Economic Letter

Past rounds of large-scale asset purchases by the Federal Reserve have lowered yields not only on the targeted securities, but also on various private borrowing rates. In particular, yields on corporate bonds and primary mortgage rates decreased in response to Fed asset purchase announcements. Notably, however, the link between rates on mortgage-backed securities and actual mortgage rates has weakened in the wake of the financial crisis.

The 2007–08 financial crisis was the biggest shock to the banking system since the 1930s, raising fundamental questions about liquidity risk. The global financial system experienced urgent demands for cash from various sources, including counterparties, short-term creditors, and, especially, existing borrowers. Credit fell, with banks hit hardest by liquidity pressures cutting back most sharply. Central bank emergency lending programs probably mitigated the decline. Ongoing efforts to regulate bank liquidity may strengthen the financial system and make credit less vulnerable to liquidity shocks.

Commodity prices have soared several times in recent years, raising concerns that overall inflation could rise substantially. However, crops, oil, and natural gas make up only about 5% of the cost of U.S. consumer goods and services. Thus, about one percentage point of the 10% cumulative inflation since 2007 reflects price rises in these important commodity categories. When the contribution of these commodities is subtracted from overall inflation, the resulting pattern is remarkably similar to that of core inflation, which excludes food and energy prices.

Some observers have argued that the nation’s high unemployment rate during the current recovery stems partly from widespread mismatches between the skills of jobseekers and the needs of employers. A recent San Francisco Federal Reserve Bank conference on workforce skills considered evidence that employers have had difficulties finding workers with appropriate skills in recent years. However, these mismatches do not appear to be much more severe than in the past. Overall, the conference proceedings suggested the U.S. economy can still produce good jobs for workers at a variety of skill levels.

Credit is a perennial understudy in models of the economy. But it became the protagonist in the Great Recession, reviving a role it had not played since the Great Depression. In fact, the central part played by credit in the downturn and weak recovery of recent years is not unusual. A study of 14 advanced economies over the past 140 years shows that financial crises have frequently led to severe and prolonged recessions. Shining the spotlight on credit turns out to be crucial in understanding recent economic events and the outlook.

States that were hit hard by the housing bust performed worse economically during the recession of 2007-09. However, the close relationship between the fall in home prices and state economic activity has largely disappeared during the recovery. High unemployment, restrained demand, and idle production capacity are national in scope. These are just the sorts of problems monetary policy can address. The following is adapted from a speech by the president and CEO of the Federal Reserve Bank of San Francisco at the University of San Diego on April 3, 2012.

The overall effect of the global financial crisis on emerging Asia was limited and short-lived. However, the crisis affected some countries in the region more than others. Two main crisis transmission channels, exposure to U.S. financial markets and reliance on manufacturing exports, determined how severely countries in the region were affected. Countries that were relatively less connected to global financial markets and relied less on trade fared better and recovered more quickly than countries that were more dependent on global financial and trade markets.

The adverse labor market effects of the Great Recession have intensified interest in policy efforts to spur job creation. The two most direct job creation policies are subsidies that go to workers and hiring credits that go to employers. Evidence indicates that worker subsidies are generally more effective at creating jobs. However, the unique circumstances of recovery from the Great Recession, especially the weak demand for labor, make hiring credits more effective in the short term.

The second round of Federal Reserve large-scale asset purchases, from November 2010 to June 2011, included regular purchases of Treasury inflation-protected securities, or TIPS. An analysis of liquidity premiums indicates that the functioning of the TIPS market and the related inflation swap market improved both on the days the Fed purchased TIPS and over the course of the LSAP program. Thus, TIPS purchases had liquidity benefits beyond the effect they may have had in reducing Treasury yields.