Toro or Like, What Do You Think of This Post?

Annie

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Nov 22, 2003
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Thoughts on the Macro Paradigm, Arnold Kling | EconLog | Library of Economics and Liberty

Several students asked why, if we were in a deep recession, we would have a contractionary monetary policy. I said that in fact the Fed poured lots of reserves into the banking system, and it paid interest on reserves to try to offset some of the expansionary implications of that huge injection of reserves.

But then another student asked, "Why didn't the Fed just raise reserve requirements? It would have been better for the deficit."

At this point, I was cornered. I had no choice but to say what I really believe about what the Fed was doing. In spite of all the sophisticated rhetoric about "quantitative easing" and "new tools for monetary policy," the only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy. If your goal were to stimulate the economy, you would inject enough reserves to do that and not pay interest on reserves. That might require buying some long-term bonds or mortgage securities, but not the hundreds of billions that the Fed actually bought.

Everything the Fed has been doing over the past fifteen months makes sense if you think of their goal as transferring wealth from taxpayers to banks. If you try to explain it as an attempt to implement an expansionary monetary policy, you won't even get past my high school students.

Now, on to Scott Sumner.

His first point is to challenge economists to come up with a definitive indicator of monetary ease or tightness. That is indeed a problem for most economists. However, I think that there is one indicator that Scott does not use which in fact might represent the mainstream view. That indicator is not the level of nominal interest rates but instead is the rate of change in the nominal interest rate. Most Wall Street economists focus on whether the Fed is raising or lowering the Fed Funds rate. When the Fed is raising the Fed Funds rate, the Street says the Fed is tightening. When the Fed is lowering the Fed Funds rate, the Street says that the Fed is loosening. Call this the "Wall Street indicator" of monetary policy. Some remarks:

1. The Wall Street indicator is implicitly accepted by many academics, even though if they thought about it they would poke all sorts of holes into it in terms of theory. But I think that the main reason that academics think that monetary policy was not tight in 2008 is that they take the view that if the Fed was lowering the Fed Funds rate then monetary policy must have been loose.

2. I personally do not buy into the Wall Street indicator. But I personally do not think that monetary policy is terribly effective. I take the view that the important interest rates are long-term real interest rates, and I do not think that the Fed can do much about those interest rates.

This leads to Scott's second issue, which is the question of why long-term nominal interest rates are so low. His view is that it is because the market expects low inflation, and I agree with that. However, he defers to the market's view, and I don't.
CATEGORIES: Macroeconomics

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I dont understand the post.
The Fed has loaded up banks with reserves by buying their government and agency debt.
But banks are in no mood to lend money. Thus monetary creation and inflation have been kept in check. Raising reserve requirements would have meant less available funds to lend.
The issue is not that banks dont have money to lend. It is that they are scared out of their wits to make loans to anyone but triple A credit prospects.

The Fed is not transferring money from taxpayers to banks. It is paying banks for assets they had.
None of this is unprecedented btw. The same has happened with every steep recession we've had. There is no confidence in the business world and Obama's policies make things even worse. No one will hire when the cost to hire is unknown. No one will expand when the cost to expand is unknown.
Once we kill the health care bill and the cap and tax bill you will see some activity.
 
I dont understand the post.
The Fed has loaded up banks with reserves by buying their government and agency debt.
But banks are in no mood to lend money. Thus monetary creation and inflation have been kept in check. Raising reserve requirements would have meant less available funds to lend.
The issue is not that banks dont have money to lend. It is that they are scared out of their wits to make loans to anyone but triple A credit prospects.

The Fed is not transferring money from taxpayers to banks. It is paying banks for assets they had.
None of this is unprecedented btw. The same has happened with every steep recession we've had. There is no confidence in the business world and Obama's policies make things even worse. No one will hire when the cost to hire is unknown. No one will expand when the cost to expand is unknown.
Once we kill the health care bill and the cap and tax bill you will see some activity.

I'd no weaker subject than econ in university, I did better in Spanish, deaf. :eek: Seems to me the point is they are flooding the banks of their choice. Lord knows, I could be wrong which is why I asked for better econ minds than mine.
 
I think the article is saying that the US Government bought bank "assets" that nobody else would purchase, because said sub-prime assets had an unknown value...due to all the foreclosures and collapsing housing market.

A conservative (read:cautious) accountant would write off all "undefinable" assets as a loss; if you cannot determine the value of the asset, you should assume you have nothing.

Thus, the government traded good taxpayer money for a "mystery box" of subprime mortgages. Because those sub-prime mortgages are virtually guaranteed to be near-worthless, Bush and Obama gave their favorite banks something for nothing.

Now, the government is still trying to milk what value they can from the "mystery boxes" of subprimes they purchased, and so are using tax incentives to stimulate the housing market. As the housing market improves, the government will recoup the "mystery box" losses. The problem is, this is a self-defeating policy. Any money the government makes through the improving housing market, will already have been spent on tax-incentives for homebuyers.

As its all a wash, in net, the Government loses money, and the banks make money, while the economy continues to suffer.

This leads to two possible conclusions:

1. Obama and his handlers have no understanding of basic economics, and so are being tricked by Wallstreet into making these foolish mistakes.

2. Obama and his handlers completely understand this dynamic, and so are sacrificing our communal good to benefit Wall Street bankers. In short, Obama's in their pocket...


Given that Obama's Treasury Secretary, Geitner, has a long history with Goldman Sachs, which has made billions from this disaster, I strongly suspect option #2.

Tim Geithner Too Close to Goldman Sachs to Be Treasury Secretary Critic Says: Tech Ticker, Yahoo! Finance
 
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Hi Annie

I'll do my best.

