Felix Salmon

America’s failing monetary policy

By Felix Salmon
November 5, 2010

Shahien Nasiripour has delivered a massive 4,000-word article on the Fed’s monetary policy, laying out with great clarity just who’s benefiting (big banks, corporations, and the U.S. Treasury) and who’s losing (the public at large, and especially retired savers and the unemployed).

To some extent, monetary policy always works like that: savers get hit when interest rates fall, while banks love it. But this time it’s even worse than usual, since businesses aren’t borrowing or investing — and insofar as they are borrowing, they’re using the proceeds to buy back their stock, rather than to employ more people.

The net result is that the banks — whose collective cost of funds is now less than 1% — are now lending overwhelmingly to just one borrower:

U.S. banks now own more than $1.5 trillion in Treasuries and taxpayer-backed debt issued by mortgage giants Fannie Mae and Freddie Mac, according to the latest weekly data provided by the Fed. It’s a 30 percent increase from the week prior to the Fed’s Dec. 16, 2008, announcement that it was lowering the main interest rate to 0-0.25 percent.

Outstanding commercial and industrial loans at U.S. banks have fallen from $1.6 trillion in October 2008 to $1.2 trillion this past September, Fed data show. The $390 billion drop is equivalent to a 24 percent reduction in credit to businesses.

It’s truly outrageous that banks are lending more money to the U.S. government than they are to all commercial and industrial borrowers combined; well done to Nasiripour for connecting these dots and for providing a much-needed dose of outrage at the way in which Bernanke’s monetary policy simply isn’t helping the broad mass of the U.S. population.

Is there something else that Bernanke could be doing, and isn’t? Nasiripour doesn’t address that question in this piece. But simply framing the problem is important enough: with fiscal policy in gridlocked Washington a non-starter, monetary policy is all that we have. And it clearly isn’t having the desired effect.

19 comments so far | RSS Comments RSS

There’s a lot I don’t understand in that article.

this is a bad start to it:
“Over the coming months, the Fed will then communicate its specific plans well ahead of any such purchases, allowing wealthy investors and firms a chance to buy those assets first so they can sell it back to the Fed at a profit.”

But who owns those bonds first? If it’s so obvious prices will rise, why sell them to “wealthy investors” below that price so they can then profit? Why didn’t he just write that higher bond prices help bond holders?

Isn’t it begging the question somewhat to assert that a program designed to stimulate the economy hurts the unemployed?

Why is it such a scandal that the banks are lending so much to the Govt? The govt is borrowing a lot of money – who would you prefer lent it to them, and why would other lenders be better for the American people? There are plenty of people out there forecasting a sell off in bonds. If the banks are stuffed to the hilt with bonds, this will help them how? I don’t quite see what you are so outraged about. Where have US banks built up this holding of government debt from? Net new lending, or buying bonds from non-US-bank holders. Why are you scandalized by this change in the composition of bond holders? I can’t see how it has any bearing on the quantity of lending to firms – what i mean is, I don’t see how holding lots of government bonds somehow constrains banks from supply credit to firms.

Posted by Luis_Enrique | Report as abusive

more … the article says pensioners are being hurt by low interest rates, but describes corporations as “sitting pretty” because they have piles of cash. So, are low interest rates hurting savers or not?

Posted by Luis_Enrique | Report as abusive

Yeah, I actually gave up on that article. If I have to click through to five pages, an article has to start making sense by the second page.

Scott Sumner has argued for a negative interest rate — instead of paying banks interest at a 0.25% rate on excess reserves, the Fed would charge a 1% or 2% penalty on excess reserves. There would be some tendency for banks to bid treasuries to negative interest rates, but there’s a finite supply of those, and lending money to reasonably safe small businesses would probably be more attractive than paying a lot of money to the fed for sitting on cash.

