An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
I've been working on a powerpoint presentation laying out some MMT basics. Ideally, it could be presented to members of Congress and staffers to help them better understand our modern system of public finance. Link here
44 comments:
Anonymous
said...
I thought the slides were pretty good. But I do have some initial reactions.
You say that bond buys are not discretionary. But it seems more accurate to say that open market purchases are not subject to much discretion given some prior determination of a Fed Funds target rate. And yet the determination of the target Fed Funds rate is a Fed policy choice, and so is itself discretionary.
This doesn't affect the basic point that the Fed sets rates.
Also, I didn't understand the comment about helicopter drops and debt monetization. They seemed to fall out of nowhere with no explanation.
Also: I thought the punchline slides, where the discussion turns to policy recommendations, were a bit vague and unsure, although stated in very aggressive terms.
And my frequent complaint: I don't believe MMT will ever get serious traction among a sizable bloc of policy makers until it produces a much more complete, compelling and detailed framework for addressing price stability management in the context of a well-developed theory of prices.
I agree, that slide about "helicopter drops" is somewhat out of place...and will probably take too much time to explain for the target audience. As for price stability, I'm intending for this to be used on Hill staff, who I doubt would be be aware of/interested in price theories. People at the Fed might ask these things, but I doubt Hill people would.
It's excellent throughout. Going to tweet it after finishing this.
A few minor comments . . . 1. Govt debt is already essentially "American Equity" since that's what NFA is. Regardless of whether the pvt sector ends up with bonds or currency, for the sector overall it's equity.
2. The Fed's not trying to directly set mortgage or Tsy rates with QE. It's directly buying a fixed qty of them in hopes that it affects rates on these. To directly set the rate, it would have to announce the rate and buy a variable qty set by the mkt. Obviously the problem is that it's approach leaves people to think that it's the qty that matters, not what happens to the rates. The facts that (a) with QE2 rates actually rose then fell after QE2 ended, and (b) rates rose when mkts suspected a taper while the Fed kept buying at same pace, both show that it's still the markets setting the rates based on expectations of Fed, not the Fed directly setting rates.
"As for price stability, I'm intending for this to be used on Hill staff, who I doubt would be be aware of/interested in price theories."
Maybe not theories, but they are certainly interested in the issue of price stability, and so the economists need the theories to back up their policy claims. Without a theoretically well-grounded and empirically persuasive story to tell here about how to conduct price stabilization policy within an MMT framework, many serious people will continue to dismiss MMT as a loosey-goosey proposal for importing the monetary recklessness of some of the most poorly managed banana republics in the world to the United States. People are often very offended when I use that kind of language, but I know from experience that that is a widespread reaction, and it deserves a more cogent response than just hand-waving.
I continue to be perplexed by how tone deaf many MMTers are about this issue. More people than I think you are aware of are fully cognizant of the fact that treasuries and dollars are just two different kinds of obligations issued by the US government, and that the government can always meet any interest obligations incurred by the former by issuing more of the latter. But they support the budget balancing religion of the Fix-the-Debters and the operational independence of the central bank as mechanisms for imposing monetary discipline on a government that might otherwise blow up its currency and destroy the market value of the public's monetary savings, or introduce a degree of price volatility into the economy that would be a persistent drag on investment and employment.
Right, Dan, inflation is a political bugaboo, and one that MMT economists admit as a constraint. That has to be addressed compellingly to convince policy makers fearful of it. The solvency issue is much simpler to dismiss as irrelevant. Inflation is not irrelevant.
The challenge is to show how MMT resolves the trifecta of economic growth (now recovery), employment (now historically high), price stability (now low CPI but fear of inflation "down the road"), as well as addressing financial stability through reform.
No real need to edit--just making ticky-tacky points as an FYI.
Regarding QE2 and rates, Tom's got it--best thing I've seen on that is this by Warren, which predicted the fall in rates after QE2 ended a few months prior. http://moslereconomics.com/2011/03/10/qe-and-the-term-structure-of-rates/
Even their own theories show their fears are unfounded.
Logical fallacy #1, in MV=PQ, M can increase because of either govt or private activities. Why would it be any more inherently inflation when We do it instead of I do it?
#2 V is constant. In other words, we can easily have inflation with balanced budgets during a private debt = money boom.
#3 Q now includes the entire breadth of all the goods the world would be willing to sell us. Its incrediblly elastic in other words.
The onus is on the other side to show why MMT would be inflationary because as far as I can tell they don't have much evidence or logic on their side.
And one last point, if you could determine that too much Govt money creation and not private sector debt is driving an inflation rate that is too high, the answer is so simple only a mainstreamer could miss it......DECREASE THE DEFICIT!! problem solved.
The problem is that the public, politicians and also central bankers are obsessed with inflation and unless MMT'ers can dispel those fears, however baseless, MMT is not going to be translated into policy.
For example, even his illustrious board of economic advisors apparently could not convince Bernie Sanders to move off the deficit dove position of taxing the rich to reduce the deficit.
"...in MV=PQ, M can increase because of either govt or private activities. Why would it be any more inherently inflation when We do it instead of I do it?
You're right. It wouldn't be Auburn. However the Fed can slow down the rate of private sector money creation and spending by jacking up the cost of funds. So it's not as though private sector money creation is unconstrained by policy.
Also, note that in the run up to the 2007/8 crisis there was a massive surge in home prices. Economists deign not to count those increases as part of "core inflation", but some would argue that's an inadequacy and blind spot in the chosen metric, and that this was a case in which bank money creation was allowed to run off the rails.
"Decrease the deficit" sounds like a potentially plausible policy for tamping down inflation. But lately, haven't MMTers taken to stressing that the deficit is "endogenous", and hence not a policy variable?
What you are doing is offering some sketchy outlines of a theory of prices. And that's good. There were no such comments in the slides. But something more systematic is needed.
Note that older people, many of them working with fixed incomes, vote in larger
My personal view, from looking at some of the debates surrounding the 70's stagflation, is that inflation is primarily a matter of self-sustaining patterns of inflationary expectations accommodated by the credit system and the central bank. But I personally wouldn't be confident in asking a bunch of US senators and other policy makers to accept my amateur theory, and in any case that theory offers no concrete policy guidance. An empirically well-supported model is needed, and some reasonably precise policy rules that are justified by the model.
Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings? If not, then where is the danger line? How does a policy maker decide where it is? And what policy tools should be used to avoid crossing it? Shouldn't these questions have solid answers?
"Note that older people, many of them working with fixed incomes, vote in larger numbers than the rest of the population. They are not about to elect someone who comes off like a monetary cowboy, running risks of inflating away the value of their life savings."
