Friday, August 29, 2014
After Dodd-Frank
(Youtube link) A talk given at the Mercatus Center / CATO conference "After Dodd-Frank: The Future of Financial Markets." (The link has videos of the whole conference.) The talk is taken from the paper "Towards a Run-Free Financial System," which answers many objections you may have to claims in the talk. (Yes, I have plugged it before on the blog and will likely do again.)
The more I read about it, the more I think it's important to define what is not a problem, and can be left alone. If we have to solve housing subsidies, Fannie and Freddie, global imbalances, Wall Street greed, compensation, inequality, savings gluts, predatory lending, financial utilities, bankruptcy law, behavioral biases of equity managers, living wills, stress tests, capital ratios, Basel regulation, macroprudential bubble-detection and pricking, complexity of derivatives, exchange vs. otc trading, and so on and so on just to save ourselves from the next crisis, we might as well give up now.
Thursday, August 28, 2014
Liquidity and IOR
Re: the big balance sheet and how it improves financial stability.
Rodney Garratt, Antoine Martin, and James McAndrews at the New York Fed have a very nice post, Turnover in Fedwire Funds Has Dropped Considerably since the Crisis, but It’s Okay.
Before the crisis, banks held about $50 billion of reserves at the Fed. That's not a lot of money. When banks want to pay each other -- say you write a check to me, so my bank has to get money from your bank -- they do it by transferring reserves through the Fedwire. So, that's why banks keep some reserves there.
But $50 billion is tiny compared to $10 trillion of M2, and banks use reserves to clear financial transactions too. A huge amount must flow by passing around these tiny reserves. How did banks do it? What happens if bank B says to bank A, "send us $10 million" and bank A didn't have $10 million left at that second in reserves?
Answer: "intraday overdrafts." The Fed would lend bank A the $10 million -- just flip a switch and put $10 million in their reserve account, and call the loan an asset corresponding to this liability. A then pays B, and works hard to make sure that it collects $10 million from C and D by the end of the day.
As you can see, such "overdrafts" accounted for 50-60 percent of all Fedwire transactions before the vast increase in reserves.
It's a system that makes a lot of sense, so long as banks never fail and don't abuse it. It allows the system to produce a much higher volume of transactions with less non-interest-bearing assets. Instead of cash in advance for every purchase, settling up once per day means you only need to cover the worst possible daily total flow, not the worst possible intraday flow, like if $10 million goes out 10 minutes before another $10 million comes in.
But now, banks have $4 trillion of reserves. They're sitting around as investments, really. As long as they pay full market interest, there is no reason for banks to go to all this effort to get by with little reserves. And we seen in the graph exactly what you'd expect. If bank A owes bank B $10 million, it just sends the $10 million, no need to borrow it for 10 minutes from the Fed.
The article explains all this well. A few quibbles
And turnover -- which they point out has plummeted as in the graph below (ignore the "counterfactual") -- is a totally misleading statistic. Turnover is transactions / reserves. Transactions haven't fallen, reserves have exploded. I presume a graph of the total number of transactions shows little change, or at least no such cliff.
But the closing paragraph is great:
H/T to Torsten Slok's weekend reading email which found the post.
Update: "Interest on Reserves and Daylight Credit" bv Huberto M. Ennis and John A. Weinberg in the Richmond Fed Economic Quarterly (2007) is a nice explanation of how the system worked. Towards the end it sketches how increasing reserves drive lower turnover, not less transactions.
Rodney Garratt, Antoine Martin, and James McAndrews at the New York Fed have a very nice post, Turnover in Fedwire Funds Has Dropped Considerably since the Crisis, but It’s Okay.
Before the crisis, banks held about $50 billion of reserves at the Fed. That's not a lot of money. When banks want to pay each other -- say you write a check to me, so my bank has to get money from your bank -- they do it by transferring reserves through the Fedwire. So, that's why banks keep some reserves there.
But $50 billion is tiny compared to $10 trillion of M2, and banks use reserves to clear financial transactions too. A huge amount must flow by passing around these tiny reserves. How did banks do it? What happens if bank B says to bank A, "send us $10 million" and bank A didn't have $10 million left at that second in reserves?
