QT on the QT (QE, RIP)

A cute title to a deadly serious post.  This is the one that should have been entitled “J’accuse.”  Let’s start with a Harper’s Index-style list of interesting facts.

1.  A few years ago Bernanke said Friedman was right; the Depression was caused by tight money by the Fed.  The Fed did cut interest rates to very low levels, and raised the base, but Friedman and Schwartz showed they should have done more quantitative easing.

2.  Bernanke’s academic writings claim that monetary policy remains effective in a liquidity trap, it is not powerless when rates hit zero.

3.  Rates fell close to zero in December 2008.

4.  QE announced March 2009.

5.  Christy Romer recently observed that:

“The fundamental cause of this second [1937] recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.”

6.  During the first half of 2009 the monetary base decreases by 5% (10% at an annual rate.)

7.  During the first half of 2009 the seasonally adjusted base falls by 3% (6% at an annual rate.)

8.  Excluding the Y2K blip, the last time the base fell so rapidly during the first 6 months of the year:  1937.  Any comments Christy?

9.  TIPS market 5-year inflation expectations closely track the MB during first half of 2009.  The MB rose from $1569 billion on March 11th to a peak of $1836 on May 20th, fell slightly for a few weeks and then plunged to $1639.  The 5 year TIPS-spreads rose from a low of 0.39% on March 11th to a peak of 1.85% on June 10th, and has since fallen back to 1.32%.  The S&P rose from 721 on March 11th to a peak of 946 on June 12th, and has since fallen to 896.  Just to be clear, I don’t put much weight on the MB correlations, nor do I necessarily expect them to continue.  My point is that if the Fed decided to try QE as an experiment, then why was it abandoned, and then reversed?  Weren’t they getting exactly the financial market response they wanted during the spring “green shoots” period?

10.  Krugman points out we are rapidly moving toward Japanese-style wage deflation.

11.  Fed officials form circular firing squad.  Janet Yellen says more stimulus is needed, but impossible.  Bernanke says more stimulus is needed, announces QE with big fanfare, and then adopts QT (quantitative tightening) with no explanation.  Lee Ohanian at the Minneapolis Fed says no stimulus is needed.

12.  In the past I’ve given the Fed the benefit of the doubt.  When I first saw the interest on reserves program it seemed like madness, totally bizarre and incomprehensible.  But I thought “they must know what they are doing.”  But when they later announced an “explanation” that Robert Hall called a “confession of contractionary intent,” I became radicalized.  These guys literally don’t know what they are doing.  They are in way over their heads.  At least the Swedish Riksbank has adopted negative rates on bank reserves.

Again, just to be clear, QE is my least favorite form of stimulus (next to the even worse “low interest rate policy,” aka the policy of deflation.)  But this is what the Fed announced to great acclaim in March, which makes me somewhat shocked that the program could be dropped, and that QT could replace it with absolutely no comment from the media, or from economists.

Do I belong in an insane asylum?  Or should I be on the FOMC (with Hall, Thompson and Svensson?)  Damned if I know.  This blog is either grossly overrated or grossly underrated, but it ain’t average.

PS.  Earl Thompson pointed out that the optimal monetary indicator is expected wage rates.  We don’t have that data, but that’s why I included both Krugman’s graph on actual wage rates, and the expected inflation data.

PPS.  My hunch is that only about 4% or 5% of the S&P gain was quantitative easing.  I base that on the fact that the S&P jumped 2% on the news, which was partially expected.  I don’t know where the rest comes from, but my hunch is Asia.  Developing Asia is the only part of the world that is actually getting a significant recovery in industrial production.  It began around March, and it has caused Asian stocks to rise more sharply than Wall Street.  In March it looked like we might be in for a deep and prolonged world recession/depression.  Investors may have seen the Asian recovery as taking that worst case off the table.  But that’s just a hunch.



33 Responses to “QT on the QT (QE, RIP)”

  1. Gravatar of James Hanley James Hanley
    3. July 2009 at 10:08

    First time visitor here, with a couple of friendly questions.

