Echo

It's official: the Fed is monetizing government debt

Wednesday, November 26, 2008

On November 2, I wrote an article about the new-found relationship between the Fed and the Treasury. Here is a bit from the article:

The Treasury is sterilizing the Fed’s liquidity measures, rather than the Fed monetizing the Treasury’s debt (just add this to a long list of unprecedented acts by the Fed and the Treasury).

At some point the Fed may choose to monetize new debt issued by the Treasury (let’s say in order to raise $700 billion to finance TARP), but I doubt it. There is already a new $1 trillion of new liquidity sloshing around in the banking system, posing huge inflationary risks.
Well, circumstances have changed. Twenty-four days later, and in a rather nontraditional manner, the Fed is now monetizing government debt.
The time has come to officially monetize government debt. Yesterday the Fed announced that it would purchase $100 billion in debt obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Bank next week. And furthermore, it will purchase $500 billion in mortgage-backed securities (MBS) – I like to call this FARP (Fed Asset Relief Program).

The purchase of GSE debt is a direct attempt to reduce the spread on government agency (GSE) debt over comparable Treasury debt, the relative borrowing costs. Basically, the Fed is targeting a lower interest rate on GSE debt. Sound familiar? Yup, that’s monetizing government debt.

The chart illustrates the difference between newly issued Fannie Mae debt and a comparable U.S. Treasury through 11/24/08. This spread has widened from an average of 29 bps (0.29%) spanning 2006-2007 to 90 bps spanning 2007-2008. Fannie Mae must pay more in order to finance its mortgage obligations, which limits its ability to roll over current obligations, and tightens the terms on new mortgage loans.

By driving down the spreads on GSE debt now, and later on mortgage-backed securities, the Fed gives the GSEs more flexibility in the mortgage market, and they can offer lower rates and better terms for potential homebuyers. That’s the theory.

I am interested to hear why the Fed is supporting the GSE debt and securitized assets that derive their value from the mortgages (MBS) rather than the mortgages themselves. The Fed could allocate a similar stock of resources to mortgages directly, where the effect would be immediate (mitigating foreclosures or offering better terms directly). However, I assume that the Federal Reserve Act prevents the Fed from doing such a thing – that sort of action probably lies in the hands of Congress. Although the immediate effects do appear to be quite positive.

Expect the Fed’s balance sheet to rise by another $100 billion (at least) in two weeks. It is official: the Fed is monetizing government debt.

Rebecca Wilder

21 comments:

Anonymous November 26, 2008 at 8:35 AM  

For the sake of the ignorant please explain what: "the Fed is monetizing government debt" means. Does it mean (as I suspect) the Fed is resorting to the printing press?

Rebecca Wilder November 26, 2008 at 8:55 AM  

Hi Anonymous,

Thank you for reading!

There is no such thing as ignorance in this blog. You can read a nice description of debt monetization at Mark Thoma’s blog here: http://economistsview.typepad.com/economistsview/2005/09/what_is_debt_mo.html

It means that the Fed is funding government expenditures by purchasing debt (either indirectly or directly). You are correct, the Fed is printing money in order to do so.

Rebecca

Stevie b. November 26, 2008 at 10:01 AM  

Hi Rebecca

Could you please comment on Prof. James Hamilton's idea that the Fed should buy TIPS?

http://www.econbrowser.com/archives/2008/11/time_for_a_chan.html

Flow5 November 26, 2008 at 10:30 AM  

The world's guru on the adjusted monetary base and bank reserves has an article on "Payment of Interest on Reserves"

http://research.stlouisfed.org/publications/es/08/ES0830.pdf

Anonymous November 26, 2008 at 10:31 AM  

Just in case I'm unable to log-in under my real name (it might be that pop-ups are blocked in my browser, rather than the Operating System, I'm just tired of fighting with it), this is Stephen Saines writing:

RW writes:
[The time has come to officially monetize government debt. Yesterday the Fed announced that it would purchase $100 billion in debt obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Bank next week. And furthermore, it will purchase $500 billion in mortgage-backed securities (MBS) – I like to call this FARP (Fed Asset Relief Program).

