Thinking About the Fed
JKH has magisterial post up on the recent dust-up over Saving as perceived in various sectoral models — one-sector (global, for instance, or government- and trade-balanced domestic private sector); two-sector (government and private including international); the most common MMT construct, the three-sector model (government, domestic private, and international); the rather uncommon four-sector model (government, international, domestic household, and domestic business); or even a seven-billion-plus-sector model, in which each individual (and business, and government) is represented as a sector.
His key point, I think — one I agree with profoundly — is that people need to be very clear on which model they’re assuming when they use the word Saving, or the construct “S.” (People sometimes use those two differently, with different implied sectoral models, sometimes within a single discussion or even a single sentence.) In most cases the different constructs of saving and S that people throw around are absolutely valid within their (implicit) sectoral models. The problem arises when people are talking about different sectoral consolidations within the same discussion, without themselves and/or their interlocutors being (fully) aware of it.
I’ve left a few glancing comments over there, but it’s prompted me to write up some thinking here that’s conceptually related.
How do we think about the central bank, and actually the nature of money and the monetary system? I see a lot of people talking past each other because they’re talking about different levels of accounting consolidation. Here are four ways to look at the Fed:
1. It’s an independent institution, separate from Treasury and the reserve-holding banks.
2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.
3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the Fed.
4. It’s part of a fully consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.
I’m not going to explore all these fully — there’s a book (or several) there — but here are some thoughts on each that might illuminate how the thinking is very different depending on which you adopt, perhaps showing how quite a lot of unecessary confusion and cross-discussion might be avoided.
1. It’s an independent institution, separate from Treasury and the reserve-holding banks.
Even though this is the “reality” of our monetary system (as a result of legislative diktat), thinking about it this way results in an odd conceptual situation. We end up with a sovereign currency issuer (Treasury) that (like a household or business) has to borrow in order to spend, and a bank (the Fed) that can issue unlimited funds ex nihilo to purchase assets. This seems exactly the opposite of how one would imagine things would work.
2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.
This is a preferred MMT construct, and it has much conceptual appeal. “Government” issues new money through Treasury spending, and Fed open-market and QE operations are basically fiddling around the edges of the money “supply,” largely for the purpose of interest-rate management. Yes, the Fed actually issues the money, but in this consolidated view “government” is doing the issuing through deficit spending, crediting people’s bank accounts with newly-created money.
3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the fed.
This makes conceptual sense, because all deposits ultimately resolve, consolidate, back to reserves at the Fed. In this construct, all the banks (including the Fed) are issuing private money as licensees of of the Fed, which ultimately derives its licensing authority from “government” (Treasury).
4. It’s part of a consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.
Looked at this way, we could conceive of it all as a single big national bank, with deposits resolving back to reserves, which ultimately resolve back to the full faith and credit of the government (Treasury).
These are fairly sloppy characterizations. I know the JKHs and SRWs, Ramanans, Vimothys et. al could (and I hope will) express them more cogently and accurately. But I wanted to keep them brief to highlight my central point:
Different views, consolidations, of these entitites result if very different understandings of “how the monetary system works.” Each (properly presented, unlike here) is valid within its own construction, and each imparts an important understanding of how things work. The problem arises, as with Saving and “S,” when a person, or people in discussion, confute and confuse these different views, or switch among them during thinking and discussions.
Cross-posted at Asymptosis.
Here’s the money quote for me:
“We end up with a sovereign currency issuer (Treasury) that (like a household or business) has to borrow in order to spend, and a bank (the Fed) that can issue unlimited funds ex nihilo to purchase assets. This seems exactly the opposite of how one would imagine things would work.”
I would argue that this not only *seems* wrong and ass-backwards, it in point of fact IS wrong and ass-backwards.
I know that Fed critics are typically stereotyped by Progressives as Tea Partying paranoid gold bugs and Ron Paul acolytes. Regardless, there actually are a few liberals out there that –myself included– who see this arrangment for what it is: a self-serving monoply created by powerful bankers to serve their own interests.
Protestations that the Fed has any meaningful “mandate” to maintain full employment, reign in inflation, or any other “civic duty” towards non-rich American citizens is basically diversionary hogwash. The Fed’s publicly stated “mandate” means about as much as “fiduciary duty” does to Goldman Sachs. The Fed is made up of its (privately owned) member banks, and it serves the interests of principal shareholders in those private banks, who just so happen to also be the very megalomaniacal plutocrats who are pushing for *yet more* financial deregulation (JOBS act).
Another way to look at all this is, why is it even necessary to create a national banking system that’s so bewilderingly complex and opaque that it requires finance wonks like Steve Roth to break it down for the rest of us slobs? Could it be that the money masters do not want us to find out just how unfair and thoroughly rigged our financial system is? Could it be that if your average Uhmurikan realized just how badly the banksters were screwing him, he might grab a pitchfork and torch and head over to the nearest FRB branch and join all the “Occupy” hippies?
@HARM:
I’m with you. The Fed is owned and run by creditors, and they manage the financial system for the benefit of creditors.
One extra percent of inflation over the next year would transfer hundreds of billions of dollars in buying power (the ability to purchase real goods and services) from creditors to debtors. It would also decrease the stock of reserve unemployed who keep wages under control.
The Fed’s #1 trigger to tighten *is* rising wages.
Incentives matter.
is there now or was there ever an empirical basis for setting NAIRU? Rather than at whatever rate the Fed thought would keep the Invisible Confidence Fairies who buy bonds and the old lady heiresses that clip the coupons (yes I know there are no longer physical coupons) content.
Because I grew up in a family with significant income insecurity with ny Dad experiences significant periods of unemployment and under-employment in the 1968-1977 period even as every uptick in real wage or downtick in unemployment was presented as some horrible harbinger of inflation. The solution to which was apparently keeping Bruce’s Dad unemployed as much as possible.
