Fed Watch: Policy Adrift

Tim Duy lets loose:

Policy Adrift, by Tim Duy: I understand the Federal Reserve Chairman Ben Bernanke is considered something of a sacred cow, our one point of light in an uncertain world. An academic who cannot be questioned by other academics. A smart person who has mastered the Great Depression and therefore “knows” what to do, and is providing the leadership to do it.

I am beginning to question all of these assumptions.

I am hoping Bernanke can step forward and clarify the direction of policy. At this moment, he has the best perch from which to guide policy between administrations. He has the opportunity to show leadership. But for now, I see a distinct lack of leadership from the Federal Reserve, and it suggests that Bernanke has used up his bag of tricks. And I don’t think that he knows what to do next. Indeed, Fedspeak is now littered with confusing statements that leave the true policy of the Federal Reserve in question.

First, policymakers appear uncertain about what to do with the Fed Funds target. The minutes of the most recent meeting tell the story:

Some members were concerned that the effectiveness of cuts in the target federal funds rate may have been diminished by the financial dislocations, suggesting that further policy action might have limited efficacy in promoting a recovery in economic growth. And some also noted that the Committee had limited room to lower its federal funds rate target further and should therefore consider moving slowly. However, others maintained that the possibility of reduced policy effectiveness and the limited scope for reducing the target further were reasons for a more aggressive policy adjustment; an easing of policy should contribute to a beneficial reduction in some borrowing costs, even if a given rate reduction currently would elicit a smaller effect than in more typical circumstances, and more aggressive easing should reduce the odds of a deflationary outcome.

Considering the forest of trees killed in studying the Japanese experience with ZIRP, one would have imagined that the Fed had already answered the question of how low can they go with the target rate. The answer is zero, and they will head there because they need to look like they are doing something. And we already know that that next 100bp are meaningless in support of economic activity; Jim Hamilton persuasively explained why this is the case here and here. Simply put, debates about the Fed Funds target are nothing more than academic masturbation. I can only imagine the flurry of memos flying around Constitution Avenue as staffers debate the last 100bp as if it was meaningful from a policy perspective. Just cut to zero. Stop the madness already and let the Fed staff go home to see their families.

With the Fed Funds target effectively a nonissue, policy needs to take a different direction. And here again I am supremely perturbed by Fedspeak as policymakers throw around the term “quantitative easing” as if it were candy on Halloween. The minutes seem to make clear that quantitative easing is not the current policy. There is no mention of the quantitative easing in the minutes themselves. The only mention is in the forecast summary:

Some participants noted that further monetary policy easing could eventually become constrained by the lower bound of zero on nominal interest rates, in which case an elevated degree of uncertainty might be associated with gauging the magnitude and stimulative effects of other policy tools such as quantitative easing.

It appears to make clear that the Fed has not yet officially initiated quantitative easing; it is relegated to the status of “other policy tools.” Indeed, no target has been announced. Nothing to the effect of “we are going to make unsterilized purchases of Treasuries until the rate on the 10 year bond declines to x%.” Or “we are making $xx billion of unsterilized bond purchases each week until the policy objective xx is achieved.” Those are explicit quantitative easing policies. What we have now is an expansion of the balance sheet to accommodate liquidity measures. This may pave the way to quantitative easing, but still maintains the Fed Funds rate as the primary target.

But then why do they keep saying they have a policy of quantitative easing? This first crossed my radar when reviewing a recent interview with Dallas Federal Reserve President Richard Fisher. I discounted his reference to quantitative easing as Fisher is something of a colorful character who often talks before he thinks. But subsequent policymakers repeated the term. Earlier this week New York Fed President Gary Stern was quoted by Stephen Beckner:

Asked whether the doubling in size of the balance sheet represents "quantitative easing," Stern said "I don't think that's a bad statement. I think the world is a little more complicated than that, but I don't think that's a bad statement."

Federal Reserve Vice Chairman Donald Kohn was more somewhat more noncommittal today. Or not. Via Mark Thoma:

Meanwhile, Kohn added that the Fed has “already” engaged in forms of quantitative easing, and “we should be looking carefully” at the effect that could have “as a contingency plan should that still-remote possibility, but I think less remote than it was, occur.” ... He said the Fed hasn’t abandoned monetary policy in favor of quantitative easing, noting the Fed’s recent reduction in its target federal funds rate. “I don’t think we’ve given up on one in favor of the other,” Kohn said. He also said there’s no “arithmetic” reason why the Fed can’t “blow up” the size of its balance sheet, which has already swelled in recent weeks to over $2 trillion.

Apparently what Fed officials think is that they 1.) already engaged in quantitative easing, 2.) doing something like quantitative easing, or 3.) might be doing quantitative easing or interest rate targeting, but are not sure which. One can only conclude that Fed officials do not understand their own policies. Policy is adrift. Be afraid; be very afraid.

Mark Thoma also points us to Rebecca Wilder, who points us to former St. Louis Federal Reserve President William Poole. Poole suggests that the Fed has already committed to quantitative easing,

William Poole … accuses the Fed of not being transparent and shifting monetary policy without announcement. Although he does not speculate as to what the new policy is, he does state that by not announcing its new policy, the Fed is breaking the law.

According to Poole: “Something is happening at the Fed that has not been announced.”

Could the Fed really be hiding a policy shift in some bizarre attempt to generate an unanticipated positive shock? If so, yet another forest of trees was killed to disseminate research on the importance of transparency in policymaking, only to have that research ignored by the policymakers who wrote it.

Ironically, I would be somewhat comforted to learn that the Fed does have a coherent, albeit unannounced, policy change. The alternative is what I suspect – Bernanke cannot elucidate a coherent policy strategy to his organization because no such strategy exists. What does exist is a potpourri of policy responses that amounts to providing liquidity at all costs, the outcome of Bernanke’s research on the Great Depression. Beyond this, the Fed is stuck in a netherworld of dual policy targets – not ready to admit the loss of the interest rate target, not ready to adopt a formal policy of quantitative easing.

Moreover, what is absolutely maddening is that Bernanke had an opportunity to dictate a course of policy that had some hope of bringing resolution to this mess – the now dead TARP. While Treasury Secretary Henry Paulson is rightfully criticized for his erratic policy choices, remember that Bernanke was Paulson’s handmaiden throughout the process. Recall Paul Krugman:

So now the whole rationale for the plan is “price discovery”: we’re going to throw lots of taxpayer funds into the pot because that will let us find the true values of troubled assets, which are higher than the fire sale prices out there, and so balance sheet will improve, confidence will return, etc, etc..

So I just did a Nexis search trying to find out when Paulson and Bernanke started talking about price discovery, which we’re now told are at the core of the plan’s logic. And the answer is …

Yesterday.

I can’t find any use of the term, or even a hint of the argument, until yesterday’s Senate hearings.

One possible explanation. It wasn’t until yesterday that they realized that it would actually be necessary to explain themselves.

But there’s another possible explanation, which I find terrifyingly plausible: the plan came first, and all this stuff about price discovery is an after-the-fact rationalization, invented when people started asking questions.

It has seemed very strange to me that such a supposedly crucial economic program would be based on such an exotic argument. My sneaking suspicion is that they started with a determination to throw money at the financial industry, and everything else is just an excuse.

This attempt at financial engineering, using auctions to allow “price discovery,” could only have come from an economist who spent more time dealing with equations than people. Unnecessarily complicated.

I think that the basic element of the original TARP plan – the removal of bad assets from the financial system – was a part of an appropriate policy path, but needed to be combined with equity stakes and recognition that the taxpayer would likely bear a cost. For example, the Treasury purchases mortgage assets at a high price, thereby recapitalizing the financial firm. In return, the Treasury receives an equity stake that dilutes that of existing shareholders to zero. Replace existing boards and top management; bar management from future employment in financial services. Treasury then auctions off the troubled assets into the financial markets (just forget about managing the portfolios until prices recover; let the assets reenter the system at a price that almost ensures an upside). The taxpayer eats the difference, but will be at least partially compensated in the future when the Treasury floats the equity stakes back into the market. This process is legislatively dictated; financial firms who hope to be allowed to continue to operate in the US would be effectively forced to participate.

