Finance Basic To Advance Level Knowledge

Now that the shrinking of the Fed's balance sheet has been announced, I thought it worth nothing what it means for the future path of the monetary base. Drawing upon the Fed's median forecast of its assets through 2025 that comes from the 2016 SOMA Annual Report , I was able to create the figures below.  The figures show the trend growth path of currency and a series I call the 'permanent monetary base' extrapolated to 2025. The latter series is the monetary base minus excess reserves. This measure has been used by Tatom ( 2014 ) and Belongia and Ireland ( 2017 ) as a more reliable indicator of the monetary base that actually matters for monetary conditions. These two measures, which reflect the liability side of the Fed's balance sheet, are plotted along side the projected path of the asset side of the Fed's balance sheet. The first figure below shows this exercise in terms of dollars and the latter one is in log-levels. What is interesting is that the...

Most folks know the arguments for and against shrinking the Fed's balance sheet on purely economic terms. For a good recap of these arguments see Cardiff Garcia , Henry Curr , and Nick Timiraos . There are however, other political economy forces at work that potentially play into the Fed's decision to shrink its balance sheet. Most folks do not go there because it is a controversial approach. For it takes a more cynical view of government officials. It goes beyond the view of the Fed as a technocratic institution filled with saintly people doing their best to stabilize the business cycles. It recognizes that people are people no matter where they work and are responsive to political incentives. Now to be clear, many good people work at the Fed because they believe in the mission. But to say the mission is the only thing they consider would be naive. Fed officials, like most people, also care about their own well-being. On the margin, this influences their decision making a...

You are going to have listen to my podcast with him to find out the answer. Here is a hint: we spent a portion of the show talking about NGDP level targeting (NGDPLT) and what it would take to actually get it implemented it at the Federal Reserve. So listen to the show to find out Larry's thoughts on NGDPLT as well as his views on secular stagnation, Fed policy since the crisis, and macroeconomic policymaking in real time. It was a fun interview.  P.S. You can also read the transcript of our interview. P.P.S. For those interested in NGDPLT here is my latest policy brief on it and here is a longer research paper on it.

This week the Fed is expected to announce it will begin shrinking its balance sheet. Will it matter?  To answer that question it is useful to first recall how and why the Fed's balance sheet was expanded. Between December 2008 and October 2014 the Fed conducted a series of large scale asset purchases (LSAPs) that expanded its balance sheet from about $900 billion to $4.5 trillion. That is an expansion of about 500 percent.  The Fed turned to LSAPs for additional stimulus when its target for the federal funds rate—the traditional tool of U.S. monetary policy—hit the zero lower bound in late 2008. The main theory the Fed used to justify the LSAPs was the portfolio balance channel. It says that because of market segmentation the Fed's purchase of safe assets would force investors to rebalance their portfolios toward riskier assets. This rebalancing, in turn, would reduce risk premiums, lower long-term interest rates, and push up asset prices. This would help the recovery...

Christina Romer, former CEA chair, called for a monetary regime change several times between 2011 and 2013. It is now several years later and it appears we did finally get a monetary regime change. Unfortunately, it is not the kind of regime change Christina advocated and actually goes in the opposite direction.  Christina called for the Fed to adopt a nominal GDP level target that would restore aggregate demand to its pre-crisis growth path. Instead, we got a regime change that has effectively lowered the growth rate and the growth path of aggregate demand. This regime change, in my view, is behind the apparent drop in trend inflation that Greg Ip recently reported on in the Wall Street Journal.  It is not easy to change trend inflation--just ask Paul Volker--but the Fed and other forces seemingly accomplished just that over the past decade. Since the end of the crisis, the average inflation rate on the Fed's preferred measure of inflation, the core PCE deflator,...