An outbreak of mass sanity
It’s starting to feel like October 2011, when there was a wave of high profile endorsements of NGDPLT. Several Fed officials have recently spoken favorably of NGDP targeting, Bloomberg.com just endorsed it, and now Michael Woodford has done so as well. He’s probably the world’s leading macroeconomist.
Hours later Saturos sent me a link from the WSJ:
JACKSON HOLE, Wyo.-A key Federal Reserve official said Friday he sees potential value in charging banks to park reserves on the central bank’s balance sheet.
In an interview with Dow Jones Newswires on the sidelines of the Federal Reserve Bank of Kansas City’s research conference in Jackson Hole, Wyo., St. Louis Fed President James Bullard says he sees potential benefit from imposing negative interest rates on the excess reserves banks currently park at the Fed.
Banks are now currently paid 25 basis points to keep money at the Fed. Even at such a negligible level, banks have parked massive amounts of cash at the central bank that could be put to work in the economy.
“I’m becoming more sympathetic” to the idea a new avenue of monetary policy stimulus could involve the Fed moving into “negative territory,” Mr. Bullard said. From the current level, “you could go to minus 25 or minus 50 (basis points). That gives it more punch” than simply cutting the level to zero, he said.
If negative rates were put in place, “it would definitely change the calculus for the banks,” Mr. Bullard said. The official noted “support has waxed and waned” inside the Fed for this action, but “now that other countries have tried negative rates, I think we could do that as well.”
Wow, where are Fed people suddenly getting all these great ideas? Maybe from that 2009 New York Fed report that discussed the option of negative IOR. And guess who they cited as first publishing an article discussing the idea. Also note that Woodford mentioned David Beckworth, so we know he’s familiar with market monetarism.
To get serious for a moment, Bullard doesn’t even have a vote on the issue, as it’s a Board decision. There’s debate about whether the Fed has the authority, but they showed in 2008 that they can get really creative. I’m told that the new FDIC fee plan is already a tax on ERs (someone should double-check), so lowering IOR to zero would effectively create a negative IOR. Also, does anyone know if the FDIC fee applies to that part of reserves that are vault cash?
I’d still vastly prefer a higher NGDP target over negative IOR.
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1. September 2012 at 00:01
For someone like me, who has supported cutting the interest on ERs at least to zero, and quite possibly to a negative rate, since reading about it on this blog, this is great news. I have, among other things, argued in favor of this on DeLong’s blog, which is the other economic blog I post on regularly, and have argued that the fact that this can be done is one of the things that shows that we are not in a liquidity trap.
I predict that Mitt Romney and the Republicans will criticise the Fed if they do this, or advocate doing it. And the people that Romney appoints to the Fed, if he wins, including the new Chair, will refuse to have anything to do with it. Some of them will actually favor returning to a gold standard and/or moving to a commodity price standard.
Real progress on monetary policy requires that Obama be reelected, and market monetarists, if they want their policies to be enacted, need to actively support Obama and oppose Romney.
1. September 2012 at 00:18
James Hamilton was one of the first to identify the FDIC fee issue. I could be mistaken, but this seems to have been the last on that subject and it links to a few earlier posts.
http://www.econbrowser.com/archives/2008/11/the_anomalous_f.html
1. September 2012 at 01:59
Thanks Vivian, I recall the rules were changed in 2010, but don’t recall the details.
1. September 2012 at 04:55
I suspect that to woo the hegemony, you’d first cut IOR (make the banks squeal) and set a LT of 4.5% from right now, maybe back a bit.
And then whatever else you do, get ready to raise rates the exact moment you cross the line, not a moment too early, and not a moment to late… the real Chuck Norris moment happens when common folks REALIZE the Fed:
1. raises rates on any increase in Fiscal.
2. lower rates on decreases in Fiscal spending.
That’s when Dems recognize that whatever public goods they want to deliver they HAVE to run the damn things making real productivity gains to fund future services growth without increase govt. % of GDP.
