By now, we all know that QE2 wasn’t all that effective in helping the economy.   And after extraordinary measures, ZIRP, bank bailouts, endless loans, etc, some are saying that the Fed is completely out of bullets.  Still, like a group of masochists, we are looking to Jackson Hole and Bernanke’s speech to shed some light on what the Fed is going to do next to help get us out of this mess.

I’ve maintained for several years now that monetary policy was going to prove highly ineffective due to the uniqueness of our recession – a balance sheet recession.  Ineffective doesn’t mean useless, but the point is that there are more effective forms of government intervention than the tools the Fed has. In fact, one could argue that the Fed’s primary tool – credit expansion – is detrimental during a credit bubble.  Currently, fiscal policy in the form of a tax cut would be most beneficial given the political environment and the need for cash flow recovery during a balance sheet recession.  But since the Congress appears dead set on blocking any bill that might further “bankrupt” the USA we’re not likely to get any sort of fiscal measures that are going to generate any substantive results.  That leaves us with the Federal Reserve.  So, it might be helpful to review what options they’ve got left (emphasis on might).

What can the Fed do?

1)  Cutting the interest rate on reserves or cutting to a negative nominal rate.

What it means – The Fed would cut the overnight interest rate from 0.25% to 0% or effectively charge a tax on holding reserves or cash.

Will it work?   – As of last night the effective Fed Funds Rate was 0.07.  Cutting it to 0% is essentially meaningless as we’re already there for all intents and purposes.  Charging a fee by setting negative nominal rates would only act as a tax on consumers and/or banks.  Some economists have proposed charging a fee on consumer deposits in order to get them to spend.  But this misses the point.  Consumers aren’t spending because they’re overloaded with savings.  Just like businesses aren’t spending because they’re overloaded with savings.  Both consumers and businesses are suffering from a lack of consistent cash flows that gives them reason to reduce their savings relative to income.  Businesses are lacking revenues via demand and consumers are paying a disproportionate amount of incomes towards debt reduction. Charging a tax on savings is the exact wrong kind of solution for the current environment.  Not only would it reduce consumer spending, but it would filter through to lower corporate revenues.

Charging negative rates on reserves is equally misguided.  This would essentially serve as a bank tax with the idea that this might make banks more inclined to loan money.  But banks don’t lend reserves.  They are never reserve constrained so there’s no such thing as charging them a fee with the hopes that they will “lend their reserves”.  Banks lend when creditworthy customers enter their establishments.   Charging a fee on reserves would only reduce the net interest income to banks while having no impact on overall consumer credit demand.  Again, this would defeat the purpose of trying to boost aggregate demand.

2)  Language change.  

What it means – The Fed would alter market expectations through a change in their statement language.  This is essentially what they did at the most recent meeting when they altered “extended period” to a specific range (2013).

Will it work? - This is confidence fairy economics in my opinion.  I don’t know how this myth of “business uncertainty” has gained so much traction, but the bottom line is that businesses don’t hire because they’re feeling certain about what Fed policy is or isn’t.  They hire when they have higher revenues and an improved operating environment that gives them the certainty of knowing that leveraging their operation will result in a higher return on investment.  Altering the language in the Fed statements can change market expectations and it might even provide businesses with some clarity about the operating environment, but it’s unlikely to make a material impact in the real economy by increasing aggregate demand and ultimately business revenues.  Therefore, I see little reason to conclude that these sorts of language alterations do much more than alter short-term expectations.  Without a fundamental driver to help consumers during the balance sheet recession, this remains a weak policy tool at best.

3.  QE3.

What is means - The Fed would purchase more securities from the private sector.

Will it work?  – This depends on several factors.  There are a lot of different things the Fed could do at this point that would differentiate QE3 from QE1 and QE2.  They could alter duration, buy different assets, target rates, etc.

The one approach I have often discussed (and the primary reason why QE2 failed) is interest rate targeting.  This would involve the Fed setting the long bond rate explicitly.  The Fed would come out and directly say that the 10 year Treasury is 1% or whatever rate they desired.  They would then be a willing buyer of all bonds at that rate.  It would not be about size, but about price.  As I have said before, my fear, is that this would be viewed as pure monetization of the US government’s debt.  And while this view is not technically accurate, perception could have harmful effects via the speculative routes.  If $600B in “monetization” caused such rampant “money printing” fears then just imagine what will happen when the Fed announces that they will be a willing buyer of every single outstanding piece of US debt?  It could make the speculative ramp from QE2 look like child’s play.  Ultimately, I believe this would cause a further margin crunch on consumers as commodities price increases would lead to further cost push inflation.

The Fed could also repeat their actions during QE1.  This is what I initially believed the Fed would resort to during QE2 (because there appeared to be no other transmission mechanism that impacted the real economy).  This could include purchases of agency debt or MBS.  Given the fact that we are beginning to see strains in the credit markets again, this might be a more viable option and could actually be a good proactive move.  But we should be clear.  Like QE1, this would serve only to shore up credit markets and would not necessarily help the economic recovery via improving the state of the US consumer.  So this should be viewed as more of a downside buffer and not a stimulative response.

As I’ve discussed before, the Fed is legally permitted to purchase municipal bonds.  But again, I not only think is unnecessary as the states don’t require aid from the Fed at this juncture, but it would also be viewed as the Fed playing a fiscal role by “funding” the state governments.  Again, I do not think this is political territory that the Fed wants to enter.

The Fed is not legally permitted to purchase equities or corporate bonds at this juncture.  Doing so would require direct aid from the primary dealers or the arrangement of some sort of special purpose vehicle.  I am not sure the Fed is going to begin dabbling in such measures which would cause a political mess and could cause Congress to question the legality of the Fed’s actions.   Under the exigent circumstances clause of the Federal Reserve Act, the Fed could intervene in markets if the downturn were to deteriorate substantially.  But I don’t think we’re at a point where such Fed action would be justified.

The Fed can technically purchase foreign government debt, but is not permitted to bail out a foreign government.  In terms of the Euro crisis, I think the Fed is likely capped at its swap lines.  Again, buying foreign debt would be a messy political environment and the Fed is not in the business of politics.

4.  Making loans directly to banks and businesses.

What it means - Much like the many funding facilities used during the financial crisis, the Fed could re-implement some of the programs to help improve credit access.

Will it work - Again, we’re no longer in a credit crisis, but establishing some of these programs could be a wise proactive measures given the recent flare up in the European banking crisis.  It won’t necessarily prove stimulative, but it could provide downside buffer.  That would be an economic positive as it would remove a substantial downside risk.

5.  Prompting Congress to provide more fiscal aid.

What it means - When Ben Bernanke implemented QE2 last year he petitioned Congress for more fiscal aid.  He could again tell Congress that we are in an unusual predicament, we are not bankrupt, we cannot “run out of money” and we can afford to spend more money to aid our citizens.

Will it work?   Prospects look grim.  A push for a payroll tax cut by Bernanke could gain some traction, but I am not getting my hopes up.*  And unfortunately, I think Dr. Bernanke believes QE is needed to help “fund” this new spending so this idea could be a moot point if he petitions Congress for new fiscal aid and then implements a QE3 programs that sparks a market response that offsets the stimulative effects via cost push inflation.

The bottom line – The Fed has options here though their toolkit is looking depleted.  They certainly have options that could prove proactive in stopping some potential hemorrhaging from any European credit contagion.  But we should be clear.  The Fed’s options in terms of stimulating the economy at this point are extremely limited.  But that doesn’t mean it doesn’t have tools in its kit that could prevent a potential recession from turning into a repeat of 2008.

