Balance sheet balance
The Fed has a huge "balance sheet" -- It owns about $3 trillion of government bonds and mortgage backed securities, which it finances by issuing about $1 trillion of cash and $2 trillion of reserves -- interest-bearing accounts that banks have at the Fed. Is this a problem? Should the Fed trim the balance sheet going forward?
On Tuesday Dec 6, I participated on a panel at Hoover's Washington offices to discuss the book "Central Bank Governance And Oversight Reform" with very distinguished colleagues, Michael Bordo, Charles Plosser, John Taylor, and Kevin Warsh. We're not afraid to disagree with each other on panels -- there's no "Hoover view" one has to hew to, so I learned a lot and I think we came to some agreement on this issue in particular.
Me: The balance sheet is not a problem. The Fed is just one gargantuan money market fund, invested in Treasuries, with a credit guarantee from the Treasury. Interest bearing reserves are perfect substitutes to bonds. The Fed is just making change, taking $20 bills (Treasuries) and giving out $5 and $10 in return. The Fed can easily run monetary policy by just paying more or less interest on reserves.
Plosser: The balance sheet is a big problem. Yes, John's right that interest bearing reserves won't cause inflation so long as banks just sit on them. But will banks just sit on them? Right now, banks don't see enough profitable lending opportunities to care. But if they do, will the Fed really pay enough interest to keep hugely inflationary amounts of reserves from feeding the money supply? What will Congress say when the Fed is paying 3%, 4%, or more to banks to bribe the banks not to lend money to American business and consumers?
Worse, focus on what the Fed is buying not what it is issuing. If the Fed were just buying short-term treasuries John might have a point. But it's buying long term bonds, intervening in the bond market; mortgage backed securities, funneling money to houses. This is credit allocation. The ECB is buying corporate bonds and the BOJ is buying stocks. Congress already raided some of the Fed's assets. So there may not be a big economic problem but there is a huge political economy problem.
(This isn't a quote, and I'm going from memory as we don't have a record of the panel. I hope I'm not mis-characterizing Plosser's view too much. If I am, well, take it as what I learned from the discussion and my own much better sympathy for a countervailing view.)
Taylor: The Fed should not just wind down the huge balance sheet, but it should go back to a very small amount of reserves that do not pay interest. Then it should go back to controlling interest rates by open market operations, and a binding money multiplier. (Taylor, being a lot more polite than the rest of us, did not go into detail on this, but I think he's worried about the Fed being able to control interest rates under interest on reserves (IOR), and whether changing interest rates under IOR with a slack multiplier will make any difference. Again, if this isn't Taylor's view, at least it is a view that I appreciate more after the discussion.)
Well, how to we reconcile this?
I think Plosser is right about the asset side of the balance sheet, and he seems to think I'm mostly right about the liability side. How to square that circle?
I think we would all be happier if the Fed did not keep maturity and credit risk on its balance sheet. Instead, if the Fed really wants to intervene quickly in asset markets and buy anything but short term treasuries (a big if, but there seemed to be consensus that at least in a crisis such purchases might have to be made) then the Fed should swap them to the Treasury within, say, 6 months, so any long-term credit allocation and risk is in the Treasury where it belongs.
(This is, I think, illegal right now. The Fed cannot deal directly with the Treasury, one of many bright little ways our ancestors set up the system to prevent inflationary finance. But that can be fixed.)
And, granted that large amounts of interest-bearing reserves are a good thing -- lots of non-inflationary oil in the economic car -- the Fed doesn't have to be the one to provide them. I brought up again my proposal that the Treasury should issue fixed-value floating-rate small-denomination electronically-transferable debt -- i.e. reserves -- to everyone, not just banks. You should be able to go to treasury.gov and sign up for the treasury's money market fund. All the Fed is doing by buying short-term treasuries and issuing reserves is creating this new class of government debt out of other kinds of government debt. Why not have the Treasury issue it directly? Then the Fed could in fact wind down its balance sheet to near nothing, without losing any of the liquidity and financial stability benefits of interest on reserves.
Plosser seems to go along. Taylor not yet, but sitting on a panel it was hard for any of us to think how this would work in a world of very small non interest bearing bank reserves. (I think it would -- Treasury floaters would not be much different from short term treasury debt from a bank's perspective.)
So we learn from each other on the panel, as well as the sharp questions from the audience. Thanks to everyone who came (and to our second panel on the Blueprint for America), it was a very productive day.