The purchase of GSE debt is a direct attempt to reduce the spread on government agency (GSE) debt over comparable Treasury debt, the relative borrowing costs. Basically, the Fed is targeting a lower interest rate on GSE debt. Sound familiar? Yup, that’s monetizing government debt.]

Rebecca: I'm struck by the similarity of this latest move to the Cdn example, save that the Cdn one is vastly simpler. The CMHC, and their bond issuing subsidiary, the Canada Mortgage Trust, are *completely* 'in-house'. I'll get back to that in just a moment, but first a note of history:

Rebecca mentions: [The Fed could allocate a similar stock of resources to mortgages directly, where the effect would be immediate (mitigating foreclosures or offering better terms directly). However, I assume that the Federal Reserve Act prevents the Fed from doing such a thing – that sort of action probably lies in the hands of Congress.] That would be the domain of the FHA (now part of HUD), and that function was much more available to the US public prior to Johnson's raid on Fannie to finance the Viet-Nam war. Fannie had to sell her fanny to private interests to raise money for the treasury. This is when the New Deal got sold down the river. Because Fannie was then officially privatized (and unofficially retained her 'Government Guarantee)(whoops, Cdn spelling), it was deemed necessary to create a male in her 'likeness', and Freddie was born, so as to avoid a monopoly. (Farcical in retrospect of what has transpired since).

The FHA to this day makes a profound case as to how much of the sub-prime fiasco could have been prevented if people had used their facilities. (Beware the website fha.com, it *is not* the HUD, on which the real FHA resides)

I must cut to the point here. Here is how *clean* things could have been as per the FHA, and Rebecca's very good point:
[qt]Friday, October 10, 2008
CMHC to buy mortgages from banks.

From the Department of Finance.

The Honourable Jim Flaherty, Minister of Finance, today announced the Government will take steps to maintain the availability of longer-term credit in Canada by purchasing up to $25 billion in insured mortgage pools through the Canada Mortgage and Housing Corporation (CMHC). This action will help Canadian financial institutions raise longer-term funds and make them available to consumers, homebuyers and businesses in Canada.

This relief to Canadian homebuyers and consumers comes at no fiscal cost to the taxpayer. Indeed, these securities will earn a rate of return for the Government that is well above the Government’s own cost of borrowing. Moreover, as insured mortgage pools in Canada already carry Government backing, there is no additional risk to the taxpayer.

"It is important to underline that Canada’s banks and other financial institutions are sound, well capitalized and less leveraged than their international peers," said Minister Flaherty. "Our mortgage system is sound. Canadian households have smaller mortgages relative both to the value of their homes and to their disposable incomes than in the U.S."

"However, it is becoming increasingly clear that the continuing disruption of global credit markets, which has been severe and protracted, is making it difficult for our financial institutions to raise long-term funding. This is beginning to affect the availability of mortgage loans and other types of credit in Canada.[...][/qt]
http://langley-financial-planning.blogspot.com/2008/10/cmhc-to-buy-mortgages-from-banks.html

I highly recommend reading the entire piece, and the blogger comments following.

There are fascinating parallels to the US system, the US is the model for the above, btw, before the US herself ruined her own magnificent model!

And a note of abject caution!

Here's an example of how close the present idiot Neo-Con gov in Canada came to blowing this (along with extending amortization periods on mortgages to 40 years, since rescinded, and some other incredible bloopers. As Rebecca stated on a similar matter: "The blind leading the blind")

[

HEATHER SCOFFIELD

With files from reporter Elizabeth Church

October 16, 2006

The federal government is quietly testing the waters about privatizing the national housing agency, Canada Mortgage and Housing Corp. -- a move that could bring billions of dollars into Ottawa's coffers but would also upset social-housing advocates and possibly cause upheaval in the bond market.

