Ben Benanke's Incompetent

[flow5]

WASHINGTON (AP) -- Federal Reserve Chairman Ben Bernanke says a key lesson learned from the 2008 financial crisis is that central banks must have a dual goal of controlling inflation while supporting the banking system.

During a speech Tuesday in Boston, Bernanke said the steps the Fed took during the crisis PROVED TO BE SUCCESSFUL. The Fed lowered short-term interest rates to record lows and expanded its portfolio of Treasury and mortgage-backed securities to push long-term rates lower.

Bernanke also noted that the Fed helped calm markets by being more explicit about its interest rate policy. He said it's a trend that will increase in the future.

The Fed has been criticized by those who say keeping rates too low for too long could fuel higher inflation later.

In September, the Fed voted to shift $400 billion of its investments to try to lower long-term interest rates. That followed the Fed's announcement in August that it planned to keep short-term rates at record lows until at least mid-2013, assuming the economy remains weak.

Both steps were approved on 7-3 votes. That represented the highest level of dissent at the Fed in nearly 20 years....

finance.yahoo.com/news/Bernanke-Crisis-taught-lesson-apf-70589651.html?x=0&sec=topStories&pos=main&asset=&ccode=

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Bernanke is a legend in his own mind. He should be fired.

[flow5]

"The Federal Reserve is accountable to the Congress for two objectives--maximum employment and price stability, on an equal footing--AND IT DOES NOT HAVE A FORMAL, NUMERICAL INFLATION TARGET"

Read more: www.foxbusiness.com/markets/2011/10/18/full-text-bernanke-on-monetary-policy/#ixzz1bB15H5gU
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As if that wasn't obvious!

[flow5]

"This broad framework is often called flexible inflation targeting, as it combines commitment to a MEDIUM-RUN inflation objective with the flexibility to respond to economic SHOCKS as needed to MODERATE DEVIATIONS of output from its potential, or "full employment," level. The combination of SHORT-RUN policy flexibility with the discipline imposed by the MEDIUM-TERM inflation target has also been characterized as a framework of 'constrained discretion.' "

====================

Some of the most obtuse language I've ever read. There are no scientific parameters, no rules-of-thumb. It's like "take a wild guess".

[jarhead1976]

Like M3 ? How much $ is out there? A private entity within the government free to do its will. They answer to no one. Great reading flow5. I am for doing away with the Federal Reserve. Let the power shift to the treasury where it belongs.

The makeup of the Federal Reserve’s board of directors poses a conflict of interest and there is concern that several financial firms and corporations could have reaped monetary benefits from their executives’ close ties to the Fed, according to a new report released today by the Government Accountability Office.

In one case, the Federal Reserve consulted with General Electric on the creation of a commercial paper funding facility and then provided $16 billion in financing to the company while its chief executive, Jeffrey Immelt, served as a director on the board of the Federal Reserve Bank of New York. Immelt is now President Obama’s “jobs czar.”

JP Morgan Chase could also have benefited from its chief executive Jamie Dimon’s position on the board of the Federal Reserve Bank of New York, according to the GAO. The bank received emergency loans from the Federal Reserve at the same time it served as the clearinghouse for the Fed’s emergency lending program.

The Federal Reserve gave JP Morgan Chase an 18-month exemption from risk-based leverage and capital requirements in 2008, the same year that the Fed gave it $29 billion to acquire Bear Stearns, according to the GAO.

Similarly, Lehman Brothers’ chief executive Richard Fuld served on the board of the Federal Reserve Bank of New York at the same time one of its subsidiaries participated in the Fed’s emergency programs.

The Federal Reserve system has come under increased scrutiny in recent years, particularly for the structure of its board of directors. Executives of banks and companies that are regulated by the Fed, and that receive emergency funding from it, often serve on the board.

“Without more complete documentation of the directors’ roles and responsibilities with regard to the supervision and regulation functions, as well as increased public disclosure on governance practices to enhance accountability and transparency, questions about Reserve Bank governance will remain,” the report states, adding that such affiliations “could create reputational risk for the Reserve Banks.”

source ABC news

[flow5]

"The idea of relying on communication probably means nominal GDP (NGDP) growth targeting, as Goldman Sachs and Pimco are now thinking about, and Joe Weisenthal points us to the work of Scott Sumner.

