All Eyes on the Fed

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Yves here. It’s frustrating seeing experts (all card carrying members of the top 10%) discuss Fed policy, taking as a given that the US economy is strong, when the headline employment figures mask a high level of involuntary part-time employment and weak labor bargaining power. It would be difficult to fill backbreaking Amazon warehouse jobs if we were in a “strong” economy by the standards of yesteryear. I recall the supposedly halcyon days of the late 1990s, where a lawyer colleague (a savvy stock market and real estate investor) who had mainly entrepreneurial clients was dubious of the strength of commercial activity outside the dot-com arena (which included companies who benefited from old-line firms making panicked moves in response). A partner in a bankruptcy specialist firm who was doing gangbusters business back then said, “The second tier of the two-tier economy is hitting the wall.”

Michal Kalecki foresaw this all in 1943. From his seminal essay on the impediments to achieving full employment:

What will be the practical outcome of the opposition to a policy of full employment by government spending in a capitalist democracy?…. We argued there that we may expect the opposition of the leaders of industry on three planes: (i) opposition on principle to government spending based on a budget deficit; (ii) opposition to this spending being directed either towards public investment—which may foreshadow the intrusion of the state into the new spheres of economic activity—or towards subsidizing mass consumption; (iii) opposition to maintaining full employment and not merely preventing deep and prolonged slumps…..

In current discussions of these problems there emerges time and again the conception of counteracting the slump by stimulating private investment. This may be done by lowering the rate of interest, by the reduction of income tax, or by subsidizing private investment directly in this or another form. That such a scheme should be attractive to business is not surprising….

It may be shown, however, that the stimulation of private investment does not provide an adequate method for preventing mass unemployment. There are two alternatives to be considered here, (i) The rate of interest or income tax (or both) is reduced sharply in the slump and increased in the boom. In this case, both the period and the amplitude of the business cycle will be reduced, but employment not only in the slump but even in the boom may be far from full, i.e. the average unemployment may be considerable, although its fluctuations will be less marked, The rate of interest or income tax is reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously.

In other words, relying on the private sector, even with government boosters like lower interest rates, to combat downturns over time results in shallower but longer expansion period. So it’s not surprising that this “groaf” period doesn’t seem all that peppy.

By Inês Goncalves Raposo, an Affiliate Fellow at Bruegel who worked previously for the Financial Stability Department of the Bank of Portugal. Originally published at Bruegel

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

The Federal Open Markets Committee (FOMC) held its third meeting of 2019 last week (April 30th and May 1st). Given the very recent change in monetary policy stance, there was no great anticipation of interest rate changes. However, despite how predictable the conclusions of the FOMC meeting were, the blogosphere still took it as an opportunity to come forth with insights both on the future of the Fed’s monetary policy instruments and on its governance.

A first line of opinions assesses the aftermath of the Fed’s latest dovish turn. Some are sceptical: Tim Duy from FedWatch argues that, while last week’s monetary policy meeting did not yield any fundamental changes, the Fed may soon reverse this path and go back to a hawkish approach. This scenario is not crystal clear – rate hikes are not foreseeable given forecasts of inflation alone, and Fed officials such as Charles Evans and Eric Rosengreen have been vocal about policy strategies allowing for above-target inflation.

Still, Duy lists three scenarios under which a policy reversal – a ‘Dove Trap’, as he calls it – could take place. First, if growth, labour-market and inflation numbers outperform expectations; second, if unemployment numbers are lower than anticipated; third, and last, if the Fed deems that we are too late in the current economic cycle to experiment with persistently above-target inflation, leaving changes in the Fed’s policy strategy for the next cycle. “Any talk of catch-up strategies in which the Fed makes up for low inflation by targeting higher inflation, for example, may only be in preparation for the next recession. In that case, it has little if any relevance for the near-term outlook.”

Others, such as Christophe Donay from Pictet, take a more upbeat stance. Donay points out that the Fed’s dovish turn and the promise “to be patient on further rate hikes” has helped markets in the beginning of the year. Signals that the end of balance-sheet reductions is near have calmed market concerns about the prospect of tightening financial conditions. Donay wonders whether this turn also means a turn of the page in central-bank policymaking – the low interest rates and the end of the economic cycle will force central banks to be creative in the event of a downturn.

