1) Marshall Auerback, at New Economic Perspectives, digs into the issue of whether the ECB is legally permitted to engage in the sort of “lender of last resort” activities that many think are key to mitigating this crisis:
The notion that it cannot act as lender of last resort is disingenuous: The ECB does have the legal mandate under its “financial stability” mandate which was provided under the Treaty of Maastricht. True it is fair to say that the whole Treaty of Maastricht is full of ambiguity. The institutional policy framework within which the euro has been introduced and operates (Article 11 of Protocol on the Statute of the European System of Central Banks (ESCB) and of the European Central Bank) has several key elements. One notable feature of the operation of the ESCB is the apparent absence of the lender of last resort facility, which is an issue raised by the WSJ today, and which Draghi uses to justify his inaction. But it’s not as clear-cut as suggested: The Protocols under which the ECB is established enables, but does not require, the ECB to act as a lender of last resort.
Proof that the ECB exploits these ambiguities when it suits them is evident in its bond buying program. The ECB articles say it cannot buy government bonds in the primary market. And this rule was once used as an excuse not to backstop national government bonds at all. But this changed in early 2010, when it began to buy them in the secondary market. The ECB also has a mandate to maintain financial stability. It is buying government bonds in the secondary market under the financial stability mandate. And it could continue to do so, or so one might argue that it could. True there is now great disagreement about this within the ECB. It has been turned over to the legal department, which itself is in disagreement, which ultimately suggests that this is a political judgement, and politics is what is driving Italy (and soon France) toward the brink.
2) Brad Plumer of the Washington Postruns down the reasons (with rejoinders from Paul De Grauwe) why the ECB might be unwilling to step in as lender of last resort (hint: the words “inflation” and “moral hazard” come up a lot).
The Levy Institute’s Pavlina Tcherneva delivered a campus-wide lecture at Bard College yesterday that discussed the Federal Reserve’s policy actions during the crisis and the future of government stabilization policy. The lecture also covered some of the themes in her working paper “Bernanke’s Paradox” (written roughly a year ago), which also appeared in the Journal of Post Keynesian Economics.
In the context of noting Bernanke’s increasingly urgent calls for more help from fiscal policy, it’s worth highlighting this portion of the working paper:
The second key implication of Bernanke’s non-orthodox approach to monetary policy is that, not only is fiscal policy effective (something rejected for decades by neoclassical advocates of the Ricardian Equivalence Hypothesis), but it is, in fact, more potent in recessions. This is because the mainstream has finally recognized that the Fed cannot alone and unilaterally rain money on the banking system … More importantly, from Bernanke’s new interpretation of monetary easing, we can extract one interesting new conclusion, namely that the Fed cannot exogenously expand the money supply without government spending. What this means is that, even if the Fed lent against a wide variety of assets, it may be able to prevent a sell-off or to put a floor on these asset prices, but it will not be able to boost aggregate demand. The only way to do this, according to Bernanke, is via a “gift” from government spending, namely through an injection of net financial assets (net wealth) from fiscal operations.
This is a great graphic put together by Kevin Drum, who calls it “The Ben Bernanke Congress-ometer” (go read the original post for context):
Remember: Ben Bernanke was appointed by George W. Bush. Prior to that he headed Bush’s Council of Economic Advisers. For all intents and purposes, he’s a Republican. It’s interesting to note that, (1) unlike his fellow Party members, Bernanke’s job prospects do not directly hinge on stagnant growth and incomes (in fact, if you listen to the GOP debates, re-election of the current incumbent might provide Bernanke with more job security), and (2) unlike most of his fellow Party members, Bernanke seems not to have abandoned, sometime around January 2009 (a date whose significance escapes me for the moment), the belief that fiscal policy can stimulate growth.
The office of Senator Bernie Sanders (Independent – Vermont) has announced the formation of a panel tasked with drafting legislation to reform the Federal Reserve. Levy Senior Scholars Randall Wray and James Galbraith and Research Associate Stephanie Kelton have been named to the team.
