The government is beginning to see the light

Before getting into the main topic of the post, I’d like to point out that Mercatus has recently published a new primer on NGDP targeting, as well as futures targeting, written by Ethan Roberts and myself. I recommend it to people who want a short introduction to the concept:

The first section will clearly define monetary policy, describe the two main methods that central banks have traditionally used to carry out policy, and analyze the weaknesses of these methods. Later sections will articulate what NGDP is and how a policy of NGDP targeting works. Subsequent sections will list the most common criticisms of NGDP targeting and explain why these criticisms are misguided, and they will present arguments in support of the policy. Finally, the primer will provide specific recommendations for how to move from the current system to a system based on NGDP futures targeting.

I have a relatively low opinion of government, so I was very pleasantly surprised to see an outstanding report on monetary policy by the Joint Economic Committee.  You really need to read the entire thing, or at least the entire chapter entitled “Macroeconomic Outlook” from page 51 to 94, but here are a few excerpts:

The Report and Federal Reserve officials find low inflation rates “puzzling,” especially given the low unemployment rates. The “Phillips Curve” theory of price inflation posits that low unemployment rates drive up wages, which leads firms to raise prices to offset rising costs. The Committee Majority explores alternative explanations for below-target inflation. Notably, monetary policy may not have been as “accommodative” as commonly perceived.

The report then began describing policy in 2008, which was aimed at rescuing banks, not the broader economy:

Federal Reserve Bank of Richmond senior economist Robert Hetzel succinctly described the unusual credit policy:

Policies to stimulate aggregate demand by augmenting financial intermediation provided an extraordinary experiment with credit policy as opposed to monetary policy.

The Fed bought financial instruments from particular credit markets segments to direct liquidity toward them, which had the effect of injecting reserves into the banking system. This action alone would incidentally ease monetary conditions, but the Fed then sold Treasury securities from its portfolio to withdraw those reserves from the banking system (called “sterilization”), thereby restricting nominal spending growth.

I also get cited a few times:

Furthermore, despite the low level of the Fed’s fed funds rate target, monetary policy arguably remained relatively tight, as monetary economist Scott Sumner notes in the context of a 2003 Ben Bernanke speech:

Bernanke (2003) was also skeptical of the claim that low interest rates represent easy money:

[Bernanke:] As emphasized by [Milton] Friedman… nominal interest rates are not good indicators of the stance of monetary policy…The real short-term interest rate… 55 is also imperfect…Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

Ironically, by this criterion, monetary policy during the 2008-13 was the tightest since Herbert Hoover was President.

Then it discusses why various QE programs had little impact:

The Fed was clear from the outset that it would undo its LSAPs eventually (i.e., remove from circulation the money it created in the future). The temporary nature of the policy discouraged banks from issuing more long-term loans. Alternatively, as economist Tim Duy pointed out during the inception of the Fed’s first LSAP program:

Pay close attention to Bernanke’s insistence that the Fed’s liquidity programs are intended to be unwound. If policymakers truly intend a policy of quantitative easing to boost inflation expectations, these are exactly the wrong words to say. Any successful policy of quantitative easing would depend upon a credible commitment to a permanent increase in the money supply. Bernanke is making the opposite commitment—a commitment to contract the money supply in the future.

Sumner (2010), Beckworth (2017), and Krugman (2018) observe similar issues. Furthermore as Sumner (2010), Feldstein (2013), Beckworth (2017), Selgin (2017), and Ireland (2018) note, payment of IOER at rates competitive with market rates led banks to hoard the reserve, which contributed at least partially to the collapse of the money multiplier (Figure 2-3).

And it wasn’t just right of center economists that objected to IOR:

Regarding IOER, former Federal Reserve Vice Chairman Alan Blinder advised in 2012:

I’ve been urging on the Fed for more than two years: Lower the interest rate paid on excess reserves. The basic idea is simple. If the Fed reduces the reward for holding excess reserves, banks will hold less of them—which means they will have to find something else to do with the money, such as lending it out or putting it in the capital markets.

He later observed in 2013:

If the Fed charged banks rather than paid them, wouldn’t bankers shun excess reserves? Yes, and that’s precisely the point. Excess reserves sitting idle in banks’ accounts at the Fed do nothing to boost the economy. We want banks to use the money.