To be sure, I make no promise that the taxpayer will walk away clean, but compared to the risk that the financial sector hobbles along forever, it would be a reasonable cost. Instead, the Treasury, apparently with the Fed’s blessing, use the TARP options of equity infusion (forced onto Paulson and Bernanke), and did only a portion of the job with a partial recapitalization. The nonperforming assets remain trapped in the system, threatening to create zombie banks. Bernanke might not be making the same mistakes as the Fed in the Great Depression, but it is starting to look like he is not willing to fundamentally address the problem of sour assets. Doing just enough to keep banks alive looks a lot like a mistake made in Japan. I am surprised that New York Federal Reserve President Timothy Geithner would accept such a plan; he understands Japan’s lost decade as well as anyone.

I think it is high time some real critical attention was placed on Bernanke. How complicit was the Fed Chairman with designing and implementing a clearly failed policy? Yes, one could argue that the ball was in Treasury’s court. But didn’t Bernanke have a duty to make TARP work, after he begged Congress for the plan? And isn’t he the one person who could stand up and say “No, Paulson is screwing this up”? Paulson will not be Treasury Secretary in January, but Bernanke will still be Fed Chairman. Bernanke can and should step into what is so clearly a leadership void. What does he owe this administration at this point?

In short, we need policy leadership. Bernanke is positioned to provide it. But will he? As of now, policy is adrift. FOMC members don’t seem to agree on the role of effectiveness of the Federal Funds target. Some think they are already engaged in a policy of quantitative easing. Some think they may be in something that looks sort of like quantitative easing. Kohn seems to think they are following two policies. Ex-FOMC member Poole is certain that they are hiding a policy change. In the meantime, while Fed officials publically debate the intent of their own policies, investor confidence is collapsing. Bernanke needs to step forward and define policy. We need to pressure him into providing that leadership - or to step aside for someone else to do it.

Comments

[Selah]

At least we are on the same page. Yes, the Fed has tried and failed and the market is still in the downturn. Monetary policy with Fed Fund Rate flucuation currently is not working. Why not lets the Keynesian stimulus package do the rescue. Give it sometimes and be patient and Ben Bernanke maybe need to stay out!

[JKH]

This rant would have been more useful if you'd provided your own definition of quantitative easing.

[ccm]

There's an important fact left out here. In order for the Fed to protect the money markets, Bernanke needed Paulson's help: first to fund him with Treasury bills and second to support him when he went to Congress for the authority to issue interest on reserves. From a WSJ article a week or so ago it sounds like, in exchange for Paulson's support of the Fed, Bernanke agreed to support Paulson's TARP.

I suspect that Bernanke's had a brutal political situation to deal with, and thus I hold out hope that economic policy will become much more coherent over the next few months.

[mmckinl]

Anyone who knows banking and knows the history of the Depression knows that the current crisis was tailor made for an FDR type Bank Holiday whereby the solvent were maintained and the insolvent liquidated.

Didn't Bernanke study the banking crisis during the Great Depression ? So why isn't he cleaning up the banking system with a bank holiday or Swedish Plan? Cronyism at its worst.

[esb]

Duy, my good man, just exactly of what are you "afraid, very afraid?"

A rise of unemployment to 10%? 12%?

A fall of the S&P 500 to 745? 605?

Youthful gangs roaming suburban streets and entering supermarkets to steal meats at gunpoint (as in Argentina in 2002)?

War?

Exactly what do you fear?

[calmo]

Investor confidence is collapsing?
But on account of BB's performance?
I think Tim represents the academics here who were so hoping that brains and historical knowledge would make a difference...B that miracle.
Listening to BB, I only hear honest anxiety (where Tim hears confusion and maybe duplicity). And I prefer that to HP who prolly bully's himself when he has no other audience.
My nibble:
Paulson will not be Treasury Secretary in January, but Bernanke will still be Fed Chairman.[why do I think his days are numbered?] Bernanke can and should step into what is so clearly a leadership void. [The Greenspan Legacy, yes? The Maestro turned Disaster leaves the field in ruins...and that dapper knight in shining armor?...over-whelming and over-whelmed ] What does he owe this administration at this point?[His political bent, unlike Greenspan's, dwarfs his academic side. He tolerates his unfortunate circumstances...unlike some of his critics, you know?]
For some of us, it is not an easy time, these "interesting times".

[hari]

TD is finally confirming - what I've always believed during my days under Myrdal - monetary policy ( Fed 500 econometric genuis and their models - cannot be anything more than a dismal science during recession.

As they say, the taste of the pudding is in the eating!

BBs/Fed can't actually deal with current policy constraints -fiscal stimulus (a la Swedish model or something like it) may, and it's a guess, have some traction at this stage of global deleveraging/deflationary trend which is spiralling across EU and Asian financial markets.

Couple of months ago, this current scenario was out of focus, BB was in control of monetary policy going forward.
Now TARP is a complete policy mess; Japanese style deflation is raising its ugly spectacle globally.

[hari]

Calmo - it's time for bed! Get some rest - while I rest the
argument BB is honestly doing what he can - I agree.

[hari]

In retrospect, blame game by TD and similar academics will not deter the deteriorating macro conditions from spiralling out of control - of Fed and Treasury.

It took some three decades or so for this (toxic) financial brew to be concocted by Libertarians and neo-libertarians. They're a sleep when it was honky dory and the upside had no barriers - whatsoever. They're all on the bandwagon of Pax Americana or whatnot.

[mmckinl]

hari,

It will be of most importance what the Fed and Treasury do as to how soon we get out this mess and what shape we are in.

We could emulate Japan and be crippled and suffer for 15 years ... or ... emulate Sweden and Norway and suffer 3 or 4 and recover very well.

[a]

Duy's my man!

"I am beginning to question all of these assumptions."

I'd like to say, And not a moment too soon. But I think the train has already left the station, and the massive amount of damage that Bernanke has done to the U.S. economy can't be undone.

[Gegner]

Once again, full marks to a! I don't know what it takes to get Bernanke to step down but he's fighting the last Great Depression and this one is nothing like it!

Nothing the 'gruesome twosome' (Mr.s Bernanke & Paulson) has has a positive effect on the economy (although Mr. Paulson's employment prospects are definitely brighter...)

In a 'global' slowdown it will be every nation for itself.

They'd (our creditors) would be absolutely delighted to bury us under a mountain of debt.

It's time, methinks, to give them a stiff middle finger.

It's not our fault that criminals got the better of them.

We'd be more than happy to extradite the miscreants for prosecution if that's what it takes to make them happy.

But the 'solution' to our manufactured crisis involves hitting the 'reset button', instituting a new currency regime...one where a dollar is a dollar no matter where its minted.

Um, if we're serious about putting an end to corruption, there will be no such thing as a 'tangible' dollar (currency)...since all crime is 'cash & carry'.

Which is to say that 'new' dollars would be non-transferable.

When you 'spend' your money it is merely erased from your account, nobody gets it.

Since the 'goal' of commerce is to provide society with goods and services there is no need for commerce to operate on/for profit. The providing of goods and services are 'profit' enough.

It also 'solves' the central 'contradiction' of capitalism.

If we are to prevent years (if not decades) of needless suffering, (not to mention civil unrest) we need to alter our system of commerce.

[hari]

I suspect BBs/Fed is trapped in GWBs *democratic capitalism*.

While Sarkosy is speaking for EU-27, he has now convened a separate global meeting, in Paris, Jan'09 (before inauguration of BO) with Blair. They're inviting left-of-centre intellectual (economic) breed to inspire their global discourse on future of international finance and economics.

Me thinks it's bridge Sarkosy is building to offset free market capitalism, and replace it with something more palatable to EU-27. G-20 Summit didn't allow it under GWB.
Japan supported US and didn't allow anything on US dollar hegemony in the final declaration - China in particular wanted it in the Declaration (People's Daily).

