China hands death sentence to solar cell makers

With public banking, for better or for worse, lending is politicized:

China hands ‘death sentence’ to 75% of solar cell makers

By Toru Sugawara

December 24 (Nikkei) — The Chinese government is pushing for a drastic shakeout of the country’s overcrowded solar cell industry, supporting only a quarter of players and practically telling the rest to get out of the business.

The Ministry of Industry and Information Technology has announced a list of 134 producers of silicon materials, solar panels and other components of photovoltaic systems as meeting certain conditions, as measured by 2012 production, capacity utilization and technical standards.

In a sector said to have more than 500 companies, the ministry’s move means that three-quarters didn’t make the cut — including the core subsidiary of Suntech Power, which went bankrupt in March, and Jiangsu Shungfeng Photovoltaic Technology, Suntech’s startup rescuer.

These firms will not be able to get credit lines from financial institutions and thus will have a tough time borrowing, according to industry insiders. They will also no longer be eligible for refunds of export tariffs, a huge blow to companies that depend on overseas business. On the home front, it will be difficult for them to participate in state-run utilities’ auctions, sharply curtailing their opportunities to win orders.

Yes, the Fed can set mortgage rates if it wants to!

One of the main reasons for the Fed’s (near) 0 rate policy is to support the housing market. And after nearly 5 years of 0 rates, and mortgage rates dipping below 3.5%, though ‘off the bottom’ housing remains far below what would be considered ‘normal’.

And then, not long ago, and immediately after the Fed first hinted at reducing its QE purchases, mortgage rates spike by over 1%:


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And, since then, mortgage refinance activity has all but vanished, and the number of mortgage applications for the purchase of homes swung from increasing nicely to decreasing alarmingly:


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The ‘Fed speak’ for this rise in rates ‘tightening financial conditions’. And one of the Fed’s concerns about tapering QE purchases was the concern that higher mortgage rates would slow the recovery. Therefore, in addition to announcing the reduction in purchases of Treasury securities and mortgage backed securities, they were careful to emphasize what’s called their ‘forward guidance’ with regard to the Fed funds rate. That is, they stated that they expected to be keeping short term rates low for the next couple of years or so, and maybe even longer than that, maybe even after unemployment goes below 6.5%, and presuming their inflation measure stops decelerating and moves back up towards their target.

Unfortunately for the Fed mortgage rates moved higher after the announcement, and not due to a burst of mortgage applications (see above charts), and not due to any immediate drop in Fed purchases, which continue in large size. Instead, what the Fed sees is a market that believes the Fed changed course because it believes the economy is recovering, and with recovery just around the corner rate hikes will come sooner rather than later. And with rate hikes on the way, investors would rather wait for the higher yields they believe are just down the road, than take the lower yields today.

Therefore, if you want to borrow today to buy a house, you have to pay investors a higher interest rate. And if you don’t want to pay the higher rate today, investors are willing to wait for those higher rates, and the house doesn’t get sold. And when the house doesn’t get sold the Fed leaves rates low for that much longer and their forecast again (they’ve been over estimating growth for 5 years now) turns out to be wrong.

So with ‘forward guidance’ not doing the trick, is there anything else can the Fed can do if it wants mortgage rates back down? Yes!

First, they can simply announce that they are buyers of 10 year treasury notes at, say, a yield of 2%, in unlimited quantities.

This would immediately bring the 10 year yield down from 2.92% to no more than 2%, and most likely the Fed would buy few if any at that price. That’s because when people know the Fed will buy at a price, they know they can then buy at a slightly lower interest rate, knowing that ‘worst case’ they can always sell to the Fed at a very small loss. That way they can earn the, say, 1.99% yield for as long as they hold the 10 year Treasury note. And there’s always a chance yields come down further as well, which means their securities increased in value as well.

And the lower 10 year rate would quickly translate into much lower mortgage rates as well. And, of course, the Fed could also do the same thing with the mortgage backed securities its already buying, which more directly targets mortgage rates.

