Fed Mulls Trillion-Dollar Policy Question

Fed Mulls Trillion-Dollar Policy Question

How much of a boost to the U.S. recovery could another trillion dollars or two buy?

None, never has, never will. get over it!!! It’s about price (interest rates), not quantity. and lower interest rates won’t do much, if anything, for aggregate demand, output, and employment.

That’s a tricky question for the Federal Reserve when it meets Tuesday to debate what would warrant pumping more money into the financial system.

QE shifts balances from securities accounts to reserve accounts. Net financial assets remain unchanged.

To battle the financial crisis, the Fed bought $1.7 trillion of longer-term Treasury and mortgage-related bonds, supplementing its pledge to keep interest rates near zero for a long time.

That lowered long term rates in general a tad or so, maybe. What brought long rates down was the notion that the Fed would be low for long due to the weak econ forecasts.

All told, it helped stabilize a collapsing financial system and to avert what could have been a second Great Depression.

Yes, buying the likes of GE commercial paper may have kept GE alive. That’s a case of taking credit risk and ‘investing’ in a company when the private sector would not, rather than using the receivership process, as happened with AIG and Lehman, though with differing degrees of govt. support.

Now, faced with a 9.6 percent jobless rate and below-target inflation, Fed policymakers are trying to gauge how much they could achieve if they resume massive quantitative easing.

Their research staff will probably tell them it’s all psychological

Few analysts expect the Fed to launch a new round of bond buying this week, and uncertainty over the impact of fresh moves may be a factor keeping the central bank on the sidelines. 
 

“I think part of the hesitancy of the committee to use quantitative easing a second time around relates to views of its effectiveness,” said Vince Reinhart, a former Fed staffer.

Exactly. The astute ones know there is no effect of consequence

At the Fed’s August meeting it decided to reinvest maturing mortgage-debt in Treasuries to keep its balance sheet steady, a move many analysts saw as a precursor to more easing.
 
Proponents of a relaunch of large-scale bond-buying say it will help prevent inflation expectations from falling and spur growth by further reducing borrowing costs for consumers and businesses.

Still mired in mythical inflations expectations theory

Skeptics say the economic recovery has just hit a weak patch. They argue that more easing could be ineffective in helping the economy, potentially damaging Fed credibility. 

 
An incremental drop in long-term yields may not be enough to force banks to stop hoarding safe-haven Treasuries and make loans to businesses instead, some analysts warn.

As if banks are turning down good loans at 5% to buy TSY secs at 1%

Some policymakers worry that more easing could fuel market imbalances or sow the seeds of sky-high inflation ahead.

 
There is also the risk that the Fed spooks investors.

All sounds very scientific to me…

“My own view is that any radical balance sheet program would be seen by many as an act of desperation which would dampen business sentiment and depress non-financial borrowing even more,” said Wrightson ICAP Chief Economist Lou Crandall.

 
Hard to Measure Success

 
Fed bond purchases can have two effects. They can increase liquidity in strained markets

As if marginal changes in liquidity alter the real economy

and, by lowering yields, force investors to look for returns in riskier asset classes, helping to boost the supply of credit in the economy.

That would lower the price of credit some from where it is, not increase the supply

In addition, some officials believe bond buying helps solidify trust among investors that the Fed will keep policy easy for longer, further helping to lower borrowing costs.

Investors know the Fed’s reaction function is based on inflation and employment, which they believe are largely functions of economic conditions.

The New York Federal Reserve Bank estimates that the $1.7 trillion of purchases lowered the yield on the 10-year Treasury note by between 30 and 100 basis points.

The estimate is based in part on the sharp drop in yields that occurred when the Fed first announced its large-scale bond-buying program.

 
But this “announcement effect” approach does not show how yields acted over the course of the program and may not appropriately capture the impact, analysts say.

 
It is tough to gauge how much of a move in yields can be tied to the Fed’s actions after the fact, and it is also extremely difficult to predict the impact of another move.

 
When it comes to the benchmark overnight federal funds rate, “you can come up with rough orders of magnitude of the impact, but with quantitative easing there is so much uncertainty, you can’t calculate it with any type of precision,” said Dino Kos, former head of the New York Fed’s markets group and a managing director at Portales Partners LLC.

 
The success of the first round of purchases may have been amplified by the stressed nature of markets at the time, as well as the fact that the purchases were focused on the smaller, less-liquid agency mortgage-backed securities market.

 
“If you show up and purchase assets when markets are stressed, you are not pushing back against much conviction so you can move prices more easily,” said Reinhart, the former Fed staffer.

 
To get a significant effect in the Treasury market—where any new round of purchases would likely be centered—could be harder, says Mark Gertler, a professor at New York University.

 
“Evidence suggests it would take a huge purchase of long-term government bonds, maybe the whole market, to really have any effect, and the effect would be quite uncertain.”

 
Rather than announcing such an eye-popping amount upfront, the Fed could decide to buy Treasuries in smaller steps, calibrated to the economic outlook at each meeting.

 
Forecasting firm Macroeconomic Advisors estimates each $100 billion in asset buys could lower the yield on the 10-year Treasury note by 0.03 percentage point.

 
That is a marginal move that could go unnoticed, though if Fed buying helped nudge up the inflation rate it could get a bit more of a bang for its buck on real rates.

 
Even a small amount of easing is not to be sneezed at, says Michael Feroli, chief U.S. economist at JPMorgan Chase.

