Monetary policy

Monetary Policy Transmission: Borrowing Constraints Matter!

Published by Anonymous (not verified) on Tue, 26/05/2020 - 6:00pm in

Fergus Cumming and Paul Hubert

How does the transmission of monetary policy depend on the distribution of debt in the economy? In this blog post we argue that interest rate changes are most powerful when a large share of households are financially constrained. That is, when a higher proportion of all borrowers are close to their borrowing limits. Our findings also suggest that the overall impact of monetary policy partly depends on the behaviour of house prices, and might not be symmetric for interest rate rises and falls.

From Micro to Macro

In a recent paper we use the universe of UK loan-level mortgage data to construct an accurate measure of the proportion of households that are close to the limits of what banks will lend them. Our rich mortgage data allow us a rare glimpse into the various factors that drove individual debt decisions between 2005 and 2017. After stripping out the effects of regulation and other developments in the macroeconomy, we then estimate the proportion of highly indebted households to construct a measure that is comparable across time (Figure 1). In doing so, we collapse the information contained within 11 million mortgages into a single time series, which allows us to explore macro questions in a tractable way.

Figure 1 – The share of conditional-LTI> 4 and LTI>5 mortgages

We use this state variable as a proxy for the share of people that are financially constrained, and use its variation over time to explore how it affects the economy’s responsiveness to monetary policy. In particular, we focus on the response of aggregate consumption when we interact it with a set of standard monetary shocks using local projection methods. This involves running regressions of consumption on monetary shocks at different horizons. We interact them with a variable that captures the proportion of highly indebted households, to see if the strength of response varies with the proportion of indebted highly households, as well as other controls.

These yield a set of impulse responses that tell us how the path of consumption might respond to an unexpected increase in the monetary policy rate. We can then take two different values of our state variable (1 standard deviation above and below the mean) to compare the path of consumption following a change in monetary policy when the share of highly indebted households is above, or below, its historic average. Intuitively, we know that a contractionary monetary shock leads to a near-term dip in consumption, which is why monetary policymakers tend to increase interest rates when they want to apply the brakes. We explore whether this pattern changes according to what else is going on, including whether more-people-than-normal are financially stretched.

State-Contingent Monetary Policy

We find that monetary policy is more powerful when a large proportion of households have taken on relatively high debt burdens. In that sense, the transmission of monetary policy depends on the state of the economy. In Figure 2 below, we look at the response of non-durable, durable and total consumption in response to a 100bp increase in interest rates. The grey (blue) swathes plot the path of consumption when there is a large (small) share of people who might be more constrained by higher debt holdings. The gaps between the blue and grey swathes suggest monetary policy is more potent when more people have higher debt levels.

Figure 2 – The response of consumption to 100bp contractionary monetary policy shock

This differential effect likely works through at least two mechanisms: first, when households increase their borrowing relative to their income, the mechanical effect of monetary policy on disposable income is amplified. Those with a large borrowings suffer the most from a proportional increase in monthly repayments! Second, households close to their borrowing limits adjust spending more in response to income changes (they have a higher so-called marginal propensity to consume). If there are more of these people, overall consumption will respond more to monetary policy. Interestingly, we find that our results are driven more by the distribution of highly-indebted households rather than a general rise in borrowing.

We also find evidence of some asymmetry in the transmission of monetary policy. When the share of constrained households is large, interest rate rises have a larger absolute impact than interest rate cuts. To some extent this is unsurprising. When your income is very close to your outgoings, the effect of a small income squeeze is very different to receiving a small windfall. So it follows that interest rate increases are likely to affect behaviour more than interest rate falls.

Our results also suggest that the behaviour of house prices affects how monetary policy feeds through. When house prices rise, homeowners feel wealthier and are more able to refinance their mortgages and release housing equity in order to spend money on other things. This can offset some of the dampening effects of an increase in interest rates. In contrast, when house prices fall, this channel means an increase in interest rates has a bigger contractionary effect on the economy, making monetary policy more potent.

Finally, we find that the household debt distribution also affects not just consumption responses, but also how monetary policy feeds through to the economy more broadly.  Running the same exercise to gauge the effects on wages, employment, real output growth and industrial production, we find a similar result: responses are stronger when more households are highly indebted.  This is likely driven by the direct effect of consumption, but also an amplification from spending through to changes in firm and labour market behaviour – or what economists call general-equilibrium effects.

Policy Implications

Our results suggest that the potency of monetary policy is not always the same. It can vary with respect to economic conditions. In particular, we show that the distribution of household indebtedness might explain some of the variation in the effects of monetary policy. It’s not so much the average level of indebtedness that matters, but rather its distribution. The greater the proportion of indebted households, the bigger the effect it has.

Economists, central bankers and other policymakers often look at the role of debt from a financial stability or regulatory perspective — how it affects the stability of individual institutions and the financial system as a whole. Our results suggest another reason why debt matters — it affects how monetary policy changes are transmitted through the economy. This is an emerging area of research, facilitated by new detailed micro-level datasets, and there’s much more for the profession to do on this topic.

Fergus Cumming works in the Monetary Policy Outlook Division and Paul Hubert works at Sciences Po – OFCE.

If you want to get in touch, please email us at or leave a comment below.

Comments will only appear once approved by a moderator, and are only published where a full name is supplied. Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

The Primary Dealer Credit Facility

Published by Anonymous (not verified) on Tue, 19/05/2020 - 9:00pm in

Antoine Martin and Susan McLaughlin

The Primary Dealer Credit Facility

This post is part of an ongoing series on the credit and liquidity facilities established by the Federal Reserve to support households and businesses during the COVID-19 outbreak.

On March 17, 2020, the Federal Reserve announced that it would re-establish the Primary Dealer Credit Facility (PDCF) to allow primary dealers to support smooth market functioning and facilitate the availability of credit to businesses and households. The PDCF started offering overnight and term funding with maturities of up to ninety days on March 20. It will be in place for at least six months and may be extended as conditions warrant. In this post, we provide an overview of the PDCF and its usage to date.


Primary dealers are trading counterparties of the New York Fed that support its implementation of monetary policy (a list of primary dealers can be found here). In that role, they help provide liquidity in the market for government securities. Primary dealers also act as market makers for other fixed-income securities and for equity securities. Most primary dealers are securities broker-dealers, so they do not have direct access to the discount window, even if they are affiliated with a bank holding company.

The coronavirus pandemic led to extreme uncertainty regarding the future path of the economy. This uncertainty, in turn, led to considerable market volatility for a wide range of assets, as investors tried to deleverage, reduce risk positions, and build up cash reserves. Michael Fleming and Francisco Ruela describe the impact of that volatility in the Treasury market in this Liberty Street Economics post. Markets for nongovernment securities were also affected, as selling pressures strained financial intermediaries’ ability to make markets for buyers and sellers of securities. By mid-March, market disruptions were so severe that the Federal Reserve determined that circumstances were “unusual and exigent” and established the PDCF, with the approval of the Treasury Secretary, under the authority provided in Section 13(3) of the Federal Reserve Act.

Funding extended to primary dealers under the PDCF may be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities. PDCF loans are made with recourse to the firm’s assets in the event of a borrower default. This contrasts with some of the Fed’s non-recourse facilities, for which the Treasury Department is providing capital to absorb any initial losses experienced.

The interest rate charged is the discount window’s primary credit rate. The PDCF accepts some securities that are not eligible collateral at the discount window, such as equities, due to the critical role primary dealers play in making markets in these instruments. Pricing and margin methodologies are similar to those used at the discount window.

Experience to Date

Lending rose quickly after the PDCF’s launch, and the weekly average of outstanding loans peaked at over $35 billion for the week ending April 15, as shown in the next chart. Outstanding loans remained in the $30-35 billion range for a few weeks, before decreasing recently, as market conditions improved. The vast majority of value-weighted PDCF loans have a maturity longer than overnight.

The Primary Dealer Credit Facility

The bulk of the assets financed in the PDCF to date have been corporate and municipal debt, as well as asset-backed securities and commercial paper. These are asset classes that were experiencing considerable volatility and pressure in early March. Market conditions have improved markedly since the introduction of a variety of Fed interventions, including the PDCF (an overview of these interventions is available here). While it is difficult to measure the importance of each individual facility to improving market functioning, the interventions together appear to have had a beneficial effect. Both cash and funding market pressures in PDCF-eligible asset classes have diminished since the PDCF launched. The chart below represents spreads in the cash market.


Comparison with the 2008 PDCF

The Federal Reserve initially established the PDCF in March of 2008, following severe strains in the tri-party repo market, associated in part with Bear Stearns’ troubles. This Liberty Street Economics post describes the tri-party repo market in simple terms, but is somewhat dated; there is now only one clearing bank for tri-party repo in the United States. A detailed account of the 2008 PDCF can be found here.