Dr. Bernanke has to announce some sort of change in policy response this Friday.  The markets are all banking on it now and he has proven time and time again that he’s a believer in the misguided idea that the markets can lead real economic growth.  I don’t believe he can announce anything that will substantially alter the economic landscape, but he’s proven more creative than he usually gets credit for.  Unfortunately, at this juncture, his toolkit is looking pretty limited on the stimulative side.  We’ll reassess his decisions when they’re in writing.

* Edited to correct payroll tax “cut”


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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.

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  • Max

    The S&P downgrade has done the Fed’s job already by taking the 10-year down to 2%. We don’t need lower interest rates, at least not lower risk-free rates. Lower risk premiums would help but the Fed doesn’t control that.

  • LVG

    The bottom line is that interest rates don’t really matter because consumers are saddled with debt. The Fed just wants to reinflate the debt bubble. They’re failing and we should all hope they continue to fail.

  • baychev

    “Consumers aren’t spending because they’re overloaded with savings. Just like businesses aren’t spending because they’re overloaded with savings. Both consumers and businesses are suffering from a lack of consistent cash flows that gives them reason to reduce their savings relative to income.”

    This is a gem :)

  • Bruce

    I was looking amongst your options for “helicopter drop”, but I didn’t see it?

  • Kostas Kalevras

    Household Debt Service Payments as a Percent of Disposable Personal Income are already at a 1995 level (down from 14% to 11,5%). A Fed announcing it’s target rate until mid 2013 will make it easier for the households to achieve this percentage in the future, which could change their spending decisions.

    Debt outstanding to disposable income has fallen from a 130,3% high to 116,2% (at 2004 levels). The most important question is how much more does the ratio has to fall before households start spending again. If it were to fall to 100% (2002 levels, essentially negating the credit bubble) that would require a write-off of around 1.5 – 1.9 trillion $ (either through debt reduction or income increase). Since corporations are reluctant to increase real compensation it seems that some other entity (government) will need to provide the additional income.

  • Robert K

    When you say that consumers aren’t spending because they are overloaded with savings, I’m not sure how this
    correlates with the fact that over half of US workers couldn’t raise $1000 in 30 days to meet an emergency, according
    to recent polls. With respect to businesses, their record cash balances (not netted out against their equally record
    bond debt levels) probably represent precautionary saving given their knowledge of the precarious nature of available
    bank credit. When banks are reeling in all but their largest customers, these precautions are justified, as they do not
    trust that they can access credit when they may need it. It is correct that both consumers and most businesses are
    fearful of the certainty of future cash flows (like in income from work or operations). The problem is that to be effective,
    income MUST flow from the bottom up, not the other way around.

  • http://kiddynamitesworld.com Kid Dynamite


    I understand that banks don’t lend reserves, and I’m certainly not suggesting that the Fed should start CHARGING interest on reserves, but I’m surprised you don’t see that if the Fed did do something like that, it definitely affects the decision making of the lender – because it impacts the relative profitability of the loan.

    In other words, if JPM can lend money to TPC at 4%, and the alternative is either 1) not lend the money and earn 25bps by keeping the reserves at the Fed or 2) not lend the money and PAY 25bps to keep the reserves at the Fed, then the decision tree is clearly affected.


  • Kostas Kalevras

    Banks are already paying a ‘tax’ through QE2 since large interest baring securities were replaced with low interest overnight reserve accounts.

    Reserve ratios are also a tax on the banks. Would increasing them increase bank lending? Will the Sharkozi-Merkel bank tax increase bank lending?

  • Oroboros

    German court to rule on Sept 7 on euro, Greek bailouts

    BERLIN (Reuters) – Germany’s constitutional court will announce its verdict on September 7 on whether the government broke the law with last year’s euro zone and Greek bailout packages, it said in a statement on Tuesday.

    The plaintiffs have argued that such interventions violate German and European laws on the right to democratic representation and on the protection of property. The government has said it is confident it did not break any laws.


  • Different Chris

    “Again, buying foreign debt would be a messy political environment and the Fed is not in the business of politics.”

    On a bit of an aside, I don’t think this point is made enough when people bring up the misguided ‘independent Fed’ criticism. What makes the Fed ‘independent’ is that it is independent from the three branches of government specifically (or so it seems to me) so that partisan politics are not in control of its actions.

    Thanks Cullen this is a great synopsis.

  • ocean

    Off top of my head some more radical options
    1. Instruct FDIC to commence orderly default of TBTF fail banks and individuals. With low consumer and bank debt levels….the good times of boring debt for prosperity can begin.
    2. Move away from instruments that lead to compounding of interest servicing payments and thereby increases in deficits and debt. That is, by swapping long term debt for short term debt (including QE), the direct monetization of debt via seignorage etc and even selling put options on treasuries to drive down yield. Also by selling put options they collect a premium that can be used as a “profit generating” center for the government.
    3. Sell all central bank gold reserves. Yes. Since we know gold is not “money” and we know MMT is an accurate description of modern monetary systems, we could load up these irrational foreign central banks with gold at these bubble like prices and use the funds for government fiscal programs. I mean how silly is it that our Fed/Treasury still holds gold on a balance sheet, when they could hold “better than gold” treasuries.
    4. Align bank lending activities more directly to “full employment” and the benefit of the domestic economy. Here is one example that does that.

  • Mattay

    I think the issue is more that people are not interested in borrowing money and adding to their debt, rather than that banks are not interested in lending people money.

  • Mattay

    Cullen, I think you left some out.

    Inflation Targeting – Is this anything other than the confidence fairy? All that this would involve is a press release saying that the Fed was targeting a certain (high) rate of inflation. But there is nothing that they can do to actually create this inflation – so really they would just be leaving interest rates at 0%. Which it already is.

    NGDP Targeting – Again, is this anything other than the confidence fairy? All that this would involve is a press release saying that the Fed was targeting a certain (high) rate nominal GDP growth. But there is nothing that they can do to actually create this nominal GDP growth – so really they would just be leaving interest rates at 0%. Which it already is.

    Trillion Dollar Bonus for Bernanke – Ben Bernanke could give himself a trillion dollar bonus. This is of course necessary in order to retain highly qualified managers in the public sector, such as Bernanke. Bernanke could then use this trillion dollars to buy a few million houses for himself, across the country. This would be stimulative, but since banks own most of the houses, the windfall would mostly end up in the hands of the banks. ;)

  • Mike J

    John Maudlin has a chart in this week’s “thoughts from the fronline” which shows a much more efficacious effect of QE.

  • Ilya

    this is too Austrian with the expansion of circulation credit idea as the source money supply at the heart of the paper. I thin k this blog will not like the article. Even though clearly growing credit at a rate higher than GDP (productive capacity) gets to TPC productive capacity constraint.

  • rvm

    Warren Mosler said it before.
    Bernanke’s toolkit resembles the toy steering wheel in the hands of the kid sitting in the back seat and trying to steer the father’s car.

  • Windchasers

    Maybe pushing rates to 0% would do something, but as CR pointed out, we’re already quite close, with the overnight Fed Funds rate at 0.07%.

    Going from 0% to -0.25%, the idea of a decision tree breaks down. Banks would suffer the negative interest rates even *if* they lent out more money. If I understand correctly, that interest is not charged on *excess* reserves held with the Fed, but on *any* reserves held with the Fed, and lending out more money does not change the amount of reserves a bank holds. The banks also have little power to drain their own reserves; this is what the Fed does when it sells Treasuries to the banks, and all the recent Treasury auctions have been quite oversubscribed. So moving to -0.25% interest would effectively penalize banks without offering any reason to increase lending.

