Federal Reservations

In case you are not aware, Bill Moyers is back and he doing his best work to date concentrating on our the changing of the rules regarding the economy. This episode where he interviews John Reed, former Citi Bank CEO and current MIT chair is most telling as it relates to the issue of why we as a nation need to do what is required by law: investigate and prosecute as the investigations dictate.

First, let me just say, you need to watch the interview. What is most telling for me is the denial that still exists in Mr. Reed. Sure, he acknowledges that it all went wrong, but it is done in the temperance of “mistake”: 

1. an error in action, calculation, opinion, or judgment caused by poor reasoning, carelessness, insufficient knowledge, etc.
2. a misunderstanding or misconception.

Here, in the interview is what puts the delusion of self preservation in applying the word “mistake” to the decisions that lead to what we have today, and I'm not just talking recession:

Setting up the question to Mr. Reed by showing a video clip, SENATOR BYRON DORGAN: (Speaking on Senate Floor) What does it mean if we have all this concentration and merger activity? Well, the bigger they are, the less likely this government can allow them to fail.
BILL MOYERS: Were you aware of the few senators who raised real concerns about removing Glass-Steagall, about what would happen?
JOHN REED: No one that I’m aware of it saw it clearly. You point out to some Senators and Congressmen who did, but somehow we described them peripheral. And I simply said, “They’re wrong.” Turned out they weren’t.
SENATOR BYRON DORGAN: (Speaking on Senate Floor) I think we will in ten years’ time look back and say, “We should not have done that, because we forgot the lessons of the past.”

The issue of calling it a “mistake” becomes even clearer when you watch the interview of Senator Dorgan which follows Mr. Reed. This is why you need to watch it. Mr Reed knows what happened. He knows why it happened. I am certain he knows where the culpability lays. But, as they say in our neck of the woods: He wouldn't say “shit” even if he had a mouthful.

What happened and what these people did was not a benign experience as the word “mistake” implies and as Mr. Reed is using it. It was intentional and wanton action taken on behalf of money. (See below: Where their heads were at)

Explaining Glass Steagall's importance beyond not letting commercial banking marry investment banking.

JOHN REED: Well, that and even more importantly, or equally importantly, since the FDIC came into existence at approximately a similar time where the government was guaranteeing deposits so that people didn't lose if a bank got into trouble.

But not only did they want to keep the banks from the business for reasons of not risking the money. They didn't want them to use the guarantee that the government provided for those deposits to leverage their position. Because, you know, if you have a deposit base that's guaranteed by the government, it sure puts you at a great advantage in terms of going into the market and playing around.

Regarding the take down of Glass Steagall

JOHN REED: When Sandy approached me on the merger [Travelers/Citi] I knew that it was right on the forefront of the legal thing. ... And what we basically were told was, "If you all want to do this within the two years we'll get the law changed."
BILL MOYERS: But you got the blessing in this two-year period of President Clinton, of the Fed, of--
JOHN REED: We had that blessing prior to.
JOHN REED: Yes. In other words, I went with Sandy to call on Chairman Greenspan. We told him we were contemplating this merger. But that it would required that the Fed would be prepared to grant us permission. And we were assured that they would.
We went and saw the Chairman of the House Banking Committee, the Chairman of the Senate Banking Committee. And we said we're talking about this merger but it could not take place if we were not assured that it would be approved at the Congressional level. We talked to the Secretary of the Treasury, I don't recall--
BILL MOYERS: Robert Rubin? He was the Secretary of the Treasury at the time.
JOHN REED: Yeah, we would've spoken to him, I'm sure. And had Bob Rubin said, "No, the Treasury feels this is wrong," we would've been careful. Because obviously, the Treasury recommends to the President on an issue of this sort. And there was no argument. No one said, “We’ll have to think about it.” And so a consensus built up. I don’t think it started in the Fed. I would guess it started in the industry, it certainly got into the Congress.

