The Fed: Money For Nothing

[Victor Galis]

I'm interested in knowing why people are so eager to try fiscal stimulus when novel monetary stimuli (in the US) AND STANDARD MONETARY STIMULI (everywhere else) are not yet exhausted.

Would you have us intentionally push inflation up so that we can have negative real interest rates or do you mean something else by "novel monetary stimuli."

If I had my way the Fed would have started buying up risky assets from day one when the TED spread (and other measures of risk premia) shot up through the roof. Besides the fact that the Fed would turn a nice chunk of change on such an operation it would also have prevented them from having to push a rope by lowering the short rate to 0 just as it was already crashing.

If we think that the Fed is too dumb and slow to respond to significantly ameliorate economic crises in novel ways then I don't see how we're going to claim with a straight face that national governments the world over are going to be able to. That's just laughable. Never mind the fact that there is little to no evidence to suggest that fiscal stimuli of any kind ACTUALLY DO ANYTHING.

So you'd have tried to pump air into a rapidly deflating bubble and lost a fair bit of money in the attempt. I'm not sure I like the way the stimulus bill turned out, but it's a heck of a lot better than just throwing away money.

Yes we could monetize the losses, but if we did that, we'd have no means to reverse that expansion when the economy picks up.

[KrazyHorse]

Would you have us intentionally push inflation up so that we can have negative real interest rates or do you mean something else by "novel monetary stimuli."

a) More inflation is better right now
b) Right now the Fed has pushed ONE interest rate to 0 (short term government debt yield). As a quick look at the yield curve and risk spreads will tell you there are a hell of a lot of other interest rates which are nowhere near 0. How about pushing them down?

[KrazyHorse]

So you'd have tried to pump air into a rapidly deflating bubble and lost a fair bit of money in the attempt. I'm not sure I like the way the stimulus bill turned out, but it's a heck of a lot better than just throwing away money.

a) The stimulus bill basically IS throwing away money
b) If you think that the current price of risk is sustainable then you're dumber than I thought (which is pretty impressive, actually)

Yes we could monetize the losses, but if we did that, we'd have no means to reverse that expansion when the economy picks up.

As long as the Fed announces ahead of time that the losses will be monetized (and doesn't spring it on people) the THREAT of monetization will cause inflation NOW, not LATER. Which is what you want in an environment which has undergone rapid asset price deflation and a flight to liquidity.

This trick won't work if you try it every time (it will increase baseline inflationary expectations) but I'm pretty sure most of the first world's central banks actually have a decent reputation for being responsible with inflation in normal times, and debt monetization this one time will not particularly affect expectations going forward. Not to mention the fact that the more the market BELIEVES the Fed's threat the less likely it is to actually have to carry it out.

[KrazyHorse]

Oh, and I like how you're presupposing that somehow a recovery takes place yet the Fed has still managed to take a loss on a broad spectrum of assets.

Do you mind explaining to me how that's going to work? Everybody else's assets increase in value but the Fed's drop, despite the fact that they're diversified?

[Kidlicious]

Whatever system we have, those who desire power will find it; I would they they had to compete with each other in looting the country, than cooperate with each other in looting the country.

At least it takes longer the first way.

You grab a jar of vaseline and I'll grab my gun.

[The Mad Monk]

You're not my type.

[Kidlicious]

You're not my type.

That's the nicest thing you've ever said to me.

[The Mad Monk]

That's the nicest thing anyone's ever said to you.

[chequita guevara]

Inflation would **** those of us on fixed incomes.

[Victor Galis]

Would you have us intentionally push inflation up so that we can have negative real interest rates or do you mean something else by "novel monetary stimuli."

a) More inflation is better right now

In the short-run almost certainly yes. The problem with inflation is what it would do to the value of the dollar. If that starts to fall too much, the Chinese might decide to stop lending so much and well... let's just see I don't see deficit reduction anywhere in the near future for the US. (See the warning China's premier gave the US last week.)

b) Right now the Fed has pushed ONE interest rate to 0 (short term government debt yield). As a quick look at the yield curve and risk spreads will tell you there are a hell of a lot of other interest rates which are nowhere near 0. How about pushing them down?

Not a bad idea.

a) The stimulus bill basically IS throwing away money

Creating jobs that produce nothing useful is much more useful than funneling the money back into the financial sector. At least in the first situation it will be spent again.

b) If you think that the current price of risk is sustainable then you're dumber than I thought (which is pretty impressive, actually)

There's a fair number of economists that aren't convinced these assets that the feds are talking of buying aren't worth much of anything. I'm not claiming the current price of risk is sustainable, I'm claiming that taking toxic assets of firms books by making up a price and buying them for that price (or subsidizing their purchase by a third party) is a terrible idea.

Oh, and I like how you're presupposing that somehow a recovery takes place yet the Fed has still managed to take a loss on a broad spectrum of assets.

Do you mind explaining to me how that's going to work? Everybody else's assets increase in value but the Fed's drop, despite the fact that they're diversified?

No it's simple. I expect the Fed to take huge losses on toxic assets, not on the other stuff. (This is assuming the Obama administration continues on the path of proposing the TARP version whatever number we're up to now.) Just because I expect economic activity to pick up at some unspecified date in the future doesn't mean I expect a return of bubble era asset prices at that point. In fact I don't.

[KrazyHorse]

Inflation would **** those of us on fixed incomes.

Whoever's on solely fixed income and didn't index is an idiot.

[KrazyHorse]

In the short-run almost certainly yes. The problem with inflation is what it would do to the value of the dollar. If that starts to fall too much, the Chinese might decide to stop lending so much and well... let's just see I don't see deficit reduction anywhere in the near future for the US. (See the warning China's premier gave the US last week.)

First off, you're now inserting all sorts of political suppositions with no real basis.

So, the Chinese are going to **** themselves in two ways according to you:

1) Selling their investments into a down (as far as exchange rates go) market
2) Choking off an export market they've developed their entire economy around

Not to mention the fact that the US government devalues the Chinese investment every time it issues new debt. Say, by spending 1.5 trillion dollars it doesn't have.

Not a bad idea.

So you've finally managed to figure out what I was describing to you?

Creating jobs that produce nothing useful is much more useful than funneling the money back into the financial sector. At least in the first situation it will be spent again.

This is the most lame-brained excuse for a Keynsian analysis yet. You obviously have no conception of how to parametrise the different unknowns in this model. Instead, you make a blanket statement which has no solid basis in theory OR IN DATA.

No it's simple. I expect the Fed to take huge losses on toxic assets, not on the other stuff.

So now the OVERPRICED ASSETS are the ones investors have gone into the PANIC MODE about?



It's funny that a panic which starts in (say) MBS and then spreads to other assets somehow magically fails to raise the risk premium (and illiquidity premium!) ON MBS above its long run value.



How the hell did you come to that brilliant conclusion? "I didn't know anything about MBS before it crashed, but according to what I can remember MBS has always been crashing therefore it always will crash"? From what I've seen of your thinking that would be about par for the course. That's the availability heuristic bias, by the way...

[chequita guevara]

Whoever's on solely fixed income and didn't index is an idiot.

You can't index unemployment.

[KrazyHorse]

AFAIK the federal gov't already is "indexing" it by extending benefits. This is a very good idea from a macro perspective, by the way; it hands cash to the most liquidity-constrained consumers while at the same time avoiding the inevitable deadweight loss that shows up when the government makes transfers in kind rather than in cash.

[KrazyHorse]

How long does unemployment run, Che? I thought it was only a couple of months. You wouldn't be talking about very much of a change in prices over that period, even in very high (for the first world) inflation.