  • AWF

    Banks Lend –then at the End of each day they Balance the Book
    If they don’t balance—then the “Bank” borrows from the FED or other Banks

    The point: Lending comes first

    TPC: “Prudence” Roche–
    The purpose of the FED– Liquify the Banking System–QE is doing that job

  • beowulf

    Like Michael Hudson says…
    Financialized wealth represents the capitalization of income flows. If a borrower earns 50 pounds sterling a year, and the interest rate is 5%, this earning power is deemed to be “worth” Y/I, that is, income (Y) discounted at the going rate of interest (i): 1,000 pounds. A lower interest rate will increase the capitalization rate – the amount of debt that a given flow of income can carry.

    The Fed should create a 13(3) program to refi every mortgage at 2.0% fixed for 30 years. If that doesn’t revive home prices, nothing will.

  • ocean

    I believe MMT and the buoyant paper are aligned on outcome but differ on “how”.
    Some MMTers may argue for fiscal stimulus to reach full employment.
    The paper argues that constraining foreign credit will boost employment.

    The more important point for me was that the currency is “public utility” and the money supply should be directed for “greater good of the country”. As opposed to the current scenario, where banks expand the money supply (i.e credit) – “at an any cost” – short maximization of profits for banking shareholders. The later can lead to instances of asset speculation such as financial crisis and his work shows the destruction of the manufacturing base in the US. I believe Cullen supports the intent of minimizing the banking financialization but may disagree with how it is achieved.

  • Different Chris

    I like this because it goes right after the major factor weighing the private sector down- housing debt. (could be wrong, but I remember seeing it as 70% of all household debt).

  • hangemhi

    “I don’t know how this myth of “business uncertainty” has gained so much traction….”

    That is republican speak designed to allow for as much deregulation as possible. Larry Kudlow says this about 10 times per show.

  • http://www.pragcap.com Cullen Roche

    Banks lend when customers, who meet their credit standards, have demand for loans. Forcing banks to loan money could entice them to reduce their standards and/or will only serve as a tax on their current cash flows as it reduces net interest.

    I don’t see how this is at all positive.

  • http://www.pragcap.com Cullen Roche

    This was not well written on my part. I am saying that consumers aren’t spending because they don’t have the cash flow. Sorry, I should have added some emphasis in there or something. The next few sentences complete my thought….

  • http://www.pragcap.com Cullen Roche
  • Fred

    You are missing the big one: increasing the central bank swap lines. Bernanke could simply alter language around the swap lines to imply that the Fed would be willing to go several multiples of what it provided in 2008/2009, the market would read that as a massive de facto Marshall Plan for Europe. It would send the EURUSD higher, the USD lower and remove the political risk of Europe’s persistent inability to expedite fiscal reforms. This is not to say the EU will not have to reconcile the monetary and fiscal misalignments – they will – but it would shift the burden much further out the curve. It’s also a very convenient way to inject global liquidity by increasing the Fed’s balance sheet in a way that is very hard for the average person to understand (read: spin).

  • http://www.pragcap.com Cullen Roche

    I mentioned the swaps:

    In terms of the Euro crisis, I think the Fed is likely capped at its swap lines.

  • ocean

    Beuwolf this moving in the right direction. When Caesar faced a similar housing crisis that stalled economic growth, he had to deal with with lenders who wanted to debts to be repaid in full even though housing had deflated. And borrowers who wanted the debts written off because they were indebted and diminished income from what appears to be a “balance sheet recession”. His solution and I quote this from Martin Armstrong

    “Caesar created a board of valuers who set the value of the property to what it had been at the time [of the loan]. He then took all interest paid by the borrower and applied it to the principal. On a VALUE basis, he backed everything out at a fixed point in time. Of course the moneylenders conspired and killed him, but the debt crisis was brilliantly solved.”


  • baychev

    This is why I picked on it. Not all consumers are cash flow constrained either, salaried aren’t, free professions feeding from the housing boom are. It is more accurate to say that the shrinking wealth effect has retrenched consumption and increased the need to save for less rosy days.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    Yes, I was going to suggest that, too. I think this would help. I don’t know if it fixes everything. But, certainly, if the Fed (or Tsy, since it owns the GSEs) were to simply purchase all conforming mortgages at 2% or whatever (with a lower rate for shorter-term mortgages, like 15y), the refinancing would enable some space for more spending/debt reduction within a given income.

    Of course, those with LTV’s of more than 80% would not be able to take advantage of this, so, again, how much it helps is debatable, though it helps some. Further, since many have seen family income drop, they may not qualify even if LTV is less than 80% (which shows the importance of doing this sort of thing right when the crisis starts instead of waiting three years). And reducing lending standards below that is what got us here in the first place.

  • baychev

    Cullen is right that in these times banks lend only to good credits, because they know they are with underwater balance sheets and need to recapitalize. You are missing another option: buy commodities with inelastic demand and hoard it to earn more than what you could on a 4% loan. Options plenty.

  • beowulf

    I like this because it goes right after the major factor weighing the private sector down…

    “There are a thousand hacking at the branches of evil to one who is striking at the root.” ~ Thoreau.

  • Fred

    Curious why you would think the Fed is “capped” as to extending swap lines? If anything, it’s the opposite.

  • beowulf

    Scott, LTV isn’t fixed. If everyone else in the neighborhood is refing at 2% fixed, home values would go up. the more V is driven up, the less L has to be marked down.

  • baychev

    Could you please take some time to explain to me (probably many others are interested as well) why MMT lumps foreign governments with the private sector, and how the transmission mechanism between deficit spending and employment works when such a big chunk of employment is outsourced to China. It looks to me that MMT is designed for an entirely different, closed economy.

  • beowulf

    Just checked a mortgage calculator, going from 5% to 2% reduces total interest paid from 48% interest (over 30 years) to 25%. For a $300,000 loan, monthly payments drop from $1600 to $1100.

    If refis done on a wholesale basis, there’s nothing to qualify for– Fed buys the mortgages and simply marks down required mortgage payment. The Fed could throw in boilerplate language that by making payment at lower amount, borrower agrees to accept United States Government lien against property (which sidesteps the “where is the note?” conundrum that banks have found themselves in). Since net earnings pass through to Tsy, the Fed would, in effect, recreate (recredit?) the Pennsylvania land bank system that Benjamin Franklin was so fond of.

  • http://kiddynamitesworld.com Kid Dynamite

    yes – I know all the MMT mantras – that’s not my point at all.

    Similarly, @Windchasers, in the comment above yours, repeated the mantra that the level of reserves in the system cannot be altered. this is also true – but banks CAN alter their own reserves – by making more loans. If those loans end up back as deposits in their own banks, then their reserves are unchanged. But if I borrow money from JPM, use it to buy a car, and the car salesman deposits the money in his account at BAC, then the reserves have flowed from JPM to BAC, even if they haven’t changed in total.

    let me try a more extreme example to illustrate my point:

    what do you think would happen if the Fed said “we will CHARGE 5% on all reserves held at the Fed” ???

    I’ll tell you what I think would happen: it would make money “toxic” – banks would have huge RELATIVE incentive to make loans now – as NOT making loans now costs them an extra 5%… see? They’d be happy to make a loan to TPC that might have slight negative expected value, because that’s still better than their alternative expected value of negative 5%!

    Similarly, of course, they’d (banks) want to charge depositors to keep their money in the bank, so that the deposits created by loans flowed like a game of HOT POTATO around the banking system.

    is this a good outcome? i don’t think so – but I want to be clear that I strenuously disagree with the repeated claim that interest on reserves doesn’t affect a bank’s desire to lend money.