A sale is not imminent, and observers believe there is no chance it would take place until after a federal election. Nor is there a cut-and-dried case in favour of privatization. But it's clear that the days of CMHC being a significant source of cash for the federal government are numbered -- with or without privatization.

CMHC, a Crown corporation charged with making housing more affordable and accessible, is making about $1-billion a year in profit and is sitting on a $5-billion reserve of retained profits.

Those reserves are expected to rise to $9.5-billion within four years, according to the agency's corporate plan.

The riches have raised a big red flag, and now CMHC faces pressure from all sides.

Private companies -- mainly U.S.-based multinationals -- are ready to rush in to the lucrative mortgage-insurance market that CMHC dominates.

Social housing advocates and opposition parties want the excess reserves to be transferred over to fund more affordable housing.

And the federal government has signalled it wants out of the housing business altogether, arguing that it's a provincial responsibility.

The solution to these pressures, sources say, could be privatization: selling the commercial parts of the agency to the private sector and keeping the social-housing parts of the corporation within government for now.

"Trial balloons are being floated around" and can be traced back to Finance Minister Jim Flaherty's office, one Bay Street source said.

"This has been in the wind for a couple of months now," said another private sector source.

Rumours and speculation are rife among those with vested interests, although officials in Mr. Flaherty's office and at the CMHC all deny having any knowledge of such chatter.

The Crown corporation was created in the 1940s so that the state's access to cheap capital could be leveraged to make mortgages and home ownership affordable for most credit-worthy Canadian residents.

It now has four divisions: affordable housing, aboriginal housing, mortgage insurance and securitization.

The first two divisions depend on government funding of about $2-billion a year. The mortgage insurance and securitization units are run like commercial operations, and that's where CMHC makes all its money. (The government does not let the agency cross-subsidize from one unit to another so that the mortgage insurance and securitization divisions are truly commercial.) About 96 per cent of the agency's profit comes from mortgage insurance. CMHC controls about 70 per cent of the country's mortgage insurance market, with the other 30 per cent held by Genworth Financial, a U.S.-based multinational formerly known as GE Mortgage Insurance Canada.

The duopoly in the growing and lucrative mortgage insurance market will officially come to an end this week. A change in rules passed earlier this year means that new entrants will be able to enter Canada's mortgage insurance market if they get approval from federal authorities, and now at least three U.S.-based companies are lining up to do so.[...][/qt]]]

Anonymous November 26, 2008 at 10:48 AM  

(My absolute apologies, I'm having severe difficulties with the blog software clashing with what I have onboard here)

continued....
[The riches have raised a big red flag, and now CMHC faces pressure from all sides.

Private companies -- mainly U.S.-based multinationals -- are ready to rush in to the lucrative mortgage-insurance market that CMHC dominates.

Social housing advocates and opposition parties want the excess reserves to be transferred over to fund more affordable housing.

And the federal government has signalled it wants out of the housing business altogether, arguing that it's a provincial responsibility.

The solution to these pressures, sources say, could be privatization: selling the commercial parts of the agency to the private sector and keeping the social-housing parts of the corporation within government for now.

"Trial balloons are being floated around" and can be traced back to Finance Minister Jim Flaherty's office, one Bay Street source said.

"This has been in the wind for a couple of months now," said another private sector source.

Rumours and speculation are rife among those with vested interests, although officials in Mr. Flaherty's office and at the CMHC all deny having any knowledge of such chatter.

The Crown corporation was created in the 1940s so that the state's access to cheap capital could be leveraged to make mortgages and home ownership affordable for most credit-worthy Canadian residents.

It now has four divisions: affordable housing, aboriginal housing, mortgage insurance and securitization.

