Reply to Williamson’s reply

Just a few quick comments on what I see as Steve Williamson’s most important points:

1.  He’s right that I erred when I implied all RGDP fluctuations at cyclical frequencies are suboptimal.  I certainly don’t believe that, and erred in leaving the impression that I do.  As an aside, I don’t even think stable NGDP growth produces the optimal path, I believe stable aggregate nominal hourly wage growth comes closer.  I favor NGDP over wage targeting for various pragmatic reasons.

2.  The big point of disagreement seems to be whether the Fed has the tools to boost NGDP when we are at the zero bound.  In another post Williamson points out that QE is ineffective if market rates fall to the IOR rate.  Then he rules out a negative IOR rate (a tax on reserves) and this implies that when rates fall to zero they will be at the IOR floor, producing policy ineffectiveness—aka a liquidity trap.  He also claims the Fed can’t reduce the IOR below zero.  I’d quibble with that.  A zero IOR would effectively be negative because of the FDIC tax on reserves, and I am pretty confident Congress would grant him the authority if Bernanke claimed it was an emergency—recall their quick response in 2008, when the Fed asked for authority for IOR.

But even if I am wrong about IOR, QE is really all the Fed needs to target NGDP, I’m happy to assume a zero lower bound for the sake of debate.  The big mistake most people make is overlooking the intertemporal aspect of monetary policy.  It’s always true that a temporary doubling of the money supply (say for one week or one month) will have almost no effect on the price level, that’s true regardless of the level of interest rates.  Why buy a house that just last week doubled in price to $400,000, if it will be worth $200,000 a month from now.  Woodford has formalized this insight.  So if we are going to talk about QE it only makes sense to talk about changes in the base that are expected to be permanent.  I claim that a permanent doubling of the base would double the expected future price level and NGDP, regardless of the current level of interest rates.   Even if rates are zero; interest rates will not be at zero forever.

As an aside, if interest rates are expected to be at zero forever, we should monetize the entire national debt, and then obviously fiscal policy will drive the price level.  But that’s not the world we live in.  So the zero bound is a side issue.  Woodford showed it’s the future path of policy that matters, and interest rates won’t be zero in the long run.

Of course the central bank doesn’t actually want to target the monetary base, they should target NGDP.  Thus they should promise to “leave enough base money in the system permanently so that NGDP is expected to rise at 5% a year.”  Indeed they don’t need to even mention the term ‘monetary base’ just say they will target NGDP along a given path, level targeting, the implication is that you’ll provide the base money needed in the long run to make it happen.  Will they be believed?  Of course,  Not once in all of human history has a fiat central bank promised to inflate and not been believed.

If the Fed announced tomorrow that they planned another $3 trillion in QE (I pick that figure as it would clearly be more than current expected), the stock market would soar and the dollar would probably plunge in the forex markets.  This is presumably because it would increase the expected future monetary base.  If the models say otherwise, we need to fix the models so that they conform to reality.  The policy works; it’s just a question of whether the Fed wants to do it.

3.  We have different views on the importance of sticky wages and prices, but those can’t be resolved in a blog debate, I just finished a 500 page manuscript on that issue.

PS.  I’ll continue answering as many comments as possible, but the pace will be slower than usual.


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76 Responses to “Reply to Williamson’s reply”

  1. Gravatar of Luis Enrique Luis Enrique
    5. July 2012 at 06:57

    Hi Scott,

    have you already seen (and responded to) arguments like this one, about negative IOR being contractionary?

    http://ftalphaville.ft.com/blog/2012/07/03/1067591/the-base-money-confusion/

  2. Gravatar of dwb dwb
    5. July 2012 at 06:57

    good post, i am glad you are engaging SW. I find his view that QE is ineffective very peculiar. in the limit, the Fed could monetize the entire treasury debt, replace it with base money, which would be like a massive tax cut (followed by a high taxes inflation later on). If QE has no effect then lets cut taxes now!!

    Somewhere between the current situation and monetizing the entire debt QE has an effect. Only way to see where we get the desired effect is to do more.

  3. Gravatar of Alex Godofsky Alex Godofsky
    5. July 2012 at 07:01

    3. We have different views on the importance of sticky wages and prices, but those can’t be resolved in a blog debate, I just finished a 500 page manuscript on that issue.

    Scott, does this mean we will be able to buy your book soon?

  4. Gravatar of Mikko Mikko
    5. July 2012 at 07:08

    Congrats on finishing the manuscript! I’m waiting for my chance to order a copy. Any chance of getting an autographed version?

  5. Gravatar of David Pearson David Pearson
    5. July 2012 at 07:21

    Scott,
    If the Fed bought all $8tr in Treasuries tomorrow, the following would arguably occur:

    -The government would no longer owe private bondholders $8tr.
    -The government would owe banks $8tr.

    “But in the future banks will use that $8tr asset into money,” you might argue.

    This confuses the issue. When banks demand reserves to create money, they can go to the Fed and borrow all they want at a zero FFR. The pre-existence of Excess Reserves is unnecessary. Therefore, banks holding $8tr in Excess Reserves is no more inflationary than holding zero. What does matter is the IOR, but Williamson correctly points out that the Fed has the explicit power to pay interest on reserves but not to tax reserves.

  6. Gravatar of Mike Sax Mike Sax
    5. July 2012 at 07:30

    “The big point of disagreement seems to be whether the Fed has the tools to boost NGDP when we are at the zero bound.”

    I think Scott he also questions that stable NGDP growth is the optimal policy-not just can you do it but the value in doing it.

  7. Gravatar of David Pearson David Pearson
    5. July 2012 at 07:31

    BTW, in addition to the ECB IOR cut to zero, here’s yet another European IOR experiment:

    “Nationalbanken, the Danish central bank, has cut its deposit rate to an historic low of negative 0.2% in an attempt to keep the euro-pegged krone stable, The Wall Street Journal reported Thursday.”

    At least the Danish market is up — .6%.

  8. Gravatar of dwb dwb
    5. July 2012 at 07:35

    btw, i have been pondering this “QE is swapping one liability for another argument” that irritates me so much and i think part of the flaw in this beguiling argument is that base money and reserves – while it may be accounted for and captured as such as a liability – is really more equity-like, meaning its a claim on currency that never needs to be repaid (debt needs to be repaid via taxes, equity does not). So QE is not “swapping one liability for another” its a change in the composition in the consolidated fiscal (Fed+treasury) balance sheet in terms of financing with “equity” (aka currency) and debt.

  9. Gravatar of Gregor Bush Gregor Bush
    5. July 2012 at 07:56

    Williamson is the ulimate “Person of the Concrete Steppes” as Nick Rowe would say. I find his focus on the mechanics of monetary policy and his complete lack of focus on expectations to be baffling.

    Whenever I encounter a POTCS, I always reposnd as you did but I take it even further: “if QE “dosen’t work” why don’t we just monetize the entire national debt? Come to think of it why do we pay taxes at all? Come to think of it, why do we work at all, why don’t we just have the Fed print money and we’ll import everything that we consume?”

    The usual response is to concede that the Fed could create a hyperinflation if it wanted to but getting inflation just a little bit higher is very difficult – but they can never explain why that is.

  10. Gravatar of Max Max
    5. July 2012 at 08:00

    Would you agree with these propositions?

    1) If the CB is targeting a nominal level, then QE isn’t needed.

    2) If the CB is targeting inflation, then QE doesn’t work. [assuming everyone has a correct understanding and this understanding is mutual]

    If yes to both…what is the point of advocating QE, doesn’t it just muddy the waters?

  11. Gravatar of Y.Alekseyev Y.Alekseyev
    5. July 2012 at 08:05

    @dwb: If the treasuries purchased by the Fed through QE are indeed to be repaid than the expansion of monetary base is a temporary one, and hence will have no effect on price level.

    In order to achieve permanent expansion, what should be happening is that the Fed purchases treasuries and then sets them on fire. That would be permanent. But that is not what’s happening. What’s happening is indeed an asset swap.

    And given the yield curve, it’s not even clear what exactly it is that happens when the Fed replaces a zero-yielding two year T-Note on the bank’s balance sheet with zero-yielding currency that continues to stay on the bank’s balance sheet.

  12. Gravatar of David Pearson David Pearson
    5. July 2012 at 08:06

    dwb,
    Interesting point. Its probably more accurate to say Reserves are convertible preferred stock. They can be converted into equity at some point, but until then act as debt. Either way both are a liability. Thus, QE results in either a contingent tax liability (through recapitalization) or a contingent currency liability (through inflation). Either way, its not accurate to say QE is stimulative. This is because banks ALWAYS have access to this “equity” at the FFR. Since the IOR is a floor for the FFR, the thing that really matters is not QE (the level of reserves) but the IOR (the price of reserves). Or, put another way, for a convertible preferred to be converted by the holder, the coupon must be low enough to make conversion attractive.

  13. Gravatar of Max Max
    5. July 2012 at 08:12

    I guess the part Williamson has trouble with is, “interest rates won’t be zero in the long run.” The key is to remember that inflation expectations are inherently unstable. They don’t need a reason to change, they need a reason (i.e. central bank commitment) not to change.

    Therefore, no policy instrument is required to create inflation. Strange but true.

  14. Gravatar of Dan Kervick Dan Kervick
    5. July 2012 at 08:17

    This is presumably because it would increase the expected future monetary base.

