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A Primer on Covid-19 and its Impact on the Supply Chains in China

By Zhio Xi
April 30, 2021

 

The issue of supply chains has been one of the most discussed economic topics in China recently. Since joining the WTO in 2001, China’s integration into the global economy has been accompanied by the reshaping of the global supply chains. Many foreign companies have transferred part of their production to China to enjoy lower labor costs. However, with the gradual increase in labor and environmental costs in China in the past decade, various companies have thought about moving production out of China. The trade conflict between the US and China in the past couple of years and the recent COVID-19 pandemic crisis greatly heated up such discussion. For instance, according to a 2020 survey of over 200 global supply chain leaders, one-third had moved manufacturing activities out of China or planned to do so in the next 2-3 years due to the global pandemic condition as well as US-China trade tensions. This article mainly addresses the impact of the Covid-19 pandemic on the supply chains in China.

The Shock of Covid-19

In terms of the Covid-19 pandemic, the impact on supply chains in China can be analyzed in terms of the trade of intermediate goods, or goods that are used as inputs into the production of final goods. The impact has two aspects. On the one hand, supply chains can be disrupted by the current and post-pandemic situations in the economies of China’s major trading partner countries and would affect directly Chinese exports to the United States, Japan, and Korea. The effects are bilateral: the lack of demand due to the lockdown in these countries can impose pressure on China’s supply chains, as foreign producers cut back on their imports of China’s goods. The possible future waves of Covid-19 in China and the associated costs and uncertainties may challenge producers as well.

Source: OECD, 2019

Note that these trade partners rely heavily on Chinese exports such as computers, electronics, electrical equipment, and textiles. The Chinese exporters in these sectors, in turn, are sensitive to demand shocks, especially those arising from subsequent waves of Covid-19 in these trade partners. For China, the major trade partners for intermediate goods imports are South Korea, Japan, and the US. The main imported goods are electronics and chemicals. Therefore, put together, the computers, electronics, textiles, and chemical industries in China’s manufacturing sector will see the largest impact during the pandemic. Among those industries, firms that rely highly on imported goods with high value added (high tech) are more fragile than firms that can find substitute source countries. For instance, firms associated with optical imaging, medical equipment, vehicle components, printed circuit boards (PCB), and integrated circuits (semiconductor) should be well prepared for the future uncertainties associated with pandemic.Chinese intermediate goods imports as a percentage of total global output (ex-China) by industry

Source: Swiss Re Institute (2020）

There is no doubt that the global supply chains are getting increasingly connected and complex, thus the real long-term impacts of the pandemic are yet to be known. China is a big importer of raw materials and a major exporter of labor-intensive goods used as intermediate goods in final production (according to one estimate, China’s world share of labor-intensive exports is 27%). One aggregate indicator that shows the effect of COVID-19 on China’s trade to date is the trend in exports and imports. The graph below shows that China’s exports have begun to recover from the sharp decline at the start of the pandemic, mid-summer 2020.

Source: General Administration of Customs

Another timely measure of the effects of the pandemic on the supply chains in China is the recent variation in the manufacturing PMI (Purchasing Managers Index, figure below): the PMI had declined to a record low of 35.7 due to the Covid-19 pandemic, but it rebounded back above 50 in twelve successive months following the virus outbreaks in China.

The Purchasing Managers’ Index (PMI) is based on a monthly survey of supply chain managers across 19 industries, covering both upstream and downstream activity. The headline PMI is a number from 0 to 100. A PMI above 50 represents an expansion when compared with the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change.

Source: The National Bureau of Statistics

Both the trends in exports and exports, and the PMI pattern illustrate several points: the impact of Covid-19 was sudden and huge; the virus was contained in a relatively short time and the supply chains in China show some resilience.

A Stress Test

Despite having the world’s largest population size as well as some of the biggest cities, China has become one of the first countries to recover from the pandemic with relatively limited damage. But it is one thing to contain the virus successfully, it is another to reboot the supply chains after the lockdown of the entire country. To some extent, the Covid-19 pandemic acted as a natural stress test for the country’s economy, the government response as well as supply chain resilience and stability. One lesson that supply chain leaders may learn from this pandemic crisis is that instead of pursuing low cost and high efficiency, firms should also focus on resilience and stability. To reach such balance between efficiency and resilience, supply chain leaders may consider measures such as creating more inventory and capacity buffers, as well as diversifying their sourcing or manufacturing bases.

The Future

To keep China as a destination country for foreign firms, one of the leading priorities of the government policies has been the development of the supply chains, especially during the era of pandemic crisis. The government measures are in two main categories: 1) further opening of the Chinese markets to global investors; 2) increasing domestic innovations and development. The measures collectively belong to what the media called “dual circulation” strategy. Such measures are expected to help China reach the goal of offshoring low-value manufacturing of goods and services but maintaining the safe and stable environment for the high-value global supply chain leaders.

The future of the world is highly uncertain. Firms in the global supply chains will gradually find their balance between risks and rewards. As a result, China’s role in the supply chains may get more quality-driven instead of quantity-driven.

A Primer on Covid-19 and its Impact on the Supply Chains in China2021-05-02T23:34:04+00:00

A Look at the New York State Budget

James Orr and Merih Uctum
February 10, 2021

Governor Cuomo recently announced the NY State budget for this year, the FY 2022 Executive Budget Financial Plan. Is New York in a deep budget hole? Will a new Federal spending bill help? In this post we dissect the executive budget and examine how economic developments affect budget projections and the bottom line for the current budget plan.

The plan projects the state’s revenues and expenditures, as well as any shortfalls in revenue, for the current fiscal year FY 2021, which began on April 1, 2020 and ends on March 31, and for each of the four subsequent fiscal years. The focus of interest is the potential shortfall of revenues in the remainder of FY 2021 and FY 2022 and the economic costs imposed on the state by the COVID-19 pandemic. It also considers the potential receipt of some additional funds from a new Federal economic stimulus bill now being negotiated in the Congress. But the plan recognizes the risk of revenue shortfalls and the uncertainty of any Federal assistance, and proposes some state income tax increases and new sources of revenue. The budget will now be discussed by the legislature and a final state budget will be enacted for the April 1 start of FY 2022.