    First, would you be willing to explain why QE is your (second) least favorite form of stimulus?

    Second, low interest rates as a deflationary policy? Clearly I’m missing something here, as I thought low interest rates were inflationary. Could you help me clear away my confusion.

    Third, as to:

    This blog is either grossly overrated or grossly underrated, but it ain’t average.

    Wouldn’t the average of those two alternatives be, well, average? Just kidding! And here’s hoping for the latter alternative.

  2. Gravatar of ssumner ssumner
    3. July 2009 at 11:15

    James, Zero interest rates occur AFTER central banks adopt highly contractionary monetary policies, i.e. policies that cause falling prices. This is always true, as far as I know (the US 1932, 1938, late 2008; and Japan late 1990s and early 2000s.) High interest rates occur during periods of highly expansionary monetary policy, such as 1978-80. The highly expansionary policies cause high inflation, which causes high interest rates. The base is also misleading, as the demand for cash soars during periods of deflationary monetary policy. If that demand is partially (but not totally) accommodated, then you can get a falling price level and a fast growing monetary base. The same examples I mentioned above, also apply to the monetary base. It is a slightly better indicator than interest rates, however, because in the long run there is a rough correlation between the base and the price level. The optimal indicator of policy is the market forecast of the goal variable. If the Fed wants 2% inflation, then the TIPS spread (current 1.32% over 5 years) shows whether policy is too easy or too tight.

  3. Gravatar of Lawton Lawton
    3. July 2009 at 12:25

    James: I’m not an economist by any means, but I’ll have a go. Others are welcome to jump in to correct me.

    In order to get out of the slump, we WANT some inflation — and of course real growth. Setting a low interest rate is an ATTEMPT to get there, but may not be enough. As an academic, Bernanke (and others) pointed out that the Fed has other tools that can work even with the interest rate at zero. However, the Fed mostly hasn’t used these tools — and has done the opposite by paying interest on reserves. (Robert Hall’s quote: “utterly inexplicable”.)

    Many people (both economists and not) believe that the Fed policy only works after “long and variable” lags. See Sumner’s great post on this. His view is that the market reacts more or less immediately. So, if the Fed is doing enough to get 2% inflation, then the TIPS market will show about 2% inflation.

    We’re not there (and TIPS is going down again) so the NET Fed policy is still tight.

    As for the monetary base (MB), it ballooned after the Fed started reacting last fall BUT (1) much of it is being kept by banks (and the Fed is paying them interest) and (2) the demand for money increased even more. I think that Sumner’s view is that the Fed should meet the demand for money, period. AND: that the Fed has sufficient tools to withdraw the money when the economy picks up, so there’s very little risk of future “hyperinflation”.

    The more I think about it, the more it appears that the “long and variable lags” issue may be one of the biggest stumbling blocks. If the lags are real, then even the most enlightened policy maker doesn’t know when they’ve done enough. If the lag isn’t real, then it’s possible to calibrate policies very quickly and with fairly high degree of accuracy. (“Accuracy” in this case being the best that can be done at the time … with the understanding that the policy should change as conditions change.)

  4. Gravatar of 123 123
    3. July 2009 at 13:37

    1. By promissing to avoid depression era mistakes Bernanke has deceived the markets and so he has increased the shock compared to expectations.
    2. Bernanke says the size of the base is not the target of his policy, the target is spreads in various credit markets. I think Bernanke would say that his stimulus has reduced the credit spreads and as a side effect reduced the base.

  5. Gravatar of Bill Stepp Bill Stepp
    3. July 2009 at 13:42


    Weren’t real rates negative for a while in 2003-4 when Al lowered the Fed-funds rate to 1%? Whatever monetary policy was then, it wasn’t contractionary. The housing bubble was well along, not to mention commodities.
    (Contrary to urban legend, the housing bubble didn’t begin when Al hit the accelerator sometime after the events of 9/11/01–it started back in 1998. The homebuilding stocks outperformed all the stock indices during that time by a mile.)

