Fed needs to stop asset acquisitions for a generation or so

by Walker Todd October 29th, 2014 8:10 pm

The Federal Open Market Committee (FOMC) meeting that ended today (Oct. 29) marked the first chance for the FOMC finally to do the right thing since the onset of the great financial crisis in the late summer of 2008. That right thing consists of resolving not to add even another dollar to the Federal Reserve System's balance sheet for at least the next ten years (and perhaps as long as 30 years) in the absence of officially declared war or national emergency. Thankfully, on an 11-1 vote, the FOMC finally adopted the initial step in that policy direction, agreeing not to make significant additions to the System's securities portfolio, for the time being.

The great financial historian Charles P. Kindleberger (1910-2003), who taught at Massachusetts Institute of Technology throughout the postwar years, was struck by what he perceived as the tension between generally Keynesian monetary policy (ignoring quantities of money and focusing instead on interest rates and unemployment rates) and generally monetarist monetary policy (giving great importance to measurement of quantities of money, tax policy, and sustainable economic growth, with the market sorting out interest rates and unemployment rates). In his Keynesianism vs. Monetarism and Other Essays in Financial History (1985), Kindleberger wrote, essentially, that long periods can pass when Keynesian policies may be pursued with benefit or at least without noticeable harm but that, when the cycles turn and the monetarist policy becomes appropriate, the monetarist approach is "so very timely." Here, reference to monetarist approaches should be understood to be attention to the quantity theory of money: Many Austrian-school economists and even some traditional Keynesians care about and pay attention to the quantity of money.

Thus, the FOMC majority could have concluded today that a Keynesian approach to the financial crisis had a nice, nearly seven-year run but that, with clear statistical evidence of diminishing benefit from the Fed's experiment in expanding reserves to levels well in excess of anything that Kindleberger would have considered wise, it is time to stop. From here on out, probably for ten years or longer (perhaps up to 30 years), the FOMC should pursue monetarist approaches to policy in which, for every dollar of assets added to the System's portfolio, another dollar is sold from that portfolio, even during emergency periods, and in which maturing assets are not replaced, with net shrinkage of the portfolio over time. The FOMC did not adopt this last policy step today, voting essentially to hold the size of the portfolio constant until further notice.

One cannot argue plausibly that necessary market liquidity would be reduced below sustainable levels by attention to the quantity of monetary base that the Fed creates. (Domestic monetary base = currency in circulation plus reserve balances held at the Fed; foreign exchange swap drawings in dollars, currently zero or near-zero, should be added to this amount to find total probable domestic claims against the Fed.) Currently, there are about $1.25 trillion of currency outstanding (with probably about 70 percent held outside our borders), plus about $2.7 trillion of reserve balances held at Reserve Banks. That is nearly $4 trillion of monetary base.

In 2007, the year before the crisis, a Fed balance sheet of "only" $929 billion sufficed to promote strong growth in a $14.5 trillion economy (nominal GDP). The Fed's balance sheet was only 6.3 percent of the entire economy. After countless interventions in the economy and a never-ending series of Quantitative Easings (econospeak for money-printing) since then, the Fed's balance sheet is nearly five times larger, but the economy is only 19.3 percent larger. The Fed's balance sheet is now 25.5 percent of GDP.

One supposes that it takes a lot more money to make the world go around these days, but the economic outcome is far smaller than one would have expected given the amount of monetary input. If the Fed has an econometric model showing how much GDP growth it expects from each new dollar of monetary input, it should disclose that model to Congress now, and if the outcomes are suboptimal or as demonstratively inefficient as I think they are, then Congress should make the Fed stop using that model to drive FOMC policy choices, if the Fed refuses to do so voluntarily.

The Fed courts a real danger of becoming, if it has not already become, the motor of a thoroughly corporatist political economy model for the United States, if not for the entire world. A central bank balance sheet equal to 25 to 50 percent of GDP was considered a hallmark of corporatism in developing economies that the World Bank was trying to reform in the post-1980 years. The Fed should be asked to tell Congress now, before the election next week, how great a percentage of GDP it wishes to hold on its balance sheet without seeking the approval of Congress.

Back to Kindleberger's point: When the time comes around for the monetarist message, it is important for central bankers to heed that message. It is, indeed, time to stop printing money (technically, this is a collaborative exercise involving both the Treasury and the Fed and, behind the scenes, both the White House and Congress).