Wray’s recent brief on the Federal Reserve, co-authored with Scott Fullwiler (“It’s Time to Rein in the Fed“), looks at our over-reliance on the Fed (something Wray has discussed elsewhere) and the relative lack of transparency and oversight, wading into issues surrounding democratic accountability and the “independence” of the central bank:
There is no difference between a Treasury guarantee of a private liability and a Fed guarantee. If the Fed buys an asset (say, a mortgage-backed security) by “crediting a balance sheet,” it is no different from the Treasury buying an asset by “crediting a balance sheet.” The impact on Uncle Sam’s balance sheet is the same in either case: it is the creation, in dollars, of government liabilities, and it leaves the government holding some asset that could carry default risk.
…in practice, the Fed’s promises are ultimately Uncle Sam’s promises, and they are made without the approval of Congress—and in some cases, even without its knowing about them months after the fact. [We are not] implying that Uncle Sam would be unable to keep such promises. There is no default risk on federal government debt, and the government can afford to meet any and all commitments it makes. Rather, we are simply emphasizing that a Fed promise is ultimately a Treasury promise that carries the full faith and credit of the United States. Our question is one of accountability: should the Fed be able to make these commitments behind closed doors, without the consent of Congress?
An earlier working paper by Galbraith et al created quite a bit of buzz for its data suggesting the presence of partisan bias in Fed policy during presidential election years (an issue that came up again quite recently), but its main arguments centered around identifying the “real” reaction function of the Fed: namely, that in recent decades the central motivating force behind Fed behavior is a fear of full employment. The paper also reveals that Fed policy plays a significant role in increasing inequality. Read the working paper here. (Galbraith’s 2009 congressional testimony on the Fed is here.)
The bowling alley cannot run out of points, and the US government cannot run out of keystrokes. Research Associate Stephanie Kelton slaps down the folk wisdom that there is nothing the government can do about unemployment because it’s “broke.” “We don’t understand our own monetary system.”
Over the past several decades, many people adopted the view that monetary policy, almost alone, could effectively control the economy. Economists, politicians and scholars came to believe that the Federal Reserve was full of neutral technocrats who dutifully fine-tuned the economy. Through their careful orchestration of interest rates, the money supply and inflation, we assumed that they could guarantee a smoothly functioning economy. Fed officials seemed to do so well at their jobs that they were never doubted. But by depending on monetary policy and discounting fiscal policy as an effective way to secure economic stability, we have created a system that is now dysfunctional.
Randall Wray and Micah Hauptman have a piece in The Hill on the problems with our over-reliance on the Federal Reserve. Due to the fact that fiscal policy is mired in political deadlock (more particularly, expansionary fiscal policy) we may be stuck relying on (inadequate) support from the Fed.
Wray recently wrote a policy brief with Scott Fullwiler (“It’s Time to Rein in the Fed”) that is relevant to this issue. From their one-pager (referring here to QE2): “…it’s truly remarkable that, three years into the crisis, the Fed still has not learned that monetary policy is about price, not quantity. The Fed is buying $600 billion in long-term Treasuries in the hope of bringing down the long-term rate. Yet, if it really understood monetary operations, the Fed would instead announce that it is standing ready to buy as many Treasuries as necessary in order to lower the long-term rate by a desired amount.”
This morning, it was announced that Thomas Sargent and Christopher Sims are the winners of the 2011 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (link to New York Times article here; link to official Nobel economics site here). Sargent and Sims’s approach is often thought to imply, among other things, that monetary or fiscal stimulus is unlikely to be of very much benefit to an economy, even one in deep recession. Of course, the Levy Institute, as a proponent of the Keynesian approach, almost always disagrees strongly with this view on macroeconomic policy, though extreme pessimism about Keynesian stabilization policies is only one possible implication of Sargent and Sims’s extensive oeuvres.
Moreover, the technical aspects of Sargent and Sims’s work are also crucial to neoclassical macroeconomics, and their influence is felt in many ways. Of special interest to me as a researcher is their work on vector autoregressions (VARs), which has led to literally thousands of studies in academic journals, even some authored by heterodox economists. (Sims’s seminal contributions to the VAR literature are the main Sims accomplishment cited in the Nobel committee’s “scientific background” paper for today’s announcement.)
