Banks and "money"

An Economist Confused About Banking by Matthew C. Klein

Commercial Banks As Creators of “Money” by Krugman

Jackson Hole and QE

At a Fed Conference, Views Differ Sharply on Stimulus’s Effect by Binyamin Appelbaum

JACKSON HOLE, Wyo. — There is still plenty of skepticism about the stimulus campaigns of the Federal Reserve and other central banks, and there is plenty of concern about the consequences. But for the first time in several years, there was also a general sense of optimism among the policy makers gathered here for an annual meeting at the foot of the Grand Tetons that things are going reasonably well. 

Unconventional monetary policy “has been a significant success altogether,” Christine Lagarde, managing director of the International Monetary Fund, said in a lunchtime address. She said the efforts continued to yield benefits and should not be unwound too quickly. 

Even for developing countries, which have sometimes criticized the efforts, the effects are “still positive,” she said. “Marginally, but still positive. 

But the conference, convened by the Federal Reserve Bank of Kansas City, underscored again the striking divide between academics, where skepticism is widespread about the benefits of the Fed’s asset purchases, and policy makers, where confidence is equally widespread. 

The Fed has accumulated more than $3 trillion in Treasury securities and mortgage-backed securities, and since last December it has been expanding those holdings by $85 billion a month in an effort to drive down unemployment and promote growth. 

The day began with a series of academic presentations criticizing the power of that approach. The most supportive said that the Fed’s purchases of Treasuries had little value, but that its purchases of mortgage-backed securities “likely have had beneficial macroeconomic effects.”
...
Policy makers tend to view these critiques as triumphs of theory over reality. They point to events in June as a kind of perverse evidence, noting that a wide range of interest rates jumped after the Fed’s chairman, Ben S. Bernanke, announced that the Fed intended to reduce its monthly asset purchases by the end of the year. The implication, they said, is that the purchases had been suppressing those rates. 

“The paper doesn’t comport very well with the experience of the last couple of months,” said Donald L. Kohn, a fellow at the Brookings Institution and a former Fed vice chairman. “We’ve had a very broad set of asset price changes.”
...

 and via DeLong

The other big question at Jackson Hole by Pedro da Costa

There are a number of possible explanations, and the reality likely combines some element of each. One, sadly, is politics. As much as the central bank likes to tout its independence, policymakers were clearly caught off guard by the blowback, both in Congress and among the public, to unconventional monetary policy. The perception that the Fed was acting recklessly, even if erroneous, was relatively widespread, even among some respected voices in the economics community. 

...
Which brings us to the issue of timing. When Bernanke laid out this-market-spooking roadmap to tapering at his June press conference, sending Treasury yields sharply higher and emerging markets steeply lower, it was hard not to wonder whether the chairman didn’t feel a sense of responsibility in wrapping up his unconventional policies at the end of his second term. Still, given Bernanke’s repeated warning about the dangers of a premature policy tightening, it is hard to imagine that the chairman would not change his mind if the second half rebound the Fed has been banking on fails to materialize.

Economic History

Panics of 1792, 1796-97, 1813, 1819, 1825

Panic of 1837

Panics of 1847, 1857, 1866

Free-Banking Era (1837-1862)

The Long Depression (1873-1896)

Starting with the adoption of the gold standard in Britain and the United States, the Long Depression (1873–1896) was indeed longer than what is now referred to as the Great Depression, but shallower. However, it was known as "the Great Depression" until the 1930s.

...Many argue that most of the stagnation was caused by a monetary contraction caused by abandonment of the bimetallic standard, for a new fiat gold standard, starting with the Coinage Act of 1873.

The Great Deflation (1870-1890)

Panics of 1884, 1890, 1893, 1896, 1901

1884 - a panic within the context of the Long Depression and Great Deflation. Fun. (By the way, did you notice that the Great Deflation is dated as beginning 3 years earlier than the Long Depression and ending six years earlier?)

Panic of 1907

Such is his power that JP Morgan single-handedly organizes a private sector bailout, rescuing the American economy. In 1910, America's leading financiers decide to create a National Reserve Bank to prevent future panics from getting out of hand. The "most interesting man in the world" won't always be around to save the day, they reason.

The British Empire maintained the gold standard until Franz Ferdinand's assassination and the onset of World War I.

By the end of 1913, the classical gold standard was at its peak but with the advent of World War I in August 1914, many countries suspended or abandoned the gold standard. According to Lawrence Officer the main cause of the gold standard’s failure to resume its previous position after World War 1 was “the Bank of England's precarious liquidity position and the gold-exchange standard.” A run on sterling caused Britain to impose exchange controls that essentially neutered the international gold standard; convertibility was not legally suspended, but gold prices no longer played the roles that they did under the Classical Gold Standard.

