Ever so slightly less contractionary

What is the significance of yesterday’s statement from the FOMC?

Here’s what the Fed said, accompanied by my running commentary:

FOMC. Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months.

JDH. You don’t say ([1], [2], [3]).

Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

JDH. I take that to mean that the Fed does not share Paul Krugman’s fear of outright deflation. They must be persuaded that they have ample firepower, should the need arise later, to persuade the public that they’re really, really not going to tolerate deflation. Notwithstanding, the ongoing downward slide in inflationary expectations is far from the optimal policy at the moment. The Fed is worried that being too convincing in communicating their intention to prevent deflation could move expectations too far in the other direction, so they don’t want to shoot their big cannons too early. But how could they give those expectations a small-epsilon nudge that at the moment seems very much called for? Maybe like this:

FOMC. To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.

JDH. Let me offer a little background on the significance of this move. The Fed’s response to recent financial strains has gone through two distinct phases. During 2007 and 2008, the Fed stepped in with direct lending measures such as the Term Auction Facility (essentially a term discount window open to all depository institutions on an auction basis), foreign currency swaps (used to assist foreign central banks in lending dollars), and the Commercial Paper Funding Facility (which helped provide loans for issuers of commercial paper). These measures were initially funded by selling off some of the Fed’s Treasury holdings, and later with expansion of reserves that remain idle at the end of each day on banks’ balances with the Fed. The purpose of this first phase was to try to provide support for these particular markets during the financial strains at the peak of the crisis.

All Federal Reserve assets, in billions of dollars, seasonally unadjusted, from Jan 1, 2007 to Aug 4, 2010. Wednesday values, from Federal Reserve H41 release.
Agency: federal agency debt securities held outright;
swaps: central bank liquidity swaps;
Maiden 1: net portfolio holdings of Maiden Lane LLC;
MMIFL: net portfolio holdings of LLCs funded through
the Money Market Investor Funding Facility;
MBS: mortgage-backed securities held outright;
CPLF: net portfolio holdings of LLCs funded through the Commercial Paper Funding Facility;
TALF: loans extended through Term Asset-Backed Securities Loan Facility plus net portfolio holdings of TALF LLC;
AIG: sum of credit extended to American International Group, Inc. plus net portfolio holdings of Maiden Lane II and III plus preferred interest in AIA Aurora LLC and ALICO Holdings LLC;
ABCP: loans extended to Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility;
PDCF: loans extended to primary dealer and other broker-dealer credit;
discount: sum of primary credit, secondary credit, and seasonal credit;
TAC: term auction credit;
RP: repurchase agreements;
misc: sum of float, gold stock, special drawing rights certificate account, and Treasury currency outstanding;
other FR: Other Federal Reserve assets;
treasuries: U.S. Treasury securities held outright.

The Fed has since wound down most of these measures, replacing them with the gradual purchase of up to $1.1 trillion in mortgage-backed securities. The Fed has also repurchased some Treasury securities, buying longer-maturity bonds than it traditionally held. The Fed’s previous plan had been to allow its balance sheet to shrink as the mortgages were gradually paid off. The new plan is to replace maturing MBS with long-term Treasuries.

Federal Reserve Treasury holdings by maturity, Wednesday levels, in billions of dollars, seasonally unadjusted, from Jan 1, 2003 to Aug 4, 2010, from Federal Reserve H41 release.

Some analysts have described the plan to replace maturing MBS with Treasury bonds in the Fed’s portfolio as preventing a decline in liquidity, though I do not think that is the best terminology. We are talking here about something very different from traditional open market operations, whose immediate impact comes from changing what I think of as true liquidity, namely the supply of excess reserves. In normal times, changing excess reserves by even a billion dollars could have a measurable effect on overnight interest rates. Today, however, there is a glut of reserves, and changes in the total quantity of reserves are largely irrelevant. To the extent that the operations we are talking about have an effect on the economy, they come not from changing the supply of reserves (on the liability side of the Fed’s balance sheet), but instead by changing the supply of the long-term assets that the Fed is holding outright. Having any effect from such changes requires operations in the hundreds of billions or even trillions of dollars.