Really, that is the touchstone. We've got the same poundoffs that told us the US is running out of money going on about inflation, no matter what the starting point. And of course, if the price of a gallon of milk goes up only in their hood, even if all others stay the same, that's "inflation from gubbernmint printing and spending". Despite there only being one brief instance of that during the late 40's
I agree that you can't leave inflation out of the discussion. At the very least it needs to be discussed as a policy risk. That said there seems to be a schizophrenic approach to the JG among MMTers. We love it but realize it by itself is polarizing so we try to stick to just talking about the mechanics of the monetary system. Why not recommend two policy approaches to inflation... JG and taxes. Personally I would recommend a Federal sales tax (to replace SS tax) and give the FED or Treasury the ability to raise and lower it within a range set by congress to combat inflation risks (excessive spending beyond productive capacity).
What about Warren's "all prices are necessarily a function of what the govt pays for things or what they let their fiscal agents lend against things..."
this sounds (to me) like a very good "MMT Inflation Theory" but again I am not libertarian at all....
Over the last 5 years (post GFC) we've had pretty stable prices in property while at the same time the Agencies have not raised the max on conforming loan limits by one penny, this is not a coincidence..
Here is video at this link where is you pick it up at the 13:00 mark Warren and Bill explain these arrangements pretty well I think....
If we think that we still need some sort of more formal theory codified within the academe of economics then I would encourage those MMT adherents that choose to remain in this corrupt institution to proceed with that effort.... but it may still not get anywhere as least the Economics school within the academe is corrupt and highly libertarian so they probably wont accept it... it may be that one has to be fully authoritarian to accept this theory... ANY libertarianism in a person at all renders them unable to accept this Theory... so once again the culprit is libertarianism screwing everything up for humanity...
"BTW why do you think it is that rates actually rose during QE2?"
JG - Scott Fullwiler is dead on right! Just look at the charts of the 10 year treasury yield. Without exception at the start of each QE operation interest rates went sharply higher. Why? Because enough traders perceived that the Fed was printing money an fueling inflation. The Fed even said that it was doing QE to raise inflation closer to its desired 2% target rate. Perception became reality, so is it any mystery that traders reacted logically by opting to put RISK ON? They sold long duration inflation sensitive Treasury bonds and the US $, while simultaneously buying equities, credit related debt instruments, commodities and emerging market assets. As each QE program was being wound down the RISK ON trade was reversed with RISK OFF. The video below features my take on this issue from about 3 years ago.
05/13/11 QE2 End Will Send Long-Bond Yields Down.... http://reut.rs/iSgCfl
"The Fed's not trying to directly set mortgage or Tsy rates with QE. It's directly buying a fixed qty of them in hopes that it affects rates on these. To directly set the rate, it would have to announce the rate and buy a variable qty set by the mkt. Obviously the problem is that it's approach leaves people to think that it's the qty that matters, not what happens to the rates."
Well said Scott! You nailed it perfectly! To take it a littler further, there would be no need for the Fed to target quantity or rates by purchasing actual bonds when they could buy derivatives like treasury futures instead. Here are a couple of more videos I produced on this issue from my Reuters days.
09/29/10 Why the “Bernanke Put” Makes Sense …… http://reut.rs/oOsYGs
"Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings?"
Great question Dan! It's easy for me to imagine how unconstrained deficit spending would at some stage of the process find its way into highly speculative outlets, or what the Austrians would call mal-investment.
"If not, then where is the danger line? How does a policy maker decide where it is?"
A market signal of some kind would be helpful.
"And what policy tools should be used to avoid crossing it?"
If there was an easy way say this without causing everyone to tune out I would, but I still think there is scope for gold to play a role of some kind here.
"Shouldn't these questions have solid answers?"
It would be very helpful for market participants to know the rules of the game.
"BTW why do you think it is that rates actually rose during QE2?"
Ed,
Here's the authoritarian take:
Read this interview with the guy at the FRBNY who is actually running the program.... do we have ears and eyes???? or we can just IGNORE WHAT THE GUY RUNNING THE PROGRAM IS TESTIFYING TO????
"“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses."
Ed, 'getting the best price' means LOWER PRICES just like at Wal-Mart.... they are price setters who get to step in front of the non-govt market participants in this "dealer market" and drive the prices DOWN hence the rates UP...
Once they exit the marketplace, then the rates fall back down towards the "natural rate" which is ZERO... and the bonds rally...
To believe any other explanation is basically monetarist/quantity theory/confidence fairy type stuff.... things happen in economics because people take action, for good or for bad...
My current thoughts are that libertarians may not be able to see this process this way... can't admit it for some reason...
"ANY libertarianism in a person at all renders them unable to accept this Theory... so once again the culprit is libertarianism screwing everything up for humanity..."
Matt - Actually it's much worse than you imagine. We have a card carrying organization with spies everywhere and operating cell networks all over the country and world. Of course, this strikes me as kind of odd because usually trying to organize libertarians to do anything in concert together is like herding cats. That said... Matt you don't know how close you are to the truth about how the first thing your garden variety libertarian thinks about when waking up and the last thing on his or her mind before going to bed is..... "How can I screw everything up for humanity today?" ;-)
When the guy running the program at the FRBNY says quote: "we are trying to get the best price we can for the taxpayer" Ed, do you think he is lying? Do you believe he is being untruthful? And he does not have this as his goal? Or do you think that what the guy running the program does is not important?
Like fiscal policy: If Congress comes out and says they are going to implement austerity, do you not think that if they go thru with that policy things get worse? iow you dont think that what any of these people say they do is important?
I'm not saying 'libertarians' are screwing everything up, I am saying 'libertarianISM' is screwing everything up... its an anti-authority form of human reasoning that I am complaining about not necessarily the people caught up in it...
Just like this thread where people are looking at "equations" like MV=PQ like it is some sort of "natural law" or something and ignore what the policymakers are actually doing...
If the govt comes out tomorrow and agrees to lend $1M against mobile homes guess what the price of mobile homes goes directly to $1M and loans will start to be made and we will see the EX POST results in so-called "money supply" levels, etc... but THE ACCOUNTING for human actions cannnot be confused for the cause of those actions...
libertarians might not be able to see things this way very much and perhaps not at all in most cases...
"“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses."
Wake me when the Fed sends out special dividend check to all the tax payers it has saved money for. When interest rates are surging higher it makes no difference whether a "34-year-old in a striped suit and rimless glasses" and his staff of 20 something year olds buy bonds from the Street at 1/64th cheaper in price.
Chief economist at Wrightson ICAP, Louis V. Crandall, mentioned in the NYT article makes much more sense. "A buyer of $100 billion a month is always going to be paying top prices..... You can’t be a known buyer of $100 billion a month and get a good price.”
"When the guy running the program at the FRBNY says quote: "we are trying to get the best price we can for the taxpayer" Ed, do you think he is lying? Do you believe he is being untruthful?"
