As a kid growing up I would have thought big time university professors would know better than this.

It should be obvious to him that markets follow expectations of future Fed policy, they don’t cause it.
The fed funds rate changes only when the Fed votes to change it, and the NY Fed has a good enough understanding of its own monetary operations to implement the FOMC’s will. The fact that under Geithner they never could hit a fed funds target is another story for another time, but rest assured it had nothing to do with bond vigilantes.

Yields are probably going up for two reasons. The first is the expectation that fiscal expansion does work and therefore the Fed is more likely to hike that much sooner. Note that GDP forecasts being raised by most all economists, who also were ready to lower forecasts if the tax cuts are allowed to expire.

The currency is a public monopoly, and as a simple point of logic (not theory or ideology) a monopolist sets two prices. One is how the item exchanges for itself, what Marshall called the ‘own rate’ and for the currency is the interest rate.

In other words, the Fed/govt. sets the entire term structure of risk free rates, one way or another, whether it likes it or not and/or knows it or not.

A monopolist also sets the terms of exchange for his item vs all other things, which for the currency is called the ‘price level’.

In other words, the price level is necessarily a function of prices paid by govt. when it spends, also whether it knows/likes it or not.

(Kindly send this along to the good professor if you have his contact info.)

Bond Vigilantes Could Target US: Roubini

Economist Nouriel Roubini on Wednesday voiced concern over a compromise on extending tax cuts struck by US President Barack Obama and Republican leaders, saying the agreement could expose the US to bond vigilantes who will drive up the price of yields.

Bond vigilantes – the term was coined by economist Ed Yardeni in the 1980s to describe major investors who demand higher yields to compensate for the perceived risks resulting from large deficits – could derail the country’s precarious recovery, some economists say.
Roubini, who has been dubbed Dr Doom since he accurately forecast the latest financial crisis, said on Twitter: “Obama-GOP tax deal costs $900 billion over two years. US kicking the can further down the road. Are bond vigilantes starting to wake up?”

Republican leaders and the White House agreed earlier this week to extend tax cuts on all income groups for two years and extend unemployment benefits in a deal which they hope will spur economic growth and cut unemployment.

Roubini is not alone in thinking the deal could worsen the US deficit and put the country at risk.

Chinese central bank adviser Li Daokui said on Wednesday the fiscal health of the United States was worse than Europe’s, and that the dollar had so far been shielded from trouble because markets are still focused on debt-laden European countries.

US bond prices and the dollar would fall when the European situation stabilizes, Daokui said.

116 Responses

  1. Hi Warren,

    You said, “…It should be obvious [to him] that markets follow expectations of future Fed policy, they don’t cause it…”

    But what if the bond markets are “pricing in” a general feeling that the “herd”, regardless of operational realities, is going to, sooner or later, abandon the dollar in lieu of some other investment (commodities, etc.)? So I guess what I’m asking is this: Is it possible that the “vigilantes” about which Roubini speaks may pursue market strategies that have little to no basis in operational truths, but that are simply one more example of human beings’ propensity to run with the herd?

    1. yes, herd mentality can drive prices for a period of time.

      but that doesn’t mean that the fed isn’t price setter for the term structure of risk free rates whether it likes/knows it or not

  2. ‘US bond prices and the dollar would fall when the European situation stabilizes, Daokui said.’

    Does anyone think that the European situation will stabilize any time soon? Phrased somewhat differently, is the Fed Reserve going to continue to bail out the Europeans? If so, which get preferential consideration?

  3. “Roubini is not alone in thinking the deal could worsen the US deficit and put the country at risk.”

    Since “deficit” is a synonym for “money created,” what does “worsen” mean? And what is the “risk”?

    “Chinese central bank adviser Li Daokui said on Wednesday the fiscal health of the United States was worse than Europe’s,. . .”

    The fiscal health of monetarily non-sovereign nations is better than the fiscal health of a monetarily sovereign nation??? Yikes! What qualifications does one need in order to become a “Chinese central bank adviser”? Any?

    As always with the debt-hysterics: Lot’s of blah, blah, blah, but zero data. They love meaningless generalities, but disdain facts.

    Rodger Malcolm Mitchell

    1. @ Roger,

      What I do now, is every time I read about debt and fiscal crises, I play a word game. I substitute words like “debt” and “deficit” for words like “rage” and “vengeance”.

      So…when I read comments like those provided by Li DaoKui, I superimpose one set of ideas and realities over the monetary and fiscal presentation. Translated thus:

      “Chinese central bank adviser Li Daokui said on Wednesday the fiscal health of the United States was worse than Europe’s,. . .” OR, in other words…

      Rage in the United States vis-a-vis the robbery and fraud committed by the financial sector upon the middle class is growing ever-more irrational and out of touch with the monetary realities of a fiat system. While such rage and lust for vengeance is reaching a tipping point in Europe, The U.S. may not be far behind. The system that is destroying the American middle class and promoting a growing gap between rich and poor is compelling even the most erudite of men to ignore operational truths in lieu of a lust for revenge and revolt.

    2. Rodger:

      Your major qualification would be your ability to get quotes into the media. Those quotes being structured to parse the official line into generally-accepted terminology.

      I’m willing to blame the US as much as anyone, but let’s not forget that bankers belong to no country. Even those resident in China.

      1. United by a common lust for power and wealth. Guided by the shining light of corporate profits.

        They are stronger than any country.

  4. Warren says “the price level is necessarily a function of prices paid by govt.” I don’t understand that. If inflation is 5% a year, government cannot get prices as of 31st December back to where they were the previous January by insisting on paying January prices. Or have I missed something?

    1. From the 7DIF book:

      ” It means that since the economy needs
      the government spending to get the dollars it needs to pay
      taxes, the government can, as a point of logic decide what it
      wants to pay for things, and the economy has no choice but to
      sell to the government at the prices set by government in order
      to get the dollars it needs to pay taxes, and save however many
      dollar financial assets it wants to.

      1. Also note that “is necessarily a function of” is not the same thing as saying “is determined at all times ONLY by.” Other things certainly matter, too, and it’s the price paid by govt RELATIVE to or GIVEN other prices that matters.

    2. I think Warren’s point is that the government has the power to fix the value of the dollar to anything it wants to — an ounce of gold, an Intel CPU, a bushel of corn, or an hour of unskilled labor. However, this necessarily involves using taxes to create demand for the dollar. If there are already too many dollars out there, then the government loses the ability to set prices unless it increases taxes to drain the excess.

      So, no, I don’t think you’re missing anything. I think Warren just left some stuff out…

      1. If private bank loans create deposits, then government does not have a monopoly on currency creation.

      2. bank loans create deposits, which are bank liabilities that can be used to pay taxes.

        this is because banks are the gov’s designated agents to do this.

        they could not create liabilities that are necessarily accepted for tax payment otherwise

      3. Paul: If private bank loans create deposits, then government does not have a monopoly on currency creation.

        Banks create deposits on their books by the stroke of a keyboard. A deposit is money that can be drawn on. That means the bank has to either provide cash at its demand window from its vault cash, or else it must have reserves at the central bank to clear any checks written on the deposit account.

