Yellen's Balance Sheet Baloney

balance sheet, Fleming, FOMC, normalization, Yellen, Selgin
Federal Reserve Flickr image: https://www.flickr.com/photos/federalreserve/16044395162/in/photolist-oYZ8Z9-qrFmQD-qahzHm-nJGRD7-qrMHGN-e2pe8V-g5Z741-EV64YQ-HgjQkX-QdAvk4-C8qhAP-PZEMtU-qLuAJv-xNxwep-tRf4Pt-pvosAh-iqUt3N-e4YJ6C-e4T5Ma-eR7ShN-fZH55c-fZHesv-e2pdRZ-fZHww8-Jciujz-SMsWNr-MuuVUz-PdhyiY-PANUZB-PyaRoL-Pdhy5G-Pdhyys-PyaRkj-PyaRbS-PdhyeE-mdSD2N-NrbVKE-MrTbVF-oupUUZ-pawKeb

balance sheet, Fleming, FOMC, normalization, Yellen, SelginOf the many questions reporters asked Janet Yellen on Wednesday, at her press conference following the FOMC's decision to raise the Fed's policy rates, my favorite was the very first, posed by the Financial Times' U.S. Economics Editor, Sam Fleming.

Here is Mr. Fleming's question:

[You've stated that the Fed wants to delay*] balance sheet normalization until [interest rate*] normalization is well under way. Could you give us some sense about "what well under way" means, at least in your mind — what kind of hurdles are you setting, what kind of economic conditions would you like to see, is it a matter of the level of the short term federal funds rate as being the main issue? What kind of role do you see the role of the balance sheet playing in the mobilization process over longer term? Is it an active tool or passive tool? Thanks.

And here is Chair Yellen's response:

Let me start with the second question first. We have emphasized for quite some time that the committee wishes to use variations in the fed funds rate target or short term interest rate target as our key active tool of policy. We think it's much easier, in using that tool, to communicate the stance of policy. We have much more experience with it, and have a better idea of its impact on the economy. So, while the balance sheet asset purchases are a tool that we could conceivably resort to if we found ourselves in a serious downturn where we were again up against the zero bound, and faced with substantial weakness in the economy, it's not a tool that we would want to use as a routine tool of policy.

Mr. Fleming didn't ask a follow-up question, so naturally I had no way of knowing what he thought of Yellen's answer. I did, however, know just what I myself thought of it, which was, not much.

In fact, I thought so little of it that I wrote Mr. Fleming to say so. As many of you may also have heard the same exchange, I thought to share my remarks to him publicly, so here they are, minus a paragraph that repeated Yellen's statement:

Dear Mr. Fleming,

Of the questions posed to Janet Yellen at today’s press conference, I thought yours especially worth asking, and thank you for having asked it. However, I also thought Yellen’s answer unsatisfactory and misleading.

Before the crisis and LSAPs, the Fed didn’t use rate changes instead of balance sheet changes for monetary control. It relied on balance sheet changes, a.k.a. open-market operations, to achieve whatever fed funds rate target it set. In other words, it had decades, dating back to the 1930s, of experience using balance sheet asset purchases (or sales) as, not only “a” policy tool, but as its principal policy tool! Rate change announcements, on the other hand, though they did indeed serve to “communicate the [Fed’s planned] stance” to the public, were incapable by themselves of implementing that stance.

In suggesting that balance sheet changes are an option the Fed might “conceivably resort to…were we again up against the zero bound,”  Yellen seems to equate balance sheet changes in general with “quantitative easing,” where the last refers to the special case, never resorted to until 2008, in which the Fed no longer treats asset purchases as a means to achieve some (positive) fed funds rate target. That confusion, if I’m correct in seeing it as such, represents a pretty elementary error on Yellen’s part. Once again, balance sheet changes were the normal means for the Fed to implement policy before 2008, though they were changes aimed at hitting an announced single-value (and market determined) effective fed funds rate.