  6. Gravatar of azmyth azmyth
    3. July 2009 at 17:57

    Bill – “Weren’t real rates negative…”
    Exactly. Real rates were negative, but nominal ones weren’t. Since we are experiencing deflation, even the close-to-zero nominal rates today are positive real rates.
    Interest rates lower than the “natural rate” are inflationary, but what is the natural rate? It adjusts because of the Fisher effect, the productivity of capital, and the time and liquidity preferences of households. A central banker can never know the natural rate, and so interest rates are a hard way to judge policy.

  7. Gravatar of ateve fom virginia ateve fom virginia
    3. July 2009 at 18:22

    I disagree with a lot written here except for one thihg:

    These guys literally don’t know what they are doing.

    There is no room for GDP expansion as any monetary expansion will go straight to crude oil market. So … yea, nobody knows how to deal with that …

  8. Gravatar of anon anon
    3. July 2009 at 20:08

    In case you didn’t see this:


  9. Gravatar of ssumner ssumner
    4. July 2009 at 06:03

    Lawton, Thanks. I should explain that Scott Lawton has correctly pushed me to improve my blog with FAQ section for new visitors. It is something I hope to do before too long. He reply here shows the need for such a section.

    123, Good point. By the way I think the October crash was the stock market realizing that they’d been fooled, and there was no “Bernanke put” against mild deflation–which we have had over the past 12 months. I just learned that the October 6 interest on reserve program was announced on Friday October 3rd. That was the day the stock market crashed, despite the House passing the bank bailout. Wouldn’t it be weird if the Fed policy contributed to this crash. Even I doubt it, despite my EMH leanings, but if someone was able to investigate the timing of the announcement against the intraday stock movements back then, I’d be interested.

    I think you may be right about the Fed’s motives, but if so it shows that QE was always a sham. The Fed was never serious about boosting the base, which means QE was never tried. So while I admit you may be right, it still makes my post worthy of attention doesn’t it? After all, most of the pundits back in March treated the QE like it was an attempt to boost the MB. Nobody predicted the base would have its biggest decline (in the first half of 2009) since 1937.

    Bill, I am not sure, but I think real rates gradually declined from 2002 to 2004, and monetary policy gradually got more expansionary. But I don’t think real rates are a reliable indicator of monetary policy. Inflation or NGDP growth expectations are a much better indicator.

    azmyth, Exactly.

    ateve from Virginia, Next time you visit Wall Street ask them to show you the room where they keep the huge pile of Federal Reserve Notes that people put “into” the stock market when they buy stocks. When I was in grad school some professors had the crazy idea that money doesn’t go “into” markets, that when you buy stock you give money to someone else who is selling.

    anon. Thanks.

  10. Gravatar of Current Current
    4. July 2009 at 07:10

    Quite aside from the merits of QE I think that the policy of paying interest on reserves is crazy.

  11. Gravatar of Joe Calhoun Joe Calhoun
    4. July 2009 at 07:12

    Hasn’t Bernanke repeatedly said that current policy is not quantitative easing?

    He makes the distinction that the “credit easing” they are purusing concentrates on the asset side of the ledger while quantitative easing concentrates on the liability side. Bernanke’s purchase of Treasuries is only effort to effect mortgage rates (and probably some other lending rates) and not an attempt to effect the base.

    While policy may have become more restrictive over the last few months, I don’t think that conflicts with what Bernanke has stated as his goal. And since spreads and CDS prices have moved in the wrong direction over the last few weeks, I suspect that the Fed will make an annoucement soon about expanding their efforts.

  12. Gravatar of anon anon
    4. July 2009 at 14:54

    Here’s a quote from somewhere; source and accuracy unknown.