By buying MBS, the Fed hoped to take enough of the supply off the market to raise the price of these assets, in other words, to lower their yield and thus encourage more borrowing. Buying MBS could in principle both lower the spread between mortgage rates and Treasury rates, and, by reducing the supply of all long-term assets, lower all long-term interest rates including the T-bond rate itself. By swapping retiring MBS for Treasuries, the Fed is saying it wants to continue the second effect, but try to ease out of the business of trying to allocate capital to housing in particular.

I am currently working on a research project to try to come up with better measures of the economic effects of these kinds of operations, whose results I hope to be sharing with readers in a few weeks. But for now, let me use the estimates from a recent study by Joseph Gagnon and co-researchers at the Federal Reserve Bank of New York. Their estimates imply that reducing the supply of long-term assets by an amount equivalent to 1% of GDP would lower the yield on 10-year Treasuries by 4.4 basis points. Let’s say we’re talking in terms of $200 B in additional long-term Treasuries purchased over the next year. That would come to 1.37% of GDP. In other words, if the Fed had done nothing, we might have seen long term yields rise by (4.4)(1.37) = 6 basis points. By yesterday’s announcement, the Fed will perhaps keep the 10-year yield at 2.80% instead of 2.86%.

I think that qualifies as a small-epsilon nudge.

35 thoughts on “Ever so slightly less contractionary

  1. Ivars

    We are approximately 1-1,5 months from the definite answers from the stock market. Situation is getting nervous.
    It seems that stock market will re-collapse after September with a brief revival before/after elections. what it means for real economy is that finally people will get mobilized to do something as hopes for wealth reconstruction disappear.
    Is that good or bad? Usually, it leads to a war after some time.

  2. Qc

    Since excess reserves are currently rewarded at the Fed fund rate, changing their level will have no impact on the overnight interest rate. In normal times, when no interest is paid on excess reserves, of course even a slight increase in excess reserves will push down overnight rates.
    As I said before, so much attention on what the Fed does or does not do is totally misplaced. All the Fed can do is to swap assets. This is of little use in the current situation. Even if the Fed tries to adjust inflation expectations by declaring that 4% is officially its new inflation target, do you thing that labor will go on strike tomorrow morning for a 4% wage increase when the unemployment rate is still around 10%? Do you think private households will dive into debt to start stockpiling gasoline and rice? Not a chance.
    It seems awkward to me that economists are so much interested in discussing the rearrangement of the deck chairs on the Titanic.

  3. kharris

    Many economists are not all that interested, but there isn’t much else to talk about in terms of policy.
    If you look at the comments from economists in response to the Fed’s move, many are along the same lines as those of our host. The range of possibilities that receive the most discussion run from the Fed being very close to helpless to Goldman’s notion that another trillion dollars in purchases would be needed to have much impact.
    The reason, as far as I can tell, that there is much focus on the Fed at all is that the alternatives are fiscal policy and micro-policy. Micro-policy is mostly doing favors for selected groups – things like targeted mortgage relief or tax cuts – and doesn’t actually change the pace of economic growth or the level of unemployment. Fiscal policy is dead because it requires congressional action.
    Economists are paying attention to monetary policy because that’s the only game in town, not because they have high expectations.

  4. flow5

    Current monetary policy is extremely deflationary. It is already a scientific fact that, ithout added fiscal/monetary stimulus/intervention, the economic activity will collapse in the 4th qtr.
    Let the markets determine interest rates, but let the FED stabilize prices.

