macroblog

When cycles collide

Yesterday we saw that initial claims for unemployment insurance declined rather sharply again last week, another hint that U.S. labor markets may be beginning to mend. But the improvement came with a word of caution from the folks at the Department of Labor, who note that these numbers are being affected by seasonal adjustments to the data that may present a misleading picture.

Virtually all of the economic information that gets reported by the data agencies has been seasonally adjusted. That is, the data are being reported after the agency has adjusted them for their usual variation for that time of year. The unemployment insurance claims data are a useful example. On an unadjusted basis, the initial claims data showed a fairly large increase last week—up 86,000 workers. But claims for unemployment compensation typically rise in early July as auto plants shut down to retool for the new model year. The jump in claims this July hasn't been as large as in years past since many of the auto plants were waylaid earlier in the year. So on a "seasonally adjusted" basis, the data showed a drop in claims of 47,000 workers.

Here we have that statistician's equivalent of an old existential puzzle: Do seasonal layoffs in the auto industry make a sound if there is no one there to lay off? We invite you to write up your own answer to that one. There is a long literature, perhaps most notably the work of Jeffrey Miron, that documents the interplay between the business cycle and the seasonal cycle. The thrust of this research is to help us better understand the general nature of economic cycles. But there are also more mundane issues we need to wrestle with. For instance, how accurate are seasonal adjustments to the data during times of severe cyclical disruption?

To provide some perspective, let's take a deeper look at the recently released June consumer price index (CPI) report. Last month, prices, as measured by the core CPI, were up 2.4 percent (annualized) from a 1.7 percent rise in May. There are a few bits of data that might cause you to scratch your head a little, given what we've been hearing about the economy lately. For instance, apparel prices jumped an annualized 8.8 percent last month. And new car prices were up 8.2 percent. So are department stores and car dealers having a better time of it than they are letting on? I don't think so. I believe the seasonal adjustments in the data offer a more reasonable explanation.

Apparel prices rose 8.8 percent on a seasonally adjusted basis but fell a whopping 25.5 percent (annualized) on an unadjusted basis. And new car prices? Well, they rose on an unadjusted basis, but not nearly as much as the seasonally adjusted data indicated (5.1 percent versus 8.2 percent). Indeed, this pattern seems to be consistent across many of the core components of the CPI in June. On a seasonally adjusted basis, the core inflation measure rose 2.4 percent. But on an unadjusted basis, the core CPI was largely unchanged for the second month in a row (up a slight 0.9 percent, annualized).

Here's a conjecture on my part. Many of the price declines that ordinarily occur in June didn't occur this year. Why? Perhaps it's because the sharp decline in business activity has resulted in such severe production and price cuts already that usual seasonal price discounts have been disrupted. In other words, in the current economic environment, there may not be much "season" to adjust for.

This isn't a criticism of seasonal adjustment. In fact, seasonal adjustment is an entirely appropriate—and necessary—transformation of the data if you are trying to see emerging trends. But it's certainly important to exercise caution when interpreting seasonally adjusted data during a period of strong cyclical movements. If the business cycle alters the usual behavior of the seasonal cycle in the data, seasonal adjustment could produce a misleading snapshot of the data. And I suspect we saw a bit of that in the June CPI report.

In closing, I want to put in a plug that the second weekly postings of the Atlanta Fed's Economic Highlights and Financial Highlights are now available on the Bank's Web site. These summaries of national economic and financial statistics complement our monthly REIN reports on the Southeastern economy.

By Mike Bryan, vice president and senior economist in the Atlanta Fed's research department

Some meaty minutes

I know that some of you are avid consumers of the minutes published following each Federal Open Market Committee (FOMC) meeting. Others not so much, but even if perusing the minutes is a taste you have yet to acquire, you might find the latest edition worth a look as it includes commentary on a number of issues that I believe are on people's minds—at least based on questions I've received following speeches.

A quick summary of what I would pick as highlights:

The Fed's balance sheet is likely to get bigger before it gets smaller, but it will get smaller.
The planning for managing to a smaller balance sheet is under way.
Whatever the future brings for the balance sheet, the time has not yet come to remove policy accommodation—either by adjusting the federal funds rate target, by removing the backstop of most liquidity programs, or by making adjustments in the FOMC's asset purchase programs (described here, here, and here).
With respect to those asset purchase programs, the point is to improve "market functioning," not target long-term market interest rates.