    Any empirical evidence of that. What percentage of people who are active in the stock market have beliefs about the monetary base? What percentage even know what the monetary base is and could distinguish it from other monetary aggregates?

  15. Gravatar of Y.Alekseyev Y.Alekseyev
    5. July 2012 at 08:21

    @Gregor Bush: I don’t think people like Williamson are ignoring the expectation channel. But I think they rightly point out that in order for the expectation channel to work, the change of expectations needs to be backed by credible instruments. I would submit that this is something worth at least thinking over.

    P.S. I find Avent’s analogy of monetary system to changing the deistance to the moon by hacking the meter in half vary appealing. I would be nice if the monetary policy worked like that. However, presently it does not. It could, if the Fed had different tools available. But not until then.

    I would suggest that the most powerful monetary tool we have is actually one that Treasury has, and has never used. It’s the seignorage thing, and it’s there in the constitution. Compared to that, all of this “omnipowerful Fed” stuff is but a dream.

  16. Gravatar of Alex Godofsky Alex Godofsky
    5. July 2012 at 08:22

    I think part of the problem here is that QE really doesn’t “do anything”. It just signals what the Fed is likely to do when we emerge from the ZLB. The thing is, you can at least in principle do the same thing just by announcing what you will do when we emerge from the ZLB without doing QE at all.

  17. Gravatar of RebelEconomist RebelEconomist
    5. July 2012 at 08:23

    @Gregor Bush, it is not that hard!

    If QE “doesn’t work” why don’t we just monetize the entire national debt?. Because, while that might allow you to get away with funding the government deficit for nothing for a while, that might lock in worse problems later (ie a return to slump if you sell the assets back to the market or hyperinflation if you don’t).

    Why is getting inflation just a little higher difficult? Because, beyond the point that, as Greenspan put it, inflation is not factored into household and business decisions (which he put at about 2%), people pay attention to it and establish indexing mechanisms which make inflation more volatile and therefore flip into hyperinflation.

    We seemed to have forgotten so many lessons that we learned from the 1970s and 80s.

  18. Gravatar of Major_Freedom Major_Freedom
    5. July 2012 at 08:26

    Of course the central bank doesn’t actually want to target the monetary base, they should target NGDP. Thus they should promise to “leave enough base money in the system permanently so that NGDP is expected to rise at 5% a year.” Indeed they don’t need to even mention the term ‘monetary base’ just say they will target NGDP along a given path, level targeting, the implication is that you’ll provide the base money needed in the long run to make it happen.

    That is why NGDP targeting is flawed. There is a “degree of freedom” going uncared for and unanalyzed here, namely, the (aggregate) money supply.

    It is a mechanistic error to believe that a long run 5% NGDP growth can be brought about by inflating the money supply at a similarly constant rate of growth. Inflation does not affect all goods and incomes equally.

    A 5% NGDP growth, because it is based on inflation, which hampers economic calculation, and increasingly stresses the real economy the longer it is imposed, cannot continue without an accelerating rate of money supply growth. The more capital and labor allocation become altered, the more they adapt to the inflation, the less they are adapted to voluntary savings and investment in the market.

    As a result, market forces, which never relent as long as humans act, put increasing pressure on this increasing alteration to be reversed. In order to prevent the market forces from reasserting themselves, which would bring about liquidations, temporary unemployment, and a decline in spending and thus a decline in status quo NGDP, it is necessary that inflation accelerate.

    Don’t think so?

    Constant growth NGDP targeting actually represents an increasing non-market force in the division of labor, the real effects of which make the antecedent money supply growth rates insufficient to maintain “spending” within the economy. Inflation puts a pressure on the real economy that deflationary market forces counter-act, which requires a higher dose of inflation in order to counter the counter-acting market forces, which puts even more pressure on the real economy that deflationary market forces will counter-act even more, which requires an even higher dose of inflation to counter the increased counter-acting market forces, and so on.

    Inflation is not a mechanistic process that merely increases nominal demands and prices, the way dropping buckets of water into a pond raises its water level. Money is not neutral. A neutral money is a contradiction in terms. Inflation is more importantly an exogenous alteration of relative price signals that are otherwise endogenous to the market, which hampers economic calculation.

  19. Gravatar of David Pearson David Pearson
    5. July 2012 at 08:34

    Many seem to be confusing cause and effect here.

    When there is no demand for bank reserves, QE is just an asset swap.

    When there is demand for bank reserves, QE leads to money creation.

    The key variable is therefore demand for bank reserves. What influences demand for bank reserves? There’s policy signaling, the IOR, real growth, etc. QE, ex-signaling, is not on that list.

    Some argue QE by itself can create a wealth effect. So can fiscal policy in an exactly equivalent fashion (issuing T-bills to buy risk assets). Therefore the wealth effect of QE is simply fiscal policy in disguise.

  20. Gravatar of Y.Alekseyev Y.Alekseyev
    5. July 2012 at 08:38

    @David Pearson: “Therefore the wealth effect of QE is simply fiscal policy in disguise.” Indeed! And without expansion in state spending, QE creates no expansion of money either. Nominal spending is essentially unaffected. And nominal spending is what we care about, right, SS?

  21. Gravatar of W. Peden W. Peden
    5. July 2012 at 09:35

    David Pearson,

    “Some argue QE by itself can create a wealth effect. So can fiscal policy in an exactly equivalent fashion (issuing T-bills to buy risk assets). Therefore the wealth effect of QE is simply fiscal policy in disguise.”

    Hoses can water gardens. So can rain in an exactly equivalent fashion. Therefore hoses are simply rain in disguise.

  22. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 09:59

    Luis:

    Negative interest rates on reserves involves the Fed reducing the banks’ reserve balances, which directly decreases the quantity of reserves. Of course, this is income to the Fed, which it transfers to the Treasury, but rather than worrying about that, there is a simple answer.

    The Fed should just sterilize the impact of charging interest on reserves by making open market purchases so that the quantity of reserves stays the same, but the yield on them is negative.

    It is just the opposite of the notion that when the Fed pays interest on reserves, this is expansionary because it is adding to the bank’s reserve balances. Of course, it is sensible to make open market sales to offset that effect.

  23. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 09:59

    Luis:

    Negative interest rates on reserves involves the Fed reducing the banks’ reserve balances, which directly decreases the quantity of reserves. Of course, this is income to the Fed, which it transfers to the Treasury, but rather than worrying about that, there is a simple answer.

    The Fed should just sterilize the impact of charging interest on reserves by making open market purchases so that the quantity of reserves stays the same, but the yield on them is negative.

    It is just the opposite of the notion that when the Fed pays interest on reserves, this is expansionary because it is adding to the bank’s reserve balances. Of course, it is sensible to make open market sales to offset that effect.

  24. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 10:11

    A privatized monetary order can undertake quantitative easing. It can create money and buy existing government bonds (and private bonds too.)

    A privatized monetary order cannot collect taxes or even force people to accept the money it issues. It cannot change the composition of the government’s debt. It cannot do fiscal policy.

    Simple consideration of the possibility of a privatized monetary order shows that quantitative easing is not fiscal policy in disguise.

  25. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 10:16

    I think the framing of charging banks to keep reserves as a tax is reasonable. It is a storage free.

    Unless Congress requires the Fed to allow banks to store money for free, then there is no reason why it can’t impose charges for this service.

    Now, I do think that if these charges get to the point where people withdraw currency and keep it in vaults, making people pay a tax would be something that would require Congressional authorization.

    But as long as it is just reserve balances, then the notion taht the interest rate has to be positive on them is wrongheaded.

    By the way, the payments are supposed to be less than current money rates. If T-bill rates, for example, are zero, then negative rates reserves would fit that.

    Also, if there is a large increase in the quanity of currency demanded, rather than printing up large denominations, issue ones. Make the storage cost as high as possible.

  26. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 10:17

    That was backwards. I think that framing the issue of charging banks to keep reserves as a tax is unreasonable. It is a storage free.

  27. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 10:23

    Oh, and by the way, when the Fed purchases bonds from nonbanking firms or households, it directly raises their reserve balance. And just because the Fed directly buys from dealers who are banks, doesn’t mean that when the dealers replenish their invetnories, the money isn’t going into the hands of firms and households exactly as it would if the Fed cut out the middleman. Which is what it is.

    This entire argument about the money just piles up in banks is based upon the credit view. The way monetary policy supposedly works is by getting the banks to make more loans, and those borrowing the money spend it.

    That isn’t it. The way it works is that those who end up with the newly created money spend it. They ened up with less government bonds and more money. They spend the money.

    No one has to borrow any more at all. In fact, it would be much better if people currently holding government and private bonds sold them and used the proceeds to buy consumer and capital goods. This isn’t more borrowing and spending. It is less lending and more spending.

    Of course, I favor the full privatization of hand-to-hand currency, so that the zero nominal bound becomes irrelevant. There shouldn’t be a zero nominal interest rate, guaranteed by the government, zero maturity asset for people to hold, much less have that be the basis of the entire financial system.

    Still, I think the problem today (rather than in all possible situations) is that the equilibrium yield is low because the Fed doesn’t target the growth path of nominal GDP.

  28. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 10:25

    I give up. When the Fed buys bonds from households or nonbanking firms, it directly increases their money balances.

