The Floor System

The new thing for me is the realization - reading Waldman - that we will be in a liquidity trap for a long time. Atlanta's Lockhart says QE is not "QE infinity."

Yesterday Steve Williamson blogged:

The quantity of reserves held by US financial institutions is now approaching $1.6 trillion, and the Fed has promised to increase that stock by $85 billion per month for the indefinite future. Thus, it seems safe to say that the Fed will be working within a monetary regime with a large quantity of excess reserves for a very long time.

All Your Base Are Belong To Us, Continued (Still Wonkish) by Krugman

Yet more on the floor with Paul Krugman by Steve Randy Waldman

Krugman "And I think he’s implying that there’s really no difference between 2(b) and 3." 3 is what MMTers argue something Krugman has discussed before.

Waldman "But Waldman definitely does not at all believe that 2(b) and (3) are equivalent when the interest rate is positive." So he's not a subscriber to MMT?

At Economic View, Sadowski links to "the Money Illusion":

Currency matters even with IOR by Scott Sumner

Which I can't make sense of. As I understand it, there are three schools of demand management: the Modern Monetary Theoryist (MMTers, far left), the Market Monetarists (rightwing) and the mainstream DeLong-Krugman-Thoma axis to which I subscribe.

A link history of this discussion:

Debt in a Time of Zero by Krugman 

It’s true that printing money isn’t at all inflationary under current conditions— that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public. 

We are living in weird economic times, where many of the usual rules don’t apply and there are big free lunches to be had. But not everything is a free lunch, even now. Sorry.

Which led to Ip's blogpost which linked to the above:

Platinomics by Greg Ip

But the politics are utterly different. We have a central bank to separate fiscal from monetary policy. The Fed implements QE when it has decided that’s the best way to carry out its monetary policy objectives. Buying a coin solely to finance the deficit is monetizing the debt, precisely the sort of thing central bank independence was meant to prevent. How could any Federal Reserve chairman justify cooperating in such a scheme, in particular since the Fed would be taking the White House’s side in a fight with Congress over a matter of dubious legality? 

Yes, the Fed has sacrificed its independence for the sake of the national interest before, such as maintaining a ceiling on Treasury yields between 1942 and 1951; but that was (initially) in wartime, and it eventually led to inflation. Would avoiding the debt ceiling be important enough to compromise the Fed's independence? Perhaps not in this one case; but it would set a precedent future presidents will happily exploit and feed the perception that America’s economic institutions are in terminal decline. America has had debt ceiling crises before (in 1957, 1985, 1996 and 2011) and survived; are the unknown risks of the platinum coin option obviously preferable to the known risks of hitting the debt ceiling?

Duy linked to both Krugman and Ip:

On The Disruptiveness of the Platinum Coin by Tim Duy

Carrying the argument further, the illusion of a difference between cash and debt at the zero bound is counterproductive because it prevents the full application of fiscal policy.  Fears about the magnitude of the government debt prevent sufficient fiscal policy, but such fears are not rational if debt and cash are perfect substitutes. If cash and debt are the same, the fiscal authority should prefer to issue cash if debt concerns create a false barrier to fiscal policy.  Still, I would argue that this is best done in cooperation with the monetary authority.  Note that this is not really a new idea, as then Governor Ben Bernanke drew a similar conclusion with regards to Japan:

However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

And then we come to the platinum coin, which threatened to expose the illusion that cash and debt are different at the zero bound.... 

...
Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet.

Waldman links to Duy and Ip:

There’s no such thing as base money anymore by Steve Randy Waldman

Krugman responds

All Our Base Are Belong To Us (Wonkish) by Krugman

Waldman responds

Do we ever rise from the floor? by Steve Randy Waldman

and then Krugman responds again (see above) and Waldman responds again (see above)

Update:

Tim Duy has another post:

My takeaway from Waldman is that under some institutional structures, there is little difference between platinum coins and government debt (or because we have debt we have a particular institutional structure?) In effect, the the zero-bound issue and platinum coin debate have forced us to think down paths that blur the lines between fiscal and monetary policy. The longer we are in at the zero-bound, the more we will challenge the existing status-quo. 

