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Buiter blog
Posted by WARREN MOSLER on October 19th, 2009
The economics profession is a disgrace. None of them seem to fathom monetary operations.
Fiscal expansions in submerging markets
By Willem Buiter
This morality tale has important consequences for a government’s ability to conduct effective countercyclical policy. For a fiscal stimulus (current tax cut or public spending increase) to boost demand, it is necessary that the markets and the public at large believe that sooner or later, measures will be taken to reverse the tax cut or spending increase in present value terms.
Not true. This is some kind of ricardian equivalent twist that is inapplicable. For example, govt spending to hire someone is a direct increase in demand. And any dollar spent due to a tax cut increases demand by that dollar. (these are minimums)
If markets and the public at large no longer believe that the authorities will assure fiscal sustainability by raising future taxes or cutting future public expenditure by the necessary amounts, they will conclude that the government plans either to permanently monetise the increased amounts of public debt resulting from the fiscal stimulus, or that it will default on its debt obligations.
In fact that has already happened. As evidenced by the price of gold in an otherwise deflationary environment.
Permanent monetisation of the kind of government deficits anticipated for the next few years in the US and the UK would, sooner or later be highly inflationary.
‘Monetization’ alters interest rates, not inflation. Only to the extent that interest rates influence inflation does monetization influence inflation. And there’s not much evidence rates have much to do with inflation, and mounting evidence they have no influence on inflation. Not to mention my suspicions that lower rates are highly deflationary.
This would raise long-term nominal interest rates
Not directly- only to the extent market participants believe the fed will raise rates over the long term.
and probably give risk to inflation risk premia on public and private debt instruments as well.
Has already happened in many places.
Default would build default risk premia into sovereign interest rates, and act as a break on demand.
This has already happened and has not functioned as a break/brake? On demand or as a constraint on deficit spending.
Beacause I believe that neither the US nor the UK authorities have the political credibility to commit themselves to future tax increases and public spending cuts commensurate with the up-front tax cuts and spending increases they are contemplating,
Since taxes serve to moderate agg demand, this implies that when economies ‘overheat’ the authorities won’t tighten fiscal policy. However, the automatic fiscal stabilizers conveniently do that for them, as tax revenues rise during expansions faster than even govt can spend. And this fiscal consolidation does induce contraction and ends the expansion. It was the too low deficit in 2006 the slowed aggregate demand and began this latest down turn, with a little help from the drop in demand when the housing frauds were discovered.
I believe that neither the US nor the UK should engage in any significant discretionary cyclical fiscal stimulus, whether through higher public spending (consumption or investment) or through tax cuts or increased transfer payments.
There is no other way to add to aggregate demand, except by letting the auto stabilizers doing the exact same thing the ugly way- through a deteriorating economy- rather than proactively which prevents further decline.
Instead, the US and UK fiscal authorities should aggressively use their fiscal resources to support quantitative easing and credit easing by the Fed and by the Bank of England (through indemnities offered by the respective Treasuries to the Fed and the Bank of England to cover the credit risk on the private securities these central banks have purchased and are about to purchase).
Qe is just an asset shift that does nothing for aggregate demand, except possibly through the interest rate channel which, as above, is minimal if not counterproductive.
The £50 bn indemnity granted the Bank of England for its Asset Purchase Facility, by HM Treasury should be viewed as just the first installment on a much larger indemnity that could easily reacy £300 bn or £500 bn.
Purchasing financial assets doesn’t alter aggregate demand.
The rest of the scarce, credibility-constrained fiscal resources
Fiscal resources are not credibility constrained.
Japan today forecast deficits of over 200% of GDP with no signs of market constraints. In fact, their 10 year JGB’s trade at about 1.3%, and they were downgraded below Botswana.
of the US and the UK should be focused on recapitalising the banking system with a view to supporting new lending by these banks, rather than on underwriting existing assets or existing creditors.
Govt capitalization of banking is nothing more than regulatory forbearance. Bank capital is about how much private capital gets lost before govt takes losses. In the US, having the Treasury buy bank equity simply shifts the loss, once private equity is lost, from the FDIC to the Treasury, which funds the FDIC in the first place.
