I'm just gonna come right out and say this and I am neither shy nor embarrassed to say it because I'm sick and tired of hearing all these fictional stories about money printing creating inflation.
The action of printing money--yes, that's right, the government literally sending out checks to people--will not and cannot create inflation in a modern, competitve, global economy. No way. No how.
In addition, it makes us wealthier.
Money to people equates to higher incomes and savings, which are then spent or invested creating higher demand and productive capacity, leading to an increase in the overall supply of goods and services, and that constitutes real wealth. In addition, the greater supply keeps prices in check.
The action of printing and spending triggers a market signal and an opportunity that the private sector (entrepreneurs and businesses) will eagerly respond to.
Only when all the resources and labor of the entire world have been engaged to the limit can inflation even be considered a possibility and that can never happen.
On the contrary, an economy that is broken, corrupt or in the grip of monopolistic forces or authorities that prohibit, usurp or otherwise deny access to labor and resources (globally), will experience inflation when it prints money.
Those who scream about money printing and inflation need to explain why they believe money printing will result in the total consumption of all available resources and real assets without any concomitant increase in output whatsoever. This is an incredibly far-fetched view.
Now go stick that in your pipe and smoke it.
83 comments:
Thenk you Mike.
SPENDING money (too much) CAN cause inflation.
The whole word "inflation" is a false metaphor in my view, it is some sort of thermodynamic metaphorical term that is not very good terminology...
If you look at the FRA for instance (ie THE LAW... if that matters anymore...) the FRA Sec 2A states:
"...so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates...."
There is no reference to "inflation" anywhere in this act...
Yet you hear all of these people going around saying 'the Fed has to prevent inflation...' or whatever.
There is no 'inflation' there are only prices...
"Its about PRICE not QUANTITY..."
rsp,
Money creation by itself does not cause inflation (contra "inflation is always and everywhere a monetary phenomenon). Spending by itself cannot cause inflation.
The cause of a continuous rise in the price level is effective demand in excess of the capacity of an economy to expand to accommodate it by increasing production.
This can happen if government expenditure exceeds the saving desire of non-government at near full employment, where labor bargaining power increases and energy and materials are bid up. Or it can happen in the case of supply bottlenecks or shocks, especially to vital resource like oil.
Looking at money creation or amount of spending in isolation from effect in demand relative to supply can never can never forecast inflation.
Any knowledgeable person (which of course includes all Austrians and right-libertarians) knows dollars exchange information in a manner transcending space and time: the instant a new dollar is created, it signals all other dollars in existence and they simultaneously devalue themselves.
This is how M is able to jump over V and land squarely on P, kicking Q into an alternate universe.
This is so stupid it doesn't deserve a reply. Ask all the people by bet on hyperinflation due to QE about that. It's refute. Go back to fantasyland.
Tom,
Ben Johannson was being sarcastic (i think). Re-read his comment with a sarcastic tone. If not, yikes!
Right Ben forgot the ;) Tom....
rsp,
PS Ben this 'alternative universe' idea has definite potential for a post...
Was not addressed to Ben, but to people that believe that stupidity.
"Only when all the resources and labor of the entire world have been engaged to the limit can inflation even be considered a possibility and that can never happen.
On the contrary, an economy that is broken, corrupt or in the grip of monopolistic forces or auhtorities that prohibit, usurp or otherwise deny access to labor and resources (globally), will experience inflation when it prints money."
This is a bit of a contradiction, given that the second paragraph does describe the world we live in to certain degree.
The first paragraph is far too simplistic. We know that inflationary pressures build up before full employment or potential output are reached.
I was just talking to my cousin's son who is an accountant about the national debt and that the national debt is a liability on the government's books and an asset on non-government books and he said I was wrong. I said, how so, that's just the accounting. He said, yes, but government has to redeem its bonds. I responded that government can never fail to meet its obligations operationally since it is the issue of the currency, and I quoted Greenspan and Bernanke to that effect. Realizing he was caught out, he answered, "That's what's wrong. We shouldn't have a central bank." So first, he claimed it was wrong factually and then had to admit that it was factually correct but he didn't like it ideologically.
y,
These "pressures" can only then result in price increases if govt accommodates the initial price increase either thru the prices it directly pays for provison or the prices its banks use for collateral purposes...
There is MMT stuff out on this...
Warren says it this way:
"prices are a function of what price the govt pays for things or what price they allow their banks to lend against things.."
rsp.
Tom that is where what I am terming 'libertarianism' (I cant think of anything else to term it...) comes in with your relative there...
rsp,
Tom,
Interesting anecdote. I think your cousin's son's response is normal. At first it's disbelief, then when the logic of it finally hits them, then it's wrong.