I suggested negative IOR way back in early 2009.

They also point out that the Fed has ignored the intent of the Congressional authorization of IOR:

The law specifies that IOER be paid at “rates not to exceed the general level of short-term interest rates.” However, from 2009- 2017, the IOER rate exceeded the effective fed funds rate 100 percent of the time, the yield on the 3-month Treasury bills 97.2 percent of the time, and the yield on 3-month nonfinancial commercial paper 82.1 percent of the time (Figure 2-5). The Fed is including its own discount rate (the primary credit rate) in the general level of short-term interest rates to demonstrate compliance with the law.

In connection to IOER, Representative Jeb Hensarling, Chairman of the House Financial Services Committee, stated:

[It] is critical that the Fed stays in their lane. Interest on reserves – especially excess reserves – is not only fueling a much more improvisational monetary policy, but it has fueled a distortionary balance sheet that has clearly allowed the Fed into credit allocation policy where it does not have business.

Credit policies are the purview of Congress, not the Fed. When Congress granted the Fed the power to pay interest on reserves, it was never contemplated or articulated that IOER might be used to supplant FOMC. If the Fed continues to do so, I fear its independence could be eroded.

The following is also an important point—making sure than monetary policy continues to be about money:

Noting that the large quantity of reserves produced by the Fed contributed to the fed funds rate trading at or below the IOER rate, John Taylor of Stanford University’s Hoover Institution said:

[W]e would be better off with a corridor or band with a lower interest rate on deposits [IOER] at the bottom of the band, a higher interest rate on borrowing from the Fed [the discount rate] at the top of the band, and most important, a market determined interest rate above the floor and below the ceiling… We want to create a connect, not a disconnect, between the interest rate that the Fed sets and the amount of reserves or the amount of money that’s in the system. Because the Fed is responsible for the reserves and money, that connection is important. Without that connection, 63 you raise the chances of the Fed being a multipurpose institution.

Most importantly, the government is beginning to recognize that it was tight money that caused the Great Recession:

The preceding observations and alternative views merit consideration. In particular, Hetzel (2009) states:

Restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008.

When people like Hetzel, Beckworth and I made that claim back in 2008-09, we were laughed at.  Who’s laughing now?


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54 Responses to “The government is beginning to see the light”

  1. Gravatar of Matthew Waters Matthew Waters
    19. March 2018 at 15:03

    On the NGDP targeting proposal, I have trouble with this scenario:

    1. Market expects NGDP growth of 2% versus 4%.
    2. Fed goes long NGDP future at $1.04. Trader puts $0.10 into margin account.
    3. NGDP growth is 2%. Fed pays $1.04 for contract actually worth $1.02. Trader takes out $0.12.

    Isn’t this is a 20% interest on reserves? It’s $0.10 of margin in and $0.12 out.

    It would be a positive feedback loop in the wrong direction. Since the margin is taken out of the monetary base, it would worsen NGDP below 2%. The functional IOR rate becomes higher still.

    If nothing else, NGDP futures as proposed is quite different from Bretton Woods. Printing dollars for gold or selling gold to destroy dollars had the direct, desired effect on gold price. NGDP futures have such a direct effect on the high NGDP side, but have the opposite effect on the low NGDP side.

    If I understand it correctly, the system works by holding the Fed accountable for its losses. If NGDP futures on the low end cause a downward spiral in NGDP growth, then the Fed would nominally have big losses. So the Fed should have an incentive to engage in extraneous policy:

    “If NGDP were expected to grow faster than the 4 percent target, the central bank would tighten monetary policy to avoid being exposed to large capital losses.”

    The Fed governors having P&L responsibility is a big jump for me. The Fed’s P&L is already artificial, with “revenues” from Treasury interest payments.

    IMO, the proposal should be tied with Bernanke’s helicopter money proposal. Have offsetting bids for Treasuries when traders go short NGDP. Have the bids be open for direct holding of Treasuries. Then have a system for directly funding Treasury and reducing tax levels temporarily. Eliminate discount window, check clearing and other functions where the Fed puts itself in place of a private organization’s credit.

