drags all Europe into recession, European demand for U.S. exports will decline, thus affecting our exporters. Some U.S. banks may own European sovereign debt, or private debt, and U.S. mutual funds may as well. This train wreck has been so slow moving that I assume that banks and mutual funds and money market funds have lessened their exposure substantially. I don’t expect the direct impacts on us to be substantial. The worrisome thing, however, is the absence of a reasonable way out of the European mess and the jeopardy it puts the Euro in. So far the “remedy” imposed by Germany as a condition to helping financially has been austerity. Austerity measures are shrinking the indebted economies, which hardly helps them with their debt. They need specific measures to curb government borrowing combined with measures to produce economic growth, presumably structural measures like labor market reform, etc. There is no easy way out. Asset sales, or privatization, would generate government revenue without shrinking the economy, but I don’t know what is available to privatize. If they were a family, selling the family jewels would be in order.

Do we ever worry about inflation again?

Yes, but right now, based on recent and current policies, inflation is not a “clear and present danger.”

What will the Fed look for to actually tighten monetary flows/economic policy.

Right now the Fed’s dual mandate is skewed. Inflation is slightly above the official target, but isn’t likely to accelerate soon, while unemployment is far above the implicit target, whatever that is. The Fed will start easing off the accelerator when those to goals are more evenly achieved. Faster GDP growth and faster employment growth will set the stage for an eventual change in policy.

What key indicators have traditionally signaled a healthy, robust economy that is vital and independent of monetary injections or government subsidy?

I would vote for entrepreneurialism, which the government can’t do much to promote except stay out of the way. A related statistic would be rapid productivity growth, or more output per unit of input, or output per hour worked. Rising productivity is what gives us a higher standard of living, but in the very short run it competes with employment growth.

What do you think of Texas A&M’s move to the SEC?

Beats me. I asked the President of A&M by phone the other day (a good man, by the way) and he said it was a long story.

“Twas a dangerous cliff, as they freely confessed,

Though to walk near its crest was so pleasant;

But over its terrible edge there had slipped

A duke and full many a peasant.

So the people said something would have to be done,

But their projects did not at all tally;

Some said, “Put a fence around the edge of the cliff,”

Some, “An ambulance down in the valley.”

In the remainder of the poem, they had quite a debate back and forth over which was preferable: a fence to prevent the falls or an ambulance to haul them off. In the end, the fence barely won out. From present indications, I’m not so sure we’ll be that lucky.

The price index for gross domestic purchases increased at a rate of 2.4 percent, compared to only 1.1 percent in the fourth quarter—not overly large, but headed in the wrong direction.

Personal consumption expenditure increased faster in the first quarter than overall GDP. PCE grew at an annual rate of 2.9 percent in the first quarter, up from 2.1 percent in the fourth. Unfortunately, real nonresidential fixed investment declined at a 2.1 rate in the first quarter after increasing at a 5.2 percent rate in the fourth. A healthier balance would have been more investment and less consumption (more saving). Perhaps this is made up by the declines in real federal government spending in both quarters–5.6 percent in the first quarter after a decline of 6.9 percent in the fourth.

External trade was a mild positive to GDP growth in the first quarter after having been a mild negative in the fourth. Real exports of goods and services increased 5.4 percent in the first quarter, double the 2.7 increase in the fourth, while real imports increased 4.3 percent after increasing 3.7 percent.

All in all, the first quarter will be reported as weaker than the fourth, but I would argue it was actually stronger—but, of course, not nearly strong enough.

This long week-end might make a fascinating topic for classroom discussion, whether led by efficient market theorists or behavioral economists or cab drivers. Do you remember the old song lyrics: “I was looking back to see if you were looking back . . .”? A chain of reasoning is a little like spelling Mississippi. You never know where to stop.

Simple answers without too much analysis are probably best. The job numbers were bad; so, the market will tank. On the other hand, surely no one expected the proverbial straight line improvement month after month, and we all knew the employment numbers were getting ahead of the underlying GDP numbers. If you didn’t know that, you should have because Gentle Ben told us. So, maybe the three-day cooling-off period will allow cooler heads to prevail.