Alternatively, this can also be simply a misunderstanding on Krugman's part if he believes that Waldman is saying that we can use platinum coins to literally monetize deficit spending with neither budgetary nor inflationary implications. I don't think Waldman is thinking this, and if he is, then I think he would be wrong.

And  commenter RebelEconomist (from the UK) at Waldman's latest:

What a lot of fuss about nothing! Americans might save themselves much confusion if they paid more attention to practices in other countries. Well before the financial crisis and QE, the Bank of England switched to paying interest on reserves to make the demand for reserves more elastic and hence make moneymarket interest rates, through which the BoE regulated its monetary stance, less volatile. Provided that the interest rate paid on reserves is a bit less than low credit risk private sector debt, the banks will still hold reserves primarily as a settlement asset, but simply hold more reserves. On May 18 2006, the day the new regime was introduced, reserves held by British banks rose about twenty fold, a demand met by the BoE, without any disturbance to inflation, sterling exchange rates or government debt markets. I explain the reasoning in more detail in this old post of mine:  

http://reservedplace.blogspot.co.uk/2009/04/easing-understanding.html 

(especially paragraphs 20-24). I suspect that the Fed always wanted to introduce such a system themselves, but found it difficult to get past populist congressmen whining about giving money away to banks, and now they have it, they are going to hang onto it for operational reasons long after they cease paying interest on reserves for QE purposes!

Commenter Tom Hinkey at interfluidity:

I think that it is unlikely that the Fed will continue the setting floor rate by paying IOR for political reasons similar to the reason that the platinum coin was smothered in the crib. It gives the game away and threatens the illusion that government finance is like firm or household finance under the current monetary regime. This is not an operational requirement since there is no operational reason for government not to fund itself directly. The illusion that government needs to be funded from revenue or borrowing from the private sector is created by political means, that is legislation, regulation, and interpretation. There is serious speculation that the central bankers’ club nixed the platinum coin gambit for this reason, and I would not be surprised to see TPTB nix payment of IOR when it no longer suits their purposes. 

Another Updated(!) 

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska

All Your Base Are Belong To Us: What Is the Question? by Krugman

Lost Decades

Do we ever rise from the floor? by Steve Randy Waldman

The Game Theory of the Post-Platinum Coin Debt Ceiling by Mike Konczal

Aaron Swartz's Lawyer: Prosecutor Stephen Heymann Wanted 'Juicy' Case For Publicity

One Way to Trim Deficit: Cultivate Growth by David Leonhardt

Krugman blogs:

As Catherine Rampell points out, this is the lowest level of core inflation ever.

But I have a question here: why do economic forecasters keep predicting a near-time rise in core inflation, even though they are also predicting high unemployment? The Survey of Professional Forecasters now predicts average unemployment of 8.7 percent in 2012, which would seem to be a recipe for continuing disinflation and quite possibly deflation; but the same forecasters predict a noticeable rise in core inflation over the next two years:

 

I don’t really understand this, except as a fundamental unwillingness to face up to the Nipponization of the US economy.

Meanwhile in Europe, the debt crisis resurfaces. Dean Baker blogs:

Ireland is in the headlines these days as its government struggles with insolvency. Remarkably, none of the news stories remember to point out that Ireland was a model of fiscal responsibility in the years leading up to its current disaster. Not only did it balance its budget, Ireland ran large budget surpluses in the 5 years preceding its collapse in 2008. Its peak surplus in 2006 was 2.9 percent of GDP, the equivalent of a surplus of roughly $420 billion in the United States.

Like the deficit hawks in the United States, Ireland's political leaders ignored the country's massive housing bubble, the collapse of which sank its economy. It is interesting to note that, while Ireland's background to the deficit crisis is generally ignored, news reports on Greece's financial difficulties routinely referred to its large budget deficits in the years leading up to the crisis.

And yet here we are in the US talking about deficits and the Catfood Commission.