  2. Gravatar of Matthias Görgens Matthias Görgens
    19. March 2018 at 18:18

    Scott, vindication feels good, doesn’t it?

    Matthew, see earlier discussion. But in short: as long as the market price of the ngdp futures is below the Fed’s target price they will keep going long, ie throw money into the economy. That raises ngdp. (And if ngdp really doesn’t rise, they will only get their 2% paid out, and not the 4% they paid for—further putting more money into the economy than they take out.)

    If you want a conceptually simpler proposal, George Selgin has some good explanation of how competitive profit seeking behaviour in a free banking regime will stabilise the multiplier between base money and nominal spending: banks automatically adjust the amount of money they create according to demand for money.

    Scott’s system doesn’t rely on making the Fed accountable for losses.

    Helicopter drops in practice means fiscal stimulus. The main problem with that is that it gives the government a bigger share of the economy. The decision about how big the government should be and how large ngdp should grow are better left independent.

    If memory serves right, Scott’s a great fan of keeping the government small-ish even in times of economic crisis, and use monetary stimulus instead.

    The best argument I can think off for increased government spending during downturns is to save on costs. Singapore seems to kick off major infrastructure projects preferably when the local construction sector has a bit of breathing room. Of course that usually coincides with downturns.

    Singapore also has an interesting alternative way to implement monetary policy: their central bank uses offers to buy and sell foreign currencies to influence local variables like inflation etc.

  3. Gravatar of Russ Russ
    19. March 2018 at 18:30

    It is time for the economists to switch to the debt-normalized GDP, or DNGDP (derived by diving nominal GDP by total debt). Using such GDP debt deflator may be more useful in predicting social stability. Officially US DNGDP will be around 1, China’s about 0.4, and Russia’s around 8.

  4. Gravatar of Matthew Waters Matthew Waters
    19. March 2018 at 18:49

    To be clear, I only have thought of helicopter money in terms of reducing taxes, not in terms of increasing spending. It could give political cover to raising spending, but you could make the same case for zero or negative rates.

    Under effective NGDPLT, gov spending will always crowd out other parts of the economy.

    I’m not sure I follow how free banking responds to increased demand for money. 1931-32 and 2008 had bank deposits lose their psychological equivalence with actual dollars. For 2008, that was money market funds and deposits by hedge funds in prime brokers.

    The Fed put the entire shadow banking sector under the discount window. And I want to get rid of the discount window.

  5. Gravatar of ssumner ssumner
    19. March 2018 at 19:30

    Matthew, I don’t understand how this relates to IOR. There is no interest on reserves in my proposal.

  6. Gravatar of Inklet Inklet
    20. March 2018 at 02:03

    Maybe a better target than NGDP is NGDP per capita, so changes in population doesn’t affect it.

  7. Gravatar of Marcus Nunes Marcus Nunes
    20. March 2018 at 05:03

    The “neutron bomb” effect. Keep the “financial houses” standing and kill the people.
    https://thefaintofheart.wordpress.com/2012/01/03/passivity-is-a-killer/

  8. Gravatar of Benjamin Cole Benjamin Cole
    20. March 2018 at 05:26

    Kudos to Scott Sumner, Marcus Nunes, David Beckworth, Robert Hetzel, Lars Christensen and other early pioneers of Market Monetarism.

    Maybe the tide is really turning.

    I think the debates going forward now, which I hope are made in fellowship and not in rancor, turn to goals and tools.

    1. NGDPLT–4%, 5% or 6%? I say aim high. The US had great years when both real growth and inflation ran near 3%. Smoking hot is a nice temperature for businesses and employees.

    2. Tools. So far, helicopter drops, aka money-financed fiscal tax cuts or outlays, are off the table.

    But what could be more effective?

    There is no question a money-financed tax cut is an expansion of the money supply, is shot directly into the economy with immediacy, and is permanent. Put your money where your money is, central-banking style. You want credibility? This is Chuck Norris without a straitjacket on.

    Negative interest on reserves is a good idea too, but I suspect banks cannot, and perhaps should not, be arm-twisted into making loans. So the reserves sit there. Whoopy-do. The BoJ pays negative interest on a portion of reserves, and they may even be slipping back towards deflation (due to an appreciating yen, strong housing construction in Tokyo and dead wages).

