The fallacy of composition lies at the very heart of monetary economics
Most people try to visualize monetary economics at the micro level. What would I do if the Fed gave me some money? What would I do if the Fed sold me some money for a T-bond? But that approach simply won’t work, as these thought experiments are subject to the fallacy of composition:
1. We all think that we control our own personal quantity of base money. And we do.
2. We think the Fed controls the total monetary base. And it does.
3. So what if the Fed increases the base, and we don’t want to hold any more money? What happens? The answer is that our attempt to get rid of this money causes a change in the macroeconomy (higher NGDP), which eventually causes us to want to hold on to the extra money created by the Fed. That is the essence of monetary theory, the very core of (non-MMT) monetary economics, not changes in interest rates that may or may not make people want to invest more.
Len Rosenthal and Brito sent me a New York Fed piece by Antinolfi and Keister that seems to fall prey to the fallacy of composition:
In other words, the size of the monetary base is determined by the amount of assets held by the Fed, which is decided by the Federal Open Market Committee as part of its monetary policy.
It’s now becoming clear where our story’s going. Because lowering the interest rate paid on reserves wouldn’t change the quantity of assets held by the Fed, it must not change the total size of the monetary base either. Moreover, lowering this interest rate to zero (or even slightly below zero) is unlikely to induce banks, firms, or households to start holding large quantities of currency. It follows, therefore, that lowering the interest rate paid on excess reserves will not have any meaningful effect on the quantity of balances banks hold on deposit at the Fed.
The passage is literally true, but in a deeper sense is misleading in a very revealing way. It relies on a “micro approach” to monetary economics, ignoring the fallacy of composition.
A lower IOER will obviously reduce the total bank demand for ERs. That’s supply and demand 101. And Antinolfi and Keister are correct that it will not change the size of the monetary base. Nor will it directly make people want to hold a single dollar more in currency. So what gives?
This attempt to get rid of ERs is essentially a OMO by the banking system. When they reduce their collective demand for ERs, the money will literally be forced out into the economy. There are several ways this might occur. A pessimistic Keynesian would say that interest rates on bank deposits would fall until people wanted to hoard more cash. An optimistic monetarist would say that the monetary injection would boost NGDP enough so that people would want to hold more cash, in order to make a larger volume of purchases. In practice, it depends on all sorts of things, most importantly on expectations of future monetary policy. What sort of signal would be sent by the lower IOER?
Even in the optimistic case, the effect on the stock of ERs would be tiny. Thus suppose ERs are $2 trillion and cash is $1 trillion. Also suppose the lower IOER boosts NGDP by 2% (an optimistic assumption.) In that case currency demand might (and I emphasize might) rise by 2%, to $1.02 trillion. And that means ERs would fall by $20 billion, to $1.98 trillion. So they are right that ERs are not significantly affected. But the macroeconomy might nonetheless be very strongly affected.
Later on they indicate that the lowering of IOER might have macroeconomic effects. So I’m not trying to say their article is factually incorrect, or that they don’t understand the fallacy of composition. Rather I’m claiming that 99% of readers would interpret the passage I cited in exactly the same way that I did. That is, they’d assume that Antinolfi and Keister were trying to show that lower IOER would not do much good, because the level of ERs would not be significantly affected. They are right that the level of ERs would not be greatly affected, but they are wrong if they are trying to imply that this means the policy would not do much good. That question can only be answered by evaluating the signalling aspect of lower IOER.
PS. Later they speculate that a negative IOER would cause banks to hoard currency. Despite the fact that I was the first to publish a paper advocating negative IOER, I’m not really a big fan of the idea. But if the Fed did go ahead with negative IOER, it would be absolutely idiotic to exempt ERs held in the form of currency.
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27. August 2012 at 19:12
The amusing irony of this post is that market monetarism is based on a form of fallacy of composition, in reverse.
It presumes that what is (allegedly) true for the macro-economy, – i.e. a constantly growing aggregate spending is “good” for aggregate employment and aggregate output – is somehow also good for the individual.
Even if state monopoly of money harms individual market participants, through such things as wealth transfer, the business cycle, and growth in government intervention, we’re supposed to pretend that this harm doesn’t exist, and not only that, but we’re supposed make the fallacy of composition in reverse and conclude that the individual is benefited from central bank intervention because it (allegedly) increase various aggregate statistics.
Earth to monetarists: “Society” improves to the extent that individuals improve. If you try to consciously improve “society”, you will invariably exploit the individual.
It’s similar to how advancing group rights and group freedoms will invariably result in exploitation of individual rights and individual freedoms of those who do not have that group as an attribute.
27. August 2012 at 19:13
Interesting post. Reminds me of this post somewhat: http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/02/fallacies-of-composition-and-decomposition-the-supply-of-money-and-reserves.html
The Fed blog post you mentioned mirrored an argument by Jan Hatzius at Goldman Sachs who in turn was also making the same argument as some other Fed paper that is available here
http://www.newyorkfed.org/research/staff_reports/sr380.pdf
27. August 2012 at 19:41
Interesting post.
What do you think banks do when they shed their ERs?
27. August 2012 at 19:43
If the Fed fails to grow NGDP by 5% annualized, would market monetarists support “unofficial” US dollar manufacturers (who are often dogmatically and ideologically smeared as “counterfeiters”) to print whatever quantity of money for themselves and their friends, such that NGDP did rise by 5% annualized?
27. August 2012 at 20:16
Major_Freedom, isn’t that close to what free bankers thing, except the people that print their own money cannot ride off the legitimacy of the state?
27. August 2012 at 20:42
@Major Freedom: “If you try to consciously improve ‘society,’ you will invariably exploit the individual.”
Right. And if you try to consciously improve a football team, you will invariably exploit the players. And if you try to consciously improve a company, you will invariably exploit the employees.
Well, at least these later bits of nonsense follow from the earlier one.
27. August 2012 at 20:51
Brito:
Major_Freedom, isn’t that close to what free bankers thing, except the people that print their own money cannot ride off the legitimacy of the state?
With the exception of the whole “pay us 35% of your income in these paper notes created by our friends, or we’ll throw you into a cage”, yes, it’s close to free banking.
I was actually asking market monetarists who explicitly call for the Fed to print whatever money is necessary to coax the population into spending 5% more each year, given the assumption that the Fed fails.
So basically, the question can be one of the right here and now. I will ask you, an NGDP targeting supporter: Given that the Fed is not inflating enough to bring about 5% NGDP growth, then would you support me “unofficially” creating US dollars for myself and my friends (let’s suppose you’re excluded, and that you have to wait for the money to be spent and respent by others until it reaches your income), in whatever quantity that will result in the BLS noticing a 5% increase in NGDP in the coming months and years?
If 5% NGDP growth is what benefits “the economy”, then surely you would be in full support of my dollar creation activity, and not only that, since you know the Fed is failing to achieve 5% NGDP growth, and since you want more money creation and more spending, surely you would be against the state throwing me into a cage if I am “caught”?
