4 Questions for a Fed Chief (Answered by a Nobody)

Bernie Sanders and Elizabeth Warren had a good piece on Huffington Post asking the new Fed chief 4 important questions.  I decided I’d play fantasy and answer the 4 questions as honestly as I could:

Question 1: Do you believe that the Fed’s top priority should be to fulfill its full employment mandate?

Answer:  That depends on what you mean.  If you mean that the Fed should try to achieve ZERO involuntary unemployment then we should all be abundantly aware that the Fed does not have the tools to achieve such a thing.  The Treasury also does not have the tools to achieve such a thing.  The only entity that could achieve permanent zero involuntary unemployment is the US Congress and you and your colleagues would have to agree to hire anyone willing and able to work.  Of course, that’s a highly political decision and one you should ask yourselves and not someone like me.

If we’re talking about hitting an unemployment rate of 4-5% based on traditional economics thinking then of course – the Fed should always shoot to enact policy that can help the nation achieve full employment.

Question 2: If you were to be confirmed as chair of the Fed, would you work to break up “too-big-to-fail” financial institutions so that they could no longer pose a catastrophic risk to the economy?

Answer: The Federal Reserve exists to support the private banking system and ensure that the economy’s payment system is always running smoothly.  This is and always has been our first priority.  After all, if we don’t achieve this then we cannot achieve our other mandates.   If I am confirmed as Fed chief I will monitor the nations banks and report my findings and recommendations to the US Congress so that we can establish and maintain the healthiest banking system possible.  However, it is not my responsibility to personally determine the proper size and scope of the US banking system.  If I should find that the US banking system, is at times, unstable, I will report my findings to you and your colleagues so you can determine the proper legislation, if needed, to rectify any problems.

Question 3: Do you believe that the deregulation of Wall Street, including the repeal of the Glass-Steagall Act and exempting derivatives from regulation, significantly contributed to the worst financial crisis since the Great Depression?

Answer:   Yes.  And you and your colleagues have failed to enact policy that will remove the same risks from potentially building up in the future.  And though you will blame me when the next financial crisis occurs, I should state for the record that I do not have the tools at my disposal to ensure that a banking crisis cannot occur.

Question 4: What would you do to divert the $2 trillion in excess reserves that financial institutions have parked at the Fed into more productive purposes, such as helping small- and medium-sized businesses create jobs?

Answer:  Pardon my directness, but I don’t think your understanding of the Federal Reserve system is entirely accurate.  The excess reserves held in the banking system are within what’s called the interbank market.  They can be thought of as the deposit money that banks and banks alone use.  These excess reserves do not “leave” the system (in the sense you imply) and they have been “parked” there strategically as a result of my predecessor’s policies.  Banks do not EVER use their excess reserves to create new loans for businesses of any size.  That is simply not how modern banking works.

The Federal Reserve has taken extraordinary measures to help shore up the US banking system in recent years.  If there is presently not enough demand for loans or businesses are not viewed as creditworthy customers then the most efficient thing for the government to do is to add net financial assets to the private sector via increased deficit spending.  This would directly improve the creditworthiness of the private sector as the Treasury bonds are an asset for the private sector without a corresponding private sector liability.  This would certainly improve the private sector’s credit standing.  But again, this is something that only you and your colleagues can achieve.  It is not within the realm of my powers to do so unless I were to take some measures that you might not be so fond of.

In short, it sounds like you are both trying to shrug your responsbilities off on an entity that simply cannot achieve the things you expect from us.  But as a good American I will try my damndest with the limited tools you have legislated to me.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Ever seen Bernanke testify before rude, clueless congressmen?

    I always admire his ability to restrain himself.

    Of course we also don’t know what he really believes in.

    • Yeah, I would want to T-Off on some of these buffoons if I were BB. Clueless is the right word – can you believe Paul Ryan’s questioning? This is the guy who warns about the US becoming the next Greece!

