Definition of 'Collaborative Commerce - C-commerce'

Definition of 'Collaborative Commerce - C-commerce'

Optimization of supply and distribution channels in order to capitalize upon the global economy and use new technology efficiently.

Investopedia explains 'Collaborative Commerce - C-commerce'

A new focus for organizations attempting to become more profitable and competitive. Collaboration promotes fresh views of suppliers, competitors and customers. The goal is for a business to move away from production and sales, shifting towards the integration of various businesses.

Wisconsin - State Median: Annual Care Costs in 2013

Cost of Care overview

Research shows that at least 70 percent of people over 65 will need long term care services at some point in their lifetime¹. And while most people think of long term care as impacting only those in senior years, 40 percent of people currently receiving long term care services are ages 18 to 64.²

The Genworth 2013 Cost of Care Survey can help families evaluate options to address the increasing cost of long term care. For the tenth consecutive year, Genworth has surveyed the cost of long term care across the U.S. to help Americans appropriately plan for the potential cost of this type of care in their preferred location and setting. The most comprehensive study of its kind, Genworth’s 2013 Cost of Care Survey, conducted by CareScout^®, covers nearly 15,300 long term care providers in 437 regions nationwide

.¹ Medicare & You, National Medicare Handbook, Centers for Medicare and Medicaid Services, Revised November 2012.

² U.S. Department of Health and Human Services National Clearinghouse for Long Term Care Information, 10/22/08.

Monthly costs provided below 

Home Care
Homemaker services	$3,813
Home health aide	$4,099
Adult Day Health Care
Adult day health care	$1,343
Assisted Living Facility
Private, one bedroom	$3,538
Nursing Home Care
Semi-private room	$7,247
Private room	$8,060

State Median is the median cost for care across the entire state.

Definitions:

Home Health Aides help those who are elderly, disabled, or too ill to live in their own homes or in a residential care facilities instead of in nursing homes. Home health aides may offer care to people who need more extensive personal care than family or friends are able to or have the time or resources to provide.

Homemaker Services make it possible for people to live in their own homes or to return to their homes by helping them complete household tasks that they can't manage alone. Homemaker services aides may clean houses, cook meals or run errands.

Adult Day Health Care centers can offer a much-needed break to caregivers. This type of care provides service at a community-based center for adults who need assistance or supervision during the day but who do not need round the clock care. The centers may provide health services, therapeutic services and social activities.

Assisted Living Facilities (referred to as Residential Care Facilities in California) are living arrangements that provide personal care and health services for people who may need assistance with activities of daily living, but who wish to live as independently as possible and who do not need the level of care provided by a nursing home. It's important to note that assisted living is not an alternative to a nursing home, but an intermediate level of long-term care.

Nursing Home Care is for people who may need a higher level of supervision and care than in an assisted living facility. They offer residents personal care, room and board, supervision, medication, therapies and rehabilitation, as well as skilled nursing care 24 hours a day.

For more information about long term care planning, please contact your financial professional.

© Genworth Financial, Inc. and National Eldercare Referral Systems, LLC (d/b/a CareScout^®). All rights reserved. Genworth, Genworth Financial and the Genworth logo are registered service marks of Genworth Financial, Inc.

106556 03/15/13

Commodities: Gold

By Noble Drakoln

From the time of the Egyptian Pharaohs to the voyage of Columbus to the New World and beyond, gold has been revered as a symbol of wealth and prosperity. Gold has also been used as currency and as a way to prop up the fiat money of various countries. One of the most significant moves to gold- and silver-backed currency occurred in 1792, which was the year that the U.S. put the dollar on the gold and silver standard.

One-hundred and seventy-nine years later, in 1971, the U.S. was removed from the gold standard by President Richard Nixon. This fundamental economic shift had a tremendous impact on the price of gold around the globe. Approximately eight years later, on January 21, 1980, gold prices catapulted from a low of $35/ounce to a record high of $850/ounce, or $2,398.21 when adjusted for inflation. On March 19, 2008, gold hit a high of $1,022.40. (Find some golden opportunities by investing in gold commodities or futures contracts, in The Midas Touch For Gold Investors.)

Currently, gold is used as an investment, in computers and in jewelry. China, South Africa, the U.S.,Australia, Canada, Indonesia and Russia collectively represent the backbone of global gold production.

Gold Contract Specifications
Ticker Symbol	Open Outcry: GC (NYMEX) Electronic: EGC (Globex)
Contract Size	100 troy ounces
Deliverable Grades	In fulfillment of each contract, the seller must deliver 100 troy ounces (±5%) of refined gold, assaying not less than .995 fineness, cast either in one bar or in three one-kilogram bars, and bearing a serial number and identifying stamp of a refiner approved and listed by the exchange. A list of approved refiners and assayers is available from the exchange upon request.
Contract Months	All months
Trading Hours	Open outcry trading is conducted from 8:20am-1:30pm EST. Electronic trading is conducted via the CME Globex trading platform from 6pm Sundays through 5:15pm Fridays, EST, with a 45-minute break each day between 5:15pm and 6pm.
Last Trading Day	Trading terminates at the close of business on the third to last business day of the maturing delivery month.
Last Delivery Day	The last business day of the contract month. Gold delivered against the futures contract must bear a serial number and identifying stamp of a refiner approved and listed by the exchange. Delivery must be made from a depository licensed by the exchange.
Price Quote	U.S. dollars and cents per troy ounce
Tick Size	NYMEX: 10 cents per troy ounce ($10 per contract)
Daily Price Limit (Not applicable in electronic markets)	No Price Limits

Understanding Gold Contracts

Like every commodity, gold has its own ticker symbol, contract value and margin requirements. To successfully trade a commodity, you must be aware of these key components and understand how to use them to calculate your potential profits and loss.

For instance, if you buy or sell a gold futures contract, you will see a ticker tape handle that looks like this:

GC8Z @ 920

This is just like saying "Gold (GC) 2008 (8) December (Z) at $920/ounce (920)." A trader buys or sells a gold contract according to this type of quotation.

Depending on the quoted price, the value of a commodities contract is based on the current price of the market multiplied by the actual value of the contract itself. In this instance, the gold contract equals the equivalent of 100 troy ounces multiplied by our hypothetical price of $920, as in:

$920.00 x 100 troy ounces = $92,000

Commodities are traded based on margin, and the margin changes based on market volatility and the current face value of the contract. To trade a gold contract on the New York Mercantile Exchange (NYMEX) requires a margin of $4,455, which is approximately 5% of the face value.

Calculating a Change in PriceBecause commodity contracts are customized, every price movement has its own distinct value. In a gold contract, a $1 move is equal to $100. When determining NYMEX's gold profit and loss figures, you calculate the difference between the contract price and the exit price, and then multiply the result by $100. For example, if prices move from $920 to $1,000, you multiply the difference, which is $80, by $100 to yield a contract value change of $8,000. 

-	Buy	Sell	Total Value
Gold Contract Price ($1 move = $100)	$92	$1,000	$80 or $8,000

Gold ExchangesThe futures contract for gold is traded at the New York Mercantile Exchange (NYMEX) through its Commodity Exchange (COMEX) division via open outcry. It is also traded electronically through the Chicago Board of Trade (eCBOT), India's National Commodity and Derivatives Exchange (NCDEX), Dubai Gold and Commodities Exchange (DGCX), Multi Commodity Exchange (MCX) and Tokyo Commodity Exchange (TOCOM).

Facts About ProductionGold mining is a business, and like any business, hard costs are associated with extracting gold from the earth. In 2008, mining gold costs around $238 per ounce. Because the cost is so high per ounce, the belief is that all of the gold ever mined barely totals 145,000 tons, an amount that could form a single cube measuring 66 feet per side.

Historically, South Africa has been the primary gold producer - with much as 80% of the world's supply at one time. In recent years, however, the country's production has significantly dropped from a high of 1,000 metric tons per year to 272 metric tons, a decline in production of more than two-thirds.

