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Archive for the 'Fed' Category

Empire State Manufacturing Survey

Posted by WARREN MOSLER on 15th April 2014

Another non bounce, this time an April survey:

Empire State Mfg Survey

The first look at the manufacturing sector this month is flat with the Empire State index barely over zero, at 1.29 vs 5.61 in March and 4.48 in February. New orders, the most important of all readings, is in the negative column at minus 2.77. Shipments show some growth, at plus 3.15, while employment shows better growth, at 8.16 vs March’s 5.88. On the negative side are unfilled orders, at minus 13.27. Inventories show a draw while price data do show some upward pressure. A positive is a more than 5 point uptick in the 6-month outlook to a very solid 38.23. This report, held back by the dip in new orders, is no better than mixed suggesting that the beginning of the spring, at least in the New York manufacturing economy, didn’t make for much of a bounce.

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Posted in Employment, Fed | No Comments »

Yellen on wages

Posted by WARREN MOSLER on 20th March 2014

When asked about the growth in hourly wages:

Most measures of wage increases are running at very low levels. Wage inflation closer to 3% or 4% would be expected given some measures, such as productivity growth. But right now it is certainly not flashing. An increase in it might signal some tightening or meaningful increase over time. I would say were not seeing that.

It’s well publicized that real wages have been lagging for maybe 40 years, as profits hit an all time high of about 11% of GDP. So as a point of logic the only way wages can stop the slide is if they grow faster than GDP grows, which leads to the ‘where the productivity growth has been going’ discussion, etc. Furthermore, in today’s economy the distribution is largely and necessarily a result of an impossibly ‘complex’, global, institutional structure rather than ‘free market forces’.

Add to that the Fed only has ‘one lever’ which is interest rates, and they all believe that lowering rates is ‘easing’, and that GDP growth promotes wage grow. So it could be that hourly wage growth of 2% that looks like it’s heading to prior highs of around 4% per se might not be all that strong a factor for quite a while in their reaction function?

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proactive fiscal tightening damages income growth

Posted by WARREN MOSLER on 10th March 2014

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Mind the gap:

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This is below prior recession levels!

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This is year over year growth in consumption of domestic product, which is GDP less capex less exports.

It shows how much ‘the consumer’ is spending on domestically produced goods and services:

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The underlying narrative is that proactive austerity damages income growth and thereafter requires a ‘jump’ in ‘borrowing to spend’/reduction in savings’ to sustain the prior levels of growth.

When growth itself brings the govt deficit down via the auto fiscal stabilizers, the needed credit growth/savings drop to replace the lost govt deficit spending is ‘already there proactively’ as it’s what drove the growth in the first place. So while the credit expansion/savings reduction needs to continue to grow to support GDP growth, the credit expansion/savings reduction doesn’t need to ‘spike up’ proactively as it does when the fiscal tightening is proactive.

So note that q3′s higher GDP growth included over 1% from additions to inventories. That represents a reduction in corporate savings from what it would have been if they had not net added to inventories. That is, consumers didn’t ‘jump the gap’ created by the ongoing increase in FICA vs the prior year, and the sequester cuts, that together proactively reduced govt deficit spending by over 1.5% of GDP (with the FICA hike adding to the automatic stabilizers as well). And Q4′s consumer spending on domestic product grew at a lower rate even as capex was higher. Also note that while capex growth for 2014 is forecast at about the same 5% as 2013, even with the high levels of energy investments, ultimately it’s largely a function of top line sales.

The reduction in net imports is a reduction in the growth of foreign savings of $ denominated financial assets, which does ‘make up’ for the reduction in govt deficit spending, depending on foreign demand. But it’s been ongoing and doesn’t look to be ‘jumping the spending gap.’

And note too that the running US deficit of about 3% of GDP is about the same as the euro zone’s and the Maastricht limit. So for me the question is whether this will make our economies converge as US income growth continues to decline?

And, as previously discussed, the 0 rate policy has worked to directly bring down personal income. Also note that personal income growth has slowed coincidentally with the approx 200,000/mo additions to total employment.

So seems that the income added by that much new employment isn’t enough to keep overall (after tax) personal income growth positive.

Posted in Deficit, Fed, Government Spending, Inflation | No Comments »

Personal interest income

Posted by WARREN MOSLER on 7th March 2014

Net personal interest income not yet growing as during prior cycles.