Regarding where their heads were at

JOHN REED: Which happened, yeah. I mean if you had asked me under oath, what probability I would have given that you would have gotten the whole group of Wall Street participants to get it wrong so to speak, I would have said zero.
BILL MOYERS: What do you think they saw that Wall Street didn't see?
JOHN REED: They simply didn't participate in the exuberance.
But I do think that, you know, this setting up the deck of cards so that we could produce what we currently are trying to withdraw from. Turns out to have been something that the word disaster is maybe not strong enough. (“Criminal” is the word we all know he is resisting.)
JOHN REED: We were carried away by the enthusiasm. And like everything else, you know, once you start you probably go a little further than you should have.
JOHN REED: Sandy Weil. I mean, his whole life was to accumulate money. And he said, "John, we could be so rich." Being rich never crossed my mind as an objective value. I almost was embarrassed that somebody would say out loud. It might be happening but you wouldn't want to say it.
JOHN REED: Yeah, Sandy Weil. And I sort of say, "Sandy, you know, we didn't do very well." And he's not comfortable with that conversation at all. I think he would still defend that it was a good merger, it just went off the tracks afterwards. I --

Regarding the economics of it

JOHN REED: No, no. It's not something you'd like to end your career with. That is for sure. No, look. We got carried away. It wasn't any small group, it was a consensus that reached the press, it reached the political world. It certainly had reached the intellectual world. I'm now, as you know, at MIT, and I say to some of my academic friends that the intellectual underpinnings of this was created at MIT and places like that, I mean—
BILL MOYERS: With the technology of the computers?
JOHN REED: Well, no. It's all of this mathematics of finance and the presumption in much of this mathematics that you can capture risk by looking at historical volatility and so forth and so on.
BILL MOYERS: Are you saying, suggesting that -- the chairman of the board of MIT's suggesting --that human intelligence no longer runs our financial system?
JOHN REED: Well, it's a little wisdom balance that judgment wouldn't hurt.

The Criminality of it (at least as I see it): See: Regarding the take down of Glass Steagall above

Showing an historical video clip, Mr. Reed speaking with Sandy Wiel

JOHN REED: Sandy called his friend the President last night and invited me to join in on the conversation and we had a good talk. So the President was in fact told last evening about what was going to happen.

JOHN REED: Well, they originated and sold into the marketplace things that should never have been originated.
BILL MOYERS: Derivatives, unregulated derivatives?
JOHN REED: Well, it was the excess mortgages, the no-doc, low-doc mortgages. And then the derivatives were a byproduct. Once you had those, then you could chop 'em up and so forth. And of course they had changed their mindset. They were in the business to make money, period.

The psyche that is protecting the conscience: Note his choice of words

JOHN REED: You're-- I mean, a consensus developed. The fact that we took it [regulation, Glass Steagall] out was a byproduct of this mistaken belief in this modern financial system that was, quote, "more efficient," was very lucrative for the United States and the U.S. economy in global terms.
And which was supposed to handle risk better. In fact, it handled risk worse. I mean, this is what the facts are because there was a much greater concentration of risk created. And so we got it wrong.
But the restraint of the government and it's agencies disappeared in the enthusiasm. (Yeah, just a “byproduct”)
And so it was this combination of the participants getting carried away, the normal checks and balances that should exist against participants.
And the thing that is astounding, frankly, and there's a lesson here that we probably haven't yet learned, is that the system can get it so wrong. It wasn't--
BILL MOYERS: So wrong?
JOHN REED: It wasn't that there was one or two or institutions that, you know, got carried away and did stupid things. It was, we all did. And then the whole system came down. You know, it became illiquid, the government stepped in. Had the government not stepped in, it really would have come to an end.

