Tuesday, February 22, 2022

Important questions unasked of the Fed

This weekend's WSJ essay "How the Fed Averted Economic Disaster"  by Nick Timiraos finally brings into public discussion the second question we should all be asking of the Fed. What happened in the grandest bailout of all time in the covid crisis, and, more importantly, having done it twice, how are we going to avoid massive bailouts becoming the normal state of affairs? (The first question, of course, is "how did you miss inflation so drastically and when are you going to do something about it?") 

They were offering nearly unlimited cheap debt to keep the wheels of finance turning, and when that didn’t help, the Fed began purchasing massive quantities of government debt outright.

Translation: When dealer banks weren't buying treasury debt fast enough, the Fed lend the banks money to buy the debt, and quickly bought up the massive amount of debt themselves. 

The Fed followed by bailing out money market funds, buying state and local government debt, buying exchange-traded funds that held junk corporate debt, and announcing a do whatever it takes pledge to keep corporate bond prices high. It worked

It worked. The Fed’s pledges to backstop an array of lending, announced on Monday, March 23, would unleash a torrent of private borrowing based on the mere promise of central bank action—together with a massive assist by Congress, which authorized hundreds of billions of dollars that would cover any losses.

...Carnival Corp. , the world’s largest cruise-line operator. Its business had collapsed as Covid halted cruises world-wide. Within days of the Fed’s announcement, Carnival was able to borrow nearly $6 billion from large institutional investors...If the hardest-hit companies like Carnival, with its fleet of 104 ships docked indefinitely, could raise money in capital markets, who couldn’t?

Let's be clear who is bailed out here: Creditors. People who lent lots of money to shaky businesses, earned nice high yields in good times, now have the Fed and Treasury bail them out in bad times. 

It worked. 

Today, nearly two years later, most agree that the Fed’s actions helped to save the economy from going into a pandemic-induced tailspin.

I agree. A crisis was imminent, a toppling of a vastly over-leveraged house of cards was in the works. As "just in time" supply chains discovered they needed a bit of extra inventory around, just in time debt financing falls apart at the slightest shock, needing a bit of cash inventory and equity buffer. 

The Fed’s initial response in 2020 received mostly high marks—a notable contrast with the populist ire that greeted Wall Street bailouts following the 2008 financial crisis. North Carolina Rep. Patrick McHenry, the top Republican on the House Financial Services Committee, gave Mr. Powell an “A-plus for 2020,” he said. “On a one-to-10 scale? It was an 11. He gets the highest, highest marks, and deserves them. The Fed as an institution deserves them.”

I also agree, almost. But  

The question now is what will be the long-term costs and implications of that emergency activism—for the Fed, the financial markets and the wider economy. 

This is the question. Why did the economy get into a situation once again, so soon, that the Fed had to engineer this massive bailout? What are you going to do to make sure you don't have to do it again and again? 

Some people have spoken: 

Paul Singer, who runs the hedge-fund firm Elliott Management, warned that the Fed was sowing the seeds of a bigger crisis by absolving markets of any discipline. “Sadly, when people (including those who should know better) do something stupid and reckless and are not punished,” he wrote, “it is human nature that, far from thinking that they were lucky to have gotten away with something, they are encouraged to keep doing the stupid thing.”

I.e., run companies with a lot of debt, buy a lot of high-yield junk debt, knowing that the Fed will do whatever it takes to keep the value of that debt from falling in bad times, even to the extent, now, of buying it directly. 

Reservations about Mr. Powell’s make-people-whole mantra weren’t limited to the free-market libertarian set.

Guilty as charged. 

The breathtaking speed with which the Fed moved and with which Wall Street rallied after the Fed’s announcements infuriated Dennis Kelleher, a former corporate lawyer and high-ranking Senate aide who runs Better Markets, an advocacy group lobbying for tighter financial regulations.

“Literally, not only has no one in finance lost money, but they’ve all made more money than they could have dreamed,” said Mr. Kelleher. “It just can’t be the case that the only thing the Fed can do is open the fire hydrants wide for everybody. This is a ridiculous discussion no matter how heartfelt Powell is about ‘we can’t pick winners and losers’—to which my answer is, ‘So instead you just make them all winners?’”