Doesn’t happen until after the Fed hikes…

Interest income

Personal interest payments

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Fed Adopts Foreign-Bank Capital Rules as World Finance Fragments

Posted by WARREN MOSLER on 24th February 2014

Beats me why the Fed should care if foreign banks have any capital if the Fed isn’t insuring their deposits or other liabilities?

Seems if they want to lend their money to people who can’t pay it back it’s their problem???

Fed Adopts Foreign-Bank Rule as World Finance Fragments

By Yalman Onaran

November 1 (Bloomberg) — The Federal Reserve approved new standards for foreign banks that will require the biggest to hold more capital in the U.S., joining other countries in erecting walls around domestic financial systems.

Banks with $50 billion of assets in the U.S. will have to meet the standard under a revised rule approved yesterday, which raised the threshold from $10 billion proposed in 2012. The central bank left out two controversial elements of the original proposal, saying those were still being developed.

Walling off U.S. units of foreign banks, designed to protect taxpayers from having to bail them out in a crisis, may increase borrowing costs for those companies and hurt their profitability. The firms say it will also raise borrowing rates for governments and consumers.

Posted in Banking, Fed | No Comments »

existing home sales chart, real final sales chart (pre weather)

Posted by WARREN MOSLER on 21st February 2014

Yes, the Fed doesn’t like QE and wants to taper, but seems to me they don’t want mortgage rates this high either. They know the only way the market will ‘bring down rates’ is if the economic weakness persists. And they suspect it very well may persist unless rates come down.

Their remaining option is TIRT (term interest rate targeting) which has yet to be discussed.

Existing Home Sales

It’s more than just weather that’s clobbering the housing market. High prices and tight inventory aren’t helping either as existing home sales fell 5.1 percent in January to a 4.620 million annual rate. The year-on-year rate is also at minus 5.1 percent, a sharp contrast to the year-on-year median price which is up 10.7 percent.

Supply of homes relative to sales did rise to 4.9 months from 4.6 months but the improvement is tied mostly to the drop in sales. Prices did come down in the month but from already high levels with the median price down 4.5 percent to $188,900.

Weather was especially cold in January and no doubt contributed to the sales weakness, especially in the Midwest, where sales fell 7.1 percent in the month, and also the Northeast where the decline was 3.1 percent. But weather in California wasn’t a problem, yet sales in the West fell 7.3 percent which the National Association of Realtors points to as evidence of non-weather constraints.

Unattractive mortgage rates are another factor holding down sales. All cash buyers continue to hold up the market, accounting for 33 percent of all sales vs 32 percent in December. In contrast, first-time buyers, who are especially sensitive to the soft jobs market, continue to account for less sales, at 26 percent vs December’s 27 percent.

This is the 5th decline in the last 6 months for this series and lack of improvement in the jobs market, not to mention this month’s severe bout of heavy weather, point to more trouble for February. For the economy, the housing market needs to snap back sharply this spring. The Dow is showing little initial reaction to today’s report.

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Not exactly gang busters even before the weather reduced incomes.

And the bad weather it’s like hurricane sandy but without the insurance spending and federal relief spending.

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Posted in Fed, GDP, Housing, Interest Rates | No Comments »

Fed: “Why Is the Job-Finding Rate Still Low?”

Posted by WARREN MOSLER on 20th February 2014

Fed: “Why Is the Job-Finding Rate Still Low?”

We conclude that while matching efficiency has declined and remained low in virtually all industries, the most important factor in the low job-finding rate is the persistently low level of vacancies per unemployed.

Posted in Employment, Fed | No Comments »

Fed Chair Yellen on fiscal

Posted by WARREN MOSLER on 11th February 2014

Good grief


From the speech:

“a long-term plan is needed to reduce deficits and slow the growth of federal debt”

And from 2010:

“In a nutshell, the problem is that, in the absence of significant policy changes, and under reasonable assumptions about economic growth, demographics, and medical costs, federal spending will rise significantly faster than federal tax revenues in coming years. As a result, if current policy settings are maintained, the budget will be on an unsustainable path, with the ratio of federal debt held by the public to national income rising rapidly.