Answer: "intraday overdrafts." The Fed would lend bank A the $10 million -- just flip a switch and put $10 million in their reserve account, and call the loan an asset corresponding to this liability. A then pays B, and works hard to make sure that it collects $10 million from C and D by the end of the day.
 |
| Source: Rodney Garratt, Antoine Martin, and James McAndrews at the New York Federal Reserve |
As you can see, such "overdrafts" accounted for 50-60 percent of all Fedwire transactions before the vast increase in reserves.
It's a system that makes a lot of sense, so long as banks never fail and don't abuse it. It allows the system to produce a much higher volume of transactions with less non-interest-bearing assets. Instead of cash in advance for every purchase, settling up once per day means you only need to cover the worst possible daily total flow, not the worst possible intraday flow, like if $10 million goes out 10 minutes before another $10 million comes in.
But now, banks have $4 trillion of reserves. They're sitting around as investments, really. As long as they pay full market interest, there is no reason for banks to go to all this effort to get by with little reserves. And we seen in the graph exactly what you'd expect. If bank A owes bank B $10 million, it just sends the $10 million, no need to borrow it for 10 minutes from the Fed.
The article explains all this well. A few quibbles
The shift in funding away from overdrafts and toward account balances has significantly increased the amount of liquidity needed to fund payments in Fedwire Funds.I think reality is the other way. The vast amount of liquidity banks have chosen, and will continue to choose so long as reserves pay market interests, mean they have abundant liquidity to fund payments directly on Fedwire. It is not "needed." (Mistaking "choice" for "need" is a favorite Econ 101 fallacy.) The minute the Fed tries to pay less on reserves than short term T bills pay, banks will choose to go back to the old system.
And turnover -- which they point out has plummeted as in the graph below (ignore the "counterfactual") -- is a totally misleading statistic. Turnover is transactions / reserves. Transactions haven't fallen, reserves have exploded. I presume a graph of the total number of transactions shows little change, or at least no such cliff.
 |
| Source: Rodney Garratt, Antoine Martin, and James McAndrews at the New York Federal Reserve |
But the closing paragraph is great:
A high turnover ratio is typically viewed as a good thing in a payment system, because more payments can be made with less liquidity. To do more with less is good when resources are scarce. However, reserves don’t have to be scarce. With interest on reserves, the Fed can implement monetary policy even though banks are flush with cash (as we noted in this Economic Policy Review article). And because banks have less need to economize on liquidity, payments are made earlier in the day, which benefits consumers and increases the resiliency of the system to operational outages or participant failures. So the large decrease in turnover should be viewed as a good thing; it is another symptom of how the high level of reserves benefits the payment system."Payments are made earlier in the day" is important. Demands for payment earlier and earlier in the day are a key part of failures.
H/T to Torsten Slok's weekend reading email which found the post.
Update: "Interest on Reserves and Daylight Credit" bv Huberto M. Ennis and John A. Weinberg in the Richmond Fed Economic Quarterly (2007) is a nice explanation of how the system worked. Towards the end it sketches how increasing reserves drive lower turnover, not less transactions.
Wednesday, August 27, 2014
Krugman on housing
I generally don't read Paul Krugman -- bad for the blood pressure -- and I even less often respond -- don't dignify the insults or feed the trolls. But I took a long plane flight yesterday, and the Times was all I had to read, so I stumbled across his column on housing.
After getting through the customary political barbs at Republicans (Rick Perry in this case), and snarky insults ("the habit economists pushing this line have of getting their facts wrong"), I found something almost sensible.
People, especially "middle class" people, are moving away from New York and to California, and to Texas and Georgia. Nominal wages in Texas and Georgia are not higher. So why do they move? Answer: Real wages are a lot higher, because the cost of living is so much less. It's practically like moving to a foreign country (in many ways!). You are earning $100,000 in the un-hip part of Brooklyn, they offer you 80,000 zingbats to move to Truckgunistan. Is it a good deal? Well, you get two dollars per zingbat, so sure!
Real wages are higher in large part because housing costs are lower. And housing costs are lower because...