I'm not sure if it was a post I read on MNE or wherever but I remeber reading that a lot of people's objections to MMT is visceral and moral. It often even seems that way with Bob Murphy, who will say 'Yeah, technically MMT is correct, but…'
I think the best way to get around this is for people to understand that banks create most of our money and they make a profit off that priviledge that the rest of us don't get. If people can see some unfairness or injustice in this, then they might be much more open to money being at least a little more democratically controlled.
Ultimately it's like people don't think that ANYONE has a right to create money. Then where does money come from??
I think people need to understand that money arises out of nothing. That's the nature of money. It's a social tool. Once they understand what money "is"…. then I think they will be much more open to the costs and benefits of different ways money can come into existence.
Tom, if the government constantly ran a deficit and the interest rate was higher than the economy's growth rate, at some point interest payments would get so large, leading to excessive demand and inflation, that taxes would have to be raised to reduce demand. At that point the government debt becomes a liability for those who pay the extra taxes. Also if there is inflation due to this excessive demand, the real value of money and government bonds falls, meaning that those holding them lose some real value and in essence are also paying an additional tax.
"These "pressures" can only then result in price increases if govt accommodates the initial price increase either thru the prices it directly pays for provison or the prices its banks use for collateral purposes..."
No, because there is already plenty of money in the economy with which people can pay the higher prices.
It takes time to bring new capacity, resources and labor on-line. It doesn't happen immediately. So the price of labor and commodities can inflate due to printing too much money too quickly. Any kind of shortage can create inflation. Full employment is a classic example. Ask anyone in the North Dakota oil patch. Bank lending is probably the largest form of printing money. That's what caused the housing bubble.
Yes and no, Mike Norman. Yes and no.
"Those who scream about money printing and inflation need to explain why they believe money printing will result in the total consumption of all available resources and real assets without any concomitant increase in output whatsoever. This is an incredibly far-fetched view."
Yes. And this criticism can be directly applied to Milton Friedman.
"Only when all the resources and labor of the entire world have been engaged to the limit can inflation even be considered a possibility," you write, "and that can never happen."
That one is tempting, but I must say No. Why? Because what you say is just about exactly the same as what John Law said before his idea created the Mississippi Bubble.
One more negative. You write:
"Money to people equates to higher incomes and savings, which are then spent or invested creating higher demand and productive capacity..."
You assume that the money will be spent rather than saved. "Spent or invested" rather than saved. This is precisely the same mistake made by Eugene Fama and John Cochrane, as pointed out by Krugman in the Dark Age post.
That is enough for today!
y,
How can that happen in any sort of meaningful way if govt doesnt jump on board the initial higher price?
Are people going to dip into savings?
I went thru this back in '03/04, me and an architect were looking at something and the price of building materials skyrocketed and the govt just raised the conforming loan limits and voila higher prices we said 'no way' thankfully...
rsp,
If the government decided not to pay higher prices for things, it doesn't mean other people wouldn't. Say the government normally buys lots of oranges, and then the market price of oranges rises, how can the government keep the price of oranges down by simply refusing to pay the higher price?
Matt,
"or the prices its banks use for collateral purposes..."
This would have the effect of raising market interest rates, which might reduce credit expansion and private spending. But if this happens before full employment is attained then you still haven't achieved your goal of full employment with no inflation.
The important part to retain is that it doesn´t matter whether deficit spending is financed by bonds or by money "printing": adding net aggregate spending at levels below full employment will lead to higher GDP and employment, not to inflation.
In fact, even neoclassical economists of the neo-keynesian persuasion will agree to this statement.
What MMT has brought as an extra, very important insight, is that in general there is no reason to think that money financing of deficits is inherently more expansionary - or more inflationary - than bond financing.
Indeed the MMT "general case" has the government (Treasury) financing all its deficit expenditures directly at her central bank.
This is only simple logic: why should a fiat money democracy maintain the fiction that governments need to borrow funds from private investors in order to net spend?
Btw, the massive doses of quantitative easing that we have observed since the 90s in Japan, the US and the UK have served to underline the fact that the central bank can hold trillions in government bonds without causing even a hint of inflation.
Perhaps the central banks should now go full way and buy back all the outstanding public debt - if only just to prove once and for all that governments simply do not need to sell bonds to the private investors in order to deficit spend.
if the government constantly ran a deficit and the interest rate was higher than the economy's growth rate, at some point interest payments would get so large, leading to excessive demand and inflation, that taxes would have to be raised to reduce demand.
