Federal Reservations

I did a couple of posts a while back asking (and concluding) what would result from the Fed ending their interest on reserves policies. (Not suggesting they do so — just wondering what the effects of that one change would be.)

I got a lot of good answers and discussion, but nobody mentioned the very interesting paper by Alex Tabarrok discussed here (emphasis mine):

…there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit. Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)

Today, the banks are no longer in bullfrog mode. The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night. Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.

This explanation finds support in a post from Liberty Street Economics (NY Fed blog). The key graphic:

Cross-posted at Asymptosis.

Originally from Angry Bear

Poking around in FRED while thinking about money created by banks and by government, I came up with the following graph, which I found to be pretty eye-popping:

Federal Debt Held by the Public as a Percentage of Total Credit Market Debt Owed

That’s a pretty profound secular shift. But far from delivering any obvious conclusions for me, it raises several questions.

• First, what’s included in TCMDO? (Is there a glossary of these measures available somewhere? I haven’t been able to find one.) I assume government bills and bonds are included — including those held by the Fed. I assume it does not include bonds held by the Social Security trust fund — nonpublic debt. (Or does it?)

• Since financial industry debt is “different,” what does the graph look like if we exclude that?

Federal Debt Held by the Public as a Percentage of (Total Credit Market Debt Owed – Financial Sector Debt Owed)

• Should we adjust for credit-market instruments held by the Fed?

• Are there more illuminating measures to display in this graph?

• What does this say about the stock of “safe assets” in the economy?

• How does this relate to JKH and Steve Waldman’s notions of government money (created through deficit spending) as “leverage” — in Michael Sankowski’s words: “JKH points out (S-I) is like the denominator in leverage. When (S-I) [govt deficit spending plus/minus trade imbalance] gets too small compared to S or I, then the private sector steps in with private creation of S. But these claims aren’t always as credible as government NFA. Plus, private sector S can sometimes be marked to market in ways which makes valuation difficult.”

Sorry to be so inconclusive. As always I’m hoping to be educated by finer minds than mine.

Cross-posted at Asymptosis.

Originally from Angry Bear

Angry Bear was started by its namesake in the latter part of 2003, and continued publishing through the editorial efforts of Mike Kimel and Dan Crawford over the last six years (see About page). 
Mark Thoma at Economist View approaches the role of econblogs through pointing to the disconnect between academics and public use of the language of economics in an article published by Academia and the Public Sphere titled New Forms of Communication and the Public Mission of Economics: Overcoming the Great Disconnect:

Fortunately, however, the “Great Disconnect”[3] with the non-academic community is being reversed with the development of new information technology. Economics blogs in particular have played a key role in turning things around.

Matt Stoller at Naked Capitalism suggests:

But something odd happened in 2008, during and in the wake of the crisis. Capitol Hill staffers and members of both parties began looking for expertise on how finance actually worked. And they began reading financial blogs. Lobbyists just didn’t or couldn’t help them understand how to deal with the massive systemic failures; they knew in some sense that the information they were getting was rigged. They just didn’t know how. The financial blogs began to tell them.


Over the course of the next few years, the financial blogs became a new alternative system which delivered one of the most valuable commodities that previously had been monopolized by financial lobbyists and institutions like the Fed – credible information. That’s why there was an actual debate during Dodd-Frank over reining in the size of banking institutions, and auditing the Fed. Instead of second order industry shills distributing information they have been fed by the PR departments of big banks, communities of end-users of finance began to talk directly to lawmakers through mediated forums on the internet.

Originally from Angry Bear

Tim Duy body-slams St. Louis FRB President James Bullard:

Estimates of potential GDP are not simple extrapolations of actual GDP from the peak of the last business cycles. They are estimates of the maximum sustainable output given fully employed resources. The backbone of the CBO's estimates is a Solow Growth model. So I don't think that Noah Smith is quite accurate when he says:

So, basically, what we have here is Bullard saying that the neoclassical (Solow) growth model - and all models like it - are wrong. He's saying that a change in asset prices can cause a permanent change in the equilibrium capital/labor ratio.

Bullard can't be saying the Solow growth model is wrong because he doesn't realize that such a model is the basis for the estimates he is criticizing. [first and last link in the original; Noah Smith link copied from elsewhere in the original post]

Go Read the Whole Thing. For those of you too lazy to do that without incentive, here's the conclusion:

Bottom Line: Bullard really went down an intellectual dead end last week. He criticized the focus on potential output, but revealed that he doesn't really understand the concept of potential output either empirically or theoretically. He then compounds that error by arguing against the current stance of monetary policy, but fails to provide an alternative policy path. And the presumed policy path, tighter policy, looks likely to only worsen the distortions he argues the Fed is creating. I just don't see where Bullard thinks he is taking us.

