"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Thursday, November 18, 2010

Really good links - Too little money chasing too many goods - Credit Easing - Will the Fed Scale Up QE2? - Leverage as a positive good - Currency war - Fed - IOR

Bill Woolsey - Recession - "Recession is NOT too little money chasing too many goods.
        It is too little money chasing too few goods."

Ben Bernanke, please bring credit easing back! Here is what you said about it in 2002:
        "If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities."

Tim Duy - Will the Fed Scale Up QE2? - "But we shouldn't kid ourselves. Flooding the market with money is dangerous business. It risks distorting prices and capital allocations. We simply don't know where the money will wash up. I know that is in vogue to believe there is a nice, obvious story that links an increase in the money supply to an increase in nominal GDP, but that only works on paper. In the real world, the paths between money and output and prices are complicated. The ultimate composition of aggregate demand matters. It matters a lot - distortions have consequences. Warsh's risks amount to a laundry list of the possible distortions that might occur as the result of ongoing quantitative easing. And he clearly takes those risks seriously.
        It makes me think that I haven't been taking those risks seriously enough. But when monetary policy is the only game in town, what choice do you have? You do what you can up to a point…but then you throw it back to Congress and say "you take responsibility for the mess you created by abdicating your role in crafting long run, stabilizing macroeconomic policies." Warsh has set the stage for doing exactly that.
        Of course, seriously, if we really have to throw this back to Congress, we are absolutely done for. Cooked. Toast. Somebody remember to tell the last guy to turn off the lights on his way out. Better to take our chances with the next bubble.
        Bottom Line: One can tell a seemingly optimistic story - the threat of the double dip is behind us, setting the stage for a nice return to potential growth. But that story holds the dark side of persistent, pernicious low levels of labor utilization. Still, I think now the Federal Reserve would have chosen the optimistic narrative had it not been for the obvious slowdown midyear. Which suggests to me they are not eager to do more, especially if growth settles back in at trend. Reinforcing that belief is the Warsh speech, which makes a strong case that further monetary policy is increasingly ineffectual and very risky. But even more important, he makes clear a belief that only Congress and the Administration have the tools to restore growth. I imagine if that view is, or becomes, a widespread opinion among policymakers, we have seen the last gasp of quantitative easing. They have abated the financial crisis, serving as the lender of last resort, and flooded the economy with cash. They have done what they can. The rest is up to the fiscal authorities. "

Brad DeLong - Leverage as a positive good - "Once we had concluded that the Federal Reserve had the tools and the competence to absorb financial shocks, the jaws of the trap snap shut. Leverage then appears to be a positive good rather than a danger. Why? Because if the past two centuries of financial market history prove anything, it is that the markets are woefully short of patent capital willing to bear risks. The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many--for that is what low long-term returns on "safe" portfolios tell us--and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few."

Menzie Chinn - QE2 and currency war - "I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)
        My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation."

Statsguy - Fed and the support of financial system - "Finally, the one CONSISTENT principle the Fed has pursued has been to support the financial system. Period. I would challenge you to name a single decision in the last 3 years that hasn’t favored the financial system. Even QEI was not unleashed until the Fed was absolutely sure the threat of rising interest rates had been crushed, and the risk of financial collapse through defaulting loans and asset depreciation had exceeded the risk of financial collapse through loss of bond valuations. AKA, liquidity crunch.
        The current QEII round has directed preferential liquidity through primary dealers, thereby supporting trading activity which has buttressed bank balance sheets (in other words, infused capital) to compensate for the bad loan book.
        You currently view Bernanke et. al.’s endorsement of QEII as an intellectual victory. Consider, for a moment, it simply reflects a closer alignment between the interests of large financial entities, and the broader economy."

Niklas Blanchard - Interest on reserves - "I think that Drum gets two things wrong in his analysis. The first is that interest on reserves is a very desirable policy that smooths out the Fed Funds rate fluctuations, reduces lending spreads, and reduces the opportunity costs of capital. Milton Friedman was the most famous proponent of interest on reserves, and Canada and Australia (if I’m not mistaken, working from memory) also pay interest on reserves.
        When Kevin says that the IOR should be zero, what he should be saying is that the Fed Funds rate should be zero, and should have been in Sept 2008 (currently 0-.25, at the time it was 2). "

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