This question is specifically designed to determine whether or not you support 5% NGDP for state control ideological reasons, or value-free economic “let’s benefit the economy” reasons.
Some caveats. Assume that I will print only so many dollars that, when added to the Fed’s printing, will result in 5% NGDP growth per year. Assume also that I just graduated with a PhD with Scott Sumner as an advisor, who has convinced me that 5% NGDP growth is optimal for both myself and everyone else.
What say you?
27. August 2012 at 20:59
Loosely related question: I keep hearing that the reason the Fed won’t let the FFR fall all the way to zero (or charge interest on reserves if they could get the authority) is that money market funds need even a slim interest spread to stay afloat, else they could collapse and cause giant disruptions to short term funding.
But I recall that the Riksbank charged 0.5% interest on reserves a few years ago (and have also since contracted their balance sheet from QE), so what’s the difference? Why didn’t that destroy the MMFs in Sweden?
27. August 2012 at 21:04
Gene Callahan:
@Major Freedom: “If you try to consciously improve ‘society,’ you will invariably exploit the individual.”
Right. And if you try to consciously improve a football team, you will invariably exploit the players. And if you try to consciously improve a company, you will invariably exploit the employees.
Except those are localized voluntary private institutions, Herr Callahan. I said “society”, as in everyone.
It’s interesting that my argument concerning “society” leads to you using analogies that contradict the context of my argument into something that I would personally agree with, as a means of somehow showing my argument is wrong.
Well, at least these later bits of nonsense follow from the earlier one.
The essence of a statist mind is to conflate voluntary, localized contracting that does not presume to include everyone in society, with the state, through the sloppy use of market based analogies to describe the state.
“You’re against the state forcing its religious views on everyone? Yet you’re in favor of a private Church requiring that its members practise certain rites! If you’re in favor of private Churches insisting on certain rules from its members, then you should be in favor of the state doing the same thing for everyone in society.”
I cannot believe I have to even make this clear to you. It’s like you completely abandoned what little reason you had left when you became a statist.
27. August 2012 at 21:15
Brito:
More specifically, would you support my dollar creation activity if it results in not only 5% NGDP growth, but it also results in your unemployment, because it just so happens that the money I create goes to your competitors, who can pay more for capital and labor, thus outbidding your employer for factors of production?
Or assuming you own your own business, it results in your bankruptcy via your competitors using the additional funds to create a new product that leads to an outright reduction in your sales revenues?
27. August 2012 at 21:17
Brito:
I am looking for simple yes and no answers. I prefer my questions not to be responded to with more questions.
27. August 2012 at 21:37
” I will ask you, an NGDP targeting supporter”
Wrong, I have no strong opinions with respect to NGDP targeting. Furthermore, I think the economy could evolve in different ways whilst still maintaining the same NGDP level, so I might not support the economy changing in a certain way even if it results in higher NGDP growth.
27. August 2012 at 21:42
“The essence of a statist mind…”
What did I tell you about pop psychology… You are so embarrassingly bad it psychoanalysis.
27. August 2012 at 21:58
“”You’re against the state forcing its religious views on everyone? Yet you’re in favor of a private Church requiring that its members practise certain rites! If you’re in favor of private Churches insisting on certain rules from its members, then you should be in favor of the state doing the same thing for everyone in society.” blah blah”
If the state was currently enforcing a religious viewpoint on society, and then someone in government decided this was wrong and tried to remove these religious laws in order to ‘improve society’, would you be against it? After all, this man is making a conscious effort from the top down to try and do something to try and improve society as a whole.
*Awaits thousands of rambling qualifications from MF about how this doesn’t apply, proving that his theories fall victim to Anthony Flew’s death of a thousand qualifications, rendering it useless and meaningless.
27. August 2012 at 23:20
Brito:
“ I will ask you, an NGDP targeting supporter”
Wrong, I have no strong opinions with respect to NGDP targeting.
But you’d be OK with it if it were policy. At any rate, generalize my question. Assume your preferred “rule” is the actual policy, and then assume the Fed fails. Then consider my proposal.
“The essence of a statist mind…”
What did I tell you about pop psychology…
What did I tell you about your irrelevant and false responses to my arguments?
You are so embarrassingly bad it psychoanalysis.
You are so embarrassingly bad at comprehending statist minds.
“”You’re against the state forcing its religious views on everyone? Yet you’re in favor of a private Church requiring that its members practise certain rites! If you’re in favor of private Churches insisting on certain rules from its members, then you should be in favor of the state doing the same thing for everyone in society.” blah blah”
If the state was currently enforcing a religious viewpoint on society, and then someone in government decided this was wrong and tried to remove these religious laws in order to ‘improve society’, would you be against it?
Such a thing would be a removal of actions taken to “improve society”, namely, the imposition of state religion. I would be for such a thing.
After all, this man is making a conscious effort from the top down to try and do something to try and improve society as a whole.
That isn’t top down. That is a removal of top down, which allows bottom up to flourish.
*Awaits thousands of rambling qualifications from MF about how this doesn’t apply, proving that his theories fall victim to Anthony Flew’s death of a thousand qualifications, rendering it useless and meaningless.
You wish.
27. August 2012 at 23:24
Brito:
Would you support my dollar creation activity if it results in not only [your preferred money inflation rule that the Fed fails to achieve] but it also results in your unemployment, because it just so happens that the money I create goes to your competitors, who can pay more for capital and labor, thus outbidding your employer for factors of production?
Or assuming you own your own business, it results in your bankruptcy via your competitors using the additional funds to create a new product that leads to an outright reduction in your sales revenues?
What say you Brito? Protect the state’s monopoly at the expense of the people, or support my actions that according to your monetary rule, are supposed to help people?
27. August 2012 at 23:31
Major:
“Brito:
Major_Freedom, isn’t that close to what free bankers thing, except the people that print their own money cannot ride off the legitimacy of the state?
With the exception of the whole “pay us 35% of your income in these paper notes created by our friends, or we’ll throw you into a cage”, yes, it’s close to free banking.
I was actually asking market monetarists who explicitly call for the Fed to print whatever money is necessary to coax the population into spending 5% more each year, given the assumption that the Fed fails.
So basically, the question can be one of the right here and now. I will ask you, an NGDP targeting supporter: Given that the Fed is not inflating enough to bring about 5% NGDP growth, then would you support me “unofficially” creating US dollars for myself and my friends (let’s suppose you’re excluded, and that you have to wait for the money to be spent and respent by others until it reaches your income), in whatever quantity that will result in the BLS noticing a 5% increase in NGDP in the coming months and years?
If 5% NGDP growth is what benefits “the economy”, then surely you would be in full support of my dollar creation activity, and not only that, since you know the Fed is failing to achieve 5% NGDP growth, and since you want more money creation and more spending, surely you would be against the state throwing me into a cage if I am “caught”?
This question is specifically designed to determine whether or not you support 5% NGDP for state control ideological reasons, or value-free economic “let’s benefit the economy” reasons.