  5. tom

    Almost right. I think what you are getting at is that the small drains to liquidity that would have been caused by the Fed’s mortgage holdings running off wouldn’t have had any affect on interest rates, at least not anytime soon.
    That is, there are far more than enough excess reserves to keep interbank overnight rates below 0.25, because, as you say, there is such a liquidity glut. Treasury already drained nearly $200 billion of reserves since February by refilling its supplementary account, and interbank overnight rates moved only very slightly.
    So this Fed move is definitely not about interest rates. But it is about liquidity. Excess reserves aren’t counted in M1 or M2, but they are part of the liquid money supply, and draining them does reduce liquidity.
    The Fed has always had a policy of rolling over its Treasury holdings, so there was no issue about them. But with the end to its purchase of mortgage holdings, there was an implied policy of a very slow long-term drain of liquidity as they ran off.
    This statement is largely symbolic, since it doesn’t have much near-term affect. I see it as basically Bernanke and cohorts waving their hands to markets and shouting, “Hey, we’re still here guys! We’re not sleeping!”
    But whether the Fed really can help matters, or knows how to, is a different matter.

  6. Bob_in_MA

    Professor Hamilton,
    I know the theory is that by lowering rates, QE makes borrowing more attractive and saving less so, so spending increases.
    But what about the negative effect on incomes? Won’t retires dependent on income from their savings spend less? And people saving for their retirement will see their savings grow more slowly. Will they really spend more?
    And how about a big bond holder, like an insurance company. If their portfolio income falls, won’t they spend less, and/or raise premiums?

  7. Qc

    Are you positive that economists do not talk about fiscal policy because “Fiscal policy is dead because it requires congressional action.” Are they really that shy as to refrain from talking about fiscal policy because it looks like a dead horse in Congress? Or are they simply completely confused by current events?
    Mainstream economists keep sputtering mutually contradicting statements like:
    “Governments should encourage banks to lend more” and
    “Private households paying off debt and cleaning up their balance sheet is a good thing”
    “US fiscal deficit deficit is a huge concern right now” and “yields on T-Bills are at historic lows right now”
    “US Government debt may not be a market concern right now, but it will be for sure further down the road” and “yields on US 30-year Treasury fell below 4% today”
    “deflation is the risk in the short term, but with all the quantitative easing done by Central banks, inflation is clearly the real danger in the long term” and “investors inflation expectations for the coming 10 years is in a free fall currently”
    “Government should run a fiscal surplus” and “the private economy should increase its saving rate” (note: these two events could occur only if the US current account turns into a huge surplus… how likely is that?)
    “it would appear that the only way out of this recession is for an important increase in private business investment” and “there is huge surplus production capacity in the economy right now”
    “dumping of the US dollar by foreigners is a clear concern since this could result in a depreciation of the US dollar” and “we should force China to revalue the renminbi relative to the dollar since a declining dollar would be great for US exports”
    I will stop here.
    Btw- this is not an attack on individual economist, but it is an all-out attack on the economic profession.

  8. 2slugbaits

    Qc Fair enough point, but I’m seeing some growing consensus among economists that fiscal action is needed. Those who opposed it the loudest have been fairly quiet over the last few weeks. And a couple of weeks ago I heard Niall Ferguson hedge a bit and say that now was probably not the right time to be abandoning fiscal stimulus:
    …and what I’ve been saying now for over a year has nothing to do with what we do right now. I wouldn’t advocate a cranking up of taxes in 2010 or a slashing of – of expenditure now. But we have to have some credible path back to fiscal equilibrium over the next five to 10 years, and that’s been conspicuously lacking since the Obama administration came into office.
    “Nothing to do with what we do right now.” Sounds like backpedaling to me. But I don’t want to criticize him too much. At least he’s willing to accept reality and modify his position…even if only for one interview.
    So I think kharris’ main point still stands. The primary obstacle to sound economic policy is a gaggle of clueless and cynical politicians. And of course Fox News. But the worst offenders among professional economists have been eerily silent lately. I think they’re hiding in the attic along with your crazy uncle.

  9. flow5

    The remuneration rate on excess reserves held at the District Reserve Banks, owned by the member banks, now exceeds the Daily Treasury Yield Curve all the way up to 1 full year. In effect, the FED has tightened monetary policy as IORs are the functional equivalent of required reserves.
    The money supply can never be managed by any attempt to control the cost of credt.