 

BILL MOYERS: But they left in place the very people who had driven the ship into the iceberg.
JOHN REED: I'm quite surprised at that. It clearly has not been a clean sweep. In other words, those of us who made mistakes, and so forth and so on, are still floating around the system. And--
BILL MOYERS: Floating it? You're running it.
JOHN REED: Well, I am not, but --
BILL MOYERS: You're not running it, they're running it.
JOHN REED: But there are many who are. I wasn't involved, obviously. I had retired in the year 2000. We're now talking 2008. So I was a knowledgeable spectator, but certainly not a participant. I was quite surprised because, frankly, the worst thing that can happen to a businessman is to go bankrupt. (Shades of Greenspan confessions?) That's the sign of ultimate failure. You ran a business and it was unable to succeed under the terms and conditions of private capital. Namely, you went bankrupt.
It's not a crime. But it certainly is a mistake. And these companies, even though they didn't have to file for bankruptcy, de facto went bankrupt. And so the managements and the boards and the regulators should have, in my mind stepped aside.
BILL MOYERS: Sounds to me like you're calling the Glass-Steagall Act back from the grave.
JOHN REED: I think I am. (At this point, he still could not say it “shit”.)

There is more in the interview. You need to see and hear it to understand. I think Mr. Reed is struggling with his conscience and wanting to clear it versus what I believe he feels is a real risk of getting tied up with the Justice Department. It has to be working on him. Though I interpret an air of feeling protected in Mr Reed do to his own wealth. As much as he knows wrong and not a mistake was done, he has no experience of the anxiety as what those in the labor economy are experiencing. He is still in denial to an extent which stops him from using his position to truly work to correct this wrong. Or maybe he just is not of the character to participate on the just side of the fight.
Mr. Reed does get one thing correct:

BILL MOYERS But when the financial community can buy the rules they want --
JOHN REED: Then you've got an unstable situation. That's an intolerable situation. I mean, obviously.

He knows.  He knows that regulation is a necessity. As the head of MIT, he could be doing so much more.
Common Mr. Reed, destiny is calling you.

Originally from Angry Bear

As (mis)conceived by most economists, money (which they confute here with currency) emerged as a solution to the time problem of barter economies: my spinach is ready now, but your apples won’t be ripe for months. How can we trade? Answer: you give me money for my spinach, and I give it back to you later for your apples.

That armchair-sourced fairy tale has been resoundingly debunked — that’s not how money (or even currency) emerged, and the Adam Smithian butcher/baker barter-exchange economy has never existed. Credit money — first embodied in tally marks on clay tablets — emerged and was in widespread use a couple of thousand years before coinage was invented (the latter largely to pay soldiers, whose itinerancy makes other methods problematic).

But the notion of barter economies lives on.

The whole system of national accounts (the NIPAs), in fact, was constructed by Simon Kuznets and company in the 30s as if we lived in a barter economy — with money being merely a time-shifting convenience, and with no accounting for financial assets at all. That accounting was only added a decade or so later, with publication of the Fed Flow of Funds accounts.

I’d like to suggest that this barter model for the real economy results in a great deal of confusion — including (especially?) among economists — largely because the NIPAs don’t usefully model the distinction between saving wheat (which can be consumed) and “saving” money (which can’t). By “useful” I mean “conceptually tractable, subject to consideration without logical error.”

I’m asserting that the barter model of the real economy results in lots of confusion and logical error. Viz: careful economic thinkers like Nick Rowe, Scott Sumner, and Andy Harless feeling the need/inclination to write lengthy think-pieces on that nature of “S.” Or the widespread misconception that “saving” (by whatever definition) “creates” “loanable funds.”

I’d even go so far as to say that those barter-model-induced logical errors pervade most thinking about economies and economics, both among economists and among the laity.

However: If you want to see a market that does operate as a barter economy, look no further than the market for financial assets. In this market, you trade your checking-account or money-market deposits for shares of Apple stock. Somebody else makes the opposite trade. The transaction is mutual and (effectively) instantaneous and simultaneous. It’s a barter.

In a very real and very counterintuitive sense, there is no money exchange in the financial markets. There are just barter swaps of financial assets.

A proleptic response to inevitable objections, and a definition of terms:

1. By “financial asset” I mean something that has exchange value — somebody will give you something in exchange for it — but that cannot be consumed (directly or through use or time/natural decay/obsolescence), providing actual human value — “utility” — in the process. (Things that can be so consumed, and do provide human utility — and derive their perceived value from that utility — are real goods/assets.)