The New York State Executive Budget

The executive budget presents the planned disbursements and the sources of revenues to fund those disbursements for each fiscal year. The final budget is enacted after discussions with the legislature and then updated quarterly. When we talk about the state budget we need to note first that there are three separate but related budgets, or funds, each with specific categories of revenues and disbursements.

The General fund is where most state tax revenues go. The categories of spending within the fund include state assistance to local areas, Medicaid and state agency operations. Medicaid is a particularly important item in the state budget because, as a program where costs are shared between the Federal and state government, the Federal share can be increased to reduce the burden on the state, even as the number of people in the program rises. Total revenues in the General fund were $79.2 billion in FY 2020.

The State fund is a broader concept which includes the General fund plus additional sources of state revenues, such as debt service funds, that help to fund state operations. It is normally considered as the state’s basic operating fund.

The third fund is the All funds measure which includes most of the State fund and federal monies which are used by the state to directly fund some categories, such as transportation spending, as well as joint federal-state programs. Total All funds receipts reached $177.4 billion in FY 2020, and the sources of funds in FY 2020 are shown in the figure below.

Figure 1: NY State FY 2020 revenue sources

Source: Mid-Year Update | FY 2021 Financial Plan (ny.gov) (Tables 15, 26).

The state is required to balance the General fund budget each year, broadly defined as having sufficient revenues to fund the planned disbursements. The figure shows that about 46% of revenues from all sources come from taxes, and most of those tax revenues are placed in the General fund. The broad categories of revenue and spending in the General fund in FY 2020 are shown below.

Figure 2: Shares of revenue and spending in the General fund: FY 2020

Source Financial Plan | NYS FY 2022 Executive Budget (page 29).

The amount of the tax revenues in the fund depends heavily on the income, business, sales and other tax revenues that are generated from economic activity, and projecting activity is key to projecting tax revenues. An example of the variability inherent in projecting revenues is the projection of tax receipts before and after the onset of the pandemic. The executive budget for FY 2021 was presented in January of 2020 and projected tax revenues of $77.1 billion, following the receipt of $72.2 billion in FY 2020. Between February and April the state lost over 900,000 jobs, about 20% of employment, as the economic fallout from the pandemic hit hard and the enacted budget for the fiscal year that began on April 1reduced projected tax receipts to $61.9 billion. The mid-year fiscal update further lowered those revenue projections to $59.1 billion as activity continued weak in the summer. A pickup in activity in the fourth quarter of 2020 raised projected revenues for the fiscal year to $62.4 billion. These changes in the tax revenue projections get great attention as the state needs to bring the General fund into balance.

Because the pandemic and its economic impact were felt broadly across all states, the Federal government passed four measures in 2020 to help alleviate the problems of workers, small businesses, and state and local governments. The largest bill, CARES Act, had $2.6 trillion of spending that included a coronavirus relief fund (CRF) to cover costs to state and local governments related to the pandemic. The categories covered included public safety, personal protective equipment, medical equipment, emergency response activities, and testing. New York received roughly $6 billion in funding for these activities. Currently, the state has regained only half of the jobs lost in the early months of the pandemic and there is still uncertainty about the future for the state and the nation.

Current Projections for FY 2021 and FY 2022

Projections for FY 2021 and FY 2022 in the General fund show a shortfall in revenues: $4.7 billion in FY 2021 and $10.2 billion in FY 2022, or a $15 billion two-year gap. The state has proposed cutting spending and raising revenues to bring the budget into balance. Below we reproduce the state’s plan to close these gaps in FY 2021 and FY 2022. The positive numbers in the table indicate either increases in revenues or declines in spending, and we highlight several key entries.

Table 1: Executive budget gap-closing plan
(millions of dollars)
UPDATED “BASE” BUDGET GAPS FY 2021
(4,772)		 FY 2022
(10,201)
Local Assistance:1
School Aid/Local District Funding Adjustment 0 1,506
Medicaid 1,230 599
All Other 991 1,265
Agency Operations 44 110
Debt Service/Capital Projects
New Revenues:		 517 135
PIT High-Income Surcharge 0 1,537
PIT Middle-Cl ass Tax Cut One-Year Pause 0 394
All Other 17 60
Federal Resources:
CRF 2,476 0
Medicaid FMAP 497 995
FEMA Reimbursement (1,000) 600
Unrestricted Federal Aid 0 3,000
­­­­­­­­­­­­­­­­­­­­­­______________________________________________________________________________

  1. Includes savings from reductions outside the General Fund that are achieved through the transfer of balances. and/(or) increase in revenues made available by spending reductions
    Source: Financial Plan | NYS FY 2022 Executive Budget (page 20).

Focusing on FY 2022, the largest spending cuts are in the categories of planned state aid to localities, $1.5 billion, or about 3% of this assistance, largely from changes in reimbursements to school districts. These cuts effectively shift some of the burden of state revenue shortfalls down to cities and towns. Medicaid spending is also cut by $600 million with the cuts planned to come partly from increased program efficiencies. Proposed FY 2022 new revenue sources include a high-income surcharge, which will raise revenue by $1.5 billion through a 2 percentage point increase on taxable income above five million dollars, to 8.8%, and a pause in the reduction of income tax rates on middle-income taxpayers which yields an additional $394 million.

Federal aid

Federal resources are also seen as potential sources of new revenue. The CRF revenues are projected to run out but Medicaid reimbursements will remain high. Spending in FY 2020 for emergency relief is expected to be reimbursed by FEMA (Federal Emergency Management Agency) over the next several years. A key factor in the projections is whether the proposed Federal stimulus bill with $350 billion for state and local governments will be passed. No such aid was contained in the December 2020 Federal stimulus bill and its inclusion in the bill now being negotiated is uncertain. The state gap closing account assumes it will receive $6 billion in unrestricted aid and allocates $3 billion in FY2022 and the same amount in FY 2023. Higher levels of aid will eliminate some of the pressure to cut spending and/or raise taxes.

