Category Archives: Banking

Bernanke testimony

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The Economic Outlook and Monetary and Fiscal Policy

Chairman Ben S. Bernanke

Before the Committee on the Budget, U.S. Senate, Washington, D.C.

January 7, 2011

Chairman Conrad, Senator Sessions, and other members of the Committee, thank you for this opportunity to offer my views on current economic conditions, recent monetary policy actions, and issues related to the federal budget.

The Economic Outlook
The economic recovery that began a year and a half ago is continuing, although, to date, at a pace that has been insufficient to reduce the rate of unemployment significantly.1 The initial stages of the recovery, in the second half of 2009 and in early 2010, were largely attributable to the stabilization of the financial system, expansionary monetary and fiscal policies, and a powerful inventory cycle. Growth slowed somewhat this past spring as the impetus from fiscal policy and inventory building waned and as European sovereign debt problems led to increased volatility in financial markets.

More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. In particular, real consumer spending rose at an annual rate of 2-1/2 percent in the third quarter of 2010, and the available indicators suggest that it likely expanded at a somewhat faster pace in the fourth quarter. Business investment in new equipment and software has grown robustly in recent quarters, albeit from a fairly low level, as firms replaced aging equipment and made investments that had been delayed during the downturn. However, the housing sector remains depressed, as the overhang of vacant houses continues to weigh heavily on both home prices and construction, and nonresidential construction is also quite weak. Overall, the pace of economic recovery seems likely to be moderately stronger in 2011 than it was in 2010.

Although recent indicators of spending and production have generally been encouraging, conditions in the labor market have improved only modestly at best. After the loss of nearly 8-1/2 million jobs in 2008 and 2009, private payrolls expanded at an average of only about 100,000 per month in 2010–a pace barely enough to accommodate the normal increase in the labor force and, therefore, insufficient to materially reduce the unemployment rate.2 On a more positive note, a number of indicators of job openings and hiring plans have looked stronger in recent months, and initial claims for unemployment insurance declined through November and December. Notwithstanding these hopeful signs, with output growth likely to be moderate in the next few quarters and employers reportedly still reluctant to add to payrolls, considerable time likely will be required before the unemployment rate has returned to a more normal level. Persistently high unemployment, by damping household income and confidence, could threaten the strength and sustainability of the recovery. Moreover, roughly 40 percent of the unemployed have been out of work for six months or more. Long-term unemployment not only imposes exceptional hardships on the jobless and their families, but it also erodes the skills of those workers and may inflict lasting damage on their employment and earnings prospects.

A very ‘dovish’ assessment of this leg of the dual mandate, indicating the low rate policy will continue.

Recent data show consumer price inflation continuing to trend downward. For the 12 months ending in November, prices for personal consumption expenditures rose 1.0 percent, and inflation excluding the relatively volatile food and energy components–which tends to be a better gauge of underlying inflation trends–was only 0.8 percent, down from 1.7 percent a year earlier and from about 2-1/2 percent in 2007, the year before the recession began. The downward trend in inflation over the past few years is no surprise, given the low rates of resource utilization that have prevailed over that time. Indeed, as a result of the weak job market, wage growth has slowed along with inflation; over the 12 months ending in November, average hourly earnings have risen only 1.6 percent. Despite the decline in inflation, long-run inflation expectations have remained stable; for example, the rate of inflation that households expect over the next 5 to 10 years, as measured by the Thompson Reuters/University of Michigan Surveys of Consumers, has remained in a narrow range over the past few years. With inflation expectations stable, and with levels of resource utilization expected to remain low, inflation is likely to be subdued for some time.

A very dovish assessment of the inflation mandate as well, which he links to the output gap and inflation expectations.

Monetary Policy
Although it is likely that economic growth will pick up this year and that the unemployment rate will decline somewhat, progress toward the Federal Reserve’s statutory objectives of maximum employment and stable prices is expected to remain slow. The projections submitted by Federal Open Market Committee (FOMC) participants in November showed that, notwithstanding forecasts of increased growth in 2011 and 2012, most participants expected the unemployment rate to be close to 8 percent two years from now. At this rate of improvement, it could take four to five more years for the job market to normalize fully.

FOMC participants also projected inflation to be at historically low levels for some time. Very low rates of inflation raise several concerns: First, very low inflation increases the risk that new adverse shocks could push the economy into deflation, that is, a situation involving ongoing declines in prices. Experience shows that deflation induced by economic slack can lead to extended periods of poor economic performance; indeed, even a significant perceived risk of deflation may lead firms to be more cautious about investment and hiring. Second, with short-term nominal interest rates already close to zero, declines in actual and expected inflation increase, respectively, both the real cost of servicing existing debt and the expected real cost of new borrowing. By raising effective debt burdens and by inhibiting new household spending and business investment, higher real borrowing costs create a further drag on growth. Finally, it is important to recognize that periods of very low inflation generally involve very slow growth in nominal wages and incomes as well as in prices. (I have already alluded to the recent deceleration in average hourly earnings.) Thus, in circumstances like those we face now, very low inflation or deflation does not necessarily imply any increase in household purchasing power. Rather, because of the associated deterioration in economic performance, very low inflation or deflation arising from economic slack is generally linked with reductions rather than gains in living standards.

It doesn’t get any more dovish than that.