There is plenty more wrong in the economics of the column -- for example, "workers" aren't a homogenous lot, and "productivity" is not a constant of nature, independent of numbers or of occupation. Hedge fund managers are productive (at least by usual measurement) in New York. That does not mean that auto assembly workers will be more productive if they move back to New York. So moving everyone back to New York and California is not likely to double GDP. But it's nice to see an admission of a major problem caused by regulation.
On the second-to-last sentence, he's still going strong
Well, today Grumpy got two good LOLs from the news.
After getting through the customary political barbs at Republicans (Rick Perry in this case), and snarky insults ("the habit economists pushing this line have of getting their facts wrong"), I found something almost sensible.
People, especially "middle class" people, are moving away from New York and to California, and to Texas and Georgia. Nominal wages in Texas and Georgia are not higher. So why do they move? Answer: Real wages are a lot higher, because the cost of living is so much less. It's practically like moving to a foreign country (in many ways!). You are earning $100,000 in the un-hip part of Brooklyn, they offer you 80,000 zingbats to move to Truckgunistan. Is it a good deal? Well, you get two dollars per zingbat, so sure!
Real wages are higher in large part because housing costs are lower. And housing costs are lower because...
high housing prices in slow-growing states also owe a lot to policies that sharply limit construction. Limits on building height in the cities, zoning that blocks denser development in the suburbs and other policies constrict housing on both coasts; meanwhile, looser regulation in the South has kept the supply of housing elastic and the cost of living low.
So conservative complaints about excess regulation and intrusive government aren’t entirely wrong,Yup. When people want to live somewhere, you can build denser and higher -- the best answer -- you can build out -- causing a lot of transportation gridlock, long commutes, and pollution as people drive by artificially low density housing on their way to work -- or you can watch prices explode.
There is plenty more wrong in the economics of the column -- for example, "workers" aren't a homogenous lot, and "productivity" is not a constant of nature, independent of numbers or of occupation. Hedge fund managers are productive (at least by usual measurement) in New York. That does not mean that auto assembly workers will be more productive if they move back to New York. So moving everyone back to New York and California is not likely to double GDP. But it's nice to see an admission of a major problem caused by regulation.
On the second-to-last sentence, he's still going strong
It would be great to see the real key — affordable housing — become a national issue.Indeed it would. But faced with the inevitable, unavoidable, logically unassailable conclusion -- we need a massive liberalization of zoning laws, planning restrictions, and so forth, allowing people to build up and dense, and thereby create an immense supply of slightly used housing too as people move out into the new stuff--his political blinders just won't let him do it:
But I don’t think Democrats are willing to nominate Mayor Bill de Blasio for president just yet.Bill de Blasio?? That champion of free markets? From that paragon of low-cost housing,.... New York City? Touting that well-proven, time-tested solution: more regulation, set-asides, rent control, government construction, and quotas? Just like they have in Texas and Georgia?
Well, today Grumpy got two good LOLs from the news.
IOR caused the recession!
Apparently saying something nice about the Fed last week stepped over some bright line somewhere.
Lois Woodhill, writing at Forbes.com, wrote one of the most unintentionally hilarious rebukes here.
The above chart
Well, well. For 6 years now, we've been debating the cause of the recession and financial crisis. Was it "global imbalances," "savings gluts," Fannie and Freddie and the CRA, "deregulated" finance, "Wall Street greed," too big to fail guarantees, predictable engineering around bad regulation, housing bubbles, and on and on. Was the recession going to happen anyway, caused by credit supply disruptions, caused by a flight to quality in a systemic run, a technology shock or what... Thank you Mr. Woodhill, we've finally found the smoking gun -- 25 bp of interest on reserves!
No, this does not appear to be a joke. It certainly gets the correlation vs. causation gold star for the week.
I'm still in "say something nice'' mode, so there are quite a few sensible things in Woodhill's column:
I think our confusion stems from the fact that I stuffed an entire narrow deposit-backing / equity financed banking proposal into one sentence: "Banks holding lots of reserves don’t go under." Oh well, opeds are short.