Scott Sumner does make some very good points here I think. In particular, he points out that monetary policy in the second half of 2008, and particularly after Lehman Brothers collapsed WAS ACTUALLY TIGHT. The reason why it is tight is that as asset markets collapsed and people deleveraging, we know that there would have been a shortage of US dollar as people needed to sell assets and obtain US dollar to paid off their debts with nothing but US dollar as their debts are denominated in that currency. As a result of that, monetary condition was actually very tight, and the demand for the dollar drove US dollar exchange rate way up. And for that matter, I have pointed out that the same might be happening with the Euro, and that’s why the Euro has actually been holding up stronger than many people would have expected. Thus despite interest rates cut, the true monetary condition was not really under the control by the Federal Reserve. Should the Fed recognised this, he argued, the monetary easing could have been even more aggressive and probably ealier.

In his paper on NGDP targeting, he wrote:

Nominal GDP targeting provides a way to address both inflation and output stability, without placing the central bank in the confusing situation of HAVING TO AIM AT TWO SEPARATE TARGETS. Consider a country where the trend rate of output growth is roughly 2.5%. A 4% NGDP target would insure a long run rate of inflation of roughly 1.5%, with modest short term variation in response to real economic shocks, such as a sharp increase in energy prices. For instance, suppose oil prices rose sharply. Under strict inflation targeting, non-oil prices would have to fall to offset the increase in oil prices. If nominal wages are sticky, the fall in non-energy prices might lead to much higher unemployment. In contrast, NGDP targeting would allow a temporary period of above 1.5% inflation, along with somewhat lower output, in order to cushion the blow on the non-oil sectors of the economy.

The preceding example might make NGDP targeting seem less “hawkish” than inflation targeting, a backdoor method of allowing excessive inflation. Yet the argument is completely symmetrical. George Selgin pointed out that NGDP targeting would produce lower than normal inflation during a productivity boom. One of the criticisms of inflation targeting is that because central banks focus on consumer prices, they allow asset bubbles to form, which eventually destabilize the economy. Nominal GDP targeting cannot completely eliminate this problem, but it would impose more monetary restraint (as compared to inflation targeting) during periods where output growth was above normal. Indeed Friedrich Hayek advocated nominal income targeting for exactly that reason, to prevent “malinvestment” during productivity booms

Read more: feedproxy.google.com/~r/AlsosprachAnalyst/full/~3/TAw9vAKAsg4/nominal-gdp-ngdp-targeting.html#ixzz1bGTKOGpB

[flow5]

www.nationalreview.com/articles/276940/case-nominal-growth-targeting-joshua-r-hendrickson?pg=1

....While the indicator variables mentioned above could still be used by market participants and commentators to forecast the Fed’s target, the stance of monetary policy could easily be judged by looking at the deviation of the particular variable from its target. For example, if the Fed announced a target for inflation between 1.5 and 2.5 percent, it could be discerned that monetary policy was too loose when the inflation rate was above that range and too tight when below that range. The Fed would then be responsible in its testimony to Congress to explain why any such deviations occurred.

....The work of Milton Friedman and his longtime collaborator Anna Schwartz presents meticulous and convincing evidence not only that inflation is a monetary phenomenon, but also that the business cycle is. According to the theory Friedman built on their empirical results, the main cause of fluctuations in nominal income is changes in actual and desired money balances. When the two differ, individuals seek to resolve the difference by adjusting nominal spending, which obviously changes nominal income. While individuals cannot collectively change the nominal supply of money, they can affect the velocity of circulation. In the short run, deviations between actual and desired money balances will have effects on both prices and real output. In the long run, however, such deviations will only affect prices. A natural policy implication is that the money supply should be adjusted to offset changes in velocity. Since nominal income is the product of the money supply and velocity, targeting nominal income accomplishes that goal.