Indeed, some have already started questioning the instruments that the Federal Reserve has at its disposal to manage the economy. While the Fed has so far mostly relied on the federal funds rate, Bill Dudley, former president of the Federal Reserve Bank of New York, writes that this target has “outlived its usefulness”. As a result of quantitative easing, he explains, banks have accumulated reserves that in turn reduce their need of borrowing or lending federal funds. As a consequence, the interest rate on reserves “has become the Fed’s most effective tool of monetary policy, putting a floor under the interest rates at which banks are willing to lend”. Dropping the federal funds target and focusing solely on the interest rate paid on reserves, Dudley argues, “would have no meaningful effect on the Fed’s monetary policy stance” and would simplify policies by “eliminating the need for technical adjustments to the interest rate on reserves to ensure that the federal funds rate stays within its range”.

Currently the Fed operates monetary policy in what is called a “floor system”, whereby the target interest rate is equal or very close to the interest rate on excess reserves (IOER). David Beckworth, from MacroMusings, argues that this could soon enough turn into a “corridor system”, where the overnight interest rate is above the IOER. This transition from floor to corridor could be caused by a large shift in the demand for reserves, moving the Fed off “the perfectly elastic or ‘flat’ portion of the bank reserve demand curve”. The shift could happen with or without a significant reduction in the supply of reserves. “The Fed, in other words, could have a relatively large balance sheet and still end up in a corridor operating system.” 

With regard to governance, Dudley highlights it as an impediment to the change in interest-rate priorities. More precisely, the future of the Board of Governors has also been a heated theme. Tyler Cowen from the Marginal Revolution drafts a supermarket list for the attributes of an ideal candidate: a record of practical managerial experience, a reasonable diplomat with some “measure of gravitas”, “high credibility with other Fed board members, most of all the chair”, “strong political skills” given the several interactions with the media, and – not least important – “well-informed views, however you might define them, on monetary policy and regulation”.

Scott Sumner from The Money Illusion weighs in and adds personal integrity to the list, but also vouches for a more decentralised Fed. In his view, a committee composed entirely of experts on monetary policy and another committee of experts on bank regulation “would allow more weight to be placed on expertise for monetary policymakers, and relatively less weight on managerial skills”.

Gregory Mankiw boils down the past success of the Fed “as a public institution” to two ingredients – first, its nonpartisan and widely shared mandate and objectives; second, the quality of their human resources, ranging from their research assistants to the board of governors. The latter group typically possesses either “proven expertise as an economist or substantial experience working in the financial sector” and is appointed for 14-year terms, a long enough term that is meant to keep the governors independent from political pressures.

Mankiw says nominees of the likes of Cain and Moore to the Fed Board are “simply not qualified” and he was “hoping that the Senate will reject them if they are nominated”. Krugman also expresses reservations with regard to Moore, and remarks that his past evaluations of the Fed’s policy, which have “always been wrong”, have gone unquestioned by the Republican senators so far. Both the candidates have since withdrawn.

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  1. OpenThePodBayDoorsHAL

    End The Fed.

    Or just call it what it is: Soviet-style top-down command-and control price fixing. Of the most important price of all: the price of money.

    Object example is the steep downturn of 1920-21. What did the Fed do? Nothing. How fast was the recovery? Almost immediate. Contrast that with 1929-39. Or 2008-present.

    The very idea that somehow the business cycle should be “smoothed out” is nonsense. For the last 9 years money has been “free”. So every last possible piece of future consumption has been brought forward. Happy now? No wonder companies are not investing: they see the prospects for future demand growth are nil. So where did we end up? Running in place. Except that savers have been decimated, and asset speculators got that second private island.

    Free your mind. End The Fed.

    1. Samuel Conner

      IIRC from Prof Wray’s “MMT Primer”, many MMT theorists think that the short term interest rate should be close to zero (the world may have entered that monetary regime at long last and may not leave it) and that interest rate policy is in any event the wrong tool of macroeconomic stabilization.

      Treasury could issue interest bearing longer term notes as a courtesy to savers (not to mention insurers, who need to generate low-risk income), though it might be better to simply use that portion of the deficit to fund an adequate retirement UBI.

      I suspect that implementation of MMT principles in US govt finances might need to be accompanied by more intrusive regulation of the parasitic parts of the finance system (the parts that exist to simply make “money from money” rather than making money by directly serving the credit needs of the real economy).

      1. rob

        The up side of MMT principles could be better executed were we to nullify the federal reserve act, and let the treasury issue our money. Without fractional reserve banking, and by not allowing banks to create money when they make loans; the money supply could be provided free of debt .

