Obama’s most costly error

It’s rather disgraceful that one must read the British press to find out about the most important thing going on right now in America.  Commenter JimP sent me this story from The Telegraph:

Ben Bernanke needs fresh monetary blitz as US recovery falters

Federal Reserve chairman Ben Bernanke is waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral.

Fed watchers say Mr Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam. The ECRI leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of -5.7 in the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so.

Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed’s balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion. But they are certain to face intense scepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts.

“We’re heading towards a double-dip recession,” said Chris Whalen, a former Fed official and now head of Institutional Risk Analystics. “The party is over from fiscal support. These hard-money men are fighting the last war: they don’t recognise that money velocity has slowed and we are going into deflation. The only default option left is to crank up the printing presses again.”

Mr Bernanke is so worried about the chemistry of the Fed’s voting body – the Federal Open Market Committee (FOMC) – that he has persuaded vice-chairman Don Kohn to delay retirement until Janet Yellen has been confirmed by the Senate to take over his post. Mr Kohn has been a key architect of the Fed’s emergency policies. He was due to step down this week after 40 years at the institution, depriving Mr Bernanke of a formidable ally in policy circles.

 Wow!  If this article is correct the implications are mind-boggling:

1.  As I have been speculating, the Fed suffers from the same sort of paralysis as it did in the Great Depression.

2.  This answers Tyler Cowen’s query about why the Fed isn’t doing what people like me suggest.  Tyler noted that Bernanke is a pretty smart guy.  Yes, he’s a much more knowledgeable economist than I am, so it’s good to know he is on my side.

3.  Commenter JimP has been hammering Obama on monetary policy almost since the beginning of this blog.  I suppose at times people might have thought JimP was a bit of a crackpot.  But guess what, Jim gets the last laugh.  Perhaps you didn’t notice a very telling fact presented in the article.  Look at the phrase “Key members of the five-man Board.”  That refers to the Board of Governors.  If you remember your money and banking classes you might think “doesn’t the Board have seven members?”  Usually it does, and it usually dominates the 12 man FOMC (which includes 5 regional bank presidents.)  But two seats were empty when Obama took office.  Did Obama rush to fill the seats so that monetary stimulus could provide support for fiscal stimulus?  No, he waited for over a year to even nominate anyone to the Board.  From this article, I infer that the recent nominees have not yet been confirmed by the Senate.  Ironically, the financial regulation bill agreed upon last night is far less important than getting those two nominees on the Board of Governors.  The buck stops at the President, but I also assume he has not been getting good advice from advisors like Summers and Romer.  Why else would he have waited so long if his economic advisers had been telling him how important it was to fill those seats?

4.  I’ve said this before, but I’ll reiterate.  Yes, the Greek crisis is the deep cause of the current slowdown (perhaps along with Chinese moves to slow investment.)  But the direct effects are tiny compared to the indirect effects.  The indirect effect was to increase the demand for dollars, thus putting deflationary pressure on the US.  The US could have offset that shock if only Bernanke had supplied more dollars.  Now we know why he didn’t. 

5.  I’ve been very schizophrenic with my blog.  Half of the time I’ve blamed Bernanke for seeming to forget what he told the Japanese to do.  The other half I’ve speculated that he wants to do more, but he can’t drag the neanderthals on the FOMC along with him.  This article has the ring of truth (although I don’t doubt the info was fed to the Telegraph by doves wanting to look good.)  Unless someone can convincing refute this story, I’m going to assume it’s accurate and I will stop bashing Bernanke.   I’ll go back to my earlier position, expressed in posts such as “Let Bernanke be Bernanke.”    However, even if the article is correct, he is not entirely blameless in this crisis:

Mr Bernanke has fought off calls from FOMC hawks for moves to drain stimulus by selling some of the Fed’s $1.75 trillion of Treasuries, mortgage securities and agency bonds bought during the crisis. But there is little chance that he can secure their backing for further purchases at this point. “He just has to wait until everybody can see the economy is nearing the abyss,” said one Fed watcher.

Gabriel Stein, from Lombard Street Research, said the US is still stuck in a quagmire because Mr Bernanke has mismanaged the quantitative easing policy, purchasing the bonds from banks rather than from the non-bank private sector.

“This does nothing to expand the broad money supply. The trouble is that the Fed does not understand broad money and ascribes no importance to it,” he said. The result is a collapse of M3, which has contracted at an annual rate of 7.6pc over the last three months.

Mr Bernanke focuses instead on loan growth but this has failed to gain full traction in a cultural climate of debt repayment. The Fed is pushing on the proverbial string. The jury is out on whether or not his untested doctrine of “creditism” will work.

“We are now walking on deflationary quicksand,” said Albert Edwards from Societe Generale.

The article also tells us who the villains are:

Kansas Fed chief Thomas Hoenig dissented from Fed calls for ultra-low rates to stay for an “extended period”, arguing that loose money risks asset bubbles and fresh imbalances. He recently called for interest rates to be raised to 1pc by the autumn.

While he has been the loudest critic, he is not alone. Philadelphia chief Charles Plosser says the Fed has blurred the lines of monetary and fiscal policy by purchasing bonds, acting as a Treasury without a legal mandate. Together with Richmond chief Jeffrey Lacker they represent a powerful block of opinion in the media and Congress.

Just like in the Great Depression, the regional bank presidents are the biggest problem.  And just like in the Great Depression, the British press had a better understanding of the deflationary impact of US monetary policy than did the American press.  Funny how things never seem to change. 

Read the entire article.

Part 2:  The Finreg bill

And speaking about how nothing ever seems to change, has there ever been a major crisis that led Congress to enact regulation that actually addressed the root problems that caused the crisis?  Obviously I haven’t read the bill, but the press summaries are certainly not promising. There was no mention of outlawing low down-payment mortgages made with federally-insured deposits, nor an mention of abolishing Fannie and Freddie.  Is there something in the bill that addresses these problems?

Part 3:  Fiscal policy in the Depression

A few commenters asked me about a recent paper, which claimed fiscal policy actually was effective during the 1930s, but wasn’t applied in anywhere near the needed amounts.  This is from a Brad DeLong post, which quotes from the paper:

http://www.nber.org/papers/w15524.pd: [F]iscal policy made little difference during the 1930s because it was not deployed on the requisite scale, not because it was ineffective…. [T]he first set of VAR exercises suggested that [multipliers] were 2.5 on impact and 1.2 after one year. Where significant fiscal stimulus was provided, output and employment responded accordingly.

Individual country experience with large fiscal stimulus was rare in this period, but where it occurred the evidence points in the same direction. One of the biggest fiscal stimuli in this sample occurred in Mussolini’s Italy during 1936-7, as a result of the war in Ethiopia. Italy ran a deficit in excess of 10 per cent of GDP in 1936 and 1937. Italian GDP grew by 6.8 per cent in 1937, by a marginal amount in 1938, and by 7.3% in 1939. According to Toniolo (1976), the Italian economy moved to full employment during this period. In France, the budget deficit increased substantially beginning in 1935, and GDP grew by 5.8 per cent in 1936. The deficit exploded in 1939, during which year the economy grew by no less than 7.2 per cent.