The economic stress and the drivers of financial market disruptions were very different in March 2020 than they were in 2008. In 2008, the repo market stress that led to the creation of the PDCF appeared to be largely driven by concerns about some dealers’ exposure to subprime mortgages. In contrast, in the current environment, investors have pulled back from risk assets to build up cash positions, due to uncertainty about the economic effects of the coronavirus pandemic and how long they will last. In the current environment, the PDCF supports the ability of primary dealers to make markets, including in risk assets, thereby facilitating the availability of credit to businesses, households, and municipalities.

Following its inception in March 2008, usage of the original PDCF increased to approximately $40 billion, before decreasing to zero by mid-2008, as shown on the next chart. This $40 billion level is roughly comparable to the peak usage of today’s PDCF.


Usage of the original PDCF increased to over $140 billion in September 2008, following the bankruptcy of Lehman Brothers. This peak is much higher than the current use of today’s PDCF. However, the range of collateral eligible for the PDCF post-Lehman was much broader than the range of eligible collateral at the PDCF today, making comparisons difficult.

Note that the volume of privately issued securities financed in the tri-party repo market is markedly lower today than in 2008; approximately $340 billion in March 2020 compared to $600 billion in August 2008. (Tri-party data starting in May 2010 are available on the New York Fed’s website. Earlier data were made public with the Financial Stability Oversight Council’s 2011 annual report.) So, it’s interesting to observe that the level of PDCF borrowing is similar today to what it was in 2008.

An important difference between the PDCFs in 2008 and 2020 is that the current incarnation offers credit to primary dealers for up to ninety days, rather than only overnight, as was the case for its predecessor. Indeed, as noted above, the vast majority of the current borrowing at the PDCF has been at term. This suggests that today’s PDCF can do more to stabilize term markets.

To Sum Up

The PDCF is one of many facilities introduced by the Federal Reserve to support the U.S. economy in the face of the coronavirus pandemic. The PDCF helps primary dealers support smooth market functioning and facilitate the availability of credit to businesses and households in their capacity as market makers for corporate, consumer, and municipal obligations.

The authors thank Steven Block, Justin Epstein, Pooja Gupta, Helene Hall, and Tim Wessel for their assistance with the data underlying the charts.


Antoine Martin is a senior vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Susan McLaughlin is a senior vice president in the Bank’s Markets Group.

Also in the Liberty Street Economics Facilities Series

Helping State and Local Governments Stay Liquid, April 10

The Money Market Mutual Fund Liquidity Facility, May 8

The Commercial Paper Funding Facility, May 15

The Paycheck Protection Program Liquidity Facility (PPPLF), May 20

The Primary and Secondary Market Corporate Credit Facilities, May 26

Related Content on

Video: The Primary Dealer Credit Facility, Explained

How to cite this post:

Antoine Martin and Susan McLaughlin, “The Primary Dealer Credit Facility,” Federal Reserve Bank of New York Liberty Street Economics, May 19, 2020,


The views expressed in this post are those of the authors 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 authors.

Inflation Expectations in Times of COVID-19

Published by Anonymous (not verified) on Wed, 13/05/2020 - 9:00pm in

Olivier Armantier, Gizem Kosar, Rachel Pomerantz, Daphne Skandalis, Kyle Smith, Giorgio Topa, and Wilbert van der Klaauw

Inflation Expectations in Times of COVID-19

As an important driver of the inflation process, inflation expectations must be monitored closely by policymakers to ensure they remain consistent with long-term monetary policy objectives. In particular, if inflation expectations start drifting away from the central bank’s objective, they could become permanently “un-anchored” in the long run. Because the COVID-19 pandemic is a crisis unlike any other, its impact on short- and medium-term inflation has been challenging to predict. In this post, we summarize the results of our forthcoming paper that makes use of the Survey of Consumer Expectations (SCE) to study how the COVID-19 outbreak has affected the public’s inflation expectations. We find that, so far, households’ inflation expectations have not exhibited a consistent upward or downward trend since the emergence of the COVID-19 pandemic. However, the data reveal unprecedented increases in individual uncertainty—and disagreement across respondents—about future inflation outcomes. Close monitoring of these measures is warranted because elevated levels may signal a risk of inflation expectations becoming unanchored.

The Survey of Consumer Expectations (SCE) is a monthly, internet-based survey produced by the Federal Reserve Bank of New York since June 2013. It is based on a twelve-month rotating panel (respondents are asked to take the survey for twelve consecutive months) of roughly 1,300 nationally representative U.S. household heads. An important feature of the SCE is that respondents receive an invitation to complete the survey on different days spread out throughout the month. This way, consumers’ expectations are captured relatively uniformly throughout the month. The SCE elicits different measures of inflation expectations. This post focuses on the short- and medium-term inflation density forecast questions in which respondents are asked to state the percent chance that the rate of inflation will fall into various bins. These density forecasts are used to calculate the three measures we focus on in this post: the individual inflation density mean (the mean of a respondent’s density forecast), the individual inflation uncertainty (measured as the interquartile range of a respondent’s density forecast), and the inflation disagreement across respondents (measured here as the interquartile range of the distribution of the respondents’ individual inflation density means).

The chart below shows the smoothed daily median of the individual inflation density mean at the one-year and three-year horizons, where the median is the point at which 50 percent of respondents expect inflation to be above this level, and 50 percent below. We also added vertical bars to the chart to mark some of the key dates in the development of the COVID-19 pandemic. We distinguish health-related events (marked by long-dashed vertical lines), from policy-related events (marked by short-dashed vertical lines). The chart shows that the medians of the short- and medium-term density means have moved up and down substantially since the outbreak of COVID-19. Thus, so far, the pandemic does not seem to have had a clear upward or downward impact on this aggregate measure of consumers’ inflation expectations.

Inflation Expectations in Times of Covid-19

The next chart shows the smoothed daily median of the individual inflation uncertainty at both horizons. Unlike inflation expectations, this measure of inflation uncertainty exhibited a clear monotonic increase during the first three weeks of March. In fact, the sharp increase in one-year ahead inflation uncertainty is unprecedented and in March it reached levels never seen since the inception of the SCE in June 2013. After peaking toward the end of March, inflation uncertainty has remained elevated in recent weeks compared to the pre-COVID-19 period. Thus, respondents have expressed more diffused beliefs about future inflation since the beginning of the pandemic. In particular, on average, they have assigned higher probabilities to extreme inflation outcomes, such as the possibility of deflation or the risk that inflation may end up being higher than 4 percent.

It is interesting to note that inflation uncertainty in the SCE is generally higher at the three-year horizon than at the one-year horizon, simply reflecting the fact that respondents usually find it more difficult to predict inflation further in the future. In contrast, since the beginning of the pandemic, inflation uncertainty has been uncharacteristically higher at the one-year horizon. This result suggests that people are especially uncertain about the impact of the pandemic on the economy in the shorter term.

Inflation Expectations in Times of Covid-19

Finally, we plot in the chart below our smooth daily measure of inflation disagreement across respondents for the short- and medium-term horizons. Inflation disagreement increased steadily through the month of March, and subsided somewhat after the signing of the CARES Act on March 27. In other words, as the crisis initially progressed SCE respondents became more divergent in their inflation expectations (that is, in their density means): some respondents expected the pandemic to produce high inflation, while others expected it to yield low inflation. In particular, the proportion of respondents who think there will be deflation next year (that is, with a density mean below zero) jumped from less than 10 percent at the end of February to more than 20 percent a month later. Likewise, the proportion of respondent who expect short-term inflation to be higher than 4 percent jumped from around 30 percent to almost 45 percent during the same period.

Note also that our measure of disagreement has been higher for short-term inflation since the start of the pandemic. This is in contrast with historical trends. Indeed, SCE respondents usually disagree more about which path inflation will take in the medium term. This inversion in the term structure of disagreement may reflect the uniqueness of the impact of COVID-19 on the economy. Indeed respondents may find it difficult to agree whether the dominant short-term economic disruption will be mostly a supply or a demand shock, and in turn whether the pandemic will produce higher or lower inflation in the year ahead. Relatedly, we also see an increase in disagreement across respondents for many other variables, including for perceived layoff risk, household spending and income growth, and expected credit access conditions. Thus, it appears that respondents have very dispersed views on where the economy is headed in the months ahead.

Inflation Expectations in Times of Covid-19

Summing up, we find that, so far, households’ inflation expectations have not exhibited a consistent upward or downward trend since the emergence of the COVID-19 pandemic. However, the data reveal unprecedented increases in individual inflation uncertainty and in inflation disagreement across respondents. These changes in beliefs may in turn affect real activity, although in the current unprecedented conditions it remains unclear in what direction and by how much. Regardless, as discussed here, close monitoring of these measures is warranted because elevated levels may signal a risk of inflation expectations un-anchoring.