The stagflation of the late 70s and early 80s was impossible, you just had to draw two lines on a chalkboard and apply some math to prove it. Similarly the combination of high employment plus over trend Real Wage and below trend inflation we saw in the late 90s was equally impossible, you just had to move those two lines down and to the right. Or whatever, I never took Econ 1 or Econ 101. On the other hand Inhave searing memories of the ‘bill bucket’, which tool allowed my parents to juggle minimum payments and due dates in a largely successful attempt to keep four boys fed. (And we always ate well, both my parents and my three brothers were or are skilled cooks. Whereas I am only alive because of can openers and microwave ovens and prepared foods).
I am still waiting for an apology from various Fed Chairmen and Governors who from the 60s to the 90s and again today prescribe austerity at any sign workers might be getting a little less behind the income curve.
Call me naive but since I started paying attention to this as a precocious 11 year old (or so) it seems the Fed just defined its statutory duty to target ‘full employment’ as meaning ‘that rate that doesn’t exceed our totally arbitrary measure of NAIRU’. I understand the principle of ‘better safe than sorry’ but in monetary affairs it seems that safety is operationally defined as the immediate interest of bond buyers and holders.
HARM
well, count me in tentatively. i don’t really understand how it works. but since i got curious about the Greek debt crisis, everything i have read shouts “predatory lenders” and “debt slavery.” IMF World Bank and the Fed. I am hoping to understand more soon. But there are smarter people than me right here on this thread who could probably learn it faster if they don’t already know.
I suspect there are other factors: offshoring and deregulation and the growth of the criminal-financial-government complex.
But if Ron Paul had any credibility he lost it with his lying editorial in the Times.
“Another way to look at all this is, why is it even necessary to create a national banking system that’s so bewilderingly complex and opaque that it requires finance wonks like Steve Roth to break it down for the rest of us slobs?”
Our Mike Kimel (Cactus) was asking this similar question when the crap hit the fan. He went as far as to ask why in the age of computers does the US citizen have to use a third party as oppose to going direct to the Fed.
@Coberly, to be perfectly fair, I don’t think Ron Paul is not some racist, gold-bugging ogre, as he’s typically portrayed in the media, and there is much to like about him. Unlike a lot of pols, he is always willing to take unpopular stands and to vote according to his principles.
However, the Right-Libertarian view of how government and business really work smacks of extreme naivete, as well as a desire to justify personal greed and self centeredness in the name of “political philosophy”. It’s almost as though Paul and his Right-Libertarian followers inhabit a world where corruption, collusion and criminal activity among powerful men simply does not exist, and where business interests are always well aligned with citizens’ best interests.
If you are interested in learning more about the IMF, the World Bank, WTO and trade policy, I’d recommend these:
Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, by Ha-Joon Chang
Unholy Trinity: The IMF, World Bank and WTO, by Richard Peet
On the Fed:
Greenspan’s Bubbles, Bill Fleckenstein
Bailout Nation, Barry Ritholtz
@Coberly, to be perfectly fair, I don’t think Ron Paul is the racist, gold-bugging ogre, as he’s typically portrayed in the media, and there is much to like about him. Unlike a lot of pols, he is always willing to take unpopular stands and to vote according to his principles.
However, the Right-Libertarian view of how government and business really work smacks of extreme naivete, as well as a desire to justify personal greed and self centeredness in the name of “political philosophy”. It’s almost as though Paul and his Right-Libertarian followers inhabit a world where corruption, collusion and criminal activity among powerful men simply does not exist, and where business interests are always well aligned with citizens’ best interests.
If you are interested in learning more about the IMF, the World Bank, WTO and trade policy, I’d recommend these:
Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, by Ha-Joon Chang
Unholy Trinity: The IMF, World Bank and WTO, by Richard Peet
On the Fed:
Greenspan’s Bubbles, Bill Fleckenstein
Bailout Nation, Barry Ritholtz
I am still waiting for an apology from various Fed Chairmen and Governors who from the 60s to the 90s and again today prescribe austerity at any sign workers might be getting a little less behind the income curve.
I hear ya, but you are in for one mighty long wait. I’m still waiting for an apology about Iraq from all my Bush-loving colleagues.
in monetary affairs it seems that safety is operationally defined as the immediate interest of bond buyers and holders.
Bruce Webb clearly “gets” NAIRU!
HARM to be imperfectly unfair, the argument “I just signed the Op-Eds and deposited the receipts from the newsletter subscriptions but that doesn’t mean I agreed” is pretty weak.
By most accounts William Randolph Hearst was not a bad man despite being an open adulterer and jingoist newspaper publisher. He just had a major role in launching maybe the second least justifiable war in American history before the War on Iraq. (I have ancestors that fought in the Mexican War of 1848, in which we didn’t even have the excuse of Anschluss, we just grabbed it).
Quite apart from Ron Paul’s consistency on aspects of monetary policy and foreign affairs and pot smoking and all that freedom stuff I have a sneaking suspicion that he would sign off on the Protocals of the Elders of Zion if the text was put before him. At some point ‘rightie’ Ron Paul merges with ‘lefty’ Lyndon LaRouche in a toxic mix. And “lovable coot” only gets you so far, okay for crazy uncle at Thanksgiving Dinner, after all you can pass the wine, but maybe you don’t want to give Uncle Paul the keys to the National Car.
HARM
thanks. i will look at the books. currently trying to read Web of Debt by Ellen Brown. Trouble is, I don’t really understand it. Don’t quite trust her logic. And really don’t trust her solutions. But if she is even half right, everything we talk about here and in the media and, of course, politics, is beside the point.