Tuesday, December 15, 2009

Bernanke Responds to Senator Bunning

by Bill McBride on 12/15/2009 05:07:00 PM

Chairman Bernanke has responded in writing to a series of question from Senator Bunning.

There are questions on Fed policy, gold, the dollar, and much more. Here are a couple of questions:

Bunning: 58. Are you concerned that the debt to GDP ratio in this country is more than 350%? Do you believe a high debt to GDP ratio is reason for tightening Fed policy? Why or why not?

Bernanke: The current ratio of public and private debt to GDP, including not only the debt of the nonfinancial sector but also the debt of the financial sector, is about 350 percent. (Many analysts prefer to focus on the debt of the nonfinancial sectors because, they argue, the debt of the financial sector involves some double-counting--for example, when a finance company funds the loans it provides to nonfinancial companies by issuing bonds. The ratio of total nonfinancial debt to GDP is about 240 percent.) Private debt has been declining as households and firms have been reducing spending and paying down pre-existing obligations. For example, households, who are trying to repair their balance sheets, reduced their outstanding debt by 1.3 percent (not at an annual rate) during the first three quarters of this year.

In contrast, public debt is growing rapidly. Putting fiscal policy on a sustainable trajectory is essential for promoting long-run economic growth and stability. Currently, the ratio of federal debt to GDP is increasing significantly, and those increases cannot continue indefinitely. The increases owe partly to cyclical and other temporary factors, but they also reflect a structural federal budget deficit. Stabilizing the debt to GDP ratio at a moderate level will require policy actions by the Congress to bring federal revenues and outlays into closer alignment in coming years.

The ratio of government debt to GDP does not have a direct bearing on the appropriate stance of monetary policy. Rather, the stance of monetary policy is appropriately set in light of the outlook for real activity and inflation and the relationship of that outlook to the Federal Reserve’s statutory objectives of maximum employment and price stability. Of course, government indebtedness may exert an indirect influence on monetary policy through its potential implications for the level of interest rates consistent with full employment and low inflation. But in that respect, fiscal policy is just one of the many factors that influence interest
rates and the economic outlook.
emphasis added
Two points: we see graphs all the time showing the total debt to GDP at around 350%, but that double counts financial intermediation.

U.S. Debt Burden Click on graph for larger image in new window.

The 240% number is probably a better representation of the debt burden of the United States. Here is an example from Rolfe Winkler at Reuters (source: Reuters)

On the structural deficits: I've been writing about this for years. Nothing is more concerning than a large structural deficit during periods of high employment (like earlier in this decade when Bernanke was Chairman of the CEA). I don't recall Bernanke every mentioning the structural deficit when he was on the CEA.
Senator Bunning: 5. We saw the crowding out of the private mortgage market caused by Freddie and Fannie’s overwhelming control of mortgages during 2002 to 2006 period. Do you think there is a danger to allowing an extended public-controlled mortgage market? And what steps is the Fed taking to reestablish a private mortgage market?
OK, this was a trick question, but Bernanke missed it. We did NOT see the crowding out of the private mortgage market in the period mentioned - in fact the private mortgage market expanded dramatically in the 2004 through 2006 period as shown in the following graph from San Francisco Fed Senior Economist John Krainer: Recent Developments in Mortgage Finance

Mortgage Market This is figure 3 from the Economic Letter. This shows the surge in non-agency securitized loans, and loans held in bank portfolios, in 2004 through 2006 (the worst loans).
[T]he sources of mortgage finance have shifted as the housing market has gone from boom to bust. Figure 3 plots the evolution of these funding sources over the past decade. Fannie Mae and Freddie Mac combined have consistently been the largest players in the market, owning or guaranteeing about half or more of the mortgages in the sample at any given time. Non-agency securitization peaked in the first quarter of 2006, when it accounted for nearly 40% of new originations.
There is much more in the Q&A.

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