fiscal policy

How the Fed Managed the Treasury Yield Curve in the 1940s

Published by Anonymous (not verified) on Mon, 06/04/2020 - 9:00pm in

Kenneth D. Garbade

https://libertystreeteconomics.newyorkfed.org/2020/04/how-the-fed-managed-the-treasury-yield-curve-in-the-1940s.html

The coronavirus pandemic has prompted the Federal Reserve to pledge to purchase Treasury securities and agency mortgage-backed securities in the amount needed to support the smooth market functioning and effective transmission of monetary policy to the economy. But some market participants have questioned whether something more might not be required, including possibly some form of direct yield curve control. In the first half of the 1940s the Federal Open Market Committee (FOMC) sought to manage the level and shape of the Treasury yield curve. In this post, we examine what can be learned from the FOMC’s efforts of seventy-five years ago.

Lessons in Yield Management

The FOMC’s efforts offer two lessons in yield curve management:

1. The shape of the yield curve cannot be fixed independently of the volatility of interest rates and debt management policies.

During World War II the FOMC sought to maintain a fixed, positively sloped curve. The policy left long-term bonds with the risk characteristics of short-term debt but a yield more than 200 basis points higher. At the same time, the Treasury pursued a policy of issuing across the curve, from 13-week bills to 25-year bonds. Faced with investor preferences for the higher yielding, but hardly riskier, bonds, the System Open Market Account had to absorb a substantial quantity of bills. A flatter curve and/or a less rigid interest rate policy might have required less aggressive interventions.

2. Large-scale open market operations may be required in the course of refixing, from time to time, the shape of the yield curve.

After 1946, Federal Reserve officials pursued a program of gradual relaxation of the wartime regime, beginning with the elimination of the fixed rate for 13-week bills, continuing with incremental increases in the ceiling rate on 1-year securities, and then moving further out the curve, with the ultimate goal of a free market for all Treasury debt. Following the elimination of the fixed bill rate in 1947, investors began to move their portfolios into shorter-term debt. The result was a massive shift in the composition of the Open Market Account as the Account bought bonds and sold bills to accommodate the changing maturity preferences of private investors.

The Coming of War

World War II began on Friday, September 1, 1939. By mid-1940, Germany had defeated Poland, France, and Belgium, and a British expeditionary force had been forced to withdraw from the continent. In a speech on October 30, President Roosevelt promised Britain “every assistance short of war” and Britain soon began placing orders for large quantities of planes, artillery, tanks, and other heavy weapons, even though it lacked the financial resources to pay. Congress signaled that it would finance whatever Britain required when it passed the Lend-Lease Act in March 1941.

Emanuel Goldenweiser, director of the Division of Research and Statistics at the Federal Reserve Board, recommended to the FOMC in June 1941 that “a definite rate be established for long-term Treasury offerings, with the understanding that it is the policy of the Government not to advance this rate during the emergency.” He suggested 2½ percent and argued that “when the public is assured that the rate will not rise, prospective investors will realize that there is nothing to gain by waiting, and a flow into Government securities of funds that have been and will become available for investment may be confidently expected.” Three months later, Goldenweiser recommended a congruent monetary policy, “a policy under which a pattern of interest rates would be agreed upon from time to time and the System would be pledged to support that pattern for a definite period.”

Financing American Participation in World War II

Active U.S. participation in World War II followed the bombing of Pearl Harbor in December 1941 and ended with the surrender of Germany in April 1945 and Japan four months later. From year-end 1941 to year-end 1945, Treasury indebtedness increased from $58 billion to $276 billion. Marketable debt accounted for 72 percent of the increase; war savings bonds and special issues to government trust funds accounted for the balance. The increase in marketable debt included $15 billion of bills, $38 billion of short-term certificates, $17 billion of notes, and $87 billion of conventional bonds.

By mid-1942 the Treasury yield curve was fixed for the duration of the war, anchored at the front end with a ⅜ percent bill rate and at the long end with a 2½ percent long-bond rate. Intermediate yields included ⅞ percent on 1-year issues, 2 percent on 10-year issues, and 2¼ percent on 16-year issues.

Experience with the Fixed Pattern of Rates

Fixing the level of Treasury yields endogenized the size of the System Open Market Account: the Fed had to buy whatever private investors did not want to hold at the fixed rates. As a result, the size of the Account increased from $2.25 billion at the end of 1941 to $24.26 billion at the end of 1945.

Fixing the pattern of Treasury yields endogenized the maturity distribution of publicly held debt. In each market sector, the Fed had to buy whatever private investors did not want to hold and, up to the limits of its holdings, had to sell whatever private investors wanted to buy beyond what the Treasury was issuing.