2. “Money,” then, would be that exchange value as embodied (or metaphorically “stored”) in financial assets. Money cannot, in fact, even exist except as it is so embodied. Financial assets are money’s sines qua non – the things without which it does not exist.

Those financial assets (and the money they embody) can be tallied — represented — on clay tablets or in electronic accounting systems, in mental accounting ledgers (“You owe me”), or in physically exchangeable representations of those ledger tallies, such as dollar bills or stock certificates.

By this definition, a dollar bill or a deposit in a checking account is a financial asset, just as much as a share of stock or a government bond is. Which means that all exchanges of financial assets are swaps. Trades. Barters.

Exchanges for real goods, however, are different. When you buy or sell a real good, money (embodied in a financial asset) moves from one account to another, and — this is key — doesn’t disappear. It keeps getting passed on, exchanged. Real goods move the other way, and do disappear. You’re trading something that only has exchange value for something that can — will – be consumed. Conceptually: Financial assets travel in circles. Real goods travel in one direction only: from birth to death, production to consumption.

A physical metaphor may help: think of the financial system (including physical currency transactions) as a giant wheel, pushing along a conveyor belt of real goods.

But economists try to think about/model these very different situations as identical — as if “money” were being exchanged for bonds (and implicitly, as if those bonds will eventually be “consumed”). Since (mental) models for barter economies must be structured very differently from models for monetary economies,* modeling both of these as the same is problematic, confusing, and productive of logical errors — and perhaps even just plain wrong.

The gist of this thinking is not new — much of it reflects ideas floated long ago by circuitists, chartalists, modern monetary theorists, and other such (g)ists. But I’m hoping the formulation as presented here may be useful to others, as it is to me, in 1. forming mental/conceptual models of how economies work, and 2. evaluating the models bruited by others — notably the inherent validity of their underlying and often unstated assumptions.

I would point out in particular that as with my discussion here, the accounting-based modeling approach of Wynne Godley (and his predecessors, successors, collaborators, and parallel travelers) begins not where Kuznets did — with the interchange of real goods and services — but with the nuts and bolts of financial accounting. This approach imposes logical constraints on economists’ reasoning, constraints that seem sadly lacking in much barter-economy thinking.

As Godley says in the conclusion to his seminal paper:

In contrast to the standard textbook methodology, which starts by making very strong behavioural assumptions based on no empirical evidence at all (for example regarding the shape and role of an aggregate neo-classical production function), [this methodology suggests that] a different paradigm is indicated in which knowledge is gradually built up by empirical study, within the formidable constraints imposed by double entry accounting.

I’m not saying it’s impossible to think logically and coherently using the NIPA/Flow of Funds economic model, with the (confusing) barter and savings models embodied in the NIPAs. I’m saying it’s very difficult — especially since economists aren’t trained in financial accounting — and that as a result logical failures are widespread.

* Nick Rowe quoting Clower: “Hang on. In a Walrasian economy there is one big market where all n goods are exchanged; in a barter economy there are (n-1)n/2 markets where 2 goods are exchanged; and in a monetary economy there are (n-1) markets where 2 goods are exchanged, one of which is money.”

Cross-posted at Asymptosis.

Originally from Angry Bear

Imagine that over the next week (in a closed American economy — the rest of the world has never existed) everyone sold all their financial assets, paid off all their debts, and deposited the remaining money (and any currency they have) in their checking accounts. No money-market funds, even. Just banks with reserve accounts at the Fed, holding everybody’s money in “cash.”

All those other financial asset prices would dive to zero. Late sellers would sell for nothing.

Would the remaining money in all the bank accounts equal U.S. government debt? That seems to be the implication of MMT thinking, because the remaining money only exists because it got spent into existence by the government deficit spending — crediting bank accounts with that fiat, ex nihilo money in the first place.

Net financial assets = gross financial assets = government debt

(If the government had always just deficit-spent instead of borrowing to cover its deficits, “government debt” would be replaced by “cumulative to-date government deficit spending.”)

I ask not just for clarity, but because (as always), I’m struggling with the relationship between fixed assets and financial assets, between saving and investment.