There is historical (cyclicality) evidence for this type of mental hemmoraging across the Atlantic - so my guess is Europeans are getting fortified for a global regulatory regime (fortress!) to oversee all financial markets.

Chinese and Indians will not object if they're allowed to protect their infant industries (and a bit more). My feeling is that Scandinavians, in particular, along with Holland, might find it counter-productive for global (GDP) growth to return after this mighty recession and deflation.

[Beezer]

Two things I know. One, those involved in the bankruptcy business are going to do very well the next couple of years.
Two, the government is going to spend a lot of money on unemployment payments.
As for anything else, it's only a wild guess.
Fiscal stimulus is a good idea, even though it goes without saying the government will misallocate quite a bit in order to cement political alliances.
Energy and sustainability reformation are also likely to be attempted, although here again government is likely to misallocate often.
Meanwhile, consumption is likely to keep shrinking, and to keep concentrating on citizens' newfound understanding about what they spend money on first and foremost--without the use of credit.
For the next couple of years, it should probably be considered a success if the gears of commerce simply keep functioning, albeit at a reduced level.

[FairEconomist]

Bernanke is trying to maintain high asset values (which requires low real interest rates) and inflate (which requires high nominal rates). This is a policy that would "normally" drive inflation very rapidly - which IMO would generate a whole host of other problems - high inflation is a very bad thing, especially for the world's reserve currency. But, in a liquidity trap, you *can't* have low real and high nominal rates, so Bernanke is spinning his wheels, dumping out liquidity the banks don't dare lend because of the risk of asset prices falling to fair levels.

Bernanke should adopt a mild quantitative easing policy, *raise* interest rates to the point that the policy will work, and explain what he's doing. What he's probably afraid of is that following this rational policy would likely drive asset values to more rational, lower, levels, and this would expose further insolvency in the banking system and result in his banking buddies mostly losing their jobs when the FDIC ends up seizing the bad banks. At some point I'd hope that he'd put saving the country from a deep depression ahead of getting a few more years of high salaries for current bank managers; but the conduct of the TARP so far dims my hopes considerably.

[yamada]

New system as below is needed, unless the price of real estate hit the bottom. FRB must play a significant role, together with the government:

Why not make use of FRB’s profit generated by their printing dollars? In this model, it won’t cause inflation. In this model, the printed dollars won’t be withdrawn, because each economic unit(including bank) legally forced to write-off next economic unit that they hold credit.

Bubble is caused by peoples’ expectation that the price of asset(real estate) will rise in future, with pouring high-powered money to the asset side of economic units’ balance-sheet. So, to solve this problem, such asset bubble on economic units’ balance-sheet must get ridden of, by the new system as below. Though it may be seen contradictory, high-powered money enables to work this new system. Please remember, no one has ever invented the solution in history.

1. Every economic unit’s(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic units.
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all.
4. Other economic unit that gets profit from the written off by the bank should next enforced to, by using the profit from the written off as original fund, write off it’s loan(or trade claim) to its each debtor, according to the amount of insolvency of each debtor. If the economic unit is unable to use all profit it earned, the remainder is taxed all. These processes are to be repeated operationally.
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. The tax claims is finally assigned to FRB. It’s up to FRB how they dispose of their above claims, considering the situation of economy, of each bank and of each economic unit. Talking about the latter two, as a option the FRB should examine the possibility of the bank’s and economic units’ turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic unit(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic unit), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and tracable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic unit, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic unit that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic units, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. In case inflation expectation exists(not now), the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic units.
10. FRB should carefully watch the rate of the number of insolvent economic units to the number of all economic units in the US, when deciding the amount of the loans(trade claim) written off on 2.
11. FRB print greenbacks(which bring about profit) correspond to the write-offs, which return to FRB as tax claim, so these greenbacks could be stored to the safe in FRB forever.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

(The above is "Yamada System")

[bakho]

Absent a much better fiscal and regulatory policy coming from the executive branch, the Fed policy options are limited. As we slide into liquidity trap territory monetary policy becomes ineffective and fiscal policy must become dominant.

Without better fiscal policy, there will be no good monetary policy options. Unfortunately, monetarists are ideologically opposed to admitting inadequacy in some situations.

[kharris]

I continue to wonder why Duy gets so much attention here, given his his own faulty record as a critic of the Fed through the recent period. He starts, once again, by making his critique about Bernanke, suggesting Bernanke doesn't know ... something, but it's not clear what.

Holding up the minutes as evidence of Bernanke's failure of leadership makes little sense. The minutes reflect the discussion of everybody of rank in the room at an FOMC meeting. That discussion is suppose to take place. It is by no stretch of the imagination a reflection of failed leadership that troubled times lead to uncertainty. Duy either doesn't understand that or is making a facetious argument.

If we think back a very few years to the Greenspan era, we find much stronger "leadership" in the sense that Greenspan was the voice of the Fed, to the point of creating a cult of personality. He spoke out against federal ownership of private assets in a way that clearly lent support to fiscal imbalance. He spoke out against regulation in a way that clearly led to federal ownership of private assets. Bernanke set about correcting that mess. He promised increased Fed transparency. Those undertakings will undoubtedly carry a price. It is not at all clear that the price will be too high.

It is also a bit misleading to point to uncertainty among policy makers as evidence of a lack of leadership. Do we want Bernanke leading us off in a direction he is unsure of, merely for the comfort of seeing him demonstrate leadership? Do we want the minutes to gloss over the actual events of the FOMC meeting? Bernanke has, after all, massively reshaped the Fed's role over the past year. No leadership there, I suppose. He told Congress he might stop hiking rates before inflation stabilized, and took a pounding in the press for it, but that proved in the end to be a pretty good call. But that's not leadership. After saddling up with Paulson to deal with the bad asset problem, he has struck off in his own direction when he could no longer support the administration view. No leadership there, I guess.

I have made the point before, and will do so again now. Everybody makes mistakes, so the fact that Duy was recently more wrong about the short-term direction of the economy than Bernanke was doesn't set Duy apart from the rest of the prognosticating world. What I object to is the high-falutin' tone and the frequent drift into convenient analysis. Surely, after so recently having been on the wrong side of appropriate Fed policy, Duy should indulge in a little humility now in critiquing the Fed. One should always prefer a legitimate argument to a convenient one. The "lack of leadership" argument seem to ignore an awful lot of Bernanke's record.

I realize that Duy's opening paragraph aims at innoculating him against the very sort of thing that I've written here. I must be one of those people who think criticism of the new Maestro is taboo, right? Don't bother with that nonsense. Bernanke is fallible. No question. Duy has, however, proven even more fallible. He needs to get down off his high horse and ask a simple question of himself. Having demonstrated that second guessing the Fed can leave any of us looking foolish, what does he recommend as an alternative to letting Bernanke do the job he was hired to do? We obviously don't want policy-according-to-Duy. Sneering won't generate interbank lending. Weekly "feet of clay" editorials won't stop the loss of jobs. What "leadership", short of charging off in some direction just to show a direction, would Duy like to see?

[Bob_in_MA]

Bernanke's apparent conclusion about the Depression was not just that the Fed made errors, but that a proactive monetary policy could have prevented things from getting as bad as they did. And it seems he's trying the various actions he'd imagined the Fed could have used in the 1930s. But there are others who have always felt that while the Fed made plenty of errors, the Depression was inevitable given the imbalances.

When this is over, just about everyone may be in the latter camp.

The idea that there is a path that will prevent calamity if only the correct choices are made (about TARP, etc.) may just be a fallacy.

[Barkley Rosser]

I am willing to defend BB here. Since August 2007 he has come forth with an amazing array of innovative policy responses, which nipped a succession of crises in the bud. Unfortunately, none of these were able to solve the underlying problem (collapse of overpyramided derivatives markets going bad due to a collapsing housing bubble in the US). If there was a mistake, it was in not managing to slow or halt the housing bubble earlier.

