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.


To bad that the reporter did not just ASK him to weigh the costs of a "too large" Fed balance sheet with the benefits of lower unemployment. And if theses costs do outweigh the benefits of higher growth, would that then shift the the more of the burden for maintaining AD to fiscal policy?

Keep hopin'- ain't gonna happen in this country though, thankfully.

'Treasury bonds are uniquely useful for savers'

Well, bunds are certainly appreaciated by a group of savers that has no interest in investing in the debt of a federal polity running a current deficit of 4%, after running one of 10% just a couple of years ago. A polity that seems unable to increase taxes to improve infrastructure or to decrease funding for war related activities.

You have understated the situation.

Two years ago, members of Congress were advocating defaulting on Treasuries. In Detroit, members of the same party are actively arguing that the Michigan Constitution position of government debt under the Michigan Constitution can be repudiated because the US Constitution gave Congress the power to redistribute wealth from those who have it to those who don't want to pay for services rendered in the past by government under the flawed reasoning that the Michigan constitution backs all government debt with the Michigan governments power to tax.

The Founders obviously intended redistribution of wealth when they put bankruptcy in the Constitution. Previously, you paid your debt or died, died in servitude or in prison, but failure to pay debt was a capital offense. The US Constitution authorize Congress to redistribute the wealth so those who borrowed and spent on lunch could get a free lunch by bankruptcy.

Clearly all the fearful and frugal taxpayers who have refused to go deep in debt because they fear bankruptcy and fear the financial sector will collapse, have caused the rise over the past three decades of bloated and incompetent government funded by borrow and wastefully spend, and they need to be punished by having their wealth redistributed by government declaring bankruptcy.

Those retirees who were product of the Great Depression and who fail to borrow and spend and fail to pump and dump derivatives of depreciating assets but instead enable government spending by buying T-bills are the evil ones, and they need to be punished by real Americans taking away their wealth, real Americans like Michele Bachmann, Ted Cruz, and the others in the Tea Party faction.

And by the way, Mormons are the ultimate evil. It was the Mormon Marnier Eccles who established the Fed as the ultimate monetizer of government debt. Obviously, if the Fed was illegitimate when Wilson created it, Eccles and his Mormon ideology made immorally illegitimate.

This puts Sumner on a extinction level collision path with Woodford. Only one argument survives, no?

"Safe assets" have no explicit value in MM. Hot potato effect is about pushing capital into unsafe assets. You can't "there be dragons" a lack of safe assets.

More to the point, a awesome country that runs in balance, HAS NO Treasuries. A CB has to be able to run MP w/o "safe assets" doesn't it?

Yeah, I thought: "MM Schism" though Sumner is papering over any differences for now.

I'm not out on the bleeding edge of NGDPLT like some of you guys- just a pragmatic supporter and well-wisher.

Maybe I need more kool-aid, but Woodford's comments resonate with my inner Austrian. Sometimes, the NGDPLT litany sounds a little "fairy dustish" (I know, I don't yet get it, right?), and my economic instincts are to be wary of any such free lunch. I haven't sorted out what a $3 trillion Fed balance sheet MEANS- it feels to me like exposure to a couple hundred billion in losses in the event of rising interest rates/inflation (not that huge of a deal, I think, in classic, breezy 21st century fashion), but this would be mirrored by gains over at Treasury from the same environment, so in a sense it's like getting an advance on debt monetization. Crazy talk?

I see your point, but saving by buying treasuries has never resonated with my inner Austrian,

To me, a great strength of the Austrians was their focus on the real effects of savings and investment. By real, I mean saving as deferred consumption invested into future productive capacity.

Buying a treasury isn't Austrian saving that leads to investment. It's deferring consumption so that someone else can consume more (Social Security, Medicare, etc) and pay you back later with interest (which is taxed both formally by the govt and informally by inflation reducing the real return to next to nothing).

From a societal perspective, wouldn't we be better off with a lot fewer "safe" investments and a lot more "real" investments?