Right, if r>g then IGBC.
But the cb controls the interest rate and the purpose of taxation is to remove $NFA when inflation to dampen inflation. No problem under functional finance is people understand the reality. See Scott Fullwiler, Interest Rates and Fiscal Sustainability.
This thread makes no sense. Are posts being deleted?
The way that inflation generally comes about it that during contractions the price level falls and during expansions returns toward its previous levels. This is recovery rather than inflation, such as asset prices fall in downturn in corporate profits and rise in anticipation of increased corporate profits. Again, a normal process of increase and decrease in valuation.
However, in booms animal spirits mount and people become less and less risk adverse. Asset price move above historical levels of prudent valuation. People feel richer and spend more either by borrowing or realizing gains from assets. Business find that they can raise prices in the face of increased demand due to increased "confindence," really animal spirits.
Price increases lower the real wages and labor starts to agitate for higher wages to recoup lost purchasing power by arguing for a share of increased profits. As full employment nears, labor bargaining power increases and then a wage-price spiral begins as firms attempt to maintain their profit margin, reluctant to share gains with labor.
This is the classic demand side story of inflationary pressure.
Most recent bouts of inflation have been supply side, however, due to monopoly and oligopoly power wrt vital resources especially petroleum. But recently part of this is increased competition for resource with emerging nations entering the market.
Government has the tools to deal with demand side inflation with functional finance. However, supply side inflation can only be met either by increasing the scarce resource, e.g., by more exploration as prices rise, or by substitution through invocation, e.g., alternative energy sources. This requires investment often including public investment in R&D, capital provision, or actual government programs like the present military programs to develop alternative energy sources.
"the MMT "general case" has the government (Treasury) financing all its deficit expenditures directly at her central bank"
no, the 'general case' has the government issuing money directly when it spends.
"This is only simple logic: why should a fiat money democracy maintain the fiction that governments need to borrow funds from private investors in order to net spend? "
I dont know, ask the POTUS:
http://www.businessweek.com/news/2013-10-11/obama-says-real-boss-in-default-showdown-means-bonds-call-shots
y,
"prices" there means not the interest rate it means the underlying price of the collateral...
iow if the banks tomorrow started to lend $1M against mobile homes, the price of mobile homes does not pass go and goes directly to $1M... at ANY interest rate...
rsp,
"or the prices its banks use for collateral purposes..."
This would have the effect of raising market interest rates, which might reduce credit expansion and private spending. But if this happens before full employment is attained then you still haven't achieved your goal of full employment with no inflation.
Not necessarily. It would exclude a lot of buyers from the market if government has imposed say a 20% requirement or even had listened to the 2004 FBI warning that the mortgage market was riddle with fraud. Those buyers would not have been able to get loans at any price in that case and demand for homes would not have exploded in problem areas
In Vallejo, which eventually went bankrupt, 79% of loans were subprime and 72% in Santa Rosa in 2006 just before the peak. Similar in Las Vegas and FL.
Jose,
"Let us first summarize the simplest, most general case. The issuer of the currency must supply it first before the users of the currency (banks for clearing, households and firms for purchases and tax payments) have it. That makes it clear that government cannot sit and wait for tax receipts before it can spend—no more than the issuers of bank deposits (banks) can sit and wait for deposits before they lend. Government spends or lends HPM into existence, and receives back what it spent or lent when taxes are paid or debts to government are repaid. That also means that at most, government can receive back in payments as much as it spent or lent....
We argue that the appropriate general case is the consolidated Treasury/Central Bank, but the reader should not confuse this attempt at defining a general case with a description of actual operations for any particular country."
(MODERN MONEY THEORY: A RESPONSE TO CRITICS Scott Fullwiler, Stephanie Kelton, L. Randall Wray)
http://www.bcra.gov.ar/pdfs/eventos/JMB_2012_Wray.pdf
Matt, if you raised bank collateral requirements suddenly a lot of people would find it harder to borrow from banks.. wouldn't this cause interest rates to rise across the market as people sought out other sources of funding?
In some area, the financing was by the owner on contract at a higher rate than the bank would charge, but the borrower realized that a bank loan was not possible even under the most liberal terms. The owner wasn't really risking in that kind of deal other than getting a property back. But with prices rising, few cared about that at the time.
Mortgage brokers also raised private capital to make loans. These were knowingly risky and so interest was higher. Since neither the borrower not the lender owned the title, these were very risky loans and some lenders got burnt in the crash.
But the demand for loans was very high from banks for securitization, so a lot of loans NINJA loans got made that the banks and mortgage companies had to eat if they held them but few did. The were already packaged and sold as MBS and a lot of this ended up being picked up by government.