        There is no need to worry about zero interest, if the treasury were allocating the money to the society,free of charge. The only way to do that is to change the bad law that created the fed and all its concubines on wall street.

        If you show up at someones house and find a system full of useless, energy wasting equipment , that doesn’t even belong there, all hooked up and “functioning”…. but wasting energy, and space, and is causing the whole system stress it shouldn’t have to deal with, and it isn’t efficient and in fact doesn’t really do a good job….. why would you worry about replacing the useless parts to keep the system operating as some, crackpot made it…. you wouldn’t.
        you would uninstall what isn’t needed, and make the system work better, more efficiently, for less cost.
        That is why monetary reform is needed. we have a system of bells and whistles who don’t really add to anything, except waste and corruption. It is time to make positive changes in the corrupt system that is “working for some”, and not for most…. . We owe it to our posterity.
        MMT doesn’t get us there… it is just saying the bells and whistles are good…. and that is patently false. We need a new law. one that is in line with the constitution, and puts the creation of money back in the hands of the treasury..
        We are a more mature country than we were a hundred years ago…. we can do this now, and the world will still value our money.

    2. skippy

      Corporations were looting themselves decades ago and it had nothing to do with the Fed, not that I ascribe to monetarism, quasi or otherwise. Crapification and divergence of wages to productivity with a side of shareholder value seems a more likely suspect.

      1. Adam Eran

        The Godfather films are not so much entertainment as prophecy and parable. They clarify the pattern for American business practice.

      2. rob

        so the feds actions before and after the looting that took place before and after 2008, are OK?
        So you think the fed has been “doing the right thing”, and it is corporations that are the real “bad guy”….
        So the 16 trillion dollars it created to bail out american and foreign multinationals, wasn’t anything.
        The QE program wasn’t contributing to any bad actors balance sheets?
        What about the corporations who are “the fed”. The fed is owned by corporations… banking corporations, all twelve branches, owned 100% by corporations… in the banking business…
        No conflicts there either….

        so even 10 decades ago….. oh wait…. the fed was there too…
        back when the JP morgan syndicate of 200 business which accounted for 1/6 of the GDP of the united states, or the rockefeller syndicate, or the mellon’s,cecil’s,whitney’s,astor’s,brown’s,walker’s,etc…..
        So when did the fed “do the right thing”?

    3. djrichard

      Think of all the downsides if we didn’t have a Federal Reserve:

      – All that creativity that goes into finding new markets for debt would have to find other outlets. Is there enough creative work out there to employ these people otherwise?

      – Without all that liquidity we’d have much less creative destruction (disruption). Though one might ask, is disruption wreaking havoc on the capitalist class? Or is it wreaking more havoc on the labor class instead?

      – Besides, who else can guarantee that the float of liquidity won’t go in reverse and suffer a bout of deflation? An issuer in the private sector? Puleeze. Asset inflation is a much safer business model with the Federal Reserve. Sure the Federal Reserve can always take the punch bowl away, but that never happens unless the party really gets out of hand (indicators being when taxi drivers start giving investment tips). Until then, “climb that wall of worry” baby! Besides, it seems the hoi polloi have finally figured out that they’re not invited to this party. In which case is there even a need to take the punch bowl away anymore?

      1. OpenThePodBayDoorsHAL

        The Fed reminds me of the Forest Service. They suppress small fires for decades, oh look, “stability”. None of those annoying local blazes. So the undergrowth grows up…until the huge conflagration comes through, it jumps up and becomes a crowning fire, and the whole forest burns down.

      2. rob

        what an illogical list of assumptions “if we didn’t have a federal reserve?”

        Now had we implemented the chicago plan of the thirties, ilk…. or maybe if the “banker’s model of the federal reserve hadn’t been passed in the first place and “public money” was incorporated in the first over a hundred years ago….. how many trillions of dollars od debt would never have been created, and not have been needed to have been “paid back”.
        To think of all the perverted wall street schemes for a century would not have ever found the funding from this goose that lays the golden debt eggs….

        right now we have a debt of 22 trillion dollars… if no federal reserve, the treasury could have been supplying all that liquidity, with no debt… so we would have 22 trillion dollars to do something else with… now think of those possibilities… We could say have treasuries issued debt instruments for borrowers to invest in, but rather than that money be earmarked to the most corrupt machine on the planet, it could be for funding environmentally responsible technology.

        People’s lack of imagination is astounding .