The following facts are clear: As of mid-2014, the Fed had expanded its balance sheet by $3.483 trillion since August 2007 (375 percent), with nearly all of the increase occurring since the onset of the crisis in September 2008. However, nominal GDP expanded by only $2.850 trillion over the same period (19.3 percent). In other words, only 81.8 cents of new GDP were created for every dollar of Fed-Treasury money printing, an exercise of remarkable inefficiency considering that, for the eleven years before the crisis, 1997-2007, about $13.88 of new GDP were created for every new dollar of money printing. Money printing is an inefficient way of creating GDP, after the crisis, but it has proved to be an efficient way of creating asset price bubbles.

Finally, if one wished to reduce the Fed's role in the economy to the level that prevailed before the crisis, about 6.5 percent of GDP (the range was 5.9 to 6.9 percent over the preceding eleven years), the current size of the Fed's balance sheet would support economic expansion to nominal GDP of $67.9 trillion, about four times the current size of GDP. Historically, it took 15 years for GDP to quadruple, 1969-1984, and that period included the high-inflation 1970s. In a period of lower inflation, after 1984, it took 28 years for GDP to quadruple again in 2012. That is why I proposed, at the beginning of this note, that we simply suspend the monetary policy operations of the Fed for a generation or so until the rest of the economy catches up to all the monetary base that recent Fed operations have created.

We still need banking supervision for as long as we have non-gold fractional reserves, we need the payments mechanisms operated by the Fed, and someone has to buy all that debt that the Treasury has for sale. But it is not clear that the Fed is the entity that should do any or all of these things. On the other hand, we have a large infrastructure investment in the Fed, and we might choose to keep it operating to perform these other functions. Just not monetary policy, not for a good long while, anyway.


Creativity and crackpots

by Kurt Schuler October 26th, 2014 11:18 pm

Isaac Asimov wrote an essay on creativity in 1959 that was only published recently.  His view is that “the person who is most likely to get new ideas is a person of good background in the field of interest and one who is unconventional in his habits. (To be a crackpot is not, however, enough in itself.)”

Monetary theory and policy have been fertile ground for crackpots (more commonly referred to as “monetary cranks”) from the beginning. Part of the attraction is that the field has some abstruse aspects. Another is that there is the appeal of seemingly getting something for nothing with the right policy, or, contrarily, the suspicion of being swindled by the powers that be.

Far be it from me to issue a blanket condemnation of monetary cranks, though. Some deserve the appellation “interesting fringe thinkers.” Though almost always wrong on the theory, sometimes they have been right on the policy when conventional opinion has been dead wrong! During deflations, schemes such as Silvio Gesell’s proposal for a currency that depreciates if not spent (which interested Keynes and Irving Fisher) offer workarounds for overly tight monetary policy and the consequent fall in velocity. During high inflations, pure gold or barter schemes offer workarounds for overly loose monetary policy.

(Scott Sumner has a recent post somewhat related to these ideas. On a point of personal privilege, though, he should know enough not to refer to Argentina’s monetary system of the 1990s as a currency board. Argentines called it the “convertibility” system. It was a quasi-currency board, with some but not all features of an orthodox currency board, and the distinction is important both in theory and in practice. Few people have looked at the evidence, but Scott should be one of them.)


Barron's on Tirole and Selgin

by Kurt Schuler October 18th, 2014 10:49 pm

Gene Epstein of Barron's is critical of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel awarded to Jean Tirole. His article "This Nobel is No Prize" quotes George Selgin. Here are a couple of paragraphs summarizing Epstein's view:

Say Adam Smith and others had never shed light on the gains that result when one nation freely exchanges goods and services with another. Without a compelling theory of the benefits of free trade, we would no doubt assume that tariffs, duties, and subsidies to domestic exporters were just a case of government doing its job. [...]

Happily, we do have a theory of free trade that mainstream economists honor, even if the theory is often honored in the breach. Unhappily, since the mainstream lacks a theory of free banking, Jean Tirole can be given a Nobel for useful formulations that include the optimal regulation of finance.


Leonard Liggio, R.I.P.

by Kurt Schuler October 14th, 2014 9:46 pm

Leonard Liggio died earlier today in Washington, D.C. He was 81 years old. His kidneys had failed recently, which I infer put a strain on his body more generally.

I wrote a short appreciation of Leonard just after his 80th birthday. For an obituary from the Atlas Economic Research Foundation, where he worked for many years, see this.

When Leonard became interested in classical liberalism, there were so few other people interested in it in that he got to know them all. His far-flung web of friendships, boundless memory, and wide reading, especially in history and political philosophy, made him a key figure in establishing a community of like-minded thinkers that is now many thousands strong and spans the world. It has today no Mises, Hayek, Friedman, Rothbard, Rand, or Nozick. To some it will seem as though we have passed from an age of giants to an age of pygmies. My view is different. As a current of thought become broader, it is harder for any single thinker to have the influence that was possible when it was smaller. The work becomes more specialized. (This blog is an example.) For the current to remain a unified current, though, it needs people who can make connections from one part to another, and Leonard was supremely talented at doing so.




