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Hutchins Roundup: Monetary policy and Treasury remittances, school budget cuts, and more


Studies in this week’s Hutchins Roundup find that shrinking the Fed’s balance sheet cuts the odds that remittances to Treasury will evaporate, school budget cuts hurt students’ test scores and likelihood of completing high school, and more.

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Shrinking the Fed’s balance sheet cuts the odds that remittances to Treasury will evaporate

How will the Federal Reserve’s balance sheet normalization program affect the income that it remits to the U.S. Treasury? Using expectations for policy and financial variables between 2017 and 2035, Michele Cavallo from the Federal Reserve Board and co-authors generate paths for interest rates, other macroeconomic variables, and remittances under scenarios with various long-run balance sheet sizes. Under all scenarios, remittances decline in the short-run as interest payments on reserves increase, and increase in the long-run as securities mature and roll off the portfolio. However, the balance sheet size matters : maintaining the current balance sheet implies a 30 percent likelihood of zero remittances in the next few years, while shrinking reserve balances to a long-run level of $1 trillion (or less) would reduce the likelihood to less than 5 percent.

School spending cuts hurt students’ test scores and likelihood of completing high school  

The Great Recession induced many states to cut public school funding. Kirabo Jackson, Cora Wigger, and Heyu Xiong of Northwestern University examine how these cutbacks affected student outcomes and whether they made schools more efficient with their spending.  Although they find some evidence that schools reduced construction spending in response to tighter budgets, they also find evidence that schools cut spending on teachers. Furthermore, these cutbacks led to a deterioration in student performance, measured by both standardized test scores and high school completion rates.

National account statistics underestimate U.S. output growth

Measuring aggregate output accurately is difficult. The Bureau of Economic Analysis (BEA) publishes two measures: Gross Domestic Product (GDP), which tracks expenditures on goods and services, and Gross Domestic Income (GDI), which tracks income received by those who produce output. The two measures are the same in theory, but not in practice, suggesting that each is measured with error. Using macroeconomic indicators from 1960 to 2017, Matteo Barigozzi of the London School of Economics and Matteo Luciani of the Federal Reserve Board introduce a new estimate of output. They assume that GDP and GDI correctly estimate output in the long-run, and that long-run GDP and GDI are driven by a common component that captures shocks to the whole economy. Under these assumptions, they isolate the temporary, idiosyncratic components of GDP and GDI that include local shocks and measurement errors. Their estimate shows that since 2010, output growth was on average 0.5 percentage point higher than BEA estimates. Their measure’s higher growth has been concentrated in the first quarter of the year, suggesting that weakness in the BEA’s first-quarter growth over the past several years may be due to mismeasurement rather than problems with seasonal adjustment.

Chart of the week: All of the net increase in employment since 2000 has been among older workers

chart 01.17.2018

Quote of the week:

“[W]hat am I worried about?…the risk of economic overheating.  Now, this seems like an odd issue to focus on when inflation is low, but it strikes me that this is a real risk over the next few years.  Not only do we have an economy that is growing at an above-trend pace-at a time when the labor market is already quite tight-but the economy will be getting an extra boost in 2018 and 2019 from the recently enacted tax legislation.  Moreover, even though the FOMC has raised its target range for the federal funds rate by 125 basis points over the past two years, financial conditions today are easier than when we started to remove monetary policy accommodation,” says New York Fed president William Dudley.

“This suggests that the Federal Reserve may have to press harder on the brakes at some point over the next few years.  If that happens, the risk of a hard landing will increase.  Historically, the Federal Reserve has found it difficult to achieve a soft landing-especially when the unemployment rate has fallen below the rate consistent with stable inflation.  In those circumstances, the Federal Reserve has been unable to both push up the unemployment rate slightly to a level that is consistent with stable inflation and avoid recession.  Now, I don’t want to imply that a recession is inevitable once the FOMC finds it necessary to nudge up the unemployment rate to a sustainable level.  The starting point in terms of the inflation rate is also important because it will influence how far the FOMC is likely to go in terms of making monetary policy tight.  Nevertheless, I think it is fair to say that the track record on this score is not encouraging.”


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