 
“If you have a headache and only one aspirin left, do you decide not to take it because you wish you had two aspirins?”

“Mosler says that since the Fed buying secs is functionally the same as the Tsy not issuing them in the first place, why not just have the Tsy stop issuing long term securities if the goal is to lower long term rates? And the benefit of lower rates is that with today’s institutional structure they probably reduce aggregate demand and thereby allow for lower taxes for a given size govt. But when the govt doesn’t understand this and keeps taxes too high we all pay the price with higher unemployment and a wider output gap.”

This entry was posted in Fed. Bookmark the permalink.

52 Responses to Fed Mulls Trillion-Dollar Policy Question

  1. SethM says:

    Can anyone tell me the actual effects of QE on the Fed’s Balance Sheet? How is QE recorded, do liabilities and assets go up?

    Reply

    Tom Hickey Reply:

    In QE, the assets of the Fed go up as do its matching liabilities on the balance sheet. The Fed takes assets purchased (bonds) onto its balance sheet in exchange for its liabilities (reserves) which become assets on the balance sheets of the banks selling the bonds. If non-banks are sellers, then the seller’s bank credits the seller’s deposit account and uses reserves (bank asset) for interbank settlement as the deposit account is drawn down in order to extinguish its liability (the deposit amount).

    Reserves don’t actually exists physically. They are spreadsheet entries that account for settlement in the interbank system, the FRS in the US.

    Reply

  2. also, regarding inflation, it’s again a political decision In fact, even just defining it is no small political decision.

    When people tell me the likes of the gov’s debasing the currency and it takes $100 to buy what $1 bought 100 years ago, or something like that, I usually say, Ok, that’s maybe 2% inflation. do you think that’s too much? too little? and they usually don’t know what to say. and then I say you are free to vote for people who will support whatever level of inflation you like. then i ask how they define it and it all gets even more vague.

    Reply

    hbl Reply:

    Makes sense that inflation is a political decision. Yeah I don’t pretend to know what the “right” level of inflation is, I was just saying that whatever the level (and it will always be variable) it acts as a tax on zero-nominal-yield savings.

    Reply

    ESM Reply:

    “When people tell me the likes of the gov’s debasing the currency and it takes $100 to buy what $1 bought 100 years ago, or something like that, I usually say, Ok, that’s maybe 2% inflation.”

    Maybe you should say instead “that’s maybe 4.7% inflation.” You know, just to be correct and all.

    Of course, the government hasn’t really debased the currency if you could have earned a comparable amount of interest on government securities.

    Reply

    WARREN MOSLER Reply:

    will do. actually they say $2 back then takes $100 now? Is 4.7 the 100 year compounded rate? haven’t checked

    Reply

  3. the decision as to whether savers should be rewarded is political, but in the context of allowing people the means of being able to not work and produce yet still consume means that much less real output and those producing the real output sharing it with those not working.

    Reply

    hbl Reply:

    You seem to suggest that maximizing consumption (and thus GDP) should be one of the goals of government. I disagree with this, though I agree with the goals of full employment and eliminating poverty. But given productivity advances, we can produce an order of magnitude more than we could a century ago, yet the evidence is we are no happier.

    If you place this much value on minimizing consumption by non-producers, you should be advocating government policy that encourages all the lazy people who only work 5 days a week to work 7 days a week, like some already do, and quit mooching off the rest for 28% of their time.

    I think it’s perfectly valid for some to want periods of saving followed by dissaving over periods of their lives, for whatever their reasons. Yes some output will be lost during their time not working in a GDP-counted way, but so what? Doesn’t quality of life count over maximal consumption?

    Also there are two types of savers:

    1. Those who save them dissave to spend down all they saved (the young mother, most retirees, etc).

    2. Those who continually save all their lives. Government policy already partially addresses this through capital gains and dividends taxes plus the estate tax. Make those taxes bigger if there is too much “hoarding” of money.

    It’s also important to recognize that when you add up these saving and dissaving patterns occurring at the micro level, at the macro level they smooth out as some people are saving while others are dissaving. So there’s partially a fallacy of composition issue here (not entirely because admittedly total output becomes lower as addressed above). But voluntary or involuntary (tax-driven) dissaving continually counters the saving effect, so why worry so much about it?

    Reply

    Tom Hickey Reply:

    You seem to suggest that maximizing consumption (and thus GDP) should be one of the goals of government.

    I think it is more about maximizing income to create the effective demand necessary to purchase the supply available at optimal output capacity at full employment. The question of optimal capacity involves sustainability, so it is not matter of unlimited growth based on unlimited resources, but rather innovative use of resources by committing funds to R&D and productive investment in new technology, especially energy.

    Reply

    hbl Reply:

    Tom, you suggest the importance of demand sufficient to fill output capacity… I agree, but think it is important to look more closely at the components of capacity. It includes labor, commodities, capital goods, etc. Now as I understand MMT the only one that truly matters is “full employment” (labor), but that is defined as a job for everyone WHO WANTS ONE. So if people voluntarily choose to work less for quality of life reasons, then capacity drops proportionately, and it takes less demand to fill it. Who cares if factories and capital equipment sit idle if everyone who wants a job has one and can meet their basic needs?