The last time around, public outrage forced at least some disquiet about "moral hazard," promises to do something so it wouldn't happen again. No More Bailouts. It produced the misbegotten Dodd-Frank law and it just happened again, on steroids. At least, though, there was the decency to notice. Outside this blog and a few other eccentrics, nobody seems to notice or care. We are now firmly in the system of huge leverage, private gain in good times, public guarantee in bad times. Where are our inequality warriors on the left, and tea party hat types on the right? Or at least, where are our economists who understand moral hazard in the middle? Where is any shame from the Fed that its army of Dodd Frank regulators and stress testers so completely missed the fact that the financial system was ripe for breakdown in the next crisis, so long as it did not exactly repeat the previous one? 

Timiaros writes 

...because the pandemic shock was akin to a natural disaster, it allowed Mr. Powell and the Fed to sidestep concerns about moral hazard—that is, the possibility that their policies would encourage people to take greater risks knowing that they were protected against larger losses. If a future crisis is caused instead by greed or carelessness, the Fed would have to take such concerns more seriously.

This is absolutely wrong.  (Bold and italic, I'm shouting from the rooftops.) The moral hazard is too much debt, both issued and bought, not enough cash lying around ready to pounce on opportunities, not enough balance sheet space to intermediate, all on the expectation that there will be no buying opportunities or danger of loss in the next dip. The source of the shock is irrelevant. This fragility was caused by just as much "greed" and "carelessness" as the last one, eternals of human nature when incentives allow them. (I can just see it now. "The Fed diagnoses that the market collapse is due to too much Wall Street greed. Therefore, we're going to let companies go bankrupt and people lose their jobs?" ) 

Pandemics happen. Wars happen. If you're of that ilk, climate risks happen. Sovereign debt collapses happen. Crises are always unpredicted. If they were predicted, they wouldn't be crises.   

So, dear Fed, well done. The house was on fire, and you sent the entire fire department and put out the fire. A lot of people made a lot of money, as the federal debt and reserves skyrocketed. And now everyone expects more of the same next time. Not just the large bank bailouts of 2008; everyone expects that in a downturn you will buy corporate and junk bonds, as many as needed to keep prices from falling and anyone from losing money. How are you going to put this genie back in the bottle?

*****

Question 2: Sarah Bloom Raskin is being questioned over the interesting coincidence that a fintech company got a "master account" at the Fed just after she joined the board. 

The question here, for the Fed, is why did the Fed deny all the other fintech companies that applied for master accounts? Why is the Fed still  forbidding narrow banks from operating? 

Explanation: A master account at the Fed is like your bank account. Except it pays daily interest, and most of all allows instant transfer of funds from one financial institution to another. Fintech companies and narrow banks would love to give you interest-paying accounts, pay you interest, and give you much better, faster, and cheaper electronic transactions. Narrow banks would invest your money entirely in those reserves at the Fed. As a result, they can never fail. I mean that -- zero chance of failure, with essentially no regulation required. Zero chance of needing a bailout or the Fed to buy up all the assets to boost their prices, as it just did. 

Why is the Fed blocking this? What you hear is a lot of fuzzy baloney about "systemic risk." Once again, as with "climate risk to the financial system," we pay the price that Dodd-Frank never defined "systemic risk," allowing the Fed to use it as a catch all for anything it likes. Narrow banks cause zero systemic risk. 

Narrow banks and fintech companies do pose a threat to traditional banks that pay you no interest, do not serve Americans with lower incomes, and charge big fees on your credit and debit cards. Hmm. Perhaps the Administration could see this as part of its pro-competition agenda? 

The central bank digital currency movement, popular on the left as well to open banking services up to all Americans, wants all of us to have master accounts at the Fed. That is not likely, but at least allowing intermediaries who are good at retail services to enter and compete might make a lot of sense. 

 



 


25 comments:

  1. Some unasked questions that need to be asked to and answered by all nominees to the Federal Reserve Board, and, of course, also to its current members.
    https://subprimeregulations.blogspot.com/2022/02/some-unasked-questions-that-need-to-be.html

    ReplyDelete
  2. Interesting you should mention Carnival Corp.

    https://www.macrotrends.net/stocks/charts/CCL/carnival/debt-equity-ratio

    It wasn't like it was a poorly run company pushed over the cliff by "greed" and "bad management".

    It's downturn was in large part a manifestation of actions taking by the US government to shut large portions of the economy down.

    If direct government actions encumber a business and prevent it from freely operating, is that government liable to compensate that business for damages?

    I mean, forget even cheap loans - should Carnival have been able to sue the federal government for the actions that it took in depriving it of business?

    "Some people have spoken:
    Paul Singer, who runs the hedge-fund firm Elliott Management, warned that the Fed was sowing the seeds of a bigger crisis by absolving markets of any discipline. Sadly, when people (including those who should know better) do something stupid and reckless and are not punished, he wrote, it is human nature that, far from thinking that they were lucky to have gotten away with something, they are encouraged to keep doing the stupid thing.”