    It does NOT affect the profitability of the loan, but the profitability of the loan is not the only consideration the bank has: the key consideration is what they’ll earn otherwise, and if you decrease this “otherwise” column, it makes the other column more appealing, relatively.

    as usual, I’m ready to be proven wrong / corrected on this – but repeating oft-repeated MMT mantras like “banks are not reserve constrained” or “loans create deposits” are not going to help my understanding at all.

  • http://kiddynamitesworld.com Kid Dynamite

    “Forcing banks to loan money could entice them to reduce their standards”

    ok – bingo. then maybe we are in agreement. that was my only point.

    i didn’t say it was a positive, but if Bernanke wants to create inflation, I think this is one surefire way: FORCE spending.

    then there’s the little matter of the hangover from this solution – when we have another crisis because we solved this crisis by making more bad loans… but I think we agree on that too.

  • El Viejo

    There are 70 million baby boomers in this country. Most own their houses and like me are shoving all they can into their 401k plans, only to watch it flow out the bottom. Nevertheless, we have most of what we want in life and are just spending less.

  • http://www.pragcap.com Cullen Roche

    More bad communication. When I say “capped” I mean to imply that that’s likely the extent of their intl operations.

  • baychev

    But there are hundreds of millions who cannot or simply do not save a dime a week, on the balance, the savings rate hovers around 5%, up 2.5% from its all time low of 2.5% in the vintage years of the housing bubble.

  • http://www.pragcap.com Cullen Roche

    I’d have to do an entire post on this. For much of the accounting, foreign transactions fall under the non-govt sector. That’s just what they are. Check this out and see the section on foreign transactions:


  • http://www.pragcap.com Cullen Roche

    Right. The last thing we need now is more bad loans because the banks feel squeezed. Besides, this gets to the real crux of the Fed’s ineptitude. WE DON’T NEED MORE DEBT!!!!!

  • ocean

    Cullen I had a similar question is this a fair assessment.

    We know the trade deficit is funded by banking loans (money supply expansion). That is when on aggregate, if american’s consume (buy) more than they produce (earn/save), they must borrow the difference (i.e expand money supply and import the excess from abroad).

    The more important question, I believe from MMT perspective is this inflationary or productive)? Provided the “productive value” (i.e. GDP growth rate) that imports create in the economy is larger than the – (inflation rate plus the nominal interest rate) – of servicing the foreign debt than the debt addition is “productive or sustainable” (ignoring exchange rate discussion for simplicity).

    That said, I’m not sure how to quantify how a cheap TV impacts GDP productively?
    Whereas, a low cost car part that is assembled in a US factory, can produce a car sold at a much higher price (arguably has greater value or productivity).

    Some would argue that the cheap TV comes at a cost of lost US jobs, lower wages and a decreased overall national income (and tax base).

    MMT would argue that the cheap TV or parts, ultimately has improved our aggregate standard of living. Even though some part of the population faces a lower loss standard of living from job loss, MMT would argue that means taxes are too high for a given level of fiscal spending (job creation programs).

    Loosely I conclude, that when borrowing either domestic or foreign or government leads to surplus economic growth (i.e. improvement standard of living) than it is productive and non-inflationary. When this borrowing is malinvested (such that borrowing does not increase standard of living or provide economic growth beyond the (inflation + nominal interest rate) of the loan than it is unproductive or inflationary. And note that spending that is channeled into asset speculation (housing, stocks, commodities and maybe treasuries) is a specific case of malinvestment.

    What austrians vs deficit spenders debate is the productivity of borrowing and I’m not clear how to answer that.

  • Plainview

    When Ben says, in his July 13th statement, that one option is:
    “to increase the average maturity of our holdings”

    — is that covered by your “interest rate targeting” point i.e pinning the ten year, which would massively load them with longer maturities?

  • Different Chris


    Please stop posting on TPC and go get elected to public office.

    -The USA


  • ocean

    I think he means he would swap 3 and 6 month short term treasuries currently on the Fed balance sheet for 10 year bonds.

  • VII

    I wanted to update on our allocations.

    We are no longer short term bearish. We turned positive yesterday. We however are still 57% in cash. My allocation for our Tax qualfied accounts below.

    FU$$$$$$$k…my trader just told me she didn’t sell the last 17% of SPY at 1200 last week. So we are only in 35-37% in cash..
    SPY-17%(I’m in no where land on this position I told to sell)
    dollar currency shorts and other currency bets-5%
    Asian currency longs-5%
    FPACX-10%(one position we’ve held forever and hope to)

    We are long term bearish 2012-2013 on stocks. BUT we do not think long term bearish shorts etc. today are going to make money. NOT HERE.

    Historically we are right where prior counter rallies have occured. So we are no longer short term bearish. In fact for us(if you disagree your not alone..I’m not saying your wrong..I’m just saying what I will be doing. Respect my right to lose money or make money with what my sweat and blood comes up with)the risk is to the upside. My target has been 1050 to buy all in. But we are now at or around where markets have in 1919-1921, 1909-1911, 1906-1907,1937-1938, 1968-1970, 1973-1974, and 2007-2008 have counter rallied.
    So any weakness down under 1100 we will be going All in. I was yesterday at 12:00 based on work by our CFA but we couldn’t get place the trades in time. Today…we missed it.
    I’m mostly worried about the ISM print on Sept 1…Europe..it’s a slow moving train wreck. All the other stuff concerns me also that concerns all of you.(along with my undergrade university football season success)
    So we are loaded and ready. I do worry about getting a level low enough to offset would could be bad ISM in advance. But we are going back in for what we see as a 1-3 month rally back up to 1240-1270.

  • presskh

    Agree, El Viejo. I am 52 and have pretty much all the material possessions I really want to have and/or worry about and will only be buying to replace essential items. I also realize that more “stuff” doesn’t really make you more happy – many times, it only adds to your burden of having to take care of it. Demographics is facet hitting the economy pretty hard and I only see that accelerating as retiring baby boomers look to downsize their homes and eliminate (not increase) their hoards of “stuff” accumulated during the last 30 years.

  • VII

    Let me just say…for those astute readers who figured this out.

    YES CULLEN HAS COST MY CLIENTS MONEY. I spend so much time on this damn site I’m late on my morning meetings with staff, returning calls and this morning my wife lectured me while I sat in my skivies on my ipad in bed posting here. DAMN YOU CULLEN…I can’t stop…where is the nearest TPC annymous meeting? I need help.

  • prescient11

    Cullen, very interesting piece and thoughts. Thank you. It’s why I love this blog! Did you hear Bob Teague (I believe that’s his name) when he stated that most everyone misunderstood QE2 and that it’s real purpose was to provide the banks with extra reserves? And that’s it. That’s why M2 didn’t move until recently after the end of QE2.

    Personally, I think the Fed has a very good handle on the shadow banking system and they are getting significant details in the field on how the Euro crisis is playing out. The Fed has to ensure that enough funding is available to get past the elections in France and Germany this fall.

    I look at it as two fold, the banks are going to need one more round of support, given continued asset deterioration and uncertainty in Europe. CDS market explains it all. Treasury still has money that was repaid from TARP, correct?

    Geithner is very proactive, very much so. I have listened to several of his recent interviews and intervention and stimulus are his main themes. I think we will see some very creative actions by the Fed and Treasury. Obama will provide political cover. This fits in the Fed.’s mandate of save the banks and spurn maximum employment.