    Now productivity will inexorably march higher, which might mean less labor is needed to provide what people want/need. In a “far future” scenario where 99% of what we need can be handled by robots, I could see this requiring a MUCH larger number of people covered by job guarantee, but perhaps many of those people will be creating art or whatever society values, and they in turn receive enough income to buy food etc from the owners of production.

    And with respect to the “unlimited growth” concern many people have, I have read books such as Natural Capitalism that discuss radical resource productivity, so I do “get” its importance and why “unlimited growth” is possible to a certain extent.

    Reply

    Tom Hickey Reply:

    I agree with the points you raise. My point is that as I understand MMT as an economic theory, its priority is full employment with price stability because that is where economic efficiency/effectiveness begins. There’s a lot more to an economy than that, but that is the bottom line for MMT since everything less is wasteful economically and socially. The challenge is to build on a solid foundation, and full employment (implying optimal capacity in a sustainable way) with price stability is the foundation. The rest is enhancement.

    hbl Reply:

    “as I understand MMT as an economic theory, its priority is full employment with price stability because that is where economic efficiency/effectiveness begins. There’s a lot more to an economy than that, but that is the bottom line for MMT since everything less is wasteful economically and socially.”

    MMT authors frequently emphasize the “full employment and price stability”, so we all agree on that. But MMT authors define “full employment” along the lines of a job for everyone who wants one. Doesn’t the non-government sector get to decide how many people that is, rather than the government?

    So anything less than WHAT EXACTLY is a waste? Anything less than 100% of working age people employed at all times? Is that what’s optimal? If not how do you define “optimal capacity”? My understanding when Bill talks about “waste” is the involuntarily unemployed, but perhaps I am mixed up.

    hbl Reply:

    And as you’re probably aware there are plenty of people advocating other ways to measure prosperity than GDP. There is much that doesn’t get counted in GDP but is no less valuable, e.g., raising children, cooking, community volunteering, etc. If someone decides to live off the grid and be self sufficient, growing their own food etc, are they a “waste” to society because they are not trading labor with the larger population, being counted in GDP, and contributing in a measurable way to supplying and demanding society’s “optimal capacity”?

    To suggest measurable employment as a policy goal for even those who don’t desire it seems to me like it would be an over-reach of government. If you did a survey and found out that 90% of the voluntarily unemployed watched TV all day and nothing else, then perhaps you could make a personal judgment that they were a waste to society, but there are plenty of other uses of time that would be grayer areas.

    Tom Hickey Reply:

    hbl, the JB acts as a price anchor and is integral to the way that MMT recommends achieving full employment along with price stability. It is neither an add-on, nor just a means for achieving full employment. It also involves price stability as a price anchor. It sets a floor price for labor and provides an employed buffer force for the private instead of an unemployed one, as at present.

    WARREN MOSLER Reply:

    price anchors are always buffer stock policies, one way or another

    Tom Hickey Reply:

    My understanding when Bill talks about “waste” is the involuntarily unemployed, but perhaps I am mixed up.

    The JG only applies to voluntary employment. No one is forced to accept a JG job. JG jobs are open to anyone that wants to work and cannot find other employment.

    Bill would end the dole and make the JG the only option for unemployment benefits. Some other MMT economists would make the JG an “employment assurance” option along with unemployment insurance.

    hbl Reply:

    Tom, I don’t consider either of your last two comments to be in any way inconsistent with what I wrote, nor am I sure which point they were a reaction to. If you intended them as a correction to something I said, I must not have communicated clearly enough.

    To recap, Warren said “allowing people the means of being able to not work and produce yet still consume means that much less real output and those producing the real output sharing it with those not working.”

    I also responded to some things you add to the discussion, but most of my points to Warren were around how we judge what “not working” and “less real output” mean, given that there is lots of valuable (to society) stuff people do with their time that isn’t counted in official labor market output. I could give many better examples than I gave before. Maybe Warren simply judges that the majority of those “not working” don’t add any value to society with how they spend their time, and perhaps if you could run the numbers he might be correct, I guess I am just biased to think more people than not like being useful.

    Tom Hickey Reply:

    hbl: Tom, I don’t consider either of your last two comments to be in any way inconsistent with what I wrote, nor am I sure which point they were a reaction to. If you intended them as a correction to something I said, I must not have communicated clearly enough.

    I was simply stating what MMT regards as the priority. All MMT’ers are in agreement about that. They disagree perhaps over details of implementation. These disagreement are with MMT, but are not MMT as a theory.

    The points that you bring up are significant details within that discussion. These points need to be fleshed out, especially with respect to formulating policy options. I am neither agreeing with what you are saying in this regard nor disagreeing. I am simply pointing out that whether the JG is a “good idea” in principle is different from what it would look like. Many people argue that without the latter the former is not decidable. MMT’ers argue that this is not the case, e.g., the JG is not only a means of employing everyone that wants to work, thereby generating an employed buffer instead of an involuntary unemployed one, but also it is a way of generating productive output in contractions and also providing a price anchor for wages as a way of controlling price stability. Conceptually and theoretically it is a “good idea.” There are a variety of ways it could be implemented, but that is secondary.

    Tom Hickey Reply:

    Ooops. “These disagreement are with MMT, but are not MMT as a theory” should be in “within the context of MMT.” That is MMT’ers agree with the theory as a whole but disagree over details and about policy implementation. I think it is important to keep this distinction in mind.

    hbl Reply:

    Ah, thanks for trying to clarify, though I have to admit I’m still not entirely clear on the segue to the JG topic. But yes I do understand how various people can have different opinions on policy implementation within the broader MMT framework.