    If QE and zero rates could revive Japan’s inflation….well maybe yet. The BoJ owns 45% of JGBs and rising.

    Side question: If US banks suspect in advance they will be compelled to pay negative interest on reserves….can they avoid taking on reserves? Will they be compelled by regulation to take on reserves that they then pay negative interest upon?

    In happy contrast, Ben Bernanke advised consideration of money-financed tax cuts 15 years ago:

    https://www.federalreserve.gov/boarddocs/speeches/2003/20030531/default.htm

    “Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt—so that the tax cut is in effect financed by money creation.”

    That is what I call bravura central banking.

    Why tweetybird around when people are out of work? Send in the choppers.

  9. Gravatar of Randomize Randomize
    20. March 2018 at 07:44

    Marcus,

    That’s an incredibly morbid analogy.

    I like it!

  10. Gravatar of Vaidas Urba Vaidas Urba
    20. March 2018 at 07:56

    Poor Fed, the more it lowers IOR, the more other rates drop, making it seem that it always overpaying.

  11. Gravatar of msgkings msgkings
    20. March 2018 at 08:06

    @ssumner: forget who said this (Gandhi?) –

    “First they ignore you, then they laugh at you, then they fight you, then you win.”

  12. Gravatar of ssumner ssumner
    20. March 2018 at 08:38

    Inklet, I agree.

    Marcus, Good analogy.

    Vaidas, Funny how other countries have been able to avoid that situation with a corridor system.

    msgkings, Thanks.

  13. Gravatar of Ralph Musgrave Ralph Musgrave
    20. March 2018 at 10:56

    Monetary policy is fundamentally flawed. There is no good reason for the state to pay interest to anyone simply for hoarding state issued money (base money). Ergo no interest should be paid to those holding it. I.e. the ideal rate of interest on government debt is zero, as suggested by Milton Friedman and Warren Mosler.

    But to be able to cut interest rates in a recession, government has to artificially raise interest rates and pay interest to “hoarders” during normal times. In short, everyone with a mortgage pays an excessive rate of interest simply to enable monetary policy to deal with recessions, when fiscal policy could perfectly well do the job. Barmy.

  14. Gravatar of Matthew Waters Matthew Waters
    20. March 2018 at 11:39

    In the scenario of 2% NGDP growth, the $0.10 margin posted would make $0.12 return. The $0.10 is taken out of the monetary base to earn 20% return. To me, that’s functionally interest on reserves.

    In slightly different terms, the returns on margin posted for NGDP futures would set a baseline for 3-month or 1-year interest rates.

    This is for NGDP futures *alone*. On the lower end of NGDP growth, NGDP futures do not provide a stable equilibrium. Interest rates would keep increasing and NGDP would keep going lower. Perhaps the limiting factor is the central bankers getting fired.

    To meet 4% NGDP growth, the Fed has to do offsetting policy outside of the futures. The Fed would have to do enough to keep the vicious cycle from happening. The mechanics of the Fed’s offsetting policy is important though. It should be buying Treasuries and then helicopter money, versus discount window or buying private assets.

  15. Gravatar of Vaidas Urba Vaidas Urba
    20. March 2018 at 12:13

    Scott,
    when Draghi fixed the policy by doing the QE, market rates got lower than IOR in the Eurozone. The reason I am arguing against the corridor system is because the corridor system appears to prohibit the effective monetary stimulus during depression.

  16. Gravatar of Vaidas Urba Vaidas Urba
    20. March 2018 at 12:51

    What should Draghi do to make George Selgin happy? https://twitter.com/georgeselgin/status/974239790886522881

  17. Gravatar of ssumner ssumner
    20. March 2018 at 12:51

    Ralph, You said:

    “when fiscal policy could perfectly well do the job”

    I’m tempted to ask whether this is a joke. Did you notice what Congress did three months ago?

    Matthew, The margin accounts are not part of reserves, so there is no IOR.

    Vaidas, I don’t see why, is there a lower bound on IOR?

  18. Gravatar of Matthew Waters Matthew Waters
    20. March 2018 at 12:58

    I should have phrased it as an interest rate floor. The margin is funded by cash or Fed reserves. If investors expect 2% NGDP, then NGDP futures offer 20% return. That’s a floor for other investments of similar duration.