    What the speech entails, I will be very interested to see. But providing market certainty, at least as to what BB can do, will do very well for the business environment. I think BB has a majority sufficiently on board to take “bold action” as far as stimulative measures go, the crisis in Europe has them very much alarmed, as they should be.

    Personally, I think BB will lay the foundation for some serious moves and perhaps appeal for more fiscal action. Very interesting to see what is happening.

  • Different Chris

    Well I’m setting up the NYC chapter, so you might as well set up something on the West Coast.

  • VII

    DC- will you sponser me?

    By the way were going into the devil himself on our next trades. We are buying the big black hole blood sucking squid himself…

    Yes we are loading up on….the financials..and ETF…wish us luck…But were going where the beta is. Thats where the meat is and that’s where we’ll eat.

  • Different Chris

    I’ll sponsor you if you sponsor me ;)

    What financial ETFs do you like?

  • baychev

    Thanks for the article, it just confirms my opinion that MMT does not apply to the USA and contemporary fiat currency systems. If you disagree, I will be glad to hear why. Here are the bunks:

    First of all, the USD is not entirely freely floating, it is being pegged or at least manipulated by many of the U.S. trade partners. Thus they import inflation in order to import employment and save in the form of net financial assets (USD and Treasuries). This means you can have both large gov’t deficits and increasing unemployment as we actually do!

    Second, net financial assets is not net savings as per the article, there are many ways a person can save, housing is a good example. Hence we can save even without gov’t deficits and we can monetize our savings as well without the need for additional gov’t deficits. Net financial assets do not happen to equal household net worth either in our fiat currency system, there are tax exemptions on many transactions that allow taxpayers to crowd out certain asset areas in order to avoid tax liabilities which limits the gov’t ability to create demand for its fiat currency.

    “The sovereign government via net spending (deficits) is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.”
    This statement makes no sense. In order one to save, he has to work to earn first, and only then to save. The notion that my savings are someone’s missed income is a misnomer as well: banking is a mechanism that connects my savings with someone’s desire to invest or spend. It looks MMT and Marxism have at least one thing in common: nationalized banking as the sole provider of savings.

    MMT is built on the premise of ever increasing leverage in the economic system, this runs counter to many laws of physics concerning finiteness on planet Earth by which we must abide, willing or not. This guy is not familiar with physics though, the department is in another building.

    “In a fiat monetary system, unemployment occurs when net government spending is too low.” Apparently this guy does not know a thing about outsourcing, competitiveness, demand, even communist basics such as social safety net.

    His flow of funds bath tub example does not accurately depict the US/China setup: 2 connected bath tubs where the currency issuer (U.S.) does not provide marginal employment in its own system through ever higher deficits, but does so in China and makes inflation rampant there as well, because there is no opportunity to save for all gov’t unemployment handout recipients in the U.S.

    On foreign transaction his pet theory that gov’t deficit spending is the only way to increase employment just breaks up: “In terms of the slightly worsening current account deficit, we can interpret that as signifying an increased desire by foreigners to place their savings in financial assets denominated in Australian dollars. This desire means that that the foreign sector will allow us to enjoy more real goods and services from them relative to the real goods and services we have to export.”
    How exactly in this described scenario increasing deficits increase employment? It looks like they are deferring it.

    Are we now on the same page: MMT is a very well thought out, logical mental exercise but just too simplified to depict our complex economic system or recommend policies to increase employment which happens to be the burning issue in our hearts.

  • VII

    thats a hard question.

    I hate them all. you could call me a financial biggot.

    We’ll be buying XLF- with my hand on my nose, I havn’t owned financials since 2009. But I do what I’m told…it seems to work.

  • http://www.pragcap.com Cullen Roche

    No, we’re not even close to being on the same page.

    Of course foreign govts can peg their currencies. That has nothing to do with whether the USD is autonomous.

    Of course consumers can save in coconuts if they want. We covered this debate thoroughly in the Robert Murphy debates.

    None of your “bunks” are warranted or backed by reality.

  • Coolidge Low

    There will be “NO” action from the Fed at this time. Market continue to collapse this fall, rally year end then resume the decent to new lows in 2012. We have hit a debt ceiling. The economy is stalling and recession is baked into the cake as we enter an election cycle. Europe is a mess. Italy is collapsing. The middle East is far from stable.

    The FED must curb the volatility or our markets will be destroyed. The primary function of the market is raising capital for industries. This type of volatility really undermines this function. The Buffoon needs to focus on price stability and not feed the animal spirits!!!!!!!!

  • Y

    First of all, the USD is not entirely freely floating, it is being pegged or at least manipulated by many of the U.S. trade partners. Thus they import inflation in order to import employment and save in the form of net financial assets (USD and Treasuries). This means you can have both large gov’t deficits and increasing unemployment as we actually do!

    This is a basic part of the sectoral balance approach. The fiscal deficits aren’t large enough to counteract the financial drain of the current account deficits.

  • Y

    Same nonsense repeated ad nauseum during the 1930s. We’re so doomed.

  • baychev

    Please reconcile then the discrepancy between the increased deficits for the past few years with the sure arm shot theory concerning employment. And please toss a number, I am not going to be too particular about it: how much more deficit spending per year could immediately solve the unemployment problem and have negligible impact on inflation?

  • Y

    Europe..it’s a slow moving train wreck. All the other stuff concerns me also that concerns all of you.

    Empty cities, excess capacity and, consequently, non-performing loans in China?

    (along with my undergrade university football season success)

    Pac 10? The inaccurately named Big 10? They’re basically a basketball conference at this point, but it’ll be interesting to see Nebraska.

  • baychev

    How much is ‘large enough’?
    Please toss a number as well. I see $250bn deficit with China producing 400k average paying jobs domestically, but 7 million in China. To create jobs for 10 million just to get to par with 2007, we must be talking in the range of 6.5 trillion additional deficit spending, 8 trillion in total. Where would inflation go in such a scenario? Remember that inflation will eat many times over any additional tax collections in the form of increasing expenditures.

  • http://www.pragcap.com Cullen Roche

    Your numbers are way off of realistic scenarios. If we use Okun’s law, we can arrive at a fairly reasonable estimate of the necessary sized deficit to reduce unemployment back to 5% and close the output gap. The rough numbers are about 1.3T in additional deficit spending per year. That’s about 8% of GDP due to the output gap of 9%. So, if we ran 2T deficits for the foreseeable future (2013/14) until the balance sheet recession ended I’d be willing to bet that this economy would get back to pretty substantial growth and near full employment. And yes, it would cause higher inflation. That’s part of the goal.

    But that’s not gonna happen so you get your wish of less spending.

  • beowulf

    Ehh, if I was an investor (and I’m not, my retirement plans involve marrying an heiress), I’d think, why not just free ride on some good old fashioned American rent-seeking?
    Mortgage REITs, borrow at 0.25%– mark it up 20fold– lend at 5.0%, pay 20% dividends (hedging with gold options wouldn’t hurt).

  • http://www.pragcap.com Cullen Roche

    Who is this heiress? And how can I get on (literally) that “retirement plan”?

  • Willy2

    If they would do a literal “”helicopterdrop”” then it would destroy the credit market.

  • ocean

    Baychev you are heading in the right direction.
    MMT is the description of the monetary system that lead to some controversial and non-intuitive conclusions, especially when viewing the government as a household.

    Based on the conclusions, MMT can suggest policy choices influenced by individual/politics idealogy. Policy recommendations can vary from one or many of
    – spending and taxation + interest rate targeting to maintain GDP growth, or
    – full employment policy or
    – improved banking sector to remove those inefficiencies or
    – even a more libertarian approach or
    – or consumer and banking debt reduction or
    – perhaps abandoning the exponential GDP growth (peak oil limit) and focus on some other sustainable target other than GDP

    I think its constructive to debate the MMT policy choices and distinguish that debate from the descriptive theory of the monetary system which is reasonable accurate model (even as much as I criticize it).