Today, with IOER and ON-RRP between them defining the Fed’s ffr target “range" — a “target” it can’t possibly miss — the Fed’s administered rate hike changes ARE the policy changes, since no balance sheet adjustments are required to make them happen. But this approach has only been in effect since the crisis, and has only been employed 3 times so far. So for Yellen to pretend that it’s one that the Fed has “more experience with” is really rather disingenuous.

Once again, thank you for asking the question.

Sincerely,

etc.

The public needs to see the Fed's arguments for maintaining its present, boated balance sheet for what they are: mere excuses. It also needs to see the delay for what IT really is:  mere stalling while the Fed and its apologists rally support, in Congress and beyond, for a permanently enlarged Fed footprint on the U.S. credit system.

(For more on the balance sheet question, see here, here, and here.)

_________________________

*The words in brackets were partly inaudible, so I reproduce them according to my own understanding. Yellen's statement itself leaves little room for doubt concerning what Mr. Fleming meant to ask.

  • I'm all for " permanently enlarging the Fed footprint on the U.S. credit system" if by that is meant a larger % and preferably 100% of the nation's money is issued by the Fed. Why should private banks be allowed to print money? Why not have restaurants and garages print money? Why can't I print money?

    The right to create or print money is an obvious subsidy for the printer involved. There is no reason to subsidize money lenders (aka banks).

    Far as I can see from the two St Louis Fed charts below, the % of money in the US which is Fed created has risen from around 10% prior to the crisis to around 30% now, but the exact percentages involved are no doubt debatable.

    https://fred.stlouisfed.org/series/BASE

    https://fred.stlouisfed.org/series/M2

    • Mattyoung

      "Why not have restaurants and garages print money?"

      That is the plan, actually. Restaurants and garages issue money all the time in the form of discount coupons which can easily be saved and borrowed. Movie theaters do it. What these private issuers are missing is S&L technology, easy to provide and the plan is to give it to them, a complete Savings and Loan software package, ready to go. There is no subsidy from government.

      • Can those “discount coupons” really be classified as money? The standard text book or dictionary of economics definition of money is something like “anything widely accepted in payment for goods and services”. Those coupons can only be used at a limited number of establishments (sometimes only at the establishment that issued them), so I don’t think they can be classified as money.

        In contrast, the liabilities of (i.e. deposits at) banks, certainly large banks, are accepted anywhere.

        • Mattyoung

          Right you are.
          But discount coupons are traded against other currencies and issuance is controlled by the S&L technology. The software cannot distinguish between major currencies and minor currencies.

          And pricing has to be be multi-currency, required for discount coupons. The new credit cards handle all of this, they can price currency risk as the issuance function and its current state are equally observable and priced.

          • Ray Lopez

            I think Mattyoung has a good argument here. And with most people paying off their purchases with the swipe of their iPhone or credit card these days (myself included), you could say money is constantly being created electronically by Visa and MasterCard.

          • Mattyoung

            The auto trading is slightly different.

            When you swipe, you signal your S&L bot right inside the bank.Your bot already knows the probability distribution of your spending, and it knows the current loan/deposit quantities in the S&L buffers. You bot will swap your deposit and loan balances to make sure your demand and the economic supply are reasonably matched the next time you go shopping. The standard S&Ls are not owned, profits zero and the currency at risk is published and guaranteed to be within some volatility bound.

            The problem the new cash model solve is the three way trade problem we get with bank profits. If I am to estimate my future currency risk, I need to track the bank profits, a nearly impossible task. So, the new technology just eliminates bank profits altogether since the optimum balance between deposits and loans is computable, to the published precision, and cannot be know to any better degree.

            However, to do this, time has to be dumped. Nothing is computable when banks bet time because time to completion can be altered at will by aggregates of time plotters, like boomers timing their pension plans, or politicians planning to stick the debt bills onto the next election. Much of central banking is about guaranteeing time sequences, but payments over time foul up price discovery.