@Matt,
I've had many issues over the years regarding people not knowing when I'm joking. Seems to be a talent.
y,
They wouldnt be raising the collateral requirements they more or less would be lowering them...
iow this is like bordering on the 'control fraud' type of thing but it is really govt morons in charge who think the 'invisible hand' is causing 'inflation' like it is thermodynamics or something...
where the banks go in to the regualtors and say: "I know last year we were doing loans on these 2500 sq ft townhouses in this same development at 125 psf, but the DoD has come in and their Iraq reconstruction contractors have wiped out all of the inventory of plywood and drywall and now the same townhouse costs $200 psf as lumber prices have doubled, so we need to have you increase the allowable appraised value of these townhouses by $75 psf this year or we wont be able to finance any" and the bank regulators just say "ok" and this ratifies the new higher price structure and townhouses start going for $200 psf.... the govt has set the price.
If govt just said "no", we will not allow you to do loans on the same townhouses for $75 psf more this year than last year, the prices could not rise.... and the builders would have to shut down for a while until the war was over and people would have to cohabitate till then....
rsp,
The U.S. was created in the mold of a Roman-style republic, ruled by elites for the benefit of elites. Our masters (senators, financiers, the corporate lords) have spent the last hundred years working to ensure the people never discover the realities of how the system works. We maintain the facade of needing to borrow because it keeps the powerful in their place and the rest of us down.
Ben you are giving them too much credit they are not that smart...
rsp,
The U.S. was created in the mold of a Roman-style republic, ruled by elites for the benefit of elites. Our masters (senators, financiers, the corporate lords) have spent the last hundred years working to ensure the people never discover the realities of how the system works. We maintain the facade of needing to borrow because it keeps the powerful in their place and the rest of us down.
And the only economists willing to say this publicly are the Marxists and Marxians.
Matt. read the early documentation about the founding of the US and the controversies and debates of the time. It's in the Federalist Papers, for example.
The debate ended up between Hamilton representing the industrial and financial interests of the North, and Jefferson and Madison who represented the interests of Southern agriculturists.
Just about the only populist democrat left standing was Tom Paine and he was marginalized.
Was it and is it a vast conspiracy? Not really. The elite just act in their best interests and the institutional arrangements of the US government were set up to facilitate their doing this. Subsequent law, regulation and policy have been developed to meed the need of the time in preserving the privilege of the power elite and extending it when and where possible, often through disaster capitalism. The military-industrial-governmental complex that grew out of the Cold War is one example of it.
Matt,
"If govt just said "no", we will not allow you to do loans on the same townhouses for $75 psf more this year than last year, the prices could not rise.... and the builders would have to shut down for a while until the war was over and people would have to cohabitate till then...."
but banks aren't the only source of funding. Builders and other real estate companies would seek out other ways to borrow from the money markets. Interest rates would rise in these markets, all else being equal.
Tom,
I was talking about this part: "Our masters (senators, financiers, the corporate lords) have spent the last hundred years working to ensure the people never discover the realities of how the system works"
Ive read bios of Hammy and others, Federalist papers, etc.. I agree those people knew how the system worked back then (ie metals...) and they made the best of it...
But these people today, I'm sorry they do not even know what the heck is even going on with our current system...
Look here is Robert Reich just today: "As a percentage of the economy, the deficit is expected to bottom out at 2.1 percent in fiscal 2015 before resuming its uphill climb, CBO says. Under current law, debt held by the public would exceed annual output by 2038. The budget office in a recent report said such outsized borrowing would be unsustainable, another reminder of creditors’ power.
“The bond market calls the shots,” says Robert Reich, a professor of public policy at the University of California at Berkeley who was secretary of Labor under Clinton. “All eyes are on the bond market right now.”
http://www.businessweek.com/news/2013-10-11/obama-says-real-boss-in-default-showdown-means-bonds-call-shots#p2
Reich is not a part of some vast neo-liberal conspiracy he is a left winger from Berkeley...
They are all stupid today... sorry.
rsp,
but banks aren't the only source of funding. Builders and other real estate companies would seek out other ways to borrow from the money markets. Interest rates would rise in these markets, all else being equal.
Credit is always available at a price. That doesn't change the interest rate, yield curve or prime rate, which is what counts.
Of course, if government acted, then banks would not be doing the lending which creates bank money that is figured into the M1 money stock. When other's lend they have to lend out existing money since they don't have access to the cb. They can create credit money, but they take all the risk and, of course, they will charge accordingly for that.
