Friday, December 2, 2022

Waller courage

While the rest of the Fed climbs on the maybe-anvils-might-fall-from-the sky climate financial risk fantasy, Chris Waller has the courage in Haiku-simple prose to state that the emperor has no clothes. 
I cannot support this issuance of guidance on climate change. Climate change is real, but I disagree with the premise that it poses a serious risk to the safety and soundness of large banks and the financial stability of the United States. The Federal Reserve conducts regular stress tests on large banks that impose extremely severe macroeconomic shocks and they show that the banks are resilient.
Granted, in my view stress tests are a lot less reliable. Stress tests didn't uncover the weakness that led to the pandemic bailout, so there is no hope of them assessing climate risk. The Fed is, let us not forget, fresh off of a second huge bailout in a pandemic their stress testers never considered, and a consequent fiscal-policy inflation that their forecasters never imagined. The "transition risk" crowd got the sign wrong on what happens to oil company profits if you restrict fossil fuel investment. A "how did we screw up so badly" effort seems more important. But we need not fight about this issue. Different logic leads to the same conclusion. 

Chris is right that it is completely obvious that "climate risk" does not conceivably imperil the financial system, or at least not with more than infinitesimal probability and a lot less than other dangers --- war, sovereign debt collapse, pandemic, etc. 

Bravo, Chris. A reckoning of this highly political move will come. Yes, the Biden administration wants a "whole of government" effort to restrict fossil fuels and to subsidize windmills, photovoltaics and electric cars (so long as they are built in the US), but the Fed is supposed to be politically independent. Because, you know, administrations and Congresses change. I suspect caving to this pressure will cost the Fed a lot. 


  1. The problem with the transition risk analysis is that people conflate cost of capital with a carbon tax. Cost of capital (or a capital charge on carbon) isn't a second best solution to a carbon tax, as profits still flow (they just take longer to be recognised) and increasingly end up with private equity. The other issue with transition analysis is people usually assume the impact is restricted to the sectors with the footprint. Costs arent passed on, inflation doesn't surge. Its a classic example of 'have data hit it with an analytical hammer'. But none of this means transition risk isn't there. Until we price carbon, we just won't know where.

  2. Giving a tax credit on EVs only benefits a few, and seems socially unjust. I think subsidizing nuclear power research and development would be a better approach.

  3. Francis Menton who writes the Manhattan Contrarian blog has recently completed an analysis of what W Germany would have to do in order to supply its electricity at any significant scale ... taking Germany as an example since it appears committed to massive scale use of solar power. To give an example inorder to supply this amounnt of solar power would require about 167,000 – 373,000 of storage facilities to provide 25,000 GWh - 56,000 GWh (in the larger estimate). Each of the storage facilities would consist of 25-40 individual storage units or a total of up to one million individual storage units.

  4. The first link in this article takes the reader to the main FRB page which states a goal of 'safe and flexible and stable monetary system and financial system'. Rather than funding the climate risk fantasy, I would prefer that the 400+ economists at the 12 reserve banks go back to their models and question why their models failed to predict the fiscal inflation we are suffering under...

  5. The Federal Reserve System's regulatory function is intended to anticipate insolvency within the federal banking sector. "Stress-testing" protocols can be upgraded to encompass any reasonable scenario imaginable. Does this mean that it can anticipate every possible negative shock to the banking system, e.g., a pandemic the response to which was the effective shutting down of virtually the entire economic system of the U.S.A., and other countries? The emphasis is on "reasonable scenario". Was the failure of the F.O.M.C. to consider the inflationary stimulus of the fiscal and monetary authorities a failure of the stress-testing regime? What steps would a money-center commercial bank need to have taken to prevent a run on its branches under that scenario? Probably nothing whatsoever -- it hasn't proven to be a shock of extraordinary proportions so far.

    Waller's observation presents one perspective. The other side of the coin suggests that there is a non-trivial risk that a federal government may at some point legislate the end to the use of non-renewable energy sources for transportation, power and heating within specific regions or within the country as a whole. Not stated, but understood implicitly is that the transition to that state will be gradual rather than abrupt, and gradual enough that the shock will be manageable. Environmentalists might wish for an abrupt stop to the use of non-renewable fuels for their own ideosyncratic purposes (e.g., fund-raising), but a Congress would be loathe to antagonize a sizeable proportion of the voters simply to satisfy an environmentalist wishlist, on the basis that a politician doesn't willingly bite the hand that feeds it. Ergo, Waller is correct insofar as a transition from non-renewable fuels will be signalled well in advance and will be managed to minimize the scope for unanticipated shocks. The FRB Board of Governors doesn't have to incorporate climate change in stress tests until that transition is signalled by Congress.