Other available fiscal resources should be focused on supporting, through guarantees and insurance-type arrangements, flows of new lending and borrowing. As regards recapitalisation and dealing with toxic assets I either favour temporary comprehensive nationalisation or the ‘good bank’ model. Existing private shareholders of the banks, and existing creditors and holders of unsecured debt (junior or senior) should be left to sink or swim without any further fiscal support, as soon as new lending, investment and borrowing has been concentrated in new, state-owned ‘good banks’.
The problem with banking is the borrowers can’t afford their payments. This needs to be fixed from the bottom up with payroll tax holiday or VAT holiday, not from the top down as he suggests.
It is true that, despite the increase in longer-term Treasury yields from the extreme lows of early December 2008, recent observations on government bond yields don’t indicate any major US Treasury debt aversion, either through an increase in nominal or real longer-term risk-free rates or through increases in default risk premia – although it is true that even US Treasury CDS rates have risen recently to levels that, although low by international standards, are historically unprecedented.
Yes, and 10 year rates in Japan are 1/3 of the US rates, and their debt is 3 times higher. He’s barking up the wrong tree.
In a world where all securities, private and public, are mistrusted, the US sovereign debt is, for the moment, mistrusted less than almost all other financial instruments (Bunds are a possible exception).
And Japan even less mistrusted with triple the deficits?
But as the recession deepens, and as discretionary fiscal measures in the US produce 12% to 14% of GDP general government financial deficits – figures associated historically not even with most emerging markets, but just with the basket cases among them, and with banana republics –
Only because those numbers include the tarp which is only a purchase of financial assets, and not a purchase of goods and services. Ordinarily tarp would have been done by the fed and the deficit lower, as it’s the Fed’s role to purchase financial assets. But this time it didn’t happen that way except for maiden lane and a few other misc. Purchases.
I expect that US sovereign bond yields will begin to reflect expeted inflation premia (if the markets believe that the Fed will be forced to inflate the sovereign’s way out of an unsustainable debt burden) or default risk premia.
That’s all priced in the TIPS and I don’t see much inflation fear there.
The US is helped by the absence of ‘original sin’ – its ability to borrow abroad in securities denominated in its own currency –
A govt doesn’t care which holders of its currency buys its securities. Deficit spending creates excess reserve balances at the Fed. The holders of those balances at the fed, whether domestic or foreign, have the option of doing nothing with them, or buying Treasury securities, which are nothing more than interest bearing accounts also at the Fed. The other option is spending those balances, which means the fed transfers them to someone else’s account, also at the Fed.
and the closely related status of the US dollar as the world’s leading reserve currency. But this elastic cannot be stretched indefinitely. While it is hard to be scientifically precise about this, I believe that the anticipated future US Federal deficits and the growing contingent exposure of the US sovereign to its financial system (and to a growing list of other more or less deserving domestic industries and other good causes) will cause the dollar in a couple of years to look more like an emerging market currency than like the US dollar of old. The UK is already closer to that position than the US, because of the minor-league legacy reserve currency status of sterling.
Meaning what? Just empty rhetoric so far.
Under conditions of high international capital mobility, non-monetised fiscal expansion strengthens the currency if the government has fiscal-financial credibility, that is, if the markets believe the expansion will in due cause be reversed and will not undermine the sustainability of the government’s fiscal-financial-monetary programme.
It’s a function of nonresident ’savings desires’ of US financial assets.
If the deficits are monetised, the effect on the currency is ambiguous in the short run (it is more likely to weaken the currency if markets are forward-looking),
Because it’s a non event for the fed to buy financial assets, apart from small changes in term interest rates.
but negative in the medium and long term. If the increased deficits undermine the credibility of the sustainability of the fiscal programme, then the effect on the currency could be be negative immediately.
Ok, lots of things can turn traders against anything that’s traded. No news there.
The only element of a classical emerging market crisis that is missing from the US and UK experiences since August 2007 is the ’sudden stop’ – the cessation of capital inflows to both the private and public sectors.
With non convertible currency and floating fx there is no such possible constraint on federal spending and/or federal lending. The private sector, and other users of the currency, is a different story, and always vulnerable to a liquidity crisis.
Hence the ECB was bailed out by the fed with unlimited swap lines (functionally unsecured dollar loans from the Fed) when its member banks got caught short dollars last year.