  19. Gravatar of George Selgin George Selgin
    20. March 2018 at 13:16

    Vaidas writes:

    “Poor Fed, the more it lowers IOR, the more other rates drop, making it seem that it always overpaying.”

    It would be easier to regret the Fed’s predicament if it weren’t the case that they haven’t once tried lowering the IOER rate since 2008!

    and:

    “What should Draghi do to make George Selgin happy? https://twitter.com/georgeselgin/status/974239790886522881.”

    I know one thing he shouldn’t try: raising the rate to 150 basis points! But then again, if he did, perhaps you would argue that lowering it again would be futile because other rates would fall just as much!

  20. Gravatar of Brian Donohue Brian Donohue
    20. March 2018 at 13:23

    Well-deserved victory lap.

  21. Gravatar of Lorenzo from Oz Lorenzo from Oz
    20. March 2018 at 16:03

    Persistence with reason using logic and evidence can actually have an effect!

    Well done!

  22. Gravatar of Gene Frenkle Gene Frenkle
    20. March 2018 at 16:41

    I think we can safely say that QE was a success now that the worst forecasts about the oil industry and Houston’s economy did not come to pass. So QE did inflate the fracking for oil bubble but it appears that particular bubble has positively impacted the economy. I guess Bernanke will go down as one of the great central bankers unless Al Gore’s predictions about climate change come true, lol ;).

  23. Gravatar of Vaidas Urba Vaidas Urba
    20. March 2018 at 22:46

    Scott,

    IOR below negative 2% wouldn’t work because of cash. So the only way to do stimulus once rates reach negative 2% is to do QE which would move you away from the corridor system towards the floor system. That’s why I think it is counterproductive to criticize the floor system.

  24. Gravatar of Bob Murphy Bob Murphy
    21. March 2018 at 06:08

    “For years people said I was crazy, but during the Trump Administration the government finally came around to my way of thinking!” — Scott Sumner

  25. Gravatar of JP Koning JP Koning
    21. March 2018 at 06:25

    “Poor Fed, the more it lowers IOR, the more other rates drop, making it seem that it always overpaying.”

    Yep, I agree Vaidas. It’s getting blamed for conditions it has no control over.

    When the Bank of Canada ran a floor system from 2009 to 2010, the repo rate often traded a bit below the deposit rate floor. But that makes a lot of sense, since the lender in a repo transaction is getting a government bond in return, which is useful as a general form of collateral, whereas if they lent to a central bank overnight they would be holding a less useful transactional asset, since many financial institutions can’t accept central bank deposits. So the lender willingly accepted a slightly lower rate to lend in the repo market. It would be silly to blame the Bank of Canada for the difference between the deposit rate and repo rate, just as it’s silly to blame the Fed, as you point out.

  26. Gravatar of ssumner ssumner
    21. March 2018 at 06:39

    Matthew, No, it’s not a “floor” for other investments.

    Vaidas, Cash doesn’t stop them from going to negative 5%, it just means that no one will hold reserves.

    Bob, Pity that the Trump Administration itself continues to hold the view that money was accommodative–check out the CEA Economic report of the President.

    I’m not one of those people who thinks that everything that happens in America is about Donald Trump.

    JP, Yes, but it’s certainly possible to maintain a system where IOR is far below short term rates, just consider 1913-2008!

  27. Gravatar of ssumner ssumner
    21. March 2018 at 06:40

    Bob, The real story is that America has had almost perfectly steady NGDP growth since I started blogging more than 9 years ago.

    Coincidence? I think not. :)

  28. Gravatar of ssumner ssumner
    21. March 2018 at 06:46

    Everyone, I don’t think that anyone would complain if the Fed paid zero interest and it was slightly above the market short term rate. That would not violate the spirit of the Congressional authorization. What they actually did does violate the spirit of the Congressional authorization.

  29. Gravatar of Vaidas Urba Vaidas Urba
    21. March 2018 at 23:43

    Scott,

    So you are in effect saying that the spirit of the law requires the Fed to exit the QE first, and only then raise the IOR from zero. This might not be an optimal policy sequence.