Investors quickly came to appreciate that they faced a positively sloped yield curve in a market where yields were at or near their ceiling levels. An investor could move out the curve to pick up coupon income without taking on more risk and then ride the position down the curve, adding to total return. This strategy of “playing the pattern of rates” led investors to prefer bonds to bills. Their preferences, coupled with the Treasury’s decision to issue in all maturity sectors, forced the Open Market Account to buy unwanted bills and to sell the more attractive bonds. By late 1945 the Account held 75 percent of outstanding bills, but—in spite of heavy bond issuance by the Treasury—fewer bonds than it had held in late 1941.

The essential problem was that the positive slope of the curve was inconsistent with the negligible volatility of rates and the Treasury’s issuance program. In early 1949, Allan Sproul, the president of the Federal Reserve Bank of New York, concluded that “in a supported market in which all obligations might be regarded as demand obligations, a horizontal rate structure would theoretically be required.”

Regaining Control

Following the cessation of hostilities in August 1945, the overarching objective of Federal Reserve officials was regaining control of open market operations. A “cold turkey” approach, abruptly terminating support for the fixed pattern of rates, was never seriously considered. Instead, officials pursued a more measured approach, first terminating the ⅜ percent fixed bill rate, then gradually lifting the caps on yields on coupon-bearing securities, starting with 1-year instruments.

The FOMC terminated the ⅜ percent bill rate on July 3, 1947. Bill yields increased to 66 basis points in July, 75 basis points in August, and 95 basis points by the end of the year. Investors had little incentive to buy 1-year securities at ⅞ percent when bill yields were rising so dramatically and the Treasury was forced to reprice its fall 1-year offerings to 1 percent, and its December offering to 1⅛ percent.

Rising bill rates triggered a reversal of the preference for bonds over bills. In the face of steady selling, bond yields rose from 2.22 percent in June 1947 to 2.39 percent in December and then to 2.45 percent a month later. The Fed sought to cushion the reversal by buying bonds and selling (or running off) bills. In the second half of 1947, the Open Market Account bought $2 billion of bonds while selling or running off $3 billion of bills. In 1948, the Account bought an additional $8 billion of bonds and reduced its bill position by $6 billion.

In late November 1950, facing the prospect of another major war, the Fed, for the first time, sought to free itself from its commitment to keep long-term Treasury yields below 2½ percent. At the same time, Secretary of the Treasury John Snyder and President Truman sought a reaffirmation of the Fed’s commitment to the 2½ percent ceiling.

The impasse continued until mid-February 1951, when Snyder went into the hospital and left Assistant Secretary William McChesney Martin to negotiate what has become known as the “Treasury-Federal Reserve Accord.” Alan Meltzer has observed that the Accord “ended ten years of inflexible [interest] rates” and was “a major achievement for the country.”

Related Reading

Kenneth D. GarbadeKenneth D. Garbade is a senior vice president in the Research and Statistics Group of the Federal Reserve Bank of New York.

How to cite this post:

Kenneth D. Garbade, “How the Fed Managed the Treasury Yield Curve in the 1940s,” Federal Reserve Bank of New York Liberty Street Economics, April 6, 2020, https://libertystreeteconomics.newyorkfed.org/2020/03/how-the-fed-manage....




Disclaimer

The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.

What MMT Is, and Why We Should Not Wait for the Next Crisis to Live Up to Our Means

Published by Anonymous (not verified) on Sun, 05/04/2020 - 12:39am in
by Yeva Nersisyan and L. Randall Wray

As MMT has been thrust into the spotlight, misrepresentations and misunderstanding have followed. MMT supposedly calls for cranking up the printing press, engaging in helicopter drops of cash or having the Fed finance government spending by engaging in Quantitative Easing.

None of this is MMT.

Instead, MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, non-convertible currencies. It concludes that the sovereign currency issuer: i) does not face a “budget constraint” (as conventionally defined); ii) cannot “run out of money”; iii) meets its obligations by paying in its own currency; iv) can set the interest rate on any obligations it issues.

Current procedures adopted by the Treasury, the central bank, and private banks allow government to spend up to the budget approved by Congress and signed by the President. No change of procedures, no money printing, no helicopter drops are required.

In the old days, governments just notched tally sticks, minted coins, or printed paper money when they spent, then collected them in redemption taxes and burned or melted down all the revenue. Today all modern governments use central banks to make and receive all payments through private banks. Government spending is still financed by money creation, and taxes destroy money—but in the form of central bank reserves. Instead of wooden sticks, we use electronic keystrokes, which the government cannot run out of. Bond sales merely swap one government liability for another, while paying off bonds reverses the operation.

Critics make a big deal of the separation of the Treasury (the government’s spending arm) and the Central Bank (the issuer of currency), claiming the latter is independent and may refuse to “finance” Treasury spending. The separation of the Treasury and the Fed does not alter government’s ability to spend. The Fed is a creature of Congress and an agency of the U.S. government. Liabilities of the Fed (notes and reserves) are obligations of the United States just like Treasury securities. Yes, different arms of the government issue these, but it doesn’t change the fact that they are liabilities of the United States.