Olivier Armantier

Olivier Armantier is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Gizem Kosar

Gizem Kosar is an economist in the Bank’s Research and Statistics Group.

Rachel Pomerantz
Rachel Pomerantz is a senior research analyst in the Bank’s Research and Statistics Group.

Daphne Skandalis
Daphne Skandalis is an economist in the Bank’s Research and Statistics Group.

Kyle SmithKyle Smith is a senior research analyst in the Bank’s Research and Statistics Group.

Giorgio Topa
Giorgio Topa is a vice president in the Bank’s Research and Statistics Group.

Wilbert van der Klaauw
Wilbert van der Klaauw is a senior vice president in the Bank’s Research and Statistics Group

How to cite this post:

Olivier Armantier, Gizem Kosar, Rachel Pomerantz, Daphne Skandalis, Kyle Smith, Giorgio Topa, and Wilbert van der Klaauw, “Inflation Expectations in Times of COVID-19,” Federal Reserve Bank of New York Liberty Street Economics, May 13, 2020,


The views expressed in this post are those of the authors 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 authors.

New Zealand Deprioritizes Growth to Improve Health and Wellbeing

Published by Anonymous (not verified) on Tue, 12/05/2020 - 11:00pm in

By James Magnus-Johnston

Last May, New Zealand Prime Minister Jacinda Ardern released a budget to improve the “wellbeing” of citizens rather than focusing on productivity and GDP growth. And, not so coincidentally, New Zealand has one of the best coronavirus outcomes of any democracy in the world. Perhaps this provides a global model to make economic health cohere with health for all life.

Jacinda Ardern

New Zealand’s Prime Minister, Jacinda Ardern, has deprioritized GDP growth in favor of improving wellbeing, and her personal approval rating is 65 percent. (Image: CC BY 4.0, Credit: Ministry of Justice of New Zealand)

To improve wellbeing, Ardern emphasized goals that focus on care for people and the planet. Goals included community and cultural connection as well as intergenerational equity. Under the policy, new spending had to focus on one of five priorities: improving mental health, reducing child poverty, addressing inequalities of indigenous peoples, thriving in a digital age, and transitioning to a low-emission economy.

While New Zealand isn’t the only country to float the idea of wellbeing over income, it is the first country to make it a reality. Guided by this philosophy, New Zealand is not in a rush to open its economy even as the headlines of a “stock market crash” or a “recession worse than 2008-09” appear in newspapers across the globe. Is Ardern’s example wise? Can we build upon it to further improve life after COVID?

Health and the Economy

In the postwar-capitalist framework, economic “health” became equated to income growth, price stability, and full employment. There are increasingly serious pitfalls to thinking of “health” as a capitalist metaphor rather than a desirable end goal. Using GDP and stock market values as measures of overall economic health made sense in the postwar era, when growth was necessary to improve human wellbeing by raising material living standards. In much of the Global North, it is now necessary to focus instead on improving wellbeing without growing our material footprint. Ardern gestures at this by focusing on mental health, inequality, and poverty, without emphasizing income.

By the postwar logic, human health and wellbeing can be upheld when there is enough money to purchase and provide care. After all, supplies and infrastructure need to be paid for. But as the American and British pandemic strategies have demonstrated, a growing economy in which GDP (or “opening the economy”) is prioritized over general wellbeing doesn’t always improve health outcomes. The USA has one of the highest COVID death rates in the world, and the US infection rate is rising as states open up. Experts on public health and leadership, like those writing in the Harvard Business Review, suggest that New Zealand’s Ardern provides a system that prioritizes maintaining and improving public health that global leaders should follow.

We can also think of health in the broader sense, i.e., health for nonhuman life. The economy is a trophic system, which means that economic health requires the consumption (i.e., death) of nonhuman life. And presently, growth is occurring on a scale that is unsustainable. Here, too, Ardern doesn’t suggest a transition to degrowth, but she does emphasize the need for a low-emission economy. Her movement away from GDP growth as a metric of economic “health” does provide an opportunity to make economic health cohere with the idea of ecological health: sustaining the power and vitality that supports all life.

One of the other tangible ways in which some have experienced a positive impact to their wellbeing during the pandemic is a temporary reprieve from productivist pressures and workplace stress. As I mentioned in a previous article, the term “capitalism” refers to Max Weber’s “modern Kultur” centering around a code of values for the 20th-century West. In this new economy, the highest virtue became “the making of money and ever more money, without any limit.” Growth-as-prosperity requires a certain level of constant busyness to prop up the outputs for mass consumption and technological improvement rather than human warmth and connection.

As a result of the pandemic, many of us have gained clarity about the things we value most, such as food, health, income security, education, mobility, access to nature, social connection, and public services. An economy designed for wellbeing can prioritize these tangible things rather than assuming that income will deliver them.

How Can We Build on Arden’s Success?

As we seek to cultivate a new normal in which health is prioritized, perhaps New Zealand offers a glimpse of the way forward. The Wellbeing Economy Alliance published a piece by Amanda Janoo and Gemma Bone Dodds that suggests that the COVID-caused “Great Pause,” as it were, provides an opportunity to improve our focus on wellbeing. They provide an argument in four parts: (1) The stock market is not a reflection of our economic reality; (2) We will enter a recession, and that’s okay; (3) Economic policies for a Great Pause; and (4) Building back better.

Basic needs

The pandemic has revealed how important it is for basic needs to be met through redistributive cash benefits. (Image: CC0, Credit: Mick Haupt)

With respect to the first two, Janoo and Bone Dodds argue that the stock market can’t possibly predict the future because the future will look starkly different from the past. As a result, trades merely reflect anxiety rather than future prosperity. Secondly, while policymakers are presently fearing a recession—a fall in GDP for two consecutive quarters—inevitably the economy will contract to ensure our collective wellbeing. As they point out, just because the economy contracts, that doesn’t mean our basic needs can’t be met. If anything, this situation has revealed that basic needs might be better met by providing cash benefits (or a universal basic income) where income is redistributed to preserve social solidarity and care. The economy won’t disappear, it will just focus on providing basic needs first. Particularly the ones that our free market sometimes fails to provide for a large part of society.

And to “build back better,” we could examine Ardern’s model and take it one small step further. To focus on health and wellbeing, economic policies should ensure basic needs are met through redistributive mechanisms without trying to balance budgets through austerity measures. Philosophically, this is an opportunity to consider how to live full and meaningful lives without unnecessary excesses. Janoo and Bone Dodds also note that during this time we’ve witnessed how many of our most precarious and poorly-paid workers, including “healthcare workers, farmers, grocery clerks, delivery drivers, and caregivers,” are in fact the most critical for our collective wellbeing.

An economy focused on improving wellbeing is not a distant theoretical idea. The postwar social welfare system helped raise material living standards by improving incomes. But in the 21st century, we have new social and ecological constraints. Ardern has provided a model for the world to refocus on health and wellbeing, and the global pandemic reveals how wise this strategy truly is.

James Magnus-Johnston headshotJames Magnus-Johnston is a PhD researcher at McGill University in the Leadership for the Ecozoic program.

The post New Zealand Deprioritizes Growth to Improve Health and Wellbeing appeared first on Center for the Advancement of the Steady State Economy.

Debt Monetization and Inflation Ideology

Published by Anonymous (not verified) on Mon, 11/05/2020 - 8:51pm in

Few common economic phenomena are as misunderstood and misrepresented as “inflation”.  Unemployment represents a concrete event that manifests itself in a straight-forward manner, loss of work, application for benefits and subsequent job search.  We can contrast this to inflation.  Economists struggle to define what inflation is. 

A “rise in the general price level” comes across as the preferred definition, but is ambiguous concept.  In actual economies with their many goods and services, the “general price level” exists as a measurement concept that no one directly perceives.  In addition, we have many statistical measures of inflation.  I focus on the commonly used consumer price index.

If we asked the proverbial person on the street, “are you unemployed”, we are likely to receive one of three replies — no, yes or “between jobs”.  Few if any adults would reply “I don’t know” or none of those”. 

We could ask the same person, “was your standard of living affected by inflation last month”?  There are many reasons why the person may find it difficult to answer.  If the Bank of England through intention or accident kept average price increase close to its 2% target, the rise might prove insufficient for the respondent to notice.  At least three characteristics of the “general price level” reinforce ambiguities of perception:  people have different consumption habits; all prices increases are not inflation; and in practice price determination falls into different processes.

To take obvious examples of the first, someone who rents accommodation will be unaffected by an increase in mortgage rates, changes in the fare for the London tube will go unnoticed by  a rural bus rider, and vegetarians will care little about meat prices. 