A myriad of factors have influenced South Africa's reduction in gold production. For example, mining gold ore has become more difficult, local economic problems have evolved, and more stringent controls have emerged. In 2007, China inched ahead of South Africa, becoming the leading gold producer with a total of 276 tons. (This asset's appeal dates back thousands of years. Find out whether it can live up to the hype in Does It Still Pay To Invest In Gold?)

Factors That Influence Gold's PriceThe price is influenced by the following factors: 

• Gold has developed widespread commercial use as a coating on electrical connectors. It can be found on various devices, from audio and video cables to computer and component cables and connectors.
• Worldwide gold production continues to underperform against worldwide demand. At the current level of production, an assumption is that in less than 45 years, our gold supply will not be able to meet the demand. 
• The World Gold Council estimates that the total gold mined annually is approximately 2,500 metric tonnes. Currently, 3,500 metric tonnes of gold is used in the jewelry, investment and commercial industry, and it is difficult to determine where the 1,000-ton gold shortfall will come from. 
• The International Monetary Fund (IMF) and the Washington Agreement on Gold (WAG) have very strict requirements in gold sales: less than 400 tons per year, and members cannot use gold to back or replace their currency.
• India is the largest worldwide consumer of gold, with an annual consumption estimated at 700 tons a year. Projections have put India's future gold demand at US$20 billion by 2010 and US$30 billion by 2015.

Conclusion

Gold's historical significance and electrical conductivity ensures that it will be in demand for a long time to come. As an investment, gold has cyclically come into and out of favor, and has experienced some of the most extreme pricing of any of the commodity markets. Whether gold will continue to be considered a viable inflationary hedge remains to be seen, but the simple fact that it is a rare and beautiful metal will always keep it in the news. 

Fool's Gold

Definition of 'Fool's Gold'

Also known as iron pyrite, fool's gold is a gold-colored mineral that is often mistaken for real gold. Fool's gold is also a common term used to describe any item which has been believed to be valuable to the owner, only to end up being not so. Investments in hot stocks that seemed too good to be true, only to crash and burn, can be referred to as investing in fool's gold. 

Investopedia explains 'Fool's Gold'

During historical periods of gold rushes, many less-than-knowledgeable miners would frequently believe that they hit the motherload upon finding a cache of fool's gold. Unfortunately, unlike the real thing, fool's gold is relatively worthless.

Governor Jeremy C. Stein At the "Finding the Right Balance" 2013 Credit Markets Symposium sponsored by the Federal Reserve Bank of Richmond, Charlotte, North Carolina April 19, 2013

Liquidity Regulation and Central Banking

I'd like to talk today about one important element of the international regulatory reform agenda--namely, liquidity regulation.¹ Liquidity regulation is a relatively new, post-crisis addition to the financial stability toolkit. Key elements include the Liquidity Coverage Ratio (LCR), which was recently finalized by the Basel Committee on Banking Supervision, and the Net Stable Funding Ratio, which is still a work in progress. In what follows, I will focus on the LCR.

The stated goal of the LCR is straightforward, even if some aspects of its design are less so. In the words of the Basel Committee, "The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario."² In other words, each bank is required to model its total outflows over 30 days in a liquidity stress event and then to hold HQLA sufficient to accommodate those outflows. This requirement is implemented with a ratio test, where modeled outflows go in the denominator and the stock of HQLA goes in the numerator; when the ratio equals or exceeds 100 percent, the requirement is satisfied.

The Basel Committee issued the first version of the LCR in December 2010. In January of this year, the committee issued a revised final version of the LCR, following an endorsement by its governing body, the Group of Governors and Heads of Supervision (GHOS). The revision expands the range of assets that can count as HQLA and also adjusts some of the assumptions that govern the modeling of net outflows in a stress scenario. In addition, the committee agreed in January to a gradual phase-in of the LCR, so that it only becomes fully effective on an international basis in January 2019. On the domestic front, the Federal Reserve expects that the U.S. banking agencies will issue a proposal later this year to implement the LCR for large U.S. banking firms.

While this progress is welcome, a number of questions remain. First, to what extent should access to liquidity from a central bank be allowed to count toward satisfying the LCR? In January, the GHOS noted that the interaction between the LCR and the provision of central bank facilities is critically important. And the group instructed the Basel Committee to continue working on this issue in 2013.

Second, what steps should be taken to enhance the usability of the LCR buffer--that is, to encourage banks to actually draw down their HQLA buffers, as opposed to fire-selling other less liquid assets? The GHOS has also made clear its view that, during periods of stress, it would be appropriate for banks to use their HQLA, thereby falling below the minimum. However, creating a regime in which banks voluntarily choose to do so is not an easy task. A number of observers have expressed the concern that if a bank is held to an LCR standard of 100 percent in normal times, it may be reluctant to allow its ratio to drop below 100 percent when facing large outflows, even if regulators were to permit this temporary deviation, for fear that a decline in the ratio could be interpreted as a sign of weakness.

My aim here is to sketch a framework for thinking about these and related issues. Among them, the interplay between the LCR and central bank liquidity provision is perhaps the most fundamental and a natural starting point for discussion. By way of motivation, note that before the financial crisis, we had a highly developed regime of capital regulation for banks--albeit one that looks inadequate in retrospect--but we did not have formal regulatory standards for their liquidity.³ The introduction of liquidity regulation after the crisis can be thought of as reflecting a desire to reduce dependence on the central bank as a lender of last resort (LOLR), based on the lessons learned over the previous several years. However, to the extent that some role for the LOLR still remains, one now faces the question of how it should coexist with a regime of liquidity regulation.

To address this question, it is useful to take a step back and ask another one: What underlying market failure is liquidity regulation intended to address, and why can't this market failure be handled entirely by an LOLR? I will turn to this question first. Next, I will consider different mechanisms that could potentially achieve the goals of liquidity regulation, and how these mechanisms relate to various features of the LCR. In so doing, I hope to illustrate why, even though liquidity regulation is a close cousin of capital regulation, it nevertheless presents a number of novel challenges for policymakers and why, as a result, we are going to have to be open to learning and adapting as we go.

The Case for Liquidity Regulation
One of the primary economic functions of banks and other financial intermediaries, such as broker-dealers, is to provide liquidity--that is, cash on demand--in various forms to their customers. Some of this liquidity provision happens on the liability side of the balance sheet, with bank demand deposits being a leading example. But, importantly, banks also provide liquidity via committed lines of credit. Indeed, it is probably not a coincidence that these two products--demand deposits and credit lines--are offered under the roof of the same institution; the underlying commonality is that both require an ability to accommodate unpredictable requests for cash on short notice.⁴ A number of other financial intermediary services, such as prime brokerage, also embody a significant element of liquidity provision.

Without question, these liquidity-provision services are socially valuable. On the liability side, demand deposits and other short-term bank liabilities are safe, easy-to-value claims that are well suited for transaction purposes and hence create a flow of money-like benefits for their holders.⁵ And loan commitments are more efficient than an arrangement in which each operating firm hedges its future uncertain needs by "pre-borrowing" and hoarding the proceeds on its own balance sheet; this latter approach does a poor job of economizing on the scarce aggregate supply of liquid assets.⁶ 

At the same time, as the financial crisis made painfully clear, the business of liquidity provision inevitably exposes financial intermediaries to various forms of run risk. That is, in response to adverse events, their fragile funding structures, together with the binding liquidity commitments they have made, can result in rapid outflows that, absent central bank intervention, lead banks to fire-sell illiquid assets or, in a more severe case, to fail altogether. And fire sales and bank failures--and the accompanying contractions in credit availability--can have spillover effects to other financial institutions and to the economy as a whole. Thus, while banks will naturally hold buffer stocks of liquid assets to handle unanticipated outflows, they may not hold enough because, although they bear all the costs of this buffer stocking, they do not capture all of the social benefits, in terms of enhanced financial stability and lower costs to taxpayers in the event of failure. It is this externality that creates a role for policy.

