Felix Salmon

Gesture politics and the Fed mandate

Felix Salmon
Nov 17, 2010 17:57 UTC

The proposal from Bob Corker and Mike Pence to abolish the dual mandate is pure gesture politics. It probably won’t even become a bill; if it does become a bill it won’t become law; and even if it does become law it won’t actually change what the Fed does.

What’s more, Corker and Pence simply don’t make any sense to the reality-based community. For instance, Corker wants the Fed to be “focusing singularly on maintaining the value of the dollar,” which sounds for all the world like a third mandate to replace or go alongside the inflation and employment mandates. What happens, for instance, if inflation is low and the dollar is falling? Or if inflation is high and the dollar is rising?

Meanwhile, Pence is declaring that QE2 “will monetize our debt and trigger inflation,” which is kinda the whole point of the exercise, since the Fed is worried that inflation is too low. Giving the Fed a simple inflation target would only make it easier to justify this kind of action when inflation is low and falling.

Neil Irwin gamely tries to come up with an example of where the abolition of the dual mandate might make a difference in practice:

In the first half of 2008, inflation was very high as energy and other prices skyrocketed. Yet the labor market was getting worse, with layoffs mounting. Bernanke and his colleagues cut interest rates to try to address the deteriorating economy, while the European Central Bank, focused as it is solely on inflation, raised interest rates to contain prices.

It’s true that the ECB was late to the rate-cutting party, although it got there eventually with 225bp of rate cuts between November 12 and January 21; in hindsight I’m sure it wishes it had started earlier. But it was hardly aggressively raising interest rates, either: there was a quarter-point hike in June 2007, to 3%, and another quarter-point hike in July 2008, to 3.25%. Meanwhile, the Fed funds rate was at 5.25% as late as September 2007, and came down to the ECB’s 3% level at the beginning of 2008.

But at that point the Fed was already in full-on crisis-fighting mode, trying to get ahead of the rapidly-deteriorating financial situation. Of course it worried about layoffs, but the main reason for the rate cuts was the financial system rather than the unemployment rate.

It’s silly to think that the U.S. central bank won’t step in to help in the face of a financial crisis. But the fact is that Corker and Pence are embarking on their Fed-bashing crusade not because they think they’re being constructive or helpful in terms of setting the parameters of US monetary policy, but rather because they’re playing to the Tea Party wing of the GOP. This is internal Republican maneuvering, and interesting mainly on a political level. As policy, it’s eminently ignorable.


I think you’re far too quick to dismiss the possibility that Corker and Pence know as little about the Fed and monetary and policy as the people they’re pandering to, and are actually being completely sincere. The answer to “Could a Senator possibly be that dim?” is always “Yes.”

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The politics of QE2

Felix Salmon
Nov 16, 2010 14:27 UTC

Allan Sloan has a good point today: by implementing QE2, Ben Bernanke has become a politician. It’s an important development: for reasons I don’t fully understand, the debate over QE2 has divided along party-political lines, with the Republicans lining up against it and the Democrats attacking them. Globally, too, as we saw in Seoul, the QE2 debate is conducted at summit level, and this time the dividing lines are even starker: it’s essentially the U.S. vs the world.

Interestingly, this is one of those old-fashioned technocrat vs technocrat policy debates, in contrast to the technocrat vs populist debates which seem to have taken over far too much airtime of late. But it’s just as shrill. And as Sloan says, it does the venerable Fed no favors to find itself on one side of a debate generating so much heat and so little light: Bernanke “was already making a high-stakes economic bet with QE2,” he says, “and now it’s a political bet, as well”. If QE2 doesn’t work — Sloan raises the specter that it “could imperil the dollar and our financial system” — then it’s not just the economy which will be harmed, but also the Fed’s long-term credibility and pre-eminence. In fact, the politics of QE2 are already hobbling the Fed’s freedom of movement, as Neil Irwin explains:

The political maelstrom that erupted after the Federal Reserve’s decision two weeks ago to take expansive action to boost the economy has reduced the central bank’s maneuvering room as it considers how to get growth on track…

“It now looks like it’s going to be hard for the Fed to do another round of aggressive policy because they know the criticism is going to undercut some of the confidence-building impacts,” said Ethan Harris, chief economist of Bank of America-Merrill Lynch.

Bernanke, then, has every reason to want to reduce the volume on this debate: the mere existence of the debate itself can easily counteract any good which comes from QE2.

One way of doing that would be to admit that QE2 is an untried experiment: while QE1 worked as a weapon in the crisis-fighting arsenal, QE2 is being asked to do something quite different. So the Fed should define much more clearly than it has done until now what exactly QE2 is designed to achieve, and what criteria might be used to determine whether it is succeeding or failing. And if it’s showing signs of failing, then the Fed should also be explicit about how and when it might be unwound.

War-gaming QE2 in this way would make the Fed seem less sure in its actions, but it might also help mute some of the harsher criticism coming its way—and thereby actually improve the chances that QE2 succeeds. Bernanke is no Maestro: no one trusts him implicitly in the way they trusted Greenspan, pre-crash. So maybe what the economy needs is for him to become a little less Olympian and a little more human.


It’s obvious why QE2 is necessary. Congress is gridlocked (already was before Nov 2). So, if Bernanke is a “Politician” because he wanted to try to address unemployment, slow growth, and a threat of deflation with the only weapon he has at his disposal, then I guess that makes him a “Politician” (as if that’s become a dirty word now). I, for one, am glad he is. I wish his detractors had some positive alternatives to offer.

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How QE works

Felix Salmon
Nov 4, 2010 16:56 UTC

Gawker’s John Cook asks me a question about how the Fed’s quantitative easing is supposed to work:

So the Fed is going to by $600 billion in U.S. Treasuries. It will presumably buy these Treasuries from private investors and institutions who had already purchased them–in other words, it won’t be handing $600 billion to the U.S. Treasury in exchange for bonds.