To some extent, though, that requires that there be reasonably safe businesses looking to borrow money; I’m not sure to what extent that’s true, either. The aggregate demand shortage is not a liquidity effect; it’s a wealth effect. Pushing more money out isn’t, per se, going to incent a lot of people to spend a lot more money just because they’re replacing somewhat illiquid assets with liquid ones. Sumner’s other big idea is a target level for NGDP, which, if made with some credibility that it was going to be maintained at least well into the next upturn in the economy, might provide some incentive for people to move from dollar-denominated assets to real assets.

I have come to agree with Sumner that those are the two best sane things the Fed could do. (Insofar as the latter project is to be driven by inflation expectations, I’d kind of like the next treasury auction to conclude with the announcement that the Fed had bought the entire issue at 0%, and was monetizing the debt. This is undoubtedly not “sane”, though. Even the two “sane” projects would be major breaks from past practice.) I have less faith than Sumner that even these things can get the economy going too terribly quickly. Even if there are great things out there that could be produced and bought in a better macroeconomic equilibrium, there’s a huge coordination problem in moving there, and I don’t know that any governmental or quasi-governmental (depending on how you classify the Fed) organizations can do a whole lot about it. We may just need to be patient.

Posted by dWj | Report as abusive

more again… he also seems to muddle up the level of reserves and ‘excess’ reserves. The banks may have X trillion in cash reserves, but if they went out and lent it to firms etc. the banking system would still have X trillion in cash reserves, it’s just that the ratio of X to assets would have fallen. This is standard money multiplier stuff – if the banks made loans, those loans end up as deposits in a bank. So you cannot infer “banks are not lending” from looking at the level of X, which he seems to be doing.

He’s right to worry that this isn’t happening (the thing we’d like about the credit money multiplier is that loans end up as deposits after having been involved in some transaction the real economy). The asset multiplier doesn’t appear to happening either – banks could be buying bonds off non-bank owners, seeing that cash re-deposited, buying more bonds etc. and expanding balance sheets until X/assets has fallen (whilst again level of X is constant), expanding the money supply in the process. Despite banks holding trillions of govt bonds, the money supply hasn’t exploded – doesn’t that tell us that banks have not been doing this? (why not? because expected real returns on holding cash reserves and holding bonds must be equal – they must be expecting capital losses on bonds. We are in a world of negative expected real returns on financial assets – this is deliberate, to stimulate investment in real capital).

He writes as if being awash with cash reserves somehow benefits the banks. I’d agree that low interest rates benefit banks to the extent it increases the spread between cost of financing and returns available on loans, bonds etc. but I don’t see how observing the level of cash reserves (which just tells us the Fed has increased the monetary base) tells us about that.

[the above is written as if I'm confident I'm right - I'm not, and am ready to be corrected]

Posted by Luis_Enrique | Report as abusive

The Fed’s purchasing program is lowering the yield on those short-term bonds, making it less attractive for banks to hold those instead of loaning them out. The more the Fed increases the monetary base, the more money will be loaned out to the general public. But in order for that to happen the Fed has to increase the base! This isn’t hard.

Posted by JTapp | Report as abusive

And remember that as the Fed purchases bonds it’s giving cash that investors use to buy other, riskier, assets. This is why the stock market is rising again. As Bernanke said: QE is about asset prices. Again, this isn’t hard.

Posted by JTapp | Report as abusive

Actually, I think Luis_Enrique is right, in essence. dWj too.

One minor point: I do not see the confusion about excess reserves that Luis_Enrique sees. Nasiripour’s figures seem to correct: http://www.federalreserve.gov/releases/h 3/current/.

Regarding Sumner’s idea of negative rates on excess reserves, I think it is worth trying. Certainly there seems no reason to pay a positive rate at present. But as with any untested idea, there is a risk of unintended consequences. I think Sumner’s assumption is that banks will respond either by shifting their reserves into risky assets, generating real investment, or else by charging more interest on deposits, in order to shrink their balance sheets. The assumption is that the latter course would provoke people into spending their money instead of saving it. So the Fed wins either way, he means. Perhaps.

Posted by Greycap | Report as abusive


Sorry if I wasn’t clear. I’m not disputing his figures, just interpretation.


