Wednesday, May 24, 2023

Hoover Monetary Policy Conference Videos

The videos from the Hoover Monetary Policy Conference are now online here.  See my previous post for a summary of the conference. 

The big picture is now clearer to me. Phil Jefferson rightly asked, what do you mean off track? Monetary policy is doing fine. Interest rates are, in his view, where they should be. He argued the case well. 

But now I have an answer: The Fed has had three significant institutional failures: 1) Its inflation target is 2%, yet inflation exploded to 8%. The Fed did not forecast it, and did not see it even as it was happening. (Nor did many other forecasters, pointing to deeper conceptual problems.) 2) In the SVB and subsequent mess, the Fed's regulatory apparatus did not see or do anything about plain vanilla interest-rate risk combined with uninsured deposits. 3) I add a third, that nobody else seems to complain about: In 2020 starting with treasury markets, moving on to money market funds, state and local financing,  and then an astonishing "whatever it takes" that corporate bond prices shall not fall, the Fed already revealed that the Dodd-Frank machinery was broken. (Will commercial real estate be next?) 

Yet there is very little appetite for self-examination or even external examination. How did a good institution, filled with good, honest, smart and devoted public servants fail so badly? That's not "off-track" that's a derailment. 

Well, two sessions at the conference begin to ask those questions, and the others aimed at the same issues. Hopefully they will prod the Fed to do so as well, or at least to be interested in other's answers to those questions. 

(My minor contributions: on why the Taylor rule is important here, where I think I did a pretty good job; and comments on why inflation forecasts went so wrong at  1:00:16 here.)


  1. Corporate real estate? Don't you mean either REITS or commerical real estate?

  2. I'll add a fourth Fed issue: FAIT is rolled out after much effort but we aren't specifically told it's asymmetric, which mathematically means the inflation target has been raised (by the amount of any overshoots). We learn this detail in subsequent speeches and press conferences and are never told the rationale. Skipping over one of the more crucial details of a new framework which has the potential to dramatically alter long-term outcomes is simply terrible communication.

  3. The long-run inflation rate target is unchanged at 2 pct. pts./annum. The control signal (input) is altered, as described in this publication:

    By adopting an averaging approach (to the control signal) to determine the monetary policy response to inflation, the FOMC has introduced a time lag into its monetary policy response. This change makes it appear that the FOMC is asleep at the wheel (as John's remarks above demonstrate). But, in fact, the FOMC is acting in line with its long-run monetary policy adopted on August 27, 2020, and reaffirmed with effectivity on January 31, 2021, January 31, 2022, and January 31, 2023.

    John's observations on the moral character of the FOMC members and staff are based on a misapprehension of the FOMC's policy. The committee members and staff are performing to the 8/27/2020 monetary policy that has been reaffirmed three times since its adoption. The change is significant, and apparently, little understood.

    The FOMC is not following the Taylor Rule or any version of the Taylor Rule. It is not pursuing a control strategy such as the LQR (Linear-Quadratic Optimal Regulator) for keeping inflation in check. If the FOMC is pursuing an optimal cost function minimization strategy, it is not clear from the policy statement what that cost function is.

    If we take R. Kaplan's (FRB of Dallas, TX) observation of the acceptable upper bound on the long-run average annual inflation rate as being between 2.25 pct. and 2.50 pct., then we can say that between 0 pct. and 2.50 pct., the FOMC will not alter its then-current monetary policy. But if the long-run average annual inflation rate rises above 2.50 pct., then the FOMC will alter its monetary policy stance in response (by raising the Discount Rate, and the FFR).

    The August 27, 2020, statement of change of policy altered the controlled variable from then-current observation of the annual rate of inflation (PCE-Price-Index) to a trailing average of N-1 recent observations of the year-year rate of inflation plus the then-current period observation of the year-year rate of inflation. This change introduces a time lag which retards the responsiveness of monetary policy to changes in the rate of inflation. During a period of rising prices (PCE price index), the FOMC will be slow to respond as it takes time for the N-period average to rise to the threshold level (say, 2.50 pct.); likewise, during a period when prices start to stablize, the FOMC will be slow to adjust its monetary policy response to reflect the decrease in the then-current inflation rate observations--interest rates will be higher for longer under the 8/27/2020 monetary policy.

    We are not told what the averaging method is, nor are we told over what period of time the averaging will conducted over (i.e., N is unknown to the public).

    In any case, the lag in the FOMC's response to increasing inflation during 2021-2022 is easily explained by reference to the FOMC's policy change announced on 8/27/2020. It is decidedly not because the FOMC and its staff have lost their marbles, or misplaced their slide-rules and computers, or lost sight of their duty to the public.

    One beneficial change arising from the adoption of the 8/27/2020 monetary policy amendments is that the FOMC is no longer conditioning its monetary policy stance based on the then-current unemployment rate dropping below the then-current presumed "natural unemployment rate" (NAIRU). In periods prior to 8/27/2020, the FOMC commenced raising the Discount Rate (FF Rate) whenever the unemployment rate dropped below the then-current NAIRU. This was a mechanical rule used by the FOMC that had the effect of inducing employment recessions in order to curtail aggregate demand directly and the rate of inflation indirectly. That is now a thing of the past, according to the policy statement.

