From an interview forthcoming in the Financial Analysts Journal.
Litterman: What impact will the big expansion in the Federal Reserve’s balance sheet have on the markets?
Fama: It has basically rendered the Fed powerless to control inflation. In 2008, when Lehman Brothers collapsed, the Fed wanted to get the markets moving and made massive purchases of securities. The corollary to that activity, however, is that reserves issued by the Fed and held by banks exploded. An explosion in reserves causes an explosion in the price level unless interest is paid on the reserves. So, the Fed started to pay interest on its reserves, which means that the central bank issued bonds to buy bonds. I think it’s a largely neutral activity.
Before 2008, controlling inflation was a matter of controlling the monetary base (currency plus reserves). But when the central bank pays interest on its reserves, it is the currency supply that determines inflation. But banks can exchange currency for reserves on demand, which means the Fed cannot control the currency supply and inflation, or the price level, is out of its control. The Fed had the power to control inflation, but I don’t think it does under the current scenario.
Litterman: How does that relate to the debt issues that the United States is facing?
Fama: The debt issues are entirely different. The debt issues are about how much we want to sacrifice the future for the present and whether we get anything in the present for the future we’re sacrificing. This has been the big debate between the Keynesians and the non-Keynesians since 2008.
Litterman: But isn’t one way out of our debt problem to inflate it away?
Fama: Yes, that’s one way to handle it, but it’s far from a great solution. If the Fed were to stop paying interest on its reserves, we’d probably have a big inflation problem. The monetary base was about $150 billion before the Fed stepped in in 2008. Currency plus required reserves are still in that neighborhood, but the Fed is holding $2.5 trillion—trillion!—worth of debt financed almost entirely by excess reserves. The price level could expand by the ratio of those two numbers, and that translates into hyperinflation. Economies typically do not function well in hyperinflation. The real value of the government debt might disappear, but the economy is likely to disappear with it.
Litterman: What would your suggestion be for monetary or fiscal policy at this point?
Fama: Simple. Balance the budget. I heard a very prominent person say in private that we could balance the budget by going back to the level of government expenditures in 2007. The economy is currently about the size it was then. If you just rolled expenditures back to that point, I think it would come close to balancing the budget.
(HT: Mankiw)
Um, I have to admit I dont fully understand what Fama is saying, guess I havent read enough economics. But I think its something about inflation coming soon, to the $US anyway. That I understand.
Jannie
14 Nov 12 at 5:58 pm
So, basically, all you need is for someone to say we are not going to spend this much next year.
Didn’t they just have an election on that and ….oh wait
Mark
14 Nov 12 at 6:28 pm
Short USD, short USD, short USD.
jasbo
14 Nov 12 at 6:31 pm
is not the layman’s translation of this:
‘they re-elected the morons who created most of this disaster, fixing it ain’t hard but they are waaaaay too stupid for that so you are all so rooted that you might as well join MacAffee and take up jamming ‘bath salts’ up your clacker as a hobby: BTW my money’s in bullion and Swiss francs’
Does that sum it up?
Mk50 of Brisbane
14 Nov 12 at 6:43 pm
Friedman (1959) advocated the payment of interest on reserves at the Fed. sargent and wallace opposed it in 1985. take your pick.
Jim Rose
14 Nov 12 at 6:45 pm
This is better: inflation makes the rich worse off and austerity makes the rest worse off. So he wants austerity.
Scapula
14 Nov 12 at 6:45 pm
Inflation makes everyone worse off.
Cato the Elder
14 Nov 12 at 6:49 pm
The mass printing of cash, resulting in the inflated stock market and falling of the US dollar are the perfect recipe for inflation.
Scapula comments and highlights once again what an ignorant fucking retard he is.
harrys on the boat
14 Nov 12 at 7:09 pm
Scapula, we live in the era of pension fund socialism. the majority of the share market is owned by retirement savings funds.
Jim Rose
14 Nov 12 at 7:13 pm
It’s a modern miracle….there is a god.
USA QE 1, 2 and 3 plus a smidgen over zero official interest rates, bailout cash strewn hither and yon, gold official suppressed via paper gold trading via the PPT….and still there’s no inflation in the chosen measures (the trick is to leave out food and fuel). Prattle away Farma.
Helicopter Ben is up for a Nobel on this loaves and fishes deal.
Hmmm…how best to bale Benjamins so they stay together on the drop?
Alfonso
14 Nov 12 at 7:14 pm
“Short USD”
Can anyone point me to a good mortgagee that will denominate my account in USD?