  • El Viejo

    Started getting back in last Friday(401k funds). Was a little disappointed yesterday, but was planning on financials a little later (looking at the Hirsch Bros Almanac) and planning a little earlier. Was considering FAS. ???

  • Y

    Let me rephrase: “were not” large enough to counterbalance the current account deficits through most of the 2000s. Now they’re large enough to finance some private sector financial accumulation in excess of the current account drain. But these are deficits largely the result of private sector unemployment and deleveraging rather than a positive choice to stimulate the economy on the part of the government.

    It’s not surprising that simply maintaining pre-recession spending, as well as replacing a proportion of lost private sector income with automatic stabilizer benefits would not eat away at unemployment. It’s part of the reason why a nominal shock greater than 1929 didn’t cause 1930s unemployment rates, but it’s not enough to close the output gap.

    Please toss a number as well. I see $250bn deficit with China producing 400k average paying jobs domestically, but 7 million in China. To create jobs for 10 million just to get to par with 2007, we must be talking in the range of 6.5 trillion additional deficit spending, 8 trillion in total. Where would inflation go in such a scenario?

    Could you elaborate on the first portion? Do you mean all the domestic jobs associated with importing $250 billion of goods from China? Or do you mean domestic jobs financed by $250 billion in federal deficit spending, simply showing that as the counterpoint to the Chinese surplus?

  • baychev

    I agree we have a fiat currency system, I do not agree we have MMT in play because some of its premises are not present. I agree with many of your suggestions concerning improving competitiveness and thus employment, I do not agree the gov’t is the best body to implement your suggestions.
    Frankly, I believe that leveling the playing field for businesses of all sizes is the best environment to create employment for motivated people, for the unmotivated the gov’t shall do something else: force them to labor in order to survive.

    What we are having is a mutually beneficial setup between US and China: the former provides standard of living even for people not willing to work, increases the purchasing power of the motivated workforce with cheap imports. The latter imports employment and inflation and the false perception of wealth. The former gains a fre ride, the latter gains competitiveness.

  • Willy2

    According to my information the US definition of “”savings”” is misleading:
    1. when one pays down debt that’s considered as savings even when one doesn’t increase one’s amount of cash/net worth.
    2. Payments to a pensionfund are also considered savings.
    My opinion is that 1) is the main driver for the rise in savings.

  • VII


    i thought i lost you.
    The other day you said something like, “my last girlfriend had a binnie baby collection….” I didn’t know what to do with that when I read it. I had built you up in my mind and to find out my hero was sleeping and conversing with a women who had a beanie baby collection. I can only imagine what this women looked like, who drove the car on your outings, how many cats you had, and how many lifetime shows you watched and wether you had matching snuggies.

    But that all changed with your heiress comment. We can now go heiress hunting(yes I’m married but my wife has never turned down a hot heiress). And seeing what the TPC has become…Cullen will be working.

  • baychev

    I think we shall be targeting the opportunity for everyone to pursue happiness. For some this is a chance for self realization, for others it is the opportunity to subsist and enjoy lowly pleasures. At no moment though we shall decide what to forcefully feed the society, this runs counter to the principle of freedom.

  • DGC

    1.3 T of additional spending per year for several years would reduce our unemployment back to 5%? Aren’t you making the assumption that spending would be directed only toward productive uses? Isn’t it much more likely that the money would be wasted on pay-offs to special interests?

  • http://www.pragcap.com Cullen Roche

    Of course. Anyone following me over the last few years has seen how critical I am of spending. So you’re right. Don’t worry. It’s not going to happen so we don’t need to worry about the waste from it. I am not sure that this govt is capable of spending it efficiently so it might be a good thing that we’re not getting it.

  • baychev

    Are you sure? I see more than 1.3T already into this year’s spending, yet no improvement in the employment number, I do not care what BLS counts as unemployed. The budget deficit is 1.4T or 800bn above pre crisis levels, another 900bn in QE2 & QE1 reinvestments, this is money that was freed up in the economy. My 8T number was concerning only wages, yours is all inclusive. Shall we ramp up war spending os simply bomb China to destroy some industrial capacity?
    I guess you mean by deficit spending protectionist ‘Buy American’ plan that runs against free trade and WTO principles?

  • VII

    One thing I don’t have is discression. Unless it is hurtfull(which I apologized to brian for being rude..which I was and I will never apologies to intertrader for anything)

    But I know not to get into a sports conversation here. It is a can of worms. Trust me we will turn this site into stupid sports comments, bashing each other every saturday or sunday about our hometown team etc. etc.

    I am passionate about my university. I hope they play tough, spirited and represent us well. Of all the things I’m looking forward to it’s sitting with my son and wife(whos dad teacher there) on a Saturday and teaching him the traditions we have.

    Other than that…we should leave specifics about schools and sports out of this blog. It’s a can of worms…it’ slike QE..it never goes away.

  • Willy2

    The FED is toothless when
    1) all assetsclasses go down even and
    2) the USD (in its capacity being the senior currency) goes up.

    Gold, silver and the Treasuries were the two last bull markets and they all seem to be rolling over. And when the 30 and 10 year T-bonds rolls over then it’s “”game over”” for the FED. And that’s the BIG difference between 2008 and now. Because with rising bondyields they can’t increase liquidity any more. Then they’ll be forced to literally “”printing money””.

  • http://www.pragcap.com Cullen Roche

    Oh geez. Now I am warmongering protectionist? :-)

    I am neither of the above. You won’t find anyone out there who is a bigger supporter of our troops abroad, but I do despise the fact that America feels this need to police the world. And yes, I agree with the Austrian premise that building bombs and dropping them on cities is a horribly unproductive way to spend money.

    QE didn’t “free up” money to be spent. That’s not what QE does. QE merely alters the term structure of outstanding debt.

    Again, you’re making lots of unfounded misrepresentations.

  • baychev

    You got me, 250bn would roughly equate to 400k $60k jobs which would be lower when you subtract health and social benefits the employer pays. But that is the value of final products, not the labor costs. My point is that we are far better off importing goods for funny money than producing outrageously expensive goods and lowering everyone’s standard. It is completely misguided though to target full employment and pretend we can maintain living standards and income levels, it just cannot happen in a globalized economy.

  • VII

    Senor El Viejo…

    You my friend are a true carnovous….I said the meat is in the beta and the beta is in financials…and you want to go after the expensive rare Kobe meat.(kobe tai..ahhh…i just had a moment sorry.)

    If one pill is good than many will really do the trick.

    I’m hindered by some things….we can’t use leverage. I’m not allowed for my clients to have discretion and use leveraged ETFs. The only investment I have not alligned with my clients is a penny stock(my little prescious seed) So..I don’t spend alot of time on the ETF your looking at. I know very little about investments I can’t use. I’m sorry I don’t have expereience with this ETF. But 3x….yes it is more of what you and I are trying to get.

    We’ve done nothing yet. No buys since last week. I don’t like the movement today to buy into.

  • baychev

    I was kidding about the bombing. It is a fact that we globally have excess capacity, thus wages and prices have to fall if money increases and demand is constant for raw commodities but non existent for final goods.
    QE did free up a lot of cash, it bailed out uneasy GSE $#17bag debt holders, it let banks recapitalize by buying gov’t debt that later could be sold to the Fed, it allowed Tepper and many insiders to cash out of their equity holdings in still insolvent banks. Porsche sales really picked up until recently in the U.S., these were hardly on credit. Of course the employment did not improve, many Joes can only hit nails with a hammer and demand is for programmers, we cannot possibly retrain them, they will be cyclically unemployed.