In a situation in which unemployment is high and expected to remain so and inflation is unusually low, the FOMC would normally respond by reducing its target for the federal funds rate. However, the Federal Reserve’s target for the federal funds rate has been close to zero since December 2008, leaving essentially no scope for further reductions. Consequently, for the past two years the FOMC has been using alternative tools to provide additional monetary accommodation. Notably, between December 2008 and March 2010, the FOMC purchased about $1.7 trillion in longer-term Treasury and agency-backed securities in the open market. The proceeds of these purchases ultimately find their way into the banking system, with the result that depository institutions now hold a high level of reserve balances with the Federal Reserve.

Although longer-term securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms of the two approaches are similar. Conventional monetary policy works by changing market expectations for the future path of short-term interest rates, which, in turn, influences the current level of longer-term interest rates and other financial conditions. These changes in financial conditions then affect household and business spending. By contrast, securities purchases by the Federal Reserve put downward pressure directly on longer-term interest rates by reducing the stock of longer-term securities held by private investors.3 These actions affect private-sector spending through the same channels as conventional monetary policy. In particular, the Federal Reserve’s earlier program of asset purchases appeared to be successful in influencing longer-term interest rates, raising the prices of equities and other assets, and improving credit conditions more broadly, thereby helping stabilize the economy and support the recovery.

Reads like he’s finally got it right, and that it’s about price not quantity.

In light of this experience, and with the economic outlook still unsatisfactory, late last summer the FOMC began to signal to financial markets that it was considering providing additional monetary policy accommodation by conducting further asset purchases. At its meeting in early November, the FOMC formally announced its intention to purchase an additional $600 billion in Treasury securities by the end of the second quarter of 2011, about one-third of the value of securities purchased in its earlier programs. The FOMC also maintained its policy, adopted at its August meeting, of reinvesting principal received on the Federal Reserve’s holdings of securities.

The FOMC stated that it will review its asset purchase program regularly in light of incoming information and will adjust the program as needed to meet its objectives. Importantly, the Committee remains unwaveringly committed to price stability and, in particular, to maintaining inflation at a level consistent with the Federal Reserve’s mandate from the Congress.4 In that regard, it bears emphasizing that the Federal Reserve has all the tools it needs to ensure that it will be able to smoothly and effectively exit from this program at the appropriate time. Importantly, the Federal Reserve’s ability to pay interest on reserve balances held at the Federal Reserve Banks will allow it to put upward pressure on short-term market interest rates and thus to tighten monetary policy when needed, even if bank reserves remain high. Moreover, the Fed has invested considerable effort in developing methods to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, the Committee could also tighten policy by redeeming or selling securities on the open market.

More evidence he’s finally got it right.

As I am appearing before the Budget Committee, it is worth emphasizing that the Fed’s purchases of longer-term securities are not comparable to ordinary government spending. In executing these transactions, the Federal Reserve acquires financial assets, not goods and services.

And he’s taken to heart some good coaching from his Monetary Affairs executives on this as well.

Ultimately, at the appropriate time, the Federal Reserve will normalize its balance sheet by selling these assets back into the market or by allowing them to mature. In the interim, the interest that the Federal Reserve earns from its securities holdings adds to the Fed’s remittances to the Treasury; in 2009 and 2010, those remittances totaled about $120 billion.

No mention that functions much like a tax, removing that much income from the non govt. sectors.

Fiscal Policy
Fiscal policymakers also face a challenging policy environment. Our nation’s fiscal position has deteriorated appreciably since the onset of the financial crisis and the recession. To a significant extent, this deterioration is the result of the effects of the weak economy on revenues and outlays, along with the actions that were taken to ease the recession and steady financial markets. In their planning for the near term, fiscal policymakers will need to continue to take into account the low level of economic activity and the still-fragile nature of the economic recovery.

Substitute ‘adjusted’ for deteriorated and it’s something I perhaps could have said. And the last sentence opens the door for further fiscal adjustment. But then it all goes bad:

However, an important part of the federal budget deficit appears to be structural rather than cyclical; that is, the deficit is expected to remain unsustainably elevated even after economic conditions have returned to normal. For example, under the Congressional Budget Office’s (CBO) so-called alternative fiscal scenario, which assumes that most of the tax cuts enacted in 2001 and 2003 are made permanent and that discretionary spending rises at the same rate as the gross domestic product (GDP), the deficit is projected to fall from its current level of about 9 percent of GDP to 5 percent of GDP by 2015, but then to rise to about 6-1/2 percent of GDP by the end of the decade. In subsequent years, the budget outlook is projected to deteriorate even more rapidly, as the aging of the population and continued growth in health spending boost federal outlays on entitlement programs. Under this scenario, federal debt held by the public is projected to reach 185 percent of the GDP by 2035, up from about 60 percent at the end of fiscal year 2010.

The CBO projections, by design, ignore the adverse effects that such high debt and deficits would likely have on our economy. But if government debt and deficits were actually to grow at the pace envisioned in this scenario, the economic and financial effects would be severe. Diminishing confidence on the part of investors that deficits will be brought under control would likely lead to sharply rising interest rates on government debt and, potentially, to broader financial turmoil. Moreover, high rates of government borrowing would both drain funds away from private capital formation and increase our foreign indebtedness, with adverse long-run effects on U.S. output, incomes, and standards of living.