Other appreciations of Leland Yeager

by Kurt Schuler October 4th, 2014 2:05 pm

Bill Woolsey

Lars Christensen

David Henderson (and see Don Boudreaux's remark in the comments)

Adrian Ravier (in Spanish)


Leland Yeager turns 90

by Kurt Schuler October 4th, 2014 8:28 am

Leland Yeager (courtesy of the Cato Instiitute)

Leland Yeager (courtesy of the Cato Instiitute)

Leland B. Yeager turns 90 years old today. He has done notable work in monetary theory—most important for this blog, laissez faire monetary systems—international monetary economics, trade, ethics, and languages.

After high school he served in the U.S. Army during World War II, translating Japanese coded messages. He earned his A.B. from Oberlin College and his M.A. and Ph.D. in economics from Columbia University. Following a brief stint at the University of Maryland, he taught for nearly three decades at the University of Virginia, where he was part of the economics dream team that included James Buchanan, Ronald Coase, Gordon Tullock, and G. Warren Nutter. Yeager finished his career at Auburn University, where he was Ludwig von Mises Distinguished Professor of Economics. He is now an emeritus professor of that institution.

Prof. Yeager has many talents. One is for languages. He knows languages as diverse as Japanese, Norwegian, Russian, and Sanskrit, as well as the usual major Western European languages that American economists sometimes knew before academic economics became largely monolingual. Another of his talents is for writing. Deidre McCloskey has cited Yeager as one of the best living stylists of economics—a low bar, but one that Yeager clears with plenty of room. Still another, as will be evident from some of the testimonials below, is for teaching. As one who saw him in action wrote, “This stuff was dynamite. Students quickly realized that Yeager had it all and anyone with half a brain knew that they had a once in a lifetime chance to wrap up the whole damn subject—if they could just get every word he uttered written down.” (Remember, it was decades before the iPad and other digital recording devices.)

Prof. Yeager’s magnum opus is his book International Monetary Relations: Theory, History and Policy. It looks like a textbook, but is actually an exceptionally lucid treatise that wrapped up the whole damn subject for its time (1969, second edition in 1976). Although nearly 40 years old, the book remains unequaled for the skill with which it weaves together the strands of theory, history and policy. I am pleased to announce that the Center for Financial Stability is working to make it available electronically later in Prof. Yeager’s 90th year.

George Selgin collected the essays by Prof. Yeager likely to be of most interest to readers of this blog in The Fluttering Veil: Essays on Monetary Disequilibrium. Roger Koppl edited a festschrift called Money and Markets: Essays in Honor of Leland B. Yeager. It reprints the most delightful portrait I know of any economist, “The Yeager Mystique,” by his former students William Breit, Kenneth Elzinga, and Thomas D. Willett. For those who want to dig deeper, there is plenty more.

Appreciations of Prof. Yeager written especially for this blog follow below. Later I will post links above to appreciations elsewhere.


Leland Yeager, by Robert Greenfield

by Kurt Schuler October 4th, 2014 8:24 am

“I like to think,” Mark Blaug’s Who’s Who in Economics (1986) quotes Yeager as saying, almost reticently it seems, “that I have made contributions toward identifying money’s role in balance-of-payments disequilibrium and  adjustment and reconciling the elasticities, absorption, and monetary approaches to the topic; grasping the implications of the fact that money serves as routine medium of exchange and lacks a market and a price of its own; more fully understanding our existing monetary system by contrasting it with a radically deregulated system [whose unit of account were defined physically but without a link to anything that could come into use as a medium of exchange and] in which media of exchange and payments services were provided by private enterprise; grasping the implications of the fact that money serves as routine medium of exchange and lacks a market and a price of its own and clarifying the nature of capital and interest  and  showing how their proper conceptualization dissolves the ‘Cambridge capital paradoxes’. ”

“I like to think….”?  Would that we all had Yeager’s modesty.  Just for the record, consider….

Apropos “identifying the role of money in balance-of-payments disequilibrium and adjustment and reconciling the elasticities, absorption, and monetary approaches to balance of payments adjustment”:

Paul Einzig, author of more than 50 books on foreign exchange, called Yeager’s International Monetary Relations: History and Theory “a book of outstanding importance…. [T]he best book on foreign exchange that has appeared since the war.”

Apropos “grasping the implications of the fact that money serves as routine medium of exchange and lacks a market and a price of its own”:

Richard Timberlake, eminent historian of U.S. monetary policy, called Yeager’s “Essential Properties of the Medium of Exchange” (Kyklos, February 1968) “one of the twentieth century’s ten most important articles on monetary theory.”

