Recently in money, interest, prices Category
Time to repost the most recent Deseret News article from yesterday.
As many observers expected the U.S. Federal Reserve began a new round of quantitative easing this fall in an attempt to stimulate the economy by increasing the supply of available money. As I discussed at the beginning of August, there is no fundamental difference between quantitative easing and the Fed's normal open market operations. In the latter case the Fed buys U.S. Treasury securities on the bond market and in the former case it buys other non-traditional financial assets. In both cases, however, it pays for these purchases by creating money.
Money in most countries in the world is issued by a central bank that is granted the monopoly right to issue the nation's currency. In the United States the central bank is actually a system of 12 regional banks that are controlled by the Federal Reserve Board of Governors in Washington, D.C. The Federal Reserve System, or Fed, is legally a private enterprise and is owned by member commercial banks. Effectively, however, the Fed is 4th branch of the government.
The members of the Fed's Board of Governors are all appointed by the President of the U.S. One of these is selected every four years to serve as the Chairman of the Fed. Currently the Chairman is Ben Bernanke, who served as a member of the Board under the previous Chairman, Alan Greenspan. While the Fed is legally owned by the member commercial banks, these banks have little direct input into the governance of the Fed these days. Member banks elect six of the nine members of each of the 12 regional Federal Reserve Banks board of directors. This board of directors, in turn, selects a president to run the regional Fed. In practice, the members of the board and the presidents are chosen in Washington by the Board of Governors.
The Federal Reserve has a great many duties. It was created in 1914 primarily to serve as a lender of last resort and address a longstanding problem the U.S. had been experiencing with bank runs. Prior to 1914 the U.S. had no central bank. There was a brief period early in U.S. history where the First and Second Banks of the United States were chartered and then disbanded, but these banks served mainly as depository and lending institutions for the U.S. government and not as modern central banks. During most of the 19th century and up through 1913, the U.S. had no central monetary authority that would step in and loan funds to banks that were hit with bank runs. As a result the nation experienced periodic bank panics where runs would occur on several banks simultaneously and led to nationwide financial crises. The Federal Reserve System was set up to help alleviate this problem.
The Fed has many other duties as well, including regulatory control over banking, facilitation of check clearing and interbank transfers, and maintaining accounts for many U.S. government agencies. The most important role the Fed plays, however, is as a creator and controller of the U.S. money supply.
One of the reasons the Fed is structured as it is, is to insulate it from political pressure. The Fed is largely independent of the Federal government. Day-to-day operational control is in the hands of the Board of Governors and the governors are appointed to very long terms of 14 years. If the Fed were more susceptible to political pressure from the president or congress they would be more likely to use monetary policy to finance government spending.
Over the years since 1914 there have been period calls by people to disband the Fed. The main reason that this has never been done is because the alternative is undesirable. If you are one of those who is not pleased with the way congress has handled the U.S. budget, imagine what things would be like if congress was also in charge of the money supply. By insulating the Fed from political pressure, we are able to maintain a much lower rate of inflation than we would otherwise have. If congress were to take direct control of the U.S. money supply you can be assured that they would quickly give in to the temptation of simply printing whatever money they needed for their desired level of spending. Delegating control to a central bank that is insulated from political influence makes it difficult or impossible to give in to that temptation.
While having an independent central bank does alleviate some problems, it creates others. One argument against a central bank is that it is undemocratic. Monopoly control of the money supply is placed in the hands of officials who are not answerable directly to the public. This often leads to the perception that the money supply is in the hands of special interests who do not have the best interests of the public in mind. In some countries and in many historical cases this perception is justified. It is not so justified in the case of the Fed.
There are alternatives to the Federal Reserve System that are democratic in nature but not prone to inflation. For example, from 1716 to 1845 Scotland had a free banking system of sorts, where two competing central banks each issued currency. More generally, free banking would allow commercial banks to issue whatever currency they desired and they could back this currency however they wished as long as the backing was truthfully disclosed. Competitive free banking would allow some banks to issue monies backed by gold or other commodities. Consumers would be free to choose what type of money they wished to hold and sellers could choose what types of money they would accept as payment. One interesting new technological option that has many of the aspects of free banking is BitCoin, an online payment system that settles payments on a peer-to-peer basis without using a bank or even a currency controlled by a central bank.
Free banking is unlikely to be adopted as official U.S. policy anytime in the near future. In the meantime, the Fed will continue to control the supply of dollars. Despite its shortcomings, the Fed is a much better arrangement that most of the alternatives.
from the Wall Street Journal, July 14th, 2011
Should the Hong Kong airport be expanded to include a new 3rd runway at a cost of $17.5 billion? Why not let the market decide?