At this point, I was cornered. I had no choice but to say what I really believe about what the Fed was doing. In spite of all the sophisticated rhetoric about "quantitative easing" and "new tools for monetary policy," the only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy.

I agree with this completely. The actions of the Fed have been first and foremost to save the financial system. I do believe that if the Fed had not done this, we truly would have gone into the Great Depression 2.0.

The financial system was arguably insolvent. The Fed is trying to repair the banking system by keeping interest rates so low such that banks can borrow at or near 0% and invest in government bonds at 3%-4%. By borrowing at 0% and lending at 4%, banks make 4% on their money, and make profits and build equity, which rebuilds the financial system since banks need equity before they can make loans.

2. I personally do not buy into the Wall Street indicator. But I personally do not think that monetary policy is terribly effective. I take the view that the important interest rates are long-term real interest rates, and I do not think that the Fed can do much about those interest rates.

I believe that monetary policy is ineffective in a deflationary spiral, because when you have deflation, the real interest rate is positive. In other words, if deflation is 5% and interest rates are 0% as they are now, the real interest rate is +5%. This is enormously restrictive. It is the same as if the interest rate was 7% and inflation was 2%. In normal times, the real rate of interest is about 2%. During recessions, the Fed often lowers the real rate to 0% or below. When the economy is overheating, the Fed often raises the real rate to 4% or above. I had read an economist few days ago who estimated that the real rate of interest is +7%. I don't know if that is correct or not, but everything I have read thus far has concluded that real interest rates are fairly high. This is the opposite of what should happen. Real interest rates should be either zero or negative. But because the Fed cannot lower interest rates below 0%, monetary policy is ineffective. Economists call this the zero-bound problem.

It is also the strongest argument for stimulus. When real interest rates are so high, the only way the economy can stay afloat is for the government to spend because consumer spending collapses as borrowing is extraordinarily expensive, and because in a deflation, consumers put off spending as they wait for lower prices, putting the economy into a negative feedback loop and a deflationary spiral. Economists refer this as "monetary velocity," or the speed at which money circulates in the economy. In a deflation, monetary velocity falls, which means economic activity falls, which feeds on itself as continuously falling prices keeps consumers from spending money.

If this had been a typical recession that we saw from 1945 to 2000, then I would think that spending $800 billion on stimulus would be absolutely insane. But I believe this time period is truly different, akin to the Depression, and the government as the last institution of demand is crucial to avoid a prolonged and deep recession. The government is necessary to keep demand up and prevent monetary velocity from collapsing.

This leads to Scott's second issue, which is the question of why long-term nominal interest rates are so low. His view is that it is because the market expects low inflation, and I agree with that. However, he defers to the market's view, and I don't.

I think that deflation is part of the answer, but I also believe that with so much liquidity sloshing around the world, financial institutions are buying up enormous amounts of bonds. This increased demand for bonds increases the price for bonds and lowers the interest rate on bonds. (The two are inversely related.) This is the reason why not only bond prices are high and interest rates are low, but also because stock prices have risen so much and why gold is at an all-time high and most likely going higher.

Hope that helps.
 
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Sorry there isn't really an increased demand for bonds at least not US bonds which look more and more suspect. US T Bonds are flooding the market which will drive the interest you have to pay to get some one to take them of your hands upward.
 
Sorry there isn't really an increased demand for bonds at least not US bonds which look more and more suspect. US T Bonds are flooding the market which will drive the interest you have to pay to get some one to take them of your hands upward.

Gary

There is increased demand for bonds.

The Treasury has been conducting record auctions, just in the past month, with decent bid to cover ratios. That's why interest rates are lower on the short end and holding in on the long end, though ticking up a little as of late. TIPS have been pretty subdued as well.

You may be right in the future but right now there is no movement away from Treasuries.
 
I tend to see this whole economic mess as having more political then real economic roots. When you consider that total assets owned by the banks and the fact that the banks still make substantial profits from defaulting loans - even with dropping real estate prices (actually the banks make more profits from defaults than non-defaults), there was no real loss taken by the banks. There was a gap, for a while, between the profits that the banks had expected during real estate appreciation versus what they were actually getting, which they called a loss.

In other words this whole collapse of the banks was a bunch of BULLSHIT.

The banks are run by a network of free liberatarian world elite billionaires and mega millionaires. This economic collapse happened just when anyone with a brain realized that all hope for a McCain/Palin victory was lost - and there would be a liberal U.S. government elected - their worst enemy since communism.

So the banks went to the federal governement and demanded 750 billion dollars with no over-site and no accountability. They held the world economy hostage and hoped that an election paraniod congress would just hand the money over - scared to death of the consequences otherwise.

Well they scared congress, but not quite as much as they hoped, so Congress gave them the money, but put at least some restrictions and over-site on it.

The banks at that point couldn't back out - though they wanted to.

So the banks, instead of using the money for what it was intended for, used it to prop up profits - and leaving the economy in a catastrophy.

The governement is doing everything it can to rectify things short of socialization of the banking system - a big mistake.

So we have an economic war between the democratically elected governments of the world against the world's economic elite - in some ways an extension of the American revolution.

For as long as governments continue to stimulate the economy the world economic elite's wealth will continue to depreciate - which is why they are in a no holds barred political battle against liberal policies, meanwhile the elitist are doing everything they can to keep the economy from recovering - attempting to turn the people against liberal government thru a long & deep economic recession.

From what I see, the governments are winning. Anyone that does not invest in the economy in the next 6-9 months will stand to lose a fortune. The economy will recover and jobs will start to return Q1-3 of next year.

The American people aren't stupid enough to elect a conservative government after the past 8 years and this economic collapse. In a way the whole plan was executed too soon - they wanted to do it while Bush was still in office. If they had waited 6 months for the Obama administration to settle in - and be blamed - the whole scam would have worked.
 

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