Blogging a whole conference can be an exhausting affair. ?Two things I did not expect — sitting in on the press conference with Lacker and Bullard, and blogging the Lunch speaker from the BIS [Bank of International Settlements].

There were a lot of themes that went around. ?I’ll try to highlight a few of them, and add my own thoughts.

What is the proper mandate for the Central Bank?

The representatives from the Fed generally thought the dual mandate worked well. ?Most of the critics favored a single mandate of preserving purchasing power of currency, and no mandate of full employment. ?The reasoning varied there, but as Plosser commented, a dual mandate is what gives the Fed wiggle room to not be rules based, but discretionary. ?Others commented that the ability of the Fed to affect labor issues is poor.

Plosser also told us to consider the actual text of the dual mandate:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

He said it was interesting how it focused on monetary and credit aggregates as the tools to affect employment, prices, and long interest rates. ?I had to admit when I heard that, that the dual mandate is better and worse than I thought. ?Better because it focuses on money and credit as a unit. ?Worse, because it gives the Fed three disparate targets, and the Fed is bad enough in trying to hit stable prices. ?It doesn’t need distractions.

Beyond that, most agreed that adding even more targets for monetary policy was a really bad idea — effects on foreign countries, level of the currency, etc.

That said, Borio of the BIS suggested that monetary policy might be better off with a single mandate focusing on growth of liabilities to avoid financial crises, because financial crises cut economic growth severely. ?This is closer to the way that I think. ?The Fed should adopt a goal of modesty, and merely try to avoid messing things up, as they did with the flood of liquidity prior to the Great Depression, and in 2003-7.

Aiming for a moderate growth in total liabilities would probably be a better version of Friedman’s idea of a constant growth in M2.

Rules vs Discretion

This one was more agreed. ?Most favored a more rules-based monetary policy. ?As noted above, the main argument was over what the rule should be.

Central Bank Independence

There are two questions on Central Bank independence. ?The first is what are they independent from, and the second is whether they are competent. ?Over both of those is a question of accountability. ?Ultimately, they are a creature of Congress, and should be directly accountable to Congress.

As I have pointed out before, the Fed protests actions that compromise their independence, while taking actions to serve the political ends of those they favor. ?Put more simply, the Federal Reserve, like many nonprofits, is managed for the good of the management of the Federal Reserve. ?They do that which maximizes their power and resources, subject to risk constraints. ?This isn’t too surprising — most bureaucracies behave that way.

Are things normal or broken?? Did the Fed rescue us, or create a bigger crisis to come?

The Fed governors and a few economists felt that things are mostly normal, while most of the rest felt that things are broken, and a greater crisis could come.

What crises could we face? ?There are the simple ones, like sending the emerging markets through the shredder. ?Many noted at the conference how the monetary policy of the big nations travels to the smaller nations under a system of floating exchange rates.

Another possibility is?with residential mortgage bonds limited to a few coupons — negative convexity is potentially high. ?Tightening, if it led to a rise in long rates, could be like 1994, one of the worst years the bond market faced.

More likely is that deflation continues, and the Fed reinforces it with more QE. ?All of the Fed’s forecasts have erred on the side of rapid growth that has not materialized. ?As it is, with demand growth limited, we continue to bump along the bottom with ZIRP, with the Fed’s balance sheet growing bit by bit.

What will happen when Fed tightens?

Maybe not much. ?Maybe too much. ?It will be interesting to see how how banks and money market funds react to slightly higher rates. ?I lean toward the “maybe not much” if/when they tighten. ?I’m still not convinced that the Fed will tighten, simply because they have let a lot of little mini-crises derail them from what could be a more important task — that of normalizing the yield curve. ?What will go “boo” next week?

