Some quick thoughts- Prudential and consumer regulations as a preferential tool for controlling bank money creation?

This quote from the Levy Institute’s recent paper entitled “Federal Reserve Bank Governance and Independence During Financial Crisis” really got me thinking:

 “Excessive private credit creation was the key policy challenge facing the Fed after WW2. The Truman Administration ran budget surpluses for several years, but strong bank lending neutralized their effects. The banks, in other words, created an amount of money just about as fast as the Federal Government, through its fiscal policy, contracted the money supply. "

MMT talks a lot about how the creation of bank money affects aggregate demand, and how permanent zero rates might be a good idea going forward. I think we should also begin discussing how growth in bank money might be controlled in this permanent zero environment. It seems to me that if raising interest rates to slow down lending is off the table, then we would need to have other tools available. Since I have been working in financial regulations for a while now, I have come to see firsthand the truth of MMT’s claim that regulations, not interest rates, truly affect lending. And anecdotally, I frequently hear compliance people complaining about how all the new Dodd-Frank rules are curtailing lending. So here are some of my preliminary thoughts on this issue: 

• The last few decades have demonstrated the failure of traditional monetary policy tools to control growth in the money supply

• We know that the Fed controls only price of required reserves, and cannot directly control quantities of bank money, since this growth is mostly demand based

• Central banks are moving away from reserve requirements and monetary aggregate targeting anyway. Cant’ push on a string during times of low loan demand

• Inflation can be caused by excessive and imprudent lending. It’s not always due to too much horizontal money creation by federal deficit spending (although its remarkable that the explosion of bad lending and large deficits of the Bush admin were *still* not enough to create inflation)

• Using interest rates to manage an economy has mostly failed, and created enormous side effects:
• Market volatility
• Creates unnecessary interest rate risk burdens for depository institutions (cost of short term funding goes up, while long term assets are fixed)
• Creates risk of deposit flight from traditional banking system into higher yielding shadow banking/money markets which are not as closely regulated or monitored

My premise is that:

• Consumer and prudential regulations can be a much more effective and precise way of reducing lending-based creation of bank money (M2), than the tradition tool of raising interest rates

• Question is how do you develop a regulatory regime that is flexible enough to be ratcheted up or down for macroeconomic needs?

• Housing finance is a major source of bank money growth and therefore aggregate demand, so it is a good place to focus, using these tools:
• Raising/lowering agency (Fannie, Freddie, FHA, VA) conforming loan limits (very influential in housing esp. now that they control so much of the market)
• Weighing of risk-based bank capital 
• Risk retention/QRM rules from the prudential regulators
• Qualified Mortgage standards from CFPB

• From the firm perspective, these changes would:
• Increase compliance risk/burdens (bad for banks)
• But decrease volatility/interest rate risk, if rates are permanently kept at zero (good for banks)

Therefore-- 

With the end goal being full employment, the primary focus of federal financial/fiscal policymakers should be to strike the right balance between US dollar creation via federal deficits, and bank money creation via net bank lending. Both of these money creation forces contribute to aggregate demand, and if they outstrip the ability of the nation to produce a commensurate level of real goods and services, can cause an undesirable rise in the price level. Policymakers should approach full employment with as much of a utilitarian mindset as possible-- the only “moral” issues that should be taken into consideration here are the deleterious social effects of involuntary unemployment. 

Thoughts?

Mike Sax — Fiscal vs. Monetary Policy: Scott Fullwiler vs. Lars Christensen

This is the essence of it: 

In any case following Fullwiler here we get a working distinction between fiscal and monetary policy that's easy to follow. Fiscal [policy] increases the net worth of the non-government sector [by increasing non-govt net financial assets  through deficits]; monetary policy increases liquidity [reserve quantity] through asset swaps [that change the composition of assets but do not affect net financial assets of non-govt]. In the liquidity trap this breaks down as you have perfect substitutes being swapped-money and bonds.

Read it at Diary of a Republican Hater
Fiscal vs. Monetary Policy: Scott Fullwiler vs. Lars Christensen

by Mike Sax

Jerry Khachoyan — The Truth About Our Economy

It has been almost 4 years since the US fell into the Great Recession and we have yet to see a strong recovery. One of the after-effects of the Great Recession has been the increased attentiveness to monetary policy. Attentiveness to monetary policy existed before the Great Recession but not to the degree seen today; since the Federal Reserve took unconventional steps in 2008 to fight the recession, it now seems like every single word or action coming of the Federal Reserve (Fed) is a do or die moment for the markets and the economy.

Well, I got bad news for all those who think monetary policy is the “Holy Grail” to our problems – it’s not. Unfortunately, this reliance on the Fed has diverted attention away from the true matter we need to concentrate on: fiscal policy. Despite what all the supporters of monetary policy say, the Fed is out of bullets. They dropped interest rates to 0% (to make borrowing more affordable), conducted QE1 which calmed markets by providing liquidity (“Credit Easing”), tried QE2 & Operation Twist (which aimed to bring longer-interests rates down) and attempted better communication measures (“Rate Easing”) as they committed to keeping interest rates near zero “at least through late 2014”.

 Despite these actions taken by the Fed, we still see high unemployment and weak GDP growth. While parts of the economy are showing strength, the two most important measures of the economy show anything but strength. anything but that. Why can’t we solve our problems if monetary policy worked in the past? Market Monetarists (strong supporters of super aggressive monetary policy) will say that the Fed (and every major Central Bank) has failed to do its job. However, this is just wrong.

The main reason we are in an economic malaise is because we are stuck in a “Balance Sheet Recession” (termed by Richard Koo)....

Read the rest at SMB|U
The Truth About Our Economy
by Jerry Khachoyan

My favorite line is the last: "We demand higher aggregate demand!"

Ashwin — The Case Against Monetary Stimulus Via Asset Purchases

I’ve advocated many times on this blog that monetary-fiscal hybrid policies such as money-financedhelicopter drops to individuals should be established as the primary tool of macroeconomic stabilisation. In this manner, inflation/NGDP targets can be achieved in a close-to-neutral manner that minimises rent extraction. My preference for fiscal-monetary helicopter drops over negative interest-rates is primarily driven by financial stability considerations. There is ample evidence that even low interest rates contributeto financial instability.

There’s a deep hypocrisy at the heart of the macro-stabilised era. Every policy of stabilisation is implemented in a manner that only a select few (typically corporate entities) can access with an implicit assumption that the impact will trickle-down to the rest of the economy. Central-banking since the Great Moderation has suffered from an unwarranted focus on asset prices driven by an implicit assumption that changes in asset prices are the best way to influence the macroeconomy. Instead doctrines such as the Greenspan Put have exacerbated inequality and cronyism and promoted asset price inflation over wage inflation. The single biggest misconception about the macro policy debate is the notion that monetary policy is neutral or more consistent with a free market and fiscal policy is somehow socialist and interventionist. A program of simple fiscal transfers to individuals can be more neutral than any monetary policy instrument and realigns macroeconomic stabilisation away from the classes and towards the masses.

Read it at Macroeconomic ResilienceThe Case Against Monetary Stimulus Via Asset Purchases
by Ashwin

No one says exactly how the central bank is going to accomplish fiscal injection, however. Most of the more obvious means are beyond central banks' authority since this impinges on the fiscal authority. The fiscal authority must first delegate some of that authority to the central bank, a political matter that seems profoundly undemocratic and politically improbable.