The first two divisions depend on government funding of about $2-billion a year. The mortgage insurance and securitization units are run like commercial operations, and that's where CMHC makes all its money. (The government does not let the agency cross-subsidize from one unit to another so that the mortgage insurance and securitization divisions are truly commercial.) About 96 per cent of the agency's profit comes from mortgage insurance. CMHC controls about 70 per cent of the country's mortgage insurance market, with the other 30 per cent held by Genworth Financial, a U.S.-based multinational formerly known as GE Mortgage Insurance Canada.

The duopoly in the growing and lucrative mortgage insurance market will officially come to an end this week. A change in rules passed earlier this year means that new entrants will be able to enter Canada's mortgage insurance market if they get approval from federal authorities, and now at least three U.S.-based companies are lining up to do so.[...][/qt]
http://www.theglobeandmail.com/servlet/story/LAC.20061016.RCMHC16/TPStory

Again, I highly recommend reading the entire article. Americans will...*should* be incredulous at the amount of 'blind leading the blind' going on.

And here's the denoument!

One of the top US experts in the field, a woman of stunning credentials, warning the Cdn Gov *not* to do what the US has done:

(note the date)
[5/24/2005

Dr. Wachter reviewed Annex 6, An Effective and Efficient Legislative Framework for the Canadian Financial Services Sector (A Consultation Document for the 2006 Review of Financial Institutions Legislation) on behalf of Genworth Financial Canada, Inc. Dr. Wachter is currently the Richard B. Worley Professor of Financial Management and Professor of Real Estate and Finance, The Wharton School, University of Pennsylvania and previously served as Assistant Secretary of Policy, Development, and Research from 1999 to 2001 at the US Department of Housing and Urban Development.
I. Introduction and Executive Summary:

Currently, Canada has one of the most efficient and accessible housing finance systems in the world. Particularly impressive are the market's characteristics of low-cost mortgage finance and high levels of homeownership. The economic underpinnings of the current housing finance system have helped to achieve important social outcomes: equitable access to mortgages for potential homebuyers throughout Canada, in both rural and urban areas, first-time ownership for Canadian homebuyers on the margin, and protection for the financial system throughout the economic cycle.

These successes are made possible, in part, due to the provision of mandatory mortgage insurance. This provision has enabled, through gradual expansion of underwriting guidelines and price reductions for high risk loan categories, the extension of the market to marginal homebuyers who otherwise would not be able to afford homeownership, or would do so at higher cost. The requirement for mortgage insurance, as currently structured in Canada, helps prevent the pervasive segmentation of mortgages by credit risk. This market segmentation can lead to a lack of transparency in mortgage pricing and lending abuses, which undermine efficient mortgage choice and sustainable homeownership. Thus the current system provides access to affordable homeownership at the same time as it minimizes mortgage portfolio and systemic risk. Furthermore, mandatory mortgage insurance supports the provision of mortgages by large and small lending institutions throughout Canada.[...report at length on the Cdn Dep't of Finance website...]
http://www.fin.gc.ca/consultresp/06Rev_40e.html

I'm fighting with this software, and there are multitudes of points the Good Doctor makes.

She also testified to Congress:
http://www.google.ca/url?sa=t&source=web&ct=res&cd=5&url=http%3A%2F%2Fgovinfo.library.unt.edu%2Fmhc%2Fendnotes.doc&ei=J28tSaqlJYy4Mu_u2Z4L&usg=AFQjCNFjXEDUJU_o-op24kGwKrl1SxSCuw&sig2=OcVXFMaqXqTAKwG3BaL2pg

I'm so busy fighting software glitches here, I can't continue making cogent points, but access those urls, and Google further. Rebecca is onto a mother lode.

Steve Saines

Don November 26, 2008 at 2:20 PM  

From Bloomberg: Rebecca, Can you tell me why they won't say so publicly, if you agree that this is what they're doing:

"The U.S. officials, speaking on condition of anonymity, said they don’t see the Fed purchases of mortgage bonds as a way of “quantitative easing,” or using central bank policy to add reserves to the banking system when interest rates are very low, even though the purchases will have that effect. "

Why didn't they just ask Poole? He's not shy.