More important, consumer price indices use average consumption weights.  The substantial difference between average and median (mid-piont) income implies that the consumption pattern of the typical person differs substantially from the weights used by the Office of National Statistics.  ONS also calculates Indices by income deciles but these are rarely used in the media. Since 2006 when the indices began, average price increases for the population in the second decile (tenth) have differed each month from those of the ninth decile by an annual equivalent of 0.3 percentage points (ONS compares deciles 2 through 9 to avoid extreme values encountered at the ends of the distribution)). 

When people in the high ninth decile show no change, prices for those in the low second decile consistently show a small annual increase (calculated from ONS statistics for 2006-2019).  The distribution bias provides sufficient reason to make individual perception of inflation differ by income groups over several months’ periods of time.  And, of course, higher income groups may not notice small changes at all.

This ambiguity is substantially increased because (my second point), in time of low inflation quality change and new products have a calculated price impact well in excess of inflation itself.  The items people purchase continuously undergo quality change as well as being joined by new products.  Over twenty years ago the United States Congress commissioned a detailed investigation into the effect on inflation measurement of such changes. 

That study, the Boskin Report, concluded that new products and product improvement contribute about one percentage point to consumer prices each year.  While we have no equivalent UK study, the internationalisation of production and consumption suggests a similar impact.  If so, when the ONS reports an annual general price increase of two percent, what we normally mean by inflation — the same thing costs more — is actually one percent or less.

Perhaps the most important problem with measuring the general price level and inflation is a third complication.  The prices in our economy fall into three distinct categories: 1) goods and services who prices are determined in international markets, 2) those whose prices result from contact arrangements of varying time lengths (including public sector prices), and 3) prices determined in short term domestic markets processes (“spot market” prices).

With this complexity of price determination in mind, we can reconsider orthodox monetary policy.  For example if the ONS measured rate of price increases goes to 3.5%, the Bank of England is mandated, on advice of the Monetary Policy Committee, to act to reduce the rate down toward 2%.  An increase in the rate at which the Bank of England lends to private banks provides the conventional tool to archive this outcome.  Finding it more expensive to access funds, banks raise their lending rates.  Businesses then find their operating costs higher and reduce output.  Slower private expansion reduces pressure on wages and prices, bringing inflation down.

If this logic were sound, it would mean that the slow down in price increases would concentrate in domestic markets, leaving international prices such as petroleum unchanged, as well as having little impact on prices under contracts of various lengths.  The most flexible prices arise in markets with unregulated wages, such as retail and wholesale trade, where pay is also quite low. 

Thus, if the logic of conventional monetary policy holds, its distributional effect should prove quite unequal, its burden carried by the lowest pad.  The occasionally encountered argument that inflation disproportionately harms the poor is false; seeking to reduce inflation disproportionately harms the poor.

How did economic policy fall into this commitment to consistently inequitable monetary policy?  The alleged problem, excessive price increases, defies accurate measurement.  We have little evidence that the solution to this alleged problem, central bank manipulation of interest rates, would have any direct effect on it.  As I argued in my previous blog, underlying this mainstream monetary policy we find the belief in automatic adjustment to full employment — market economies naturally seek full employment, and government provoked inflation is the major source of instability.

A specific model of the economy provides the bridge from the belief in self-adjusting markets to mainstream monetary policy, the infamous Quantity Theory of Money.  In its simplest form that theory views the economy as generating one common output and money as created by governments.  In the simple neoliberal monetary world market economies automatically find full employment; only one output is produced; governments control the money supply; and inflation results from too much government created money chasing too little output.

But market economies tend to generate unemployment not full employment.  Real economies produce many goods and services with quite different process of price determination.  Governments and central banks at most influence not determine money in circulation.

Inflation is not the result of too much money.  That is its consequence.  In a third blog I focus on that issue — what causes a broad and persistent increases in prices, when that is a problem, and what policies to manage it.

picture credit :

The post Debt Monetization and Inflation Ideology appeared first on The Progressive Economy Forum.

The Money Market Mutual Fund Liquidity Facility

Published by Anonymous (not verified) on Fri, 08/05/2020 - 9:00pm in

Marco Cipriani, Gabriele La Spada, Reed Orchinik, and Aaron Plesset


This post is part of an ongoing series on the credit and liquidity facilities established by the Federal Reserve to support households and businesses during the COVID-19 outbreak.

Over the first three weeks of March, as uncertainty surrounding the COVID-19 pandemic increased, prime and municipal (muni) money market funds (MMFs) faced large redemption pressures. Similarly to past episodes of industry dislocation, such as the 2008 financial crisis and the 2011 European bank crisis, outflows from prime and muni MMFs were mirrored by large inflows into government MMFs, which have historically been seen by investors as a safe haven in times of crisis. In this post, we describe a liquidity facility established by the Federal Reserve in response to these outflows.

The Fed Intervention and Its Goals

From March 2 to March 23, the assets under management (AUM) of prime and muni MMFs dropped by $120 billion (15 percent of the industry) and $9 billion (7 percent of the industry). To prevent outflows from prime and muni MMFs from turning into an industry-wide run, as happened in September 2008 when one prime MMF “broke the buck,” the Federal Reserve announced the establishment of the Money Market Mutual Fund Liquidity Facility, or MMLF, on March 18. Under this facility, the Federal Reserve Bank of Boston provides loans to eligible borrowers (U.S. depository institutions, bank holding companies, and branches and agencies of foreign banks), taking as collateral eligible securities purchased from prime and muni MMFs. The U.S. Department of the Treasury provides $10 billion of credit protection to the Federal Reserve from the Treasury's Exchange Stabilization Fund.

The set of eligible collateral was gradually expanded over time; it now includes U.S. Treasuries, government-sponsored enterprise (GSE) debt, first-tier asset-backed and unsecured commercial paper (CP), top-tier negotiable certificates of deposit (CDs), municipal short-term debt, and variable rate demand notes (VRDNs). All securities accepted under the facility must have a residual maturity lower than twelve months or, in the case of VRDNs, must be putable within 12 months. The facility officially opened on March 23, and usage has been robust, with outstanding loans of more than $50 billion as of April 14.

The facility, which has many similarities with the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) put in place during the 2008 financial crisis, can be beneficial in two ways. First, by facilitating the sales of securities, it helps MMFs meet redemptions in an environment in which secondary market liquidity is strained. Second, by reassuring MMF investors that funds will be able to meet redemptions in the future, it reduces their incentive to withdraw preemptively, thereby reducing overall outflows. As outflows abate, prime and muni MMFs can continue to fund American businesses, states, and other localities.

The Direct Effects

The facility has been very successful, over a short period of time, at slowing investor outflows from prime and muni MMFs and improving conditions in money markets. As the charts below show, since the facility's inception to the end of March, prime MMFs only suffered a $20 billion decline in AUM, more than half of which occurred over the first two days after the inception (before CDs and VRDNs became eligible collateral on March 25); on April 2, prime MMFs started to experience moderate inflows.

Similarly, outflows from muni MMFs stopped on March 25, when VRDNs (an important part of their portfolios) became eligible collateral; muni-MMF AUM have been increasing since and are now back at their level at the beginning of the year.



By helping prime and muni MMFs meet redemptions without having to sell in disorderly markets, the MMLF has also supported the net asset value (NAV) of prime and muni MMFs. As the chart below shows, in the second half of March, for the bottom 10th percentile of prime and muni MMFs, the NAV per share dropped below $1 by more than 10 basis points (a large drop for the MMF industry) only to recover after the facility was put in place. In addition, the NAV of the median fund also dropped below $1, went back to $1 by early April, and has been above that level since. Similarly, by converting less liquid collateral (such as CP and CDs) into cash, the facility has also allowed prime and muni MMFs to rebuild their buffers of liquid assets, which had been partly depleted over the high redemption period.


Finally, although the effect of the facility cannot be easily disentangled from other interventions of the Federal Reserve, conditions in money markets also improved shortly after the introduction of the MMLF. For instance, as the next chart shows, rates on 30‐day AA asset‐backed CP, which peaked at 2.37 percent on March 23, traded at 0.54 percent on April 17.


The Indirect Effects

Offshore USD MMFs are funds domiciled abroad that, similarly to domestic MMFs, invest in dollar-denominated money-market instruments with short maturity and high credit quality; also similarly to domestic funds, they can be broadly classified into government and prime funds, depending on whether they hold mainly public or private debt. They mainly cater to institutional investors.

As the charts below show, from March 4 to March 23, offshore USD prime MMFs lost $90 billion of their AUM (23 percent of the industry size), whereas offshore government MMFs witnessed inflows of about $54 billion, similar to their domestic counterparts. By easing broad money-market conditions, the MMLF also had a positive effect on offshore USD prime MMFs. After the MMLF came into place, outflows from offshore prime MMFs slowed significantly, and since April 1, their AUM have increased constantly throughout April 17.