Posted by Luis_Enrique | Report as abusive

“…well done to Nasiripour for connecting these dots…”

Connecting the dots? This data is available in the FRB’s easily readable weekly H8 report.

C&I lending is down mainly because solvent businesses don’t see a need to borrow. Send a corporate borrower with a good balance sheet to just about any bank in the country and they will get a loan.

Posted by Bob_in_MA | Report as abusive

Creating money and buying something with it are two separate acts. So the Fed chooses to buy T Bills and the consequences of where the money flows stems from what those selling the do with the money.

The Fed could buy anything with this new money – it doesn’t have to be an investment (excepts investments are easier to reverse). So the Fed could write a cheque for 3000 USD to each adult American citizen and help speed up the deleveraging, buy up and demolish some of the excess housing, even buy foreign government bonds (like the Chinese) to force down the dollar.

One of the people on the MPC – think it was Posen – said QE is like watering a garden – wherever you point the hose you know the water’s gone somewhere.

But as any gardener knows, when you water a garden you water the plants you want to grow.

Posted by Madameski | Report as abusive

It is always nice to know that Bernanke is on side with banks and big Corporations. The trickle down effect doesn’t work and this isn’t going to work.

Putting money in the hands of those who will grow and grow the economy is the only answer and it sure as hell isnt in the coffers or hands of banks and bankers.

Why not offer incentives to grow. the more you grow the less you owe… in taxes? The more you grow and hire, the more subsidies you receive? Money available in ioncrements at lower rates.

Small amounts with paperwork to back it and inspectors (more jobs) to enforce the money spent as stated and actual jobs created,so that cheaters (banks included) don’t jump on it as is done with most Government incentives. (The American greed is good Capitalist policies defend such acts you know)

The answer is… You need more Fiscal conservatives in office, not former bankers and bankers who think printing ‘mo money’ is always an answer no matter how many times it has failed and inflation spirals. No one trusts money printing and putting more money in the bankers hands, whilst next calling on taxpayers to bring down the deficit. Trust from the people is the only way to get the economy back on track and money flowing again.

The only trickle down effect from the monetary policies will be the inflation that ripples out of politically motivated stonewalling and bank coddling. And of course what you do affects us as well, thanks for nothing!

Posted by hsvkitty | Report as abusive

hsvkitty, who is going to pay for those incentives? As well as the paperwork and inspectors? Ugh. I can think of ten thousand ways to game that system, so I’m sure that corporations will come up with one that works. Would be a very expensive boondoggle.

You could go a long way towards encouraging growth by cutting the corporate tax rate (and simultaneously raising the tax rate on dividends and capital gains). Give corporations an incentive to invest here rather than investing overseas and bringing only their profits home.

Posted by TFF | Report as abusive

Exactly TFF… everyone thinks how to game the system rather then how to make it work and ensure it cannot be gamed. Again the greed is good capitalism makes for lack of incentive to make jobs for those who are not already gaming the system, (eg: large corporations and banks)

Where do you pay for it? A Government that works for the banks and large Corporations is not Governing, but being run by lobbyists… incentives for start ups and jobs should be a priority.

Thanks for not just saying ugh, and making a proposal on your own, but excuse me , why would simply cutting the tax rate be any more likely to ensure jobs (I can see it used to increase executive bonuses) if not monitored for compliance? Are you assuming cutting tax rates will spur growth, just because you say that’s why you are doing it? Isn’t my ‘the more you grow the less you owe’, but being monitored for fraud and ensuring compliance, in alliance with your thoughts but ensuring jobs?

The SEC is a toothless organization because everyone knows (and it continues to be obvious) that it doesn’t do it’s job, they don’t have the people to enforce the law, hand slaps and fines for an iota of the infraction, whereas it should be equal or more, plus jail time… If the big boys can play like that and get away with it, why would the smaller players care if they rip off or abuse incentives.

