Fed in 2008 Showed Panic of 1907 Was Excessive

Friday, 10 May 2013 09:18 AM

The Federal Reserve has learned how to lessen economic slumps as it turns 100 years old.

An analysis by San Francisco Fed economists Early Elias and Oscar Jorda found that if there had been a central bank during the financial panic of 1907 to lower interest rates as much as the Fed did during the 2008 turmoil, the U.S. economy would have contracted two percentage points less than it actually did.

“The presence of the Fed as monetary authority and lender of last resort distinguishes the financial crisis of 2007-08 from the 1907 panic,” the authors wrote. “In the recession associated with the recent financial crisis, losses in economic activity and employment were less severe.” Unemployment would have been 2.5 million higher in 2009 without modern monetary policy making, said Elias and Jorda.

U.S. gross domestic product per capita shrank by more than 10 percent in the recession that accompanied the 1907 panic. In the recent slump, the slide was about 5 percent as the Fed axed its key benchmark interest rate to near zero.

The 1907 panic is often credited with leading to the creation of the Fed. In the absence of a central bank, J. Pierpoint Morgan, the founder of what would become JPMorgan Chase & Co., orchestrated a rescue of the banking system.

Aside from the absence of a central bank, the 1907 and 2008 episodes have close parallels, the economists wrote in the May 6 edition of the Fed Bank’s Economic Letter.

Union Pacific’s stock took a hit at the start of the last century; so did Bear Stearns Cos. shares in 2008. The 1907 plunge in copper and New York City bonds was reflected by Fannie Mae and Freddie Mac’s free fall last decade. The 1907 version of Lehman Brothers Holdings Inc. collapse was Knickerbocker Trust Company and AIG’s counterpart was the Trust Company of America, the economists said.

* * *

A weaker yen is unlikely to help boost Japan’s exports because the nation’s role in international markets has shrunk over the past two decades.

So says Steven Englander, head of Group of 10 currency strategy at Citigroup Inc in New York. He calculates that in 1992, Japan was by far the dominant exporter in Asia and even in 2003 its shipments made up about a third of all those from big Asian economies. That’s slightly more than Germany’s share in the euro zone now.

Still, by the end of 2012, Japan’s slice of regional trade was 15 percent despite the fact that the yen fell 20 percent from early 2005 to the middle of 2007, Englander said. The reason is that developed countries with different brands, high- value products and established supply chains don’t compete on price alone.

The upshot is “a weaker exchange rate is not likely to help Japanese exports nearly as much as hoped,” Englander said.

* * *

U.S. farm income could slide in 2014, forcing farmers to use wealth accumulated since 2009 to finance growth and smooth spending, according to the Federal Reserve Bank of Kansas City.

A surge in farm profit may peak as producers meet the recent pickup in demand -- which has been fueled by expanding populations and incomes in developing countries -- by investing to increase their production capacity.

The combination of rising supplies and higher production costs could cut farm profits by 2014, said economists Jason Henderson and Nathan Kauffman. The U.S. Department of Agriculture predicts net farm incomes to fall as much as 25 percent next year from 2013 and remain around that level for a decade.

This would force farmers to tap existing wealth and run up debt. Although debt ratios are currently low, an increase similar to the 1973-1980 period, when farm debt rose by 43 percent, could pose a risk to farm finances, Henderson and Kauffman said.

The Kansas City Fed study came as Bloomberg News reported this week that a panel of bankers warned the Fed in February that stimulus may be creating a “bubble” in the price of U.S. farmland.

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Large advanced economies such as the U.S. take longer to recover from housing-led recessions than small, rich rivals such as Denmark, according to Thomas Lam, chief economist at OSK-DMG.

The gap in recovery between typical recessions and those triggered by a housing slump often persists more than nine years from the trough in big economies, Singapore-based Lam said in a May 6 report.

By contrast, the upturn from a property crash in small advanced economies is generally faster than a standard recovery after two quarters and quickens so that it becomes entrenched after three years.