"Quantitative easing was a tool of monetary policy that the Bank of Japan used to fight deflation in the early 2000s.

The BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. More recently, the BOJ has also been flooding commercial banks with excess liquidity to promote private lending, leaving commercial banks with large stocks of excess reserves, and therefore little risk of a liquidity shortage.[1]
The BOJ accomplished this by buying much more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities and extended the terms of its commercial paper purchasing operation."

I'm not sure why, if it's going to have that effect, it wouldn't be considered a positive side effect.

Don the libertarian Democrat

Flow5 November 26, 2008 at 4:03 PM  
This comment has been removed by the author.
Flow5 November 26, 2008 at 4:07 PM  

"However, I am still skeptical about our ability to detect bubbles early enough to make a general policy of leaning against them successful on average" Donald Kohn.

How can these guys spend their entire life studying economics and not know how to forecast with precision. They are stupid. Dr. Thomas (a cardiac surgeon) figured it out in his spare time. The accuracy is just amazing.

Flow5 November 26, 2008 at 4:22 PM  

Roubini concludes:
[T]he Fed, together with the Treasury, started to implement some of the “crazier” policy actions... an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion –
http://calculatedrisk.blogspot.com/

Total Reserves include excess reserves which receive remuneration (payment of interest at a market or inter-bank rate)

Excess reserves act by draining commercial bank legal reserves (i.e., they increase reserve requirements). Thus an increase in total reserves cannot be interpreted as inflationary.

However, required reserves have exploded. That is more telling. [didn't look, my first comment was in error. You can tell by required reserves]

dmg555 November 26, 2008 at 7:42 PM  

Thanks for staying on top of this. To me it is the single most important macroeconomic event to be following. If we are monetizing the debt over the current financial crisis what are we going to do when we have to face the over promised Medicare and social security issues. I don’t understand why this isn’t the most talked issue in all the macroeconomic blogs. It would appear to me you’re the first to put it right out there and call it what it is. I look forward to following the story as it progresses.

Rebecca Wilder November 27, 2008 at 8:26 AM  

Hi Don,

Good to hear from you?

Honestly, I don’t know what else you could call it – government purchasing MBS and credit directly? That sounds like quantitative easing to me – and Kohn said that the easing has already started. http://blogs.wsj.com/economics/2008/11/19/feds-kohn-deflation-risk-bigger-but-still-small/

In my book, the Fed can call it whatever it likes – monetization, easing, whatever - it’s not like they are going to tell us anyway. To me, the Fed purchasing MBS is better than an outright purchase of Treasuries because the yields on those bonds are already so low. Why not target an market that is actually going to do some macro-economic good, like the MBS market. I wonder if they will purchase CMBS, too? Probably not, but those spreads are very, very wide.

Thanks for reading and Happy Thanksgiving!

Rebecca

Hi Stephen,

Thank you for the article and blog link. Very interesting stuff. I didn’t realize that Canada had already started a similar program. It is unfortunate that with F/F becoming explicit and huge government-run firms, that they are the ones to be shored up by the U.S. government rather than the housing market directly. You should read Krugman’s take on this: http://krugman.blogs.nytimes.com/2008/11/25/the-fed-is-confusing-me/

Rebecca

Hi Flow5,

Thank you for all of your comments! And thank you for the link to the paper on interest-rate targeting.

I am wondering, you said, “However, required reserves have exploded.” I see required reserves falling over the last two-week reserve period and further, that they have been rather stable since October 2007. Did you mean to say excess reserves have exploded? That would be more highly correlated with the article that you sent me.

Rebecca

Hi Stevie,

The idea that eventually the Fed will need to take back the liquidity once the credit markets free up (i.e., bank lending flows again) is rather troubling because how do you unwind a bunch of collateral that the market may not want?

I have always said that the credit crisis will have been contained once the markets price in inflation. So in this case, if the Fed bought up TIPS as a measure of policy, it would be very easy to unwind these bonds when inflation expectations come back to the market – even if the other assets are still unwanted (e.x., whatever collateral the Fed has accepted for its various programs TAF, PDCF, TSLF, etc.).