As MMT explains, since bonds can only be purchased with reserves (the government will take only its obligations in payments to itself), the reserves must be supplied first before bonds can be purchased. It demonstrates how the Fed provides the reserves needed to buy the Treasuries even as it never violates the prohibition against “lending” to the Treasury by buying the bonds directly. The Fed has to ensure that funds to buy the bonds are available to safeguard the payments system, to achieve its interest rate targets and for financial stability considerations.

None of this is optional for the Fed. It cannot refuse to clear government checks. It is the government’s bank, after all, and is focused on the stability in the payments system.

Case in point: the Fed engaged in repo operations last September to add reserves to the system when Treasury bond sales and corporate tax payments left the market without its desired level of liquidity, pushing repo rates above the Fed’s desired levels. Any disturbance in the Treasury market will have ripple effects as many financial institutions have sizable holdings of Treasuries. Indeed, the Fed’s very first intervention during the pandemic was in the form of repo operations, citing “disturbances” in the Treasury market.

Government can make all payments as they come due. Bond vigilantes cannot force default. While their portfolio preferences could affect interest rates and exchange rates, the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. Bond vigilantes cannot hold the nation hostage—the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a firm commitment to keep rates low. In any event, the Fed is a creature of Congress, and Congress can seize control of interest rates any time it wants.

Finally, even if the Fed abandons low rates, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bond holders. If that’s seen as undesirable, Congress can always tax away whatever it deems as excessive.

What we emphasize is that sovereign governments face resource constraints, not financial constraints. We’ve always argued that too much spending—whether by government or by the private sector—can cause inflation.

In conclusion, MMT rejects the analogy that a sovereign government’s budget is just like a household’s. The difference between households and the sovereign holds true in times of crisis and also in normal times, regardless of the level of interest rates and existing levels of outstanding government bonds (i.e. national debt). The sovereign can never run out of finance. Period.

That doesn’t mean MMT advocates policy to ramp up deficits. For MMT a budget deficit is an outcome, not a goal or even a policy tool to be used in recession. There’s no such thing as “deficit spending” to be used in a downturn or even a crisis. Government uses the same procedures when spending no matter what the budgetary outcome turns out to be. We won’t know until the end of the fiscal year as the outcome will depend on the performance of the economy. And the spending will already have occurred before we even know the end-of-the-year budget balance.

MMT recognizes that the constraint faced by government is resource availability. Below full employment government spending creates “free lunches” as it utilizes resources which would otherwise be left idle. Unemployment is evidence that the country is living below its means. A country lives beyond its means only when it goes beyond full employment, when more government spending competes for resources already in use. Full employment means that the nation is living up to its means.

The most important lesson we must learn from this crisis is that the ability of the government to run deficits is not limited to times of crisis. Indeed, it was a policy error to keep the economy below full employment before this crisis hit in the belief that government spending was limited by financial constraints. Ironically, the real limits faced by government before the pandemic hit were far less constraining than the limits faced after the virus had brought a huge part of our productive capacity to a halt!

We hope the Coronavirus will teach us that in normal times we must build up our supplies, our infrastructure and institutions to be able to deal with crises, whatever form they may take. We should not wait for the next national crisis to live up to our means.

What MMT Is, and Why We Should Not Wait for the Next Crisis to Live Up to Our Means

Published by Anonymous (not verified) on Sun, 05/04/2020 - 12:39am in
by Yeva Nersisyan and L. Randall Wray

As MMT has been thrust into the spotlight, misrepresentations and misunderstanding have followed. MMT supposedly calls for cranking up the printing press, engaging in helicopter drops of cash or having the Fed finance government spending by engaging in Quantitative Easing.

None of this is MMT.

Instead, MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, non-convertible currencies. It concludes that the sovereign currency issuer: i) does not face a “budget constraint” (as conventionally defined); ii) cannot “run out of money”; iii) meets its obligations by paying in its own currency; iv) can set the interest rate on any obligations it issues.

Current procedures adopted by the Treasury, the central bank, and private banks allow government to spend up to the budget approved by Congress and signed by the President. No change of procedures, no money printing, no helicopter drops are required.

In the old days, governments just notched tally sticks, minted coins, or printed paper money when they spent, then collected them in redemption taxes and burned or melted down all the revenue. Today all modern governments use central banks to make and receive all payments through private banks. Government spending is still financed by money creation, and taxes destroy money—but in the form of central bank reserves. Instead of wooden sticks, we use electronic keystrokes, which the government cannot run out of. Bond sales merely swap one government liability for another, while paying off bonds reverses the operation.

Critics make a big deal of the separation of the Treasury (the government’s spending arm) and the Central Bank (the issuer of currency), claiming the latter is independent and may refuse to “finance” Treasury spending. The separation of the Treasury and the Fed does not alter government’s ability to spend. The Fed is a creature of Congress and an agency of the U.S. government. Liabilities of the Fed (notes and reserves) are obligations of the United States just like Treasury securities. Yes, different arms of the government issue these, but it doesn’t change the fact that they are liabilities of the United States.