Another indirect effect of the facility was to stem the inflows into government MMFs. As mentioned above, government funds received large inflows during the last two weeks of March. Such inflows led to increased usage of the overnight reverse repurchase agreement facility (ONRRP) as government MMFs sought investment opportunities for the large inflows they were receiving. Moreover, if they had continued, these inflows may have put pressure on funds’ NAV, especially in an environment with very low interest rates. As the charts below show, after the establishment of the MMLF, as investors became more confident about the outlook of the prime MMF sector, inflows into government funds receded.




The MMLF helped reduce outflows from prime and municipal MMFs. The facility not only helped avoid a broad run on the MMF industry but also eased the strains in money markets that had emerged since the second week of March. Because of its positive effect on secondary markets, the facility has also had a beneficial impact on offshore MMFs, which it does not directly target. By helping prime and muni MMFs meet demands for redemptions and by reducing outflows from the industry, the facility not only improves overall market functioning but also supports the provision of credit to the real economy.

Marco Cipriani is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.


Gabriele La Spada is a senior economist in the Bank’s Research and Statistics Group.


Reed Orchinik is a senior research analyst in the Bank’s Research and Statistics Group.

Aaron Plesset is a senior research analyst in the Bank’s Research and Statistics Group.

Also in the Liberty Street Economics Facilities Series

Helping State and Local Governments Stay Liquid, April 10

The Commercial Paper Funding Facility, May 15

The Primary Dealer Credit Facility, May 19

The Paycheck Protection Program Liquidity Facility (PPPLF), May 20

The Primary and Secondary Market Corporate Credit Facilities, May 26

How to cite this post:

Marco Cipriani, Gabriele La Spada, Reed Orchinik, and Aaron Plesset, “The Money Market Mutual Fund Liquidity Facility,” Federal Reserve Bank of New York Liberty Street Economics, May 8, 2020,


The views expressed in this post are those of the authors 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 authors.

The macroeconomics of Robert Solow: A partial view

Published by Anonymous (not verified) on Tue, 05/05/2020 - 10:09am in

During a hearing before a Congressional Committee on Science and Technology, Robert Solow (MIT) described himself as a "generally quite traditional, mainstream economist".

In my view, either Prof. Solow is unaware of who qualifies as a "traditional, mainstream economist" these days or the definitions of the words "traditional" and "mainstream" need to be completely changed!

Consider, for instance, his views on the notion of "expansionary fiscal consolidation":

[H]ow does a human race with limited with situations in which the short run need for policy are quite different from the long run need for policy? The feeble-minded, it seems to me, attempt to solve this problem [by asserting] that fiscal consolidation is really expansionary in the short run. I have never been able to understand the mental processes that underlie that statement. But I will take it seriously only -- only -- when its protagonists faced with a situation of clear excess demand propose fiscal expansion. Because if fiscal consolidation is expansionary then fiscal expansion must be contractionary. I don't believe that would happen. So I don't take that argument seriously at all. I think it's cooked up to make a real difficulty go away. (The Feasibility of European Monetary and Fiscal Policies: Rethinking Policy from a Transatlantic Perspective)

...on the supposed lack of microfoundations in Keynesian economics:

You know, there is something a little ludicrous in the belief that microfoundations for macroeconomics were invented some time in the 1970s. If you read Keynes's General Theory or Pigou's Employment and Equilibrium (or many lesser works) you will see that they are full of informal microfoundations. Every author tries to make his behavioral assumptions plausible by talking about the way that groups or ordinary economic agents might be expected to act...But you can recall Keynes's argument that the marginal propensity to consume should be between zero and one, or his discussion about whether the marginal efficiency of investment should be sensitive to current output or should depend primarily on "the state of long-term expectations". Those are microfoundations. (2004, p. 659)

...on the claim there is a connection between the money supply and price level:

[T]he financial press sometimes writes as though there is some special direct connection between the money supply and price level. So far as fundamentals are concerned, monetary policy works through its effects on aggregate nominal demand, just like fiscal policy, in the long run, too. The only direct connection I can think of is itself the creation of pop economics. If business people and others become convinced that there is some causal immaculate connection from the money supply to the price level, completely bypassing the real economy, then the news of a monetary-policy action will generate inflationary or disinflationary expectations and induce the sorts of actions that will tend to bring about the expected outcome and thus confirm the expectations and strengthen the underlying beliefs. (1998:4)

...on the problem with Milton Friedman's reliance on correlations between and M and other variables to infer policy conclusions and the assumption of an exogenous money supply (with John Kareken):

The unreliability of this line of argument is suggested by the following reducto ad absurdum. Imagine an economy buffeted by all kinds of cyclical forces, endogenous and exogenous. Suppose that by heroic, and perhaps even cyclical variation in the money stock and its rate of change, the Federal Reserve manages deftly to counter all disturbing impulses and to stabilize the level of economic activity absolutely. Then an observer following the Friedman method would see peaks and troughs in monetary changes accompanied by a steady level of economic activity. He would presumably conclude that monetary policy has no effects at all, which would be precisely the opposite of the truth. (Karaken and Solow, 1963, p. 16)

...on choosing the right model in macroeconomics:

[I] believe rather strongly that the "right" model for an occasion depends on the context --  the institutional context, of course -- but also on the current mix of beliefs, attitudes, norms, and "theories" that inhabits the minds of businessmen, bankers, consumers, and savers. (2004, p.xi)

...on the problems with the DSGE model:

I do not think that the currently popular DSGE models pass the smell test. They take it for granted that the whole economy can be thought about as if it were a single, consistent person or dynasty carrying out a rationally designed, long-term plan, occasionally disturbed by unexpected shocks, but adapting to them in a rational, consistent way. I do not think that this picture passes the smell test. The protagonists of this idea make a claim to respectability by asserting that it is founded on what we know about microeconomic behavior, but I think that this claim is generally phony. The advocates no doubt believe what they say, but they seem to have stopped sniffing or to have lost their sense of smell altogether. (For more, see here and here)

...on the difference between budgetary and real resources costs:

The trouble is that the great world -- including a large part of the intellectual world -- has lost sight of the fundamental difference between budgetary costs and real resource costs. An unemployed worker and an underutilized or idle plant is not something we're saving up for the future. Today's labor can't be used next year or the year after. And the machine time in a plant that's down can't be redone two years from now or three years from now. Three years from now we hope that the plant will be running for current uses. So there's that important sense in which idle resources are almost - and maybe literally - free to the economy. The problem is to get them used in a reasonable way. (see 22:00 here):

...on the importance of fiscal policy for stabilization purposes:

I start from the belief that non-trivial imbalances of aggregate supply and demand do occur in modern industrial capitalist economies, and last long enough that public policy should not ignore them...When such imbalances occur, fiscal policy is a useful tool. The single instrument of monetary policy can not do justice to the multiplicity of policy objectives; and the Ricardian equivalence claim is in practice not nearly enough to convince a realist of the ineffectiveness of fiscal policy. The real obstacles to the rational conduct of fiscal policy are the uncertainties about the proper target for real output and employment, and the tendency for stabilization goals to become inextricably tangled in and distracted by distributional and allocational controversy. (Is fiscal policy possible? Is it desirable?, p. 23)

...on the long run potency of deficit spending financed by bonds vs. deficits financed by money creation, and on the contractionary nature of open market purchases of government bonds (with Alan Blinder):

[N]ot only is deficit spending financed by bonds expansionary in the long run, it is even more expansionary than the same spending financed by the creation of money. [Foonote: An interesting corollary of this is that an open-market purchase, i.e. a swap of B for M by the government with G unchanged, will be contractionary!] (Blinder and Solow: Does Fiscal Policy Matter? 1973)

...on how statements by a central bank can influence how the public translates relative price changes into expectations about the consumer price index:

There are various interest groups in the economy: bankers, investors, savers, lenders, borrowers, buyers and sellers and what not. There is no reason for them to react in the same way. How does one aggregate expectations?