    ReplyDelete
  3. "This is the question. Why did the economy get into a situation once again, so soon, that the Fed had to engineer this massive bailout? What are you going to do to make sure you don't have to do it again and again?"

    Funny, I was just reading about one possible cause of this this morning:

    "Exorbitant Privilege? Quantitative Easing and the Bond Market Subsidy of Prospective Fallen Angels"

    https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr1004.pdf

    ReplyDelete
  4. The Fed fails to understand that whenever wealth:gdp is high, the system will be prone to crisis (higher valuations make a flight to cash more attractive). Bailouts reward existing asset owners and creditors at the cost of keeping assets expensive for potential future owners.

    ReplyDelete
  5. The American economy seems to thrive on borrowing. Even the creation of new money only occurs when commercial banks lend.

    The gigantic real estate sector is soaked in debt.

    Solutions?

    Make equity dividends tax free?

    Stimulate macroeconomic growth through money-financed fiscal programs (primarily tax holidays) and not borrowing?

    I think I agree with the thrust of this column, but you will have to concoct a new method for stimulating macroeconomic growth other than the build up of debt.

    If I understand matters correctly, there is already a huge amount of "cash on the sidelines."

    ReplyDelete
    Replies
    1. BC,

      "Solutions?"

      It is a misconception that the Federal Government must borrow under any circumstance. This misconception is perpetrated by more than 100 years of war dog economists (J. Yellen included), policy makers, politicians, and media cohorts.

      It is Constitutionally permitted for the US Treasury to sell equity claims against future tax revenue. Those equity claims should be a public good (as defined by Paul Samuelson) being both non-rivalrous (my claim on future tax revenue does adversely affect the government's financial position) and non-exclusive (equity sold by Treasury is available to any US taxpayer and is sold on demand rather than as a consequence of deficits).

      Understand that government bonds are a rivalrous good because of the Ponzi limit. It is illegal for the U.S. Treasury to pay bondholder interest payments with the sale of new bonds (Ponzi finance).

      "I think I agree with the thrust of this column, but you will have to concoct a new method for stimulating macroeconomic growth other than the build up of debt."

      Equity sold by the US Treasury would reduce the federal debt regardless of other spending / taxation programs instituted by the Federal Government.

      Irving Fisher and a group of economists proposed a similar plan (called the Chicago Plan) calling for equity financed banking and the elimination of the federal reserve as lender of last resort.

      What I would propose is that since the unified banking system (courtesy of Robert Rubin, Larry Summers, and Alan Greenspan) refused to convert their outstanding debt into equity shares back during the crisis of 2010-11, the US Treasury should take their place as the seller of equity.

      Larry Summers and Robert Rubin had the opportunity to institute such a program but instead chose to sell TIPs and inflation indexed bonds instead (modeled after "Linkers" in Great Britain).

      Linkers, TIPs, and other inflation linked securities suffer the same problem that traditional bonds do - they are a rivalrous good in that the returns on them to individual holders are paid from available tax revenue supplied by all tax payers. During a stagflationary scenario where inflation rises but tax revenue falls, the payments on them can be put at risk.

      They (TIPs and other inflation indexed bonds) also suffer a political risk in the US. Because the inflation indexed component on them was not legislated into existence by Congress, a future Congress (seeking to cut federal expenditures) can chose to set the inflation component to whatever they feel like (including negative values) to fund government programs.

      I have outlined all of this in my Blog including an augmented Taylor rule describing both monetary policy and Treasury policy rules.

      Delete
    2. Ben,

      "If I understand matters correctly, there is already a huge amount of cash on the sidelines."

      You understand correctly. See:

      https://fred.stlouisfed.org/series/WDDNS

      The run up in demand deposits began around 2010.

      What that should tell you is that capitalism broke around that time and has never been fixed.

      And so you might ask yourself - stock indexes are near all time highs, why isn't all this money on the sidelines investing in stocks?

      Two reasons:
      1. The 9-11 attack revealed a weakness in the consolidation of equity markets centered in New York City. A centralized market works great but also puts up a big target for the nefarious.

      2. See the Ellsberg Paradox - https://en.wikipedia.org/wiki/Ellsberg_paradox

      "It is generally taken to be evidence for ambiguity aversion, in which a person tends to prefer choices with quantifiable risks over those with unknown risks."