As MMT explains, since bonds can only be purchased with reserves (the government will take only its obligations in payments to itself), the reserves must be supplied first before bonds can be purchased. It demonstrates how the Fed provides the reserves needed to buy the Treasuries even as it never violates the prohibition against “lending” to the Treasury by buying the bonds directly. The Fed has to ensure that funds to buy the bonds are available to safeguard the payments system, to achieve its interest rate targets and for financial stability considerations.

None of this is optional for the Fed. It cannot refuse to clear government checks. It is the government’s bank, after all, and is focused on the stability in the payments system.

Case in point: the Fed engaged in repo operations last September to add reserves to the system when Treasury bond sales and corporate tax payments left the market without its desired level of liquidity, pushing repo rates above the Fed’s desired levels. Any disturbance in the Treasury market will have ripple effects as many financial institutions have sizable holdings of Treasuries. Indeed, the Fed’s very first intervention during the pandemic was in the form of repo operations, citing “disturbances” in the Treasury market.

Government can make all payments as they come due. Bond vigilantes cannot force default. While their portfolio preferences could affect interest rates and exchange rates, the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. Bond vigilantes cannot hold the nation hostage—the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a firm commitment to keep rates low. In any event, the Fed is a creature of Congress, and Congress can seize control of interest rates any time it wants.

Finally, even if the Fed abandons low rates, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bond holders. If that’s seen as undesirable, Congress can always tax away whatever it deems as excessive.

What we emphasize is that sovereign governments face resource constraints, not financial constraints. We’ve always argued that too much spending—whether by government or by the private sector—can cause inflation.

In conclusion, MMT rejects the analogy that a sovereign government’s budget is just like a household’s. The difference between households and the sovereign holds true in times of crisis and also in normal times, regardless of the level of interest rates and existing levels of outstanding government bonds (i.e. national debt). The sovereign can never run out of finance. Period.

That doesn’t mean MMT advocates policy to ramp up deficits. For MMT a budget deficit is an outcome, not a goal or even a policy tool to be used in recession. There’s no such thing as “deficit spending” to be used in a downturn or even a crisis. Government uses the same procedures when spending no matter what the budgetary outcome turns out to be. We won’t know until the end of the fiscal year as the outcome will depend on the performance of the economy. And the spending will already have occurred before we even know the end-of-the-year budget balance.

MMT recognizes that the constraint faced by government is resource availability. Below full employment government spending creates “free lunches” as it utilizes resources which would otherwise be left idle. Unemployment is evidence that the country is living below its means. A country lives beyond its means only when it goes beyond full employment, when more government spending competes for resources already in use. Full employment means that the nation is living up to its means.

The most important lesson we must learn from this crisis is that the ability of the government to run deficits is not limited to times of crisis. Indeed, it was a policy error to keep the economy below full employment before this crisis hit in the belief that government spending was limited by financial constraints. Ironically, the real limits faced by government before the pandemic hit were far less constraining than the limits faced after the virus had brought a huge part of our productive capacity to a halt!

We hope the Coronavirus will teach us that in normal times we must build up our supplies, our infrastructure and institutions to be able to deal with crises, whatever form they may take. We should not wait for the next national crisis to live up to our means.

The End of Austerity Speak

Published by Anonymous (not verified) on Mon, 30/03/2020 - 9:42pm in

Fiscal Policy & the Ancien Idéologie

On 11 March the new chancellor presented his Spring budget. While the budget
was unambiguously expansionary after a decade of cuts and freezes, as the Shadow
Chancellor pointed out it did not restore expenditures to their 2010 levels especially
for local government
. But for all its shortcomings and faults it marked a first
step towards ending the rhetoric of fiscal austerity.

In response to the shift on austerity by a Tory government, reactions to
the budget demonstrate more than anything else how engrained in the media was the
ideology of austerity, what we might call austerity speak. Typical was an FT article that while praising the Chancellor
because he “rose to the occasion” with “a careful orchestration of
fiscal and monetary policy”, said his budget “flung money at a grateful
population”. To reinforce the message, the author told us that “it’s easy
to throw money around” but harder to “spend it well”.

This rhetoric of being loose with money comes not only from the business-friendly FT and media on the right. A Guardian news article referred to the budget as “a spending spree”, designed to “win over [the] public.” The Guardian’s economics editor, who is one of the UK’s most progressive mainstream commentators on economic issues, hinted at the budget’s problems in an article that assessed that the Chancellor “can count himself relatively lucky” that the Institute for Fiscal Studies did not attack him more vigorously.

The source of this IFS criticism becomes clear in another article by Elliot that carries the headline “Sunak’s spend, spend, spend budget”. The author comes close to praise because the Chancellor has acted “to break the economy out of its low-growth, low-investment, low-productivity trap”. The first sentence of the article refers to this break as a “giveaway budget”. A jointly authored article by Elliot and Stewart pursued the pejorative language, writing that the Chancellor “turns on the spending taps”, and reported that the sacked Chancellor Javid “warned against abandoning all spending rules”.