  30. Gravatar of George Selgin George Selgin
    22. March 2018 at 06:30

    Scott: “JP, Yes, but it’s certainly possible to maintain a system where IOR is far below short term rates, just consider 1913-2008!”

    You took the words right out of my mouth!

    Vaidas: “So you are in effect saying that the spirit of the law requires the Fed to exit the QE first, and only then raise the IOR from zero. This might not be an optimal policy sequence.”

    Of course the legal solution may not be optimal now. The law wasn’t meant to address what to do to unwind a system established by breaking it. It is nevertheless perfectly possible to switch from a floor to a corridor arrangement. Establishing a “marginal” corridor using a tiered-rate system is one possibility. Then gradually reducing the quantity of reserves will slowly erode the higher-IOER rate tier. At some point, a corridor is what remains. Choosing the correct upper-tier IOER rate, which could be zero or even (where is practical) negative, is of course crucial.

  31. Gravatar of George Selgin George Selgin
    22. March 2018 at 06:51

    JP writes: “When the Bank of Canada ran a floor system from 2009 to 2010, the repo rate often traded a bit below the deposit rate floor…It would be silly to blame the Bank of Canada for the difference between the deposit rate and repo rate, just as it’s silly to blame the Fed, as you point out.”

    This example begs the question: In June 2010, the BofC re-established a corridor system, by withdrawing surplus reserves it had supplied during the floor-regime interval. Doing so eventually allowed it to increase its overnight rate, while at first leaving the IOR lower bound unchanged. Eventually, it raised the IOR rate also, but only while keeping it a constant distance below the overnight rate. Canada’s overnight repo (CORRA)rate, in turn, stuck closely to the policy rate, not the IOR rate.

    Given that the BofC was able to do these things once it chose to, why is it “silly” to observe, in retrospect, that the BofC’s prior decision to move to a floor system was “to blame” for the presence of a below-IOR CORRA rate?

  32. Gravatar of George Selgin George Selgin
    22. March 2018 at 07:08

    P.S. to my last: It _would_ be silly to hold the BofC responsible for the difference between the CORRA and its policy rate. But while that difference may be hard-wired into the Canadian money market, the difference the deposit (IOR) rate and the repo rate is not.

  33. Gravatar of Rodrigo Rodrigo
    22. March 2018 at 07:43

    Professor

    It seems to me that the fed is well on its way to invert the yield curve if it sticks to its current quarter point rate hike policy every time they meet. It seems long term rates and the stock market react inversely to what the fed does with short term rates.

    Would you not consider this(inverterd curve) to be a policy error?

  34. Gravatar of JP Koning JP Koning
    22. March 2018 at 10:30

    Sure, the BoC could have removed the deposit rate-to-repo rate premium by going back to a corridor system, as you say. Let’s imagine that the BoC needed to run a floor system because it wanted to do some QE, or for payments reasons, or because it wanted to implement the Friedman rule. If so, the repo rate would trade a bit below the rate on BoC deposit. This would be quite natural, and would not represent an implicit subsidy to those holding superior-yielding deposits–after all, financial institutions have good reasons for bidding the Canadian repo rate below the deposit rate. Nor could the BoC, assuming it wished to keep running a floor system, do anything to remove that rate gap.

  35. Gravatar of Vaidas Urba Vaidas Urba
    22. March 2018 at 10:50

    “would not represent an implicit subsidy to those holding superior-yielding deposits–after all”

    Hear, hear!

  36. Gravatar of George Selgin George Selgin
    22. March 2018 at 11:00

    JP, I agree with you: a floor system means a gap of the sort we’ve been discussing. That’s why I regard my own argument against the current U.S. arrangement not simply as an argument in favor of reducing IOER, or for getting it below other rates, but an argument favoring a corridor system over a floor system except where a floor absolutely can’t be avoided, e.g., because of an IOER lower bound problem, zero or below zero. I don’t think anyone here who is arguing for getting IOER back below other short-term rates imagines that one could do that and still maintain a floor system.

    I also don’t think subsidies are the main concern with a floor system. The bigger concerns are (1) that it is a bad idea to have a system that reduces the potency of OMOs if one can avoid it; and (2) because a regime in which the size of the CB balance sheet is a free parameter invites the CB to become entangled in fiscal policy.