No, I'm quite sure that Mr. Frost is quite convinced that he is doing God's work on this earth. However, even if he didn't believe that to be the case, I doubt he would reveal his doubts by announcing to the world in the NYT that his efforts had no value whatsoever.
Ed they DO pay a "dividend" to the taxpayers when they credit the TGA with the "excess profits" of the Fed a few times per year... they think this is helping Bernanke himself has taken great credit for this in his Congressional testimony...
Ed Mike has explained this process before here and is related to what he is developing with his "market composition" approach .... experienced traders know how this works here is Mike from a while back in 2010:
"The Fed is buying "scale down" and in effect, causing the selloff. They're doing this because they're fixated on quantity ($600 bln) as opposed to price (interest rate). I remember when I was a floor trader. I had clients in the oil business--big firms--who would sometimes want to protect a certain price. They'd give me an order that would be, "Buy 100 (crude), 'worst.'" That meant buy it up...aggressively. When Japan used to actively intervene in FX markets, they wouldn't scale down their dollar buying (or sell yen scale up), they'd buy dollars aggressively to put the USD/JPY exchange rate to a certain level. The Fed is not doing this. By signaling to the market that they will buy scale down, they are actually creating this selloff as nervous longs look to sell before the largest buyer lowers its bid again and as speculative shorts compete for a better price." -- Mike Norman, 2010
And Ed the SCALE of this QE program from the Fed is just unprecedented... over significant periods they are buying in excess of what is being issued as they have been buying through surplus months... So do they ever RAISE their bids? This is what we should be investigating.... ie "What are they doing...
Look at the title of Justin's post here: "THE FED SETS THE RATES" .... it is either true or it is not...
btw Credit where due you also got the trade correct calling the big rally coming out of this QE2 sell-off which was a great call... same thing should happen again if they ever cut off the current QE operation... rsp,
Matt - The Fed cannot target interest rates by announcing a quantity of bonds it will buy over a specific period of time. The Fed exercised absolute control over the fed funds rate by announcing a TARGET RATE. The market knew that the Fed stood ready to buy or sell as many treasury securities as necessary to make the fed funds rate adhere to that target. That way, the market did most of the heavy lifting for the Fed.
Beyond that, during QE2 I monitored each and every Fed asset purchase in real time and I can tell you with certainty that Fed purchase prices published on the Fed website were more or less equally distributed both above and below the market snap shot prices of the bonds being purchased. In plain English, I could see no pattern of the Fed consistently buying below the market. Moreover, the only way that primary dealers would continue to buy Treasury securities at each auction would be if they had some expectation that they would be able to offload them to the Fed at a profit at the QE buy backs. It was just another subsidy to the bond trading houses on Wall Street.
All the Times reporter people did was schedule an interview with the FRBNY people and then go in there and interview them as to what they were doing and the people told them what they were doing then the Times people wrote it up... ... I cant see how those events can be 'absurd' its a pretty simple chain of events...
Ed I dont think the Fed was setting the Funds Rate with the QE their intention is to buy US govt securities with newly created reserve balances hence increasing the "money supply" hence 'quantitative easing' then the banks have "more money to lend out".. its pure QUANTITY theory hence the name "QUANTITATIVE easing"... they did not announce a "target rate" associated with the QE they announce 'quantity not price' with MMT it is always about "price not quantity"... ALWAYS... unless you are a libertarian then looks like this belief can be infirm and fleeting...
And we know how they do this from the NYT article is to generally 'get the best price for the taxpayer' in the bond markets they do their buying within... (USTs and Agency bonds...) so yes there are short term dynamics/swings which your monitoring picked up, but the general trend will be down in this scenario... and then UP when they finally exit the marketplace...
If what I am saying is true then if the Fed ever stops the QE then cet par we should see rates go back down/bonds rally again... ie the exact opposite of what their goals are... I guess we'll see... if they ever stop doing this...
"Ed I dont think the Fed was setting the Funds Rate with the QE..."
Agreed. It was not my intention to suggest that the Fed was targeting the fed funds rate with QE. However, before QE and before the credit crisis the Fed would explicitly target the funds rate. I don't know if it is possible to test it, but in theory, if there was $1 of excess reserves in the commercial banking sector, that would be enough to drive the fed funds rate down to 0.00% bid.
"their intention is to buy US govt securities with newly created reserve balances hence increasing the "money supply" hence 'quantitative easing' then the banks have "more money to lend out"
Except that banks don't lend out reserves. Those reserves are sitting on account at the Fed as EXCESS RESERVES earning 0.25% o/n.
".. its pure QUANTITY theory hence the name "QUANTITATIVE easing"... they did not announce a "target rate" associated with the QE they announce 'quantity not price' with MMT it is always about "price not quantity"... ALWAYS... "
Yes... What I'm saying is that the Fed should have targeted a rate rather than quantity.
According to the Fed narrative, QE was intended to bring down long term interest rates to benefit the mortgage market and housing sector. Problem is that they proceeded by targeting QUANTITY rather than targeting a specific long term rate like the 10-year Treasury yield at say 2.5% like they did during WW2. The Fed can't target rate and quantity any more than one can hit 2 birds with 1 arrow.
(knew what you meant Ed...) Well Ed if your point is that what the article reveals is "absurd" as far as the Fed policy as somehow being supportive/stimulative to real economic outcomes then yes there is an absurdity that I can see there but what I was saying is that the article itself was not 'absurd' per se... iow I believe what the article reveals about the details of the actual Fed operations is true and accurate reporting...
"You're right. It wouldn't be Auburn. However the Fed can slow down the rate of private sector money creation and spending by jacking up the cost of funds."
Although this sounds reasonable, I don't accept this broad statement and its real world impacts on faith alone. Where is the evidence that private sector debt growth is negatively impacted by higher interest rates. I don't see it. Not to mention that the economic impact of interest rate changes are so dynamic, I've yet to see anyone make the case that they actually understand the effects,
"Decrease the deficit" sounds like a potentially plausible policy for tamping down inflation. But lately, haven't MMTers taken to stressing that the deficit is "endogenous", and hence not a policy variable?"
Of course the deficit is endogenous. Thats why you can't ever predict exactly what the deficit will be. The policy choices always frame the floor and ceiling of the endogenous deficit result. If we cut FICA to 0%, the impact on the deficit can certainly predicted to be bigger than not cutting FICA, but what the actual dollar amount of deficit increase is 100% endogenously determined within the policy framework. I don't see how this is controversial at all.
"What you are doing is offering some sketchy outlines of a theory of prices."
Pretty safe to say that every current mainstream price theory is nothing more than "sketchy outlines" so why should MMTer's be any different?
"And that's good. There were no such comments in the slides. But something more systematic is needed."
Thats for people better at math than me.
Note that older people, many of them working with fixed incomes, vote in larger
"Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings?"