Amid this language of spending sprees, turning on taps and warnings of violating rules, one searched in vain for a favourable judgement about increased spending as a budget strategy. The FT editorial board provided a rare example of an assessment almost void of value-laden language, referring to “the right budget for the moment” that seized the “opportunity provided by low interest rates to invest”.

Ancien Idéologie gets Shock Therapy

In March 2020 the UK economy faced two major economic shocks, each on its
own sufficient to provoke a recession, the corona virus and uncertainties associated
with leaving the European Union. With interest rates low and public borrowing under
2% of GDP, the technical case for a fiscal expansion should be obvious to any open
minded commentator. Why then the widespread anxieties about an expansionary budget
and the negative language of sprees and giveaways?

Two explanations present themselves, the persistence of the austerity ideology
and a much older ingrained ideology in the UK media. For almost a decade the Tory
austerity ideology preached a doctrine of balanced budgets, to the point that it
went unchallenged, accepted as valid without need of justification. This false imperative
to balance the budget received independent verification from the Institute for Fiscal
Studies, which repeatedly stressed the dangers of deficit spending. Despite
its focus being microeconomic
and budgets requiring a macroeconomic analysis,
the media embraced the IFS as Britain’s definitive source on public finances.

Judging deficit spending as a prima
facie
problem does not explain all pejorative language found in the media, especially
use of “giveaways” and “hand-outs”. Such polemics have a long
history in the UK media, reinforced by repeated reminders that all spending eventually
increases the “burden on taxpayers”.

These terms are regularly applied to all budget statements Conservative and
Labour. For example, whether a Tory chancellor will have the space for tax cuts
to attract voters appears as a common pre-budget speculation, as do queries that
a Labour government will find the tax revenue to deliver spending to its core constituency.
This approach to public sending betrays a deep distrust of both the public sector
and the political process. It treat public spending as the instrument used by cynical
politicians to curry favour with voters rather than the legitimate or even preferable
alternative to private provision.

Thus, the proposal in the Labour manifestos of 2017 and 2018 for free (i.e., public payment of) university tuition fees could be described even by centre-left commentators as a bribe for young voters. The NHS represents a striking exception to this cynical view of public spending, which in the second half of March became the vehicle for a profound paradigm change by the Tory government and in public perception.

Difference a Week Makes

Towards the end of March rhetoric of spending sprees and handouts disappeared,
swept away by the threat of a national health disaster. Larry
Elliot who as in 11 March referred
to a “spending spree”
and a “spend, spend, spend” budget, on
20 March abandoned such rhetoric
. Two days later on
22 March he completely embraced
and lauded the extraordinary increase in public
spending by the Tory Chancellor in a deeply insightful article,

…[A] model [of limited spending] that has failed not once but twice has
been ditched. Governments recognise they have to support their citizens through
this. 

“Supporting citizens” and taking responsibility for stabilising
the national economy are central tasks for every responsible government. The execution
of those tasks should require no justification, just as the public accepts the need
for a well-funded NHS protecting our health. The NHS has the responsibility for
the nation’s health. The Treasury has the responsibility for a stable economy that
provides decent incomes for all.

Once we re-recognise that over-riding public responsibility, we should dismiss
the ideologically driven anxieties about excessive government spending, encouraged
by mainstream economists of the centre-right and centre-left. In retrospect, we
can see that the threat to economic stability in the UK, US and Europe lay not in
the remote possibility of too much public spending but in the reality of not enough.
If spending rules are necessary, they need ones to insure adequate funding not frugality.

The Progressive Economy Forum firmly states
on our web site that it opposes austerity and the current ideology and narrative
of neoliberalism, campaigns to bring austerity to an end and ensure that austerity
is never used again as an instrument of economic policy. Is it too early to say
that we are at last making progress in these aims?

Furthermore will there be at some point a reckoning for those who increased our public debt and caused needless suffering by pursuing a reckless and damaging ideology to shrink the state only to abandon this when it became politically expedient and in the face of national emergency?

Photo credit: Flickr/HM Treasury.

The post The End of Austerity Speak appeared first on The Progressive Economy Forum.

Affordable housing, homelessness and the upcoming federal budget

Published by Anonymous (not verified) on Fri, 20/03/2020 - 10:14am in

I’ve written a ‘top 10’ overview of things to know about affordable housing and homelessness, as they relate to Canada’s upcoming federal budget. The overview is based on the affordable housing and homelessness chapter in the just-released Alternative Federal Budget.

A link to the ‘top 10’ overview is here.

Affordable housing, homelessness and the upcoming federal budget

Published by Anonymous (not verified) on Fri, 20/03/2020 - 10:14am in

I’ve written a ‘top 10’ overview of things to know about affordable housing and homelessness, as they relate to Canada’s upcoming federal budget. The overview is based on the affordable housing and homelessness chapter in the just-released Alternative Federal Budget.

