Archive for the ‘Monetary Policy’ Category

Brexit Dilemma: Why Did the UK Reduce Interest Rates to Only 0.25 Percent Today?

Lekha Chakraborty | August 4, 2016

by Abhishek Anand and Lekha Chakraborty [1]

The global market was eagerly waiting for the July Monetary Policy Statement of the Bank of England (BoE). Speculation was rife that, post Brexit, the BoE would become the latest entrant into the set of central banks experimenting with negative interest rate policy (NIRP) in a desperate bid to reinvigorate its economy.

Remember that the global financial markets were shaken after the referendum result and the pound plunged to a three-decade low. The BoE governor Mark Carney had to step in with a pledge to provide $345 billion for the financial system of the country. He also issued a statement that “the BoE has put in place extensive contingency plans” to deal with a “period of uncertainty and adjustment.” Analysts had their own predictions regarding the BoE’s possible monetary policy stance. JPMorgan Chase & Co., Goldman Sachs, and ING Bank were of the opinion that the BoE could lower its key interest rate in its July meeting. The result of a Bloomberg survey showed that in the event of Brexit, credit-easing measures such as quantitative easing (QE) and rate cuts may be the immediate options resorted to. The global importance of Brexit could be gauged from the fact that the Fed has had to delay to the fourth quarter of this year its plan of a possible interest rate hike in a bid to support global economic recovery.

However, the market was left surprised by the BoE’s decision to maintain its bank rate unchanged. The Monetary Policy Committee at BoE voted 8-1 to leave borrowing costs at 0.5 percent and hinted that it would launch a stimulus package in August. Today, the BoE reduced rates to 0.25 percent.

But why did NIRP not find favor with the BoE? After all, by the end of March 2016 as many as six central banks had adopted NIRP in an attempt to counter sluggish growth and deflationary pressures (fig 1). The latest country to join this mad race is the Bank of Japan, which announced in its January 2016 monetary policy statement a negative interest rate of –0.1 percent to current accounts that financial institutions hold at the Bank. continue reading…


Paul McCulley Has Had It with Orthodox Macroeconomists

Michael Stephens | June 13, 2016

Writing in The Hill, Paul McCulley argues that his profession’s fussy obsession with the Fed’s zero-point-whatever monetary policy is leading us into a dead end: “after a financial crisis, itself spawned by bursting of a bubble in private-sector debt creation, the power of monetary policy to generate robust aggregate spending growth is severely truncated.”

The policy problem we need desperately to solve — whose solution is key to a robust recovery, McCulley argues — is fiscal: “fiscal deficits need to be dramatically bigger.” To that end, he adds, it’s time to place the concept of “central bank independence” in its proper context:

Central bank independence has its time and place. But when economic growth is milquetoast and the reality is that inflation is too low, not too high (with the risk of outright deflation in the event of a recessionary shock), there is no reason whatsoever for the monetary and fiscal authorities to act independently — as if they were oil and water — in pursuit of the common public good.

Right now, what the country needs is for the fiscal authority to exercise its latitude to purposely ramp up its spending more than its taxing, and for the monetary authority to print however much money is necessary to keep interest rates low, unless and until inflation smacks the economy in the face. And the fiscal and monetary authorities need to openly declare that these actions are a political joint venture.

Yes, my profession needs to remember that macroeconomics, as a discipline, is about solving collective action problems. The solutions are often politically messy, offending the sensibilities of the moneyed class. Such is the nature of effective democracy: Messiness that delivers for all.

Read it all here.

Related: “Central Bank Independence: Myth and Misunderstanding


Of Voices in the Air and Never-Ending Dreams of Helicopter Drops

Jörg Bibow | May 31, 2016

Confusions about so-called helicopter money (HM) continue unabated. My recent letter to the editor of The Financial Times, titled “’Helicopter money’ is a muddled fiscal policy by another name,” has not met with universal approval. In fact, it seems to have ruffled some feathers and caused some annoyance.

Simon Wren-Lewis is a case in point. In a response to my letter (and a piece in the FT by John Kay) published on the Mainly Macro blog, Wren-Lewis reiterates his concerns that trying to distinguish fiscal from monetary policies is ultimately pointless and that central banks need to have HM in their armory since otherwise delegating stabilization would be dangerously incomplete. Mr. Wren-Lewis is perhaps best known for his selfless efforts at trying to wring any sense out of mainstream macroeconomics – an endeavor that takes a lot of wringing indeed. Another case in point is fellow helicopter warrior J. Bradford DeLong, who re-published Wren-Lewis’s HM elaborations on his own blog with the remark “intellectual garbage collection.” The wisdom of HM is just too obvious to be challenged, it seems.