    “It seems a nothingburger to me because the Riksbank hasn’t implemented QE yet. The reserves in the Swedish banking system should be balanced, and looking at the latest Riksbank balance sheet, on 23 June they only had SEK 43 million outstanding on their overnight deposit facility. In other words, no bank is going to be paying this negative rate in reality. If Sweden were to go down the QE route, the deposit and lending rates would likely be sidelined and the Riksbank would pay a zero or positive interest rate on all reserves, just as the Fed and the BoE are doing now. No-one really knows what would happen if a banking system with hugely excessive reserves had a negative interest rate imposed on those reserves, but it’s easy to imagine scenarios where you reach extremely high inflation very quickly as banks play pass-the-parcel with reserves. Monetary velocity could quickly get out of control.”

  13. Gravatar of StatsGuy StatsGuy
    5. July 2009 at 05:20

    I agree with Joe that Bernanke may be targeting interest rates, particularly mortgage rates, to keep costs down and people in their homes. AND, I also agree that the current policy toward QE (just enough to spark fear, but only 1/6th of the anticipated 1 year deficit) is mostly about setting expectations. And to that extent, QE did its job back in March. Moving forward, additional risks of QE have cropped up, mostly surrounding fears of financing the US fiscal deficit (e.g. capital flight).

    The Fed seems to think the “crisis” portion of the crisis is over. Christina Romer, btw, may not… but she has publicly commented that she feels more sympathetic to the policymakers in 1937, and better understands the tremendous public pressure they must have been under. That certainly hints at something.

    Unfortunately, the Fed is still being somewhat unresponsive. If Bernanke wanted to target interest rates, then one would expect that he would continue to expand direct programs in the mortgage secondary markets. It appears he has:


    Most recent data:


    In fact, ALL of the Fed balance sheet components have been shrinking since 12/20 EXCEPT the US securities and home mortgage securities components. The overall FED balance sheet has actually shrunk a bit, and interestingly it seems to track the business environment (sharp dip from 12/08 to 2/09, then rebounds, then starts to dip again in 5/09).

    The issue with interest rates is that the spread between mortgage rates and expected inflation (if you look at TIPS) is nice and fat. I suspect this is part of the official policy to allow banks to “earn their way” out of their balance sheet holes through a hidden subsidy that is less transparent to the public.

  14. Gravatar of ssumner ssumner
    5. July 2009 at 05:22

    Current, I disagree.

    Joe, Excellent comment. At some level you have to be correct. Otherwise the current actions literally make no sense. My post was actually directed against the press and pundits. In March their was almost an universal perception that the Fed was engaging in QE, both from those that supported the policy and those that opposed it. The Fed may not think the MB is at all important, but lots of other people do. Christy Romer (a Keynesian) thinks that increases in the MB (caused by gold flows to the US on the eve of WWII) helped get the US out of the Depression. She always points to 1937 as the big mistake by the Fed. She ought to be horrified that the base has fallen at the fastest rate since 1937 in the past 6 months.

    I’d like to zero in on one other point you made:

    “And since spreads and CDS prices have moved in the wrong direction over the last few weeks, I suspect that the Fed will make an announcement soon about expanding their efforts.”

    The last few weeks. . . hmmm. . . what has happened in the last few weeks? The answer is that the monetary base has fallen very sharply. Is it possible that this might help explain the deterioration in credit conditions? Maybe the markets also thought the Fed was serious about QE, and were disappointed to find out that they weren’t. If monetary policy is endogenous, then we are in the same boat as Japan. And that’s not good.

    I admit that it might just be paranoia on my part, but it is interesting that these contractionary moves by the Fed keep getting associated with falling equity prices. Remember the October 3rd 2008 decision to pay interest on reserves? It was followed by a market crash. (I originally said it was October 6th–but that was the implementation date.) In any case stocks fell continuously from October 3-10.

    anon, Very interesting. I certainly agree with the last part that negative interest rates move you out of a liquidity trap. If combined with massive QE it would lead to high inflation.

    But I don’t understand the middle part. If the Riksbank thought it would have no expansionary effect, why would they do it? Remember that you don’t want to create high inflation, you simply want 2% inflation. So it may not take much in the way of reserve injections to be very effective if combined with negative interest on reserves.