    As for pandemics, some events simply have to dealt with as they arise. Otherwise, the amount of capital required to back-stop a commercial bank might well be nearly infinite to cover every possible eventuality.

    1. TBTF yes. The DFI's have a monopoly on the public’s savings. The remuneration rate is above short-term rates, money market funding rates, which is illegal. I.e., the yield curve is artificially inverted.

      They have impounded 14 trillion dollars of funds that are un-used and un-spent, one in which its interested parties seeking to influence the House & Senate Banking Committees spent in campaign contributions, amounts each year, typically exceeding all other industry and labor groupings. The ABA and Keynesian economists have achieved their objective: that there is no difference between money and liquid assets.
      To wit:
      #1 The Depository Institutions Deregulation and Monetary Control Act of 1980 (H.R. 4986, Pub.L. 96–221)
      #2 The Garn–St Germain Depository Institutions Act of 1982 (Pub.L. 97–320, H.R. 6267, enacted October 15, 1982)
      #3 The Riegle-Neal Interstate Banking and Branching Efficiency Act of September 29, 1994 [IBBEA] PUBLIC LAW 103-328 [H.R. 3841]
      #4 The Financial Services Regulatory Relief Act of 2006 (FSRRA) PUBLIC LAW 109–351—OCT. 13, 2006
      #5 The Emergency Economic Stabilization Act of 2008 (Division A of Pub.L. 110–343, 122 Stat. 3765, enacted October 3, 2008), viz., the acceleration in the payment of interest on IBDDs from 2011 to Oct. 2008

    2. You're suggesting that the Federal Reserve Bank of New York is flouting the law?

  6. The Fed fails to adequately fulfill its current mandate(s). Now it's trying to deal with climate questions failing to distinguish between risk and uncertainty as is too often the case! I agree with Kwaku about putting the staff to work doing their real job which they have failed to do properly since 2007 or before!

  7. Looking back to your June 10th, 2021, blog-post, 'The end of "the end of inflation" ', one finds via the embedded link to the Booth School of Business IGM survey for June 2021, a link to a paper by Ray Fair, Yale Economics, in which professor Fair concludes,
    "The only tool the Fed has to lower infation according to the model is to increase the unemployment rate by raising interest rates. This efect is modest and takes time." -- Ray C. Fair, in "What do price equations say about future infation?", Business Economics (2021) 56:118–128, Published online: 2 June 2021. © National Association for Business Economics 2021.

    PDF of this article is available at

    'The Grumpy Economist' June 10 2021 blog-post includes an embedded link to the University of Chicago's Booth School of Business Administration's "The Initiative on Global Markets" survey of economics professors. The survey is a representative sample of opinion on the path of inflation from mid-2021. It illustrates the difficulty of determining future inflation rates based on the limited information available on the survey date. Ray Fair is one of 38 professors of economics who participated in the June 2021 opinion survey.

    Ray Fair's article in Business Economics (June 2021) describes an econometric exercise to ascertain an econometric model of inflation, the unemployment rate, and the effect of the FRB's FOMC response to inflation. Fair does a reasonable job of modelling the phenomenon using an estimated expenditure path of the American Rescue Plan Act of 2021. The opening sentence of the article reads, "This paper uses an econometric approach to examine the inflation consequences of the American Rescue Plan Act of 2021."

    Familiarity with econometric methods and statistical estimation improves comprehension, but Fair does a good job of explaining his results in plain language. The conclusions are straight-forward and based on the work described in the body of the article. Eight references are listed. An end-note states, "Ray C. Fair is professor of economics at Yale University."

    A key implication of Fair's study is that adaptive expectations have reasonable predictive power. Fair explains:
    "Household and firm expectations tend to difer considerably from market expectations and those of professional forecasters. There is evidence that the strongest predictor of household’s and firms’ infation forecasts are what they believe infation has been in the recent past, which are not always accurate beliefs. There is also little evidence that frms know much about monetary policy targets. Further survey evidence regarding firms is in Candia et al. (2021), which support these conclusions. It seems clear that firms’ infation expectations are not rational, nor even very sophisticated. The assumption used here, that infation expectations depend only on past infation, may be the best that one can do." [Citations omitted.]

    1. Please stop posting so much. You don't have much to say and clutter the comments section.


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