But first recall here that Bradford DeLong is the supposedly “New Keynesian” macroeconomist who a few years back published a piece titled “The Triumph of Monetarism?” in the Journal of Economic Perspectives, arguing – quite correctly actually! – that New Keynesianism was really muddled New Monetarism by another name. It is also the same new monetarist economist who not so long ago published a piece together with Larry Summers titled “Fiscal Policy in a Depressed Economy,” in which the two argued that the time was right for governments to ramp up their investment spending and not worry about debt. That argument made quite a bit of sense to me at the time – and it still does today, as I suggested in my FT letter.

In any case, I was quite amused when at an event at the Brookings Institution on May 23 Larry Summers proclaimed that: “Helicopter money, hear me, helicopter money is fiscal policy. There is no such thing as helicopter money that isn’t fiscal policy.” That may well be just yet another useless point to make of course. But I will leave it to Messrs. Wren-Lewis and DeLong to do the intellectual garbage sorting of Mr. Summers’ remark.

Moving on, a rather interesting piece was published on VoxEU by Claudio Borio (together with Piti Disyatat and Anna Zabei). Borio’s earlier research at the BIS focused on central banks’ operating procedures. He isn’t someone who can be easily fooled about what central banks are doing or not doing. Furthermore, and this may not be a coincidence, he is also one of those rare cases among monetary economists who clearly identified what I long ago dubbed the “loanable funds fallacy” in Ben Bernanke’s “saving glut hypothesis” (see here). continue reading…


Bibow on Helicopter Money in the FT

Michael Stephens | May 19, 2016

In the Financial Times, Jörg Bibow writes in reaction to an article by Stephanie Flanders on “helicopter money” — the idea of having the central bank directly credit citizens’ bank accounts (or, in the thought experiment, to print bank notes and drop them from helicopters) with the aim of generating increases in consumer spending.

Bibow observes that helicopter money is really just fiscal policy, properly understood, and adds that it is preferable that elected fiscal authorities actually do their job — increase spending — during a period of inadequate demand; perhaps by investing in the “energy infrastructure,” as Bibow suggests.

Read the letter here.


Is There a Solution to Brazil’s Crises?

Michael Stephens | April 5, 2016

This is the first of a series of blog posts on the Brazilian crisis by Felipe Rezende.


There are two major crises Brazil’s President Dilma Rousseff is facing: one is a political crisis and the other is Brazil’s sharpest recession in 25 years.

Brazil’s Political Crisis

The political crisis has two main pillars: a) a vast corruption scandal (with evidence of a kickback scheme funneling billions of dollars from state-run firms and, more recently, in a massive data leak over possible tax evasion, Brazilian politicians linked to offshore companies in the Panama Papers); and b) impeachment proceedings to move forward against President Dilma Rousseff.

The Federal Court of Accounts (TCU) announced in 2015 that it had rejected the accounts of Rousseff’s administration for the year 2014. In a unanimous vote, the TCU ruled Dilma Rousseff’s government manipulated its accounts in 2014 to “disguise fiscal deficits” as she campaigned for re-election. The allegation is that Ms. Rousseff manipulated Brazil’s account books to hide a growing fiscal deficit.

The argument is that the federal government borrowed money from public banks (which is forbidden by the Fiscal Responsibility Law) to pay for social programs. So, they argued she allegedly committed an administrative crime.

Once we understand how the government spends and what bonds are for, then we can analyze TCU’s decision. The Treasury has an account—known as Treasury Single Account—with the central bank. When the Treasury spends, its account with the central bank is debited and the bank’s account with the central bank is credited. This is followed by a credit to the beneficiary’s bank account. That is, the public bank then makes payments to the social program beneficiary by issuing deposits (Case 1).

Case 1. The Treasury spends using its account with the central bank

Case 1_Rezende_Brazil

The issue at hand is that the federal government made payments for social programs using its public banks but it delayed payment to the same banks. That is, the federal government did not use its account at the central bank to credit the public banks’ account with the central bank while public banks made those social benefits payments. So, public banks made the payment (by creating demand deposits) and on the asset side there was an increase in credits (“loans”) to the Treasury (Case 2), which is forbidden by the fiscal responsibility law. In a “normal” transaction banks’ reserve balances (that is, government IOUs) with the central bank would go up, but because the Treasury delayed payments to banks there was in increase in balances owed by the Treasury to the public banks. This led the TCU to conclude that this was a “financing” operation. continue reading…


Tcherneva on the Jobs Numbers

Michael Stephens | March 7, 2016


Auerback on Debt and the US Economy

Michael Stephens | February 8, 2016


Applying the Brakes: Four Long and Winding Roads to “Normalcy” for the Fed

Michael Stephens | December 15, 2015

by Daniel Alpert

It is highly likely that this week will see the Federal Reserve’s Open Market Committee elect to increase the Fed Funds policy rate of interest for the first time since June of 2006, and after slashing the rate to the lowest level in history—approaching the so-called zero lower bound.