It’s said that the true wealth of the nation — the “national savings” — consists of its real assets: stuff that can be consumed in the future through use and time/natural decay. The NIPAs only count “fixed assets” — hardware (equipment), software, and structures, so let’s pretend that those constitute all real assets (which they don’t in actuality — not by a long shot). Net investment — purchases/creation minus consumption of fixed assets — increases the stock of fixed assets/”savings.”

In theory, financial assets are just financialized, monetized representatives, proxies, for the real, fixed assets that underly them. And indeed over the (very?) long term, the quantity of fixed assets and net financial assets rise together. Both are much larger today in the U.S. than they are in Thailand, or the U.S. in 1910. Financial-asset values wander all over — even over decades — based on “animal spirits,” but again in the long term…

If that’s so, then in our thought experiment:

Net financial assets = gross financial assets = government debt = fixed assets

The quantity of fixed assets increases over time through net investment. But by MMT thinking, net financial assets can only increase through government deficit spending (or trade surpluses). What is the mechanism whereby government deficit spending is translated into more net financial assets that embody the increased stock of fixed assets?

I imagine a necessarily political mechanism something like the following:

1. People and businesses buy/create fixed assets, resulting in more economic activity — creating/consuming, buying/selling, spending/income.

2. Those increased quantities (both stocks and flows) create more demand for government services. Both individuals and businesses would be decidedly unhappy, I’m thinking, if today’s government were the same size it was, at least in absolute terms, in 1870. (Conservatives and libertarians may say otherwise, but they’re talking through their hats.)

3. Legislators and executives who don’t provide those increased services don’t get re-elected.

4. Taxation lags behind spending — resulting in deficits — because A) people hate taxes and vote against politicians who raise them, and B) if deficit spending is not sufficient to match the increases in fixed assets, depressions result, and the “fiscally responsible” leaders get voted out.

5. The new money from government deficit spending is used to purchase financial assets, driving their prices up to (roughly) match the value of fixed assets.

This is thinking of government and the Fed as one consolidated entity. If you think of them as separate, you can imagine a different mechanism, in which the Fed and the congress/president are engaged in a constant chicken game over inflation, unemployment, and GDP growth, to determine how and when to increase the amount of money/net financial assets (ultimately through deficit spending) to match the stock of fixed assets.

These mechanics would also explain how buying/creating a bunch of drill presses will — through a long, tangled, and messy political process, and in the long but not the short run — result in more “loanable funds.”

Cr0ss-posted at Asymptosis.

Originally from Angry Bear

Continuing with one of my current hobbyhorses:

Ryan Avent reports on the American Economic Association meeting, with special attention to a presentation by Robert Hall:

Monetary policy: The zero lower bound in our minds | The Economist.

Mr Hall argued that:

A little more inflation would have a hugely beneficial impact on labour markets,

And a reasonable central bank would therefore generate more inflation,

And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore

The Federal Reserve must not be able to influence the inflation rate.

… Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don’t get it; it seems to me that very smart economists have all but concluded that the Fed’s unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. …a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank.

Emphasis mine. I, of course, am less charitable, and impute other motives.

Hat tip to David Beckworth, whose feelings I fully understand:

I found the whole affair so depressing that I wasn’t able to drag myself to many sessions.

Cross-posted at Asymptosis.

Originally from Angry Bear

I want to thank all the commenters on my last post — at Angry Bear, at Asymptosis, and at Mike Norman’s blog. You’ve provided me with exactly the education I hoped to achieve. Here’s hoping others benefited similarly.

I asked: what would happen if the the Fed cut the interest rate on reserves from its current .25% to zero. I was not suggesting it should be done. I simply wanted to understand what would happen if that one variable changed.

I want to summarize the conclusions I’ve come to based on all the discussion.

This is me speaking, based on sifting and considering all the responses. I won’t link to all the excellent comments that brought me to this. (Though I do want to highlight the Angry Bear comment by Bad Tux beginning “At 0% IOR”. It arguably explains things better than I do here, and at significantly less length.)

First, the market monetarists responses. Scott Sumner said (in comments a while back on his blog, which I linked from my original post):

It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.

