Friday, November 12, 2010

The Men of Good Will


The balance sheet of the Federal Reserve greatly expanded as a result of its response to the recent financial crisis. I don't know why anyone would care either way about it, but some people have expressed concern about that balance sheet being reduced back to something close to what it was, at some point.

Maybe it can be done this way:

1. The Fed sells assets to the public.

For the public, this means that people with money to invest -- people with savings -- exchange some of that savings for assets the Fed is selling. This reduces "money in savings" in our economy, which is something we need to do.

For the Fed it means that the makeup of the balance sheet shifts to fewer non-money assets, and more money. Bringing money into the Fed's coffer reduces the risk and potential severity of inflation.

2. The Fed uses this influx of cash to make payments against private-sector debt: mortgages, and credit-card bills, and car payments, any sort of private-sector debt. But since mortgages are the problem, perhaps we should focus there.

For the Federal Reserve, the size of the balance sheet is reduced, because money is destroyed when debt is repaid. The money the Fed uses to pay down private-sector debt is money that ceases to exist. On the balance sheet maybe they can write it off as "goodwill."

For the lender, it completes the transaction, repaying loans and restoring the creditor's savings. It reduces risk by reducing debt.

For the debtor, it is direct help with the bills. It frees up regular income for other things. It serves the purpose of a debt jubilee.

For the economy as a whole, the accumulation of debt is reduced, which is the essential precondition to renewed growth.

Maybe it can be done this way.


Addendum


In a recent post, Bilbo provides this graph:


That dark blue cloud there, beyond the purple mountain and above Red Beach -- that dark blue cloud is "Fed Agency Debt Mortgage-Backed Securities Purch." Assuming I understand the hobbit-speak, that's the bad mortgages the Fed bought up. Eliminate that dark blue cloud, and the Fed's balance sheet returns very nearly to the size it was before this whole mess started.

Those are the mortgages I want the Fed to pay off.

Who would receive payment? The Fed.

Forgive us our debts.

5 comments:

Tschäff said...

I'm enjoying your fascinating journeys into the way our currency system works. Lets take apart your last entry:

The Fed sells assets to the public.
For the public, this means that people with money to invest -- people with savings -- exchange some of that savings for assets the Fed is selling. This reduces "money in savings" in our economy, which is something we need to do.


Why is less savings a good thing for the non-government sector? I don't know about you, but I could use more, and will reduce my spending to have it (which of course is not good for businesses and employees of that businesses income). Another point is that it sells an asset, usually a tsy sec and buys reserves. If a bank is selling the treasury, deposits don't change as a result, but the bank's reserve balance contracts. If I don't plan on spending that deposit any time soon, I might wish to purchase a treasury for a riskless better return. If I hold a deposit or a treasury, net financial assets haven't changed, just the term structure.

Always when the fed or tsy sells a tsy sec reserves are drained from the seller's bank. This would put upward pressure on the fed funds rate. In the new era of excess reserves, a whole lot of treasuries have to be sold before that starts to happen.

The Arthurian said...

Maynard said, "It is astonishing what foolish things one can temporarily believe if one thinks too long alone." Thanks for keeping an eye on me. You are so comfortable with technical terms and details! Oh, and you can see I have copied your style, bolding the text that I quote:

Why is less savings a good thing for the non-government sector?

This is why. (The graph must be viewed in the context of economic performance: Depression... Correction... Golden Age.)

And this is why. Things are out of balance.

Art

Tschäff said...

I haven't yet wrapped my mind around what the ratio of M2 to M1 will tell you, but just from what I know of history, I think it may tell you something about how much bank credit was being generated. M3 to M1 would be even better.

Here is one that you'll really like though from a fellow student of the monetary system:

‎1817-1821:
U. S. Federal Debt reduced 29%. Depression began 1819.

1823-1836:
U. S. Federal Debt reduced 99%. Depression began 1837.

1852-1857:
U. S. Federal Debt reduced 59%. Depression began 1857.

1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.

1880-1893:
U. S. Federal Debt reduced 57%. Depression began 1893.

1920-1930:
U. S. Federal Debt reduced 36%. Depression began 1929.

1998-2001: U. S. Federal Debt reduced 9%. Recession began 2001

source: http://rodgermitchell.com/US-National-Debt-Clock.htm

The Arthurian said...

Oh I absolutely do like that list!
Vincent Cate has a vaguely similar list... Now all I need is the time and ambition to compare them!

I haven't yet wrapped my mind around what the ratio of M2 to M1 will tell you...

Just using the simple definitions:

M1 = Money-in-circulation; and
M2 = M1 + Money-in-savings

I use (M2-M1)/M1 to compare the level of savings to the level of money in circulation.

Perhaps for MMT it does not hold; but I always figured the money in savings was the source of lending and the source of credit-use; so that a high level of savings-relative-to-M1 will be associated with a large accumulation of debt. But regardless of the direction of causality, I can show it to you.

The Arthurian said...

Or, try this:

The M2/M1 ratio is abnormally high... meaning that most of our money has settled out of circulation and into savings. But this is a condition associated with periods of economic depression. Therefore, I say we must reduce the level of savings.