      It takes a lot more than economic sophistication to make it in that position. As much as I like Cullen’s answers, I don’t think he’d sit very well with Congress.

  2. Outstanding, Cullen. This blends nicely with your “Dual Mandate? Bah!” post (don’t recall the actual title :)). The best line for me in this post:

    “In short, it sounds like you are both trying to shrug your responsibilities off on an entity that simply cannot achieve the things you expect from us.”

  3. Question 5: How would you explain to my grandmother why irresponsible banks have been allowed to recapitalize at the expense of savers and those reliant on income?

    • Yes, your question gets to the white elephant in the room. I’ve watched this for years now, and looked for some way to explain how a country turns on those less greedy or content with compounding and security. That group is primarily our retired and elderly. The only thing I can see as an explanation is they were easy prey for our politicians. Those that had the longest voting future got the prize.

      • Yup, they are doing peachy with unemployment, underemployment, student loans and a tax burden that is going to increase a lot with all the additional retirees.

    • Just what kind of return should you expect as a ‘saver’?

      “Please explain how an economy growing at 0.6% is going to generate the income to pay you 6% on your savings? ”

      ” If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that. If savers want higher returns they have to put their money at risk.” So with CPI at 2.9 % and growth at 0.6 %, you need 3.5% to match economic growth (ignoring tax) – where can you get this return risk-free ?”


      Savers are not sacred cows, redux


      • From your link (http://coppolacomment.blogspot.com/2013/08/carney-and-death-of-unreasonable.html): “But is it reasonable for savers to expect that the purchasing power of their capital should be preserved, or even increased, over time?” Wrong question. It is not so much that savers “expect” the purchasing power to be preserved as they expect fair rent for the use of their property. When their money is lent out to others at interest, it is not fair that the banks make all the money. Savers are not expecting profit (unless they lock up their deposits in a CD), so much as fair rent. Fair rent means their money is not losing value in the bank. Otherwise, they might as well not put it in the bank. If they lock up their deposit, the rent should be an interest rate exceeding the rate of inflation.

        The writer’s misunderstanding of savers’ expectations is evident in this line, “But a positive inflation rate, even a small one, means that savers suffer erosion of their capital over time. The interest rate on savings is a compensation for that loss.” The bank has no responsibility to compensate savers for inflationary erosion. The bank does have responsibility to compensate savers for using their property to make money for itself.

        “If the economy is growing at 0.6%, the risk-free rate of return cannot be any higher than that.” This is just wrong. The basis for the savers’ expectations is not the growth of the economy, but the piece of the action the bank is getting by lending out their property. The growth rate of the economy is immaterial. If the bank lends the saver’s money at 6%, and the rate of inflation is 2.9%, the saver should get that 2.9% part, and the bank can keep the remaining 3.2 % as its profit. If the saver has locked up their deposit, the bank should compensate the saver even more, and retain less as profit as its cost of doing business with funds not on withdrawal demand.

      • “Savers are not sacred cows”

        David Glasner had this to say to a hard money guy convinced that the PIIGS had it coming to them and deserved nothing but more of the same… who also seemed to favor “savers” over debtors:

        “And would you mind explaining why transferring wealth from creditors by price inflation (actually by inflation greater than expected) is theft, but transferring it from debtors by price deflation (actually by inflation less than expected) is not theft?”

  4. Question #6
    Is Andy Kessler correct in the view that The central bank’s purchases of Treasurys are leading to collateral shortages in the vital, $4-trillion repo market?

  5. “This would directly improve the creditworthiness of the private sector as the Treasury bonds are an asset for the private sector without a corresponding private sector liability”


    How can you have an asset without a liability, except if paid in cash?

    Isn’t the private sector’s ‘liability’ an increase in taxes to pay for the bond?