  10. Bryce

    I think Bob_in_MA raises excellent questions. Never mind the unfairness of the harm to the innocent retiree or insurance company trying to minimize risk.
    A separate question: Can you create money out of thin air to depress long-term interest rates without distorting the allocation of resources away from the optimal? Doing so creates a very fundamental misleading prices, of the sort that created the crisis in the 1st place.

  11. ppcm

    Would the liquidity matrix be much larger in scope and vocation as to include as well the funding requirements of the banks and financial units?
    Trust in mutual suspicion is the new inter banks brave world,no agreement on Basle 3,no understanding in Banks balance sheets,complete blindness in their contingent liabilities (average 45 trillion usd in derivatives),in their interest rates swaps, inspire them to deposit the savers cash with the ECB.
    The derivatives of this situation are multiple,banks do not trust each others but shareholders do,banks do not trust each others but central have to,banks do not trust each others but depositors must,Banks do not trust each others but bonds holders do.
    Banks do not trust each others and logic does concur with them.
    Banks Deposit Record $394 Billion With ECB, Avoiding Loans to One Another By Gabi Thesing – Jun 3, 2010
    Banks lodged 320.4 billion euros ($394 billion) in the ECBs overnight deposit facility at 0.25 percent, compared with 316.4 billion euros the previous day, the Frankfurt-based central bank said in a market notice today. Thats the most since the start of the euro currency in 1999. Deposits have exceeded 300 billion euros for the past five days.

  12. Qc

    Good point. Nevertheless, knowing well the huge ego prevailing in academic circles, I do not count on the deficit worrywarts (e.g. Greenspan, Roubini,Rogoff, Ferguson, Sachs, even Krugman is deeply worried about the debt level in the “long run”…) admitting they were collectively completely wrong. James Galbraight is a notable exception.
    A country with its own floating non convertible currency 1) decides what short term interest rates are on its sovereign debt 2)could never run out of its own currency 3) could never become insolvent. Greece may run out of Euros. But the US will never run out of US dollars. Canada will never run out Canadian dollars. Japan will never run out of Japanese Yen. The UK will never run out of UK Pounds.
    Just by looking at yields on U.S. Treasuries, it is quite straightforward to conclude that the market right now is begging on its knees for more fiscal stimulus and an increase in deficit. Why are economists -typically so quick at singing the praise of the free market- ignoring market signals? Is it because they are so busy at creating and discussing imaginary problems like “social security insolvency” and “US Government Sovereign debt crisis”.
    I am sorry to say that the economic profession is in a state of intellectual insolvency. Just like insolvent banks that were trying to blame their problems on short sellers, you can count on economists to try to divert attention by talking about how “Social Security is a huge problem” and “the natural rate of unemployment is now at around 8%” instead of acknowledging the deep flaws in the the mainstream economic profession theoretical framework.
    I do hope that, as you said, that the worst offenders among professional economists will be silent for a while, and that they are going to go hide in the attic along with my crazy uncle. They might actually have something to learn from him about banking, monetary and fiscal operations in a country with its own floating non convertible currency.

  13. Qc

    The US Government is maxing out? Are you kidding me? It is borrowing on 10 years this morning at 2.68%! The most heavily indebted country in the world -Japan- is borrowing this morning for 30 years at 1.63%.

  14. Jeff

    More bad news (new claims for unemployment up again) this morning. The Fed really should be stepping up to change people’s expectations. Bailing out bad actors while letting aggregate demand go down the tubes clearly has not worked. It’s long past time to try some of Scott Sumner’s ideas.

  15. markg

    Qc (and Tom),
    The US govt only “borrows” back the currency it issues when it spends. There is really no need to do this. The govt can spend without borrowing. This will only increase bank reserves, which are really just overnight govt securities. And the MMT crowd must be right when they say excess reserves are not inflationary. Everyone should carefully read what Qc has posted in this thread. Then go to the MMT blogs and get the full explanation of what Qc correctly states!

