The Fed Still Has a Powder Keg at Its Disposal
(Bloomberg Opinion) - The editors of the Wall Street Journal published a column last week called "The Fiscal Federal Reserve," exhorting Chairman Jerome Powell to urge Congress to do more for unemployed Americans who struggling with small businesses and buckled state and local governments. "Powell is signing up to monetize trillions of dollars for more spending," they wrote.
In many ways, Powell and his colleagues were actually quite reluctant to send their messages. They could be a lot more forceful - the only question is whether they want to open Pandora's potential box.
Since June, the Fed has been explicitly buying US government bonds worth $ 80 billion every month. This was originally done under the guise of ensuring the smooth "functioning of the market". However, minutes of the central bank's September meeting indicated that officials now view purchases as "contributing to accommodative financial conditions in a way that supports economic recovery." This is the way the central bank says the stock market is on the up, credit spreads on investment grade corporate bonds are tight, and risky companies can easily find willing lenders. In other words, the Fed is supporting asset prices, which while helping keep a recovery on track, disproportionately benefits the richest Americans, who own the vast majority of stocks and bonds.
Assume that central bankers do not view these bond purchases in the context of financial markets, but rather link them more closely to fiscal policy initiatives. It cost approximately $ 300 billion to send $ 1,200 to Americans across the country earlier this year. That's less than four months for Treasury purchases at the current rate. House spokeswoman Nancy Pelosi asked for $ 436 billion in federal aid to states and cities. That's about five months. Both are examples of the kind of expenditure the Fed cannot make itself and which hit Main Street much faster than the wealth effect of higher asset prices.
Eric Rosengren, President of the US Federal Reserve in Boston, and Robert Kaplan, President of the US Federal Reserve in Dallas, on Thursday again criticized the failure of Congress to pass another round of aid and defended the central bank's push for a deal at the Capitol Hill. "It's not that we don't have tools," said Rosengren. "But the fiscal policy instruments are much more effective." Kaplan added separately, "I think the Fed can do more and I'm sure we will review all of our options, but these are not a substitute for fiscal policy."
Powell and the rest of the central bank leadership could better explain to Congress - and the American public - what the Fed is capable of. Nothing prevents them from boosting Treasury Department purchases to offset additional federal spending on unemployment benefits or grants to state and local governments. You could lean on the “Fiscal Fed” label to get the US through the coronavirus crisis.
Powell has gradually started to turn in that direction. "The recovery will be stronger and faster if monetary and fiscal policy continue to work side by side," he said last week. The editorial has blown that phrase, claiming it "sounds like he sees the Fed as a political partner to Congress and the Treasury" and suggests, "He can read the polls as well as anyone and he can See the Biden Presidency coming ".
In reality, central bank circles have been talking about the idea of a more synergistic monetary and fiscal policy for years. After the global financial crisis, simply lowering interest rates to zero - or even negative - just didn't work. All it did was channel the greatest profits to wealthy wealth owners, who have less propensity to spend every additional dollar they receive, while wages stagnated for lower and middle-class Americans, who were more inclined to make money to spend. It's not exactly a recipe for a healthy economy.
The Fed may be reluctant to fully support working with Congress because it is giving up the game. The purchase of US Treasuries, which were issued to cover tax aid spending, would put the central bank more in the realm of "money financing" and modern monetary theory than its current way of using "quantitative easing" to address "accommodative financial terms" to promote. But if the Fed really wanted to bring home the importance of tax aid, it could allude more directly to this type of coordinated economic strategy.
Ray Dalio, Founder of Bridgewater Associates, saw a move towards MMT in May 2019 as "inevitable". This passage sums up the Fed's current battle perfectly:
The main decision makers in engineering puzzles around the world to be solved in the years to come are how the economic machine can be brought to economic welfare for most people when monetary policy does not work. I don't mean that monetary policy doesn't work at all. I mean, it's going to do little to stimulate economic prosperity in the way we're used to stimulating economic activity, through rate cuts (what I call monetary policy 1) and quantitative easing (what I call) monetary policy 2). This is because it will not be effective at producing money and credit growth (i.e. purchasing power), and it will not be effective getting into most people's hands to increase their productivity and wealth. So I believe that we need to move on to monetary policy 3, which is fiscal and monetary coordination that has a form that we have not seen in our lifetimes, but that of others or in distant places has existed in various forms. It is inevitable that this shift will occur as it is inevitable that central bankers will want to ease if interest rates are fixed at 0% and if quantitative easing does not hit the target.
Now compare that to what Rosengren told Bloomberg News about the limits of buying more government bonds to stimulate the economy: "That is not to say that it does not help directionally, just the extent of the impact when rates are already this low . is probably a lot less than what we want, which is why I think you hear Federal Reserve spokespersons calling for more fiscal policy, ”he said. The feeling is practically the same.
But here's the part Dalio makes explicit but Fed officials don't dare to go:
The main configuration of MMT is to set interest rates at 0% and tightly control inflation by changing fiscal surpluses and deficits, creating debt that the central banks will monetize. An added benefit of this approach is that the money and credit created can be used in a more targeted manner to fund the intended uses than if the central bank buys financial assets from those who have financial assets and uses the money, that they get from the central bank to buy the financial assets they want to buy.
Here is a hypothetical example. Last week I wrote that the Fed should extend its municipal liquidity facility deadline and lower interest rates to provide cheaper funding for state and local governments. But what if the central bank instead simply promised to buy the $ 436 billion in government bonds needed to fund the Democrats' proposal to extend federal funds to governors and mayors? It's hardly an unprecedented sum: Recall that in the weeks leading up to March 25 and April 1, the central bank's balance sheet grew by $ 586 billion and $ 557 billion, respectively.
The risk, of course, is that such obvious coordination could call the value of fiat currency into question. Lacy Hunt of Hoisington Investment Management, who has been a bond bull for more than three decades, told me in August that the only significant risk he sees on the horizon is that the Fed will fund government spending directly. “In that case, the inflation rate would rise. In a very short time, however, everyone would be completely unhappy because nobody wants to hold money, ”he said.
For their part, MMT advocates believe that inflation is the main mandatory constraint on government spending. Given that the Fed has adjusted its overall monetary policy framework to encourage price growth above its 2% target to make up for years of underrun, it stands to reason that the central bank doesn't mind raising inflation expectations (within ) to increase reason).
It's not clear what Fed officials would need to publicly commit to keeping interest rates low and increasing their bond purchases in direct response to the tax support. You seem satisfied with calling for a compromise in Washington amid the headlines from Pelosi, Senate Majority Leader Mitch McConnell, Treasury Secretary Steven Mnuchin, and others.
For this reason, the term “fiscal Fed” feels - at least for now - like an exaggeration. It's entirely possible that we haven't seen anything.
This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist on the debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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