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The Future of the Fed April 27, 2011

The Future of the Fed April 27, 2011. Joseph Gagnon April 27,2011. Zero Is Not A Bound on Monetary Policy. Monetary Policy Tilts the Balance Between Savers and Spenders. Usually it operates on the short-term interest rate.

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The Future of the Fed April 27, 2011

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  1. The Future of the Fed April 27, 2011

  2. Joseph Gagnon April 27,2011 Zero Is Not A Boundon Monetary Policy

  3. Monetary Policy Tilts the Balance Between Savers and Spenders • Usually it operates on the short-term interest rate. • But monetary policy can operate on long-term interest rates, i.e., bond prices. • Monetary policy can operate directly on other asset prices, such as equities, real estate, and foreign exchange.

  4. There is no limit to the amount of private spending that can be created by monetary policy under any circumstances. • Abusing this power deteriorates the balance between output/employment and inflation. • Not an immediate concern in United States. • But current situation will not last forever.

  5. Central banks prefer to operate on short-term interest rates to minimize the variability of their income.

  6. Aggressive Fed actions in 2008-2009 prevented a second Great Depression. • Financial shock was larger than 1929. • But, “a lot” is not the same as “enough.”

  7. In December 2009 I called for $2 trillion QE2. • In November 2010 Fed announced $0.6 trillion QE2. • Fed faced opposition to QE2 from many politicians and financial market pundits. • Fed had little support for QE2. • Fed is uncertain about QE2 effects. • This timidity has cost America at least 1 million jobs.

  8. For rest of 2011, Fed should do another $0.6 trillion in QE2. • But, the window for QE2 is closing. • Economy is recovering, albeit at a slower pace than it could have. • The scope for monetary stimulus depends not on today’s unemployment rate, but the rate expected in 1 to 2 years.

  9. Joerg Bibow, Skidmore College and Levy Economics Institute “The Future of the Fed”, Roosevelt Institute NYC, April 27, 2011 Domestic Mandate, Global Reach-The Fed Conundrum

  10. The Fed as a Domestic Policymaker • Fed met its LOLR challenge • Fed’s pre-crisis blunders concerned regulation & supervision, not monetary policy. Fed has to live up to its R&S duties. • Dodd-Frank limits on Fed 13(3) emergency lending authority shift burden to act (quickly) to Treasury/Congress • Fed continues to take its “dual mandate” seriously • Mandate should not be re-focused on price stability only • ECB is the warning example • Does not mean Fed MP conduct cannot be improved. Scrutiny is warranted. CBI needs to be balanced. • Highly accommodative Fed policy is here to stay • Even as QE2 may end in June • Absorbing “excess liquidity”, when needed, technically no problem • Given labor market slack & wage inflation at 2%, no inflation risk The Federal Reserve Now J Bibow

  11. The Challenge at Home output gap • Scenario A: the “not so great ‘00s” • Scenario B: “eurosclerosis” • Scenario C: better than “roaring ‘90s” • Not even “maximum employment” by 2014 under Scenario C • Employment-to-population ratio sharply down! The Federal Reserve Now J Bibow

  12. The Fed as a Global Policymaker • Fed has domestic mandate, but sets global monetary policy benchmark. • World economy is not an optimum currency area though. • Financial globalization has created a policy-domain problem. • As part of wider conflict between democracy and globalization. • Floating exchange rates are not the solution. • Argument to let “market forces” determine exchange rates unconvincing from EM perspective when foreign policy decisions are key driving force (“currency wars”). • For EM it’s reserve accumulation vs. capital controls. • It’s about reclaiming lost policy space. • EM reject new constraints through IMF rules on capital controls. • It seems G-20 can’t agree on anything anymore. The Federal Reserve Now J Bibow

  13. Reconciliation Mission Impossible? • Dollar’s status still very convenient to some. • Wall Street, large corporates; “exorbitant privilege” • But extra drag on U.S. labor market & wages. • Magnifying “globalization-competitiveness-inequality nexus” • Political problem (“democratization of credit” band-aid failed) • “The dollar is our currency, but your problem” (Connally). • Or today perhaps? “It may be your reserve currency, but it’s also a bit of an inconvenience to us right now.” • Also, the oil factor • Mix of: key reserve currency status, financial globalization, rudimentary U.S. welfare system, and U.S. aversion against fiscal policy is putting excessive burden on Federal Reserve. • Likely to provoke bubbles and global tensions. The Federal Reserve Now J Bibow

  14. Perry Mehrling Roosevelt Institute, NYC April 27, 2011 The Fed Throughout History:Origins and Recent Crisis

  15. Political Economy of the Fed, 1913 • Memories of 1907 (JP Morgan) • And 1910 (Jekyll Island) • Memories of 1862 (Greenbacks) • Real Bills Doctrine, a political frame • British version, Trade bills • versus finance bills (Wall Street) • versus Treasury bills (Washington) • American adaptation • versus central banking (regional structure) • pro manufacturing and farming bills

  16. The Fed and the Real World:“Silos and Silences” • Government Finance(WWI, WWII) • From Ben Strong to McChesney Martin (1952) • Capital Finance? • From National Banking to Shadow Banking • International Role of the Dollar? • From Gold to the Eurodollar System From Bank Credit to Capital Market Credit

  17. The Language of Money, 1952-2007

  18. From LOLR to Dealer of Last Resort, and International LOLR

  19. The New Fed and the Real World:Breaking the Silence • Government Finance • QE2 as Government BankWar Finance • Capital Finance • Shadow Banking and Dealer of Last Resort • International Role of the Dollar • Eurodollar System and InternationalLOLR

  20. Brave New World • Technical Challenges: from banks to markets • Liquidity, funding and market • Solvency, institutions and instruments • Stabilization Policy, prices and quantities • Political Economy Challenges • The Fed and Government (fiscal dominance) • The Fed and Wall Street (TBTF, dealers’ club) • The Fed and Globalization (China, Euro)

  21. Thomas Palley New America Foundation Mail@thomaspalley.com A Federal Reserve for the 21st Century:Reforming the Fed’s Governance, Economic Philosophy and Conduct of Policy

  22. Figure 1. A program to reform the Fed. Federal Reserve Reform Monetary Policy Governance Economic Philosophy Regulatory Reform

  23. Figure 2. Monetary policy reform Monetary Policy Inflation Targeting Balance Sheet Regulation New Interest Rate Targets Relation to the Rest of Macro Policy

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