"...we must figure out how much ... is "enough" over the long term as we also tailor our demand to resource availability at any given moment. This is easy, relatively speaking, for miners and nearly impossible for airport planners because miners have something the planners don't: a market price for their product and for their capital.
"In the airport context, putting a price on capacity would mean fully liberalizing the air traffic market and then auctioning off take-off and landing slots. Hong Kong could adopt a unilateral open-skies policy to welcome any and all comers, and also remove the remaining restrictions on so-called fifth-freedom traffic rights that would allow a carrier from Country A to fly between Hong Kong and Country C. Meanwhile, auction take-off and landing slots to the highest bidders, each slot being valid for some reasonable number of years.
"Then, let the airport operator figure it out. Privatize the Airport Authority (currently a government body), and see if the bond market thinks its expected income from slot sales will be sufficient to cover the capital expense of new capacity. Just like a mining firm."
The price mechanism could be implemented in lots of places that currently it is not. This is just one good example.
One of Jeff's most insightful arguments is one that he has been making for as long as I've known him. In this week's issue of his weekly economic newsletter, The TEA Leaf, Jeff drives the point home, yet again, in compelling fashion.
"What [Ron] Paul and other Fed critics don't understand is that the Federal Reserve has an overseer...something or someone IT has to answer to. That something is the American bond market."
Thanks to Mark Showalter for pointing me to this great resource, and thanks to the Cleveland Fed for the most simple, beautiful, and interactive display of economic data that I have seen yet. Here's to central bank transparency!
The proposed auto bailout has been one of the most discouraging pieces of government action since the beginning of our current financial crisis. Ford's decision to stick with the market is one of the silver linings in the ominous clouds of the global recession. Ford does, of course, run the risk of not beeing able to compete in the short-run with GM and Chrysler and their new influx of government cash. But that's not really where the competition is anyway. The real contest is to see which U.S. company will be able to compete with their Japanese counterparts. I think the market will look favorably on Ford's long-run positioning.
Just look at what has happened to the stock prices of Ford and GM since December 20, 2008. The market has spoken.
Well, I just came across a fund that is taking a like-minded strategy. The fund is called the Congressional Effect Fund. The fund's basic strategy is to capture the above average returns on the stock market on those days when Congressmen are on vacation. A great idea and much easier to implement than my strategy. The average annualized return to the S&P 500 when congress is in session (1965-2009)? 0.31%. The average annualized return to the S&P 500 when congress is out of session? 16.15%.
Hat tip to DoL'er (and fellow Georgian) Frank Stephenson.
"In addition, as time has passed and prices have fallen, solvency issues have come to the forefront - the balance sheet problems are no longer hidden by overpriced assets - and the solvency problems must be addressed directly. That means that if there is no separate program to provide an infusion of capital, simply removing the toxic assets from the balance sheets through government purchases at current prices - prices so low that the banks are insolvent - won't be resolve the problem."If the prices of "toxic" assets has fallen overtime, isn't this evidence of a very low true value of the assets? The original argument was that a panic had temporarily suppressed the prices of said assets and that the government only need take hold of these assets until prices rebounded. From what I can tell, the credit crisis is not as severe as last fall. So if the price of assets is lower now and the credit crisis not as severe, shouldn't one conclude that the continuing fall in these asset prices is due to a deterioration in the fundamentals of those assets?
"How do banking panic's come to an end? Some history is instructive. During the 19th century, in the USA, the solution to banking panics was the institution of the private bank clearinghouse, which evolved over the century to the point where banks' response to panics was fairly effective... This system was abandoned with the founding of the Fed and the subsequent adoption of deposit insurance. These were institutions aimed [at] preventing a panic from happening. But they are not equipped to solve the information problem that arises if a panic does happen. Clearinghouse loan certificates attacked the problem directly."
Related to these recent numbers, Bryan Caplan posits an excellent question:
"If the government had followed a laissez-faire policy for the last six months, and output, employment, housing, and financial markets stood exactly where they stand today, what fraction of people would conclude that 'Events decisively prove that laissez-faire is a disaster'?"
And the fall in the price of oil from mid-2008 levels ought to put a lid of the "peak oil-ers".
So maybe mean reversion is the best way to model and forecast home and commodity prices. Is it also the best way to forecast the growth in the value of equities? Mankiw posts the following picture:
One of the best economics music videos out there:
I know it's been a while since this first made the rounds, but it's still a great piece of work. Thanks to a reader for suggesting we archive it on the jokes page.
For more (and some more recent) work by Columbia B-school students, go to http://www.cbsfollies.com/
Taylor shows that monetary policy during the start of the housing boom deviated significantly from the "rule" it had been following for the previous 20+ years. Taylor and his coauthors find evidence that this amplified the boom and bust in the housing market. While not everyone agrees with this conclusion, Taylor presents some convincing counter factual experiments.