That was their ’sudden stop’ and it happened only because of foreign currency issues, not euro issues, and it happened to the private sector, not the public sector. Not to say current institutional arrangements don’t make the euro national govts subject to liquidity issues, but that’s another story.
There has been a partial sudden stop of financial flows, both domestic and external, to the banking sector and the rest of the private sector, but the external capital accounts are still functioning for the sovereigns and for the remaining creditworthy borrowers.
Yes, it’s about credit worthiness for borrowers who are users of a currency and not govts. In their currency of issue.
But that should not be taken for granted, even for the US with its extra protection layer from the status of the US dollar as the world’s leading reserve currency. A large fiscal stimulus from a government without fiscal credibility could be the trigger for a ’sudden stop’.
The fact that this article has any credibility speaks volumes.
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October 19th, 2009 at 2:13 pm
Yet another big name now on record when everything he predicts doesn’t come true. That’s about the only good thing about this crisis . . . though from what I’ve seen over the last few years, it’s going to take a lot more than just being exceedingly wrong to discredit these folks.
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October 19th, 2009 at 3:12 pm
Yeah, it doesn’t much matter. People were predicting doom and hyperinflation in Japan all through the 90s, now they just mostly ignore it, or wave it away with talk about “trade surpluses”.
If I were ever made president of a university, the first thing I would do is fire all the economics professors and appoint the janitors to replace them. My reasoning is that at least the janitors might be capable of learning something about economics…
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October 19th, 2009 at 4:28 pm
Sweet post.
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October 19th, 2009 at 4:30 pm
Regarding Japan: The MOF should just instruct the BOJ to buy up all the outstanding JGBs? Then, with no debt, S&P & Moodys will have to give them an upgrade;)
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October 19th, 2009 at 9:14 pm
Krugman has an interesting interpretation of China’s potential role in US “quantitative easing”.
http://krugman.blogs.nytimes.com/2009/10/19/americas-chinese-disease-not-quite-what-you-think/
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Matt Franko Reply:
October 20th, 2009 at 2:15 am
JKH,
Dr. K says; ““quantitative easing†— a misleading term, but I guess we’re stuck with it. What it basically means is that the Fed is selling Treasury bills or their equivalent (interest-paying excess bank reserves are essentially the same thing), while buying other assets, expanding its balance sheet enormously in the process.”
Is he implying that the Fed is selling Treasuries to get the funds to buy the MBS? Does he mean the Fed “sells” reserves? The Fed’s own statement on MBS purchases says the Fed is simply creating new reserve balances as funds to buy MBS. He seems a bit confused here.
But on the other hand he also does imply that he thinks bank (excess) reserves are equivalent to short term Treasuries…should now not be hard for him to accept Warrens policy proposal to end Treasury issuance and replace with interest bearing Central Bank balances since they are equivalent to him…
Thks,
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JKH Reply:
October 20th, 2009 at 7:11 am
Matt,
I’m not sure he’s confused; I think he’s implicitly protesting against and simplifying the more typical use of QE language which in itself is very confusing.
“Quantitative easing†normally refers to the case of a central bank’s increase in risk free assets such as Treasury bonds, with an increase in risk free liabilities – usually bank reserves – as a result. The emphasis is on the nature of the liability expansion, using an assumed standardized type of asset expansion.
Bernanke uses the term “credit easing†to describe instead a central bank’s increase in risky assets, and an increase in “risk free†liabilities issued by them. The emphasis in credit easing is on the nature of the asset expansion, with the same type of liability expansion as QE.
As another complication, quantitative easing usually refers to an expansion of bank reserves without paying interest on bank reserves. Paying interest on reserves makes the easing somewhat nominally “less†in the sense that those who erroneously believe in the “reserve multiplier†effect would and do think that this has some different effect on bank lending. This is basically wrong-headed thinking, as pointed out by this blog and others espousing modern monetary theory. Nevertheless, that error notwithstanding, the language used to differentiate easing modes is poor.
Also, the Fed originally sold Treasury bonds from its asset portfolio to make way for the initial stage of credit easing. Although it didn’t expand its balance sheet, it was effectively engaging in credit easing more or less in Bernanke’s sense. Then, when it ran out of Treasuries to sell, it started expanding its balance sheet, ramping up credit easing further.
