I testified this AM at the House Finance subcommittee on monetary and fiscal policy. Three R witnesses and yours truly, so I didn’t get to say all I wanted—after all, monetary and fiscal covers a lot of ground! So, why else have a blog if I can’t use it to post the stuff I didn’t have time to get into?
Here’s my testimony, which elaborates on these three points:
–Contrary to some of the claims made at the hearing, the Fed’s interventions were highly effective in reducing the damage from the Great Recession, reflating credit markets, and pulling the recovery forward. The Fed’s not perfect, for sure, but a lot of people and businesses would be a lot worse off today if the Fed had sat on the sidelines.
–Under certain conditions, particularly recessions or weak, demand-constrained recoveries, monetary and fiscal policy are critical complements. In this regard, the pivot to austerity budgets by both us (starting in around 2010) and European economies was a lasting economic mistake. Ben Bernanke made this very point to this very committee back in 2013:
“Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health. The economy’s performance both over the near term and in the longer run will depend importantly on the course of fiscal policy.”
–Title X of the CHOICE Act, the brainchild of the R’s on this committee, proposes to micromanage the Federal Reserve in ways that would be hugely detrimental to its independence and its ability to carry out its mandates. As a side point, perhaps interesting to monetary wonks here at OTE, the title’s insistence on the 1993 vintage of the Taylor rule is out of step with much research on the variables, values, and coefficients that would go into such a rule today.
I didn’t get to push back on an issue that conservatives on the committee were, IMHO, way too overheated about: the Fed’s payments of interest on excess reserves, or IOER. This was cast as a big, distortionary intrusion into private lending markets (see George Seglin’s testimony). I don’t see that at all.
Like Bernanke and Kohn, I view IOER as a necessary part of the hydraulics of monetary policy when the Fed’s balance sheet is large. Since bank reserves held at the Fed are far above their historical levels, marginally raising or lowering reserves—which is how the Fed hits its funds rate target (ffr)—don’t move the ffr the way they used to. Now, the Fed must wiggle the IOER—the interest rate it pays to banks on their reserves—around to move the funds rate. Right now, for example, the IOER is 1.25%, the upper end of the ffr target.
The Finance Committee Rs argue that this distorts credit markets and crowds out private lending. Why would a bank undertake the risk of lending to any old borrower when the Fed will give you a better, risk-free rate?
That’s not a crazy concern, but one thing we didn’t see from the panel was any evidence that it was occurring. For one, banks get zero interest on required reserves—the assets they must keep on hand to meet depository obligations—so no issue there. As far as excess reserves are concerned, B&K argued back in 2016 (when the IOER was a mere 0.25%), “the only potential loans that would have been affected by the Fed’s payment of interest are those with risk-adjusted short-term returns between precisely zero and one-quarter percent—surely a tiny fraction of the total.”
What about now, amidst a considerably higher rate? Still nothing much to see, folks. According to the NFIB survey on credit access by small businesses, “four percent of owners reported that all their borrowing needs were not satisfied, up 1 point and historically very low…only 1 percent reported that financing was their top business problem.” Flow of funds loan data on bank lending show a bit of a dip since the IOER has gone up, so maybe there’s something there, but there’s simply no correlation between these variables (the IOER rate and credit flows) since the IOER program began in 2008. Credit market indexes (eg, GS’s FCI, below, or the Chicago Fed’s version) show relatively loose credit conditions.
Then there’s what I see as a major conceptual flaw in the opposing arguments I heard today: Fed policy is presented as all costs, no benefits. Suppose, instead of the result I just described, you could prove the IOER is crowding out private borrowing. Checkmate, right?! Wrong. The alleged allocative cost of this crowd-out (because the market so flawlessly allocates credit, right?—there’s also a strong case of amnesia in a lot of this work) must be weighed against the growth and jobs impact of monetary stimulus.
I try to bring that sensibility to my testimony. You can see if it works for you. OTE’ers know that I’m far from uncritical of Fed policy, especially lately, what with their normalization campaign occurring as inflation is drifting down and wage growth is kinda stalled out at around 2.5%. And btw, if I were going to ding IOER, it would be for subsidizing banks for doing nothing (Bernanke and Kohn point out that such subsidies are typically but a few basis points, i.e., the IOER – the effective FFR, or 1.25 – 1.16 today; okay, but still…).
But for years now, the Fed’s been about the only thoughtful, deliberative public institution working to improve the US economy. The idea of turning their keys over to today’s Congressional conservatives seems an act of willful economic destruction.
Well they could enact a tax on reserve system institutions related to their excess reserves. Of course, you’d schedule the rates and incidence factors to favor use of reserves for lending to ventures that are not just doing financial asset trading r related to such trading, right? As a complement to the Fed normalization efforts this might speed things up.
It is an upside down world to pay IOER but consider recouping it via taxation isnt it? And doesnt the public need to borrow even more to pay this new subsidy?
A different Congress us needed in order to frame the complementary policies that we need.