      With publicly traded equity stocks there is a level of ambiguity / unknown risk that people may not tolerate - for instance the risk of a bunch of hijackers crippling the markets using airplanes as bombs.

      With equity sold by the Treasury, the risk is individualized.

      The best example I can give (as far as government programs) is Social Security. Social Security benefits are a risk asset in that you may end up paying more in taxes than what you receive in benefits.

      And yet it is a program that has stood the test of time with bi-partisan support despite being illiquid (I can't sell my accrued benefits to my neighbor).

      Delete
  6. John, this is a dangerous way to think. Monetary policy is too blunt an instrument to punish a few bad actors without punishing the entire economy. The Fed must provide us with nominal stability. That's its job, its whole reason to exist. The Fed must do this whether or not any particular company or industry shows good character.

    Kenneth Duda
    Menlo Park, CA

    ReplyDelete
  7. I'm interested to know if you feel a Universal Basic Income is feasible and/or advisable?

    ReplyDelete
  8. As at December 2021, some 78.5% of total federal debt is held by the American public, according to the Federal Reserve Bank of St. Louis. It's difficult to see how this proportion of debt held domestically presents a risk of sovereign default.

    Paul Singer is a speculator in financial markets. This is public knowledge. He would welcome a reduction in the number of competitors he faces daily, wouldn't you say?

    The Fed's mandate is price stability and full employment. How would a financial collapse help the Fed achieve either or both of those mandates? Paul Singer's operations might be spared, but who is Paul Singer to dictate what the Fed will or won't do in a crisis?

    From 2019Q4 to 2021Q3, in nominal dollars, the federal debt increased by $5.2 trillion, base money increased by $3 trillion, total reserves increased by $2.5 trillion, M2 increased by $5.4 trillion, and, nominal GDP increased by $2.3 trillion (after decreasing by $2.2 trillion by 2020Q2--a turn-around of $5.5 trillion). Of that $5.2 trillion increase in federal debt during that period, the American public holds $5.1 trillion of it. A little inflation is a small price to pay.

    The net effect of that debt increase is a redistribution of asset ownership amongst the American public. In the long-term, the federal debt will be repaid by the cohort of Americans who pay the greater share of federal taxes. That cohort is likely to be the largest holder of federal debt, directly or indirectly, as well. What goes around comes around; as Ing. Vilfredo Pareto, the Italian economist of the Laussane School noted in his population studies. This effect would not have been lost on the economists advising the White House in 2020, or the Fed economists advising the FOMC at the time.

    Finally, an observation: Decisions are made on the basis of information known at the time the decision is rendered. Hindsight is 20:20, it is said. After the fact, we can say whether a decision was right or wrong, and punish the transgressors through word or deed, as Congressional committees often do. But, the criticism is often of an academic character and largely unlikely to shed light on what should have been done based on the situation analysis by the decision-makers at the time in the heat of the moment. The legislation that results is, as you point out, and as I pointed out to colleagues in the investment business at the time, in the case of the Dodd-Frank bill, worse than the condition it was intended to cure. Aside: It continues to astonish this observer that good men and women continue to seek to serve in positions of public trust knowing full well that they will be punished for it whether deserved or not.

    ReplyDelete
    Replies
    1. "The Fed's mandate is price stability and full employment."

      Actually, the only Fed mandate is price stability.
      See Humphrey Hawkin's Act of 1979.

      https://en.wikipedia.org/wiki/Humphrey%E2%80%93Hawkins_Full_Employment_Act

      "MANDATES the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price stability."

      Notice - The direction is given to the Federal Reserve board of governors. This is separate and distinct from the Federal Reserve Open Market Committee.

      Somehow even supposedly well trained economist either don't understand or just ignore the distinction.

      https://en.wikipedia.org/wiki/Federal_Reserve_Board_of_Governors

      https://en.wikipedia.org/wiki/Federal_Open_Market_Committee

      And while there is an overlap between the two groups (the 7 board members are also FOMC members), the responsibility for price stability lies with the board.

      The full employment mandate comes from an older Act of Congress - see:

      https://en.wikipedia.org/wiki/Employment_Act_of_1946

      Do people read anymore?

      Delete
    2. OEE,

      "In the long-term, the federal debt will be repaid by the cohort of Americans who pay the greater share of federal taxes. That cohort is likely to be the largest holder of federal debt, directly or indirectly, as well."

      https://fred.stlouisfed.org/series/FDHBFRBN

      The Federal Reserve banks (as holders of nearly $6 Trillion in government debt) are far and away the largest single cohort. And so they are going to pay the greatest share of taxes?