Outlook

The outlook for the state budget depends on numerous factors, but key among them are progress in controlling the spread of the COVID-19 virus. New waves of the virus this winter or spring could lead to a further clampdown on economic activity. The strength of the recovery in the nation and state economies will determine the path of tax revenues going forward. Risk abound, but a break out of pent-up demand as the virus abates would give a needed boost to the economy and revenues. Finally, should the Federal stimulus bill currently being negotiated provide significant unrestricted aid to states and localities there is a potential to avoid any of the cuts and tax increases in the current gap closing plan.

A Look at the New York State Budget2021-02-24T00:49:15+00:00

New York’s Employment Gains Slow in November

The number of jobs in New York State continued to increase in November though at a slower pace than in October, even taking into account the phasing out of the 2020 census jobs. The New York State Department of Labor reported that employment statewide increased by 29,500 (seasonally adjusted) in November following an increase of 32,300 in October; private sector job counts in the state were up by 36,300 in November following an increase of 54,800 in October. The slower gains in the state this month follow the pattern of slowing job gains nationwide. The U.S. Bureau of Labor Statistics reported that employment in New York City was up by 10,500 in November, below the 23,200 jobs gained in October. Employment levels in the both the state and the city are now roughly 10% below their pre-COVID-19 peaks.

The unemployment picture in New York continued to improve in November. The state’s unemployment rate fell to 8.4 % from 9.2% in October, but still above the 6.7% unemployment rate nationwide. In New York City, the unemployment rate fell to 12.1% in November from 13.0% in October.

The New York State Department of Labor reported filings of initial claims for Unemployment Insurance in the state totaled 58,311 during the week ending December 12, slightly below the previous week’s filings but above the four-week average of 53,500. Nationally, filings of initial claims for Unemployment Insurance also rose in the week ending December 12 over the prior week and the prior four-week average. In New York City, filings of initial claims for Unemployment Insurance totaled 26,762 during the week ending December 12, slightly above last week’s filings and the prior four-week average of 23,000.

New York’s Employment Gains Slow in November2021-01-12T23:22:27+00:00

New York’s Economy Trying to Heal From the COVID-19 Crisis

Fadime Demiralp and James Orr
October 31, 2020

Deep declines in employment across New York resulted from the efforts to contain the COVID-19 outbreak. Where does the economy stand? What factors will affect the recovery? We address these questions in this post. In March New York declared a state of emergency, public schools were closed, and an executive order was issued requiring residents to stay-at-home and all non-essential businesses to shut down. Containment efforts in states across the nation led to deep declines in aggregate economic activity. In New York, a phased reopening of economic activities got underway in May and currently the state’s economy is largely reopened, though with some important exceptions. A smooth process of recovery would generally have minimal new virus-related disruptions, employment returning to its pre-COVID-19 level, a so-called V-shaped recovery, and no spillovers that create longer-term negative economic impacts. In New York, employment has turned around and is well off its March/April lows, but recent job gains have slowed. Next, we use trends in employment to describe where the New York economy is in the recovery process and then outline the factors that might have an impact on the recovery.

New York hit hard by the COVID-19 crisis

After the first reported COVID-19 case in late February, New York saw daily new cases rise to as much as 10,000 in mid-April before stabilizing at about 600 by mid-June. The pattern reflects the timing of new cases in New York City.

September saw the start of a rise in the number of daily new cases and localized clusters in the city, though the number of new cases is well below those of the Spring. Within New York City, the cases were relatively concentrated in areas with large household sizes and lower incomes, and the highest rate of new cases was among those aged 75 years and older. Deaths from the virus were concentrated in areas with large Black and Latino populations, as well as among the elderly; over 32,000 state residents and more than 23,000 city residents to date have died.

The state’s executive order was essentially a lockdown that, together with precautions by individuals to avoid the risk of contagion, resulted in a huge decline in economic activity in New York State and New York City. Early indications of the magnitude of the downturn came from March business surveys and the massive filings of initial claims for unemployment insurance. The impact was then reflected in job counts. The monthly index of employment shows huge declines in March and April in New York State, New York City and the nation: Employment in New York City fell by 944,000, or 20% of total city jobs, statewide by 1.945 million, also roughly 20% of the state total, and nationally by 22 million, about 15%.

Unemployment rates also rose dramatically, rising from around 4% just prior to the crisis and peaking around 16% nationally and in New York State and over 20% in New York City.

Some of the hardest-hit industries in New York City were, predictably, those considered non-essential, affected by travel restrictions, and where face-to-face transactions are the norm, including hotels and restaurants, retail, segments of healthcare and social assistance, personal services, building services and transportation and warehousing. All non-essential construction projects were halted. Industries where office work was more typical were able to avoid major losses by having their workers work-at-home, including the information, finance and professional and technical services industries.

Signals from the real estate market reflect the recent weakness. In the residential market in the city, and Manhattan in particular, school closings, social distancing and work-from-home orders were associated with a sudden outmigration. It is not clear how permanent this is, but more mobile, higher-income residents appear to be those most likely to be moving; lower-income residents who have lost their jobs may have difficulties paying their rent. The market now has a rising rental inventory, more than double that of last summer and, in Manhattan, rents are down roughly 8% from a year ago. The commercial market is also weak: New leases in Manhattan were reported to be down more than 60% in August from last year’s monthly average, office rents are down, and sub-letting of space is on the rise. Bucking this trend is the ongoing purchases and leases of significant amounts of office space by major high-tech companies, suggesting they continue to pursue their long-term expansion plans in the city.

The COVID-19-related weakness in the state and city was compounded by the dampening effect of efforts throughout the country to address the rising number of new virus cases. In fact, the national economy was shown to have entered a recession in February. The national scope of the decline gave the impetus for broad monetary and fiscal programs to mitigate economic hardships for workers, businesses and state and local governments, and to maintain smooth functioning of financial markets. Congress is currently debating additional fiscal support.

Where does the economic recovery in New York City stand?

The phased reopening has been underway since the stay-at-home order ended on May 28. In New York City, ongoing social distancing practices still restrict some consumer activities and tourists and most office workers have yet to return. Focusing on employment, the recent decline was more than four time larger than in either the prior two downturns—that following the 9/11 attack in 2001 or the financial crisis that began in 2007.


