Robert Waldmann’s "How to Solve Many Problems," This Time with a Question Mark
by Mike Kimel
Robert Waldmann’s “How to Solve Many Problems,” This Time with a Question Mark
The other day I noted that the S&P 500 leads the economy. A few days before that, my colleague, Robert Waldmann suggested that perhaps it might make sense for the government to issue bonds and use the proceeds to buy risky assets, such as stocks.
Leaving aside the question of whether the government can pick winners, or whether most investors can either (not to mention the government’s recent willingness to swap good debt for bad debt held by banks, which amounts to a very dumb version of what Robert suggested), does the fact that the S&P seems to lead the economy provide a reason for the government to follow Robert Waldman’s prescription? And if the government did get into that business, would the correlation between the S&P 500 and economic activity go away? Or might this even be a more efficient or effective way to conduct monetary policy than buying and selling securities from a small group of banks (and where the purchases and sales are telegraphed so the folks on the other side can game the system), which is how things are done even when times are good?
This was written on the fly in less than five minutes, including finding the old links, so I haven’t thought any of it through, but… what am I missing here?
I’m surprised to be reading this stuff at AB. The Federal Reserve has had a policy in place since 2008 called QE. The primary objective of this policy was to “Increase Asset Prices”. The policy was directed to risky assets like stocks and bonds.
And it has worked, stocks and bonds are “up” as a result. You call that success? You want more of that?
How many readers at AB got rich in the stock market in the past 24 months? Very few is my guess. Those that got rich in this cycle are the same old top 5% who own the assets going up in value. There is very little tax revenue generated by this so we end up with 10% deficits.
Now you want to take this to the next level. You want the central government to start buying stocks and bonds so it too can make a fortune. And when that happens the deficits will go away and happy day will return for the 98% that have nothing to show for this.
Yes there is a correlation to the stock market and the economy. But you can’t make the economy stronger by buying stocks (creating artificial value). In this case the dog is the economy, the tail is the stock market. It’s the dog that wags the tail. It is not the tail that is wagging the dog.
Wouldn’t direct purchase in the “private” markets be government competing with the private sector? One of the big no no’s of the Milton followers?
Personally, I would not like to see the government change toward making a profit. It’s bad enough we are becoming a security state with war making abiliity such that the human experience is removes. Add profit intent and we’ll be worse than any name brand governance system that has come before.
We have gone down the road of turning government into a business way to far for my liking. Government is not a business, not even a non profit business.
Find a better way, like your suggestion of people having direct access to the Fed now that everything can be done via the Net.
Maybe I’m the only one that noticed this, but we are running a Federal deficit around 10%, only a little over half of government spending is coming from taxes, the rest from financing the deficit, and the Fed is presently indirectly buying the entire deficit, and these purchases average a 7 year duration.
Traditionally, monetary policy was implemented buying and selling short term t-bills because the price of these stays the same, unlike long term Treasuries. So in spite of the fact that the Fed has a rotten track record of timing monetary policy, and already monetary policy has degraded into the the “Greenspan-Bernanke Put”, at least using t-bills they get a 1-1 ratio between money injected/withdrawn and t-bills on the Fed balance sheet. They will be even more confused if the price of the Fed balance sheet changes and can also spook the bond market when they announce they will commence the sale of a trillion or so of long term bonds. As an alternate move, Ben now has the option of paying interest to banks on reserves held at the Fed. Whoopee! Another handout for banks.
So it looks to me that the Treasury needs to get back in the biz of collecting taxes, Congress get back in the biz of fiscal policy, regulators doing regulating, and the Fed out of the biz of being a pension fund for banks. We certainly don’t need the Fed to become a mega hedge fund for banks. Not to mention that “moral hazard” problem if the financial industry knows it has a buyer for any dumb “high risk” paper it wishes to generate, or have a high frequency trading firm pump up the price on stock and then dump it on the government so we can pay for it in taxes someday.
Unless of course we believe we don’t have enough income inequality.
Daniel Becker: “Wouldn’t direct purchase in the “private” markets be government competing with the private sector?”