The U.S. is “by and large” tracking the outline projected by the model of big advanced economies, Lam said. This suggests the economy could expand 1.9 percent this year and accelerate to 2.7 percent in 2015 before slowing to 1.3 percent in 2017.

* * *

Johns Hopkins University professor Laurence M. Ball is refreshing his call for central banks to target a 4 percent inflation rate.

In a paper for the Central Bank of Turkey, Ball argues an increase in the inflation goal would ease the constraints on monetary policy when interest rates fall near zero.

The result would be less severe economic downturns and little in the way of cost because he argues 4 percent inflation would not generate significant harm for the economy. That rate is about double the amount that modern central banks view as a sign of price stability.

“If central banks raised their inflation targets from two to four percent, the economic benefits would exceed the costs,” said Ball.

A higher goal would raise the long-run level of so-called nominal rates, allowing them to fall further before reaching zero and leading to a more muted slowdown, said Ball. He argues data show little evidence an economy’s efficiency is much lower with 4 percent inflation.

Ball’s campaign has so far fallen on deaf ears, something he links to an “excessive aversion to inflation” linked to theory and the double-digit price gains of the 1970s. Fed Chairman Ben S. Bernanke said in 2010 that policy makers opposed a higher target because it “would likely entail much greater costs than benefits.”

“The strong opposition to this policy is a puzzle,” said Ball. “Theoretical research has underestimated the danger of low inflation arising from the zero bound problem.”

* * *

The European Central Bank has typically tended to overestimate economic growth in the euro area and underestimate inflation since it began releasing projections in 2000.

A review of its track record released yesterday by the Frankfurt-based central bank found projection errors for both inflation and expansion were “significantly higher” during the financial crisis period, particularly in the recession of 2009. Unexpected developments in oil prices played a key role when forecasts were off, the study said.

Still, the ECB’s performance “compares reasonably well” with that of other international institutions and private sector economists, the central bank said. While in line with counterparts on estimating growth, the ECB was more accurate in projecting inflation, it said.

* * *

Almost all the divergence in incomes between poor and rich countries in the past two centuries can be linked to the use of technology, according to a study released this week.

Using data since 1820, Harvard Business School’s Diego A. Comin and Marti Mestieri of the Toulouse School of Economics sought to explain different growth rates in incomes even with technology widespread. Their report, published by the National Bureau of Economic Research, encompassed 25 technologies and their use over 132 countries.

They found that the lag time between the adoption rates of technology had narrowed between rich and poor countries. Steam and motor ships were adopted far slower than computers, for example.

Still, Comin and Mestieri found there has been a split in the rate of penetration, reflecting the different intensities with which new technologies have been embraced.

The different use of technology means developed economies took a century to reach the modern long-run productivity growth rate of 2 percent. Developing countries needed twice that time. This represents 80 percent of the four-fold increase in the income gap between rich and developing countries, they said.

* * *

The future may lie in the MIPS rather than the BRICs.

Malaysia, Indonesia, the Philippines and Singapore have a fan in Scott Minerd, chief investment officer of Guggenheim Partners LLC, who says each enjoy the favorable demographics, infrastructure needs and low labor costs that bode well for their growth outlook.

If their trajectory is similar to that of Brazil, Russia, India and China in the past decade, their equity market returns may be in the order of several hundred percent between now and the middle of the next decade, Minerd said in a May 8 report.

While the equity markets of the BRICs increased 600 percent since the late 1990s, potential growth rates have since appeared to slow, he said, adding since the end of the 2008 global financial crisis, equity markets in the MIPS have “substantially outperformed” the BRICs and could continue to.

--With assistance by Andy Sharp in Tokyo. Editors: Paul Badertscher, Chris Fournier

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

© Copyright 2018 Bloomberg News. All rights reserved.

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Fed in 2008 Showed Panic of 1907 Was Excessive: Cutting Research
Friday, 10 May 2013 09:18 AM
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