Monday, June 4, 2012

Yglesias Comment Mirroring

I've been unable to force myself to post here enough to get the blog going, so for at least a while I'm going to try cross-posting my substantive comments from Yglesias' blog.  Perhaps after a while this will get me in a good enough posting habit that I can do something a bit more reader-friendly.  For now, here goes:

Today Yglesias links to a Mike Konczal interview of former Fed staffer Joe Gagnon.


After all, right now the European Central Bank is refusing to engage in the volume of monetary activism that the European Union needs and the Fed is refusing to engage in the volume of activism that the United States needs. 

This is quite a triple bank shot, but the reasoning is more or less sound. More than anything it points up how ludicrous our self-induced paralysis is - it can't be the case that a currency war between the two most important economies in the world would maximize human welfare. There MUST be better policies available. 

As for the linked post, I appreciate learning that the Fed is currently authoritzed to buy FCR in large quantities as I wasn't sure that was the case.  

I hope that people read the full interview, especially the part where Gagnon makes it ABSOLUTELY CLEAR that the only impact of Fed asset purchases of bonds is through the interest rate channel: 

In the Treasury market, yields on three-year notes are only 0.3 percent, so the Fed must buy five-year to 30-year bonds to have any effect. With the 10-year yield at 1.5 percent, the scope for further effects is modest. Even if the Fed bought every 10-year Treasury, it would be hard to get the yield much below 1 percent, because the risks on such a bond become tremendously skewed toward future losses. 

Gagnon is exactly right - since Fed policy operates through the interest rate channel, when rates are as low as they go Fed policy doesn't do anything. The point of "unconventional" monetary policy is NOT to stimulate the economy directly but to lower long rates. Once long rates hit bottom Fed asset purchases no longer have any effect. 

So, if the Fed bought every MBS in the economy Gagnon believes we could lower the mortgage rate for prime borrowers to somewhere a shade under three percent. Would that impact lending? Of course! It would mean that people who are not creditworthy at 3.75 percent but are creditworthy at, say, 2.75 percent could get a loan. That would be stimulative.  

So, I will direct to this post anyone who accuses me in the future of saying the Fed is powerless. The Fed has the power to set interest rates, and could lower long rates a bit more by buying up mortgage backed securities. The Fed could also theoretically buy foreign currency. It has no other powers. 

For the record I don't at all share Gagnon's belief that it would be a good idea to authorize the Fed to intervene in the stock market.

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