And to be sure, there are plenty of thoughtful reasons to disagree with my analysis. And there are plenty of other areas to remain critical about Fed policy. I remain dubious of "macroprudential" policy and whether monetary policy can do anything at all about long-term labor-force participation -- people who aren't working and aren't even looking for work.
Lois Woodhill, writing at Forbes.com, wrote one of the most unintentionally hilarious rebukes here.
 |
| Source: Louis Woodhill at Forbes.com |
The above chart
...shows what happened the last time the Fed raised the IOR rate [to 0.25%] (remember, it was zero for 95 years).
The plunge in velocity overwhelmed the Fed’s frantic money creation during the period immediately after it started paying IOR. NGDP tanked, taking RGDP and employment with it.
Look, something caused the economic collapse of 2008-2009. Given the evidence, IOR looks a lot like a man caught at a murder scene with a smoking gun in his hand.Interesting. Interest on reserves caused the recession!
Well, well. For 6 years now, we've been debating the cause of the recession and financial crisis. Was it "global imbalances," "savings gluts," Fannie and Freddie and the CRA, "deregulated" finance, "Wall Street greed," too big to fail guarantees, predictable engineering around bad regulation, housing bubbles, and on and on. Was the recession going to happen anyway, caused by credit supply disruptions, caused by a flight to quality in a systemic run, a technology shock or what... Thank you Mr. Woodhill, we've finally found the smoking gun -- 25 bp of interest on reserves!
No, this does not appear to be a joke. It certainly gets the correlation vs. causation gold star for the week.
I'm still in "say something nice'' mode, so there are quite a few sensible things in Woodhill's column:
Given that the Fed stands ready to serve as the “lender of last resort,” it is capital, not reserves, that determines a bank’s ability to weather a financial crisis.JC: Yes, and I think I'm pretty vocal on the extreme end of the narrow deposit-taking, 100% capital investment banking fringe. (I've plugged my papers enough on the blog already, so won't do so again.)
The Fed’s most important job—and one that only it can do—is to provide the U.S. economy (and the world) with a stable dollar.JC: Indeed on the former, and not so sure on the "can do" part even there.
I think our confusion stems from the fact that I stuffed an entire narrow deposit-backing / equity financed banking proposal into one sentence: "Banks holding lots of reserves don’t go under." Oh well, opeds are short.
And to be sure, there are plenty of thoughtful reasons to disagree with my analysis. And there are plenty of other areas to remain critical about Fed policy. I remain dubious of "macroprudential" policy and whether monetary policy can do anything at all about long-term labor-force participation -- people who aren't working and aren't even looking for work.
Monday, August 25, 2014
Musgrave on 100% reserves
In a comment on an earlier post, Ralph Musgrave pointed to his interesting new paper on 100% reserve banking.
I haven't read the paper yet, but I love the Table of contents, reproduced partially below.
The name "narrow Banking" or "full reserve banking" needs improvement. It's really very wide banking -- so long as the banking is funded by equity or long-term debt. To say "narrow" is almost a fallacy in itself, and perpetuates the fallacy that bank lending will dry up. Maybe "Equity financed banking" or "full reserve deposit taking" would be better. Can anyone think of a name that is both sexy and accurate?
