I interpret these remarks by James Bullard, president of the St. Louis Federal Reserve Bank, as throwing down the gauntlet to federal policymakers:
CHICAGO, Jan. 7, 2012 /PRNewswire/ — Federal Reserve Bank of St. Louis President James Bullard previewed a new research paper he will release next week, titled “Death of a Theory,” at an event sponsored by the Korea-America Economic Association on Saturday. The event was held during the annual meeting of the American Economic Association/Allied Social Science Associations.
In his remarks, Bullard discussed business cycle stabilization using fiscal rather than monetary policy. The former attempts to react to aggregate shocks to the economy through changes in taxes and spending, while the latter reacts to aggregate shocks by targeting the nominal interest rate or by influencing inflation and inflation expectations through quantitative easing when the interest rate is at the zero lower bound.
Bullard noted that over the two decades leading up to the financial crisis, the conventional wisdom concerning macroeconomic stabilization was that fiscal policy was in fact not a good tool. Shorter-run stabilization issues should be handled by the monetary authority while fiscal authorities should focus on a stable taxing and spending regime to achieve economic and political goals over the medium and long run.
not to mention the economist advocates of using fiscal stimulus during economic downturns. Considering Fed Chairman Bernanke’s reluctance to deploy additional monetary tools, it may signal a brewing battle among the Fed governors as well.
Firstly, the idea that fiscal and monetary policies are separate is an illusion. Whether you fiddle with interest rates, spend or change tax policies they are all ultimately methods for controlling the supply of money. Depending on the situation some are more or less effective than others.
Secondly, monetary policies the central bank has pursued ARE an attempt to stimulate the economy. Every step the Fed has taken over the last four years has been intended to push aggregate demand, all of them unsuccessful because the central bank does not and cannot add to the money supply by increasing net financial assets in the real economy.
Third, I have no idea what Bullard is talking about when he implies we must return to monetary policy to manage the economy: we never stopped using monetary policies. QE, QE2, Operation Twist, paying interest on reserves, allowing interbank interest rates to fall, massive asset swaps, pumping reserves up to record levels, all done on the theory that stimulating additional lending would provide economic stimulus.
Let me put it this way: I know what the FOMC is. I know what it does. I also know that more than 95% of americans have never heard of it. If I, who closely observe its actions, do not alter my spending and saving habits based on its operations, then how is one to expect those oblivious to its very existence to change THEIR habits? The Federal Reserve cannot manage the current economic downturn and those who think it can if it just tries a little harder are in denial.
What has the central bank done with all its policies?
http://research.stlouisfed.org/fred2/series/BASE
We can see it has more than tripled the monetary base. Why? Greg Mankiw and colleagues would tell us that the monetary base is “high-powered” money due to the money multiplier. Banks leverage that money by a factor of ten or more and thereby increase the supply of money available to the greater economy.
But as I’ve stated many times, the multiplier is a myth:
“The role of reserves and money in macroeconomics has a long history. Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations. Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons . . . Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending.”
http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf
Bullard’s comments are distressing because fiddling with the monetary base is ALL the central bank can do. In calling for us to double down on “monetary” policy he asks us to keep trying the same thing and pray for a different result.
Who wants lemon with their Hemlock???
Maybe the answer to our problems doesn’t reside in fiscal or monetary policy. Just a thought.
@Andy,
The problem is we have a monetary system in which government is the private sector’s only source for money. If the private sector wants to accrue financial wealth then those dollars must come from government spending in excess of what it taxes. Once we understand this then we are forced to consider how government approaches the private sector’s financial needs, and that means monetary/fiscal policy. It’s something we can never get away from.
Ben, similar is not the same. The microeconomic effects of fiscal policy are different from those of monetary policy.
Ok…, raising the interest rate is seen as being a contractionary with regards to the money supply. How exactly does this translate into less government spending?
@Steve Verdon
Let’s say the inter-bank interest rate rises. In theory this will make loans more expensive and thereby make it more difficult for businesses and individuals to borrow; essentially we’ve reduced available credit and reduced economic activity, but we’re also pulling more money out of the real economy because we have higher payments to make to our banks. Assuming fiscal policy (spending) is static, we have increased the flow of money out of the real economy relative to the inflow from government spending, meaning fewer dollars.
The same thing happens if we just reduce government spending without fiddling with interest rates. If it drops beneath the rate at which loan repayment and saving reduces money in circulation then the supply will fall. It’s not that raising interest rates means less money flowing from the government sector to the private, it’s that money will flow OUT of the economy into the banking system at a faster rate.