Certainly, the Fed can add TIPS to its assets that it purchases – frankly, I don’t know what else they hold, so why not?

Thank you for reading! And thank you for commenting.

Rebecca


p.s. you all should be with your families right now and so should I!
Happy Thanksgiving.

midas mulligan November 27, 2008 at 1:45 PM  

thanks for the highly intelligent posts. As Milton Friedman and Anna Schwartz so ably showed, history says that inflation is always a monetary phenomenon. I had seriously doubted that all of this liquidity could ever be sterilised anyway, but now it appears that Berstanky won't even try...One thing that i'm trying to understand though, is why Japan, after 20+ years of ZIRP, plus quantitative easing, etc., never stoked big time inflation...do you have any thoughts on the factors that suppressed inflation there, i.e., were they terribly successful in sterilising the liquidity, high savings rate, big creditor nation, something else? many thanks.

Anonymous November 27, 2008 at 5:17 PM  

Stephen Saines here.

Rebecca: Excellent reference to Krugman. I will attempt later to detail some comparisons, and ask some pertinent questions of you, but as it stands, as far as I can tell, (and from what I recall, which may be faulty) the FMs still have some private shareholders, and are therefore not completely part of the US Govt. That is a two edged sword, for many reasons to be discussed later.

As to the Cdn comparator,
be aware of this:
NHA MBS Auction Operations
http://cmhc.ca/en/hoficlincl/mobase/auop/index.cfm

On this matter, Canada has taken the model the US pioneered (the FHA one) and one-bettered the US, by keeping it *in-house*....exactly as Krugman laments the US doesn't. That was more the US compromising her own history than Canada leaping ahead.

There is a lot to discuss (and it is controversial in this nation as to whether Canada is "printing money" to do this or not. Most claim not! (It would be a case of a dog eating its own tail).

I suspect book-keeping methods due to some remaining shareholders of the US FMs as being the root of the difference.

Here is the some info at this time to preface the case I'll describe later:

[Canada Mortgage and Housing Corporation Supports Canadian Credit Markets

OTTAWA, October 10, 2008 — Canada Mortgage and Housing Corporation (CMHC) will purchase up to $25 billion in insured mortgage pools as part of the Government of Canada’s plan, announced today, to maintain the availability of longer-term credit in Canada.

The first purchase of $5 billion will be made October 16, 2008 through a competitive auction process. The mortgages involved are high-quality assets that are already guaranteed through government-backed mortgage insurance. The Government will announce a schedule of future purchase dates to take place over the coming weeks.

Canada Mortgage and Housing Corporation (CMHC) has been Canada’s national housing agency for more than 60 years. CMHC is committed to helping Canadians access a wide choice of quality, affordable homes, while making vibrant, healthy communities and cities a reality across the country.

Please refer to the backgrounder for details on the competitive auction process.

For more information please contact:

Stephanie Rubec
CMHC Media Relations
Tel: 613-748-2300 ext. 3064
srubec@cmhc-schl.gc.ca

Julie Girard
CMHC Media Relations
Tel: 613-748-4684
jagirard@cmhc-schl-gc.ca]

http://cmhc.ca/en/corp/nero/nere/2008/2008-10-10-1700.cfm#CP_JUMP_179850

That looks *remarkably* similar, if not identical to the US purpose:

[Release Date: November 25, 2008
For release at 8:15 a.m. EST

The Federal Reserve announced on Tuesday that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.

Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Federal Reserve's primary dealers through a series of competitive auctions and will begin next week. Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end. Purchases of both direct obligations and MBS are expected to take place over several quarters. Further information regarding the operational details of this program will be provided after consultation with market participants.]

http://www.federalreserve.gov/newsevents/press/monetary/20081125b.htm

Note! The FHA, which directly holds mortgages, as well as (as far as I know, MBS) is not included in the above excercise.

