The Future of the Fed April 27, 2011. Joseph Gagnon April 27,2011.

The Future of the FedApril 27, 2011

Joseph GagnonApril 27,2011

Usually it operates on the short-term interest rate.

But monetary policy can operate on long-term interest rates, i.e., bond prices.

Monetary policy can operate directly on other asset prices, such as equities, real estate, and foreign exchange.

There is no limit to the amount of private spending that can be created by monetary policy under any circumstances.

Abusing this power deteriorates the balance between output/employment and inflation.

Not an immediate concern in United States.

But current situation will not last forever.

Central banks prefer to operate on short-term interest rates to minimize the variability of their income.

Aggressive Fed actions in 2008-2009 prevented a second Great Depression. Financial shock was larger than 1929.

But, “a lot” is not the same as “enough.”

In December 2009 I called for $2 trillion QE2.

In November 2010 Fed announced $0.6 trillion QE2. Fed faced opposition to QE2 from many

politicians and financial market pundits. Fed had little support for QE2. Fed is uncertain about QE2 effects.

This timidity has cost America at least 1 million jobs.

For rest of 2011, Fed should do another $0.6 trillion in QE2.

But, the window for QE2 is closing. Economy is recovering, albeit at a slower

pace than it could have. The scope for monetary stimulus

depends not on today’s unemployment rate, but the rate expected in 1 to 2 years.

Joerg Bibow, Skidmore College and Levy Economics Institute

“The Future of the Fed”, Roosevelt InstituteNYC, April 27, 2011

Fed met its LOLR challenge Fed’s pre-crisis blunders concerned regulation & supervision,

not monetary policy. Fed has to live up to its R&S duties. Dodd-Frank limits on Fed 13(3) emergency lending authority

shift burden to act (quickly) to Treasury/Congress Fed continues to take its “dual mandate” seriously

Mandate should not be re-focused on price stability only▪ ECB is the warning example

Does not mean Fed MP conduct cannot be improved. Scrutiny is warranted. CBI needs to be balanced.

Highly accommodative Fed policy is here to stay Even as QE2 may end in June Absorbing “excess liquidity”, when needed, technically no

problem Given labor market slack & wage inflation at 2%, no inflation

riskThe Federal Reserve Now J

Bibow

The Federal Reserve Now J Bibow

Scenario A: the “not so great ‘00s” Scenario B: “eurosclerosis” Scenario C: better than “roaring ‘90s” Not even “maximum employment” by 2014 under Scenario C

Employment-to-population ratio sharply down!

output gap

Fed has domestic mandate, but sets global monetary policy benchmark. World economy is not an optimum currency area though.

Financial globalization has created a policy-domain problem. As part of wider conflict between democracy and

globalization. Floating exchange rates are not the solution.

Argument to let “market forces” determine exchange rates unconvincing from EM perspective when foreign policy decisions are key driving force (“currency wars”).

For EM it’s reserve accumulation vs. capital controls. It’s about reclaiming lost policy space. EM reject new constraints through IMF rules on capital

controls. It seems G-20 can’t agree on anything anymore.The Federal Reserve Now J Bibow

Dollar’s status still very convenient to some. Wall Street, large corporates; “exorbitant privilege”

But extra drag on U.S. labor market & wages. Magnifying “globalization-competitiveness-inequality

nexus” Political problem (“democratization of credit” band-aid

failed) “The dollar is our currency, but your problem”

(Connally). Or today perhaps? “It may be your reserve currency, but

it’s also a bit of an inconvenience to us right now.” ▪ Also, the oil factor

Mix of: key reserve currency status, financial globalization, rudimentary U.S. welfare system, and U.S. aversion against fiscal policy is putting excessive burden on Federal Reserve. Likely to provoke bubbles and global tensions.

The Federal Reserve Now J Bibow

Perry MehrlingRoosevelt Institute, NYC

April 27, 2011

Memories of 1907 (JP Morgan) And 1910 (Jekyll Island)

Memories of 1862 (Greenbacks)Real Bills Doctrine, a political frame

British version, Trade bills▪ versus finance bills (Wall Street)▪ versus Treasury bills (Washington)

American adaptation▪ versus central banking (regional structure)▪ pro manufacturing and farming bills

Capital Market

Federal Reserve

Banking

Money Repo Rate Target Fed Funds

Commercial Paper

Treasury Bills C&I lending

Credit Corporate Bonds

Treasury Bonds Mortgage lending

Government Finance QE2 as Government Bank War Finance

Capital Finance Shadow Banking and Dealer of Last

Resort International Role of the Dollar

Eurodollar System and International LOLR

Technical Challenges: from banks to markets Liquidity, funding and market Solvency, institutions and instruments Stabilization Policy, prices and quantities

Political Economy Challenges The Fed and Government (fiscal dominance) The Fed and Wall Street (TBTF, dealers’ club) The Fed and Globalization (China, Euro)

Thomas PalleyNew America [email protected]

Federal Reserve Reform

Governance EconomicPhilosophy

MonetaryPolicy

RegulatoryReform

Monetary Policy

InflationTargeting

Balance SheetRegulation

New InterestRate Targets

Relation to theRest of Macro

Policy