        That is to say, there is a hierarchy of money, and the apex of the hierarchy, which is required for settlement, is either bank reserves or physical currency (in the US notes and coin). Bank reserves are created by the Fed, and notes and coins come from the Treasury. The Fed and Treasury are government agencies, so all that passes for money in the economy involves settlement in either cash or reserves. Only “government money” aka base money, serves for final payment in the settlement of transactions.

        BTW, in the US banks are not private entities. They are public/private partnerships. Banks have to have access to the Federal Reserve System, and the government places qualifications on this access and its continuation.

      4. Also, in the US, banks are allowed daylight overdrafts at the Fed, so rest assured your checks will never bounce because your bank doesn’t have a positive reserve balance at the Fed.

      5. Deposits aren’t currency.

        The bank has to have currency to clear any drawings on the deposit – otherwise you can’t spend it anywhere.

        When you store your money in a bank, the bank converts your currency into a deposit and then uses the currency you’ve given it to clear somebody else’s deposit.

        That, along with a state insurance policy, is why we need less currency in the system than we have deposits.

  5. “Roubini, who has been dubbed Dr Doom since he accurately forecast the latest financial crisis….”

    This guy raised to stardom due to his predictions, and now he is all over the media place.

    Hasn’t any of MMT economist made such forecasts?
    We desperately need an MMT Roubini!

    1. Dr Wray said the economy was going into the shitter back in 99 because of the budget surplus. Boy was he every right.

      1. So because he said that the economy was going to go bad, and because he gave a particular reason that it would, and because it did go bad, that means it must be for the reason he said it was going to?

    2. I have. On CNBC earlier this year I called the bottom of the euro and was ridiculed for it. See video on this website.

      I also called the turn in stocks in March 09 on this website a day or two before the absolute bottom.

      And I called for stocks going up when the s and p was about 1025 on this website saying that with a 9% budget deficit there wasn’t going to be a double dip that was being priced in.

      I also called the turn in aggregate demand in June 06 on my bulletin board.

      On Oct 26 on this website I called the top for the yen.

      My last very bad call was in 2008 when I didn’t think the fed would cut rates as long as inflation expectations were high and rising, even though the economy was heading south.

      1. Warren, you should have better promoted yourself!
        Have you ever thought about hiring PR professionals?

  6. If Dr. Doom can be deemed a star based on the “stopped clock syndrome” (a stopped clock is right twice a day), then I too insist on being elevated to stardom based on my June 5, 2005 speech to a group at the University of Missouri, Kansas State, where I said, “. . . because of the Euro, no European nation can control its own money supply. The Euro is the worst economic idea since the recession-era, Smoot-Hawley Tariff. The economies of European nations are doomed by the Euro.”

    Better hurry with the elevation, as I am 75 years old, and growing weary of the battle to educate those who refuse to understand the implications of monetary sovereignty.

    Anyway, ESM said, ” . . .this necessarily involves using taxes to create demand for the dollar. If there are already too many dollars out there, then the government loses the ability to set prices unless it increases taxes to drain the excess.”

    While I agree taxes create demand for dollars, they don’t have to be federal taxes. There are ample state and local taxes to do the job. I believe Warren and Randy agree. So federal taxes can (and ultimately should) be zero.

    As for “too many dollars,” are you talking about inflation? If so, increasing “taxes to drain the excess” is a certain path to recession or depression, as well as being too slow, to political, too uncertain and not incremental enough. Raising taxes to fight inflation is a worse idea even than was the euro, and that is saying something.

    Rodger Malcolm Mitchell

    1. “If Dr. Doom can be deemed a star based on the “stopped clock syndrome” (a stopped clock is right twice a day)…”

      While I understand Roubini’s forecasts flailed around for a few years being bearish about the wrong things (trade deficits, etc), I read a 50+ page PDF from him in January 2008 that was startling detailed and accurate. It predicted a tremendous amount of what unfolded that year. Given how much less accurate his work has been since then, it makes me wonder whether he was visited briefly by someone in a time machine from the future 🙂 But really I think he just clued into the industry level issues even though he shares the widespread flawed understanding of many macro issues.

      Rvm said “Hasn’t any of MMT economist made such forecasts?”

      Though I’m sure most have seen it, this sometimes get cited regarding those who “saw it coming” (not that I think highly of all of them!):

      As I understand it Randall Wray comes the closest among public-facing MMTers (he is mentioned in conjunction with Godley in that paper) but he was very early and not specific enough to carry a lot of credibility with the public, despite understanding the real issues that would eventually lead to crisis. But yes, such another loud and accurate forecaster would carry a lot of credibility!

      1. Beyond the numerous papers written by Randy starting in late 1990s (he didn’t stop there), there are several other notable ones:

        1. Rob Parenteau’s wp on household debt at LEvy in 2006
        2. Eric Tymoigne’s paper on household debt, mortgages, etc., in Challenge in 2007 (written in 2006)
        3. Numerous papers on EU going back to 1999. Kregel in 1999. Stephanie Bell-Kelton in 2003 (wp at CFEPS and edited book on the Euro). RAndy also did several on the Euro area, and the meaning of sovereign currency.
        4. Strategic Analyses at Levy starting in late 1990s to present.
        5. Randy and Jan Kregel started writing quite a bit on the mortgage crisis beginning in 2007-8.
        6. Randy wrote on “money manager capitalism,” via Minsky, throughout the 2000s, that’s basically the paradigm for understanding commodities and real estate bubbles.
        7. Stuff on the EPIC website will show that Warren was spot on regarding the trade deficit, Euroland vs. US solvency, financial engineering, etc.

      2. Forgot to add . . .

        there are many, many others. For instance, I was in US News & World Report in 2005 warning of problems brewing with household debt (all data used by the author in that article were from me, though unattributed).

      3. Sorry, I guess my summary was seriously lacking in depth and accuracy — thanks for the longer list! I’ll be curious to look some of them up when I have time. But even having read MMT blogs for a while now I had been left with the impression that many warnings were in somewhat broad terms about government surpluses, excess private sector debt, etc. I don’t remember seeing quotes since then about exactly how a crisis would manifest itself. (Probably me misremembering and not having looked the references up before). I did say above that Wray clearly “understood the real issues…”, so to be clear, I’m not questioning MMTs ability to foresee what has unfolded.

        My point with the Roubini example was that I think what led to his fame was just how specific and accurate he was in 2008, and that his presentations were shaped for public consumption and not overly academic. For example here’s the powerpoint I mentioned, from Jan 2008:

        and he followed it in Feb 2008 by a list of twelve steps that would unfold, along with a timeline, and they largely did. So he could cite his predictions all year long as things progressed, and the media attention snowballed.

        The examples you listed may well have been just as specific and publicly-accessible while failing to catch the public eye for other reasons, I clearly fall short on knowing this history.

    2. My point was that MMT needs a star-economist.
      How that MMT economist will raise to stardom isn’t important once he/she is there, IMO.
      I don’t know if Prof. William K. Black shares the MMT views, but he is closest to such status at present.

      1. Until we get that star economist, lets get someone to put out some rival videos to those annoying Austrian bent videos on the web that go about scaring people about govt debt, debt based money, quantitative easing and pushing guns and gold. They have creepy looking and talking characters but they are apparently as popular as Oprah.