1. September 2012 at 07:22
Hey Scott,
The new FDIC model is very complicated and is hard to generalize from. However, the best way to think about it would be that the fee increases based on the riskier the liability issued is. So raising excess reserves by short term borrowings would be pretty costly while raising excess reserves by insured deposits would not be. I believe the asset (whether excess reserves, vault cash, or short term lending) is pretty immaterial. There are also very heavy factors based on the FDIC’s confidential risk assessment, the bank’s current asset – liability mix, and counterparty exposures.
One thing to keep in mind here is that a lot of ERs are held by non-domestic banks that are not subject to FDIC charges. This shift has largely taken place since the implementation of the new FDIC fee in spring 2011 and is likely attributable to it. This is why it is essential, IMO, that the IOER rate move back to zero instead of just a modest cut. Otherwise the impacts to real economy would be muted as foreign banks just continue or increase their arbitrage. This note here gives some detail on this little known angle: http://www.alliancebernstein.com/CmsObjectABD/PDF/EconomicPerspectives/SpecialCommentary_110624.pdf
Glad to see you are making more headway in the war of ideas.
1. September 2012 at 07:52
Williams calls for open ended purchases totaling AT LEAST 600 billion. The hawks want negative IOR, the doves want an open ended commitment. Beautiful. http://www.bloomberg.com/news/2012-08-31/williams-calls-for-at-least-600-billion-more-in-fed-purchases.html
1. September 2012 at 08:18
The the QE3 front, Fed balances are shrinking?
http://ftalphaville.ft.com/blog/2012/08/31/1140881/if-qe3-is-so-close-why-is-the-feds-balance-sheet-shrinking/
1. September 2012 at 09:05
Commercial banks can do nothing with excess reserves except lend them to other banks that may need short term require reserves. When they loan them to another bank it goes into that banks reserve account so the excess reserves in the banking system as a whole do not change. The only entity that reduce excess reseres in total is the Fed. The Fed pays a positive interest rate on excess reserves in order to be able to maintain a high balance sheet. If they did pay interest then banks lending to other banks would drive the fed rate to zero.Paying interest near the Fed Fund target rate allows the Fed to maintain its target rate. Excess reserves have no effect on banks commercial lending.
1. September 2012 at 09:09
“An outbreak of mass sanity” coincidentally 3 months before the election? #fallisaspecialtimeofyear
1. September 2012 at 10:29
I sure hope the “big name” economists who are signing onto NGDPLT give credit to the market monetarist bloggers who’ve been writing about it for years.
In Krugman’s two recent posts about Woodford’s paper he does not mention market monetarism at all.
http://krugman.blogs.nytimes.com/2012/09/01/woodford-on-monetary-policy-sort-of-wonkish/
http://krugman.blogs.nytimes.com/2012/09/01/monetary-versus-fiscal-policy-revisited/
1. September 2012 at 10:45
Speaking of James Hamilton;
http://www.econbrowser.com/archives/2012/08/us_monetary_pol.html
————–quote—————
One key liability is the dark green region corresponding to currency held by the public– the green money that you and I carry around. This has increased only modestly despite all the emergency lending, QE1, or QE2. I know some of you have heard again and again that the Fed did all this by “printing money”, but as a physical statement, this simply is not true. Dollar bills with pictures of George Washington (or C-notes with Ben Franklin’s portrait) have never been printed in anywhere near the amount of the Fed’s various actions. In fact, it would be quite a challenge logistically to print them in the quantity necessary to match the surge in Fed assets over the last 4 years.
[see graph at Hamilton’s blog]
Instead, the Fed’s assets have been acquired by creating reserves, which are simply credits that banks maintain in their accounts with the Fed. Although banks could, in principle, ask to convert these credits into green currency, for four years banks have instead been content to let the reserves just sit there. Those who insisted that all this “money creation” would lead to runaway inflation have so far at least proved to be spectacularly wrong.