  16. Tom

    Qc: I’m not kidding. Yes, Treasury rates don’t reflect any worry about US government long-term solvency, even if you look at those rates in real terms. Neither did the rates Greece was paying until early this year. There’s also the matter of the difficulty of finding anything else that would be safe if the US government defaulted. But the reality is, there is no recovery trajectory, and without one, the US will within 30 months reach total indebtedness levels similar to those Greece had when it blew up. And the US also has a similar portion of its debt held by foreigners.
    As for Japan, as I’ve pointed out here before, it also has very large foreign exchange reserves, which is why most analysts look at its net debt, which recently passed 100% of GDP. But what really makes Japan different is its population’s high savings rate and high tolerance for very low domestic interest rates (they don’t move to foreign banks, as Europeans would if their rates went as low). That allows Japan’s government to borrow at such low rates and avoid any significant amount of foreign borrowing. Japan’s outlook is nonetheless grim as its aging demographic is bringing down that savings rate which is projected to turn negative. And since most savings is in government debt, the only way people get it back is by taking the interest out of new deposits (which doesn’t work if they’re shrinking), or by taking it out of their own collective tax payments.
    Markg: What you’re talking is not fiscal policy but monetary policy: monetizing deficit spending. That is what Zimbabwe did and essentially what all hyperinflationary regimes have done. It wouldn’t only increase bank reserves.

  17. Steve

    Since 70% of economy is driven by consumer and the consumer had his credit cutoff and payments on old debt increased, there is no money being circulated to drive the economy. Either take care of the consumers, so new businesses have a chance to sell something or wallow in the mud for a decade. If, the credit had been slowly withdrawn and interest rates on consumer debt had been lowered by the banks on existing notes, then at this point we would already be in recovery. Instead the Fed and the Gov. scared the hell out of small business and the consumer. I repeat, stick a fork in us. We are so done! It will be a generation before the damage to the economy and restoration of the middle class wealth, which was stolen in 2007-2009, has a chance of being recouped. We are soooooo DONE!

  18. Qc

    Greece does not have its own floating non-convertible currency. The Greek situation is not comparable to the US situation in any way, shape or form. But let’s forget about the US for a moment, could use please explain to me why the UK Government has continuously been able to enjoy extremely low yields on its bonds while PIGS countries were being punished by the market although the UK deficit and debt prospect situation is worst than some PIGS countries? One reason: the UK has its own floating non convertible currency. Ireland could run out of Euros, but the UK can not run out of UK pounds. Ireland has to rely on the wisdom, kindness and huge discretionary power of non-elected ECB officials -mostly French and German- to provide it with the much needed Euros these days.
    In conclusion, do you know where are the economists that were presenting Ireland as the role model for the rest of the world for how well austerity measures work? I guess they are hiding in the attic along with my crazy uncle. I hope Jean-Claude Trichet -aka Mr. Austerity-is-Great-for-the-Economy- will join them soon.

  19. 2slugbaits

    Tom: There are two ways to drive up the debt/GDP ration. One way is to increase debt. The other way is to have a shrinking GDP, or at least a GDP growth rate that is less than the interest rate. Right now deficit hawks are oblivious to the second possibility, which is actually the far more likely one. The US is not Greece. The US has a strong central government with lots of maneuver room to increase taxes over the long run. Not the case with Greece,which was a weak govt unable to command any allegiance to its tax base. And the US dollar enjoys a priveleged status. Yes, if we tried real hard we could become Zimbabwe, but it’s more likely that we become a zero growth economy that is gradually overcome with indebtedness and high unemployment. Those are all arguments for giving the economy the fiscal kick in the butt that it needs. Instead of multiple half measures with stimulus packages that are just big enough to avert disaster but not big enough to set the economy right, we should accept the facts and do what it takes. We certainly have to worry about deficits over the longer run and that means tackling Medicare and DoD budgets and raising taxes. But those are longer term problems.
    I don’t understand why people don’t believe fiscal stimlulus is ineffective at the zero bound. We saw that to the extent that we did try it the economy responded, and now that the fiscal stimulus is winding down we see that the economy is drying up. My recommendation is that we send Larry Summers back to Harvard and push through a stimulus package that is designed to overshoot trend growth rather than a working off of a plan that approaches trend growth from below.