        Surely we can steal that format and give a dissenting view…….. aka …… the truth.

      2. Greg, people want to be scared. It’s like kids watching horror shows. They also love to be outraged over their own projections onto others.

        Very, very few people in the world are interested in truth, because there is a price that goes with knowing it. You are morally obliged to act on it. So most people, consciously or unconsciously, go out of their way to avoid truth.

      3. Greg, your suggestion makes perfect sense to me.
        I think MMT enthusiasts should be even formally organized somehow.

      4. Their economics might be all wrong, but it’s hard to argue with them when their predictions have been right. I’ve been saying for years that gold is in a bubble and has nothing to do with the real world. And, yet, here we are at $1,400/oz.

        Roubini was the same way. He doesn’t understand this stuff at all, or at least didn’t for the years leading up to the financial crisis. I was a subscriber to his newsletter, commented on his blog a bit, and had a conversation or two with his collaborator, Brad Setzer. For years, they argued that the unsustainable size of the twin deficits (trade and budget) were going to bring the US economy to ruin. Well, they were right about a crisis happening, but they were right for the wrong reasons. Still, they got a lot of credit — or at least Roubini did.

        What MMT needs is for several proponents to make really bold predictions, and then attribute the correct ones (if any) to the consequences of an MMT analysis. I got some traction with friends and colleagues by claiming back in 2006 that budget deficits of almost any size are sustainable, and that in fact the deficit in 2006 was too small. There was some skepticism about $500B deficits being sustainable, but this naturally erodes when you finally arrive at $1.3T deficits as far as the eye can see, along with low interest rates and no inflation.

        I’m not sure what these bold predictions can be at this point. Predicting a huge stock market rally might be one, but fiscal policy hasn’t gotten to the point where I am THAT bullish. Predicting the collapse of gold would be a good one, but I don’t thing there is any MMT reason for that to happen, and in any case, its will probably be decoupled from fundamentals forever, just like sports franchises or art.

      5. @ESM re “Predicting the collapse of gold would be a good one, but I don’t thing there is any MMT reason for that to happen, and in any case, its will probably be decoupled from fundamentals forever, just like sports franchises or art.”

        If I’m not mistaken, doesn’t ‘money manager capitalism’ (not sure I like the term, being a money manager :)) entail Minsky-like dynamics thanks to leveraged speculation? At some point, once there’s enough systemic fragility involved, commodities [previoulsy housing and related financial assets] will tank and the USD (assuming it’s still the primary funding currency for all the smartest cretins in the room) will move inversely.

        As an aside, I’ve come across some interesting stuff on demographics that I think can be tied to one of Steve Keen’s ideas re slowing credit demand. If anyone wants to discuss:

      6. ESM said “Well, they were right about a crisis happening, but they were right for the wrong reasons.”

        Yes those early predictions were right for the wrong reasons, but as I understand it, this was the critical piece that led to Roubini’s fame, despite not coming til Feb 2008 when it was obvious to many (despite being still a tiny minority) that things were unraveling:

        The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster

        (had to link to a copy to find it)

        While it’s likely a lot of this was derived from the “best of” the econoblogosphere and elsewhere and not all his own thinking, Roubini stuck his neck out with concrete predictions and timeframes and understood how the financial stuff was likely to impact the real economy. (Even the prescient Calculated Risk put out a post in I think the first half of 2008 asking his commenters “why so bearish?”) So Roubini got to cite those predictions all year long and got ever-increasing attention because of all the events making headline news.

        Those circumstances aren’t likely to repeat themselves any time soon and I agree with Pebird below that the opportunity for such meaningful headline-worthy predictions will only come organically, and that current efforts are likely better spent elsewhere. For example, it sounds like Warren’s made a bunch of good calls but not on events that most people even know occur.

      7. With the media, timing is everything. Timing and having “star quality”, which also means NOT speaking truth to power.

        Roubini’s luck was putting out his dire predictions before anyone could forget them before the crisis. And, he is charismatic.

        However, he either holds back his powder or doesn’t fully understand the mechanisms:

        1) he would not be a star if he articulated the criticisms beyond the standard debt bubble stuff – which virtually everyone in the US would agree with,

        2) he is becoming a deficit hawk – talking about the dangers of GDP/deficit ratios – whether he strongly believes that or is trying to keep the spotlight, I don’t know.

        IMHO, if Roubini started talking about governments not having spending limitations, and that deficits should be increased, he would quickly be relegated to occasional 15 second spots on Fox. And I think he knows that. These guys are smart and realize what it takes to have their 15 minutes of fame.

        Saying we need a media star is like saying we need to capture the White House. It is misunderstanding political power. That is the kind of thinking that have killed US political movements throughout history. The power that the powerful have at their disposal are NOT necessarily the same mechanisms that should be used by those wanting serious reform.

        I am not saying that a media star would be a bad thing – but it will come when/if it comes organically. Trying to engineer not only won’t work, it will backfire. I think there are better forms of organization where our attentions s/b spent.

      8. Right, the time to make predictions is when there is plenty of time to act on them. Markets are basically accumulation and distribution mechanism. The folks that consistently make money in large trades accumulate on the way up and distribute toward the top. Small traders can act quickly, but large one’s not so much. It’s an incremental process for the money managers. This is especially true of illiquid markets. It would have been relatively useless to call the top in the RE bubble, leaving no time to get out advantageously.

      9. “IMHO, if Roubini started talking about governments not having spending limitations, and that deficits should be increased, he would quickly be relegated to occasional 15 second spots on Fox. And I think he knows that. These guys are smart and realize what it takes to have their 15 minutes of fame.”

        Because they really believe what they do, right or wrong. They are not trying to hide something.

  7. These “bond vigilante” dudes sure seem to have a lot of power. Yet nobody claims to be one. Just once I’d like to see a guy on the cable news with “bond vigilante” listed under his name. “Yup, I’m a bond vigilante, any country gets outta line, I’m gonna take it down…”

  8. Unrelated to the post, but this is disappointing:

    Jon Stewart clearly does not understand modern monetary operations. I went over to the Daily Show’s website to try and point out some of mistakes Jon made in his reasoning and actually had a pretty interesting discussion with some of the commentators over there. My conversation there raised questions about why the most recent QE operations do not, on net, add financial assets to the U.S. economy. If someone has time, would you mind answering them.

    1) The Treasury Bills the Fed purchased in the most recent QE operations were purchased with reserves that the Fed created “ex-nihlo,” or “out of thin air,” as some people say, correct?

    2) Treasury Bills purchased by the Federal Reserve are assets of the Federal Reserve, no? So as the Fed purchases T-Bills there must also be a corresponding increase on the liability side of the Fed’s balance sheet, correct? Didn’t that corresponding increase come from the newly created reserves?

    3) So why isn’t that considered by MMTers to be an increase in net-financial assets? I understand that loans create deposits and that reserves are not strictly necessary for loan creation other than for liquidity management purposes (at least I think I do), but that seems to me to be a separate issue from how the reserves should be classified.