It is widely understood that the federal government is on an unsustainable fiscal path. Yet, as a nation, we have done little to address this critical threat to our economy. Doing nothing will not be an option indefinitely; the longer we wait to act, the greater the risks and the more wrenching the inevitable changes to the budget will be. By contrast, the prompt adoption of a credible program to reduce future deficits would not only enhance economic growth and stability in the long run, but could also yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence. Plans recently put forward by the President’s National Commission on Fiscal Responsibility and Reform and other prominent groups provide useful starting points for a much-needed national conversation about our medium- and long-term fiscal situation. Although these various proposals differ on many details, each gives a sobering perspective on the size of the problem and offers some potential solutions.

This is absolute garbage from the good Princeton professor.

With this testimony he continues to share the blame for the enlarged output gap.

Because he fears we could be the next Greece, he remains part of the process that is turning us into the next Japan.

Of course, economic growth is affected not only by the levels of taxes and spending, but also by their composition and structure. I hope that, in addressing our long-term fiscal challenges, the Congress will seek reforms to the government’s tax policies and spending priorities that serve not only to reduce the deficit but also to enhance the long-term growth potential of our economy–for example, by encouraging investment in physical and human capital, by promoting research and development, by providing necessary public infrastructure, and by reducing disincentives to work and to save. We cannot grow out of our fiscal imbalances, but a more productive economy would ease the tradeoffs that we face.

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The Influence of the Sub Prime Fiasco on the Last Business Cycle

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I recently sent this with regard to the question of how high the deficit might need to be for full employment, as per my earlier post showing we may be needing ever lower taxes for a given size govt (a higher deficit) for full employment:

The federal surplus years of the late 90’s were supported by the private sector willing and able to borrow to both fund consumption and fund impossible and often fraudulent .com business plans. Private sector debt was growing at about 7% of gdp into y2k, with 2% of gdp being eaten up by the federal surplus, and the other 5% and more by other demand leakages/net savings of financial assets- trade deficit, pension fund contributions and asset appreciation, etc.

This unsustainable process bled us dry and shortly after y2k it all went bad. Near 0 rates and a small ‘stimulus’ did nothing to close the output gap. Finally, in 2003, Bush came through with a then massive fiscal adjustment that got the deficit up to about 8% of gdp (annualized) for q3 03 which was enough to turn things around, and the economy improved enough to not cost him the election.

But it was pretty modest growth, like today, until it picked up to a respectable pace with the agg demand created by what was later to be recognized as the housing fraud. The borrowing to buy housing binge was the consumer debt expansion that drove gdp growth for the year or so before it was discovered.

After the frauds were discovered, maybe in mid 06 or so, the new borrowing to buy housing fell off. With that support from aggregate demand pulled, there was no longer enough demand to sustain employment and home prices, which leveled off and began to fall, undermining the asset side of the banking system. The 170 billion stimulus in the first half of 08 worked to support demand, allow people to make mtg payments, etc. and gdp returned to about +2.5% in q2 08.

However, the fall in real estate values took down Bear and Lehman, and the fed failed to adequately support the liability side of its banking system (that is, provide continuous liquidity regardless, and do the deed on the asset side- wiping out shareholders and other capital including bond holders to absorb losses, liquidate insolvent firms no one wants to buy, put people in jail, etc. etc. but NEVER allow even the implication of a liquidity crisis. This was done during the s and l crisis which prevented that from spilling over to the real economy the way this one did.) Around July/aug 2008, in fact, is when I began calling for a full payroll tax holiday as the right response to a financial crisis like the one we were in. The real economy needed the people who were working for a living armed with enough income to make their payments (if the wanted to) and do their normal shopping from income rather than credit which the banking system was failing to provide. That simple keystroke could have prevented the entire real sector collapse, and the financial sector could have been left to more or less fend for itself and hopefully come through in a greatly reduced fashion.

So my point is, the mtg fraud first accelerated the economy, and then when that support was pulled the economy collapsed when govt was not forthcoming with a fiscal adjustment to replace the lost aggregate demand.

That is, the sub prime fiasco first added support to gdp that would not have been there, and then that support was removed when the frauds were discovered.

I see the real lesson to be learned as the govt always has the means and even responsibility to make immediate fiscal adjustments to support demand. In other words, make sure there are enough consumer spending dollars for business to compete for.

And, at the same time, to not support moral hazard by letting companies (particularly financial institutions) fail and investors take all the losses first during organized insolvency proceedings.

If govt. had done this in mid 08- provide the continuous liquidity to the banking system and suspend all FICA contributions- it all would have been much different. The fall in housing prices and new construction would not have been nearly as severe, delinquencies and foreclosures would have been much lower, far fewer banks would have failed, car sales would not have fallen nearly as far and the car companies would not have needed bailouts, and so on down the line. Note that even the crash of 1987 did not take out the real economy, even though it followed the then staggering losses from the s and l crisis, as bank liquidity was never allowed to be in question.

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AMI Perpetrated Innocent Fraud

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For all practical purposes, fractional reserve banking ended in 1934 when we went off the gold standard. Today’s banking is not reserve constrained.

At best, this is a case of innocent fraud.

Telling that Kucinich was convinced to go along with this.

Nor are there any critics in the media I’ve seen who know any better.

AMI wrote:
Dear Friends of the American Monetary Institute,
(Please pardon multiple emails)
 

A positive note and appeal on the last day of the year:
 

On December 17th, major progress occurred towards monetary reform when Congressman Dennis Kucinich (D, Ohio) introduced legislation which changes a corrupt private money system using bank credit for money, into to a sustainable and just system based on using government created money, under our constitutional system of checks and balances. It ends whats known as fractional reserve banking!
 