So why isn’t the Fed doing this? Probably out of fear of offering to buy unlimited quantities might lead to them buying ‘too many’ Treasury securities. This fear, unfortunately, stems from their lack of understanding of their own monetary operations. Treasury securities are simply dollar balances in securities accounts at the Fed. When the Fed buys these securities they just debit the owner’s securities account and credit the reserve account of his bank. And when the Treasury issues and sells new securities, the Fed debits the buyer’s bank’s reserve account and credits his securities account. Whether the dollars are in reserve accounts or securities accounts is of no operational consequence and imposes no particular risk for the Fed, so those fears are groundless.

Second, the Fed (or Treasury or the Federal Financing Bank) could lend directly to the housing agencies at a fixed rate of say, 3% for the further purpose of funding their mortgage portfolio of newly originated agency mortgages. The agencies would then pass along this fixed rate, with some permitted ‘markup’ and fees to the borrowers. The Fed would then be repaid by the pass through of the monthly payments including prepayments made by the new mortgages. This would target mortgage rates directly and, as these mortgages would be held by the agencies and not sold in the market place, dramatically reduce what I call parasitic secondary market activity.

Has any of this been discussed? Not publicly or seriously that I know of.

Here’s a piece I wrote several years ago on these and other proposals:
Proposals for the Banking System, Treasury, Fed, and FDIC

And this which includes why it’s the Fed that sets rates, and not markets:
The Natural Rate of Interest Is Zero

Blinder editorial in WSJ

The Fed Plan to Revive High-Powered Money

Don’t only drop the interest rate paid on banks’ excess reserves, charge them.

That would be a tax that reduces aggregate demand

By Alan S. Blinder

December 10 (WSJ) — Unless you are part of the tiny portion of humanity that dotes on every utterance of the Federal Open Market Committee, you probably missed an important statement regarding the arcane world of “excess reserves” buried deep in the minutes of its Oct. 29-30 policy meeting. It reads: “[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage.”

They don’t realize paying interest on Fed liabilities is a subsidy to the economy any more than Professor Blinder does.

As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous. The Fed is famously given to understatement. So when it says that “most” members of its policy committee think a change “could be worth considering,” that’s almost like saying they love the idea. That’s news because they haven’t loved it before.

So what exactly are excess reserves, and why should you care? Like most central banks, the Fed requires banks to hold reservesmainly deposits in their “checking accounts” at the Fedagainst transactions deposits. Any reserves held over and above these requirements are called excess reserves.

Not long agosay, until Lehman Brothers failed in September 2008banks held virtually no excess reserves because idle cash earned them nothing.

No, because Fed policy was to keep banks net borrowed, and then implement its policy rate via the Fed’s interest rate charges for the subsequent ‘reserve adds’ which were functionally loans from the Fed.

But today they hold a whopping $2.5 trillion in excess reserves, on which the Fed pays them an interest rate of 25 basis pointsfor an annual total of about $6.25 billion. That 25 basis points, what the Fed calls the IOER (interest on excess reserves), is the issue.

Yes, thereby supporting their policy rate decision, which happens to be a ‘range’ a bit above 0, which also happens to be a display of the Fed’s failure to understand monetary operations.

Unlike the Fed’s main policy tool, the federal-funds rate, the IOER is not market-determined. It’s completely controlled by the Fed. So instead of paying banks to hold all those excess reserves, it could charge banks a small fee, i.e., a negative interest rate, for the privilege.

At this point, you’re probably thinking: “Wait. If the Fed charged banks rather than paid them, wouldn’t bankers shun excess reserves?” Yes, and that’s precisely the point. Excess reserves sitting idle in banks’ accounts at the Fed do nothing to boost the economy. We want banks to use the money.

Reserves are assets. They can’t be ‘used’ to boost the economy. Banks can sell their reserves to other banks, but in any case the total persists as Fed liabilities. Nothing the banks can do will change that.