    You say “I am simply pointing out that whether the JG is a “good idea” in principle is different from what it would look like. Many people argue that without the latter the former is not decidable. MMT’ers argue that this is not the case… Conceptually and theoretically it is a “good idea.” There are a variety of ways it could be implemented, but that is secondary.”

    I think this needs separating into three pieces: (1) theory, (2) implementation details of said theory, and (3) testing in the real world to discover unintended consequences, etc.

    I think you’re saying we don’t need to know implementation details (#2) to verify whether a theory (#1) is a “good idea”. But the trouble is, we do need the results of testing (#3) to be sure the theory (#1) really is a “good idea”. And of course testing (#3) depends on implementation details (#2), so in that respect the implementation details can be important also in evaluating the soundness of a theory.

    For example, “From each according to his ability, to each according to his need” sounded great in theory, but has anyone figured out an implementation of it yet that works better in practice than the alternative theoretical systems, given unintended consequences?

    Maybe it comes down to your definition of “good idea”. We might be on the same page here if that label leaves room for some tentativeness.

    To be clear, I personally think the JG seems to be a very good idea! I just felt the need to respond to what I quoted above. I guess it mirrors the question of whether “no bonds” policy is a good idea, which is probably why you brought up the JG. In both cases I think there could be unintended consequences which could potentially outweigh the benefits. While it’s likely the implementation could be modified to minimize the negatives, I’m not sure that it’s ALWAYS possible to do so for every theory.

    Tom Hickey Reply:

    hbl, I agree with everything you say here. I brought up the JG because it is a key element of MMT that all MMT’ers accept, to my knowledge. The no bonds proposal is not a key element of MMT, although some strongly recommend it. However, all MMT’ers admit — again, as far as I am aware — that in principle no bonds could be done if the law were changed to permit it. However, all would point out that if the system were being designed from scratch, there would be no operational need for bonds, since a monetarily sovereign government funds itself with its monopoly issuance of a nonconvertible floating rate currency.

    I have gone into this in detail because there some confusion about MMT has popped up over time among both people new to MMT and critics of MMT elsewhere in the net. It is important to understand what MMT is and is not, and what is essential to it as a theory and what is not, e.g. proposed by some as policy options.

    But, in so far as MMT is an economic theory, it must stand or fall on the basis of results feeding back from implementation. Here, the devil is in the details, since it is virtually impossible to design controlled experiments in economics, so there is always dispute over “results.” That said, some of the “trials” in which MMT principles have been implemented already have turned out positively.

    Moreover, an economic theory does not have to work perfectly, e.g., in the sense of economic efficiency, when public purpose involving social matters is involved. Social criteria may superseded economic criteria, at least in the minds of those that do not equate policy with economics. For example, the JG gets “extra points” for resolving the pesky social/humanitarian problems of persistent unemployment.

    hbl Reply:

    Tom,

    I think we’re on the same page with respect to these topics. Thanks for the discussion!

    To the extent that we’re now just trying to be clear to third party observers, none of my points here have been an attempt to discredit core MMT concepts. This was a discussion of policy options within the MMT framework. I was even careful to label optional bond payments by the government as “fiscal policy for…” rather than “necessary interest on offer to entice the private sector to let the government borrow”, the latter being clearly false as revealed by MMT.

    Tom Hickey Reply:

    Agreed.

    BTW, I wasn’t only addressing you directly in every detail of my comments. A lot of people read the comments, so I find it useful to remember that we are potentially reaching than each other. Some of the things I brought in are misunderstood, and I wanted to clarify the issues.

    Moreover, I am not an expert in MMT, so when I make a mistake, I appreciate it being pointed out to me. If I don’t state what I think, then I could go on being mistaken without knowing about it. So I do it for my own knowledge also. For example, I had thought that the JG was a liberal add on, but I was correct on that when it was pointed out that it is integral to achieving optimal employment/output along with price stability, since it serves as an anchor for the price of labor.

    WARREN MOSLER Reply:

    you’re pretty much an expert
    :)

    WARREN MOSLER Reply:

    the monetary system functions first to move real resources from private to public domain to provide desired public infrastructure

    for a given size govt (and given ‘financial conditions’) taxes should then be set at a level that coincides with full employment in the private sector.

    Reply

  4. Digger says:

    The proposal to stop issuing bonds and set fed funds at zero was what got my intial attention with Warren’s proposals since that was already part of my thinking as far as solutions.

    Henry Ford and Thomas Edison agree.
    http://prosperityuk.com/2000/09/thomas-edison-on-government-created-debt-free-money/

    Frederick Soddy repeatedly made the point that only debt, not money should not bear interest. http://nesara.org/articles/soddy88.htm and http://nationaleconomy.net/frederick-soddy-revolutionary-scientist/

    Most monetary reformers I read and have worked with agree but many go futher and propose that we change to only vertically-created money ie. turn the Federal Reserve into a bank of issue only and have all other banks be banks of deposit.

    Reply

  5. Also, I don’t see any point in the govt paying interest on reserves or issuing bonds with regard to inflation.

    why bother? what public purpose does it serve?

    and, to the previous post, there is no such thing as the market setting rates based on inflation per se. all the markets ever do is set rates based on perceived fed reaction to inflation. if they knew the fed would never react to inflation and just leave rates at 0, the term structure of risk free rates would remain near 0

    Reply

    hbl Reply:

    “why bother? what public purpose does it serve?”