But those higher rates would shut a lot of people out of the market, since they could not afford the monthly nut. And these are also tightly secured loans. Default and get your legs broken.
y,
My point was that, if the central banks bought back all the outstanding public debt bonds (in the case of Japan, the BoJ has already done so for about 50% of the total) then we'd have a real life application of the MMT "general case".
"Credit is always available at a price. That doesn't change the interest rate, yield curve or prime rate, which is what counts."
Taking Matt's example ("we need to have you increase the allowable appraised value of these townhouses by $75 psf this year"), non-bank lenders would appraise the townhouses at the higher value and lend accordingly but at a higher rate than if the collateral restrictions on banks hadn't been put in place. This will affect non-bank market interest rates in general (they will rise) especially when this turn to non-bank funding happens across the whole economy and not just in one sector.
Jose, it's slightly different because the Treasury has to keep issuing bonds to deficit spend. I'm not entirely sure if it has to keep issuing bonds to pay interest to the central bank on the bonds it holds or if this comes out of tax revenue. 'Market Monetarists' seem to claim that the effect of QE is greatly diminished if it's expected that the central bank will drain all or most of the excess reserves added by QE in the future.
y,
those types of loans are very limited... and would cap out quickly... as Tom indicates they are "junk".
There may be some financing at those higher rates for a short time . back 8 years ago everybody moved to open up a commercial paper facility but AT THE END of it all...
They all got it going, Countrywide, Brookfield, Thornburg, FriedmanBillingsRamsey in my area, etc... but this was at the end and AFTER the banks started the whole thing.... and the whole thing soon collapsed.
The banks have to get involved to really get things going and THEN the B-money people come in once things start to heat up.... that is the tip-off that it is soon going to blow up as those B-money people dont have access to the Fed...
And usually there is an expansion in direct govt purchases in some way like before the GFC we had a huge increase in govt spending on the GWOT, DHS, Medicare drugs, and no child left behind... the GOP was on the move and $NFA injection was soaring...
now we have the out of paradigm Dems and they think "we are out of money" and everything but oil (monopoly) is depressed... if somehow the oil cartel is busted we get another leg down in prices including housing imo and the govt will simply lend against housing at the lower prices...
rsp,
though according to them this expectation effect depends to a large degree on when people expect the central bank to drain the reserves. If they think the CB will drain them as soon as inflation ticks up, then the effect of QE will be more muted. If they expect the CB to allow inflation to rise to a high level before they drain the reserves then the effect of QE will be greater. This seems to be their argument as far as I can make out.
Matt, that's changing the subject a bit. I not sure money market funds and shadow banks really count as 'B money'. My understanding of the MMT ZIRP proposal is that the government could maintain a zero or thereabouts base rate, but that market rates would fluctuate as usual in response to all sorts of things. So it seems to me that the central bank could curtail bank lending via more restrictive collateral requirements - rather than by raising the base interest rate, which is the usual technique - but that the effect of this in the broader market would be for interest rates to rise. Warren Mosler's argument has always seemed to be that the govt sets one price, such as the base interest rate or the ELR wage, and then market prices fluctuate around and above that.
y,
the Treasury has to keep issuing bonds to deficit spend
It could issue non-interest bearing notes to the Central Bank.
See the paper by Stephanie Bell, "Functional Finance: What, Why and How", Figure 3.
right, I meant that it has to keep issuing bonds now, as things stand.
Taking Matt's example ("we need to have you increase the allowable appraised value of these townhouses by $75 psf this year"), non-bank lenders would appraise the townhouses at the higher value and lend accordingly but at a higher rate than if the collateral restrictions on banks hadn't been put in place. This will affect non-bank market interest rates in general (they will rise) especially when this turn to non-bank funding happens across the whole economy and not just in one sector.
Yes, but it wouldn't affect the prime rate, which is what banks charge their best customers, and this is how most bank credit works since the best customers — large corporations — are the biggest borrowers. The subprime market is rather limited generally, although it got magnified during the bubble owing to fraud masquerading as "financial innovation."
I'm not talking about the subprime market particularly. Corporations usually borrow in commercial paper markets as far as I'm aware, not so much directly from banks.
Lowest rate in the private sector is prime rate since banks are working off the rate at which they can borrow, i..e, the FFR. This is the lowest rate, since banks are considered the most secure borrowers due to tight supervision and government backstop. Those in the money market that don't have access to the cb have to pay more and charge a higher rate unless they want to lend at a risk-weighted disadvantage to get the business, which is not likely.
y, the market monetarist are bonkers. They think that reserves do something that they don't.
