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February 4, 2013

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 13 Jan 2013 12:06 AM PST
Posted: 12 Jan 2013 02:16 PM PST
Tim Duy:
On The Disruptiveness of the Platinum Coin, by Tim Duy: Apparently fiscal and monetary cooperation is alive and well - the US Treasury and the Federal Reserve conspired to kill the platnium coin idea. In retrospect, we should have seen this coming. As the debate continued, it became increasingly evident that the platinum coin threatened the conventional wisdom in very deep and profound ways. It was a threat that could not be endured by Washington.
This realization hit me this morning, working on my last piece. Begin with the effectiveness of monetary policy at the zero bound. Or, more accurately, the lack of effectiveness as the Federal Reserve is swapping one zero-interest asset for another. Rarely do we take this to its logical conclusion for fiscal policy: If there is no difference between cash and Treasury bonds, why should we issue bonds at all? Why not simply issue cash? In other words, at the zero bound, what is the argument against monetizing deficit spending?
Indeed, the lack of any difference explains how Japan can sustain massive fiscal deficits year after year. At the zero bound, cash and government debt are the same thing. We would assume that as long as inflation was not a concern (which it wouldn't be at the zero bound), the fiscal authority could issue as much cash as it wants, so why couldn't it issue as many bonds as it wants? After all, at the zero bound the two are equivalent. Hence Japan continues to defy predictions of doom despite ongoing debt issuance.
Carrying the argument further, the illusion of a difference between cash and debt at the zero bound is counterproductive because it prevents the full application of fiscal policy. Fears about the magnitude of the government debt prevent sufficient fiscal policy, but such fears are not rational if debt and cash are perfect substitutes. If cash and debt are the same, the fiscal authority should prefer to issue cash if debt concerns create a false barrier to fiscal policy. Still, I would argue that this is best done in cooperation with the monetary authority. Note that this is not really a new idea, as then Governor Ben Bernanke drew a similar conclusion with regards to Japan:
However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.
And then we come to the platinum coin, which threatened to expose the illusion that cash and debt are different at the zero bound. By extension, the platinum coin threatened to expose as folly any near-term deficit reduction plan. If you could issue a coin to support near term spending without inflationary consequences, what exactly is the rational for tighter policy now? There is none - but that would run directly contrary to the conventional wisdom among Very Serious People on both sides of the aisle that the debt needs to be addressed right now.
And just think about what it would mean for the Fed if it became evident that, even if only temporarily at the zero bound, deficit spending could be monetized with no impact on inflation. The lines between monetary and fiscal policy would blur further, threatening the existing state of affairs in Washington. Monetary policymakers would face an increasingly hard time defending their need for independence as akin to an Eleventh Commandment.
Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:
I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet.
Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.
Bottom Line: The platinum coin idea was ultimately doomed to failure because neither the Federal Reserve nor the Treasury could allow for even the remote possibility it might be successful. Its success would not just alter the political dynamic by removing the the debt ceiling as a threat. The success of a platinum coin would fundamentally alter the conventional wisdom about the proper separation of fiscal and monetary policy and the need to control the debt immediately.
Posted: 12 Jan 2013 01:48 PM PST
Ezra Klein:
Treasury: We won't mint a platinum coin to sidestep the debt ceiling: The Treasury Department will not mint a trillion-dollar platinum coin to get around the debt ceiling. If they did, the Federal Reserve would not accept it.
That's the bottom line of the statement that Anthony Coley, a spokesman for the Treasury Department, gave me today. "Neither the Treasury Department nor the Federal Reserve believes that the law can or should be used to facilitate the production of platinum coins for the purpose of avoiding an increase in the debt limit," he said. ...
Republicans are now free to take the economy hostage if they so desire. The question is whether Obama can make them pay for it politically if they decide to invoke this threat.
But maybe they've kept a card up their sleeve? Paul Krugman:
So What Will You Do, Mr. President?: If I'd spent the past five years living in a monastery or something, I would take the Treasury Department's declaration that the coin option is out as a sign that there's some other plan ready to go. Maybe 14th Amendment, maybe moral obligation coupons or some other form of scrip, something.
And maybe there is a plan.
But as we all know, the last debt ceiling confrontation crept up on the White House because Obama refused to believe that Republicans would actually threaten to provoke default. Is the WH being realistic this time, or does it still rely on the sanity of crazies? ...[D]efault ... would risk a huge collapse of confidence.
So is there a plan, or will it just be another case of tough talk followed by a tail-between-the-legs retreat?
As I said, if we didn't have some history here I might be confident that the administration knows what it's doing. But we do have that history, and you have to fear the worst.
Yep -- hard to be confident that "there's some other plan ready to go," and it's also hard to be confident that Obama can win the battle politically -- make the political cost so high that Republicans back off on any threats. So here we are again.
