From a friend:

At the conference on Friday, NY Fed President Dudley presented a chart that showed the long-term impact on the budget deficit of lower Fed remittances of interest income over time (his point was that it would lead to a larger deficit and the Treasury should not assume recent levels of Fed remittances).

I asked him in Q&A if he considered that in the short-term, the interest being accrued by the govt sector would typically be accrued by the non-govt sector and it could thus be viewed as a form of fiscal drag, and that maybe it should be offset by looser fiscal policy elsewhere if the economy warranted it due to a large output gap.

His response, not surprisingly, was:
‘You are factually correct, but’:

  • A lot of that interest income goes to non-u.s. investors, so its not like the U.S. economy loses all that interest income.
  • The propensity to consume of savers is lower than that of borrowers.
  • The drain on interest income is more than offset by easier financial conditions elsewhere (via equities, credit spreads, etc).

That’s just how their models work/they see the world.

33 Responses

  1. And you’re saying their models are no good?

    One has to consider the other side of the balance sheet, too. Lost interest income is counterbalanced by lower interest cost for debtors, credit spreads, etc. All the things he mentioned…propensity to consume, etc.

    1. @Mike Norman,
      But doesn’t the interest income move vertically to the Treasury and lost to the horizontal economy while the offsets primarily remain within; the overall effect being a net lost of purchasing power within the horizontal economy – i.e. deflationary?

      That would sure come as a surprise to most people.

      1. @Bob Salsa, The offsets might remain within, but if they are correlated with an expanded volume of overall activity?

        If there are 100 lenders lending $1 million each to 100 borrowers at 5% interest in Year One, and then the same 100 lenders are lending $1 million each to the same 100 borrowers at 1% interest in Year Two, then there is just an offset or income shift. The lenders are going to get less interest income; the borrowers are going to pay less of their income in interest; overall activity stays the shame.

        But if lowering the interest rates results in in an increase in overall lending – with for example, to 110 lenders lending $1.1 million each to 110 borrowers – then there is not just an income shift, because the lending and borrowing is financing some real, value-adding economic production which raises GDP by $X.

        So if the amount of interest income the Fed has to drain to drive the interest rate down to 1% is $Y, then I guess the question is whether X > Y or Y > X.

      2. @WARREN MOSLER, I think you forget part Warren. Not only the national debt (tsy secs), but all nfa that we hold, i.e. tsy secs (debt), reserves and cash, form our equity (net worth) to support the credit structure.
        Do you agree?

      3. @Walter,

        “Not only the national debt (tsy secs), but all nfa that we hold, i.e. tsy secs (debt), reserves and cash, form our equity (net worth) to support the credit structure.”

        Those are all govt liabilities, i.e. “debt.”

    2. @Mike Norman,

      With the next round of debt ceiling battles on the horizon, this issue is likely to get more attention, especially with regard to whether the $1.6 Trillion of Fed Tsy holdings should even apply to the debt ceiling.

      1. @Art Patten,

        Art – Leave it to you to ask trick questions. Hard to see how it would be hyperinflationary if the cash proceeds from all those Fed Tsy purchases keep coming back to the Fed as excess reserves. Then again, nothing exceeds like excess!

        Here’s my take on the debt ceiling from last July when I was still at Reuters. The link may not work for you on a MacBook.

    3. and lower rates shifted income from savers to bank net interest margins which has to mean a reduction in aggregate demand.
      and when did an economy with 0 rates ever pick up without a fiscal impulse?

      1. @WARREN MOSLER,

        “when did an economy with 0 rates ever pick up without a fiscal impulse?”

        Great question. Most of the macro profession thinks negative rates would do the trick, but if they don’t understand Fullwiler’s explanation that fiscal injections ARE “helicopter drops,” it’s not clear how they’ll get there.

        Aside, this seems like one of the biggest gaps in arguments made by NGDP-targeters. For example, Scott Sumner has argued that because inflation in both Australia and Canada (both rather open economies, ahem) is correlated with money supply and not total govt liabilities, then QTM (with M defined only as high powered money and not NFAs) must hold everywhere. F-L-I-M-S-Y…

    1. @wh10,
      Especially with massive deleveraging keeping consumer and business spending at a minimum. The propensity to consume is now lower for everyone save the 1%ers.