...on the use of "expectations" to explain macro policy outcomes:

[T]o rest the whole argument on expectations -- that all-purpose unobservable -- just stops rational discussion in its tracks. I agree that the expectations, beliefs, theories, and prejudices of market participants are all important determinants of what happens. The trouble is that there is no outcome or behavior pattern that cannot be explained by one or another drama starring expectations. Since none of us can measure expectations (whose?) we have a lot of freedom to write the scenario we happen to like today. Should I writing a different play, starring somewhat different expectations? No thanks, I'd rather look at data. (1998:93)

...on the claim of self-correcting markets and the role of aggregate demand in causing output fluctuations:

Capitalist economies do not behave like well-oiled equilibrium machines. For all sorts of reasons they can stray above or below potential output for meaningful periods of time, though apparently they are sightly more likely to stray below than above. Even apart from considerations of growth, macro policy should lean in the general direction that will nudge aggregate demand toward potential, whenever a noticeable gap occurs. The relevant point is that this strategy is also growth-promoting. Whatever the level of real interest rates, excessively weak aggregate demand -- and the prospect of weak and fluctuating aggregate demand -- works against investment. Few things are as bad for expected return on investment as weak and uncertain future sales...Successful stabilization contributes to growth too. (Role of macroeconomic policy, p. 301)

...on the need for public policy to address the unemployment of unskilled labor:

It needs to be insisted that the root of the problem lies in the enormous range of earning capacities generated by the interaction of modern technology (and other influences on the demand for unskilled labor) with the demographic and educational outcomes on the supply side of the labor market. There is no really good way for a market economy to deal humanely with that spread. (Too Optimistic)

...on the fallacy of self-correcting markets and the limits of monetary policy during deep recessions:

One important lesson that I hope we have learned from the crisis and the deep recession still going on is that economies like ours can experience uncomfortably long intervals of general excess supply or excess demand. Of course, we -- economists and interested civilians -- used to know that. But it was widely forgotten during the Great Moderation and the accompanying optimism among economists and civilians about smoothly self-correcting markets. The general belief than was that monetary policy was an adequate tool for taking care of any minor blip. During long and deep recessions, however, it has become evident that monetary policy may reach its limits without being able to generate enough aggregate demand to close the excess supply gap. (IMF Talk: Macro and Growth Policies)

...on the problems with Ricardian equivalence:

What might interfere with [the claim that it is optimal for households to save a tax reduction]? Any number of things: if households had been unable to consume as much as their optimal plan required because they lacked liquid assets and could not borrow freely, then the added liquidity provided by the tax reduction would enable them to consumer more now. If the Treasury were a more efficient, less risky, borrower than many households, then the appearance of some new public debt would also affect real behavior. And, of course, if consumers do not look ahead very far or very carefully, if they give little weight to the interests of descendants, or if they tend to ignore or underestimate the future implications of current budgetary actions, then Ricardian equivalence will fail, and tax reduction financed by borrowing will indeed be expansionary. All those "if" clauses strike me as very likely to be real and quantitatively important, and that suggests that Ricardian equivalence is not a practically significant limitation on fiscal policy. (Is fiscal policy possible? Is it desirable?, p. 12)

...on the problem with the natural rate of unemployment hypothesis:

Let me try to explain what nags at me in all this...We are left here with a theory whose two central concepts, the natural rate of unemployment or output and the expected rate of inflation have three suspicious characteristics in common. They are not directly observable. They are not very well defined. And, so far as we can tell, they move around too much for comfort -- they are not stable. I suspect this is an intrinsic difficulty. I have no wish to minimize the importance of, say, inflationary expectations. But we are faced with a real problem: here is a concept that seems in our minds to play an important role in macro behavior, and yet it's very difficult to deal with because it escapes observation and it even escapes clear definition. 

On the natural rate of unemployment, I think the behavior of the profession exhibits problems. In order to make sensible use of this kind of theory, you want the natural rate of unemployment to be a fairly stable quantity. It won't do its job if it jumps around violently from one year to the next. But that's what seems to happen. We, the profession, are driven to explaining events by inventing movements of the natural rate, which we have not observed and have not very well defined. The issue came up first in the passage of the big European economies from 2 percent unemployment, on average, to 8 or 9 percent unemployment, on average, within a few years. The only way to explain that within the standard model is to say that the natural rate of unemployment must have increased from something like 2 percent to something like 8 or 9 percent. The actual facts that could account for any such dynamics never seemed to me or to any critical person to be capable of explaining so big a change. So we are left with inventing changes in the natural rate of unemployment to explain the facts, and it is all done in our heads, not in any tested model. I regret to say that you often find this kind of reasoning: the inflation rate is increasing because the unemployment rate is below the natural rate. How do you know that the unemployment rate is below the natural rate? Because the inflation rate is increasing. I think we are all good enough logicians to realize that this is exactly equivalent to saying that the rate of inflation is increasing, and nothing more. 

It seems to me that we ought to be thinking much more about the determinants of whatever you choose to call it. I hate to use the phrase "natural rate" but of course I do. It was a masterpiece of persuasive definition by Milton. Who could ever want an unnatural rate of unemployment? (Fifty years of the Phillips Curve: A Dialogue on what we have learned, p.84)

...and more on the natural rate of unemployment:

There is nothing like an adjustable, unobservable parameter to keep a theory afloat in rough seas...I think the doctrine [of the natural rate of unemployment] to be theoretically and empirically as soft as a grape. To say that in the long run the unemployment rate tends to return to the natural rate of unemployment is to say almost nothing. In the long run the unemployment rate goes where it goes. You can call where it goes the natural rate; but unless you have a more convincing story than I have seen about the length of the long run and the location of the natural rate, you are only giving a tendentious name to a vague concept (1998, pp. 9, 91)

Monetization: Justification, Process and Outcomes

Published by Anonymous (not verified) on Fri, 01/05/2020 - 2:22am in

Rational Monetary Policy Returns

For decades neoliberal ideology
drove discussions and practice of monetary policy.  The essence of neoliberal monetary policy,
enthusiastically adopted by neoclassical economists, has a simple premise
leading to a simpler policy process. 

The neoliberal approach assumes
that market economies tend to automatically adjust to full utilization of
resources with a stable price level. 
Inflation causes instability and excessive public sector expenditure is
the cause of inflation.  Sound fiscal
policy requires balanced budgets, and monetary policy reinforces fiscal policy
by repressing inflation.  Central banks
repress inflation through the management of interest rates.  To achieve successful monetary management
central banks must be independent of political influence.

The neoclassicals criticized
Keynesians for allegedly unsuccessful attempts to use fiscal policy to manage
the economy — fiscal “fine tuning”.  However, neoliberal monetary dogma demanded faith
in the monetary equivalent.  If one
accepts the questionable claim that inflation causes systemic instability, the
neoliberal policy response requires acceptance of a more dubious hypothesis,
that small changes in interest rates would have a substantial impact on
inflation rates without a substantial impact on output.

So-called inflation targeting set
precise and low inflation goals, typically in the 2-3% range (2% or less for
the European Central Bank and within one percentage point of 2% for the Bank of
England).  The central bank rate served
as the instrument to achieve the target. 
One must marvel that this simplistic hypothesis reached a level of
acceptance to become policy in many countries — that in a complex economy open
to international trade and capital flows, small changes in domestic central
bank rates would quickly produce predictable changes in the rate of change of
the price level.

More importantly, in the
neoliberal era monetary and fiscal policy consciously contradicted rather than
complemented each other.  To the limited
extent that fiscal policy acted in an expansionary manner — before 2008 —
monetary policy sought to constrain demand and prices.  After 2010 obsession with balancing budgets
constrained recovery, while monetary policy sought ineffectively to stimulate
recovery (so-call Quantitative Easing).

Monetization and the Virus Crisis

In early April of this year as
the virus raged in Britain, the Chancellor announced further extraordinary budget
outlays.  This expansion in spending made FT headlines by the manner in which
it would be financed.  Rather than
financing through offering public debt in financial markets (“gilts”
as the bonds are called for historical reasons), the Treasury would sell the
bonds directly to the Bank of England.

This financing arrangement involves an exchange within the public sector.  In a rather strange comment, a former Bank of England official reassured the FT that the financing “was unlikely to turn Britain into Zimbabwe”.  The comment was strange to the point of economic illiteracy because bonds sales by governments to central banks have a long history among advanced market countries.

For example, this April the Federal
Reserve System held 15.8%
of  the US
public debt, while other
federal agencies owned an additional 10%
(the largest being the Social
Security Trust  Fund), for an
intra-government total of 26%.  In the
United Kingdom the intra-governmental ownership of public debt is higher.  Before the April policy announcement the Bank of England
held about 30%
of UK debt.

Why Use Monetization

Acceptance of the neoliberal
hypothesis and its implied framework of an otherwise stable economic system led
to the reduction,
trivialization, of monetary policy
to interest rate management.  The pre–neoliberal emphasis on central banks
buying and selling public bonds faded to obscurity.  This earlier approach derived from an
analysis that considered interest rates an ineffective tool for short term
economic management.  In place of
interest rate adjustment central bank bond transactions sought directly to
increase (bond purchases) and decrease (bonds sales) bank liquidity.

The bond transactions could be
used to reinforce the effects of fiscal policy, making macroeconomic policy
more effective.  As I explain in detail
in my new book Debt Delusion,
governments “live within their means” by use of taxation and
borrowing to fund expenditure.  In a
democratic society social necessity determines public expenditure.  Rational governments use taxation and
borrowing to fund those expenditures in a manner that maintains economic
stability and fullest possible utilization of resources.

