I did a long interview today with Tom Keene of Bloomberg Radio on the current recession and Federal Reserve policy. You can listen to it by clicking here.
I did a long interview today with Tom Keene of Bloomberg Radio on the current recession and Federal Reserve policy. You can listen to it by clicking here.
I heard portions of the interview. Tom Keene is the best financial reporter bar none. He knows and understands markets and asks questions which matter.
Prof. Hamilton: Nice interview. The purchase of short term foreign securities is a great idea. A few questions:
Why do Fed officials say the payment of interest on reserves “allowed” them to flood the economy with more reserves? Obviously that’s not true in a technical sense, is it because they thought that without interest payments the increase in the base would be inflationary? And is that why the target rate has not yet fallen to zero? Policy currently seems way too contractionary in the sense that the internal Fed forecast should equal their policy goal. There must be some reason why the Fed has not already cut rates to zero–surely it is not because they are pleased with expected nominal spending growth?
You mention that we need to act before deflation develops. I agree, but even deflation expectations can be a problem for markets, and they have already set in, (although they can be reversed.) We are used of thinking about Fed credibility in terms of upside breakouts in inflation, but between July and October the Fed lost credibility in terms of preventing deflation. Some of this loss of credibility occurred before Lehman, and actually contributed to the intensification of the financial crisis. (Partly for reasons you identified–generals fighting the last war.) The rest occurred after Lehman, when the markets (correctly) sensed a lack of Fed (and ECB, BOJ) leadership to do what it takes to prevent deflation. Let’s not forgot that the Europeans are making roughly the same mistake–and without the zero-bound interest rate excuse. The BOJ is, of course, hopeless.
Listening to you interview I realize I totally misunderstood your earlier post about Plan C. Professor, I withdraw my agreement.
You are not even subtle about your call for inflation in the economy. The methodology of Plan A has always been a failure but money economists are only now understanding what many of us have been saying for decades. Plan B likewise is a failure and again it is methodology.
Finally, contrary to what you say economics today is not different than it has been in the past. If economic events don’t fit your model that is not because we are in a “new” economy, but there is a good chance that you need to rethink your model. It is like a mother watching a parade and as the band passes she shouts with glee, “Look! My son is the only one in step.”
Oh this would be the most amusing thing I have see this year if it were not so sad.
We all know that the Chinese communists are now more capitalist than the US and their economist are making more sound recommendations than US economists but now the Zimbabwe Central Bank commends the US Federal Reserve for finally using the same wisdom as the Zimbabwe CB has for years.
http://www.rbz.co.zw/pdfs/2008%20MPS/AprilMPS2008.pdf
Excerpt:
As Monetary Authorities, we have been humbled and have taken heart in the realization that some leading Central Banks, including those in the USA and the UK, are now not just talking of, but also actually implementing flexible and pragmatic central bank support programmes where these are deemed necessary in their National interests.
That is precisely the path that we began over 4 years ago in pursuit of our own national interest and we have not wavered on that critical path despite the untold misunderstanding, vilification and demonization we have endured from across the political divide.
I am confident that Ben Bernanke will show the same unwavering loyalty to this methodology that the head of the Zimbabwe Central Bank has shown.
DickF: Why are the only options on the table -2% deflation or +10,000% inflation? I advocate 3% inflation. What’s wrong with that?
Dear Prof. Hamilton,
I hear your interview with Tom Keene of Bloomberg Radio. It was very interesting. It started me thinking about the alternatives you discuss. It seems to me that you and most of the other economists are saying it is necessary for the Government (through the Federal Reserve or the Treasury) to throw lots of money into the economy NOW. Then in one or two or five years, work on the difficulties if any at that time. Withdraw money from the economy or raise interest rates or what ever.
This brings me to an idea of a suggestion, which I hope you will be kind, enough to respond to.
The idea:
The Government creates a NEW mortgage-issuing entity. Call it Mortgages for Anyone Just permit Fannie Mae and Freddie Mac to do their thing, hopefully they will shrink. Mortgages for Anyone will issue a mortgage to anyone with the following criteria. The interest rate will be 5%/year, (the interest rate the banks will pay the Government) the life term of the mortgage will depend on the monthly payment which will be fixed at 30% of the monthly disposal income of the applicant. Obviously, this means that some mortgages will have a life of maybe 30, 40, 50 or more years. Since the Government owns the mortgage provide it does not matter.