2dogs
14 Nov 12 at 7:19 pm
Its not my problem if the US thinks its banks are too big to fail or that governments have made savers a hostage to Wall Street.
If the above were a ‘perfect recipe for inflation’ we’d have had it by now.
Scapula
14 Nov 12 at 7:22 pm
Meanwhile the yield on thirty year treasuries are at near record low levels. High – or hyper – inflation implies a negative real return on these securities. I vaguely remeber this bloke saying something about efficient markets … When did he give up the EMH and decide that he could outsmart the market?
PSC
14 Nov 12 at 7:29 pm
Alfonso the annual rate both headline and core CPI inflation in the US is 2.0%. There is no consipracy.
sdfc
14 Nov 12 at 7:31 pm
I actually agree with PSC here, The bond market, last time I looked, was tipping around 1.4% inflation in the US over the next 10 years.
I also agree with Scott Summer. We live in a world of sticky incomes and prices. In this world I would prefer the Fed target GDP.
JC
14 Nov 12 at 7:36 pm
JC / PSC – read what he said:
Sinclair Davidson
14 Nov 12 at 7:41 pm
No that’s fine Sinc. But the Fed pays .25% interest on reserves. I presume the argument is that if it didn’t pay the funds would be lent the borrowers and we would see a monetary expansion as a result.
I’m not sure I buy this argument. The banks could simply purchase T-bills or as a last resort simply go to cash in a vault. The interest on a $1 trillion in reserves is around $2.5 billion for the banking system. It’s not as though they are making a mozza out of it.
Secondly, banks are finding it difficult to lend in the markets because of various issues.
JC
14 Nov 12 at 7:49 pm
Jesus sinc, was just about to give scapula a serve and say yes if they stop paying their debts, with a few expletives, and you beat me to it
Harrys on the Boat
14 Nov 12 at 7:50 pm
Fama is a jackass.
The problem is unemployment in the US and anyone who listens to Fama’s screeching that the problem is inflation – needs a brain transplant.
Alice
14 Nov 12 at 7:52 pm
Yep.
Sinclair Davidson
14 Nov 12 at 7:53 pm
You don’t need to. All you need to do is borrow Aussie Dollars and then sell Aussie for a forward date thereby crating a sort of derivative loan. In other words you can recreate the loan though the futures market.
You understand that you would have what’s called a carry trade, right? You would be running currency exchange risk.
JC
14 Nov 12 at 7:56 pm
Sacpula says
”
Its not my problem if the US thinks its banks are too big to fail or that governments have made savers a hostage to Wall Street.
If the above were a ‘perfect recipe for inflation’ we’d have had it by now.
and we didnt and we havent and it hasnt been a frigging problem for decades BUT they do have a big problem with unemployment.
Since when did economists turn to fighting non existent problems and ignoring real problems.
Jesus I hate these “beware high inflation” phonies.
They threw taxpayers money at the banks and a shitload went into obscene bonuses. If that isnt corruption I dont know what is.
Its up to the American people to clean up its Fed because its well and truly stuffed.
Alice
14 Nov 12 at 7:58 pm
Alice
Sop being an idiot. The banks paid back of the TARP money and many good banks were forced to take the money whether they wanted it or not.
JC
14 Nov 12 at 8:00 pm
AND Jim Rose says
”
Scapula, we live in the era of pension fund socialism. the majority of the share market is owned by retirement savings funds.
NOT BY THE CHOICE OF THE PEOPLE.
Pension fund soiualism comes in the form of mandatory super ie the government passes legislation to ROB you of your wages and firced savings and then those savings funds blow enormous bubbles in the stockmarket, which hey guess what, rob you in fees to financial institutions, then rob you again when these guys get to blow bubbles with your lost wages.
Stuff that.
The entire socialism is the massive subsidies being plowed by governments towards banks at the eordinary mans expense.
Dont get me started. I dont need the government to force me to save and I dont trust how they tell me to save. Ive got my savinbgs out of super (bar the legislated bit) and Im doing much better.
Untristowrthy bastards just see super as a pool of captured funds they can plunder (banks, financial advisers, managers and the ATO).
All of them bastards. This was Keatings grand idea wasnt it? and what a dick he was.
If the government paid the pension for lazy buggers that didnt save for their retirement the whole exonomy and everyone in it would have been better off. Enforced super is a massive CROC and hereis that dumby Julia now going for 12%.
Cant see the woods for the trees. NO sense at all. Its just a take.
