6 Thoughts on Monetary Policy

1) If you are looking for an article that describes how the Fed’s new lending facilities work, look here. It shows the effects on the Fed’s balance sheet of each program.

2) Well, I guess the Fed is willing to further risk its balance sheet in order to force LIBOR down. Now, this may have knocked 10 basis points off of the TED spread in the short run, but I am not sure what it will do long term. It may do nothing, because the LIBOR lending markets are so much larger than the Fed. As is noted in this piece:

Still, RBS Greenwich Capital chief economist Stephen Stanley cautions that adding AAA-rated asset-backed debt may not do the trick. “This is not likely to be a major change, as the highest quality ABS were getting financed without too much difficulty already,” he wrote in commentary.

3) As I have noted before, the Fed cannot, and should not, solve every lending problem. There is a tendency for the financial system to adjust to monetary laxity and ask for more. This is just another aspect of the way our government operates, absorbing many medium-sized crises at the risk of an eventual run on the Dollar.

4) Should the Fed pay interest on reserves? At present, the Fed has banks lend to each other through the interbank market; if the Fed paid interest, the Fed funds market could become an explicit market where banks loan money to the Fed, rather than to each other. Now for the Fed to issue debt would allow them more flexibility in their balance sheet, but at a price. We would have a central bank with additional liabilities beyond the currency, and that would have an impact on their ability to do monetary policy.

5) Funny how the Republicans grab for something unusual — pointing a finger at the Fed for commodity price inflation. The Fed does have a small role there, but the bigger factor is the development of China, India, Brazil, and many other places that need raw materials in a way they did not previously.

6) Though I disagree with this paper, it is worth a read. I am not a monetarist, I am more of an Austrian economist. I acknowledge that economic systems are not stable, and that is a good thing in the intermediate-to-long run. In my opinion, the main weakness of monetarism is that it fails to recognize asset inflation. When the money supply is growing too rapidly, the money goes somewhere. If savers predominate, it goes to assets, if spenders, to goods and services. We mismeasure savings in the US — it is higher than commonly believed. As such, growth in the money supply boosted asset prices. But as the Baby Boomers gray, that balance will tilt as they draw on assets to finance consumption.

What is needed is a willingness for central bankers to stand in the way of investment/lending booms, and raise rates to deflate investment/lending bubbles before they deflate themselves, with large consequences to the economy. That’s not coming anytime soon.

Comments

[icandoitdon]

"Funny how the Republicans grab for something unusual — pointing a finger at the Fed for commodity price inflation. The Fed does have a small role there, but the bigger factor is the development of China, India, Brazil, and many other places that need raw materials in a way they did not previously."

i'm not sure this is a partisan issue. but the fed has, indeed, contributed substantially to commodity price inflation by promoting cheap money and lots of it at the risk of rising inflation. the resulting decline in the value of the dollar pushes speculative money into hard assets, including commodities, both here and abroad. housing is the recent exception only because of fradulent and irresponsible borrowing and lending practices that led to the meltdown in housing prices. underlying demand alone does not nearly account for a doubling and tripling of such a broad swath of commodity prices.

"What is needed is a willingness for central bankers to stand in the way of investment/lending booms, and raise rates to deflate investment/lending bubbles before they deflate themselves, with large consequences to the economy. That’s not coming anytime soon."

It's not coming at all. The fed has never, in its history, quelled an investment/spending boom. it is contrary to every instinct they have nothwithstanding their mission to promote price stability.

[OJO Zafado]