A nominal-income target has an additional benefit over inflation targeting in that it requires less information and knowledge on the part of policymakers at the Federal Reserve. As noted above, fluctuations caused by monetary factors are divided between prices and real output in the short run, but economists still lack any semblance of a consensus on the precise division. Some variation of the Phillips curve is the closest concept available, but plots of the data look more like a constellation of stars than a stable, downward-sloping curve. By targeting nominal income, however, such a short-run division is made irrelevant.

In addition, a nominal-income target does not require the central bank to know the source of rising or falling inflation. Under an inflation target, a negative supply shock, such as a sudden rise in oil prices, would lead to a contractionary monetary policy that would make the resultant economic slowdown worse. Under a nominal-income target, the Fed would not have to contract, since rising prices combined with a temporary slowdown in output would leave nominal income stable. An inflation target would cause a similarly ill-advised response to positive supply shocks caused by rising productivity. A nominal-income target, again, would not. Under a nominal-income target, monetary policy responds only to what it can actually control. Under an inflation target, the Federal Reserve would be required to pinpoint the cause of inflationary pressures in real time....

[flow5]

In his latest US Economics Analyst note, Goldman Sachs economists Jan Hatzius and Sven Jari Stehn say that the Federal Reserve should massively expand asset purchases with the goal of bringing nominal GDP back to pre-crisis levels.

Joe Weisenthal at Business Insider quotes from the note:

With short-term interest rates near zero and the economy still weak, we believe that the best way for Fed officials to ease policy significantly further would be to target a nominal GDP path such as the one shown in the chart on the right, indicating that they will use additional asset purchases to help bring actual nominal GDP back to trend over time. The case would strengthen further if deflation risks reappeared clearly on the radar screen.

www.cnbc.com/id/44950117

[flow5]

Crude Oil
86.18
-2.35 -2.65%

Oil price falling out of trend. Money growth is important now.

Thomson Reuters/Jefferies CRB index of 19 commodities fell 1.3 per cent, marking its biggest one-day dip so far in October

[flow5]

"Long bond yields are now only about 1% above the year-over-year rate of core inflation, when they typically exceed core inflation by at least 2%"

seekingalpha.com/article/300613-of-inflation-and-bond-yields?ifp=0&source=email_partial_daily_dispatch

[flow5]

Just Released: Fed Proposes Simpler Rules for Banks’ Reserve Requirements
Richard Roberts*

Reserve requirements—a critical tool available to Federal Reserve policymakers for the implementation of monetary policy—stipulate the amount of funds that banks and other depository institutions must hold in reserve against specified deposits, essentially checking accounts. On October 18, 2011, the Fed proposed to simplify the rules that govern these requirements, with the aim of reducing cost and burden on depository institutions and on the Federal Reserve. The simplifications will also allow the Fed to modernize the infrastructure that supports reserve administration without compromising the role that reserve requirements play in the conduct of monetary policy.

In this post, I summarize what the Fed proposes, which includes: 1) creating a common two-week maintenance period for all depository institutions, 2) sunsetting the contractual clearing balance program, 3) creating a “band” around reserve requirements to replace carryover, and 4) using “direct compensation” to replace as-of adjustments.

Establish a Common Reserve Maintenance Period

A reserve maintenance period is the time over which an institution must hold the daily average amount of reserves that the Fed requires it to hold. Today, smaller institutions generally use a one-week maintenance period, while larger institutions use a two-week period. Moreover, each year some switch from one length maintenance period to the other. Having two different maintenance periods does not serve a purpose for the implementation of monetary policy, and managing the dual system imposes costs both on depository institutions that switch between maintenance periods as well as on the Federal Reserve. The Fed proposes to implement a common two-week reserve maintenance period no earlier than the third quarter of 2012.

Eliminate the Clearing Balance Program

A clearing balance is an amount that an institution agrees to maintain with the Fed in addition to its reserve requirement. These extra balances earn implicit interest, known as earnings credits, which may be used to offset Fed service charges and reduce the risk of an overdraft to reserve accounts.

Now that the Fed pays interest on reserves, there is no need for institutions to set aside a separate balance earning its own rate of return to pay for service charges. Additionally, at current interest rates, the implicit interest rate that is paid on contractual clearing balances is below the rate paid on excess reserves. As a result, institutions could earn a greater return and use the earnings for any purpose by canceling their contractual clearing balance arrangement with their Reserve Bank. The contractual clearing balance program is cumbersome to maintain and requires legal agreements between depository institutions and the Federal Reserve.