A link to the ‘top 10’ overview is here.

Lagarde: A Rookie Mistake?

Published by Anonymous (not verified) on Fri, 13/03/2020 - 5:51am in

So the ECB has spoken in response to the Coronavirus crisis, and it was a problematic response to say the least. I watched Christine Lagarde’s Q&A with journalists, which as usual was the most interesting part of the press conference. But boy, I wish today it had not taken place…

The bottom line is that Lagarde made a huge misstep in stating that the ECB is not going to close the spreads. I hope it is just a communication misstep, otherwise Italy (and probably other countries) will pay a heavy price.

But let’s see what happened today.

First, there is an attempt to put on the Eurozone governments’ shoulders most of the burden of reacting to a shock that will be “significant even if temporary”. Lagarde said clearly, towards the end of the press conference, that what she fears most is insufficient fiscal response coming out from the Eurogroup meeting next Monday:

It is hard to disagree with this approach. To target firms’ liquidity problems one cannot count on banks alone, (especially in countries where they have still not completely recovered from the sovereign debt crisis). As a side note, I welcome the provisions contained in the Italian €25bn package, such as the temporary lifting of short-term businesses obligations towards the government (VAT, social contributions, taxes). These seem to be the right measures to ease short term liquidity constraints.

But let’s look into what the ECB itself commits to do. Besides technicalities that I did not study yet, there will be two sets of measures:

  1. The first set concerns (continued) provision of cheap liquidity to banks, in order to ensure continuing supply of credit to the real economy. This will be ensured through a new and temporary long-term refinancing scheme (LTRO), together with significantly better terms for the existing targeted loan programs. This amount to a large subsidy to banks. Loans conditions will be more favorable for banks lending to Small and Medium Enterprises, which are the ones more likely to become strapped for liquidity in the current situation. Furthermore, as a supervisor, the ECB engages in operational flexibility when implementing bank specific regulatory requirements, and to allow full utilization of the capital and liquidity buffers that financial institutions have built. I am unclear on how much this will work in order to keep the flow of credit flowing, but overall, my sentiment is that on cheap and easy financing to banks and (hopefully) to firms, there is little more ECB could do.
  2. The second set of measure is a ramping up of QE, with additional €120bn (until the end of the year). Lagarde seemed to suggest that the ECB could use flexibility to deviating from capital keys, the quota of bonds the ECB can buy from each country. This means that maybe more help will be given to countries like Italy, and the ambiguity was probably on purpose.

But then came the Q&A, and with it, disaster. At a question by a journalist on Italian debt and yields, Lagarde replied the following:

This also made it on the ECB twitter feed:

This simple sentence was a reversal of Mario Draghi 2012 “whatever it takes“. Mario Draghi, in 2012, had basically announced that the ECB would act as a crypto-lender of last resort (conditional, way too conditional, but still), and since then the scope for speculation has been greatly reduced. Spreads have been much less variable since then (I wrote a paper with Roberto Tamborini, on that, that just came out).

Protection from the ECB against market speculation is what countries like Italy would need most. Fiscal policy is the tool that can be better targeted towards supporting the supply side of the economy and preventing liquidity problems from evolving into bankruptcies. Lagarde herself stated it many times in the past few days, and again today.

So, governments should be put in the conditions not to worry, at least for a while, of market pressure. Lagarde should have said the exact opposite: “we commit to freezing the spreads for n months so that governments can focus on supporting their productive sector, and restoring more or less normal aggregate demand conditons”. Lagarde said the opposite. And here is the effect of that on Italian ten year rates. Look what happened at around 3pm, when she answered the question:

The yields Other Eurozone peripheral countries had similar behaviours. Why did Lagarde say that? Maybe Because she wanted to appease fiscal hawks ahead of the Eurogroup meeting of next week, so that they are more willing to agree on a fiscal stimulus? Or because she was afraid to be accused to be too soft on Italy? Or to actually care about one single country, which is what the ECB is not supposed to do? Or was it simply a communication misstep? A rookie mistake? Whatever the reason, it is clear that Lagarde made a huge mistake, and even apparently she partially backpedaled in a NBC interview shortly thereafter, this is what remain of today’s press conference.

So, my assessment of today’s ECB move is mixed. It was as good as it gets on financing the banking sector, and we just have to cross finger that this is enough to keep credit flowing.

But it is disappointing on the support of expansionary fiscal policies. All the more disappointing that the ECB and Lagarde have insisted on the need for a fiscal response “first and foremost”.

My only hope is that that was a misstep, or just lip service to fiscal responsibility. If market pressure prevents governments from supporting their firms, and if liquidity problems evolve into solvency problems, a “significant but temporary” shock will become a permanent hit to long-term growth capacity. And let’s not forget that the Eurozone economy is today more diverse and less resilient than it was in 2008.