If the Fed turned the IOER negative, banks would hold fewer excess reserves, maybe a lot fewer. They’d find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want.

When banks buy securities or lend, their reserve account is debited and the bank of the seller of the securities or of the borrower gets its reserve account credited. That is, the assets called reserves are merely shifted from one bank to another, with the quantity of reserves held by the banking system remaining unchanged.

A second reason for cutting the IOER answers some of the criticisms the Fed has taken for its asset-buying programs called quantitative-easing: Doing so would stimulate the economy without increasing the size of the Fed’s balance sheet. In fact, the Fed could probably shrink its balance sheet.

Why would charging banks a fee stimulate the economy?

And further note that, before the current budget agreement, these ‘fees’ were called taxes, and for a good reason! ;)

To understand why, think back to the good old days, when excess reserves were zero. When the Fed injected reserves into the banking system, banks would use those funds to increase lending, thereby creating multiple expansions of the money supply and credit. Bank reserves were called “high-powered money” because each new dollar of reserves led to several additional dollars of money and credit.

I’ll give Professor Blinder the benefit of the doubt and assume the ‘good old days’ were the days of the gold standard, a fixed fx regime, where banking was continuously reserve constrained, interest rates were market determined, and bank lending was thereby constrained by the necessity to keep ‘real dollars’ on hand to meet depositors potential demands for withdrawals.

With today’s floating fx policy none of this is applicable.

The financial crisis short-circuited this process. As greed gave way to fear, bankers decided to store trillions of dollars safely at the Fed rather than lend them out. High-powered money became powerless money.

Here it seems he conflates the issue of liquidity and interbank lending with the issue of lending to the real economy, along with more inapplicable gold standard analysis.

Banking is always a case of loans creating deposits. And with today’s institutional structure, when deposits carry reserve requirements, in the first instance those requirements are functionally overdrafts in that bank’s reserve account at the Fed. And an overdraft is a loan, and booked as a loan from the Fed on statement day if it persists. So in fact loans create both deposits and any required reserves at the instant the loan is funded.

So rather than ‘high powered money’ as is the case with a gold standard, reserves today are best thought of as residual.

The Fed compounded the problem in October 2008 by starting to pay interest on reserves. And these days, the 25-basis-point IOER looks pretty good compared with most short-term money rates.

As it always is due to ‘market forces’. The entire term structure of rates continuously adjusts to the Fed’s policy rate which generally imposed by targeting the Fed funds rate.

If banks were charged rather than paid 25 basis points, they would find holding excess reserves a lot less attractive. As some of this excess central-bank money became “high-powered” again, the Fed would want less of it. So its balance sheet could shrink.

I don’t follow this part at all. Banks always find holding reserves ‘unattractive’ as the Fed funds rate is likewise their marginal cost of funds. So reserves are, in general, never a profitable investment, and banks are always looking for investments that yield more, on a risk adjusted basis, than their cost of funds.

What are the arguments against turning the IOER negative? Over the years, Fed officials have made three, none of them cogent.

One is that cutting the IOER would have only modest stimulative effects. Well, probably. But are there more powerful tools sitting around unused? Besides, there is at least a chance that we’d get more new lending than the Fed thinks.

There’s a much larger chance that this new tax, though modest, will nonetheless reduce aggregate demand. With the economy a large net saver, and the govt a large net payer of interest, in general higher rates increase income and lower rates decrease income.

Second, there is a limit to how far negative the IOER can go. After all, banks can earn zero by keeping paper money in their vaults. So if the Fed charged a very high fee for holding excess reserves, bankers might find it worthwhile to pay the costs of bigger vaults and more security guards in order to keep huge stockpiles of cash. Sure. But a mere 25 basis point fee is not enough incentive for them to do so.

If it was realized negative rates are a tax, the argument would never get this far.