Alice
14 Nov 12 at 8:08 pm
BS JC – total BS
They used tarp to pay themselves the same bonuses they paid when the bubble was two second from blowing up and sticking to their faces.
You know they did.
Alice
14 Nov 12 at 8:10 pm
Alice the 30s provided ample evidence as to what happens when you let banks fail en masse.
sdfc
14 Nov 12 at 8:15 pm
Actually, it’s this:
“I, Fama, who don’t even understand what a bubble means or know what caused the GFC, have been running round like a chook with my head cut off, yelling about how hyperinflation will ruin us all. Despite absolutely zero sign of an inflation breakout, I am doubling down.”
By the by, Sinc, how’s that stagflation prediction of yours going?
m0nty
14 Nov 12 at 8:16 pm
Well.
Sinclair Davidson
14 Nov 12 at 8:21 pm
you’re such and acidic fat fuck, Monster.
How’s your Slipper prediction going?
How did it go? Oh yea, he’d be back in his speaker’s seat in no time. Lol
JC
14 Nov 12 at 8:21 pm
I doubt that any system is 25 cents on the $1 away from hyper-inflation
Jim Rose
14 Nov 12 at 8:21 pm
Let them fail sdfc. They didnt fail in the 30s either – at least not in Austrlia. They were bailed out then and tne depression went on and on.
Thats crap. They failed in the 1890s and they were over it much faster than the great deoression.
Bailing out banks is bullshit. What other industries get bailed out like these bastards? no-one. Who gave them the right to cry poor and get bailed out?
You want the market to work? Then no-one gets bailed out.
NO subsidies to any industry and of all industries the financial sector is the wealthiest and least in need of subsidies.
Its regulatory capture pre and post GFC that got the banks bailed out, nothing else.
Alice
14 Nov 12 at 8:21 pm
No Alice the US lost about a third of its banks during the depression. The result was deflation.
It took the eastern Australian economy about a decade to escape the 1890s depression.
sdfc
14 Nov 12 at 8:25 pm
Sinc
as for you “well” post
Thats a long way off in terms of any prediction of inflation / stagflation isnt it?
(which is just typical of famaesque warning bells on infaltion ie “beware five years from now inflation will be here”
Except it isnt, it never comes, its a ghost to keep the interest rates low so asset prices stay high (which suits the wealthy well)
BUT the problem is unemplyment NOW and soon even the wealthy wont be worrying about inflation but more about the fact that people cant afford to buy their crap and retail trade sucks.
Alice
14 Nov 12 at 8:28 pm
I don’t see any justification for your horse frightening there, just bog standard structural change up the food chain from physical goods to services. Gerry Harvey losing his shirt would not lead to stagflation.
m0nty
14 Nov 12 at 8:29 pm
No it dd not take the Australian economy a decade to escape to tehe 1890s deoression sdfc. They got a double whammy in terms of the great drought which had nothing at all to do with the 1890s deoression which was recovering by 1896 and then the drought hit.
The great depression of the 30s lasted longer and that was because the banks were bailed out and they had few stimualtory policies.
Alice
14 Nov 12 at 8:31 pm
Alice – sluggish economic growth and high unemployment is the indicator for stagflation. Australian unemployment is high relative to even Treasury estimates of NAIRU and the non-mining economy is tanking. Inflation is heading up (so much so that the RBA didn’t cut rates this month despite being tipped to do so until the CPI data came out). So I’m quite comfortable saying the the economy is in trouble.
Sinclair Davidson
14 Nov 12 at 8:31 pm
m0nty – even Steve Keen has lost his job. (Although he’ll be snapped up by one of the other uni’s – many of his colleagues won’t).
Sinclair Davidson
14 Nov 12 at 8:33 pm
Anyway sdfc to compare the great depression in the US to the 1930s deoression in Australia is quite inappropriate. Different economies with different pressures but we did it tough because we bailed out the banks and dutifully paid bacl British loans (On British Treasury insisitence) whereas Britain turned around defaulted on its loans to the US.
And here we are today acting all concerned about the possibility of Greeg default or Spainish or Italian default??
Default I say and be done with it. Take out some of those banks that are insisting on austerity on the people. Let the banks share the downturn and the risks of their own investments. Who the fuck are the banks to sit on a throne and demand protection and usterity on ordinary people
because protection capital P is what they are getting.
Alice
14 Nov 12 at 8:37 pm
Whaaaat? Steve Keen has lost his job?