    Anyone know the source of this quotation?

  15. Gravatar of StatsGuy StatsGuy
    5. July 2009 at 05:30


    That model assumes a closed economy. In an open economy, interest rates clear internationally. Hence the issues with capital flight. In an open economy, actions designed to decrease liquidity can trigger flight to liquidity in non-domestic currencies. Even worse, _anticipation_ of such action can trigger flight, since everyone expects the value of the domestic currency to decline when everyone flees from it.

    I think a large portion of the constraints felt by central bankers has to do with lack of international coordination (and the ECB’s hardline stance). The problem is forcing investment dollars to be put to use rather than just sitting in cash. A risk with using negative rates on reserves is that banks may simply move cash to the next-safest-alternative (which could be out of the country) rather than making loans or investing in anything productive.

  16. Gravatar of StatsGuy StatsGuy
    5. July 2009 at 05:47

    Pls forgive me for multiple posts (wish I could collapse them). Here is Christina’s quote:

    “As someone who has written somewhat critically of the short-sightedness of policymakers in the late 1930s, I feel new humility. I can see that the pressures they were under were probably enormous. Policymakers today need to learn from their experiences and respond to the same pressures constructively, without derailing the recovery before it has even begun.”


  17. Gravatar of ssumner ssumner
    5. July 2009 at 06:42

    statsguy, I agree 100% with your Romer quotation. They were under great pressure and we do have to learn from their mistakes. So far we are repeating the mistakes.

    I don’t agree with your first comment however. The goal is simply to get banks out of cash. It makes no difference whether they make “productive loans” or not. The goal is reflation. Once reflation is expected there will be much more demand for “productive loans.”

    In any case, the distinction between productive loans and non-productive loans is the real bills doctrine, which has been pretty much discredited. If banks perceive the assets they buy with the cash to be productive, then there is no reason for an economists to second-guess them.

  18. Gravatar of ssumner ssumner
    5. July 2009 at 07:11

    Statsguy, You said:

    “And to that extent, QE did its job back in March. Moving forward, additional risks of QE have cropped up, mostly surrounding fears of financing the US fiscal deficit (e.g. capital flight).”

    This gets things exactly backward. The whole point of QE is to reduce the fiscal deficit, and thus reduce fears surrounding that deficit. If we had had enough QE to generate our normal 5% nominal GDP growth over the past 12 months, we wouldn’t be in a deep recession, and we would have at most few hundred billion dollar deficit, not nearly $2 trillion. Our fiscal nightmare is precisely because we didn’t do enough QE.

    Romer’s new humility is not because she has changed her views on what should be done–notice she emphasizes that we need to learn form our past errors–but rather that she realizes how many misguided people in both 1937 and today are warning about inflation when the real risk is deflation.

    And the crisis is far from over, policy is still way too contractionary. Unemployment is 9.5% and going higher, maybe much higher. All we have done is avoid the worst case, but the Fed can certainly not stop here, we need much more stimulus, as should be clear from the rapidly falling inflation expectations in the bond market.

    BTW, The Fed’s balance sheet isn’t a useful indicator, as it includes Treasury deposits at the Fed. Look at the monetary base instead. But the base is also shrinking, so your basic point there is correct.

  19. Gravatar of daddysteve daddysteve
    5. July 2009 at 17:04

    Spend our way out of debt. Yeah right. You all sound like you need a new shepherd.

  20. Gravatar of StatsGuy StatsGuy
    5. July 2009 at 17:18

    I absolutely concede your point on QE being too-little-too-late. I remember, and will always remember, the stomach-sinking feeling in September, and then October, and then November, and then December… day after day painfully watching the government/Fed do _nothing_ while massive damage was inflicted, while a lame duck Congress blamed a lame duck President, and Obama tried to remain neutral and above the fray until Jan 20th. I also remember going into the crisis, thinking that _this_ time things wouldn’t unravel because we couldn’t possibly be as stupid as we were in 1929.