Krugman argues this is irrelevant because the money will just be used for another purpose, but he doesn’t realize that the money doesn’t go into a money vault, it just disappears into the ether as the bank repays the reserves it used to create the deposit. In our system banks act to facilitate wealth creation but in the process act as a net drain on financial assets.
I’m sorry Ben, but I think this is just not quite right…it is like Objectivism…sure it is a very consistent and logical world view, but it just doesn’t seem right.
It sounds like you see all money as being government spending or something. Sure, the amount of money in the economy is reduced, but how that translates into less government spending is not clear at all to me, still.
This seems to contradict what you wrote earlier,
The implication here is that lowering the interest rate, expanding the money supply, is some sort of government spending. I just don’t see that. Yeah, I see how raising/lowering the interest rate expands/contracts the money supply, but I don’t see that as identical to government spending.
@Steve Verdon
“It sounds like you see all money as being government spending or something. Sure, the amount of money in the economy is reduced, but how that translates into less government spending is not clear at all to me, still.”
What I’m attempting to say is not that all money belongs to the government, but that government is the original source of all money in the economy. It can’t be any other way because the feds have monopoly control of the dollar. No one else can print them, electronically or otherwise. If everyone could make their own money this dynamic would be non-existent but in the system we currently have, the private sector requires government spending if it wants to accrue financial wealth.
Let’s say it’s just you and me in our own “economy” with a total of $100 in circulation. I sell things to you, you sell things to me and that $100 provides our income. Now let’s say you decide to begin saving money, so at the end of the year you put $5 away. Obviously we’ll only have $95 in circulation after that, which means my income must drop. The more you save, the more my income drops. The only way to avoid this is for someone to print an amount of money that is at least equal to your rate of saving. That’s the role the federal government is playing and it gets that money into the economy via spending. Loose monetary policies attempt to do the same via the money multiplier.
“The implication here is that lowering the interest rate, expanding the money supply, is some sort of government spending. I just don’t see that. Yeah, I see how raising/lowering the interest rate expands/contracts the money supply, but I don’t see that as identical to government spending.”
This is correct. What I’m saying is that fiscal and monetary policies are in reality different methods intended to reach identical ends. The central bank tightens interest rates to reduce money supply, but the same thing happens if taxes are raised or spending is reduced. The CB lowering rates can’t increase the money supply but it can help reduce the outflow. Government increasing spending or lowering taxes is increasing the money supply.
The big difference is the CB knows what it is attempting to do and Congress doesn’t; Senator X doesn’t think of larger deficits in terms of growing the money supply, he just spends to please his donors and constituents. Congressman Y isn’t thinking of slowing the growth of the money supply when he advocates raising taxes, he just does it to please his donors and constituents. But in the end the Congress’ fiscal polices are actually monetary policies.
I’d agree if my money goes into a tin can buried in my back yard. But it doesn’t, that is one area I have a problem with this.
Does it slow the growth of the money supply? After all the government does spend the tax revenues. I agree higher taxes, theoretically, will reduce economic activity due to deadweight loss, but not sure it has much impact on the supply of money.
So it isn’t just government spending that can allow the private sector to increase their financial wealth.
Maybe so, but that doesn’t mean they have identical implications for the economy as a whole.
For example, increasing debt without consideration of whether people will keep lending to us is one dubious assertion you have made. You’ve implicated in the past that there is no issue in this regard. You’ve also indicated, if memory serves, that we can just create more money to deal with the problem. However, I don’t think it works quite that way. If you start creating more and more money it will have less and less real impact. Especially once people figure out what you are doing.
If there are limits to money creation, then there it seems to me there are limits on how much we can borrow as well.
@Steve Verdon
If you want to understand how this works, you need to think like a street hustler. Much of what the Fed and US government does would be illegal if done by any other entity. A good street hustler may not score high on the IQ test, but he would understand how this works. Most economics is gobbledygook because the economists have no idea of how the game works.
“For the Snark was a Boojum, you see.”
@Ben Wolf
… The only way to avoid this is for someone to print an amount of money that is at least equal to your rate of saving. …
The money printed is counterfeit, but since it is created by the Fed, it looks like real money. If money is printed to replace the saved money, the $5 is now worth $4.92, and each dollar is worth $0.95. Hence, my money has been debased.
Let’s say it’s just you and me in our own “economy†with a total of $100 in circulation. …
The problem here is that the size is too small to use as an example. This presumes a modern functioning economy, and it is dependent upon that economy. This is not a trivial objection. In 1066AD, the example would be nonsensical.
