Economic Letter

When the housing boom of the past decade turned into a bust, falling house prices played a primary role in driving up delinquency and foreclosure rates. As housing values fell, distressed borrowers lost equity, which hindered their ability to escape delinquency by prepaying their mortgages by refinancing or selling their homes. Falling house prices may have especially impinged on subprime and adjustable-rate borrowers. These homeowners may have counted on being able eventually to refinance into loans with terms more affordable than those of their original mortgages.

The severe global economic downturn and the large stimulus programs that governments in many countries adopted in response have generated a resurgence in research on the effects of fiscal policy. One key lesson emerging from this research is that there is no single fiscal multiplier that sums up the economic impact of fiscal policy. Rather, the impact varies widely depending on the specific fiscal policies put into effect and the overall economic environment.

During the recent recession, unemployment duration reached levels well above those of past downturns. Duration has continued to rise during the uneven economic recovery that began in mid-2009. Elevated duration reflects such factors as changes in survey measurement, the demographic characteristics of the unemployed, and the availability of extended unemployment benefits. But the key explanation is the severe and persistent weakness in aggregate demand for labor.

During the financial crisis of 2007–09, the Federal Reserve took extraordinary steps to stem financial panic. Since then, the Fed has also taken extraordinary action to boost economic growth. The Fed continues to do its level best to achieve its congressionally mandated goals of maximum employment and stable prices. The following is adapted from a speech by the president and CEO of the Federal Reserve Bank of San Francisco at The Columbian’s Economic Forecast Breakfast January 10, 2012, in Vancouver, Washington.

Real estate prices in a local market can be driven by an identifiable group of purchasers. In Hawaii, residents of both the U.S. mainland and Japan have been significant purchasers of homes. An analysis suggests that house prices in Hawaii were driven primarily by purchasers from the U.S. mainland for most of the 1975–2008 period. But, during Japan’s “bubble economy” in the late 1980s and immediately thereafter, house prices in Hawaii were driven primarily by demand from Japan.

Federal Reserve announcements of future purchases of longer-term bonds may affect asset prices by changing market expectations of the future supply of targeted securities. Such announcements may also affect asset prices by signaling that the stance of conventional monetary policy is likely to remain loose for longer than previously anticipated. Research suggests that these signaling effects were a major contributor to the cumulative declines in Treasury security yields following the eight Fed announcements in 2008 and 2009 about its first round of large-scale asset purchases.

In 2010, statistical experiments based on components of the Conference Board’s Leading Economic Index showed a significant possibility of a U.S. recession over a 24-month period. Since then, the European sovereign debt crisis has aggravated international threats to the U.S. economy. Moreover, the Japanese earthquake and tsunami demonstrated that the U.S. economy is vulnerable to outside disruptions. Updated forecasts suggest that the probability of a U.S. recession has remained elevated and may have increased over the past year, in part because of foreign financial and economic crises.

To understand the effects of news on bond markets, it is instructive to look beyond individual maturities and consider the entire term structure of interest rates. For example, unexpected changes in monthly nonfarm payroll employment numbers cause large movements at short and medium maturities, but do not affect long-term interest rates. Inflation news affects the long end of the term structure. Monetary policy actions vary in their effects on interest rates, but cause volatility at all maturities, including distant forward rates.