An experimental bond-trading program being run at the Federal Reserve Bank of New York could fundamentally change the way the central bank sets interest rates.
Fed officials see the program, known as a "reverse repo" facility, as a potentially critical tool when they want to raise short-term rates in the future to fend off broader threats to the economy. Of particular concern for the Fed is finding a way to contain inflation once the trillions of dollars it has sent into the financial system get put to use as loans.
Like the plumbing beneath the floorboards in a home, this program is unseen by most investors and it isn't part of the Fed's current efforts to spur growth. Launched this year, it is still in a testing stage and isn't expected to be fully implemented for years.
Under this system, the Fed would raise short-term interest rates by borrowing in the future against its large and growing securities portfolio.
The Fed traditionally has managed short-term interest rates by shifting its benchmark federal-funds rate, an overnight intrabank rate. It did this by controlling how much money flowed into and out of the banking system on a daily basis. Small adjustments could significantly impact short-term rates. Since the Fed has pumped $2.5 trillion into the economy by purchasing bonds, the old system won't work unless the central bank pulls much of this money out. Instead, what Fed officials increasingly envision is a system in which it would tie up this money as needed by offering investors and banks interest on their funds.
The stakes are enormous. Right now banks aren't lending this money aggressively. But as the economy expands and lending picks up, the Fed will need to tie up the money to ensure it doesn't cause the economy or financial markets to overheat.
"The Federal Reserve has never tightened monetary policy, or even tried to maintain short-term interest rates significantly above zero, with such abundant amounts of liquidity in the financial system," according to a draft of a new research paper by Brian Sack, the former head of the New York Fed's markets group, and Joseph Gagnon, an economist at the Peterson Institute for International Economics and a former Fed economist.
Short-term rates—which serve as a benchmark for long-term rates for mortgages, car loans and other borrowing—are now near zero and the Fed doesn't plan to raise them for a couple of years. In normal times, the Fed cuts short-term rates to spur growth and raises them when it wants to slow growth.
When it does want to raise rates, the Fed under the repo program would use securities it accumulated through its bond-buying programs as collateral for loans from money-market mutual funds, banks, securities dealers, government-sponsored enterprises and others.
The rates it sets on these loans, in theory, could become a new benchmark for global credit markets.
The head of the New York Fed's markets group, Simon Potter, in a speech at New York University this month, described the new program as "a promising new technical advance."
Some market observers are going a step further and arguing that the Fed should abandon the fed-funds rate as its main lever for managing a broad spectrum of rates in the financial system.
Mr. Sack is among them. In his draft paper with Mr. Gagnon, they say the reverse-repo program should become a linchpin for the way the Fed manages interest rates in the future.
Mr. Sack, who is now co-director of global economics at the hedge fund D.E. Shaw, and Mr. Gagnon argue the Fed should discard its effort to target the fed-funds rate and instead use these repo trades as a primary way of guiding the borrowing rates that ripple through the economy.
The paper is notable because Mr. Sack, during his tenure at the New York Fed from 2009 to 2012, led the central bank's effort to find new ways to manage short-term interest rates.
Barclays analyst Joseph Abate said the repo program appears to have set a floor under short-term lending rates even during the small-scale tests. The general-collateral rate—the borrowing rate for the most common type of repo—has recently settled at about 0.10%, about 0.05% above the fixed rate the Fed has set for the repo facility and about 0.05% higher than it was earlier in the fall before the tests were launched.
Mr. Abate also said the Fed should abandon its fed funds target and stick with this program.
"The Fed has a very powerful tool on its hands," he said.
Without new tools like the repo facility, the Fed might not be able to control interest rates or it might be forced to take financially destabilizing steps such as selling the securities in its portfolio in a hurry.
The idea for the repo program bubbled up from the New York Fed's market group in part because another tool wasn't working well. Officials had seen a program known inside the Fed as IOER, for "interest on excess reserves," as the main avenue for managing short-term rates amid the flood of money in the system. Under this program, the Fed pays banks 0.25% for cash they keep at the central bank. In theory, when the Fed wants to raise short-term rates, it would raise this interest rate. Rather than lend out money, banks should want to keep it with the Fed.
In reality, the IOER program hasn't worked well, in part because some big market players including Fannie Mae and Freddie Mac can't participate. The fed funds rate has hovered well below the Fed's 0.25% floor for years. That isn't a problem now because the Fed wants to hold rates very low, but it raises concerns that the central bank won't have tight control of rates when the time comes to raise them.