Update
Discussion now available online, embed below, link here. Now we can see how my memory matches up with the facts.
On Tuesday Dec 6, I participated on a panel at Hoover's Washington offices to discuss the book "Central Bank Governance And Oversight Reform" with very distinguished colleagues, Michael Bordo, Charles Plosser, John Taylor, and Kevin Warsh. We're not afraid to disagree with each other on panels -- there's no "Hoover view" one has to hew to, so I learned a lot and I think we came to some agreement on this issue in particular.
Me: The balance sheet is not a problem. The Fed is just one gargantuan money market fund, invested in Treasuries, with a credit guarantee from the Treasury. Interest bearing reserves are perfect substitutes to bonds. The Fed is just making change, taking $20 bills (Treasuries) and giving out $5 and $10 in return. The Fed can easily run monetary policy by just paying more or less interest on reserves.
Plosser: The balance sheet is a big problem. Yes, John's right that interest bearing reserves won't cause inflation so long as banks just sit on them. But will banks just sit on them? Right now, banks don't see enough profitable lending opportunities to care. But if they do, will the Fed really pay enough interest to keep hugely inflationary amounts of reserves from feeding the money supply? What will Congress say when the Fed is paying 3%, 4%, or more to banks to bribe the banks not to lend money to American business and consumers?
Worse, focus on what the Fed is buying not what it is issuing. If the Fed were just buying short-term treasuries John might have a point. But it's buying long term bonds, intervening in the bond market; mortgage backed securities, funneling money to houses. This is credit allocation. The ECB is buying corporate bonds and the BOJ is buying stocks. Congress already raided some of the Fed's assets. So there may not be a big economic problem but there is a huge political economy problem.
(This isn't a quote, and I'm going from memory as we don't have a record of the panel. I hope I'm not mis-characterizing Plosser's view too much. If I am, well, take it as what I learned from the discussion and my own much better sympathy for a countervailing view.)
Taylor: The Fed should not just wind down the huge balance sheet, but it should go back to a very small amount of reserves that do not pay interest. Then it should go back to controlling interest rates by open market operations, and a binding money multiplier. (Taylor, being a lot more polite than the rest of us, did not go into detail on this, but I think he's worried about the Fed being able to control interest rates under interest on reserves (IOR), and whether changing interest rates under IOR with a slack multiplier will make any difference. Again, if this isn't Taylor's view, at least it is a view that I appreciate more after the discussion.)
Well, how to we reconcile this?
I think Plosser is right about the asset side of the balance sheet, and he seems to think I'm mostly right about the liability side. How to square that circle?
I think we would all be happier if the Fed did not keep maturity and credit risk on its balance sheet. Instead, if the Fed really wants to intervene quickly in asset markets and buy anything but short term treasuries (a big if, but there seemed to be consensus that at least in a crisis such purchases might have to be made) then the Fed should swap them to the Treasury within, say, 6 months, so any long-term credit allocation and risk is in the Treasury where it belongs.
(This is, I think, illegal right now. The Fed cannot deal directly with the Treasury, one of many bright little ways our ancestors set up the system to prevent inflationary finance. But that can be fixed.)
And, granted that large amounts of interest-bearing reserves are a good thing -- lots of non-inflationary oil in the economic car -- the Fed doesn't have to be the one to provide them. I brought up again my proposal that the Treasury should issue fixed-value floating-rate small-denomination electronically-transferable debt -- i.e. reserves -- to everyone, not just banks. You should be able to go to treasury.gov and sign up for the treasury's money market fund. All the Fed is doing by buying short-term treasuries and issuing reserves is creating this new class of government debt out of other kinds of government debt. Why not have the Treasury issue it directly? Then the Fed could in fact wind down its balance sheet to near nothing, without losing any of the liquidity and financial stability benefits of interest on reserves.
Plosser seems to go along. Taylor not yet, but sitting on a panel it was hard for any of us to think how this would work in a world of very small non interest bearing bank reserves. (I think it would -- Treasury floaters would not be much different from short term treasury debt from a bank's perspective.)
So we learn from each other on the panel, as well as the sharp questions from the audience. Thanks to everyone who came (and to our second panel on the Blueprint for America), it was a very productive day.
Update
Discussion now available online, embed below, link here. Now we can see how my memory matches up with the facts.
0 yorum:
Post a Comment