Organizations without teeth are what make incentives a boondoggle. Handing out money like HAMP was/is a boondoggle. Giving money to lenders at no interest so they can charge high interest is a boondoggle. The economy hasn’t been helped to any degree, but the banks surely won’t see any of that as a waste! H

ow can ensuring jobs with more paperwork and more jobs to doso, be a boondoggle if the growth of the economy and more jobs AT HOME is a good thing.

Do you think printing money and handing it out without regard for inflation or the people who really need it,is a better idea ?

“Give corporations an incentive to invest here rather than investing overseas and bringing only their profits home.”

Agreed TFF, so what incentives other then monetary might work?

Posted by hsvkitty | Report as abusive

If I understand it properly, hsvkitty, corporate tax rates play a key role for a corporation in deciding WHERE to invest. They prefer to have their income generated in countries with low corporate tax rates, bringing home only as much cash as is needed to operate their home offices and pay dividends.

The US corporate tax rate is among the highest in the world, which discourages corporations from investing in their US operations. You ought to be able to reduce the corporate tax rate (which depends on where the investment is happening) and raise the dividend/capital-gains tax rates (which do not depend on where the investment is happening) to come up with a revenue-neutral policy that increases US investment.

Or maybe I’m misguided. Wouldn’t be the first time.

As for printing money, the whole purpose of printing money is to destroy wealth (and debts) rapidly. Given that wages are higher than elsewhere, and debts are unbearably high, a certain amount of wealth destruction is necessary. Printing money does a better job of distributing the pain than foreclosure.

My personal economic situation will fare best in a *low* inflation environment (I’m a saver, not a borrower, and am closer to retirement than to college). But I don’t expect Bernanke to think of me when deciding economic policy.

Posted by TFF | Report as abusive

By the way, I like your idea. Just don’t think it can be enforced effectively.

Posted by TFF | Report as abusive

By the way, I like your idea. Just don’t think it can be enforced effectively.

Posted by TFF | Report as abusive

Well TFF, that would be assuming that the cost of employing at home go down and tax cuts are 2.5% and not 35%

Right now, many large Corporation are NOT paying taxes and operate outside the country and sell the product in the states. How does a tax cut incentive help when they are not paying taxes on their business except a few measly percentages.

For example… Google and Facebook and countless others:

http://www.bloomberg.com/news/2010-10-21  /google-2-4-rate-shows-how-60-billion-u -s-revenue-lost-to-tax-loopholes.html

Click on the model to see how it’s done
http://www.businessweek.com/technology/g oogle-tax-cut/google-terminal.html

If the loopholes were closed, the money could be better used, maybe even to make more jobs at home, but then the lobbyists would be complaining about protectionism again. And touting how UnAmerican it is to deny large Corporations exorbitant amounts of money by taxing them.

Again the Capitalist wheel of greed spins out of control and in the end, just how nationalistic and American is atax policy that allows such loopholes to exist. Ok cut their tax rate… they still operate and hire overseas and outsource.

Posted by hsvkitty | Report as abusive

hsvkitty, I’m not 100% confident that I understand it properly, but I believe one dodge is to assign manufacturing profits to the subsidiary in the country where the manufacture occurs. If they manufacture in the US, then they pay US corporate tax on those profits. If they manufacture elsewhere, then they pay no tax on the profits unless/until they are brought home. Thus they have a very strong incentive to manufacture overseas and to reinvest profits overseas, bringing home as little profit as possible.

Regardless, it seems sensible to NOT establish a system whereby your domestic operations operate at a significant competitive disadvantage. Thus I would tax them at the other end of the conduit (dividends and capital gains) rather than at the corporate end. This isn’t “feeling sorry for corporations”, it is trying to construct a system that works the way it is supposed to instead of pushing manufacture overseas.

And yes, I’m perfectly open to other suggestions for closing loopholes. Anybody selling in the US ought to pay US tax on those products.

Hm… Sounds perhaps like a VAT to me?

Posted by TFF | Report as abusive

It is always there as rate of interest falls, savers used to get a problem and bank used to get increase. Monetary policy is also one of the system of Central bank, so it is highly affected by it.

Posted by Nikkilarsson | Report as abusive

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