The developing V-shape pattern of employment recovery in the first seven months since the crisis started shows a bounce off the bottom and contrasts with the more gradual upturns in the two earlier cycles. The shape has flattened out a bit in the past two months, however, and there is now a fair amount of variation in employment recovery across industries.

Looking at five affected industries, employment in the healthcare and social assistance sector had a relatively small percent decline but has plateaued about 6% below its pre-COVID-19 level. The huge size of the sector means jobs are down about 45,000. The professional and business services sector also had a relatively modest percent decline, an important component related to services to buildings, and employment has been slow to recover. Retail tradeemployment had a much larger percent decline, including losses in clothing and department stores. The industry is still 10% below its pre-COVID-19 level.
Construction jobs had a large decline and a fairly strong bounce, characteristic of a V-shaped recovery, and has levelled off about 10% below pre-COVID-19 levels. Employment in the accommodation and food service sector was extremely hard hit, falling about 70%, or 250,000 jobs, before beginning to recover. A full return to business in this sector will likely require eliminating remaining restrictions on bars and restaurants and the return of customers in the varied base that it serves—residents, office workers, domestic and international tourists and business travelers–who will all need to feel much more comfortable in an environment based on individual contact. Although job gains there continue, the industry is still more 40% below its pre-COVID-19 level.

Looking ahead

The New York employment figures have clearly been moving in the right direction but the pace of recovery has slowed after the bounce off the March/April lows. However, initial claims for unemployment insurance in recent weeks are down and do not indicate a surge in job losses in either New York State or New York City. For New York City, forecasts have jobs down significantly from pre-COVID-19 levels this year though the pickup that began in May is expected to continue in 2021. The range of job forecasts is wide, and numerous risks remain. Local risks include a pickup in residential outmigration flows, or decisions by outmigrants not to return, and the reconfiguration of office work in a way that keeps significant numbers of workers at home or otherwise outside the city. Roughly 10% of office workers to date have returned. For governments, potential revenue shortfalls for both the state and city that lead to cutbacks in spending and services could weigh down economic activity. A follow-up federal fiscal package could address budgetary aid for state and local governments. Nationally, GDP is expected to grow in the second half of 2020 and into 2021, and should help support local industries—professional services, manufacturing, finance—that serve broader domestic markets. International travel and tourism are already highly constrained and the timing of a pickup here remains uncertain.

The full return to pre-COVID-19 levels of employment, or essentially a return to the trend of residents, consumers and businesses desiring proximity and feeling the traditional pull of the city, will be greatly supported by the development of a vaccine for the virus that reduces the need for social distancing and make shoppers, transit riders, tourists and office workers more comfortable being in the city.

Podcast link

New York’s Economy Trying to Heal From the COVID-19 Crisis2020-11-02T17:06:51+00:00

The Fed’s enlarged balance sheet: The Expanding Importance of Bank Reserves (Part II)

Fotis Siokis
September 30, 2020

Introduction

With an enlarged balance sheet, what is the new operating regime of the Fed (or how does it conduct monetary policy) and what are its options? In this second post we address these questions. In Part 1 we discussed the action taken by the Fed to limit the economic damage from the pandemic and stabilize the highly volatile financial markets. We showed how in early March, the Fed first reduced the federal funds target rate to near zero levels. Then, moving beyond the conventional monetary policy tools, the Fed introduced an aggressive quantitative easing plan, purchasing unlimited amounts of longer-term assets ( U.S. Treasuries and agency mortgage-backed securities) and utilizing a variety of liquidity facilities. The aggressive response to the coronavirus crisis caused an enormous expansion of the Fed’s balance sheet, well above the elevated levels of the Great Recession. The superabundance of reserve balances held by banks at the Fed is attributed predominantly to the vast preponderance of excess reserves.

How does the excess liquidity environment affect monetary policy and why? The Federal Funds Rate and the Floor System

Historically, banks used to hold a minimum amount of excess reserves in the Fed just to meet transaction obligations. With limited excess reserves, the Fed could easily use the interest rate policy and, by conducting open market operations, steer the target of the federal funds rate. However, the dramatic increase of banks reserves held at the Fed impaired the mechanism of influencing the federal funds target rate. This is because the Fed could no longer rely on small changes in the supply of aggregate reserves to adjust the level of the federal funds rate. This outcome along with the authorization of the Fed to pay interest on banks reserves, under the Financial Services Regulatory Relief Act of 2006, signaled the beginning of a new policy regime. The Interest on Excess Reserves assumed a very powerful key role, in terms of “navigating” the federal funds rate and consequently the whole spectrum of short-term interest rates.

The interest on excess reserves as an administered rate sets the “floor” for the federal funds rate, below which banks have no incentive to lend to other banks. Although the two move closely together, a fed funds rate drifting far below the interest on excess reserves triggers arbitrage actions, in which banks borrow at the lower fed fund rate and deposit it as reserves and thus earn the higher interest on reserves. As can be seen in Figure 1, the fed funds rate is trading below interest rate on reserves since other institutions such as government-sponsored enterprises that have deposits at the Fed without earning interest on reserves, transact with other depository institutions and other institutions at the fed funds rate.

In addition, allowing other non-depository institutions, such as money–market funds or broker-dealers, to deposit funds for very short periods with the Fed, these funds earn a fixed interest rate less than the interest rate on reserves , called the overnight reverse repurchase program. With this program on board, the Fed complements the interest rate on excess reserves facility and increases the control over the fed funds target rate. The two interest rates serve as the upper and lower limits of the fed funds target range.

Figure 1. The evolution of interest on excess reserve and the federal funds rate
Source: FRED, Federal Reserve in St. Louis

In addition to the control of the interest rates, the Fed oversees a wider set of organizations (both the regulated and the shadow banking systems), and it can mitigate the economic incentives especially by depository institutions to engage in usurping excessive amounts of maturity transformation to finance long-term lending with short-term borrowing.