    4) In summary, before the creation of new reserves by the Fed there was some balance between assets (T-Bills) and liabilities (reserves). To purchase additional T-Bills the Fed has to increase its reserve position so that assets match liabilities. These reserves are created by the Fed from nothing. Why should the fact that the additional reserves play a very small part in the process of credit extension affect their classification as a financial asset?

    Thank you for your time.

    1. Thinking about this more deeply and drawing an asset/liability T-chart for myself, I believe the answer to my questions comes from consolidating the Fed and Treasury’s balance sheets. So yes, the Fed expands the liability side of it’s balance sheet by creating new reserves to purchase T-Bills, but that increase in liabilities is offset by a decrease in the liabilities of the Treasury. So: the current holders of T-Bills get a new deposit when the Fed purchases the T-Bills from them. Those holders’ net worth remains unchanged (plus deposits, minus T-Bills). The Fed gains an asset (the T-Bill), but also incurs a liability (the reserves necessary to backstop the original T-Bill holder’s deposit). However, the increase in the Fed’s liability is offset by a corresponding decrease in the Treasury’s liabilities. So on-net no new financial assets are created or destroyed. The Treasury’s medium to long term liability (the T-Bill) is converted to a shorter term Fed liability (the reserve). Is this correct? Sorry to take up so much blog space, but it’s important for me to try and work this stuff out in my head if I want to tell others about why QE is not dangerous.

      1. How did the tsys enter nongovernment. They were bought with deposit that were settled in reserves. Where did the reserves for purchase come from. Deficit spending and the $-4-$ offset requirement. When the Fed purchases bonds, it just takes the bonds back and replaces the reserves that bought them in the first place, and those reserves are used to credit the deposit accounts of the bond sellers.

        Treasury issues debt. Fed supplies reserves. Treasury spends, injecting reserves into the banking system. Tsys are purchased and settled through reserves, withdrawing reserves. As far as reserves go, it’s a wash. OMO and POMO just reverses the process and takes tsys out out the economy and returns reserves to the banking system.

        What make this seem complicated is that reserves are used for settlement. Most people don’t understand how these banking operations work and tend to think of reserves as cash. The purpose of cash in the economy is to allow for direct and immediate settlement without going through the interbank system, as would be required with checks. Reserves is how non-cash transactions get settled in the interbank system, the FRS in the US.

    2. 1. All reserves are created out of nothing. Banks create all deposits out of nothing, too. This is the “magic of money.”

      2. When the Fed purchases assets for its book, it does so using reserves it creates, which add to its liabilities. When a bank purchases an asset for its book, e.g., a loan is an account receivable, it does so by creating a deposit as a liability. This is just how banking works.

      3. There is no increase in net financial assets, only a change in the composition of assets and the term structure of debt, increasing nongovernment liquidity. One type of asset (bond) was withdrawn from the economy and another type (reserve) provided in its place. In effect, the seller of the bond received equivalent cash in return. No increase in assets. Actually, nongovernment NFA decreases with the change in term structure/increase in liquidity, since future interest that would have been paid on the bond goes to the Fed instead, and from the Fed to the Treasury after deducting expenses.

      Similarly, when a bank creates a deposit by making a loan, there is no increase in net financial assets, the net being zero.

      Only Treasury deficit expenditure creates nongovernment net financial assets, and only taxation withdraws net financial assets from the economy. Tys issuance just changes the composition and term structure of existing assets, neither increasing nor decreasing them.

      4. “Why should the fact that the additional reserves play a very small part in the process of credit extension affect their classification as a financial asset?” Don’t understand the point of the question.

      1. Yeah, my first post was confused because I hadn’t considered the Treasury Department’s balance sheets. The comment that threw me off on the Daily Show’s website was this:

        “This is complete nonsense. Treasury Bills cannot decrease in quantity as the supply of bank reserves increase. Double entry accounting isn’t just something to be ignored. As the Fed purchases Treasury Bills, they do not go away. So you’re incorrect on that point. And as the Fed purchases the Treasury Bills, there must be an offsetting entry on the liability side of the books (Assets = Liabilities + Equity), so the Federal Reserve creates new money in order to purchase the Treasury Bills as the offsetting liability. You’re right that it starts out as bank reserves (as can be seen with the rapid increase in excess reserves from 8/2008 to present), but it can be loaned out by banks as well.”

        Obviously, the part about reserves being “loaned out,” is incorrect, but the first part about the Fed not being able to simply increase assets without increasing corresponding liabilities threw me a little. M0 certainly has increased with the Fed’s QE operations, but as you point out Tom, and as I realized shortly after I drew an asset/liability T-chart for myself, that increase has been offset by a corresponding decrease in Treasury Bills. So on net, no new financial assets have been created or destroyed. The term-structure of the liabilities have been altered and they have also been shifted from one part of the government (The Treasury) to another (the Fed). I hope I’m getting this correct.

      2. It’s the separation of the government into different bits that helps with the obfuscation, plus the myth that the Fed is somehow ‘independent’.

        When you combine the balance sheets of the entities and eliminate the x-posts in the journals, then the true nature of what is happening becomes clear.

      3. NKlein, you can always clear up existing misunderstandings by exchanging them for new ones ex nihilo :-).

        I think the great confusion surrounding the effects of QE are buried in the fact that T-bills and deposits are both liabilities to government and assets to the private sector, but only deposits are ‘mirrored’ (my term) in reserves. So any exchange of the prior for the latter will expand the banking sector’s balance sheets and the difficulty lies in explaining why this has no effect on economic activity. HBL’s balance sheet visualiser is helpful to picture what happens to whom: One still has to explain the fact that reserves aren’t lent out, i.e. that credit won’t pick up, and point out that households’ balance sheets do not actually expand.

      4. On second thoughts, maybe that’s not quite precise. At least the first part. I need an accountant :-).

      5. If it helps, the “full faith and credit” of the US is basically a call on the public. Fed equity derives from the public – the fact that we are formed (constituted) as a sovereign country.

      6. the full faith and credit with regard to the govt liabilities is merely a reference to the nation’s willingness honor its promises to credit accounts at the Fed

      7. “The term-structure of the liabilities have been altered and they have also been shifted from one part of the government (The Treasury) to another (the Fed). I hope I’m getting this correct.”

        Yes, nongovernment exchanges tsys, a Treasury liability, for bank reserves, a Fed liability. If a non-bank is the seller, then the bank receiving the reserves from the Fed purchase credits the seller’s deposit account. All this nets to zero. There is no increase or decrease in nongovernment NFA, other than the interest payments that will no longer be received by nongovernment due to the sale of the bonds to government.

      8. Uhgg, I’ve confused myself again.

        1) Assume three parties: NKlein, the Fed, and the Treasury Department.

        2) Also assume that NKlein has positive net-worth held in the form of a T-Bill. That T-Bill is an asset of NKlein and a liability of the Treasury Department.

        3) Now we have QE. The Fed purchases the T-Bill from NKlein by expanding its balance sheet.

        4) The effects of this balance sheet expansion are as follows:

        a) NKlein’s net-worth is unchanged. Instead of holding his financial asset in the form of a T-Bill he now holds it in the form of deposits. These deposits are liabilities of the Fed whereas before the T-Bill was a liability of the Treasury. No change in net financial assets.

        b) The Fed uses reserves created out of nothing to purchase the T-Bill from NKlein. The increase in liabilities (reserves) exactly matches the increase in assets (T-Bill). So no change in net-financial assets.

        c) The Treasury Department’s liability is gone because NKlein no longer holds a T-Bill.