Of course not.
"If not, then where is the danger line?"
Who knows? But if we overshoot, the data will tell us and we can always reign it in.
Let me ask you the corollary? How many new dollars created will cause inflation and how much?
See, nobody can answer the other side of the equation either.
"How does a policy maker decide where it is?"
Wait for the data, error on the side of full utilization of our real resources and not on the side of runaway inflation (whatever that means).
"And what policy tools should be used to avoid crossing it?"
Taxing, spending, and private lending regulation authority obviously.
"Where is the evidence that private sector debt growth is negatively impacted by higher interest rates."
Auburn - I'll give you an example. After the 2001 recession, mortgage lending shifted to adjustable rates (ARMs) which helped fuel the housing bubble because the Fed held rates too low for too long. ARMs rates were low because the they were indexed to short term rates at the front end of the yield curve and the yield curve was steep. However, as the Fed began raising rates in 2004 it signaled the beginning of the end for the housing bubble because it was only a matter of time before the rising rates would render sub-prime mortgagees unable to make their monthly payment.
I would never say that there could never be a situation where increasing interest rates by the Fed would not hurt the economy.
In a way you made my point for me. You pointed on a special situation having to do with variable rate sub-prime mortgages. A completely unique set of circumstances from where I'm sitting.
Like I said, I dont buy the monetarist and mainstream Fed tuning approach via interest rates because there is no evidence that things are that simple. Interest rates impacts are a nightmare of tangled inter-dependencies between the nominal amount of private debt, public debt, economic activity or outlook and a hundred other variables. My position is that NOBODY understands the nature of the interest rate impact very well.
For example, what is the net macro impact of a 3% increase in the FFR at the present time? In other words does the $480 billion increase in the deficit as income for T-bond holders or the (positive) or the increase in defaults and disposable income spent on private sector debt servicing have bigger impact? What if the amount of T-bonds were $30T and privater debt was only $30 trillion?
Its my claim that nobody knows the answer as it can't be known.'
Is there a historical correlation between private debtt growth and interest rates? show me the data.
Is there a historical correlation between business investment and interest rates? show me the data that explains how the Reagan debt boom expansion happened with a FFR above 6%.
Let me finish by repeating what I said to Dan above, it FEELS logical that higher interest rates would be bad for the economy, but reality doesn;t care about how I feel about things. Thiss is what separates real scientists from economists.
Ed, check out what the Agencies were doing with the conforming loan limits during that period in the early 2000's.... they kept raising them.... I remember a time where in my area they were $210k and now they are at $417k so guess what? Housing prices have more than doubled in my area.... it is about price not quantity...
Same currently with auto loans they keep raising the amounts they will do on auto loans and allowing longer terms of up to 8 years to keep the payments down, etc... and car prices keep going up...
"All prices are necessarily a function of what the govt pays for things or what the govt lets its fiscal agents lend against things".... this is the MMT "theory of inflation" if we HAVE to use this metaphor "inflation" at all so that the morons can understand that we are talking about the dynamics behind what the price levels are....
libertarians have a hard time accepting the "govt LETS its fiscal agents" part...
libertarians have some sort of a brain fart when they hear "govt lets" and rationality starts to escape them immediately at that point...
libertarians then start to examine things like "money supply" as somehow this ex post accounting data becomes more relevant than the decisions being made by the actual magisterial people in the govt positions...
libertarians just immediately start to flee the concept of "govt control" of any form... they have a very hard time accepting it... it leads them to a point where these human's brains turn into scrambled eggs and they start to believe that ex post accounting data has more relevance than what the magistrates are actually doing...
How appropriately a timed piece is this one by Lord Keynes given our discussion here about a formal theory of prices and the (I believe) myth that any school of economic thought has anything remotely resembling a robust and realistically applicable theory of prices?
I don't buy the "rates too low too long" argument. The cb is not charged with preventing asset bubbles but with balancing employment and price stability. The way price stability is defined, asset appreciation doesn't count toward inflation. The reason that rates were kept low is because inflationary expectations were low for other factors that the Fed assessed to be key indicators. The BOG and FOMC did not want to contract the economy by raising rates to counter a supposed asset bubble when there is no science of bubbles.
The problems were imprudent lending and moral hazard leading to sharp practices if not rampant fraud. The Fed failed as chief regulator in permitting this to take place, especially after the 2004 FBI warning of massive fraud in the mortgage industry. But even before that, prudent bankers should have realized that the collateral they were liquifying was not being discounted enough for the risk involved. If they didn't realize it or act on it, then regulators should have.
But at least some banks did recognize it as revealed by Chuck Prince's statement about "musical chairs." When the music stopped abruptly with the freeze up of the repo market, Lehman got stuck without a chair and all the other big banks took a hit to some degree and had to be bailed (other than Chase IIRC —Dimon got that right) .
Tom - Putting aside the Fed's dual mandate for the moment, I have never understood how a small group of FOMC members could know better than the market about what level interest rates should be. In this regard, central banks as they currently exist are too much like central planning for my tastes. It is preposterous to think that a group of FOMC members could know what the theoretically correct interest rate should be for the economy at any one point in time other than by accident.
Yes, there was rampant fraud and I know people involved in prosecuting a long list of people perpetrating it, but the bulk of the problem in mortgage space was as you say "imprudent lending and moral hazard". Michael Lewis's book, "The Big Short" gives a pretty good rendition of what went wrong. A lot of residential real estate was built that shouldn't have been because credit was misallocated to borrowers who were not credit worthy and low interest rates had a lot to do with it.
44 comments:
I thought the slides were pretty good. But I do have some initial reactions.
You say that bond buys are not discretionary. But it seems more accurate to say that open market purchases are not subject to much discretion given some prior determination of a Fed Funds target rate. And yet the determination of the target Fed Funds rate is a Fed policy choice, and so is itself discretionary.
This doesn't affect the basic point that the Fed sets rates.
Also, I didn't understand the comment about helicopter drops and debt monetization. They seemed to fall out of nowhere with no explanation.
Also: I thought the punchline slides, where the discussion turns to policy recommendations, were a bit vague and unsure, although stated in very aggressive terms.
And my frequent complaint: I don't believe MMT will ever get serious traction among a sizable bloc of policy makers until it produces a much more complete, compelling and detailed framework for addressing price stability management in the context of a well-developed theory of prices.
Dan,
I agree, that slide about "helicopter drops" is somewhat out of place...and will probably take too much time to explain for the target audience. As for price stability, I'm intending for this to be used on Hill staff, who I doubt would be be aware of/interested in price theories. People at the Fed might ask these things, but I doubt Hill people would.
It's excellent throughout. Going to tweet it after finishing this.
A few minor comments . . .
1. Govt debt is already essentially "American Equity" since that's what NFA is. Regardless of whether the pvt sector ends up with bonds or currency, for the sector overall it's equity.