The expanding role of the Fed may lead to difficulties ahead

Inevitably, the Fed operates in an enduring environment of enlarged balance sheets. Judged by historical standards, the advent of an enlarged balance sheet is probably here to stay. With successive quantitative easing measures starting from the Great Recession and onwards, excess reserves have grown enormously. Particularly from September 2012, and due to signs of weaker than expected labor market conditions, the Federal Open Market Committee began a third round of large-scale asset purchases (Quantitative Easing, QE3), equal to $ 85 billion per month, which later decreased to $ 75 billion per month. As a result of QE3, depository institutions reserves increased dramatically (Figure 2, period 2012-2015), since banks receive cash in the form of reserves in exchange for their Treasury securities.

Figure2. Currency in circulation and Banks’ Deposits

Attempts to decrease asset holdings and consequently the reserves could be very challenging by causing disruptions in monetary policy and an arrhythmia in financial market functioning. Consider for example the incident in mid-September 2019 in which a reduction of the balance sheet was in progress, by means of not reinvesting the proceeds of bonds that were maturing, a process called normalization policy. It proved quite difficult to achieve the required federal funds target rate without the continuous interventions of the open market Fed’s desk. To assure markets that the system had ample supply of reserves, the desk had to conduct term and overnight repurchase agreement operations in the amount of $60 billion in short-term Treasury securities per month and for at least six months.

Yet, some of the liquidity facilities introduced by the Fed, such as the program of buying investment-grade corporate debt from primary and secondary markets, could open the Pandora’s box. Not only the Fed assumes credit risk, which could be quite worrisome and constrain the efficacy of monetary policy, but also the employment of multidimensional tools could blur the boundary between monetary and fiscal policy, threatening the Fed’s policy independence.

The issue of independence deserves broader consideration because, under the terms of an enlarged balance sheet, the Fed in the role of a multipurpose vehicle could create the conditions for off-budget fiscal policy and credit allocation attempts.Political interference as it happened in the past and particularly in 2015, where the Fed funded a transportation bill under congressional mandate, could limit the Fed’s independence which is widely viewed as an important pillar of sound monetary policy.

Discussion

Increased purchases of longer-term assets illustrate the fact that central banks increasingly rely on balance sheet policy rather than the traditional interest rate policy. This reliance is likely due to the fact that the supply of reserves is greater than the demand, creating the need to establish new levels of interest on excess reserves as the floor and the ON RRP as a subfloor. Therefore, the interest on excess reserves as the new instrument of monetary policy is complementary to maintain a large balance sheet and offers an opportunity to improve financial stability.

Also, worth noting that recently Chair Jerome Powell announced a change in the inflation targeting policy, shifting from a 2% target to “a flexible form of average inflation targeting” strategy. The new framework indicates that the Fed will now allow inflation to overshoot 2% temporarily-with the average to be 2%- to compensate for times when the rate falls for quite some time, as it does right now, below the 2.0% target. As it stands, the layout of the new average inflation targeting strategy is not so explicit. The Fed should provide adequate details as to how it will calculate the average inflation, and it should provide some form of forward guidance regarding the time period that inflation remain above the 2% target, or it will be tied to the state of the economy.

In principle this new framework is constructed to (i) to create more inflation, although the Fed’s main challenge is to demonstrate how this can be achieved, after years of undershooting  2%, (ii) give some space to monetary policy and (iii) contain inflation expectations close to 2%. Hence, for those reasons the new inflation targeting framework points to a monetary policy where short term interest rates will stay close to zero lower bound area for at least the next couple of years, even if the unemployment rate reaches low levels.

Lastly, the regime in setting up interest rates is analogous to that of other central banks like the European Central Bank or the Bank of Japan.  The major difference is that, with zero lower-bound interest rates, these two central banks have operated for quite some time in an environment of negative banks’ deposit interest rates. Could the fed contemplate a similar financial environment?

The Fed’s enlarged balance sheet: The Expanding Importance of Bank Reserves (Part II)2020-11-02T01:18:44+00:00

New York’s Employment Gains Slow Modestly in August

The number of jobs in New York State increased in August at a slightly slower pace than in July, and were boosted by the start of hiring for the 2020 census. The New York State Department of Labor reported that employment statewide increased by 153,300 (seasonally adjusted) in August following an increase of 161,000 in July; Federal government employment in the state in August rose nearly 21,000.  The state’s job count is now about 14% below its pre-COVID-19 peak in February.  The increase in employment nationwide in August also slowed from July, the total boosted as well by census hiring; employment nationwide is now about 7.5% below its pre-COVID-19 peak.   The U.S. Bureau of Labor Statistics reported that employment in New York City was up by 108,000 in August, above the 42,400 job gain in July.  Employment in the city is now roughly 15% below its pre-COVID-19 peak.

The unemployment picture in New York improved significantly in August.  New York State’s unemployment rate fell more than three percentage points from July to 12.5%. The state’s rate is above the 8.4% unemployment rate nationwide. In New York City, the unemployment rate fell to 16.0% in August from 19.9% in July.

The New York State Department of Labor reported filings of initial claims for Unemployment Insurance in the state totaled 71,641 during the week ending September 19, above the previous week’s filings and up from the prior four-week average of 64,102. More than 3.8 million workers in New York have filed an initial claim for Unemployment Insurance since the start of the COVID-19 pandemic. In New York City, filings of initial claims for Unemployment Insurance totaled 41,463 during the week ending September 19, also above the previous week’s filings and up from the prior four-week average of 35,662.

New York’s Employment Gains Slow Modestly in August2020-09-26T16:29:54+00:00

New York’s Employment Recovery Slows in July

The number of jobs in New York State increased in July but at a slower pace than in June, and the statewide unemployment rate ticked up.  The New York State Department of Labor reported that employment statewide increased by 176,600 (seasonally adjusted) in July following an increase of 274,000 in June.  Employment statewide is still 15% below its pre-COVID-19 peak in February.  The increase in employment nationwide also slowed in July, though total employment is now about 9% below its pre-COVID-19 peak.   The U.S. Bureau of Labor Statistics reported that employment in New York City was up by 56,000 in July following a gain of 101,000 in June.  Employment in the city is now roughly 17% below its pre-COVID-19 peak.   