        If the “public money” side of the debate won over a hundred years ago, we would have not had the same wall street trash:
        who are the national security state, the military industrial complex, the academic industrial complex, the prison industrial complex, the healthcare industrial complex,the political duopoly,the agricultural industrial complex,etc….
        the fed, was created by the same robber barrons who have wreaked havoc all over the globe, for centuries.
        Our republic , might actually have made itself useful, rather than just a fob on a hill, that it is today..

        The fed wasn’t the answer, it was the banker’s choice. And the banker’s are not the local banker’s who do banking, they are the elite, who rule the world. they decide who gets unlimited funding, and who doesn’t. They have created our history as a happenstance to their business model.

        It is time to hit the elite where it hurts, in their money making machine…. the fed.

  2. timbers

    The Fed’s Inflation Fraud Report is like you guys say on here, a self licking ice cream cone.

    The inflation numbers don’t include enough of where all the Fed money is gong via ZIRP and QE – into assets, which have experience massive inflation. The Fed sees low inflation because it excludes these from it’s inflation report or gives them too little wieght. The Fed gives more weight to things bought by those who don’t benefit from ZIRP and QE…people who’s income is declining, hence reported inflation is understated and seemingly can’t rise.

    So the Fed is waiting for inflation to show up in a report designed to not report inflation caused by the Fed. Thus the Fed is trapped an eternal Dovish policy of giving more money to the asset class.

    1. rob

      That sounds like “the point”.
      The fed is there to “dance with who brung ’em”
      They can have all the money they can make and are owed a debt for….. what a wonderful world it is …..for some.

    2. Oh

      Like you say inflation numbers are a joke because they don’t reflect reality. ZIRP has already created a huge rise in asset prices. It has helped the top 10% and rentiers.

      1. John

        The real economy doesn’t seem to matter … Housing, food, healthcare, education etc

    3. Wukchumni

      And in grandma alt-a dinner news, cans of Fancy Feast went from 57 to 64 Cents in the local supermarkets, and using Fed math, that works out to 2% inflation, tops.

  3. rob

    We need a serious discussion on monetary reform.
    We need to end the federal reserve act, stop creating all this debt, when we create money. End fractional reserve banking, end the “free lunch” the banking industry gets by being allowed to create money by making loans, end this power wall street has over the rest of the economy.
    The 112th congress HR 2990 was a bill that needs to be re-proposed, and adopted… “the NEED act”
    To end the fed. and roll the function of the fed into the treasury, so we can create our money without debt.

    We need to get past the mumbo jumbo that is MMT, and address the reality that nothing progressive is going to happen by letting the wall street banks and financial system players control our money. We are not experiencing a system where the good of the people is on the agenda. WE CAN CHANGE THAT.

    1. skippy

      If you had not noticed America can create its own money, politics and ideology aside, distribution is another thing.

      Money and Debt are synonymous outside the advent of the Fed, read about it.

        1. skippy

          I’ve got no issues with interest on money till rentier level et al, still it seem divergence between wages and productivity kicked off a cornucopia of credit abuse.

          Try going back there and workout all the issues, just saying the fed or credit did it is a bit information lite … people did stuff …

          Search an old Frontline show on CC.

      1. rob

        Sorry skip,
        I have read about it…
        the federal reserve act actually prevents the US from creating its own money(except coins).. it is the federal reserve act that specifically prevents the US from issuing its own money, as was done by lincoln.
        So politics and ideology aside, the US does not create its own money.
        Private banks do. some of them are contractually obligated to provide whatever money, the treasury creates debt instruments for…
        You seem really slow on this point…
        What part of the government creates money (besides coins)? And I mean US government, not a contractor for the US government.
        The fed is like blackwater is to the military,or state dept.. or anyone else who wants to hire them. they are given special permission to act in lieu of armed forces, and given rights of immunity, but they are NOT the military, and they are not the government..
        The 12 fed banks are owned by shares, and the US government owns NONE of those shares. Who pays the salaries of the fed committee’s?
        So why don’t you show me some PROOF the fed IS the US gov’t..

        And if the government can create it’s own money, why doesn’t it do so? and why does it still feel the need to create a debt, for something it can just do by keystroke?
        It is called the federal reserve act. you should look it up sometime.

  4. leondarrell

    Bill Black’s idea of banks and now corporations having incentives to loot themselves is most relevant. The salaryman class and investor class have incentivized the diversion of funds thru internal accounting to juice dividends and buyback stock with active/tacit Wall Street collusion. Anyone expecting a good end to this doesn’t know history (or doesn’t care).

