Download Zero Is Not A Bound on Monetary Policy

The Future of the Fed
April 27, 2011
Joseph Gagnon
April 27,2011

Usually it operates on the short-term interest rate.

But monetary policy can operate on long-term
interest rates, i.e., bond prices.

Monetary policy can operate directly on other asset
prices, such as equities, real estate, and foreign
exchange.

There is no limit to the amount of private
spending that can be created by monetary
policy under any circumstances.
 Abusing this power deteriorates the balance
between output/employment and inflation.
 Not an immediate concern in United States.
 But current situation will not last forever.

Central banks prefer to operate on shortterm interest rates to minimize the variability
of their income.

Aggressive Fed actions in 2008-2009
prevented a second Great Depression.
 Financial shock was larger than 1929.

But, “a lot” is not the same as “enough.”


In December 2009 I called for $2 trillion QE2.
In November 2010 Fed announced $0.6
trillion QE2.
 Fed faced opposition to QE2 from many
politicians and financial market pundits.
 Fed had little support for QE2.
 Fed is uncertain about QE2 effects.

This timidity has cost America at least 1
million jobs.


For rest of 2011, Fed should do another $0.6
trillion in QE2.
But, the window for QE2 is closing.
 Economy is recovering, albeit at a slower pace
than it could have.
 The scope for monetary stimulus depends not on
today’s unemployment rate, but the rate
expected in 1 to 2 years.
Joerg Bibow, Skidmore College and Levy Economics Institute
“The Future of the Fed”, Roosevelt Institute
NYC, April 27, 2011

Fed met its LOLR challenge
 Fed’s pre-crisis blunders concerned regulation & supervision, not
monetary policy. Fed has to live up to its R&S duties.
 Dodd-Frank limits on Fed 13(3) emergency lending authority shift
burden to act (quickly) to Treasury/Congress

Fed continues to take its “dual mandate” seriously
 Mandate should not be re-focused on price stability only
▪ ECB is the warning example
 Does not mean Fed MP conduct cannot be improved. Scrutiny is
warranted. CBI needs to be balanced.

Highly accommodative Fed policy is here to stay
 Even as QE2 may end in June
 Absorbing “excess liquidity”, when needed, technically no problem
 Given labor market slack & wage inflation at 2%, no inflation risk
The Federal Reserve Now J Bibow
real GDP (pre-crisis)
real GDP (crisis)
2.50%
1%
4%
in billions of chained 2005 dollars
16,000
15,000
14,000
13,000
12,000
11,000
10,000
2001




2002
2003
2004
2005
2006
2007
2008
2009
2010
Scenario A: the “not so great ‘00s”
Scenario B: “eurosclerosis”
Scenario C: better than “roaring ‘90s”
Not even “maximum employment” by 2014 under Scenario C
 Employment-to-population ratio sharply down!
The Federal Reserve Now J Bibow
2011
2012
2013
2014

Fed has domestic mandate, but sets global monetary policy
benchmark.
 World economy is not an optimum currency area though.

Financial globalization has created a policy-domain problem.
 As part of wider conflict between democracy and globalization.

Floating exchange rates are not the solution.
 Argument to let “market forces” determine exchange rates
unconvincing from EM perspective when foreign policy decisions
are key driving force (“currency wars”).

For EM it’s reserve accumulation vs. capital controls.
 It’s about reclaiming lost policy space.
 EM reject new constraints through IMF rules on capital controls.

It seems G-20 can’t agree on anything anymore.
The Federal Reserve Now J Bibow

Dollar’s status still very convenient to some.
 Wall Street, large corporates; “exorbitant privilege”

But extra drag on U.S. labor market & wages.
 Magnifying “globalization-competitiveness-inequality nexus”
 Political problem (“democratization of credit” band-aid failed)

“The dollar is our currency, but your problem” (Connally).
 Or today perhaps? “It may be your reserve currency, but it’s also
a bit of an inconvenience to us right now.”
▪ Also, the oil factor

Mix of: key reserve currency status, financial globalization,
rudimentary U.S. welfare system, and U.S. aversion
against fiscal policy is putting excessive burden on Federal
Reserve.
 Likely to provoke bubbles and global tensions.
The Federal Reserve Now J Bibow
Perry Mehrling
Roosevelt Institute, NYC
April 27, 2011

Memories of 1907 (JP Morgan)
 And 1910 (Jekyll Island)


Memories of 1862 (Greenbacks)
Real Bills Doctrine, a political frame
 British version, Trade bills
▪ versus finance bills (Wall Street)
▪ versus Treasury bills (Washington)
 American adaptation
▪ versus central banking (regional structure)
▪ pro manufacturing and farming bills
1.
Government Finance (WWI, WWII)
 From Ben Strong to McChesney Martin (1952)
2.
Capital Finance?
 From National Banking to Shadow Banking
3.
International Role of the Dollar?
 From Gold to the Eurodollar System
Money
Credit
Capital Market
Federal Reserve
Banking
Repo
Rate Target
Fed Funds
Commercial Paper
Treasury Bills
C&I lending
Corporate Bonds
Treasury Bonds
Mortgage lending

Government Finance
 QE2 as Government Bank War Finance

Capital Finance
 Shadow Banking and Dealer of Last Resort

International Role of the Dollar
 Eurodollar System and International LOLR

Technical Challenges: from banks to markets
 Liquidity, funding and market
 Solvency, institutions and instruments
 Stabilization Policy, prices and quantities

Political Economy Challenges
 The Fed and Government (fiscal dominance)
 The Fed and Wall Street (TBTF, dealers’ club)
 The Fed and Globalization (China, Euro)
Thomas Palley
New America Foundation
[email protected]
Federal Reserve Reform
Governance
Economic
Philosophy
Monetary
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Regulatory
Reform
Monetary Policy
Inflation
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Balance Sheet
Regulation
New Interest
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Relation to the
Rest of Macro
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