It’s a subsidy, isn’t it? 😉
If the strategy were to buy low and sell high, then, yes the gov’t would be in competition with the private sector. But if the strategy were to buy and hold, then it might function as a countercyclical feedback mechanism, to help stabilize the system. Instead of raising taxes, the gov’t collects dividends. Much more palatable. 😉
I would disagree as the governement does not “earn” or “make” money. We are the government. The government is best viewed as a very specific extention of our ability to live/reduce risk. It is not the part of us that works to earn an income and it should never be. It should remain a tax funded entity in order to keep our personal and human connection to us.
Of course, that means viewing taxes as something positive and not as a negative.
To think of government earning an income outside of us funding our essentials for reducing the risk of life and living is to think robotic warfare is ok. Both are only means to removing the responsibility for making the decision.
Government is not a business. It is not a family unit. It is a machine which is an appendage of us that we use to provide services that make living less riskful and more comfortable.
Then again, we changed our education system from one that serves us to one the serves business and thus fund it via business and wonder why society as represented by our elected can’t accomplish great visions anymore or more gremain to education, why it’s failing.
Recent research suggests that there has been a very tight correlation between stock performance and inflation expectations since 2008. If you view inflation expectations as a proxy for nominal GDP expectations then this makes sense. And the data shows there is no lag:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1749062#
http://www.themoneyillusion.com/?p=8659
http://krugman.blogs.nytimes.com/2011/02/02/inflation-and-stock-prices/
http://motherjones.com/kevin-drum/2011/02/yes-our-problem-low-demand
http://yglesias.thinkprogress.org/2011/02/inflation-and-stock-prices/
in other words the it’s not so much that stock prices are driving GDP as they are a symptom of growth expectations. So you need to boost growth expectations. What are the policy implications?
Waldmann’s idea of issuing bonds to purchase risky assets is fine but it likely would only have a very modest effect since you’re not really doing anything to increase the money supply, and hence increase expectations of higher nominal GDP. Furthermore there is the practical reality that it will never happen with the Republicans running the House.
Could the Fed “print money” to buy risky assets? Sure, why not, they already did in 2008 when they purchased a trillion dollars worth of toxic MBSs. Of course part of the problem with QE in general right now is that most of this money ends up as inert reserves thanks to IOER. Get rid of IOER and the banks will have less reason to sit on their assets.
And in the final analysis it doesn’t really matter what the Fed buys with freshly printed money, as long as it prints it. In fact what if QE2 had been in the form of helicopter drops of $2000 a head for every person in America? That would have probably worked even better, eh?
I know, it’ll never happen, but as long as we’re talking about fantasies I couldn’t resist.
Bruce is correct. The policy is already in effect through QE1, QE Light, and QE2.
“what am I missing here?”
–The policy is pretty much trickle down economics on steroids. The well off front run the Fed, purchasing bonds just to flip them over to the central bank at a premium. If you don’t have the funds to do that, purchase stocks you think the extra liquidity will go (via the primary dealers).
“does the fact that the S&P seems to lead the economy provide a reason for the government to follow Robert Waldman’s prescription?”
–The S&P 500 is up around 27% since QE2, yet we’ve downgraded the GDP growth forecasts. Don’t confuse cause and effect. In other words, correlation does not imply causation.
Daniel Becker: “I would disagree as the governement does not “earn” or “make” money.”
If that is to me, I never said that it did. I said that collecting dividends (under boom conditions — sorry if that was not clear) could be countercyclical, and more palatable than raising taxes. 🙂
Mark A. Sadowski: “And in the final analysis it doesn’t really matter what the Fed buys with freshly printed money, as long as it prints it.”
Do you mean the long run? Wouldn’t it have been better for us now if the Fed had bought state and municipal bonds? Or helicopter drops, as you say?
Min,
I’ll settle for whatever we can get. But personally I think helicopter drops would work better than any of the alternatives.
Besides, I don’t know about you, but I could use a couple grand.