        The end.

        I understand why NKlein has not experienced a change in net financial assets. His asset is now in the form of deposits instead of a T-Bill. He still has positive net-worth so there is no difference between the two asset classes (excluding interest rate payments).

        I understand why the Fed has not experienced a change in net financial assets. The liabilities created from nothing exactly match the asset it purchased from NKlein (the T-Bill).

        My confusion is with 4c. The Treasury Department’s liability is no more, but there has been no corresponding decrease in assets. Why isn’t this a change in NFA?

      9. NKlein1553,

        Treasury’s liability has not gone.

        Treasury still has a liability – the same T-bill.

        Treasury and the central bank are operationally separate, with separate balance sheets.

        The T-bill doesn’t disappear at the day to day level of actual operations – either as a liability or an asset. The T-bill continues to exist as a liability of Treasury and an asset of the central bank.

        So given the continuation of the T-bill liability, NFA has not changed in the way you suspected.

        At a higher conceptual level of combining the balance sheets of the central bank and Treasury, the central bank T-bill asset effectively cancels out the Treasury T-bill liability. The resulting net “state balance sheet” position with respect to that particular T-bill is zero – it is both an asset and a liability from a state perspective – or equivalently, neither after netting. But it is important that the starting point for that consolidation is that of both an asset and a liability as represented in the constituent central bank and Treasury balance sheet inputs to the consolidated construction- the input is not just a central bank asset. So again, NFA is not affected just as a result of conceptualizing a netting effect at the consolidated state level.


        You can further track the operation of the actual deconsolidated/operational bookkeeping and its effect on NFA, by examining what happens when the T-bill matures.

        When the T-bill held by the central bank matures, the central bank will debit Treasury’s deposit account at the central bank for the proceeds of the maturity.* That will eliminate both an asset and a liability from the central bank’s perspective.

        That transaction will have the following discrete NFA effects in terms of each of the CB and Treasury balance sheets:

        CB Treasury bill asset down
        CB deposit liability (to TR) down*
        CB NFA effect: zero

        TR Treasury bill liability down
        TR deposit asset (with CB) down*
        TR NFA effect: zero

        * This assumes TR has enough funds in its account with the CB in order to cover the amount of the T-bill maturity. And this is a safe operational assumption, based on a separate discussion as to how that comes about, which may involve co-ordinated new T-bill issues, or TR deposit account transfers from the commercial banks, etc. For example, you can think of TR “rolling” the T-bill position into a new issue as assuring continuity in the overall NFA position, without TR going into overdraft at the CB. And it makes sense practically speaking because then the outstanding debt of TR, which is a core NFA position, has remained the same.

      10. Hey JKH, thank you very much for the comment. I think I understand now. In the Asset/Liability T-chart I made for myself, keeping the Treasury T-Bill as a liability of the Treasury Department and an asset of the Fed makes seems to make all the liabilities and assets balance (I think). If you or anyone else has a minute, I wonder if you wouldn’t mind looking at the T-chart I made and telling me if I have it correct now. I’ve made my hand written T-chart into a google document and will try linking to it now. Not sure if it will work. Again, thank you so much for your help:

      11. OK, the link seems to work. The headings aren’t centered like they’re supposed to be, but other than that the content appears to be correct.

      12. NKlein, Great idea with the g-doc and the t-account!

        In case JKH doesnt see this….

        Are you increasing your net worth in the first transaction? If Im reading this correctly, I think that may be unchanged if you are just trading funds in your bank account for a Treasury security of equal value….

        Glad to see this idea!

      13. Hey Matt, thanks for the input. As per your suggestions, I added numeric examples and changed the symbol “+Net Worth,” to the words “Positive Net Worth,” so that people won’t confuse the starting out point of positive net worth with an increase in net worth due to horizontal transactions. By my calculations everything nets out to zero and the assets and liabilities seem to balance balance, but I’d still love to hear from someone who isn’t an amateur like me.

      14. NKlein1553,

        Looks pretty good.

        I’m out for a while, so I’ll come back to this on the weekend. I might have a minor comment or two then – but it looks OK as far as I can tell now.

      15. NKlein1553,

        A few minor comments/suggestions on your text, by point:

        1. OK

        2. Suggest: N. transfers $ 100 from bank X to a new deposit with HSBC, with HSBC being paid $ 100 in reserves by the payee bank. That identifies the function of reserves in your example as being the means of interbank payment, avoiding confusion with the (unintended) idea of a 100 per cent reserve requirement. N.’s deposit as an asset is offset by N.’s $ 100 equity (net worth), but this aspect is separate from the identification of an asset offsetting the Fed’s reserve liability. At this stage, the Fed has just accommodated the movement of $ 100 in reserves from bank X to HSBC, thereby changing the distribution of reserves among banks, but not the size of reserve liabilities, nor necessarily the size/composition of its assets at the time of N.’s transfer from X to HSBC.

        3. Suggest: N. pays the government treasury $ 100 for the bond, and Treasury deposits $ 100 in its account with the Fed.

        4. OK

        5. Suggest: the Fed purchases the $ 100 bond from N., and N. deposits the money with HSBC. The Fed then credits HSBC with reserves.

        Again, this precludes misinterpretation that there is a 100 per cent (“stock”) reserve requirement against the deposit. The $ 100 reserve change is instead the result of the central bank, as payer/creator of the original funds, crediting HSBC with funds. It supplies these reserves as the means of settling this payment liability, the result of which happens to crystallize a “stock” liability on the central bank’s balance sheet – effectively because it is the currency issuer.

        Final note, from:

        “Who is eligible to sell Treasury securities to the Federal Reserve under this program?

        The Federal Reserve Bank of New York’s primary dealers are eligible to transact directly with the Federal Reserve. Dealers are encouraged to submit offers both for themselves and their customers.”

        – This is background detail about the full routing of payments from the central bank to ultimate non-bank sellers of treasuries. People sometimes assume only bank asset portfolios and bank reserves are affected by QE. This is wrong for the most part. As you’ve correctly described, both bank reserves and bank deposit liabilities are affected for the most part. It’s just that the routing of payments to non-bank sellers of treasuries is via primary dealers, who effectively act as agents for non-bank sellers. The net result is that QE changes both bank and non-bank holdings of treasuries, but more so the latter on a net basis, in which case it also changes bank deposit liabilities, as you’ve described. Bottom line is that your presentation is correct, which is the most important thing. It just skips the intermediate step of a primary dealer acting as agent on behalf of a non-bank seller, which is the less important thing, but an interesting detail. And I wouldn’t suggest muddying your presentation with that detail; just keeping it in mind.