  29. Gravatar of David Pearson David Pearson
    5. July 2012 at 10:29

    W. Peden,

    Hoses do not water gardens in an exactly equivalent fashion as rain. One uses a scarce resource and creates a liability for replacing it; the other does not.

    The analogy somewhat matches risk asset QE. Done by the Fed, it creates a contingent tax liability outside of the appropriations process and crowds out the government’s ability to tax; done by Treasury, it uses the government’s ability to tax.

  30. Gravatar of David Pearson David Pearson
    5. July 2012 at 10:32

    @Bill Woolsey:

    “They ened up with less government bonds and more money. They spend the money.”

    Excess reserves are not “money”.

  31. Gravatar of Major_Freedom Major_Freedom
    5. July 2012 at 10:40

    He’s right that I erred when I implied all RGDP fluctuations at cyclical frequencies are suboptimal. I certainly don’t believe that, and erred in leaving the impression that I do. As an aside, I don’t even think stable NGDP growth produces the optimal path, I believe stable aggregate nominal hourly wage growth comes closer. I favor NGDP over wage targeting for various pragmatic reasons.

    You are as powerless in imposing NGDP targeting as you are in imposing wage targeting. There is no reason why an economist has to worry himself with “pragmatic” matters of the moment that are the domain of politics, not economics.

    As Hayek noted:

    “But the present political necessity ought to be no concern of the economic scientist. His task ought to be, as I will not cease repeating, to make politically possible what today may be politically impossible. To decide what can be done at the moment is the task of the politician, not of the economist, who must continue to point out that to persist in this direction will lead to disaster.”

    So why are you advocating for NGDP targeting even though you know it is not optimal? Shouldn’t you as an economist be advocating for what is optimal, so as to turn what is currently politically impossible into a possibility?

    You said “Wage targeting comes closer”. Closer to what exactly? If NGDP targeting is not optimal, and if wage targeting is “closer” (to the optimal?), then what is the optimal, and why aren’t you doing what Hayek said all economists should do, which is fighting tooth and nail to turn the currently impossible into the possible?

    Who else will do this but economists? Forget “pragmatism.” Pragmatism is code speak for opportunism in state violence, of grabbing money, purchasing power, and wealth from the hapless citizenry. If everyone were “pragmatists”, the human race would never advance. Advancement is made on the trails blazed by heretical, on the fringe, doctrinaire, “pure hearted” ideologues.

    If you want to be “pragmatic”, then shouldn’t you advocate for a free market in money production experiment in, say, one or two states? Just to see what happens? Why do the pragmatist’s experiments always have to be in the direction of state control? The excuse that it would be “politically infeasible”, is exactly the reason why we’re all here now dealing with the central banks, which previous generations of “pragmatists” considered inevitable as well. Pragmatists are just engaging in a self-fulfilling prophecy. “We can’t change the fundamentals because the fundamentals have not been changed by others before us.” How in the world is progress possible in this cesspool of circular reasoning?

    I claim that a permanent doubling of the base would double the expected future price level and NGDP, regardless of the current level of interest rates.

    I claim that a permanent growth rate of NGDP via inflation requires an accelerating aggregate money supply.

    As an aside, if interest rates are expected to be at zero forever, we should monetize the entire national debt, and then obviously fiscal policy will drive the price level. But that’s not the world we live in. So the zero bound is a side issue. Woodford showed it’s the future path of policy that matters, and interest rates won’t be zero in the long run.

    Woodford failed to include a single mention of how even “expected” monetary policy hampers economic calculation, since he also views inflation mechanistically.

    We have different views on the importance of sticky wages and prices, but those can’t be resolved in a blog debate, I just finished a 500 page manuscript on that issue.

    I bet there is not a single mention of any standard for what would constitute non-sticky wages, nor why such a standard is justified for the real world of human actors acting in a state of partial ignorance of each other. I also bet there is not a single mention of economic calculation.

  32. Gravatar of StatsGuy StatsGuy
    5. July 2012 at 10:46

    “As an aside, if interest rates are expected to be at zero forever, we should monetize the entire national debt, and then obviously fiscal policy will drive the price level. But that’s not the world we live in.”

    This is really a nifty point (not unlike Joe Gagnon’s). Note that it’s not entirely disassociated from the world we live in. The Fed has sold almost its entire stock of short term debt to buy long term debt.

    Here’s a semi-recent chart,

    http://3.bp.blogspot.com/-HV6hILIu0GM/T4gnfcO7rkI/AAAAAAAABDQ/-mgmG5_1_k8/s1600/USDebtMaturity.PNG

    Consider that if market expectations hold, a significant portion of that short term debt (at near 0%) will be monetized through the (still very low) rate of inflation. Even 7-10 year debt has an effective zero yield (and may have a subzero yield). This does create maturity risk, THEORETICALLY, but only if the Fed refuses to buy, unless the Fed utterly loses all credibility. In other words, unless there is an alternative, liquid, and STABLE place to park wealth (and gold is NOT it, because the source of wealth stability for money is sticky nominal prices), then the dollar is going to remain unchallenged unless monetary easing really does cause inflation – in which case the objective is achieved.

    And if not, then hallelujah – monetize and cut taxes!

  33. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 11:06

    Pearson:

    Imagine a world with no national debt.

    There is a central bank. It only purchase “risk assets.”

    It’s profits go to the Treasury.

    Yes, the better it does in avoiding loss, the more money it pays to the Treasury.

    This doesn’t make monetary policy into fiscal policy.

    Who told you that monetary policy had to involve zero risk?

    Who told you that monetary policy was a shift between money and the shortest government bonds?

    Monetary policy is about changing the quantity of money.

  34. Gravatar of Major_Freedom Major_Freedom
    5. July 2012 at 11:07

    Bill Woolsey:

    A privatized monetary order can undertake quantitative easing. It can create money and buy existing government bonds (and private bonds too.)

    A private money producer that buys existing government bonds is not engaging in quantitative easing.

    A private money producer that buys its own outstanding bonds would be engaging in a form of quantitative easing, with the major difference being, of course, the private money producer is not using threats of violence to coerce others into paying it a tribute in the currency it produces. The government does this, so when it quantitatively eases its own debt, it is FORCING money devaluation, i.e. purchasing power taxation.

    If a private money producer monetized its own debt, it is subject to the market rejecting its currency by individual choice, without being coerced by the private money producer if they do reject it and trade in some other currency instead.

    A privatized monetary order cannot collect taxes or even force people to accept the money it issues. It cannot change the composition of the government’s debt. It cannot do fiscal policy.

    Simple consideration of the possibility of a privatized monetary order shows that quantitative easing is not fiscal policy in disguise.

    Your logic is flawed. You cannot infer from

    1. Private money producers not being able to engage in government fiscal policy; and

    2. Private money producers are able to buy their own outstanding debt,

    that

    3. Quantitative easing is therefore not fiscal policy in disguise.

    ——-

    What you have to instead argue is that

    Just like

    A private producer of money, let’s call him Mr. Frascal, produces money and buys his own outstanding debt, then he is engaging in “Frascal policy”, because by producing his own money and buying the outstanding debt on his cash flows, he is able to promote his own activity by spending more of the money he produces, with no additional external claims on his cash flows. By monetizing his own debt, he can engage in more spending that suits his interests.

    It is also the case that

    A governmental producer of money, let’s call it “Mr. Fiscal”, produces money to buy its own outstanding debt, then the government is engaging in “Fiscal policy”, because by producing its own money and buying the outstanding debt on its cash flows, it is able to promote its own activity by spending more of the money it produces, with no additional external claims on its cash flows. By monetizing its own debt, it can engage in more spending that suits its interests.

    ——

    In other words, quantitative easing allows the fiscal side of the state to have more money than they otherwise would have had, and that enables the state to spend more money than they otherwise would have spent, ceteris paribus, without any additional external claim on its cash flows (since the debt is being extinguished).

    The state’s central bank is in fact a fiscal institution, for it CREATES the money the state spends, through purchasing the debt the government itself issues. QE is a way for the state to spend more without additional borrowing or taxation. That is indeed a fiscal policy in disguise.

  35. Gravatar of o. nate o. nate
    5. July 2012 at 11:13

    I’m trying to work out the Fed’s rationale for paying IOR on excess reserves in the current environment. Currently they’re paying 0.25% on excess reserves and the fed funds target is 0-0.25%. When the policy was unveiled they set the level of IOR at the “lowest target federal funds rate for a reserve maintenance period less 75 basis points”. The purpose was to keep the fed funds rate from falling significantly below their target due to all the liquidity they were supplying. (At that time, the fed funds target was 1.5%.) So why pay IOR now when the lower end of the fed funds target is 0%? It doesn’t seem to be consistent with their stated policy.

  36. Gravatar of Bill Woolsey Bill Woolsey
    5. July 2012 at 11:13

    Rebelecoomist:

    Market Monetarists favor a target growth path for nominal GDP.

    At most, they favor rapid growth in nominal GDP to return to the growth path of 1984-2007.

    While it is possible, and perhaps likely that this will involve higher than 2% inflation, the experience of the 1970s was a return of nominal GDP to its past growth path, but rather an accelearation of the growth rate of nominal GDP.

