Thursday, March 25, 2010

Top Fed official doesn't understand monetary operations

Yesterday (3/24) I was on Fox and we had Kansas City Fed President Thomas Hoenig on and he was talking about the need to reverse the "extraordinary measures" that the Fed has taken since the crisis because it raises the potential for huge inflation.

Specifically, Hoenig spoke with great concern about how the Fed must sell off its huge portfolio of mortgage backed securities.

I sat there listening to this guy, utterly dumbfounded that he does not even understand basic monetary operations.

From his comments one could surmise that Hoenig believed the purchase of MBS was nothing more than some kind of irresponsible speculation--a position the Fed took for monetary gain--which it now has to carefully sell in order to "book" the profits.

He should know that the Fed's purchase of mortgage backed securities was the way by which it sets interest rates. To get mortgage rates down, the Fed needed to purchase MBS and that's what it did. It was not a "trade."

The Fed's purchase of securities--whether they be MBS or Treasuries or anything--is always the mechanism it uses to manipulate reserve balances higher and that puts downward pressure on rates.

"Exiting" is achieved by simply doing nothing, because the Treasury's ongoing sales of securities functions to drain reserves automatically. In the last six months the Treasury has sold nearly $4 trillion of securities. That is nearly four times the current level of system reserves!

It is very disturbing that such a high level monetary official is so lacking in knowledge when it comes to basic operational realities of the Fed and government finance.


Mike Sandifer said...

Isn't it great that we have a Fed that is moving in exactly the opposite direction that our current needs require? To worsen matters, their policies aren't even coordinated with fiscal policy. It's as if no one in charge even understands basic macroeconomics.

By the way, how can it ever be justified to have so many non-economists in control at the Fed?

mike norman said...

The problem as I see it, Mike, is twofold:

First, mainstream economics has been infused with neoclassical ideology, perhaps permanently. It may work in the long-term, but as Keynes said, in the long-term we're all dead.

Second, we've never really had a merit-based system. It's really about who you know. That means a lot of these guys who are in there running policy have the connections or are part of some, "Good ol' boy" network.

Sad but true.

Ryan Harris said...

In the last couple days Hoenig, Bullard, and Bernanke have all said that the Fed needs to get back to holding only Treasury Securities. Why should the central bank not hold other types of debt or securities?

mike norman said...

TB: Yes, it's a crazy oomment. They forget that it's all about setting rates, not about what type of security they hold. If they want mortgate rates lower they buy MBS. If they want the price of Beanie Babies lower they buy Beanie Babies. They don't even seem to understand why they bought them in the first place!!!