    Rapid QE back then could have halted this, and if implemented quickly it would have moved _against_ a massive unwinding of debt positions that reflated the dollar. No capital flight would have occurred.

    But in the past 2-3 months, the dollar’s revaluation has reversed. There is now a risk of a run on the currency (indeed, a mini-run occurred), and the issue with QE is this: are we prepared to do enough of it? Because if we do it just a little, but _hint_ at more (and fail to bring the budget in line, which is inevitable), then we’ll end up borrowing more debt while establishing future expectations of default/monetization. This could yield a currency run, which might be tolerable except for two legacies of the last administration:

    1) oil dependence

    2) the short term nature of US debt financing.

    Notably, the average maturity of US debt has dropped from 60-70 months a decade+ ago, to 48 months…


    This means that if rates rise, it could _quickly_ drive an even larger budget deficit as servicing costs rise, which could then spiral out of control. And I think this is partly what the Fed fears.

    Also, as ‘123’ notes above, having a Fed that everyone _expects_ to be expansionary (thus driving up interest rates) which then turns contractionary (thus decreasing the money supply) is doubly bad…

    As to how likely a run on the dollar is, who knows? A lot of currency hedge funds are waiting for a secular anti-dollar trend to emerge (and would probably all jump in together, which could create the trend they want). OTOH, I would laugh myself silly if the ECB and BoJ then stepped in with an unlimited dollar credit line to prevent their exports from free-falling, thus catching the trend-traders in a covering rally with their pants down.

  21. Gravatar of anon anon
    5. July 2009 at 23:07

    And you might be interested in this as well:


  22. Gravatar of Current Current
    6. July 2009 at 01:50

    Current: “Quite aside from the merits of QE I think that the policy of paying interest on reserves is crazy.”

    Scott: “Current, I disagree.”

    But haven’t you said that you disagree with paying interest on reserves? I’m confused.

  23. Gravatar of azmyth azmyth
    6. July 2009 at 09:08

    StatsGuy – I was thinking of a closed economy model since the U.S. is so big. I’ll have to research capital flight a bit before I respond more.

  24. Gravatar of Scott Sumner Scott Sumner
    6. July 2009 at 11:28

    stasguy, Your first paragraph could have been written by me–exactly my feeling back then.

    I am not worried about a run on the dollar. I do agree that it would be bad if there was an expectation of expansionary policies that wasn’t followed through on. They do need actions, not just words.

    Thanks anon, Harrison credits Mankiw and Buiter with the idea. Actually this blog has been pushing the idea of negative interest on reserves. I tried but failed to interest Mankiw in the idea. Mankiw and Buiter discussed negative interest rates on all currency. I published the Idea in early January, and have been pushing it since last fall.

    Current, Sorry, I thought you were commenting on Sweden’s action, which is a negative interest rate on reserves. You are right, I do oppose positive itnerest on reserves, at least at the present time.

  25. Gravatar of Econon00b Econon00b
    7. July 2009 at 06:41

    I believe I read some criticism of QE that essentially said that by executing a QE strategy (and diluting the dollar) the Fed was in fact monetizing debt. Actually this might have been on CNBC with Rick Santelli.

    This was right around when China was saber rattling about the dollar end of May/early June and I believe shortly thereafter Geithner made a visit to China to essentially tell them that we would not monetize government debt.

    Do you think there is a connection between the Fed championing a QE policy and abandoning it because of China’s fears that it would devalue the dollar?

  26. Gravatar of ssumner ssumner
    8. July 2009 at 05:54

    Econon))b, I don’t think China had much effect. I now think that the Fed never intended to do any QE, that was simply the market’s interpretation. In my newest post I point out that the Fed has not “monetized the debt” (another popular misconception.)

  27. Gravatar of anon anon
    9. July 2009 at 03:50

    You may be very interested in this.

    Sorry for long paste; this is an email letter just out, not yet available as a link:

    Interest Rates go Negative: Compare Riksbank (Sweden) with our Federal Reserve

    July 9, 2009

    Negative nominal interest rates are very hard to understand intuitively. That said, we now have a central bank using them.