Some caveats. Assume that I will print only so many dollars that, when added to the Fed’s printing, will result in 5% NGDP growth per year. Assume also that I just graduated with a PhD with Scott Sumner as an advisor, who has convinced me that 5% NGDP growth is optimal for both myself and everyone else.
What say you?”
I can’t speak for Brito but I know what I say, I say go for it. Because the Fed is so bad at providing liquidity, it would be morally (though not legally justified) to counterfeit. (thats assuming the counterfeit notes were perfect)
27. August 2012 at 23:55
Brito, I would assume you’d just answer this one.
27. August 2012 at 23:57
Cory D has a fine new piece for you non-techies out there.
http://boingboing.net/2012/08/23/civilwar.html
28. August 2012 at 00:11
Oh LOL now Major Freedom is calling Gene Callahan a statist! This is too much!
And once again he demonstrates his complete ignorance as to how logic works. Tip: think about what would make your comment true. Now think about what would make Gene’s examples true. Now make the connection.
Or alternatively: suppose everyone on earth died except that football team. Now is there a difference between your arguments?
“It’s interesting that my argument concerning “society” leads to you using analogies that contradict the context of my argument into something that I would personally agree with, as a means of somehow showing my argument is wrong.”
Yes MF, that’s called “refuting someone”. Not that you would knoe.
28. August 2012 at 00:15
Oh wait it gets better:
“It’s similar to how advancing group rights and group freedoms will invariably result in exploitation of individual rights and individual freedoms of those who do not have that group as an attribute.”
and then you argue the exact opposite direction in response to Callahan.
28. August 2012 at 00:50
Edward:
I can’t speak for Brito but I know what I say, I say go for it. Because the Fed is so bad at providing liquidity, it would be morally (though not legally justified) to counterfeit. (thats assuming the counterfeit notes were perfect)
Thanks for your response. I am actually quite surprised someone here would say they would support it.
Followups:
Why would my actions be “moral”?
What is the importance of the notes being perfect counterfeits, as opposed to imperfect counterfeits? Suppose they’re imperfect and yet they still circulated as money. Wouldn’t my actions have the same effect on nominal demand? Wouldn’t I still be benefiting others as long as they were accepted as money?
Going further, suppose I too failed. Suppose I overshoot, and suppose the Fed still fails, and NGDP growth goes to 6%. Taking things from the other direction, if we suppose the Fed is unwilling to remove liquidity from the economy in order to reduce NGDP, and I am not willing to destroy other people’s money, would it be “moral” for my friend Pyro to go out and destroy other people’s money in such an amount that leads to NGDP growth going back to 5% per year?
Saturos:
Oh LOL now Major Freedom is calling Gene Callahan a statist! This is too much!
Are you for real? Callahan IS a statist. You’re in denial.
And once again he demonstrates his complete ignorance as to how logic works.
This is an empirical observation, induced from Callahan’s statements.
Tip: think about what would make your comment true.
Already did.
Now think about what would make Gene’s examples true. Now make the connection.
Callahan’s examples contradict the context of my argument.
Or alternatively: suppose everyone on earth died except that football team. Now is there a difference between your arguments?
If that football team is the only group of people left, there would no longer be a football team genius. There’d be nobody left to play.
A rather acute problem of universals is very ingrained in your philosophy I see.
“It’s interesting that my argument concerning “society” leads to you using analogies that contradict the context of my argument into something that I would personally agree with, as a means of somehow showing my argument is wrong.”
Yes MF, that’s called “refuting someone”. Not that you would knoe.
He didn’t “refute” me. He didn’t address my argument. He introduced a new argument that doesn’t talk about “society”, but voluntary, localized interactions.
Try again.
28. August 2012 at 00:53
Saturos:
Oh wait it gets better:
“It’s similar to how advancing group rights and group freedoms will invariably result in exploitation of individual rights and individual freedoms of those who do not have that group as an attribute.”
and then you argue the exact opposite direction in response to Callahan.
Huh? That is in the SAME “direction” as Callahan! From universal to concrete individual.
28. August 2012 at 00:56
Scott, Yichuan Wang has a great post: http://synthenomics.blogspot.com.au/2012/08/interest-on-excess-reserves-illustrated.html
HT David Beckworth on Twitter
MF, “…who do not have that attribute” contradicts “Except those are localized … I said “society”, as in everyone.”
Gotta go now, byeeeee.
28. August 2012 at 01:14
“So what if the Fed increases the base, and we don’t want to hold any more money? What happens?”
Perhaps we increase our demand to hold money without getting rid of it?
You make it sound like the money demand debates never happened.
28. August 2012 at 02:58
Ritwik,
Is there a viable demand function for money where liquidity preference is infinite? I only know of Keynes’s attempt.
28. August 2012 at 03:45
Saturos:
MF, “…who do not have that attribute” contradicts “Except those are localized … I said “society”, as in everyone.”
I wasn’t personally advancing the theory “It’s similar to how advancing group rights and group freedoms…”. That was me characterizing the position of those who seek to advance “society.” I was saying those positions are similar.
You misunderstand.
28. August 2012 at 05:06
Prof. Sumner, this is not your best post, by a long shot. A dismissal of microfoundations as a fallacy of composition is not something you really want to put in print and have come back to bite you some day.
28. August 2012 at 06:42
RPLong, My monetary model has microfoundations (it’s simply S&D), I’m saying a micro view can lead one astray if you’re not careful. The price level is a macro variable, but it’s also the value of money (inverted). Money is where micro and macro interact.
Saturos, I can’t get Wang’s blog in China.
Brito. They buy assets when they want to reduce ERs.
28. August 2012 at 08:57
MF, put it this way, if we’re talking about outside money then the only sort of people I support ‘making new money’ are people who operate within a transparent organization that must adhere to specific laws, but also I do not think all ‘money printing’ is created equal, which is why I’ve said before I’d rather a different system where the money is used only to pay for needed and productive activities across the whole country, rather than the current system, rather than going to primary dealers. If this private group of individuals were to be like this then fine, but it would be a contradiction since now they are fully transparent, agents of an accountable organization and operate on a not for-profit basis they are no longer private in any meaningful sense.
On the other hand, inside money is a different story, banks already essentially create new money all the time, and are private organization. However, they only loan when there are worthy customers, I cannot expect them to expand credit beyond this to their detriment.
28. August 2012 at 09:02
“Brito, I would assume you’d just answer this one.”
Why? I’m not a hardcore monetarist, just because I comment on this blog a lot, I don’t consider myself a Market Monetarist, I don’t see why MF should care what I think.
28. August 2012 at 09:04
Oh MF, and if you’re asking whether I support a policy even if it results in my unemployment despite being better for everyone overall, then yes, or at least if I were to oppose it that would be purely for selfish reasons.