He called it the National Employment Emergency Defense Act (“NEED”) HR 6550 because it would solve the unemployment crisis our nation is in. It solves many other crises as well. Please ask your representatives, whether Republican or Democratic to read it here http://www.govtrack.us/congress/billtext.xpd?bill=h111-6550
 

This is an important monetary step forward for our people and for humanity. Progress consists of taking such steps in the right direction, educating people and gaining their support. It will take time and a sustained effort. It needs to be supported, both verbally and financially. We deeply thank those of you who are giving such support.
 

Now if you have not gotten to that stage yet, the American Monetary Institute does need your help: If you understand the importance of what we do, and appreciate the work we do, please make a tax deductible donation to the institute of $25, $50 or more, by sending your check payable to the:
 

American Monetary Institute
P.O. Box 601,
Valatie, NY 12184
 

You can also donate through PayPal using the donate buttons at our website at http://www.monetary.org
If you have not yet read The Lost Science of Money book, this is a good time to order it, at our home page.
 

The stage has been set by Congressman Kucinich for 2011 to be an important year to discuss and gain support for this “NEED” Act, HR 6550. Thats a part of what we do. Please help the American Monetary Institute continue to develop materials that educate our citizenry on how beneficial this non-partisan Act would be for our nation and give what you can.
 

I hope you had good Christmas holidays and wish you a Happy New Year!
Warm regards,
Stephen Zarlenga

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Kucinich

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pitiful stupidity/ignorance of monetary operations.

Very good post/critique by Bill on same goes into more detail:

http://bilbo.economicoutlook.net/blog/?p=12866

On Thu, Dec 23, 2010 at 10:55 AM, Scott Fullwiler wrote:
 

http://www.scribd.com/doc/45753797/NEED-ACT
 

Kucinich wants to end “private money creation” by banks or anyone else.
 

“Sec. 102. Unlawful for Persons to Create Money.
Any person who creates or originates United States money by lending against deposits, through so-called fractional reserve banking, or by any other means, after the effective date shall be fined under Title 18, United States Code, imprisoned for not more than 5 years, or both.”

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china inflation – ft article

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Sounds like the ‘managing expectations’ they teach at the western universities.

Inflation is under control, says Chinese regulator

By Jamil Anderlini

December 17 (FT) — “The recent inflation is completely different from the periods of very high inflation that China has encountered in the past,” Mr Liu, chairman of the China Banking Regulatory Commission, said on Friday.

“There is overcapacity for most industrial goods in the Chinese market and it’s impossible for upstream inflation to be transmitted downstream.”

The relatively sanguine assessment also partly explains why Beijing appears set to grant Chinese banks a lending quota next year that is roughly the same as this year’s, or even slightly higher, even though the economy is already awash with liquidity.

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euro endgame

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On Sun, Nov 28, 2010 at 7:24 PM, wrote:

I’ve tried to think of a happy ending here and there simply isn’t one.

That’s like thinking for the endgame of the US if you believe the federal budget needs to be balanced. There isn’t one in that case either.

The end game is always for the fiscal authority to run a deficit. Which means the ECB in the euro zone.

They won’t let the Euro collapse which means Germany leaving is out of the question. But Germany won’t just become the funding source for all of these periphery nations.

Right, it has to be the ECB. Just like Texas can’t fund the other states.

I think they should just vote to remove Ireland and Greece with a partial debt restructuring. They’d actually be doing them a huge favor while also avoiding massive collateral damage in the banking system.

Likewise, the ECB has to fund the deposit insurance to make it credible and workable.

Then they could target their efforts on saving Spain and the Euro.

Problem is, they all need to be saved.

As credit sensitive entities like the US states their debt to gdp ratios need to be below 20% to be ‘stand alone.’

The reason Luxembourg is that low is because they never did have their own currency, and so never could get higher than where they were.

The other national govts had their own currencies before joining the euro, and therefore had deficits appropriate for being the currency issuer, which is equal to non govt savings desires. Problem was they joined the euro, turned over the currency management to the ECB, and kept their old debt ratios. The informed way to have merged would have been to have the ECB take over their national debts, and let them start clean. But it happened the way it happened and now they have to move forward from here.

Ireland and Greece go it alone, the world panics for a few months and then everyone realizes that we’re all better off. Then the Euro continues to exist until it causes another crisis in 15 years (assuming no central funding system is created)….

They already have a central funding system in place- the ECB buying nat govt bonds in the secondary markets. While far from my first choice on how to do things for a variety of economic and political reasons, it does function to keep member nations solvent, for as long as the ECB keeps doing it.

My proposal remains the most sensible but not even a consideration- per capita ECB annual distributions to the govts to pay down debt of the member nations beginning with an immediate 10% of GDP distribution. To do this they first have to understand why it’s not inflationary, which means they have to understand inflation on the demand side is a function of spending, and the distribution does not increase govt spending.

That’s a big leap from their inflation expectations theory of inflation. They believe that anything that increases people’s expectation of inflation is what actually causes inflation. And they believe that because they have still failed to recognize that the currency itself is a (simple) public monopoly.

That means the price level is a function of prices paid by the govt of issue when it spends, whether it knows it or not, and not a function of expectations.