Third, a negative IOER could drive short-term interest rates even closer to zero, as banks moved balances from their reserve accounts into money market instruments. And that, we are told, would wreak havoc in the money markets. Really? Perhaps that was a legitimate concern three years ago, but we have now lived with money-market rates hugging zero for years, and capitalism has survived.

And if we eliminated the FDIC deposit insurance cap there would be no need for money market funds in the first place.

Besides, the Fed paid no interest on reserves for the first 94 years of its existence, the European Central Bank has been paying its banks nothing since July 2012, and the Danes have been charging a fee since then. In no case did anything terrible happen.

Instead the banking system was kept net short reserves, and the Fed- the monopoly supplier of net reserves- used the rate charged to cover that ‘overdraft’ to set its policy rate.

That said, suppose the policy failed. Suppose the Fed cut the IOER from 25 basis points to minus 25 basis points, and banks didn’t react at all; they just held on to all their excess reserves. In that unlikely event, cutting the IOER would neither provide stimulus nor enable the Fed to shrink its balance sheet. However, the Fed would start collecting about $6.25 billion per year in fees from banks instead of paying them $6.25 billion in interesta swing of roughly $12.5 billion in the taxpayers’ favor. Some downside.

Like any other tax…

Mr. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is the author of “After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead” (Penguin, 2013).

Bank lending and state deficits

Loans negative and states borrowing less, thanks!

Top link is the change in total credit levels y/y in the commercial banking system using monthly data points through sept 2013. The numbers are seasonally adjusted. Trend going negative (looks to have last topped off in December 2012) in conjunction with federal deficit reduction and state & local deficit reductions. The bottom link has 3 series you can click on one for state & local and one for federal and one for consolidated gvt net borrowing or lending (looking at the federal or consolidated numbers they move flat 4q 2012 to 1q 2013 but spike upwards 1q 2013 moving forward. almost at the same exact time the credit levels started going negative).

Bank credit

State borrowing

QE is bad for banks

The Fed’s quantitative easing policy per se is nothing but bad for banks.

1. QE forces the member banks to have excess reserves as assets on their balance sheet. These balances earn only .25% lowing the banking system’s net interest margin, return on assets, and return on equity.

2. To maintain high enough average net interest margins (that include the holding of excess reserves) to attract capital, banks tend to charge a bit more for loans to business and consumers, which causes more borrowers to go direct to credit markets and private lenders in general. In other words, QE tends to support disintermediation, as those who can avoid the banks do so.

3. QE lowers interest income paid by govt to the economy, as per the $100 billion of Fed profits turned over to treasury last year. Lower interest income makes the economy that much less credit worthy, thereby lowering its ability to borrow and service bank loans.

Bottom line- QE is a tax on the economy.
And QE is functionally the same as the tsy not having issued the securities in the first place.

However I favor, for example, the tsy not issuing anything longer than 3 mo bills, which is functionally ‘QE max’

Yes, it reduces aggregate demand.

But, for example, I’d rather get my aggregate demand, for a given size govt, from lower taxes than from the tsy or Fed paying interest.

But that’s just me.
;)

AMI report

AMI keeps hitting new lows:

Prof. Joseph Huber from Martin Luther University in Germany gave an outstanding presentation of the New Currency Theory (NCT) which supports monetary reform, and compared this with his analysis of Modern Money Theory (MMT). Professor Huber found that MMT reflects banking doctrine much more than currency teachings, and concluded that to be supportive of monetary reform, any economic theory must break off the shackles of banking doctrine and adopt the new currency teachings for monetary sovereignty.

One of the highlights of the conference was at the gala dinner when Professor Huber was presented with the AMI Advancement of Monetary Science Award for his work. Professor Huber showed his modesty by being genuinely surprised to be given such an award, even though it is thoroughly deserved. Dr. Michael Kumhof and Prof. Kaoru Yamaguchi are the only other persons who have previously received this award.