28. August 2012 at 09:08
“Such a thing would be a removal of actions taken to “improve society””
A removal of an action is an action itself, and that is a non sequitur since you made no mention of this, you only spoke of whether someone tries to ‘consciously improve society’, that is doing exactly that.
28. August 2012 at 09:37
Scott, what if there are no safe assets to buy, and would rather just hoard cash with no interest rather than take additional risk?
28. August 2012 at 09:58
Brito, I just meant it seems like you to answer directly.
28. August 2012 at 10:37
Brito:
MF, put it this way, if we’re talking about outside money then the only sort of people I support ‘making new money’ are people who operate within a transparent organization…
There is actually no such thing as a fully transparent institution anywhere on the planet, for the simple fact that knowledge in society is dispersed among the population, which leads to inevitable information asymmetry in social life. (See Hayek).
that must adhere to specific laws…
Whose laws? What laws?
but also I do not think all ‘money printing’ is created equal, which is why I’ve said before I’d rather a different system where the money is used only to pay for needed and productive activities across the whole country, rather than the current system, rather than going to primary dealers.
Short of everyone receiving dollars at the same rate at the same time, an institution with state enforced monopoly privilege of money creation is inevitably going to be controlled by individuals who decide who gets the initial flow of dollars and who doesn’t. If you want to replace the primary dealer system, then wouldn’t your preferred route be no less group-based and privilege oriented? Why should someone NOT in the special group of your choice, support your preference, which is being backed not by asking or permission or request, but brute force?
Also, you say “needed” and “productive.” Needed and productive determined by who? You do realize that your values are certainly different from mine, and both your values and my values are different from everyone else’s too, right? If you value an additional road, but I value an additional school, and resources are scarce such that we can only choose one or the other, then why should your preferences for those resources overrule mine, or vice versa? Is it merely a simpleton matter of might makes right for you? Where we settle our disagreements not by recognizing who has legitimate property rights and protecting the decisions of the owner, but who has the biggest guns and army, including non-owners?
Why should your preferred person or group of people decide what is “needed” and what is “productive” for myself and my family, when it comes to our own lives? Why should some random group of strangers I have never even met, and whose opinions I do not care for, who know very little about my desires and my needs, impose their values on me when it comes to my person and my means of life?
Obviously in your worldview it’s not the individual who is to decide his own values for his own person and means of life. I am not permitted to exercise valuation of things for myself. Obviously “others” are going to be considered justified in expressing their own values, and they are going to be considered morally justified in including me into it (by force if I peacefully resist of course, or else your “solution” will break down).
If this private group of individuals were to be like this then fine
What if the institution is a real world one, where there is not full transparency? What if the institution adheres to a specific set of laws agreed to by the specific parties associated with it, via contracting, but their own laws for themselves differ from your preferred laws for yourself and those you deal with? Why should their values for themselves be imposed on you and those you do business with, and why should your values for yourself and those you do business with be imposed on them and those they do business with?
What is the justification for you forcing me to manage my own property in ways you desire, rather than what I desire?
but it would be a contradiction since now they are fully transparent, agents of an accountable organization and operate on a not for-profit basis they are no longer private in any meaningful sense.
Are you kidding me? There exists a plethora of private, not-for-profit organizations, private accountable organizations, and relatively transparent private organizations.
The state is the least transparent institution ever to exist in human history. They can hide information behind “legal” guns, according to their final authority, whereas private organization managers are forced by the state to reveal information they otherwise do not want to release. The CIA, FBI, NSA, Pentagon, Congress, White House, all these state agencies invoke “national security” to maximize information asymmetry between them and the public, and to make the public almost completely ignorant of what they are actually doing. They go after whistleblowers. Many in the state want to kill Julian Assange for example. For what? Exposing war crimes and making the state more transparent.
For you to sit there and say that a transparent, accountable non for profit organization cannot be considered private, hence it must be “public”, is nothing but a twisted conceptualization of the state vis a vis private institutions, that views the state as more transparent, more accountable, and more not for profit than private institutions. How many politicians have been tried for war crimes? How many have been imprisoned for looting social security? How many police officers who trafficked drugs, murdered, and raped, been imprisoned? What incentive do those in the state have in minimizing their own power and imprisoning of their own? It would be like saying a defendant who is his own judge, is going to be more transparent than a private institution that has to answer to third party arbitrators.
On the other hand, inside money is a different story, banks already essentially create new money all the time, and are private organization. However, they only loan when there are worthy customers, I cannot expect them to expand credit beyond this to their detriment.
Customers who are not worthy of higher interest rate loans suddenly become “worthy borrowers” when banks engage in credit expansion, which lowers interest rates temporarily. Being a worthy borrower depends in part on interest rates. You can’t hold worthiness constant when considering bank credit expansion. The worthiness itself changes. Just consider the tremendous expansion of mortgage loans to subprime and other less worthy borrowers when the incredible debt inflation from the Federal Reserve System put mortgage rates at record lows.
“Brito, I would assume you’d just answer this one.”
Why? I’m not a hardcore monetarist, just because I comment on this blog a lot, I don’t consider myself a Market Monetarist, I don’t see why MF should care what I think.
You’re not a hardcore monetarist? So you support a free market money standard then, and would like for the Fed to be abolished?
I think you’re evading the question because you’re afraid of going down that road for fear of having your views overturned rather abruptly. Prove me wrong.
Oh MF, and if you’re asking whether I support a policy even if it results in my unemployment despite being better for everyone overall, then yes, or at least if I were to oppose it that would be purely for selfish reasons.
Brito, not that this necessarily means anything to you, but I cannot possibly respect you. Saying to me that you would sacrifice your own welfare for the sake of “society” is exactly the mentality that allows totalitarianism to spread. Totalitarianism is sacrifice of the individual for the sake of the “fatherland”, “society”, par excellence.
No wonder I despise your attitude, reject your views, and think you’re wrong. Your morality calls for self-sacrifice. That ideology colors serves as a foundation for your entire “economics” worldview.
“Such a thing would be a removal of actions taken to “improve society””
A removal of an action is an action itself
I am not saying there is no action. I am saying that it is removing a specific action, namely, the specific actions of some people “improving society” via state religion. Removing those actions is itself an action yes, but it a removal of the specific action I am talking about, not action per se.
and that is a non sequitur since you made no mention of this
Just because you made a careless and sloppy inference, based on a straw man, and then asked a rhetorical question assuming it was a “gotcha”, it doesn’t mean what I said is a “non-sequitur”. I answered the assumption tacit in your rhetorical question, which is the assumption that someone who removes an action that “improves society”, because it is an action, is somehow the same thing as an action that “improves society” also, and on this basis, I have to support someone “improving society” by infiltrating the state and removing the state imposed religion in order to be consistent. I addressed that tacit assumption. It wasn’t a non-sequitur to address that assumption. If you never made that assumption, I would not have addressed it. How can I possibly have “made a mention” of a response to an assumption you made, before you even made it?
you only spoke of whether someone tries to ‘consciously improve society’, that is doing exactly that.
