Macro Roundup

blog post/chart from St. Louis Fed, yield curve inversions aren’t just a leading indicator of recessions but a cause of them. can pinch bank lending margins and contract loan activity. the curve isn’t inverted now, but the spread has flattened.

“…An inverted yield curve—or a situation in which market yields on shorter-term U.S. Treasury securities exceed those on longer-term securities—has been a remarkably consistent predictor of economic recessions. However, simply because inversions forecast recessions does not necessarily mean that inversions cause recessions. Why might a yield curve inversion cause economic activity to slow?….The figure below illustrates the tendency of banks to tighten lending terms when the yield curve inverts. It plots the yield on 10-year Treasury securities minus the yield on two-year securities….Why is this important? Researchers have found that the economy tends to slow after banks tighten their lending standards, suggesting that an inversion of the yield curve could cause economic activity to slow by leading banks to reduce the supply of loans.3Thus, an inverted yield curve might do more than predict a recession: It might actually cause one….”

Normally, the yield on 10-year securities exceeds the yield on two-year securities, reflecting the fact that the yield curve is usually upward sloping. The yield curve is downward sloping (or inverted) when the yields on shorter-term securities are higher than those on longer-term securities, as in 2000 and 2006. Both of those inversions were followed by the start of a recession within a few months.

The Fed has surveyed banks on their lending terms continuously since 1990.2 The chart shows that the net percentage of banks tightening their lending standards on commercial and industrial loans began to rise around the time that the yield curve inverted in 2000 and 2006.

Why is this important? Researchers have found that the economy tends to slow after banks tighten their lending standards, suggesting that an inversion of the yield curve could cause economic activity to slow by leading banks to reduce the supply of loans.3 Thus, an inverted yield curve might do more than predict a recession: It might actually cause one.

Notes and References

1 October 2018 Senior Loan Officer Opinion Survey on Bank Lending Practices.

2 The Fed also surveyed banks on their lending terms from 1967 to 1983.

3 Lown, Cara S.; Morgan, Donald P.; and Rohatgi, Sonali. “Listening to Loan Officers: The Impact of Commercial Credit Standards on Lending and Output.” Federal Reserve Bank of New York Economic Policy Review, July 2000. Also, Bassett, William F.; Chosak, Mary Beth; Driscoll, John C.; and Zakrajsek, Egon. “Changes in Bank Lending Standards and the Macroeconomy.” Journal of Monetary Economics 2014, Vol. 62,pp. 23-40.

The figure below illustrates the tendency of banks to tighten lending terms when the yield curve inverts. It plots the yield on 10-year Treasury securities minus the yield on two-year securities.

Can an Inverted Yield Curve Cause a Recession?

An inverted yield curve—or a situation in which market yields on shorter-term U.S. Treasury securities exceed those on longer-term securities—has been a remarkably consistent predictor of economic recessions. However, simply because inversions forecast recessions does not necessarily mean that inversions cause recessions. Why might a yield curve inversion cause economic activity to slow?

Banking and Yield Curve Inversions

One possible channel is through the banking system. Banks engage in maturity transformation. That is, on average, the loans in a typical bank’s portfolio have a longer term to maturity than the deposits and other funds they use to finance those loans. In essence, banks transform their short-term liabilities (such as deposits) into longer-term assets (such as business and consumer loans).

Normally, banks can profit on the spread between the yields on longer-term assets and the interest they pay on deposits and other short-term liabilities. However, bank profits get squeezed when short-term interest rates rise relative to the yields on long-term assets. This can lead banks to cut back on their lending, which, in turn, can put the brakes on economic activity.

Tightening Lending Standards

Recently, the Federal Reserve asked banks how their lending policies might change in response to a hypothetical moderate inversion of the yield curve.1 Many of those surveyed indicated that they would tighten lending standards or price terms on every major loan category.

When asked why they would do so, several potential reasons were given:

David Wheelock, “Can an Inverted Yield Curve Cause a Recession?,” Federal Reserve Bank of St. Louis, December 27, 2018, https://www.stlouisfed.org/on-the-economy/2018/december/inverted-yield-curve-cause-recession

• An inversion could cause loans to be less profitable relative to the bank’s cost of funds.
• An inversion would cause their banks to be less risk tolerant.
• An inversion may signal a less favorable or more uncertain economic outlook.