Or not!

Bank of America, for example, acquired Merrill Lynch and Countrywide, the latter much to its sorrow given the many problems that came with it that still plague Bank of America. Chase grew, in part, by acquiring Bear Sterns and Washington Mutual, with both acquisitions supported by the government. Wells Fargo acquired ailing Wachovia. One thing these acquisitions had in common was that had they not been made by the acquiring banks, the government probably would have had to do it itself. Indeed, the government and the banking regulators encouraged and assisted these transactions, or, should I now say aided and abetted.

The case of Bank of America seems particularly unfortunate since it had buyer’s remorse regarding Merrill, but was “encouraged” by the government to go through with the deal anyway. I suppose the law requires an acquirer to be responsible of the debts and deeds of the acquiree, but the alacrity with which Bank of America has been vilified, threatened and sued for the sins of others that might have been inherited by the government seems unseemly to me.

I own stock in the banks mentioned above as well as others. Large bank stocks are undervalued, you know.

The second and third estimates both had real GDP growing at an annual rate of 3 percent in the fourth quarter, the largest growth rate of last year. Unfortunately, they also both showed that inventory accumulation, a.k.a “inventory investment” accounted for almost two-thirds of the growth. Removing the inventory buildup left real final sales up at only a 1.1 percent annual rate, well below the satisfyingly round headline number of three percent.

By contrast, inventory liquidation actually pulled down the headline estimate in the third quarter, making it a stronger quarter in terms of real final sales than the fourth. Real final sales in the third quarter were up 3.2 percent, above the headline real GDP number of 1.8 percent. While acknowledging that the reasons for inventory accumulation make them tricky to interpret, I would nevertheless argue that the economy weakened considerably in the 4^th quarter of 2011. We’ve all been so hungry for good news that most have chosen not to notice the setback

Here’s how the WSJ put it in the first two paragraphs of its story on March 8:

“Federal Reserve officials are considering a new type of bond buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up the money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.”

The odd thing is that unintended sterilization is exactly what happened during the so-called QE1 and QE2. The Fed purchased bonds, which created an equal amount of bank reserves and deposits (money). Normally, because of fractional reserve banking, this would lead to a further multiple expansion of bank deposits and the money supply. That mostly didn’t happen because the banks held onto the excess reserves created rather than lend or invest them. Multiple money expansion did not happen and expectations of accelerating inflation were not met.

Banks now get a 25 basis point interest rate return on their reserve deposits with Federal Reserve Banks, including their excess reserves. So, in effect, the Fed has already been borrowing them. Those reserves are assets to the owning banks but are liabilities of the owing Fed. In other words, these reserves created by QE1 and QE2 have already been largely sterilized by the Fed borrowing them back at low rates. This is why the Fed’s operations haven’t been as effective as hoped in stimulating the economy nor as inflationary as the critics feared.

In addition to the unintended sterilization of bond purchases under QE1 and QE2, the more recent “operation twist” is on its face a sterilization effort—that is purchases of longer dated debt is matched by sales of shorter dated debt. That doesn’t just sterilize new reserves; it avoids creating new reserves.

By the way, I believe the word “sterilization” got the meaning we are using for it in this context in foreign exchange intervention. If a central bank buys foreign currency to hold down the exchange rate of the domestic currency, it creates more domestic money. Central bank net purchases of any asset, or services for that matter, tend to create money. If more money creation is considered not desirable then the purchases of foreign exchange are matched by sales of some other asset, usually bonds, hence offsetting or “sterilizing” the purchases.

The WSJ report said that the Fed hoped to “subdue worries” about future inflation, not prevent future inflation. In other words, it would sterilize in some different way just to give a greater appearance of sterilization. I know it must be frustrating for the Fed to have it’s critics continue to charge that it is stoking inflation while inflation falls instead, but I would think Mr. Bernanke could find a way to explain the sterilization that is already taking place and not have to create a new program simply for the optics that has the same effect.