    • DRR, I have the same roadblock on that, too.
      Now if we treated a T-bond as a dollar (sort of like an interest-bearing checking account), I think the MR paradigm would be more transparent and honest.
      Seen in that light, QE would just be a matter of the T-bonds being redeemed.
      And it would be more clear to the public that the debt doesn’t ‘have to be paid back.’

    • Not until the tax bill comes due perhaps! The gov may plan to never pay down the debt. … or perhaps they plan to steal the money from another nation.

    • The liability is that of the US govt meaning that no pvt sector entity has the corresponding liability. It could be seen as a positive at times for the govt to run large deficits because it cannot “run out of money”. Therefore, the govt can accept the financial burden at times when the pvt sector cannot….

      • I understand the distinction for accounting purposes between the private sector and the public sector, but really, any liability of the U.S. government is a liability to the taxpaying private sector — even if it’s just the inflation constrant, then inflation is a potential liability to the private sector.

        • Sure. Inflation is always the constraint. But it’s not a “liability” of the pvt sector. You have to be careful trying to apply an accounting term in these discussions where it doesn’t apply.

          If you want to argue that more NFA can reduce living standards then build the case. But that’s not a liability of the pvt sector. It’s a potential reduction in living standards. A “burden” might be a more appropriate way of stating it.

          • This is what I always felt inside before I ever heard of MMT/MMR etc.

            Even in high school it made no sense to me when I would read reports that broke down the national debt on a per capita basis, with the articles stating that on average that is what each American owed in national debt. It simply made no sense to me, as I had no such liability, and there is no mechanism for the national debt to be paid by any citizen. So how was it in any contractual way my debt – it simply is not.

            That points to a question that should be asked of people who think it is the citizens’ debt – “what mechanism would ever make a citizen pay any of it?” If the other person is half bright, he will think about the question and arrive at the answer, inflation is the only constraint – it is no private sector debt.

      • Cullen: “the US govt cannot run out of money”
        DRR: “taxes pay for the bond”

        Me thinks DRR may have out-MR’ed the master :)

          • Or the Tsy can simply roll the bond over indefinitely: simple example: Tsy sells a bond, spends the proceeds and thus creates a debt (neg. equity) for itself, say $100 worth. When the bond matures, they sell another to pay the principal. they could go on like this forever, and never pay off that original debt… just let it ride at that original level. Only the interest on the bond would make the debt grow larger (requiring them to sell some additional small bonds) and if the interest they’re paying is less than the inflation rate, then in a real sense the debt is decreasing over time anyway (even though it’s nominal value is slowly increasing)!

            • Tom, could you see a possibility that the Treasury might have trouble finding new borrowers not only for the new debt but the rolling over debt?
              Or do you see the Fed’s ability to buy the bonds as making that irrelevant?
              Is there a fomulaic way to express how fast the debt can grow? When does it become a problem?
              Just saying ‘inflation constraint’ is vague. Also, a constraint on future me is not a powerful constraint on present me. I.e., in the future we’ll be dead, so who cares what the inflation rate will be!

              • My simple example here is very limited. I can show you what I mean with it: Say the Tsy pays 1% on that bond but inflation is running at 2%. So Tsy has to sell another bond for $101 to pay the principal and interest. The old bond is retired and the new Tsy debt is $101. But inflation was 2%, so they actually lost 1% of their debt! Do you see? This example is not meant to sketch reality, just to show a possibility. I’m not saying they need another $100 bond to fund the gov… in this example it was a one time thing. But they never pay it off, and the nominal amount they owe can continue to grow slowly over time:

                year 1: $100
                year 2: $101
                year 3: $102.01
                … etc

                but the REAL amount they owe can actually decrease.

              • So to answer your question about borrowers, in this simple example I don’t see a reason, except that a 1% investment sucks when inflation is running 2%… but losing 1% a year is better than 2% a year, so there may be some takers. After all, it is a risk free asset!… which does slightly better than holding cash.

  6. Question #1 was clearly re: the Fed’s mandate, so they’d probably ask you to talk about that