Sinc you must know damn well sluggish growth and high unemployment has no risk for inflation at all unless there is some underlying commodity prices affected by other things eg oil in the 1970s, wool in the 1950 a la Korean War.
There is none of that. This high unemployment and sluggish growth portends deflation if anything, not stagflation at all.
Alice
14 Nov 12 at 8:40 pm
Let’s see. What started to go off the rails in 2007/08? The GFC, you say? How about elections in Australia, followed by the USA?
blogstrop
14 Nov 12 at 8:43 pm
Alice – maybe you’re using the word ‘deflation’ in a different sense to me. I don’t see deflation at all (it is actually quite rare).
Sinclair Davidson
14 Nov 12 at 8:46 pm
And that proves stagflation is coming… how?
m0nty
14 Nov 12 at 8:48 pm
That shows the problem go beyond Gerry Harvey. Anyway doesn’t worry me.
Sinclair Davidson
14 Nov 12 at 8:50 pm
The stagflation call was a bad one Sinc, no two ways about it. That’s okay, we all make mistakes.
m0nty
14 Nov 12 at 8:53 pm
If you say so – happy to be Cassandra.
Sinclair Davidson
14 Nov 12 at 8:55 pm
Sinc – do we agree that either (1) the market is not efficient, or (2) the market sees the probability of moving from 0.25 to 0 rates on reserves as non-inflationary, or (3) the market agrees the reduction is (hyper)inflationary but thinks the probability of reducing the rate on reserves as indistinguishable from zero?
PSC
14 Nov 12 at 8:56 pm
PSC – right now the bond market is forecasting that the Fed will successfully reverse the QE process without inflation breaking out.
Sinclair Davidson
14 Nov 12 at 8:58 pm
Cassandra or the Boy Who Cried Wolf, it’s a fine line!
m0nty
14 Nov 12 at 8:59 pm
I agree with Monty Sinc. Calling for stagflation wasnt a good call. OK maybe we dont have deflation yet either but we a treading water in the economy and unemploymemt is a problem. Cant hide it behind casual gigs forever.
Alice
14 Nov 12 at 9:02 pm
How can the fed “reverse” the bailout? Too late – they gave it away to the banks.
Alice
14 Nov 12 at 9:03 pm
‘…sluggish economic growth and high unemployment is the indicator for stagflation.’
And may help to explain the low trading volume.
For savvy investors who think outside the box, the time to get back into stocks may be now.
IMHO obviously, not giving financial advice
Greg P.
14 Nov 12 at 9:05 pm
Exactly what I said would be happening.
Don’t know. Ask PSC and JC – they have money on the line.
Sinclair Davidson
14 Nov 12 at 9:06 pm
Ok Sinc ask JC to explai how a bailout can be “reversed”. All I know is Id like to see all of it piring back in and back into taxpayers funds (does that include the foreign banks the US fed bailed out??)
My goodness, is that like asking Eddie Obeid to reverse his land deals with McDonald that netted him a 60 mill return for a 200K outlay?
Wouldnt it be good if that happened in reverse as well ie the taxpayers made the 60 mill and got charged 200K as should have happened if these bastards werent so corrupt.
I guess things could be worse. It could be Papaua New Guinea where when the mining companies give money to the government for the people, it is withdrawn by government officials within a few days.
Thats nice. Never thought it would happen in Australia but it appears to have been happening.
Alice
14 Nov 12 at 9:13 pm
Bailouts are a blight on society, as a more personal tragedies, however hilariously pariodied. Let’s take leaf from Wynona and Christian.
https://www.youtube.com/watch?v=i-w1GeH8KPU
.
14 Nov 12 at 9:25 pm
Essentially a wonderful argument about whether it is M1, M2, M3 or some broader measure of money that matters. For an alternative view, that BM is tight:
http://www.econtalk.org/archives/2012/10/hanke_on_hyperi.html
Pyrmonter
14 Nov 12 at 9:58 pm
On that we agree Dot (finally on one thing we finally..actually….agree… just on this one thing mind you)
“Bailouts are a blight on society”
Alice
14 Nov 12 at 10:28 pm
OK, assuming the $US is going to inflate, what would be the best asset types to hedge in? There are plenty variables but gold, property, and blue chips always feature.
The problem with property and some shares is that they are visible and can be appropriated to some higher cause. Gold is not so appropriateable.
Jannie
14 Nov 12 at 10:30 pm
Alice
Granted the drought didn’t help however the major cause of the crisis was the deflation which lasted until 1897. Real and nominal exports both increased after 1896, so no I don’t buy the drought as the major cause of the ongoing poor performance in GDP growth.