If the Government uses the money from the new STIMULUS proposal 500 billion or 1000 billion many mortgages may be written and many foreclosures (either actual or predicted) will not occur. The economy will receive its stimulus from the extra money available to households from a reduced mortgage payment, and from the removal of questionable assets from the Banks portfolio. Households will spend because their adjustable mortgage situation has been cleaned up, any likewise, with banks their questionable assets have been reduced or eliminated.
I realize that some might say that the government is bailing out the banks or investors, but isnt that what the government is doing now? This concept is understandable to Main Street it helps to stabilize the housing market and is implemented in an organized controlled manner. In the future when the economy is viable Mortgages for Anyone can increase its criteria so that it reduces its mortgage portfolio thereby returning the capital to the Government.
Your comments would be very appreciated.
Yours truly,
John L. Morace
The groups, firms and individuals that profited by constructing this house of card should be the ones who pay the costs of the collapse, in so far as that is possible. Paulson looks immediately at sending them financial resources rather than charging them for the cleanup. Why is that?
To preserve Federal resources and simultaneously reduce the credit squeeze, we need to return to the issue of why banks suddenly refused to lend to each other several months ago.
Banks did not know whether other banks were sound because they did not know which banks had the “toxic assets” that destroyed Lehman Brothers, AIG, Washington Mutual.
This lack of information can be overcome by the U.S. Congress. The needed law would modify a law passed in 2000 titled “Commodities Futures Modernization Act”. The new law would say that all contracts covered by this 2000 act will not be enforced in a court of the U.S. unless a copy of this contract is on deposit with the Federal Deposit Insurance Corporation.
The FDIC will then make public which private firms has investments in a) Real estate mortgages, b) Insurance against default of real estate mortgages. With this information, banks can then determine which counterparties they wish to avoid and which they wish to deal with.
The advantage of this scheme is that the firms that participated heavily in toxic assets will be forced to the wall; those that avoided this “get rich quick” scheme will survive. Poetic justice. A strong deterrent against future misbehavior. Also, an efficient way to reduce the size of the financial sector (said reduction is required because a major source of past profits is gone). Equally important, the Paulson approach of trying to “save” individual financial firms will be rendered superfluous.
Recognize that many pension funds, mutual funds, private investors will lose money from implementation of this proposal. Accept that reality. No firm that refused to take advantage of the profits to be gained from buying the toxic assets will be impacted by this proposal. Hopefully, all participating firms will have made enough profits in past years, from their participation, to pay for the loses.
The public would like the costs of the financial meltdown to be paid from past profits, not the public treasury.
This proposal assumes that enough financial firms will remain standing after this shakedown to provide credit to fund the U.S. economy.
JDH wrote:
DickF: Why are the only options on the table -2% deflation or +10,000% inflation? I advocate 3% inflation. What’s wrong with that?
Professor,
It doesnt solve the problem. At best it only postpones the inevitable. With the amount of uncertainty in the markets today it will take massive amounts of liquidity to move them. It is your fixation on inflation that causes me concern. The problem is uncertainty not liquidity. Bernanke is already almost to the point where he will have to pay banks to take his money. An inflation targeting methodology is better than what the FED has used in the past, as demonstrated by the Australian example, but, while this methodology may keep chronic inflation down, it is virtually ineffective in a contraction.
But under your plan (Milton Friedman reincarnated) you would have a 3% rise in prices caused by inflation for how many years? Will inflation increase the number of goods (the actual solution to the problem)? Will inflation improve management decisions and save the auto companies? Inflation might increase consumption, but isnt that our current problem? Didnt we stimulate real estate consumption to the point of creating a glut in real estate that could not be sustained?