It's Worse Than You Think.

Originally from Angry Bear

Or: It’s The Velocity, Stupid.

I got quite a bit of blowback on my recent post suggesting that economists don’t understand accounting.

In response I give you Exhibit A: the almost-ubiquitous notion that more saving increases the supply of “loanable funds” — hence that more saving causes or at least allows more investment. (The absolute classic fallacy of the S=I accounting identity.)

On casual consideration, it seems like it would be right, right? You spend less than your income, so you have more money (stuffed in your mattress?), and you can lend it out.

Or more likely: you “put money in the bank” – deposit more than you withdraw — so the bank has more money; it can lend more.

It’s A Wonderful Life.

Here’s Mankiw in his textbook, saying exactly that:

You really have to wonder sometimes where economists get this stuff that they put in their textbooks.

Nick Rowe attempted to save this conceptual situation recently in a comment posted hereabouts (emphasis mine):

Suppose there’s an increased demand for financial assets by households (a rightward shift in the demand curve). Will that increased demand lead to an increased quantity of investment by firms and an increased quantity of financial assets sold to households (a movement along a supply curve)? It may do. That depends on the model. It’s a behavioural question, not an accounting question.

His questions in the middle, and the last statement, are completely on the money. But his explanation begins right in the midst of the conceptual confusion, putting the modeling cart before the behavioral horse. The behavior doesn’t “depend on the model”; the model’s accuracy and usefulness depends on its assumed human response to incentives and constraints.

Or perhaps, rather, he’s climbed aboard the wrong behavioral horse — one that is wandering off rather aimlessly.

The “desire to save” is a conceptual representation, a mini-model, if you will, of one aspect of the economic situation. I’m suggesting that that construct is outside of, peripheral and irrelevant to, the behavioral chain of cause and effect.

People might want to save more/spend less in aggregate for various reasons:

• Times are tough — GDP and employment are weak — and they’re worried about future ability to consumption.

• Times are good, and they’re satisfying all their consumption desires.

• Rich people have a larger proportion of income and wealth, and their lower marginal propensity to consume drags down aggregate spending, relative to income and wealth.

Or some other scenario. (As Keynes said — not looking up the exact quote here – all economic activity is driven by the desire to consume.)

In the second scenario banks will want to lend more — but not because people and businesses (want to) save more. If that were true, banks would also want to lend more in the first scenario — which is completely contrary to what actually happens. (The results in the third scenario seem uncertain.)

Here’s a syllogism to make this widespread confusion clearer:

More investment results in more prosperity.

More saving results in more investment.

More pessimism (or less-confident optimism) results in more saving. (I think monetarists will stipulate to this.)

So more pessimism results in more prosperity!

Mankiw’s conceptual confusion is inevitable, and arises from two causes:

1. He’s starting with snaky (and conceptually confused) assumptions about the sources of human behavior, and:

2. New but related subject: He’s trying to think about flows (and get tender young minds to think about flows) using static, of-an-instant models like the standard S/D and IS-LM diagrams. The problem, when you’re trying to think about “supply,” is that a flow can’t exist in an instant (only stocks can); it’s a meaningless, impossible concept. And since stocks in our discussion here are unaffected by saving, he’s in a pickle, cause it’s all about flows. (And no: “comparative-static” methods don’t solve the conceptual confusion; they arguably only contribute to it because they impart the illusion of time and dynamism.)

The only way (that I know of) to model “flow supply” in a conceptually coherent way – or even think or talk about it really, which is mental modeling — is using a dynamic simulation model. Of late I’ve been quite taken with the power grid as a good metaphor for a dynamic model of the economy — one that I’ll expand and expound upon in a future post.

For now I’ll leave you with this: Clower/Burshaw on the difference between “stock supply” and “flow supply,” or peruse the literature here. Nick also talks quite a bit about the largely forgotten old 70s notion of “nominal” (roughly: “potential”) supply and demand — though mainly regarding money, not real goods.

* I won’t even touch here on the widespread misconception among economists regarding bank lending, except to say that in practice bank lending is not constrained by deposits — banks lend most of their deposits then lend (much) more based on their excess capital (times X) — which, thus, is their effective constraint on lending. Not deposits.

Cross-posted at Asymptosis.

Originally from Angry Bear<

Robert Waldmann comments on the Freddie Mac story recently in the news (lifted from Stochastic Thoughts):

Freddster (noun): Fraudster who profits from conflict of interest at Freddie Mac (the knife).

Jesse Eisinger, pf ProPublica and Chris Arnold, of the public sector NPR News have the most interesting article about ruthless greedy uh socialism I guess at public sector Freddie Mac.
   
The idea is that Freddie Went long on the interest payments on mortgages and not the principal repayments. This means the harder it is to refinance, the better for Freddie Mac. Freddie Mac also has huge regulatory power to decide how hard it is to refinance Freddie Mac insured loans. The conflict of interest is clear.