There are two broad types of policy tools available to deal with this sort of liquidity-based market failure. The first is after-the-fact intervention, either by a deposit insurer guaranteeing some of the bank's liabilities or by a central bank acting as an LOLR; the second type is liquidity regulation. As an example of the former, when the economy is in a bad state, assuming that a particular bank is not insolvent, the central bank can lend against illiquid assets that would otherwise be fire-sold, thereby damping or eliminating the run dynamics and helping reduce the incidence of bank failure.

In much of the literature on banking, such interventions are seen as the primary method for dealing with run-like liquidity problems. A classic statement of the central bank's role as an LOLR is Walter Bagehot's 1873 book Lombard Street. More recently, the seminal theoretical treatment of this issue is by Douglas Diamond and Philip Dybvig, who show that under certain circumstances, the use of deposit insurance or an LOLR can eliminate run risk altogether, thereby increasing social welfare at zero cost.⁷ To be clear, this work assumes that the bank in question is fundamentally solvent, meaning that while its assets may not be liquid on short notice, the long-run value of these assets is known with certainty to exceed the value of the bank's liabilities.⁸ One way to interpret the message of this research is that capital regulation is important to ensure solvency, but once a reliable regime of capital regulation is in place, liquidity problems can be dealt with after the fact, via some combination of deposit insurance and use of the LOLR.

It follows that if one is going to make an argument in favor of adding preventative liquidity regulation such as the LCR on top of capital regulation, a central premise must be that the use of LOLR capacity in a crisis scenario is socially costly, so that it is an explicit objective of policy to economize on its use in such circumstances. I think this premise is a sensible one.⁹ A key point in this regard--and one that has been reinforced by the experience of the past several years--is that the line between illiquidity and insolvency is far blurrier in real life than it is sometimes assumed to be in theory. Indeed, one might argue that a bank or broker-dealer that experiences a liquidity crunch must have some probability of having solvency problems as well; otherwise, it is hard to see why it could not attract short-term funding from the private market.

This reasoning implies that when the central bank acts as an LOLR in a crisis, it necessarily takes on some amount of credit risk. And if it experiences losses, these losses ultimately fall on the shoulders of taxpayers. Moreover, the use of an LOLR to support banks when they get into trouble can lead to moral hazard problems, in the sense that banks may be less prudent ex ante. If it were not for these costs of using LOLR capacity, the problem would be trivial, and there would be no need for liquidity regulation: Assuming a well-functioning capital-regulation regime, the central bank could always avert all fire sales and bank failures ex post, simply by acting as an LOLR.

This observation carries an immediate implication: It makes no sense to allow unpriced access to the central bank's LOLR capacity to count toward an LCR requirement. Again, the whole point of liquidity regulation must be either to conserve on the use of the LOLR or in the limit, to address situations where the LOLR is not available at all--as, for example, in the case of broker-dealers in the United States.¹⁰ 

At the same time, it is important to draw a distinction between priced and unpriced access to the LOLR. For example, take the case of Australia, where prudent fiscal policy has led to a relatively small stock of government debt outstanding and hence to a potential shortage of HQLA. The Basel Committee has agreed to the use by Australia of a Committed Liquidity Facility (CLF), whereby an Australian bank can pay the Reserve Bank of Australia an up-front fee for what is effectively a loan commitment, and this loan commitment can then be counted toward its HQLA. In contrast to free access to the LOLR, this approach is not at odds with the goals of liquidity regulation because the up-front fee is effectively a tax that serves to deter reliance on the LOLR--which, again, is precisely the ultimate goal. I will return to the idea of a CLF shortly.

The Design of Regulation
Once it has been decided that liquidity regulation is desirable, the next question is how best to implement it. In this context, note that the LCR has two logically distinct aspects as a regulatory tool: It is a mitigator, in the sense that holding liquid assets leads to a better outcome if there is a bad shock; it is also an implicit tax on liquidity provision by banks, to the extent that holding liquid assets is costly. Of course, one can say something broadly similar about capital requirements. But the implicit tax associated with the LCR is subtler and less well understood, so I will go into some detail here.

An analogy may help to explain. Suppose we have a power plant that produces energy and, as a byproduct, some pollution. Suppose further that regulators want to reduce the pollution and have two tools at their disposal: They can mandate the use of a pollution-mitigating technology, like scrubbers, or they can levy a tax on the amount of pollution generated by the plant. In an ideal world, regulation would accomplish two objectives. First, it would lead to an optimal level of mitigation--that is, it would induce the plant to install scrubbers up to the point where the cost of an additional scrubber is equal to the marginal social benefit, in terms of reduced pollution. And, second, it would also promote conservation: Given that the scrubbers don't get rid of pollution entirely, one also wants to reduce overall energy consumption by making it more expensive.

A simple case is one in which the costs of installing scrubbers, as well as the social benefits of reduced pollution, are known in advance by the regulator and the manager of the power plant. In this case, the regulator can figure out what the right number of scrubbers is and require that the plant install these scrubbers. The mandate can therefore precisely target the optimal amount of mitigation per unit of energy produced. And, to the extent that the scrubbers are costly, the mandate will also lead to higher energy prices, which will encourage some conservation, though perhaps not the socially optimal level.¹¹ This latter effect is the implicit tax aspect of the mandate.

A more complicated case is when the regulator does not know ahead of time what the costs of building and installing scrubbers will be. Here, mandating the use of a fixed number of scrubbers is potentially problematic: If the scrubbers turn out to be very expensive, the regulation will end up being more aggressive than socially desirable, leading to overinvestment in scrubbers and large cost increases for consumers; however, if the scrubbers turn out to be cheaper than expected, the regulation will have been too soft. In other words, when the cost of the mitigation technology is significantly uncertain, a regulatory approach that fixes the quantity of mitigation is equivalent to one where the implicit tax rate bounces around a lot.

By contrast, a regulatory approach that fixes the price of pollution instead of the quantity--say, by imposing a predetermined proportional tax rate directly on the amount of pollution emitted by the plant--is more forgiving in the face of this kind of uncertainty. This approach leaves the scrubber-installation decision to the manager of the plant, who can figure out what the scrubbers cost before deciding how to proceed. For example, if the scrubbers turn out to be unexpectedly expensive, the plant manager can install fewer of them. This flexibility translates into less variability in the effective regulatory burden and hence less variability in the price of energy to consumers.¹² 

Scrubbers and High-Quality Liquid Assets

What does all this imply for the design of the LCR? Let's work through the analogy in detail. The analog to the power plant's energy output is the gross amount of liquidity services created by a bank--via its deposits, the credit lines it provides to its customers, the prime brokerage services it offers, and so forth. The analog to the mitigation technology--the scrubbers--is the stock of HQLA that the bank holds. And the analog to pollution is the net liquidity risk associated with the difference between these two quantities, something akin to the LCR shortfall. That is, when the bank offers a lot of liquidity on demand to its customers but fails to hold an adequate buffer of HQLA, this is when it imposes spillover costs on the rest of the financial system.

In the case of the power plant, I argued that a regulation that calls for a fixed quantity of mitigation--that is, for a fixed number of scrubbers--is more attractive when there is little uncertainty about the cost of these scrubbers. In the context of the LCR, the cost of mitigation is the premium that the bank must pay--in the form of reduced interest income--for its stock of HQLA. And, crucially, this HQLA premium is determined in market equilibrium and depends on the total supply of safe assets in the system, relative to the demand for those assets. On the one hand, if safe HQLA-eligible assets are in ample supply, the premium is likely to be low and stable. On the other hand, if HQLA-eligible assets are scarce, the premium will be both higher and more volatile over time.

This latter situation is the one facing countries like Australia, where, as I noted earlier, the stock of outstanding government securities is relatively small. And it explains why, for such countries, having a price-based mechanism as part of their implementation of the LCR can be more appealing than pure reliance on a quantity mandate. When one sets an up-front fee for a CLF, one effectively caps the implicit tax associated with liquidity regulation at the level of the commitment fee and tamps down the undesirable volatility that would otherwise arise from an entirely quantity-based regime.