David Glasner argues

According to the Hawtrey-Cassel explanation, the source of the crisis was a deflation caused by the joint decisions of the various central banks — most importantly the Federal Reserve and the insane Bank of France — that were managing the restoration of the gold standard after World War I.

The earlier countries left the gold standard, the earlier they exited the Great Depression. There was also the fiscal government stimulus of arming for World War II.

The Bretton Woods system (1944-1971)

Triffin's Dilemma

In 1960 Robert Triffin, Belgian American economist, noticed that holding dollars was more valuable than gold because constant U.S. balance of payments deficits helped to keep the system liquid and fuel economic growth. What would later come to be known as Triffin's Dilemma was predicted when Triffin noted that if the U.S. failed to keep running deficits the system would lose its liquidity, not be able to keep up with the world's economic growth, and, thus, bring the system to a halt. But incurring such payment deficits also meant that, over time, the deficits would erode confidence in the dollar as the reserve currency created instability.

The rise of Japan and Europe.

In the late 1960s, the dollar was overvalued with its current trading position, while the Deutsche Mark and the yen were undervalued; and, naturally, the Germans and the Japanese had no desire to revalue and thereby make their exports more expensive, whereas the U.S. sought to maintain its international credibility by avoiding devaluation.[21] Meanwhile, the pressure on government reserves was intensified by the new international currency markets, with their vast pools of speculative capital moving around in search of quick profits.[20] 

In contrast, upon the creation of Bretton Woods, with the U.S. producing half of the world's manufactured goods and holding half its reserves, the twin burdens of international management and the Cold War were possible to meet at first. Throughout the 1950s Washington sustained a balance of payments deficit to finance loans, aid, and troops for allied regimes. But during the 1960s the costs of doing so became less tolerable. By 1970 the U.S. held under 16% of international reserves. Adjustment to these changed realities was impeded by the U.S. commitment to fixed exchange rates and by the U.S. obligation to convert dollars into gold on demand.

Nixon cancels the dollar's direct convertibility into gold.

Stagflation

Misery Index

Okun found by adding the unemployment rate to the inflation rate.

1 percent inflation better than 4 percent inflation? Really? Deflation reduces misery? Really?

Misery Index (band) - a deathgrind band from Baltimore, Maryland

Jimmy Carter and Ronnie Raygun deregulate as a means to promote growth (or what their wealthy campaign contributors want). Carter's deregulation and inflation czar was Alfred E. Kahn. Reagan signals war on organized labor by breaking PATCO. Income redistributes upwards. Volcker breaks inflation and tosses many people out of work.

Kahn's strong advocacy of deregulation stemmed largely from his understanding as an economist of marginal-cost theory. In his time at the New York Public Service Commission he was instrumental in using marginal costs to help price electricity and telecommunications services; this was novel at the time but is routinely performed today.

Deregulation (privatization)

LBJ privatizes Fannie Mae (housing)

Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) phased out a number of restrictions on banks' financial practices, broadened their lending powers, allowed credit unions and savings and loans to offer checkable deposits, and raised the deposit insurance limit from $40,000 to $100,000 (thereby potentially lessening depositor scrutiny of lenders' risk management policies). 

In October 1982, U.S. President Ronald Reagan signed into law the Garn–St. Germain Depository Institutions Act, which provided for adjustable-rate mortgage loans, began the process of banking deregulation, and contributed to the savings and loan crisis of the late 1980s/early 1990s. 

In November 1999, U.S. President Bill Clinton signed into law the Gramm–Leach–Bliley Act, which repealed part of the Glass–Steagall Act of 1933.

W. Bush attempts to privatize Social Security but fails.

Obama makes noises about "reforming" Social Security (via price index) and Medicare but hasn't yet. 

Obamacare incomplete (far from it) step in right direction towards single-payer.

Creation of Consumer Finance Protection Bureau 

Krugman says real interest rates were above historic norms during the 80s and 90s.

Savings and loan crisis (1980s)

Black Monday (1987)

Early 1990s jobless recovery Unlike Volcker's recovery, similar to subsequent recoveries after the dot-com and housing bubbles.

Japanese asset price bubble (1980s)

Lost Decade (Japan, 1990s-)

Abenomics

End of the Soviet Empire. West Germany absorbs East Germany. China abandons Marxism, embraces Capitalism. TINA.

European common currency (1 January, 1999)

Swedish banking crisis (early 1990s)

Latin American debt crisis (late 1970s and 80s)

1994 crisis in Mexico Improvised bailout of U.S. banks works.