Of course, I don't expect you to take my word for it. Here it is, straight from the source:

On where the Fed's balance sheet is headed:

"Staff projections suggested that the size of the Federal Reserve's balance sheet might peak late this year and decline gradually thereafter."

On confidence in managing the balance sheet:

"… the staff briefed the Committee on a number of possible tools that the Federal Reserve might employ to foster effective control of the federal funds rate in the context of a much expanded balance sheet. Some of those tools were focused primarily on shaping or strengthening the demand for reserves, while others were designed to provide greater control over the supply of reserves. In discussing the staff presentation, meeting participants generally agreed that the Federal Reserve either already had or could develop tools to remove policy accommodation when appropriate."

On the commitment to keep an "exit strategy" front of mind:

"Ensuring that policy accommodation can ultimately be withdrawn smoothly and at the appropriate time would remain a top priority of the Federal Reserve."

On the timing of exit strategy implementation:

"… participants viewed the availability of the liquidity facilities as a factor that had contributed to the reduction in financial strains. If the Federal Reserve's backup liquidity facilities were terminated prematurely, such developments might put renewed pressure on some financial institutions and markets and tighten credit conditions for businesses and households. The period over year-end was seen as posing heightened risks given the usual pressures in financial markets at that time. In these circumstances, participants agreed that most facilities should be extended into early next year. However, participants also judged that improved market conditions and declining use of the facilities warranted scaling back, suspending, or tightening access to several programs…

"In their discussion of monetary policy for the period ahead, Committee members agreed that the stance of monetary policy should not be changed at this meeting. Given the prospects for weak economic activity, substantial resource slack, and subdued inflation, the Committee agreed that it should maintain its target range for the federal funds rate at 0 to ¼ percent. The future path of the federal funds rate would depend on the Committee's evolving expectations for the economy, but for now, members thought it most likely that the federal funds rate would need to be maintained at an exceptionally low level for an extended period, given their forecasts for only a gradual upturn in activity and the lack of inflation pressures. The Committee also agreed that changes to its program of asset purchases were not warranted at this time."

And a clarification of what those asset purchase programs were designed to accomplish:

"The asset purchase programs were intended to support economic activity by improving market functioning and reducing interest rates on mortgage loans and other long-term credit to households and businesses relative to what they otherwise would have been. But the Committee had not set specific objectives for longer-term interest rates, and participants did not consider it appropriate to allow the Desk discretion to adjust the size and composition of the Federal Reserve's asset purchases in response to short-run fluctuations in market interest rates."

There is a lot of other interesting information in the minutes, including a discussion of how the size and composition of the balance sheet might impact Federal Reserve income streams and the Committee's latest gross domestic product growth and inflation forecasts.

Not bad work for a couple of days.

By David Altig, senior vice president and research director at the Atlanta Fed

A funny thing happened update

More than a week has passed since the Regulation D changes went into effect, and it appears that the changes are having a noticeable, if not dramatic, impact on pricing in the funds market—see the updated effective funds rate chart below.

The funds rate did fall last week, and it is possible that the softening was related to an increased supply of fed funds by Federal Home Loan Banks as they sought to reduce their excess reserve balances because they no longer earned interest on those balances. But if that is in fact the explanation, the effect was not large: Fed funds are still trading in a relatively narrow range between about 5 and 40 basis points each day. Though, as the chart shows, the effective fed funds rate has drifted lower so far in July—it was at 15 basis points on Friday, July 10, down from 20 basis points on July 1. The current rate is well above the January low of 8 basis points.

Despite the large increase in supply of funds in the market that might have resulted from the Reg D change, it seems to me that the opportunity for arbitrage profits is helping keep the effective funds rate hovering in the neighborhood of the interest rate paid by the Fed to eligible institutions on their reserve balances.

By John Robertson, vice president in research at the Atlanta Fed

Economic and financial data, neatly wrapped

In the course of an average week, the research department of the Atlanta Fed goes over a lot of data. We periodically bundle the standard data releases into a document that we use as background for our monetary policy discussions.

We thought if these summaries are useful internally, then a wider audience will also find them valuable. So beginning today we will publish our Economic Highlights and Financial Highlights, exclusive of any proprietary data, on our Web site. We anticipate updating these digests weekly.

These summaries of national economic and financial statistics complement our monthly REIN reports on the southeastern economy.

If you find these weekly digests useful—or not—please drop us a note with your feedback.

By Mike Bryan, a vice president and senior economist in the Atlanta Fed’s research department.