    To the degree that a return to the growth path of nominal GDP to the Great Moderation results in people introducing indexing, that will soon be worthless, it will still not possibly cause hyperinflation.

    Market Monetarist do not propose targeting the unemployment rate or real GDP. It is those sorts of targets, attempting to manipulate a supposedly long run phillips curve, for which indexing could cause a rapid acceleration of inflation.

    Scott:

    All it takes is a bit of that inflation talk, and everything you ever said about nominal GDP is forgotten. And yes, I know you had it right there in your post. Nominal GDP target.

    Maybe it is hopeless.

  37. Gravatar of flow5 flow5
    5. July 2012 at 11:15

    Remunerated excess reserve balances (IOeR’s):

    IOeR’s result in a cessation of circuit income & the transactions velocity of funds. IOeR’s propagate stagflation. IOeR’s reduce real-output. Our nascent economic rebound was the inevitable result.

    IOeR’s are the FED’s credit control device. IOeR’s (1) ABSORB both existing bank deposits within the CB system (taking Treasuries, or safe assets, off the market), as well as; (2) ATTRACT monetary savings from the non-banks (shadow banks).

    IOeRs are used to monetize debt, & to absorb CB deposit liabilities (offsetting any expansion of Reserve Bank credit on the asset side of its balance sheet, e.g., the prior expansion its liquidity funding facilities). An increase in Fed’s liabilities (IOeR’s), in effect sterilized (QE1’s & QE2’s) assets purchases (Treasury securities, agency debt, or agency MBS). I.e., IOeR’s sterilize open market operations of the buying type. IOeR’s are contractionary.

    IOeR’s alter the construction of a normal yield curve, they INVERT the short-end segment of the YIELD CURVE – known as the money market. IOeR’s (like during the credit crunch of 1966), induce dis-intermediation (where the non-banks, or Shadow banks, shrink in size but the size of the commercial banking system remains the same).

    IOeR’s compete with money market “paper” (Shadow Bank paper). The financial instruments traded in the money market include Treasury bills, commercial paper, bankers acceptances, certificates of deposit, repurchase agreements (repos), municipal notes, federal funds, short-lived mortgage and asset-backed securities & Euro-Dollar CDs (liabilities of a non-U.S. banks operating on narrower regulatory margins).

    The money market is differentiated by its position on the yield curve (i.e., short-term borrowing & lending with original maturities from one year or less). Domestic liquidity funding is customarily benchmarked (cross-border interconnectedness) by the London interbank market LIBOR indexes & foreign exchange swaps.

    In turn, money market paper funds the capital market (earning assets greater than 1 year). This is referred to as borrowing short & lending long. Non-bank financial intermediaries in the capital market include: hedge funds, SIVs, conduits, money funds, pension funds, selective mutual funds, hedge funds, sovereign wealth funds, insurance companies, banks , foundations, and colleges and universities, & individuals as well and other non-bank financial institutions.

    The non-banks are the most important lending sector in our economy (or pre-Great Recession), represented 82% of the pooling & lending markets (see: Z.1 release, sectors, e.g., MMMFs, commercial paper, GSEs, etc.).

    The Board of Governors has the power to change the remuneration rate (as it had the power to selectively change Reg. Q ceilings) — in order to meet its employment objectives.

  38. Gravatar of Saturos Saturos
    5. July 2012 at 11:23

    “As an aside, if interest rates are expected to be at zero forever, we should monetize the entire national debt, and then obviously fiscal policy will drive the price level.”

    No, if nominal interest rates are expected to be zero forever, then we should do actual helicopter drops to get a higher trend rate of inflation, then continue with NGDP targeting. Or reform the currency. Don’t you ever let Congress seize control of the whole (nominal) economy.

    “… I just finished a 500 page manuscript on that issue.”

    Oh God YES.

  39. Gravatar of flow5 flow5
    5. July 2012 at 11:26

    You would get higher rates of real-output by getting the commercial banks out of the savings business (thereby matching savings with real-investment)…or by eliminated IOeR’s.

    I.e., the CBs never loan out existing deposits (saved or otherwise). Every time a CB makes a loan to, or buys securities from, the non-bank public, it initially creates an equal volume of new money.

    Savings are impounded within the CB system. And the source of all savings/time deposits within the CB system is demand deposits, directly via the bank’s undivided profits accounts, or indirectly via the currency route. Money flowing to the non-banks actually never leaves the CB system as anyone who has applied double-entry bookkeeping on a national scale should know.

    Lending by the non-banks is non-inflationary, ceteris paribus (matches savings with investment), whereas lending by the commercial banks is inflationary (doesn’t match savings with investment).

    Stagflation began in the mid 60’s, when Reg Q ceilings trumped the rates the thrifts could competitively meet.

  40. Gravatar of Saturos Saturos
    5. July 2012 at 11:33

    What do we think about this paper?
    http://www.economist.com/blogs/freeexchange/2012/07/inequality

  41. Gravatar of David Pearson David Pearson
    5. July 2012 at 11:40

    Woolsey,

    Any Fed purchase of a risk asset can be replicated by:
    -The Fed issuing reserves to buy T-bills.
    -Treasury using the proceeds to buy the risk asset.

    Where does monetary policy stop and fiscal policy begin? Lots of fiscal actions — the second step above — can, “change the quantity of money.” I would take your argument to its logical conclusion, but its obvious the line between fiscal and monetary authority has to be drawn somewhere. The intent of legislation was for that line to be drawn at LOLR asset purchases. In those circumstances, Congress wanted to shield emergency liquidity operations from the political process.

    Of course, the Fed’s authorizing legislation has broad loopholes that allow it wide latitude. I would argue that taking advantage of that latitude and being independent of Congressional interference are two incompatible objectives. Indeed, we have already had ample evidence of this since 2007.

  42. Gravatar of flow5 flow5
    5. July 2012 at 11:43

    “Shadow banking also refers to the creation of assets that are thought to be safe, short-term, and liquid, and as such, “cash equivalents” –Governor Daniel K. Tarullo

    With QE, Bernanke took safe assets (Treasury’s) off the market. Safe assets are used for repo collateral & re-hypothecation.

    The payment of interest began on Oct 9th.

    $2,255m……… 9/10/08
    $68,763m……. 9/10/08
    $136,050m….. 10/08/08
    $281,707m ….10/22/08
    $363,643m….. 11/05/08
    $604,746m…..11/19/08
    $621,518m….. 3/11/09
    $794,546m……8/26/09
    $1,217,550m… 2/23/11
    $1,601,995m… 8/10/11
    $1,490,564m… 6/13/12

    Excess reserves are functionally equivalent to short-term treasuries (which are also highly liquid, unencumbered, & riskless, earning assets).
    ———————-…

    TREASURY’S ON THE FED’S BALANCE SHEET INCREASED BY 50%

    1,133.2 August 13, 2008
    Increased by 50%

    1,799, June 13, 2012
    Increased by 50%

    ———————-…

    The intersection between the remuneration rate & the Daily Treasury Yield Curve Rates has continued to shift to the right. As the intersection moves to the right monetary policy becomes tighter.

    The daily treasury yield curve rates fell below the remuneration rate on:

    8/9/11 for 2 year
    2/28/11 for 1 year
    8/19/09 for 6 month
    3/04/09 for 3 month
    9/26/08 for 1 month

  43. Gravatar of Major_Freedom Major_Freedom
    5. July 2012 at 11:43

    Bill Woolsey:

    Oh, and by the way, when the Fed purchases bonds from nonbanking firms or households, it directly raises their reserve balance.

    The firms and households directly increased the Fed’s bond assets. The firms and households gave up their debt assets. Those at the Fed on the other hand didn’t give up anything to acquire the debt assets, because they just created the money out of thin air. They started with no debt assets, and then they acquired debt assets. Zero assets were given up.

    The costs of the lost debt assets therefore falls on those who hold cash but did not sell bonds to the Fed.

    You sloppily lumped in all firms and households into a collective blob that gains cash when the Fed buys bonds, when it is actually the case that the Fed only credits SOME people’s accounts with cash, which of course equivalently devalues the cash balances of everyone else. It’s just relatively minor per person so people like you conveniently ignore it. But the costs are there. You cannot simply assume the Fed raises the reserve balances of the private sector. It raises the reserve balances of some people, and equivalently decreases the purchasing power of other people. There is no NET GAIN here. It is an introduction of a gain for some and a mandatory loss for others.

    Contrast that with free trade, where that which is traded represents gains to the parties involved with no mandatory loss on others, and you’ll see why your fictitious comparison of QE to market process money production is utterly fallacious.

    And just because the Fed directly buys from dealers who are banks, doesn’t mean that when the dealers replenish their invetnories, the money isn’t going into the hands of firms and households exactly as it would if the Fed cut out the middleman. Which is what it is.

    That is also false, this time on multiple levels. For one thing, not everyone who owns money does, or should, own government debt. You’re still ignoring those people whose purchasing power is equivalently reduced by the gains to those who sell to the Fed. This loss is HUGE. It is at least equivalent to the gain in the Fed’s balance sheet.

    You are also ignoring the fact that the middlemen take a type of “haircut”. When they buy bonds from the market, they lower their bid prices in order to make a cut in reselling them to the Fed at a higher price. Or, at least they charge fees to the bond sellers that is an equivalent reduction in price. For one bond, this isn’t much, but when the primary dealers sell trillions of dollars worth of bonds to the Fed, and buy trillions more from the Treasury, these sums are large.