The Constitution give Congress the power in the following order:

The power to tax to pay debt...

The power to borrow in good credit...

Those who go around claiming to defend the Constitution are the ones who claim the first power of Congress, the power to tax to pay debt, is theft. Then they claim the second power, borrowing, should be unconstitutional.

The American Revolution succeeded because of borrowing because the Congress had no power to tax and had to operate as a charity. The leaders of this charity saw that those who worked for the charity were treated like pariahs by those who benefited the most from the work of the charity.

The charity workers under George Washington were spat on by their neighbors when they returned home, after all their property was taken from them by tax collectors and bankers.

The charity worker in Mass who refused to take the abuse was Daniel Shays. He served under Washington, lost everything in service to the ideal of the American war of independence, and then was spat on. He tried to lead a revolution of his own to gain his freedom from oppressive debt collectors.

He is the name we know today responsible for the US Constitution that was written to first and foremost give Congress the power to tax to pay debt.

The power to tax to pay debt means Congress was supposed to tax before incurring debt.

Reagan oversaw the conservatives which included backers like Milton Friedman who argued for cutting taxes and then borrowing to spend. Clearly the intention was to restore the post American Revolution spite for those who worked for the borrow and spend Congress that won American independence.

It was an effort to take America back to 1887 when Congress was a charity, that no one wanted to support, but they expected to protect them from the British. Congress had bailed out the Tea Party hotheads, so the Tea Party hotheads were expecting Congress to bail them out again if the British ever returned.

(The real Tea Party hotheads were in Rhode Island who were the first to rebel, and then blocked all taxation by Congress, creating the gridlock and crisis in Congress in 1886-7. Rhode Island only agreed to be taxed when they were threatened with being excluded from the union.)

The Austrians obviously believe the Tea Party free lunchers always win when it comes to tax and spend, leaving the Continental Congress borrow and spend as the model for both government. and the Donald Trumps who declare bankruptcy whenever they want wealth redistributed into their pockets.

An awesome country that runs in balance would still generate treasuries to
1. Rollover existing debt into new treasuries.
2. Smooth cash flow over time, since inflows are generally periodic and less certain and outflows are generally regular and planned.

I think I understand your point, but let me try to paraphrase:

I must pay someone $10 today, and will receive $20 in two weeks. So I borrow $10 now at 10% (biweekly rate), receive $20 in two weeks, and pay off my $11 debt at that time.

BUT: now suppose I have access to a great investment that pays me 20% (biweekly again, for consistency). So instead of paying back that $11, I roll my debt: maybe I pay $1 and roll the other $10. Meanwhile I have $19 to invest at 20%. Shampoo, rinse, repeat. Awesome! Free money!

That is one reason to roll debt, and it is a good reason. Of course, there is another possible reason: the expected $20 never arrived, and now I must roll because it's the only option available to me.

The main reason I don't like to see us rolling our debt is that it is very easy for the first scenario to become the second.

Well, at this point we're rolling our debt because it's just not feasible to pay it off. The US Govt owes $16T. It took in 2.5T in revenues last year and spent $3.5T, give or take a few billion.

Most of that debt is in shorter term instruments, so they just issue new bonds to pay off the principle on the old bonds as they reach the end of their life.

I don't have any real systematic aversion to government finance through borrowing, but at this level the big problem is is
1. Even if the government spent nothing, it'd take 6 years to pay off the debt.
2. The government is not spending nothing, it's spending dramatically more than it takes in.

That's unsustainable.

In a less crazy world though, I'd look at debt as, in some cases preferable to tax. Why?
Well, suppose in a simple world the government is gonna spend $2T of a $10T economy. They could either set taxes at 20%, or they could borrow and pay an extra 1% interest in a year.
If they borrow, they still have to tax the following year to pay it off. So they have to tax $2.02T.
Generally though, I'd note two things
1. If the economy grows by more than 1%, this results in a lower tax rate. If the economy grew by, say, 3%, the economy is now $10.3T, meaning the required tax has fallen to 19.6%. A country that can borrow more cheaply than it can grow can keep it's taxes lower.

