Benn Steil


A graphical take on geoeconomic issues, with links to the news and expert commentary.

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Is Bernanke Right on QE3 and the Mortgage Market?

by Benn Steil and Dinah Walker
Mortgage Rates and QE3

Fed Chairman Ben Bernanke defended QE3 at his September 13 press conference by arguing that it would lower mortgage rates and increase home prices.  Over 80% of U.S. household debt is mortgage debt, so the extent to which he is right could be of considerable consequence to the future path of economic recovery.  Read more »

Benchmarking the Fed’s Dual-Mandate Performance

by the Center for Geoeconomic Studies
The Dual Mandate

The Fed has a dual mandate to pursue price stability and maximum employment.  How should these be defined?  In January, the Fed set itself a long-run inflation target of 2%, while in June the midpoint of Fed board members’ and Reserve Bank presidents’ long-run unemployment predictions was 5.6%.  Our figure above shows actual inflation and unemployment performance relative to these targets going back to 2002.  What stands out is the divergence that opens up, particularly on the unemployment front, after Lehman Brothers failed in September 2008.  The sum of the deviations reached its peak in July 2009, as shown in the small box in the upper left of the figure.  Though it has since declined fairly steadily, it is still well above zero – zero being a benchmark for fulfilling the combined mandate.  This suggests that the Fed’s doves should continue to hold the upper hand. Read more »

More Evidence That LIBOR Is Hazardous to Economic Health

by the Center for Geoeconomic Studies

Central bankers necessarily spend a great deal of time studying economic and market data that they believe to be forward-looking indicators of the economy’s health.  One such is the so-called “LIBOR-OIS spread” – the spread between the London Interbank Offered Rate (the rate at which major banks can supposedly borrow from each other, unsecured by collateral, for three months) and the Overnight Indexed Swap rate Read more »

More Evidence That LIBOR Is Manipulated, and What It Means

by the Center for Geoeconomic Studies

Barclays’ admission that it deliberately understated the interest rates at which it could borrow between September 2007 and May 2009 suggests grievous flaws in the widespread process of using LIBOR (the London Inter-Bank Offered Rate) as a benchmark off which to price commercial loans, mortgages, and other forms of lending.  Our figure above illustrates this by comparing LIBOR with so-called NYFR Read more »

Can Household Risk-Aversion Measures Predict Fed Policy?

by the Center for Geoeconomic Studies
risk aversion

The so-called Taylor Rule in monetary policy suggests how the Federal Reserve should adjust interest rates based on movements in inflation and economic output.  Although the Fed has never explicitly followed such a rule, it described fairly well the path of interest rate policy under much of Alan Greenspan’s tenure as chairman. Read more »

Where Have All the Profits Gone? Karl Marx Could Have Told You

Labor and Dividend Income

Since 2009, labor’s share of income in the United States has plummeted while personal dividend income as a percentage of disposable income has soared. This is not surprising for the early stage of a recovery in which firms are earning more with less and the stock market has been buoyant. The divergent trends between the two over the last 30 years, however, is notable and important. The small upper-right figure shows that dividend income as a percentage of after-tax corporate profits leapt markedly and permanently in the early 1980s. This corresponds with a general upward trend in corporate profits as a percentage of gross domestic product since that time; a time in which labor’s share of income has fallen almost continuously. Dividend income, not surprisingly, accrues largely to the stock-owning wealthy, as the small bottom-right figure shows. The fuller picture is one of growing inequality; one for which the globalization of business is frequently fingered as a primary culprit. But globalization itself makes the data difficult to parse. When an American firm uses components provided by foreign firms they appear from the data to have no labor content.