    This entire argument about the money just piles up in banks is based upon the credit view. The way monetary policy supposedly works is by getting the banks to make more loans, and those borrowing the money spend it.

    That isn’t it. The way it works is that those who end up with the newly created money spend it. They ened up with less government bonds and more money. They spend the money.

    Primary dealers are primarily in the business of investing in financial securities: debt, equity, options and other derivatives. They don’t just “spend” the new money on their own consumption. While there are additional bonuses, dividends, and other compensation that do end up being “spent”, the overwhelming majority of the inflation is filtered through financial securities, loans, equity investments, and derivatives hedging/speculation.

    No one has to borrow any more at all. In fact, it would be much better if people currently holding government and private bonds sold them and used the proceeds to buy consumer and capital goods. This isn’t more borrowing and spending. It is less lending and more spending.

    No mention of economic calculation. No mention of how the price system is hampered to the extent that investors cannot know which alternative projects to invest in that are in line with actual consumer time preferences.

    Just “Buy more consumer goods, and buy more capital goods, and the economy will boom” mechanics.

    Of course, I favor the full privatization of hand-to-hand currency, so that the zero nominal bound becomes irrelevant. There shouldn’t be a zero nominal interest rate, guaranteed by the government, zero maturity asset for people to hold, much less have that be the basis of the entire financial system.

    Interest rates are affected by inflation. Yes, there shouldn’t be zero nominal interest rates, but there also shouldn’t be non-market nominal interest rates.

    Still, I think the problem today (rather than in all possible situations) is that the equilibrium yield is low because the Fed doesn’t target the growth path of nominal GDP.

    Then explain why interest rates kept falling post-1995, despite the reversal in the rate of M2 growth turning from decreasing to increasing, and why they kept falling post-1985, despite the stabilization of NGDP growth.

  44. Gravatar of flow5 flow5
    5. July 2012 at 12:13

    The “velocity of pledged collateral” could be significant metric too. A “collateral squeeze” developed due to higher & higher haircuts. Falling prices acted as a margin call on the Shadow bank’s earning assets. As counter-party risks grew, so did dis-intermediation (analogous to bank credit contraction within the commercial banking system). But there was no government intervention or backstops in the largely unregulated Shadow banking system to forestall its liquidity runs.

  45. Gravatar of flow5 flow5
    5. July 2012 at 12:15

    Shadow banks do create money & credit (like the Euro-dollar market does). The Shadow banking market’s liabilities don’t come from “deposit-taking” but originate through the pledging & re-pledging of acceptable collateral (i.e., via hypothecation & re-hypothecation). In 2007, re-hypothecation made up half of the financing arrangements in the Shadow banking system.

    “HYPOTHECATION is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults”

    “RE-HYPOTHECATION occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings”

    Acceptable collateral (safe assets, e.g., governments) for the Shadow banks have long served as the prudential reserves for the E-D banks (U.S. dollar-denominated liquid assets held in U.S. banks). Eurodollars are large denomination time deposits (negotiable credit instruments that are regarded as money). Outside of any regulatory authority, shadow bank lending & funding operations are a hybrid (somewhere in between CBs & non-banks).

    Like E-D banks, the volume of prudential reserves held by each Shadow bank is dictated by “prudence” – not by any legal requirement administered by a monetary authority (nor by exchange controls). Shadow banking collateral-chains are delimited by haircuts & clearing balances (analogous to reserve requirements). Like the E-D system, there is no FDIC insurance, discount window borrowing, or government guarantee for Shadow bank collateral, no Federal backstop to forestall liquidity runs.
    The Shadow banking system grew as collateral-chains shifted within a successive number of financial intermediaries (domestic & foreign). That is, the collateral pledged by Shadow banks was increasingly re-pledged to other Shadow banks.

    The larger the volume of primary assets (collateral pledged originating outside the intermediary, vs. derivative assets (collateral pledged & recycled within an intermediary), the higher the credit multiplier & “velocity of collateral pledged” became. In other words given a wider distribution of prudential reserves amongst a larger number of financial intermediaries, the larger the volume of credit created. Thus was laid the economic basis for a highly interdependent & international system of Shadow banking.

    It is noteworthy that In December of 1995 (with the onset of the housing bubble), the liabilities of the US Shadow banking system first surpassed the liabilities held by the US commercial banking system (flow of funds Z.1).

    “while the collapse in shadow banking has been somewhat offset by increasing liabilities at traditional banks solely courtesy of the Fed” — ZeroHedge. Not so, the combination (mix) of liabilities as described by ZeroHedge will produce stagflation (business stagnation accompanied by inflation.

    At the height of the financial boom, in 2007, the aggregate shadow banking sector accounted for 39% of total financial assets (includes credit market assets, deposits and cash, money market fund shares, and repos), according to the Federal Reserve. Today, this share has dropped to less than 28% (see table 1). On the other hand, the formal banking sector’s share of total financial assets was slightly more than one-third in 2007 and then bounced back to about 45% in 2011.

    The Deloitte Shadow Banking Index shows the volatile shadow banking system totaled $9.53 trillion at the end of 2011 “’ more than 50 percent below its peak in 2008

  46. Gravatar of flow5 flow5
    5. July 2012 at 12:16

    Lending by the non-banks is not accompanied by an increase in the volume of money, but is associated with an increase in the velocity, or turnover of existing money. Here investment equals savings (and velocity is evidence of the investment process), whereas in the case of the CB credit, investment does not equal savings, but is associated with an enlargement and turnover of new money (bank credit & the money stock).

    I.e., the growth of the non-banks is prima facie evidence that existing funds/savings have already been invested/spent, i.e., transferred/transmitted by their owners/savers/creditors to borrowers/debtors.

    The housing boom-bust (the misallocation & mal-distribution of available credit within the residential & commercial mortgage markets), was primarily fueled through the introduction of financial innovations: CMOs, CDOs, CDSs, ABSs CLOs, CFOs(securitization & credit enhancements), via (SIVs, SPEs, other non-banks, etc.)

    Just as during the 79-82 boom-bust cycle, financial innovations were directly responsible for increasing money turnover. The housing bubble was characterized by its colossal money flows (money X velocity). The means-of-payment money times its transactions rate-of-turnover explains the change in property values.

  47. Gravatar of TallDave TallDave
    5. July 2012 at 12:23

    I’ll freely admit there was a point when I wasn’t sure what else the Fed could do, but now it seems obvious that as a central bank, they can keep buying assets with printed money as long as there still any assets anywhere they don’t already own.

  48. Gravatar of flow5 flow5
    5. July 2012 at 12:26

    Permanent open market operations (POMOs) should be divided into 2 separate classes (#1) purchases from & sales to: the commercial banks; & (#2) purchases from, and sales to: others than banks:

    (#1) Transactions between the Reserve banks & the commercial banks directly affect the volume of member bank reserves without bringing about any change in the money supply (an asset swap). The “trading desk” “credits the account of the member clearing bank used by the primary dealer from whom the security is purchased”. This alteration in the assets of the commercial banks (the banks’ reserve balances or IOeR’s), increase – by exactly the amount the Primary Dealer’s government securities portfolio was decreased.

    These reserve balances (IOeR’s) are not just the result of an asset swap. IOeR’s are assets defined by economists to be outside-of-the properties normally assigned to the money aggregates. I.e., IOeR’s are not a medium of exchange. They do not circulate outside of the inter-bank market (i.e., IOeR’s may reflect reserve velocity, not transactions velocity). They do not require Basel II regulatory capital. They are not a reservable liability.

    (#2) Purchases and sales between the Reserve banks & Non-bank investors directly affect both bank reserves & the money supply.

    Note: the non-bank public includes every institution, corporation, the U.S. Treasury, the U.S. Government, State, & local governmental jurisdictions, foreigners, & every person (everyone except the commercial and the Reserve banks).
    ———————-…
    “As of May 2012, Federal debt held by the public was $11 trillion (includes SOMA holdings), while the intra-governmental debt was $4.76 trillion, to give a combined total public debt outstanding of $15.77 trillion” -Wikipedia

    As of January 2011, foreigners owned $4.45 trillion of U.S. debt, or approximately 47% of the debt held by the public of $9.49 trillion and 32% of the total debt of $14.1 trillion
    ———————-…
    So the Fed has plenty of ammunition (government debt outstanding). Government’s in the secondary market (held by the non-bank public) may be monetized (financing government spending) through open market operations of the buying type (Central Bank POMO’s).

  49. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. July 2012 at 12:31

    http://noahpinionblog.blogspot.com/2012/07/excess-volatility-and-ngdp-futures.html

    Thursday, July 05, 2012

    Excess volatility and NGDP futures targeting
    -Noah Smith

    “Steve Williamson has a post arguing against NGDP targeting. I just wanted to throw my two cents in, and consider an issue that Steve didn’t mention.