The reverse-repo program extends the Fed's reach beyond traditional banks to Fannie, Freddie and others, and in theory should give the central bank more control over interest rates. Mr. Sack and Mr. Gagnon say the Fed should use the IOER program in conjunction with the reverse-repo program to set rates.
The Fed has been testing the repo program with 139 different counterparties in the past few months, including 94 money-market funds, and setting an interest rate of 0.05%.
"By reaching financial institutions that are ineligible to earn [interest on excess reserves]…the facility widens the universe of counterparties that should generally be unwilling to lend at rates below those rates available through the central bank," Mr. Potter said in his speech.
"It is easy to confuse what is with what ought to be, especially when what is has worked out in your favor."
- Tyrion Lannister
"Lannister. Baratheon. Stark. Tyrell. They're all just spokes on a wheel. This one's on top, then that's ones on top and on and on it spins, crushing those on the ground. I'm not going to stop the wheel. I'm going to break the wheel."
- Daenerys Targaryen
"The Lord of Light wants his enemies burned. The Drowned God wants them drowned. Why are all the gods such vicious cunts? Where's the God of Tits and Wine?"
- Tyrion Lannister
"The common people pray for rain, healthy children, and a summer that never ends. It is no matter to them if the high lords play their game of thrones, so long as they are left in peace. They never are."
- Jorah Mormont
"These bad people are what I'm good at. Out talking them. Out thinking them."
- Tyrion Lannister
"What happened? I think fundamentals were trumped by mechanics and, to a lesser extent, by demographics."
- Michael Barone
"If you want to know what God thinks of money, just look at the people he gave it to."
- Dorothy Parker
Saturday, December 14, 2013
Rudi Dornbusch and the Salvation of International Macroeconomics (Wonkish) by Krugman
The Keynesian Revolution, the Monetarist Counterrevolution, the New Classical Purge, the Neo-Keynesian Restoration: Saturday Focus (December 14, 2013) by DeLong
The Neo-paleo-Keynesian Counter-counter-counterrevolution (Wonkish) by Krugman
Neo-Paleo-Keynesians Krugman and DeLong by Robert Waldmann
More Paleo-Keynesianism (Slightly Wonkish) by Krugman
Inequality isn’t ‘the defining challenge of our time’ by Ezra Klein
Inequality, Ezra, Paul, and the Unifying Theory (and Evidence) by Jared Bernstein
Well, here’s a unifying theory: demand-side policies that that significantly lower unemployment will also reduce inequality. It’s right there in figures 2.5-2.7 of my new book with Dean Baker on getting back to full employment.
A major factor driving inequality, particularly earnings’ gaps, is the diminished bargaining power of middle and low-wage workers. In an economy like ours, with little (not-enough, IMHO) pressure from collective bargaining, low minimum wages, and a large low-wage sector relative to other advanced economies, very tight job markets are about the only friend working families have.
Second, my point here is that full employment enforces a more equitable distribution of growth. That’s not saying anything about the impact of inequality on growth itself, though the theory I develop in my CAP paper does introduce what I think are potentially important feedback loops between inequality, debt bubbles, and recession, with a generous sprinkling of money-in-politics to close the loop.Inequality As A Defining Challenge by Krugman
Third, there’s the political economy aspect, where you can argue that policy failures both before and, perhaps even more crucially, after the crisis were distorted by rising inequality, and the corresponding increase in the political power of the 1 percent. Before the crisis, there was an elite consensus in favor of deregulation and financialization that was never justified by the evidence, but aligned closely with the interests of a small but very wealthy minority. After the crisis, there was the sudden turn away from job creation to deficit obsession; polling suggests that this wasn’t at all what the average voter wanted, but that it did reflect the priorities of the wealthy. And the insistence on the importance of cutting entitlements is overwhelmingly a 1 percent thing.
