Monetary Policy:
Contemporary Issues
ECO 473 - Dr. Dennis FosterW.A. Franke College of Business
Monetary Policy: Contemporary Issues
I Heading into crisisII The failuresIII Fed inaction & actionIV What has the Fed
accomplished?V The problem with policyVI The Austrians & rethinking
policyVII Outlook for the economy
What does the Fed Want?
• Policy? Stimulate spending by reducing interest rates.
• Why? They are Keynesians.
• Effect? Creates housing boom.
• A healthy & strong economy with low unemployment and low inflation.
I.
Head
ing
in
to c
risi
s
Federal Funds rate of interest, 1995 to 2004
30 year mortgage rate, 1995 to 2004
Median home prices, 1999 to 2006
Home sales, 1999 to 2006
Sept.
2005
The Bear Stearns Story• $133.20 - 52 week high prior to
collapse.• 2007 - Lost billions in collapsing
subprime market; slowly recovering.• March 2008 - Assets/equity = 35
Lots of assets in MBS.
• Spring 2008 - Clients pulling out funds.• 3/10/08 - Turned down for $2 b. loan
Continued loss of confidence in Bear all week.
• 3/13/08 – Cash from $10 b. to $2 b.
$400 b.
Assets
II.
Th
e f
ailu
res
• Tried to get LOC w/JPM for $25 b.• 3/14/08 – Fed lends $13 b. for 3 days.• JP Morgan deal - $2 per share!• Fed creates Maiden Lane LLC
– Fed loans ML $30 b.– JPM “sells” bad assets to ML.
• 3/24/08 - New stock deal - $10/share.• Cost to the Fed?• Was Bear TBTF? Yes!
– What about Lehman?
The Bear Stearns Story
The Three Failures:IndyMac WaMu Lehman
• IndyMac– Spun off from Countrywide.– Not a “mac”– Overleveraged on “Alt A” loans.
• WaMu– Shut down 100’s of offices 2007-08.– Sub-prime victim.– Final 10 days lost $17 b. in cash w/d
• Lehman Brothers– Losses = $7 b. in Q2 & Q3– Final day: $1 b. in cash
$32 b.Assets
$300 b.
Assets
$640 b.
Assets
Did the Fed see this coming?
III. F
ed
inact
ion &
act
ion
Did the Fed see this coming?
• Cut interest rates.• Lend to everyone.• Quantitative Easing.
What did the Fed do?II
I. F
ed
inact
ion &
act
ion
Federal Funds rate of interest, 2004 to 2015
IV.
What
has
the F
ed
acc
om
plis
hed
?
Fed Lending Programs: 2008-2010
See Appendix B for details
30 year mortgage rate, 2004 to 2015
Housing Revisited
Median home prices, 1999 to 2015
Housing Revisited
190,000
Home sales, 1999 to 2015
Housing Revisited
The Fed charts new territory.
MonetaryBase
$4 tr.
$2.6 tr.
ExcessReserves
$2.5 tr.
Fed-held USTreasuries
$1.7 tr.Fed-held
MBS
V.
Th
e p
roble
m w
ith
polic
y
+649%
+178%
+44%
The Quantitative Easing Programs
A Tale of Four Recoveries +25 Q
+33%
+24%
+18%
+14%
What is the exit strategy?
• The FED will have two choices:• Continue policy hyperinflation• Halt policy recession
• Or . . . Wage/Price controls?
What has the Fed done?
• Has it maintained the value of the dollar?
• Has it stabilized the economy?• Has it reduced moral hazard?• Has it lessened distributional
problems?• Is the risk of inflation gone?
Rethinking Policy:The Austrian School of Thought
• Recessions are the solution,not the problem!
• Keynesian policy - interest to spending.• Leads to misallocation of resources.• Leads to an unsustainable boom.• Leads to eventual conflict (C vs. I).
• What should we do? Wait!!VI.
Th
e A
ust
rian
s &
reth
inki
ng
polic
y
2008 1981
1920
2015 Nov. 5%
Rothbard - A Return to Sound Money
Get back on the gold standard.Define $ in terms of gold.No more suspensions of payment in gold.
Abolish the Federal Reserve.Redeem every $ of M1 in gold…
Get government out of money.Bank notes will replace FRN.
100% reserve ratioOr, let banks fail.Abolish FDIC, US Mint.
The Results of Sound Money
1. No bank panics.2. No convoluted regulation.3. No inflation.4. No discretionary monetary policy.5. No monetizing of federal gov’t.
debt.
6. An end to the business cycle!!
GDP (2015) = $23.5 tr. vs. $16.4 tr.
1990 - 2015 net gain = $59 tr.
3.8%
What if … ?
• Let bad firms/banks go bankrupt.– We don’t lose real resources!!!!!
• Abolish Fannie & Freddie.
• End the Fed.
• End the government monopoly on money.
What is the Outlook?• Interest rates will stay low.
Yellen hints at increases.Banks awash in cashEconomic performance is weak.
• Inflation is still a looming danger.Where will all the money go?Can the Fed stop rising inflationary expectations?
• Worst case scenario?Economy surges, banks lending, and dramatic inflation.Recession within 3 years???
• Best case scenario?Economy is sluggish, Ur stagnant, and and banks hold massive XS reserves.Another year (or 2?) on the knife edge.
VII.
Ou
tlook
for
the e
con
om
y
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ECO 481:Public Choice Theory
Dr. Dennis FosterFCB #208
The W.A. Franke College of BusinessNorthern Arizona University
Spring 2016
W h y G o v e r n m e n t F a i l s
Monetary Policy:
Contemporary Issues
ECO 473 - Dr. Dennis FosterW.A. Franke College of Business
Appendix A: Stock prices collapse ofIndyMac, WaMu, Lehman Bros.
Term Auction Credit
Appendix B: Fed Lending Programs
Primary Dealer Credit
Appendix B: Fed Lending Programs
Commercial Paper MMMF
Appendix B: Fed Lending Programs
Asset-backed Securities
Appendix B: Fed Lending Programs
Monetary Policy:
Contemporary Issues
ECO 473 - Dr. Dennis FosterW.A. Franke College of Business
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