The Fed proposes sunsetting the contractual clearing balance program beginning no earlier than the first quarter of 2012.

End the Carryover of Excess/Deficient Reserve Positions

“Carryover” allows an institution with a small excess or deficiency of reserves in one period to use it or make it up in the following maintenance period. In turn, the payment of interest on reserves is delayed by at least one maintenance period, because the subsequent maintenance period must be completed to account for the potential use of carryover.

The Fed proposes creating similar flexibility by establishing a “band” of either a percentage or a dollar amount around each depository institution’s reserve requirement. If the depository institution maintained balances that were below the requirement, but still within the band, the depository institution would not be deemed to be deficient. Similarly, if a depository institution held balances that were above the requirement, but still within the band, it would not be deemed to be in an excess position. Only balances that fell outside of the band would be considered either deficiencies or excesses. Such an approach would be more straightforward and would allow interest payments to be accelerated.

The Fed proposes to implement a penalty-free band around reserve balance requirements no earlier than the third quarter of 2012.

Eliminate “As-Of Adjustments”

“As-of adjustments” are issued by the Fed to neutralize the effect of a transaction-processing or deposit-reporting error on a depository institution's reserve position. In an environment where the Federal Reserve is regularly making interest payments on reserve balances, replacing transaction-based as-of adjustments with some form of direct compensation seems beneficial to depository institutions and the Federal Reserve. Depending on the correction that is needed, either a credit or a debit would be made to the depository institution’s account. This change would allow the Federal Reserve to remedy transaction errors more quickly and would result in reduced administrative burden. For these reasons, the Federal Reserve proposes to eliminate transaction-based as-of adjustments and replace them with direct compensation. As-of adjustments that result from deposit revisions would be eliminated.

The Fed proposes to eliminate the use of as-of adjustments no earlier than the first quarter of 2012.

Bottom Line

The Board of Governors has requested comments on these simplifications by December 19, 2011. Should the modifications be implemented, the cost and burden on depository institutions and on the Fed should decrease. Additionally, the simplifications will allow the Fed to modernize the infrastructure that supports reserve administration without compromising the role that reserve requirements play in the conduct of monetary policy.

[flow5]

Low Interest Rates Have Benefits …and Costs


In late December 2007, most economists realized that the economy was slowing. However, very few predicted an outright recession. Like most professional forecasters, the Federal Open Market Committee (FOMC) initially underestimated the severity of the recession.

In January 2008, the FOMC projected that the unemployment rate in the fourth quarter of 2010 would average 5 percent. But by the end of 2008, with the economy in the midst of a deep recession, the unemployment rate had risen to about 7.5 percent; a year later, it reached 10 percent.

The Fed used a dual-track response to the recession and financial crisis. It adopted some unconventional policies, such as the purchase of $1.25 trillion of mortgage-backed securities. And the FOMC reduced its interest rate target to near zero in December 2008 and indicated its intent to maintain a low interest rate environment for an “extended period.” Recently, some economists have begun to discuss the costs and benefits of maintaining extremely low short-term interest rates for an extended period.

Benefits of Low Interest Rates
In a market economy, resources tend to flow to activities that provide the greatest returns for the risks the lender bears. Interest rates (adjusted for expected inflation and other risks) serve as market signals of these rates of return. Although returns will differ across industries, the economy also has a natural rate of interest that depends on factors such as the nation’s saving and investment rates. When economic activity weakens, monetary policymakers can push the interest rate target (adjusted for inflation) temporarily below the economy’s natural rate, which lowers the real cost of borrowing. To most economists, the primary benefit of low interest rates is their stimulative effect on economic activity. By reducing interest rates, the Fed can help spur business spending on capital goods—which also helps the economy’s long-term performance—and can help spur household expenditures on homes or consumer durables like automobiles. For example, home sales are generally higher when mortgage rates are 5 percent than when they are 10 percent.

A second benefit of low interest rates is improving bank balance sheets and banks’ capacity to lend. During the financial crisis, many banks, particularly some of the largest banks, were found to have too little capital, which limited their ability to make loans during the initial stages of the recovery.