2. Borrowing and lending is a consensual act. Ultimately, if taxes can be somewhat reduced via voluntary activity, that seems good.

The other missing piece is the declining federal deficits. From 2008 through 2013, total credit (TCMDO) has grown by about $3.7 trillion. The federal debt grew $5.6 trillion, a larger amount due to deleveraging in the financial and household sectors (see Z1). The Fed's balance sheet grew by about $3 trillion over the same period, or about 80% of the total increase in debt. With the federal deficits coming down, were other credit to continue growing at the same pace (the decline in federal credit growth is not offset by rising debt elsewhere), the Federal Reserve would effectively be purchasing 100% of all new credit in America.

I have a hard time understanding why we should care that there aren't enough T-Bills for the Repo market when the reason for this "shortage" is that they've been replaced with bank reserves. As I understand it, the point of the Repo market is to get something even more liquid than a T-Bill to an institution that needs them on a temporary basis.

In other words, why isn't the following claim incorrect: At the ZLB T-bills and bank deposits are nearly perfect substitutes. This, there can't simultaneously be a shortage of T-bills and a surplus of bank reserves. There can only be a shortage of T-Bills + Reserves and if that's currently the case, the Fed should do more QE, not less.

I know that folks involved in shadow banking sector will have a story about how they don't have enough T-Bills. But that isn't by itself an argument for tapering. I'm interested in a thoughtful discussion of why the inner workings of the shadow banking system should drive monetary policy.

Also, there's no intrinsic reason that an economy can have a limitless supply of risk free assets that yield >0 in real terms.

This is exactly what I've always thought about the supposed "safe asset shortage".

From the piece:

Treasuries provide a convenience yield not available from other assets (including bank reserves)

Why don't bank reserves provide the same convenience yield or better?

Where is the quantitative estimate of the harm that would be done per unit reduction in the quantity of safe assets?

Base money is the safest asset; when the Fed purchases T-bonds for newly created money, it does *not* reduce the extant quantity of safe assets.

The Fed could purchase foreign government bonds.

The Fed could be authorized to purchase riskier assets.

This is the part of Sumner's argument that has never made sense to me. His argument is based on the premise that purchasing federal treasuries is somehow a neutral operation. His argument against the Keynes is that a larger federal deficit is a more activist policy with social costs. His defense against the Austrians is that his preferred policy is neutral fiscally. But in some sense MM versus Keynes is really just a question of the aggregate total of reserves and t-bills. Under MM you keep the total fixed and change the distribution. But surely by doing so you are changing the distribution of assets in the economy (and not just the quantity of reserves!) which is a policy whose impact you need to examine. And Sumner is adamant that there is nothing going on here, which is really a claim that merits more attention than he provides.

The interesting thing is that there are really two debates happening in parallel. First is what to target: NGDP, inflation, unemploying, NGDPLT, etc. The second is the preferred policy instrument: gov deficits, rate targetting, forward guidance, QE, etc. I don't see anything inherently contradictory about an NGDPLT target using a mix of fiscal and monetary stimulus (or even with some simple money creation, a la MMT). But I don't really see any public intellectuals clearly advocating this kind of view. Maybe Woodford is somewhere in that neighborhood though.

Sumner's argument isn't about QE per se. It's that the ZLB does not in fact prevent the Fed from creating inflation/managing nominal income. QE is one means to that end.

Sumner is also not saying the fiscal stimulus doesn't work, again per se. He argues that it doesn't work if the monetary authority adjusts policy to hit its target, offsetting any stimulus that moves away from that target, as the Fed did late last year to neuter US fiscal austerity moves.

This doesn't sound like a very Dynamic Policy for the Economy. Are We feeling that constrained?

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