A failure to address these fiscal challenges would expose the United States to serious economic costs and risks. A high and rising level of government debt relative to national income is likely to eventually put upward pressure on interest rates, thereby restraining capital formation, productivity, and economic growth. Indeed, once the economy has recovered from its downturn, fiscal deficits will crowd out private spending. Large fiscal deficits will also likely put upward pressure on our current account deficits with the rest of the world; the associated greater reliance on borrowing from abroad means that an increasing share of our future income will be required to make interest payments on federal debt held abroad, thereby reducing the amount of income available for domestic spending and investment. A large federal debt will also limit the ability and flexibility of policymakers to address future economic stresses and other emergencies, a risk that is underscored by the critical fiscal policy actions that were taken to buffer the effects of the recent recession and stabilize financial markets in the wake of the crisis. And a prolonged failure by policymakers to address America’s fiscal challenges could eventually undermine confidence in U.S. economic management.”

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Fed is not swayed by any single number, Fisher tells CNBC

Posted by WARREN MOSLER on 10th February 2014

What about 2 consecutive numbers, like Dec and Jan jobs?

Fed is not swayed by any single number, Fisher tells CNBC

February 7 (Reuters) — The U.S. central bank is unlikely to reverse its decision to wind down its bond-buying program in reaction to the weaker-than-expected January jobs report released on Friday. “I will say this about the rest of our committee, is they are not swayed by a single number. They are thoughtful people,” Dallas Federal Reserve Bank President Richard Fisher said on CNBC, referring to the Fed’s policy-setting Federal Open Market Committee.

Posted in Economic Releases, Employment, Fed | No Comments »

The unconscious liberal

Posted by WARREN MOSLER on 3rd February 2014

Macroeconomic Populism Returns

By Paul Krugman

February 1 (NYT) — Matthew Yglesias says what needs to be said about Argentina: theres no contradiction at all between saying that Argentina was right to follow heterodox policies in 2002, but it is wrong to be rejecting advice to curb deficits and control inflation now. I know some people find this hard to grasp, but the effects of economic policies, and the appropriate policies to follow, depend on circumstances.

Yes, unemployment- source of the greatest economic loss as well as a social tragedy and a crime against humanity, is always the evidence deficit spending is too low. There is no exception as a simple point of logic. The currency is a simple public monopoly, and the excess capacity we call unemployment- people looking to sell their labor in exchange for units of that currency- is necessarily a consequence of the monopolist restricting the supply of net financial assets.

I would add that we know what those circumstances are! Running deficits and printing lots of money are inflationary

Why the undefined ambiguous empty rhetoric?

and bad

What does ‘bad’ mean here? For example, there is no evidence that inflation rates at least up to 40% hurt real growth, and more likely help it. Politically, however, it may be ‘very bad’. But those are two different things.

in economies that are constrained by limited supply;

Limited supply of what? Labor? Hardly! In fact, full employment is even more critical, if that’s possible, when there are limited supplies of other resources. Wasn’t Rome built without electricity, oil, bulldozers, the IMF, etc. etc.? OK, it took more than a day, but it was built. There is always more to do than people to do it. Economically, unemployment is never appropriate policy.

they are good things when the problem is persistently inadequate demand.

Unemployment is the evidence of this ‘inadequate demand’ which is necessarily created by taxation, the ultimate source of all demand for a given currency. In fact, taxation functions first to create unemployment- people looking for work paid in that currency. That’s how govt provisions itself- it creates people looking for jobs with its taxation, then hires those unemployed its tax created. What sense does it make for govt to create more unemployed than it wants to hire??? Either hire the unemployed thus created, or lower the tax!!!!!!!!!!!!

Similarly, unemployment benefits probably lead to lower employment in a supply-constrained economy; they increase employment in a demand-constrained economy; and so on.

With more that needs to be done than there are people to do it, the economy isn’t supply constrained until full employment. And nominal unemployment benefits are about the level of prices, wages, and the distribution of income rather than the level of potential employment, etc.

So sometimes the relationship and money looks like this, from the best economics principles textbook:

This is more about ‘inflation’ causing ‘money’ as defined.

But sometimes it looks like this:

This is more about partially defining ‘money’ as reserve account balances at the Fed but not securities account balances (tsy secs) at the Fed.

And just to repeat a point Ive made many times, those of us who understood IS-LM predicted in advance that the actions of the Bernanke Fed wouldnt be inflationary, while the other side of the debate was screaming debasement.

It’s not about ISLM, which is fixed fx analysis. It’s about recognizing that there is always precious little difference between balances in reserve accounts at the Fed and securities accounts at the Fed.

