'In Praise of Econowonkery' by Mark Thoma

In the comment section, I did a link dump about the floor system safe asset paradigm shift genealogy.

Key Terms and Semantics*

Part Three

I guess my genealogy and key terms posts are all about macroeconomic demand management by the government via fiscal and monetary policies. The government is reacting to financial crises like the one in 2008 brought on by long-term secular trends in income and credit/debt creation/management.

Sterilization

downward nominal wage rigidity (DNWR)

Zero interest-rate policy (ZIRP)

nominal GDP level target

Opitmal Control Path

"extend and pretend"

Part Two

Commercial Paper

Part One

Interest on Excess Reserves (IOER)

Open Market Operations (OMO)

Hot Potato Effect

Monetary Base

Floor System

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Bloggily thinking out load here. Parts One and Two links.

floor system safe asset paradigm shift genealogy*

Oct. 20, 2011

What If We Paid Off The Debt? The Secret Government Report by David Kestenbaum (Planet Money)

Sept. 5, 2012

The Untold Story Of How Clinton's Budget Destroyed The American Economy by Joe Weisenthal

Jan. 2, 2013

Debt in a Time of Zero by Krugman

Jan. 7

On The Folly of Inflation Targeting In A World Of Interest Bearing Money by Ashwin Parameswaran

The end of RoRo, or is it? by Izabella Kaminska

Jan. 8

The liquidity trap heralds fundamental change by Frances Coppola

Jan. 9

Platinomics by Greg Ip

Jan. 12

On The Disruptiveness of the Platinum Coin by Tim Duy

Jan. 13

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

A Trap of My Own Making by Tim Duy

Jan. 14

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

Floor Systems by Stephen Williamson

Jan. 15

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

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

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

Money and Debt, Continued by Tim Duy

Do sofas refute monetarism? by Nick Rowe

Currency matters, even with IOR by Scott Sumner

The Waldman-Krugman-Sumner Debate: It's the IOER Path by David Beckworth

Base money basics by Merijn Knibbe

Unifying The Fiscal And Monetary Functions: A Policy Proposal by Ashwin Parameswaran

All Your Bases and Dead Presidents Are Belong to the Government? by Cullen Roche

More on Floor Systems by Stephen Williamson

Jan. 16

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

Understanding the Permanent Floor—An Important Inconsistency in Neoclassical Monetary Economics by Scott Fullwiler


Jan. 17

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

All Your Dorks Are Belong to This by Cullen Roche

Krugman, Kaminska, and Waldman by Scott Sumner

Monetary Policy: From Managing the Monetary Base to Setting an Interest Rate Floor by Peter Dorman

Let’s Talk About Interest on Reserves by Josh Hendrickson

Jan. 18

A confederacy of dorks by Steve Randy Waldman

THE PERMANENT FLOOR 2004 by Scott Fullwiler

Two extreme fiscal/monetary worlds by Nick Rowe

AND NICK ROWE IS THE LATEST ECONOMIST TO JOIN THE INARTICULATE DORKS... by Brad DeLong

The Coin is Dead! Long Live the Coin! by Michael Sankowski

Furthering Understanding of the Permanent Floor by Joshua Wojnilower

Shinzo and the Helicopters (Somewhat Wonkish) by Krugman

Jan. 19

Waldman Thinks Bernanke Will Go for (Flawed) Exit #1 by Robert Murphy

Murphy of the bad inflation bet, I think.

Jan. 28

Safe Assets and Financial Crises by Carola Binder

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*provisional. Times are not sorted. Updated from Jan. 19th posting.

Safe Assets

HOISTED FROM THE ARCHIVES: THE SAFE ASSET SHORTAGE AND THE CURRENT DOWNTURN by DeLong

Safe Assets and Financial Crises by Carola Binder

Mark Thoma has shared a link to a new working paper by Gary Gorton and Guillermo Ordoñez called "The Supply and Demand for Safe Assets." The paper brings to mind a once-confidential document written by economists in the Clinton Administration called "Life After Debt" which was recently made public by the team at NPR's Planet Money. The report notes:

In the year 2000, the U.S. Treasury began actively buying back the public debt; we should all appreciate the tremendous achievement this represents for the Nation as a whole... We must realize however, that a sharp reduction in Federal debt and the possible accumulation of a Federal asset raises at least three important issues. First, investors looking for an asset free of credit risk can no longer count on an abundant supply of U.S. Treasury securities, and Treasury securities may no longer provide a reliable benchmark for other interest rates. Second, the Federal Reserve may have to change the mechanisms by which it conducts monetary policy. Third, continued surpluses after the public debt has been paid off will require the Federal. government to acquire assets; either directly or though the Social Security Trust Fund. This raises issues about what kinds of assets might be acquired, and the best way to manage this task.”