      Well, gosh, why the heck are any of the rest of us paying taxes? Just have the Federal reserve banks put a bunch of deposits in the US Treasury account and call them "taxes".

      Delete
    3. On your 2nd post, FRestly, you have overlooked a salient fact -- the FRBs pay 100% of their net income to the U.S. Treasury. In effect, the FRBs' marginal tax rate is 100%.

      On your 1st post, FRestly, you have read the objectives of the Hawkins-Humphrey act of 1978 too narrowly. Wikipedia (your citation) states:
      "In brief, the Act:
      o Explicitly states that the federal government will rely primarily on private enterprise to achieve the four goals.
      o Instructs the government to take reasonable means to balance the budget.
      o Instructs the government to establish a balance of trade, i.e., to avoid trade surpluses or deficits.
      o Mandates the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price stability.
      o Instructs the Board of Governors of the Federal Reserve to transmit a Monetary Policy Report to the Congress twice a year outlining its monetary policy.
      o Requires the President to set numerical goals for the economy of the next fiscal year in the Economic Report of the President and to suggest policies that will achieve these goals.
      o Requires the Chairman of the Federal Reserve to connect the monetary policy with the Presidential economic policy."

      The fourth and the seventh of these seven bulleted requirements ties the actions of the FRB and FOMC to the requirements placed on the government. The fifth requirement closes the control loop on the FRBs' actions in implementing monetary policy.

      In other words, fiscal policy and monetary policy are required to act together in harness. The fourth mandate is:
      o Mandates the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price stability.

      To maintain long-run growth, a condition of ‘full employment’ is a requisite, for otherwise monetary policy would be less than optimal as a different monetary policy that gives rise more efficient utilization of the nations resources (including labor) would yield a higher rate of economic growth. The physical feedback loop is personal consumption expenditures -- the unemployed consume less while placing a greater burden on government for social support and spending, ergo higher social transfers which reduce resources for productive economic growth (i.e., higher levels of taxation or government borrowing to fund transfers to the unemployed). Fiscal and monetary policies that achieve productive ‘full employment’ increase social welfare and reduce the tax burden on productive sectors of the economy, thereby reducing the ‘dead hand’ of government. Full employment in this sense is an implicit objective of the 1978 Act. And, it is in this sense, that the twin mandates are understood, a.s.

      Delete
    4. OEE,

      The problem is when government ignores it's own requirements:

      1. Explicitly states that the federal government will rely primarily on private enterprise to achieve the four goals.

      2. Instructs the government to take reasonable means to balance the budget.

      3. Instructs the government to establish a balance of trade, i.e., to avoid trade surpluses or deficits.

      My point is that relying JUST on the central bank to accomplish all of these goals makes all of them difficult to achieve - which is why I isolated the explicit directions given to the Fed Board of Governors.

      With price stability responsibility given to the central bank, the responsibility for the rest falls upon government.

      If instead we want to rely solely on the central bank to achieve ALL of the goals, then it (the central bank) must get into the business of credit allocation deciding which business investments will lead to lower inflation, reduction in trade balance, reduction in federal budget deficits, etc.

      If we are going to rely solely on the central bank to achieve all of these goals, then we should grant them the tools to achieve them including:

      1. Rejecting private loans to companies / individuals that offshore their tax liability or simply dodge any tax liability.

      2. Rejecting private loans to companies / individuals that speculate on the price of commodities and other raw / intermediate goods.

      3. Rejecting loans to the federal government itself and any bank / business that purchases bonds issued by the federal government.

      Delete
    5. OEE,

      "On your 2nd post, FRestly, you have overlooked a salient fact -- the FRBs pay 100% of their net income to the U.S. Treasury. In effect, the FRBs' marginal tax rate is 100%."

      No, I didn't overlook that the FOMC can CHOOSE to either pay the interest payments that they receive from the federal government to banks as interest on reserves or they can CHOOSE to return the interest payments to the Treasury. There is no legal mandate that the FOMC must return interest payments back to the Treasury. The FOMC's marginal tax rate is whatever they want it to be.

      "To maintain long-run growth, a condition of full employment is a requisite, for otherwise monetary policy would be less than optimal as a different monetary policy that gives rise more efficient utilization of the nations resources (including labor) would yield a higher rate of economic growth."

      The point of my post was this - relying SOLELY on the central bank to achieve multiple economic objectives (for instance balance of trade and budget) is a recipe for trouble.

      In the somewhat hypothetical, if the federal government set the age at which you begin receiving retirement benefits at age 45 instead of 65, how close do you think you would get to full employment REGARDLESS of what the central bank does?