    1. Preservation of purchasing power for savers so as not to actively discourage responsible saving (if concerned about too much going to the “top end”, raise marginal tax rates on dividends and capital gains).

    2. Higher market stability which implies higher real economic stability (major swings in household wealth induce major and disruptive changes in attempted savings rates). See China, for example… negative real interest rates on bank deposits (due to government mandated ceiling on deposits) and historically unprecedented price/income bubbles in property values. But we’ll have to see if it ends badly.

    “all the markets ever do is set rates based on perceived fed reaction to inflation. if they knew the fed would never react to inflation and just leave rates at 0, the term structure of risk free rates would remain near 0″

    This somewhat challenges my current understanding, but I’m just an engineer and you’re a market veteran, so I acknowledge that you may be right and will have to think it through. Here’s an example snapshot of the yield curve in 2006. It only starts at 3 months, but are you suggesting the short end (perhaps shorter than 3 months?) would have remained at zero if the Fed was expected to be at and stay at zero? As I spelled out in a comment on Bill’s blog (via the link I included above) I think bank deposit rates would still be above zero as they get pulled slightly higher by loan assets at banks… slightly different than one day bonds but perhaps yields would end up set similarly by the market? I’ll have to spend more time on this.

    Reply

    warren mosler Reply:

    what public purpose is there in encouraging savings, which means not spending income?

    Just means output will go unsold/unemployment rise unless someone else spends more than their income.

    So with all our taxed advantaged savings, the result is we need what are deemed ‘large’ govt deficits to sustain output and employment.

    I’m ok with that. I like lower taxes for a given sized govt. But those pushing for more savings are also pushing for smaller govt deficits. can’t have it both ways.

    and either way, we can get the same macro outcomes with or without people not spending incomes (saving)

    And yes to your last point on interest rates. the euro dollar futures pretty much reflect market indifference levels for future fed rate decisions

    Reply

    hbl Reply:

    “what public purpose is there in encouraging savings, which means not spending income?”

    I said “not actively discourage” which is not the same as “encourage”. In my opinion fiscal policy should be neutral with respect to encouraging/discouraging savings. But the scenario you are talking about would discourage savings, with inflation a constant tax on savings held as government liabilities.

    Picture a young woman who wants to work for five years and live frugally and save so she can afford to take the next five years off to raise a baby herself, without having to send the child to daycare. I think she has that right. But the faster her savings are eroded the harder time she will have doing that. Or a near-retiree who follows his advisers advice to invest “conservatively” in mostly low risk fixed income and money markets, but then loses purchasing power faster than expected during retirement and has to make unexpectedly large sacrifices to survive. Just micro examples, but they affect quality of life and people’s happiness and anxiety levels. And the flip-side as I discussed before is the effect of all those who DO desperately bid up risky investments to try to avoid the inflation tax (see real estate in China).

    Reply

    warren mosler Reply:

    Yes, anyone has the right to live as frugally as they want.

    Yes, it takes enough pay for any given set of conditions to be able to save and take time off.

    If we want some group of people to be able to live without working we have the likes of social security for seniors.

    We can subsidize mothers who raise their own children if we want to without penalizing those who don’t, etc.

    If living frugally and consuming less serves some public purpose we can put incentives into place for that to happen.

    In fact, the incentives built into institutional structure are very rarely ‘neutral’ and so it’s always a matter of what serves public purpose and what doesn’t

    hbl Reply:

    Warren, as issuer of the currency that people use for both spending and saving, I think the government is responsible for recognizing that negative real interest rates on a large portion of aggregate household wealth (say, 2%-5% inflation in conjunction with 0% nominal yield government liabilities) would have some combination of the following effects relative to if that money earned something closer to the rate of inflation:

    A. Some people will choose to spend money more money rather than save it.

    B. Some people will still save but likely feel ongoing anxiety and perhaps have to change plans as their purchasing value erodes (to an unpredictable degree as inflation moves up and down… even with a JG buffer there would be some supply-side-driven fluctuation).

    C. Some people will avoid the “hot potato” asset that is negative real yield government liabilities, and bid up other assets (real estate, stocks, etc), typically following the latest momentum trend. Perhaps into bubble territory, which then corrects when the bubble gets too big. Again see China’s low deposit rates and high real estate prices (nature of correction TBD for that one).

    D. There will be some reduction in wealth disparity (though I still think this would be better achieved via IRS tax policy).

    Weighing the relative degree of those effects and determining which served or undermined public purpose does get a bit subjective without us having a lot of history to draw on. My personal judgment is [A] would be a relatively small effect in general, with [B] or [C] together the largest… probably with [C] relatively larger at times when inflation is relatively higher. You seem to highly value [A] (and perhaps [D]?) and not think that [B] or [C] undermine public purpose, which I respect as a valid viewpoint, despite disagreeing.

    As for targeting policy to subsidize mothers, retirees, etc… while we do some of that already, that sounds like a lot of micromanaging and would likely elicit a lot of “command and control” government fears from some political types. How do we judge and legislate support for all the possible reasons for saving that support public purpose, and prevent “gaming” of the system? (Weddings, 20% down payments on houses, once in a lifetime vacation, an adoption, etc… which are worthy?) But I do think some targeted policies are appropriate, so I’m not saying this is completely a bad idea, it just seems like one of the cases where there may be a broader, more “automatic” remedy.