          • I'm not an expert on how these discount coupons work, but I take it it's something like if I spend more than $100 at Walmart, I get a promise from Walmart that I get $5 off my next purchase. But that $5 promise can't actually be used to purchase anything other than at Walmart, I assume. It can, as you seem to suggest, be sold for cash. But then a house or car can be sold for cash. Houses and cars are not money. Does that make sense????

        • George Selgin

          For goodness sake, Ralph: that you would be allowed to create money doesn't mean that you could succeed! You would not be granted a monopoly, like the central banks you so cherish.You would have to make your money more attractive than that of many other potential supplies having the same freedom, including long-established financial institutions.

          Imagine my making, before a roomful of geeks,a case for a government monopoly of computers on the grounds that otherwise every Tom, Dick, or Harry will be out there producing shoddy computers and fobbing them off on innocent consumers. I would be laughed out of the room!

          The geeks can afford to laugh because my monopoly proposal isn't the law of the land. Alas, I can't laugh at your proposal, and neither can anyone else, because it more-or-less is.

          • Ray Lopez

            Nice analogy about PCs and geeks, but with professional licensing the government makes this argument all the time for hair dressers, doctors, lawyers, and all kinds of other professionals. And for government made PC's for other reasons, like industrial infant industry arguments, Brazil did just that (made it illegal to import computers). So to answer your question: why aren't you laughed out of the room today vis-à-vis private money? I think because the arguments being made are not compelling enough for society to take you, George Selgin, seriously enough. As a start, I think the monetarist baggage of sticky prices and money illusion is more of a burden than a benefit (such arguments need to be avoided when making policy prescriptions, since the public can correctly ask if money is not neutral, why shouldn't the government be in charge of such an important lever in the economy?), but that's a topic for another day.

          • George, Nice analogy with computers, but I don’t think it holds and for the following reasons.

            Money can be issued by the state at essentially zero cost, as Milton Friedman pointed out. In contrast, there are very real costs involved in private banks doing that job: they have to check up on the creditworthiness of customers wanting a stock of money, allow for bad debts and so on. And that of course raises an obvious question, namely how do private banks muscle in on the money creation business?

            You alluded to the answer to that question in your Capitalism Magazine article “Is Fractional-Reserve Banking Inflationary?”. That is, given a plentiful supply of base money, commercial banks can print money and lend it out at below the going rate of interest because it costs them nothing to come by that money. They have to check up on the credit worthiness of borrowers of course, but actually coming by the money costs them nothing, unlike other lenders who have to either earn money they lend or borrow it at the going rate of interest.

            That additional lending is inflationary (as your article points out), thus commercial banks effectively rob anyone who has a stock of money. In short, private money creation involves an externality.

            That argument of mine raises another obvious question: why aren’t commercial banks lending like crazy at the moment given the excess amount of base money? My answer is that interest rates are currently so low that they can’t “undercut”. I.e. the rate of interest is currently zero near enough, thus so called interest currently charged by banks is made up almost entirely of the costs of checking up on creditworthiness, bad debts, etc. I.e. it’s not actually interest at all.

            That argument of mine needs fleshing out quite a bit, but hopefully some readers will get the idea.

          • Ray Lopez

            Nice! Now reconsider your answer, R.M., with the presumption of no deposit insurance. Does it still hold?

          • Yes I think it does, unless I've missed something. Reason is that even with deposit insurance, private money creation is still inherently more expensive that public money creation as I pointed out earlier. In fact the cost of the insurance reflects that. I.e. there is no need for insurance in the case of public money creation.

          • Ray Lopez

            @R.M. – I think you missed something. Consider this: you have a choice of putting your hard earned wealth in the form of paper fiat called "George Selgin's fiat money", with a picture of George on the bill, backed by gold, or, in the US dollar, with a picture of George Washington, but with no FDIC insurance, just a promise to pay. Which is more secure, long term? I would say it's the other George, think about it? 🙂

          • George Selgin

            "Money can be issued by the state at essentially zero cost, as Milton Friedman pointed out." Friedman repudiated that view. See his "The Resource Costs of Irredeemable Paper Money": https://www.jstor.org/stable/1833052?seq=1#page_scan_tab_contents

          • I didn't know about that Friedman paper. It's typical Friedman, i.e. clear and readable. But I'm not sure that it is relevant to the present discussion. My reasons are thus.