Of Turning Japanese

A scary chart from Mary Daly, vice president of the Federal Reserve Bank of San Francisco. (via Krugman, via Mark Thoma)

Brad DeLong doesn't believe the QE2 will be enough. (sorry no link) Dean Baker argues that we are already - as they used to say in Vietnam - in the shit. (sorry no link) If we cross past zero, it won't mark anything new just that we are continuing our descent of disinflation. The point when we entered a Keynesian situation is where we crossed the rubicon.

What is needed is a larger QE and more fiscal stimulus.

Democrats, the election, the stimulus and Keynes by Sewell Chan

But that seems unlikely, as long as the recovery plods along slowly. "It would be a mistake to attribute the distancing from Obama’s stimulus entirely to political caution or opportunism," said Robert S. Weisbrot, a historian at Colby College. "As much as those factors may be important, it is dismaying how little evidence there is to show for it. Maybe we need even more, but surely $800 billion should have counted for something"

Krugman blogs

During the pre-crisis period, spending grew slightly faster than GDP --that’s Medicare plus the Bush wars -- while revenue grew more slowly, presumably reflecting tax cuts.

What happened after the crisis? Spending continued to grow at roughly the same rate -- a bulge in safety net programs, offset by budget-slashing at the state and local level. GDP stalled -- which is why the ratio of spending to GDP rose. And revenue plunged, leading to big deficits.

But I’m sure that the usual suspects will find ways to keep believing that it’s all about runaway spending.

What the usually good Sewell Chan fails to report is that the much of the stimulus was ineffective tax cuts and that much of the rest was canceled out or negated by the anti-stimulus of the 50 state governments and the stalling of GDP growth. Currently the economy is growing too slow to create enough jobs and aggregate demand which is why we'll see more action from the Fed.

We're Turning Japanese I Really Think So

Interesting e-mail from St. Louis Fed President Jim Bullard to blogger Tim Duy. (via Mark Thoma)

Which is funny because Duy seems despondent lately.* Bullard seems to say that he sees more positive data than Duy does and suggests that Fed policy will happen incrementally not in big "shock and awe" doses. I do remember reading that Bullard was warning of deflation. So maybe the Fed will keep acting incrementally until the data turns positive. Also according to the committee minutes, they believe the economy will turn around very, very slowly, so maybe that's what we're experiencing and the negative data points are just "noise." But they keep having to revise downwards, just at the Obama administration low-balled the stimulus.
--------------------------------
 * He links Krugman about America turning Japanese.

The whole point of that paper was that when you’re up against the zero lower bound, it doesn’t matter how much money you print -- not unless you credibly promise higher inflation.

And of course, now we’re all Japanese.

And at Jackson Hole, Bernanke said there is no desire on the committee to promise higher inflation. So either the private sector will pick up on its own or we're up a creek without a paddle. Japanese punk:

GISM was a Japanese mid-paced hardcore punk band (with heavy metal influence) formed in Tokyo, Japan in 1980. Even though the guitar style resembled heavy metal style riffs and solos, GISM were one of the first Japanese hardcore bands, while at the same time drawing influence from the early industrial/avant-garde music scene; something extremely uncommon in punk bands at that time.

The acronym GISM had many different variations; they include: God In the Schizoid Mind, Guerrilla Incendiary Sabotage Mutineer, General Imperialism Social Murder, Genocide Infanticide Suicide Menticide & Gnostic Idiosyncrasy Sonic Militant.

...

In Lady Gaga's video for the song "Telephone," released in March of 2010, the performer wears a spiked leather jacket featuring a GISM back patch. Whether Lady Gaga is actually a fan of the band is unclear. However, the director of the music video, Jonas Akerlund, is former member of the Swedish metal band Bathory and could very well be the reason for the jacket's appearance in the video. The jacket also features patches for the UK crust bands Icons of Filth and Doom.

Lady Gaga knows we're turning Japanese. The difference with the Japanese Lost Decade is that our banking system seems to be in better shape with lots of bad banks going under or being absorbed by other banks. The banks are still profitable but are not lending because of a lack of demand. This seems different to me than the Japanese Lost Decade's legions of "zombie banks."