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It seems odd to put up an actual substantive post on Christmas day, nonetheless here is my New York Times column on financial regulation.

Despite these problems, the United States may oddly enough be facing this new financial turmoil in a relatively safe position, though whether it’s safe enough remains to be seen. The Federal Reserve took the lead on future capital requirements just last week, but for the shorter run there is a more important Fed policy move. Starting in late 2008, as a response to our financial crisis, the Fed bought government and mortgage securities from banks on a very large scale.

Bank reserves at the Fed rose from virtually nothing to more than $1.6 trillion. Then the Fed paid interest on those reserves to help keep them on bank balance sheets.

It is estimated by Moody’s that America’s biggest banks now have liquid assets that are 3 to 11 times their short-term borrowings. In other words, it’s the cushion we’ve been seeking. Furthermore, a lot of those reserves sit in the American subsidiaries of large foreign-owned banks, protecting the European system, too.

This new safety comes not from regulatory micromanagement but rather from the creation of additional safe interest-bearing assets. While European economies have been losing safe assets through debt downgrades, the United States financial system has been gaining them.

Here is a relevant link from The Economist.  Here are links to Brad DeLong, David Wessel, and others, on related points.  Here is David Beckworth on safe assets.  The scarcity of safe assets is a critical theme today, and still we lack a satisfactory theory of collateral.  For instance, how many macroeconomists are well equipped to answer how “putting OTC derivatives on exchanges” will affect interest rates and output?

Here is another bit, which shows I have been changing my mind on interest on reserves:

The Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation — although market forecasts and bond yields don’t bear this out — while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.

Here is my earlier blog post, T-Bills as a substitute for financial regulation.  Here is my earlier post on monetary policy and bank recapitalization.  I view these as one piece, trying to explain why Bernanke has not been more aggressive with monetary policy along some dimensions.

The Fed (possibly) has foreseen that a scarcity of safe assets is a major macroeconomic problem — most of all in Europe — and has acted to limit this problem in the United States, even at the cost of having tighter money.  That means interest on reserves as a kind of synthetic T-Bills policy.  The interest induces demand to hold liquid reserves, which increases the buffer against a European financial implosion.  You can think of this policy as a substitute for the failure of regulators to get capital requirements right.

Overall, that means a monetary policy having to play the role of fiscal policy and regulatory policy, all at the same time.  No wonder so few people are happy with the outcome.

Through this lens, the Fed looks better, Congress, Dodd-Frank and the financial regulators look worse.  That dysfunctional government prevents an effective fiscal policy response — good and also politically sustainable projects — looks worse too.

Addendum: Arnold Kling comments.

Esther Dyson reports, the link is added by me:

Specifically, Insidr brings together consumers who have practical questions about how to deal with a specific company and (mostly) former employees of that company. For example, you want to know whether you can still get the unlimited-data-roaming plan that your friend has, but the company refuses to give you a straight answer. Somewhere, a former employee (or perhaps a knowledgeable phone-store saleswoman) knows the answer.

This is from Michael P. Keane, from the new Journal of Economic Literature (gated, ungated here), emphasis added by me:

I survey the male and female labor supply literatures, focusing on implications for effects of wages and taxes. For males, I describe and contrast results from three basic types of model: static models (especially those that account for nonlinear taxes), life-cycle models with savings, and life-cycle models with both savings and human capital. For women, more important distinctions are whether models include fixed costs of work, and whether they treat demographics like fertility and marriage (and human capital) as exogenous or endogenous. The literature is characterized by considerable controversy over the responsiveness of labor supply to changes in wages and taxes. At least for males, it is fair to say that most economists believe labor supply elasticities are small. But a sizable minority of studies that I examine obtain large values. Hence, there is no clear consensus on this point. In fact, a simple average of Hicks elasticities across all the studies I examine is 0.31. Several simulation studies have shown that such a value is large enough to generate large efficiency costs of income taxation. For males, I conclude that two factors drive many of the differences in results across studies. One factor is use of direct versus ratio wage measures, with studies that use the former tending to find larger elasticities. Another factor is the failure of most studies to account for human capital returns to work experience. I argue that this may lead to downward bias in elasticity estimates. In a model that includes human capital, I show how even modest elasticities—as conventionally measured—can be consistent with large efficiency costs of taxation. For women, in contrast, it is fair to say that most studies find large labor supply elasticities, especially on the participation margin. In particular, I find that estimates of “long-run” labor supply elasticities—by which I mean estimates that allow for dynamic effects of wages on fertility, marriage, education and work experience—are generally quite large.