I think Krugman is using the language in a far more general and inclusive way. I think he uses quantitative easing to describe any situation in which a central bank increases the market supply of “risk free†assets, on a net risk basis. This includes the initial stage just described, where the Fed was selling Treasuries, and the current stage where it is increasing excess reserves (liabilities). It also includes the traditional case where the Fed buys risk free bonds and increases reserves – it’s withdrawing long dated bonds and supplying short dated (demand) reserves, which in risk terms means it is net supplying the market with a “higher quality†(shorter maturity) of government quality asset.
This allows for capturing foreign exchange intervention by any central bank in any currency with the same language. China buys dollars and invests them mostly in Treasuries. It issues liabilities that include a sort of RMB t-bill as well as bank reserves. This increases the net supply of RMB risk free assets to the market, so in Krugman’s definition this would constitute quantitative RMB easing.
In the big picture, using his definition, I think he’s making the following point:
The Fed is engaged in dollar QE by expanding its balance sheet and issuing mostly excess reserves as a result.
China is engaged in RMB QE by expanding its balance sheet and issuing RMB risk free liabilities as a result.
China is also engaged in dollar QT – quantitative dollar tightening, using a definition consistent with Krugman’s use of the term QE. This is because China is withdrawing the supply of US treasuries from the market. So the existing situation is that China is currently undoing or “diseasing†some of the Fed’s QE.
He then suggests that if China were to sell its Treasuries, this would constitute dollar QT unwinding; i.e. it would constitute dollar QE.
At least that’s the way I interpret it.
P.S.
“Selling†an asset has the same effect as “issuing†a liability. Selling treasury bills/bonds from an asset portfolio or issuing reserves has the same QE effect ala the Krugman definition. Also, China issues RMB treasury bills directly from the central bank. The right way to view all of this is to consolidate treasury and central bank balance sheets so that the consolidated entity issues reserves, currency, bills, and bonds. It trades on the asset side (through the CB) in whatever – bills, bonds, credit risk, FX reserves.
P.P.S.
My guess is that Krugman could be forced into Mosler’s paradigm with a mere 3 days of his head in a vice. I think he partly sees it.
This would be easy compared to the near impossible task of standard neo-classical conversion.
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Warren Mosler Reply:
October 20th, 2009 at 8:03 am
A missing distinction is that what’s normally called qe doesn’t alter net financial assets of that currency held by the non govt sectors.
Buying dollars, in the case of China, adds yuan net financial assets to the non govt sectors.
So if the US bought fx, it would, unlike current qe meaures, increase non govt holdings of dollar net financial assets.
The way I say it is that buying fx is ‘off balance sheet’ deficit spending.
And the fact remains that k, a nobel prize winner, honored professor, nyt writer, etc. doesn’t hold a candle in his understanding of the monetary system to readers of this blog.
JKH Reply:
October 20th, 2009 at 9:01 am
Yes.
FX intervention increases non government domestic currency net financial assets. Which I guess is the important point, consistent with a broad brush view of what domestic “easing†means – as in your deficit spending interpretation of FX intervention.
Although it’s still the case that FX intervention doesn’t increase non government net financial assets per se.
E.g. in the case of China, the government issues financial assets for what it accumulates. The private sector loses in external and dollar assets what it gains in government and Yuan assets. And the foreign sector still has a net liability position – just with the Chinese government instead of the private sector. In total, FX intervention does not change the combined government and private sector financial balance (i.e. current account) with the external sector, apart from asset price changes, etc. China’s government and private sector combined have net financial assets with ROW through the cumulative current account surplus. PBOC intervention doesn’t change that, other things equal.
Curious Reply:
October 20th, 2009 at 3:22 pm
What is the difference between government fx purchases and those swap lines the fed established?
If the foreign governments use the swap lines to provide $ liquidity to the market, the end result seems identical, no?
JKH Reply:
October 20th, 2009 at 3:45 pm
Fed swap lines are effectively (unsecured) dollar loans to foreign central banks.
If the Fed/Treasury undertook FX purchases, this would also provide dollars to the market.