My views on fiscal policy are complicated.  First, I think it is less powerful than monetary policy.  Second, I think it is wasteful, as it incurs future tax obligations that hurt the supply-side of the economy.  But most importantly, I think the effect cannot be quantified because it depends on whether the central bank tries to accommodate or sterilize the fiscal stimulus. 

In the two examples cited in DeLong post, France and Italy, monetary policy was extremely accommodative.  Both countries were on the gold standard until 1936, when they sharply devalued their currencies.  That’s not to say that fiscal policy has no effect, it might have forced the central banks to devalue.  My point is that fiscal stimulus must always be examined in the context of monetary policy.  If you have conservative central banks that are rigidly targeting the price level, then fiscal stimulus may be ineffective.  But in fairness to the other side, I’m sure you could build a plausible argument that under the sort of dysfunctional Fed described above, it might have a stimulative effect.  Perhaps Bernanke is not strong enough to take any unconventional policy initiatives, but is strong enough to prevent the conservatives from inhibiting fiscal stimulus through a premature exit strategy.  But as I said, I don’t think fiscal policy is very powerful even if there is no push-back from the Fed.

The more important point is that if Obama and the Congressional Democrats knew all this, there would have been a much greater sense of urgency about monetary policy, and especially the need to fill those seats.  They might also pressure the Fed (in Congressional hearings) to actually fulfill their dual mandate. 

BTW, I don’t like dual mandates; I prefer NGDP targeting.  But right now a dual mandate approach (inflation and unemployment targets) would be better than the status quo.


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56 Responses to “Obama’s most costly error”

  1. Gravatar of Paul Zrimsek Paul Zrimsek
    25. June 2010 at 08:04

    [F]iscal policy made little difference during the 1930s because it was not deployed on the requisite scale, not because it was ineffective…

    Further shrinkage of the General Theory?

  2. Gravatar of Doc Merlin Doc Merlin
    25. June 2010 at 08:06

    “No, he waited for over a year to even nominate anyone to the Board.”

    That is fairly typical of Obama, his modus operadi is to use nominations as little as possible, and try to have his folks in the white house run things directly.

  3. Gravatar of Morgan Warstler Morgan Warstler
    25. June 2010 at 08:50

    For Meltzer, the courageous, damn-the-sages stance that Thatcher took three decades ago should guide President Obama today. “If Obama announced a strategy to deal with the long-term debt and stopped doing things to increase the uncertainty that businesses face, it would do a great deal to stimulate the economy,” declares the 82-year old Meltzer.

    “Keynes championed temporary deficits to stimulate consumption during recessions,” says Steve Hanke, an economist at Johns Hopkins. “But he also insisted that deficits disappear during recoveries, so that budgets would be balanced or in surplus during most of the business cycle.”

    http://money.cnn.com/2010/06/24/news/economy/stimulus_spending_cuts.fortune/index.h

  4. Gravatar of acerimusdux acerimusdux
    25. June 2010 at 08:54

    These conditions really do likely require some sort of fiscal policy component. Yes, in theory, an expansion of money alone in the real economy might be enough. But how does one achieve that, exactly? It’s hard to see how you avoid the problem of “pushing on the proverbial string”. Gabriel Stein suggests purchasing more bonds from the non-bank private sector, but I doubt that that would do much either to change the “cultural climate of debt repayment”. If recipients simply exchanged their safe low risk, low interest treasuries, for safe low risk, low interest bank deposits, you would again see this money all simply sitting in bank reserves, with no more expansion of broader aggregates than you are seeing now.

    It remains true that the simplest and surest way to ensure that newly printed dollars are actually spent, or put in the hands of consumers, is to, well, actually spend them, or put them in the hands of consumers.

    I would personally prefer to see the Fed buy up long term US government debt; why not just reduce the outstanding debt held by the public by $1 trillion? And if the congress chooses to reissue some of that to engage in temporary short term stimulus spending to help close the output gap, so much the better.

    The real story of the history of fiscal stimulus is that it not only has been very effective, it also has usually been very easily withdrawn once the economy was well into recovery. WW II is especially instructive. Spending was cut quite rapidly in postwar years with seemingly no negative consequences for economic growth.

  5. Gravatar of Ted Ted
    25. June 2010 at 08:55

    This is basically what I had assumed all along. I remember reading Bernanke’s article on Japan and his article on alternative monetary policy at the zero lower bound and I simply didn’t buy it that he had just changed his mind. I assumed there was institutional constraints of some kind. I pretty much agree with JimP that this was Obama’s biggest failure. This leads to question of is Romer doing her job, or is Obama ignoring Romer (surely she doesn’t believe the ZLB is a constraint …)?

    Also, yes, you are correct in assuming that his two nominees haven’t been confirmed yet.

    And the nominees don’t look to provide promising support for Bernanke’s goals either.

    Janet Yellen, as the replacement for Kohn as Vice-Chair, while not an inflation hawk, is caught in the liquidity trap mentality. I don’t think she’d support an inflation target. She might support quantitative easing, but from speeches she seems to view the function of QE as improving financial markets and credit conditions, which seems beside the point. I’ve also seen her speak uncomfortably often about an “exist strategy,” but perhaps I’m reading too much into that.

    Peter Diamond, while no doubt a talented economist who has done important work in optimal taxation, search-and-match labor models, and social security – but those studies have almost nothing to do with the doings of the FOMC. He’s never written anything about monetary policy, so I really don’t know what to make of him. That, of course, doesn’t mean he won’t support Bernanke, but from his writing it’s impossible to know what he believes. It actually seems he’d be better suited for a council of economic advisers position. Maybe Obama should do a Diamond-Romer swap.

    Sarah Raskin is a random Maryland bank regulator. She may be a fine bank regulator, but I don’t know what that has to do with monetary policy at all. The choice seems rather illogical, given her background. The only reason I can think of is that Obama is trying to look like he’s “serious” about regulating the banks. Given her background though, I’m not particularly confident she’d support aggressive policy. My guess is she’d be much like the bankers on the board who would work against Bernanke.

    I don’t see these stunning choices that will clearly support Bernanke.

  6. Gravatar of Jon Jon
    25. June 2010 at 09:26

    That doesn’t answer why he wouldn’t attempts change on the interest on reserves. There is a fair concern that the fed shouldn’t be subsidizing the housing market do directly.

    That has been one of bb mistakes all along, he’s pushed a view of the fed as industrial policy maker. First it was the banks and his liquidity obsession. Then it was the housing market.

    I don’t believe that report is quite so insightful. He has been spending his political capital in all the wrong ways for years.

  7. Gravatar of Master of None Master of None
    25. June 2010 at 09:28

    I’ve read about 1,500 posts/articles on Google Reader this week. This was the best. Congrats.

  8. Gravatar of JimP JimP
    25. June 2010 at 09:38

    It is this weird passiveness of Obama that I just don’t get.

    It would seem to me to be a political winner for Obama to have a deflation/inflation debate with the Republicans. Even Rogoff (no liberal Democrat he) says that 6% inflation for 3 years or so would be a good idea. Price level targeting would be even better, obviously. But what central banker is going to explicitly call for higher inflation without Presidential support? (Think Roosevelt in 1933 – the only thing we have to fear is fear itself – the amazing power of expectations. Remember – it took Roosevelt, the President, to do this. The President sets the tone, not the central bank.)