… That’s the role the federal government is playing and it gets that money into the economy via spending. …
The Fed issues dollars, and money gets into the economy through the Fed crediting accounts. This can be lending to banks based upon their excess reserves, or it can be purchasing assets – government debt primarily. The money that the Fed used for these transactions does not need to exist, and the non-existent money is counterfeit. The Fed’s books do not balance.
(In order to understand what is going on, think like a street hustler. The techniques are the same.)
… Loose monetary policies attempt to do the same via the money multiplier.
As you have noted, the Money Multiplier is a myth. I would go further. It is nonsense. I believe MMTer’s noticed that Fractional Reserve Banking does not make any sense in creating money. Deposits are offset by loans, and the entire system should balance. I started to read your above link, but it started to make my head hurt. That anybody believes this nonsense is amazing, but that it takes 58 pages with graphs to come to this conclusion is troubling.
… but that government is the original source of all money in the economy. It can’t be any other way because the feds have monopoly control of the dollar. …
The Fed issues currency, but it does not make it valuable. The monopoly control only extends to the physical or electronic representation of the value of the dollar. If the Fed were suddenly to cease to exist, the dollars would still have value, and to the extent people trusted them, they would still be used. This trust would require people believing money was not being created physically or electronically.
… in the system we currently have, the private sector requires government spending if it wants to accrue financial wealth.
I think this is part of MMT, but you have gone off the rails. If the government were to suddenly decrease its spending, financial wealth would still be accrued. In the case that the Fed stopped printing money, the existing dollars would become more valuable as the economy expanded.
The dollar issued by the Fed is a medium of transactions, and they represent value with or without government spending. Any sufficiently trusted and stable medium could be used in place of dollars – gold, oil, commercial paper, yens, cheeseburgers, etc.
… The CB lowering rates can’t increase the money supply but it can help reduce the outflow. …
I agree, but rate adjustments can work if there is an existing demand. In the present downturn, the demand is lowered, and the rates are not having the expected effect. This has exposed the Money Multiplier as nonsense.
… Government increasing spending or lowering taxes is increasing the money supply.
Government debt can be used to increase the money supply, but this would require the Fed to purchase this debt. Additionally, the money supply is decreased when the Fed sells assets or calls in loans. While much government spending is wasted, the money is still going into the economy. The money for this spending comes from borrowing and taxing. This does not add or subtract money from the system. The Fed is the only entity that can create money, and therefore, it is the only entity that can increase the money supply.
The big difference is the CB knows what it is attempting to do …
Alan Greenspan thought he could control the economy through the money supply, but like the Sorcerer’s Apprentice, he was woefully inadequate for the task. Bernanke and company are idiots, but they are useful to the politicians.
“For the Snark was a Boojum, you see.”
@TastyBits
“The Fed issues dollars, and money gets into the economy through the Fed crediting accounts. This can be lending to banks based upon their excess reserves, or it can be purchasing assets – government debt primarily. The money that the Fed used for these transactions does not need to exist, and the non-existent money is counterfeit. The Fed’s books do not balance.”
This is incorrect. Net financial assets are created only when Congress authorizes spending. The Fed then transfers reserves to the recipient’s banks and desposits are created in their accounts. Bank reserves are of strictly limited utility and cannot be used for making loans outside the banking system. Nothing has been “counterfeited”, whicn means to illegally imitate something. The government is fully authorized to create money as it desires.
“Government debt can be used to increase the money supply, but this would require the Fed to purchase this debt. Additionally, the money supply is decreased when the Fed sells assets or calls in loans. While much government spending is wasted, the money is still going into the economy. The money for this spending comes from borrowing and taxing. This does not add or subtract money from the system. The Fed is the only entity that can create money, and therefore, it is the only entity that can increase the money supply.”
The government has a printing press and does not need to issue debt when it wants to spend. The Fed does not in any sense fund deficit spending. When the Fed sells assets or calls loans this makes changes in the monetary base, not the money supply. The two are different.
Your assertion the Fed is the only entity which can create money is flatly untrue. Not only is it barred by its charter from doing so, the only entity empowered to produce additional dollars is the Department of Treasury, which is exactly what happens when government spends. Congress authorizes Treasury which authorizes the Fed to transfer new reserves into the banking system, what is called a vertical transaction. Again, the CB’s playground is the monetary base which is insulated from the money supply.