2. The Fed's not trying to directly set mortgage or Tsy rates with QE. It's directly buying a fixed qty of them in hopes that it affects rates on these. To directly set the rate, it would have to announce the rate and buy a variable qty set by the mkt. Obviously the problem is that it's approach leaves people to think that it's the qty that matters, not what happens to the rates. The facts that (a) with QE2 rates actually rose then fell after QE2 ended, and (b) rates rose when mkts suspected a taper while the Fed kept buying at same pace, both show that it's still the markets setting the rates based on expectations of Fed, not the Fed directly setting rates.
Best,
Scott Fullwiler
"As for price stability, I'm intending for this to be used on Hill staff, who I doubt would be be aware of/interested in price theories."
Maybe not theories, but they are certainly interested in the issue of price stability, and so the economists need the theories to back up their policy claims. Without a theoretically well-grounded and empirically persuasive story to tell here about how to conduct price stabilization policy within an MMT framework, many serious people will continue to dismiss MMT as a loosey-goosey proposal for importing the monetary recklessness of some of the most poorly managed banana republics in the world to the United States. People are often very offended when I use that kind of language, but I know from experience that that is a widespread reaction, and it deserves a more cogent response than just hand-waving.
I continue to be perplexed by how tone deaf many MMTers are about this issue. More people than I think you are aware of are fully cognizant of the fact that treasuries and dollars are just two different kinds of obligations issued by the US government, and that the government can always meet any interest obligations incurred by the former by issuing more of the latter. But they support the budget balancing religion of the Fix-the-Debters and the operational independence of the central bank as mechanisms for imposing monetary discipline on a government that might otherwise blow up its currency and destroy the market value of the public's monetary savings, or introduce a degree of price volatility into the economy that would be a persistent drag on investment and employment.
Scott,
Thanks, I really appreciate the input. I'll make the appropriate edits. BTW why do you think it is that rates actually rose during QE2?
BTW why do you think it is that rates actually rose during QE2?
Inflationary expectations and belief in a bond bubble.
Right, Dan, inflation is a political bugaboo, and one that MMT economists admit as a constraint. That has to be addressed compellingly to convince policy makers fearful of it. The solvency issue is much simpler to dismiss as irrelevant. Inflation is not irrelevant.
The challenge is to show how MMT resolves the trifecta of economic growth (now recovery), employment (now historically high), price stability (now low CPI but fear of inflation "down the road"), as well as addressing financial stability through reform.
No real need to edit--just making ticky-tacky points as an FYI.
Regarding QE2 and rates, Tom's got it--best thing I've seen on that is this by Warren, which predicted the fall in rates after QE2 ended a few months prior. http://moslereconomics.com/2011/03/10/qe-and-the-term-structure-of-rates/
Sorry Dan but I just have to disagree about your belief MMTers need our own price theory.
History and mainstream "theorizing" already prove that inflation is not a big risk.
First of all, there is no historical correlation between deficits and inflation:
http://research.stlouisfed.org/fred2/graph/?graph_id=161902&category_id=0
or YoY:
http://research.stlouisfed.org/fred2/graph/?graph_id=161902&category_id=0
Even their own theories show their fears are unfounded.
Logical fallacy #1, in MV=PQ, M can increase because of either govt or private activities. Why would it be any more inherently inflation when We do it instead of I do it?
#2 V is constant. In other words, we can easily have inflation with balanced budgets during a private debt = money boom.
#3 Q now includes the entire breadth of all the goods the world would be willing to sell us. Its incrediblly elastic in other words.
The onus is on the other side to show why MMT would be inflationary because as far as I can tell they don't have much evidence or logic on their side.
And one last point, if you could determine that too much Govt money creation and not private sector debt is driving an inflation rate that is too high, the answer is so simple only a mainstreamer could miss it......DECREASE THE DEFICIT!! problem solved.
The problem is that the public, politicians and also central bankers are obsessed with inflation and unless MMT'ers can dispel those fears, however baseless, MMT is not going to be translated into policy.
For example, even his illustrious board of economic advisors apparently could not convince Bernie Sanders to move off the deficit dove position of taxing the rich to reduce the deficit.
And then see Tim Worsall's Modern Monetary Theory Means We Shouldn't Have A Progressive Tax System
We can't just wave this stuff off.
"...in MV=PQ, M can increase because of either govt or private activities. Why would it be any more inherently inflation when We do it instead of I do it?
You're right. It wouldn't be Auburn. However the Fed can slow down the rate of private sector money creation and spending by jacking up the cost of funds. So it's not as though private sector money creation is unconstrained by policy.
Also, note that in the run up to the 2007/8 crisis there was a massive surge in home prices. Economists deign not to count those increases as part of "core inflation", but some would argue that's an inadequacy and blind spot in the chosen metric, and that this was a case in which bank money creation was allowed to run off the rails.
"Decrease the deficit" sounds like a potentially plausible policy for tamping down inflation. But lately, haven't MMTers taken to stressing that the deficit is "endogenous", and hence not a policy variable?
What you are doing is offering some sketchy outlines of a theory of prices. And that's good. There were no such comments in the slides. But something more systematic is needed.
Note that older people, many of them working with fixed incomes, vote in larger
My personal view, from looking at some of the debates surrounding the 70's stagflation, is that inflation is primarily a matter of self-sustaining patterns of inflationary expectations accommodated by the credit system and the central bank. But I personally wouldn't be confident in asking a bunch of US senators and other policy makers to accept my amateur theory, and in any case that theory offers no concrete policy guidance. An empirically well-supported model is needed, and some reasonably precise policy rules that are justified by the model.
Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings? If not, then where is the danger line? How does a policy maker decide where it is? And what policy tools should be used to avoid crossing it? Shouldn't these questions have solid answers?
Forgot to complete this paragraph:
"Note that older people, many of them working with fixed incomes, vote in larger numbers than the rest of the population. They are not about to elect someone who comes off like a monetary cowboy, running risks of inflating away the value of their life savings."
Really, that is the touchstone. We've got the same poundoffs that told us the US is running out of money going on about inflation, no matter what the starting point. And of course, if the price of a gallon of milk goes up only in their hood, even if all others stay the same, that's "inflation from gubbernmint printing and spending". Despite there only being one brief instance of that during the late 40's
I agree that you can't leave inflation out of the discussion. At the very least it needs to be discussed as a policy risk. That said there seems to be a schizophrenic approach to the JG among MMTers. We love it but realize it by itself is polarizing so we try to stick to just talking about the mechanics of the monetary system. Why not recommend two policy approaches to inflation... JG and taxes. Personally I would recommend a Federal sales tax (to replace SS tax) and give the FED or Treasury the ability to raise and lower it within a range set by congress to combat inflation risks (excessive spending beyond productive capacity).
