Central banks, rabbits, printing presses and dead ends
The Wall Street Journal has
an article about money and the printing presses. At the end it quotes Ben Bernanke for his ultimate
belief in the printing press. Here.
But should we join him in that belief?
Money supply continues to
perform more or less normally. Monetary velocity has slowed but that in and of
itself is not particularly odd.
What is most peculiar in an
historic context, but totally understandable by today’s standards, is that the
money multiplier no longer works. Under the old system we would see banks get
fully ‘loaned out.’ That is, they would loan funds until the banking system’s
excess reserves were negligible. But now
the amounts of excess reserves in the system are vast. The Fed has pumped up
its balance sheet and there are billions of billions of excess reserves that
are not being lent. This is the ultimate example of what economists call
pushing on a string. And it is now NORMAL- not a special case of sorts. So do the
printing presses still work?
Banks do not lend funds because
they now have strict capital requirements to make loans. Loans not only need to
be funded with deposits but they to be backed by capital and the bank needs to
pass stress tests imposed by the Fed based on what is on its balance sheet. Because
of the capital requirement, banks are more careful about making loans. For one
thing bankers will not engage in so called ‘riskless arbitrage’ and blow up their
balance sheets as they once did. Bank loans are the way money is created. If
banks make loans more slowly, then money creation itself will slow. Banks make
loans under much more restrictive conditions these days. And bank loans have
more competition these days, too, as banks are being paid returns on the excess
reserves they own. Banks can hold excess
reserves and earn the return on reserves nearly risk free. That raises the hurdle
for risky lending as well.
Not all bank reserves become
money supply in this model. They do not get turned into M2 assets/liabilities.
And a wedge is created between the Fed’s balance sheet growth and the growth of
conventional monetary assets held by the public. When Bernanke talks about the printing
presses saying that they will have an eventual impact, it depends on what he means
by ‘the printing press.’ Since the reserve channel is not functioning and that
does not seem to be particularly temporary ‘the printing press’ is not bank
reserve growth.
It is not clear how much monetary
stimulus matters in this environment. QE worked by removing safe assets and
forcing the public to acquire riskier assets. It pushed rates lower through
asset purchases LSAP (large scale asset purchases) - at least for a while-
there were at least announcement effects. And while some have said that QE has
many of the same effects of a traditional Fed policy easing, those similarities
appear to be fleeting and there are side effects from QE. If this were a drug,
I’m not so sure that the FDA would so easily approve it. In short there is no one
for one equivalent between QE and a cut in the Fed funds rate.
Negative rates of interest
are being considered apparently in the U.S. (‘not off the table’ to use Yellen’s
lexicon) and are being used in some countries.
That distortive policy seems particularly dangerous. Central bankers are
getting desperate and have done their best to try portraying some novel policies
as analogs to tried and true conventional policies. This is just like in the
financial crisis when the private sector employed derivatives that were poorly
understood while they pretended they had been fully vetted and were
well-behaved. I think markets are also coming to this point of view regarding central
bank behavior especially since the BOJ implemented negative rates and got the
opposite exchange rate reaction that it expected.
It is now clear that some of
these novel policies are starting to show their quirks and how they are different
rather than the same as traditional policy. And markets are frightened. Central
banks seem to be overstepping the boundaries of their understanding. Are they going
down the rabbit hole? Have they reached a dead end and have all the different
ways that central banks have to run the printing presses stopped working?
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