Several weeks back, we spoke a bit about the extent to which Mario Draghi’s “QE-Infinity” (subject to the capital key) could actually pave the way for fiscal stimulus to take the reins from monetary policy when it comes to shouldering the burden of engineering sustainable growth and averting a deflationary spiral.
Last month, as Draghi spoke after the September ECB statement, critics were quick to charge that the legendary central banker had effectively undercut his own exhortations for fiscal policy by announcing open-ended QE.
The argument (if that’s what you want to call it) essentially says that if governments know central banks are in the game forever, they will have no incentive to move aggressively forward with fiscal stimulus.
Read more: How Draghi’s ‘QE Infinity’ Actually Paves The Way For Fiscal Policy To ‘Take Over’
Amusingly, that argument emanated last month from some of the very same critics who have spent the last half-decade criticizing central banks for encouraging fiscal largesse with arm’s length debt monetization.
To those critics we would ask: Which is it? Do central bank asset purchases encourage irresponsible fiscal policy by effectively underwriting the issuance of government debt? Or do central bank asset purchases discourage fiscal stimulus by sending a message to politicians that monetary policy will continue to shoulder the burden, thus alleviating the need for governments to act?
For BofA’s Barnaby Martin, one “overlooked” aspect of QE is the way in which it “‘transforms’ sovereign debt-to-GDP ratios by moving bonds from risk-averse investors towards more risk-tolerant central banks”.
“If QE is sizable enough, the transformation in debt-to-GDP ratios can be meaningful”, Martin wrote last month. You can see that clearly in the following two charts, excerpted from his latest note, dated Thursday:
(BofA)
“QE helps ‘de-risk’ financial markets, by moving bonds from risk-averse investors towards more risk-tolerant central banks (buy and hold)”, Martin said Thursday, in the course of reiterating a handful of points he made previously. “This means that over the longer term, higher sovereign debt levels can be attainable, while keeping bond market ‘tantrum’ risks in check”, he adds.
That contention will drive some QE critics crazy. There’s more than a little evidence to support the notion that the further down the road we get towards central banks cornering government bond markets, the higher the risk of tantrums as liquidity disappears and those markets simply cease to function. Indeed, we got a mini-tantrum in JGBs just four days ago.
Read more: Chaos In JGB Land Sparks Global Bond Rout After Margin Calls, ‘Horrific’ Auction In Japan
Intermittent flareups notwithstanding, Martin reminds you that although “Japan has one of the highest government debt-GDP ratios across the globe… volatility of JGBs has been relatively low since 2010”. That, he says, is “partly because” of BoJ ownership of JGBs.
After detailing the extent to which the fiscal response in Europe has been “piecemeal” thus far and will likely take time to morph into a bloc-wide, coordinated push, BofA characterizes the future of the monetary-fiscal policy nexus as a “public-private partnership”.
“The reality… is that central banks can’t step away from supporting the market”, Martin says. “They will need to be present for a long time, in our view, laying the groundwork for potentially higher debt levels in the future…à la Japan”.
(BofA)
If this sounds like MMT (modern monetary theory) to you, that’s because, taken to its logical extreme, it is.
“In fact, low rates and QE will become essentials in helping governments create ‘fiscal space’ and manage the transition to higher debt levels and, at the extreme, participate in ideas such as MMT, in our view”, BofA says.
MMT matriarch and Bernie Sanders advisor Stephanie Kelton would be proud.
“Greater coordination between fiscal and monetary authorities is almost certainly the wave of the future”, she told Bloomberg in a July interview from (appropriately) Tokyo. While Kelton said central banks won’t admit to having lost their independence, the bottom line is that “you’re going to see central banks responding in more accommodative, coordinating ways”.
“QE Infinity debases and makes the currency risky”… then explain why the yen hasn’t collapsed.