My view is that the Fed never had the power, and lacks the power today, to solve our primary economic problems. However I believe it did have the power, and successfully exercised the power, to prevent our problems from becoming even worse.
——————endquote————–
1. September 2012 at 12:46
Scott, I do believe that you have some reason to be optimistic about the US. This is 1932 after all. So we will soon see some Roosevelian resolve. However, you know in Europe we do not believe in reason. We are surrounded by Keynesians and Calvinists. Reason is not an option in Europe. It is very depressing, but I hope if the Fed will show the way it might not matter how irrational European policy makers are.
1. September 2012 at 15:12
I just read the two Krugman pieces and despite the fact that he endorses the Woodward paper (which strongly endorses NGDPLT), Krugman still mostly pays reverence to his sacred cows (liquidity traps and the necessity of fiscal stimulus). Krugman is agreeing with much of what market monetarists have already written about NGDP targeting and QE/expectations channel, but still managing to claim that doing so does not contradict his most well-known beliefs and theories.
Krugman hints that he still believes the liquidity trap theory when he says, “the central bank can still gain traction if it can convince the public that it will pursue a more inflationary policy than previously expected after the economy recovers.”.
This is flat out wrong. We do not need further inflation after the economy recovers, in fact the post-trough NGDP trend of roughly 4% is acceptable given the demographics of slowing working-age population — what is needed is a large one-off adjustment to erase the huge gap in NGDP trend that arose during 2008-09, followed by a credible commitment to NGDPLT. The Fed does not have to commit to be irresponsible, but because Krugman believes in liquidity traps and fiscal stimulus he is forced to say that the effectiveness of Fed policy is mostly limited to the period after the economy recovers. In reality, it is the commitment to correcting the NGDPLT gap that will allow for full recovery in the first place.
In the latter piece, Krugman goes on to say;
“Current monetary policy is indeed ineffective in a liquidity trap; but there is still scope for central bank action in the form of credible commitments to keep monetary policy easy in the future, when the economy is no longer at the zero lower bound.”
Current policy however consists of paying IOR, and the neutralizing effect of such a policy makes it difficult to prove if the current environment is evidence of the existence of the type of liquidity trap that Krugman envisioned in his earlier writings. Furthermore if a liquidity trap does exist, then how does one get to the point where “the economy is no longer at the zero bound.” If we’re in a liquidity trap, monetary policy is by definition unable to move us off the zero bound. Is Krugman suggesting that fiscal policy will give the lift to economic growth that shakes nominal interest rates off the zero bound?
Also of note, Krugman agrees with Woodford that QE works primarily through the expectations channel — if that is indeed the case, then the problem of the zero bound is easily avoided by maintaining expectations of a level path target for a variable such as NGDP. It also suggests that there is no such thing as a liquidity trap; there are only periods of time where the central bank fails to provide adequate liquidity and either fails to meet expectations or dissolves previous expectations completely.
1. September 2012 at 17:39
A few points.
1) This political play is so predictable. Fed follows a tight policy four 4 years to screw Obama and the Dems. In expectation of a Republican victory in November, they begin talking up a more expansionary policy now. After November they implement the policy and miracle of miracle we get an economic recovery under the Republicans.
2) It doesn’t matter what Romney and the Republicans are saying about Gold and Bernanke. That’s just politics to keep the whacko Paulites on board. After November they just call expansionary monetary policy something other than QE 3/4 or a higher inflation target, and 99.9999% of the population and the media don’t know the Republicans have done a 180.
3) When talking about the ZLB and whether rates are high or low, I amazed that not more attention is paid to the fact that you need to be looking at nominal rates/(real growth x inflation), e.g. nominal interest rates/NGDP rates. That what’s determines if rates are expansive or contractionary. Scott has made this point on numerous occasions. Even at a nominal ZLB on the numerator, there is still unlimited room to move the denominator up. Looked at another way, you need to compare the nominal cost of capital to the nominal return on capital.