Musgrave's Fourty-four fallacies regarding full reserves:
Section 2: Flawed arguments against FR. .............................. 36
1. FR limits the availability of credit? ................................................................. 36
2. Central bank money is not debt free?............................................................ 38
3. Bank capital is expensive for tax reasons?.................................................... 38
4. FR means the end of banks?......................................................................... 39
5. Central banks will still have to lend to commercial banks? ............................ 39
6. FR stops banks producing money from thin air which can fund investments?... 41
7. Investments under FR might not be viable? .................................................. 41
8. FR will not reduce pleas by failing industries to be rescued by government? 42
9. The cost of converting to FR will be high?..................................................... 42
10. Central bank committees won’t be politically neutral? ................................... 42
11. Administration costs of FR would be high?.................................................... 44
12. The cost of current accounts will rise under FR?........................................... 44
13. FR is dependent on demand injections? ....................................................... 45
14. The effect of FR on inflation and unemployment is unclear?......................... 45
15. FR would drive business to the unregulated sector?..................................... 46
16. The state cannot be trusted with peoples’ money?........................................ 46
17. Vested interests would oppose FR?.............................................................. 47
18. FR will reduce innovation by banks? ............................................................. 48
19. Deposit insurance and lender of last resort solves banking problems?......... 48
20. Lenders will try to turn their liabilities into “near-monies”? ............................. 49
21. Anyone can create money, thus trying to limit money creation is futile?........ 50
22. Advocates of FR are concerned just with retail banking? .............................. 51
23. Central banks will still have to lend to commercial banks? ............................ 39
24. It wasn’t just banks that failed in 2008: also households became overindebted?...........................................................................................................52
25. Creation of liquidity / money is prevented?.................................................... 53
26. Funding via commercial paper would be more difficult under FR? ................ 54
27. FR is nearly the same as monetarism? ......................................................... 54
28. There is no demand for safe or warehouse banks?....................................... 55
29. FR would cause a stampede to safe accounts? ............................................ 56
30. FR would raise the cost of funding banks?.................................................... 56
31. Fractional reserve is not fraudulent? ............................................................. 57
32. FR will not stop boom and bust? ................................................................... 58
33. Bank shareholders will demand a high return to reflect their uncertainty about
what a bank actually does? ................................................................................. 60
34. FR reduces commercial bank flexibility? ....................................................... 60
35. FR would not stop bank runs?....................................................................... 61
36. Vickers’s flawed criticisms of FR. .................................................................. 61
37. Regulating loans is better than FR? .............................................................. 68
38. FR doesn’t insure against liquidity shocks?................................................... 69
39. Government couldn’t produce enough money under FR? ............................. 70
40. FR prevents all lending?................................................................................ 70
41. Banks will try to circumvent FR rules?........................................................... 72
42. Converting to FR involves a huge bailout of existing banks? ........................ 72
43. The Money Creation Committee would not regulate demand accurately? .... 75
44. Interest rate gyrations would be larger under FR?......................................... 76
I haven't read the paper yet, but I love the Table of contents, reproduced partially below.
The name "narrow Banking" or "full reserve banking" needs improvement. It's really very wide banking -- so long as the banking is funded by equity or long-term debt. To say "narrow" is almost a fallacy in itself, and perpetuates the fallacy that bank lending will dry up. Maybe "Equity financed banking" or "full reserve deposit taking" would be better. Can anyone think of a name that is both sexy and accurate?
Musgrave's Fourty-four fallacies regarding full reserves:
Section 2: Flawed arguments against FR. .............................. 36
1. FR limits the availability of credit? ................................................................. 36
2. Central bank money is not debt free?............................................................ 38
3. Bank capital is expensive for tax reasons?.................................................... 38
4. FR means the end of banks?......................................................................... 39
5. Central banks will still have to lend to commercial banks? ............................ 39
6. FR stops banks producing money from thin air which can fund investments?... 41
7. Investments under FR might not be viable? .................................................. 41
8. FR will not reduce pleas by failing industries to be rescued by government? 42
9. The cost of converting to FR will be high?..................................................... 42
10. Central bank committees won’t be politically neutral? ................................... 42
11. Administration costs of FR would be high?.................................................... 44
12. The cost of current accounts will rise under FR?........................................... 44
13. FR is dependent on demand injections? ....................................................... 45