WSJ write up of Fed's bew consumer credit #. Note they don't show gross debt as a % of GDP
"...Consumer debt, including credit cards, auto and student loans and personal loans, is on pace to top $4 trillion in 2019.That comes even as mortgage debt approaches levels last seen during the housing meltdown. Homeowners owed about $10.3 trillion on mortgages at the end of the third quarter, up 2.8% from a year earlier, according to Federal Reserve data. Mortgage debt peaked at $10.7 trillion in early 2008...."

great new NEBR paper finds that the interplay btw population and firm demographics explains the increase in concentration, decline in firm entry rates and the decline in the labor share

"...The US economy has undergone a number of puzzling changes in recent decades. Large firms now account for a greater share of economic activity, new firms are being created at a slower rate, and workers are getting paid a smaller share of GDP.... Three long-term changes in the US economy have attracted a great deal of attention. First, economic activity is being concentrated in fewer firms. For example, the fraction of workers employed by large firms increased by 6 percentage points since 1978. Second, the entrepreneurship rate — the ratio of new firms to total firms — has nearly halved since the 1970s. Third, the share of GDP going to labor, once thought to be stable, has declined since 1975....This paper shows thatchanges in population growth provide a unified quantitative explanation for these long-term changes. The mechanism goes through firm entry rates. A decrease in population growth lowers firm entry rates, shifting the firm-age distribution towards older firms. Heterogeneity across firm age groups combined with an aging firm distribution replicates the observed trends. Micro data show that an aging firm distribution fully explains i) the concentration of employment in large firms, ii) and trends in average firm size and exit rates, key determinants of the firm entry rate. An aging firm distribution also explains the decline in labor’s share of GDP. In our model, older firms have lower labor shares because of lower overhead labor to employment ratios. Consistent with our mechanism, we find that the ratio of nonproduction workers to total employment has declined in the US....We close by discussing the sources of labor force growth. We decompose labor force growth into three components: birth rates sixteen years prior, the growth in participation rate, and a residual term that captures rates of migration, death and institutionalization. We find that birth rates sixteen years prior account for the bulk of changes in labor force growth. We conclude that the rise and fall of labor force growth is primarily due to the baby boom..."

Hugo Hopenhayn, Julian Neira and Rish Singhania, "From Population Growth to Firm Demographics: Implications for Concentration, Entrepreneurship and the Labor Share," National Bureau of Economic Research, December 2018, https://www.nber.org/papers/w25382

new NBER paper supports your view that potential high impact entrepreneurial efforts come out of the "Google's" of the world. increases in corporate R&D leads to "R&D-induced spawning" note these spillovers do not harm the parent firm, but they are not beneficial

"...We show that corporate investment in research and development (R&D) increases the rate at which employees depart to launch new firms. This effect is not obvious, as R&D might increase the firm’s growth options or make it a more interesting place to work, leading to greater employee retention. Evidence that many successful entrepreneurs are former employees of high-tech, large firms motivates our research (Bhide 2000,Klepper 2001). Especially relevant is Gompers, Lerner & Scharfstein (2005), who observe that around 40 percent of venture capital-backed executive teams previously worked at a public company, often those with entrepreneurial cultures..... There is a robust relationship between firm R&D investment and entrepreneurial spawning. A one standard deviation increase in R&D is associated with a 18.7 percent increase in entrepreneurial spawning, relative to sample mean of 1.3 percent.The model includes firm, state-year, and industry-year fixed effects, as well as a rich array of time-varying firm characteristics, including total investment and establishment-level payroll and employment. Further, the results are robust to including four-digit SIC code fixed effects, suggesting that narrow industries do not explain the result. Finally, they are robust to several measures of entrepreneurial spawning.... This paper shows that corporate R&D investment leads to entrepreneurial spawning, in which employees depart to launch their own firms. We do this both in tightly controlled fixed effects regressions and in an instrumental variables approach, where we instrument for R&D using federal and state R&D tax credits. We find that for the parent firm, the spawning effect of R&D yields no obvious contractual benefits, nor is it observably costly. Our evidence is consistent with corporate R&D being a new channel for knowledge spillovers, as well as a new source of high-tech startups. Our results have two policy implications. First, the spawning effect of R&D implies greater corporate underinvestment in R&D relative to the social optimum than previously thought. Second, the presence of knowledge spillovers are one motivation for offering firms tax credits that lower their cost of R&D investment. The spawning effect of R&D is much larger in the instrumental variables model than in the fixed effects regression. This suggests, albeit in a partial equilibrium sense, that R&D tax credits are effective in that they lead to greater R&D-induced entrepreneurial spawning, which is likely a form of knowledge spillover.Our finding also speaks to the theory of the firm. Zingales (2000) writes that “Entrepreneurship is the process by which new firms are created. But new firms are created to exploit growth options existing firms cannot or do not want to exploit. Thus, a theory able to explain what growth options existing firms are willing and able to exploit will also identify the opportunities for entrepreneurial activity.” We offer a concrete mechanism tying entrepreneurship to the growth options that an incumbent does not to exploit.....In sum, it appears likely that R&D-induced spawning is a direct form of knowledge spillover. We document that a remarkable 88 percent of spawns are located in the same state as the parent...."