1997 Asian financial crisis Harsh IMF-imposed structural adjustment programs (courting "investor sentiment") don't work well. China resolves to build up reserves even as its capital controls helped it avoid currency run.

1998 Russian financial crisis

Dot-com bubble followed by jobless recovery in 2000s

Argentine crisis of 2001-2002

US housing bubble (2002-2006)

Global financial crisis of 2007-2012

European Feedback Cycle of Doom

Republicans in Congress push sequestration and fiscal austerity while the Fed maintains ZIRP and quantitative easing.

Fannie and Freddie (single-payer housing)

Socialize housing finance! by Michael Pollack

(via Doug Henwood)

This Age of Bubbles by Krugman

54 Years Of Real Interest Rates by Krugman

Great Depression: Central Bank mismanagement

 Why Hawtrey and Cassel Trump Friedman and Schwartz by David Glasner

Not only did Friedman get both the theory and the history wrong, he made a bad move from his own ideological perspective, inasmuch as, according to his own narrative, the Great Depression was not triggered by a monetary disturbance; it was just that bad monetary-policy decisions exacerbated a serious, but not unusual, business-cycle downturn that had already started largely on its own. According to the Hawtrey-Cassel explanation, the source of the crisis was a deflation caused by the joint decisions of the various central banks — most importantly the Federal Reserve and the insane Bank of France — that were managing the restoration of the gold standard after World War I. The instability of the private sector played no part in this explanation. This is not to say that stability of the private sector is entailed by the Hawtrey-Cassel explanation, just that the explanation accounts for both the downturn and the subsequent prolonged deflation and high unemployment, with no need for an assumption, one way or the other, about the stability of the private sector.

Emphasis added.

bubblicious emerging markets

This would not be surprising to those who have read Krugman's 1999 book The Return of Depression Economics.

Generation B (For Bubble) by Krugman

So, the flood of money into emerging markets now looks in retrospect like another bubble. For the moment, I don’t see a good reason to believe that the bursting of this particular bubble will be catastrophic — what made the Asian crisis of 1997-8 so bad was the high level of foreign-currency denominated debt, and that seems less of an issue now. In fact, the main danger, as Ryan Avent says, seems to be policy overreaction: countries raising interest rates to defend indefensible exchange rates, leading to unnecessary slumps. But I have to admit that I’m less certain than usual about my diagnosis, because I’m still coming up to speed on the Indian economy in particular. 

Here, however, is a side question: why have we been having so many bubbles? 

The answer you hear from a lot of people is that it’s all caused by excessively easy money. But let’s think about the longer-term history for a bit. Here’s long-term U.S. interest rates since the early 1950s: 

 

As you can see, there was a period of very high rates in the inflationary 70s and early 80s. Rates fell after the Volcker stabilization, but they stayed relatively high by 50s/60s standards through the late 80s, the 90s, and even for much of the naughties. 

Now, the thing you need to realize is that the whole era since around 1985 has been one of successive bubbles. There was a huge commercial real estate bubble (pdf) in the 80s, closely tied up with the S&L crisis; a bubble in capital flows to Asia in the mid 90s; the dotcom bubble; the housing bubble; and now, it seems, the BRIC bubble. There was nothing comparable in the 50s and 60s. 

So, was monetary policy excessively easy through this whole period? If so, where’s the inflation? Maybe you can argue that loose money, for a while, shows up in asset prices rather than goods prices (although I’ve never seen that argument made well). But for a whole generation? 

So what was different? The answer seems obvious: financial deregulation, including capital account liberalization. Banks were set free — and went wild, again and again.

AV Club review of "Destino" from The Bridge

Under the Dumb

AV Club review of "The Fourth Hand" from Under the Dome

Breaking Bad

Slate TV Club discusses Breaking Bad

Krugman, Keynes, Kalecki, Konczal by John Quiggin

Keynes, Kalecki, Konczal, etc. by Krugman

Will: Rogues Gallery Stalwart

The sequester’s a public health hazard by George Will

Unfortunately, recent government behavior has damaged the cause of basic science. It has blurred the distinction between fundamental research and technical refinements (often of 19th-century technologies — faster trains, better batteries, longer-lasting light bulbs). It has sown confusion about the difference between supporting scientific research and practicing industrial policy with subsidies — often incompetently and sometimes corruptly dispensed — for private corporations oriented to existing markets rather than unimagined applications. And beginning with the indiscriminate and ineffective 2009 stimulus, government has incited indiscriminate hostility to public spending.

"Government has incited indiscriminate hostility to public spending?" What a dishonest hack. What a hypocrite!

George Will Wants the Government to Do Scientific Research  by Dean Baker

George Will Now Against Intentional Irrationality by Jonathan Chait