    Overall, thanks, I appreciate your dialog on this.

    WARREN MOSLER Reply:

    lots of nations have had very high rates of real growth with high rates of inflation for extended periods of time, including Italy not all that long ago and for a more extreme example Turkey.

    and with high real investment (which = real savings)

    interest rates are a political choice, not an economic necessity

    Tom Hickey Reply:

    hbl, as I understand MMT and its approach to functional finance and sectoral balances, the aim is to achieve full employment/optimal capacity utilization along with price stability. The way I put is this: A monetarily sovereign government as monopoly currency issuer has the sole prerogative and corresponding sole responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity). If the government issues currency as nongovernment net financial assets in an amount that results in effective demand in excess of the capacity of the productive economy to absorb it, demand will rise relative to the goods and services that the economy can supply, and inflation will occur due to excess demand relative to supply. Conversely, if the government falls short in maintaining this balance by creating too few nongovernment net financial assets to stimulated sufficient effective demand to purchase supply at optimal capacity and full employment, then contraction and unemployment result, due to insufficient demand relative to supply. The government attempts to achieve balance through fiscal policy (currency issuance and taxation) and monetary policy (interest rates), based on analysis of data in terms of sectoral balances — contribution of government, households and firms, and foreign trade.

    What is implied is that income be sufficient to generate effective demand sufficient to purchase the goods and services for sale at optimal capacity and that productive investment be sufficient to grow the economy in proportion to population growth.

    Other factors are subservient to achieving this objective unless they contribute to it. It seems to me that a reasonable level of saving fits in here. Fiscal policy just needs to accommodate it.

    The traditional idea that a little bit of inflation is good is based on disincentivizing hoarding and instead incentivizing investing productively by putting a slight charge on saving. If the real rate of interest is about 1% historically, then adding another 1% inflation “tax” discourages excessive saving while keeping inflation low.

    hbl Reply:

    Tom, I agree with the high level objective and that “other factors are subservient to achieving this objective unless they contribute to it.”

    And to be clear I don’t think a 1% inflation “tax” is anything to be concerned about. I was thinking into the context of the 2%-5% range that has been more common, but I’m not sure MMT authors have ever been willing to associate “price stability” with any ranges, have they? I’m pretty sure I’ve seen people ask Bill where he thought inflation might range in the context of “full employment”, without answer. And of course it might just be too hard to even speculate. But I have some memory of a comment along the lines that anything less than 30% annual inflation isn’t harmful to growth (it’s a vague enough memory that I’m probably making it up!)

    I think I understand everyone’s points here. My own judgment is that maintaining something close to purchasing power for savers contributes to the objective via adding to demand and reducing volatility of demand. (And to return to Warren’s early points about needing a larger deficit if people save more… well in a “no bonds” scenario I’m pretty sure public perception would already have changed enough to accept the importance of large enough government deficits). But it’s fair to argue that the “purchasing power preservation” fiscal payments to savers could have been better spent in other areas (given finite productive capacity), and there are probably plenty of specific scenarios for which I could be convinced that the other fiscal policy targets would have been preferable.

    Tom Hickey Reply:

    hbl, as I recall some MMT’er said that historically moderate inflation is not a problem and contributes to growth. I think the standard of inflation for MMT is staying below the general price inflation that occurs when effective demand at optimal capacity/full employment exceeds the ability of the economy to accommodate it with further supply, since the opportunity cost of not doing this is the greatest that an economy has to bear.

    A lot of things are involved that make it difficult to put a specific figure on inflation targeting. For example, a broad and deep social safety net with pension program greatly reduces the need to save. This can justified for economic reasons as well as humanitarian, in that it increases effective demand/discretionary spending, making for a larger and more productive economy than would be possible if high savings were prudent owing to risk of job loss and medical expenses, and retirement provision.

    hbl Reply:

    Reposting without the link I included before, as the comment didn’t appear:

    “why bother? what public purpose does it serve?”

    1. Preservation of purchasing power for savers so as not to actively discourage responsible saving (if concerned about too much going to the “top end”, raise marginal tax rates on dividends and capital gains).

    2. Higher market stability which implies higher real economic stability (major swings in household wealth induce major and disruptive changes in attempted savings rates). See China, for example… negative real interest rates on bank deposits (due to government mandated ceiling on deposits) and historically unprecedented price/income bubbles in property values. But we’ll have to see if it ends badly.

    “all the markets ever do is set rates based on perceived fed reaction to inflation. if they knew the fed would never react to inflation and just leave rates at 0, the term structure of risk free rates would remain near 0″

    This somewhat challenges my current understanding, but I’m just an engineer and you’re a market veteran, so I acknowledge that you may be right and will have to think it through. Consider the yield curve in 2006, for example, where the 3-month rate was over 5%. Are you suggesting that if the Fed had kept the interbank overnight rate at 0%, then any one day bonds issued by the treasury at market determined prices at that time would have yielded 0%? Would the 3 month treasury rate have been significantly lower than 5% as a result?

    Reply

  6. Yes, I’ve been advocating a 0 rate policy for a long time. See ‘0 is the natural rate of interest’ on this site.

    reserves are functionally one day bonds, so the 0 bonds thing is actually a recommendation to issue nothing more than one day bonds.