No, it is consciously REMOVING an action that was intended to “improve society”.
By your “logic”, NO action can be anything BUT “improving society.” For even if a reversal of improving society is made, then you’re saying we still have to categorize it as improving society! That eliminates any possibility of action that is NOT intended to improve society.
See, the reason why you cannot see anything BUT actions that improve society when it comes to “good intentions”, is that you don’t consider selfish actions to be inherently good. Improvement is only possible in the public sphere, not the private, individual sphere.
If you want, you can pretend in your next post that your thinking and learning about the above is a series of corrections to my arguments. I don’t mind.
28. August 2012 at 10:38
Morgan:
Brito, I just meant it seems like you to answer directly.
More accurately, it is normal for Brito to answer others not me directly, because I ask questions that are relatively rarer and more “fringe.”
28. August 2012 at 11:05
Hi, Scott– I came in late on this. There is a throwaway line at the end of your post I wanted to ask about. When you said the Fed should not exempt ERs in currency form from the negative interest rates, just how would they do that? Do they have the legal power to assess some kind of tax on ERs held in currency? Would there be ways for banks to hold equivalent of ERs, say fully hedged holdings of euros, in a way that would have transactions costs lower than the Fed’s charge on currency ERs? Does Denmark, which has negative interest on ERs already, penalie ERs in currency? If so (or if not) have Danish banks increased currency holdings? Just wondering about all these things. Maybe you could do a post on the Danish experiment with negative IOER.
28. August 2012 at 11:09
Brito,
“Scott, what if there are no safe assets to buy, and would rather just hoard cash with no interest rather than take additional risk?”
As a trader at Solomon Brothers once told me, “There are no bad bonds, just bad prices.” At some level of rates, banks will extend credit. So, are rates artificially low? Why?
Professor,
“So what if the Fed increases the base, and we don’t want to hold any more money? What happens? The answer is that our attempt to get rid of this money causes a change in the macroeconomy (higher NGDP),”
How?
“which eventually causes us to want to hold on to the extra money created by the Fed.”
Easy money causes us to want to hold extra money?
“That is the essence of monetary theory, the very core of (non-MMT) monetary economics,”
Really?
“not changes in interest rates that may or may not make people want to invest more.”
This may get at the “how” question above! And without answering the “how” question you have the assertion that easy money IS NDGP, and the rest of the statement is irrelevant.
28. August 2012 at 11:14
Hi, Scott– I came in late on this. There is a throwaway line at the end of your post I wanted to ask about. When you said the Fed should not exempt ERs in currency form from the negative interest rates, just how would they do that? Do they have the legal power to assess some kind of tax on ERs held in currency? Would there be ways for banks to hold equivalent of ERs, say fully hedged holdings of euros, in a way that would have transactions costs lower than the Fed’s charge on currency ERs? Does Denmark, which has negative interest on ERs already, penalize ERs in currency? If so (or if not) have Danish banks increased currency holdings? Just wondering about all these things. Maybe you could do a post on the Danish experiment with negative IOER.
28. August 2012 at 12:00
“There is actually no such thing as a fully transparent institution anywhere on the planet, for the simple fact that knowledge in society is dispersed among the population, which leads to inevitable information asymmetry in social life. (See Hayek).
More pseudo-intellectual rhetoric, that’s not even what I mean by transparent, it means that knowledge is accessible, not that everybody knows everything about the organization. And what the hell is this, you’re the one who created this ridiculously unrealistic thought experiment: ” Assume that I will print only so many dollars that, when added to the Fed’s printing, will result in 5% NGDP growth per year. Assume also that I just graduated with a PhD with Scott Sumner as an advisor, who has convinced me that 5% NGDP growth is optimal for both myself and everyone else.”
It’s insane and obnoxious to attack me for using an unrealistic assumption when we’re dealing with a fantasy thought experiment which is already unrealistic. Whether such an organization is possible is irrelevant in this scenario, it’s just another excuse for you to be preach your religion.
“Whose laws? What laws?”
Great, this is just going to descend into debates regarding the legitimacy of the state. I have been debating this stuff for years, you act as if I’m unaware of the plethora of arguments for (and against) anarchism. This is a debate about monetary policy, this is NOT a debate about the legitimacy of the state, I have no interest in debating such an issue with you since you are too ideologically bound to anarchism to debate in good faith.
“Short of everyone receiving dollars at the same rate at the same time”
Perhaps, the main type of monetary expansion I argue for is new money funded reductions in sales and payroll taxes, that affects (nearly) everyone.
“then why should your preferences for those resources overrule mine, or vice versa?”
This ‘problem’ is completely irrelevant to my policy specifically, this problem is a problem for all government spending, it’s not an argument specific to my policy. All my policy is is just a suggestion about how to conduct monetary policy, given that government spending is not going to go away any time soon, it’s not a comprehensive political manifesto about how government should be structured. Your posts are far too abstracted from what is actually being discussed here. You’re like that annoying solipsist who whenever people are discussing matters of science just chirms “but how do you really KNOW that your perceptions are accurate, how can you be sure that this reality is real, how can you know anything other than that your own thoughts exist..?” That’s nice, and might be up for discussing, but it’s really not pertinent here.
“What is the justification for you forcing me to manage my own property in ways you desire, rather than what I desire?”
I have not said anything about forcing you to mange property in certain ways.
“Are you kidding me? There exists a plethora of private, not-for-profit organizations, private accountable organizations, and relatively transparent private organizations.”
Sorry, but by definition I define any organization that is accountable to the entire population, not for profit and transparent as a public organization. If you define that as private then that’s fine, but it’s just semantics and is not interesting or relevant.
” The CIA, FBI, NSA, Pentagon, Congress….”
The USA is not the only state, I never said that states today in their entirety are fully transparent (by the way I can so fucking easily name just as many disgustingly abhorrent and non transparent private organizations, live in the fucking real world please rather than your extremist fantasy anti-reality religion), so please stop with these insane strawman, mr Strawman King.
“Customers who are not worthy of higher interest rate loans suddenly become “worthy borrowers” when banks engage in credit expansion, which lowers interest rates temporarily. Being a worthy borrower depends in part on interest rates. You can’t hold worthiness constant when considering bank credit expansion. The worthiness itself changes. Just consider the tremendous expansion of mortgage loans to subprime and other less worthy borrowers when the incredible debt inflation from the Federal Reserve System put mortgage rates at record lows.”
I fail to see the relevance, banks are private organizations and I don’t support compelling them to expand credit if they don’t want to, if they decided to engage in expansion for their own reasons then good for them.
“No wonder I despise your attitude, reject your views, and think you’re wrong. Your morality calls for self-sacrifice. That ideology colors serves as a foundation for your entire “economics” worldview. ”
No, this is not a sacrifice, this is me doing what I want because I value it, I am ‘maximising my utility’. Let me ask you the same question, if you were a pharmaceutical CEO that mainly sells drugs for the treatment of AIDS, but then some scientists found a cure for AIDS, would you be against this cure being dispersed to the population, even though this would result in your company going bankrupt as there is no need for your treatment any-more? Do you consider those that do support the dispersement of the AIDS cure as evil totalitarians?