Moreover, it bears reemphasizing that having a CLF with an up-front fee is very different from simply allowing banks to count central-bank-eligible collateral as HQLA at no charge. Rather, the CLF is like the pollution tax. For every dollar of pre-CLF shortfall--that is, for every dollar of required liquidity that a bank can't obtain on the private market--the bank has to pay the commitment fee. So even if there is not as much mitigation, there is still an incentive for conservation, in the sense that banks are encouraged to do less liquidity provision, all else being equal. This would not be the case if the CLF were available at a zero price.

What about the situation in countries where safe assets are more plentiful? The analysis here has a number of moving parts because in addition to the implementation of the LCR, substantial increases in demand for safe assets will arise from new margin requirements for both cleared and noncleared derivatives. Nevertheless, given the large and growing global supply of sovereign debt securities, as well as other HQLA-eligible assets, most estimates suggest that the scarcity problem should be manageable, at least for the foreseeable future.

In particular, quantitative impact studies released by the Basel Committee estimate that the worldwide incremental demand for HQLA coming from both the implementation of the LCR and swap margin requirements might be on the order of $3 trillion.¹³ This is a large number, but it compares with a global supply of HQLA-eligible assets of more than $40 trillion.¹⁴ Moreover, the eligible collateral for swap margin is proposed to be broader than the LCR's definition of HQLA--including, for example, certain equities and corporate bonds without any cap. If one focuses just on U.S. institutions, the incremental demand number is on the order of $1 trillion, while the sum of Treasury, agency, and agency mortgage-backed securities is more than $19 trillion.¹⁵ 

While this sort of analysis is superficially reassuring, the fact remains that the HQLA premium will depend on market-equilibrium considerations that are hard to fully fathom in advance, and that are likely to vary over time. This uncertainty needs to be understood, and respected. Indeed, the market-equilibrium aspect of the problem represents a crucial distinction between capital regulation and liquidity regulation, and it is one reason why the latter is particularly challenging to implement. Although capital regulation also imposes a tax on banks--to the extent that equity is a more expensive form of finance than debt--this tax wedge is, to a first approximation, a fixed constant for a given bank, independent of the scale of overall financial intermediation activity. If Bank A decides to issue more equity so it can expand its lending business, this need not make it more expensive for Bank B to satisfy its capital requirement. In other words, there is no scarcity problem with respect to bank equity--both A and B can always make more. By contrast, the total supply of HQLA is closer to being fixed at any point in time.¹⁶ 

Policy Implications
What does all of this imply for policy design? First, at a broad philosophical level, the recognition that liquidity regulation involves more uncertainty about costs than capital regulation suggests that even a policymaker with a very strict attitude toward capital might find it sensible to be somewhat more moderate and flexible with respect to liquidity. This point is reinforced by the observation that when an institution is short of capital and can't get more on the private market, there is really no backup plan, short of resolution. By contrast, as I mentioned earlier, when an institution is short of liquidity, policymakers do have a backup plan in the form of the LOLR facility. One does not want to rely too much on that backup plan, but its presence should nevertheless factor into the design of liquidity regulation.

Second, in the spirit of flexibility, while a price-based mechanism such as the CLF may not be immediately necessary in countries outside of Australia and a few others, it is worth keeping an open mind about the more widespread use of CLF-like mechanisms. If a scarcity of HQLA-eligible assets turns out to be more of a problem than we expect, something along those lines has the potential to be a useful safety valve, as it puts a cap on the cost of liquidity regulation. Such a safety valve would have a direct economic benefit, in the sense of preventing the burden of regulation from getting unduly heavy in any one country.

Perhaps just as important, a safety valve might also help to protect the integrity of the regulation itself, by harmonizing costs across countries and thereby reducing the temptation of those most hard-hit by the rules to try to chip away at them. Without such a safety valve, it is possible that some countries--those with relatively small supplies of domestic HQLA--will find the regulation considerably more costly than others. If so, it would be natural for them to lobby to dilute the rules--for example, by arguing for an expansion in the type of assets that can count as HQLA. Taken too far, this sort of dilution would undermine the efficacy of the regulation as both a mitigator and a tax. In this scenario, holding the line with what amounts to a proportional tax on liquidity provision would be a better outcome.¹⁷ 

One situation where liquid assets can become unusually scarce is during a financial crisis. Consequently, even if CLFs were not counted toward the LCR in normal times, it might be appropriate to count them during a crisis. Indeed, while the LCR requires banks to hold sufficient liquid assets in good times to meet their outflows in a given stress scenario, it implicitly recognizes that if things turn out even worse than that scenario, central bank liquidity support will be needed. Allowing CLFs to count toward the LCR in such circumstances would acknowledge the importance of access to the central bank, and this access could be priced accordingly.

Finally, a price-based mechanism might also help promote a willingness of banks to draw down their supply of HQLA in a stress scenario. As I noted at the outset, one important concern about a pure quantity-based system of regulation is that if a bank is held to an LCR standard of 100 percent in normal times, it may be reluctant to allow its ratio to fall below 100 percent when facing large outflows for fear that doing so might be seen by market participants as a sign of weakness.

By contrast, in a system with something like a CLF, a bank might in normal times meet 95 percent of its requirement by holding private-market HQLA and the remaining 5 percent with committed credit lines from the central bank, so it would have an LCR of exactly 100 percent. Then, when hit with large outflows, it could maintain its LCR at 100 percent, but do so by increasing its use of central bank credit lines to 25 percent and selling 20 percent of its other liquid assets.¹⁸ This scenario would be the sort of liquid-asset drawdown that one would ideally like to see in a stress situation. Moreover, the central bank could encourage this drawdown by varying the pricing of its credit lines--specifically, by reducing the price of the lines in the midst of a liquidity crisis. Such an approach would amount to taxing liquidity provision more in good times than in bad, which has a stabilizing macroprudential effect.

This example also suggests a design that may have appeal in jurisdictions where there is a relatively abundant supply of HQLA-eligible assets. One can imagine calibrating the pricing of the CLF so as to ensure that lines provided by central banks make up only a minimal fraction of banks' required HQLA in normal times--apart, perhaps, from the occasional adjustment period after an individual bank is hit with an idiosyncratic liquidity shortfall. At the same time, in a stress scenario, when liquidity is scarce and there is upward pressure on the HQLA premium, the pricing of the CLF could be adjusted so as to relieve this pressure and promote usability of the HQLA buffer. Such an approach would respect the policy objective of reducing expected reliance on the LOLR while at the same time allowing for a safety valve in a period of stress. The limit case of this approach is one where the CLF counts toward the LCR only in a crisis.

Conclusion
By way of conclusion, let me just restate that liquidity regulation has a key role to play in improving financial stability. However, we should avoid thinking about it in isolation; rather, we can best understand it as part of a larger toolkit that also includes capital regulation and, importantly, the central bank's LOLR function. Therefore, proper design and implementation of liquidity regulations such as the LCR should take account of these interdependencies. In particular, policymakers should aim to strike a balance between reducing reliance on the LOLR on the one hand and moderating the costs created by liquidity shortages on the other hand--especially those shortages that crop up in times of severe market strain. And, as always, we should be prepared to learn from experience as we go.