Four Final Notes

1. The Fed should not do fiscal policy, or quasi-fiscal policy. ?The Fed is less effective at its main task of monetary policy because they go after areas outside the core of what they have to do: buying MBS rather than Treasuries only, buying long Treasuries rather than short Treasuries, and being a financial & systemic risk regulator. ?A monetary policy that is not aggressive will avoid systemic risk… but the Fed went too far many times in easing policy, and not far enough in tightening policy when it was needed.
2. The session on the “knowledge problem” was interesting and right, but it is basically the problem that any bureaucrat runs into. ?So long as you have regulation, the knowledge problem will exist. ?That said, you didn’t need to have this session at a monetary policy conference, because the problem is not unique to monetary policy.
3. Hilsenrath took up an argument of mine about the Fed — it is an intellectual monoculture of neoclassical economists. ?Lacker argued that neoclassical economists often disagree with each other, so it’s not a problem. ?It *is* a problem, though, because the methods don’t lead to good forecasts, and thus good policy.
4. I think the Fed needs to revisit their models, and think more broadly — labor use is getting affected by demographics, technology and global trade. ?These factors aren’t going away, and they are resulting in a permanent reduction in opportunities for the lesser-skilled areas of the workforces in the developed world, until the whole capitalist world is developed, and wage rates finish equalizing globally.

What should the Fed expect? ?Its ideas are flawed at their core as the world has changed, and closed-economy macroeconomics don’t apply well. ?Their efforts to change tinker at the edges, and don’t realize their tools aren’t effective. ?Better to set modest goals for monetary policy of a stable price level with no debt bubbles. ?That is achievable, and it is better to do what you can do well, than attempt things beyond your ability.

Rep. Bill Huizenga
Chairman, House Subcommittee on Monetary Policy and Trade

Suggested FSOC is a tool of the Fed to press fiscal agenda. ?60 new regulations, thousands of pages.

High degree of discretion… Fed makes it up as it goes, like Jazz.

Government knows best is not ?what is best for the economy as a whole.

The dual mandate allows the Fed to do things that go outside of what would be a strict monetary mandate — and what it can ultimately affect.

His bill HR 3189 will likely pass the House in the next few weeks, and then will head over to the Senate (where who knows will happen to it).

Aims to increase transparency and accountability of the Fed, and give more weight to the regional presidents. ?How large the audits would be is open. ?Emergency lending powers would be reduced. ?Five of seven governors and nine of twelve regional Fed Presidents would have to approve any emergency lending.

Fed would have to take a rules based strategy for monetary policy.

Q&A

1) David Malpass: Would the bill change IOER?

No.

2) Any audit of the IOER?

Not at present.

3) endthefed.info — goes into article 1.10 of the Constitution to have the states insist on commodity money — gold and silver?

How do we get back to a gold standard? ?How could we educate the public on its value? ?Would back money with a basket of commodities.

4) Torres of Bloomberg: what if the Fed buys more assets in another recession years from now?

Would lead to frustration. ?The Fed should not be in that business. ?Thinks many politicians are hypocritical because they tell the Fed what to do, and yet he gets accused of meddling with central bank independence.

5) Moderator notes that Elizabeth Warren wants to limit emergency lending — any chance for bipartisanship?

Quite possible, but banks will oppose it.

6) Alex Pollock: Sen. Shelby’s bill — how do you see his bill?

He doesn’t know enough to say, but he wants to get his bill through the House.

7) wouldn’t the Fed getting heavier regulation crash the equity markets?

This isn’t a question of that, everyone should have the same information and access to credit.

8) Can we keep Alexander Hamilton on the $10?

There are efforts to do that….

9) Buchanan suggested a monetary rule that would be in the Constitution?

They aren’t prescribing a rule. ?Only holding them to a rule that the?Fed itself?would specify.

10) What of the Senate Bill, and how will you work with it?

Speaker Ryan is handling the House well. ?We would like to do this on a bipartisan basis.

11) What to do with all of the reserves held at the Fed? Seiniorage?

Happy to take money away from Congress.

PANEL 4: THE FED?S EXIT STRATEGY VS. FUNDAMENTAL REFORM

Moderator: Craig Torres
Reporter, Bloomberg

Jerry L. Jordan
Former President, Federal Reserve Bank of Cleveland

Lawrence H. White
Professor of Economics, George Mason University

Kevin Dowd
Professor of Finance and Economics, Durham University

Torres introduces White, who talks about the need for a Fed exit from credit policy

QE was not a monetary policy. ?M2 anemic amid a huge rise in the monetary base. ?High powered money ain’t. ?Did not want to see M2 rise, which would lead to inflation.

Fed sterilized through interest on excess reserves [IOER]. ?This favored housing over other uses of credit. ?Fiscal policy masquerading as monetary policy.

Dramatic impact on its portfolio duration and income. ?Record interest income. ?Most gets?gets rebated to the Treasury, rest to the banks. ?Thinks Fed’s average maturity has moved from 4 to 12 years. ?Buiter predicted it. ?Fed is doing it all?for the Treasury.