“I am not saying there is no action. I am saying that it is removing a specific action, namely, the specific actions of some people “improving society” via state religion. Removing those actions is itself an action yes, but it a removal of the specific action I am talking about, not action per se.”
Irrelevant, this guy is consciously trying to improve society.
“No, it is consciously REMOVING an action that was intended to “improve society”.”
Irrelevant, this guy is consciously trying to improve society. He is engaging in what you admit “is itself an action”, to improve society, which makes your religious extremist moral absolutism nonsense.
“By your “logic”, NO action can be anything BUT “improving society.” For even if a reversal of improving society is made, then you’re saying we still have to categorize it as improving society! That eliminates any possibility of action that is NOT intended to improve society.”
Doesn’t follow at all.
“Improvement is only possible in the public sphere, not the private, individual sphere.”
I didn’t say that in the slightest, I’ve read classical economics, I’m perfectly aware about how people pursuing their own interests can improve outcomes as a whole, the difference between me (and people like Adam Smith) and you is that I’m not a religious extremist in that like almost all I acknowledge that this isn’t a universal truth, and that in some circumstances it doesn’t always hold.
28. August 2012 at 12:01
The hacks over at politico are speculating about Romney’s cabinet.
Glenn Hubbard…Treasury secretary ? Seems like a good bet. It is not like Romney who has surrounded himself with tight money guys is going to suddenly start picking Market Monetarist for his cabinet.
Despite what “independents” like to believe… elections have consequences.
http://www.politico.com/news/stories/0812/80233.html
28. August 2012 at 12:20
“So what if the Fed increases the base, and we don’t want to hold any more money? What happens? The answer is that our attempt to get rid of this money causes a change in the macroeconomy (higher NGDP),”
How?
You own long T-bonds. The Fed buys them from you. You sell them to it because the price is attractive to you. Now you own money (newly created by the Fed) instead of the T-bonds. But you don’t want to own money, if you did you would have owned money to begin with instead of T-bonds.
So, what do you do with the money? You buy something with it. How can buying something with it *not* increase demand?
If you buy a nice lunch, car, vacation, any goods/services, that increases demand.
If you buy the closest substitute to the T-bonds you sold, say long corporate bonds, that bids up their price and pushes down the cost of business borrowing. That increases demand as other investors in corporate bonds now have new profits to spend and stronger balance sheets, so they now spend/invest more… and businesses have stronger balance sheets, and lower cost of borrowing coupled with lower profit hurdles to meet, so they spend/invest more.
NGDP increases.
28. August 2012 at 12:37
Brito:
“There is actually no such thing as a fully transparent institution anywhere on the planet, for the simple fact that knowledge in society is dispersed among the population, which leads to inevitable information asymmetry in social life. (See Hayek).
More pseudo-intellectual rhetoric
I’m sorry, did you explain how I provided “pseudo-intellectual rhetoric” the first time, such that your use of “more” us justified? I must have missed it.
that’s not even what I mean by transparent, it means that knowledge is accessible, not that everybody knows everything about the organization.
The very reason not everyone knows everything about an organization is precisely because such knowledge is inaccessible. Accessibility contains a subjective component. I cannot access the totality of information that exists the minds of every other person in our society, because my mind is physically incapable of apprehending the totality of information. There is no difference in terms of accessibility between an infinite mind that can see only through a small hole, and a finite mind that has a 360 degree view.
No organization, even if it tried, can make accessible to every person everything there is to know about the organization.
And what the hell is this, you’re the one who created this ridiculously unrealistic thought experiment: “ Assume that I will print only so many dollars that, when added to the Fed’s printing, will result in 5% NGDP growth per year. Assume also that I just graduated with a PhD with Scott Sumner as an advisor, who has convinced me that 5% NGDP growth is optimal for both myself and everyone else.”
It’s insane and obnoxious to attack me for using an unrealistic assumption when we’re dealing with a fantasy thought experiment which is already unrealistic.
My thought experiment is not unrealistic. It is realistic. You are completely evading my thought experiment and you’re making up excuses not to address it.
Whether such an organization is possible is irrelevant in this scenario, it’s just another excuse for you to be preach your religion.
No, it’s relevant in this scenario. A non-Fed activity of printing money to raise NGDP to 5% per year, to correct Fed “failure”, is relevant to the very question I am asking. It IS the question I am asking.
“Whose laws? What laws?”
Great, this is just going to descend into debates regarding the legitimacy of the state.
Too bad you made all sorts of assumptions that themselves require justification. If someone invoked God as a premise 5 stages back, and another insisted that assumption be addressed, then it would be bad form for the person to become exasperated and refuse to budge and then consider the other side wrong.
I have been debating this stuff for years, you act as if I’m unaware of the plethora of arguments for (and against) anarchism.
I don’t see how that follows. How is merely asking you what laws you were referring to, and whose laws you were referring to, “acting as if you’re unaware” of some debate or another?
This is a debate about monetary policy, this is NOT a debate about the legitimacy of the state, I have no interest in debating such an issue with you since you are too ideologically bound to anarchism to debate in good faith.
That’s hilarious, considering the fact that a debate about monetary policy PRESUPPOSES a state, and as such, those who advocate for monetary policy are already ideologically bound to statism. Does that mean you cannot debate in good faith? Why are you as pro-state not ideologically bound and can debate in good faith, but I as pro-anarchy am ideologically bound and cannot debate in good faith?
You’re presenting a double standard and pretending it’s not.
“Short of everyone receiving dollars at the same rate at the same time”
Perhaps, the main type of monetary expansion I argue for is new money funded reductions in sales and payroll taxes, that affects (nearly) everyone.
My being taxed of less money, cannot be the equivalent of getting money from a printing press. The absence of an expenditure is not the same thing as an income.
“then why should your preferences for those resources overrule mine, or vice versa?”
This ‘problem’ is completely irrelevant to my policy specifically, this problem is a problem for all government spending, it’s not an argument specific to my policy.
But you’re advocating for it, so it HAS become your argument. You adopted it.
Someone who advocates for something that presupposes X cannot defend himself on the basis that others are presupposing the same thing in advocating for Y.
All my policy is is just a suggestion about how to conduct monetary policy, given that government spending is not going to go away any time soon, it’s not a comprehensive political manifesto about how government should be structured.
It’s tied up with your “suggestion”. If I “suggested” that Stalin kill only capitalists, and not petty bourgeoisie, and say “given he is killing people that’s what I would do”, then it would be evasion to deny that I am making particular assumptions and holding them as valid.
Your posts are far too abstracted from what is actually being discussed here.
It’s interesting how you interpret what I am discussing, as not what is being discussed. You’re not the final judge over what is discussed. Everyone contributes. You’re being evasive again.