      If you are going to rely SOLELY on the central bank to achieve multiple economic goals, then the ONLY way that happens is for the central bank to pick and chose which loans will result in higher employment, lower trade deficit, etc. - aka, credit allocation.

      Delete
    6. Do you have evidence that the federal government is not relying primarily on the private sector to achieve the four goals?

      I stress again that you are interpreting the language of the Acts too narrowly. You have emphasized that the government is "- relying SOLELY" on the FRB "...to achieve multiple economic objectives (for instance balance of trade and budget)... ." How do you arrive at that conclusion?

      Then, "... if the federal government set the age at which you begin receiving retirement benefits at age 45 instead of 65, how close do you think you would get to full employment REGARDLESS of what the central bank does?" The real world example that fits your hypothetical scenario is Malaysia in the 1990s. The retirement age was set at 55 years of age, and it didn't negatively affect "full employment". Indeed, the government's policy was intended to promote full employment by forcing older workers out of the workforce when they reached the official mandatory retirement age, thereby opening positions to younger workers at a time when the Malaysian demographic statistics were highly skewed to the young. But that is government policy working through the private sector, not the central bank.

      The concept of full employment does not imply that there will be no unemployment. In any event the term "full employment" does not appear in the 1946 Act or 1978 Act. "Full employment" is just a short-hand way of describing the neutral rate of unemployment -- i.e., the level of unemployment at which the price level neither increases nor decreases, ceteris paribus. You will recognize this as the "Phillips Curve" effect. The parallel concept is the 'neutral rate of interest' which is that rate of interest that neither accelerates economic growth and thereby lifting the rate of inflation, nor decelerates it giving rise to deflation. This is a Wicksellian concept, though the term Wicksell used was "the natural rate of interest" and it applied to the private sectors' cost of capital--if the bank rate exceeded the natural rate of interest, recession resulted, but if the bank rate was below the natural rate of interest, economic expansion resulted. At the natural rate of interest, growth was steady and the private sector earned its cost of capital. The concept of inflation was worked into this conceptual model, and employment followed the normal course--rising during economic expansion and falling during recessions.

      The trade balance depends on private sector competitiveness and government policy (excl. of the central bank, though the bank rate has an impact on the rate of foreign exchange which affects the balance of trade to a degree). A country whose currency serves as the World's reserve currency will inevitably run a trade deficit. Discontinue the USD as the World's reserve currency if you would rather run a trade surplus.

      Your last point is germane. Since the central bank does not engage in credit allocation decisions in normal economic situations (financial crises being excepted as being non-normal situations), we can infer, on the basis of this criterion, that the FRB is not being relied upon solely as the agent for the government to attain "the four goals".

      I now punt the ball back into your court.

      Delete
    7. OEE,

      "Do you have evidence that the federal government is not relying primarily on the private sector to achieve the four goals?"

      Government stimulus checks?
      Have you had your head stuck in the mud all of this time?

      "The retirement age was set at 55 years of age, and it didn't negatively affect full employment. Indeed, the government's policy was intended to promote full employment by forcing older workers out of the workforce when they reached the official mandatory retirement age."

      If we are going to arbitrarily define full employment as basically whatever age the federal government thinks is appropriate, then why not 22 years old? Problem solved!!! Anyone over the age of 22 that is not working is considered retired.

      "Your last point is germane. Since the central bank does not engage in credit allocation decisions in normal economic situations (financial crises being excepted as being non-normal situations)..."

      Not really. See John's statement above:

      "This is absolutely wrong. (Bold and italic, I'm shouting from the rooftops.) The moral hazard is TOO MUCH DEBT, both issued and bought....The source of the shock is irrelevant."

      When you understand that a government Treasury can sell equity in lieu of debt / bonds, then everything else falls into place including:

      1. Increasing the natural rate of interest / real economic growth rate

      2. Reducing trade deficits

      3. Increasing employment

      4. Restoring central bank independence focused on price stability.


      "A country whose currency serves as the World's reserve currency will inevitably run a trade deficit."

      Nope, incorrect. The dollar has been the world's reserve currency since the Bretton Woods agreement. It wasn't until the Nixon shock and later Reaganomics that we developed persistent trade deficits.

      I have explained this to you more times than I can count.