The WSJ article did not quote any sources by name, but the tone implied that the author got his information from some Fed policymaker. I’m surprised and disappointed that such a conversation took place and also disappointed that Fed policymakers seem to be actively planning a new round of quantitative easing. While it’s important that they keep the balance sheet growing slowly to provide for continued modest money growth, that can be done without a new Q program. What they should be focused on, in my opinion, is how to allow interest rates to rise a bit in the context of a generally accommodative policy. Interest rates have already been too low for too long in my opinion and the end of 2014 is a long time more.

My car is upside down, you bet

But I’m getting me a consolidation loan

And finally getting out of debt

Bob McTeer

Well, it may be hard to borrow your way out of debt, but sometimes it buys time, and time is money. One of the few major contributions to the European debt crisis is the ECB’s lending to European banks. Long-term low-interest loans help the banks themselves as well as put them in a position to buy European sovereign debt, an excess of which is the main problem. It buys debtor countries some time to become less so. It goes a long way toward making the European debt crisis a condition that doesn’t portend disaster tomorrow.

The second round of ECB lending attracted some 800 European bank borrowers, reportedly more than participated in the first round because of more relaxed collateral requirements. Oddly, those collateral requirements are established, not by the ECB, but by the national central banks. We may quibble that those are anything but riskless assets for the banks, but what national bank regulators are going to downgrade and mark down their own sovereign debt to fail their own banks? In other words, Italian banks can buy Italian government debt, and both debtor and creditor, and even the bank regulator, have an incentive to treat them as sound if “held to maturity.”

Cries of hyper-inflation resulting from “printing money” are already being heard. While some increase in inflation cannot be ruled out, the more likely outcome will be similar to the U.S. experience. The combination of TARP’s injection of capital into the banking system and the Fed’s loans to banks and debt purchases brought similar predictions of hyper-inflation. It didn’t happen because circumstances increased the banks desire to hold excess reserves and those reserves were never translated into multiple money expansion as would have been likely under normal circumstances. The Fed’s actions may not have been sufficient to stimulate the economy sufficiently, but they were necessary to prevent a contraction precipitated by banks trying to get more liquid. The good news is that money has to be spent to cause inflation and it must be created to be spent. The bad news is that money has to be spent to stimulate the economy and feed a vigorous expansion and it must be created to be spent. There is no reason to expect the outcome to be different in Europe under similar circumstances.The American experience in the Depression also demonstrated the folly of “moping up” excess bank reserves that the banks themselves did not consider excess under the extraordinary circumstances.

Another disaster that didn’t happen in the U.S. case is a precipitous decline in the foreign exchange value of the dollar, and for similar reasons. Money not created is not going to be spent on other currencies. The dollar may be called weak, but it’s no weaker than it was prior to the financial crisis and the actions taken to deal with it. It’s instructive, I think, to note that the Euro actually strengthened following this second round of ECB lending.

I know all this sounds like heresy, but the key is to keep counterfactuals in mind. What is seen is not much improvement. What is not seen is disaster averted—for now.

Even if the U.S. administration had been predisposed toward invasion, anyway, it would have lost its rationale, and Saddam would have been saved major inconvenience. Instead, he played a coy game of denial with a wink and limited inspections apparently designed to give the impression that he had the weapons. He was too clever by half.

Iran may now be playing the same dangerous game of denial with a wink. Chances are that Iran is making or about to make nuclear weapons; but, if its line about peaceful uses of nuclear energy is true or could yet be turned into truth, now is the time to stop playing games.

Of course, I’m not a dog person and won’t be until the expected life span of my chosen one exceeds my own. What I am is someone interested in irrelevant associations and disambiguation. So, naturally, I recalled President Kennedy’s speech in West Berlin where he declared, “Ich bin ein Berliner.”  Not to be outdone, President Nixon  later went to Peking and declared, “I am not a Pekingese.”

Here’s what gets me. At some point, probably late at night, Peking became Beijing. So why  did Peking Duck not become Beijing Duck? And why did a Beijingese not win the dog show?