There’s something else to be said about Argentina and, it seems, Turkey namely, that were seeing a mini-revival of what Rudi Dornbusch and Sebastian Edwards long ago called macroeconomic populism. This involves, you might say, making the symmetrical error to that of people who think that running deficits and printing money always turns you into Zimbabwe; its the belief that the orthodox rules never apply. And its an equally severe mistake.

Unfortunately most of the ‘orthodox rules’ apply to the fixed fx policies in place when they were first stated, and not to today’s floating fx.

Its not a common mistake these days; a few years ago one would have said that only Venezuela was making the old mistakes, and even now its just a handful of countries. But it is a mistake, and we need to say so.

Yes, mistakes are being made by all of the headline economists and the global economy is paying the price.

Posted in Deficit, Emerging Markets, Employment, Fed, Government Spending | No Comments »

Growing Pains

Posted by WARREN MOSLER on 29th January 2014

FLASH- Fed to taper another $10 billion

Maybe they are concerned about all the interest income they are removing from the economy?

General comments:

For GDP to grow at 3% all the pieces have to ‘average’ 3% growth

And if anything is growing at a slower pace than last year, something else has to grow at a faster pace or GDP growth slows.

So the growth rate of car sales has slowed and is expected to slow further this year:

How about housing?

Pending home sales year over year change:

New mortgage applications to purchase homes:

Purchase apps year over year:

Retail sales growth has been generally slowing and has yet to show signs of increasing:

How about orders for durable goods?

Is the income growth there to support higher levels of spending?

Is the growth rate of employment increasing?


Maybe consumers are somehow borrowing to spend at a higher rate?

How about the foreign sector?

Well, it was helping, but we need the rate of change to increase to have more of an impact than last year. And with GDP around $17 trillion, last year’s rate of increase has to be exceed by about $7 billion/mo to add an additional .5 to GDP. And the substantial currency depreciation of the EM’s isn’t going to help any.

Just saying, something big needs to start growing a lot just to keep GDP growth positive?

So what happened to growth?
Private sector spending (including non residents) in excess of income may no longer be keeping up with the reduction in the federal govt’s spending in excess of its income (deficit spending spending)?

Maybe the federal deficit is too low for current credit and financial conditions?

Deficit as a % of GDP through Sept 13. It’s even lower currently:

Posted in Credit, Emerging Markets, Employment, Fed, Housing | No Comments »

Emerging market currencies

Posted by WARREN MOSLER on 24th January 2014

Seems no one is pointing out how this is all looking a lot like ‘catch up’ vs last year’s yen move?

As previously discussed, the proactive yen move from under 80 to over 100 vs the dollar- a 30% or so pay cut for domestic workers in terms of prices of imports- was an internationally deflationary impulse.

It’s called ‘currency wars’ with the exporters pushing hard on their govts to do whatever it takes to keep them ‘competitive’. And all, at least to me, shamelessly thinly disguised as anything but. And, in fact, it’s not ‘wrong’ to call it ‘dollar appreciation’ rather than EM currency depreciation given the deflationary bias of US (and EU) fiscal and monetary (rate cuts/QE reduce interest income for the economy) policy.

This is a highly deflationary force for the US (and EU) via import prices and lost export pricing power, also hurting earnings translations and, in general weakening US domestic demand, as increased domestic oil output doesn’t reduce net imports as much as would otherwise be the case.

And while I’m not saying energy independence is a ‘bad thing’ note that the UK has been largely ‘energy independent’ for quite a while, so there’s obviously more to it.

The optimal policy move for the US is fiscal relaxation- like my proposed FICA suspension- to get us back to full employment and optimize our real terms of trade. (and not to forget the federally funded transition job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment as the economy booms).

But unfortunately Congress is going the other way and making it all that much worse.

Emerging market currencies take a battering

By Katrina Bishop

January 24 (CNBC) — Emerging market currencies continued to take a beating on Friday — with Turkey’s lira hitting a new record low against the dollar yet again — amid growing concerns about the U.S. Federal Reserve’s monetary guidance.

On Friday, the dollar strengthened to 2.3084 against Turkey’s currency. Investors also piled out of the South African rand and Argentina’s peso, and both the Indian rupee and the Indonesian rupiah fell to two-week lows against the dollar. Meanwhile, the Australian dollar fell to $0.8681 – its lowest level in three-and-a-half years.