      Delete
    8. FRestly, a response to your reply:
      ● "Government stimulus checks?" -- I would say that the transfer payments made in 2020 and 2021 are not evidence that the government is not relying on the private sector to achieve the four goals.
      ● "Have you had your head stuck in the mud all of this time?" Your remark is intemperate, and not worthy of your abilities, nor is it conducive to a rational discussion of events and measures taken by the government and private sector in this forum. Save it for the bar room.
      ● "If we are going to arbitrarily define full employment as basically whatever age the federal government thinks is appropriate, then why not 22 years old? Problem solved!!! Anyone over the age of 22 that is not working is considered retired." If you say so. The example of Malaysia was presented in response to your earlier remark, and not a recommendation for the USA which has the opposite problem--i.e., a population demographic which is increasingly weighted towards the elderly and an insufficient proportion of younger working age adults.
      ● "Not really. See John's statement above: "This is absolutely wrong. (Bold ... ."" John Cochrane's statement pertains to "moral hazard", i.e., the negative externality imposed upon society by private sector actors who rely on limited liability to avoid shouldering the consequences of their actions when the market moves against their leveraged positions and the Federal Reserve and the federal government are forced to step in to stop runs on the financial intermediaries that result from those actors' behavior. He is speaking from the perspective of a general tax payer whose future income and wealth will be burdened by government taxes and/or inflation arising from the government's and/or the Federal Reserve's support to the markets. His remark does not speak to credit allocation by the Federal Reserve System, per se.
      ● "When you understand that a government Treasury can sell equity in lieu of debt / bonds, then everything else falls into place" This is your conception of a security that the U.S. Treasury could, theoretically speaking, utilize. For its effectiveness, it relies on the private sector to take up the hypothetical securities, as we've discussed previously. It is not a security that the Treasury has issued up to the present time.
      ● "Nope, incorrect. The dollar has been the world's reserve currency since the Bretton Woods agreement." The USD was not the world's reserve currency at the time of the Bretton Woods agreement (July 1944). The Bretton Woods arrangement became functional in 1958. The agreement pegged the value of the USD to gold at $35/troy oz. A currency peg to gold has straight-forward dynamics that require the country pegging to gold to maintain a positive or neutral trade balance. If that country runs a trade deficit, then it must either close the trade deficit and run a trade surplus or it must raise its interest rates to attract gold to it, or lose its gold reserves. The agreement collapsed because the US wasn't prepared to discipline itself to maintain the peg. France which was running a trade surplus with the US at the time demanded gold in exchange for dollars; Nixon then broke the peg because the US had printed more dollars than there was gold in Fort Knox to back those dollars. It took until 1971 for the system to break. Nothing happens overnight.
      ● "I have explained this to you more times than I can count." Scolding now?

      Delete
    9. OEE,

      "Government stimulus checks? -- I would say that the transfer payments made in 2020 and 2021 are not evidence that the government is not relying on the private sector to achieve the four goals."

      What in your mind would be evidence?

      "...and the Federal Reserve and the federal government are forced to step in to stop runs on the financial intermediaries that result from those actors' behavior."

      No one "forced" Hank Paulson, Ben Bernanke, etc. to convert bank debt to Treasury debt - who are you trying to kid here? Paulson could have told his investment banking friends to convert their debt liabilities to equity shares (the Chicago Plan) OR he could have begun selling equity shares out of the Treasury and using the funds to pay off banking debt.

      I have explained this to you more times than I can count. - Scolding now?

      Pretty much. It took seemingly forever to get you to engage in a discussion of government equity, which I do appreciate when you finally came around. So sometimes I get exasperated.

      "This is your conception of a security that the U.S. Treasury could, theoretically speaking, utilize. For its effectiveness, it relies on the private sector to take up the hypothetical securities, as we've discussed previously. It is not a security that the Treasury has issued up to the present time."

      Because? I mean really I don't get it. Has this country been at war for so long that the fields of economics and public policy have become entirely enshrouded in the fog of war?

      Delete
    10. The Chicago Plan was proposed in 1933 by Irving Fisher, et al., and answered in 1935 in the negative. It was resurrected in 1939, and then shelved. It was again resurrected in 2012, with modifications in a working paper published by the IMF, but never gained traction. In 2019, Christine Lagarde dismissed it, saying that she was not convinced "that eliminating the role of private banks in the supply of ‘broad’ money is a good idea". [Wikipedia: Chicago Plan]

      John Cochrane, in this blog space, has promoted "narrow banking" (essentially, The Chicago Plan of Irving Fisher, et al.) while noting that the FRB has rejected every application for 'Narrow Banks'.