Nonetheless, as with any research in the social sciences, the VAR approach to empirical work in macroeconomics has been subjected to many critiques and revisions since Sims (and to some extent Sargent) got the VAR ball rolling in the late 1970s and early 1980s. continue reading…
In his Congressional testimony on October 4th, Federal Reserve Chairman Bernanke uncharacteristically praised the benefits of fiscal policy, calling it “of critical importance” and conveying concerns with the looming deficit reductions. He cautioned: “an important objective is to avoid fiscal actions that could impede the ongoing economic recovery.”
Many economists expressed worry that such advocacy of fiscal policy will erode America’s (already) wavering confidence in the Fed and will further weaken their support for austerity measures. More troubling still, the economists said, was the possibility that the public may follow suit and start demanding from Congress bolder government action on the jobs front.
A few dissenting scholars thought that it was high time for Bernanke to put his money where his mouth was, so to speak. Among them was Dr. Tcherneva, who had studied Bernanke’s academic proposals for government action during crises and his actual policy moves as Fed Chairman during the Great Recession (2011).** “I am not at all surprised that Chairman Bernanke is making the case for fiscal policy” Tcherneva said. “I am only astonished that it took him so long. After studying his policy prescriptions for the case of Japan, I am left with the nagging conclusion that Bernanke actually favors fiscal policy over monetary policy. And while the reasons for this position are tucked away in his 2000 paper,*** they were nowhere to be found in his testimony before Congress. This too was very surprising. Considering his scholarship, I was expecting a very different speech today” Tcherneva said.
And indeed Tcherneva may have been right. In a breaking development, housekeeping personnel at the Federal Reserve Board building in D.C. have found a crumpled draft of what appears to be the original speech Chairman Bernanke had intended to deliver. In an exclusive, we reprint the original draft below. Paragraphs in bold are the only ones that made it into the final version. continue reading…
Michael Hudson on the ECB and eurozone national central banks’ restricted abilities to purchase government debt:
Their banks have perpetuated the “road to serfdom” myth that a central bank runs the danger of fueling inflation if it creates money – in contrast to commercial banks, which supposedly run no such danger if they create money on their own computer keyboards. It is not considered inflationary for them to charge interest to the government, which then needs to pay by taxing the economy at large.
When you find this kind of distortion being popularized and even written into law, there always is a special interest at work. The supposed contrast between “bad” central banks and “good” commercial banks is a lobbying effort seeking to monopolize credit creation in the hands of commercial banks, by promoting a travesty of how central banks are supposed to act.
The reality is that commercial banks have fueled an enormous asset-price inflation in recent years. The debt they have created imposes an interest burden that deflates the economy – even while adding to the cost of living and doing business. Meanwhile, central banks monetize government deficits that are supposed to spur recovery, not simply be giveaways to financial institutions and other vested interests. …
Whether a bank is private or public, money and credit are created electronically on computer keyboards. So it is a myth that government money is more inflationary. But this myth has a political function reflecting private self-interest: it blocks the “public option” of creating money without paying interest to banks which have obtained the privilege of creating credit freely. They are not lending out peoples’ savings deposits, but are creating deposits much like they used to print bank notes. They then look for customers willing to pay interest.
Hudson, a Research Associate here at the Institute, was interviewed for the “Guns and Butter” radio program on the topic of debt deflation in the eurozone and the US. (Transcript posted over at Naked Capitalism).
According to Alan Blinder, writing in theWall Street Journal, the Fed’s latest operation includes a detail (“the sleeper in the package”) that is aimed at boosting the housing market:
For more than a year now, the Fed has been allowing its portfolio of agency debt (e.g., Fannie Mae and Freddie Mac) and mortgage-backed securities (MBS) to shrink naturally as mortgages are paid off and securities mature. To maintain the size of its balance sheet, the Fed has been reinvesting the proceeds in Treasurys. But starting “now” (the Fed’s word), and continuing indefinitely, those proceeds will be reinvested in agency bonds and MBS instead. The objective here is exactly what it was for the first round of quantitative easing, QE1: to reduce spreads between MBS and Treasurys (which had widened a bit), and thereby to help the ailing housing market.
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