Via Kevin Drum where commenter Andrew Sprung wrote

Could Einsinger and Arnold''s story have been prompted by an administration leak as a prelude to a recess appointment to replace DeMarco at FHFA?

I hope so, or rather I wish I had any hope that it is so. But at least it is a hint that someone in the White House has decided to put pressure on DeMarco.  I also look forward to testimony by the Freddie Mac CEO Charles Haldeman who I expect will have considerable trouble recalling details (see HR Block).
   
Here is a summary of the conflict of interest from Eisenger and Arnold with human interest and Freddie Mac efforts to respond to the accusation deleted.

Those mortgages underpin securities that get divided into two basic categories.
One portion is backed mainly by principal, pays a low return, and was sold to investors who wanted a safe place to park their money. The other part, the inverse floater, is backed mainly by the interest payments on the mortgages ... . So this portion of the security can pay a much higher return, and this is what Freddie retained.
In 2010 and '11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals.

[skip]

It’s ... a big problem if people ... refinance their mortgages. That’s because a refi is a new loan; the borrower pays off the first loan early, stopping the interest payments. Since the security Freddie owns is backed mainly by those interest payments, Freddie loses.

[skip]

Restricting credit for people who have done short sales isn’t the only way that Freddie Mac and Fannie Mae have tightened their lending criteria in the wake of the financial crisis, making it harder for borrowers to get housing loans.
[skip]
just as it was escalating its inverse floater deals, it was also introducing new fees on borrowers, including those wanting to refinance. During Thanksgiving week in 2010, Freddie quietly announced that it was raising charges, called post-settlement delivery fees.
In a recent white paper on remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are “another possible reason for low rates of refinancing” and are “difficult to justify,” the Fed wrote.
A former Freddie employee, who spoke on condition he not be named, was even blunter: “Generally, it makes no sense whatsoever” for Freddie “to restrict refinancing” from expensive loans to ones borrowers can more easily pay, since the company remains on the hook if homeowners default.

Originally from Angry Bear

Matt Yglesias has a great post over at Moneybox (paragraph breaks added):

The need for regime change.

… The Depression discredited the gold standard and a whole set of related notions.

The Great Inflation discredited ideas about the Phillips Curve …

We had, until recently, the Great Moderation Consensus that … the Federal Reserve has the ability to stabilize the macroeconomy by fiddling with interest rates.

Well now here we are and the Federal Reserve can’t stabilize the macroeconomy by fiddling with interest rates.

That calls for the creation of a new regime.

I’ve dumbed it down a bit here. He also talks about employment, for instance, including this great line:

…if the government isn’t abandoning the idea of full employment then they have a mighty strange way of showing it.

But I think I’ve imparted the main question. We’ve been or are going through a paradigm-falsifying “moment.” (As always, some good thinking will be cast aside along with some bad.)

What will move into the vacuum left by the (at least partially) ravaged Great Moderation paradigm?

Courtesy of David Beckworth and The Kauffman Foundation (PDF), here’s how econobloggers would like that question to be answered (thanks, FTA, for the great question):

Personally, I fondly envision some coherent amalgam of the M&M gang: Market Monetarists (NGDPers) and Modern Monetary Theorists (with a decent dose of the Austrian’s insight into real-economy production and productivity). I’m guessing that some have already ventured (some parts of) this amalgamation, quite possibly in posts I’ve already read and since forgotten. Thoughts? Links?

(Even as I post this I find that vimothy, JKH, and Steve Randy Waldman are worrying productively at parts of this very question in the comments here.)

Cross-posted at Asymptosis.

Originally from Angry Bear

I just searched Harvard, U Chicago, and a few other top econ departments’ course offerings and major requirements. The string “account” barely appears.

Chicago says quite explicitly:

Courses such as accounting, investments, and entrepreneurship will not be considered for economics elective credit.

Much less requirements!

No wonder so many economists:

• Have such profound misunderstandings of the National Income and Product Accounts and the Fed Flow of Funds reports (and how they relate to each other). Nobody ever taught them how to read or understand the darn things.

• Have such crazy notions about how producers think when they’re setting prices.

Speaks volumes.

Cross-posted at Asymptosis.

Originally from Angry Bear

Freddster (noun): Fraudster who profits from conflict of interest at Freddie Mac (the knife).

Jesse Eisinger, pf ProPublica and Chris Arnold, of the public sector NPR News have the most interesting article about ruthless greedy uh socialism I guess at public sector Freddie Mac.