By keeping short-term interest rates low, the Fed helps recapitalize the banking system by helping to raise the industry’s net interest margin (NIM), which boosts its retained earnings and, thus, its capital. Between the fourth quarter of 2008, when the FOMC reduced its federal funds target rate to virtually zero, and the first quarter of 2010, the NIM increased by 21 percent, its highest level in more than seven years. Yet, the amount of commercial and industrial loans on bank balance sheets declined by nearly 25 percent from its peak in October 2008 to June 2010. This suggests that perhaps other factors were working to restrain bank lending.

A third benefit of low interest rates is that they can raise asset prices. When the Fed increases the money supply, the public finds itself with more money balances than it wants to hold. In response, people use these excess balances to increase their purchases of goods and services and of assets like houses or corporate equities. Increased demand for these assets, all else equal, raises their price.

The lowering of interest rates to raise asset prices can be a double-edged sword. On the one hand, higher asset prices increase the wealth of households (which can boost spending) and lower the cost of financing capital purchases for business. On the other hand, low interest rates encourage borrowing and higher debt levels.

Costs of Low Interest Rates
Just as there are benefits, there are costs associated with keeping interest rates below the natural level for an extended period. Some argue that the extended period of low interest rates (below the natural rate) from June 2003 to June 2004 was a key contributor to the housing boom and the marked increase in household debt relative to after-tax incomes. Without a strong commitment to control inflation over the long run, the risk of higher inflation is one potential cost of the Fed’s keeping the real federal funds rate below the economy’s natural interest rate. For example, some point to the 1970s, when the Fed did not raise interest rates fast enough or high enough to prevent what became known as the Great Inflation.

Other costs are associated with very low interest rates. First, low interest rates provide a powerful incentive to spend rather than save. In the short term, this may not matter much, but over a longer period, low interest rates penalize savers and those who rely heavily on interest income. Since peaking at $1.33 trillion in the third quarter of 2008, personal interest income has declined by $128 billion, or 9.6 percent.

A second cost of very low interest rates flows from the first. In a world of very low real returns, individuals and investors begin to seek higher-yielding assets. Since the FOMC moved to a near-zero federal funds target rate, yields on 10-year Treasury securities have fallen, on net, to less than 3 percent, while money market rates have fallen below 1 percent. Of course, existing bondholders have seen significant capital appreciation over this period. However, those desiring higher nominal rates might instead be tempted to seek more speculative, higher-yielding investments.

In 2003-04, many investors, facing similar choices, chose to invest heavily in subprime mortgage-backed securities since they were perceived at the time to offer relatively high risk-adjusted returns. When economic resources finance more-speculative activities, the risk of a financial crisis increases—particularly if excess amounts of leverage are used in the process. In this vein, some economists believe that banks and other financial institutions tend to take greater risks when rates are maintained at very low levels for a lengthy period. Economists have identified a few other costs associated with very low interest rates. First, if short-term interest rates are low relative to long-term rates, banks and other financial institutions may overinvest in long-term assets, such as Treasury securities. If interest rates rise unexpectedly, the value of those assets will fall (bond prices and yields move in opposite directions), exposing banks to substantial losses.

Second, low short-term interest rates reduce the profitability of money market funds, which are key providers of short-term credit for many large firms. (An example is the commercial paper market.) From early January 2009 to early August 2010, total assets of money market mutual funds declined from a little more than $3.9 trillion to about $2.8 trillion.

Finally, St. Louis Fed President James Bullard has argued that the Fed’s promise to keep interest rates low for an “extended period” may lead to a Japanese-style deflationary economy. This might occur in the event of a shock that pushes inflation down to extremely low levels—maybe below zero. With the Fed unable to lower rates below zero, actual and expected deflation might persist, which, all else equal, would increase the real cost of servicing debt (that is, incomes fall relative to debt).

www.stlouisfed.org/publications/itv/articles/?id=2082

[flow5]

The CBs aren't lending because IOeRs & T-Bills aren't, as some economists maintain, "close substitutes".