By September and the collapse of Lehman and AIG, indeed the Fed had run out of arrows. It was too big, and that is why BB was shouting in a phone at Paulson. Now we have the Fed playing effective world central bank, having emptied out its holdings of Treasuries and taking on all kinds of dodgy foreign paper to keep the whole system afloat, backed by the Treasury. This has been the ultimate policy tool, a complete transformation of how the Fed operates, taking on a global role in the absence of true global central bank. It is a dazzling performance, even if in the end it fails to save us from a very bad recession or even depression.

[baileyman]

Bernanke may be a student of the depression, but doesn't he come to the problem with a neo-liberal orientation that may tilt his conclusions?

[Less Than Zero]

"The answer is zero, and they will head there because they need to look like they are doing something."

The US does not have the Japanese postal saving system to fund businesses. Short term corporate financing is done largely via commercial paper, and going to zero here could shut down the commercial money markets. Money market funds would not be able to meet their expense ratio while maintaining $1.00 per share. This would undo the money market guarantee program, and make funding short term corporate paper problematic.

The root of this problem is world savers will not loan to private entities, especially US private entities. Neither qualitative, nor quantitative easing will entice foreign savers to loan to US private entities. The main point is still being missed, which is to reassure foreign savers that US private entities will pay them back (in real terms).

"The nonperforming assets remain trapped in the system, threatening to create zombie banks."

The non marketable loans need to be removed. However, future brokered loans must be marketable overseas for lending to recover. This means higher lending standards, not lower. It means complete disclosure of credit risk. Foreign savers must be convinced that the numbers are complete and accurate.

[ken melvin]

Passingly strang4e to discover that those who preached of the miracles of markets aren't really believers themselves; on the other hand, I guess it's not.

At the core, a monetary policy based on a model of low interest equals investment is based on a non-functioning model.

[Low]

"At the core, a monetary policy based on a model of low interest equals investment is based on a non-functioning model."

That appears to be the case. After a slight blip up in the 2nd quarter (they couldn't borrow anything), the US personal savings rate is again dropping. Domestic supply of savings does not equal demand for credit when rates are too low.

http://www.bea.gov/briefrm/saving.htm

We are dealing with the aftermath of depending upon volatile foreign savings now. It leaves at the first sign of trouble, and the credit system shuts down. Its too bad that savers don't exist or matter in the models policy uses.

[Alfred]

An academic drizzle where one academic criticizes another one. What difference does it make if the Fed does QE or is still targeting FF. The actions of the Federal Reserve are absolutely meaningless at this point. They can do nothing to avert the crisis that is upon us and is just getting worse. Their only effective action is to provide a liquidity backstop for capital constrained (semi-)financial institutions to avert a systematic collapse of the whole banking system, at least for now. All central banks are basically at 0!! at this point and practice QE, the Target rates will follow in due time.

A more meaningful point would be to discuss the justification of the Federal Reserve Bank system and their statutes. The lack of transparency and independence of this institution has brought us this misery in the first place. I am amazed by how ignorant the sc experts are on this subject matter as if the harm inflicted would not be enough already. Poole and some other wise man at the Cato Institute were identifying excessive leverage, the private sector and maybe lack of regulation as the bad boys causing this malaise, and yet they failed to recognized the felonious mistakes taken by the FOMC itself. I guess it just proves it is easier to swipe in front of your neighbors door then ones own.

[dd]

It's time for Bernanke to step to the plate.
Bernanke has much power under the abysmal Gramm Leach and he ought exercise it. Paulson has had his bid to save OTC derivatives and the failed CMO/CDO structures (slicing and dicing bad mortgage/loan pools into "bonds" with clawbacks to a SIV "insured" with CDS to attain creditworthiness and avoid regulatory reserve provisions was imprudent at best). The entire structure was designed to generate banking and other professional fees. It violated the basic regulatory tenets (prudence, protection, and economic purpose), undermined professional ethics, blurred distinct legal structures into a whole so confusing that it takes months to dissect counterparty positions, and ultimately confidence in the entire system.
Time to hit the reset button and Bernanke can do it with the broad powers the Fed has over bank holding companies. No fan, as he bought into the derivatives magic; but enough has been expended on the virtual. The real economy needs to be saved.

[dd]

Might add that one of the lessons of the GD was efforts to restart the securities magic failed and wasted precious time and resources.

[esb]

I suggest that ya'all take a look at the instant action in F and GM as the drama moves to its inevitable conclusion.

What I hear is that the suppliers are starting to refuse shipment of parts and other materials, putting the "forks" in.

Game over.

I had an interesting discussion with someone many of you probably know over at NTRS last evening and he opined that following a failure of GM/F the upper midwest could see entire towns essentially vacant.

Vacant towns ... now that is something of which to be afraid, very afraid.

[JKH]

Barkley Rosser,

Nice rational counterpoint to an overly charged post.

[Winslow R.]

I sympathize with Duy's frustration, but do wish it had appeared earlier.

Quantitative easing will have no effect on the 'real economy' as long as the 'real economy' lacks access to the Fed.

Ben Bernanke has redesigned the Fed but has so far failed to take it towards its logical conclusion, citizen access.

Ben Bernanke allowing State access to the Fed would be a huge step forward and would help relieve pressure on the economy while giving the Fed greater control over the economy once a recovery does occur.

I'd like to see more discussion on specific policy proposals the Fed could implement, perhaps this Duy post is the opening salvo.

QE and FF rate manipulation, with the current Fed structure, are useless given the broken monetary transmission mechanism.

This has been obvious for years. The Taylor-rule driven target is a hilarious example of what is so wrong with today's understanding of the financial system. The linkage between the FF rate and the real economy is just not there no matter how many times we clap our hands.

The FF rate is a brake, not an accelerator.

Intermediators between the Fed and the real economy are not there to protect the value of money but rather to suck vital life from entrepreneurs.

Just because those same intermediators splash a few dollars upon economists shouldn't make them lose their sense of professionalism.

This is more bad news.....

" Obama picks Orszag, who has written on the dangers of rising deficits
> for interest rates, and on the government’s fiscal “gap” into the infinite
> horizon, to head OMB.
>
> ”Peter Orszag, the head of the Congressional Budget Office, was picked
> to head Obama’s Office of Management and Budget, a top Democratic
> source told CNN on Tuesday. Orszag worked at the Clinton White
> House as special assistant to the president at the National Economic
> Council and served on the Council of Economic Advisers.”

http://www.moslereconomics.com/2008/11/20/re-obamas-pick-for-omb/#comments

[calmo]

Great expectations...facing mark-to-market writedowns, but not here.
Thank you all for letting me see this mo better.
..what to add to this discussion without messing up what I think is a pretty fine example of chairmanless leadership.

Ok, this B it, the addendum: in kharris's exquisitely written post we hear her disappointment/frustration/anger with TD's performance (present, past and future)...not unlike Tim's (present and possibly future) disappointment with Bernanke's performance, yes?
You figure that might soften kharris up a little? I'm hoping.

Anybody else need softening up? Barkley? It is a dazzling performance, even if in the end it fails to save us from a very bad recession or even depression. This is not the piano...and TAF, TARP, etc need to be judged on something more than their novelty. Without some efficacy "dazzling" = "spectacular" (a la Gary Trudeau's description of Trump's most recent wife)...we need the dazzling bridge to...bridge.
Ok, I still have great expectations for youall.

[calmo]

Time to thank dd for informing us non-professionals.

[JKH]

kharris,

Excellent counterbalance. Thanks for a thoughtful and fair comment.

[Patrick]

Setting aside Occam's razor and putting on my tin foil hat:

According to Krugman, one of the conditions necessary to get out of a liquidity trap is to create the expectation that the central bank will be mildly irresponsible with respect to inflation. Could all this confusion be a clever ploy by Ben et. al. to manipulate expectations?

On second thought... that's too far fetched even for the tin foil hat.

says...

Im in shocked disbelief that Alan "Bubbles" Greenspan and Ben "Helicopter" Bernanke did not and do not know what they are doing! They both exude the gravitas of a banker and use big words. They ignored sound banking regulation principles and flooded the world with cheap money. Bankers. Sheeesh. What's the problem? What else are they gonna do? Who's complaining about it now?