What about Warren's "all prices are necessarily a function of what the govt pays for things or what they let their fiscal agents lend against things..."
this sounds (to me) like a very good "MMT Inflation Theory" but again I am not libertarian at all....
Over the last 5 years (post GFC) we've had pretty stable prices in property while at the same time the Agencies have not raised the max on conforming loan limits by one penny, this is not a coincidence..
Here is video at this link where is you pick it up at the 13:00 mark Warren and Bill explain these arrangements pretty well I think....
http://mikenormaneconomics.blogspot.com/2011/11/infaltion.html
If we think that we still need some sort of more formal theory codified within the academe of economics then I would encourage those MMT adherents that choose to remain in this corrupt institution to proceed with that effort.... but it may still not get anywhere as least the Economics school within the academe is corrupt and highly libertarian so they probably wont accept it... it may be that one has to be fully authoritarian to accept this theory... ANY libertarianism in a person at all renders them unable to accept this Theory... so once again the culprit is libertarianism screwing everything up for humanity...
rsp,
"BTW why do you think it is that rates actually rose during QE2?"
JG - Scott Fullwiler is dead on right! Just look at the charts of the 10 year treasury yield. Without exception at the start of each QE operation interest rates went sharply higher. Why? Because enough traders perceived that the Fed was printing money an fueling inflation. The Fed even said that it was doing QE to raise inflation closer to its desired 2% target rate. Perception became reality, so is it any mystery that traders reacted logically by opting to put RISK ON? They sold long duration inflation sensitive Treasury bonds and the US $, while simultaneously buying equities, credit related debt instruments, commodities and emerging market assets. As each QE program was being wound down the RISK ON trade was reversed with RISK OFF. The video below features my take on this issue from about 3 years ago.
05/13/11 QE2 End Will Send Long-Bond Yields Down.... http://reut.rs/iSgCfl
"The Fed's not trying to directly set mortgage or Tsy rates with QE. It's directly buying a fixed qty of them in hopes that it affects rates on these. To directly set the rate, it would have to announce the rate and buy a variable qty set by the mkt. Obviously the problem is that it's approach leaves people to think that it's the qty that matters, not what happens to the rates."
Well said Scott! You nailed it perfectly! To take it a littler further, there would be no need for the Fed to target quantity or rates by purchasing actual bonds when they could buy derivatives like treasury futures instead. Here are a couple of more videos I produced on this issue from my Reuters days.
09/29/10 Why the “Bernanke Put” Makes Sense …… http://reut.rs/oOsYGs
10/27/2010 News Update: Yields Climb Higher to Pre-QE Talk Levels........ http://reut.rs/sA5MbI
"Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings?"
Great question Dan! It's easy for me to imagine how unconstrained deficit spending would at some stage of the process find its way into highly speculative outlets, or what the Austrians would call mal-investment.
"If not, then where is the danger line? How does a policy maker decide where it is?"
A market signal of some kind would be helpful.
"And what policy tools should be used to avoid crossing it?"
If there was an easy way say this without causing everyone to tune out I would, but I still think there is scope for gold to play a role of some kind here.
"Shouldn't these questions have solid answers?"
It would be very helpful for market participants to know the rules of the game.
"BTW why do you think it is that rates actually rose during QE2?"
Ed,
Here's the authoritarian take:
Read this interview with the guy at the FRBNY who is actually running the program.... do we have ears and eyes???? or we can just IGNORE WHAT THE GUY RUNNING THE PROGRAM IS TESTIFYING TO????
http://www.nytimes.com/2011/01/11/business/economy/11fed.html?pagewanted=all&_r=0
Quote:
"“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses."
Ed, 'getting the best price' means LOWER PRICES just like at Wal-Mart.... they are price setters who get to step in front of the non-govt market participants in this "dealer market" and drive the prices DOWN hence the rates UP...
Once they exit the marketplace, then the rates fall back down towards the "natural rate" which is ZERO... and the bonds rally...
To believe any other explanation is basically monetarist/quantity theory/confidence fairy type stuff.... things happen in economics because people take action, for good or for bad...
My current thoughts are that libertarians may not be able to see this process this way... can't admit it for some reason...
rsp,
"ANY libertarianism in a person at all renders them unable to accept this Theory... so once again the culprit is libertarianism screwing everything up for humanity..."
Matt - Actually it's much worse than you imagine. We have a card carrying organization with spies everywhere and operating cell networks all over the country and world. Of course, this strikes me as kind of odd because usually trying to organize libertarians to do anything in concert together is like herding cats. That said... Matt you don't know how close you are to the truth about how the first thing your garden variety libertarian thinks about when waking up and the last thing on his or her mind before going to bed is..... "How can I screw everything up for humanity today?" ;-)
Ed,
When the guy running the program at the FRBNY says quote: "we are trying to get the best price we can for the taxpayer" Ed, do you think he is lying? Do you believe he is being untruthful? And he does not have this as his goal? Or do you think that what the guy running the program does is not important?
Like fiscal policy: If Congress comes out and says they are going to implement austerity, do you not think that if they go thru with that policy things get worse? iow you dont think that what any of these people say they do is important?
Trying to understand the libertarian pov....
rsp,
Ed,
I'm not saying 'libertarians' are screwing everything up, I am saying 'libertarianISM' is screwing everything up... its an anti-authority form of human reasoning that I am complaining about not necessarily the people caught up in it...
Just like this thread where people are looking at "equations" like MV=PQ like it is some sort of "natural law" or something and ignore what the policymakers are actually doing...
If the govt comes out tomorrow and agrees to lend $1M against mobile homes guess what the price of mobile homes goes directly to $1M and loans will start to be made and we will see the EX POST results in so-called "money supply" levels, etc... but THE ACCOUNTING for human actions cannnot be confused for the cause of those actions...
libertarians might not be able to see things this way very much and perhaps not at all in most cases...
rsp,
Matt - That NYT article is patently absurd.
"“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses."
Wake me when the Fed sends out special dividend check to all the tax payers it has saved money for.
When interest rates are surging higher it makes no difference whether a "34-year-old in a striped suit and rimless glasses" and his staff of 20 something year olds buy bonds from the Street at 1/64th cheaper in price.
Chief economist at Wrightson ICAP, Louis V. Crandall, mentioned in the NYT article makes much more sense. "A buyer of $100 billion a month is always going to be paying top prices..... You can’t be a known buyer of $100 billion a month and get a good price.”
"When the guy running the program at the FRBNY says quote: "we are trying to get the best price we can for the taxpayer" Ed, do you think he is lying? Do you believe he is being untruthful?"
No, I'm quite sure that Mr. Frost is quite convinced that he is doing God's work on this earth. However, even if he didn't believe that to be the case, I doubt he would reveal his doubts by announcing to the world in the NYT that his efforts had no value whatsoever.