As to why is key to Krugman's question.

I'm going to dig some more on this, as this is a discussion very close to my heart. It is one of the *exquisitely key* factors to the US being in the situation she is now in.

I repeat (and will reference later) Canada considers that this *is not* a case of printing money, since the CMHC is already a Gov't Corp. It therefore follows, arguably, that the action is not Inflationary, or ostensibly, Deflationary. It is policy neutral, and yet allows the banks much greater latitude to lend with no change in policy.

Btw: A very interesting interview:

Recessionary Dodge
http://www.bnn.ca/squeezeplay.aspx

It is an interview with David Dodge, the former BofCan Governor, who has made some very revealing remarks on Greenspan's private comments in the past. He is not so unguarded this time, but the interviewer reveals more second person after the interview.

Anonymous November 27, 2008 at 10:19 PM  

With monetizing the debt, is there a historical perspective for the price of gold? Roubini is palying aa case for deflation, of which I agree from knowing most of my friends cutting WAY bck as well aas losing jobs.

Are we increaasing our risk of being "Weimaar America" with these new actions aand not deflation?

Thanks in advance

Anonymous November 28, 2008 at 12:36 PM  

So, in layman's terms - is the Fed essentially choosing certain near-term inflation (in increasing the money supply via these purchases) versus higher inflation expectations (by increasing govt debt which would need to be paid at some point)? Do you think this is an effort by BB et al to "anchor inflation expectations" -www.bis.org/review/r070712a.pdf?

Flow5 November 28, 2008 at 4:11 PM  

It is true that required reserves have dropped over the latest two week reporting period.

However, if you take the period from Sept08 until Oct08, required reserves rocketed c. $5b (an enormous historical volume).

Also, historically, the bi-weekly fluctuations needed to be averaged as a monthly figure.

Legal reserves used to be published on a weekly basis. Then later, the currency figure required for reserve calculation was no longer available in a timely manner...etc, etc...less & less accurate.

Further, ignore the seasonally mal-adjusted data...and more...the Board of Governors figures are inaccurate (it's definition & it's calculation).

Rebecca Wilder November 28, 2008 at 8:16 PM  

Hi Anonymous,

You said, "Are we increaasing our risk of being "Weimaar America" with these new actions aand not deflation?"

Is this you, Stephen?

I don't know what the Fed's exit strategy will be - how it is planning on unwinding the liquidity. But the Fed's successful unwinding of liquidity (when the economy is ready) depends on what kind of collateral it is accepting in exchange for the lending programs (which is completely undisclosed), and if there is a well-defined market for this collateral when the economy turns around. Furthermore, how quickly the economy comes out of the recession will determine how big is the inflation risk. If it is a slow recovery, then the Fed can incrementally take back the liquidity by simply allowing the loans to come to term - some of this could happen without the Fed even performing one open market operation. If it is quick, then the Fed may simply be too late.

As long as the credit markets see a stark improvement before the economy turns around, then the Fed could very well take back the liquidity without too much of a problem.

But either way, there is a nasty recession underway, and inflation (as you say) is not going to be the Fed's risk objective for a few quarters. So right now, all of the liquidity is rather harmless, but in the medium term I am not so sure.

Some say that the Fed will get it right, and take back the liquidity with ease before the markets price in inflation (expect it). I, however, think that there is a growing risk that they get it wrong; hence I attach a slightly heavier weight to inflation problems.

Thank you for reading and commenting!

Rebecca


Hi another anonymous,

Thank you as well for reading and commenting!

You said, "So, in layman's terms - is the Fed essentially choosing certain near-term inflation (in increasing the money supply via these purchases) versus higher inflation expectations (by increasing govt debt which would need to be paid at some point)?"

I think that the near-term inflation risk is small at best. The economy is in a nasty recession (as I stated to the above anonymous comment) and rising prices will not occur under such slackening demand. So near-term inflation is not certain from the Fed's liquidity measures.