    When he talks about “NGDP targeting”, Scott Sumner actually means the following (quoting Williamson):

    “In its current incarnation, here’s how NGDP targeting would work, according to Scott Sumner. The Fed would set a target path for future NGDP. For example, the Fed could announce that NGDP will grow along a 5% growth path forever (say 2% for inflation and 3% for long run real GDP growth). Of course, the Fed cannot just wish for a 5% growth path in NGDP and have it happen…One might imagine that Sumner would have the Fed conform to its existing operating procedure and move the fed funds rate target – Taylor rule fashion – in response to current information on where NGDP is relative to its target. Not so. Sumner’s recommendation is that we create a market in claims contingent on future NGDP – a NGDP futures market – and that the Fed then conduct open market operations to achieve a target for the price of one of these claims.
    So basically, the Fed would do its utmost to keep NGDP futures prices on a certain path.”

    I have a problem with that. The problem is called “excess volatility”. According to some theories, asset prices should be an optimal forecast of (discounted) future payouts – for example, the price of a stock should be an optimal forecast of discounted future dividends, etc. An optimal forecast should not respond to “noise”; in other words, if something happens that doesn’t affect dividends, it shouldn’t affect the forecast. This means that actual dividends should be more variable than prices – the dividends should have lots of “surprises”.

    But we can actually look at whether or not this is true! All we have to do is wait for actual dividends to come in, and then see whether past prices bounced around less than the dividends, or more. Robert Shiller was one of the first to do this, and here is what he found:

    [Graph]

    The jagged black line is the S&P 500, and the lighter, less jagged lines are dividends discounted by various discount rates. It’s easy to see that no matter what discount rate we use, stock prices are a lot more variable than the fundamental value of stocks. This means that there is “noise” in stock prices – prices may respond to information about dividends, but they also respond to some other stuff that has nothing to do with dividends. They display “excess volatility”. Lots of researchers have tried to kill the excess volatility puzzle, but none have really succeeded. In other words, markets may be “efficient” in the sense that you can’t predict future returns, but those returns are probably going to depend partly on things other than fundamental value.

    Now back to NGDP futures targeting. An NGDP futures price will probably experience excess volatility too. It will bounce around more than changes in actual NGDP. This means that the Fed will be trying to hit a very volatile moving target. One quarter, futures prices will soar, the next month they will crash, and the Fed will be trying to keep up, tightening dramatically in the first quarter and loosening dramatically in the second. This will happen even if a true optimal forecast of NGDP (which of course no one really knows) is relatively stable! Asset market volatility will cause policy volatility.

    If you think that policy volatility has no costs, this is fine. But if you think that the Fed bouncing around wildly from quarter to quarter sounds scary, you should be scared of NGDP futures targeting. For example, volatile Fed policy, even if it adheres rigidly and credibly and permanently to an NGDP futures targeting rule, may cause expectations to become more volatile if a substantial number of economic actors fail to believe that NGDP targeting will succeed in hitting the target. That could cause volatility in things like inflation and real GDP.

    Of course, this is also true of any Fed policy rule that takes market prices as a measure of expectations (for example, using TIPS spreads as a measure of inflation expectations) and then responds to those “expectations”. This is one reason why, contra John Taylor, I support combining rules with judgment. But even in terms of rules, we can make guesses about excess volatility. If excess volatility is an increasing function of actual volatility, then using NGDP futures should worry us more than using inflation expectations. Real GDP bounces around a lot more than inflation, as this graph from Stephen Williamson shows:

    [Graph]

    If excess volatility is, say, 50% of actual volatility, then using NGDP futures in Fed policy is going to cause a lot more bouncing around than using inflation futures alone.

    Anyway, this is not to say that NGDP targeting is a hopeless idea. But the futures-market aspect of what Scott Sumner is proposing relies on a version of market efficiency that is much stronger even than what most finance professors would accept.”

  50. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. July 2012 at 12:44

    Saturos,
    “What do we think about this paper?”

    I like it. Especially the part about capital incomes on pages 20-21:

    “Second, these results suggest that the response of income inequality would likely be even more pronounced if the top 1% of the income distribution were included. This is because the source of income for the top 1% is quite different from that of other groups. The CBO (2011) reports that the top 1% received only 40-50% of their total non-capital gain income from labor earnings between 1980 and 2007 while financial income and business income accounted for approximately 30% and 20% respectively. Because financial income rises persistently while business income declines only briefly after contractionary monetary shocks, and because their labor earnings are likely to rise at least as much as the 90th percentile, one can reasonably speculate that the total income of the top 1% would rise by more than most of the households in the CEX. Thus, our results likely provide a lower bound on the effects of monetary policy shocks on income inequality.”

    This somewhat matches what we observe in the Great Depression and more recently:

    Capital income (dividends, interest and rent) share of personal income % (Source: Piketty and Saez) and NGDP growth rate and implicit price deflator

    Year-Share-Deflator-NGDP
    1929″”21.3″”-0.4″”-6.4
    1930″”21.8″”(-3.7)-(-12.0)
    1931″”22.0-(-10.4)-(-16.1)
    1932″”23.2-(-11.7)-(-23.3)
    1933″”21.1″”(-2.7)-(-3.9)
    1934″”19.0″”-5.6″”-14.7
    1935″”17.4″”-2.0″”-11.1
    1936″”17.6″”-1.0″”-14.3
    1937″”17.1″”-4.3″”-9.7

    Note that shares of capital income vary inversely with inflation and the rate of NGDP growth.

    Let’s take a look at the share of noncapital gains personal income derived from capital income from 1929-37. But as we do, keep in mind that capital gains income as a share of personal income fell from 7.7% in 1929 to 2.6% in 1930 and never exceed that level with the exception of 1936 when it was 3.7%. A graph showing the proportion of capital gains income to all personal income is here:

    http://www.kentwillard.com/photos/graphs/net-capital-gains-as-percent-of-individual-income.jpg

  51. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. July 2012 at 12:45

    It goes without saying the bottom 90% are highly dependent on wages and salaries for their taxable income. The top 10% on the other hand are much more dependent on capital and capital gains income. In 1929, which was a record year for capital gains during the pre-World War II period, capital gains nevertheless only ranged from 7.6% of all income for P90-95 to 22.7% of all income for P99.99. Capital income on the other hand varied from 18.9% of all income for P90-95 to 54.7% of all income for P99.99. A graph showing the distribution the sources of noncapital gains income for the top 10% in 1929 and in 1998 (Piketty and Saez) is here:

    http://noumignon.livejournal.com/37706.html

    The following is from Piketty and Saez (capital gains in share) and the BEA:

    Pretax Taxable Personal Income share (%) of the bottom 90% and NGDP growth and the GDP implicit price deflator
    Year-P0-90-Deflator-NGDP
    1929″”56.0″”-0.4″”-6.4
    1930″”56.8-(-3.7)-(-12.0)
    1931″”55.6-(-10.4)-(-16.1)
    1932″”53.6-(-11.7)-(-23.3)
    1933″”54.8″”(-2.7)-(-3.9)
    1934″”54.8″”-5.6″”-14.7
    1935″”56.5″”-2.0″”-11.1
    1936″”54.9″”-1.0″”-14.3
    1937″”56.5″”-4.3″”-9.7

    Notice that income shares of the bottom 90% generally trended downward with deflation and falling NGDP and did the opposite with inflation and rising NGDP. The top 10% on the other hand saw their income shares increase during the contractionary period. In fact the split in income shares in Hoover’s last full year of 1932 was the lowest for the bottom 90% and the highest for the top 10% on record until 2005.

  52. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. July 2012 at 12:45

    Here is capital income, NGDP growth rates and inflation for the period from 1961 through the present day:

    http://research.stlouisfed.org/fred2/graph/?graph_id=78612&category_id=0

    Note that capital income was rarely more than 14% of personal income during the age of accelerating inflation and has been always much higher during the era of disinflation.

  53. Gravatar of Major_Freedom Major_Freedom
    5. July 2012 at 13:13

    Saturos:

    No, if nominal interest rates are expected to be zero forever, then we should do actual helicopter drops to get a higher trend rate of inflation, then continue with NGDP targeting. Or reform the currency.

    “we should do actual helicopter drops”

    What lunacy.

    Don’t you ever let Congress seize control of the whole (nominal) economy.

    Don’t you ever let Congress’ central bankers seize control of the whole nominal economy either.

    The same problem of a lack of individual private property, and economic competition subject to profit and loss in the production of money itself, and thus a functioning price system for the production of money, remains there whether the Fed or the Treasury is in charge of the governmental printing press.

    I always find it funny watching monetarists shedding crocodile tears about not trusting Congress with the printing press, on the basis that Congress will allegedly inflate too much. It’s funny because I see years upon years of endless monetarist pleading to the Fed to print more money than they do, and that it is better to err on the side of inflation than deflation. Why aren’t monetarists in favor of Congress taking control of the printing press?

    I have a hypothesis: Monetarists subconsciously want to be in a situation of blaming the Fed for lack of inflation, so as to present their own more extreme inflationist worldview as the solution. That’s the only way problems caused by inflation can be solved by inflation. It’s not even necessarily intentional on their part. It’s an organic outgrowth of inflation. They cannot connect inflation itself to economic problems, so the only available option in their minds is that there somehow isn’t enough inflation. They see status quo NGDP growth, and incorrectly infer that this past NGDP growth is somehow a reflection of a healthy, growing economy. They can’t grasp that even 4% NGDP growth year after year can still be a result of monetary inflation that is far too high, and generating incredible malinvestments, and that a healthy NGDP would fluctuate, or even gradually fall for stretches of time.