I’m presuming he says “slightly expansionary” based on the theory Mark Thoma gives us in a November 17 post that Cameron was nice enough to link to on Angry Bear:

it would slightly lower the incentive for banks to hold cash rather than loaning it out, and more loans would help to spur the economy

So banks could lend a quarter point cheaper, or loosen their lending requirements slightly. Assuming there’s some decent amount of demand at lower rates (elasticity of demand is appreciably > 0), or that good borrowers are asking for loans but being turned down cause they’re too risky, this could have a small effect. Scott’s “other moves” presumably include NGDP level targeting by the Fed, but that’s all beyond the contained question I asked here.

James Oswald — who cites himself as a market monetarist but who seems to understand and adhere to much MMT thinking in his other comments and writings — said at Asymptosis:

There is no reason to think they [reserves] would not decrease back to the pre-IOR levels, at least over time, pushing around around 1.4 trillion dollars of high powered money into the economy and triggering significantly higher inflation.

This doesn’t seem to make any sense at all. (And I rather doubt that the Sumners and Beckworths of this world would agree with it.)

In (simplistic) theory, taking IOR nominally negative (the extreme case) would make banks want to instead hold physical currency, with its higher (zero) nominal return. Continuing the simplistic theory, that more-liquid money would be lent and spent more.

But:

1. There are significant costs and management headaches associated with holding currency — trucks, warehouses, security guards, all that rot.

2. It’s completely unclear why banks holding warehouses full of currency would have any incentive effects on borrowing and lending — hence real-economy purchases/velocity. Lenders and real-economy borrowers do their thing because they see valuable risk/return opportunities in the real economy. Changing the form of banks’ holdings will not affect that real-economy reality. Recent history: the QE trades — giving banks reserves in return for bonds — doesn’t seem to have had such an effect, if the massive runup in excess reserves is any testament.

3. Explaining #2: For banks, currency is (see #1) less liquid than reserves. They’re not carrying it in their pockets so they can buy gum at the corner store. They want to make loans; are they going to make them in cash?

4. Even if they did make the move to currency:

A) They couldn’t all do it; there’s not enough currency around.

B) The effect would be to reduce the amount of currency “in circulation” (it’s stuffed under banks’ mattresses), presumably prompting exactly the opposite of what market monetarists suggest:

a. Less real-economy spending/circulation/velocity and

b. Deflation — dollar bills would be harder to come by, so they’d be more valuable relative to real goods

At least in the discussions I’ve been perusing, this “currency” theory of “pushing” “more-liquid” money into circulation doesn’t make any sense. At all.

Market monetarists do seem to at least loosely and implicitly adhere to the (questionable) theory that people and businesses spend more because they hold money in more-liquid form — and they might even confute bank’s incentives and behavior with people’s incentives and behavior at times — but still this currency thinking is probably not a good or widely held market-monetarist theory. In any case it deserves unequivocal debunking.

So: Numerous cogent and convincing commenters agree that taking IOR to zero would have negligible first-order effects on lending and spending. And (invoking authority here) Mark Thoma agrees, in the post cited above:

It probably wouldn’t do much

But – considering the practical, workaday effects on the financial system such as those depicted in the currency fantasy above — Thoma links to an article by Todd Keister from the NY Fed. In short, IOR of zero would break a whole lot of financial entities’ business models. The gang at Mike Norman’s blog point to the problems already facing primary dealers, which could be (greatly?) exacerbated by a drop to zero. StreetEye on Angry Bear says that it would trash the main-street banking model. And etc. Various institutions would die or just withdraw their services/trades from the financial system.

The second- and third-order effects of such eventualities could have profound negative impacts on the real economy.

Which perhaps explains another thing I’ve been wondering about: why did the Fed institute IOR in the first place, and why did it do so when it did?

We can at least give the Fed credit for understanding the business models of various financial entities. When they saw interest rates heading toward zero, they instituted IOR to prevent the systemic lockup/breakdown described above.

IOW, nothing (much) to see here folks. Move along.

Sorry if I’m so dull that I had to go through all this to figure it out.