Despite the reported increase in jobs, New York State’s unemployment rate rose modestly to 15.9% in July from 15.6% in June.  The state’s rate is above the 10.2% unemployment rate nationwide.  The rise in the state’s unemployment rate can be partially explained by an increase in the state’s labor force in July of more than 200,000.  In New York City, the unemployment rate fell to 19.8% in July from 20.2% in June. 

The New York State Department of Labor reported filings of initial claims for Unemployment Insurance in the state totaled 63,178 during the week ending August 15, moderately above the previous week’s filings but down from the July weekly average of roughly 88.000.   In New York City, filings of initial claims for Unemployment Insurance totaled 33,591 during the week ending August 15, also above the previous week but down from the July weekly average of roughly 45,000. 

New York’s Employment Recovery Slows in July2020-08-31T17:10:46+00:00

The Federal Reserve and its balance sheet: A Herculean task in mitigating the economic effects of the coronavirus pandemic (Part I)

Fotis Siokis
July 30, 2020

Introduction

Global pandemic events in history, beyond death and destruction, have caused major economic fallout and collapses in international trade. The recent COVID-19 pandemic belongs to this category and is considered the most perilous pandemic in the last 150 years apart from the Spanish influenza. The effects of the pandemic on the global and particularly on the U.S. real economy were immediate and devastating, causing a paralysis in economic activity and a dramatic increase in the unemployment rates, while financial market functioning was severely disrupted. To ensure that the economic damage induced by the pandemic would not be permanent or long lasting in light of these developments, the Federal Reserve (FED) responded rapidly and boldly by expanding the scope of its tools and instituting exceptional and unprecedented measures. In this post we describe the array of both conventional and unconventional monetary tools that were put to work and discuss some of the challenges for monetary policy going forward.

An Outline of Recent Federal Reserve Actions

In early March, the Fed went to work beginning with the reduction of the federal funds target rate to near zero in two subsequent not regularly scheduled Fed meetings. Moving beyond the conventional monetary policy tools, in mid-March the Fed proceeded with the use of unconventional tools, many of them employed in the previous financial crisis of 2007-2009. The Fed introduced an aggressive quantitative easing plan with purchases of unlimited amounts of longer-term assets, that is, U.S. Treasuries and agency mortgage-backed securities (ABS). The stated purpose of the purchases was to improve liquidity in the treasury and ABS markets. Similarly, the Fed utilized a variety of liquidity facilities, ranging from U.S. dollar swap lines to primary- and secondary-market corporate and municipal liquidity facilities, to main street new and expanded loan facilities for small- to medium-size enterprises. Although the analysis of all liquidity facilities initiatives is not within the scope of this article, we present them on Table 1.

Table 1: The FED’s action in response to the coronavirus threat

Source: Federal Reserve Board

We also discuss two main initiatives, namely the Commercial Paper Funding Facility and the introduction of a new-implemented measure, the Secondary Market Corporate Credit Facility. The reader should consult https://www.brookings.edu/research/fed-response-to-covid19/ for a thorough analysis of all facilities.

Two Liquidity Facilities explained

  1. Commercial Paper Funding Facility.

The Fed introduced for the second time the Commercial Paper Funding Facility in an attempt to provide ample liquidity and to encourage investors to reengage in term lending in the market. It was first created on October 27, 2008, as a result of the credit crunch faced by the financial intermediaries. Commercial paper is a short-term mostly unsecured debt instrument, issued with a discount, by corporations. Its purpose is to finance a wide range of economic activity and tends to have very short maturities ranging from a few days to several months. As an instrument, commercial paper is used widely for financing short-term liabilities. But because of the COVID-19, the market was placed under severe pressure. With very limited market demand, and investors reluctant in assuming unsecured debt, corporations were constrained and unable to issue longer-term commercial paper. The Fed, as of April 6th, and acting as a Lender of Last Resort began making purchases, mostly of high-rated eligible 3-month commercial paper (both unsecured and asset backed paper). The purchases are made through the employment of a Special Purpose Vehicle with a private corporation to serve as the investment manager. Since the introduction of this specific facility, the interest rates for all grade paper seem to have fallen (figure 1).

Figure 1. Interest rate on overnight AA Nonfinancial Commercial Paper
Source: Federal Reserve
  1. Secondary Market Corporate Credit Facility.

The second facility that distinguished itself from the others is the Secondary Market Corporate Credit Facility. While other major central banks have regularly used this facility in purchasing investment-grade corporate debt, the Fed engaged in such an action for the first time. Since May 12, it started purchasing exchange-traded funds (ETFs), and bonds mainly with investment grade of BBB and higher, in order to provide ample liquidity to corporates and calm down the volatile bond markets. As of May 20, the Fed holds around $1.8 billion of ETFs. The rational of buying ETF’s lies in the fact that such action could impact the prices of a wider spectrum of bonds. However, in addition to investment grade bonds, the Fed engages in ETFs purchases with high yield bonds including the so-called “fallen angels”, corporates that lost their investment grade due to adverse economic conditions. On some occasions “fallen angels” bonds were downgraded to speculative or junk grade. Purchasing of high-yield bonds, and, also investment grade corporate bonds could open Pandora’s box, since not only does the Fed assume credit risk, which could be quite worrisome and constrain the efficacy of monetary policy but also could threaten, along with other multidimensional activities, the Fed’s policy independence. The recent announcement of Hertz’s bankruptcy could be served as an example. Although, Fed’s exposure is limited or non-existent, the assumption of such credit risk could send mixed and blurred signals to the market. The purchases under the Secondary Market Corporate Credit Facilities program are made through the introduction of a special purchase vehicle and managed by a private firm. Since the introduction of the facility, the index of the high-yield ETFs increased considerably (figure 2).