Brace yourself

ps. You can find my live tweeting during the Q&A (a bit confused at times. Live tweeting is not my thing!) here:

The Treasury's Budget Report breaks the law on fiscal rules

Published by Anonymous (not verified) on Thu, 12/03/2020 - 3:27am in

Tags 

UK, fiscal policy

“The Treasury must explain the reasons for any departure from the previous mandate and/or supplementary targets.“

From the current Charter for Budget Responsibility’s fiscal rules

“The Treasury may from time to time modify the Charter… When the Charter is modified the Treasury must lay the modified Charter before Parliament.”

From the 2011 Budget Responsibility and National Audit Act 2011

—————-

There’s no getting away from it – in the manner in which it has put forward today’s Budget, the government – and specifically the Treasury – have acted in breach of the law.  The government’s Budget Report is required to set out how it is meeting the present, legally prescribed fiscal rules and targets. It has ridden roughshod over this requirement, instead laying down rules that - whatever their merit may be - have no legal basis or standing. It has ignored the statutory rules for changing the rules, laid down by the Conservative-led government in 2011.

The 2011 Act

The proposed new fiscal framework, for which a review is announced today, is likely to be better (allowing for more public spending, if well directed) than the fiscal rules of ex-Chancellors George Osborne or Philip Hammond.  But that provides no reason or excuse to ignore the clear legal rules enacted and approved by Parliament.

We have criticized the “fiscal rules” put forward by post-2010 Conservative governments, but until now they have followed their own procedural rules.  Not this time.

The legal framework comes from the Budget Responsibility and National Audit Act 2011, which set up the “independent” Office for Budget Responsibility (OBR) and also, in Section 1, provided a requirement for there to be a Charter for Budget Responsibility, prepared by the Treasury, and “relating to the formulation and implementation of fiscal policy and policy for the management of the National Debt.”

By Section 1(2), the Charter must in particular set out

(a) the Treasury’s objectives in relation to fiscal policy and policy for the management of the National Debt,

(b )the means by which the Treasury’s objectives in relation to fiscal policy will be attained (“the fiscal mandate”), and

(c) matters to be included in a Financial Statement and Budget Report prepared under section 2.

The Charter is an important formal, legally prescribed matter –

“(4) The Treasury must lay the Charter before Parliament.

(5) The Treasury may from time to time modify the Charter.

(6) When the Charter is modified the Treasury must lay the modified Charter before Parliament.

(7) The Charter (or the modified Charter) does not come into force until it has been approved by a resolution of the House of Commons.”

Section 2 of the 2011 Act provides the requirements for the annual Budget Report, including:

(1) The Treasury must prepare a Financial Statement and Budget Report for each financial year.

(2) The contents of a Financial Statement and Budget Report must conform to any provision set out in the Charter…

The 2017 Charter

The current Charter of Fiscal Responsibility is dated Autumn 2016, but was approved by Parliament in early 2017.  It has not been replaced.   It sets out an overall “objective”:

3.1 In order to provide for sustainable public finances, ensure confidence in the economy, and support the effectiveness of monetary policy, the Treasury’s objective for fiscal policy is to: return the public finances to balance at the earliest possible date in the next Parliament. [My emphasis]

The ‘objective’ is supported by the ‘fiscal mandate’, which the Charter reminds is laid down in primary legislation:

3.2 The Treasury is required by the Budget Responsibility and National Audit Act 2011 to set out the means by which its objective in relation to fiscal policy will be attained (“the fiscal mandate”). This act also requires the OBR to assess the government’s performance against the fiscal mandate.

3.3 In order to achieve the above objective, the Treasury’s mandate for fiscal policy in this Parliament is a target to reduce cyclically-adjusted public sector net borrowing to below 2% of GDP by 2020-21

3.4 The Treasury’s mandate for fiscal policy is supplemented by a target for public sector net debt as a percentage of GDP to be falling in 2020-21

3.5 To ensure that expenditure on welfare remains sustainable, the Treasury’s mandate for fiscal policy is further supplemented by  a target to ensure that expenditure on welfare in 2021-22 is contained within a predetermined cap and margin set by the Treasury at Autumn Statement 2016.

The Charter also prescribes what happens if there is an economic shock:

3.6 In the event of a significant negative shock to the UK economy, the Treasury will review the appropriateness of the fiscal mandate and supplementary targets as a means of returning the public finances to balance as early as possible in the next Parliament.  

So what should happen if a Government decides as a matter of policy to change course, or it feels that economic circumstances require a change?  The Charter, once more, is clear and precise:

“3.7 Should the Treasury wish to change its mandate for fiscal policy or supplementary targets, this shall be achieved through the formal process for modifying this Charter for Budget Responsibility (“the Charter”) set out in Section 1 of the Budget Responsibility and National Audit Act 2011. The Treasury must explain the reasons for any departure from the previous mandate and/or supplementary targets.”