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1. The views that follow are my own and are not necessarily shared by my colleagues on the Federal Reserve Board. I am grateful to members of the Board staff--Sean Campbell, Mark Carlson, Burcu Duygan-Bump, Michael Gibson, William Nelson, and Mark Van Der Weide--for many helpful conversations and suggestions. Return to text

2. See Basel Committee on Banking Supervision (2013), Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools (PDF)  (Basel: Bank for International Settlements, January), p. 1. Return to text

3. Although bank liquidity was not regulated prior to the crisis, it played an important part in the supervisory process. For example, in the CAMELS ratings used by supervisors, the "L" stands for "liquidity." Return to text

4. For an elaboration of this argument, see Anil K. Kashyap, Raghuram Rajan, and Jeremy C. Stein (2002), "Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-Taking,"  Journal of Finance, vol. 57 (February), pp. 33-73. Return to text

5. See Gary Gorton and George Pennacchi (1990), "Financial Intermediaries and Liquidity Creation,"  Journal of Finance, vol. 45 (March), pp. 49-71. Demand deposits may also represent a form of insurance against liquidity shocks, as argued in Douglas W. Diamond and Philip H. Dybvig (1983), "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, vol. 91 (June), pp. 401-19. Return to text

6. See Bengt Holmström and Jean Tirole (1998), "Private and Public Supply of Liquidity," Journal of Political Economy, vol. 106 (February), pp. 1-40. Return to text

7. See Diamond and Dybvig, "Bank Runs," in note 5. Return to text

8. The underlying premise of solvency is captured in Bagehot's famous dictum for use of the LOLR: In times of crisis, the central bank should lend freely (and at a penalty rate) to banks, provided that the banks are solvent and that the loans are adequately collateralized. See Walter Bagehot ([1873] 1999), Lombard Street: A Description of the Money Market (London: King; reprint, New York: Wiley). Return to text

9. This is, of course, not to say that the LOLR should not be used in extreme circumstances--only that doing so comes with a cost, so policy should seek to reduce the likelihood that it will have to be used. Return to text

10. The fact that broker-dealers do not have access to the LOLR in the United States is, of course, ultimately a policy choice, and one that can be thought of as reflecting exactly the considerations discussed here: Whatever its merits, extending the LOLR to broker-dealers would increase taxpayer exposure and potentially exacerbate moral hazard problems. Hence there may be a rationale for restricting its availability and relying on regulation instead. Return to text

11. Even in this simple full-information case, one cannot generally attain the social optimum on both the mitigation and conservation dimensions using just a mandate to install scrubbers as the only regulatory instrument. By contrast, a tax on pollution, which decentralizes output and mitigation decisions to the firm, can, under full information, attain the optimum on both dimensions. Return to text

12. On the flip side, however, the same flexibility means that there will be more variability in the total amount of pollution generated by the plant--because when costs of mitigation are high, less mitigation will be done. So in the face of uncertainty, one cannot conclude that a price-based tax regime is necessarily superior to a quantity-based mitigation regime. This reasoning follows the classic analysis of Weitzman; see Martin L. Weitzman (1974), "Prices vs. Quantities,"  Review of Economic Studies, vol. 41 (October), pp. 477-91. Return to text

13. To be more precise, global incremental demand coming from swap margin requirements is estimated at $1.24 trillion; see Basel Committee on Banking Supervision and Board of the International Organization of Securities Commissions (2013), Margin Requirements for Non-Centrally Cleared Derivatives: Second Consultative Document (Basel: Bank for International Settlements and IOSCO, February). Of this $1.24 trillion, $810 billion reflects margin (net of collateral already collected) on uncleared swaps, and $420 billion reflects margin on swaps that will migrate to central clearing. In addition, global incremental demand coming from the LCR is estimated at $2.39 trillion; see Basel Committee on Banking Supervision (2012), Results of the Basel III Monitoring Exercise as of 30 June 2011  (Basel: Bank for International Settlements, April). However this latter number is based on the December 2010 version of the LCR; the recalibration of the LCR in the January 2013 final version will reduce this value for U.S. banks by roughly one-third. Extrapolating this result to the global level suggests that incremental demand resulting from the LCR will fall by roughly $800 billion to $1.6 trillion. Return to text

14. Committee on the Global Financial System (forthcoming), Asset Encumbrance, Financial Reform and the Demand for Collateral Assets (Basel: Bank for International Settlements). Return to text

15. According to Federal Reserve Board flow of funds data, as of December 31, 2012 the total stock of U.S. Treasury securities stood at $11.6 trillion, and the total stock of agency debt and mortgage-backed securities stood at $7.5 trillion. A caveat here is that agency mortgage-backed securities are considered Level 2 assets, so they can count for at most 40 percent of any bank's total holdings of HQLA. Return to text

16. This is not to say that banks cannot adjust on other margins if HQLA is in unexpectedly short supply. For example, they can do less liquidity provision, by terming out their funding or by extending fewer credit lines. This is like the power plant doing more conservation and less mitigation: It reduces the upward pressure on the price of scrubbers (or HQLA), at the cost of cutting back on a set of services that presumably has some social value. Return to text

17. To be sure, it is possible that the rules could be diluted in the context of a price-based CLF mechanism as well, for example, through the administration of collateral-eligibility criteria or haircut requirements. Return to text

18. This presumes that the bank in question is able to present adequate collateral to the central bank to secure the central bank credit line. Return to text

Governor Sarah Bloom Raskin At the "Building a Financial Structure for a More Stable and Equitable Economy" 22nd Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies, New York, New York

April 18, 2013

Aspects of Inequality in the Recent Business Cycle

Thank you for asking me to join you today at this conference and to be a part of your continuing inquiry into how the ideas and legacy of Hyman Minsky can inform and shape our understanding of financial markets and the economy.

This speech expands on remarks I made in March to the National Community Reinvestment Coalition, in which I explored the roles that monetary and bank regulatory policy play in reducing the unemployment, economic marginalization, and financial vulnerability of millions of moderate- and low-income working Americans. Today I am interested in continuing this exploration by examining an issue of growing saliency that macroeconomic models used at central banks and by academics have not traditionally emphasized--specifically, how such economic marginalization and financial vulnerability, associated with stagnant wages and rising inequality, contributed to the run-up to the financial crisis and how such marginalization and vulnerability could be relevant in the current recovery.

To isolate my proper subject here, I want to be clear that I am not engaging this afternoon with the concern that many Americans have that excessive inequality undermines American ideals and values. Nor will I be investigating the social costs associated with wide distributions of income and wealth. Rather, I want to zero in on the question of whether inequality itself is undermining our country's economic strength according to available macroeconomic indicators.

Economists have documented that widening income and wealth inequality has been one of the most notable structural changes to the U.S. economy since the late 1970s. This change represents a dramatic departure from the three decades prior to that time, when Americans enjoyed broadly rising incomes and shared prosperity. Indeed, many of you in the room have shed important light on the recent trends in inequality and on the potential role of fiscal policy in addressing them. You have also explored how these trends are relevant to issues of financial stability. I won't attempt to repeat this strong line of research and analysis. Instead, my remarks today are specifically focused on adding to the conversation about how such disparities in income and wealth could be relevant for a macro understanding of the financial crisis and the recovery and the appropriate course of monetary policy today.

I will argue that at the start of this recession, an unusually large number of low- and middle-income households were vulnerable to exactly the types of shocks that sparked the financial crisis. These households, which had endured 30 years of very sluggish real-wage growth, held an unusually large share of their wealth in housing, much of it financed with debt. As a result, over time, their exposure to house prices had increased dramatically. Thus, as in past recessions, suffering in the Great Recession--though widespread--was most painful and most perilous for low- and middle-income households, which were also more likely to be affected by job loss and had little wealth to fall back on.

Moreover, I am persuaded that because of how hard these lower- and middle-income households were hit, the recession was worse and the recovery has been weaker. The recovery has also been hampered by a continuation of longer-term trends that have reduced employment prospects for those at the lower end of the income distribution and produced weak wage growth.

Of course, it is not part of the Federal Reserve's mandate to address inequality directly, but I want to explore these issues today because the answers may have implications for the Federal Reserve's efforts to understand the recession and conduct policy in a way that contributes to a stronger pace of recovery. Traditionally, the distribution of wealth and income has not been a primary consideration in the way most macroeconomists think about business cycles. But if inequality played a role in the financial crisis, if it contributed to the severity of the recession, and if its effects create a lingering economic headwind today, then perhaps our thinking, and our macroeconomic models, should be adjusted.