      16. Thanks JKH. I had actually sent the asset/liability T-chart to one of my college roommates who now works at Goldman Sachs to see what he thought and he immediately shot back to me that I had assumed a 100% reserve requirement without explicitly stating so. I was kind of aware I did this when I added in the numbers to my original T-chart, but kept it anyway because Nolan’s positive net-worth (assets > liabilities) being offset by the Fed’s negative net-worth (liabilities > assets) seemed to fit well with the common MMT refrain that for the private sector to save the public sector needs to run a deficit (ignoring the current account). Although, I may be confusing stocks and flows here as Nolan’s positive net-worth in my example is a stock and the MMT claim about public sector deficits equaling private sector savings is about flows. I get the distinction and I’m sure there’s a way to express the MMT claim about flows in terms of stocks, but it’s hard for me at least to find the words. I also realize that in reality it wouldn’t be the Fed that had negative net-worth, but the Treasury Department as most people tend to hold their savings either directly in Treasury Bonds, or in mutual funds that hold Treasury Bonds on their behalf.

        Finally, even assuming a 10% reserve requirement doesn’t seem to change the fact that net financial assets are not increased by quantitative easing. And this was the point I was interested in teasing out for myself. So instead of everything summing to zero and balancing, everything will sum to 90 and balance. Same result, just slightly different numbers. Thanks again for the input JKH. Thanks to you I think I’ve unconfused myself now.

      17. NKlein1553

        You’re welcome; a few more thoughts:

        NFA flow
        = government deficit
        = (new issue of reserves, currency, or bills/bonds held by non government) – (private sector assets acquired by the central bank/treasury)
        = “income statement” change / balance sheet change

        NFA stock
        = cumulative government deficit
        = (outstanding reserves, currency, or bills/bonds held by non government) – (private sector assets held by the central bank/treasury)
        = balance sheet position

        (“private sector assets” = claims on non government sector)


        CB swap of reserves for private sector assets
        No principal effect on deficits or NFA
        Future net interest margin of CB changes, which changes future deficit marginally
        Changes total of (outstanding reserves, currency, or bills/bonds held by non government)


        CB swap of reserves for government bonds
        No principal effect on deficits or NFA
        Future net interest margin of CB changes, which changes future deficit marginally
        Changes composition but not total of (outstanding reserves, currency, or bills/bonds held by non government)

        Bottom line is that NFA generation requires government deficit spending (fiscal policy), not asset swaps (monetary policy).

        Amazing how this stuff never gets any easier to summarize.

      18. JKH:

        CB swap of reserves for private sector assets
        No principal effect on deficits or NFA

        I get the accounting but I have a feeling there is something in there that isn’t compliant with standard MMT usage. But then I may well be mistaken.

        I recall Bill Mitchell using the term ‘quasi fiscal’ to describe the act of exchanging private sector financial assets for government issued financial assets as under QE1. With other words it does change NFA. That seems consistent with my understanding of vertical transactions although it seems at odds with the resulting accounting statement as you depict it. What is the fundamental difference between a govt. agency buying private bonds as opposed to any real resources or services? Sure, it’s risky and purely financial in nature, but why is it not vertical?

      19. gets to the core of something I first discussed way back in soft currency economics.

        the price level is a function of prices paid by govt when it spends, and/or collateral demanded when it lends.

        and what’s happening today in china with the use of loans from state owned banks

        a loan from govt that is never collected, and functionally isn’t treated like a liability of the borrower, is functionally a fiscal transfer.

        govt loans are immediate fiscal transfers ‘matched’ by future payments to govt (looks a lot like taxes?) which are presumably equal liabilities for the borrower.

        in any case, it’s about aggregate demand with regards to the macro economy

      20. My understanding of the term “quasi-fiscal,” is that the purchase of private sector assets only becomes a vertical transaction if there is a default or if the federal government in some way pays above market prices for the private assets. This is the reason why the Fed is generally restricted from purchasing anything other than (credit) risk-free assets in conducting open market operations. So if the baseline assumption is that the Fed will not realize any losses on its portfolio of private assets, then those private assets are (credit) risk free by assumption and hence the Fed’s purchase of them is a non-vertical transaction. I think the reason why Professor Mitchell calls Fed purchase of private sector assets “quasi-fiscal,” policy is because really the no-loss-realization assumption is questionable.

      21. only becomes a vertical transaction if there is a default or if the federal government in some way pays above market prices for the private assets

        One should apply that logic to all government spending. It only counts towards the deficit to the extent that it is over-priced or of no use to the public. Case dismissed :-).

      22. NKlein1553, Oliver,

        That’s partly why I used the phrase “principal effect”.

        Meaning there is no vertical effect at the point of principal exchange – i.e. $ 100 of reserves for $ 100 of other assets, with net cash effect of zero on the non government balance sheet and therefore net NFA effect of zero. In the case of QE1, non government ends up with a claim on government and a claim due to government, with no net effect on its net balance sheet position with government. In the case of QE2, different claims on government are just swapped, with no net effect on the non government balance sheet position with government.

        The difference versus government deficit spending is that there is a net $ 100 principal effect following deficit spending. $ 100 of government spending generates $ 100 of non government income, of which the full $ 100 is non government saving. And that results in non government NFA increasing by $ 100.

        Not sure how “quasi-fiscal” is used by Prof. Mitchell, but it could apply to just about any variation around the effect on interest income relating to any principal amount, as I alluded to.

        Various examples:

        A QE2 swap of reserves paying .25 per cent interest for government bonds earning 3 per cent interest has an immediate beneficial impact on CB net interest margins of 2.75 per cent, which translates to an increase in the remittance to treasury, a corresponding reduction in the deficit, and a knock-on decrease in non government saving and net financial assets.

        A QE1 swap of reserves paying .25 per cent interest for private sector loans earning 4 per cent interest would have a similar effect for 3.75 per cent.

        Finally, in addition, a QE1 swap of reserves for private sector loans where a loss was eventually incurred would then reduce earnings of the CB, which translates to a reduction in remittance to treasury, a corresponding increase in the deficit, and a knock-on increase in non-government saving and net financial assets. (You can think of that increase as the equivalent of the “write-off” of the original non government liability. A reduction in a liability is a benefit.) HOWEVER, it is wise not to pre-judge the idea of “paying too much” for the assets at the outset. Better to wait and see what cash flows eventually do or don’t materialize, before concluding anything specific about the “quasi-fiscal” effect. TARP is an example of this. The specific cash flow related to TARP repayments has been greater than originally expected.

      23. Thanks for the detailed explanation, JKH. I can see the financial argument and I know it is being used everywhere to justify the bailouts. Although financially sound (at least in hindsight), it seems morally questionable or at least economically tautological in that the bailed-out institutions would always come out stronger in relation to their competitors, especially if their troubled assets were initially not bought at market prices. I guess one valid question is, who benefits from the ‘detoxified’ papers in the end? And then there are other questions such as, who benefits along the way and is there a way to have one without the other?

        Anyway, I watched an interview with the head of the Swiss national bank where he justifies his actions during the crisis among other things. Talk about a too big to fail problem in Switzerland, sheesh… Don’t know about your German skills, but it may be of interest to others. It’s not technical but the interviewer poses some intelligent questions imo. There is an interesting passage where the he (the banker) portrays his views on central bank independence and is then asked to explain why no other institution within government is endowed with the same amount of leeway and confidentiality. He takes the bull by its horns in answering that he imagines there could well be other departments with similar powers, such as an independent fiscal authority. The aim being, of course, to keep fiscal policy more in line with economists’ (i.e. deficit hawk) agendas than with anything vaguely resembling public purpose. Is there an accredited body of economic work that propagates such measures? Scary.