Apropos “contrasting our existing monetary system with a radically deregulated system [whose unit of account were defined physically but without a link to anything that could come into use as a medium of exchange and] in which media of exchange and payments services were provided by private enterprise”:

Milton Friedman called “A Laissez Faire Approach to Monetary Stability” (Journal of Money, Credit, and Banking, August 1983) “absolutely splendid.” (I hope that readers won’t consider my quoting Friedman’s remark self-serving.  I know that thanks to my having a name beginning with “G” and to Yeager’s generosity, I have received as co-author of this particular article more than a fair share of credit.)

Apropos “clarifying the nature of capital and interest and showing how their proper conceptualization dissolves the ‘Cambridge capital paradoxes’”:

The editors of Economic Inquiry called Yeager’s “Toward Understanding Some Paradoxes in Capital Theory” (September 1976) their journal’s article of the year.

And then there is Yeager’s treatise on ethics (Ethics as Social Science, 2001); his collected writings on political economy (Is the Market a Test of Truth and Beauty? 2011); and his translation (1983) of a 1919 book (Ludwig von Mises, Nation, State and Economy) that, had it appeared in English originally, not in German, might well have taken a place alongside Keynes’s Economic Consequences of the Peace (1919).

I could go on, citing additional journal articles (many, on monetary theory, collected in George Selgin, ed., The Fluttering Veil:  Essays on Monetary Disequilibrium, 1997) and books (e.g., with David Tuerck, Trade Policy and the Price System, 1976).  Instead, I’ll conclude by mentioning a tribute whose very title shows the esteem in which Yeager is held by colleagues and students alike—“The Yeager Mystique: The Polymath as Teacher” (William Breit, Kenneth Elzinga, and Thomas Willett, Eastern Economic Journal, Spring 1996).

Robert Greenfield is Professor of Economics and Finance at Fairleigh Dickinson University


Leland Yeager, by Jim Dorn

by Kurt Schuler October 4th, 2014 8:20 am

Leland Yeager has been a guiding light in instilling in his students and colleagues the logic of the price system, whether it be in advanced price theory, which he taught at the University of Virginia when I was a Ph.D. student, or international trade. His appreciation for the institutional infrastructure of a market system was clearly seen in his teaching and in his scholarship. His discipline and love of learning is legendary. On this his 90th birthday, we can all be thankful for his many contributions to the economics profession and for his friendship over the years. Happy birthday, Leland!

Jim Dorn is Vice President for Monetary Studies at the Cato Institute


Leland Yeager, by Kenneth Elzinga

by Kurt Schuler October 4th, 2014 8:17 am

Leland Yeager at 90. My first reaction was: a lifetime of scholarship of the highest order. My second reaction: what a privilege to have been a colleague of Leland’s when he was on the faculty at the University of Virginia—where so much of his exemplary scholarship took place. My third reaction: what an honor to be counted among Leland’s friends.

In everyday language, a “know it all” is a pejorative expression. But in the case of Leland Yeager, the expression “know it all” applies in a positive way. Not that Leland is omniscient; no person is. What struck me and my colleagues about Leland is that he genuinely knows so much—about economics, about languages, about current events, about philosophy—about most everything that an educated person might try to comprehend. Graduate students at the University of Virginia appreciated the fact that Leland took teaching very seriously. Students recognized that if they could “get it all down,” and then digest Leland’s classroom material, they would have a good understanding of any topic Leland was teaching that day. In an academic culture that sometimes places a premium on cleverness, Leland always exhibits a passion for truth and sound thinking. Those of us who know him could not imagine him dissembling. Truth really matters to Leland.

Kenneth Elzinga is Robert C. Taylor Professor of Economics at the University of Virginia


Leland Yeager, by Warren Coats

by Kurt Schuler October 4th, 2014 8:14 am

Dear Leland,

You were already a legend when I arrived in Charlottesville in 1970 as an assistant professor in the economics department you were then chairing. I quickly learned to come to your office well prepared with the questions I wished to ask and issues I wished to discuss. I also quickly confirmed that your clear and insightful writing was reflective of your analysis in general, which you were always prepared to share. The big surprise was that you were also an excellent cook.

The economics profession and I are grateful beneficiaries of your scholarship.

I am privileged to have been your colleague and friend. As you turn 90 and pass another milestone, I wish you all the best in this next chapter.



Warren Coats has worked in many countries, including such hot spots as Afghanistan, Bosnia, Iraq, and South Sudan, as an official of the International Monetary Fund or a consultant on monetary and financial reform

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