As far as MMT goes, it’s fairly easy to see that global QE did little to structurally solve any problems in the long-run, but QE may have provided some stability for failing corrupt entities — but the main factor that added stability was simply time, i.e., the weak hands were shaken out during the collapse and the strong hands continued on with production and consumption. The QE illusion may have bought some time, but its stimulation for the average person was never measurable. As for Japan, the biggest take away is the control and management of gov debt and the helping hand of taxpayers to support low growth — which seems to be somewhat like the trump economy, i.e., very little growth, massive debt and lower unemployment — and all that relates to distortions of The Philips Curve and the conundrums related to the Participation Rate and crashing yields. The Baby Boom Mess going forward will make this entire mess into afar larger mess …
I remain lost in the confusion of how Treasury and Fed are interconnected to debt, surplus and deficit as all that relates to the Fed balance sheet — and the latest IOER/SRF. None-the-less, the latest crap I’ve read suggests the un-important trump deficit deficit may have been somewhat linked to recent (and prior) congressional budget compromises, which may have brought about quirky distortions with normal Fed activities. This is so far over my head that I apologize for posting, but what the hell, it’s a puzzle — just like MMT and the concept as to why (up to this point) Japan hasn’t become Argentina.
Monetary Policy and the Federal Reserve:
Current Policy and Conditions September 4, 2019
… By accounting identity, the assets on the Fed’s balance sheet exactly match the sum of its liabilities and surplus. By statute, Congress has limited the size of the Fed’s surplus as a budgetary offset for unrelated legislation. P.L. 114-94 capped the surplus at $10 billion. P.L. 115-123 reduced the surplus from $10 billion to $7.5 billion. P.L. 115-174 reduced the surplus from $7.5 billion to $6.825 billion.
FRED chart showing their assets/liabilities: https://fred.stlouisfed.org/graph/?g=p52l
Oh no, not again!
Mr. H, et al, I’m seriously just chasing a general theme here, which started with the IOER chaos. After reading far too much stuff, which is way over my head, I’m just curious if the trump debt machine, aka Treasury deficit machine (and the GOP trump fiscal budgets) have in some way altered money markets in some weird 3-d chess kinda way. Since day one, when trump took over, the spending spree of trillions was somewhat overlooked by a lot of people that were excited about tax cuts and the pea and shell bullshit associated with MAGA and the re-birth of Reaganomics V2. The trump budgets spread massive debt out over a YUGE timeline and then lie about almost everything along the way — so my general motivation is to look under the hood because, I don’t believe anything about anything in the trump fake fantasy — and I believe the deficits will become a YUGE issue, which trump and his fellow GOP gangsters want to run away from.
It’s interesting that trump the bully is playing so many games with the Fed Boneheads and then, to add pressure to that game, congress gets to play games with Fed surplus capital, which of course helps make the deficit game look just a little better (as they look for pennies, in a trillion dollar farce).
Just some ideas that are out there, but sort of points to the concept that the Fed structure is screwed up and can be taken advantage of by the bad guys — what a surprise!
Monetary Policy and the Federal Reserve:
Current Policy and Conditions September 4, 2019
By accounting identity, the assets on the Fed’s balance sheet exactly match the sum of its liabilities and surplus. By statute, Congress has limited the size of the Fed’s surplus as a budgetary offset for unrelated legislation. P.L. 114-94 capped the surplus at $10 billion. P.L. 115-123 reduced the surplus from $10 billion to $7.5 billion. P.L. 115-174 reduced the surplus from $7.5 billion to $6.825 billion.*
The Congressional Budget Office (CBO) estimated that P.L. 115-174 would reduce the budget
deficit by $23 million over 10 years.7 CBO estimated that only one provision would reduce the
deficit–Section 217 requires the Federal Reserve (Fed) to transfer $675 million from its surplus
account to the Treasury, where it is added to general revenues. CBO estimated that this provision
would increase revenues by $478 million on net over 10 years.8 CBO assumed when making the
estimate that the Fed would finance the transfer by selling Treasury securities, which otherwise
would have earned $177 million in income that would have been remitted to the Treasury in the
next 10 years. Thus, the provision can be thought of as shifting Fed remittances from the future to
the present, as opposed to representing new economic resources available to the federal
government.