    By jealously protecting the Fed’s alleged “independence”, monetarists who suspect that the Fed will inflate less than monetarists believe they should, can then blame economic problems which have been CAUSED by inflation, on an alleged lack of their own monetarist views being practiced at the Fed:

    “Oh no! You can’t blame us! We said the Fed failed by not printing enough money! If they listened to us, if only they inflated more, everything would have been fine. You can trust us. Inflation is still a good thing, but only if OUR ideas are dominant. Our intellectual investment has not been a waste of time!”

    Then why not give control of the printing press to Congress? Won’t they give you the inflation you so crave, inflation that the Fed is too “intelligent” to make the mistake of doing?

    “Oh no! That would expose our shenanigans and make the rabble realize just how deceitful and destructive inflation really is! We can’t have that! The Fed must remain “independent” so that we can continue our careers of being right all along, that the Fed isn’t inflating enough. Congress will give the people what we want, and that would be fatal to our careers as fiat bug political strategists.”

    ———–

    No individual spends 5% more each and every year, year in and year out. Why should a population of individuals spend a collective 5% more each and every year, year in and year out?

    If I spend $5000 less this year as compared to what I spent last year in my particular market, why in the world does another person have to spend an additional $5000 this year as compared to what they spent last year in their particular market?

    If I spend $5000 more this year as compared to what I spent last year in my particular market, why does another person have to spend $5000 less this year as compared to what they spent last year in their particular market?

    What’s the logic? What’s the explanation here? What is the connection between an individual’s spending, and two or three or four people’s collective spending? If 3 people decide to reduce their spending in Nevada, what good would 1 wealthy person spending more money in New York do, such that “NGDP” didn’t fall?

    Why does my reduction in spending money, say on the clothes I buy, have to be offset by another’s increase in spending money, say on the food they buy?

    Why does there have to be offsetting spending brought about by the Fed on a national scale, rather than a global scale, or a city or state scale? Would anyone suggest that it is cheaper for a person who lost their job in Las Vegas, Nevada where US dollar spending fell, to move to NY, New York where US dollar spending increased, than for a person living in Niagara Falls, NY where US dollar spending fell, to move a few miles away to Niagara Falls, Canada where there are no US dollar incomes? What if spending in Niagara Falls Canada fell from last year, and yet a person from Niagara Falls, NY still moved there? Isn’t that enough to refute the notion that aggregate spending has to increase at a national level?

    If not, what would have to occur before NGDP theory is falsified in the minds of its advocates?

  54. Gravatar of Mike Sax Mike Sax
    5. July 2012 at 13:26

    W. Peden so the analogy you’d draw between fiscal policy and QE is between rain and water from a hose? Which one is which? And as for your garden both rain and the hose do the trick of watering it.

  55. Gravatar of Jim Glass Jim Glass
    5. July 2012 at 13:58

    If the Fed bought all $8tr in Treasuries tomorrow, the following would arguably occur:

    -The government would no longer owe private bondholders $8tr.
    -The government would owe banks $8tr.
    ~~~~

    And also, as an individual from whom the Fed bought long-term Treasuries, I would now hold money instead of bonds. But I don’t want to hold money, I want to be receiving interest, that’s why I owned long-term T-bonds to begin with. So now I will take the money I received for my T-bonds and use it to buy a substitute for what I just sold, high-quality corporate bonds.

    This purchase (and many other such purchases by others like me) increases the demand for corporate bonds without increasing their supply, thus the bonds increase in price and the interest rate paid on corporate borrowing via bond issuance falls. This strengthens the balance sheets of corporations and also those who invest in corporate bonds, which combined with the lower cost of borrowing encourages them at the margin to spend and invest more, and also likely increases stock market valuations. (See the aftermaths of the various QEs).

    Of course I, as a diversified investor, initially also owned corporate bonds and stocks, in addition to my T-bonds. Thus the increase in their value results in gain to me.

    This increase in my personal wealth makes me feel good, so I decide to spend some of it on a nice celebratory dinner, a nicer summer vacation than I’d originally planned, and maybe on buying that new car I’ve been thinking about…

    The idea that expansive money policy stimulates the economy only through bank lending is extremely myopic.

  56. Gravatar of David Pearson David Pearson
    5. July 2012 at 14:53

    @Jim Glass,
    The sequence you suggest could be exactly replicated by the Treasury issuing T-bills to the Fed and using the proceeds to buy risk assets. The so-called wealth effect could just as easily be an artifact of fiscal policy.

    Given that a public sector purchase of risk assets creates risk for taxpayers, which is preferable:

    -for taxpayers to have a say in that risk creation through the legislative appropriations process;

    or,

    -for the Fed to put taxpayers at risk outside of that process?

    In the absence of demand for bank reserves (at the ZLB), the size of the Fed’s risk asset holdings represent the size of the contingent tax liability created on behalf of taxpayers. For those that ask, “why shouldn’t the Fed buy up all the bonds,” the answer is, “because this would transfer risk from private investors to taxpayers without their consent.”

  57. Gravatar of Max Max
    5. July 2012 at 16:09

    Bill,
    “Monetary policy is about changing the quantity of money.”

    Really? I say that monetary policy is about influencing the profitability of investment. It does this by changing the money interest rate and/or expected inflation. Neither of which depends on the quantity of (base) money.

  58. Gravatar of Max Max
    5. July 2012 at 16:20

    For the people who keep asking, “if QE doesn’t work, then the Fed should monetize the entire national debt. Wouldn’t that be wonderful?”

    No, actually, there’s nothing particularly wonderful about it. Debt is debt, whether it’s in the form of bank reserves or treasuries. “But money doesn’t pay interest!”, you say. In fact money DOES pay interest, since 2008. And anyway, if money didn’t pay interest, then the Fed would be obligated to sell back the treasuries when a positive interest rate is needed. Hopefully sooner rather than later, right?

  59. Gravatar of dwb dwb
    5. July 2012 at 17:22

    @max,
    ” No, actually, there’s nothing particularly wonderful about it. Debt is debt, whether it’s in the form of bank reserves or treasuries. “But money doesn’t pay interest!”, you say. In fact money DOES pay interest, since 2008. And anyway, if money didn’t pay interest, then the Fed would be obligated to sell back the treasuries when a positive interest rate is needed. Hopefully sooner rather than later, right?”

    no, treasuries cannot be redeemed for those pieces of paper and electronic deposits used to pay for things. if the debt was extinguished there would be significant seniorage revenue and taxes could be nearly eliminated. you have to imagine what happens if the govt pays for everything with newly minted cash.

  60. Gravatar of ssumner ssumner
    5. July 2012 at 17:26

    Luis, Yes, I addressed that somewhere.

    David, I don’t see where you are respondeding to my argument. You seem to be just repeating the liquidity trap argument, which has already been proved wrong by the markets.

    The fact that interest rates are zero is not important unless they are expected to always be zero.

    Max, I think QE “works” it’s just that I think there are better tools.

    You said;

    “I guess the part Williamson has trouble with is, “interest rates won’t be zero in the long run.””

    Well then we agree. If interest rates are expected to be zero forever, then obviously OMOs have no impact.

    Dan, I’m open to alternative suggestions. One possibility is that the market doesn’t see reserves and T-securities as being perfect substitutes, after all, the Fed buys longer term debt with positive yields.

    Alex, You said:

    “I think part of the problem here is that QE really doesn’t “do anything”. It just signals what the Fed is likely to do when we emerge from the ZLB. The thing is, you can at least in principle do the same thing just by announcing what you will do when we emerge from the ZLB without doing QE at all.”

    Yes, but it’s ALWAYS true that 99% of the impact from a monetary annoucement flows from the expected impact on future policy.

    David, You said;

    “When there is no demand for bank reserves, QE is just an asset swap.

    When there is demand for bank reserves, QE leads to money creation”

    Don’t you have these reversed? If there’s demand for reserves then the money supply doesn’t rise.

    Mark, I left a comment over at Noah’s blog. Obviously he misunderstood what the NGDP futures proposal is all about.

    Max, You said;

    “And anyway, if money didn’t pay interest, then the Fed would be obligated to sell back the treasuries when a positive interest rate is needed. Hopefully sooner rather than later, right?”

    Why? If it’s to prevent high inflation, then I agree. But there’s no legal obligation.

    Saturos, I’ll take a look at the paper.

    If I missed anyone’s question, ask it again and I’ll try to get it tomorrow.

  61. Gravatar of ssumner ssumner
    5. July 2012 at 17:31

    Saturos, So they think low rates are easy money. In that case how can we trust anything else they have to say?

  62. Gravatar of Jim Glass Jim Glass
    5. July 2012 at 22:25

    @David Pearson

    @Jim Glass, The sequence you suggest could be exactly replicated by the Treasury issuing T-bills to the Fed and using the proceeds to buy risk assets. The so-called wealth effect could just as easily be an artifact of fiscal policy.

    And yet the sequence is not created that “could be” way, but entirely from the normal Fed buying of T-securities, classic monetary policy methodology since the creation of the Fed.

    Money is put into people’s hands and they buy things with it — corporate bonds (increasing bond prices and reducing borrowing costs), restaurant meals, vacations, cars, etc. (increasing the velocity of money). Bank lending not necessary (though it will likely increase as a consequence, not the cause, of the increased economic activity.)