Finally, very much tying in with this, is the question of what progressive think tanks should research. Klein suggests that “how to fight unemployment” should be a more central topic than “how to reduce inequality.” But here’s the thing: we know how to fight unemployment — not perfectly, but good old basic macroeconomics has worked very well since 2008. There’s no mystery about the economics of our slow recovery — that’s what happens when you tighten fiscal policy in the face of private deleveraging and monetary policy is constrained by the zero lower bound. The question is why our political system ignored everything macroeconomics has learned, and the answer to that question, as I’ve suggested, has a lot to do with inequality.Inequality and Incomes, Continued by Krugman
Ezra Klein Misses the Mark: Inequality and Unemployment Are the Same Problem by Dean Baker
These are the people who are most likely to get jobs. And those with jobs will also have the opportunity to work longer hours. And, a tight labor market will create conditions in which workers at the bottom will have more bargaining power. Walmart and McDonalds will be paying workers $15 an hour if that is the only way that they can get people to work for them.Is the American Left Wrongheaded? And Is the WCEG Part of the Problem?: Ezra Klein vs. Ashok Rao and Brad DeLong and **UPDATE** Steve Randy Waldmann: Friday Focus (December 13, 2013) by DeLong
For this reason, the high unemployment policy that Congress is pursuing with its current budget policy is a key factor in the upward redistribution of income that we have seen in the last three decades. This means that people concerned about inequality should be very angry over budgets that don't spend enough to bring the economy to full employment (also an over-valued dollar). So Ezra is absolutely right that progressives should be yelling about unemployment, but inequality is a very big part of that picture.
And then there are the political consequences of inequality. A more unequal economy is one in which the voice of the rich speak louder in the political debate, and the rich want to keep what is theirs. Before 1975 the U.S. made a uniquely large effort to educate its people, and win the race between education and technology. The result was a middle-class society for white guys (and, alas, for white guys alone). Then came what Robert Kuttner calls The Revolt of the Haves: the great pulling-up of the ladder of free public higher education. The consequence was another factor pushing for the great widening of income inequality, as America began to lose the race between education and technology. And the consequence was that 0.3%/year of American real economic growth simply vanished as we were no longer making the requisite educational effort to keep our population the best-educated in the world. Over 35 years that failure has made us another 10% poorer–and more unequal to.Terrible by Steve Randy Waldman
"There is little tension between addressing inequality and pursuing the other goals Klein says we should focus on. Klein sets up a straw man when he arguesTen Theses on Growth, Employment, and Inequality by Matt Yglesias
A world in which inequality is the top concern is a world in which raising taxes on the rich is perhaps the most important policy choice the government can make. A world in which growth and unemployment are top concerns are worlds in which very different policies — from stimulus spending to permitting more inflation — might be the top priorities."
The Defining Problem of Our Age by Ashok Rao
Friday, December 13, 2013
"A multiplier is dY/d(G-T). (Note that part of Y is also G-T, so a multiplier > 1 => a positive secondary impact of the deficit. And a secondary impact means both that T will increase - offsetting the original stimulus, and that non-government GDP will grow reducing - not increasing the relative size of the government sector.)
Binyamin Appelbaum had an interesting post about how many economists would like to see a higher rate of inflation to help recover from the downturn. The piece emphasizes the role of inflation in lowering real wages, with the argument that lower real wages are necessary to increase employment.
While there may be some truth to this point, it is worth fleshing out the argument more fully. At any point in time, there are sectors in which demand is increasing and we would expect to see rising real wages and also sectors where demand is falling and we would expect to see real wages do the same (e.g. Wall Street traders -- okay, that was a dream).
Anyhow, when inflation is very low, the only way to bring about declines in real wages in these sectors is by having lower nominal wages. Since workers resist nominal pay cuts, we end up not having this adjustment and therefore we end up with fewer jobs than would otherwise be the case. However it is an important qualification in this story that it is not about reducing real wages for all workers, only for some subset.
The other important point is that higher inflation promotes growth in other ways. First and foremost it makes investment more profitable by reducing real interest rates. Firms are considering spending money today to sell more output (e.g. software, computers, Twitter derivatives etc.) in the future. If they expect to sell this output for higher prices because of inflation, then they will find it more profitable to invest today. If we can keep interest rates more or less constant and raise the expected rate of inflation, then firms will have much more incentive to invest. This process seems to be working successfully in Japan at the moment.
Finally, inflation reduces debt burdens. Everyone who has debt in nominal dollars, such as homeowners, students, state and local governments, and the national government, will see the real value of its debt fall in response to inflation. This reduces their debt burden and makes it easier to spend. This would likely also be an important source of demand growth from higher inflation.
While many economists do emphasize the wage story, to my mind the other parts are likely more important. And, if higher inflation leads to more employment, this will increase workers' bargaining power and allow them to achieve wage gains that are likely to quickly offset any losses due to inflation -- although the Wall Street traders may not make up the lost ground.