Interest on Reserves: History and Rationale, Complications and Risks
By Peter Ireland
… the Fixing America’s Surface Transportation Act of 2015 drew directly on the Fed’s surplus capital, earned as profits from its carry trade, to help fund federal highway spending; the Bipartisan Budget Act of 2018 did the same to finance more general increases in government spending. The risks of pushing still further are described most vividly by Plosser (2017: 8):
As Taylor (2016: 719) notes, IOER “enables the Fed to be more like a discretionary multipurpose institution rather than the rule-like limited purpose institution that has delivered good policy in the past and that can deliver good policy in the future.”
==> Analysts deride the move as little more than an accounting gimmick. The Fed already returns the interest earned on its portfolio of holdings to the Treasury Department. That payment was worth $80 billion last year alone. The Fed’s surplus account provides a capital buffer in years when the central bank suffers losses, but ultimately, the money belongs to Uncle Sam anyway.
“Legislators who care about the integrity of the budgeting process should not support this budgetary sleight-of-hand,” former Fed Chairman Ben Bernanke wrote in a 2015 blog post.
The move two years ago also created a dangerous precedent, said Sarah Binder, a senior fellow at the Brookings Institution who studies the relationship between Congress and the central bank. That Congress would return to the trough for the new budget deal underscores the Fed’s political vulnerability.
“Congress treating the Fed like a cash cow is Exhibit A in the myth of Fed independence. A decade of criticism from the Hill has weakened the Fed’s political standing – making it easy prey for politicians who want to claim they’ve paid for new spending,” Binder said. “If the Fed’s public standing were stronger, lawmakers might have second thoughts about raiding the Fed’s rainy day funds.”
https://www.cnbc.com/2018/02/09/congress-taps-federal-reserve-to-pay-for-budget-deal.html
==> Macroeconomics Blog (Aidan Savage Nov 2018)
Policy Implications
The Fed’s floor system, in short, has caused banks to increase their investment in the Fed at the expense of investing in the private sector. The question, then, becomes whether the Fed is any better than banks in allocating this credit. Put differently, is the Fed as a financial intermediary–funding short and lending long–really providing a better financial service than would have been provided by the private sector financial firms? It is not obvious to me that the answer is yes.
What is obvious to me is that the Fed’s floor system creates a whole set of other problems. First, as a profitable financial intermediary, the Fed is setting itself up for political shenanigans. Recall Congress taping into the Fed’s capital surplus in 2018 and 2015. Though these transfers were relatively small and to some extent accounting gimmicks, they show how tempting a large, profitable Fed balance sheet can be to Congress.
Why not print money and have the Fed (a risk tolerant “investor”) buy 20% of the equity market and buy every dip? This would lower the cost of equity and potentially increase investment (P,P&E) and in people. And if profits fall due to competition (ie lower inflation) then just buy more stock in a downdraft (which may not happen due to the Fed purchased) AND real consumer purchasing power increases. It is foolproof, nothing can go wrong.
Don’t be absurd. That would be like if a company borrowed money to buy their own shares at its highest price instead of making capital investments, or if a government printed money so that it could buy its own debt.
If you had your policy, shares would go up because the Fed would be ultra-accommodative and because the number of tradable shares would be reduced by one-fifth. The Fed could then use these capital gains and dividend income to buy Treasurys. Congress could then reduce income taxes further, and the Fed can use the coupon payments from the Treasurys to give -2% interest loans to banks, who can park that money back at the Fed for +2%. Eventually, even though the money supply would be at record levels, liquidity would probably still be thin so the Fed and the banks can just switch commercial paper every day as needed. Inflation would be kept in check by not measuring things that cost more. Political discontent would be kept in check by social media, guns, and reality TV, and income inequality would be countered by unlimited streaming options and enhanced cell phone features.
When ‘would’ this happen Harvey?
Re: Chicago Fed Letter, No. 395, 2018
“These reductions generally occur when the Treasury approaches the debt ceiling–a limit set by Congress on the amount of money the government can borrow. Similar to a household that wants to pay its bills without taking out a loan, the Treasury, when it faces a tight debt limit, must spend down its checking account until Congress allows it to borrow more.”
==> Interesting relationships between Fed rates and Treasury capital:
https://fred.stlouisfed.org/graph/?g=p5hX