    “why shouldn’t the Fed buy up all the bonds,” the answer is, “because this would transfer risk from private investors to taxpayers without their consent.”

    OK, so now the point moves from “money policy is ineffective at the zero FFR” to “money policy is effective at the zero FFR, but at the risk of the Fed possibly incurring an investment loss from buying longer-maturity T-securities”.

    That is an entirely different and much milder objection, addressed by Prof Sumner back two posts ago. But the gist is that the Fed in fact has been making money hand over fist from its longer-term investments … effectively spurring the economy via monetary policy would create huge additional amounts of tax revenue for the Treasury … the legal mandate of the Fed does *not* include ‘avoid investment losses’ … and the amount of losses suffered by the Fed that would be required to actually drop a resulting liability for them on taxpayers would be so implausibly large as to be an imaginary number.

    After all, nobody is suggesting that the Fed actually buy all outstanding T-securities. It’s merely a thought experiment that illustrates money policy is effective at a zero FFR.

  63. Gravatar of Saturos Saturos
    5. July 2012 at 22:26

    Scott, you sound like Matt O’Brien:

    http://www.theatlantic.com/business/archive/2012/07/liebor-is-an-existential-crisis-for-the-big-banks/259384/

    If Barclays will lie about something as fundamental as Libor to profit on its trades, how can clients trust them on anything?

  64. Gravatar of Benjamin Cole Benjamin Cole
    6. July 2012 at 02:23

    Excellent blogging by Sumner.

    I have to agree with Milton Friedman; QE will work, even with poor leadership from the Fed. People who sell bonds to the Fed will have to buy other assets (good) or spend the money (good). I suppose they can bank the money, in which case banks would become so flooded with reserves they would have to start lending sooner or later.

    If the Fed committed to $100 billion a month in QE (I prefer buying Treasuries only) until NGDP growth targets were hit for some period (one year, say) I think we would get growth, some inflation, and we would wipe out (monetize) $1-2 trillion in debt. Hard to see a downside here.

  65. Gravatar of 123 123
    6. July 2012 at 04:08

    Bill Woolsey:
    “No one has to borrow any more at all. In fact, it would be much better if people currently holding government and private bonds sold them and used the proceeds to buy consumer and capital goods. This isn’t more borrowing and spending. It is less lending and more spending.”

    Good monetary policy will help us to achieve optimal level of debt. Ceteris paribus the level of debt is higher when monetary policy is optimal, just like the level of employment is higher when monetary policy is optimal. Ben Bernanke has explained during the lates press conference how his monetary stimulus helps the credit markets by making it more attractive for banks to look for the credit spread earnings instead of earning low safe yield.

  66. Gravatar of Max Max
    6. July 2012 at 11:00

    “if the debt was extinguished there would be significant seniorage revenue and taxes could be nearly eliminated.”

    seniorage is actually negative, since for some crazy reason the Fed is paying more on reserves than the treasury pays on bills.

  67. Gravatar of dwb dwb
    6. July 2012 at 11:48

    @Max
    “seniorage is actually negative, since for some crazy reason the Fed is paying more on reserves than the treasury pays on bills.”

    we were considering the case where the Fed retires ALL the outstanding publicly held debt. there is a considerable stock of treasury debt that pays more than 25 bps, starting 2 years and out:

    http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

  68. Gravatar of dwb dwb
    6. July 2012 at 11:53

    @max,

    i just looked it up and the weighted average interest rate on the total stock of outstanding marketable US treasury debt is just north of 2.1%. I keep asking: if QE is ineffective, why not just replace all this debt with currency or reserves paying only 25 bps??? there is like 8 trillion held by the public we could redeem and cut taxes.

  69. Gravatar of Max Max
    6. July 2012 at 12:50

    Seniorage is the difference between short term debt and money. Long term vs short term is a different issue. In general, in the proverbial long run, it’s cheaper to issue short term than long. But right now, it’s not such a hot idea, because long term yields are ridiculously low. By buying long term bonds the Fed is betting against itself – it makes money only if it fails. Which to me, is not confidence inspiring.

  70. Gravatar of dwb dwb
    6. July 2012 at 17:05

    @max:
    “Seniorage is the difference between short term debt and money.”

    no: technically seniorage is the value of money in excess of the cost to produce it, so we are both being a little fast and loose with the definition here. If it costs .01 to print $1 then the seniorage revenue is .99. technically, the avoided cost on the outstanding debt (when the Fed buys it) is not revenue since its reduced interest payments. Seniorage “revenue” happens when those reserve balances are converted to currency. However, i am using seniorage loosely to include all avoided costs.

    The Fed is not betting against itself buy buying long term bonds. its replacing debt with currency and avoiding future tax collection.

    If the Fed bought all the outstanding debt and retired it the avoided interest costs would be about 400 Bn dollars. In addition, since the federal government could spend freely by printing fiat money without tax collection, the govt could stop collecting taxes.

    Clearly that’s stimulative!

    Somewhere between buying the entire national debt and retiring it, and what the fed has already done (~2 Tn), is about the right amount of QE (a number which depends on how much the market believes the Fed determination – right now we are all skeptical so i would say at least 1.5 Tn).

    I can guarantee you: if the Federal reserve retired the national debt and started financing the govt by printing money, inflation would rise to at least 35% per year. you should not doubt that.

    QE is effective: its merely a question of credibility (determination to print money) and permanence (how long the market expects those reserves to be convertible to currency).

  71. Gravatar of dwb dwb
    6. July 2012 at 17:35

    if the Fed bought all the US treasuries, this would become about 400 BN of avoided interest costs handed back to the treasury.

    http://www.federalreserve.gov/newsevents/press/other/20120110a.htm

  72. Gravatar of ssumner ssumner
    6. July 2012 at 18:00

    Saturos, That does sound similar.

    Thanks Ben.

  73. Gravatar of Saturos Saturos
    6. July 2012 at 20:18

    Ben Cole

    “QE will work, even with poor leadership from the Fed.”

    Only if it’s permanent. If it’s temporary it’ll be hoarded. And yet the Fed is currently having to alternate between satisfying journalists who have suddenly realized that the Fed isn’t doing enough, and satisfying the Republicans that the Fed will “pull out” in time to prevent hyperinflation – or indeed any inflation above 2%.

  74. Gravatar of Max Max
    6. July 2012 at 22:33

    “The Fed is not betting against itself buy buying long term bonds. its replacing debt with currency and avoiding future tax collection.”

    It’s only avoiding taxes if it saves interest payments. Which it will not if the economy recovers. That’s because short term interest rates will rise above current (ultra low) long term rates.

    You are assuming that short term rates will remain low no matter what.

    “If the Fed bought all the outstanding debt and retired it the avoided interest costs would be about 400 Bn dollars. In addition, since the federal government could spend freely by printing fiat money without tax collection, the govt could stop collecting taxes.”

    You’re changing the subject to deficit spending. The treasury doesn’t need the Fed to monetize in order to run a deficit. Nor does monetization “help” run a deficit, unless there’s a default risk premium in the bonds, which is not the case.

    Check this out:

    http://www.treasury.gov/connect/blog/Pages/Chart-of-the-Day-Lengthening-the-Average-Maturity-of-Outstanding-Treasury-Securities-.aspx

    “Since the depths of the financial crisis in late 2008, Treasury has lengthened the average maturity of outstanding marketable Treasury securities by nearly 32 percent.

    In fact, the average maturity of outstanding marketable Treasury securities (63.9 months in May 2012) is now at its highest level in a decade. It is also above the 30-year historical average of 58.1 months between 1980 and 2010.

    The average maturity of outstanding marketable Treasury securities reached 70.9 months in May 2001. Over the course of the next seven years, it ultimately declined to a 28-year low of 48.5 months in October 2008.

    Moving forward, we intend to continue gradually lengthening the average maturity of outstanding Treasury securities.”

    While the Fed has been “quantitatively easing”, the Treasury has been (with considerably less publicity) been “quantitatively tightening”. So much for that.

    The average maturity is about 5 years. The 5 year bond is yielding 0.64%.

  75. Gravatar of Bill Woolsey Bill Woolsey
    7. July 2012 at 03:28

    Pearson:

    When the Fed was founded, it was supposed to create money by making loans to banks on the security of real bills–loans made by the banks to the private sector.

    Government bonds were initially forbidden to the Fed, but then allowed so they could earn income.

    The Fed was modeled on the Bank of England, which was a private bank.

    Who said that monetary policy _must_ involve an independent branch of the government creating reserves (and currency) by buying and selling government debt?

    Max:

    I still think monetary policy is about creating and destroying money. I would add that adjusting the yield paid on money itself is also part of monetary policy.

    I grant that statements by he central bank about the nominal anchor have nominal (and real) effects. But if we imagine an office that makes nominal anchor announcements but with no ability to impact the quantity of money (or the yield paid on money) it’s pronouncements would be irrelevant.

    And if there is a body that adjusts the quantity of money and the yield paid on it but says nothing about the nominal anchor, then it will still have nominal effects.

  76. Gravatar of Scott Sumner, Stephen Williamson, MMT and 'Concrete Steppes' | Last Men and OverMen Scott Sumner, Stephen Williamson, MMT and 'Concrete Steppes' | Last Men and OverMen
    26. February 2017 at 03:56

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