The way that QE works is to drive up prices on higher risk financial assets is by taking low risk assets off the table. So you have the choice to get historically low yield for safety, or go into a higher risk vehicle, which many have chosen to do.
This flattens the yield curve and keeps mortgage rates low too.
actually the lowest rate is normally the overnight repo rate, not the fed funds rate, surprisingly enough.
It takes time to bring new capacity, resources and labor on-line. It doesn't happen immediately. So the price of labor and commodities can inflate due to printing too much money too quickly.
This would be due to fiscal policy lag.
Any kind of shortage can create inflation.
That's what we call a supply side shock.
Full employment is a classic example.
Can cause inflation due to bottlenecks as in the first quoted point.
All these things can be ameliorated.
As Warren says, Treasury spending by crediting deposit accounts and the Fed buying the bonds in the market is effectively the same as Treasury just crediting bank deposits. There is no problem with Treasury spending directly in an indirect way in coordination with the Fed bond buying, as Marriner Eccles said how many years ago. It's how WWII was finance and functionally the same as Lincoln issuing greenbacks. And it's no different from ordinary OMO. The Fed supplies liquidity as it is needed at the rate it sets. With setting the rate to zero or paying IOR, the effect of excess rb is nil, so OMO is not needed to hit the target rate.
QE affects the yield curve by taking bonds off the table and increasing bidding on the remaining bonds, which lowers the interest rate, as long as the Fed doesn't get in its own way with the buying by bidding up prices. This flattens the curve.
yeah I don't get the market monetarist explanations of how QE goes from rising asset prices to rising spending on goods and services. It has to do with some intertemporal smoothing type hocus pocus I think.
Higher asset prices may (theoretically) lead to higher spending because of a wealth effect.
If the market price of my house or my financial portfolio goes up that might induce me to spend more.
Of course, said effects might not be quantitatively significant from a macroeconomic POV. In that case, the expected (by the MMs) recovery simply won't happen.
Better to rely on good old "increased deficit spending", a tested strategy that has already promoted recovery in hundreds of instances in the last decades.
actually the lowest rate is normally the overnight repo rate, not the fed funds rate, surprisingly enough.
True, the FFR is the interbank rate, while the overnight repo rate is borrowing from Fed and putting up collateral
Jose, the wealth effect only seems to work pro-cyclically at is maximum at the peak of a boom-bust cycle. The Fed tried to increase consumption through the wealth effect induced by the run up in equity from QE, but it hasn't worked.
Rising wages induce greater efficiency, innovation and adoption of more productive technology to overcome the shortage of labor that is leading to increased bargaining power.
Tom,
no the overnight repo rate is a market rate between banks, financial companies and others (not the Fed). It's normally lower than the fed funds rate. Strange but true. Something I learnt from Perry Mehrling recently.
notes from Mehrling's online course:
"Stigum says that in general the overnight repo rate is a bit lower than the overnight Fed Funds rate, and a bit higher than the three month Treasury bill rate. Why should this be? She suggests two reasons for this, but neither is convincing. First, she observes that repo is secured credit whereas Fed Funds is unsecured, and concludes that 5-10 basis point differential is compensation for the higher risk involved in Fed Funds. I don’t buy it. In the Fed Funds market, control of credit lines is the way that banks avoid credit risk, and they set these lines in order to ensure that they face essentially zero risk of default. No one lends 1MM overnight to gain only about $100 interest if they have any concern at all about default. It would be better simply to forego the interest, and it is easy to do that simply by foregoing the loan.
The second reason given is that there are many economic entities that cannot invest in Fed Funds but can invest in repo, and they might tend to push rates on repo below Fed Funds. I don’t buy this one either. There are plenty of agents who can borrow at the repo rate and lend at the Fed Funds rate—your typical bank for example—so the question is why this arbitrage does not close the gap.
In my view, we are closer to the institutional facts of the matter if we think of the Fed Funds target as a kind of penalty discount rate that dealers have to pay if they are unable to meet their survival constraint by borrowing at the repo rate.3 Dealers expand their balance sheets to the extent possible on very thin capitalization while holding essentially no cash reserves, depending instead on the repo market to raise cash as needed. If they run into trouble, (which is to say if they find themselves with insufficient collateral for additional repo borrowing) they rely in the first instance on their clearing banks for a dealer loan, which is priced over Fed Funds since the bank depends on the Fed Funds market to fund the loan. But that’s just for the occasional last minute mistake. More fundamentally, and more routinely, dealers can rely on the Fed itself for a repo loan priced at the Fed Funds rate, since that is the rate that the Fed is trying to establish with its daily intervention.