So the end result is similar in terms of dollar liquidity (including the initial effect on banks reserves at the Fed).
But the effect on the FX market is more muted in the case of dollar swaps, because the swap contracts include (embedded) forward FX hedging terms. There would likely be a more substantial spot rate effect in the case of outright spot FX purchases.
That’s my understanding of it, anyway.
Matt Franko Reply:
October 22nd, 2009 at 7:56 am
JKH,
Ive had some time to go back and look at the H41s and yes the Fed did initially reduce (sell) some treasury holdings at first. At begining of 2008 they had appox $800B and over the course of 2008 it fell to approx $500B, so it looks like they sold about $300B. Balance sheet grew some because they implemented the special liquidity programs (TAF, CPFF, swaps, etc..) over the same time. Then when they started the “QE” in earnest on Jan 1 2009, Treasury holdings have gone steadily up this year back to the approx $800B level.
Question: I know it is spilled milk, but do you think this selling of Treasuries by the lender of last resort over that time was helpful? If you were a business and some customers were stringing you out 60-90 days so you go to your lender for a 60-day draw and instead they force you to buy a CD? That doesnt sound like any type of easing to me, “quantitative” or otherwise.
JKH Reply:
October 22nd, 2009 at 8:49 am
Matt,
I’m not sure I follow your analogy exactly, but…
The initial sale of treasuries made some sense to the degree the Fed wanted to pursue “credit easing “. They did that initially through asset switching rather than liability expansion, being somewhat constrained in the latter – it took some time to get approval to pay interest on reserves, which was required for lower bound control on the fed funds rate (although that didn’t work so well because some non-banks like Fannie and Freddie still held non-reserve non-interest earning balances at the Fed.) Also, there was some political unease with the idea of building up excessive treasury balances at the Fed as the offset to asset expansion. When they got the go-ahead to pay interest on reserves, they started more aggressive balance sheet expansion, including excess reserve expansion. They’ve also wound down much of the extraordinary Treasury funding to date, effectively replacing that with excess reserve expansion.
There’ve been a lot of balance sheet changes over the past year. Interestingly, the net increase in size is ball-park equal to the increase in treasuries, which correlates roughly with their announced treasury purchase program.
My interpretation of it is that they’ve held their own on “credit easing†(although the composition has changed significantly, with substantial MBS purchases over the past year, and the wind down of some other programs), and they’ve moved ahead with “quantitative easing†as traditionally defined – i.e. increasing treasury holdings and increasing excess reserves as a result.
But I’m not sure that addresses your point, which I may be missing …
JKH Reply:
October 22nd, 2009 at 9:39 am
P.S.
I think the credit easing component of the Fed’s activity was designed to increase the supply of credit to the private sector, with some targeted, albeit limited programs, along the lines of the business requirement in your example (e.g. commercial paper funding). Can’t speak to how effective it’s been.
(Plus TARP capital for banks, which has been controversial to say the least, in terms of its effectiveness as a bank lending catalyst.)
Matt Franko Reply:
October 22nd, 2009 at 11:04 am
JKH, Thanks for analysis.
My analogy: Perhaps Bear Stearns and Lehman needed some “lender of last resort” style help from the Fed in their Inv. Banking Group while at the same time their primary dealer operations were having to buy treasuries from the Fed. (seems to me cross purposes).
October 19th, 2009 at 10:50 pm
so the big k is saying the use should directly sell the dollar to get it lower to cut imports and increase US domestic demand
doesn’t he know anything about real terms of trade?
doesn’t he know we can increase domestic demand with a payroll tax holiday and increase our total output and consumption?
did i say the mainstream economics profession is a disgrace?
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winterspeak Reply:
October 20th, 2009 at 12:08 pm
LOL Warren! The big K won his big N for his *work* on international trade!
I guess those N guys are as savvy about trade as they are about other branches of human affairs.
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October 20th, 2009 at 1:36 pm
Something I’ve been wondering — given that banks are not reserve constrained, what is a “bank run”?
The usual story is that banks have leant out most of their deposits, so cannot fulfil withdrawl requests when they come in. But in PK, that does not make sense.
If a customer withdraws their money, the bank debits a liability, and debits a reserve. It’s capital position IMPROVES no?