Despite the tentative nature of these conclusions, I do think it is vital to explore these issues, and, in the spirit of Minsky, I hope my remarks spur more inquiry and discussion. I should also note that the views I express are my own and not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee (FOMC).

Trends in Income, Wealth, and Debt
In order to "level set" our understanding, let me begin by reviewing some of the changes to the structure of income, wealth, and debt in the years leading up to the Great Recession--changes that have had significant implications for the well-being of most American households. Long before the recession--decades before, in fact--income data show only sluggish increases in real incomes for low- and middle-income American households, and more-rapid increases for high-income households, resulting in a much greater concentration of income among those at the very top of the income distribution. As just one example of the broader trend, according to the Congressional Budget Office, between 1979 and 2007, inflation-adjusted, pretax income for a household in the top 1 percent more than doubled, while, in contrast, income for a household in the middle of the income distribution increased less than 20 percent.¹ Over these years, the share of pretax income accruing to the top 1 percent of households also doubled, from 10 percent to 20 percent, while the share accruing to the bottom 40 percent fell from 13 percent to 10 percent. These growing disparities of total income are largely due to the increasing concentration of labor income, which, on average, accounted for more than 70 percent of all income over this period. In addition, the distribution of other sources of total income--such as profits from small businesses, capital gains and dividend income, rental income, and the like--also became more concentrated over this period.

Many have argued that these disparities in income are hindering economic growth through their effects on consumption. Intuitively, one might assume that the growing concentration of income at the top could lead to less consumer spending and aggregate demand, as wealthier households tend to save more of their additional income than others. However, there is no definitive research indicating that these income disparities show mixed results on the question of whether there are stable differences in the marginal propensity to consume across households with different incomes.² More generally, the evidence is equivocal as to whether there is an empirical relationship between higher income inequality and reduced aggregate demand. In my view, understanding the links between greater concentrations of income, variation in spending patterns throughout the income distribution, and the effect of that variation on aggregate consumption--and, ultimately, growth--requires more exploration.³ 

But since household behavior is surely driven by more than the size of the paycheck coming in the proverbial front door, the distribution of wealth--as distinct from the distribution of income--could have clearer implications for the macroeconomy. Indeed, wealth inequality is greater than income inequality in the United States, although it has widened little in recent decades. For example, according to the Survey of Consumer Finances (SCF), a survey conducted every three years by the Federal Reserve Board, the top one-fifth of families ranked by income owned 72 percent of the total wealth in the economy in 2010, whereas families in the bottom one-fifth of the income distribution together owned only 3 percent of total wealth in 2010.⁴ 

Hence, families with more-modest incomes have much less wealth to cushion themselves against income shocks, such as unemployment. For example, in 2010, the median value of financial assets was less than $1,000 for families in the lowest income quintile. Moreover, what wealth low- and middle-income families do have is typically concentrated in housing. For families in the top quintile of income, the value of residential properties accounted for about 15 percent of total wealth in 2010. For families in the middle and lower half of the income distribution, the ratio of their home values to total net worth was near 70 percent. In contrast, stock market wealth (and the value of other securities) constitutes a very small share of wealth for low- and middle-income families.

Because the wealth of people at the lower end of the distribution is concentrated in housing, these households are disproportionately exposed to swings in house prices. This compositional effect was intensified during the housing boom, as the share of wealth accounted for by housing grew even faster for low- and middle-income families than for high-income families. That said, the increases in homeownership and house values during the boom were largely financed by rising mortgage debt. Thus, the direct positive effect of rising house prices on most households' net worth was largely offset by the negative effect of increased debt that households took on. On net, mortgage debt and home values moved up together. But when house prices began falling, the mortgage debt and repayment obligations remained.

To be sure, the increase in mortgage debt prior to the recession occurred across all types of households. But it was families with modest incomes and wealth largely in their homes that were the most vulnerable to subsequent drops in home values.

The question then arises as to why households with poor income prospects sought out levels of mortgage debt that would ultimately prove so problematic. Putting aside the practice, in the run-up to the crisis, of lenders steering households to mortgage debt products that were more costly than what such households may have otherwise qualified for, one reason may have been that many households in the middle and lower end of the income distribution, whose wage earnings were stagnant, did not recognize the long-run and persistent trends underlying their lack of income growth.⁵ If households thought they were merely going through a rough patch, it would have been quite reasonable for them to borrow money to smooth through it--to make home improvements, for example, or to send a child to college.⁶ At the same time, many people believed that the sharp increases in their home values had made them permanently richer and that house prices would never turn down, a belief that appears to have been shared by many households in the upper part of the income distribution as well. In fact, purchasing a house using debt was a profitable investment in the early 2000s. While it is hard to know with any certainty what these individual households believed at the time, it seems quite plausible to me, as others have argued, that stagnant wages and rising inequality, in combination with the relaxation of underwriting standards, led to an increase in the use of credit unsupported by greater income.⁷ 

Inequality and the Great Recession
Given these developments, when house prices fell, household finances were struck a devastating blow. The resulting fallout magnified this initial shock, ushering in the Great Recession. Let me lay out this argument in more detail.

As I mentioned earlier, low- to middle-income families held a disproportionate share of their assets in housing prior to the financial crisis and hence were very exposed to what was a historic decline in house prices. And so, while total household net worth fell 15 percent in real terms between 2007 and 2010, median net worth fell almost 40 percent. This difference reflects the amplified effect that housing had on wealth changes in the middle of the wealth distribution.

The unexpected drop in house prices on its own reduced both households' wealth and their access to credit, likely leading them to pull back their spending. In particular, underwater borrowers and heavily indebted households were left with little collateral, which limited their access to additional credit and their ability to refinance at lower interest rates. Indeed, some studies have shown that spending has declined more for indebted households.⁸ 

Compounding the effect of falling house prices on household wealth and credit was the fact that these low- to middle-income households are also composed of some of the groups that have historically borne the brunt of downturns in the labor market. During recessions, the young, the less educated, and minorities are more likely to experience flat or declining wages, reduced hours, and unemployment.⁹ While this disparity is not a new phenomenon, dealing with a loss in labor income during the most recent recession was a heightened challenge to households that had mortgage obligations and no other forms of wealth to cushion the blow. The adverse developments in the labor market added to the difficulty most households were having in repaying their existing debts and in accessing credit in the recession.

These low- to middle-income households that bore the strains in both housing and labor markets, and had little wealth cushion, had more difficulty making payments on their mortgages and other consumer credit debt. For example, among the mortgages originated from 2004 to 2008, almost 25 percent of those in low-income neighborhoods were foreclosed on or in serious delinquency as of 2011, more than twice the rate of mortgages originated in higher-income neighborhoods. Higher-income households had also taken on debt and were affected by declines in asset prices. But these households entered the recession with a larger wealth buffer and higher incomes, so they generally were still able to service their debts. The sharp rise in defaults and delinquencies put extraordinary stress on most households' finances, intensified the financial crisis, and exacerbated the effect of the initial economic shocks. Indeed, a rapid downward spiral of tighter credit, declines in asset prices, rising unemployment, and falling demand caused severe distress and a pullback in spending that was ultimately widespread across households.

Inequality and the Recovery
I have argued that rising inequality and stagnating wages may have led households to borrow more and to pin their hopes for economic advancement on rising home values, developments that exacerbated the severity of the financial crisis and recession. Now we are nearly four years into the recovery, which has been weak. In my view, this same confluence of factors has also contributed to the tepid recovery.

If my theory about why households overextended themselves before the financial crisis is correct, then it is likely also true that households have had a rude awakening in the years since. Not only did they receive an unwelcome shock to their net current wealth, but they also undoubtedly have come to realize that house prices will not rise indefinitely and that their labor income prospects are less rosy than they had believed. As a result, they are curtailing their spending in an effort to rebuild their nest eggs and may also be trimming their budgets in order to bring their debt levels into alignment with their new economic realities. In this case, the effects of the plunge in net wealth and the jump in unemployment on subsequent spending have been long lasting and lingering.

