Typography

David Andolfatto and Larry White have been having an interesting debate on the public finance case for having a large (or small) Federal Reserve balance sheet. In this post I'll make the case that American taxpayers are better off having a large Fed balance sheet, perhaps not as big as it is now, but certainly larger than in 2008. To explain why, we're going to have to go into more detail on some central banky stuff. The chart below illustrates the growth of the Fed's balance sheet. Prior to the 2008 credit crisis, the Fed owned around $900 billion worth of assets (green line), these being funded on the liability side by $800 billion worth of banknotes (red line), a slender $10-15 billion layer of reserves (blue line), and a hodgepodge of other liabilities. The Fed now owns an impressive $4.5 trillion in assets. These are funded by around $1.5 trillion worth of banknotes and $2.3 trillion worth of reserves. So the lion's share of the increase in the Fed's assets i...

 In a recent podcast with Robert Hall, Russ Roberts asks: "If the Fed was so aggressive, why didn't we have inflation? And does that mean that Milton Friedman and others were wrong?" It's a good question. Because I find monetary policy confusing, I want to try answering Russ's question with an analogy to an example that doesn't involve money. Say there are two types of gold rings, those with diamonds and those without. The price of gold rings with diamonds exceeds the price of rings without diamonds by a wedge that equals the price of the diamond. A technology emerges that can create diamonds at zero cost. The supply of diamonds will rapidly grow until they become like water; while boasting desirable qualities, a diamond will sell for $0. When this happens the price of gold rings with diamonds will equal the price of gold rings without. Using this analogy, we can understand why—despite having been so aggressive—the Fed didn't create inflation. Treasury de...

Imagine waking up in the morning and checking the hockey scores, news, the weather, and how much the central bank has adjusted the gold content of the dollar overnight. This is what a 21st century gold standard would look like. Central banks that have operated old fashioned gold standards don't modify the gold price. Rather, they maintain a gold window through which they redeem a constant amount of central bank notes and deposits with gold, say $1200 per ounce of gold, or equivalently $1 with 0.36 grains. And that price stays fixed forever. Because gold is a volatile commodity, linking a nation's unit of account to it can be hazardous. When a mine unexpectedly shuts down in some remote part of the world, the necessary price adjustments to accommodate the sudden shortage must be born by all those economies that use a gold-based unit of account in the form of deflation. Alternatively, if a new technology for mining gold is discovered, the reduction in the real price of gold is f...

It's been a while since I blogged about Canadian monetary policy, but Luke Kawa's recent tweet on the topic of Canada's effective lower bound got me thinking. BoC has referred to 0.25% as its "effective lower bound" -- Shenfeld suggested that any lower, BoC thinks there'll be problems in money mkts — Luke Kawa (@LJKawa) August 4, 2015 Luke is referring here to CIBC chief economist Avery Shenfeld's recent missive on how the Bank of Canada might react if the Canadian economy's losing streak were to continue. According to Shenfeld, the Bank of Canada has one final quarter point cut left in its quiver—from 0.5% to 0.25%. Should the bleeding continue, Governor Stephen Poloz can then turn to forward guidance and only when that has been exhausted will quantitative easing become a possibility. Really? The Bank of Canada can't go below 0.25%? Has Shenfeld not been following what has been occurring outside Canada's borders over the last twelve months? ...

David Beckworth had a very interesting pair of posts outlining how QE would only have had a meaningful effect on the economy if the associated monetary base growth was permanent. One addendum I'd add on the topic is that even permanent expansions of the monetary base can have no effect on the economy. The best example of this is the "cashing up" of the Reserve Bank of New Zealand (RBNZ) in 2006, an event that doesn't get the attention that it deserves in monetary lore. Banks typically hold deposit balances at their central bank in order clear payments with other banks. Because New Zealand's clearing and settlement system was suffering signs of stress in the mid-2000s including delayed payments, hoarding of collateral, and increased use of the RBNZ standing lending facilities, the RBNZ decided to 'flood' the system with balances to make things more fluid. This involved conducting open market purchases that bloated the monetary base (comprised of currency...