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JKH Reply:
October 20th, 2009 at 2:57 pm
Banks are not reserve constrained means in a collective sense the banking system doesn’t need reserves to lend and expand assets. An individual bank only need maintain its required share of aggregate reserves at the central bank, and it can get them from the rest of the group in normal course by selling/maturing assets or raising deposits. This assumes the bank is in good credit shape itself, and has nothing to do with the false “multiplier†idea. The central bank supplies enough reserves to satisfy the system reserve requirement resulting from the collective asset and liability expansion.
The same thing holds for repayment of deposits. Banks collectively are not reserve constrained and banks individually can replenish any interbank reserve effect due to the repayment of individual deposits, again by selling/maturing assets or raising new deposits in normal course. System wide deposit contraction which rarely occurs may reduce the aggregate reserve requirement marginally, which the central bank will adjust for after the fact.
A bank run will cause an individual bank a problem in maintaining required reserves, because of difficulty in implementing other asset/liability initiatives necessary to maintain required reserve balances. But the central bank is still lender of last resort for individual banks, at least until it and/or the FDIC decides to put it out of business. None of this contradicts PK or the nature of the collective reserve dynamic.
This has nothing to do with capital directly, unless a bank experiencing a run is selling assets at a loss to maintain its required reserve position, or other losses are occurring at the same time, which may be contributing to the cause for the run.
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zanon Reply:
October 20th, 2009 at 4:54 pm
OK, so it may make sense to look at this in two different cases to help me understand.
1. If everyone decides to take the deposits out of their checking account at a particular bank for whatever reason, that’s called a “bank run” and the bank will shut down. This was certainly true before the FDIC guarantee, but I think it’s still true now even with the guarantee. So, in the case of a regular commercial bank, why would having everyone withdraw their deposits cause the bank to shut down? Why can’t the bank just have its reserves run down, and borrow what it needs overnight?
2. In a hedge fund, or some other class of fund, I can see redemptions triggering the sale of assets at bad prices, which then further depress those asset prices. So let’s leave that case out.
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warren mosler Reply:
October 20th, 2009 at 5:27 pm
exactly, the fed should fund any member bank without penalty or stigma. the current self imposed constraint is highly counterproductive
zanon Reply:
October 20th, 2009 at 7:23 pm
What’s the penalty or constraints for a commercial bank?
I still don’t get it — the bank has a bunch of withdrawls, and debits its liabilities. It also debits its reserve account.
It falls below its reserve requirements — big deal. The sun goes down and it borrows what it needs overnight just like it would anyway. Sun rises, life goes on.
Why are bank runs a problem for commercial banks?
Curious Reply:
October 21st, 2009 at 1:59 am
That makes sense Zanon.
I don’t see a problem either.
Zaid Reply:
October 21st, 2009 at 2:54 am
A typical bank’s assets are funded through short-term wholesale funds, deposits, and capital. Deposits are by far the cheapest form of funding. In the case of a bank run, the bank can 1) go the wholesale market, e.g. Fed Funds, 2) it can sell assets, or 3) it can pledge some assets to borrow money directly from the Fed’s discount window.
1) We’ve all seen what happens to the wholesale funding markets when bank runs become public (Northern Rock, Bear Sterns, etc). Wholesale financing dries up, and abruptly because it’s short-term by nature.
2) We’ve also witnessed what happens when asset liquidations become disorderly and cause asset prices to collapse, wiping out bank capital in a self-reinforcing process. In this latter case, the FDIC will force the bank’s closure.
3) The third option requires that the bank have assets eligible for discount window lending. During the crisis governments around the world accepted a wider range of assets to be pledged using a variety of temporary funding facilities. But as Warren says, this is not the place for market discipline. This is still an unnecessary self-imposed constraint. In the case of the US, the Fed should be able to lend in unlimited quantities to the bank. The FDIC already regulates banks and will force closure if credit quality deteriorates beyond some threshold.
zanon Reply:
October 21st, 2009 at 1:52 pm
ZAID: Thank you. Your explanation was helpful.
So, it sounds like, during a run, access to funds via the reserve account dries up as banks with excess reserves refuse to lend to the bank experiencing the run.