But the return journey to interest rate policy rate normalcy will be a long and winding one. The ability to influence longer term interest rates, over which the Fed has no direct control, will be even more limited (in fact, after the Fed’s move and any interim market volatility, long term market interest rates are likely to fall if the global economy maintains it present trend).

Yet it is very clear that the policy makers at the Fed are quite anxious to regain the control over monetary policy that they very much lack at the zero lower bound—if only to be able to do something when a new recession emerges.

Here, then, are the four routes that the Fed may choose to head down in order to achieve interest rate normalization, and my opinion of how effective (or ineffective) each policy is likely to be if implemented.


The Policy Rates—Fed Funds and the Discount Rate

How it Works:
The Federal Reserve Banks are the banks to the banking industry. When a bank is short of liquidity (generally overnight) it can obtain loans from the Fed, based on the quality of its balance sheet and/or the pledge of specific assets (discounting). The Fed sets a target rate for each of these policy rates and, in normal times, these rates often act as a benchmark for banks’ own short term lending to clients, as banks lend at a margin to their own cost of funding.

Effectiveness in Current Environment:
When lending activity is brisk, and bank liquidity is tighter, the Fed Funds rate (and, to a far lesser extent, the discount rate, as discounting is far less common) can have a substantial impact on market interest rates. But today, banks are awash in surplus liquidity. Even if a bank needs an overnight injection of liquidity, it can easily find that from another bank, happy to lend the money rather than leave it idle. The banking system in the aggregate has over $2 trillion of excess reserves (vs. mandatory reserves), most of which is on deposit at the Fed itself. So raising the Fed Funds rate will have no real effectiveness other than psychological.


Paying Banks Interest on Bank Reserves

How it Works:
Prior to the financial crisis, whatever small amounts (less than $200 billion) that the banking industry had on deposit at the Fed earned no interest. In the distress of the crisis, in one of the many ways that the Fed bailed out the banking system, the Fed commenced paying interest on reserves at 25bps per annum. In theory, of course, paying interest to banks to have their funds sit idle is contractionary. But income was far more important to banks in the crisis and reserves were building at a frantic pace relative to lending opportunities. If the Fed were to tighten by increasing interest paid on reserves, it could – in theory – slow (or raise the cost of) market lending.

Effectiveness in Current Environment:
Here we get into a “through the looking glass” sort of policy world. Why, with the economy less than robust, would the Fed want to discourage or limit bank lending in the first place? Yet, the whole purpose of monetary tightening is to do exactly that in order to lessen the chance of the economy overheating in the future (as well as, at the zero bound at which we now find ourselves, to enable the Fed to regain control of monetary levers). But here too there is a problem in assuming that such a move would be effective. There simply isn’t a lot of loan demand by creditworthy borrowers. Sure, there are plenty of non-creditworthy borrowers out there who would love to have money, but lending to them is (at least post-financial crisis) not the business of banking. So paying more interest on reserves (while certainly welcome by the banks) is unlikely to force up market rates all that much.


Reverse Repurchase Agreements

How it Works:
As most everyone knows, the Fed was on a five-year-plus buying binge to acquire U.S. Treasury and Mortgage Backed Bond Securities, beginning in 2009. It now owns trillions of dollars of government debt and government-guaranteed debt. The easiest way to force interest rates higher (which would be traumatic at this time) would be to simply dump those securities back into the market (see next slide). Instead, the Fed can pull money (cash) out of the system by “borrowing” against the securities it holds on a short term basis to banks and non-banks with excess cash. As it offers more of these securities for overnight or short term “repo” it would at some point push the rates it pays on the repo contract higher, because it will reduce the availability of excess cash laying around

Effectiveness in Current Environment:
At this time, reverse repos constitute the Fed’s greatest hope for managing interest rate policy. They have the advantage of being flexible and very reversible if things go downhill in the economy. The NY Fed’s open market operations unit can offer fewer or more repo contracts each day to adjust market interest rates. Furthermore, since the Fed owns securities of varying maturities, it can play up and down the yield curve, in theory. The problem is, this has never been done before in scale and no one knows how it will really play out, or—of greater importance, perhaps—how the market will work to “game” the Fed’s repo activity in order to better profit from it.


“Quantitative Tightening”

How it Works:
As alluded to above, the Fed—in theory—could simply sell back to the market the enormous volume of government securities it acquired post-financial crisis. This would be a blunt instrument of the highest order. If they sell enough securities, it would push interest rates higher by draining cash from the system.