Ed they DO pay a "dividend" to the taxpayers when they credit the TGA with the "excess profits" of the Fed a few times per year... they think this is helping Bernanke himself has taken great credit for this in his Congressional testimony...
Ed Mike has explained this process before here and is related to what he is developing with his "market composition" approach .... experienced traders know how this works here is Mike from a while back in 2010:
"The Fed is buying "scale down" and in effect, causing the selloff. They're doing this because they're fixated on quantity ($600 bln) as opposed to price (interest rate). I remember when I was a floor trader. I had clients in the oil business--big firms--who would sometimes want to protect a certain price. They'd give me an order that would be, "Buy 100 (crude), 'worst.'" That meant buy it up...aggressively. When Japan used to actively intervene in FX markets, they wouldn't scale down their dollar buying (or sell yen scale up), they'd buy dollars aggressively to put the USD/JPY exchange rate to a certain level. The Fed is not doing this. By signaling to the market that they will buy scale down, they are actually creating this selloff as nervous longs look to sell before the largest buyer lowers its bid again and as speculative shorts compete for a better price." -- Mike Norman, 2010
And Ed the SCALE of this QE program from the Fed is just unprecedented... over significant periods they are buying in excess of what is being issued as they have been buying through surplus months... So do they ever RAISE their bids? This is what we should be investigating.... ie "What are they doing...
Look at the title of Justin's post here: "THE FED SETS THE RATES" .... it is either true or it is not...
btw Credit where due you also got the trade correct calling the big rally coming out of this QE2 sell-off which was a great call... same thing should happen again if they ever cut off the current QE operation... rsp,
Matt - The Fed cannot target interest rates by announcing a quantity of bonds it will buy over a specific period of time. The Fed exercised absolute control over the fed funds rate by announcing a TARGET RATE. The market knew that the Fed stood ready to buy or sell as many treasury securities as necessary to make the fed funds rate adhere to that target. That way, the market did most of the heavy lifting for the Fed.
Beyond that, during QE2 I monitored each and every Fed asset purchase in real time and I can tell you with certainty that Fed purchase prices published on the Fed website were more or less equally distributed both above and below the market snap shot prices of the bonds being purchased. In plain English, I could see no pattern of the Fed consistently buying below the market. Moreover, the only way that primary dealers would continue to buy Treasury securities at each auction would be if they had some expectation that they would be able to offload them to the Fed at a profit at the QE buy backs. It was just another subsidy to the bond trading houses on Wall Street.
Ed,
"Matt - That NYT article is patently absurd."
How can that article be absurd?
All the Times reporter people did was schedule an interview with the FRBNY people and then go in there and interview them as to what they were doing and the people told them what they were doing then the Times people wrote it up... ... I cant see how those events can be 'absurd' its a pretty simple chain of events...
rsp,
"How can that article be absurd?"
Matt - Don't everything you read..... even if it is published in the NYT, as Gospel.
Ed I dont think the Fed was setting the Funds Rate with the QE their intention is to buy US govt securities with newly created reserve balances hence increasing the "money supply" hence 'quantitative easing' then the banks have "more money to lend out".. its pure QUANTITY theory hence the name "QUANTITATIVE easing"... they did not announce a "target rate" associated with the QE they announce 'quantity not price' with MMT it is always about "price not quantity"... ALWAYS... unless you are a libertarian then looks like this belief can be infirm and fleeting...
And we know how they do this from the NYT article is to generally 'get the best price for the taxpayer' in the bond markets they do their buying within... (USTs and Agency bonds...) so yes there are short term dynamics/swings which your monitoring picked up, but the general trend will be down in this scenario... and then UP when they finally exit the marketplace...
If what I am saying is true then if the Fed ever stops the QE then cet par we should see rates go back down/bonds rally again... ie the exact opposite of what their goals are... I guess we'll see... if they ever stop doing this...
rsp,
I think I'm becoming dyslexic....
"How can that article be absurd?"
Matt - Don't everything you read..... even if it is published in the NYT, as Gospel.
I meant to write... Don't BELIEVE everything you read..... even if it is published in the NYT, as Gospel.
"Ed I dont think the Fed was setting the Funds Rate with the QE..."
Agreed. It was not my intention to suggest that the Fed was targeting the fed funds rate with QE. However, before QE and before the credit crisis the Fed would explicitly target the funds rate. I don't know if it is possible to test it, but in theory, if there was $1 of excess reserves in the commercial banking sector, that would be enough to drive the fed funds rate down to 0.00% bid.
"their intention is to buy US govt securities with newly created reserve balances hence increasing the "money supply" hence 'quantitative easing' then the banks have "more money to lend out"
Except that banks don't lend out reserves. Those reserves are sitting on account at the Fed as EXCESS RESERVES earning 0.25% o/n.
".. its pure QUANTITY theory hence the name "QUANTITATIVE easing"... they did not announce a "target rate" associated with the QE they announce 'quantity not price' with MMT it is always about "price not quantity"... ALWAYS... "
Yes... What I'm saying is that the Fed should have targeted a rate rather than quantity.
According to the Fed narrative, QE was intended to bring down long term interest rates to benefit the mortgage market and housing sector. Problem is that they proceeded by targeting QUANTITY rather than targeting a specific long term rate like the 10-year Treasury yield at say 2.5% like they did during WW2. The Fed can't target rate and quantity any more than one can hit 2 birds with 1 arrow.
(knew what you meant Ed...) Well Ed if your point is that what the article reveals is "absurd" as far as the Fed policy as somehow being supportive/stimulative to real economic outcomes then yes there is an absurdity that I can see there but what I was saying is that the article itself was not 'absurd' per se... iow I believe what the article reveals about the details of the actual Fed operations is true and accurate reporting...
rsp,
"You're right. It wouldn't be Auburn. However the Fed can slow down the rate of private sector money creation and spending by jacking up the cost of funds."
Although this sounds reasonable, I don't accept this broad statement and its real world impacts on faith alone. Where is the evidence that private sector debt growth is negatively impacted by higher interest rates. I don't see it. Not to mention that the economic impact of interest rate changes are so dynamic, I've yet to see anyone make the case that they actually understand the effects,
http://research.stlouisfed.org/fred2/graph/?graph_id=158451&category_id=0
"Decrease the deficit" sounds like a potentially plausible policy for tamping down inflation. But lately, haven't MMTers taken to stressing that the deficit is "endogenous", and hence not a policy variable?"
Of course the deficit is endogenous. Thats why you can't ever predict exactly what the deficit will be. The policy choices always frame the floor and ceiling of the endogenous deficit result. If we cut FICA to 0%, the impact on the deficit can certainly predicted to be bigger than not cutting FICA, but what the actual dollar amount of deficit increase is 100% endogenously determined within the policy framework. I don't see how this is controversial at all.