Comments on Volcker article

Here’s my take on the Volcker article

My comments in below:

The Fed & Big Banking at the Crossroads

By Paul Volcker

I have been struck by parallels between the challenges facing the Federal Reserve today and those when I first entered the Federal Reserve System as a neophyte economist in 1949.

Most striking then, as now, was the commitment of the Federal Reserve, which was and is a formally independent body, to maintaining a pattern of very low interest rates, ranging from near zero to 2.5 percent or less for Treasury bonds. If you feel a bit impatient about the prevailing rates, quite understandably so, recall that the earlier episode lasted fifteen years.

The initial steps taken in the midst of the depression of the 1930s to support the economy by keeping interest rates low were made at the Fed’s initiative. The pattern was held through World War II in explicit agreement with the Treasury. Then it persisted right in the face of double-digit inflation after the war, increasingly under Treasury and presidential pressure to keep rates low.

Yes, and this was done after conversion to gold was suspended which made it possible. And they fixed long rates as well/

The growing restiveness of the Federal Reserve was reflected in testimony by Marriner Eccles in 1948:

Under the circumstances that now exist the Federal Reserve System is the greatest potential agent of inflation that man could possibly contrive.
This was pretty strong language by a sitting Fed governor and a long-serving board chairman. But it was then a fact that there were many doubts about whether the formality of the independent legal status of the central bank—guaranteed since it was created in 1913—could or should be sustained against Treasury and presidential importuning. At the time, the influential Hoover Commission on government reorganization itself expressed strong doubts about the Fed’s independence. In these years calls for freeing the market and letting the Fed’s interest rates rise met strong resistance from the government.

Not freeing the ‘market’ but letting the Fed chair have his way. Rates would be set ‘politically’ either way. Just a matter of who.

Treasury debt had enormously increased during World War II, exceeding 100 percent of the GDP, so there was concern about an intolerable impact on the budget if interest rates rose strongly. Moreover, if the Fed permitted higher interest rates this might lead to panicky and speculative reactions. Declines in bond prices, which would fall as interest rates rose, would drain bank capital. Main-line economists, and the Fed itself, worried that a sudden rise in interest rates could put the economy back in recession.

All of those concerns are in play today, some sixty years later, even if few now take the extreme view of the first report of the then new Council of Economic Advisers in 1948: “low interest rates at all times and under all conditions, even during inflation,” it said, would be desirable to promote investment and economic progress. Not exactly a robust defense of the Federal Reserve and independent monetary policy.

But in my humble opinion a true statement!

Eventually, the Federal Reserve did get restless, and finally in 1951 it rejected overt presidential pressure to maintain a ceiling on long-term Treasury rates. In the event, the ending of that ceiling, called the “peg,” was not dramatic. Interest rates did rise over time, but with markets habituated for years to a low interest rate, the price of long-term bonds remained at moderate levels. Monetary policy, free to act against incipient inflationary tendencies, contributed to fifteen years of stability in prices, accompanied by strong economic growth and high employment. The recessions were short and mild.

I agreed with John Kenneth Galbraith in that inflation was not a function of rates, at least not in the direction they believed, due to interest income channels. However, the rate caps on bank deposits, etc. Did mean that rate hikes had the potential to disrupt those financial institutions and cut into lending, until those caps were removed.

In general, however, the ‘business cycle’ issues are better traced to fiscal balance.

No doubt, the challenge today of orderly withdrawal from the Fed’s broader regime of “quantitative easing”—a regime aimed at stimulating the economy by large-scale buying of government and other securities on the market—is far more complicated. The still-growing size and composition of the Fed’s balance sheet imply the need for, at the least, an extended period of “disengagement,” i.e., less active purchasing of bonds so as to keep interest rates artificially low.

Artificially? vs what ‘market signals’? Rates are ‘naturally’ market determined with fixed fx policies, not today’s floating fx.

In fact, without govt ‘interference’ such as interest on reserves and tsy secs, the ‘natural’ rate is 0 as long as there are net reserve balances from deficit spending.