Effectiveness in Current Environment:
This method is anathema in the Fed’s current thinking. It could only be reversed by a resumption of quantitative easing and would push interest rates much higher and very rapidly. This is a supply and demand issue. The Fed holds the largest inventory of U.S. government bonds on the planet and if the market believes that inventory is going to be dumped, the price of bonds will plummet, driving interest rates higher and the economy of the U.S., if not the world, into a nose dive.

Daniel Alpert is the Managing Partner of Westwood Capital, LLC and a fellow in economics at The Century Foundation.


Can Public Money Creation Work? Some Answers from Canadian History

Michael Stephens | November 13, 2015

by Josh Ryan-Collins

The theoretical and policy arguments for monetary reform are becoming more accepted by economists and establishment figures. The financial crisis blew apart the idea that deregulated private money creation by commercial banks leads to more efficient outcomes and allocation of capital, as has been noted by Martin Wolf of the Financial Times and Lord Adair Turner, amongst others. Yet there are few examples of how public money creation – and its variants – can support economic growth without causing negative side effects, not least inflation.

Is monetary financing inflationary?In a new working paper, I examine the case of the Bank of Canada (the Canadian central bank) in the 1935-1975 period, perhaps the most interesting example of public money creation in the 20th century in the English speaking world. Throughout this period the Bank of Canada engaged in significant direct or indirect monetary financing of government debt. In other words, the central bank created new money that was credited to the government’s account either via purchase of government bonds or direct lending. On average, about one-fifth of government debt was financed and held by the central bank, with all interest returning to the state (Figure 1).

Figure 1: Monetary financing and consumer price inflation in Canada, 1935-2012[1]

JRC_Fig 1

This monetary financing supported the Canadian state to recover from the Great Depression, fight World War II, enable post-war reconstruction and, in the 30 years following the war, enjoy the longest period of economic growth and high employment in its history. The Bank also created one of the worlds’ largest industrial development banks for the financing of small and medium sized enterprises (SMEs), eventually providing a quarter of all loans to SMEs, again funded via public money creation.

It is a remarkable story and one few economists or economic historians have examined. Even more remarkable is the fact that this vast monetisation program did not prove to be inflationary. continue reading…


Fed Fiscal Policy, Treasury Monetary Policy

Michael Stephens | June 4, 2015

Don’t miss this post by Scott Fullwiler at New Economic Perspectives.

Fullwiler is reacting to Clive Crook’s Bloomberg column advocating “helicopter drops” (having the Fed simply send checks to households). Helicopter drops or “helicopter money” proposals are widely cast as monetary policy operations (Crook describes helicopter money as a monetary-fiscal “hybrid”) and defended as either preferable to fiscal stimulus or as the only remaining option in light of political obstacles to increasing government spending (to wit, the GOP Congress/Dem White House combination).

For Fullwiler, this way of framing helicopter money is problematic — and relies on a skewed understanding of our policy options:

I find it completely counterproductive to have a theory of macroeconomics in which we define fiscal policy and monetary policy based on who is acting. If the US Congress and Treasury choose to send $1 trillion to households without raising taxes, it’s called fiscal policy. But if the Fed does the exact same thing, it’s apparently called monetary policy. I think this only confuses our understanding of the macroeconomic policy mix and makes it more difficult to have an economics profession that can give good policy advice.


It seems much clearer to simply say that (a) the act of creating a deficit—raising the net financial wealth of the non-government sector—is fiscal policy, and (b) the act of announcing and then supporting an interest rate target with security sales (or purchases, or interest on reserves)—which has no effect on the net financial wealth of the non-government sector—is monetary policy. In the case of (a), whether the Treasury or the Fed cuts the checks, it’s fiscal policy, and with (b), whether the Treasury or the Fed sells securities, it’s monetary policy.

In other words, fiscal policy is about managing the net financial assets of the non-government sector relative to the state of the economy, and monetary policy is about managing interest rates (and through it, to the best of its abilities, bank lending and deposit creation) relative to the state of the economy. This is in fact how Randy Wray explained both in his 1998 book; it’s also how Warren Mosler explained them in his 1996 paper. That is, from the beginning, MMT has labeled monetary and fiscal policies by their functions, not by who was doing what.

I think this is a much more useful taxonomy because it makes clear from the start that (1) the currency-issuing government isn’t constrained while (2) the interest rate on the national debt is a policy variable. All kinds of human suffering the past 6+ years may have been avoided if those two basic points were widely understood.

Read it.

Fullwiler spoke at the last Minsky conference on issues related to central bank operations (actual, vs. textbook): you can hear his remarks here; slides here.