      24. Oliver,

        I’m going to be very interested to find out a few years from now just how much of the intervention ended up being the bail-out of a “Minsky moment”, and how much ended up as the absorption of long term losses.

      25. not to forget govt ‘injecting’ bank capital is nothing more than regulatory forbearance.

        or that the problem with the autos and others was govt. grossly overtaxing us for the given size govt at the time as evidenced by the collapse in agg demand.

        business competes for consumer dollars. some do well, some fail.

        govt’s role is to tax such that the consumer dollars there to be competed for.

      26. You mean when the hangover wears off :-). I’m guessing it will be completely inconclusive and each side will be blaming the other for not having done enough to make things better.

        Thanks again for your continued detailed inputs!


  9. Hello,

    I have a question.

    Not being an economist, most of the comments here are over my head – but –
    by whatever legerdemain creates

    and sends checks or credit to people who:
    -are not really disabled (I know 5 myself)
    -get pregnant at 16 (go to any high school)
    -bill 3 times the going rate for government contracts
    -fight unwinnable wars
    -supply material for unwinnable wars
    -own failed banks
    -own failed entities overseas
    -own unprofitable corporations
    -promote and encourage excessive litigation
    -charge rapacious bills for medical care
    and drugs……
    -borrow Fed money at a low rates and speculate in the markets at everyone else’s expense

    when there is REAL work that needs doing

    aren’t we all going to get poorer until
    government stops supporting these activities – and promotes profitable REAL

    1. Not arguing that any of these things are a good use of funds, but that is a political question. From the MMT macro point of view, government promotes REAL enterprise by supplying the appropriate amount of net financial assets for effective demand to match optimal productive capacity, full employment (~2% frictional) and price stability. The net financial assets are injected through deficit expenditure, and withdrawn through taxation. How this is targeted is both an economic issue and a political issue. The economic issues involve considerations like efficiency, e.g., multiplier effects, and effectiveness in meeting goals. Goals are determined politically, as are the distributional issues.

      1. Tom, I state this a bit differently.

        For me Govt is for the provision of ‘public infrastructure’ however broadly defined.

        This leads to the notion of the ‘right sized govt’ based on public purpose, etc.

        And a ‘supporting tax structure’ that results in desired levels of employment/capacity utilization.

        So with regard to net financial assets, it’s not about ‘supplying’ the right amount of financial assets as it is about removing the right amount of financial assets.

      2. Yes, I was including “injecting” and “withdrawing” under “supplying.” Supplying NFA generally includes both in shifting proportions. It’s the balance that counts, and the proper balance is a political question given the condition of the economy in any period.

        I would prefer to see minimal taxation of consumption and production in order to incentivize productive activity and investment, and maximal taxation of economic rent to disincentivize rent-seeking and increase income distribution and productive investment.

    2. yes, you got it

      not to say i agree with each/every item listed specifically

      and you missed the most damaging thing it does- for a given size govt it tends to grossly over tax us as evidenced by unemployment and excess capacity in general

  10. MMT needs more people understanding it. All of you MUST EDIT the wiki of the US deficit & budgeting pages (anyone can edit it)to enlighten the masses because millions of people & students in their formative years are consulting it(because it comes up 1st on google searches) as a resource for education & writing papers & the debt hawks/Austrians/Paulians are editing it to brain wash more gold-standard deficit doom-sayers

    1. Besides reaching MILLIONs of students & lay people who consult Wikipedia for reference, rename Modern Monetary Theory to Modern Monetary Economics .. MARKETING 101: to lay people, “theory” means guess or hypothesis instead of a good working model so they will doubt it despite empirical evidence just like “Theory of evolution” .. Austrians economics doesn’t call itself Austrian Theory & open itself up to doubt.. they just call it Austrian economics.. MMT shold do the same IF IT WANTS ACCEPTANCE INSTEAD OF lay people(who vote) to doubt them…

      DROP THE THEORY part & just call it “Modern Monetary Economics” … don’t ever mention theory or you might as well call it ‘Modern Monetary Hypothesis” when it comes to acceptance by the voting general population who never took advanced science or economics courses in university

      Don’t shoot yourself in the foot by ever mentioning theory, LOL

      Notice that all the successful models that are accepted by the general laypeople never include theories in their names nor are they called theories by laypeople(who equate it as just a hypothesis/guess).. no Austrian theory, no gold-standard theory, no deficit theory… don’t handicap yourselves vs. them by calling it Modern Monetary Theory..

      Modern Monetary Economics.. MME … period

      1. Makes sense. The “bible” of stock-flow consistent monetary economics based on national accounts is Godley & Lavoie’s Monetary Economics.

      2. except they leave out the connection to value, same as the circuit guys. In other words, they don’t start at the beginning which is why anyone would sell real goods and services for units of the currency.

        Therefore they miss the inflation story.

        This website nails the inflation story.

      3. Taking the question seriously, from the history, the bulk of the article was the only contribution of someone calling himself “Unorthodoxy.rules” whose first language might not be English, after a more promising start by Nbarth. I believe both have accuracy problems about the history of the subject, something which could probably be said of most endogenous money theorists, too. 🙂 Personally, I just added a link to a paper by Lavoie. Was afraid to start working on it, fearing that after reading it closely I might understand less than before. 🙂

    2. Great suggestion. The entry on “Chartalism” needs work, too, and there wasn’t even a specific, detailed entry on MMT last time I checked.

    3. This is a good point. I have visited some of the wiki pages and noted this also. This should be a project for visitors on Warren’s site here. Maybe we can convince Warren to send out the call to clarify misinformation on wiki out there.

  11. hbl,

    Slightly tangential .. but a bit of history …

    Talking of Bezemer, Godley and Roubini … you can see Roubini quoting Godley in his articles about the US current account in particular his article, “A Critical Imbalance in U.S. Trade”

    There is of course a crucial difference between Godley’s approach and Roubini’s – the latter is a Monetarist!

    Also talking of heterodoxy, Wynne Godley commanded a lot of media attention in his Cambridge days. Sadly they cut his funding for being so correct and Keynesian! However they also put him in the “Six Wise Men” – HM Treasury’s forecasters.

    Here are two fine scans from the British media – one on him, one by him (with Francis Cripps)

    “Apostles Of The Apocalypse”

    “A Budget That Will Produce A Hyper-slump Such As Britain Has Not Seen Before”

    They called him the “The Cassandra Of The Fens”

    – Huge fan

    1. Ramanan, I’d already gathered you were a Godley fan (!), but thanks for the interesting snippets! You are quite a specialist of heterodox economics history and of knowing/finding extremely obscure information (other threads)… You should use your particular super powers to help with the ever-discussed-but-never-initiated wiki project 🙂

    1. Mostly I think it has to do with Fed officials targeting a quantity of securities and not a specific interest rate. Apparently there was some front running of the Fed’s QE operation that offset their purchases. However, if the Fed had just declared it would purchase any and all securities of the duration they were targeting at a specific price, then probably Fed officials could have hit their interest rate target. Although, some commentators (more so on Bill Mitchell’s website than here) have been critical of this argument. I’m mostly thinking of a commentator who calls him or herself RSJ. I’m not sure I fully understand the arguments and counterarguments, but I think RSJ believes market forces determine interest rates at longer maturities and that attempts by the Fed to set rates at these longer maturities will cause the rate structure to become dislocated from the private market. So the Fed will end up having to purchase all of the long term securities at the desired maturity and this means that those securities will cease to be a reference point relied on by the private market to determine the risk free interest rate. Those criticizing RSJ essentially say: so what? Why should the government give such a subsidy to private credit markets?