Therefore, the bank that is short reserves must go to the discount window even if the system as a whole is not short of net reserves. But, the Fed requires collateral to lend against. If the bank does not have the quantity/quality of assets, the discount window shuts, and effectively the bank becomes reserve constrained.
Is that right?
Zaid Reply:
October 22nd, 2009 at 12:19 am
You got it right!
anon Reply:
October 22nd, 2009 at 2:03 am
Not quite right.
“during a run, access to funds via the reserve account dries up as banks with excess reserves refuse to lend to the bank experiencing the run”
Not the other banks directly, so much as the wholesale market customers of the other banks refusing to deposit with it or roll over its paper. That depletes reserves just as much.
And the FDIC can shut a bank down even if it is still liquid – i.e. still has sufficient funds in its reserve account, even with collateralized borrowing from the Fed. The FDIC can shut it down if it is deemed insolvent – i.e. no capital.
Zaid Reply:
October 22nd, 2009 at 10:37 am
Anon, true. Point #1 was meant to be a general reference to wholesale funding… so that would include inter-bank lending, CDs, commercial paper, etc.
During the crisis, even money market mutual funds were experiencing runs because people were afraid of holding bank paper indirectly.
October 20th, 2009 at 3:38 pm
“Although it’s still the case that FX intervention doesn’t increase non government net financial assets per se.”
When china buys dollars and sells yuan to someone, that’s a new yuan deposit and increases yuan net financial assets. this is what i call ‘off balance sheet deficit spending’
If the CB and govt understood banking they would lend to all member banks in unlimited quantities at their target interest rate (as in my ‘proposals’) not doing this is another ’self imposed constraint’ that does makes vulnerable to ‘runs’ as happened to WAMU and yet another example of what happens with a govt that doesn’t understand its monetary system.
swap lines vs fx purchases. yes, in the first instance the Fed lending to the ECB would have produced the same result as the Fed buying euros from the ecb. But by lending (unsecured) the ECB has to pay the Fed back, while by purchasing the Fed decides what it wants to do next with its euro deposits.
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JKH Reply:
October 20th, 2009 at 3:56 pm
Understood. FX purchases increase net financial assets in the domestic currency, and that’s very analogous to deficit spending effect on net financial assets.
My second point was on the all-currency position, which is arguably less relevant.
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October 20th, 2009 at 4:22 pm
so, in your travels, how many people in the world do you think understand any of this outside readers of this site, umkc blog, billy blog?
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winterspeak Reply:
October 20th, 2009 at 4:55 pm
Frankly, no one.
Steve Keen comes close. Wray?
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warren mosler Reply:
October 20th, 2009 at 5:25 pm
randy yes, more than close. and he’s a umkc prof. steve misses the mark by a lot unfortunately
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JKH Reply:
October 20th, 2009 at 5:06 pm
I think there may be a few involved in operational reserve management within the commercial banks that understand the core premise of why the multiplier is a bogus concept, and some things that flow from that. They’re the ones who are actually involved in responding to the full spectrum of institutional flows that affect bank reserve positions. But such operational people typically wouldn’t be inclined to expand it to a more comprehensive macroeconomic view. Likewise, some involved in counterpart positions at the central banks might have a grasp on the true operation of the reserve system. I would guess there might be a handful of select individuals in the commercial and central banks that understand the system in this sense. As would typically be the case, that understanding likely wouldn’t move up through to the top of the house. (E.g. I still can’t believe that Bernanke uses language like “lend reserves†in his speeches.)
The biggest problem is with the economics profession, because it has the most responsibility to understand the facts on the ground, if it is going to influence policy properly. For the most part, the profession simply doesn’t understand how the banking system works. This is a tragedy as much as a disgrace. And that’s just the starting point for what you need to know to get through to the full impact on economics as a whole. You then have to build an understanding of the concept of an integrated government/central bank position and the effect of fiscal policy on bank reserves, etc. etc.
So the answer is – very few would even know the rudimentary banking system building blocks, let alone the wider economic scope of what is being discussed at these blogs. That’s why the profession’s lack of understanding of reserve system operations is such a tragedy, and why the textbook explanation of the multiplier is truly criminal in its incompetence. So much depends on that starting point.