    (bonds are just savings accounts at the fed)

    Reply

    hbl Reply:

    Warren,

    Isn’t the big difference that you advocate the government not paying interest on reserves? (Or just something small like the current 0.25%).

    But might not even one day bonds issued by the treasury have a yield that is something close to the rate of inflation (assuming the market gets to roughly set the yield), which therefore requires “fiscal payments” (interest) in that amount by the government? Clearly the shortest term rates are around 0 now but in “normal” times of higher inflation and less market uncertainty, they’ve been much higher.

    Reply

    warren mosler Reply:

    reserves are functionally ‘one day bonds’ and I’d not pay anything on them.

    yes, the fed could charge any interest on reaserves to the tsy, etc.
    but the whole thing with the fed/tsy is silliness.

    The fed should just do all the spending for the tsy.

    And no one should care if anything gets ‘charged’ to the fed or tsy. it’s all the same govt. and both are agents of congress.

    Reply

  7. Tom Hickey says:

    hbl, this discussion began when Randy Wary posted this over at New Economic Perspectives, putting forward the no bonds proposal. Since then (Nov 19, 2009), there has been a lot discussion on MMT blogs in the comments. Bill Mitchell is also on board with no bonds-no subsidy.

    The no bonds proposal is about recognizing the operational reality that the government does not need to finance itself by (fictitious) borrowing. Some who agree with no bonds would still allow the Fed to target the overnight rate by paying an equal support rate on excess reserves. Others would let the overnight rate go to zero with excess reserves.

    The point of no bonds is to get rid of the voluntary political requirement to offset deficits with Treasury issuance that is needless operationally under the current monetary system. I proposed continuing the issuance of retail savings bonds in low denominations aimed at retail savers, which was very popular during WWII (they were called “war bonds” then). This would be a voluntary option rather than a deficit offset requirement.

    Reply

    hbl Reply:

    Tom,

    I have seen the “no bonds” discussion a few times, though I didn’t know the history (thanks). What I hadn’t seen was your suggestion of retail savings bonds, and the theory as I understand it sounds very worthwhile to me (subject to getting the details right).

    “No bonds” as a way to recognize the operational reality that our government can spend without borrowing makes complete sense to me.

    That’s a very different justification to the one Bill usually implies with comments such as “government bonds represent corporate welfare to these unproductive and unnecessary elements in our society”. I was just questioning the pros and cons of the optional fiscal policy of providing dividend payments to those who have savings that consist of government liabilities.

    Reply

    Tom Hickey Reply:

    The principle problem (which Warren addresses in 7 Deadly Innocent Frauds) is the government-finance-is-like-household-finance false analogy, which is used to justify all sorts of nonsense. The sure way to kill that is no-bonds or even a serious public discussion of no-bonds as an operational option.

    I am not qualified to propose or critique a detailed plan for this, so I will leave that to those more expert in this. But I am opposed in principle to government subsidies that are not justified in terms of public purpose, and I am also concerned with central bank independence, when that means that a small group of unelected and unaccountable technocrats have undue power over the economy and therefore people’s lives.

    So I would like to see no-bonds if indeed bond issuance is a subsidy that is not justified by public purpose, and I would also like to see the Fed out of the interest rate setting business, since this is price setting at a command level entrusted to people with questionable knowledge and motives. It seems to be anti-capitalistic and anti-democratic.

    Reply

    hbl Reply:

    Tom,

    I agree with your statements here. See my latest comments on Bill’s blog, also. I think the market should set interest rates on most government liabilities (after disconnecting them from government spending, as you say) so that there is some inflation protection, and I would agree to get the Fed out of the rate setting business. If the government ends up paying “too much” in dividends to the most wealthy, raise the marginal tax rates on dividends (and probably capital gains too).

    Reply

  8. hbl says:

    Ah, just the topic I’d finally gotten around to asking about on Bill Mitchell’s blog! See several comments starting here.

    What is the MMT-inspired take on the combined effect of both pushing REAL interest rates [more] negative and increasing the quantity of short duration assets (perhaps beyond what the non-government sector desires to hold on aggregate). (Hi JKH, I see you made this duration point too).

    Via portfolio preferences affecting market prices, is this likely to either drive asset prices higher (one time shift) or add to the instability in asset prices (momentum-driven increases followed by plunges as they get too far ahead of the underlying economy’s actual cash flows). This is a commonly stated concern that I have not seen MMT authors address, even when they suggest a “no sovereign bonds” approach might better fulfill public purpose. But are treasuries better described as “corporate welfare” (Bill) or “fiscal policy to [approximately] preserve savers’ purchasing power and assist with market stability” (my label for the sake of discussion)?

    Reply

    Tom Hickey Reply:

    hbl, the no bonds proposal is part of a package that would disincentivize flows that do not go to demand/income, supply/productive investment, and a reasonable level of savings i.e., toward supporting the real economy instead of wealth acquisition by elites (“rentierism”), e.g. by taxing away economic rent and leveling the playing field by eliminating cheating.

    Most economists are interested in flattening the business cycle. MMT’ers are also interested in eliminating the financial cycle that ends (badly) in Ponzi finance. The way to both lies through equilibrating supply/productive investment and demand/income globally. This requires eliminating parasitism. Subsidies are dead weight and parasitic.