I was struck by the same remark quoted by the previous respondent. Globalization of our economy has always been most advocated by the Oligarchy. That is the investor class. They argued that it would benefit all. Workers would have more access to worldwide capital markets to invest their retirement monies. High tech jobs would flourish. Some of that has certainly happened. These days though most workers are trimming their investments into retirement vehicles as they struggle to keep up with this week's heating oil and gasoline bills. They are no longer realizing real wage growth. Those "unions" still get blamed for all the bad stuff they are causing. Even as most of them in the private sector have been effectively decimated or put out of business. Many of their members that are still left, even vote Republican. The Republicans will not raise taxes like those Democrats. The sad truth is that the current Republican leadership has been the most irresponsible in modern history. They have corrupted the Laffer curve of economics, by inserting a last axiom. "Then icrease spending on a massive scale". This has sharpened the Laffer Curve into a U-turn. One that Ben the Dollar Slayer could not resist making despite the very large sign, "U-Turn Prohibited". That sign was posted for the public safety. Ignoring it has resulted in Ben driving the bus off the road and over a cliff. As a BSC bond holder I would like to thank all of you and especially Ben for helping us out of a terrible jam! Ben is a toady to the "Dummya" that elevated him. As long as the Oligarchs best interests are protected we can let the next generation or group of politicians sort it all out after we are dead. It has certainly worked for Ron Reagan. Boomers will not be able to spend their retirement on consumption as they will have to continuously reduce what they take from their retirement funds to sustain the nest egg out to their expected longevity. Only by spending less of it and reinvesting more of it post retirement will the funds have any VALUE left in them as oil soars to $300/BBL and gold to +$2000 an ounce. The Dollar Slayer has let the genie out of the bottle! The US currency (linen fiat) is being echewed even by the Chinese as they buy fewer Treasury bonds and find the idea of a "strategic petroleum reserve" more appealing than a bigger stake in the US dollar. We have nothing to fear but taxes themselves. The currrent group of politicos are already pandering for votes to see who can out tax cut who. McCain is not a lunatic? Postulating that he as President, would end ALL, that's right folks!!! ALL!!!!, earmarks pork barrel spending to buy votes by cutting gas taxes to encourage more consumption. He seems to have a very sanguine outlook on the political atmosphere in the country. It seems he expects his Republican buddies to be even more successful in the Quad elections than they were in the Bienniel elections. We shall I am sure in the next 4 years find a way to abolish all taxes on every one. Maybe we could invade Venezuela, like we did Mexico and Iraq and establish a successful Gangsterocracy like they now have in Russia. How much will we have to pay the nation's colleges and universities to stay in busines when this fall's enrollments drop off by 10-15%? Let's give away some more money to college students! Any good politician will tell you that after4-5 years in college more than half those who graduate will find a job working somewhere other than at a giant box store. Of course this is a partisan issue! The wealthy can protect their wealth by adhering to the Keynsian axiom, "When the situation changes I change my mind. What do you do?" The wealthy buy BRIC, Nat resources, precious metals and high yielding inflation ptrotected subordinated debt of GSE's like FNM-P. If you are a poor working slob you hope there is something left in the account when you try to buy some gas on your debit card. You hope you will not be in the next round of layoffs and you hope John McCain becomes the next President because you can not afford to pay anymore taxes. Of course the current scenario of stagflation is the most regressive of all taxes. But that's why the wealthy have Smith Barney and good tax accountants. They can pay for it!

[Whisper On The Wind]

Boy, you sure can tell it's an election year.

[flow5]

There are some exceptionally bright economists on the Fed's technical staff. They are just behind the scenes. But that doesn't preclude them or their superiors from making bad judgements.

I for sure don't know how to calculate the effect of inflation stemming from the dollar sliding against other currencies. And I don't know the answer to this, but won't lenders in the E-dollar market have to make adjustments for a falling dollar? Doesn't this add some risk (basis points) to the equation? Is there such a thing as a perfect currency hedge?

This line is insightful: "What is needed is a willingness for central bankers to stand in the way of investment/lending booms,..." Amen.

Does anyone know when a commercial bank is a financial intermediary? I pose the question because the money creating depository institutions have always been treated like financial intermediaries, intermediary between saver & borrower (Congress et. al.)

The answer to this question is that by raising reserve ratios to 100%, the money creating depository institutions would become financial intermediaries no longer able to create money, serving only as conduits between savers and borrowers.

Then the funds for setting up deposits would ORIGINATE OUTSIDE the banks (not through the creation of new money), just as the funds for setting up share accounts originated outside the savings-and-loan associations.

So why should be member commercial banks be allowed to buy their liquidity? The banks are always under regulated in this area (beginning with the Negotiable CD in 61). It's not a question of if there will be banking problems but when.

[flow5]

www.bloomberg.com/apps/news?pid=20601087...
Bernanke on payment of interest on prudential or liquidity reserves.

The historical record proves that pegging interest rates has never worked.