            Friedman deals with the question as to whether a country's basic unit of money should be commodity based (e.g. gold) or fiat. As he rightly says, the fiat option is not cost free, and he cites as one example the inflation that has occurred since the gold standard was abandonned. However, what private banks do is to lever up the country's basic form of money which is a different question. So for example if a country is on the gold standard, that will keep control of inflation, but that merit automatically extends to "levered up" money, i.e. privately issued money.

            So I'm provisionally sticking to my point that private money involves a cost that public money doesn't: that's the cost incurred by private banks in the form of checking up on the credit-worthiness of those it supplies money to and allowing for bad debts, etc.

    • In my world you would be able to print your own money Ralph. In fact, you can. Public companies issue securities and while the federal government prohibits competing currency systems that prevent wide scale use of financial assets as forms of daily transactional money, these securities are used to buy other companies just as if they were using "cash". Now, whether people would prefer your money over other options is a totally different question.

      • Milton, I realize all sorts of strange bits of paper are used in the world's financial centers in lieu of cash (e.g. the securities you refer to), but for the vast bulk of transactions, e.g. buying a house or car or settling trade debts between small and medium size firms, only good old fashioned dollars will do. So I'd classify the use of securities in lieu of cash as barter. But I accept this is a grey area: there is no sharp distinction between money and non-money.

    • George Selgin

      "Why should private banks be allowed to print money? Why not have restaurants and garages print money? Why can't I print money?"

      Banks? because they have done an excellent job in the past, when allowed to do so without the corrupting interference of governments (see, among other things, my previous post); restaurants and others, even yourself? Why not let them try? So long as consumers can laugh at their poor efforts and take their business elsewhere, what harm?

      You in contrast favor, not just the present gov't monopolies of paper currency, but their further expansion, though the users of their products have no choice but to bear the consequences of their misconduct, having nowhere to escape. In short, you prefer monopoly to competition. I am happy to let my other readers decide who ought to bear the greater burden of proving his system the more benevolent.

      "The right to create or print money is an obvious subsidy for the printer
      involved. There is no reason to subsidize money lenders (aka banks)." I lose patience with you, Ralph, when you say such things. Every first year econ student knows that merely allowing a firm to engage in a business isn't the same as granting it a "subsidy."

      • “Why not let them try?” My answer is thusly.

        Money is a liability of banks, and banks always promise that that money is totally safe. That is a blatantly fraudulent promise because the money is loaned on to borrowers who are quite clearly less than totally competent. In fact regular as clockwork throughout history banks have failed: the 2007/8 crisis being just the most recent example. Or as Adam Levitin put it in the first sentence of the abstract of his paper “Safe Banking”: “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and relending of deposits.”

        If banks were allowed to create money and had to make it abundantly clear in their publicity that that money IS NOT totally safe, then that would be OK by me. In fact the latter is pretty much what money market mutual funds have recently been forced to do: that is MMMFs which invest in anything more risky than government debt have to let the value of their liabilities or “money” float. Quite right too. That “money” then effectively becomes equity, not a deposit or "money".

        • George Selgin

          "banks always promise that that money is totally safe. That is a blatantly fraudulent promise"

          That is not true. You confuse banks with the FDIC. You show me an old bank contract that declares that notes bear zero risk and I'll eat my hat.

          Banks hold capital and sometimes make other arrangements (note safety funds; extended liability; notes a first lien) to assure their note holders that the likelihood of losses is slight. But they never declare notes absolutely safe–again, only the insurance arrangements make such a declaration.

          Really, the proliferation of false statements — not just inaccurate ones but patently false ones — among the comments on this site is getting to the point where I'm sorely inclined to shut them down. Apart from that,if your positions are such that you can't defend them without making things up, perhaps you should consider changing them!