"What you are doing is offering some sketchy outlines of a theory of prices."
Pretty safe to say that every current mainstream price theory is nothing more than "sketchy outlines" so why should MMTer's be any different?
"And that's good. There were no such comments in the slides. But something more systematic is needed."
Thats for people better at math than me.
Note that older people, many of them working with fixed incomes, vote in larger
"Do you believe that no matter how large the deficit grows, and no matter under what macroeconomic conditions and what percentage of capacity the economy is running at, the private sector will simply absorb all of the excess money as unspent savings?"
Of course not.
"If not, then where is the danger line?"
Who knows? But if we overshoot, the data will tell us and we can always reign it in.
Let me ask you the corollary? How many new dollars created will cause inflation and how much?
See, nobody can answer the other side of the equation either.
"How does a policy maker decide where it is?"
Wait for the data, error on the side of full utilization of our real resources and not on the side of runaway inflation (whatever that means).
"And what policy tools should be used to avoid crossing it?"
Taxing, spending, and private lending regulation authority obviously.
"Where is the evidence that private sector debt growth is negatively impacted by higher interest rates."
Auburn - I'll give you an example. After the 2001 recession, mortgage lending shifted to adjustable rates (ARMs) which helped fuel the housing bubble because the Fed held rates too low for too long. ARMs rates were low because the they were indexed to short term rates at the front end of the yield curve and the yield curve was steep. However, as the Fed began raising rates in 2004 it signaled the beginning of the end for the housing bubble because it was only a matter of time before the rising rates would render sub-prime mortgagees unable to make their monthly payment.
Hey Ed,
I would never say that there could never be a situation where increasing interest rates by the Fed would not hurt the economy.
In a way you made my point for me. You pointed on a special situation having to do with variable rate sub-prime mortgages. A completely unique set of circumstances from where I'm sitting.
Like I said, I dont buy the monetarist and mainstream Fed tuning approach via interest rates because there is no evidence that things are that simple. Interest rates impacts are a nightmare of tangled inter-dependencies between the nominal amount of private debt, public debt, economic activity or outlook and a hundred other variables. My position is that NOBODY understands the nature of the interest rate impact very well.
For example, what is the net macro impact of a 3% increase in the FFR at the present time? In other words does the $480 billion increase in the deficit as income for T-bond holders or the (positive) or the increase in defaults and disposable income spent on private sector debt servicing have bigger impact? What if the amount of T-bonds were $30T and privater debt was only $30 trillion?
Its my claim that nobody knows the answer as it can't be known.'
Is there a historical correlation between private debtt growth and interest rates? show me the data.
Is there a historical correlation between business investment and interest rates? show me the data that explains how the Reagan debt boom expansion happened with a FFR above 6%.
Let me finish by repeating what I said to Dan above, it FEELS logical that higher interest rates would be bad for the economy, but reality doesn;t care about how I feel about things. Thiss is what separates real scientists from economists.
Auburn I agree with everything you write here....
Ed, check out what the Agencies were doing with the conforming loan limits during that period in the early 2000's.... they kept raising them.... I remember a time where in my area they were $210k and now they are at $417k so guess what? Housing prices have more than doubled in my area.... it is about price not quantity...
Same currently with auto loans they keep raising the amounts they will do on auto loans and allowing longer terms of up to 8 years to keep the payments down, etc... and car prices keep going up...
"All prices are necessarily a function of what the govt pays for things or what the govt lets its fiscal agents lend against things".... this is the MMT "theory of inflation" if we HAVE to use this metaphor "inflation" at all so that the morons can understand that we are talking about the dynamics behind what the price levels are....
libertarians have a hard time accepting the "govt LETS its fiscal agents" part...
libertarians have some sort of a brain fart when they hear "govt lets" and rationality starts to escape them immediately at that point...
libertarians then start to examine things like "money supply" as somehow this ex post accounting data becomes more relevant than the decisions being made by the actual magisterial people in the govt positions...
libertarians just immediately start to flee the concept of "govt control" of any form... they have a very hard time accepting it... it leads them to a point where these human's brains turn into scrambled eggs and they start to believe that ex post accounting data has more relevance than what the magistrates are actually doing...
Pretty sad to watch this disgrace...
rsp,
Matt - Don't be sad :-(. Be HAPPY! :-D
How appropriately a timed piece is this one by Lord Keynes given our discussion here about a formal theory of prices and the (I believe) myth that any school of economic thought has anything remotely resembling a robust and realistically applicable theory of prices?
http://socialdemocracy21stcentury.blogspot.com/2014/03/no-constants-in-human-behaviour.html?utm_campaign=MMT&utm_source=twitterfeed&utm_medium=twitter
To put in more simply, a theory of inflation that can actually make usable predictions is IMPOSSIBLE.
I don't buy the "rates too low too long" argument. The cb is not charged with preventing asset bubbles but with balancing employment and price stability. The way price stability is defined, asset appreciation doesn't count toward inflation. The reason that rates were kept low is because inflationary expectations were low for other factors that the Fed assessed to be key indicators. The BOG and FOMC did not want to contract the economy by raising rates to counter a supposed asset bubble when there is no science of bubbles.
The problems were imprudent lending and moral hazard leading to sharp practices if not rampant fraud. The Fed failed as chief regulator in permitting this to take place, especially after the 2004 FBI warning of massive fraud in the mortgage industry. But even before that, prudent bankers should have realized that the collateral they were liquifying was not being discounted enough for the risk involved. If they didn't realize it or act on it, then regulators should have.
But at least some banks did recognize it as revealed by Chuck Prince's statement about "musical chairs." When the music stopped abruptly with the freeze up of the repo market, Lehman got stuck without a chair and all the other big banks took a hit to some degree and had to be bailed (other than Chase IIRC —Dimon got that right) .
Tom - Putting aside the Fed's dual mandate for the moment, I have never understood how a small group of FOMC members could know better than the market about what level interest rates should be. In this regard, central banks as they currently exist are too much like central planning for my tastes. It is preposterous to think that a group of FOMC members could know what the theoretically correct interest rate should be for the economy at any one point in time other than by accident.
Yes, there was rampant fraud and I know people involved in prosecuting a long list of people perpetrating it, but the bulk of the problem in mortgage space was as you say "imprudent lending and moral hazard". Michael Lewis's book, "The Big Short" gives a pretty good rendition of what went wrong. A lot of residential real estate was built that shouldn't have been because credit was misallocated to borrowers who were not credit worthy and low interest rates had a lot to do with it.
I agree that cbs setting interest rates is a command system run by a small group of technocrats. and it should be eliminated.
However, in the UK, it's the banks that set Libor rather than the BOE, and that fared even worse in that it was gamed.
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