The Fed did not purchase stocks. Look at its balance sheet. You display utter ignorance with your plainly false claim.
The proposal is similar to QE 1 but very different from QE 2. In QE2 the Fed purchsed 7 year Treasury notes. I propose buying high yielding assets. 2% nominal is not what I call high yielding. It is true that QE2 will reduce the deficit. By financing at 0.25% (deposits at the Fed) not 2% the Federal Government with save about 10.5 billion a year. That’s nice. It is, however, not the solution to the deficit. My proposal is much larger both in the dollar value of the purchases and the average yield on the assets.
You assert that QE2 like QE1 drove bond prices up. You are wrong again. The, 5 year, 7 year and 10 year constant maturity iominal interest rats are higher now than when QE2 started (you can choose your start date from August 26 when Bernanke first mentioned QE2 until December when the actual purchases started). From the first announcement and through the period of purchases of 7 year notes, the price of 7 year notes has fallen.
http://research.stlouisfed.org/fred2/graph/?graph_id=43182&category_id=0#
Your claim that, following QE2 bond prices went up is just like the claim that the Earth is flat. It shows contempt for the facts.
You clearly don’t know which direction bond prices have changed and are unwilling or unable to use FRED.
Your amazing ignorance doesn’t surprise me, but I warn pther readers of this thread not to trust any claim of fact made by Bruce Krasting. He doesn’t know what he is talking about and makes claims of fact based on his hunches and without checking the data.
Dear Daniel Becker
Yes this would be competing with the private sector. In particular, if the high yields on risky assets were driven down, naive investors would not be attracted to them. The financial services industry makes its profits from charging those investors fees and on average buying from them when prices are low and selling when they are high. The proposal would hur t the financial services industry. Also it is socialism.
The Federal Government already seeks profits by patenting inventions. The proposal would not create a role for profit finding bureaucrats. The proposal is to buy a fixed percentage of all assets — no discretion, no way to perform better than other civil servants, no benefit from bribing the bureaucrats no power to threaten managers to not buy their shares unless they do something. I think this would prevent the bad aspects of socialisms and also prevent the Federal Government from acquiring those aspects of profit seeking businesses which you fear.
Allowing people access to the Fed first of all would require the Fed to obtain the capacity to evaluate ordinary people’s credit worthiness which it sure doesn’t have.
Much more generally, I absolutely do not mean to discuss private investment in risky assets. We have that already. There are disadvantages. Huge amounts of money are spent keeping track of who owns what (the fees). Individuals bear risk. People are not all maximally sophisticated and the sophisticated gain and the expense of the less sophisticated. This creates huge incentives to understand the mistakes of the less sophisticated. This effort is not socially useful.
The key observation behind my proposal is due to Mehra and Prescott (yes that Prescott) who note that the low price of stock would make no sense if all risk were shared by everyone. This says that stock is worth much more to us acting together (as in the Treasury) than we value it as individuals. I think the reason is that individuals are irrational — irrationally afraid of stock and also unable or unwilling to diversify properly. I note I do not now and never have owned a share so I am calling myself irrational.
The only possible problem with my proposal is that an aggregate downturn would cause a huge Federal deficit. This is what we economists call an automatic stabilizer and it is a very good thing.
But huge losses to households in a recession do *not* stabilize demand. The proposal only makes sense for public ownership.
Dear Min
Yes exactly that’s the point. However I do think (see my reply) that the Feds buying and holding would reduce the size and profitability of the financial services industry. The purchases would drive up the price of stock and drive down the return. This would make playing the market less attractive to individual investors. Basically if the Feds shift to more risky assets, the private sector will shift towards safer assets (like the extra Treasury securities).
Safer assets are also more boring to the individual investor and to the pension fund manager. So less playing the market. It is this playing the market by individual investors and penion fund managers which causes the huge profitability of the finanicial services industry.
So the program would hurt them, not by competing but by making asset prices more boring.
My proposal is a purchase of risky assets once. So no timing and no sppoking (or reassuring markets). I was thinking of the Treasury not the Fed.