The annual Budget Report

In paragraph 3.11, the Charter also lays down what must be in the annual Budget Report:

“The Budget Report shall provide, at a minimum:

  •         an explanation and costing of the impact of all significant fiscal policy measures introduced by the government since the last Budget and an explanation of the methodology used to cost the fiscal impact of each of these measures

  •        an explanation, where necessary, of how these policy measures maintain the path of the public finances in a position consistent with:

    •    the objective for fiscal policy

    •   the mandate for fiscal policy, where consistency will be assessed by the OBR

    •    the level of the welfare cap and pathway, against which the OBR will monitor relevant welfare spending”

The Treasury, to underline the point, is under a legally founded duty to explain not whether but how the budget’s policy measures maintain the path consistently with the ‘objective’ laid down in the Charter - of returning the public finances to balance as soon as possible in this Parliament, and how they do so in relation to the ‘mandate.’  The answer, of course, is that they don’t.

The only wriggle room provided by the Charter’s clear wording is that the Budget Report must give an explanation, where necessary, of how these policy measures maintain the path of the public finances.  But in my view it is impossible to hold that it is not “necessary” to give an explanation when you are in the act of tearing up the rules you should be explaining you are adhering to. 

The alternative is to bring forward an amendment – even a temporary amendment – to the fiscal rules, which the government has had time to do.  It has chosen not to do so, but to ride roughshod over the law.

Instead, the 2020 Budget Report sets out a wholly different set of fiscal rules which not only have no legal status, but contradict the existing ones:

“1.12 The fiscal framework

This Budget has been delivered to meet the following fiscal rules:

to have the current budget at least in balance by the third year of the rolling five-year forecast period

to ensure that public sector net investment (PSNI) does not exceed 3% of GDP on average over the rolling five-year forecast period

if the debt interest to revenue ratio is forecast to remain over 6% for a sustained period, the government will take action to ensure the debt-to-GDP ratio is falling

The Budget also sets the spending envelope for the upcoming CSR within these rules, which allow for significant investment in growth-enhancing infrastructure while maintaining control of day-to-day spending.”

Review of “fiscal framework”

Instead of complying even minimally with the legal requirements concerning the rules, the government simply announced a review of the UK’s “fiscal framework”:

“Interest rates are expected to remain at very low levels for an extended period. This has prompted an international debate around the implications of this environment for fiscal sustainability and the role of fiscal policy. In this context, the Chancellor has announced that HM Treasury will conduct a review of the UK’s fiscal framework, to:

  •  ensure that it remains appropriate for the current macroeconomic environment

  • support the ambitious new policy agenda of the government to invest in and level up every part of the country

  • keep the United Kingdom at the leading edge of international best practice in macroeconomic policy

The review will report back by Autumn Budget 2020, to allow the government to confirm its fiscal objectives for the Parliament.”

Then, hidden away, we finally find a reference to the actual current fiscal rules:

“When the review is concluded, HM Treasury will lay before Parliament a new Charter for Budget Responsibility; the Autumn 2016 Charter therefore remains in force at the current time.  The Budget has been delivered within the fiscal rules set out above in paragraph 1.34. The Chancellor wrote to the OBR ahead of the Budget to ask it to assess the government against these rules, in addition to those set out in the Autumn 2016 Charter.”

(This is curious wording also in that the fiscal rules set out above are in 1.12, not 1.34 which has no bearing on the matter). 

The OBR’s report

The OBR’s new economic and fiscal outlook report does indeed look (from page 154) at how the government’s proposals fare against the “legislated” fiscal targets - but it does not look (nor is it required to) at how the government’s plans fare against the “objective” of having the public finances (including investment) in balance over this Parliament. It finds (no surprise) that at least one of the targets will not be met. The evidence is clear that the Charter’s ‘objective’ will be missed by a mile.

As we’ve seen, the Treasury is given the duty, under the Charter, of reporting on how it is complying with the overall objective

What the government should have done

The answer here is really quite simple. Comply with the law, as enacted and approved by Parliament.

The process, after all, is simple.

Draft a modified Charter, in accordance with the 2011 Act, which changes the objective, and the fiscal targets or mandate to meet your manifesto. Put it before Parliament, get it approved by Resolution. You can then do your review, and change it again late this year or next. It’s easy and laid down by law.

But this government thinks it is above the law, and can ignore it, with no one noticing or feeling able to challenge it. It’s maybe a small sign, but it’s the clear sign of an autocratic government at work.

the 2020-21 Alberta budget

Published by Anonymous (not verified) on Tue, 10/03/2020 - 3:21am in

I’ve written a ‘top 10’ overview of the 2020-21 Alberta budget, tabled on February 27.

The link to the overview is here.

the 2020-21 Alberta budget

Published by Anonymous (not verified) on Tue, 10/03/2020 - 3:21am in

I’ve written a ‘top 10’ overview of the 2020-21 Alberta budget, tabled on February 27.

The link to the overview is here.

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