  • Cirrus

    What would happen if we made all primary residence mortgage payments tax deductible for the next ten years (principal and interest)?

  • Anonymous


    How about QE3 that subsidizes private corporations to continue building out global infrastructure and reducing tariffs like the one mentioned?

    “Those are no-brainers right now,” Oberhelman said about the agreements. “Our customers in Colombia incur a $300,000 tariff on our big trucks that go there. And guess who wants in badly? Our competitors from Japan and China…We want to keep those jobs and those are jobs right here in Illinois” where Caterpillar is based.
    In the past, improving infrastructure, particularly at ports, airports, and roads, “helped in the short term create jobs,” he said, and it made the U.S. “more competitive in the long term,” he said.
    As for the administration’s latest infrastructure program as part of the economic stimulus package, “It got some legs and we saw some activity last year — and we’re still seeing a little bit from that,” he said.
    But Oberhelman thinks similar programs worked better in China and elsewhere in the world than they did in the U.S.
    “We either didn’t do enough or didn’t do it the right way,” he said of the U.S. program.
    There are two big issues, he said. First, it takes time to get an infrastructure program going and second, you have to find a way to pay for it.
    “We have to look at creative private/public alternative means of financing, and nobody wants to hear about it, but it’s going to take sacrifice from everybody [because] it puts people back to work immediately,” he said, and, “It’s an investment in our competitiveness

  • El Viejo

    Ha! Yeah, just considering at this stage. I get a repertoir ready in my head and I watch the news and look down the road and look for blood in the streets and a conjunction with a seasonal low and then pull the trigger or not based on what I read in the risk down the road. (The first part of buying low and selling high is to buy low) I see a one month rally also, and then maybe another dip. If Europe starts to get their act together why not FAS? Keep an eye on the German court decision (Sep 7th ?). In the long term Europe may be doomed unless they can restructure and consolidate debt.

    Next year seems to be shaping up, in my head at least, as a lack luster (general malaise) year, but that won’t stop the market from becoming overvalued. All the best to ya!

  • Roger Ingalls

    I think an idea along these lines makes sense. Of course, it would put me out of business (I’m a loan originator).

    If the big idea doesn’t work then some modified version of what we currently have would be nice.

    1. Allow those that are current on their mortgages to refi to market rate, WITHOUT REGARD TO PROVING THEIR INCOME! I cannot tell you how many folks cannot refi who clearly have the ability to make their payments, and have been making their payment, but cannot prove the income. Self employed especially.

    2. Allow those that have NON-Freddie Fannie loans to refi at greater than 100% LTV, somewhat like the HARP loans that allow up to 125% refinancing (no cash out, of course).

    The HARP plan was really good, and allowed loads of people to refi from mid 6%’s to mid 4%. It was “sorry Charlie” if your loan wasn’t Fannie Freddie though.

  • El Viejo

    I hear they look for eligible batchelors on cruise ships. Nothing like increasing your odds and enjoying yourself at the same time. Ha! Must say I’ve considered it myself.

  • Y

    I went (I are now an edukated graduate) to a pretty big football and basketball school. Never did go to a game – I do find the statistics, rankings and conference reorganizations fascinating, though.

  • El Viejo

    Yeah, sounds like savings definition needs revamping, kind like CPI. Maybe we need a neutral centerline to let us know if we lean to the left or to the right. (like the CPI 2% mark) Maybe we should have a normal age adjusted amount of debt and a weighted system for good and bad debt. Total it all up and we get a weighted, age adjusted average for the population as a whole. This might compensate for demographics as well.

  • John Zelnicker

    Cullen — I have had the idea since the NASDAQ bubble popped that most, if not all of the 20th century asset bubbles were caused in large part by the financialization of some part of the American economy. This includes the financialization of the whole economy in a way with the mutual fund explosion of the 60’s and 70’s leading to the economy as a whole being in a sort of bubble. (Inflated “wealth”.)

    NASDAQ, housing, commodities, gold & silver, all have had bubbles in my lifetime and the changes in investment vehicles and tactics that allowed traders and speculators to enter the market have financialized each one.

    Far too much human intelligence and labor is going into creating new financial vehicles and activities that add nothing to our national asset base. The brain drain from the math and engineering schools to Wall Street is indicative of this and it contributes to the problem.

  • wh10

    You act like this is an outlandish claim, but a significant portion of the mainstream economic community believes, as well, that the deficit spending over the past couple years was not large enough given the size output gap we have, and we just learned it was even larger than we thought. The output gap was measured $2-2.5 trillion I think. The fiscal stimulus bill was $750 billion. Do the math, it’s not even close, even assuming a multiplier of 1.5. It’s like using a drug that could work but dosing it too low.

  • wh10

    Ah, sorry for the redundancy, I see you got into this below.

  • http://www.pragcap.com Cullen Roche

    Even worse, the CBO confirms that the stimulus was working. The hyperinflationists were 100% wrong. The bond yield fears proved 100% wrong. And look at us. We’re still convincing ourselves that we’re bankrupt! It’s a sad day in Amerca when politics trumps intelligent analysis.

  • Roger Ingalls

    That was an interesting rant. The Caesar stuff starts on page 27.

  • wh10

    Here are some interesting thoughts from Mosler on this-


  • wh10

    The hypothesis in a nutshell:

    “So my point is, maybe, at least over the last few decades, we’ve always needed larger budget deficits than imagined to sustain full employment via something other than an unsustainable private sector credit boom? And with today’s politics, the odds of pursuing a higher deficit are about as remote as a meaningful private sector credit boom.”

  • Different Chris

    Never stay in a leveraged ETF overnight.

    But that’s just my opinion.

  • Lori

    John Maynard Keynes saved capitalism during the Great Depression by realizing what role income distribution plays in an economy and then this role was attributed to the minimal government at that time. Today neither the government nor the Fed are left with any options to help the staggering income inequality in USA, which is the main root cause of this crisis. Trying to squeeze what ever has left in the pocket of the average consumer will be disastrous for the global economy and socially dangerous.

  • suckmybishop

    (Re-attempt at posting this)
    I agree that monetary policy is less effective than usual. However, with much respect for you in general, this is a Pathetic Article.

    On point 3)
    It is a fallacy to think the Fed can effectively “target” 10-yr interest rates. The only way real way to get the market to participate at such a low yield that far on the curve is if the Fed makes some commitment to keeping short-term rates low for a specific and long period of time (or if inflation expectations justify such a yield). While the bond market is largely at the whim of the Fed, the market is not retarded. They will simply not participate in a market (on the long side at least) where the Fed attempts to set 10-yrs at 1%, if they believe there is a risk that the overnight rate will be 3% five years from now. The only way to effect this would gradually require the Fed to increase the balance sheet to a rather absurd level. In fact, the Fed has experimented with a way to effect change on the long-term end of the curve. This brings me to your point 2)
    The “language change” has nothing to do with confidence fairy economics. No non-financial business has ever directly changed their business decisions based on a Fed policy decision, so you’ve put up a caricature of the recent Fed action. Lenders however will be affected by this. As you’ll notice, the 2-yr yield (and 5-yr and 10-yr) has dropped substantially thanks to the Fed action– to record lows, lower than even 2008 when people feared deflation. Part of this is of course to fears about economic growth, but there is no question that this Fed statement has been effective. Because a substantial fraction of consumer debt is on a 2-yr timescale, this makes a large difference for lenders.