“The market is in panic mode. We have huge psychological fear that is going to emerging markets, despite a global environment that hasn’t changed that much,” Benoit Anne, head of global emerging market strategy at Societe Generale, told CNBC.

“My bias at this stage — although it’s a bold one — is that this is all about the credibility of the Fed with respect to its forward guidance. This fear that the Fed is going to tighten quicker than expected is translating into emerging markets.”

The U.S. central bank has promised that it will not raise interest rates until unemployment hits 6.5 percent – but some analysts are concerned that rate hikes could come sooner than expected.

U.S. monetary policy has always had a significant on emerging markets, and the Fed’s bond-buying program boosted risk sentiment, causing investors to turn their back on so-called “safe havens” and pile into assets seen as riskier – such as emerging market currencies.

Speculation of Fed tapering in 2013 hit emerging markets hard, with currencies including India, Turkey, Russia and Brazil coming under intense pressure in 2013.
But Anne added these recent moves were likely to be more temporary.

“It’s a matter of weeks rather than the whole year 2014 as a total write off for emerging markets,” he said. “Although it will take the Fed re-establishing its credibility towards forward guidance before we see respite in emerging markets.”

Posted in Currencies, Deficit, Employment, Fed | No Comments »

Plosser comments

Posted by WARREN MOSLER on 14th January 2014

Too sorry for comment.

Just one of many of same. It’s the ongoing saga of the blind leading the blind:

Perspectives on the Economy and Monetary Policy

By Charles I. Plosser

Posted in Fed | No Comments »

History will have a field day with this one!

Posted by WARREN MOSLER on 7th January 2014

After watching Japan for 20 years and the US for the last 5 he never did figure out that low rates impart a deflationary bias.

From Keynes:

Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

Book 4, Chapter 12, Section 5, p. 158

Posted in Fed, Interest Rates | No Comments »

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

Posted by WARREN MOSLER on 20th December 2013

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

Posted in Bonds, Fed, Interest Rates | No Comments »

Tapering- Chairman Bernanke decides to declare victory and move on!

Posted by WARREN MOSLER on 18th December 2013

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How Concerned is Bernanke about his possible legacy?

Posted by WARREN MOSLER on 18th December 2013

I suspect the Chairman is seriously concerned about living out his life with his legacy, as told by the mainstream, going something like this:

“Blindsided by an intense financial crisis, the Chairman, a champion of full employment and student of the Great Depression, did everything he could come up with to support growth and employment. However, after nearly 5 years of 0 rates and massive QE were beginning to hint at positive results, and just as his term ended, he fell asleep the switch, allowing mortgage rates to spike by over 1%, sending the economy back into recession.”


The latest housing starts spike seems most likely to be revised lower or followed by a big drop.

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Purchase Applications:

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Housing Starts:

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Posted in Fed, Housing, Interest Rates | No Comments »

Blinder editorial in WSJ

Posted by WARREN MOSLER on 13th December 2013

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).

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fed rate setting

Posted by WARREN MOSLER on 12th December 2013

Of course all they have to do is pay interest on all reserve balances…

Fed Moves Toward New Tool for Setting Rates (WSJ) An experimental bond-trading program being run at the Federal Reserve Bank of New York could fundamentally change the way the central bank sets interest rates. Fed officials see the program as a potentially critical tool when they want to raise short-term rates in the future to fend off broader threats to the economy. Launched this year, it is still in a testing stage and isn’t expected to be fully implemented for years. The Fed would use the facility to raise short-term interest rates by borrowing in the future against its large and growing securities portfolio. When it does want to raise rates, it will use securities it accumulated through its bond-buying stimulus programs as collateral for loans from money-market mutual funds, banks, securities dealers, government-sponsored enterprises and others. The rates it sets on these loans, in theory, could become a new benchmark for global credit markets.

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FOMC’s Bullard coming around to what I posted in 2008?

Posted by WARREN MOSLER on 22nd November 2013

“I think the December 2008 FOMC decision unwittingly committed the U.S. to an extremely long period at the zero lower bound similar to the situation in Japan, with unknown consequences for the macroeconomy,” Bullard said. Pointing to the Bank of Japan’s long struggle against deflation and slow growth, Bullard said he has seen “no evidence” that a faster economic recovery results from quickly lowering interest rates to near zero.

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