    We need an open and clear debate – in which Obama makes the optimistic case. Let the deflationists make their grim and moralistic predictions. It is entirely clear that the fiscal path is politically dead. Germany et al are going to give us deflation unless Obama steps up to the plate. If he does so, and in my opinion only if he does so, does he have any chance for another term.

    I actually think this does go back to something I said on this blog long ago. Roosevelt knew the deflationists. He was born of that political class. He hated them and loved to fight them. Lets hope Obama might come to be like that as well.

    Somehow Obama needs to understand that deflation actually does benefit some people (the current owners of the currency.) Sweetness and light doesn’t work with those folks.

    Fighting does, or might.

  9. Gravatar of Richard A. Richard A.
    25. June 2010 at 10:00

    If Bernanke is interested in stimulating the growth in the money supply, why doesn’t he advocate the elimination of paying interests on excess reserves? This would tend to let the money multiplier rebound. Could it be he just wants to expand the monetary base to buy more MBS?

  10. Gravatar of thruth thruth
    25. June 2010 at 10:14

    Interesting short paper from St Louis Fed from last year:

    http://research.stlouisfed.org/publications/es/09/ES0937.pdf

    “The effectiveness of these actions [the Feds actions in the crisis] is questionable for at least three reasons. First, despite the 325-basis-point reduction in the funds rate target, longer-term rates, which are widely regarded as important for consumer and business spending decisions, declined much less. Indeed, some important lending rates remain essentially unchanged. Second, economic and finance theory suggests that reallocating credit will have no positive macroeconomic effects unless financial markets allocate credit inefficiently; and a large body of empirical evidence suggests that financial markets are highly efficient. Thus, the Fed’s reallocation of credit might have had, at most, a minimal positive effect. Indeed, the effect could be negative if the credit allocation caused by the Fed’s activity was less efficient than the previous market allocation. Third, many analysts argued that the financial crisis was caused by a shortage of liquidity—markets were “frozen up.” Sterilized lending cannot deal with this problem because it does not increase the total quantity of credit available to the market.”

    “The failures of Lehman Brothers and AIG resulted in a monumental increase in the Fed’s existing lending programs.
    For example, TAF and primary credit lending increased
    from about $180 billion for the week ending September 10, 2008, to about $510 billion for the week ending November 12, 2008. Moreover, the Fed introduced a series of new lending programs. Unable to sterilize such massive lending, the monetary base increased from about $850 billion for the week ending September 10, 2008, to about $1.75 trillion for the week ending January 7, 2009.3 The monetary base has remained at about this level since then.
    Since this so-called quantitative easing the economy has
    shown marked signs of improving.”

  11. Gravatar of Benjamin Cole Benjamin Cole
    25. June 2010 at 10:19

    Very interesting post. Still, you have many crying about a hyper-inflation ahead. Scott Grannis (Califia Beach) is always concerned about easy money.
    The Telegraph, btw, is a bit on the racy side.

  12. Gravatar of Benjamin Cole Benjamin Cole
    25. June 2010 at 10:23

    BTW, I went over to ECRI website, and they say no double-dip.

    “The good news is that there’s still no “double dip” in sight.”

  13. Gravatar of Luis H Arroyo Luis H Arroyo
    25. June 2010 at 10:31

    Very very good article, sincerely. But I don´t know really if the deflationary risk is so near, indeed. I think that there is a quite certain risk in Europe, but that means more capital from Europe through America. The interest rate of ten years treasury bonds has lowered to today´s 3,15%, but the slope curve is quite positive, I think, long away of the levels in the crisis. The price inflation is positive. I don´t see so near a deflationary process. but I agree on the fiscal debt risk, and on the doubtfull effectiveness as you say: “the effect cannot be quantified because it depends on whether the central bank tries to accommodate or sterilize the fiscal stimulus.”
    I think that the first should be to anchor the long term fiscal expectations, and stand by more in the monetary policy to fight the sign of deflation.

  14. Gravatar of David Beckworth David Beckworth
    25. June 2010 at 10:51

    Thanks Scott and JimP, you just answered the question I asked over at my blog.

  15. Gravatar of thruth thruth
    25. June 2010 at 10:53

    darn it. where I paraphrased:

    “The effectiveness of these actions [the Feds actions in the crisis] is questionable for at least three reasons….”

    I meant write:

    ““The effectiveness of these actions [the Feds actions leading up to the crisis] is questionable for at least three reasons….”

  16. Gravatar of Indy Indy
    25. June 2010 at 11:01

    Speaking of deflation and low-interest, low-down-payment mortgages – is anyone else worried that at a 40-year-low of only 4.69% APR (for 30-year-fixed) and FHA minimum down payments of only 3.5% (plus the effect housing credits had on prices) – that there’s no way that house prices wouldn’t decline further in a more “normal” environment, say, 5.5-7% APR, 10-20% down, and no credits?

    If PITI and Debt-to-Income ratios stayed the same, and wages don’t rise fast, then families of the same household income would not be able to afford the payments on the same price houses. Not good. Where’s that in the financial reform legislation indeed…

  17. Gravatar of Doc Merlin Doc Merlin
    25. June 2010 at 11:37

    @JimP

    Possibilities:

    1. Fixing the problem would deprive him of his crisis and thus weaken his power. *CONSPIRACY*
    2. He is a leftists and thus favors fiscal solutions.
    3. Because we have an independent monetary authority, using monetary authority doesn’t give him as much control over the situation as fiscal authority.
    4. He really has no clue what he is doing, and neither do his advisors.

  18. Gravatar of ThomasL ThomasL
    25. June 2010 at 12:01

    @Benjamin

    “Still, you have many crying about a hyper-inflation ahead.”

    Yes, and I imagine you always will with fiscal policy the way it is, and with the explosion of commitments to SS and Medicare/Medicaid less than a decade away.

    Without some credible alternative to printing the money, people have reason to fear it.

    That doesn’t really focus on Bernanke’s actions now, but everything he does now is reminding people of what’s ahead, and just how badly positioned we are.

    The Fed rushing out to purchases trillions of worthless MBSs and bad agency debt was hardly a consolation to anyone not selling them. Because it would be stupid and irresponsible for any operating bank to do, people assume it is also stupid and irresponsible for a central bank to do. Any argument on that eventually devolves into the Fed needing to restore confidence. It obviously won’t succeed in that when people think the actions it is taking are irresponsible or corrupt.

    This is a basic problem I have with monetarists, as they are tinkerers that always figure they know best how to fix things for everyone else. That enables all manner of consequentialist thinking that isn’t consistent with freedom. Keynesians want to run up gigantic deficits to hire more teachers, so that the economy won’t fail so that, “Can’t you see, it is really for your own good, because if the economy tanks you’ll be even worse off than paying for all this.” So helpful of them to decide that for me…

    Monetarists are just the same, except they want to save the world one dollar at a time. “Don’t you see, if the money supply fell, people couldn’t repay their debts, and everyone would be so much worse off, you’ll really thank us later if you just let us tweak this a little…”

    They never seem to ask whether they have the moral right to manipulate the value of the currency; they just do it and expect thanks, and sometimes a fancy title like Maestro.

    Should we manipulate the value of any price that changes in some way that some expert doesn’t like?

    We are far from a free market in money, but we could do a lot better without the tinkerers intent on fixing everything by their pet scheme, while at the same time manipulating everyone else’s lives and all they work and plan for.

