PANEL 2: FED POLICY AND THE ALLOCATION OF CREDIT

Moderator: Mark A. Calabria
Director of Financial Regulation Studies, Cato Institute

Malinvestment vs capital flowing to most productive sectors of the economy.

Jeffrey M. Lacker
President, Federal Reserve Bank of Richmond

Fed’s response led to misallocation of capital.

Monetary expansion was needed to prevent a collapse.

Initial Fed lending was sterilized — equivalent to issuing Treasuries, and lending the proceeds.

Fed could have just bought Treasuries, and not MBS or other securities.? To do otherwise distorts credit incentives.? It creates an appearance of unfairness.

Many contend as a result that credit allocation should not be an aspect of Fed policy. May compromise the independence of the Fed to do so.

Cornerstone of CB independence is control of liabilities.? Assets are more open to choice.? Thus it becomes a path of least resistance in a crisis.? Creates moral hazard, and probabilities of future economic distress.? Threatens CB independence.

Contain the willingness to intervene either by CB habit or law.? Would conflict with lender of last resort, which was more a product of a commodity money era.? Not elastic credit needed but elastic currency.

CB asset policy is an unfinished aspect of Central Banking.? This should be a top priority for action.

Allan H. Meltzer
University Professor of Economics, Carnegie-Mellon University,
and Distinguished Visiting Scholar, Hoover Institution.

Bailing out Bear Stearns was a mistake, and other non-commercial banks, including AIG.? Added to uncertainty of the situation, Fed then increased supply of credit, bought MBS and long-term Treasuries.? Fed acted too soon, if they had waited, they might have been able to do less.

Speculators front-run the Fed.

Fed doesn’t care about exchange rates except in a crisis — US Dollar down 15% recently.

Operation Twist not needed because they acted too soon, economy expanding rapidly now (?!)

Fed is too short-term oriented.

Believes that things will only normalize when housing values fall to their eventual equilibrium levels.

Chart on base velocity vs LT AAA Corp Bond yields.? Current conditions consistent w/ ’20s and ’60s.? Here’s my version, really only consistent with 1932-33 at present.

Greater centralization of the Fed and US Government control over the Fed.

Thinks higher future inflation is highly likely.

Fed has done well when it has followed the Taylor Rule.? Flip-flopping from one aspect of the dual mandate to another has not worked well.

Phillips Curve does not work, and the present Fed uses it for erroneous forecasts.

Fed kept monetary policy too low for too long and created the crisis.

Fed needs to be more accountable for its actions.

George Selgin
Professor of Economics, University of Georgia

Jokes that the Federal Reserve should be done away with, or that it should be significantly modified.

Describes how monetary policy works.? Little need for a discount window a common topic before.

Fed channels liquidity through soundest counterparties — primary dealers.? But if primary dealers are impaired, they become liquidity sponges.? Happened in 2008, so they worked to rescue primary dealers, excluding Lehman. [PDCF?]

Discount window didn’t help because of stigma, and thus the TAF was created.

1) End primary dealer system.? Not needed anymore with modern technology for auctions.

2) End Treasuries only.? Original Fed was not that way; avoid monetization of US debt. Let many parties bid for credit from the FOMC.

Eventual disbanding of FOMC, let a computer do it.

Roger Garrison
Professor of Economics, Auburn University

Natural rates of Interest and Economic Growth

The Fed attempts to expand growth beyond the natural rate of growth, and accelerates it beyond, setting up the conditions for a slump.

FOMC actions every eight weeks; learns once a decade when a crisis occurs.

Taylor Rule has no concept of the natural rate of interest.

Concludes that the Fed oversupplied credit, creating a boom and then the bust we are currently in.

Q&A

Opinions on Nominal GDP targeting?

Meltzer: easy to say, hard to do.? Follow Taylor Rule.? Lacker agrees.

Selgin thinks it is a much better idea.

Garrison: target a zero growth rate. Prices would fall.

 

 

 

PANEL 1: RETHINKING THE GLOBAL FIAT MONEY SYSTEM

Moderator: Mary Anastasia O’Grady
Member, Editorial Board, Wall Street Journal

Comments that the Fed buying MBS reminds her of the Latin American countries that she covers.

Benn Steil
Director of International Economics
Council on Foreign Relations

Central bankers as Churchillian war leaders, rather than dull technocrats.

Y = C + I + G? Economists treat C, I, and G as easy substitutes but they have different effects over time.

Krugman advocated creating a housing bubble, to replace the NASDAQ bubble.? (DM: They are trying to create new bubbles now via QE.)

Sweden and Australian central banks sold foreign assets to buy dollars and euros during their financial crises.

Central banking effective when governments can borrow near the policy rate of the central bank w/a tight correlation.? Implies that the ECB is no longer an effective CB for the fringe.

Central Bankers not particularly effective with fiscal policy.

Can Central Banks act without capital?? Will German taxpayers recapitalize the ECB? Doubtful.

On the Fed:

If the Fed got into trouble (negative net worth), the Treasury would back up, recapitalize it.

Suggests that the Fed should exchange MBS with the US Treasury for Treasuries.? Suggests that MBS will produce significant losses.

George Melloan
Former Deputy Editor, Wall Street Journal

Jokes about what a nickel could buy during the (big Baby Ruth bar) Depression and now (a jellybean).

Talks about post-WWII monetary policy in Britain, and how British Socialism led them astray.? War in Vietnam did much the same thing in the US, leading Nixon to end Bretton Woods.

Dollar’s primacy increasingly questioned.

Inflation coming as the Fed creates credit to fund the US government.

Doubts that multilateral currencies like the SDRs of the IMF would work. The Euro proves that.

The US needs monetary reform, but we might need to fail before that comes.? Gold, bitcoins, scrips, barter if things break down.? Fiat currencies are liquid, barter is inefficient.

If the US dollar goes, a lot else will go down as well. (DM: think about Chinese banks.)

Gerald P. O?Driscoll Jr.
Senior Fellow, Cato Institute

Gold standards can be done if the currencies reflect the fair values of the currencies.? I.e. France made its currency too cheap post-WWI, and Britain too expensive.

Gold standards are not always associated with deflationary periods with low growth.

No monetary system survives big wars.

Nixon went off the gold standard when the CPI was at a high 4.2%.? Monetary policy run by the seat of the pants then.

Argues that classical liberalism requires a gold standard.

Q&A

Fiat currencies even larger proportionately in Africa.? Give seniorage as foreign aid to Africa?

O’Driscoll: dollarization is faux gold.? Gold would be better.? Seniorage can’t be given away.? We need it.

Steil: Helps the African countries get along fine.? Dollarization of Panama has not hurt them; they know the US won’t send help.

O’Grady: Argentines tried to find a way to use US Dollars, but wanted seniorage, thus but devalued instead.

Question to Steil on Operation Twist, duration risk to Fed?

Steil: Operation Twist worked for several nations.? 40 bp move would wipe out Fed capital.? ECB purchases of PIIGS debt an alternative to Eurobonds, bailouts, etc.

Isn’t fractional reserve lending the problem?

O’Driscoll: leverage would come from other sources.? MMMFs?

Melloan: Politicization of monetary policy is the problem.

DM: misses the concept that asset-liability mismatches with leverage produces failures.

O’Grady: Wouldn’t a single mandate solve things?

All of the panel expressed doubts on this point.? The Fed needs it to hide, but they would find other ways to do it.