So while in fact it is the economy that needs the govt’s funds to pay its taxes, and therefore the economy is ‘price taker’, they instead believe that it is the govt that needs the economy’s funds to be able to spend.

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FMOC Minutes

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New Forecasts (central tendency and range of forecasts) in Table 1 below: Long-Run inflation forecast of 1.6-2.0% is basically their target; 2011 and 2012 unemployment forecasts revised up by 0.6-0.7%. Note that low-end of GDP forecast for 2011 is 2.5%. This is above many other forecasters.


Interesting Observations from FRB Staff; Outlook revised up, basically on assumption of improved financial conditions; and in turn inflation higher due to less slack and weaker $

The staff revised up its forecast for economic activity in 2011 and 2012. In light of asset market developments over the intermeeting period, which in large part appeared to reflect heightened expectations among investors that the Federal Reserve would undertake additional purchases of longer-term securities, the November forecast was conditioned on lower long-term interest rates, higher stock prices,
and a lower foreign exchange value of the dollar than was the staff’s previous forecast.

The downward pressure on inflation from slack in resource utilization was expected to be slightly less than previously projected, and prices of imported goods were anticipated to rise somewhat faster.

FOMC Members-Recap of debate of pros/cons of LSAPs; sizing LSAPs; and setting an inflation target, and setting a long-term interest rate target

Although participants considered it quite unlikely that the economy would slide back into recession, some noted that continued slow growth and high levels of resource slack could leave the economic expansion vulnerable to negative shocks. In the absence of such shocks, and assuming appropriate monetary policy

They do assume what they do has quite a bit of influence over the outcomes.

participants’ economic projections generally showed growth picking up to a moderate pace and the unemployment rate declining somewhat next year. Participants generally expected growth to strengthen further and unemployment to decline somewhat more rapidly in 2012 and 2013.

Several noted that the recent rate of output growth, if continued, would more likely be associated with an increase than a decrease in the unemployment rate.

While underlying inflation remained subdued, meeting participants generally saw only small odds of deflation, given the stability of longer-term inflation expectations

They remain steeped in inflation expectations theory as previously discussed.

and the anticipated recovery in economic activity.

Most saw the risks to growth as broadly balanced, but many saw the risks as tilted to the downside. Similarly, a majority saw the risks to inflation as balanced; some, however, saw downside risks predominating while a couple saw inflation risks as tilted to the upside.

Participants also differed in their assessments of the likely benefits and costs associated with a program of purchasing additional longer-term securities in an effort to provide additional monetary stimulus, though most saw the benefits as exceeding the costs in current circumstances. Most participants judged that a program of purchasing additional longer-term securities would put downward pressure on longer-term interest rates and boost asset prices; some observed that it could also lead to a reduction in the foreign exchange value of the dollar. Most expected these changes in financial conditions to help promote a somewhat stronger recovery in output and employment while also helping return inflation, over time, to levels consistent with the Committee’s mandate. In addition, several participants argued that the stimulus provided by additional securities purchases would help protect against further disinflation and the small probability that the U.S. economy could fall into persistent deflation–an outcome that they thought would be very costly. Some participants, however, anticipated that additional purchases of longer-term securities would have only a limited effect on the pace of the recovery; they judged that the economy’s slow growth largely reflected the effects of factors that were not likely to respond to additional monetary policy stimulus and thought that additional action would be warranted only if the outlook worsened and the odds of deflation increased materially. Some participants noted concerns that additional expansion of the Federal Reserve’s balance sheet could put unwanted downward pressure on the dollar’s value in foreign exchange markets. Several participants saw a risk that a further increase in the size of the Federal Reserve’s asset portfolio, with an accompanying increase in the supply of excess reserves and in the monetary base, could cause an undesirably large increase in inflation.

This flies in the face of any understanding of banking and actual monetary operations, as well as recent Fed research.

However, it was noted that the Committee had in place tools that would enable it to remove policy accommodation quickly if necessary to avoid an undesirable increase in inflation.


Participants expressed a range of views about the potential costs and benefits of quantifying the Committee’s interpretation of its statutory mandate to promote price stability by adopting a numerical inflation objective or a target path for the price level. In the end, participants noted that the longer-run projections contained in the Summary of Economic Projections, which is released once per quarter in conjunction with the minutes of four of the Committee’s meetings, convey considerable information about participants’ assessments of their statutory objectives. Participants discussed whether it might be useful for the Chairman to hold occasional press briefings to provide more detailed information to the public regarding the Committee’s assessment of the outlook and its policy decision making than is included in Committee’s short post-meeting statements.


In their discussion of the relative merits of smaller and more frequent adjustments versus larger and less frequent adjustments in the Federal Reserve’s intended securities holdings, participants generally agreed that large adjustments had been appropriate when economic activity was declining sharply in response to the financial crisis. In current circumstances, however, most saw advantages to a more incremental approach that would involve smaller changes in the Committee’s holdings of securities calibrated to incoming data.


Finally, participants discussed the potential benefits and costs of setting a target for a term interest rate. Some noted that targeting the yield on a term security could be an effective way to reduce longer-term interest rates and thus provide additional stimulus to the economy. But participants also noted potentially large risks, including the risk that the Federal Reserve might find itself buying undesirably large amounts of the relevant security in order to keep its yield close to the target level.

No mention at all of the interest income channels, which act to reduce interest income in the economy as rates fall.

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Next Debt Crisis May Start in Washington: Bair

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She’s as much a part of the problem as any of them.