[Bruce Wilder]

Yes, good counterpoint, Barkley.

I have always been a skeptic about Ben Bernanke, because I think he was fundamentally wrong about the Great Depression, so I have not had to have the scales lifted from my eyes. Bernanke is a reactionary conservative, whose "idea" about the Great Depression was that countering the deflation would have been enough to preserve the plutocracy's privileged position from collapse and restructuring. Provide enough of a monetary expansion at the moment of de-leveraging, and all can go on as it has, fundamentally unchanged. Most importantly, an extreme distribution of income needs not to be reformed.

Barkley offers, "If there was a mistake, it was in not managing to slow or halt the housing bubble earlier." But, of course. No bubble, no collapse. But, no bubble? Hank Paulson would not have come to the Treasury with $500 million in his personal pocket, without that bubble. The Bush Administration would not have witnessed some kind of business expansion. Hmmm.

And, too many seem to think that the collapse of the housing bubble can be usefully slowed or halted, even if they think its inflation could not be even detected reliably. That's crazy talk, of course, but it is common.

Tim Duy has revised his thinking about the now discarded TARP, but I cannot say he persuades me on this point. The banks could sell their toxic waste into the private market, if the private market knew what it is worth. Accelerating the data collection and analysis in valuing MBS would have been a worthwhile project -- would still be a worthwhile project. Fannie and Freddie are well-staffed and well-equipped to do the job.

But, ultimately, the economic problems require restructuring, not just more liquidity. Deep, pervasive restructuring. Profound changes in the distribution of income, and a reduction in the concentration of income at the top. We cannot be paying bankers, let along auto execs, tens of millions per year, and expect systems to survive the adverse incentive pressures of rewards of that magnitude. We cannot so favor the financial industries, while destroying manufacturing, and have the economy "prosper".

[lark]

ultimately, the economic problems require restructuring, not just more liquidity. Deep, pervasive restructuring. Profound changes in the distribution of income, and a reduction in the concentration of income at the top.

In the tangled frightwig that is our interconnected world, changes in the distribution of income will have to come from changes in the job mix. Less finance - and more manufacturing. Less real estate - and more manufacturing. Adding manufacturing jobs in the USA implies a wrenching transformation in BWII. That's going to be tough.

[K Ackermann]

Here is how a simpleton such as myself views what is going on:

Fed/Treasury announce they will do anything needed. They create a slew of facilities and rush to congress to get money fast!

They double the balance sheet.

They announce TARP is misnamed, and won't be purchasing troubled assets, but instead will be providing liquidity.

They announce they will not ask for the other $350b.

Now, the last two points, from this simpleton's POV, sound just like they are giving up. Credit is starting to lock up again, and I am hearing none of the "will do anything" talk from the government.

If you squint real hard, you can almost see capitulation by the government. Almost as if they are going to let the free market work its magic.

Painful? You betcha!

[macburger]

Bruce W
Bernanke is a reactionary conservative, whose "idea" about the Great Depression was that countering the deflation would have been enough to preserve the plutocracy's privileged position from collapse and restructuring. Provide enough of a monetary expansion at the moment of de-leveraging, and all can go on as it has, fundamentally unchanged. Most importantly, an extreme distribution of income needs not to be reformed.

Perfectly stated.

[Bruce Wilder]

The collapse of housing values, and the discovery that a lot of mortgages were badly underwritten, triggered a massive de-leveraging of securities, founded on mortgages. The Fed and Treasury tried to meet that crisis, by financing a fall back from the shadow banking sector to traditional, commercial banking.

I suppose that the hope was, that the "panic" -- the "crisis of confidence" -- would pass. That is, that this would remain strictly a financial or banking event.

Well, it didn't. I have no idea how anyone could look at the disappearance of $8 trillion in housing wealth and think that consumer confidence would not be affected, but they didn't ask me.

Now, the real economy is tanking across the board. The "de-leveraging" that follows is a decline in the stock market, and a series of major, major bankruptcies. We're no longer trying to figure out which banks are sound. We're sorting out which firms will survive. Good-bye, Circuit City; hello, Best Buy.

Of course, the out-going Administration is giving up. The Bush recession is now the Obama depression. And, the "risk" to the economy is no longer the completely unexpected crises of the last 8 years; now the risk to the economy is the anti-"free market" policies of taxes and regulation of a Democratic Administration.

[S]

bernanke is nto a conservative first of all.

bernanke is also an abject failure.

Tim geitner has overseen the destruction ans will be as significant a failure.

the solution is getting all these guys out of the equation and imposing a rational perosn who underatnds that there is no fancy trickery to make this thing go away.

the rational choice is to raise rates shake out the bamnkrupt take the pain and begin the rebuild.

Instead we will get false confidence in a strong dollar while the debasement ensures. In short order another CARP (as in scurrency devaluation) will be shoved down the US taxpayuers throat in the name of killing it to save it.

The fact that paulson and bernanke are even part of this solution is a joke in itself. The guys who created the problem are going to fix it.

rinse wash repeat.

[hari]

FT/Buiter - *Re-Lend It or Lose It*

This is innovative and may facilitate inter-bank lending if implemented by Fed/CBs.

Worth discussing/debating, me thinks.

[craig tindale]

the Fed should have always had a private debt target, the bubbles are easy to see in debt levels, when debt to income levels hit historic highs and these are coincident with asset price bubbles then a high school student can join the two.

Bernanke studied monetary policy in the depression, he just about missed all the context of that monetary history

anyones that read Bernankes work knows hes a radical dressed up in conservative clothing, his work on monetary transmission through asset channels is a case in point, here we have a fed governor who wrote papers in 1997-99 about stimulating consumption by stimulating asset channels via lowering the cost of credit, a fed governor that openly discusses stimulating asset and credit growth as a policy tool while debt to income ratios are at all time highs.

Thats not conservative its plain and simple stupid

stupid get what stupid does

[kthomas]

The more I look at this, it seems to me the Bush Amdin (Dick Cheney) wanted this situation. They always seem to make money from the misery of others.

[David M. Dickson]

Gary stern is president of minneapolis fed, not ny fed, whose president it tim geithner (sp?), for what it is worth

[Winslow R.]

While I agree credit growth through asset based loans may be Bernanke's favored transmission mechanism, I don't think its ALL 'plain and simple stupid' given he is in charge of monetary policy and doesn't have many other options.

Increasing asset prices is a lot easier (just ask an appraiser) than creating new assets.

Any ideas to improve the mechanism to reach that private debt target?

[Barkley Rosser]

Regarding all this talk of Bernanke and Geithner as failures, allow me to remind people that in Sept. 2006 Geithner gave a speech in Hong Kong that essentially said, "the derivatives market is now so entangled and complicated that we do not know what is going on, and if (when) it blows up, we will not know what to do, and certainly the sorts of quickie meetings to hand out the pain that were done in 1998 will not work."

So, they knew by then what a mess it was, and that their usual tools would not work. That is why starting immediately in August 2007 they were employing new tools. If they had not done so then, we quite likely would have had a full scale global collapse at that time. It is easy to take it for granted now that we did not then.

[don]

Patrick -
Indeed. See also G. Mankiw's post. The whole game is price expectations.
Mark -
I would have preferred to see comments on Greg's post - no putdown intended for TD - I like his stuff.

[Sandman]

People still don't get it was the market itself that created the bubble in the first place. The FEDS problem was that it didn't try to stop it and thus followed the IRX down to 1% rates in the early 00's. The market always wants cheap credit. It was why the FED was created by the Morgan's of the world in the first place as a private bank. The problem is the FED never does its job.

For the most part, the Boom was and has been over since 2000. The rest of the world didn't overly join in the 90's and had more room to run this decade if the US consumer could just consume at a decent(but in real terms quite a bit less than the 90's US boom). The final blowoff made it worse however. The Fed should have forced the US consumer who was to optimistic after the 90's boom to get some reality. The consenquences would have been probably 2-3 more recessions by 2010, but they would have been small and we would be ready to roll foward in the 10's. Sadly we get one massive recession that may turn into a depression.