You’re like that annoying solipsist who whenever people are discussing matters of science just chirms “but how do you really KNOW that your perceptions are accurate, how can you be sure that this reality is real, how can you know anything other than that your own thoughts exist..?”
You’re like that annoying opportunist who clings to the skirt of others and always redirects everyone’s attention to them instead of you.
That’s nice, and might be up for discussing, but it’s really not pertinent here.
Yes it is. I have decided it is pertinent enough to discuss. You don’t tell me what I can and cannot discuss.
“What is the justification for you forcing me to manage my own property in ways you desire, rather than what I desire?”
I have not said anything about forcing you to mange property in certain ways.
Monetary policy presupposes it, sucker. See why I bring it up? It’s because I know you don’t know.
“Are you kidding me? There exists a plethora of private, not-for-profit organizations, private accountable organizations, and relatively transparent private organizations.”
Sorry, but by definition I define any organization that is accountable to the entire population, not for profit and transparent as a public organization.
Sorry, but by definition I define that as a private institution.
If you define that as private then that’s fine, but it’s just semantics and is not interesting or relevant.
What’s the difference between a transparent, not for profit, accountable institution that does not have final territorial authority over security and protection (jurisdiction), and a transparent, not for profit, accountable institution that does have final territorial authority over security and protection (jurisdiction)?
“ The CIA, FBI, NSA, Pentagon, Congress….”
The USA is not the only state, I never said that states today in their entirety are fully transparent (by the way I can so fucking easily name just as many disgustingly abhorrent and non transparent private organizations, live in the fucking real world please rather than your extremist fantasy anti-reality religion), so please stop with these insane strawman, mr Strawman King.
Caveats and caveats and caveats…
“Customers who are not worthy of higher interest rate loans suddenly become “worthy borrowers” when banks engage in credit expansion, which lowers interest rates temporarily. Being a worthy borrower depends in part on interest rates. You can’t hold worthiness constant when considering bank credit expansion. The worthiness itself changes. Just consider the tremendous expansion of mortgage loans to subprime and other less worthy borrowers when the incredible debt inflation from the Federal Reserve System put mortgage rates at record lows.”
I fail to see the relevance, banks are private organizations and I don’t support compelling them to expand credit if they don’t want to, if they decided to engage in expansion for their own reasons then good for them.
I was making a point that it is wrong to assume worthiness is constant, regardless of the quantity of bank credit, as if interest rates changing has no effect on worthiness judgments.
“No wonder I despise your attitude, reject your views, and think you’re wrong. Your morality calls for self-sacrifice. That ideology colors serves as a foundation for your entire “economics” worldview. “
No, this is not a sacrifice, this is me doing what I want because I value it, I am ‘maximising my utility’.
By that definition no sacrifice is ever possible. Sorry, but I define sacrifice as willing to incur losses for random strangers.
Let me ask you the same question, if you were a pharmaceutical CEO that mainly sells drugs for the treatment of AIDS, but then some scientists found a cure for AIDS, would you be against this cure being dispersed to the population, even though this would result in your company going bankrupt as there is no need for your treatment any-more?
I am not in favor of patent laws, so…
Do you consider those that do support the dispersement of the AIDS cure as evil totalitarians?
Are they initiating force like the state that backs your monetary policy advocacy?
“I am not saying there is no action. I am saying that it is removing a specific action, namely, the specific actions of some people “improving society” via state religion. Removing those actions is itself an action yes, but it a removal of the specific action I am talking about, not action per se.”
Irrelevant, this guy is consciously trying to improve society.
It’s not irrelevant. He is in reality removing what was intended to improve society. He can call it rainbows and unicorns it doesn’t matter.
“No, it is consciously REMOVING an action that was intended to “improve society”.”
Irrelevant, this guy is consciously trying to improve society.
It’s not irrelevant. He is in reality removing what was intended to improve society. He can call it rainbows and unicorns it doesn’t matter.
He is engaging in what you admit “is itself an action”, to improve society, which makes your religious extremist moral absolutism nonsense.
No, he is removing what was intended to improve society.
“By your “logic”, NO action can be anything BUT “improving society.” For even if a reversal of improving society is made, then you’re saying we still have to categorize it as improving society! That eliminates any possibility of action that is NOT intended to improve society.”
Doesn’t follow at all.
Sure it does. If removing what was intended to benefit society is still benefiting society, it is impossible to label any action as not intended to benefit society.
“Improvement is only possible in the public sphere, not the private, individual sphere.”
I didn’t say that in the slightest, I’ve read classical economics, I’m perfectly aware about how people pursuing their own interests can improve outcomes as a whole, the difference between me (and people like Adam Smith) and you is that I’m not a religious extremist in that like almost all I acknowledge that this isn’t a universal truth, and that in some circumstances it doesn’t always hold.
You must have missed the part where the state pursuing its interests necessarily results in violations of individual well-being.
28. August 2012 at 13:04
Jim Glass,
You own long T-bonds. The Fed buys them from you.
First, the Fed buy short paper. Second, and mor importantly, I don’t own T-notes. Banks, insurance companies, pension funds, money funds and foreign central banks on the vast quanty of T-notes.
If XYZ insurance company sells their T-Note, then likely they are going to use the proceeds from that sale to buy AA rated corporate paper. Okay, what does the seller of that corporate paper do? They buy new-issue corporate paper. This puts cash on the corporate ballance sheet, and this can turn into investment.
Monitary policy is all about turning money into investment.
Now, in the current state of the world, the bank sells its T-noe, earning 0.10% to the fed, and what do they do with the cash? The let it sit at the fed where it can earn 0.25%. Interest on excess reserves is definately short circuiting the feedback loop that turns the money created from open market operations into investments (NGDP).
28. August 2012 at 15:16
Doug M,
So, since the ECB reduced its Deposit (IOR equiv) rate to zero, its NGDP should spike?
28. August 2012 at 18:13
Jim Glass, “You own long T-bonds. The Fed buys them from you.” >First, the Fed buy short paper.
If you don’t think the Fed has been buying long, you really haven’t been paying attention. And what do you imagine stops the Fed from buying long if it wants to?
Second, and mor importantly, I don’t own T-notes. Banks, insurance companies, pension funds, money funds and foreign central banks on the vast quanty of T-notes.
Well, maybe *you* don’t own any, but the Treasury says private investors own $8.5 trillion of the debt.
You apparently agree with what I said happens if T-bonds are bought from individuals. Now let’s look at firms.
OK, say the Fed buys long T-bonds (or long mortgage securities, whatever) from a bank or insurance company. It sells them because the price is attractive (profit!) The price of long bonds has gone up a lot as rates have fallen, and goes up *more* as the Fed buys them up.
Now the bank or insurance company owns money (newly created by the Fed) instead of the T-bonds. But it doesn’t want to own money, if it did it would have owned money to begin with instead of T-bonds.
So, what does it do with the money? It buys something with it. How can buying something with it *not* increase demand?
Perhaps it will buy office furniture, new tech systems, open a new office, hire some new employees, all of which increase demand.