  4. On the question of whether the FRB regulators were remise not to take a harder line with SVB, and First Republic Bank (the FDIC was the regulator or record for Signature Bank), the first point in rebuttal to the argument advanced above in the article is that the FRB regulation of banks relates to maintenance of the stability of the banking system as a whole, and not to the maintenance of the stability of its constituent parts (i.e., individual banks or bank holding companies). The second point in rebuttal is that the actions of regulators are tempered by the litigious environment that makes regulation both more difficult to effect and slower to take effect--the regulated entities "lawyer up" and dispute each point of contention. This was said to have been characteristic of the regulators' dealings with SVB management.

    SVB's failure was baked in during 2021. It's demand deposits surged, and it had insufficient opportunities to lend those funds out to its customer base (the funds deposited represented capital flowing into venture-capital funded start-up companies who had no great need for bank loans to finance internal growth). The response SVB made was to increase holdings of long-term MBS and CMBS issued by government agencies (Fanny-Mae, and Freddy-Mac) that enjoyed Capital Tier - 1 advantages. The mistake made by SVB was two-fold:(a) severe liability and asset maturity mismatches, and (b) designating the assets as "held-to-maturity" for accounting and financial reporting purposes. (a) arose because of a need to generate income on the funds on deposit in order to attract more deposits. (b) arose because of a need to avoid taking charges to comprehensive income arising from small changes in the value of the investments if interest rates should increase marginally.

    The FOMC's statements of 8/27/2020 were misinterpreted by SVB's management. By the time the FOMC changed its monetary stance from expansionary to contractionary, it was too late for SVB to take remedial action--it couldn't re-class the "held-to-maturity" assets as "available-for-sale" assets on just a few MBS and CMBS for if it changed the designation of one of the class, it was forced under accounting rules to change the designation on all in the class, and that would have a large impact on comprehensive income and raise going-concern questions by the bank's auditors.

    SVB management skewered itself, and the bank was effectively bankrupt by 12/31/2022, if not earlier. When that became known, the bank run was on, and the bank was 'road-kill' from there onward. The FRB wasn't at fault -- it never had a mandate to save SVB from itself. Likewise, for First Republic Bank.

  5. “Humpty Dumpty. Can we put him together again?”
    Comment to Ricardo Reis [1]
    By Federico Sturzenegger, Universidad de San Andres, Harvard Kennedy School and HEC

    [1] BIS Working Papers No 1060, December 2022:
    "The burst of high inflation in 2021–22: How and why did we get here?"
    by Ricardo Reis URL-

    Federico Sturzenegger discusses Ricardo Reis's paper "The burst of high inflation in 2021-22: How and why did we get here?". FS anchors his remarks with references to the inflationary experience of central banks in Turkey and Argentina (FS was governor of the central bank of Argentina). He discusses 'inflation expectations', monetary policy, the quantity theory, supply shocks, John Cochrane's "very interesting observations on the impact of rising interest rates on fiscal policy and expectations for the inflation rate", and his own experience vis-a-vis monetary policy and two-step interest rate increases on inflation expectations. The tone is light, and breezy, but serious at the same time.

    Ricardo Reis's paper is a broad discussion of the 2021-22 inflation surge in the U.S. and anchoring inflation expectations after de-anchoring and money base increases in 2020. As FS states in his discussion paper, there are no equations to be found in Reis's paper, not a one.

    The two discussants' papers are appended to R. Reis's presentation (paper).

  6. The rate-of-change in our means-of-payment money supply, the proxy for inflation, hit record highs in November 2020. It was no happenstance that we got inflation down the road.

    Contrary to Powell, never are the commercial banks intermediaries, conduits between savers and borrowers, in the savings->investment process. Money and credit creation is a system-wide process. The necessity of Covid-19’s Treasury’s debt-support operations should have been foreseen, and thereby offset, by raising reserve ratios – not by eliminating them.

    In 2010, the PBOC’s RRR went to 18.5% – “to sterilize over-liquidity and get the money supply under control in order to prevent inflation or over-heating”

    As Dr. Milton Friedman pontificated in a letter to Dr. Leland Pritchard (his classmate in Chicago): From Carol A. Ledenham’s Hoover Institution archives: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.

    1. I also thought so at the time (2020). It made little sense to engage in expansionary monetary policies when there was effectively no opportunity to buy our way out of the pandemic. What was an extra $500 worth at time? You couldn't know whether you'd be lying stone-cold on a slab the next day or not. But here we are, alive today, and the recession was a short "V-shaped" recession and e-commerce became a thing. Inflation today is nothing compared to Volcker's day in the limelight when mortgage loan rates topped 21%/annum and a 14%/annum mortgage rate was "affordable". I was there that day too.


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