    Not everybody’s the same. A little deflation would be good for me; inflation would be bad. For people with more debt, their situation is the reverse. So what. We all take risks. If you hold too much cash you take on inflation risk. If you take out too much debt, you’re taking on some deflation risk. Deflation is less common, but again, so what.

    Everybody takes risks and every now and again you get bitten. I resent people deciding they know just how to fix it all up right for everybody. I wouldn’t want people to do harm against debtors through intentional deflation any more that I want them to do harm against debt holders through intentional inflation.

    It really does matter if you have someone manipulating these outcomes purpose, picking who wins and who loses on each transaction. Just like it matters whether or not a rock rolls over on me accidentally or you push down on me on purpose. One is gravity and bad luck, the other is assault.

    I know Scott would argue he doesn’t want that either. He wants stable, predictable 2% inflation all the time. There are a lot of issues that make it hard to get there. Some fairly technical problems are discussed in George Selgin’s “Less than Zero,” when discussing the alternative of a productivity norm, which I’d love to hear Scott’s thoughts on.

    One important, not technical problem is that the Fed is unlikely to be able to control inflation with that level of accuracy, since inflation is so difficult to measure, and liquidity is difficult to withdraw (ie, your 2% in a recession can become your 20% on the far side).

    Our fiscal circumstances wouldn’t allow just 2% anyway, so no 2% target is credible to the public. The Fed probably can’t target it that accurately, and they couldn’t be believed to commit to that level even if they were able.

    Discretionary inflation is far too powerful a weapon to believe they’d ever give it up.

    Another objection is that all these purchases to beef up the balance sheet are nothing but bailouts by another name. Stealing purchasing power from dollar holders at large and handing it to irresponsible and well-connected profligates — covering up the mistakes of free-wheeling bankers and politicians’ ambitions, and their unholy progeny, the GSEs. But they get theirs, and they get it first. Richard Cantillon anyone?

    The whole notion of manipulating money prices is as morally bankrupt as manipulating food prices. I don’t believe that experts can do it better, but even if they could I wouldn’t grant that they had the right to attempt it without the consent of every dollar holder.

    Obligatory: End the Fed

  19. Gravatar of scott sumner scott sumner
    25. June 2010 at 13:05

    Paul, Yes, see my post on the General Theory.

    Doc Merlin, This time it hurt him.

    Morgan, Meltzer’s half right. We need smaller deficits, but he doesn’t seem to realize that we need much easier money.

    acerimusdux, The pushing on the string argument is not relevant here. If you want to get cash in the hands of consumers just put a penalty interest rate on the trillion dollars in ERs held by banks. They will quickly push the money out into the economy. Indeed so fast you’d have hyperinflation if some wasn’t removed.

    Ted, Good points. I knew they were lightweights but assumed they’d support Bernanke. If not, then Obama made an even bigger mistake than I assumed. Putting a regulator on the FOMC is like putting a plumber on the Supreme Court. It just shows how little understanding the political world has of the issues at stake here.

    Jon, Yes, perhaps I let him off too easy. I believe the Board can change the rate without FOMC approval. But at least he is fighting for easier money. It shows what he is up against. But I agree to this extent. Even if Bernanke got his way 100%, it would probably still be too little.

    Thanks Master of None.

    JimP, You have been right on this issue from the beginning. The advisors to Obama are also partly to blame–at least my hunch is that they are partly to blame.

    Richard, Good point. As I said to Jon he isn’t totally blameless. He’s trying to micromanage this too much.

    thruth, The problem with their argument is that the asset markets crashed during the big open market purchases of 2008—so there really isn’t any evidence the purchases helped. Again, the problem was partly interest on reserves.

    Benjamin, I agree that an outright double dip is still less than 50/50, but the risk is higher than it should be.

    You said:

    “The Telegraph, btw, is a bit on the racy side.”

    So am I. :)

    Luis, I agree, the likely outcome is less than 1% inflation (core)

    Thanks David.

    Indy, Prices can rise along with interest rates if money is made much easier. Otherwise housing prices could fall further.

    Doc Merlin, I vote for choice four. This “crisis” might cost him Congress.

    Thomas. The Fed is here to stay, I’d rather it not create recessions that lead to massive debts that lead to future inflation if we aren’t able to repay those debts.

  20. Gravatar of ThomasL ThomasL
    25. June 2010 at 13:16

    Scott,

    Appreciate you taking the time to reply.

    Are you suggesting that the trajectory of USG debt would be sustainable if not knocked off trend by recessions?

  21. Gravatar of q q
    25. June 2010 at 13:53

    it’s a nice article, and the responses above about obama (and his advisors) being misguided, but this article doesn’t really prove anything about what bernanke thinks. there aren’t any credible sources quoted here re: the alleged deep disagreement between bernanke and the fed governors. most of the quotes are irrelevant to that — they are just talking heads spouting about the economy, nothing to do with the article headline.

    i don’t doubt that this _could_ be the story, but there’s no evidence here, folks.

  22. Gravatar of thruth thruth
    25. June 2010 at 14:32

    @Scott Sumner: “The problem with their argument is that the asset markets crashed during the big open market purchases of 2008—so there really isn’t any evidence the purchases helped. Again, the problem was partly interest on reserves.”

    I provided the link to demonstrate that there are some people at the Fed fully endorsing an expansion of the Fed balance sheet.

    On the merits of the argument: What do you attribute the subsequent improvement in conditions to? stress tests? equity injections? natural causes? Note that a lot of the stuff in 2008 is short-term LLR activity. The MBS purchases (in my mind the real, or at least more powerful, QE) didn’t begin until Mar 2009. We still have interest on reserves…

  23. Gravatar of Tom Waye Tom Waye
    25. June 2010 at 16:38

    Agreed with Master of None, very interesting post. I’m no expert on the American system, but does having a central bank so heavily influenced by politics undermine its ability to conduct monetary policy? I don’t mean directly — ie, it’s difficult to get things done, as the post says — but more the effecs on markets. Surely an unpredictable central bank leads to unstable markets? Sorry if this is obvious, just curious and all.

  24. Gravatar of e e
    25. June 2010 at 16:40

    This is somewhat off topic but I thought I had a handle on the keynesian argument for fiscal stimulus from your back and forth with Thoma, where Thoma had an argument that the govt creates a project, pays 50 cents on the dollar down the road, monetizes the other 50 cents of marginal debt which creates inflation thats a good thing anyways. Then i remembered Delong saying this:

    “The obvious policy is the long-term debt neutral stimulus: spending increases and tax cuts for the next three years, standby tax increases with triggers and spending caps with triggers thereafter, all calculated to guarantee that the debt is no larger ten years from now than in the baseline.”

    It seems to me that if you deficit spend now, but credibly promise to pay for it within a fixed number of years you wont create inflation. Am I thinking about this wrong?

    If I am right then it seems like Delong is back to a kind of “get the ball rolling” or “start the lawnmower engine” type of analogy. It makes some intuitive sense with people sitting accomplishing nothing, but I cant see how you get away from crowding out. Like I said before though it seems very likely that I just dont know enough background and am making a mistake.

  25. Gravatar of Poor, Poor Growth «  Modeled Behavior Poor, Poor Growth «  Modeled Behavior
    25. June 2010 at 17:26

    [...] hypothesis, other than that it is a choice of the central bank. However, as Scott Sumner points out today, it’s seemingly only a choice of a few members of the central bank, namely: Thomas [...]