14. The effect of FR on inflation and unemployment is unclear?......................... 45
15. FR would drive business to the unregulated sector?..................................... 46
16. The state cannot be trusted with peoples’ money?........................................ 46
17. Vested interests would oppose FR?.............................................................. 47
18. FR will reduce innovation by banks? ............................................................. 48
19. Deposit insurance and lender of last resort solves banking problems?......... 48
20. Lenders will try to turn their liabilities into “near-monies”? ............................. 49
21. Anyone can create money, thus trying to limit money creation is futile?........ 50
22. Advocates of FR are concerned just with retail banking? .............................. 51
23. Central banks will still have to lend to commercial banks? ............................ 39
24. It wasn’t just banks that failed in 2008: also households became overindebted?...........................................................................................................52
25. Creation of liquidity / money is prevented?.................................................... 53
26. Funding via commercial paper would be more difficult under FR? ................ 54
27. FR is nearly the same as monetarism? ......................................................... 54
28. There is no demand for safe or warehouse banks?....................................... 55
29. FR would cause a stampede to safe accounts? ............................................ 56
30. FR would raise the cost of funding banks?.................................................... 56
31. Fractional reserve is not fraudulent? ............................................................. 57
32. FR will not stop boom and bust? ................................................................... 58
33. Bank shareholders will demand a high return to reflect their uncertainty about
what a bank actually does? ................................................................................. 60
34. FR reduces commercial bank flexibility? ....................................................... 60
35. FR would not stop bank runs?....................................................................... 61
36. Vickers’s flawed criticisms of FR. .................................................................. 61
37. Regulating loans is better than FR? .............................................................. 68
38. FR doesn’t insure against liquidity shocks?................................................... 69
39. Government couldn’t produce enough money under FR? ............................. 70
40. FR prevents all lending?................................................................................ 70
41. Banks will try to circumvent FR rules?........................................................... 72
42. Converting to FR involves a huge bailout of existing banks? ........................ 72
43. The Money Creation Committee would not regulate demand accurately? .... 75
44. Interest rate gyrations would be larger under FR?......................................... 76
Thursday, August 21, 2014
A Few Things the Fed Has Done Right
WSJ Oped, here.
I'll post the whole thing in 30 days.
The Oped builds on a new paper, Monetary Policy with Interest on Reserves, and on Toward a Run-Free Financial System. In the latter, I advance the idea that the Fed and Treasury should first offer interest-paying money, and then stamp out private substitutes, just as the US first offered banknotes and then stamped out run-prone substitutes in the 19th century. Interest on reserves, a big balance sheet, and opening reserves to all are a first step.
There are some big unknowns which I don't touch on in the oped. (That's what the cryptic last paragraph refers to.) Will the Fed really be able to control interest rates just by raising the rate on reserves? And while also controlling the size of the balance sheet? Will interest rates thus controlled have the expected effect on the economy? The first paper spends a lot of time on the latter question.
It's not so obvious the Fed can control interest rates and the balance sheet. If the Fed said, tomorrow, interest rates shall be 5%, and started paying 5% on reserves, would Treasurys, mortgages, credit cards, bank deposits, etc. all really rise 5 percentage points instantly? If you pay your nanny $50 per hour, will all nannies suddenly get $50 per hour?
If the Fed said "5%, come and get it, give us your Treasurys and we will give you 5% reserves'' it would be clearer. But then the Fed would lose control of the balance sheet, and would likely expand -- a lot -- a reversal of the usual sign for a tightening.
Now, there is an arbitrage argument that the Fed can raise rates while keeping the balance sheet unchanged: Banks try to steal each others' depositors by offering more interest on deposits. Then Treasury holders try to hold bank deposits. I read the reverse repo program as a lack of faith that banks are anywhere near that competitive any more. In the reverse repo program, if a non-bank financial institution gets reserves, bank-held reserves and bank deposits have to go down dollar for dollar, a little noticed consequence and incentive to competitive behavior.
But then the question goes to another level. If Treasury rates rise 5%, and expected inflation doesn't jump 5% in neo-Fisherian delight, capital would flow in from abroad.
To see it more clearly, suppose the Treasury said "ok, the Fed wants rates to be 5%. So rather than auction debt, we'll set the price. 5%, how much do you want?'' The answer would be "a lot!'' But the end result is no different.
It's easy to set a price if you let quantities adjust. It's a lot harder if you also want to control the quantity.
My bet: The Fed will seem fine to be in control of loudly-telegraphed 0.25% bp rises, as open-mouth operations rather than actual open market operations seemed to provoke previous rate hikes. They will never try 5% overnight and we find out if they really control interest rates.
As Federal Reserve officials lay the groundwork for raising interest rates, they are doing a few things right. They need a little cheering, and a bit more courage of their convictions ...I like the large balance sheet and market interest on reserves. I just want them to be permanent, not additional tools for Fed discretionary policy.
I'll post the whole thing in 30 days.