In times of extreme economic and
social need such as wars, recessions and the current covid-19 crisis, public
borrowing serves as a major instrument to maintain stability and protect health
and livelihoods.  The role of borrowing
involves more than funding, though that is its immediate purpose.  The interaction of spending — fiscal policy
— and borrowing — allows monetary policy to play a central role in economic

This interaction becomes clear by
inspecting the two vehicles for managing public bond sales, financial markets
and the Bank of England.  Current
spending needs associated with the health crisis provide an instructive
concrete example.  At the end of February
2020 the central government annual budget involved borrowing of about £40
billion or 1.8% of GDP.   Almost all
revenue comes from general taxation; there are few taxes “earmarked”
for specific expenditures.  Thus, the £40
billion in borrowing and the £790 billion in annual revenue funded composite

Having identified (however
accurately) needed expenditure, the government has the choice of what vehicle
to use for the borrowing, bond sales to financial markets or to the Bank of
England.  At least three considerations
influence which vehicle to use.  First,
the desired rapidity of fiscal expansion plays a major part in deciding how to
finance expenditure.  Bond sales in  financial markets leave the monetary base
unchanged; the sale takes money out of circulation and the subsequence
expenditure returns it.  A government
might prefer this sequence if the economy is near full utilization.

Providing the private sector with
a safe asset is second reason for bond sates to financial markets.  Evidence suggests that the demand for bonds
by banks and other financial institutions is
frequently quite high
; indeed, that financial markets could
absorb a considerable amount of bonds
given the uncertainty caused by the
corona crisis.

If the economy is depressed, the
combination of a fiscal stimulus and a monetary boost is appropriate.  Selling bonds to the Bank of England combines
monetary expansion with a fiscal boost. 
The bond sale creates new credit which the government spends.

The regulation of interest rates
provides another motivation for monetization. 
In the early 2010s several EU governments suffered speculative attacks
on their bonds that drove interest rates to unsustainable levels.  This speculation severely undermined the
ability of governments to service their debts. 
Had EU rules not prohibited it, the governments could have prevented
that speculation by selling their bonds to their central banks or directly to
the European Central Bank.  The British
government faces no effective restriction on sales to the Bank of England.  This implies that monetization provides an
effective mechanism for regulating the interest rate on the debt.  If the government offers bonds for sale and
private buyers do not purchase them, the Bank of England serves as fault buyer
at the prevailing bond rate.

Preventing speculation and complementing fiscal policy provide strong motivations for monetization.  Possible inflationary effects provide the main argument against.  I address that possibility in a separate blog.

Image credit: Flickr/American Advisors Group

The post Monetization: Justification, Process and Outcomes appeared first on The Progressive Economy Forum.

Social Solidarity Requires a Universal Basic Income

Published by Anonymous (not verified) on Thu, 30/04/2020 - 12:30am in

By James Magnus-Johnston

Going forward in these uncertain times, a universal basic income could be the best way to maintain social solidarity—whether referring to health, wellbeing, or public order. “Solidarity,” writes Eric Klinenberg, “motivates us to promote public health, not just our own personal security. It keeps us from hoarding medicine” and prompts us “to knock on our older neighbor’s door.” It is a structure and a mindset that breaks down the barriers of inequality and improves trust, maintaining the cohesion and the stability of society.

Social solidarity

A basic income is an expression of care and solidarity among members of society across divides of age and opportunity. (Image: CC0, Credit: Matthias Zomer)

A universal basic income (UBI)—otherwise known as a guaranteed income, living wage, minimum income (or its cousin, the “reverse income tax”)—is an ongoing cash benefit for anyone that falls below a certain income threshold. Spain has already embraced a universal basic income, and others may soon follow if the length of the crisis becomes protracted.

Economic stability is essential for strengthening social solidarity as the coronavirus continues to spread. The COVID-19 pandemic drives home the fact that, if everyone’s basic needs are met, we can take care of ourselves (and shelter-in-place) with less fear and anxiety. A universal basic income could improve social and health outcomes, as well as avoid a protracted economic crisis for months and even years to come.

Reaching for Revenue Neutrality

By reducing the number of conditional cash transfers for employment and disability insurance (among other programs), a UBI may not be as expensive as commonly thought. In Canada, former conservative senator Hugh Segal has become a vocal proponent of a nationwide UBI program. The Basic Income Network estimates that a nationwide UBI program would cost $76 billion before savings. After factoring in a reduction in other federal programs, the cost comes to approximately $44 billion. Provinces, collectively, would save over $30 billion—some of that from net federal transfers.

In the context of an economic crisis, there are further savings still. Canada spent $362 billion on mortgages to keep banks solvent during the 2008 financial crisis. Supporting households and individuals is a far more affordable proposition.

Maintaining Social Order and Health

The COVID-caused recession struck at a time when inequality had already reached historic levels. Social solidarity was precarious when the crisis began. Poverty levels in OECD countries were unnecessarily high, at an average of 11.7 percent of the population; 18 percent in the USA.

Recovery from the recession provides an opportunity to correct rather than entrench economic inequality. While temporary cash benefits will keep people sheltered and fed in the short term, they will not prevent the economic contraction that will emerge along with a likely wave of private defaults (which will disproportionately affect those of lower income). A guaranteed income would create long-term security and diminish socioeconomic divides.

Furthermore, there would be huge savings within the public health sector. Those who live at the margins worrying how to feed or shelter themselves suffer from poorer health; the understandable worrying exacerbates stress-induced illness and addictions. If everyone received a living wage, individuals would have easier access to medicine and clinics. A “side” benefit—hardly a minor one—would be a reduction in the spread of viruses conducive to pandemics.

Life-Affirming Simple Living

Fishing with family

A basic income would help people replace a precarious and anxious work culture with life-affirming, creative, and healthier pursuits. (Image: CC0, Credit: Re-Essa Buckels)

From an ecological perspective, a basic income has made sense for many years because it enables a simpler, more frugal lifestyle than attempts at keeping up with higher-spending Smiths and Jones. Simple living allows individuals to dedicate more of their time to meaningful family activities rather than constantly struggling to stay afloat in an intense job market.

A UBI incentivizes folks to replace tedious jobs with life-affirming, creative pursuits. With an increase in automation over the last 30 years, job productivity is no longer coupled with the production of income, which has been stagnant over roughly the same time period. Contract, or “gig” work, and clerical jobs have also increasingly replaced labor-intensive ones. A basic income would allow folks to devote energy to passions and priorities outside of these redundant and monotonous careers. They could dedicate themselves to family, artistic, or artisanal projects. They might even have more energy to volunteer for causes they care about.

Solidarity and Hope for the Long Term

For now, a basic income will help secure basic needs and maintain public order as physical distancing will likely be advisable or even required (at least intermittently) for the next 12-18 months. As we look to the long term, we should also recognize the merits of a UBI in helping to balance social, ecological, and economic needs. A simpler, less energy-intensive lifestyle can foster a greater sense of overall wellbeing, improve health outcomes (for individuals, families, and the planet), and save people from anxiety-ridden jobs. While the pandemic may have revealed the weaknesses of an industrial society, it also revealed a world filled with hope and social solidarity. Now’s our chance to maintain that world.

James Magnus-Johnston headshotJames Magnus-Johnston is a PhD researcher at McGill University in the Leadership for the Ecozoic program.

The post Social Solidarity Requires a Universal Basic Income appeared first on Center for the Advancement of the Steady State Economy.

The COVID-19 Pandemic and the Fed’s Response

Published by Anonymous (not verified) on Thu, 16/04/2020 - 6:11am in

Michael Fleming, Asani Sarkar, and Peter Van Tassel

The COVID-19 Pandemic and the Fed’s Response

The Federal Reserve has taken unprecedented actions to mitigate the effects of the COVID-19 pandemic on U.S. households and businesses. These measures include cutting the Fed’s policy rate to the zero lower bound, purchasing Treasury and mortgage-backed securities (MBS) to promote market functioning, and establishing several liquidity and credit facilities. In this post, we briefly review the developments motivating these actions, summarize what the Fed has done and why, and compare the Fed’s response with its response to the 2007-09 financial crisis.

The Spread of COVID-19

On December 31, 2019, the World Health Organization (WHO) was informed of an outbreak of a pneumonia of unknown cause in Wuhan, China. The outbreak was later attributed to a novel coronavirus (COVID-19 is an acronym for the disease caused by this virus). Cases increased in China and then began to spread internationally in January and February. A sharp increase in global confirmed cases was noted in March, with the WHO declaring COVID-19 a global pandemic on March 11 (see the chart below which highlights the exponential growth in confirmed cases). In the United States, the first case was reported on January 21, with cases rising rapidly thereafter and tallying the highest confirmed case count of any country as of March 26.