Also, she continues to support taxing banks for FDIC losses, which works counter to Fed rate setting policy.
Across the board taxes on banks hike rates charged to borrowers, while the Fed is trying to get them down.

Also, why should a good bank be charged for losses of failed banks, when bank assets, lending policies, and operations in general are fully regulated and supervised by the FDIC? She’s making good banks pay for FDIC failures.

Banks are designated agents of the Fed, public/private partnerships established for public purpose, govt. regulated and supervised, and as such should not be charged anything for FDIC insurance. It makes no sense for the govt. to charge one of its agencies for its support.

Next Debt Crisis May Start in Washington: Bair

The US needs to take urgent action to cut its debt in order to prevent the next financial crisis, which may start in Washington, Sheila Bair, chair of the Federal Deposits Insurance Corp. (FDIC) wrote in an editorial in the Washington Post.

The federal debt has doubled over the past seven years, to almost $14 trillion, and the growth is a result of both the financial crisis and the government’s “unwillingness over many years to make the hard choices necessary to rein in our long-term structural deficit,” Bair wrote.

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Ireland Seeks Rescue for Banks as EU Struggles to Stem

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Letting the banks fail would have been a highly deflationary event, that presumably has been discounted to some degree by markets. This would include depreciation of Irish bank financial assets, etc.

This helps remove that deflationary risk, and in that sense is ‘inflationary’ in that it works against those deflationary forces.

Also, as you pointed out, there is as yet no new austerity required for this package.

Also reinforced is the notion that any member nation can have a banking crisis that’s too big for it to support.

This further reinforces the notion that the entire euro zone is ultimately supportable only by the ECB.

In any case, it looks like the will is still there to keep the euro zone muddling through at some minimal degree above crisis level, whatever the cost.

Ireland Becomes Second Euro Nation to Seek Aid

By Joe Brennan and Dara Doyle

November 22 (Bloomberg) — Ireland became the second euro country to seek a rescue as the cost of saving its banks threatened a rerun of the Greek debt crisis that destabilized the currency. The euro rose and European bond risk fell.

A package that Goldman Sachs Group Inc. estimates may total 95 billion euros ($130 billion) failed to damp speculation that Portugal and Spain would need to tap the emergency fund set up by the European Union and International Monetary Fund after the Greece rescue. Moody’s Investors Service said a “ multi-notch” downgrade in Ireland’s Aa2 credit rating was “most likely.”

“Speculative actions against Portugal and Spain are not justified, though it can’t be excluded,” Luxembourg Prime Minister Jean-Claude Juncker said today on RTL Luxembourg radio. “In a moment where financial markets have an excessive tendency to punish those countries that didn’t stick 100 percent to an orthodox consolidation, one can never exclude that similar things will happen.”

The aid, which Irish officials said as recently as Nov. 15 they didn’t need, marks the latest blow to an economy that more than doubled in the decade ending in 2006. The bursting of the real-estate bubble in 2008 plunged the country into a recession and brought its banks close to collapse. With Irish bond yields near a record high, policy makers are trying to keep the crisis from spreading.

Threat to Euro

“Clearly because of the size of their loan books, the huge risks they took, they became a threat not only to the state but to the” entire euro region, Lenihan told Dublin-based RTE radio in an interview today. “The banks will be downsized to the real needs of the Irish economy” to “Irish consumers and Irish businesses. That has to be the primary focus of Irish banks.”

Ireland will channel some aid to lenders via a “contingent” capital fund, Finance Minister Brian Lenihan said.

The euro rose 0.5 percent to $1.3740 at 10:30 a.m. in London. Irish 10-year notes rose, sending the yield down 24 basis points to 8.11 percent. Ireland led a decline in the cost of insuring against default on European debt, according to traders of credit-default swaps. Contracts on Irish government bonds dropped 28.5 basis points to 478.5, the lowest level since Oct. 29, according to data provider CMA in London.

“Ireland had no choice,” said Nicholas Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for money managers. “The market will still be waiting for the details of the assistance and the conditionality, but there should be a relief rally.”

U.K., Sweden

The U.K. and Sweden may contribute bilateral loans, the EU said in a statement. Lenihan declined to say how big the package will be, saying that it will be less than 100 billion euros. Goldman Sachs Chief European Economist Erik Nielsen said yesterday the government needs 65 billion euros to fund itself for the next three years and 30 billion euros for the banks.

Talks will focus on the government’s deficit cutting plans and restructuring the banking system, the EU said in a statement. Irish Prime Minister Brian Cowen, who spoke at the same press briefing as Lenihan, said the banks will be stress tested. Ireland nationalized Anglo Irish Bank Corp. in 2009 and is preparing to take a majority stake in Allied Irish Banks Plc, the second-largest bank.

Lenihan and Cowen appeared minutes after finance chiefs issued a statement endorsing an aid request to calm markets. Allied Irish emphasized the fragility of the system on Nov. 19, reporting a 17 percent decline in deposits this year.

Stabilizing Situation

“In the short term, it will stabilize the situation, there’s no doubt about that,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, who estimates a package of between 80 billion euros and 100 billion euros. “But as we’ve seen in the case of Greece, uncertainty will remain.”

The package for Ireland will total as much as 60 percent of gross domestic product, compared with 47 percent for Greece.