  26. Gravatar of Jon Jon
    25. June 2010 at 19:12

    Scott, glad you made sense of my iphone commenting…

    I’d like everyone to marvel at this comment from the NYFED:

    “The program to purchase direct obligations from housing-related GSEs was intended to reduce the cost and increase the availability of credit for the purchase of homes.

    I think that more or less pulls the veil off of QE. It was fiscal policy not monetary policy. ‘Off-balance-sheet’

    Disgusting, and that’s why Bernanke will have trouble getting anywhere with the FOMC.

  27. Gravatar of W. Peden W. Peden
    25. June 2010 at 22:13

    More from the Telegraph on US monetary conditions-

    http://www.telegraph.co.uk/finance/economics/7769126/US-money-supply-plunges-at-1930s-pace-as-Obama-eyes-fresh-stimulus.html

    - which makes the point that, had more attention been paid to M3, US monetary policy would have been far more responsive, more quickly, both to the housing bubble and deflation.

    What worries me is that, around the world, concern with fiscal policy is overshadowing monetary policy, despite their relevant importance. Both budget hawks and budget doves are distracting attention from the still-present dangers of deflationary economics.

  28. Gravatar of acerimusdux acerimusdux
    26. June 2010 at 01:21

    Scott,

    Negative interest on reserve deposits? Lets assume you did something to prohibit banks from instead simply holding the excess as vault cash, rather than deposits with the Fed. Then yeah, banks would get money to their depositors, but they would do it most easily by creating incentives for some of them to close their accounts. They would increase fees, or simply pay negative interest to depositors. This will do nothing to increase economic activity.

    Keep in mind, the rate on excess reserves also serves as a floor for the Federal Funds rate. As that goes negative, the incentive will be for banks to reduce their deposits rather than have to make unprofitable loans with their excess.

  29. Gravatar of Mattias Mattias
    26. June 2010 at 02:26

    I think the key quote from the article is:

    “But there is little chance that he can secure their backing for further purchases at this point. “He just has to wait until everybody can see the economy is nearing the abyss,” said one Fed watcher”

    This makes a lot of sense. I’m afraid though there are a lot of gold bugs out there that just never will get it. They are just completely convinced that the Fed is already printing money like crazy and hyperinflation is just around the corner. Can you imagine how they would interpret a new massive QE by Bernanke? The gold price is already at a ATH!

  30. Gravatar of thruth thruth
    26. June 2010 at 04:47

    @Jon: ““The program to purchase direct obligations from housing-related GSEs was intended to reduce the cost and increase the availability of credit for the purchase of homes.”

    I think that more or less pulls the veil off of QE. It was fiscal policy not monetary policy. ‘Off-balance-sheet’”

    At the risk of sounding like a Fed apologist, I disagree.

    The NY Fed’s statement was a narrow explanation of the direct effects of the MBS purchases, which the public can easily digest. The reason I believe the Fed was justified in buying those securities and other agency debt is because they already were backed by Treasury (i.e. the fiscal part was a done deal) yet still traded at enormous spreads above Treasury yields. The intended purpose of the GSEs is to ensure an active secondary market for mortgages. Claims to those mortgages are distributed throughout the financial system as a result of the GSEs activities, with the GSEs holding most of the credit risk. In the crisis, the liquidity for trading those claims completely dried up and spreads skyrocketed, but the GSE conservatorship plus pledges from Treasury did nothing to improve that situation. The Fed’s purchases restored liquidity and took a bunch of illiquid assets off of financial institution sheets, giving them cash instead. The real benefits are monetary.

    To repeat, the Fed does not bear any more credit risk in holding those instruments than it does holding Treasury securities, so it is not much different from a QE involving long term Treasury debt. I would like to see more transparency on the prices paid, but the purchasing process was competitive (i.e. buying from the lowest priced sellers)

  31. Gravatar of scott sumner scott sumner
    26. June 2010 at 05:48

    ThomasL, The trajectory before 2008 was sustainable, but only if government spending and taxes were stable as a share of GDP. Obviously if the entitlements are not reformed they would be unsustainable. But my main argument is that the fiscal stimulus has made the debt situation even worse. We were going to need to do budget reforms–now those reforms will be even more painful.

    q, Well it is true that Bernanke asked Kohn to delay his retirement. I suppose it could have been for some other reason, but I do find the Telegraph story to be plausible–albeit biased toward the dovish viewpoint.

    thruth, You said;

    “On the merits of the argument: What do you attribute the subsequent improvement in conditions to? stress tests? equity injections? natural causes? Note that a lot of the stuff in 2008 is short-term LLR activity. The MBS purchases (in my mind the real, or at least more powerful, QE) didn’t begin until Mar 2009. We still have interest on reserves…”

    Perhaps we were talking past each other. I thought “improvement in conditions” meant improvement in the economy. If it refers to banking, then perhaps they are correct. But I would note that between September 2008 and March 2009 the estimated future losses to the US banking system doubled (according to IMF estimates) so I’m not even sure banking improved. But let’s say I am wrong, and it did improve. My point is that banking distress did not cause the recession, tight money did. The injection of reserves did not provide monetary ease, due to IOR. Thus the economy did not improve. So there is nothing for me to explain, as I don’t accept the argument that things got better. The March OMP of MBSs might have helped a bit, but I’m inclined to think that the recovery in China was the most important factor preventing a steeper downturn (of course the downturn was already pretty steep.)

    Tom, You are exactly right. The unpredictability of monetary policy is the biggest problem. It doesn’t so much matter whether they follow my recommendation of 5% NGDP growth, but they need some sort of transparent target so that markets know where they are trying to steer us.

    e, I am not sure DeLong would agree that his suggestion would not increase inflation. You might be right, but any demand stimulus that doesn’t increase inflation will, ipso facto, fail to boost AD. I’m not saying fiscal stimulus can’t work, there are scenarios where it can. I’m saying the crucial factor is whether the central bank agrees to play ball.

    Jon, It was both fiscal and monetary. And I agree that they should stick to T-securities, and stop trying to micro manage specific sectors of the economy.

    W Peden, Thanks, I did a post on that last month.

    acerimusdux, Last year I had a lot of posts on this and swatted away every objection. If you are worried about bank deposits falling due to fees charged to depositors, just pay banks a large enough positive interest rate on required reserves to offset the negative interest on ERs. Trust me, it would work.

    But I am not saying this is the best way for the Fed to target NGDP, it isn’t. I just want to point out that it is easy to solve the problem of bank hoarding of ERs, if you think that is the factor restraining monetary stimulus. I am confident that it is not the problem, so I don’t think negative rates on ERs are in any way necessary to boost NGDP with monetary stimulus. Setting a price level of NGDP target and doing level targeting is the key.

    Mattias, Yes, the gold bugs are a problem, just like in the 1930s (albeit for slightly different reasons.)

    thruth, That’s a very good argument. Of course in the long run I’d like to see these institutions wound down and abolished. But if the MBSs were effectively T-securities already, then they is no harm done by this extra step.

  32. Gravatar of Jon Jon
    26. June 2010 at 09:34

    Thruth, you make several points which I’d like to address.

    First and most basically: The credit quality of the Fed’s portfolio is not a concern of my mine, so I do not feel it directly addresses the issue at hand.