      I hope that was a coherent explanation. I hate to represent RSJ’s views because he/she clearly knows more about this topic than me, but I think I’ve covered the basics. I’m sure others will correct me where I’ve made mistakes.

      1. Oh, it looks like I misread your original comment. I was talking about current the current QE operations associated with Chairman Bernanke. You might have been referring to something else as current Treasury Secretary Geithner hasn’t worked at the Fed for about two years.

      2. Thanks for the response, but I was referring to Warren’s remark: “The fact that under Geithner they never could hit a fed funds target is another story for another time.”

    2. I believe he’s referring at least in part to the fact that the GSE’s, i.e. primarily Fannie and Freddie, maintain deposit balances at the Fed on which no interest is paid (by statute). That means that if Fannie and Freddie have surplus balances at the Fed, they may be motivated to put them into the market at whatever rate they can get – including a rate that’s lower than interest on reserves. That means that the Fed funds rate is not a perfectly effective lower bound for the Fed funds rate. And that means that the Fed loses some operational control over the Fed funds rate.

      The question has been asked as to why the banks couldn’t arbitrage that discrepancy out of the system – i.e. borrow from the GSE’s and either relend or redeposit with the Fed themselves – until the funds rate was driven up to the IOR rate. The answer has something to do with balance sheet ratio management and capital management of the banks – they just didn’t have the appetite to do a lot of that type of arbitrage, I guess, in the circumstances.

      You would think this problem could be resolved by some fairly easy statute modification – i.e. by paying the GSE’s interest on their balances.

      He may also be referring in part to the early part of the crisis, before interest was paid on reserves. There was huge volatility in the funds rate at that time, as the Fed was trying to gauge the precautionary demand for reserves in that explosive environment.

      That’s my recollection; probably isn’t perfect.

      1. meant:

        “That means that the IOR rate is not a perfectly effective lower bound for the Fed funds rate.”

      2. “You would think this problem could be resolved by some fairly easy statute modification – i.e. by paying the GSE’s interest on their balances.”

        Or by exective order (after all, GSEs are owned by the govt), the President could simply enjoin GSEs from lending out reserves for less than Fed’s IOR rate.

    3. I think the problem with hitting the target was that during the worst days of the financial crisis, banks were not behaving like they normally did. Prior to 2008, banks had done billions of dollars worth of loans in the FF market based on telephone calls, and they could all be counted on to “loan out” all of their excess reserves. Since the primary tools for setting the overnight rate was the FF target, it was fairly easy for the Fed to add/withdraw funds in order to set the rate.

      But after the Lehman bankruptcy, suddenly no one knew who would be next. The FF market didn’t seem so safe anymore, so you had banks deciding to hold on to reserves, even if they made no interest, because they no longer trusted their counterparties. This completely disrupted both the FF market and the commercial paper market, with the rate continuing to skyrocket even as the fed added massive amounts of reserves to the system.

      It all pointed to the ultimate ridiculousness of the whole FF market, since all reserves come form the Fed anyway and it should just directly set the rate anyway. They’ve taken baby steps to fix it since then (Like IOR), but there’s still a lot of resistance based on flawed understanding of the monetary system – witness the outrage over the recent revelations that the Fed loaned “Trillions” to banks and other corporations.

      1. “It all pointed to the ultimate ridiculousness of the whole FF market, since all reserves come form the Fed anyway and it should just directly set the rate anyway.”

        Right, push overnight loans from interbank market to discount window. One benefit is that interest is captured by the Fed. So if the Fed moves interest rates up, Tsy increased debt service would be partially offset from the increased interest income passed through by the Fed.

    4. the ny fed was only ‘allowed’ to intervene once a day rather than continuously.

      there were issues of eligible collateral

      agencies weren’t paid interest on their fed balances after the fed started paying interest on reserves.

      the simple/elegant solution was for the fed to trade fed funds directly.

      while some have told me no further authority is needed for the fed to trade fed funds, geithner never thought about it or even began to request any authority that may have been needed to do that.

    1. It’s a bit beyond me but I believe Ramanan referred to a chapter from the Godley/Lavoie book in reply to someone who had asked about the effects of QE on banking and shadow banking activity, if I’m not mistaken. I can’t find the post but maybe one of the two will see this and help out.

      1. I don’t think I referred to their text, because they don’t go into that.

        The financial crisis (minus the real economic one) was “A Run on the Repo”

        box 2, page 5 here.

        “The Federal Reserve’s Primary Dealer Credit Facility”
        Tobias Adrian, Christopher R. Burke, and James J. McAndrews

        The shadow banking collapsed because of the run on the repo and the Fed’s operations tried to heal that.

        The zerohedge article seems to get data from Z.1 Q2 2010 released recently to analyze if it has been healed.

      2. Thanks for the reference, Ramanan.

        It seems that the problem with repo market has only been papered over though through “forbearance,” e.g., twisting arms at FASB to allow mark to model instead of mark to market and Fed ops manipulating the markets. The underlying would assets still seem to be dodgy, so while the number may have improved the problem hasn’t gone away. As far as I understand the mountain of toxic assets hasn’t cleared.

        I haven’t gone through the whole article closely but from the conclusion it seems that the Fed is backstopping the whole mess, assuming risk without having regulatory authority over the collateral pledged, thereby adding to moral hazard by guaranteeing stability.

      3. @Tom

        It doesn’t matter if the underlying assets are dodgy or not. It only matters if they are properly marked to market and have reasonable liquidity. Since the beginning of this year, it seems like that’s the case.

        Leverage in the system may be increasing now, but we have a long way to go before we get back to the boom times. The main problem right now, to paraphrase a NY gubernatorial candidate, is that the “tax is too damn high.”

      4. Oliver,

        It sounds like the post you are recalling might be this one by me?

        In response, Ramanan passed on a link to a chapter by Marc Lavoie that shared the theme of the mechanics of the private sector determining its own money supply. Lavoie focused mostly on the bank loan versus equity issuance decision for a corporation (I think), while I focused mostly on the bank loan versus bond (or equivalent) issuance. My post was basically pointing out that even when QE involves buying treasuries from non-banks, that expansion in the money supply may not “stick” in the medium term, depending on changes in private sector liquidity preference.

        I’m not sure that ZH article gives enough info to conclude much. The last graph shows one month positive growth in total financial sector liabilities. Even if it’s the start of a trend, that just means the end of deleveraging within the financial sector specifically, which as Tom points out has forbearance to help it. But household debt patterns matter more to the real economy (yes, there can be some correlation between the two, so it’s not worth just dismissing…)

Leave a Reply

Your email address will not be published. Required fields are marked *