Robin Hood , N.C. Wyeth, 1917 There were plenty of reports in the press this year accusing central banks of behaving like King John, stealing from the poor to help the rich. Rich people's wealth tends to be geared towards holdings of stocks and bonds whereas the poor are more dependent on job income. By pushing up the prices of financial assets, central bank quantitative easing helped rich people while leaving the poor in the dust. There are a lot of problems with the King John critique of quantitative easing. First, a good argument can be made that QE had almost no effect on prices. Insofar as purchases were considered temporary by market participants, then the newly created money would not have been spent on stocks and whatnot, its recipients preferring to keep these balances on hand in order to repay the central bank come the moment of QE-reversal. If so, the large rise in equity prices since 2009 is due entirely to changes in the fundamentals and animal spirits, not QE. But le...

There's a counterintuitive meme floating around in the blogosphere that quantitative easing doesn't do what we commonly suppose. Somehow QE reduces inflation or causes deflation, rather than increasing inflation. Among others, here are Nick Rowe , Bob Murphy , David Glasner , Stephen Williamson , David Andolfatto , Frances Coppola , and Bill Woolsey discussing the subject. Over the holidays I've been trying to wrap my head around this idea. Here are my rough thoughts, many of which may have been cribbed from the above sources, though I've lost track from which ones. Let's be clear at the outset. Inflation is a rise in the general price level, deflation is a fall in prices. QE is when a central bank purchases assets at market prices with newly issued reserves. In equilibrium, the expected returns on all goods and assets must be equal. If they aren't equal then people will rebalance towards superior yielding assets until the prices of these assets have risen high...

Before 2008, visualizations of central bank activity largely focused on interest rates. These visualizations were easy to make, just a line graph showing a central bank's target rate and the actual overnight rate, perhaps within a narrow channel bounded at the top by the central bank's lending rate and at the bottom by its deposit rate. The one below, pinched from the Economist, is a decent example. But then the credit crisis hit. Rates plunged to zero where they have stayed ever since. Central bank policy moved away from conventional manipulation of the short term rate towards more unconventional policies, thus rendering the classic line graph less relevant. Two of the more important of these new unconventional tools are quantitative and qualitative easing. A good chart must be capable of illustrating the expansion of a central bank's balance sheets (quantitative easing) and contortions within that balance sheet (qualitative easing). In this context, stacked area charts ha...

1,682 is the number of days that the Dow Jones Industrial Average has spent rising since hitting rock bottom back in March 6, 2009. It also happens to be the number of days between the Dow's July 8, 1932 bottom and its March 10, 1937 top. From that very day the Dow would begin to decline, at first slowly, and then dramatically from August to November when it white-knuckled almost 50%, marking one of the fastest bear market declines in history. Comparisons of our era to 1937 seems apropos. Both eras exhibit near zero interest rates, excess reserves, and a tepid economic recovery characterized by chronic unemployment. Are the same sorts of conditions that caused the 1937 downturn likely to arise 1,682 days into our current bull market? The classic monetary explanation for 1937 can be found in Friedman & Schwartz's Monetary History . Beginning in August 1936, the Fed announced three successive reserve requirement increases, pushing requirements on checking accounts from 13% t...

Hand operated rolling mill, for putting the edge impression on to coins I've been reading about the medieval monetary system lately. What a fascinating and complex mechanism, and a good reminder that we should not be using the word medieval as a synonym for primitive or unenlightened. Medieval coinage, I've come to discover, is also a highly confusing subject. A quote that John Munro attributes to Karl Helleiner seems apropos: "There are two fundamental causes of madness amongst students: sexual frustration and the study of coinage." Studying odd, imaginary, or historical monetary systems is rewarding not only because of the aha! moment that understanding provides, but also because of what these systems reveal about our modern one. Readers may have noticed that for the last two months I've been posting rather obsessively on monetary policy, a topic I've typically avoided. Here's my attempt to combine monetary policy and medieval coinage into one post,...