      Your "Government Equity" concept is hypothetical in nature. It requires a taxpayer who is willing to purchase forward contracts from the IRS, i.e., pay cash money, to pre-pay a future uncertain tax liability some n years ahead of the liability's due date. It is not the Chicago Plan. It would not raise money in any situation like that which occurred in late 2008 and 2009. The players then were not regulated commercial deposit taking banks, but were unregulated or self-regulated 'investment banks', and hedge funds and insurance companies. Contrary to your assertion, the two alternatives facing Paulson and Bernanke at that instant were (1) to provide unlimited access to federal funds (Treasury or FRB) or (2) allow the U.S. financial system to work it out for themselves without federal assistance at the risk of significant damage to the U.S. financial system collectively and to the reputation of U.S. government. Hindsight is 20:20 and you are applying that normative standard here in your remarks.

      What I stated viz. "Government Equity" ("GE") was (a) I'm not a buyer, and (b) you haven't had any success in convincing the Sec. of the Treasury or the Chairman of the Federal Reserve Bank System to buy into it and present it to Congress for approval. I pointed out the inherent risks that GE (as first described by you in this blog space) presented to a potential purchaser and why I thought that it would not be an attractive proposition to a business owner. I haven't troubled to follow up on your latest variation on GE, so you may consider my views to be 'out of date'. Be that as it may be, there is no likelihood that GE will be adopted by the Treasury anytime soon, in my humble opinion.

      As to the Chicago Plan, forcing commercial banks to reduce their loans outstanding to the level of their book equity plus deposits--i.e., eliminating fractional banking in the U.S.--would lead to an economic depression presaged by widespread bankruptcies and considerable population dislocations. John Cochrane's support for "Narrow Banks" (no fractional banking) is limited specifically to bank charters for new banks (essentially 'savings and loan' companies, or 'trust companies') that can only lend up to 100% of their reserves held in the Federal Reserve Bank System or as vault reserves (cash, bullion and species). The point of these new 'Narrow Banks' is to access the FRB's federal funds rate or interest on excess reserves ("IOERs"), and not as sources of new loans although that is not necessarily precluded. 'Narrow Banks' would not be able to compete against the regulated fractional-banking system banks for loans and deposits (which come with those loans and other services).

      As to the question, "What in your mind would be evidence?", my reply is that I am not the one challenging the status quo--it is up to the challenger of the status quo to prove the validity of his thesis, or give it up.

      Delete
  9. Seems to me the Fed needs better tools, if they can be engineered. You know the saying - if you're a hammer, everything looks like a nail: pandemics, wars, climate threats, natural disasters. But maybe liquidity is the best hammer/tool in the toolbox.

    I've often wondered if 5/5/5 is an economic sweet spot: 5% UNRATE, 5% FFF, and NAIRU = 5%.

    ReplyDelete
    Replies
    1. It worked pretty well through the 1990's until a bunch of economists thought it was a good idea to fund a bunch of investment bank bailouts and never-ending wars on the cheap.

      https://fred.stlouisfed.org/series/DFF

      Delete
  10. Powell's job was to control the money stock so as to control inflation. But Powell continues to buy bonds, he removed Reg. D restrictions on savings' withdrawals, and he eliminated reserve requirements. Powell hasn't reversed anything he unleased and inflation is at 40-year highs.

    ReplyDelete
  11. The truth is probably closer to, if the fertilizer had been allowed to hit the fan, the economy would briefly have tanked. Pols and voters would have seen that the price of COVID panic was too high and gone back to business as usual. By now the US economy would be back on course with the reversal showing as only a brief dip in the rearview mirror. The doubtless well-meant rescue measures have only succeeded in multiplying the misery, and extending its timescale for decades to come.

    ReplyDelete
  12. Jeff Sparshott reports in "Real Time Economics" that former New York Fed President Bill Dudley has opined that the FOMC has got it wrong in an article critical of Chmn. Powell published by Bloomberg News: https://www.bloomberg.com/opinion/articles/2022-03-29/is-a-recession-coming-the-fed-has-made-it-inevitable?mod=djemRTE_h

    In essence, Mr. Dudley points out that the three examples of FOMC tightening that Chmn. Powell cites in defense of the FOMC's tardiness do not share the same economic circumstances that characterized those earlier bouts of credit contraction 'engineered' by the FOMC. Mr. Dudley asserts that the FOMC has been laggard in responding to the uptick in fiscal stimulus and expectations of future inflation, an argument Mr. Dudley asserts he made in June of 2021.

    I have no doubt that we will find, in hindsight, that Mr. Dudley's apprehensions concering the FOMC's contractionary policies are not misplaced for this business cycle.

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.