Nor is there any technical or operational reason for unwinding QE. Functionally, the Fed buying securities is identical to the tsy not issuing them and instead letting its net spending remain as reserve balances. Either way deficit spending results in balances in reserve accounts rather than balances in securities accounts. And in any case both are just dollar balances in Fed accounts.

Moreover, the extraordinary commitment of Federal Reserve resources,

‘Resources’? What does that mean? Crediting an account on its own books is somehow ‘using up a resource’? It’s just accounting information!

alongside other instruments of government intervention, is now dominating the largest sector of our capital markets, that for residential mortgages. Indeed, it is not an exaggeration to note that the Federal Reserve, with assets of $3.5 trillion and growing, is, in effect, acting as the world’s largest financial intermediator. It is acquiring long-term obligations in the form of bonds and financing those purchases by short-term deposits. It is aided and abetted in doing so by its unique privilege to create its own liabilities.

The Fed creates govt liabilities, aka making payments. That’s its function. And, for example, the treasury securities are the initial intervention. They are paid for by the Fed debiting reserve accounts and crediting securities accounts. All QE does is reverse that as the Fed debits the securities accounts and ‘recredits’ the reserve accounts. So it can be said that all QE does is neutralize prior govt intervention.

The beneficial effects of the actual and potential monetizing of public and private debt, which is the essence of the quantitative easing program, appear limited and diminishing over time. The old “pushing on a string” analogy is relevant. The risks of encouraging speculative distortions and the inflationary potential of the current approach plainly deserve attention.

Right, with the primary fundamental effect being the removal of interest income from the economy. The Fed turned over some $100billion to the tsy that the economy would have otherwise earned. QE is a tax on the economy.

All of this has given rise to debate within the Federal Reserve itself. In that debate, I trust that sight is not lost of the merits—economic and political—of an ultimate return to a more orthodox central banking approach. Concerning possible changes in Fed policy, it is worth quoting from Fed Chairman Ben Bernanke’s remarks on June 19:

Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of [asset] purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program.

I would like to emphasize once more the point that our policy is in no way predetermined and will depend on the incoming data and the evolution of the outlook as well as on the cumulative progress toward our objectives. If conditions improve faster than expected, the pace of asset purchases could be reduced somewhat more quickly. If the outlook becomes less favorable, on the other hand, or if financial conditions are judged to be inconsistent with further progress in the labor markets, reductions in the pace of purchases could be delayed.

Indeed, should it be needed, the Committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.

Implying QE works to do that.

I do not doubt the ability and understanding of Chairman Bernanke and his colleagues. They have a considerable range of instruments available to them to manage the transition, including the novel approach of paying interest on banks’ excess reserves, potentially sterilizing their monetary impact.

Reserves can be thought of as ‘one day treasury securities’ and the idea that paying interest sterilizing anything is a throwback to fixed fx policy, not applicable to floating fx.

What is at issue—what is always at issue—is a matter of good judgment, leadership, and institutional backbone. A willingness to act with conviction in the face of predictable political opposition and substantive debate is, as always, a requisite part of a central bank’s DNA.

A good working knowledge of monetary operations would be a refreshing change as well!

Those are not qualities that can be learned from textbooks. Abstract economic modeling and the endless regression analyses of econometricians will be of little help. The new approach of “behavioral” economics itself is recognition of the limitations of mathematical approaches, but that new “science” is in its infancy.

Monetary operations can be learned from money and banking texts.

A reading of history may be more relevant. Here and elsewhere, the temptation has been strong to wait and see before acting to remove stimulus and then moving toward restraint. Too often, the result is to be too late, to fail to appreciate growing imbalances and inflationary pressures before they are well ingrained.

Those who know monetary operations read history very differently from those who have it wrong.

There is something else that is at stake beyond the necessary mechanics and timely action. The credibility of the Federal Reserve, its commitment to maintaining price stability, and its ability to stand up against partisan political pressures are critical. Independence can’t just be a slogan. Nor does the language of the Federal Reserve Act itself assure protection, as was demonstrated in the period after World War II. Then, the law and its protections seemed clear, but it was the Treasury that for a long time called the tune.