    • Hannibal Smith

      Come on, the Fed doesn't even have any legal authority to issue money — for good reason. And we're talking about an anarchronistic Politburo here… you really want a handful or two of inclusive Ivory Tower old farts deciding what is and what isn't the appropriate level of the money supply for hundreds of millions of people when that arrogant model has failed to generate better outcomes everywhere it's been tried? It sure worked great in the ex-USSR or during the 70's under "Monetarism"! No, I'll keep money supply creation in the hands of the relatively efficient private sector with the Fed/FDIC as backup for illiquidity or insolvency — exactly as it is today. Of course private money issuance has costs… everything in life has costs, but government or a public option doesn't have a profit seeking motive to keep expenses and wasteful spending in check (among many other unique limitations) so it won't be cheaper. You need a perfect fantasy world that does not exist, especially one where the private sector doesn't decide what is to be collectively used as money. We never would have cryptocurrencies, for one thing.

      • " the Fed doesn't even have any legal authority to issue money". Really? As I remember, the Fed printed hundreds of billions so as to implement QE.

        • Hannibal Smith

          Yes, really, the Treasury has the legal authority (i.e. it emits bills of credit and coins money). But what I meant was the Fed is not in the business of providing money directly to the private sector for its own use. Whatever money people falsely think the Fed "prints up" is just internal accounting entries and is only used exclusively within the FRS, i.e. a "credit" of bank reserves as a swap for Treasuries.) It might as well be Monopoly money as its of no use to anyone. Typically, when we all talk about "money" we mean fiat currency, coins, cryptocurrencies or the lesser degrees of "moneyness" with various Treasuries that consumers operating in the real economy use, own and have control over.

  • Mattyoung

    We never got an explanation from Bernanke either. Frankly, this was bailing out Congress. I think central bank backing means exactly that, bail out Congress as necessary.

  • Ray Lopez

    I will ask the "elephant in the room" aka "Emperor has invisible clothes" question: what's wrong with the Fed keeping the bloated reserves on their balance sheet forever? Essentially it means the public taxpayers will have spent $3T to buy junk paper (or some of it being junk), but then again the Afghanistan / Iraq wars were about that amount collectively. Further, to the extend the Fed reserve bonds are not junk and they are paid off (in 30 years or whenever) the money can be used to pay down the massive cumulative Federal budget deficit?

    • George Selgin

      And mine: https://www.alt-m.org/2017/02/23/shrinking-the-feds-balance-sheet/

      Basically, it boils down to whether you think the Fed employs savings more productively that commercial banks do.

      • Ray Lopez

        I like this answer, it's very clever, thank you. And thanks to Milton Churchill's reply (I had read Larry White's post before I posted). The way I see it: at worse, the $3T or so extra on the Fed balance sheet either will become a taxpayer loss at some point (if interest rates rise), or if rates remain low will continue to be profitable or perhaps break even. If commercial banks clamor for more money, due to the Trump rally, the money can be 'relent' to them for more productive lending than simply holding the Fed assets until they mature. All in all then, "much ado about nothing", insofar as $3T USD is nothing.

      • Spencer Hall

        Selgin:

        Neither Central banks nor commercial banks ever "employ" savings. DFIs always, from the standpoint of the entire economy, create new money whenever they lend/invest. They do not loan out existing deposits, saved or otherwise. All bank held savings are lost to both consumption and investment. This is the sole source of stagflation and secular strangulation ("arrested development").

        • George Selgin

          This is nonsense, Spencer. It amounts to saying that there is no such things as "financial intermediation," for what you claim never happens is precisely what that expression refers to.

          It is, of course, occasionally though rarely the case that when someone contradicts what the mass of other experts has long maintained, the iconoclastic view is in fact correct. I get that; I have been there myself. Nevertheless, the odds are generally that the generally accepted view has some merit. In any event, it takes more than a mere assertion, however bold, to refute it.