  20. markg

    monetizing deficit spending is a term from the days (gone bye) of the gold standard. The US floats its currency. All spending above taxing increases the net financial assets of the private sector. Whether those assets are long term treasuries or reserves makes no difference other than the term to maturity (1 day to 30 years). It’s a quite simple yet fascinating system (floating rate currency). I am surprised it is so difficult for most economics professors (except the MMT guys) to understand!

  21. Qc

    Nice explanation. From my discussions with mainstream economists, I have to conclude that they simply don’t want to understand modern monetary theory. For if they did, they would have to throw their entire professional achievements as well as their personal ambition in the dustbin. You don’t become chief economist of IMF by saying that “all spending above taxing by the government increases the net financial assets of the private sector”. And this is true also for entry level economist position in government. Perhaps surprisingly, the private sector is more open to MMT thinking than governments and universities.
    Also, from my personal experience, most mainstream economists don’t even know how to read a balance sheet. When they come up to me with debt level figure for the US Government, I ask them about the asset side. I also typically follow up with this question:
    The US Government owns something like 30% of the landmass of the United States in addition to heritage assets (e,g. Mount Rushmore National Memorial, Yosemite National
    Park, the U.S. Constitution, and the Bill
    of Rights preserved by the National Archives, the Jefferson Memorial, the Washington Monument, the Library of Congress, etc), could you please let me know how much these assets are valued at on the US Government balance sheet?
    Below is the response:
    These assets are valued at a grand total of zero dollars. The US Government could never possibly suffer a liquidity crisis since it will never run out of its own non convertible floating currency, so it does not bother assigning any value to these assets because it will never have to sell them in any case. Of course, such accounting approach would make no sense for a private business since a private business running out of US dollars is a distinct possibility. Therefore, private businesses typically try to show off its asset base in order to convince the market that it is financially sound and that a liquidity/solvency crisis is not in the card -thereby trying to lower its cost of capital. This very basic fact should make any analogy between a private business financial situation and the US Government financial situation bullcrap on the face of it.
    Note- I am not sure how serious this is, but some in Germany seemed to love the prospect of Greece having to sell some islands to get its much needed supply of gold. oh sorry, I meant supply of Euros… (http://www.guardian.co.uk/world/2010/mar/04/greece-greek-islands-auction)

  22. ppcm

    There are no doubts about not only the privilege of melting its own currency but the privilege of using available financial instruments and arrangements for suiting its own purposes.The economists may feel either in dismay or wise,the alternative to both is doubt.
    Series: DGS10, 10-Year Treasury Constant Maturity Rate
    When pushed to their penultimate thresholds public debts and fiat currencies may draw attention on the assets backing both.
    BBC Sunday, 11 October 2009
    Gordon Brown is to announce the sale of 16bn worth of assets by the government in a bid to shore up public finances
    Mr Brown will say premature cuts risk “snuffing out” the economic recovery when the job of fixing the global economy is only half done.
    The plan is to sell a “portfolio of non-financial assets” held by Whitehall and local authorities over the next two years.
    They will include the Tote bookmakers, Dartford crossing, the student loan book, the Channel Tunnel rail link and – having protected national security – the government’s stake in Urenco.
    No need to remind the extent of UK total external debt and no need either to assess the real assets value.

  23. lilnev

    Bob_in_MA: If the Fed drives interest rates down, it does so by bidding up the the current market price of the bond. It’s not a “loss of income” for the bond-holder, it’s a windfall gain as all of that future income is brought forward into the present. If anything, the wealth effect from this might drive more spending rather than less.