Tania Babina and Sabrina T. Howell, "Entrepreneurial Spillovers from Corporate R&D," National Bureau of Economic Research, December 2018, https://www.nber.org/papers/w25360

"...A 2015 study published in PLOS ONE followed how many null results were found in trials funded by the National Heart, Lung and Blood Institute before and after researchers were required to register their protocols at a public website. This rule was introduced in 2000 in part because of a general sense that researchers were subtly altering their work — after it was begun — to achieve positive results. In the 30 years before 2000, 57 percent of trials published showed a “significant benefit.” Afterward, only 8 percent did...."
Aaron Carroll, Congratulations on the Promotion. But Did Science Get a Demotion?"New York Times, December 31, 2018, https://www.nytimes.com/2018/12/31/upshot/congratulations-on-the-promotion-but-did-science-get-a-demotion.html

terrific new Corrado, using AWS data finds massive falls in prices not being captured by GDP

after his adjustment"....boost the average annual growth rate during 2007-2015 by roughly 2 percentage points compared with official estimates. For nominal GDP growth, including this own-account investment would add three basis points per year to the growth rate during this period..."

David Byrne, Carol Corrado, Daniel E. Sichel, "The Rise of Cloud Computing: Minding Your P's, Q's and K's," National Bureau of Economic Research, October 2018, https://www.nber.org/papers/w25188

"....Cloud computing—computing done on an off-site network of resources accessed through the Internet—is revolutionizing how computing services are used. However, because cloud is so new and it largely is an intermediate input to other industries, it is difficult to track in the U.S. statistical system. Moreover, there is a paucity of systematic information on the prices of cloud services. To begin filling this gap, this paper does three things. First, we define the different segments of cloud computing and document its explosive expansion. Second, we develop new hedonic prices indexes for cloud services based on quarterly data for compute, database, and storage services offered by Amazon Web Services (AWS) from 2009 to 2016.....Our basic finding is that prices for cloud services have fallen rapidly and that the use of the cloud has grown tremendously as has investment in the related infrastructure of IT equipment and software. For our analysis of prices, we assembled a unique data set with quarterly data on prices and characteristics for cloud services offered by the largest provider, Amazon Web Services (AWS), since the first quarter of 2009 when AWS began posting prices on the Internet. The data cover AWS’ basic compute, database, and storage products..... These indexes fall rapidly over the sample period, with quickening (and double digit) rates of decline for all three products starting at the beginning of 2014..... For AWS, the price for their compute product fell at an average rate of about 7 percent during 2000-2016. Price declines were slower before 2014 and more rapid starting in the beginning of 2014. Interestingly, 2014 is the year when Microsoft and Google began posting prices for their cloud offerings on the Internet. We suspect that AWS’ large price declines were a response to that change in the competitive environment. For AWS’ database product, prices fell at an average rate of more than 11 percent during 2009-16. Here too, prices fell relatively modestly until the beginning of 2014, after which they fell at an average rate of more that 22 percent through the end of 2016. AWS’ storage product followed a similar pattern, with prices falling at an average annual rate of about 17 percent during 2009-2016 and even faster declines starting in 2014.....Finally, we highlight the puzzle of why investment in IT equipment in the NIPAs has been so weak while capital expenditures have exploded for IT equipment associated with cloud infrastructure. We suggest that cloud service providers are undertaking large amounts of own-account investment in IT equipment and that some of this investment may not be captured in GDP..... As seen in figure 9, nominal IT equipment and software investment including our estimate of own-account would be $58 billion higher in 2015 than in the official estimates, amounting to 0.32 percent of GDP. For nominal investment in IT equipment, adding this own-account investment would boost the average annual growth rate during 2007-2015 by roughly 2 percentage points compared with official estimates. For nominal GDP growth, including this own-account investment would add three basis points per year to the growth rate during this period..... We find that cloud computing has exploded. By available measures, the quantity of cloud activity has grown extremely rapidly as has associated capital investment. At the same time, prices of basic cloud services have fallen rapidly since 2009, based on a unique dataset we assembled. However, because cloud is so new and so much of it is intermediate input, it is challenging to track in the statistical system, and the available data do not distinguish between cloud-based and traditional services, whether services are purchased or produced internally, or generated at the “edge.” We highlight one area where real GDP may be understated by a noticeable amount as a result of changes in the economy related to the rise of cloud computing...."