The purchases will be in increments of $1 million. Now, the kind of people who own $1 million and more in U.S. Treasuries tend to be people with a lot of money. And that money was kind of sitting there, and for some reason or another they decided to put it into treasuries, right?

So now along comes the Fed and says to those private investors and institutions, “Hey, I’d be happy to convert those treasuries into cash for you!” And they negotiate over price or there’s an auction or whatever, and the investors get their cash and the Fed gets its treasuries.

And so then these private institutions and investors are sitting there with a pile of cash. So why wouldn’t they just buy treasuries with it, which is what they had previously decided would be the wisest thing to do with that money?

The idea is to get those people to spend that cash in stimulative ways, right? But shouldn’t we assume that people who are sitting on large quantities of treasuries are sitting on them for a reason, and would likely continue to sit on them, even if they suddenly came into some cash?

John has a few of the details wrong, but at heart he’s absolutely right. The way that QE works is that the Fed will publish a schedule of how many Treasury bonds it intends to buy and when. It will then go out and buy those bonds from “the Federal Reserve’s primary dealers through a series of competitive auctions operated through the Desk’s FedTrade system.”

In English, what that means is that the New York Fed has a direct line to the biggest banks in the world (Goldman Sachs, Morgan Stanley, Deutsche Bank, etc — 18 in all). And it gets all those banks to compete with each other, either directly or on behalf of their clients, for who will sell the Fed the Treasury bonds it wants at the lowest price. The winners of the auction get the Fed’s newly-printed cash*, and give up Treasury bonds that they own in return.

The people selling Treasury bonds to the Fed, then, are big banks, who are told in advance exactly how many Treasury bonds the Fed wants to buy. As a result, they’re likely to buy Treasuries ahead of the auction, with the intent of selling them to the Fed at a profit. This is pretty much what John said would be going on, only they buy the bonds before the auction, rather than afterwards. Once the banks have made that profit, it’ll get paid out in bonuses to the people on the bank’s Treasury desk, with the rest going to their shareholders. We’re not exactly helping the unemployed here.

More generally, the Fed isn’t going to be buying any more bonds than the Treasury is issuing — so it’s not going to be lifting a lot of holders of Treasury bonds out of their long-term investments. But insofar as the Fed is forced to offer such high prices that investors simply can’t say no, those investors are probably just going to take the proceeds and invest them in agency debt instead from Fannie Mae and Freddie Mac. That debt is just as safe as Treasuries, and it even yields more than Treasuries, to boot.

What’s emphatically not going to happen is that the people who used to own Treasury bonds will take the Fed’s billions and suddenly turn around and spend them buying croissants at their local family-owned bakery. We’re talking about monetary policy here, not fiscal policy: the aim here is to bid up the price of Treasury bonds, which means that the yield on Treasuries will fall, and that those lower interest rates will somehow feed through into greater economic activity. The aim is not to take $600 billion and spend it on stuff in the real economy. That would be a second stimulus, and the chances of a second stimulus right now are hovering around zero.

Which is why Brad DeLong puts the value of buying $600 billion in Treasury bonds at about $7 billion in total, rather than anything near the headline $600 billion figure. The Fed is playing around with interest rates here — that’s its job. It’s not trying to directly stimulate demand.

*I should also take this opportunity to answer a question from CJR’s Dean Starkman, who asks where the money is coming from. The answer is that in a fiat-money system such as ours, the central bank can simply print as much money as it likes. If it wanted, it could literally go down to the local printing press, print out a bunch of $100 bills, put them in armored trucks, and send them over to JP Morgan or whoever sold them those Treasury bonds.** But that would be silly. So instead it simply increases the amount registered as on deposit at JP Morgan’s bank account at the New York Fed.

If JP Morgan had $100 billion in that bank account before, and then sells the Fed another $50 billion of Treasury bonds, then the Fed will just credit that $50 billion to JP Morgan, and the new balance in JPM’s account is $150 billion. Central banks can do that, which is why they’re so powerful. The amount of money in the system has just increased by $50 billion, and the Fed hopes that somehow that increase will feed through into higher inflation. Whether it will or not, however, depends on the degree to which JP Morgan can take that $50 billion and lend it out into the real economy. So far, banks have been bad at boosting their lending. And there’s not a lot of evidence that they’re getting any better.

**Update: Alea tells me I’m wrong on this: it’s the Mint which prints paper money, not the Fed, and all paper money is backed by Treasury-bond collateral.


Alea is incorrect. The Dept of Treasury’s Bureau of Printing and Engraving prints paper money on behalf the Fed (and netting 4 cents a bill regardless of denomination). The US Mint is a separate Treasury agency that coins money. Coin money is a different kettle of fish, the Fed buys coin from the Mint at face value. The Mint’s costs stay in its Public Enterprise Fund, the Secretary of Treasury sweeps the profits into miscellaneous receipts (31 USC 5136) So every dollar coin that costs 12 cents to mint adds 88 cents to general revenue.

The Secretary is granted authority to mint platinum coins of whatever “specifications, designs, varieties, quantities, denominations, and inscriptions” that he prescribes (31 USC 5112(k)). As we saw with the dollar coin, a coin’s face value bears no relationship to its cost of production. Remember too, coin seigniorage is booked as revenue, not debt. A trillion deficit could be covered tomorrow by the Secretary directing the Mint to coin a $1 trillion piece (or ten $100 billion coins, easier to make change) and then showing up at the drive-in teller to make a deposit (the interest on reserve payments enable the Fed to peg the federal funds rate without having to sell Treasuries to drain excess reserves).

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