It is true that the deficit is now 10% of GDP. However, it is forecast to decline. I use the CBO alternative forecast.
I support higher taxes on the rich (also lower taxes on the poorer 60%). I have proposed balancing the budget with only tax increases on income over 250,000/ yr (and no tax cuts for anyone 🙁 ). I think this would work with Kennedy Johnson era tax rates (that is a euphemism for 70% but I like to stress the fact that such rates were consistent with extremely rapid GDP growth like no other time in US history when FDR wasn’t President).
However, I also think it could be done with buying risky assets. Given current returns, I think that gain from buying 10% of the stock (that’s 5 trillion worth) would be around $ 300 billion in an average year (with *lots* of fluctutation). That would just about do it (really honest). Of course the plan would drive the price of stock up and might drive the price of Treasuries down (it shouldn’t but it might). But then there are coroporate bonds too (not much). Well uh maybe 15%. And maybe I assumed Bush tax cuts would expire.
It’s in the ball park. Roughly. give or take 10 trillion.
The Fed can’t helicopter drop money. That would be fiscal policy. It requires congressional approval (as in the helicopter drops of 1600 over 2 years per family in the ARRA).
The Fed can buy assets or loan. It can’t give.
Calling a rebate “monetary policy” is like calling a banana monetary policy. It can be helpful if you want to say silly things about monetary policy, but it has nothing to do with the real USA.
Money may be disbursed only as appropriated by law. The FOMC can’t replace Congress. If the Federal Reserve act were written so that it could helicopter drop money, then the act would be unconstitutional (and you *know* Ron Paul would sue if they tried — he would also win, probably 9-0 in the Supreme court).
Bob,
It’s a fantasy. Sort of like your proposal.
I think my original proposal would stabilize the economy. The idea is the Treasury gets some of the illusory gains in a bubble meaning less irrational exuberance and, vice versa, it bears much of the loss in a crash so less panic and everyone trying to save more and paradox of thrift and all that.
This works only because people are too myopic to remember that they own the Treasury (that is because (as argued by Ricardo who is usually misquoted) there is not Ricardian equivalence).
On the other hand, open market operations in stock seem to me to place too much power in the hands of civil servants (my name is on a paper which seems almost to advocate such operations — along with “Brad DeLong”, “Andrei Shleifer” and “Larry Summers” (yes that Larry Summers) but it’s too crazy for me).
I would propose just buying once and holding. This means I don’t trust civil servants to guess better than the market. The idea is that it is good for the Treasury to buy, because it has huge immense gigantic risk bearing capacity and risk bearing is highly rewarded.
The idea is really due to John Quiggin (who was arguing against privatization in Australia). It is based on the work of Mehra and Prescott (yes that Prescott — interpreting him as the justifier of Socialism is part of the fun).
Prescott’s got my goat on his paper concerning hours worked and tax burden. Anything that takes him down a notch has my interest. Evidently Lane Kenworthy has some research that contradicts that finding.
Thanks, Robert. Glad I understood something about your idea. 🙂
Nasty tone to your response. Why?
Are you denying that the objective of the Fed’s QE was to raise asset prices? That the Fed’s goal was to raise the value of stocks? If so I suggest you read what Bernanke has said.
No the Fed did not buy stocks. They can’t. But the policy did drive money out of money funds into stocks.
The policy was driven to reduce yields in the maturity where the US has the most debt. The five year area.
A year ago the 5 year was 2.18% today it is 1.71%
A year ago the 10 year was 3.10% about the same today
A year ago the S&P was 1030 today 1330.
Just what facts am I wrong on?
Kevin,
“The S&P 500 is up around 27% since QE2, yet we’ve downgraded the GDP growth forecasts. Don’t confuse cause and effect. In other words, correlation does not imply causation.”
The argument was that the S&P generally leads (of course other factors matter), and the biggest effect on GDP generally lags S&P by 16 quarters. That would be four years. Last I checked, 16 quarters ago the S&P had peaked and began sliding down. Timing isn’t perfect, in part because a whole host of other things matter.