Why Michael Woodford supports monetary tapering (Kaminska wins)

In an excellent, follows up on my original question, there should be more of this kind of reporting piece, Matthew Klein writes:

“For Woodford, the most important point is that the Fed’s balance sheet cannot keep growing without imposing costs on the financial system and broader economy — even when inflation is low and unemployment is high. While Woodford didn’t explicitly tell me what those costs were, a possible explanation can be found in this brief passage from the paper he presented at last year’s Jackson Hole Economic Symposium:

An increase in the safety premium obtained by making “safe assets” (in the relevant sense) more scarce would in itself be welfare-reducing. If Treasuries provide a convenience yield not available from other assets (including bank reserves), then reducing the quantity of Treasuries in the hands of the public reduces the benefits obtained from this service flow.

In other words, Treasury bonds are uniquely useful for savers. When the Fed makes these securities more expensive — or restricts their supply through asset purchases — the central bank harms regular savers without doing much to boost the broader economy. Moreover, the relative scarcity of newly-issued Treasury bonds has been causing havoc in the repo markets.

Woodford suspects that the Fed agrees with him. In fact, he thinks that the pace of tapering will (and should) be determined almost exclusively by the size of the balance sheet rather than the health of the economy:

This explains, in my view, how it was possible for Fed officials to indicate that it would likely be time to begin slowing the rate of purchases later in the year, even while admitting that it was not yet time for the tapering to begin last spring. The point was not so much that they felt confident that they could already predict labor market conditions in the remainder of the year, but rather that they could already predict how large the balance sheet would have gotten by later in the year — and they knew that, barring substantial unexpected developments with regard to economic conditions, they would be concerned by then about allowing the growth of the balance sheet to continue too much further.

Hopefully this explains why someone known as a monetary “dove” can support tapering without being inconsistent.”

TC again: To keep the difference between Klein and Woodford especially clear, I have refrained from indenting the block of material as a whole.

Here is Izabella Kaminska on collateral shortage.


Comments for this post are closed