Figure 2. The evolution of Investment Grade and high-yield ETFs Indexes
Source: Bloomberg

An Anatomy of the Fed’s Balance Sheet and the Emerging Challenges

The particularly aggressive response to the coronavirus crisis caused an enormous expansion of the Fed’s balance sheet, much higher than the already-elevated levels generated by the Great Recession crisis. The Fed’s balance sheet consists of assets and liabilities (plus the capital account). The asset side contains mainly the purchases of US treasury debt, Mortgage Back Securities (MBS) and federal agency debt securities, among other items, while the liability side contains Depositary Institutions’ reserves, both required and excess, plus outstanding currency (Federal Reserve Notes). Both of these items, in general, comprise the monetary base. When the Fed conducts expansionary monetary policy, it buys securities from commercial banks (and other dealers) and credits the related fund in depository institutions’ account held at the Fed. Therefore, it should be made clear that an increase in assets causes an increase in liabilities as well. Depository institutions keep required and excess reserves at the Fed for regulation compliance, to take care of transaction obligations, and to build a liquidity buffer in adverse situations. Depository institutions borrow and lend excess reserves at the effective Fed funds rate, which is influenced by the Fed’s policy.

Table 2. The Fed’s balance sheet, selected dates (in $ billions)

Source: Board of Governors, Factors affecting Reserve Balances, Consolidated Statement of Condition of All Federal Reserve Banks

Table 2 depicts the Fed’s balance sheet in three different time periods. Since the onset of the 2007 crisis, the assets as well as the liabilities have grown dramatically as a result of bond buying, commonly known as quantitative easing. The balance sheet expanded from $850 billion at the onset of the Great Recession crisis to almost $ 4.5 trillion by the end of 2014 and to the gargantuan size of $ 7.1 trillion in May 2020. The major component of the assets comprises the holdings of the U.S. Treasury bonds, which grew from $ 768 billion in 2007 to $ 4.4 trillion in 2014 and to approximately $6.0 trillion in May 2020. From the liability side, the reserves have grown from $28 billion prior to the crisis to almost $ 2.6 trillion at end of 2015 and owing to coronavirus monetary policy actions spiked to $ 4.8 trillion on May 20th, 2020, almost 160 times as great as the August 2007 figure. The growth of the balance sheet over time is also depicted in figure 3.

Figure 3. The evolution of the Fed’s balance sheet up to June 2020 (in $ billions)
Source: FRED, Federal Reserve of St. Louis.

The superabundance of reserve balances is attributed predominantly to the vast preponderance of excess reserves. It is argued that this could potentially be inflationary, since banks reserves are a component of the monetary base, which in the last decade grew at an unprecedented pace. However, although the balance sheet expanded to over $ 7 trillion, which ranks the highest among the major central banks, as a ratio to GDP, it is modest. Specifically, the Fed’s holdings are equal to 37% of GDP, compared with112% for Bank of Japan, 50% for European Central Bank and 57% for the Bank of England.

Conclusion

The recent events of increased purchases of longer-term assets illustrate the fact that central banks will rely more and more on balance sheet policy than on the traditional interest rate policy. Based on market estimates, the Fed’s balance sheet will grow further to the level of $9 as we entered into a deep recession placing over 38 million people out of employment. The liquidity facilities introduced by the Fed, with most of them extended through the end of this year, certainly could not cure the economic damage induced by the pandemic. But it is an imperative and a novel effort of mitigating the disastrous effects of it.

The Federal Reserve and its balance sheet: A Herculean task in mitigating the economic effects of the coronavirus pandemic (Part I)2020-10-04T16:25:08+00:00

New York’s Labor Market Steadies in May  

By Jim Orr,

The New York State Department of Labor reported that employment statewide increased by 98,000 (seasonally adjusted) in May, a recovery of about 5.0 % of the nearly 2 million jobs lost in the March/April period.  This gain was below the nationwide recovery in May of about 11.0 % of the jobs lost.  The bulk of May’s job gains in the state occurred outside of New York City: The U.S. Bureau of Labor Statistics reported that employment in the city was up by 6,000 in May, after having fallen by 944,000 in March/April.

New York State’s unemployment rate fell to 14.5% in May from 15.3% in April.  The state’s rate was moderately above the 13.3% unemployment rate nationwide in May.  The unemployment rate in New York City rose to 18.3% in May from 15.0% in April. 

The New York State Department of Labor reported filings of initial claims for Unemployment Insurance in the state totaled 97,000 during the week ending June 13; one month ago (the week ending May 16) new filings totaled 229,000.  In New York City, filings of initial claims for Unemployment Insurance totaled 50,000 during the week ending June 13; one month ago the number of new filings was more than 116,000. 

New York’s Labor Market Steadies in May  2020-06-27T06:27:01+00:00

The Pandemic and the Emerging Markets Crisis: How Fragile are the Economies?

Utku Demir and Merih Uctum 
June 11, 2020

The Emerging Market (EM) economies that came out of the 2008 financial crisis relatively faster than advanced economies are hard hit by a quadruple-whammy this time: the pandemic, capital outflows, economic recession, and debt crisis. In March 2020, more than USD100 billion flew out of the EMs.

This analysis looks at the flight to the safety of global investors and its impact on these economies that owe more than $8 trillion in foreign-currency debt.

The EMs have come a long way since the 1990s when they were unable to borrow in their currency, a phenomenon dubbed “the original sin” by Eichengreen and Hausmann, which made them dependent on external financial conditions. Adverse global conditions could lead to capital flight and depreciation of their exchange rate, which pushed their economies into insolvency since the value of the debt burden rose in local currency. If foreign creditors lost confidence in the local economy, they could abruptly reduce the international flow of the capital in the economy. This phenomenon is also often accompanied by domestic residents increasing their investment abroad. Called a “sudden stop,” the abrupt reversal of capital flows would be often accompanied by recession and a currency crisis through a run on EMs currency. During the last several decades, however, following improved economic and financial management and strengthened banking systems, most EMs have been able to borrow in their currencies. Yet, they now face another problem, the “original sin-redux,” as described by Carstens and Shin: since the performance of investors in EMs in local currency is evaluated in USD, a depreciation of the EM currency is costly for investors. So, during an international crisis, this heightened risk leads to capital flight and further depreciation of the currencies.  