    • Hannibal Smith

      Yield chasing behavior. Unintended consequence from the idiots in Ivory Towers. I say we abolish the Board and replace them with robots.

  • Spencer Hall

    There was a dramatic contraction in "credit" velocity (the impoundment of savings within the CB system, or more specifically, "savings" velocity, the transfer of title of non-bank assets within the commercial banking system), following the rate hike on 12/15/16 (which swallowed up R-gDp). Same for the hike on 12/17/15 (which swallowed up N-gDp). There should be another dramatic contraction in DD Vt following Yellen's latest rate hike (again swallowing up R-gDp).

    The bond market has already foreseen this.

    These #'s have become extremely volatile due in large part the volatility of the Treasury's General Fund Account.

    parse; dt; real-output; inflation

    01/1/2017 ,,,,, 0.13 ,,,,, 0.19
    02/1/2017 ,,,,, 0.08 ,,,,, 0.16
    03/1/2017 ,,,,, 0.09 ,,,,, 0.16
    04/1/2017 ,,,,, 0.06 ,,,,, 0.16 economy bottoms
    05/1/2017 ,,,,, 0.06 ,,,,, 0.19 inflation temporarily peaks
    06/1/2017 ,,,,, 0.04 ,,,,, 0.16
    07/1/2017 ,,,,, 0.05 ,,,,, 0.13
    08/1/2017 ,,,,, 0.03 ,,,,, 0.17
    09/1/2017 ,,,,, 0.03 ,,,,, 0.18
    10/1/2017 ,,,, -0.01 ,,,,, 0.18

    The H.6 release / money stock has slowed. Percent change at seasonally adjusted annual
    rates M1…. M2

    03 Months from Nov. 2016 TO Feb. 2017…. 3.7…. 5.0
    06 Months from Aug. 2016 TO Feb. 2017…. 3.3…. 5.5
    12 Months from Feb. 2016 TO Feb. 2017…. 8.2…. 6.4

  • Hannibal Smith

    I think you're nitpicking. I took it to mean Yellen was referring to the Fed engaging in illegal fiscal policy when she was talking about QE. That was only QE1 from what I recall. That legal loophole has since been rectified by Congress, so I don't know that the Fed can ever do again what they did with the mortgage bonds. But hey, in a "crisis", the "law" is only scribbles on paper…

    • George Selgin

      Fleming's question had nothing to do with QE. I also have no idea what "legal loophole" you have in mind. For better or worse, the Fed didn't need Congress's permission to buy all those Treasury securities and MBS,

      • Hannibal Smith

        You're missing the point; it's not about Fleming. Yellen said this: "So, while the balance sheet asset purchases are a tool that we could conceivably resort to if we found ourselves in a serious downturn where we were again up against the zero bound, and faced with substantial weakness in the economy, it's not a tool that we would want to use as a routine tool of policy."

        Check The Federal Reserve Act before 2009. You won't find mortgage bonds listed. There's a reason the Fed held them all in the Maiden Lane trust, etc.. Nonetheless, the Fed is no longer allowed to monetize that as Congress passed legislation prohibiting it. Because that was clearly engaging in illegal fiscal policy and that is not within the Fed's powers, either now or then.

        So that is my interpretation of what you think is a "discrepancy" because we all know the Fed engages in open market operations to set the FFR, so its hardly "not a tool that we would want to use as a routine tool of policy." I'm pretty confident Yellen knows exactly what she was talking about.

        • George Selgin

          No Sir. It is you who are missing the point of my post, which is precisely that Yellen's answer was not an appropriate answer to Fleming's question. By changing the topic to QE, she effectively dodged that question, which was about the conditions under which the Fed would renew using adjustments, and particularly reductions, to its balance sheet (that is, OMOs, not QE per se) as ordinary means of monetary control. In short, Yellen spun the question–and spun you with it!

          And none of this has anything to do with what Yellen really does or doesn't know. Appearing to be obtuse is the very essence of spin!