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Weekly Economic Commentary


It is not Enough to Tell the Fed to Target Nominal GDP – You Have to Tell it How

August 15, 2011

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In the August 15 edition of the Financial Times, Clive Crook wrote an op-ed piece urging the Fed to target nominal GDP growth. This is not the worst Fed “mandate” that has been recommended. But it is not enough to recommend a mandate or a target to this Fed. You also have to explain to it how to maximize the probability of actually achieving its mandate. Targeting a fed funds rate won’t do the trick, especially under current circumstances. I would suggest that if the Fed were to accept Mr. Cook’s recommendation of it targeting nominal GDP growth, the Fed should choose as an intermediate target growth in the sum of Federal Reserve, commercial bank, S&L and credit union credit. Chart 1 shows that the correlation between the year-over-year percent change in this credit aggregate and the year-over-year percent change in nominal GDP is 0.61 from Q1:1954 through Q4:2007.

DEC 8/15/2011 Chart 1


In 2008, there was a significant divergence between the growth in this credit aggregate and the growth in nominal GDP. You may recall that in 2008, the over-the-counter money and capital markets froze up. Businesses, fearing the onset of another depression and with the commercial paper market shut down, tapped their back-up lines of credit at commercial banks quite heavily. The Fed through open the discount window and created new lending facilities to nondepository financial institutions that were desperate for liquidity with the interbank loan market frozen. Thus, this credit aggregate soared. But entities were borrowing not to spend, but rather to be as liquid as possible. Thus, although the sum of Fed, bank, S&L and credit union credit soared in 2008, growth in aggregate spending, as represented by nominal GDP, plunged. Even including this unusual 2008 episode, the correlation between growth in this credit aggregate and growth in nominal GDP remained relatively high at 0.56 (see Chart 2).

DEC 8/15/2011 Chart 2

I would leave it to the Fed’s crack econometric staff to determine how fast the sum of Federal Reserve, commercial bank, S&L and credit union credit should grow in order to hit a nominal GDP growth target. But this is how the Fed could do it. Scrap fed funds rate targeting. Rather, increase or decrease the Fed’s balance sheet such that the sum of Fed, commercial bank, S&L and credit union credit grows at the rate that the Fed’s econometricians believe is consistent with the Fed’s nominal GDP target growth rate.


Senior Loan Officers Survey – Demand for Loans is Soft, Underwriting Standards Are Mixed

By Asha Bangalore

The Fed’s Senior Loan Officers Survey for the third quarter shows a softening of demand for loans from both businesses and households (see Chart 3).  The Fed’s plan to hold the policy rate unchanged until mid-2013 is partly designed to shake off the reluctance to borrow.  The latest survey report fails to raise expectations of strong growth in loan demand, for now.

DEC 8/15/2011 Chart 3



Underwriting standards for loans remain favorable for the most part.  Loan underwriting standards remained favorable for residential mortgages and large businesses but were strict for small firms and held steady for commercial real estate loans in the third quarter compared with the second quarter (see Chart 4). 

DEC 8/15/2011 Chart 4


DEC 8/15/2011 Chart 4DEC 8/15/2011 Chart 4

At the same time, loan officers indicate that spreads for small business loans had moved up while that for large firms held steady.  Essentially, small businesses have to cross larger hurdles to obtain loans compared with large firms. 

DEC 8/15/2011 Chart 5

Also, the willingness to lend to consumers edged down in the third quarter slightly compared with responses of the second quarter (see Chart 6).  In sum, this survey does not present a case for projections of strong growth of the U.S. economy in the near term. 

DEC 8/15/2011 Chart 6


The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.