  24. Bob_in_MA

    There are some unintended consequences of Fed bond purchases. Goldman Sachs came out with a note saying it would generally be bad for financial companies, since it would decrease their margins. And clearly policy now is to provide banks with a wide margin so they can use these elevated earnings to cover their write-downs.
    Also, this was on Bloomberg:
    “Fannie Mae and Freddie Mac mortgage bonds tumbled, with prices for certain debt falling the most relative to Treasuries this year, on concern that refinancing will accelerate after the Federal Reserve said it would buy more government notes to restrain borrowing costs.”

  25. Bob_in_MA

    Yes, obviously. But your point is only relevant if savers bought no new bonds and could afford to sell before maturity. The average retiree has something like a laddered portfolio. CDs, etc., mature and need to be reinvested continually. Each month the 401k saver makes a new contribution that will be at current prices. And think of MetLife, every day they must have bonds mature and cash that needs to be reinvested.
    If Joe Retiree’s 5 year Treasury rolls over, he receives the principal he invested and now must reinvest at current rates. If he sells his 5 year bond purchased in 2007 now, two years before maturity, he will receive a profit on principal, but will lose the interest spread when he must reinvest at a lower rate.
    Savers aren’t traders.

  26. adp

    OK, the Fed is just firing the first shot at additional ease. The economy absolutely needs the housing market to recover significantly from current levels. Fiscal stimulus at this point is problematic for a lot of practical and other reasons. As we are seeing in the markets now, lower Treasury rates are not translating into lower mortgage rates.
    I haven’t heard this discussed anywhere but the big guns would appear to be pegging mortgage prices, say FNMA 3.5% 30 year prices, low enough to get mortgage rates down 1/2 of a percent or so. Bernanke, in an earlier paper, mentioned the Fed could peg Treasury yields to a low level by announcing they would buy enough bonds to defend a certain interest rate level. The Fed could do the same with mortgage backed securities. (It would be more involved than this, but this is the basic concept.) They would not need to actually buy tons of the bonds because the market would quickly readjust to the announced pegged level. When the Fed bought the trillion plus of mbs, the main goal was to supply the liquidity needed to drive mbs yields lower while also sopping up supply. Trading had virtually stopped. Now that the liquidity is there, the need is to get the rates lower. Announcing a pegged level would be more efficient than an announcement to buy a certain amount of bonds. Buying Treasury securities in small volume adds a little liquidity, but not much else. Lowering Treasury yields from current levels is not likely to translate into lower borrowing costs on spread product. Pegging mortgage rates lower would provide significant stimulus.

  27. Tom

    Qc: You should read some research on government bonds that looks at them from the perspective of a buyer. An independent currency is an advantage but for a very different reason: it allows the country to devalue, lowering its real wages in foreign currency terms, thus boosting exports and its ability to repay foreign debt. The possibility of monetization is a frightening risk, not an advantage. From the perspective of the national economy, debt monetization is the same as a forced restructuring, you screw the holders of debt (in our case mostly foreign central banks and US pensioners), and you give up your ability to borrow further, ie, it implies either immediate reduction of the deficit to zero, or a switch to monetizing the deficit.
    The UK’s debt situation is better than some PIIGS, worse than others. UK average maturity is long. Other factors also matter, such as private foreign debt, the general health of the economy (Spain’s main problems). Germany’s rates are lower than UK’s. Trichet is very right, but no one in the US is listening, and Europe won’t hold up any better than the US when the US debt blows up.
    US debt is absolutely comparable to Greece. Very similar economic structural problems, weak competitiveness, bloated service sector, bloated wages, bloated public sector, addicted to capital inflows paying for imports. Because of that, the theoretic ability of the US to devalue is not really functional. To devalue the government would have to stop borrowing first, as the borrowing is part of the cycle of capital inflows driving up the dollar and paying for imports. The US has the advantage that it’s too big to shun, disadvantage that it’s too big to bail out.
    2slugbaits: If the government “needs” a “fiscal kick in the butt”, then why has sustained deficit spending of more than 10% of GDP since 2h08 only produced a mild, mostly inventory rebound that is already flattening out? How much more kick do you think the economy “needs”? Sustained deficit spending of 20% of GDP? How much GDP growth would that have to generate so that debt-to-GDP would come down? Do the math yourself, but I think your theory would work if an extra 10% of deficit produced an extra 20% GDP growth. Or if you’re modest and you think only another 2% of deficit spending will do it, then I think you’d need that to generate at least an extra 10% of GDP growth, in order to bring debt/GDP down. It’s amazing how many people buy into this swiss cheese logic. There is one and only one way for the US to stop its growth of debt-GDP, let alone bring it down: austerity.
    Markg: you’re wrong: monetizing the deficit is not an archaic term, it refers to government deficit spending funded by fresh central bank issue of money, in a fiat currency system. I’m no fan of the gold standard, I think it’s just a weak attempt to avoid responsibility for sound economic policy. Having a gold standard doesn’t stop downward pressure on your currency during recession, which thus leads to a run on the currency that demonetize the economy, as in the 30s. But the gold standard does rule out monetizing the deficit, except by spending down gold reserves as long as they last.