The Oped builds on a new paper, Monetary Policy with Interest on Reserves, and on Toward a Run-Free Financial System. In the latter, I advance the idea that the Fed and Treasury should first offer interest-paying money, and then stamp out private substitutes, just as the US first offered banknotes and then stamped out run-prone substitutes in the 19th century. Interest on reserves, a big balance sheet, and opening reserves to all are a first step.
There are some big unknowns which I don't touch on in the oped. (That's what the cryptic last paragraph refers to.) Will the Fed really be able to control interest rates just by raising the rate on reserves? And while also controlling the size of the balance sheet? Will interest rates thus controlled have the expected effect on the economy? The first paper spends a lot of time on the latter question.
It's not so obvious the Fed can control interest rates and the balance sheet. If the Fed said, tomorrow, interest rates shall be 5%, and started paying 5% on reserves, would Treasurys, mortgages, credit cards, bank deposits, etc. all really rise 5 percentage points instantly? If you pay your nanny $50 per hour, will all nannies suddenly get $50 per hour?
If the Fed said "5%, come and get it, give us your Treasurys and we will give you 5% reserves'' it would be clearer. But then the Fed would lose control of the balance sheet, and would likely expand -- a lot -- a reversal of the usual sign for a tightening.
Now, there is an arbitrage argument that the Fed can raise rates while keeping the balance sheet unchanged: Banks try to steal each others' depositors by offering more interest on deposits. Then Treasury holders try to hold bank deposits. I read the reverse repo program as a lack of faith that banks are anywhere near that competitive any more. In the reverse repo program, if a non-bank financial institution gets reserves, bank-held reserves and bank deposits have to go down dollar for dollar, a little noticed consequence and incentive to competitive behavior.
But then the question goes to another level. If Treasury rates rise 5%, and expected inflation doesn't jump 5% in neo-Fisherian delight, capital would flow in from abroad.
To see it more clearly, suppose the Treasury said "ok, the Fed wants rates to be 5%. So rather than auction debt, we'll set the price. 5%, how much do you want?'' The answer would be "a lot!'' But the end result is no different.
It's easy to set a price if you let quantities adjust. It's a lot harder if you also want to control the quantity.
My bet: The Fed will seem fine to be in control of loudly-telegraphed 0.25% bp rises, as open-mouth operations rather than actual open market operations seemed to provoke previous rate hikes. They will never try 5% overnight and we find out if they really control interest rates.
Wednesday, August 20, 2014
Lazear on Labor
Ed Lazear has a very nice short column, Job Turnover Data Show Lots Of Churning, Little Job Creation on Investor's Business Daily.
Modern labor economists see employment and unemployment as a search and matching process with a lot of churn. The popular impression, echoed in most media discussion, is that there is a fixed number of jobs, and people just wait around for more jobs to be "created." That's what it may feel like to an individual, but that's not how the economy works. Lazear's column puts in one very short space some of the better ways to think about unemployment.
The central fact of labor markets is huge churn, not a fixed number of lifelong jobs:
Modern labor economists see employment and unemployment as a search and matching process with a lot of churn. The popular impression, echoed in most media discussion, is that there is a fixed number of jobs, and people just wait around for more jobs to be "created." That's what it may feel like to an individual, but that's not how the economy works. Lazear's column puts in one very short space some of the better ways to think about unemployment.
The central fact of labor markets is huge churn, not a fixed number of lifelong jobs:
During the typical month when jobs increase by about 100,000, 5.1 million workers are hired and five million separate from their jobs, resulting in a net change of +100,000 jobs.
During the worst month of the most recent recession (June 2009), when net jobs decreased by almost half a million, there were still 3.6 million hires.
The labor market is dynamic; even through sluggish periods, there is tremendous churn.Recessions are not what you think:
One might expect that hires would fall and separations would rise in recessions.
Not so. There are lots of hires in booms but also a large number of separations; and in recessions there are lower levels of both hiring and separations...
Workers quit to move to better jobs when the labor market is strong.
...as was typical in this and previous recessions, separations declined along with hiring. Because hires are so large and variable, net job creation depends in large part on what happens to hires.
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