    In its July 2, 2009 press release, Sweden’s central bank explained that it cut its policymaking “repo rate” to 0.25%. Its penalty lending rate was cut to 0.75%. Most observers expected it to cut its reserve deposit rate to zero. The observers saw zero as the realistic lower bound of interest rates. They were wrong.

    Sweden’s reserve deposit rate was set a -0.25%. That’s right. A negative interest rate is now at work in one of the G-10 countries. This rate means a penalty is charged against a deposit placed in the central bank under the reserve deposit rules. The banking institution that deposits with its central bank will receive an actual deduction from the deposit account. It will get back less money than it puts in.

    Negative nominal interest rates are designed to discourage an activity. They are rare. The most dramatic one that I remember in my professional career was instituted by Switzerland several decades ago. At that time there was a flight from the US dollar into other hard currencies around the world. The US was leaving the Bretton Woods fixed exchange rate regime which had prevailed since the end of World War II. Massive inflows into the Swiss franc were resulting in a build up of interest bearing deposits in Swiss banks.

    The Swiss banking system could not process the deposit inflows from around the world in a way that enabled them to maintain traditional banking spreads and functionality. These flows were motivated by global money transfers out of the US dollar. After lowering rates did not stem the incoming flows the Swiss authorities finally imposed a 5% negative interest rate on non-Swiss citizens. That’s right. You put a hundred francs in a savings account and at the end of the year you got back 95 francs. That is how a negative interest rate works.

    The Swiss accomplished their purpose. Massive inflows from US dollars into Swiss francs came to a screeching halt and promptly reversed. Human behavior changed.

    The Swedish central bank is trying to use negative interest rates to alter risk taking behavior in Sweden. It wants its member banks to use excess reserves to acquire risk assets rather than just place them with the central bank. Hence it has moved its reserve deposit rate to a negative number. It did this because it has lowered its other policy rate to near zero and it decided to maintain its band around them.

    Time will tell if this policy works. It will be observed closely by the other G-10 central banks including our Federal Reserve. They should observe with good reason.

    Policy interest rates in most parts of the world are now near zero. Gradually the world’s central banks are committing themselves to a longer period of these very low rates. In Sweden the term repo loan to its member banks is now out to 1 year. The European Central Bank recently did a large infusion of reserves with a 1 year facility. The US Federal Reserve has not followed this pattern and favors the shorter term. Shorter terms mean more uncertainty. More uncertainty means higher risk premiums. Higher risk premiums mean more market volatility and tepid economic recovery.

    In the US, our Federal Reserve seems to be behind the eight ball. It still uses shorter facilities and it still tries to communicate without press conferences after every meeting and with the arcane language of “fed speak.” The financial crisis notwithstanding, our Fed has not achieved transparency and still functions with a foggy cloud of opacity.

    Our Fed is also threatened politically and fears an attack on its central bank independence. It has been held political hostage at the Board of Governors level by Senator Christopher Dodd and the Senate Banking Committee. Dodd kept two of the seven governor seats vacant by refusing to hold a confirmation hearing for the Bush presidential appointees. He is personally responsible for the failure of the United States to operate with a full Board of Governors during the recent financial crisis. We will never know how many actions didn’t happen because of Dodd’s obstinacy. We will never know how many homes were foreclosed in the United States because the Chairman of the US Senate Banking Committee played politics with our central bank.

    So far President Obama has continued this political structure. Obama promised “change.” In monetary affairs we’ve gotten worsening actions, and tax scofflaw appointments. And, do to politics, we still only have five of the seven governor positions filled. The Fed still has to achieve unanimity to make an emergency decision. The law is designed for the Fed to operate under a super majority rule and NOT a unanimity rule. The law is not designed to give very sitting Fed governor a veto over any emergency decision. Yet that is how it has operated for three years. Thank you, Senator Dodd and now, thank you, President Obama.