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winterspeak Reply:
October 20th, 2009 at 7:25 pm
Agreed. The economics profession is where you need to have influence because those guys make policy. They also have no responsibility or accountability whatsoever, and it’s clear what a corrosive impact that has had.
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JKH Reply:
October 20th, 2009 at 7:57 pm
Enjoyed your follow up strafing of Buiter today.
JKH Reply:
October 20th, 2009 at 5:11 pm
Actually, while Steve Keen obviously understands the reserve system better than most, by his own admission he has not looked very closely at the sector financial balance approach, or the net non government financial asset concept. He’s pretty much focused on an endogenous money model at this stage.
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Jason Reply:
October 23rd, 2009 at 1:32 pm
As one who is not an economist by profession, and mingles professionally with Government workers who are analysts constantly bombarded with poltical script and mainstream economics I can safely say that my answer to your question Warren is ZERO. (except a good friend, who is an economist, with much training from Levy inst. who I used to debate with as a member of the “other side”, who finaly told me to come to this site and read through it. That was a year ago and I am still here faithfully reading!)
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Jason Reply:
October 23rd, 2009 at 1:34 pm
I will add that I have some training in economics, with a master’s degree in public admin, which required several advanced econ courses. I would say that was enough economics to lead me astray ;)
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WARREN MOSLER Reply:
October 25th, 2009 at 2:18 pm
thanks! who’s your friend that pointed you this way?
October 20th, 2009 at 6:39 pm
Note to interested:
I came across a recent paper at the BIS that looks to be an update to a report that Warren posted here back in March by the same authors wrt the Feds forex liquidity swaps. 30+ page pdf file. Resp,
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October 21st, 2009 at 7:22 am
Warren: nice to see Buiter being dissected. If you can bear to wade thru more hot air (or what I think is hot air) look at the UK’s latest National Institute Economic Review. Sign in or log in here: http://ner.sagepub.com/cgi/login
One article by Ray Barrell ends “a structural deficit of 6 per cent of GDP requires significant rises in taxes and cuts in spending. These would leave current generations with less to consume and benefit our descendants.†Hope that wets your appetite. This is at: http://ner.sagepub.com/cgi/reprint/210/1/58
More in the same vein and in the same edition of NIER is here: http://ner.sagepub.com/cgi/reprint/210/1/58
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October 21st, 2009 at 8:42 am
thanks, it’s like fighting the hydra!
maybe after chopping someone up we need some way to burn him to the ground. figuratively of course.
i’ll try starting a deficit terrorist list.
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October 21st, 2009 at 2:46 pm
Therefore, the bank that is short reserves must go to the discount window even if the system as a whole is not short of net reserves. But, the Fed requires collateral to lend against. If the bank does not have the quantity/quality of assets, the discount window shuts, and effectively the bank becomes reserve constrained.
Is that right?
YES, BUT WHAT HAPPENS IS THE BANK IS LEFT WITH AN OVERDRAFT AT THE WINDOW, WITHOUT SUFFICIENT COLLATERAL, SO THE FDIC SHUTS IT DOWN. OPERATIONALLY IT WOULD OPERATE INDEFINITELY WITH AN OVERDRAFT IN ITS FED RESERVE ACCOUNT. IT’S A POLITICAL DECISION TO SHUT IT DOWN.
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zanon Reply:
October 21st, 2009 at 3:29 pm
Got it. If the FDIC did not shut it down, it could just go deeper and deeper into overdraft, but be as functionally free to make loans etc. as before.
So, if they have political support, banks can keep on operating no matter what their reserve and capital position is. Makes sense, really.
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anon Reply:
October 21st, 2009 at 3:33 pm
but banks are still allowed to fail under the Mosler plan, are they not?
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October 21st, 2009 at 5:52 pm
but banks are still allowed to fail under the Mosler plan, are they not?
yes, as the point of this public/private partnership we call banking is to have the private sector price risk rather than the public sector.
that means private sector capital has to be at risk for this process to function as desired for public purpose.
insufficient private capital alters the pricing of risk.
if we instead want the public sector to price risk the banks can be run by the public sector.
either way i limit bank activities as per my ‘proposals’ on this website which also makes things a lot easier for the regulators and supervisors so we don’t need as many and are a lot ’safer’ as well.
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