Fed shouldn’t allocate credit. ?Takes away Congress’s job of wasting money. [DM: he said it, not me] ?Now a demand comes for a Puerto Rico bailout. ?Can’t give away money costlessly, even if you print it.

Lowers penalty for failure. ?At present the Fed has no plans to exit credit allocation; Congress will have to act to end it.

Jerry Jordan: Fed built the financial bubble. ?13th Fed res bank? ?Think he’s talking about Fannie and Freddie…

Monetary authorities as eunuchs. ?Political Viagra needed. ?Has fiat money run its course?

Foreign banks borrowing from the FHLB.

Money multipliers broken, high powered money does not exist. ?Central bank balance sheet is unrelated to money conditions in the economy. ?QE can be contractionary. ?There is no possible exit from QE. ?Stopping QE was good, but ending it will not happen, because IOER and reverse repos are the rule. ?IOER borrows from banks and RR borrows from money market funds and GSEs.

Zero experience on IOER and Rev repos. ?Who knows what would happen if inflation rose?

Conclusion: aggressive Fed policy has had no impact on inflation, and the Fed does not truly affect credit at present. ?Thee are no tools now for dealing with a rise in inflation.

Torres: things are anything but normal now.

Dowd: Extreme Keynesian Policies have not delivered.

Hi recommendation: Recommoditize the dollar, recapitalize the bank, restore strong governance to banking, and roll back government intervention

?? Put Hetty Green on the $10 bill!

Commodity standards with a feedback rule. [DM: quack, quack]

Banks need to run with high levels of capital in order to take more risks. ?Higher standards, and less gameable. ?Riskier positions would be penalized.

Banks would not be able to pay bonuses, dividends, buy back stock until they were compliant. ?SIFI banks only at 7% GAAP capital, 5% under IFRS. ?Social consequences of higher bank capital levels are zero. ?Capital is not a “rainy day fund.” [True]

Bank directors would be limited to unlimited personal liabilities. ?Bring back double liability for shareholders? ?Unlimited liabiity for shareholders. ?Look at the investment banks; when they went public, they threw risk control away.

GSEs and Fed ?would be wound down. ?Oligarchy of bankers block reform. ?Take the crony out of capitalism.

Q&A

1) High capital requirements but deregulating — what are you proposing??Depositors will seek highest return, and create another type of moral hazard.

D: Aims for getting the government out of the economy.

2) Bert Ely: possibility for capital arbitrage? ?Also shadow banking?

D: Capital rules created capital arbitrage.

Another fellow suggested that banks would be entirely equity funded.

3) Question on abolishing cash?

D: Deflationary collapse.

4) What would happen if people were taxed for holding cash?

Much held by foreigners — punish them with negative interest rates. ?But it will never happen.

5) To Larry: what of negative interest rates. ?Wouldn’t assets still stay at the Fed for regulatory reasons?

W:???

6) Transition from monetary to fiscal policy at the Fed?

Bernanke’s theory was that housing had to be preserved above all else. ?Same thing for long term rates. ?Debt service costs to Treasuries reduced.

7) Wouldn’t negative interest rates destroy GDP?

Yes. then asked about whether there were any bond investors. ?Asked what would happen if the Fed tried to sell its mortgages.

Answer from one manager: I wouldn’t want to be the first buyer, and I wouldn’t trust the actions of the Fed… so the market and prices would back up considerably.

 

PANEL 3: MONETARY POLICY AND THE KNOWLEDGE PROBLEM

Moderator: George Melloan
Former Deputy Editor, Wall Street Journal

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

Alex J. Pollock
Resident Fellow, American Enterprise Institute

David Malpass
President, Encima Global LLC

Melloan introduces Gerald P. O?Driscoll Jr.

The Knowledge Problem — Hayek argued that knowledge is dispersed — impossible to aggregate it without incentives. ?What everyone knows is more than what regulators know. ?There is no way that a central planner (or banker) could know what the right answer is for economics. ?As such, socialism morphed to become social democracy. ?USSR collapsed.

Rules encapsulate important knowledge gained by society over time, which enables actors to have a better idea of what to do. ?Disclosure reduces fraud.

Monetary policy discretion gives too much power to a small group of men.