As for the 30s, real GDP was expanding again by 1932, it wa a comparatively short though severe event here.
There was no banking crisis in Australia in the 30s, it was largely a terms of trade driven event.
sdfc
14 Nov 12 at 11:07 pm
Cheer up dudes. It’s not like Catallaxy links, sources and commentators have much of a successful prediction record. The sun will come up tomorrow and put the candlemakers out of business for another day.
Major Major
14 Nov 12 at 11:13 pm
sdfc, the U.S. lost many small banks but the share of lost deposits out of total deposits was small. According to Cole and Ohanian:
• about 5 percent of U.S. deposits were in failed/suspended banks between 1930-33.
• if bank failures was a key factor, states with more deposits in suspended or failed banks should have had bigger depressions, but they did not.
Most interestingly, Cole and Ohanian refer to long Irish bank strikes in the 1960s and 1970s that did not cause a recession. One Irish bank strike lasted 6 months. Apparently, a lot of people banked at the pub.
See Murphy, A. E. (1978). Money in an economy without banks: The case of Ireland.
Jim Rose
14 Nov 12 at 11:31 pm
Fama is basically saying that the US federal government needs to start behaving like an adult is in charge but the electorate just gave 4 more years to the self-righteously indignant teenager who knows better.
Sorta Major Major/Graeme but worse.
JamesK
14 Nov 12 at 11:39 pm
Jim
Friedman puts the total decline in commercial bank deposits at 42% while the source I have been using “General Statistics of All Banks in the US 1914-41″ shows a 37% decline. Either way that is a significant destruction of the money supply.
Can’t comment on the Irish bank strikes or if any deposits were destroyed as a result.
sdfc
15 Nov 12 at 12:02 am
thanks sdfc, deposits lost in failures & suspension is different from fewer deposits as demand for currency increases.
Romer and bernanake attribute much of the loss of output to the bank closures, not to fewer deposits.
Jim Rose
15 Nov 12 at 12:09 am
The major impact of bank closures is on deposits and by extension the money supply Jim.
The money supply is basically the liablities of banks. It is why we can’t treat commercial banks as just another business.
sdfc
15 Nov 12 at 12:15 am
By the way you are misrepresenting Bernanke.
sdfc
15 Nov 12 at 12:15 am
@Alice
There are some suggestions that I could make to get ‘things’ going if you wish to hear and I will put them forward with or without your agreement.
And I will leave alone your notion of privatising the banks and the fact of their historical place in the development of Australia.
But I have one question for you.
If you will kindly address it I will be appreciative.
How do we create wealth in and for Australia?
NoFixedAddress
15 Nov 12 at 1:51 am
“You understand that you would have what’s called a carry trade, right? You would be running currency exchange risk.”
Remember flows out of Australia in an economic crisis. You would be basing your decision of an event without precedent.
The Beer Whisperer
15 Nov 12 at 8:54 am
Actually, historically it is not. Prior to central bank manipulation within the last 100 years, deflation was common, albeit short-lived.
The Beer Whisperer
15 Nov 12 at 9:55 am
“This is better: inflation makes the rich worse off and austerity makes the rest worse off. So he wants austerity.
Scapula
14 Nov 12 at 6:45 pm”
Inflation makes debtors better off, in particular, governments, and savers worse off, by lowering the purchasing power of the currency. Being rich or poor is only relevant to the extent in which it enhances or detracts from your capacity to borrow or save. Typical left-wing envy economics, and devoid of substance or evidence.
The Beer Whisperer
15 Nov 12 at 10:23 am
“how’s that stagflation prediction of yours going?
Well.”
Ah, Alan Kohler. An island of sanity in a sea of pseudo-intellectual neo-Marxist sewage.
The Beer Whisperer
15 Nov 12 at 10:37 am
“I guess things could be worse. It could be Papaua New Guinea where when the mining companies give money to the government for the people, it is withdrawn by government officials within a few days.”
That is disgusting. A bit of tribal justice might be justifiable. It just goes to show, most countries’ enemies are their own leaders. We don’t even have to look overseas.
The Beer Whisperer
15 Nov 12 at 10:48 am
“How do we create wealth in and for Australia?”
Appropriately reward risk.
The Beer Whisperer
15 Nov 12 at 10:56 am
Wow, talk about coming late to the party!
The Beer Whisperer
15 Nov 12 at 10:58 am