    Claims to those mortgages are distributed throughout the financial system as a result of the GSEs activities, with the GSEs holding most of the credit risk. In the crisis, the liquidity for trading those claims completely dried up and spreads skyrocketed, but the GSE conservatorship plus pledges from Treasury did nothing to improve that situation.

    One possible reason being that the Treasury never pledged unlimited capital to the GSEs until the last possible moment in late Decemeber. Nine months after the Fed program began. Second, even though they have made such a pledge there is reason to doubt that pledge given the fiscal situation. The press is very much alive with op-eds calling on the Treasury to cut the GSEs lose.

    Second, you seem fixated on ‘credit’ risk. A 30yr obligation also has inflation-risk; now still there is a spread over treasuries, but 30yr treasuries are fairly obscure and have ‘legal demand’ from insurance companies.

    Scott writes:

    It was both fiscal and monetary.

    Interestingly, you’ve done the most to dissuade me from that position. Basically, by issuing reserves and paying interest on those reserves, the Fed’s action appears very simpler to a treasury operation of selling t-bills and buying mortgages.

    The monetary characteristic is very slight (the former makes base-money whereas the latter consumes base money); however, that’s an irrelevancy given such an over-saturated pool of reserves.

    The final aspect is that the maturity of the Fed’s portfolio has shifted. They had a portfolio with an average maturity of around 4 years before the crisis. They now have a portfolio with an average maturity of around 20 years, and in that portfolio they assets which appear to imply a very low expected rate of inflation.

    Which might lead one to believe that the Fed is quite serious about the base expansion being temporary, and as a ‘bank’ has a lot on the line to make it so.

  33. Gravatar of John Salvatier John Salvatier
    26. June 2010 at 09:45

    Think about this: Bernanke must not think very strongly that the US needs looser monetary policy because otherwise, he would call up Obama and convince him that as the Chief of the Federal Reserve he thinks the most important issue in the country right now is monetary policy and that the US needs much looser monetary policy, but that he can’t make that happen without support. He could convince Obama to nominate doves to the committee and to press for their confirmation. It doesn’t seem like that has happened, therefore Bernanke disagrees with the premise. Thoughts?

  34. Gravatar of Jeff Jeff
    26. June 2010 at 09:59

    Scott,

    Suppose the Fed did impose a negative interest rate on deposits at a Federal Reserve Bank. If I were a banker facing that situation, I could just exchange all my excess reserves for currency and stash it in my vault. What then?

  35. Gravatar of acerimusdux acerimusdux
    26. June 2010 at 10:11

    Scott,

    All you are doing now is creating inefficiency by having a rate disparity between required and excess reserves. And of course, no manipulation of either of those rates will have any direct impact at all on loans. Those are rates on deposits, not on loans.

    The biggest impact I can see on lending is that it might somewhat inhibit very short term and overnight lending due to the transaction costs of individual banks having to precisely manage the level of reserves at the end of the day. Overnight lending profitability depends on low transaction costs. You can’t afford to add too much red tape there.

    Raising the interest rate on required reserves will have little impact on incentives to hold deposits or make loans. As long as there are excess reserves in the system, banks with shortfalls will be able to cheaply borrow to meet those requirements and collect that interest. There is no incentive to actually hold onto those reserves rather than borrow them.

    Suppose you set a very high rate, say 10%, so that a bank would want to accept a new deposit. Suppose 10% of the new deposit is required reserves, so they would get 10% on that, or 1% of the total. And suppose they pay a penalty of 1% on the other 90% which becomes excess reserves, so about 9/10 of a percent of the total. OK, they are still coming out ahead now by only about a tenth of a percent. All you have succeeded in doing here, with a very large manipulation in interest on reserves, is cause a change equivalent to what would be a very small change in the gap in effective rates for the bank on loans compared to deposits.

    And it’s doubtful that this would even lead to a net increase in bank activity after considering the additional transaction costs and inefficiencies. You have essentially abandoned the ability to manage the Federal Funds rate effectively, while causing as much stimulus as only a tenth of a percent lowering of the Federal Funds rate, and you are doing that through a more costly and less efficient mechanism than managing the Federal Funds rate. Meanwhile, the systemic changes that would be required, such as also taxing vault cash, would be much the same as those necessary to implement negative Federal Funds rates.

    Ultimately, trying to encourage bank lending by adding excess reserves to the system, and then trying to punish any banks caught holding them, would be the very definition of pushing on a string. You have done nothing to increase the demand for loans, or to lower the cost of capital for banks. The only things that will impact loan making are liquidity, cost of capital, the default risk of prospective borrowers, and the interest rate borrowers are willing to pay.

    You have a theory, but it’s one that hasn’t been tried, and I think with good reason.

  36. Gravatar of Ted Ted
    26. June 2010 at 11:38

    I’m wondering if Larry Summers is telling Obama nothing can be done on the monetary front. I remember in a paper he wrote at least two decades ago where he argued against a long-run zero inflation target partially on the grounds that we needed to avoid a “zero interest rate trap.”

    He appears to be pushing that view recently as well too:

    May 2010: http://www.whitehouse.gov/administration/eop/nec/speeches/fiscal-policy-economic-strategy

    “In settings where an economy’s level of output is constrained by demand where the Federal Reserve is unable to relax that constraint, fiscal policy will through the multiplier process have significant impacts on output and employment. … Moments like the present – when the economy faces a liquidity trap and when the Federal Reserve is constrained by a zero bound on interest rates, and when the financial system is functioning imperfectly because of credit problems in financial intermediaries and because of overleveraged borrowers – are moments when these conditions, for fiscal policy to have an expansionary impact, are especially likely to obtain.”

    Or here July 2009: http://dyn.politico.com/printstory.cfm?uuid=8991C732-18FE-70B2-A8410DAF98025BEC

    “Economists in recent years have become skeptical about discretionary fiscal policy and have regarded monetary policy as a better tool for short-term stabilization. Our judgment, however, was that in a liquidity trap-type scenario of zero interest rates, a dysfunctional financial system, and expectations of protracted contraction, the results of monetary policy were highly uncertain whereas fiscal policy was likely to be potent.”

    Assuming he’s as influential and overbearing as the press reports him as (as if I can trust that?), then he might have already convinced Obama there is nothing that the Fed can do and any argument to the contrary is silly because the effects of monetary policy may be, in Summers words, “uncertain” where as fiscal policy is “potent.”

  37. Gravatar of Luis H Arroyo Luis H Arroyo
    26. June 2010 at 12:01

    Is not J Taylor a cheat?
    See http://johnbtaylorsblog.blogspot.com/ where he use Zolti/$ data To prove that it has not depretiate in 2009. But REER and Zolti/euro data say clearly that it does depretiate.
    see the true data in my bolg.

  38. Gravatar of thruth thruth
    26. June 2010 at 14:34

    @Jon: “One possible reason being that the Treasury never pledged unlimited capital to the GSEs until the last possible moment in late Decemeber. Nine months after the Fed program began. Second, even though they have made such a pledge there is reason to doubt that pledge given the fiscal situation. The press is very much alive with op-eds calling on the Treasury to cut the GSEs lose.”

    The long-term fiscal situation is the one that matters. The only real way to address that is via benefit cuts and tax increases. For now, the market has confidence this will happen. A one-time $500billion or so increase or decrease in the net deficit doesn’t change the long-term situation.