EM economies are no strangers to capital flight. In recent history, several episodes led to capital outflows from these countries. Since the Global Financial crisis, they have been hit by the Taper Tantrum when the Fed decided to stop quantitative easing, which led to a market selloff of EM currencies in a panic; a Renminbi devaluation that reduced its value against the USD for the first time in 20 years and rattled the markets; and the 2018 EM selloff following global trade uncertainties and the strength of the USD. The market panic of this year has been more severe. As the spread of the coronavirus ripped through financial markets and fears of a recession gripped investors, capital flows to EMs collapsed at the onset of the pandemic. Although some of the outflows slowed down and new inflows took place since then, the decline has been much more severe than the financial crisis or any other episode of market disturbance to these economies (Figure 1).

Figure 1. Comparison of portfolio outflows episodes (percent of International Investment Position)

Source: International Monetary Fund, World Economic Outlook, April 2020.

In conjunction with massive capital flight, the value of EM currencies collapsed. Since January 2020, the fall in EM exchange rates due to the pandemic-induced lockdown was compounded by plummeting oil and commodity prices, which adversely affected the exporters. The flight to safety by investors, who piled into the dollar as the virus spread over the continents, exacerbated the free fall of these currencies. Figure 2 depicts the change in the value of EM currencies since the beginning of each episode. In the first 90 days of the pandemic, the decline in the currencies was severe but more abrupt than the decline during the same period of the Great Financial crisis.

Figure 2. Comparison of currency depreciation episodes (bilateral EM rates against the US$)

Source: Federal Reserve Economic Data and authors’ calculations. EM economies include China, Mexico, Korea, India, Brazil, Taiwan, Singapore, Hong Kong, Vietnam, Malaysia, Thailand, Israel, Indonesia, Philippines, Chile, Colombia, Saudi Arabia, Argentina, and Russia.

Not all countries have been impacted by capital flight in the same way. To examine this, we can consider variations in exchange-traded funds (ETFs). 

An ETF is a type of investment fund that consists of portfolios that track the price and yield of an underlying index. As such, EM ETFs are readily available and can give an understanding of the recent fluctuations in portfolio flows from these economies. Earlier in the year, most EMs, except for the Philippines, have seen sharp declines in net ETF positions, which shows the extent of capital flight from these economies in March (Figure 3). The outflow was abrupt and substantial, paralleling the collapse of their currencies. 

Although the net positions subsequently improved, they remain well below the 2018 levels.

Figure 3: Exchange-Traded Funds (year-over-year percent change)

Source: Investing.com, ETF Equities in the United States Market, issuers: iShares for all countries except Argentina. The issuer for Argentina: Global X

As a result of these massive shocks, EM economies are grappling with the fallout from the pandemic, shutdowns, loss of cheap financing, a staggering recession both at home and abroad, and an inability to service their debt to foreign creditors. Despite the G20’s initiative to suspend debt repayment by the poorest countries, it does not cover the debt owed to private creditors. Further, many EM countries are excluded from this deal; several of them are therefore facing a risk of default, as illustrated by Argentina’s May 22 default, its 9th since 2001.

To analyze the severity of default risk, various indicators are used to assess the vulnerability of economies to sudden stops. 

Typical indicators include the level of external debt as a share of exports, the ratio of debt service to international reserves, and the ratio of current account balance to GDP. In this analysis, we will instead use the Guidotti-Greenspan rule, since it compares the country’s international reserves to its short-term external debt with a maturity of one year or less. If the ratio is greater than or equal to 1, then the economy has built sufficient reserves to weather a massive flight of short-term capital for one year (Figure 4).  

Figure 4: Guidotti-Greenspan rule of reserve adequacy (Reserves/short-term external debt by remaining maturity)

Source: SP Global Ratings, Sovereign Risk Indicators 2020 Estimates, as of April 24, 2020, and authors’ calculations.

Argentina and, in particular, Turkey stand out as having chronically inadequate international reserves to resist a sudden stop of capital flows. In 2020, South Africa fell into the same category of dangerously low reserves. India and Indonesia are currently in a relatively safe zone. They both have just sufficient reserves to cover a short-term crisis, although Indonesia’s ratio has been declining since 2017. If the EM crisis deepens, both of these economies are likely to suffer from a run on reserves. The other five countries, Brazil, China, Mexico, the Philippines, and Russia, have sufficient reserve adequacy without needing foreign borrowing for at least one year.

These conclusions should be evaluated against the current health crisis that the economies are facing. If a country’s health system is overwhelmed by infected people who need to be hospitalized, the economy’s opening will only aggravate the crisis and delay recovery. Figure 5 displays total cases, cases per 1 million population, and tests per 1 million population.

Figure 5: Total cases of infection as of June 6/2020

Source: https://www.worldometers.info/coronavirus/?utm_campaign=homeAdvegas1?

Despite Brazil and Russia satisfying the reserve adequacy criterion, they have the world’s second and third highest numbers of cases respectively after the United States and are ranked above all the EM countries in our analysis (first panel). Brazil is holding second place worldwide even after accounting for the population; among the EM countries studied, it has the highest cases per 1 million people (second panel). Some political leaders argue that high numbers only reflect high rates of testing.
If a country has high testing and high number of cases, then this is a valid argument. However, if there are low testing and a high number of cases, then this is not the case–in fact, the actual number of cases is likely to be even higher than the official numbers. In regards to testing, the worst performing countries in our sample are mostly those economies satisfying the reserve adequacy condition: Brazil, the Philippines, India, Mexico, and Indonesia (third panel). Argentina stands out as deficient in both reserve adequacy and testing. With low rates of testing and increasing numbers of infections, India and Indonesia are in danger of facing adverse economic conditions and/or a financial crisis.
EM economies are facing a rare case of twin crises, economic/financial, and pandemic. These potentially amplify each other and therefore need to be addressed simultaneously. Countries that tackle the health crisis as seriously as the economic slowdown are expected to fare better and return to attracting foreign investment in a virtuous cycle. By contrast, countries prioritize solving the economic crisis over protecting people for a rough ride.

 

 

The Pandemic and the Emerging Markets Crisis: How Fragile are the Economies?2020-06-15T08:07:05+00:00
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