1. September 2012 at 17:58
‘This political play is so predictable. Fed follows a tight policy four 4 years to screw Obama and the Dems.’
So why did the Fed screw John McCain?
1. September 2012 at 18:33
So why did the Fed screw John McCain?
Those were Republican appointees who screwed McCain.
These are Obama’s appointees screwing him.
See the pattern?
1. September 2012 at 18:55
Randy, Thanks for that info on ERs and FDIC.
Everyone, Lots of good points, but John Wilkins needs to be careful in saying the banking system cannot reduce ERs. It can, by buying assets from the public, and then lowering the interest rate on deposits so that the public is less likely to redeposit the money back in the banking system. You reduce ERs by increasing currency held by the public.
1. September 2012 at 22:27
The Fed as Central Planner: http://econlog.econlib.org/archives/2012/09/the_federal_res.html
2. September 2012 at 00:34
Um.. what???
“A revealing example of where we are going emerged last spring, admirably documented on the Fed’s website. Using its bank-regulation authority, the Fed declared that the banks that had robo-signed foreclosure documents were guilty of “unsafe and unsound processes and practices”–though robo-signing has nothing to do with the banks taking too much risk.
The Fed then commanded that the banks provide $25 billion in “mortgage relief,” a simple transfer from bank shareholders to mortgage borrowers–though none of these borrowers was a victim of robo-signing.
The Fed even commanded that the banks give money to “nonprofit housing counseling organizations, approved by the U.S. Department of Housing and Urban Development.” Why? Many at the Fed see mortgage write-downs as an effective tool to stimulate the economy. The Fed simply used its regulatory power to help meet that policy goal.”
And this is why the GOP / Mitt Romney love the Fed.
I suspect this is going to go off like a bomb.
2. September 2012 at 04:01
[…] A critical mass of sanity in macroeconomics? […]
2. September 2012 at 09:38
Scott:
The banking system can only reduce its actual reserves holdings if the public holds more currency.
However, it can reduce its excess reserves by increasing required reserves, which it does by expanding deposits subject to reserve requirements.
For example, if a bank purchases an asset from a member of the nonbanking public, then the seller immediately has a larger balance in his checkable deposit. The required reserves then rise approximately 10% of added balance in the checkable deposit, which is approximately 10% of the value of the asset purchased. Leaving aside any increase in currency demand, _excess_ reserves fall an equal amount. Total reserves stay the same, required reserves increase, and excess reserves fall.
Now, if the person holding the checkable deposit has a sweep agreement, then there is no increase in reported checkable deposit, no increase in required reserves, and no decrease in excess reserves.
It is true that if banks pay less interest in deposits, this should somewhat increase the demand for currency, and so reduce excess reserves.
However, the _benefit_ of the lower interest on deposits is not to get people to demand for currency, but rather to motivate them to spend on goods and services, or at the very least, riskier financial assets.
Similarly, the benefit of banks purchasing assets and there being an increase in the quantity of deposits, isn’t that excess reserves decrease. The benefit is that they may spend some of those deposits on goods and services, or at least, on riskier assets.
2. September 2012 at 10:48
Common sense isn’t as widespread as one might like;
http://johnhcochrane.blogspot.com/2012/08/the-future-of-central-banks.html
‘…fiscal policy (the ability to write checks to voters, aka helicopter drops)….’
Helicopter drops are fiscal policy?
3. September 2012 at 05:57
Still a long way to go. Equities may have recovered from a slight blip down after the speech, and the S&P is still strongly up YTD, but the long bond yield sagged. The market that matters needs to hear from Bernanke, as you said.
My worry also remains that unless Bernanke really shows that he knows what he is doing and why his credibility will be weak. And even if he persuades the market he is for real in wanting NGDP up, then when NGDP really is shooting up well above 5% he will be equally hopeless in taking action to cool the economy down. I know it seems like a luxury problem for now, but I care about it.