Think of it this way. At the morning auction, dealers bid for the money. Bids that are below the Fed Funds rate will not be attractive to the Fed. It wants to supply needed reserves, but also to retain discipline in the market by keeping reserves scarce. It does that by accepting bids that are at or above the Fed Funds rate. For their part, dealers are willing to bid above the market repo rate, even if they think they will be financing most of their needs at the market repo rate, so long as they face any probability of having to ask for a dealer loan from their bank, which charges typically FF+50bp. So long as they get the money from the Fed for less than they could get it at their clearing bank, they are happy. The end result is the pattern we see, that the Fed funds rate tends to be above the repo rate.
Observe how thinking about the balance sheet relationships helps us make sense of the typical price relationships. We observe how the institutional mechanism of the daily auction serves to establish a premium on the best money in the system, and that premium provides an incentive for agents throughout the system to try to meet their obligations at the clearing rather than roll them over to another day. That premium shows up in the slight premium of fed funds over repo, and it also shows up in the typical premium of overnight money over longer term money, such as the three month bill. The answer to the otherwise puzzling pattern of interest rates in the money market is nothing more than the natural hierarchy of money and credit."
https://d396qusza40orc.cloudfront.net/money%2Flecture_notes%2FLec%2007--Repos%2C%20Postponing%20Settlement.pdf
“Again all this is changed since the crisis. Currently repo is higher than Fed Funds, which definitely shows that the difference is not a premium for default risk. Above I argued that a situation of repo < FF could be understood as a particular balance between elasticity and discipline, with the Fed keeping the better money (FF) at a premium in order to establish some discipline. Analogously, it seems we could think of the opposite situation of repo > FF as the opposite balance, with the Fed keeping the better money at a discount in order to establish some elasticity. In effect the market rate of interest is the repo rate, and the official rate is the Fed Funds rate. The Fed is trying to set up incentives for banks to borrow at the Fed Funds rate and lend at the repo rate, so supporting short term credit markets more generally. The fact that the gap stands now at 15 basis points suggests that this strategy is not working very well—that is a large gap in money market terms, even if it seems small to us.”
@Tom Hickey,
You're suggesting the so-called "wealth effect" is simply a manifestation of Minsky's Euphoric Stage?
@Matt Franko
We do have considerable evidence of deliberate cover-up. Galbraith's recent column where he drew attention to the debt ceiling as a political smokescreen. Government's sale of war bonds and the personal income tax as methods of "funding" WWII when behind the scenes the technocrats were well aware these measures were solely an inflation check. The current President who I am convinced knows government is not broke yet says it anyway. There are many more examples.
"Ben you are giving them too much credit they are not that smart..." - Matt
Matt, the people enacting policy may not be but the handful of elites manipulating them certainly are...
Read "Tragedy and Hope" by Carroll Quigley
This is a plan that has been in motion since the early 1800's.
I just started reading Monetary Economics by Wynne Godley and Marc Lavoie:
In the preface Godley briefly recounts his professional life, including:
"In 2002 I returned to the United Kingdom where I continued doing similar work, initially under the benign auspices of the Cambridge Endowment for Research in Finance, and more recently with the financial support of Warren Mosler, who has also made penetrating comments on drafts of this book."
I had no idea.
http://dl4a.org/uploads/pdf/Monetary+Economics+-+Lavoie+Godley.pdf
Ben,
You say 'we have evidence' and then provide none in the paragraph.... Galbraith is NOT a moron in this... Roosevelt/Eccles/Marshall are not Bush2/Greenspan/Rumsfeld.... you being 'convinced' about O is not 'evidence'...
Paul,
Was going off of the gold standard and then going all around pretending to act like a moron who dosent realize that we went off gold part of "the plan"?
does Quigley reveal this crafty tactic in his book?... C'mon bro....
rsp,
Bem J "You're suggesting the so-called "wealth effect" is simply a manifestation of Minsky's Euphoric Stage?"
Yes, seems so anecdotally, based on what's happened during and as a result of the crisis. Someone would have to study this empirically to confirm it, but it seems logical that people are influence by feeling wealthy when time are good that feeling wealthy when time are bad. This would contribute to cyclical fluctuations in saving desire.
y, thanks for the Mehrling quotes. Sounds right.
With regards to repo and fed funds, I think a major source of the spread is the fact that the GSE's (Fannie and Freddie) do not have access to the fed funds market, This creates a market segmentation effect. When rates were away from zero, this did not show up as much.
Since this did not appear to matter too much, I did not dig into the details.
Read "Tragedy and Hope" by Carroll Quigley
This is a plan that has been in motion since the early 1800's.