“Alan Greenspan thought he could control the economy through the money supply, but like the Sorcerer’s Apprentice, he was woefully inadequate for the task. Bernanke and company are idiots, but they are useful to the politicians.”
As I said, the CB knows what it is TRYING to do. But in direct contradiction to your belief in the overwhelming power of the Fed, Greenspan and company have failed at every turn because the CB cannot add to the money supply. They’ve been attempting to do so for four years now without any success whatsoever. Do you really think their actions over that period haven’t been an attempt to reinflate? Yet it never seems to happen no matter how many monetary tools the employ. The only way the Fed can create net financial assets via monetary policy is to make loans and deliberately take losses, which it can’t do because this would violate its charter.
Ben,
I’m skeptical that the solutions to our current economic problems will be found in fiscal or monetary policy. In other words, I think our problems are structural.
@Andy
I think you’re largely correct. Even if we got our politicians understanding concepts like sectoral balances it wouldn’t change the incestuous and corrupt relationships between government and big donor industries distorting the real economy.
@Ben Wolf
I should have removed the “counterfeit” line. I removed the following paragraph, and this slipped through. “Counterfeit-like” would have been better. It does not matter what entity is creating the money; the result is the same.
The Fed is a private entity, but it does work in tandem with Treasury. Because it is private, it is able to keep scrutiny to a minimum, and what they are doing behind closed doors is not necessarily what people think is happening. Many people were surprised at what Fannie and Freddie were doing.
This is where I differ with most people, and it looks like I have gone off the rails. To me, the system looks like it was designed by hustlers. To a hustler, the rules are for saps and marks. They are not necessarily crooks, but the conduct may be deemed unsavory. I suspect that much of what MF Global was doing was legal, but they knew how to work the system.
Monetary Base vs. Money Supply. I stand corrected. The differences between the M’s are not as significant as advertised, but I will not argue the point. The amount of Credit/Debt is a lot more significant, but that is another matter.
As I said, the CB knows what it is TRYING to do. …
I was not disagreeing with you, but I think Bernanke and Geithner are idiots. I agree that the Fed cannot push money out the front door, and since the demand for the money is down, the low interest rate is not having the predicted effect. Alan Greenspan was “the maestro” because there was demand. After the stock market (dot com) bubble, Greenspan should have learned his lesson, but instead he teamed up with Paulson to bring us the Housing bubble. Greenspan and Paulson thought they could avoid a catastrophe.
(I am not arguing that they were the sole cause, but they did contribute greatly.)
“For the Snark was a Boojum, you see.”
IOeRs induce dis-intermediation (where the intermediaries shrink in size but the CB system stays the same), within the money market. IOeRs have altered the construction of a normal yield curve, they have INVERTED the short-end segment (i.e., the remuneration rate @ .25% is higher than the daily Treasury yield curve 2 years out – .26% on 01/09/12).
I.e., in this case: “it’s that money will flow OUT of the economy into the banking system” The most important lending sector in our economy are the financial intermediaries (non-banks) — or pre-Great Recession, 82% of the pooling & lending markets (Z.1 release, sectors, e.g., MMMFs, commercial paper, GSEs, etc.).
It is money & banking 101:
(A) The commercial banks create new money (in the form of demand deposits) when making loans to, or buying securities from the non-bank public; whereas lending by financial intermediaries simply activates existing money.
(B) Bank lending expands the volume of money & directly affects the velocity of money, while intermediary lending directly affects only the velocity.
(C) The lending capacity of the commercial banks is determined by monetary policy, not the savings practices of the public.
(D) The lending capacity of financial intermediaries is almost exclusively dependent on the volume of monetary savings place3d at their disposal. The commercial banks, on the other hand, could continue to lend if the public should cease to save altogether.
(E) Financial intermediaries lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the commercial banks lend no existing deposits or savings: they always, create new money in the lending & investing process.
(F) Whereas monetary savings received by financial intermediaries originate outside the intermediaries, monetary savings held in the commercial banks (time deposits & the saved portion of demand deposits) originate, with immaterial exceptions, within he commercial banking system. This is demand deposits constitute almost the exclusive net source of item deposits.
(G) The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can bank loans (if monetary policy permits & the opportunity is present ) which amount to several times the initial excess reserves held.
(H) Monetary savings are never transferred from the commercial banks to the intermediaries; rather are monetary savings always transferred through the intermediaries. The funds do not leave the banking system.
I.e., IOeRs cause a cessation of circuit income & the transactions velocity of funds. IOeRs absorb savings and reduce real-output.