would note that while it might be missing in GDP Mr. Market seems to be pricing it into AMZN/MSFT value versus peer firms not in the space

".... 17 of 30 studies (57%) published prior to 2000 showed a significant benefit of intervention on the primary outcome in comparison to only 2 among the 25 (8%) trials published after 2000 (χ2=12.2,df= 1, p=0.0005).There has been no change in the proportion of trials that compared treatment to placebo versus active comparator. Industry co-sponsorship was unrelated to the probability of reporting a significant benefit. Pre-registration in clinical trials. gov was strongly associated with the trend toward null findings....The number NHLBI trials reporting positive results declined after the year 2000. Prospective declaration of outcomes in RCTs, and the adoption of transparent reporting standards, as required byclinicaltrials.gov, may have contributed to the trend toward null findings...."

Robert Kaplan and Veronica Irvin, "Likelihood of Null Effects of Large NHLBI Clinical Trials Has Increased over Time," PLOS One, August 5, 2015, https://journals.plos.org/plosone/article

"...By buying Treasurys and mortgage-backed securities, the Fed acquired or offset some 45% of all federal debt issued during the Obama era—about four times the share of federal debt the Fed purchased during World War II..... Historically, banks held few excess reserves as the Fed did not pay interest on them. The money supply changed when the Fed altered bank reserves through lending or buying and selling securities. Now if market interest rates rise and the Fed does not act by raising the rate it pays on reserves, the money supply increases as banks increase lending. As a result, to maintain any given money supply, the Fed must respond to changes in market interest rates. In doing so the Fed becomes an interest-rate follower, not a leader...."
Phil Gramm and Thomas Savings, "The Fed’s Obama-Era Hangover,"Wall Street Journal, January 1, 2018, https://www.wsj.com/articles/the-feds-obama-era-hangover-11546374393

Amy Harmon, "James Watson Won’t Stop Talking About Race,"New York Times, January 1, 2018, https://www.nytimes.com/2019/01/01/science/watson-dna-genetics-race.html

"...The key point to realize is that in today’s globalized corporate system, a lot of any country’s corporate sector, our own very much included, is actually owned by foreigners, either directly because corporations here are foreign subsidiaries, or indirectly because foreigners own American stocks. Indeed, roughly a third of U.S. corporate profits basically flow to foreign nationals - which means that a third of the tax cut flowed abroad, rather than staying at home. This probably outweighs any positive effect on GDP growth. So the tax cut probably made America poorer, not richer... Meanwhile, since the tax cut isn’t paying for itself, it will eventually have to be paid for some other way - either by raising other taxes, or by cutting spending on programs people value. The cost of these hikes or cuts will be much less concentrated on the top 10 percent than the benefit of the original tax cut. So it’s a near-certainty that the vast majority of Americans will be worse off thanks to Trump’s only major legislative success......"
Paul Krugman, "The Trump Tax Cut: Even Worse Than You’ve Heard,"The New York Times, January 1, 2018, https://www.nytimes.com/2019/01/01/opinion/the-trump-tax-cut-even-worse-than-youve-heard.html

Gordon Green and John Coder, "Household Income Trends," Sentier Research, December 28, 2018, http://www.sentierresearch.com/Charts/HouseholdIncomeIndex_UnemploymentRate_11_2018.jpg