Georgetown history professor Quigley was given access to this information by the elite — he was a member of the CFR for instance. They wanted this known because they were proud of their contribution to civilization — Lloyd Blankfein "doing God's work." In their view capitalism lifted humanity to the stage of civilization that it enjoys and they were the architects and engineers that brought it about and are still bringing it about. Quigely was a conservative and his report is a conservative celebration of the conservative message that some are better than others aka the 'great men' theory of history. For the contribution, the meritocracy enjoys privilege not by birth, as the nespotic aristorcacy, but by merit and only merit allows them to maintain it. This is an ingrained belief structure of the ruling elite under capitalism and representative democracy and they are not going to change it. They are in fact digging in and doubling down now that they own the most powerful governments in the West and are gaining ground in the market economies of the East.
There are two things that the wealthy consider and balance. First is the effect of inflation on financial wealth, which make them fear inflation-reflation as a drain. Second is their knowledge that inflation increases the value of real assets and reflation i increases nominal profits, and reduces unwanted inventory by stimulating the economy after a contraction, which can result in real gains since nominal wages generally don't keep up with inflation.
They know that they are dealing with tradeoffs here, and they are also well aware of the power of government, so they seek to get the best hedged deal out of economic policy through their political influence.
@Matt Franko,
Galbraith wrote the debt ceiling was enacted to "fool the rubes back home", while Washington told the public war bonds were for one purpose while enacting them for an entirely different reason. I think that constitutes evidence.
"Was going off of the gold standard and then going all around pretending to act like a moron who dosent realize that we went off gold part of "the plan"?"
Matt…The plan is still working…we're still running our money system as if we were on a gold standard…as is Europe only more so.
I don't see any change coming in the near future.
Have you read the book? I haven't finished it, but there are patterns emerging.
"This is an ingrained belief structure of the ruling elite under capitalism…" - Tom
This was Quigley's view until some time after the book was published. There is evidence his views reversed before he died a few years later. Watch the interview (5 parts) on youtube he gave in 1964. Quite interesting.
"does Quigley reveal this crafty tactic in his book?... C'mon bro…." - Matt
Matt, money controls what gets taught at elite universities, money controls who gets access to the game, money controls who gets to be in Congress and who gets to be President.
Obama is not in control, he does what he's told or he will be gotten rid of. Or he belives this crap just as Quigley did when he wrote the book.
Over my lifetime (66+ years) there have been many Presidents and many thousands of Congresscriiters of varying political affiliations both Conservative and Liberal.
Looking back there has been no intelligible difference in foreign or economic policy regardless of who was in power.
We have always had a war economy (since before WWI) and we have always existed under gold-standard thinking (except when at war…only then does the paradigm change).
I don't see how this could possibly be accidental.
"the GSE's (Fannie and Freddie) do not have access to the fed funds market"
Really? I thought they had accounts at the Fed? I know they don't receive interest on their reserves, unlike banks, for some reason, but I've never heard before that they can't borrow in the Fed Funds market.
Here's the NY Fed:
"some lenders in the federal funds market are not eligible to earn interest on reserves and hence may be willing to lend in the market at lower rates. The government-sponsored enterprises Fannie Mae, Freddie Mac, and the Federal Home Loan Banks fall into this category."
http://libertystreeteconomics.newyorkfed.org/2012/04/corridors-and-floors-in-monetary-policy.html
This says that GSEs are lenders in the fed funds market... so why couldn't they also be borrowers?
"Was going off of the gold standard and then going all around pretending to act like a moron who dosent realize that we went off gold part of "the plan"?"
Matt, I left out another piece of "evidence", or whatever people want to call it…
Nixon drove a stake in the heart of the "gold standard"…Nixon was opposed to free-trade…Nixon was impeached…brought down by a couple of still-wet-behind-the-ears-rookie-reporters.
One might think the Washington Post was given the green light as opposed to being pressured to leave the story on the back burner. Maybe those young guys were great reporters, but you sure couln't tell it by Woodards career since…he's a frigging bumbling idiot.
…and very liitle has changed wrt policy since except the elites have even more power and wealth.
Paul I'll try to find a copy of the book... rsp,
Matt, a free (as in beer) pdf copy is available here:
http://www.carrollquigley.net/pdf/Tragedy_and_Hope.pdf
It's a tough read…methodical and dense
Not only Tragedy and Hope but also The Evolution of Civilization and several other books and articles by Quigley are available to either read online or download at carrollquigley.net.
Quigley is important not only as a historian, although his work is a bit dated, but also because his work has been influential with politicians and in foreign policy. He taught at Georgetown University's School of Foreign Service.
Post a Comment