Make sense?

Cross-posted at Asymptosis.

Originally from Angry Bear

by Rebecca Wilder

Fractional Money Multipliers

Money multipliers – the stock of money divided by a measure of base money (generally reserves plus currency in circulation) – are dwindling to fractions of what they used to be. FT Alphaville draws our attention to this fact on the Euro area (EA) using SocGen’s analysis. The money multiplier is a representation of base money (generally reserves plus currency in circulation) – are dwindling to fractions of what they used to be. FT Alphaville draws our attention to this fact on the Euro area (EA) using SocGen’s analysis. The money multiplier is a representation of how much credit is leaving the banking system via lending and growth (or inflation) enhancing monetary activities.

As FT Alphaville points out, the EA M3 multiplier is just over 3/4 its average 2007-2008 level, 7.67 vs 10.

But this is global! The US M2 money multiplier is a little over 2/5 the size of its average 2007-2008 level, 4.1 vs. 9.3. By this simple measure, I’d say that the US is in worse shape than is the EA.

Of note, my visual is a bit different from that in FT Alphaville.

Specifically, I don’t agree with SocGen’s estimates that the EA money multiplier drops in December to roughly 6. Given that December 2011 EA base money has been published, a 6.2 M3 multiplier implies that M3 dropped by 15% in 1 month. That’s unlikely.

To my readers: There’s a 92% probability that I’ll be serving on a grand jury for the next three months. Since I’ll need to keep up with all matters EA, I’ll probably be blogging at a higher frequency and in less depth (like this one).

Rebecca Wilder

Source data: The Federal Reserve publishes money supply and monetary base data, which can be easily downloaded at the St. Louis Fred database. ECB data can be found here and here.

Originally from Angry Bear

For the non-cognoscenti: "IOR" is interest on reserves. Banks keep money in their accounts at the Fed. In October, 2008 the Fed started paying .25% interest on those accounts.

The Fed's also engaged in "quantitative easing," a.k.a. open-market purchases on steroids, creating new money and using it to buy $1.6 trillion dollars worth of bonds from banks. The money is deposited in banks' reserve accounts.

The result: banks have $1.6 trillion dollars in excess reserves (in excess of what they're required to hold) sitting in their accounts at the Fed.

This is the heart of the "pushing on a string" argument -- giving the banks more reserves (making their holdings more "liquid") doesn't (necessarily) increase real-economy transaction volumes (on consumption or investment), either directly through spending by the banks or via bank loans to people and businesses who will spend it. This $1.6 trillion in new money issued by the Fed is effectively stuffed in an electronic mattress.

So I'm curious what would happen if the Fed no longer paid IOR.

I asked Scott Sumner this a while back:

if tomorrow the Fed dropped IOR to zero or even negative, what would happen to:

o Excess reserves
o NGDP
o Inflation

He gave a somewhat less than satisfactory answer:

The IOR question is a good one, and at the risk of being annoying I’m going to slightly dodge the question. I do think it would be expansionary, but it’s hard to know how much, because it’s almost inconceivable to me that it would be done by itself, without any other policy changes. It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.

Less than satisfactory (for me) because he often engages in these kind of simplified thought experiments. Change Variable X, ceteris paribus: what would happen?

I'm basically asking for a free education here (hoping others would appreciate such an education as well), but I'm also hoping to spur a discussion on a tightly focused question that has not been cogently discussed, as far as I can find. (I certainly could have missed it. Pointers welcome.)

Cross-posted at Asymptosis.

Originally from Angry Bear

Whether it's Market Monetarist NGDP targeting (a.k.a. Damn The Inflation Rate; We Need Growth!) or Menzie's recommendation of Conditional Inflation Targeting with a notably higher target, everything tells us that somewhat higher inflation is the current path to greater and more widespread long-term prosperity.

Raising the expected inflation rate will lower real interest rates and spur investment and consumption. It will also make it difficult for the de facto dollar peggers, such as China, to sustain their policies. The resulting real depreciation of the dollar would stimulate production of U.S. exports and domestic goods that compete with imports, boosting American production. The United States would get faster growth, an accelerated process of deleveraging, a quicker recovery, and a firmer foundation upon which to address long-term fiscal problems.