    Since government bond issuance is is operationally unnecessary for a monetarily sovereign government, interest on government bonds constitutes a subsidy and is a form of social and economic parasitism unless it can be justified on grounds of promoting public purpose. Since interest goes mostly to the wealthy, I don’t see how it is related to advancing public purpose.

    BTW, I would still have the government voluntarily issue retail savings bonds in the amount the public wished to purchase and make purchasing them routinely simple and accessible, since reasonable saving falls under promoting public purpose.

    Of course, the chief problem with the MMT program as a whole is political in that it challenges elites and undercuts the status quo by returning the economy to actual capitalism instead of socialism for the wealthy and well-connected.

    Reply

    beowulf Reply:

    BTW, I would still have the government voluntarily issue retail savings bonds in the amount the public wished to purchase and make purchasing them routinely simple and accessible, since reasonable saving falls under promoting public purpose.

    Exactly for many years, the Post Office sold savings bonds.
    http://en.wikipedia.org/wiki/United_States_Postal_Savings_System

    Reply

    hbl Reply:

    Hi Tom Hickey,

    Your comments are generally very intelligent and thoughtful, I wish I could fit in more discussion! I don’t really disagree with much of what you said here. It is clearly true that wealth has been increasingly concentrated at the top within the population in recent decades. I agree that the best public policies would be those that slowed or reversed this to some extent (or at least didn’t add to it!)

    One such approach is to allow government liabilities to have a negative inflation-adjusted return, which would be very likely under the “no bonds” proposal. But my question amounts to whether the societal COSTS (and unintended consequences) of this approach outweigh the BENEFITS. The fact is, people react to policies in both expected and unexpected ways, and can cause widespread damage as a result.

    And the “economic rent” or “subsidy” that is treasury dividend payments in practice doesn’t exceed the simultaneous “tax” that is inflation resulting from an economy running at or near capacity (I’m just talking about regular inflation here, not high/hyper inflation). And government public purpose should be aiming to keep the economy near that capacity (with respect to employment). So there isn’t really much net gain in purchasing power via treasuries. Plus, private bond buyers certainly insist on dividends paid to them at least covering [expected] inflation.

    I haven’t see the “retail savings bond” concept you mention, and part of my point has been that a certain amount of savings aligns with public purpose. Can you point me to a broader discussion I missed elsewhere? That seems like a solid idea, and I’m wondering if your implication is these might be limited to a certain amount per individual, otherwise they would be equivalent to current treasury bonds.

    Reply

  9. brian says:

    Good stuff, my question is does QE shift buyer base of assets into other things and create inflation (not necessarily good) in other forms? As an example, China no longer buying / and potentially selling treasurys into the bid of the Fed shifting USD reserves into EURO or GBP or other resources? Does QE shift USDs into different assets as FED is new buyer?

    Reply

    Matt Franko Reply:

    Brian,
    I think all it would do immediately would be to increase reserve balances at depository institutions (bank account balances). ie any/all (including China) sellers of Treasuries would exchange them for bank account balances net.

    The Feds bid would basically be a price setting action, QE doesnt really do anything other than adjust the “spreadsheet” entries. No new NFAs are created/provided to the non-govt sector via QE, only Fiscal can really do that.

    Fed cant do much right now…they really have no ‘bullets’ left, but they dont want to admit it, and that is a shame because Congress then continues to think they dont have to necessarily increase fiscal.

    We’re stuck with bad leadership/policy for the time being, at least until Warren is sworn in at the Senate…

    Resp,

    Reply

    Tom Hickey Reply:

    All the Fed can do is 1) influence the price of money by setting overnight rate and through using QE to influence the yield curve, and 2) increase or decrease liquidity by buying and selling assets.

    Lowering interest rates makes borrowing less expensive while also decreasing the amount of interest paid out. Lowering the amount of interest paid out is disinflationary in that it affects incomes of savers. Lowered rates potentially increase money in circulation, generating inflationary pressure, but only if funds are actually borrowed and spent, and that hasn’t been happening in a contractionary environment in which saving and delevering is preferred. So nothing big to expect from rates.

    QE increases liquidity when the Fed purchases assets by increasing bank reserves corresponding to the deposit accounts credited. However, this is unlikely to lead to more spending, since asset holders in aggregate sell asset to shift asset holdings rather than to spend. So while QE would lead to lower long term rates in the bond markets, perhaps sparking more investment (which hasn’t happened yet with low rates due to contraction), it could drive up the price of other assets, for example, commodities like petroleum in anticipation of a price rise owing to the announced “end of the recession,” or increased flow into equities, driving up equity markets globally, especially in emerging nations. Again, nothing material to expect for the real economy from QE, unless perhaps a switch from bonds to equities might result in a sustained run up in equities that would increase the wealth effect and inspire more spending domestically.

    AS Matt says, the sad thing is that the Fed is bluffing that it can do something to increase NAD when it can’t and this is leading Congress and the administration into fiscal inaction, although in fairness, there is not much that can happen with political gridlock.

    As far as the sectoral balances go, the US is improving exports by jacking up those arms sales. But that’s about all that’s happening.

    We’re out there on a wing and prayer. No real policy.

    Reply

    JKH Reply:

    They should call it duration easing (DE) rather than quantitative easing (QE).

    They’re just swapping Q’s of different duration – short duration Q (bank money and/or reserves) for long duration Q (treasuries). This effectively is not a net Q supply.

    Can affect the price of duration marginally by altering supply short and long.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>