Typography

George Selgin had an interesting post describing how the Fed appears to be breaking the law by paying too much interest to reserve-holders. This is an idea that's cropped up on the blogosphere before, here is David Glasner, for instance. I agree with George that the the letter of the law is being broken. That's unfortunate. As Section 19(b)(12)(A) of the Federal Reserve Act stipulates, the Fed can only pay interest "at a rate or rates not to exceed the general level of short-term interest rates." With three month treasury bills currently around 0.33% and the fed funds rate at 0.4%, the current interest rate on reserves (IOR) of 0.5% exceeds the legal maximum. Unlike George, I don't think the Fed deserves criticism over this. If the letter of the law is being broken, the spirit of the law surely isn't. If there is a spirit residing in the law governing IOR, it's the ghost of Milton Friedman. Since the Fed's inception in 1913, IOR had been effectively...

Would it make sense for firms to try to slow down their equity structure? Equity markets are made of two classes of participants. The minority consists of long-term investors who, like Ulysses, have 'tied themselves to the mast' and would rather fix things when a company runs into problems than sell out. The majority is made of up rootless speculators and nihilistic indexers who cut and run the moment the necessity arises. Because their holding period is forever, the long-term investor class does all the hard work of monitoring a company and agitating for change. Keeping management honest is the only recourse they have to protecting their wealth. Speculators and indexers are free loaders, enjoying the same upside as investors without having to contribute to any of the costs of stewardship. How might long-term investors be compensated for the extra expenses they incur in tending the garden? One method would be for a firm's management to institute a slow/fast share structure ...

National Bank of Greece depository receipt certificate ( source ) If you're like me and you like to: 1) explore anomalies in markets; and 2) mix equity analysis with monetary analysis, then you'll like this post. A sneak peak: by the end, we'll be able to use equity markets to figure out the unofficial exchange rate between a Greek euro and non-Greek euro. For the last few weeks shares of Greek banks have diverged dramatically from their overlying depository receipts (see chart below). A bit of background first. A depository receipt is much like an exchange-traded fund, except where an ETF holds a bundle of different stocks, a depository receipt represents just one stock. That stock is usually listed on an out-of-the-way market (like Greece), whereas the depository receipt trades on a major exchange like New York. Investors interested in owning a foreign stock can avoid currency conversion costs and foreign settlement problems and instead purchase the New York-listed depos...

Measuring liquidity is a pain in the ass. The value of a good, say an apple, is easy to calculate; just look at the market price for apples. Unfortunately, doing the same for liquidity is much more difficult because liquidity lacks its own unique marketplace. Liquidity is like a remora , it never exists on its own, choosing instead to attach itself to another good or asset. For instance, a bond provides an investor with both an investment return in the form of interest and a consumption return in the form of a flow of liquidity services. Since the price of this combined Frankenstein reflects the value that an investor attributes to both returns, we can't easily disentangle the value of the one from the other. Here's a symmetrical (and equally valid) way to think about this. If liquidity is a good then illiquidity is a bad , where a bad is anything with negative value to a consumer. This bad doesn't exist on its own but, like a virus, infects other goods and assets. While a...

It would be wrong to blame the economics blogosphere's failure to foresee the 2008 credit crisis on complacency. Better to say that bloggers were distracted. Instead of sifting through sub-prime and CDO data, they were grappling with an entirely different threat, the impending Wile E. Coyote moment in the U.S. dollar. The perpetual racking-up of ever larger debts by the U.S. to the rest of the world for the sake of funding current consumption, and the eventual dollar collapse that this implied, was believed to be tripping point numero uno at the time. Look no further than Paul Krugman, who in September 2007 (in just his fourth blog post) had this to say: The argument I and others have made is that the U.S. trade deficit is, fundamentally, not sustainable in the long run, which means that sooner or later the dollar has to decline a lot. But international investors have been buying U.S. bonds at real interest rates barely higher than those offered in euros or yen — in effect, the...

In his first blog skirmish , Ben Bernanke took on Larry Summers' secular stagnation thesis, generating a slew of commentary by other bloggers. If the economy is in stagnation, the econ-blogosphere surely isn't. I thought that Stephen Williamson had a good meta-criticism of the entire debate. Both Bernanke and Summers present the incredibly low yields on Treasury inflation protected securities (TIPS) as evidence of paltry real returns on capital. But as Williamson points out, their chosen signal is beset by static. Government debt instruments like TIPS are useful as media of exchange, specifically as collateral, goes Williamson's argument. Those who own these instruments therefore enjoy a stream of liquidity services that gets embodied in their price as a liquidity premium. Rising TIPS prices (and falling yields) could therefore be entirely unrelated to returns on capital and wholly a function of widening liquidity premia. Bernanke and Summers can't make broad assumptio...

Here's a conundrum. Many commentators have been trying to puzzle out why stocks have been continually hitting new highs at the same time that bond yields have been hitting new lows. See here , here , here , and here . On the surface, equity markets and bond markets seem to be saying two different things about the future. Stronger equities indicate a bright future while rising bond prices (and falling yields) portend a bleak one. Since these two predictions can't both be right, either the bond market or the stock market is terribly wrong. It's the I'm with stupid theory of the bond and equity bull markets. I hope to show in this post that investor stupidity isn't the only way to explain today's concurrent bull market pattern. Improvements in financial market liquidity and declining expectations surrounding the pace of consumer price inflation can both account for why stocks and equities are moving higher together. More on these two factors later. 1. I'm with...

Does a lowering of a central bank's interest rates create inflation or deflation? Dubbed the ' Sign Wars ' by Nick Rowe, this has been a recurring debate in the economics blogosphere since at least as far back as 2010. The conventional view of interest rate policy is that if a central bank keeps its interest rate too low, the inflation rate will steadily spiral higher. Imagine a cylinder resting on a flat plane. Tilt the plane in one direction —a motif to explain a change in interest rates—and the cylinder, or the price level, will perpetually roll in the opposite direction, at least until the plane's tilt (i.e. the interest rate) has been shifted enough in a compensatory way to halt the cylinder's roll. Without a counter-balancing shift, we get hyperinflation in one direction, or hyperdeflation in the other. The heretical view, dubbed the Neo-Fisherian view by Noah Smith (and having nothing to do with Irving Fisher), is that in response to a tilt in the plane, the...

I like to say that everything is money, which is just another way of saying that all goods are liquid to some degree or other. Whether it be a house, a banknote, or ice cream, each of these items carries a liquidity premium. How large are these liquidity premia? It's difficult to get good measurements, but there are a few venues that offer a glimpse of this rare beast. One of them is equity markets. More specifically, we can use restricted stock studies to tease out liquidity premia. Imagine that your shares in Microsoft, normally so easily exchanged on various stock markets like the New York Stock exchange or NASDAQ, were restricted for a period of time in a way that prevented you from trading them. Apart from this impairment, your illiquid Microsoft shares are exactly like any other Microsoft share: they provide you with a dividend, voting power, and a contingent claim on firm assets should Microsoft decide to wind up the business. The price you'd be willing to pay to own t...