Like the market monetarist approach, Chinn's proposal is basically for an automatic stabilizer based on unemployment levels, that anchors expectations (emphasis mine, both above and below):

a policy that would keep the Fed funds rate near zero and supplemented with other quantitative measures as long as unemployment remained above 7 percent or inflation stayed below 3 percent. Making the unemployment target explicit would also serve to constrain inflationary expectations: As the unemployment rate fell, the inflation target would fall with it.

As I said a while back:

Automatic stabilizers are the key to effective 1) policy and 2) expectation-setting. Because 1) They happen, and 2) People know they’re gonna happen. Could be fiscal or monetary, largely a question of where you inject the money.

In other words:

Demand Inflation Now! Up the Real Economy

Full disclosure: as a wealth-holder/creditor, the policy proposed here is directly contrary to my own short-term best interests. I would much prefer to see a crash in financial asset prices resulting from deleveraging and slow-growth expectations, so I could buy those assets cheap with all the cash I'm sitting on. But for whatever crazy reasons, I'd rather that my (and your) children and grandchildren spend their lives in a thriving and widely prosperous country.

Cross-posted at Asymptosis.com

Originally from Angry Bear

Bloomberg notes:

Fed’s Once-Secret Data Released to Public By editor
Bloomberg News today released spreadsheets showing daily borrowing totals for 407 banks and companies that tapped Federal Reserve emergency programs during the 2007 to 2009 financial crisis. It’s the first time such data have been publicly available in this form.
To download a zip file of the spreadsheets, go to http://bit.ly/Bloomberg-Fed-Data. For an explanation of the files, see the one labeled “1a Fed Data Roadmap.”
The day-by-day, bank-by-bank numbers, culled from about 50,000 transactions the U.S. central bank made through seven facilities, formed the basis of a series of Bloomberg News articles this year about the largest financial bailout in history.
“Scholars can now examine the data and continue the analysis of the Fed’s crisis management,” said Allan H. Meltzer, a professor of political economy at Carnegie Mellon University in Pittsburgh and the author of three books on the history of the U.S. central bank.

Originally from Angry Bear

Randall Wray made a fascinating observation a while back:

Since 1776 there have been six periods of substantial budget surpluses and significant reduction of the debt. ... The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929.

And I confirmed it (graphs):

Every depression in U.S. history was preceded by a big drop in nominal Federal debt.

Except this one. (Assuming that it would have been a depression absent herculean efforts by the Fed et al.)



There was that dip in the 90s, but if we want to posit that, based on history, it was an at-least-necessary cause of the crash, we have to ask: why, in this case, did it take almost a decade to have its effect?

A lot of things have changed since 1929.

• We have the FDIC and similar (explicit and implicit).

• The Fed is a much more active player in controlling government "debt" levels.

• The financial system is far more globalized. International flows of financial capital are much larger in proportion to the real economy.

• The stock of outstanding private debt is proportionally much bigger relative to government debt. Ditto the issuance and retirement of private debt relative to government issuance.

• In the 00s in particular, private debt issuance went crazy.

I think there might be a story about private debt carrying the economy for years after government debt got pulled, so we didn't experience the effect right away.

But I'd love to hear other and better-articulated stories to explain what strikes me as a pretty big anomaly.

This brief conversation might provide a springboard:

rjs: as i've understood it, when it became clear to george bush that if clinton surpluses continued & our debt was paid down, the financial system would soon experience a dearth of safe assets & would freeze up; so his adminstrations tax cuts were initiated in order to keep levels of AAA assets high enough for the markets to operate...

David Beckworth: I remember some commentators making that point back in the early 2000s. It would have been interesting to have seen, though, what would have happened had the debt been paid down. Would structured finance made even more AAA-securities to compensate? Would interest rates been lower back then too?

rjs certainly gives George Bush far too much credit for monetary sagacity. But the general point remains.

Cross-posted at Asymptosis.

Originally from Angry Bear