Or perhaps it will buy the closest substitute to the T-bonds it sold, say long corporate bonds, which bids up their price and pushes down the interest rate on them and the cost of business borrowing. That increases demand as other investors in corporate bonds now have new profits to spend and stronger balance sheets, so they now spend/invest more … and businesses now have stronger balance sheets, and lower cost of borrowing coupled with lower profit hurdles to meet, so they spend/invest more.
Or perhaps the bank/insurance company will do both, reinvesting the T-bond sale proceeds mostly in bidding up the value of corporate bonds while spending some of its profit on purchases. The ratio doesn’t matter, as they both increase demand.
NGDP increases.
Monitary policy is all about turning money into investment.
And not *at all* about portfolio re-balancing and bidding up(down) the price of assets, goods, services, employees, with resulting effects on demand, as described above? When did this happen?
Interest on excess reserves is definately short circuiting the feedback loop that turns the money created from open market operations into investments (NGDP).
Of course it is, to the extent it effectively converts money to interest-bearing T-securities. But this doesn’t in any way conflict with the statement:
The difference IOR makes is that it gives people an incentive to want to hold the money, instead of to not want to hold the money.
Which doesn’t at all change the answer to what happens if people don’t want to hold the money.
28. August 2012 at 19:29
Brito and Ed Dolan, I think we learned in 2008 that the Fed can do pretty much whatever it want. Currency is already considered part of reserves.
If banks switch to euros, that’s fine. The whole point is to reduce demand for US base money. But again, I see negative IOR as a sideshow, it’s not needed for monetary stimulus.
I don’t know much about Denmark, Lars Christensen has probably done a post, since he’s Danish.
29. August 2012 at 06:41
For goodness’ sake, Scott, get rid of MF. I thought that this post on an issue that has become topical again might generate some thought-provoking comments, but it got hijacked immediately. A few days ago, I had cause to look up some of your posts from last year, and I was struck by how much richer the comment thread was, with contributions from many more people including some well regarded commentators. MF does not respond to appeals to be a considerate citizen, so just remove his comments.
29. August 2012 at 14:43
Scott,
When I read that article, I came to much the same conclusions. It seemed like they were trying to imply that there’s no macro impact. Is that some sort of joke? If the policy has virtually no macro effect, why did they adopt the pmt of interest on reserves?
30. August 2012 at 20:23
Support for, or opposition against (the payment of interest on excess reserve balances) demarcates the ignorant from the intelligent.
Remunerated excess reserve balances absorb existing volumtary savings from within the commercial banking system & attract monetary savings from the non-banks & shadow banks. I.e., the remuneration rate induces dis-intermediation (where the size of the non-banks shrinks, but the size of the commercial banking system remains the same).
The Fed forced a contraction in the size of the shadow & non-banking systems (creating liquidity problems in the process), by outbidding (inverting the short-end of the yield curve), the non-banks for voluntary savings (i.e., caused the shadow banks to go broke).
The reverse of this operation cannot exist. Transferring saved deposits through the non-banks cannot reduce the size of the commercial banking system. Deposits are simply transferred from the saver to the non-bank to the borrower, etc.
30. August 2012 at 20:35
(1) the high in our Central Bank’s reserve position (percentage of reserves to note & deposit liabilities), was 91.1 in 1941.
Then in 1968, legal reserve & reserve ratio requirements against the Federal Reserve Note, demand deposit, & inter-bank demand deposit liabilities of the Reserve banks (Central Bank) were eliminated.
————-
(2) prior to the payment of interest on excess reserve balances, the high in the ratio of excess reserves to required reserves was 1.12 in November 1935.
This trend (ratio) was reversed as the economy recovered & loan demand picked up.
(3) the ratio of excess reserves to required reserves fell to 1,898b/43,437b = 0.044 on July 16, 2008.
I.e., the member commercial banks routinely minimized their non-earning assets (excess reserves) from 1942 until Oct 2008.
The ratio of excess reserves to required reserves (Aug 22, 2012) is 14 to 1.
——————-
SEE: “Divorcing Money from Monetary Policy”
http://bit.ly/RX1av2
“…this link is severed, leaving the quantity of reserves and the interest rate target to be set independently. In this floor-system approach, interest is paid on reserve balances at the target interest rate. This policy allows the central bank to increase the supply of reserves, perhaps even significantly, without affecting the short-term interest rate”
Germany found that this conclusion was flawed. They have been borrowing at negative rates of interest after the ECB deposit rate cut.
Consider that: the Financial Services Regulatory Relief Act of 2006:
“By helping to stabilize the demand for voluntary reserve balances, this authority may allow the Federal Reserve to implement monetary policy WITHOUT the NEED for REQUIRED RESERVE BALANCES. In these circumstances, the Board–as authorized by the act–could consider REDUCING or even ELIMINATING reserve requirements, thereby reducing a regulatory burden for all depository institutions”
WHY??? “These measures should help the banking sector attract liquid funds in competition with nonbank institutions and direct market investments by businesses”
Support for, or opposition against (the payment of interest on excess reserve balances) demarcates the ignorant from the intelligent.
Remunerated excess reserve balances absorb existing volumtary savings from within the commercial banking system & attract monetary savings from the non-banks & shadow banks. I.e., the remuneration rate induces dis-intermediation (where the size of the non-banks shrinks, but the size of the commercial banking system remains the same).
The Fed forced a contraction in the size of the shadow & non-banking systems (creating liquidity problems in the process), by outbidding (inverting the short-end of the yield curve), the non-banks for voluntary savings (i.e., caused the shadow banks to go broke).
The reverse of this operation cannot exist. Transferring saved deposits through the non-banks cannot reduce the size of the commercial banking system. Deposits are simply transferred from the saver to the non-bank to the borrower, etc.
My favorite objection:
“In a letter of March 15, 1981, Willis Alex&er of the American Bankers Association claims that: ‘Depository Institutions have lost an estimated $100b in potential consumer deposits alone to the unregulated money market mutual funds.’ As any unbiased banker should know, all the money taken in by the money funds goes right back into the banks, in the form of CDs or bankers acceptances or other money market instruments; there is no net loss of deposits to the banking system. Complete deregulation of interest rates would simply allow a further escalation of rates by the banks, all of which compete against each other for the same total of deposits.”
Written by Louis Stone – whom the movie “Wall Street” was dedicated to – Vice President Shearson/American Express
=================
The FDIC fee on assets is an example of what would happen if the remuneartion rate was lowered: As an FDIC fee is assessed on CB assets (including excess reserves) of US banks, but is not assessed on foreign-owned bank subsidiaries which operate in the US. This gives foreign-related US banks a 15-basis-point cost advantage over a US based banks. That explains why excess reserves held at foreign-related subsidiaries are disproportionately larger than those held by domestic banks. It also shows that lowering the remuneration rate (by lowering costs) will drive money to higher yielding assets (even if the difference is miniscule)