      40% of T securities are non-Us investors. That leaves 60%- the US investors, losing significant income. Every single state has pension issues, whether the state itself or a locality within it’s border.

      But what can the Fed do? They are not the deciders of the looseness fiscal policy. And “elsewhere” is the deficit hawk Congress.

  2. It’s interesting to here him acknowledge some of the key fundamentals of MMT and respond with reasonable and plausible considerations, rather than the knee-jerk neoclassical babble.

  3. So I guess his answer is, “It is a fiscal drag, but not as much of a drag as it would be if those payments had been scheduled to go only to ordinary, high-consuming, All-American households.”

    To me the response should be that the low treasury borrowing rates would only justify the policy if they were inducing the government to run a larger deficit. But since the government is actually decreasing its deficit, it looks like lose-lose right now.

    But I can see why Fed officials are frustrated by lack of fiscal response by the legislature to a sequence of policies that have been designed to reduce all real and political monetary policy hurdles standing in the way of fiscal expansion.

      1. @roger erickson, I believe that they believe their institutional “independence” requires them to refrain from publicly second-guessing the political branches of government.

  4. Savers have just as much propensity to spend their income as does anyone else. A retiree takes their principal buys a bank CD, bond, or treasury in order to protect their principal and derive some income to pay for their needs, i.e. consumption. Albeit not raising a family, there is no shortage of expenses for these people, i.e. healthcare cost, food, utilities etc, etc….Has anyone seen the cost for a retiree to live in a respectable condition?

    What Dudley should of said if he was being honest is, “these savers are not borrowers so why should we make it easier for them”? They want to make it easier for the banks to maintain a spread and hopefully induce people to borrower at cheap rates. Who cares if Grandma’s retirement income was just cut by 75%.

  5. In a balance sheet recession, borrowers are savers too. Granted, they’re trying to pay down debt rather than clipping (Treasury) coupons, but I would think any vertical flows help at the margin. A good follow up might have been, “OK, but how can the govt offset or exceed the lost interest income?”

    1. In fact, Dudley seems to have danced right around this question-?

      “it could thus be viewed as a form of fiscal drag, and that maybe it should be offset by looser fiscal policy elsewhere if the economy warranted it due to a large output gap.”

  6. Warren – one thing has always bothered me about the interest income channel.

    You argue – convincingly to my mind – that since the private sector is a net creditor in aggregate, higher interest rates should be stimulative. But how does one reconcile this observation with Volker’s 1981 Fed Funds hikes to c. 18%, which proved highly deflationary?

    So at what point does a base rate hike become disinflationary? Is it when it starts provoking private sector defaults (ie the inflection point depends on private sector debt affordability)?


    1. the deflation in the 80’s was a result of the deregulation of nat gas in 1978 that caused a shift from oil to gas for electric production.
      opec cut oil output by over 15 million bpd to keep the price over 30 but it wasn’t enough and prices crashed down to $10.

      The cpi however stayed a lot higher than otherwise due to the lingering high rates from the Fed.

  7. What do you think he means with point 3?

    Drain on interest income more than off set by equities via capital gains?
    And with regards to credit spreads – how do they assume there the mechanism to net add to aggregate demand?

    1. @walter, Fisher assumes that firms’ investment plans are highly sensitive to margin cost of debt or equity – so any decrease in risk-free rates and/or risk premia will lead to investment increasing, which would help to offset any fiscal drag.

      I have been in discussions with BoE economists on this topic and they are very explicit about this being a rationale for QE. I am trying to persuade them that in the real world, firms determine their levels of investment (in the real sense of fixed capital formation) based on non-numeric factors; a fall in WACC from 9% to 8.5% along is not going to see firms building lots of new factories!

      But then, Fisher would likely reject the classic MMT framing that in general more private sector NFA is a ‘good thing’.

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