Pollock says that the Fed does not know what it is doing, and can’t know what it is doing. ?The problem is too complex, and the knowledge to get and interpret to too hard. ?Fed biggest SIFI of all, and creates more systemic risk than anyone. ?The Fed as a result has not done well in the past, and is unlikely to do so in the future.

Financial instability was not destroyed by the Fed; experts are often given to aggressive actions from bad theories. ?Faith in experts is a secular religious problem.

Prices quintupling in a lifetime is considered price stability.

“The Fed must be independent.” But if the Fed is not competent, then should it be independent? ?How and to whom should the Fed be accountable. ?No part of a democratic government should be unaccountable. ?The Fed must be responsible to Congress. ?That said, the Fed has often been a useful lapdog to the Congress… funding deficits, etc. ?Congress in 1963 agreed with this idea at the 50th anniversary of the Fed.

Humphrey Hawkins does not help accountability. ?Financial Accountability Improvement Bill — FOMC would have to make detailed reports to the Congress, including dissenting opinions.

Banking committees in both houses captured by the housing industry.

Calls for a joint committee on the Federal Reserve; should also be able to audit the Fed in any way appropriate.

“The money question” affects so many things that it needs to be broadly discussed.

David Malpass — Post-monetarism: the Fed’s Growth Options

Negative effects of Fed policy on the economy. ?Fed is huge and distortive.

ECB — buy anything at any time.

ZIRP will weigh on growth for decades.

Post-monetarism — direct regulation of the financial system. ?Monetary and credit policies merged. ?Credit growth is slower as a result. ?Required bank reserves have fallen and are rising now. ?No transmission of M0 into other aggregates. ?Fed buys long bonds and advantages them — benefits government and corporations.

Core capex orders are weak. ?Employment to population ratio at a low, forget the unemployment rate. ?Median household income is declining — increased inequality.

Fed has four options to boost growth:

a) move rates above the zero bound. ?Aids savers and would be a loosening of credit. ?Maybe the interbank laon market would increase.

b) taper reinvestment, and free up Treasuries for liquidity and collateral. ?Fed assets at $4.5T. ?Banks assets currently at Fed.

c) Increase repo borrowing. ?Fed Liabs at $4.4T. ?More credit gets pushed out to banks. ?Would be more idle cash to lend.

d) Fed has a severe bunching of maturing assets in the short run. ?Presently would invest maturing assets long. ?Should the Fed own long duration assets?

Q&A — 1) no one has the interests of everyone else at heart. ?Central bankers have poor incentives — they maximize for themselves

O’D: even with good motives, they can’t get it right

M: Quis Custodes Custodiet.

2) Freedom: gold can’t be counterfeited, debased, maximize freedom.

P: American dollar good as gold — Bretton Woods. ?Silver Certificates were repudiated.

 

 

LUNCHEON ADDRESS

Claudio Borio
Head, Monetary and Economic Department, Bank for International Settlements ?[praised by the Economist and others]

1) How do we view equilibrium?

How can we tell if market rates are at an equilibrium or not? ?Inflation as disequilibrium or financial imbalances?

Monetary policy affects credit and growth. ?Output deviations are short-term, financial cycles are longer term 16-20 years.

Rates should be near what the equilibrium rate should be. [DM:?how do you know that rate?]

2) Monetary neutrality — Financial crises create permanent losses of GDP. ?Debt overhangs, resource misallocation:

• Financial booms overcome productivity growth
• Labor gets reallocated to lower productivity areas
• Sectoral misallocation of resources — 6% of GDP lost

Allocation, not total amount of credit is key. ?Blancesheet reform and structural reforms. ?Macroeconomic models need to move beyond one simple benchmark.

3) Deflation can be good or bad — deflation is not always bad for output — the link between deflation and growth?is weak, and nonexistent without the Great Depression

No evidence of Fisherian debt deflation, but property prices react to private debt levels. [DM: not sure what he is going for here]

Supply driven deflations are good, demand driven bad.

Thus move away from deflation to avoiding financial crises.

4) Different view of the fall in real rates — Global rise in debt, and rates go lower because it is difficult to incent people to take on more debt.

Low rates in one place can influence behavior elsewhere — thus the recent increase in external dollar liabilities. ?Also, low interest?rates globally.

5) Early warnings of banking distress — if we focus on financial crises, how do you craft policy?

If you use credit measures — can get a better view of GDP

Macroprudential policy operates in a similar way.