The idea is that Freddie Went long the interest payments on mortgages and not the principal repayments. This means the harder it is to refinance, the better for Freddie Mac. Freddie Mac also has significant regulatory power to decide how hard it is to refinance Freddie Mac insured loans. The conflict of interest is clear.

via Kevin Drum where commenter
Andrew Sprung wrote
"Could Einsinger and Arnold''s story have been prompted by an administration leak as a prelude to a recess appointment to replace DeMarco at FHFA?"

I hope so, or rather I wish I had any hope that it is so. But at least it is a hint that someone in the White House has decided to put pressure on DeMarco.
I also look forward to testimony by the Freddie Mac CEO Charles Haldeman who I expect will have considerable trouble recalling details (see HR Block)


After the jump I cut and paste a summary of the conflict of interest from Eisenger and Arnold with human interest and Freddie Mac efforts to respond to the accusation deleted.

Those mortgages underpin securities that get divided into two basic categories.

One portion is backed mainly by principal, pays a low return, and was sold to investors who wanted a safe place to park their money. The other part, the inverse floater, is backed mainly by the interest payments on the mortgages ... . So this portion of the security can pay a much higher return, and this is what Freddie retained.

In 2010 and '11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals.

[skip]

It’s ... a big problem if people ... refinance their mortgages. That’s because a refi is a new loan; the borrower pays off the first loan early, stopping the interest payments. Since the security Freddie owns is backed mainly by those interest payments, Freddie loses.

[skip]

Restricting credit for people who have done short sales isn’t the only way that Freddie Mac and Fannie Mae have tightened their lending criteria in the wake of the financial crisis, making it harder for borrowers to get housing loans.

[skip]

just as it was escalating its inverse floater deals, it was also introducing new fees on borrowers, including those wanting to refinance. During Thanksgiving week in 2010, Freddie quietly announced that it was raising charges, called post-settlement delivery fees.

In a recent white paper on remedies for the stalled housing market, the Federal Reserve criticized Fannie and Freddie for the fees they have charged for refinancing. Such fees are “another possible reason for low rates of refinancing” and are “difficult to justify,” the Fed wrote.

A former Freddie employee, who spoke on condition he not be named, was even blunter: “Generally, it makes no sense whatsoever” for Freddie “to restrict refinancing” from expensive loans to ones borrowers can more easily pay, since the company remains on the hook if homeowners default.

Originally from Angry Bear

Richard Williamson asks a sensible and straightforward question: If, as Modern Monetary Theorists propose, banks’ reserve levels put no significant constraints on their lending, why don’t we have 100%-reserve banking — and presumably no runs on banks as a result?

First an explanation — I hope simple, clear, and generally accurate (if simplified):

Say you start your own bank. You take in $100 in checking-account deposits and lend it all out, holding no reserves. That’s not safe or even workable. You need some buffer so your depositor’s checks will clear.

So there’s a rule: you can only lend $90, and you leave $10 sitting in your “reserve account” at the Fed — essentially your bank’s checking account. When everybody’s checks clear each night through the Fed’s system, reserves get transferred between banks, and you’ve got enough on deposit so nothing bounces.

If the Fed says you need to hold 12% reserves instead of 10%, that means you can lend $88 instead of $90 — not exactly the massive asphyxiation of the “money multiplier” that many people imagine.

That multiplier is actually related not to your reserves, but to your bank’s capital — the money that you and others have invested. That capital is your bank’s buffer against losses from making bad loans. It’s your “skin in the game.”

The amount of capital limits how much you can lend (irrespective of 90%-lent deposits). If the allowed capital-to-loans ratio is 10%, you can lend $10 for every dollar in capital. Now that’s a money multiplier.

The reserve ratio and the capital ratio are completely different things.

So back to Richard’s question: if the Fed required 100% reserves, the banks couldn’t lend out all those checking-account deposits. The quantity of “loanable funds” would decline. But banks could still lend, 10-to-1 (or so), against their capital.

What do those numbers look like in practice? U.S. checking and savings deposits total about $6 trillion right now.

Circa 90% of that would be removed from the loanable funds market. Call it $5 trillion — sounds like a lot.

But total credit market debt outstanding is about $55 trillion.

That makes $5 trillion sound…not insignificant (and profound at the margin), but less onerous.

Which raises my question, one that I’m not knowledgeable enough to answer: Would 100%-reserve banking result in there being more bank capital available — more equity investments in banks — which via its money-multiplying power would offset or more than offset the otherwise decline in loanable funds?

Would we end up with roughly the same amount of credit market debt outstanding?

The answer, it seems to me, would depend on a whole lot of complex and interacting incentive effects. Anyone care to take a stab?

P.S. Like me, you’ve no doubt noticed that debt outstanding is in fact about ten times bank deposits. Does this put the big-picture lie to the MMTers’ claim that lending is not reserve-constrained? Is it just a coincidence? Other?

Cross-posted at Asymptosis.

Originally from Angry Bear