And didn’t do a worse job.

In the last analysis, independence rests on perceptions of high competence, of unquestioned integrity, of broad experience, of nonconflicted judgment and the will to act. Clear lines of accountability to Congress and the public will need to be honored.

And a good working knowledge of monetary operations.

Moreover, maintenance of independence in a democratic society ultimately depends on something beyond those institutional qualities. The Federal Reserve—any central bank—should not be asked to do too much, to undertake responsibilities that it cannot reasonably meet with the appropriately limited powers provided.

I know that it is fashionable to talk about a “dual mandate”—the claim that the Fed’s policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory. It is operationally confusing in breeding incessant debate in the Fed and the markets about which way policy should lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic. It is illusory in the sense that it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience.

The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity.

Completely wrong. With floating fx, it can only set rates. It’s always about price, not quantity.

Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.

Back in the 1950s, after the Federal Reserve finally regained its operational independence, it also decided to confine its open market operations almost entirely to the short-term money markets—the so-called “Bills Only Doctrine.” A period of remarkable economic success ensued, with fiscal and monetary policies reasonably in sync, contributing to a combination of relatively low interest rates, strong growth, and price stability.

Yes, and the price of oil was fixed by the Texas railroad commission at about $3 where it remained until the excess capacity in the US was gone and the Saudis took over that price setting role in the early 70’s.

That success faded as the Vietnam War intensified, and as monetary and fiscal restraints were imposed too late and too little. The absence of enough monetary discipline in the face of the overt inflationary pressures of the war left us with a distasteful combination of both price and economic instability right through the 1970s—a combination not inconsequentially complicated further by recurrent weakness in the dollar.

No mention of a foreign ‘monopolist’ hiking crude prices from 3 to 40?

Or of Carter’s deregulation of nat gas in 78 causing OPEC to drown in excess capacity in the early 80’s?

Or the non sensical targeting of borrowed reserves that worked only to shift rate control from the FOMC to the NY fed desk, and prolonged the inflation even as oil prices collapsed?

We cannot “go home again,” not to the simpler days of the 1950s and 1960s. Markets and institutions are much larger, far more complex. They have also proved to be more fragile, potentially subject to large destabilizing swings in behavior. There is the rise of “shadow banking”—the nonbank intermediaries such as investment banks, hedge funds, and other institutions overlapping commercial banking activities.

Not to mention restaurants letting people eat before they pay for their meals. This completely misses the mark.

Partly as a result, there is the relative decline of regulated commercial banks, and the rapid innovation of new instruments such as derivatives. All these have challenged both central banks and other regulatory authorities around the developed world. But the simple logic remains; and it is, in fact, reinforced by these developments. The basic responsibility of a central bank is to maintain reasonable price stability—and by extension to concern itself with the stability of financial markets generally.

In my judgment, those functions are complementary and should be doable.

They are, but it all requires an understanding of the underlying monetary operations.

I happen to believe it is neither necessary nor desirable to try to pin down the objective of price stability by setting out a single highly specific target or target zone for a particular measure of prices. After all, some fluctuations in prices, even as reflected in broad indices, are part of a well-functioning market economy. The point is that no single index can fully capture reality, and the natural process of recurrent growth and slowdowns in the economy will usually be reflected in price movements.

With or without a numerical target, broad responsibility for price stability over time does not imply an inability to conduct ordinary countercyclical policies. Indeed, in my judgment, confidence in the ability and commitment of the Federal Reserve (or any central bank) to maintain price stability over time is precisely what makes it possible to act aggressively in supplying liquidity in recessions or when the economy is in a prolonged period of growth but well below its potential.

With floating fx bank liquidity is always infinite. That’s what deposit insurance is all about.
Again, this makes central banking about price and not quantity.

Feel free to distribute.