  37. Gravatar of George Selgin George Selgin
    22. March 2018 at 11:06

    On the matter of subsidies: a question worth ponedring is this: how can the Fed consistently pay an IOER rate above the yield on Treasury bills? The answer, I believe, is either (1) by taking on duration risk or (2) by cross-subsidizing reserves by sacrificing part of the seigniorage earned on currency. I leave it as an exercise for readers to decide whether there is anything wrong with either of these alternatives, or to suggest some other possibilities I’ve overlooked.

  38. Gravatar of James Alexander James Alexander
    22. March 2018 at 11:14

    With 4 out of 7 vacant seats on the Fed Board, Congress could easily implement changes. I can think of 4 names.

  39. Gravatar of Brian Brian
    22. March 2018 at 17:31

    This report and your commentary completely ignores the fact that banks don’t lend reserves. So paying interest on reserves has little bearing as to whether a bank will want to increase lending or not. It has to do with the availability and cost of funds and demand for loans.

    It also ignores the fact that once reserves are in the banking system, in aggregate there is no way to get rid of them. They have to reside somewhere within the banking system. You can argue there would be a hot potato affect, but as a risk averse bank post crisis, would you opt to make as many loans as possible with the hope the deposits get transferred to another bank, or just pass the cost of the excess reserve penalty onto the consumer?

    And didn’t Europe try this with inconclusive results? You can only push on a string so much.

    I’m sure you’ll have another excuse as to why my arguments are invalid and that if monetary policy would only get MORE extreme then we’d finally get that darn inflation up. But with the BOJ buying sovereign bonds, corporate bonds and equities, there is still NO evidence monetary policy is effective.

  40. Gravatar of Scott Sumner Scott Sumner
    22. March 2018 at 17:34

    Vaidas, Last in, first out, seems logical to me.

    Rodrigo, It might be, but I’m not at all certain that the curve will invert as planned.

    James, Can you think of 4 names that Trump would pick and Congress would confirm.

  41. Gravatar of ssumner ssumner
    22. March 2018 at 19:03

    Brian, I simply refuse to talk about whether banks “loan out reserves”, as it’s such a mindbogglingly stupid debate on so many levels. (check out the MMTers)

    As far as making monetary policy “more extreme”, I want to do exactly the opposite, go back to the boring unextreme monetary policy of the Great Moderation, when NGDP grew at 5%/year and interest rates were normal and there was no QE or IOR.

  42. Gravatar of James Alexander James Alexander
    22. March 2018 at 23:03

    Fair point. If Trump doesn’t get the vacancies filled there is a huge danger that monetary policy gets made by the mob, or an unpredictable shifting alliance of voting regional Fed chiefs. But I don’t need to tell you how that might end. We read it in 2008 minutes where a weak Bernanke … .

  43. Gravatar of Ralph Musgrave Ralph Musgrave
    23. March 2018 at 01:17

    Scott, I agree that fiscal policy has problems. I set out what I was trying to say in more detail here:

    https://seekingalpha.com/article/4158421-pure-monetary-policy-make-sense-pure-fiscal-policy

  44. Gravatar of Vaidas Urba Vaidas Urba
    23. March 2018 at 03:26

    George:
    “How can the Fed consistently pay an IOER rate above the yield on Treasury bills?”

    Seigniorage on IOER is lower than seigniorage on ON RRP operations, but I believe it is still positive. However, I would support making these two rates equal.

  45. Gravatar of George Selgin George Selgin
    23. March 2018 at 05:10

    Vaidas, I agree that it makes little sense to have the two different rates. IF one is to have a floor, it should be a proper floor, not a floor + subfloor

    In fact, if the Fed stuck to “bills only,” a strict floor system would generally reduce rather than increase its Treasury remittances, as the Fed earns less on required reserves, and profits very little if at all (depending on the maturity and yield of the T-bills it acquires) on excess ones.

    The profits of the present IOER set-up are pretty-much entirely due to the duration risk the Fed took on. Consequently as i-rates rise the Fed will book losses, and its remittances will shrink accordingly.