The COVID-19 Pandemic and the Fed’s Response

Effects on the Economy and Markets

The coronavirus’s high transmissibility and rapid spread spurred public health experts to advocate for increasingly aggressive countermeasures, which governments then implemented. Social distancing rules imposed restrictions on work and movements deemed nonessential, and advisories and restrictions limited travel between countries and, sometimes, within countries.

Consequent to these actions, activities and services requiring face-to-face transactions and large congregations of people declined significantly. Firms in the transportation, retail, and services sectors were especially affected, but productivity suffered more generally as employees got sick and supply chains were disrupted. Many individuals lost their jobs, were forced to reduce spending, and faced financial hardship.

In the United States, in particular, initial claims, which reflect the number of workers filing for unemployment insurance for the first time, totaled an unprecedented 16.8 million during the three weeks ending on April 4. Alongside the loss of jobs, consumer confidence plunged and the Weekly Economic Index fell to a level not seen since the 2008 financial crisis. In the New York, New Jersey, and Connecticut area (an epicenter of the outbreak), about 40 percent of service firms and 30 percent of manufacturing firms reduced payroll staff.

As revenues plummeted and firms ran low on cash, their borrowing needs increased. Firms drew down their lines of credit from banks and attempted to borrow in short-term funding markets. Unusually high funding needs and pullbacks by key suppliers of short-term funds (such as prime money market funds) led to higher rates and stressed markets, prompting the Fed to step in, as described below. Costs for borrowing longer term in corporate bond markets also increased markedly, especially for lower-rated issuers and issuers directly affected by social distancing measures.

As coronavirus cases spread outside China, global asset prices dropped. The S&P 500 index declined steeply, triggering market-wide circuit-breakers that halted trading three times in March. By March 23, the stock market had fallen 34 percent from its February 2020 high (see chart below). Investors sought the safety of U.S. government bonds, pushing yields to record lows. Measures of implied volatility rose sharply, indicating high uncertainty about the future. Typical relationships in financial markets broke down, such as those between stock prices and Treasury yields, amid heightened illiquidity in the Treasury market and forced selling by leveraged hedge funds.

The COVID-19 Pandemic and the Fed’s Response

The Fed’s Response

The Fed employed both conventional and unconventional policy tools to address the economic and financial disruptions caused by the pandemic. The Federal Open Market Committee (FOMC) quickly cut the target range for the federal (fed) funds rate to the zero lower bound, citing risks to economic activity from the coronavirus (see chart below). The FOMC lowered the target range by 50 basis points on March 3 and an additional 100 basis points on March 15. Both changes occurred between scheduled meetings, with the latter being the first on a weekend since the policy of announcing rate changes started in 1994. Reductions in the Fed’s policy rate tend to lower interest rates more broadly (such as for mortgage rates), spurring borrowing and spending by both consumers and businesses.

The COVID-19 Pandemic and the Fed’s Response

Moreover, to address disruptions in funding markets, the Fed increased the sizes and terms of its repo operations, starting March 9. On March 15, the FOMC reaffirmed the role of its repos in supporting the smooth functioning of short-term U.S. dollar funding markets.

The FOMC also announced on March 15 that it would use its full range of tools to support the flow of credit to households and businesses. In particular, the FOMC said it would increase its holdings of Treasury securities and agency MBS by at least $500 billion and $200 billion respectively, to support the smooth functioning of financial markets. After buying $340 billion in securities in the week of March 15, the FOMC announced on March 23 that it would continue to purchase Treasury securities and agency MBS “in the amounts needed” to support market functioning and the effective transmission of monetary policy (see chart above for purchases in March) and that it would include purchases of agency commercial mortgage-backed securities in its agency MBS purchases.

The Fed announced related measures on March 15 to support the credit needs of households and businesses. The Fed encouraged depository institutions to borrow from the discount window by lowering the primary credit rate (the discount window borrowing rate for banks) by 150 basis points, including a 50 basis point narrowing relative to the fed funds rate. The Fed further supported lending by reducing reserve requirements to zero and by encouraging the use of intraday credit extended by Reserve Banks for facilitating payments.

The Fed also took several supervisory and regulatory actions in recent weeks to support financial institutions and the economy. It temporarily relaxed the leverage ratio that large and community banks have to maintain, it encouraged banks to use their capital and liquidity buffers to lend to households and businesses in a safe and sound manner, and it offered regulatory reporting relief to small financial institutions. The Fed also encouraged banks, savings associations, and credit unions to offer responsible small-dollar loans to consumers and small businesses and to work constructively with borrowers affected by COVID-19.

In addition, the Fed established a series of funding and liquidity facilities to promote the smooth functioning of financial markets and flow of credit in the economy (see table below). Two facilities are designed to support credit to large employers so they are able to maintain their business operations and capacity (PMCCF and SMCCF; see all acronyms defined in the table). Three additional facilities support credit to small- and medium-sized businesses through new and expanded loans, enabling employers to maintain payroll and employees (MSNLF, MSELF, and PPPLF). Three other facilities aim to mitigate disruptions in short- and medium-term markets that support credit provision to individuals and businesses (CPFF, MMLF, and TALF). The Municipal Liquidity Facility purchases loans from state and local governments to help them manage cash flow pressures and the Primary Dealer Credit Facility provides funding to primary dealers to support market liquidity and functioning. Most of these facilities are backed by equity investments or credit protection from the U.S. Department of the Treasury, using funds appropriated by Congress under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).

Given the global nature of the pandemic, the market for borrowing U.S. dollars (which are widely used in international transactions) was also disrupted. The Fed has standing dollar liquidity arrangements (swap lines) with five foreign central banks that allow the latter to lend U.S. dollars to banks and firms in their own countries. To further improve the functioning of U.S. dollar funding markets, the Fed announced on March 19 temporary swap lines with nine additional central banks. Moreover, the Fed announced on March 31 the launch of a new facility (the FIMA Repo Facility) to allow foreign central banks to raise U.S. dollars against their holdings of U.S. Treasury securities at the Fed. This arrangement reduces foreign central banks’ incentives to sell U.S. Treasuries in the open market.

The COVID-19 Pandemic and the Fed’s Response

Responding to the COVID-19 Pandemic versus

the Financial Crisis of 2007-09

The Fed’s response to the pandemic has elements that are similar to and different from its actions in 2007-09. One similarity is that a broad range of financial markets were stressed in both instances, motivating the Fed to assist these markets with conventional and unconventional tools. One difference with the pandemic is that the Fed introduced facilities to provide credit to large employers to maintain operations and capacity, and introduced the Main Street Lending Program to support small- and medium-sized businesses. These programs aimed at nonfinancial firms reflect the widespread and rapid impact of COVID-19 on the real economy. In contrast, the 2007-09 crisis started in the financial sector, explaining why policy efforts at the time targeted that sector.

Another difference is the speed and scale with which the Fed responded. During the financial crisis, the fed funds rate stood at 5.25 percent in the summer of 2007. It was not until December 2008 that the target rate was first brought to the zero lower bound. Moreover, unconventional policy tools, including liquidity facilities and LSAPs, were introduced progressively and with gradually expanding size through the crisis in response to the turmoil in financial markets, including the bankruptcies and government-led recapitalizations of several large and systematically important financial institutions.

In contrast, the response to COVID-19 has featured fed funds rate cuts, Treasury and MBS purchases, liquidity facilities, and credit programs, announced in rapid succession over the course of just a few weeks. This reflects the alarming speed with which the pandemic and its impact spread, affecting economic activity and financial-market functioning. The actions likely also reflect lessons learned and experience gained from the financial crisis, including the use of unconventional policy tools that are now more familiar and quicker for the Fed to put into effect.

Summing Up

The economic and financial disruptions precipitated by the COVID-19 pandemic triggered an unprecedented response by the Fed. The Fed applied its usual tools to mitigate the effects, cutting its policy rates and providing liquidity to the banking system, as well as tools rarely used or newly created, including several liquidity and credit facilities. But because the COVID-19 pandemic is fundamentally a health crisis, it ultimately requires a medical resolution. Nonetheless, the Fed’s policy actions are important for alleviating the economic fallout until such a resolution is found and for facilitating the restart of the economy thereafter.

Michael Fleming

Michael Fleming is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Asani Sarkar

Asani Sarkar
is an assistant vice president in the Bank’s Research and Statistics Group.

Peter Van Tassel

Peter Van Tassel is an economist in the Bank’s Research and Statistics Group.

How to cite this post:

Michael Fleming, Asani Sarkar, and Peter Van Tassel, “The COVID-19 Pandemic and the Fed’s Response,” Federal Reserve Bank of New York Liberty Street Economics , April 15, 2020,


The views expressed in this post are those of the authors 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 authors.