Overall debt levels remain higher than before the house price boom, and many families continue to struggle to keep up with their monthly payments. Although many households have significantly reduced their debt levels, many others probably have far to go.¹⁰ It is hard to know just what the optimal debt-to-income ratio is, but, in my view, households will likely aim for something lower than before the financial crisis: Households are probably working toward lower, more-manageable debt service obligations; the heightened uncertainty in the recession may have raised the desired level of financial buffers; and, to the extent that households saw the negative shocks to house prices and income as permanent, they are reducing their spending and thus their demand for new borrowing. While the process of household deleveraging has affected the spending and borrowing of many households, there is no doubt that the process has been more acute for those that have experienced unemployment, underemployment, or slower wage gains.

To make matters worse, there is also some evidence to suggest that the factors that contributed to the rise in inequality and the stagnation of wages in the bottom half of the income distribution, such as technological change that favors those with a college education and globalization, are still at play in the recovery--and perhaps may have accelerated.¹¹ About two-thirds of all job losses in the recession were in middle-wage occupations--such as manufacturing, skilled construction, and office administration jobs--but these occupations have accounted for less than one-fourth of subsequent job growth.¹² In contrast, the decline in lower-wage occupations--such as retail sales, food service, and other lower-paying service jobs--accounted for only one-fifth of job loss and more than one-half of total job gains in the recovery.¹³ 

It is not only the occupational and industrial distribution of the new jobs that poses challenges for workers and their families struggling to make ends meet, but also the fact that many of the jobs that have returned are part time or make use of temporary arrangements popularly known as contingent work. The flexibility of these jobs may be beneficial for workers who want or need time to address their family needs. However, workers in these jobs often receive less pay and fewer benefits than traditional full-time or "permanent" workers, are much less likely to benefit from the protections of labor and employment laws, and often have no real pathway to upward mobility in the workplace.¹⁴ 

Wage gains have remained more muted than is typical during a recovery. While this phenomenon likely partly reflects the trends in job creation that I have already discussed, weak wage growth also reflects the severe nature of the crisis: Typically, those who are laid off during recessions struggle to find reemployment that is of comparable quality to their previous job, and research has shown that, on average, a person's income remains depressed for decades following job loss, and that income losses over one's working life are especially severe when the job loss occurs during a recession.¹⁵ 

Indeed, while average wages have continued to increase (albeit slowly) on an annual basis for persons who have remained employed, the average wage for new hires has declined since 2010.¹⁶ Although it is too early to state with certainty what the long-term effect of this recession will be on the earnings potential of those who lost their jobs, given the severity of the job loss and sluggishness of the recovery--with nearly 9 million jobs lost and still almost 2-1/2 million jobs below pre-recession employment levels--it is very likely that, for many households, future labor earnings will be well below what they had anticipated in the years before the recession.

Implications for Our Thinking about the Macroeconomy
I have focused most of my remarks on the experiences of households at the lower ends of the income and wealth distributions, those households whose incomes improved the least in the years prior to the financial crisis and that suffered disproportionately as a result of the crisis and ensuing recession.

To be clear, my approach of starting with inequality and differences across households is not a feature of most analyses of the macroeconomy, and the channels I have emphasized generally do not play key roles in most macro models. The typical macroeconomic analysis focuses on the general equilibrium behavior of "representative" households and firms, thereby abstracting from the consequences of inequality and other heterogeneity across households and instead focusing on the aggregate measures of spending determinants, including current income, wealth, interest rates, credit supply, and confidence or pessimism. In certain circumstances, this abstraction might be a reasonable simplification. For example, if the changes in the distribution of income or wealth, and the implications of those changes for the overall economy, are regular features of business cycles, then even an aggregate model without an explicit focus on distributional issues would capture those historical regularities.

However, the narrative I have emphasized places economic inequality and the differential experiences of American families, particularly the highly adverse experiences of those least well positioned to absorb their "realized shocks," closer to the front and center of the macroeconomic adjustment process. The effects of increasing income and wealth disparities--specifically, the stagnating wages and sharp increase in household debt in the years leading up to the crisis, combined with the rapid decline in house prices and contraction in credit that followed--may have resulted in dynamics that differ from historical experience and which are therefore not well captured by aggregate models. How these factors have interacted and the implications for the aggregate economy are subject to debate, but I have laid out some possible channels through which there could be effects and that I believe represent some particularly fruitful areas for continued research.

Implications for Monetary Policy
The arguments that I have laid out suggest that paying attention to the experiences of different types of households may be important for the way we understand and interpret the macroeconomic events of the past several years. As a consequence, these differential experiences may also have implications for the conduct of monetary policy. Arguably, the FOMC's conduct of monetary policy in recent years has in part been designed to address this particular landscape. In response to continuing low levels of resource utilization, the FOMC has kept monetary policy highly accommodative by keeping its primary policy instrument, the federal funds rate, at an exceptionally low level; by supplementing this move with forward guidance about the funds rate; and by initiating unconventional policy actions such as large-scale asset purchases. One channel through which these policies operate is by putting downward pressure on longer-term interest rates, thereby encouraging firms to invest in plants and equipment and helping enable households to purchase cars and other durable goods and also to refinance their mortgages. Lower interest rates also support the prices of homes and other assets, which can lead to additional spending. The resulting boost to demand leads firms to hire and invest further, strengthening the economy as a whole. To be sure, every household is different, and the particular mix of assets, skills, and opportunities that each has will determine how much it is able to share in the recovery. But accommodative monetary policy that lifts economic activity more generally is expected to increase the odds of good outcomes for American families.

Of course, it is also relevant to consider whether the unusual circumstances--the outsized role of housing wealth in the portfolios of low- and middle-income households, the increased use of debt during the boom, and the subsequent unprecedented shocks to the housing market--may have attenuated the effectiveness of monetary policy during the depths of the recession. Households that have been through foreclosure or have underwater mortgages or are otherwise credit constrained are less able than other households to take advantage of the lower interest rates, either for homebuying or other purposes. In my view, these effects likely clogged some of the channels through which monetary policy traditionally works. As the housing market recovers, though, I think it is possible that accommodative monetary policy could be increasingly potent. As house prices rise, more and more households have enough home equity to gain renewed access to mortgage credit and the ability to refinance their homes at lower rates. The staff at the Federal Reserve Board has estimated that house price increases of 10 percent or less from current levels would be sufficient for about 40 percent of underwater homeowners to regain positive equity.

It is my view that understanding the long-run trends in income and wealth across different households is important in understanding the dynamics of the macroeconomy and thus also may be relevant for setting monetary policy to best reach our goals of maximum employment and price stability. I believe that the accommodative policies of the FOMC and the concerted effort we have made to ease conditions in the mortgage markets will help the economy continue to gain traction. And the resulting expansion in employment will likely improve income levels at the bottom of the distribution. However, given the long-standing trends toward greater income and wealth inequalities, it is unlikely that cyclical improvements in the labor markets will do much to reverse these trends.

Conclusion
It strikes me that macroeconomists are far from a comprehensive understanding of how wealth and income inequality may affect business cycle dynamics. My remarks today are given only in the spirit of describing how that relationship might be further explored. I have said nothing about the social costs associated with such trends, nor have I provided much detail on what is occurring at the top end of the income and wealth distribution and the effects of those trends on the recovery. Nonetheless, I believe that, given the wide income and wealth disparities in the United States, this area is ripe for more research.

In recent years, the Board has increased its efforts to measure and understand differences in the economic situations faced by different types of families. A particularly strong source of data to improve our understanding of the role for inequality and heterogeneity is the SCF. The triennial SCF marks its 30th anniversary this year, as the fieldwork for the 2013 survey begins this month. The data we collect on U.S. families are a fundamental input for many different types of research projects being undertaken by Board economists, in other government agencies and research centers, and in academia. In addition, the Board, in partnership with other members of the Federal Reserve System, is engaged in a wide range of analysis and research using rich and timely data on households' use of consumer credit. And the Board continues to support direct efforts to understand differences in spending and saving behavior across households, such as studies of stimulus policies in the Thomson Reuters/University of Michigan Surveys of Consumers.