Let me make a quick comment to clear up unnecessary confusion (can't do much about the deliberate confusion). The notion of inflation being a way to lower wages in the U.S. refers to the wages of some workers, not all workers. There are always industries seeing increased demand and some seeing reduced demand. The response to the latter would be lower wages. That is difficult to bring about in a situation of near zero inflation and nominal wage rigidity. By having higher inflation so that real wages can fall in these industries, we can increase employment, output, and real wages more generally. That is the argument. Folks can say why that may not work, but it's really not worth anyone's time to deliberately misrepresent it so you can say it's stupid.
We know the economy needs a bubble; but how big? by Nick Rowe
Secular Stagnation: A Deficit of Demand by Ryan Avent
Republican Inflation Paranoia Is Political Suicide by Romesh Ponnuru
The third and biggest risk is that Republicans would eventually gain power and then impose an excessively tight policy. Errors of this sort have in the past proved disastrous - - not only economically but also, for conservatives, politically. Excessive tightness by the Federal Reserve made the New Deal possible in the 1930s. Money was much too tight in 2008, too, and it led to the swollen Democratic majority that enacted President Barack Obama’s health-care law. In recent years, deflationary policies have hurt right-of-center parties in Argentina and Sweden as well.Hahaha, unusual argument from a Republican economist. Likewise by Martin Feldstein. Will they have their membership cards taken?
Thursday, December 12, 2013
Fed Moves Toward New Tool for Setting Rates: 'Reverse Repo' Program Could Be Critical to Fending Off Inflation
So, for the most part, something White House aides hastily drew up in the summer of 2011 as a trigger has become, for the most part, settled policy. How did a result the administration would have dismissed as a worse-case scenario come to pass? The first reason is that the White House mistakenly took Republican denunciations of the long-term debt at face value. Since Republicans appeared desperate to cut retirement programs, Obama assumed they would trade some form of higher tax revenue to get it. But the GOP’s opposition to higher taxes in any form, even closing loopholes, has trumped its commitment to lower spending for more than three decades.
Second, the administration failed to grasp that, alongside their aversion to higher taxes, conservatives had turned against policy-making itself. This is a transformation I failed to notice as well when I assumed in 2011 that the parties would find a way to muddle through and avoid the pain. The 2011 debt-ceiling agreement rested on the premise that, if the default was budget cuts deliberately designed to make both parties unhappy, both parties would cut some kind of deal.
But the conservative movement opposes not just the substance of compromise but the process itself....
It is true that this deal, by itself, never balances the budget. But even if that’s your goal, why should that prevent you from supporting something? The normal standards of evaluating legislation – does this improve things relative to the status quo – have become completely alien on the right. Look at the way Barbara Mikulski, one of the most liberal senators, frames the deal: “I will have to take a $45 billion downgrade from the Senate number, but the House is coming up $45 billion, so I think that’s a rational compromise.”
Halfway between what one party wants and what the other party wants is her definition of a fair bargain. Now look at how conservatives frame the same thing. Here’s a Heritage Foundation op-ed:
Under the deal, discretionary spending would rise to $1.012 trillion in 2014 and $1.014 trillion in 2015, a $63 billion total increase (though it does little to provide a real and sustained fix for President Obama's mismanagement of defense). This is a significant achievement for the president, who believes that government spending is a panacea to America's economic woes.There’s no sense whatsoever that the other party, which controls one chamber of Congress and the White House, ought to have any say at all. “My party should get everything” is the presumed starting and ending point.
...And here are some positives:Fischer, who holds both U.S. and Israeli citizenship and lives in New York, stepped down as governor of the Bank ofIsrael on June 30, midway through his second five-year term. He was credited with helping his nation weather the global economic crisis better than most developed countries.
. . .I don’t quite understand that last comment, as the Fed was already cutting rates in 2007. Does anyone know what they mean? In any case, Israel came closer to NGDP level targeting that anyone else that I am aware of, with the possible exception of Australia. So if Fischer is a discretionary policymaker, at least he’s a talented discretionary policymaker.
Fischer earned a reputation as a trailblazer as the first central banker to cut interest rates in 2008 at the start of the global crisis and the first to raise them the following year in response to signs of a financial recovery.
I wish Obama had picked Christy Romer, but I certainly support Fischer. He’s highly talented and a mainstream monetary economist. Bernanke and Draghi (and many other famous economists) were his students.
Unprecedented Austerity by Krugman
"You can see that there was a brief, modest spurt in spending associated with the Obama stimulus — but it has long since been outweighed and swamped by a collapse in spending without precedent in the past half century. Taking it further back is tricky given data non-comparability, but as far as I can tell the recent austerity binge was bigger than the demobilization after the Korean War; you really have to go back to post-World-War-II demobilization to get anything similar.