  5. Susan the other`

    Dudley – the Fed funds rate has outlived its usefulness and the Fed should just go with interest paid on excess reserves. So instead of a “floor” rate we will have a “corridor” rate that fluctuates within a close range of possibilities? Couldn’t quite follow, but it sounds like Dudley is saying that we find ourselves without any real options to juice the economy. So we should just administer the proper dose of adjustment in real time. The economy is what it is. And money only responds to the economy. Whereas if MMT were able to operate by direct spending, the economy could be coaxed forward in useful directions. Money well spent. The FOMC sounds like a dutch auction anyway… or like the LIBOR technique… kind of an aimless grab for money you hope will bring some return somewhere. What I see here is banks in search of an economy. And maybe a little chagrinned that the free market doesn’t apply to money at all. What a revelation. The banks really can’t move things – only the government and the people can. Inflation is close to meaningless these days.

    1. OpenThePodBayDoorsHAL

      Look at loan originations. The BOE admits that’s how money is created. But with ZIRP we’ve pulled all future demand to the present, which then instantly becomes the past. So businesses don’t lend. All you’re left with is debt service and no groaf.

      I think The Fed knows this. The transmission channel for them to get money out there is broken. So they choose Transmission Channel #2: the asset markets. Make them go up and suddenly there’s “more” money out there. But Oops 85% of stock market gains go to 5% of people. Nice system for the rentiers…not so much if you actually do work for a living.

  6. Chauncey Gardiner

    Thank you for an insightful post, particularly Yves’ intro with the extract from Kalecki’s 1943 essay that concisely summarizes the inadequacy of reliance on private investment under current policies. Perhaps nowhere is this more self evident than in the counterproductive arena of massive corporate stock buybacks, the emergence of zombie companies, and related declining productivity under the Fed’s QE-ZIRP regime.

    However, I would add that in addition to the title of the article, my own eyes are also on the U.S. Treasury. I am seeking to understand the flow of funds to and from the Treasury General Account through the 19 global Primary Dealers. It would be useful to know whether those funds are flowing into the stock market, and if proceeds from the issuance of U.S. Treasury debt are being used to increase stock and corporate junk bond prices as a matter of policy. If so, what if any authority to do so exists beyond an executive order over three decades ago under then President Reagan to form the President’s Working Group on Financial Markets, colloquially known as the Plunge Protection Team; and whether we are being treated to another round of executive overreach without transparency, controls or oversight?

    Given the financialization of the U.S. economy and geopolitical considerations, there might be some arguments for a policy of financial markets support. However, its specific objectives, limits, and related current actions should be subject to public consideration and discussion, and passed into statute by Congress; as among other flaws – such as affording opportunities for insider abuse and contributing to economic inequality – it heralds the end of so called “free markets”, a basic tenet of capitalism as a system.

  7. Sound of the Suburbs

    The FED never really stood a chance.

    They are trying to run the economy with an economics that doesn’t consider debt, neoclassical economics.

    Greenspan and Bernanke can’t see the problems building before 2008.

    No one can work out what caused 2008, and afterwards and they attribute it to a “black swan”.

    Janet Yellen is not going to be looking at that debt overhang after 2008 and so she can’t work out why inflation isn’t coming back.

    It’s called a balance sheet recession Janet, you know, like Japan since the 1990s.

    Jerome Powell is not looking at the debt overhang after 2008 and so thinks the US economy is fixed and raises interest rates. Raising interest rates with all that debt in the economy will soon cause a downturn and there is no way he will get anywhere near normalising rates.

    The FED don’t stand a chance until they start looking at private debt.

    1. Sound of the Suburbs

      Trying to run the economy with an economics that doesn’t consider debt, neoclassical economics.

      The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression.

      No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.

      Better shelve this for a few decades until everyone has forgotten.

      Now they have forgotten we can use it for globalisation.

  8. Oregoncharles

    “It may be shown, however, that the stimulation of private investment does not provide an adequate method for preventing mass unemployment.”

    For one thing, and often forgotten, a large portion of private investment is to “increase productivity” – that is, eliminate jobs. That phrase always means LABOR productivity, not capital or resource productivity. Increasing labor productivity inproves the general welfare ONLY if there is full employment.

    This logic is all too obvious; ignoring it reveals that most economics is propaganda for the merchant class, not science or even in the public interest.

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