There is much work to be done on understanding the ways in which income and wealth inequality and other forms of household heterogeneity affect aggregate behavior, and the implications for monetary policy. The times demand that we continue to analyze such dynamics and their implications, in partnership with academics, our Federal Reserve System colleagues, and policy analysts representing many different types of government and private-sector institutions.

Thank you for your attention and the creative thought you bring to today's economic challenges.

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1. See Congressional Budget Office (2011), Trends in the Distribution of Household Income between 1979 and 2007 (PDF) (Washington: CBO, October). Return to text

2. The survey article by Attanasio and Weber (2010) describes several conditions that raise a household's propensity to consume additional income, such as temporary income shocks, borrowing constraints, and low liquidity. However, existing studies do not provide clear evidence that people with permanently low income have a high marginal propensity to consume. See Orazio P. Attanasio and Guglielmo Weber (2010), "Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy,"  Journal of Economic Literature, vol. 48 (September), pp. 693-751.Return to text

3. One concern with rising inequality and stagnating wages is that low- and middle-income households will turn to credit and wealth extraction to maintain their consumption growth. One sign of this behavior would be consumption inequality rising much less than income inequality. Researchers--including Krueger and Perri (2006); Aguiar and Bils (2011); and Attanasio, Hurst, and Pistaferri (2012)--have produced mixed findings on this basic question, although, taken together, there is growing evidence that consumption inequality has also risen substantially over the past several decades. See Dirk Krueger and Fabrizio Perri (2006), "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory,"  Review of Economic Studies, vol. 73 (January), pp. 163-93; Mark A. Aguiar and Mark Bils (2011), "Has Consumption Inequality Mirrored Income Inequality?"  NBER Working Paper Series 16807 (Cambridge, Mass.: National Bureau of Economic Research, February); and Orazio Attanasio, Erik Hurst, and Luigi Pistaferri (2012), "The Evolution of Income, Consumption, and Leisure Inequality in the US, 1980-2010,"  NBER Working Paper Series 17982 (Cambridge, Mass.: National Bureau of Economic Research, April). Return to text

4. The specific measure used to group families for these wealth calculations is the stable component of income, referred to in the SCF as "normal" or "usual" income. In the SCF, after families have reported their actual incomes for the year, they are asked whether this was a normal year. If the answer is no, they are asked what their income usually would be in a normal year. Using normal income as a classifier removes the systematic bias in average wealth that arises when, for example, normally high-income families are temporarily in the lowest income group because they had a particularly bad year. Return to text

5. In a separate line of inquiry on the social dynamics of spending, Bertrand and Morse (2013) find that moderate-income households spend more if they live in states with rapid spending growth among high-income households, which suggests another channel for inequality to increase debt. See Marianne Bertrand and Adair Morse (2013), "Trickle-Down Consumption,"  NBER Working Paper Series 18883 (Cambridge, Mass.: National Bureau of Economic Research, March). Return to text

6. In fact, recent research shows that these trends in annual inequality are mostly due to rising disparities in the component of a household's income that is stable over time, rather than rising disparities in the component that varies from year to year. See Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos (2011), "Rising Inequality: Transitory or Permanent? New Evidence from a U.S. Panel of Household Income 1987-2006," Finance and Economics Discussion Series 2011-60 (Washington: Board of Governors of the Federal Reserve System, December). Return to text

7. For example, Rajan (2010) has argued that rising inequality resulted in the relaxation of credit standards, which led to the financial crisis, and Kumhof and Ranciere (2011) present a model with such features. However, Bordo and Meissner (2012) look at data from 14 advanced countries and do not find a general relationship between inequality and credit booms. Meanwhile, Bhutta (2011, 2012) finds that federal programs aimed at increasing homeownership only modestly increased the availability of mortgage credit to lower-income borrowers. See Raghuram Rajan (2010), Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton, N.J.: Princeton University Press); Michael Kumhof and Romain Ranciere (2011), "Inequality, Leverage and Crises," CEPR Discussion Paper 8179 (London: Centre for Economic Policy Research, January); Michael D. Bordo and Christopher M. Meissner (2012), "Does Inequality Lead to a Financial Crisis?"  NBER Working Paper Series 17896 (Cambridge, Mass.: National Bureau of Economic Research, March); Neil Bhutta (2011), "The Community Reinvestment Act and Mortgage Lending to Lower Income Borrowers and Neighborhoods,"  Journal of Law and Economics, vol. 54 (November), pp. 953-83; and Neil Bhutta (2012), "GSE Activity and Mortgage Supply in Lower-Income and Minority Neighborhoods: The Effect of the Affordable Housing Goals,"  Journal of Real Estate Finance and Economics, vol. 45 (June), pp. 238-61. Return to text

8. See Atif Mian, Kamalesh Rao, and Amir Sufi (2011), "Household Balance Sheets, Consumption, and the Economic Slump (PDF),"  unpublished paper, University of Chicago, Booth School of Business, November; and Karen Dynan (2012), "Is a Household Debt Overhang Holding Back Consumption?" Brookings Papers on Economic Activity, Spring, pp. 299-358. Return to text

9. An Organisation for Economic Co-operation and Development study by Ahrend, Arnold, and Moeser (2011) documents across a wider range of countries that individuals with low incomes tend to lose the most from adverse macroeconomic shocks. See Rudiger Ahrend, Jens Arnold, and Charlotte Moeser (2011), "The Sharing of Macroeconomic Risk: Who Loses (and Gains) from Macroeconomic Shocks,"  OECD Economics Department Working Papers 877 (Washington: OECD Publishing, July).Return to text

10. In contrast to the decrease in overall debt, student loans have continued to rise at a solid pace. The outstanding level of student loan balances is nearly twice its level five years ago and now represents the largest component of consumer (nonmortgage) lending. The increase in student loans is likely related to broader developments in the recession and exposes the households holding these loans to new risks. Return to text

11. The poverty rate has risen sharply since the onset of the recession, after a decade of relative stability, and it now stands at 15 percent, significantly higher than the average over the past three decades. See Carmen DeNavas-Walt, Bernadette D. Proctor, and Jessica C. Smith (2012), Income, Poverty, and Health Insurance Coverage in the United States: 2011 (PDF), U.S. Census Bureau Current Population Reports P60-243 (Washington: U.S. Government Printing Office, September). Return to text

12. See National Employment Law Project (2012), "The Low-Wage Recovery and Growing Inequality," Data Brief, report (New York: NELP, August), http://nelp.3cdn.net/8ee4a46a37c86939c0_qjm6bkhe0.pdf. Return to text

13. These patterns were also observed during the recessions of the early 1990s and early 2000s--the so-called jobless recoveries--but not prior to then. See Nir Jaimovich and Henry E. Siu (2012), "The Trend Is the Cycle: Job Polarization and Jobless Recoveries,"  NBER Working Paper Series 18334 (Cambridge, Mass: National Bureau of Economic Research, August); and Christopher L. Foote and Richard W. Ryan (2012), "Labor-Market Polarization over the Business Cycle," Public Policy Discussion Paper 12-8 (Boston: Federal Reserve Bank of Boston, December). Return to text

14. See U.S. Department of Labor, Commission on the Future of Worker-Management Relations (1994), "Contingent Workers," in Fact Finding Report. Return to text

15. See Steven J. Davis and Till von Wachter (2011), "Recessions and the Costs of Job Loss," Brookings Papers on Economic Activity, Fall, pp. 1-55. Return to text

16. See Jesse Rothstein (2012), "The Labor Market Four Years into the Crisis: Assessing Structural Explanations," ILRReview, vol. 65 (July), figure 11, p. 486. Return to text