Focusing on financial crises would neglect inflation.

His conclusion is that a monetary focus on financial stability will lead to the best growth in GDP.

1990s a disequilibrium situation, with asymmetric monetary policy leading to an explosion in debts.

Quotes Twain on what you know that just ain’t so is that which hurts you.

Q&A 1) Tavlas — low inflation makes it difficult to get out of debt. Eurozone deficit nations can’t regain competitiveness, can’t reduce wages enough.

B: You make good points, but asset prices matter highly — we need to look at those.

2) Selgin — if productivity-driven, it will not be deflationary.

B: repair is slow; monetary policy could not do much to fix?a financial crisis

3) Real time, difficult to tell whether supply or demand-driven.

B: Booms and busts would be reduced if we did this.

PANEL 2: INFLATION, DEFLATION, AND MONETARY RULES

Moderator: Jeffrey A. Miron
Senior Lecturer, Harvard University, and Senior Fellow, Cato Institute

Charles I. Plosser
Former President and CEO, Federal Reserve Bank of Philadelphia

John B. Taylor
Mary and Robert Raymond Professor of Economics, Stanford University

George A. Selgin
Director, Cato Center for Monetary and Financial Alternatives

Scott B. Sumner
Director, Program on Monetary Policy, Mercatus Center, George Mason University

=–==-=-

Missed Plosser.

Got here in time to hear Taylor. Mentions the effects of non-rule-based monetary policy. ?Notes how capital controls are being tolerated more and more. ?More and more volatility in financial markets.

Mentions how he called the change in 2003-5, and how QE is essentially anti-rule in its application. ?”QE begets QE.”

Central banks follow each other more and more. ?Rules based policy is not impossible per se. ?If more nations were to follow them, you could get a global economy that is rule based.

“Rule-based policy begets rule-based policy.” Would not threaten independence of Central Banks.

Selgin — Real & Pseudo Monetary Rules [playing off Friedman Real and Pseudo Gold Standard]

Should rule out capricious monetary policy a la Venezuela — avoid political influence. ?Could allow for a more timely policy than discretion might achieve. ?Rules aid credibility.

Rules are no good if they aren’t followed and enforced. ?Robust rules would not lead to regret.

Pegged exchanged rate is a pseudo-rule. ?Audit the Fed has weak rules and enforcement/consequences.

A psuedo rule could be worse than discretion. ?When the rule breaks there could be negative results.

Suggests that a contractual rule provides sanctions. ?Nonadherence to a standard leads to losses. ?Monetary policy via government promises versus private contract will fail, promises will be broken.

If monetary instruments are targets, easy to achieve, but may not do good for the economy. ?Feedback rules could be the best. ?Long and variable lags will apply.

Dollarization, Bitcoin, blah, blah, blah… slight diss of Scot Sumner

Scott Sumner: Nudge the Fed to a rules based, nominal GDP based approach. ?Central banks move slow. Three pragmatic reforms:

1. Define stance of monetary policy — is policy easy or tight?
2. Make Fed more accountable — revisit past policy ex post
3. Take small steps toward NGDP targeting.

We don’t clearly know whether policy is truly tight or loose. ?What is the right variable?

Interest rates don’t measure the status of monetary policy. ?Asset prices showed policy was tight as prices fell in 2008. ?Mishkin — NGDP.

NGDP looks at both the supply side and demand side. ?Bernanke admitting mistakes [DM: but does not admit anything on the 2000-2005 overexpansion of liquidity].

Asks that the Fed look back over 1-2 years to analyze how monetary policy really was in terms of tightness. ?Level targeting within bounds would give guidance to decisions.

NGDP futures market proposed. ?[DM: that is a punters market, and won’t work.

Q: to Sumner: NGDP includes govt spending, so it can be gamed.

S: too big too exclude. ?Aggregate nominal labor compensation might be better as a target.

Q: David Malpass: what would work better for tight/loose than interest rates?

Taylor: money growth — rules vs not are a more important thing

Q: Bert Ely: Why not let the market dictate policy?

Selgin: that could be gamed. ?Fiat money is artificially scarce. ?Not sure what you would actually target, feed back, etc.

Q: is the dual mandate a good thing?

Plosser: the dual mandate is important. ?Actual text of the dual mandate is important — and it does have its problems, because it creates discretion.