    This appalling behavior is still ignored by most market observers and most media. That is the citizen’s loss and the journalist’s failure. We hope the price paid for this political interference with central bank independence doesn’t become a repeat of the US dollar crisis we saw in the 1970s when President Nixon revoked dollar/gold convertibility and the US left the Bretton Woods regime.

    There will be some discussion about central bank independence today at 1:15 on CNBC Power Lunch. I do not know who else will be in the conversation and how long a time span it will cover. But this writer has been asked to be one of those interviewed. And, I have been advised that there is an opposing point of view. The issue to be discussed is the role of the Fed as a regulator. For me that means the role of the central bank in an even more intense political role and that means with even less independence.

    Readers may want to read the monetary policy report of the Swedish central bank to see what a clear and understandable monetary policy explanation can look like. Check out http://www.riksbank.com and the July 2 release and the full report. Imagine if our Federal Reserve presented the monetary policy outlook for the United States and the view of the rest of the world with such descriptive clarity of the policy options being considered. Maybe if they did that, maybe if they realize how deeply damaged the Fed is and how the political forces in the US are threatening central bank intendance, maybe if the country realized how important this issue is for the value of the currency, maybe, just maybe, we might get enough attention to reverse this slide that is taking our country into a monetary abyss.

    If there is no warehouse fire or other breaking news, we may just have some serious discussion about central bank independence and what a central bank is supposed to do to maintain and preserve the store of value characteristic of the nations’ money, provide a medium of exchange and set the standard for a unit of account. That is the job of the central bank. Its second task is to explain that job to the citizens.

    To see how to do both in the midst of a financial crisis we may want to look to Sweden. They are trying and have learned the hard way with the Scandinavian banking and financial crisis two decades ago. And they have managed to report their methods and actions in English as well as Swedish.


    David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com

  28. Gravatar of ssumner ssumner
    9. July 2009 at 05:25

    Thanks anon, For some reason, the Riksbank link didn’t open.

  29. Gravatar of anon anon
    9. July 2009 at 07:56

    That’s odd. It opens for me.

    Try again:


  30. Gravatar of anon anon
    9. July 2009 at 07:58

    Also, here’s the link to the article now:


  31. Gravatar of 123 123
    10. July 2009 at 04:25

    Tim Congdon in his article “Unnecesarry recession” explains why Bernanke this particular policy – he says Bernanke is not a monetarist but creditist:

    “Our starting point is a recondite article in the May 1988 issue of the American Economic Review, on “Credit, money and aggregate demand” by Ben Bernanke and Alan Blinder. Both authors later became prominent in the Federal Reserve, with Bernanke receiving the ultimate accolade when he was appointed chairman of the board of governors in February 2006. The article’s emphasis was on “the special nature of bank loans”. Following the lead of the Harvard economist, Professor Benjamin Friedman (not to be confused with the redoubtable Milton Friedman of Chicago), Bernanke and Blinder referred to “new interest in the credit-GNP relationship”. By “credit” they meant bank lending to the private sector.

    The 1988 article received numerous citations in other economists’ journal articles, the key metric of academic stardom. In 1995, Bernanke was encouraged by this success to write a further article, with New York University Professor Mark Gertler, on “the credit channel of monetary policy transmission”. The heart of their argument was that “informational frictions in credit markets worsen during tight-money periods”, with the difference in cost between internal and external funds to companies enhancing “the effects of monetary policy on the real economy”. The remarks on “informational frictions” were a dutiful allusion to Joseph Stiglitz, awarded the Nobel Prize for economics in 2001, who had written on “asymmetric information” as a cause of imperfections in financial markets.

  32. Gravatar of 123 123
    10. July 2009 at 04:25

    Here is the link for the abovementioned article:


  33. Gravatar of ssumner ssumner
    10. July 2009 at 11:23

    Anon, Thanks, I did finally get it (my home computer has trouble opening links for some reason, but my office computer is better.) The interviews were interesting.

    123, I like the Congdon piece a lot, and plan to use it in a future post. Thanks.

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