3. September 2012 at 09:36
“Commercial banks can do nothing with excess reserves except lend them to other banks that may need short term require reserves. When they loan them to another bank it goes into that banks reserve account so the excess reserves in the banking system as a whole do not change. The only entity that reduce excess reseres in total is the Fed.”
You clearly need a lecture from ECON 101 here. I apologize to the great majority of the people on this site that understand this for taking up this space and boring them with things they have learned years ago.
If banks make loans their excess reserves decrease either directly or indirectly. And, for the the entire economy, bank credit and M1 increase, which provides the economy with a monetary stimulus.
The simplest, and most obvious, case is if the borrower takes the money he/she borrowed in the form of currency. In that case the both the bank’s excess reserves and its total reserves decrease by the amount of the loan and the bank has turned the excess reserves, which pay little or no interest, into an earning asset. As a result, for the entire economy, both bank credit and the supply of M1 have increased and both total and excess reserves in the banking system have decreased.
Since the borrower usually does not take the borrowed money in the form of currency but as an increase in a transactions deposit, the situation becomes more complicated, but the results with respect to the total supply of bank credit and M1 in the economy is the same. The only difference is that for the entire banking system total reserves do not change, but since required reserves increase, excess reserves decrease.
In this case when a bank makes a loan its total and excess reserves will decrease either directly or indirectly, so that if a bank makes loans and does not have excess reserves equal to the amount of the loans, it will become deficient in reserves, which makes it reluctant to do this.
If the bank has excess reserves and makes loans up to the amount of its excess reserves the specific details of what happens depend on whether the person who gets the money when the person who borrowed it spends it redeposits it in the same bank or a different bank. The typical case is that it is redeposited in a different bank, call it BANK TWO. When the bank, call it BANK ONE, makes the loan it increases the amount of bank credit by the amount of the loan. Since there is no offsetting reduction in bank credit anywhere else, the total amount of bank credit in the economy increases by the amount of the loan. Also since transactions deposits at BANK TWO increase by the amount of the deposit, the total M1 in the economy increases by the amount of the loan BANK ONE made. Also a result of the check clearing, BANK ONE loses reserves equal to the amount of the loan. But BANK TWO gains reserves equal to the amount of the loan so that total bank reserves are unchanged. But with the increase in transactions deposits on the account of BANK TWO, due to the deposit of the check, its required reserves increase and therefore its excess reserves decrease. But with the reserve requirement being only a fraction of the transactions deposit, the increase in required reserves is less than the increase in tototal reseres. BANK TWO therefore now has gained excess reserves. Provided the bank does not want to hold the additional excess reserves, this will lead to further adjustment throughout the banking systerm leading to further increases in required reserves and therefore reductions in excess reserves, until the excess reserves in the banking system have decreased to the level the banks want them to be equal to.
If the person who gets the borrowed money when it is spent redeposits it in BANK ONE, the details are different but the results for the total bank credit and M1 in the economy and total and required reserves for the economy are the same. And if banks use the excess reserves to buy securities instead of making loans some of the details will differ but the result are, once again, the same.
3. September 2012 at 09:43
“The hawks want negative IOR, the doves want an open ended commitment.”
Negative IOR, to the extent that it is effective, will increase bank lending and purchases of securities and increase the rate of growth of M1 and it thererfore dovish. It move the economy in the same direction as a committment to purchase sucurities.
3. September 2012 at 09:50
“These are Obama’s appointees screwing him.”
That is only partially correct. Bernake was a horrible, possibly fatal, blunder on Obama’s part and one of his other appointees had to be a Republican to get the Republicans to approve the two appointments. Therefore Obama has only 4 out of 12 Democrats on the FOMC. But where have these 4 people been. They appear to have been missing in action. The most important doves on the FOMC are some of the Presidents of individual the individual Federal Reserve Banks (as, of course, are some of the most important hawks). The Obama adminitsration’s failure to promptly fill the vacancies on the BOG with full employment hawks is a self-inflicted wound that may well turn out to be fatal.