    The major limitation to everything the Fed does, is the fact that there is generally too much private-sector debt. So how does the recipe in point 2 help this? Well inflation is clearly helpful in this respect. I personally believe Fed action along the lines of this recipe will strongly change produce inflationary pressures.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    A few problems here,

    First, I dealt with the negative nominal interest rate issue over two years ago on the KC blog in two separate posts.

    Second, making the loan doesn’t necessarily get rid of the reserves. Yes, they may flow out as the deposit created by the loan is withdrawn, but they may flow in if the bank’s customers receive payments. Just making a loan isn’t enough; this is about managing payment flows.

    Third, even if it does get banks to lend more, that is rather short-sighted for the bank, because it’s far worse off than not lending if the loans go bad.

    Fourth, banks will shift their portfolios around and buy Tsy’s at auction–which drains the reserve balances. Tsy rates would fall to indifference levels relative to the reserve tax, while banks would be lining up at auctions.

    Fifth, banks would trade in virtually all of their reserve balances for currency and fill up their vaults instead of hold reserve balances that are taxed.

    Sixth, banks would start charging customers for deposit accounts to try and maintain spreads.

    Overall, I don’t see much more lending, if any. I see a portfolio shift by banks and a move to push the reserve tax onto customers, which will essentially be a tax on pvt savers.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    Yes, potentially, although a refi doesn’t have nearly the effect on V as an increase in sales. As I said, it would help, though it’s not clear how much. I actually proposed this in a chapter I wrote for my book in early 2009, though I used a 4% rate, which seems silly now. And you make a good point about the Fed’s options–this would be a far easier way to provide relief to homeowners in trouble with mortgage payments that were affected more by the downturn than by taking on way more debt than they could ever repay in hopes of selling in a few years.

  • http://neweconomicperspectives.blogspot.com Scott Fullwiler

    Let me clarify . . .there WOULD be more lending because of the sharp drop in interest rates, as the reserve tax would effectively set the fed funds rate at that level and bring other rates down with it.

    But my point is that it’s not the fact that banks are being taxed that would create the lending–from the bank’s perspective, the issue is (a) setting lending rates and deposit rates to maintain as much spread as possible, (b) shifting out of reserves as much as possible on a daily basis, (c) finding ways to penalize depositors if deposit rates can’t be lowered enough (in order to keep profits from falling) without losing deposits to competitors.

    Note that all of the above are completely unrelated to a reduction in lending standards. That’s my point, and I think that’s where Kid is mistaken.

  • Dan Kervick

    Instead of a flat negative interest rate on reserves, isn’t there some combination of Fed actions and Congressional legislation that could set graduated interest rates on all kinds of savings, depending on the size of the savings cache in question? A solid interest rate for working people and middle class people who need to save, lower interest rates for accounts with more savings, and negative interest rates on accounts over a certain ceiling amount?

  • Michael Covel

    Question, before a follow-up question, but where would it all be today if Fed/Congress had done nothing since Sep 08?

  • clydeDNA

    “The Fed can technically purchase foreign government debt”…”They certainly have options that could prove proactive in stopping some potential hemorrhaging from any European credit contagion.” I would think this could be very beneficial to the USA. Question, if the Fed bought Greek/Spanish/Italian/etc government Euro debt with $US, would this add to Fed reserves? I understand they could do this via the IMF, but what about directly and keep these bonds on the shelf and give the interest due back to those countries. This would amount to “printing money”. The world’sproblem since 2008 is that the world is short of currency. There is lots of work to be done, there are lots of workers out of work, but no money to make this happen! There are not enough real $US to go around. There are plenty of debt $US, but these dollars issued by banks carry with them usury. These countries don’t need more debt, they need plan old printed $US or Euros (the latter they are not going to get). Uncle Sam had a lot of good customers in these countries but now nobody is working and thus no money for buying anything. I think this is the real cause of the “Arab Spring”, no work, no money, no happy.

  • http://www.pragcap.com Cullen Roche

    The Fed could target the long bond rate and set it in the same way they target the short rate. Ben Bernanke has explicitly stated this. So I stopped reading your comment after that point. Just after you so DISrespectfully said my article was “pathetic”. Please try to understand how monetary operations work before you insult someone’s work, when it’s clear that you have NO idea what you’re talking about.

  • ocean

    Austrian Response: Well along the way of cleansing the years of accumulated bad debt from the artificially low interest rate policy. And when appropriate threshold is achieved organic investment, demand and economic growth will resume.

    Neo-Keynesian Response: Well into the Second Great Depression facing a continuing deflationary death spiral with massive GDP contraction, unemployment, asset market deflation and very likely riots etc

  • suckmybishop

    well bernanke knows better than I, so I apologize

  • beowulf

    I remembered why “2% interest rate” stuck in my head. It was in this guy’s gubernatorial platform (I hope you didn’t think I had some kind of macroeconomic formula in my head). :o)

  • beowulf

    Rule 26 Cullen
    “The game is to be sold, not told”.

  • beowulf

    Ehh, I’m not even sure what a beanie baby is, its just the customary “widget” for Ebay examples. I didn’t want to corrupt young Chris by using as my example, “let’s say you had some extra hash and wanted to sell it on Silk Road”.

  • suckmybishop

    looking at the Bernanke statement that I believe you were referring to:
    ” A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields.”

    In fact, if you had read my post, this is exactly what I said. Naively, this is similar to how the Fed affects the short-term rates, but also requires a multi-year commitment. I was pointing out that the Fed can’t just expect to bully the market by saying the 10-yr rate is now X%. Such a policy requires a stated commitment to keep short-term rates low on at least a 5 year timescale, otherwise the 10-yr yield won’t necessarily cooperate. From here, I argued that your 2nd point was incorrect, because the language change is necessary to bring about targeting a longer term interest rate.

    I think your article oversimplified some things. I regretfully insulted you because i think most of your work is more careful. peace

  • beowulf

    Dread nought Roger. Its not like the Fed has the staff to go out and originate loans. Even under a nationalized mortgage system (whether run by Fed or Tsy), they will still need private sector loan originators for the front end paperwork.

  • http://www.pragcap.com Cullen Roche

    I guess when your pimpin began our friendship ended. Noted.

  • suckmybishop

    The Fed isn’t just going to create reserves without worrying about the consequences. Unless the market was under the impression that short term rates would be “exceptionally low” for at least 5-7 yrs (in the 10-yr, 1% example), it would be very difficult for the Fed to defend that rate without drastically increasing its balance sheet (QE2 is small beans). You aren’t really arguing about this, are you? Suppose you were a bank sitting with a stack of 10-yr bonds. If you thought there was a substantial risk of the short-term rate going to say 3-4% in year 8,9,10, then you’d immediately sell your 10-yr treasuries unless you thought that you could sell it at T+1 to some sucker at a similar price. These bonds will just be hot potatoes that eventually end up with the Fed.

  • suckmybishop

    well, i’m reading bernanke’s deflation speech in more detail, and it seems the Fed has actually pulled off long-term bond price-capping in the past. As I expected, it required a decade long commitment to short-term rates, which involved them purchasing the bulk of the 90-day bills. Via this mechanism, they didn’t actually have to purchase absurd amounts of the long maturity stuff.

  • http://www.pragcap.com Cullen Roche

    The Fed would set the rate in the same way they set the short rate. It’s that simple.

  • suckmybishop


  • http://www.pragcap.com Cullen Roche

    You might think it’s funny, bu thats how monetary ops are performed. Sorry if you dont agree.