Economic Letter

The Federal Reserve’s current large-scale asset purchase program, dubbed “QE2,” has a precedent in a 1961 initiative by the Kennedy Administration and the Federal Reserve known as “Operation Twist.” An analysis finds that four of six potentially market-moving Operation Twist announcements had statistically significant effects and that the program cumulatively caused a significant but moderate 0.15 percentage point reduction in longer-term Treasury yields. These results can be used to estimate QE2’s effects.

While the market for Treasury inflation-protected securities (TIPS) has developed considerably over the past decade, the debate over whether their issuance benefits the U.S. Treasury remains contentious. Information from inflation swap rates in conjunction with a joint model of yields for nominal non-inflation-protected Treasury bonds and TIPS provides evidence that, even under conservative assumptions, the TIPS inflation risk premium has been large enough in recent years to offset the liquidity disadvantage of the series. This suggests that overall the Treasury has benefited from issuing TIPS.

To make financial conditions more supportive of economic growth, the Federal Reserve has purchased large amounts of longer-term securities in recent years. The Fed’s resulting securities portfolio has generated substantial income but may incur financial losses when market interest rates rise. Such interest rate risk appears modest, especially relative to the Fed’s policy objectives of full employment and price stability.

Prices of commodities including metals, energy, and food have been rising at double-digit rates in recent months. Some critics argue that Federal Reserve purchases of long-term assets are fueling this rise by maintaining an excessively expansionary monetary stance. However, daily data indicate that Federal Reserve announcements of large-scale asset purchases tended to lower commodity prices even as long-term interest rates and the value of the dollar declined.

In the recent recession and recovery, the unemployment rates, part-time employment trends, and earnings growth of recent college graduates have closely mirrored the patterns they displayed during the cyclical recession of 2001 and the subsequent jobless recovery. Recent college graduates are typically not subject to structural frictions that can contribute to weak labor markets, such as mismatches between the skills of job seekers and the needs of employers. Similarities in the labor market experiences of recent college graduates in the two recessions and recoveries suggest that the current high unemployment rate is primarily cyclical.

The euro area faces its first sovereign debt crisis, highlighting the fiscal imbalances of member countries. Troubled countries are implementing austerity measures, with adjustments focusing on the short and medium run. However, a long-run solution to Europe’s problems requires economic reforms that increase competitiveness and reduce labor costs in the peripheral countries. Such reforms would promote convergence of the euro-area economies and enhance the long-run sustainability of monetary union.

Economists drew a number of lessons from the Asian financial crisis of 1997-98 for preventing such episodes or mitigating their effects. Some of those are similar to lessons drawn from the global financial crisis of 2007-09. But differences in economic development and sophistication of the financial systems of East Asian countries compared with those of the United States and Western Europe made it difficult to apply the lessons of the earlier crisis.

Recent labor markets developments, including mismatches in the skills of workers and jobs, extended unemployment benefits, and very high rates of long-term joblessness, may be impeding the return to “normal” unemployment rates of around 5%. An examination of alternative measures of labor market conditions suggests that the “normal” unemployment rate may have risen as much as 1.7 percentage points to about 6.7%, although much of this increase is likely to prove temporary. Even with such an increase, sizable labor market slack is expected to persist for years.

Initial claims for unemployment insurance averaged a stubbornly high 468,000 in the year ending December 2010, but have recently come down quickly. Many analysts interpret this as a sign that layoffs were too high to support a strong labor market recovery during most of 2010. However, claims data may have exaggerated layoffs in 2010 because the fraction of unemployed workers applying for benefits was higher than before the recession. If the proportion of eligible workers who applied were held constant, 2010 claims would have averaged roughly 20% less than the actual reading.