1. Whatever It Takes Laurence H. Meyer January 8, 2009 Presentation to the National Economics Club

2. © Macroeconomic Advisers2 January 2009 Signature Features of MA Forecast Recession, transition, and recovery –Deep recession through middle of 2009 –Transition to below trend growth in 2 nd half –Robust growth in 2011 Inflation –Very low, below 1% in 2009, below ½% 2010 –Serious risk of deflation Policy –Whatever it takes: near zero funds rate + unconventional policy –Fiscal: complement, second and significant stimulus package

3. © Macroeconomic Advisers3 January 2009 Compared to What? Early 1990s: Bank capital shortage Fall 1998: LTCM, etc. 2001 Recession: Wealth destruction, bursting bubble 1981-82: Worst postwar recession Japan in 1990s: ZRP and QE The Great Depression: debt-deflation “The aftermath of financial crises” (Reinhart & Rogoff)

4. © Macroeconomic Advisers4 January 2009 Aftermath of Past Financial Crises

5. © Macroeconomic Advisers5 January 2009 Core PCE Headline PCE H F FOMC comfort zone Percent H F MA Forecast Summary Percent Real GDP growth Unemployment rate GDP growth and Unemployment Forecast Macroeconomic Advisers forecast prepared December 24, 2008. Inflation Forecast

6. © Macroeconomic Advisers6 January 2009 Recession Comparisons Macroeconomic Advisers forecast prepared December 24, 2008.

7. © Macroeconomic Advisers7 January 2009 The Assumed Fiscal Stimulus Package Macroeconomic Advisers forecast prepared December 24, 2008.

8. © Macroeconomic Advisers8 January 2009 Treasury Supply: A Lot in the Pipeline Net Treasury Borrowing (4-quarter rolling sum) Federal Debt Held by the Public (% of GDP) Projected 2010Q4 $ billions Projected 2009Q1

9. © Macroeconomic Advisers9 January 2009 A Synchronized Global Recession Change in Real GDP (4-quarter moving average) Percent H F *At market exchange rates Global GDP Growth (4 th quarter to4 th quarter) Macroeconomic Advisers forecast prepared December 24, 2008. Note: Macroeconomic Advisers forecast for foreign GDP is based on projections by Oxford Economics. MA US GDP World GDP

10. © Macroeconomic Advisers10 January 2009 Deflation: A Serious Threat Inflation Forecast Confidence band based on historical errors of consensus forecast as computed by Reifschneider and Tulip (2007) and reported in FOMC minutes. Deflation Risk Core PCE Headline PCE 95% confidence band H F FOMC comfort zone Percent Macroeconomic Advisers forecast prepared December 24, 2008.

11. © Macroeconomic Advisers11 January 2009 Forecast with Deflationary Concerns Percent Baseline Forecast Deflation: A Serious Threat Core PCE Inflation H F Macroeconomic Advisers forecast prepared November 5, 2008. Core PCE Inflation Inflation Expectations

12. © Macroeconomic Advisers12 January 2009 Credit Conditions: The Dominant Forecast Factor Corporate Yield Spread (Moody’s Baa less Treasury) Basis points Percent of banks Banks’ Willingness to Lend* (Senior Loan Officer Survey) * Share of institutions more (positive) or less (negative) willing to make consumer installment loans.

13. © Macroeconomic Advisers13 January 2009 Credit Conditions: Gradual Recovery Percentage points Actual Fitted Baa Corporate Yield SpreadConforming Mortgage Spread Percentage points Actual Fitted H F

14. © Macroeconomic Advisers14 January 2009 Fed Liquidity Policies: A Summary

15. © Macroeconomic Advisers15 January 2009 Improvement in Interbank Funding Market Libor Credit Spread (Relative to OIS Rate) Basis points 3-month rate 1-month rate Percent Effective funds rate 3-month Libor rate Federal Funds Rate and Libor *Effective federal funds rate is a ten-day moving average. The range shown shows the intraday variation, measured as +/- one standard deviation.

16. © Macroeconomic Advisers16 January 2009 The New Policy Regime Broader use of Fed’s balance sheet to achieve objectives Intention of these policies is to influence financial conditions -Monitor credit conditions to gauge success -But no explicit targets Quantitative easing of a different sort -Policies will inject large amounts of reserves -But goal is not the level of reserves No single measure to summarize Fed actions -Watch the H.4.1 -Makes communications challenging Governance issues -All decisions made by FOMC -Even though 13(3) programs under authority of Board

17. © Macroeconomic Advisers17 January 2009 Whatever It Takes 1.To the (almost) zero bound: why the range? 2.Purchase private assets: offset credit shock –Attempt to lower risk spreads, increasing credit availability –New programs for agency MBS; consumer, small business ABS 3.Purchase longer-term Treasuries –Attempt to lower long-term rates (term spreads) –Clearly within their authority –In combination with greater fiscal expansion 4.Policy commitment language –Convey staying at low rates for longer than anticipated –“Some time” similar to “considerable period” language of 2003

18. © Macroeconomic Advisers18 January 2009 Monetary Policy: To the (Almost) Zero Bound Current MA forecast Market expectations H F MA Call vs. Market Expectations Percent Macroeconomic Advisers forecast prepared December 24, 2008.

19. © Macroeconomic Advisers19 January 2009 Prescribed Funds Rate: Taylor Rule Perspective Backward-looking Policy Rule (Based on macroeconomic outcomes) Percent Forward-looking Policy Rule (Based on FOMC & MA forecasts) H F Macroeconomic Advisers forecast prepared December 24, 2008.

20. © Macroeconomic Advisers20 January 2009 Fed Balance Sheet: Massive and Growing 1,774 3,7882

21. © Macroeconomic Advisers21 January 2009 Reserves: More than Needed Composition of Reserves Total Amount of Reserves $ billions Total reserves Other reserves Reserves through lending programs $ billions Required reserves Excess reserves

22. © Macroeconomic Advisers22 January 2009 Treasury Yields: Historic Lows Treasury Yields Yield Curve Slope (10 year-2 year spread) Ten-year Treasury yield Two-year Treasury yield Actual Residual Fitted

23. © Macroeconomic Advisers23 January 2009 Keys to an Eventual Rebound 1.Drags do not continue at current pace -Credit conditions begin gradual improvement -Equity prices rebound -Housing activity stabilizes -Home prices fall at slower pace 2.Overwhelming policy response –Very large fiscal stimulus package –Monetary policy and balance sheet policy

24. © Macroeconomic Advisers24 January 2009 Housing Construction: In Search of a Bottom Housing Activity Thous. units H F Pp Contribution of residential investment to GDP (right) Housing starts (left) House Price Indexes (4-quarter percent change) Percent FHFA purchase-only index Case-Shiller index H F Case-Shiller cumulative decline-33.2 OFHEO cumulative decline -12.9 Macroeconomic Advisers forecast prepared December 24, 2008.

25. © Macroeconomic Advisers25 January 2009 Trillions $ H F Household Net Worth (4-quarter change) Equity Prices: Sharp Decline, then Rebound Next Year S&P 500 Index Index H F Long-term fair value range Macroeconomic Advisers forecast prepared December 24, 2008.