And:

For a time, the AAA-rated top tranches of these manufactured assets were considered really safe, and it was like the "normal times" in the model when lenders trust that on average, collateral quality is good enough that they don't need to pay the extra cost to check on it. But then it became apparent that the average quality was much lower, and these assets became less effective collateral, and the financial crisis began. There are at least some claims that the Clinton surplus kicked off the rise in mortgage-backed securities issuance. (I included two graphs below, made using data from FRED, in case you want to evaluate the claims for yourself.) If you decide to read "The Supply and Demand for Safe Assets," please do also look at Krishnamurthy and Vissing-Jorgensen's empirical counterpart. Or, for something lighter, listen to Planet Money'sepisode "What If We Paid Off The Debt? The Secret Government Report."

I think I should add Binder's post and Gorton & Ordoñez's working paper to my paradigm shift geneology.

reading the paradigm shift genealogy

I'm currently slowly going through my paradigm shift genealogy timeline, and will add some quotes here to help me digest what they all are discussing. 

1. From Krugman on Jan. 2:

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.

2. From Coppola on Jan. 7. Them is referring to Keynes and Krugman.

So for them, the liquidity trap is a phenomenon associated with very low nominal interest rates - an abnormal situation by any standard. And we have had very low nominal rates for five years now, so it would be reasonable to assume that the liquidity trap we now find ourselves in is due to interest rates being near-zero, and that once we have restored the economy to sufficient health to allow interest rates to rise to historic norms, normal service will be resumed. 

But that's not actually the current situation. We have interest-bearing money. Yes, interest rates on money are very low at the moment. And therefore - as I explained above - so are yields on the investments which are near-substitutes for money. But if interest rates were to rise, would this change?

I can't see any reason why it should. Because interest-bearing money is freely exchangeable with government debt - and indeed the shadow banking system constantly performs that intermediation - the equivalence between government debt and interest-bearing money would hold at any level of interest rates. We are indeed in a liquidity trap, but it's not because of economic distress and near-zero interest rates. It is because the nature of money has fundamentally changed. Money is no longer just "cash". Money is any financial asset that flows freely and is readily exchangeable for currency.

3. From Duy on Jan. 12

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. 

Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.

 4. Waldman on Jan. 13

What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive).

5. Duy on Jan. 13

I think what I had in mind is this (and I admit that I am not wed to this, a little open-microphone now): The Fed has a portfolio of bonds which is a indirect transfer from Treasury which in turns allows it to pay interest on reserves. Lacking such a portfolio, the Fed would need to receive a direct transfer from the Treasury to pay interest on reserves. Operationally, these are the same. As long as both have the same objective function, it makes no difference if the Treasury's transfer goes through the middleman of a bond or just directly to the Fed. But what if the Treasury does not have the same objective function, does not want higher interest rates, and thus does not want to transfer the resources to the Fed? What claim does the Fed have on the Treasury to force it to act?  

Somewhere in this space is why we have come to accept the importance of an independent central bank. Indeed, this is a concern should the Fed need to pay interest on reserves that exceed the interest earned on its bond portfolio. Then the Fed would need to turn to the Treasury and say "Remember when we paid you $89 billion? Well, we need some of that back now."    

Ultimately, though, I have to agree with Waldman when I allow for the two authorities to have the same objective function. This is another way of saying that one side effect of the zero bound is the blurring of what many thought were sharp lines between fiscal and monetary authorities.

6. Waldman on Jan. 15

If “the crisis ends” (whatever that means) and the Fed reverts to its traditional approach to targeting interest rates, Krugman will be right and I will be wrong, the monetary base will revert to something very different than short-term debt. However, I’m willing to bet that the floor system will be with us indefinitely. If so, base money and short-term government debt will continue to be near-perfect substitutes, even after interest rates rise. 

Again, there’s no substantive dispute over the economics here. Krugman writes:

"It’s true that the Fed could sterilize the impact of a rise in the monetary base by raising the interest rate it pays on reserves, thereby keeping that base from turning into currency. But that’s just another form of borrowing; it doesn’t change the result that under non-liquidity trap conditions, printing money and issuing debt are not, in fact, the same thing."

If the Fed adopts the floor system permanently, then the Fed will always “sterilize” the impact of a perpetual excess of base money by paying its target interest rate on reserves. As Krugman says, this prevents reserves from being equivalent to currency and amounts to a form of government borrowing. So, we agree: under the floor system, there is little difference between base money and short-term debt, at any targeted interest rate! Printing money and issuing debt are distinct only when there is an opportunity cost to holding base money rather than debt. If Krugman wants to define the existence of such a cost as “non-liquidity trap conditions”, fine. But, if that’s the definition, I expect we’ll be in liquidity trap conditions for a very long time! By Krugman’s definition, a floor system is an eternal liquidity trap.

Am I absolutely certain that the Fed will choose a floor system indefinitely? No. That is a conjecture about future Fed behavior. But, as I’ve said, I’d be willing to bet on it.