Cowen plans to announce the government’s four-year budget plan this week and said an agreement with the EU and the IMF will come “in the next few weeks.” Cowen also faces an election in Donegal in northwest Ireland on Nov. 25 to fill a vacant parliamentary seat. The vote threatens to erode Cowen’s majority. He has the support of 82 lawmakers, including independents, compared with 79 for the combined opposition.

The bailout follows two years of budget cuts that failed to restore market confidence as the cost of shoring up the financial industry soared.

Merkel’s Trigger

Lenihan cancelled bond auctions for October and November and announced 6 billion euros of austerity measures for 2011 on Nov. 4 in a bid to restore investor confidence. Those efforts failed after German Chancellor Angela Merkel triggered an investor exodus by saying bondholders should foot some of the bill in any future bailout.

The risk premium on Ireland’s 10-year debt over German bunds, Europe’s benchmark, fell to 523 basis points today. It widened to a record 652 basis points on Nov. 11, with the yield reaching a record 9.1 percent. In 2007, it cost Ireland less than Germany to borrow. Its 10-year spread then fell to as low as 77 basis points less than bunds. The ISEQ stock index has plunged 70 percent from its record in 2007.

Ireland will draw on the 750-billion-euro fund set up by the EU and IMF in May as part of the Greek bailout to protect the currency shared by 16 countries.

Irish Reversal

Irish officials initially resisted pressure from the EU to take any aid, saying they were fully funded until the middle of 2011. European leaders sought to head off contagion from Ireland and reduce pressure on the European Central Bank to prop up the country’s lenders by providing them with unlimited liquidity.

Cowen defended his reversal on the need for aid. “I don’t accept I’m the bogeyman,” he said. “Now circumstances have changed, we’ve changed our policies.”

Yields on bonds of Spain and Portugal have jumped amid concern that fallout from Ireland would spread. The extra yield that investors demand to hold Portuguese 10-year bonds instead of German bunds climbed to a record 484 basis points on Nov. 11.

“It probably won’t halt contagion. The sovereign crisis isn’t yet over,” said Sylvain Broyer, chief euro-region economist at Natixis in Frankfurt. “Ireland is in the middle of a difficult crisis.”

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A failure of theory and practice- comments on Fed Chairman Bernanke’s speech

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Emerging from the Crisis: Where Do We Stand?

Chairman Ben S. Bernanke

November 19, 2010

The last time I was here at the European Central Bank (ECB), almost exactly two years ago, I sat on a distinguished panel much like this one to help mark the 10th anniversary of the euro. Even as we celebrated the remarkable achievements of the founders of the common currency, however, the global economy stood near the precipice. Financial markets were volatile and illiquid, and the viability of some of the world’s leading financial institutions had been called into question. With asset prices falling and the flow of credit to the nonfinancial sector constricted, most of the world’s economies had entered what would prove to be a sharp and protracted economic downturn.

By the time of that meeting, the world’s central banks had already taken significant steps to stabilize financial markets and to mitigate the worst effects of the recession, and they would go on to do much more. Very broadly, the responses of central banks to the crisis fell into two classes. First, central banks undertook a range of initiatives to restore normal functioning to financial markets and to strengthen the banking system. They expanded existing lending facilities and created new facilities to provide liquidity to the financial sector. Key examples include the ECB’s one-year long-term refinancing operations, the Federal Reserve’s auctions of discount window credit (via the Term Auction Facility), and the Bank of Japan’s more recent extension of its liquidity supply operations.

He still doesn’t understand that the obvious move is to lend unsecured to member banks in unlimited quantities. The liability side of banking is not the place for market discipline; it’s the asset/capital side.

To help satisfy banks’ funding needs in multiple currencies, central banks established liquidity swap lines that allowed them to draw each other’s currencies and lend those funds to financial institutions in their jurisdictions; the Federal Reserve ultimately established swap lines with 14 other central banks.

He still doesn’t realize what the fed did was to lend approx $600 billion unsecured to foreign governments, for the sole purpose of bringing down LIBOR settings, and that there are far more sensible ways to bring down LIBOR settings. Nor has he realized the public purpose behind prohibiting us banks from using LIBOR in the first place.

Central banks also worked to stabilize financial markets that were important conduits of credit to the nonfinancial sector. For example, the Federal Reserve launched facilities to help stabilize the commercial paper market and the market for asset-backed securities, through which flow much of the funding for student, auto, credit card, and small business loans as well as for commercial mortgages.

Nor has the fed understood how to utilize its member banks, which are public private partnerships, to further public purpose. Rather than buy the collateral in question for its own portfolio, the Fed could have empowered its member banks to do it by such means as, for example, allowing them to put that specific collateral in segregated accounts where the fed would cover losses. This is functionally identical to the fed buying for its own account, but without the costly need for the fed itself to establish trading desks, back office operations, and other associated support structure.

In addition, the Federal Reserve, the ECB, the Bank of England, the Swiss National Bank, and other central banks played important roles in stabilizing and strengthening their respective banking systems. In particular, central banks helped develop and oversee stress tests that assessed banks’ vulnerabilities and capital needs. These tests proved instrumental in reducing investors’ uncertainty about banks’ assets and prospective losses, bolstering confidence in the banking system, and facilitating banks’ raising of private capital.

They did this entirely because they were concerned about the banks’ ability to fund themselves, which again misses the point of the liability side of banking not being the place for market discipline. Again, the right move was to lend fed funds to the banks in unlimited quantities on an unsecured basis.