Cycles always seem to repeat:
Post 1812 boom turned into the 1819-25 bust
Jackson era boom turned into a bust that was as bad as the Great Depression and didn't fully end to the Mexican war in 1846
The great long depression of 1870's-1890's saw the rise of "alternatives" to the capitalist system form
The WWI/Roaring 20's boom turned into the Great Depression
The post-war boom fizzled in the mid-70's/early 80's which could have been called a world depression. What is funny, during the last long cyclical downturn, it was blamed on TO MUCH regulation.

Hardly new in many respects. I think looking for "pefection" is the problem of economics in general. The boom/busts cycles seem persistant.

[Barry]

Mark Thoma: "I think it is high time some real critical attention was placed on Bernanke. How complicit was the Fed Chairman with designing and implementing a clearly failed policy? Yes, one could argue that the ball was in Treasury’s court. But didn’t Bernanke have a duty to make TARP work, after he begged Congress for the plan? And isn’t he the one person who could stand up and say “No, Paulson is screwing this up”? Paulson will not be Treasury Secretary in January, but Bernanke will still be Fed Chairman. Bernanke can and should step into what is so clearly a leadership void. What does he owe this administration at this point?"

One of the lessons of the Bush II administration is that, by and large, these guys will let things go to h*ll (for others, or course), rather than risk their reputations among their fellow elites.

And remember, he doesn't have any real skin in the game; he has a golden parachute awaiting him, so long as he's in good odor with the elites. And $350 billion buys a lot of good odor.

[dd]

There are some of us who have been on Geithner watch forever. Calmo once told me to knock it.
Corrigan watch before that:
Trying to Put Some Reins on Derivatives
http://www.nytimes.com/2005/09/16/business/16credit.html
The Fed blew it on derivatives but given it's current expanded powers it can move toward resolution. See no signs of that.

[Bruce Wilder]

Bush's bad economic management will require the Obama Administration to come up with at least $600 billion in new spending in his first month in office!

Viva fiscal policy!

[the buggy professor]

1) Barkley Rosser's comments favorable to the Bernanke and the Federal Reserve seem largely on target --- at any rate, if (unlike the other posters in this thread) you consider the marked uncertainty that would face any monetary policymaking in the face of economic and financial problems without parallel for 3 decades or so. . . and maybe even since the Great Depression.

To wit: (i.) A major credit-crunch and a system-wide financial crisis; (ii.) Possibly emerging deflation . . . a problem that didn't exist as late as July 2008 when the CPI rose at an annual 5.0 rate (headline, not core); (iii) Economies bogged down in the US especially, but also in Europe and elsewhere, in excessively high leveraged debt; (iv.) Tremendous imbalances in savings rates, reserve accumulation or its opposite, and footloose capital totaling tens of trillions of dollars suddenly disappearing in a matter of weeks in stock and bond markets; and (v.) All this, in various degrees, on a global scale.

……………

2) What follows is a housekeeping list, set out very sketchily, of the kinds of policymaking uncertainties for monetary policymaking these days. As you’ll see, the comments here will try to add some empirical heft to the comments left by Duy and posters in this thread by referring to the contradictory evidence that we have as policy-guidance help drawn from the US experience in the 1930s Great Depression and from Japanese experience in the 1990s and into the first four years or so of this decade.

….
3) Start with interest rate targeting vs. quantitative money-expansion. Consider the former first, which boils down to an emerging ZIRP policy: a nominal zero-interest rate.

--- Specifically, would a ZIRP work by itself to stave off or reduce the impact of a potentially large recession, at least in conjunction with a recapitalization of more solvent banks in the US? Would the success in influencing aggregate demand --- either consumer spending or business investment --- depend on future price expectations regarding price movements: in particular, inflationary or deflationary. For that matter, as things stand now, how would the Fed know how to distinguish between disinflation (a slowing down of inflation, which reached a 5.0% annual rate in headline CPI in July) and emerging deflation?
-- Note that if deflation occurs, a ZIRP policy would have to deal with the problem of rising real interest rates . . . exactly as happened in Japan in the mid- and late-1990s. How, if that situation emerges in the US, would a ZIRP be able to influence the real economy, through increased aggregate demand for investment and consumption?.

The top-skimming answer: to judge by recent Japanese experience with a ZIRP --- which began only in the spring of 1999, a good 7 years into the serious stagnation/deflation dilemmas of the economy there) --- the only way this could happen would be to reverse the downward price-expectations of the Japanese public and business-managers. Unfortunately, the actual deflation rate of core CPI in Japan deteriorated from 0% to -1% at its maximum for the next three years --- between early 1999 and early 2002. So, the nominal ZIRP, actually turned into an increasingly higher real interest rate. . . and yet, the big puzzle here, is this: survey data (seemingly unknown to the overwhelming majority of economists in Japan, or here, or everywhere) revealed that downward deflation-expectations in Japanese households were never more than ½ of the actual falling price-level . . . at any rate, for a year ahead.

………....

4)) Enter the Second Policy Tool: Quantitative Money Expansion or QE

Let’s stay with the recent Japanese experience. In particular, with deflation occurring despite the ZIRP introduced in the spring of 1999 and si with real interest rates actually rising, the Japanese Central Bank started pursuing a QE policy in March 2001. Here other looming uncertainties faced them, which are still not fully resolved in academic studies, and which simultaneously, therefore, offer little guidance to our Federal Reserve today.

First and foremost, which channels would work with expanded QE to influence favorably aggregate demand? In Japan, only two were available, and that seems to be the case in the US today: (i.) increasing banks’ excess reserves . . . until the managers feel confident about their liquidity to deal with emergencies of any sort); and (ii) influencing the future course of the public’s and business expectations on short-term interest rates.

Concentrate for the moment on expanding excess bank reserves. In Japan, a quandary still remains from the record of such QE policy: specifically, is it that bank reserves need to be increased at a steady or fast rate --- or is it, alternatively, that simply a high level after some increases would suffice to reassure bank management that their banks liquidity was ensured sufficiently to start lending more energetically?

And that wasn’t the end of the uncertainties on this score, far from it. Banks, after all, could get the excess reserves: would they then start lending them out with confidence? Conversely, would there be sufficient demand by households and businesses for loans? In short, what would be the money multiplier?

….....

5) Enter the US experience in the US Great Depression, which Japanese authorities presumably knew.

As it happened, the monetary base (currency and reserves) between 1929 and 1933 expanded 18% in the US, but the simultaneously the money multiplier fell by 38% and the overall money supply declined therefore by 28%. Yet oppositely, in the serious US recession of late 1937 until mid-1938, the 46% price recovery since FDR’s arrival in office (early 1933) was reversed, and the price level fell 11%, while industrial production fell 37% (vs. 52% between 1929 and 1933).

Enter the puzzle here, which faces the US Federal Reserve today.

For in that period after 1937-38, a very rapid economic recovery occurred. The trough of the serious 1937-38 recession was reached in May 1938. All at once industrial production began rising sharply at an annual rate of 47 percent; by December 31, it had risen a good 25%, and by August 1940 it had risen 58% since the trough. And yet --- the puzzle here --- deflation continued throughout the recovery except for parts of 1939. That deflation ended in August 1940, the reason for singling the date out a moment ago.

At which point a pivotal question rears up: how --- contrary to almost all theoretical understanding --- can you get price deflation with a very rapid growth in both industrial production and GDP . . . exactly what occurred in the US for over 27 months? It was the exact opposite experience of the recovery from the huge plunge in GDP and the price level between 1929 and 1933: between FDR’s arrival in office in March 1933 until the 1937-38 recession, recovery in output went hand-in-hand with the recovery in prices.

…..

Worse yet for theoretical policy-guidance for today’s Federal Reserve, monetary growth in the recovery period after May 1938 was markedly strong, rising three times more swiftly than in the recovery between 1933 and mid-1937 . . . and yet, the point underscored once more, despite strong monetary growth and a very fast recovery of output, prices declined throughout most of the next 27 months. (Afterwards, by late summer 1940, the war in Europe had expanded, France had fallen, US lend-lease was started, and any deflationary expectations were altered by concerns about short- and mid-term shortages in industrial plant and raw materials.)