Posted: 12 Jan 2013 11:19 AM PST
Tim Duy:
Safe Assets and the Coordination of Fiscal and Monetary Policy, by Tim Duy: Kansas City Federal Reserve Bank President Esther George considers the long-run consequences of Federal Reserve policy:
But, while I agree with keeping rates low to support the economic recovery, I also know that keeping interest rates near zero has its own set of consequences. Specifically, a prolonged period of zero interest rates may substantially increase the risks of future financial imbalances and hamper attainment of the FOMC's 2 percent inflation goal in the future.
A long period of unusually low interest rates is changing investors' behavior and is reshaping the products and the asset mix of financial institutions. Investors of all profiles are driven to reach for yield, which can create financial distortions if risk is masked or imperfectly measured, and can encourage risks to concentrate in unexpected corners of the economy and financial system...The push toward increased risk-taking is the intention of such policy, but the longer-term consequences are not well understood.
We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances. Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels. A sharp correction in asset prices could be destabilizing and cause employment to swing away from its full-employment level and inflation to decline to uncomfortably low levels. Simply stated, financial stability is an essential component in achieving our longer-run goals for employment and stable growth in the economy and warrants our most serious attention.
Brad DeLong wonders:
The Fed's current Quantitative Easing ∞ program involves its buying risky bonds--thus diminishing the pool of risky assets that the private sector can hold. Esther George objects because… it does not make complete sense to me...Because there is less in the way of risky assets for the private sector to hold--and because that pushes prices of risky assets up and returns on risky assets down--QE ∞ actually makes private-sector portfolios riskier? Is that the argument?
I think DeLong is looking at a continuum of assets from safe to risky, where cash anchors the safe end of the continuum. Right next to cash is the somewhat riskier Treasury security. Thus by exchanging cash for Treasury securities, you by definition must be removing risk from the continuum, and thus the public's portfolio is now less riskier.
But, as he notes, this is obviously not how George views the situation. And, note that George claims that the intention of Fed policy is in fact to push people into riskier portfolios, which implies that the Fed believes that they are in fact making the public's portfolio more, not less, risky. This implies that DeLong's view is not just in opposition to George's, but to that of the majority of policymakers as well.
I think a way you can explain George's position if you consider Treasuries as less risky than cash. At first, this sounds crazy, but if you assume there is no default risk (which I don't think there should be if you can print currency of the same denomination as the bond), then the Treasury bond may be perceived as a safer because it provides some return. Assuming no default risk, for any given inflation rate, the Treasury bond will thus be a safer store of value. If you viewed the world from this perspective, then the Fed is increasing riskiness of the public's portfolio.
This, however, is not how I think the Fed considers the situation. I think the Fed tends to view the public's desired cash holdings as roughly constant (although the rise in deposits would call this into question). If by QE the Fed swaps out some of the safe Treasury securities for cash, the public, not wanting to hold anymore cash, takes the cash and, by default, purchases riskier assets, and thus is left with holding a portfolio of riskier assets. George believes this disrupts the natural order of things by creating financial market distortions.
In any event, I tend to take this in a different direction from here. George appears to be saying that the Fed is eliminating (more accurately, removing) the safe assets that the public wants to hold. Suppose that this is true. Does this mean that the Fed should reverse policy to increase the proportion of safe assets in the public's hands? Or does it mean that another agency - perhaps a fiscal authority, hint, hint - should take action to increase the proportion of safe assets in the public's hands?
Once again, we come back to the issue of coordinating monetary and fiscal policy. If the public has a strong demand for noncash safe assets, monetary policy has something of a secondary role by providing an accommodative environment by which the fiscal authority can issue those assets. If the proportion of safe to risky assets is not "correct", the the fiscal authority should have a role in correcting that imbalance. In this world, then, it is not really the actions of the monetary authority that is creating the financial sector imbalances that concern George. It is the lack of action by the fiscal authority that creates those imbalances. George should be criticizing the fiscal authorities, not the monetary authority.
In other words, if a recession is the result of the public shifting to safe assets, the Fed is trying to respond by taking away the option of safe assets, leaving only risky assets. Instead, the Fed should view their role creating an environment (making clear that default is not an option) that allows the fiscal authority to issue more safe assets.
All of this, however, suggests that fiscal policy has a much greater role in stabilizing economy activity than conventional wisdom would hold. I suspect, however, that thinking along these lines is anathema to Federal Reserve officials who maintain that stabilization policy is the domain of monetary policy only. But if in fact there needs to be greater cooperation, and instead we continue to rely solely on monetary policy, then we will continue to experience less-than-satisfactory economic outcomes which will eventually endanger the cherished independence of central banks.
In short, I don't think you can have a discussion about the influence of monetary policy on the riskiness of the public's portfolio without including some discussion about the role of the issuer of those safe assets, the fiscal authority.

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