And to do this when the private sector is still deleveraging and interest rates are at the zero lower bound is just awesomely destructive."
Wednesday, December 11, 2013
Alan Blinder: The Fed Plan to Revive High-Powered Money: "Don't only drop the interest paid rate paid on banks' excess reserves, charge them:** Unless you are part of the tiny portion of humanity that dotes on every utterance of the Federal Open Market Committee, you probably missed an important statement regarding the arcane world of 'excess reserves' buried deep in the minutes of its Oct. 29-30 policy meeting. It reads: '[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage.' As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous. The Fed is famously given to understatement. So when it says that "most" members of its policy committee think a change 'could be worth considering', that's almost like saying they love the idea. That's news because they haven't loved it before..."(via DeLong)
Tuesday, December 10, 2013
Monday, December 09, 2013
Sunday, December 08, 2013
Still playing around with the question of secular stagnation. Based on some recent conversations, it seems to me that it’s useful to put some numbers to the issue – to quantify, at least roughly, the hole that seems to have developed in sustainable demand.
In doing all this, the key point is NOT to focus on events since crisis struck; this is not a case of taking a business-cycle slump and imagining that it will last forever. Instead, the argument is that the sources of demand during the good years – the Great Moderation from 1985-2007 – are not going to be available even when the aftereffects of crisis have faded away.
CBO thinks that we’re looking at potential growth around 1 percentage point slower than it was during the Great Moderation. To think about how this affects demand, consider the simple “accelerator”, in which producers, other things equal, invest enough to keep the ratio of capital to output constant as the economy grows. Here’s the ratio of fixed assets to GDP:
It’s somewhat above 2. This says that other things equal, a 1 percentage point drop in potential growth would reduce investment spending by 2 percent of GDP.
So between the end of rising leverage and slowing potential growth, we seem to be depressing aggregate demand by 4 percentage points. That’s a lot!
The average real rate during the GM years was 1.9 percent. Given the factors I’ve described, it seems hard to avoid the conclusion that the average real rate looking forward will have to be negative. If inflation stays relatively low, e.g. 2 percent, this would mean an economy that often, perhaps usually, finds itself in a liquidity trap.
What might change this scenario? One key point could be trade. Before the 1980s, the US had more or less balanced trade. During the Great Moderation era, it ran an average current account deficit of 3 percent of GDP. Eliminating that deficit somehow would reverse most of my shortfalls. I would say, however, that the most likely way to reduce the deficit would be via a weaker dollar, achieved through low real interest rates, achieved in turn with a higher inflation target.
In general, I do think the secular stagnation conversation is a real step forward. So it's a bit frustrating, in this context, to see Krugman speculating about the "natural rate" in terms of a Samuelson-consumption loan model, without realizing that the "interest rate" in that model is the intertemporal substitution rate, and has nothing to do with the Wicksellian natural rate. This was the exact confusion introduced by Hayek, which Sraffa tore to pieces in his review, and which Keynes went to great efforts to avoid in General Theory. It would be one thing if Krugman said, "OK, in this case Hayek was right and Keynes was wrong." But in fact, I am sure, he has no idea that he is just reinventing the anti-Keynesian position in the debates of 75 years ago.
The Wicksellian natural rate is the credit-market rate that, in current conditions, would bring aggregate expenditure to the level desired by whoever is setting monetary policy. Whether or not there is a level of expenditure that we can reliably associate with "full employment" or "potential output" is a question for another day. The important point for now is "in current conditions." The level of interest-sensitive expenditure that will bring GDP to the level desired by policymakers depends on everything else that affects desired expenditure -- the government fiscal position, the distribution of income, trade propensities -- and, importantly, the current level of income itself. Once the positive feedback between income and expenditure has been allowed to take hold, it will take a larger change in the interest rate to return the economy to its former position than it would have taken to keep it there in the first place.
There's no harm in the term "natural rate of interest" if you understand it to mean "the credit market interest rate that policymakers should target to get the economy to the state they think it should be in, from the state it in now."And in fact, that is how working central bankers do understand it. But if you understand "natural rate" to refer to some fundamental parameter of the economy, you will end up hopelessly confused. It is nonsense to say that "We need more government spending because the natural rate is low," or "we have high unemployment because the natural rate is low." If G were bigger, or if unemployment weren't high, there would be a different natural rate. But when you don't distinguish between the credit-market rate and time-substitution rate, this confusion is unavoidable.DeLong and Mason tweet on subject