  46. Gravatar of Vaidas Urba Vaidas Urba
    23. March 2018 at 13:46

    George,

    Bills only policy would be pointless during the crisis, as Fed would be purchasing an asset that is more liquid than reserves.

    The Friedman rule says the Fed should book neither profits nor losses on average, so the reduced profitability of the Fed is fine.

    I really don’t get why you favor a statist bills-only monetary policy which subsidizes trading in the government security market. Flexible OMOs you describe in one of your papers seem to be a better alternative.

  47. Gravatar of George Selgin George Selgin
    23. March 2018 at 13:59

    Vaidas, I wasn’t making any normative claims. I merely made a factual observation about how the Fed’s extraordinary remittances of late depended on the long duration of the assets it presently owns. I do in fact favor the Flexible OMOs I’ve written about elsewhere. I’m glad you see some merit in that.

  48. Gravatar of Vaidas Urba Vaidas Urba
    23. March 2018 at 22:50

    George, there are many reasons why remittances are so high:
    1. ex-post luck
    2. normal duration risk premium
    3. excess risk premium due to abnormally low liquidity in the government securities market

    To the extent remittances represent the third reason, this is optimal. A move to bills-only policy would be counterproductive, a move to diversified flexible OMOs would be an improvement.

  49. Gravatar of George Selgin George Selgin
    24. March 2018 at 03:28

    “excess risk premium due to abnormally low liquidity in the government securities market.”

    In ’09 and ’10 (QE1 and some QE2) this was a factor; but not so much, so far as evidence suggests, afterwards. https://www.treasury.gov/connect/blog/Pages/A-Deeper-Look-at-Liquidity-Conditions-in-the-Treasury-Market.aspx

    Even w.r.t. QE1, there seems to be little doubt that the Fed took on a lot of risk, particular with its MBS purchases. Fed authorities themselves acknowledged this. A very good analysis here https://ftalphaville.ft.com/2017/10/02/2194266/the-fed-is-going-to-make-interest-rate-risk-great-again-sort-of/

  50. Gravatar of George Selgin George Selgin
    24. March 2018 at 03:32

    But of course I agree that QE with “bills only” would be pointless.

  51. Gravatar of Gene Frenkle Gene Frenkle
    24. March 2018 at 08:45

    Ralph, the problem with fiscal policy is that through decades of trial and error we have crafted a fairly solid ongoing fiscal stimulus with welfare, SS, and Medicare (and to a lesser degree defense spending). So the obvious issue with the Obama fiscal stimulus of 2009 is that the next dollar spent will be less productive than the ongoing fiscal stimulus. So the job market did not pick up until the Obama stimulus ran out at the end of 2013 because the stimulus expanded welfare spending to able bodied adults.

  52. Gravatar of Gene Frenkle Gene Frenkle
    24. March 2018 at 09:06

    Btw, the notion QE had “little impact” is incorrect because most of its impact was related to fracking for oil. So the reason people think QE had “little impact” is because of oil’s inverse relationship with the larger economy. So 2015-2016 was very similar to 1985-86 in that the overall solid numbers are undermined by tumult in the oil market. The difference is that the 1980s featured malinvestment in Houston while these past several years apparently featured productive investment in Houston.

    I believe China’s economic growth created an energy crisis that initially the global elite were unsure how to solve and that crisis is the foundation of all of the economic issues we have had since 2001. Heck, even the Iraq War was precipitated by the need for more cheap oil to help China and the global middle class continue to expand. Now that frackers appear to be making cheaper oil work macroeconomic issues should be solvable if we don’t overreact to any issues because with cheap energy most problems can be solved in America.

  53. Gravatar of ssumner ssumner
    24. March 2018 at 10:11

    Ralph, You lost me with the first sentence. Adjusting interest rates is NOT monetary policy.

    Gene, Government spending is not ongoing fiscal stimulus. An increase in the cyclically adjusted deficit is fiscal stimulus.

  54. Gravatar of Gene Frenkle Gene Frenkle
    24. March 2018 at 17:37

    I am just explaining why Keynesian fiscal stimulus is ineffective in the context of a generous welfare state like America. The really productive government spending is ongoing and so the next dollar spent is less productive.

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