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It’s Time to Euthanize Sovereign CDSs

by the Center for Geoeconomic Studies

Imagine life insurance contracts that wouldn’t pay off if officials declared heart attacks to be “voluntary.” Welcome to the world of sovereign credit default swaps, or CDSs.  When the Greek debt deal was announced on October 27, the eurozone leadership insisted that the banks were taking a 50% write-down “voluntarily,” meaning that Greek CDS contracts would not be triggered.  This was done to protect official creditors like the ECB and IMF, to avoid rewarding speculators, and to prevent possible financial contagion.  In response, Greek CDS prices plunged 20 percentage points.  Policymakers didn’t seem to care, but they should.  Those who bought CDSs believing that they were prudently insuring their bond holdings now face unexpected losses.  Sovereign CDSs have lost so much credibility that the troubled investment bank Jefferies felt it necessary to state publicly that it was not using them.  This credibility loss has spread to other sovereign CDSs, as shown in the bottom part of the figure above: the correlation between PIIGS debt spreads and CDS prices has plunged, indicating that CDSs are no longer viewed as reliable sovereign credit risk insurance.  Using CDS prices as a measure of default risk is now like setting your watch to a defective clock.  Yet the market is unlikely to die owing to Basel III bank capital regulations, which still treat CDSs as meaningful offsets against certain types of sovereign credit exposures.  This gives banks a perverse incentive to hold them just to reduce their capital requirements.  Given the permanent political distortion that Europe has introduced into the sovereign CDS market, it would be best now if the market could simply be shuttered.

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Are Stocks Cheap?

by the Center for Geoeconomic Studies

Weak economic data, a Washington debt standoff, a downgrade of U.S. federal debt, and rising European default fears helped send the S&P 500 stock index down 16% between July 22and August 6.  As the figure above shows, equity prices of late imply the worst earnings growth rate expectations in 25 years—such expectations even turned negative last week.  This dour outlook stems partly from renewed risk-aversion, which ironically redirected cash into downgraded U.S. debt, but it also reflects a sharp rise in concerns about where new profits will come from.  Operating margins and profits are near all-time highs, but revenues are still below their 2008 peak and real consumer spending has grown by only 2% over the past year.  Corporations currently have strong balance sheets and the lowest net debt-to-revenue ratio on record, but this is largely the result of cost-cutting which may have run its course.  In short, either stocks are very cheap or growth prospects very dim.

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Is the ECB Draining its own Powers?


Back in 2000, the European Central Bank’s first president, Wim Duisenberg, explained how he knew the Bank’s operational framework for implementing monetary policy was working well.  It was, he said, successfully “steering short-term market interest rates” where the Bank wanted them to go.  Prior to the financial crisis, that was indeed the case: the ECB’s policy rate was tightly connected to important short-term interest rates, such as the 3-month government borrowing rate.  In a growing swath of the eurozone, however, this is no longer the case.  As the figures above show, the correlation between the ECB’s policy rate and actual government borrowing rates in Spain, Greece, Italy, Ireland, and Portugal has plummeted since the ECB began its debt-buying program.  The market’s view of default risk on eurozone government debt has increasingly come to dominate these rates, which themselves strongly influence borrowing rates in the private sector.  By Duisenberg’s criterion, monetary policy in the eurozone is becoming less and less effective.  The only thing that will reverse this trend is a resolution of Europe’s growing bank and government debt crisis.  Yet by continually insisting that debt restructuring is out of the question, the ECB is only delaying such a resolution – and almost surely making it more costly.

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Greek Debt Crisis – Apocalypse Later


The difference between Greek and German government bond yields can be used to estimate the market’s view of the likelihood of a Greek default. The chart above shows these probabilities over different time frames on three different dates. On April 30th, no European plan was yet in place to address the ballooning Greek debt, and default was considered a real possibility in the short term. On May 11th, just after the European Stabilization Mechanism (ESM) was announced, markets sharply cut their view on the odds of default across all time horizons. However, the market’s analysis of the ESM has become much more nuanced since then. On September 1st, the market’s view of the probability of default within two years was lower than before the ESM was announced, but higher over longer time frames. Read more »