…….

6) Back to Japan again. As it turned out, Japanese experience of simultaneous deflation and economic recovery more or less paralleled the puzzling recovery of the US in the late 1930s.

Japan experienced continued deflation from early 1999 (when ZIRP was introduced) for the next three years --- this, despite the introduction of QE a year or so earlier. With deflation still lingering, Japanese economic recovery began in the summer of 2002 and continued for the next four to five years. (QE was terminated in March 2006 and ZIRP in June 2006.)

Do lags in monetary policy’s impact on consumer-demand and on business-investment explain the Japanese and US late 1930s’ experiences? Maybe; but remember --- US recovery between 1933 and into mid-1937 coincided with a strong upsurge in prices. There seems, in short, no clear policy-guide to be drawn from these contradictory trends.

…….

7) Let’s restate the major uncertainties here that face the Federal Reserve today, as they faced Japanese policymakers in the 1990s and into this decade.

(i.) Do you have to deal with future inflation/deflation expectations if monetary policy --- whether ZIRP or QE --- are your only policy instruments? US experience in the 1930s reveals contradictory lessons. Recent Japanese experience is no less ambiguous.

(ii.) If you do have to deal with them, will either ZIRP or QE be enough to reverse future deflationary expectations as Krugman (and others) argue, or not? And by using both policy instruments together or separately?

(iii.) What would be the transmissions for QE to operate on aggregate demand? You can increase bank reserves or try to influence real short-term interest rates. If it’s bank reserves, is it sufficient to just raise them or do you need to continue to increase them until . . . well, until aggregate demand for investment or consumption or both narrow the gap between potential GDP-growth and actual?

Nor is that all.

(iv.) Like Paulson and Bernanke today, Japanese monetary policymakers in the late 1990s and into this decade weren’t certain whether you could just use a ZIRP or QE policy or both, or recapitalize the banks as well, or recapitalize the banks and force at the same time a liquidation of non-performing loans. Japanese policymakers only added recapitalizing banks as a separate policy after ZIRP (in 1999), 7 years into the troubled financial system. They dealt with non-performing loans through a new Financial Supervisory Agency only in this decade --- and really only in 2003 did the policy take hold. Then, as late as 2004 --- as the Japanese economy seemed finally to pull out of deflation and stagnation and rack up some years of slow but solid GDP growth from mid-2002 until recently --- the Japanese government.

(v.) And finally, does a recovery from a serious recession that generates deflation require that deflation itself be reversed? US experience in the 1933-early 1937 period suggests yes; its experience in the recovery after the recession that began then and lasted until the spring of 1938 suggests no. And Japanese experience is more ambiguous, but tilts toward a no too.

...........

8) So what can we conclude about Tim Duy’s and others sharp criticisms of the Bernanke Fed’s performance this fall in dealing with our financial crisis and growing economic recession?

Simply this: it’s not at all clear --- just the opposite --- what their Archimedean economic-point can possibly be for such hard-hitting blows because the economic record of monetary policy for the US in the Great Depression and for Japan in the 1990s and into this decade is riddled with ambiguities, uncertainties, and contradictions.

…….

Michael Gordon, Aka the Buggy Professor

[BJ Feng]

Why do you people still think the FED or Treasury has the power to stop this collapse? Isn't it obvious that they've done just about everything that was recommended and more. Now that everything tried hasn't worked, people are coming up with anything they can think of and blaming the FED and Treasury for not implementing those ideas sooner. Well those ideas weren't part of the consensus view on how to move forward.

There are a million ideas out there, some of them quite foolish, but when we try the consensus "fixes" and they don't work, then the rest ask why their own personal solutions weren't tried. Must we go through all the ideas out there before everyone admits that there is nothing that can be done to stop this deleveraging? That slowing it down was the best that could be done, and by all indications, Treasury and FED HAVE slowed it down and prevented a bigger catastrophe from occurring?

Look at all the different programs the FED instituted. The commercial paper program, the money market program, etc. etc. etc. The FED has grown its balance sheet by more than a TRILLION dollars!

Congress was already reluctant in giving Paulson $700 billion. It's clear that he needed several times more money to be able to do the TARP as he initially wanted to. That is purchase all the toxic assets out there to separate them from the financial institutions. What are the chances he would have gotten, oh let's say, $2.5 Trillion? How about none.

People have to be realistic, and this is a symptom of liberal ideology. That government can correct and dictate what the economy does, that only a lack of will prevents the all powerful government from waving a hand and making things great. STOP YOUR DELUSION! Government cannot make people lend money to corporations. They can't make investors buy credit card asset backed paper. They can't make people recapitalize Citigroup, or lend GM more money, or even lend solid companies like Apple money at the same rates they used to get. They can't make people spend more, or force people to recognize a higher value for homes than they currently perceive.

Artificially propping up the housing market won't work either. People know that housing prices were way overpriced and should fall by 50% or more. Someone has to take those losses, and until those losses are taken, why would anyone want to invest? Why take the risk of further write downs? Government stopping foreclosures aren't going to make housing prices rise, that will just kill off transactions. Everyone will still know that institutions hold these mortgages and will have to take future losses, or take a lot of time to wait for those homes to get back into positive equity. Until then, those institutions are walking dead.

Hey, we have to experience some amount of pain, this is what happens when you are forced to live within your means, when you aren't able to consume by borrowing ever more credit. At some point, you have to lower consumption and we get this. When people finally understand as they do now, there is simply nothing the government can do to force them to spend unwisely again for the short term. I should say nothing prudent, I'm sure the government can start giving out even more ridiculous loans to homeless and those who obviously have no way to pay. That's the only method I see, start loaning a guy who makes $18,000 a year $1 million and tell him to spend it. Of course he'll default and we'll be in a worse situation later on. The bubble was UNSUSTAINABLE! You can't now blame the FED and Treasury for failing to sustain the UNSUSTAINABLE!

[K Ackermann]

BJ Feng, what you utter is complete rubbish. To call criticism of the Fed the product of liberal ideology says what? That conservatives are not allowed to be critical?

Are you happy with the details of the Fed's policies? If you are, I'd like to know where you got them.

Are you just fine with the $130b tax break for bank holding companies? Do you think it should have required discovery as opposed to it being declared up front?

Having to sue to find out what the taxpayer is holding for collateral?

Now let me ask you; is oversight and accounting a liberal or conservative ideology?

Also, the last time I checked, it's still a free country. As long as that holds true, you should let people speculate and blow off steam. If you don't, far worse things happen. It's human nature.

P.S. Bernanke blows.

[BJ Feng]

What I'd like to see more of is honest assessment, not Monday quarterbacking. Paulson could not have asked Congress for a bailout much earlier. There has to be, not only justification, but a visible crisis to do what he's doing. There would have been no political or public support for Paulson to ask for hundreds of billions before the crisis started to show itself. He could not have moved earlier, he moved early enough to anticipate Freddie and Fannie's collapse.

As for the FED, I believe that they should release details of what they are holding unless there is a compelling reason for them not to. I suspect they are holding a lot of stuff that they are not supposed to. They are only supposed to accept QUALITY assets as collateral, but I speculate that they are accepting lesser assets because they are doing everything they can to prop up the banks and add liquidity. Furthermore, if people actually find out what the banks have, they might be so scared that they lose all confidence in the banks and start selling shares en masse like what is happening to Citigroup. There might be no chance of private equity infusions after that and the banking system could collapse. This is just speculation, but I believe I'm on the right track. Bernanke inherited a huge problem. The only criticism is that he didn't raise rates faster, but the bubble was going to pop and we were going to be in this mess one way or another. By the time he entered the FED, and had enough time to acquaint himself, it was already too late for him to stop a crisis from occurring. He's taken extraordinary steps, I can't count the number of new, never before enacted programs the FED has come up with. At some point, you have to say he did all he could, he's not God, he can't perform miracles.