    On the pledge, the govt doesn’t have a credible way of letting F/F fail. In addition to the financial sector spillovers, there’s a very real risk that cutting the GSEs loose would also impact the cost of Treasury’s debt issuance. So sure, the US govt backing isn’t complete, but it’s still complete enough to justify the Fed’s actions as Treasury’s banker.

    “Second, you seem fixated on ‘credit’ risk. A 30yr obligation also has inflation-risk; now still there is a spread over treasuries, but 30yr treasuries are fairly obscure and have ‘legal demand’ from insurance companies.”

    Not really fixated, I realize that there are prepayment and various other risks inherent in MBS and I’m arguing that the spreads more than compensated for those risks. The fiscal/monetary distinction is always going to be fuzzy in these cases, but the absence of credit risk is important.

    There’s probably a pretty strong case that the Fed should have focused its QE on Treasury securities instead of “Agency” debt. On the other hand, QE with Treasuries alone might not have the same degree of monetary stimulus because in the crisis Treasuries could be used in repo transactions (giving them a money like characteristic) but MBS could not.

    I agree with Scott that GSEs should be wound down and dissolved, but given the Congress likes putting people in houses and propping up housing wealth, I don’t see that happening.

  39. Gravatar of e e
    26. June 2010 at 16:33

    Thanks for the help scott, sounds like its more complicated than i thought, although it still seems to me like rational expectations implies that “deficit neutral on a 10 yr time frame” wouldnt behave much differently from deficit neutral today.

  40. Gravatar of scott sumner scott sumner
    26. June 2010 at 17:30

    Jon, Yes, I forgot about the interest. In that case it is fiscal policy.

    jsalvatier, Maybe, I don’t know if that sort of pressure is considered acceptable. But you might be right.

    Jeff, The interest penalty would apply to all excess reserves including vault cash.

    Check out this post from last year for more details:

    http://www.themoneyillusion.com/?p=1032

    acerimusdux, Check out the link above. There is one small error in your post and one area where we are far apart.

    The small error is your numerical example. If my plan were in effect then ERs would be only a tiny percentage of RRs (as in normal times.) In your example you seem to assume that ERs are 10 time larger than RRs. It would be closer to the reverse.

    More importantly, the whole point of my plan is to reduce bank demand for reserves, so that the money flows out into the economy. It is not intended to increase bank lending, and I completely agree with you that there would be no direct impact on bank lending.

    Ted and Luis, Both great comments. I quoted you both in my new post.

    e, I suppose there is some Keynesian model where real expenditures that are temporary can have some effect. I honestly don’t know if these models are assuming Ricardian equivalence (which is closely related to ratex.)

  41. Gravatar of thruth thruth
    26. June 2010 at 18:40

    @Jon: “Basically, by issuing reserves and paying interest on those reserves, the Fed’s action appears very simpler to a treasury operation of selling t-bills and buying mortgages.”

    good point. but same would apply if you replace “mortgages” with “10 year T-bonds”.

  42. Gravatar of Jeff Jeff
    26. June 2010 at 18:53

    Scott,

    If you charge me a penalty on vault cash, I just set up a nonbank subsidiary and have it hold the cash. Or I can lend it the cash, and hold the IOU’s as assets rather than the cash.

    I don’t think you can make a penalty rate actually work in the real world. A clever lawyer could easily come up with a half-dozen ways to avoid the penalty in less time than it took me to write this comment.

    I do agree with you that targeting the expected level of NGDP would be a good policy for the Fed to pursue. But a negative rate on excess reserves seems unworkable to me.

  43. Gravatar of Someone Stop Bernanke Before He Kills Again Someone Stop Bernanke Before He Kills Again
    26. June 2010 at 19:45

    [...] Scott Sumner has found a scary Telegraph article explaining Bernanke’s plans for the economy. Of course, [...]

  44. Gravatar of thruth thruth
    27. June 2010 at 05:24

    @Scott “Perhaps we were talking past each other. I thought “improvement in conditions” meant improvement in the economy. If it refers to banking, then perhaps they are correct.”

    I think they meant improvement in the economy.

    “But I would note that between September 2008 and March 2009 the estimated future losses to the US banking system doubled (according to IMF estimates) so I’m not even sure banking improved.”

    The MBS purchases didn’t really get going until March. The IMF stability report is all over the place. By Oct 2009, The same IMF estimates show about the same level of US losses that they estimated in Apr 2008

    “The injection of reserves did not provide monetary ease, due to IOR. [...] The March OMP of MBSs might have helped a bit,”

    Given Jon’s comments, is your story that, in effect, the MBS purchases did not result in QE because of interest on reserves? Does that mean you don’t think the MBS purchases have any monetary effect or just a more subtle effect (captured in some broader monetary measure such as M3). I see you changed your mind and called it all fiscal above…

    “but I’m inclined to think that the recovery in China was the most important factor preventing a steeper downturn (of course the downturn was already pretty steep.)”

    I’m sympathetic to that argument that the Chinese played an important role. Would like to see it quantified though. Seems a stretch to think it was all China.

  45. Gravatar of scott sumner scott sumner
    27. June 2010 at 06:38

    thruth, Yes, I see that you are right. It was sloppy thinking on my part to forget that the agency debt was already effectively T-debt. Is the Fed buying any MBSs that aren’t agency debt?

    Jeff, I’m sorry, but here I think you are the one being a bit naive. The Fed can include any subsidiary in the rule. Despite the recent use of the term “bankster”, bank presidents are not gangsters. If the Fed threatens to imprison bank presidents who cheat on the reserve rule by hiding $100s of billion in cash from the Fed, then they won’t do it. It’s really that simple. People forget how much money a trillion dollars really is. In the form of cash it would not be easy to hide. Believe me, if the Fed wanted banks to hold less reserves they could make them do so.

    And why would banks want to cheat so badly? They could hold T-bills if they are so desperate for liquidity. It’s not like they’d make massive profits holding lots of zero interest cash.

    thruth, Go back and read the last part of the quotation. They are specifically talking about the reserve injections of Sept 2008 to Jan 2009, not the March 2009 policy.

    From the beginning I’ve compared interest-bearing reserves to Treasury debt, I just sometimes forget to make the point. I year ago I argued that QE was not effective partly because of interest on reserves, and partly because it was viewed as temporary (as in Japan.)

    It doesn’t matter to me whether it’s called “not really QE” or “QE that’s ineffective due to IOR.” It amounts to the same thing. I suppose I haven’t even been consistent in my own writings.

    No, not all China, but China was the first significant economy to recovery. It immediately pushed commodity prices up higher, and that jump-started lots of other commodity producers like Brazil. One could say the developing world as a whole prevented a deeper depression, although in any counterfactual you must also consider that if the economy had gotten much worse the Fed might have been more aggressive, so it’s hard to sort out causality. But the reserve injections of late 2008 clearly didn’t work.

  46. Gravatar of thruth thruth
    27. June 2010 at 08:33

    @Scott: “Go back and read the last part of the quotation. They are specifically talking about the reserve injections of Sept 2008 to Jan 2009, not the March 2009 policy.”