Central banks are also playing an important ongoing role in the development of new international capital and liquidity standards for the banking system that will help protect against future crises.

Again, misses the purpose of capital requirements, which is the pricing of risk. Risk itself is controlled by regulation and supervision.

Second, beyond necessary measures to stabilize financial markets and banking systems, central banks moved proactively to ease monetary policy to help support their economies. Initially, monetary policy was eased through the conventional means of cuts in short-term policy rates, including a coordinated rate cut in October 2008 by the Federal Reserve, the ECB, and other leading central banks. However, as policy rates approached the zero lower bound, central banks eased policy by additional means. For example, some central banks, including the Federal Reserve, sought to reduce longer-term interest rates by communicating that policy rates were likely to remain low for some time. A prominent example of the use of central bank communication to further ease policy was the Bank of Canada’s conditional commitment to keep rates near zero until the end of the second quarter of 2010.1 To provide additional monetary accommodation, several central banks–among them the Federal Reserve, the Bank of England, the ECB, and the Bank of Japan–purchased significant quantities of financial assets, including government debt, mortgage-backed securities, or covered bonds, depending on the central bank. Asset purchases seem to have been effective in easing financial conditions; for example, the evidence suggests that such purchases significantly lowered longer-term interest rates in both the United States and the United Kingdom.2

Yes, with little or no econometric evidence that lower rates added to aggregate demand. Nor is there any discussion of this controversy.

In fact, it looks to me like lower rates more likely reduced aggregate demand through the interest income channels, and continues to do so.

Although the efforts of central banks to stabilize the financial system and provide monetary accommodation helped set the stage for recovery, economic growth rates in the advanced economies have been relatively weak. Of course, the economic outlook varies importantly by country and region, and the policy responses to these developments among central banks have differed accordingly. In the United States, we have seen a slowing of the pace of expansion since earlier this year. The unemployment rate has remained close to 10 percent since mid-2009, with a substantial fraction of the unemployed out of work for six months or longer. Moreover, inflation has been declining and is currently quite low, with measures of underlying inflation running close to 1 percent. Although we project that economic growth will pick up and unemployment decline somewhat in the coming year, progress thus far has been disappointingly slow.

Yes, the Fed continues to fail to deliver on both of its dual mandates.

In this environment, the Federal Open Market Committee (FOMC) judged that additional monetary policy accommodation was needed to support the economic recovery and help ensure that inflation, over time, is at desired levels.

That is, they were concerned about falling into deflation.

Accordingly, the FOMC announced earlier this month its intention to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee also will maintain its current policy of reinvesting principal payments from its securities holdings in longer-term Treasury securities. Financial conditions eased notably in anticipation of the Committee’s announcement, suggesting that this policy will be effective in promoting recovery. As has been the case with more conventional monetary policy in the past, this policy action will be regularly reviewed in light of the evolving economic outlook and the Committee’s assessment of the effects of its policies on the economy.

Note that comments from FOMC members have repeatedly shown they lack a fundamental understanding of actual monetary operations, and are promoting policy accordingly

I draw several lessons from our collective experience in dealing with the crisis. (My list is by no means exhaustive.) The first lesson is that, in a world in which the consequences of financial crises can be devastating, fostering financial stability is a critical part of overall macroeconomic management. Accordingly, central banks and other financial regulators must be vigilant in monitoring financial markets and institutions for threats to systemic stability and diligent in taking steps to address such threats. Supervision of individual financial institutions, macroprudential monitoring, and monetary policy are mutually reinforcing undertakings, with active involvement in one sphere providing crucial information and expertise for the others. Indeed, at the Federal Reserve, we have restructured our financial supervisory functions so that staff members with expertise in a range of areas–including economics, financial markets, and supervision–work closely together in evaluating potential risks.

Systemic liquidity risk comes from the fed not realizing it should always be offering fed funds at its target rate in unlimited quantities.

That limits risks to bank shareholders (and unsecured debt which is functionally part of the capital structure), and to the FDIC/taxpayers where it has failed to adequately regulate and supervise and losses exceed private equity.

Second, the past two years have demonstrated the value of policy flexibility and openness to new approaches. During the crisis, central banks were creative and innovative, developing programs that played a significant role in easing financial stress and supporting economic activity. As the global financial system and national economies become increasingly complex and interdependent, novel policy challenges will continue to require innovative policy responses.

Unfortunately, it also demonstrated the consequences of not understanding monetary operations and bank fundamentals. For example, there was and continues to be a complete failure to recognize that the treasury buying bank capital under tarp was functionally nothing more than regulatory forbearance, and not an ‘expenditure of tax payer money’

Third, as was the focus of my remarks two years ago, in addressing financial crises, international cooperation can be very helpful; indeed, given the global integration of financial markets, such cooperation is essential.

It is not. This is another example of failure to understand banking fundamentals and monetary operations. The US is best served by independent banking law, regulation, and supervision.

Central bankers worked closely together throughout the crisis and continue to do so. Our frequent contact, whether in bilateral discussions or in international meetings, permits us to share our thinking, compare analyses, and stay informed of developments around the world. It also enables us to move quickly when shared problems call for swift joint responses, such as the coordinated rate cuts and the creation of liquidity swap lines during the crisis. These actions and others we’ve taken over the past few years underscore our resolve to work together to address our common economic challenges.

Sadly, it’s the blind leading the blind, and we all continue to pay the price.

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