[craig tindale]

The Feds intentional inflation of assets prices through monetary transmissions to consumers throught the real estate channel, referred to by Bernanke himself in various Princeton papers as "money rains" or "helicopter drops" have been disastrous. Close reading of Keynes, Schumpeter, Friedman, Minksy and various others all warn about the dangers of monetary stimulus and tell us to focus on the fiscal side of things, as monetary alone will cause more problems than it solves. Raining credit on consumers so that they bid up asset values and the through what Bernanke refers to as the "wealth effect", feel wealthier and through credit consume a portion of their new found equity is ludicrous policy, it casts the US consumer in a perpetual borrower, with no thought given to his long term economic well being. To do this when private debt is rising to historic multiples of income shows a complete disregard to ones own (and the countries) ultimate economic well being.

The very basis of the Feds economic intention is mis directed, the Fed in order to ensure short term price stability and employment, has institutionalized a devils pact that see the countries debt to income ratio expand toward a eventual reckoning of generational proportions.

Bernankes underlying philosophy of "keep the party going at all cost " consumption for its own sake has no underlying long term relationship to the wealth and health of the country, its a philosophy that has lost its purpose.

[dd]

Oh my BJ; read some legislation and take a pill. The Fed has known than longer than forever where the system was heading and maybe it's just best to say there were no solutions to the monetary illusion. Then again why reward "capital" so far above "labor." Little more thought in that area could have solved many of the issues.

[dd]

Oddly enough Geithner watch has reached its apex and Calmo I think I deserve an apology:
Obama Said to Pick Geithner as Treasury Secretary
http://www.bloomberg.com/apps/news?pid=20601087&sid=a7V42kGHp.4o&refer=home

I wish him the best.

[dd]

Dear Tim,
Please re-establish the once much vaunted stability of the bond markets. You know what to do.
Plus I might add that the CDS on Treasuries are a distinct violation of the Patriot Act.
Tks
dd

[calmo]

I knew that word of TG's appointment would send dd and mo (lookit that 500 DOW bump)...and me too.
Of course I was happy with the appointment of BB too, to put that in some perspective.

Of course I apologize (and again, too, just as soon as I visit the archives to discover whatitwas that "knocked" you).
You B the best!
We B so glad you have your way with Tim and can dump those CDSs into the trashcan.

Time to salute Gordon, aka "the buggy professor" (not likely a carriage builder nor an entomologist) for that...work.
So a teacher, who still has the time and still finds the joy? I can warm up to teachers, but professors...not so much, you?
Ordinarily, I would complain about the length, or the length and the excessive formality, or the length, the formality and the disrespect for others who might want to squash a few characters onto the stage too...but I'm in awe of your...work.
I B back later after some fermentation...

[dd]

Geithner will not dump CDS. He, like Obama hopes the engine can be restarted. Why not give it one more go round?
Methinks it's possible given the level of hope; but all analysis of CMO (aka "Plausible Deniabilty Bonds"...copyright 2008 dd) indicates the impossibility but perhaps an extension of the resolution date to 2011 is possible.
Good Luck future Mr. Treasury Secretary.

[dd]

So, calmo some of us are ardent researchers.
Herewith a short chronology and the postings are excerpts:
Still on Geithner watch. When he gives the all clear then no worries about an unexpected banking implosion.
Posted by: dd | Link to comment | September 07, 2007 at 06:50 AM
calmo says...
Such faith in Geithner dd...well it's not contagious....
Posted by: calmo | Link to comment | September 07, 2007 at 08:32 AM
http://economistsview.typepad.com/economistsview/2007/09/john-berry-fed-.html

dd says...
Perhaps the Fed understands that a financial recession is inevitable given that industry's behaviors; but the rest of the economy may well eek out a slow growth pattern. To ease when easing has done little to restart securitization is a fool's game. Other forces must step in and this shifts some pressure to Paulson as he knows better than any Fed member where the bodies are buried in financial land.
Posted by: dd | Link to comment | December 11, 2007 at 06:13 PM
Greetings dd, I suppose no mention of the NYFed means Geithner has kept quiet?
Posted by: calmo | Link to comment | December 11, 2007 at 11:46 PM
Geithner watch:
Geithner Says Fed, Central Banks Reviewing More Tools....
Posted by: dd | Link to comment | December 13, 2007 at 11:19 AM
http://economistsview.typepad.com/economistsview/2007/12/the-fomc-cuts-t.html

Calmo, thank you for challenging me to think it through.
So enjoy the discussion.

[calmo]

So more than a year ago dd --I did go back through the archives and even to approx those dates looking for those "knocks", without success.
So thank you for putting my eye on them now and taking the trouble with your somewhat less organized colleague (me!).

I don't know any of the Fed members very well, and certainly personally, not at all. There are some I like more than others, but Geithner rarely makes the headlines...unlike Fisher..who I like (entertainment/relief) but discount (see above).
So I learn to trust other opinions, or at least lean on them to shape my own. When it comes to say, SS, it's Webb and when it's banking, it's you, dd.
So with "not contagious" I meant (and still mean) I'm leaning (and heavily) on your decades of experience...that I don't have. Your respect for this banker carries a lot of weight with me, even though I don't have it...maybe only due to lack of exposure to Geithner or your commendations of him.

Hoping to hear more from you as Citi is rescued in an effort to halt the financial skid.

[dd]

Respect is an important; but it's more of a "faith" issue. If anyone can pull it off it's Geithner; mind you it's all a relative time issue and then there's the unsavory notion of the merger between a Constitutional entity and bankers (sigh).
Once the Dems won C's rescue inevitable. The big boys were playing a vicious game and still are; but now C will have parity with GS. Both IMHO insolvent in their own ways; but then every financial institutions suffers from the disease. Prudence is a lost art form; but faith and hope are happy illusions of the trust and confidence variety. So, anything is possible.

[dd]

Calmo, something else for you:

A new economic team

Posted on Sunday, November 23rd, 2008

By bsetser

As Calculated Risk notes, before moving to New York I worked for Mr. Geithner at both the Treasury and the IMF. Mr. Geithner was, by the end of the 1990s, in charge of Treasury’s International Affairs division, so almost everyone who worked there — Tim Duy and Nouriel Roubini to name two — also worked for Mr. Geithner. At the IMF, Mr. Geithner encouraged the IMF to pay more attention to balance sheet vulnerabilities — and helped to push a paper I worked on with a group of talented young IMF economists through the IMF’s internal review process.

It consequently is no surprise that I am thrilled that Mr. Geithner looks to be Obama’s choice for Treasury Secretary. I am also pleased that President-Elect Obama also found a way to pull Dr. Summers — a voracious consumer of economic and financial analysis, including economic and financial blogs — into the administration. The current, severe crisis will provide plenty of work for both. Like Noam Scheiber, I hope that the combination of Dr. Summers’ intellectual creativity and Mr. Geithner’s disciplined analysis and political acumen proves fruitful.

I also suspect that Felix is right. The immediate challenge facing Mr. Geithner and Dr. Summers is finding a way to contain the current financial and economic crisis. Citi is a case in point. But once we emerge from the current crisis, the Treasury and Fed will need to build global consensus on how to regulate too-big-to-fail international banks — one that balances the world’s need for a banking system that lends with the need for banking system that doesn’t take on too much risk in good times, leaving taxpayers with the bill in bad times.

I know from experience that Mr. Geithner puts a great deal of effort into his (relatively infrequent) speeches. Those looking for insight into Mr. Geithner’s world view could do far worse than to start by picking out a few of his major policy addresses over the past few years and tracing the evolution of his thinking.

Back when I worked for Nouriel I often posted detailed commentary on Mr. Geithner’s speeches.

On financial regulation try: Things that keep the President of the New York Fed up at night as well as Felix’s comments on Geithner’s post-Bear testimony.

On external adjustment try: What Geithner said, and then some; Geithner states the obvious and “Substantial accumulation of dollar reserves masks the impact of deficits.”

My guess is that we will soon be bearing more about the need to build better shock absorbers into the structure of our financial system.

http://blogs.cfr.org/setser/2008/11/23/a-new-economic-team/