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Yes, he’s been calling for an economic collapse, that began in July. But looks like yet another case of ‘better lucky than good’ as he here demonstrates a lack of understanding of monetary and fiscal policy.

Roubini: Policies will lead to “much higher real interest rates on public debt”

From Dr. Roubini: Desperate Measures by Desperate Policy Makers in Desperate Times: the Fed Moves to Radically Unorthodox Policies as Economy Is in Free Fall and Stag-Deflation Deepens

Stag-deflation? Whatever.

Another batch of worse than awful news greeted today Americans getting ready for the Thanksgiving holiday: free falling consumption spending, collapsing new homes sales,

They’ve been very low but relatively flat for a while, as actual inventories of new homes for sale fell to multiyear lows.

falling consumer confidence, very high initial claims for unemployment benefits,

Initial claims actually fell a bit, as did continuing claims. And personal income is still growing though at a modest 0.3%. For some reason he has turned to sensationalism. Must be the overdose of TV cameras.

collapsing orders for durable goods. It is hard to get any worse than this but the next few months will serve even worse macro news. At this rate of contraction as revealed by the latest data it would not be surprising if fourth quarter GDP were to fall at an annualized rate of 5-6%.

And Roubini concludes:

[T]he Fed, together with the Treasury, started to implement some of the “crazier” policy actions that we discussed last week: a) outright purchases of agency debt and MBS to the tune of a whopping $600 billion;

This is far from crazy. The treasury should have been funding the agencies from inception. The fact that the government is finally coming around to this after more than 30 years is a move towards sanity.

b) another $200 billion of loans to backstop the consumer and small business credit markets (credit cards, auto loans, student loans, small business loans);

OK, but he doesn’t point out that the securities must be rated AAA and appropriate ‘margining’ will be applied. That is very conservative banking by any measure. Not to mention the $20 billion first loss piece the treasury is putting up from its TARP funds. If any agent is ‘crazy’ in this case it’s the treasury, not the Fed.

c) an effective policy of aggressive quantitative easing as the balance sheet of the Fed – already grown from $800 billion to over $2 trillion – will be expanded further as most of the new bailout actions and new programs will be financed via injections of liquidity

When the Fed buys securities it credits member bank reserve accounts, which now pay interest. (Is that what he means by ‘financed via injections of liquidity?’ What’s the problem here?)

rather than issuance of public debt.

Interest bearing reserve accounts are functionally identical to one day treasury securities.

The Fed is buying financial assets and the sellers in exchange have interest bearing deposits.

What’s the problem?

This is all nothing more than convoluted rhetoric that has not been thought through.

Effectively the Fed Funds rate has been abandoned as a tool of monetary policy …

That makes no sense. The FOMC continues to set a target for the Fed funds rate which the NY Fed continues to be responsible for hitting. That’s Geitner’s main job- to keep the Fed funds rate at the FOMC’s target. The Fed funds rate obviously remains a tool of monetary policy.

the Fed is now relying on massive quantitative easing and direct purchases of private sector short term and long term debts to try to aggressively push down short term and long term market rates.

Yes, in addition to its Fed funds target, the Fed is also targeting longer term rates. In fact, the Fed has always had the option of targeting the entire term structure of rates.

But that is not how quantitative easing has been defined. It was defined in the context of Japan, where the BOJ bought JGP’s to sustain excess reserves in the banking system under the mistaken notion that increasing the quantity of reserves would somehow alter the real economy. It was about quantity, not price. And it did not work as they expected.

Desperate times and desperate economic news require desperate policy actions


The Treasury will be issuing in the next two years about $2 trillion of additional debt

It may net spend that much, and issue that much debt along with that net spending.

These policies – however partially necessary – will eventually lead to much higher real interest rates on the public debt

Maybe, but interest rates go up because the Fed raises them or because the markets anticipate the Fed will raise them. It is mainly about anticipating the Fed, rather than funding pressures, particularly for short term securities.

and weaken the US dollar

Yes, deficit spending that does not have positive supply side effects does have a weakening effect on the dollar, but it may simply stop it from getting as strong as it may have, rather than actually push it down vs other currencies.

once this tsunami of implicit and explicit public liabilities and monetary debt

What is ‘monetary debt’ as distinguished from ‘public liabilities?

driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings

Government deficits in their local currency increase the savings of the non government sectors by the same amount.

Government deficit = private sector savings (net financial assets) as per national income accounting.

– and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.

Start to ponder???

To continue to attract massive inflows of capital, the U.S. might have to start paying higher interest rates on the public debt.

Totally inapplicable with a non convertible currency and a floating exchange rate. The causation is domestic credit expansion funds foreign savings, not vice versa. Loans create deposits. He’s probably got that backwards as well.

This is one of the concerns that Volcker (previous post) expressed in early 2005.



6 Responses

  1. Isn’t there the possibility, however, that increased deficits in local currencies worldwide will decrease demand for external financial assets (i.e., dollars), and thus decrease our current account deficit and thus our real terms of trade?

  2. You seem to be saying that the reserves deposited at the Fed on which they are paying interest imply some kind of sterilization. Perhaps, but if, in effect, they’ve swapped a “one-day T-bill” for an illiquid asset like ABS, there is clearly a lot more “liquidity” in the system.

    As for Geithner’s job being to hit the Fed funds target, if that’s the case he’s probably not qualified to be Treasury Secretary, since the effective Fed Funds rate has been closer to .25% than 1% for about a month now.

    The Fed is definitely in “Quant Easing” mode, however ill-defined their version of that policy may be.

  3. Brian

    My take on Warren’s point was that the Fed buying the securities (ABS or otherwise)–which creates a one-day, interest paying “time deposit” that can be continuously rolled over at the target rate–is functionally the same as the Treasury issuing bonds when it purchases them. That’s why he suggested that the TARP was more appropriately considered as a monetary policy operation.


  4. Let me say this more precisely. . .

    When the Tsy buys an ABS, it credits reserve balances to bank reserve accounts.

    When the Fed buys an ABS, it credits reserve balances to bank accounts.

    Any Tsy bond sales by the Tsy or the Fed simply replace reserve balances with longer term “time deposits.”

    No difference.

  5. Hi Warren,

    I am going to start blogging over at Daily Kos on the proposal to suspend income taxes, chartalist money theory, and other economic proposals. I did this before to great effect. I think this is going to be widely embraced by the Kos crowd.

    If you’ve never been there, it is much more intelligent than you would expect. There are some extremely intelligent people who blog there, and others who read and comment there regularly. More importantly, there are hitters who read kos every day. It is going to be a good way to popularize these important ideas

  6. 1. yes. i wouldn’t encourage them, and instead quietly go it alone, pretending we are doing something awful…

    5. Sounds good, never hear of it. what’s the url?

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