Will we keep Plan C forever? If so will the countries of the world actually prefer a currency that will lose about 1/3 of its value every 10 years? This plan would really put China in the economic drivers seat, especially if they ever figure out how simple it would be to stabilize their currency though they are doing a better job than the US now. How long before a stable yuan is the worlds reserve currency? It seems that we are doing everything we can to help them by suppressing our economy and distorting our currency value.
The current plans that Treasury and the FED are using obviously are not solving the problem, but they are so convinced that they are right they just keep throwing more and more money at the problem with no effect. (Insanity is doing the same thing over and over expecting a different result.) As I said, your suggestion is much, much better than when they are doing, but what they are doing is ineffective and your suggestion is a band-aid when we need a solution.
DickF is right on target. I especially liked the following:
‘Will inflation increase the number of goods (the actual solution to the problem)? Will inflation improve management decisions and save the auto companies? Inflation might increase consumption, but isnt that our current problem? Didnt we stimulate real estate consumption to the point of creating a glut in real estate that could not be sustained?
Will we keep Plan C forever? If so will the countries of the world actually prefer a currency that will lose about 1/3 of its value every 10 years? This plan would really put China in the economic drivers seat, especially if they ever figure out how simple it would be to stabilize their currency though they are doing a better job than the US now. How long before a stable yuan is the worlds reserve currency? It seems that we are doing everything we can to help them by suppressing our economy and distorting our currency value”.
John L. Morace – May I comment upon your proposal? Fresh thinking is obviously needed concerning mortgages.
Tying monthly payments to disposable income is not attractive to me because disposable income changes frequently. I would anticipate the temptation to cheat by lying about the monthly disposable income would be irresistible to many – especially when the ones that cheat begin to brag about how they outwitted the government. A large governmental program to prevent cheating is also not attractive. Sorry.
Mr. Morace – Getting new people into vacant homes will cease to be a problem when the supply of vacant homes becomes large enough to drop the price of houses BELOW the “normal” relationship between income and the price of a mortgage that people can afford. I say below because an extreme on the downside is just as likely as was the extreme on the upside. And declining incomes will also push in the same direction.
John L. Morace – May I comment upon your proposal? Fresh thinking is obviously needed concerning mortgages.
Tying monthly payments to disposable income is not attractive to me because disposable income changes frequently. I would anticipate the temptation to cheat by lying about the monthly disposable income would be irresistible to many – especially when the ones that cheat begin to brag about how they outwitted the government. A large governmental program to prevent cheating is also not attractive. Sorry.
JDH,
Its interesting to witness your debate with the deflationists. They believe the Fed can’t create inflation. When the obvious (the Fed can monetize) is pointed out, they default to, “well, that’ll cause hyperinflation so the Fed will never do that.”
Of course, that argument holds no water. As you point out, there’s no hair trigger on hyperinflation. It would take some time to build up to that point.
Where I think you err, however, is in overestimating how easy it is to control inflation expectations. In fact, much of the current crisis could have been avoided if the Fed had hiked rates more quickly in 2004/2005. Greenspan adopted the “measured pace” hike policy because he worried that the economic recovery was fragile, and too-rapid hikes might suttle it. We’ll face the same choice in a couple of years, and the Fed will likely make the same decision. Especially since contracting the money supply will involve selling vast amounts of risk assets into a market with uncertain — and probably shallow — appetite for the paper.
I say the above because, for once, we should have a debate over monetary policy where the costs of Fed actions are fully acknowledged. My principle beef with Greenspan/Bernanke is that they consistently presented easing as a “free lunch”. We can argue the point, but certainly this (i.e. 1% policy rates of 2002/2003) is one PROBABLE contributor for the mess we find ourselves in today.
I say the above because, for once, we should have a debate over monetary policy where the costs of Fed actions are fully acknowledged.
David Pearson,
Great point!
Might I also add the cost of congressional action. I never have understood why they always get a pass.
I would be very interested in comments from this learned audience on the monetarist view on the causes of the crisis as explained in this article: http://www2.nationalreview.com/monetary.html
It says that the housing and stock market bubbles were symptoms rather than causes of the credit crunch, and that the primary cause is excessive US government spending, made possible by the liquidation of global US dollar reserves. Well, if I understood it correctly.