    Yeah, sorry, I was unconsciously interposing my own view that all of the stuff between Sept 2008 and Jan 2009 was short-term and not really credible QE. The purchase of long dated MBS and agency debt seemed a little more credible. I need to think more about the role of interest on reserves in neutralizing those purchases too. The view expressed by folks like Cochrane that Treasuries are defacto currency because of their repo value is fairly entrenched.

  47. Gravatar of thruth thruth
    27. June 2010 at 08:46

    @Scott Sumner: “Is the Fed buying any MBSs that aren’t agency debt?”

    Not that I know of (i.e. not part of what is shown as MBS on the Feds balance sheet breakouts). The non-agency stuff in the other programs like TALF and Maiden Lane are mostly TARP backed or have really big haircuts. The Maiden Lanes are the diciest and the most dubious use of the Feds mandate. Most of the risk was offloaded to TARP, but not at the time.

  48. Gravatar of Silas Barta Silas Barta
    27. June 2010 at 10:00

    Yes, the economy will definitely collapse if the Fed doesn’t print up more money to make shoddy loans for purchases people don’t want, and it’s a shame that folks at the Fed are stopping Bernanke from such a wise action.

  49. Gravatar of scott sumner scott sumner
    28. June 2010 at 06:11

    thruth, I knew they had some dicey stuff from Bear Stearns, etc, but it’s good to know that the big MBS purchases are agency debt. Some of it may be junk, but the Treasury is already committed to cover it, as you said, so the Fed is not adding any additional risk to the consolidated government balance sheet.

    Silas. I agree. :)

  50. Gravatar of Jeff Jeff
    28. June 2010 at 08:41

    Jeff, I’m sorry, but here I think you are the one being a bit naive. The Fed can include any subsidiary in the rule. Despite the recent use of the term “bankster”, bank presidents are not gangsters. If the Fed threatens to imprison bank presidents who cheat on the reserve rule by hiding $100s of billion in cash from the Fed, then they won’t do it. It’s really that simple. People forget how much money a trillion dollars really is. In the form of cash it would not be easy to hide. Believe me, if the Fed wanted banks to hold less reserves they could make them do so.

    The Fed, having no authority to prosecute crimes, cannot imprison anyone. The best they could do on that score is make a referral to the Justice Department. There’s no need for the banks to “hide” the cash; loaning it to someone who just locks it up in a secure vault is perfectly legal and above-board. You can write a bunch of new laws and regulations, and wait a decade or two for the courts to tell you which ones are actually enforceable. But in the meantime, negative interest rates on excess reserves are pretty easily gotten around.

    And why would banks want to cheat so badly? They could hold T-bills if they are so desperate for liquidity. It’s not like they’d make massive profits holding lots of zero interest cash.

    Again, it’s not cheating, any more than the tax deduction I take for my mortgage interest is. But aside from that, you can make the very same arguments you’re making here about banks holding excess reserves when the rate paid on them is zero. Why don’t they just hold Treasuries? At a couple of points during the recent crisis, the demand for short-term Treasuries was so great (probably because, as Gorton has pointed out, haircuts in the repo markets for everything else went up drastically) that nominal yields to maturity actually went negative. Maybe there really aren’t enough of them to go around, and trying to force banks to hold them will drive their yields negative again. Of course, Treasury could fix this by shortening the average maturity of the debt, but recently they’ve been doing the opposite.

    I’m not at all convinced that a penalty rate on excess reserves is needed. If the Fed were to announce that henceforth it would target the expected level of NGDP and then commenced massive open market purchases of Treasuries of every maturity, and nothing happened, then maybe I’d be willing to try it. But I don’t think it would be either quick or easy, as the implementation would be held up by lawsuits, and there might be some unpleasant unintended consequences.

  51. Gravatar of Silas Barta Silas Barta
    28. June 2010 at 09:28

    Scott_Sumner: I can’t tell exactly what you mean — are you joking, or do you knowningly accept that this is what your economic reasoning as led you to, and you accept it anyway?

  52. Gravatar of MattJ MattJ
    28. June 2010 at 11:02

    Unless I have missed a big change, the Treasury is not capable of committing to covering the GSE debt. They are committed to covering all GSE losses through the end of 2012, which is the maximum they are allowed to do under current legislation. Covering any more GSE debt would require new legislation, which I view as very unlikely coming from this or the next Congress.

    Scott- Have you addressed Plosser and Lacker’s views that the Fed does not have the legal authority to purchase bonds? Regardless of whether you think it is the right thing to do, do you believe the Fed has the legal authority to do so? The arguments I have read claiming they do not have struck me as convincing; I’d be interested in your opposing viewpoint.

  53. Gravatar of Another Dip in the Inflation Forecast | EmpirestateFX.com Another Dip in the Inflation Forecast | EmpirestateFX.com
    29. June 2010 at 04:10

    [...] Scott Sumner argues that “the Fed suffers from the same sort of paralysis as it did in the Great [...]

  54. Gravatar of Another Dip in the Inflation Forecast | Another Dip in the Inflation Forecast |
    29. June 2010 at 06:51

    [...] Scott Sumner argues that “the Fed suffers from the same sort of paralysis as it did in the Great [...]

  55. Gravatar of scott sumner scott sumner
    29. June 2010 at 07:29

    Jeff, You said;

    “The Fed, having no authority to prosecute crimes, cannot imprison anyone. The best they could do on that score is make a referral to the Justice Department. There’s no need for the banks to “hide” the cash; loaning it to someone who just locks it up in a secure vault is perfectly legal and above-board. You can write a bunch of new laws and regulations, and wait a decade or two for the courts to tell you which ones are actually enforceable. But in the meantime, negative interest rates on excess reserves are pretty easily gotten around.”

    Now we are getting somewhere. Yes, the money will be loaned out. Perhaps some will end up in private vaults, but people are already free to do that today. My point was that the Fed could get rid of excess reserves if they wanted to. Money held in private vaults isn’t bank reserves. The real questions is how much private demand for currency is there, and how much would there be if we had a 5% NGDP growth target.

    It’s possible that the Fed might print a quadrillion dollars, and buy up the entire stock of wealth in the world, without creating any inflation. But is it likely?

    You said;

    “Again, it’s not cheating, any more than the tax deduction I take for my mortgage interest is.”

    Of course it would be cheating. I said the fee would apply to all bank reserves. Vault cash is bank reserves.

    You said;

    “I’m not at all convinced that a penalty rate on excess reserves is needed. If the Fed were to announce that henceforth it would target the expected level of NGDP and then commenced massive open market purchases of Treasuries of every maturity, and nothing happened, then maybe I’d be willing to try it.”

    I completely agree, and have made the same point dozens of times. My only point is that if the Fed wants to get rid of ERs, they can easily do so. T-bill bill rates can’t go strongly negative, because otherwise the Chinese would hold Federal Reserve notes. One other point, they should definitely stop paying interest on reserves.

    BTW, In 2009 the Swedes imposed negative interest on ERs. They did that about 2 months after about 100 commenters told me it can’t be done.

    Silas, I think RGDP would rise if the Fed printed up more dollars. If they don’t then real growth will be lower. Don’t most economics textbooks say the same thing?

    MattJ, I don’t know whether the Fed has the legal authority. It is a minor technical issue, in my view. The government recently said they would essentially cover all of F&F’s losses. If they needed more Congressional authorization–they’d get it. (I don’t know if they do.)

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