  28. Qc

    I guess we will not convince you. In fact, you seem so convinced by your own rhetoric that I guess you are aggressively shorting US Treasuries right now using as a role model guys that would have made a killing shorting Greek bonds in the last year. I wish you good luck with this strategy. I would remind you however that guys that would have gone ultrashort US Treasuries starting in May 2008 would be done more than 50% by now (see http://www.google.com/finance?q=NYSE:TBT ). For my part, I am long US Treasuries (long dated). In fact, a significant share of my family’s wealth is parked in US Treasuries.
    One of us is wrong. We will know within the next two years.

  29. Tom

    Qc: Don’t be goofy, no one’s not telling you to short Treasuries when the Fed’s a buyer. I’m telling you that fiscal policy is dead because even Obama knows he can’t afford to increase the deficit when it is already into its third year above 10% of GDP. Yes I expect the big blowup in 2012, 2013 latest.

  30. 2slugbaits

    Tom While it’s true that deficit spending is approximately 10% of GDP, that is not quite the same thing as stimulus spending. The fallacy in the your argument is to assume that deficit = stimulus. Not true. Some of the deficit is just year-to-year carryover of the structural deficit that Bush left us with. A lot of the deficit is due to declining revenues rather than additional spending. The stimulus itself only added about 2 percentage points per year to the deficit, and about 40% of that was with inefficient tax cuts and an extension of the AMT, which was not new stimulus because it was already baked in the cake. You asked how much stimulus spending would have been enough. Well, Romer and Bernstein initially estimated $1.3T…we got half that. That the weak stimulus package would boost GDP and growth beginning in mid-2009 and then begin to fade in mid-2010 was both predictable and predicted, but not by conservatives. Conservatives argued that the stimulus wouldn’t even have a short term effect; liberals of my stripe argued that a puny stimulus would only have a short term effect. I think the Obama team assumed (naively) that they would undershoot the first stimulus and if a second stimulus was needed they believed they would get a second bite at the apple. They were wrong.

  31. Qc

    I appreciate your advice not to be goofy… but you reiterated that you expect a big blowup in 2012 or 2013. I would guess this big blowup you foresee would be in the form of much higher interest rate on US Government debt.
    If you are right, you are going to make a killing by shorting US Treasuries ahead of the big blow up and I am going to loose my shirt. Why would you not put your money where your mouth is if you are that convinced? Just wondering.

  32. Tom

    Well, I think it should be obvious, but ok. The value of Treasuries is subject to unpredictable government decisions. Such as, the Fed could increase purchases of Treasuries as the crisis approaches, converting any decline in the value of Treasuries into a weakening dollar. Besides, even if I was confident that the Fed would not increase purchases of Treasuries, and thus Treasury yields would explode in 2012-2013, I would want to wait till I was certain that yields had bottomed – in trading, early equals wrong.

  33. KevinM

    “The value of Treasuries is subject to unpredictable government decisions.”
    What was the last government decision you did not find predictable?

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