However, as the economy cycles out of the recession (in a couple/few quarters), the inflation risk will be more prevalent.

As for the Fed buying government debt, I have only really seen evidence of debt monetization with the Fannie and Freddie announcement. Other than that, excess reserves are too high to imply that debt monetization is actually occurring.

I think that BBet al (nice, by the way) might be concerned about downward pressure on inflation expectations, but they are even more concerned with the immediate credit crisis.

Thanks for reading and thank you for your comments!

Rebecca
p.s. I will reply to further comments tomorrow! Have a great evening everyone.

Rebecca Wilder November 28, 2008 at 8:22 PM  

HI Midas,

Thank you for commenting!

You said, “do you have any thoughts on the factors that suppressed inflation there, i.e., were they terribly successful in sterilising the liquidity, high savings rate, big creditor nation, something else?”

I think that you are right on all of the above. Japan’s problems are too much for one comment – it is a mix of reluctant policy, high saving tendencies, surging fiscal imbalances, poor policy decisions (raising consumption taxes in the middle of a recession), etc.

I will defer to Paul Krugman on this one. He has published many articles on Japan and listed them all here: http://web.mit.edu/krugman/www/jpage.html

Thank you again for your participation!

Rebecca

Flow5 November 29, 2008 at 12:59 PM  

Ignore seasonal-mal-adjustments, Why? the "real bills doctrine" is fallacious (& there are "true ups", re-alignments of seasonal factors, etc.)

Reserve ocillations, why? the Fed can't hit reserve volume targets.

(1) Lagged (prior to 1984) institutions required reserves were based on its average daily deposit liabilities in
the computation period two weeks earlier

(2) the contemporaneous reserve maintenance period was lengthened
from one week to two weeks; and it covered 14 days ending every other Wednesday.

(3) the current reserve maintenance period covers 14 days; with a 30 day lag.

Reserve maintenance has been repeatedly lengthened. Deficiencies have been doubled (2% to 4%), etc.

Monetarism entails the following:

The sine qua non of monetary management is total current control by a central monetary authority over the volume of legal reserves held by all money creating institutions, and over the reserve ratios applicable to their deposits.

Monetary authorities have to have complete discretion over changes in reserve ratios. This is essential since under fractional reserve banking (the essence of commercial banking), these ratios determine the minimum volume of legal reserves a bank must hold against a specified volume and type of deposit liability.

Monetary authorities have long recognized that the volume of bank legal reserves, combined with the reserve ratios applicable to various classes of bank deposits, determined the limits and, since 1942, the amounts of bank credit creation.

The first rule pertaining to reserves and reserve ratios should be to require that all money creating institutions have the same legal reserve requirements, both as to types of assets eligible for reserves, as well as the level of reserve ratios.

I.e., member commercial banks should have UNIFORM reserve ratios, for ALL deposits, in ALL banks, irrespective of size

Necessarily, the only type of bank asset that the Fed is in a position to constantly monitor and absolutely control are commercial inter-bank balances in the District Federal Reserve banks (this was the original definition of legal reserves in the Federal Reserve Act and it is the only viable definition-pre-1959 requirements pertaining to assets).

manish November 6, 2009 at 2:56 AM  

Hello,
i really like your comment many knowledgeable information in this site and every articles in this site really very nice thanks for share it.
In the United States, and in many other countries, the government does not have the right to issue new currency to pay its bills – it must instead finance the deficit by issuing new bonds and selling them to the public to acquire the necessary money to pay its bills. However, if these bonds do not end up in the hands of the public, the only alternative is for them to be purchased by the central bank. For the bonds not to end up in the public hands the central bank must conduct an open market purchase. This action by the central bank increases the monetary base through the money creation process. This process of financing government spending is called monetizing the debt.[2] Monetizing debt is a two step process where the government issues debt to finance its spending, the central bank purchases the debt from the public and the public is left with high powered money.
Debt management plan--Debt management plan

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