As Ellen Brown pointed out July 15, 2011:

"an MIT study reported in September 2010 showed that immediately after the Lehman collapse, the interbank lending markets were actually working. They froze, not when Lehman died, but when the Fed started paying interest on excess reserves in October 2008. According to the study, as summarized in The Daily Bail:

. . . [T]he NY Fed's own data show that interbank lending during the period from September to November did not "freeze," collapse, melt down or anything else. In fact, every single day throughout this period, hundreds of billions were borrowed and paid back. The decline in daily interbank lending came only when the Fed ballooned its balance sheet and started paying interest on excess reserves"

[jarhead1976]

The GAO wants more transparency? Who runs this country ? Oh yeah the FED
NEW YORK (CNN) -- The Federal Reserve banks need to better prevent conflicts of interest, according to a new government report that highlights transparency issues with financial executives serving on the banks' boards.

All 12 reserve banks should more "clearly document the roles and responsibilities of the (board) directors," according to a Government Accountability Office (GAO) audit released Wednesday.

The report focuses on scenarios in which executives pose apparent conflicts of interest by serving on boards that regulate financial houses where they also have business relationships.

An example, it notes, occurred when then-chairman of the New York Fed's board of directors Stephen Friedman owned shares in the investment firm Goldman Sachs, but in September 2008 provided it and other banks billions of dollars in federal funding in response to the unfolding financial crisis.

Friedman was granted a waiver by the Federal Reserve Board in January 2009, the report said. But the board was unaware that he had purchased additional shares in Goldman Sachs through an automatic stock purchase program.

The former chairman, who resigned in May 2009, could not be immediately reached for comment.


The GAO, meanwhile, said that "without more public disclosure of governance arrangements, such as board of director bylaws and director eligibility and ethics policies, there may be continued concerns about Reserve Bank governance and the integrity of the Federal Reserve System."

Just WOW! No prosecution

[flow5]

Sir Walter Scott:

"Oh what a tangled web we weave"

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It's not a very independent organization. Money, politics, & general indiscretion all rule.

See: "Bill Gross Was Right: Fed Board Member Tarullo Calls For Restart Of MBS Monetization"

[flow5]

NEW YORK (Reuters) - The Federal Reserve SHOULD CONSIDER BUYING MORE MORTGAGE BONDS to support a fragile economic recovery, a top Fed official said on Thursday, while two other officials argued the central bank's current policy is appropriate.

...."There is need, and ample room, for additional measures to increase aggregate demand in the near to medium term, particularly in light of the limited upside risks to inflation over the medium term," said Tarullo, who as a Fed Governor has a permanent vote on monetary policy.

Because the ongoing housing problems are so central to the recession and the anemic nature of the subsequent expansion, the Fed should refocus its efforts on housing, Tarullo said.

"I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities," he added. The Fed bought $1.25 trillion worth of mortgage-related debt, starting in 2009.

beta.finance.yahoo.com/news/fed-debate-more-easing-heats-000905035.html

[flow5]

Percent change at seasonally adjusted annual rates

...............................................................M1............M2
------------------------------------------------------------------

3 Months from June 2011 TO Sep. 2011....... 38.2....... 21.1
6 Months from Mar. 2011 TO Sep. 2011........ 25.7....... 14.6
12 Months from Sep. 2010 TO Sep. 2011....... 20.4....... 10.1

[flow5]

research.stlouisfed.org/publications/mt/20111101/mtpub.pdf

The financial crisis of 2008 was a liquidity crisis—that is, a period when some creditworthy households and firms could not obtain sufficient liquid (money) balances to complete necessary transactions. Most visible was the closure of the repurchase agreement (repo) market, in which both banks and non-banking firms alike typically exchange securities for short-term cash.

The Federal Reserve responded to the crisis by initiating an extraordinary set of assistance programs under the authority of Section 13(3) of the Federal Reserve Act.1 An unusual aspect of these programs was that they sought to assist individual firms or industries.

In normal times, the Federal Open Market Committee (FOMC) SETS A TARGET FOR THE FEDERAL FUNDS RATE & ENFORCES IT BY CHANGING THE SIZE OF THE FED'S BALANCE SHEET TO CHANGE THE AGGREGATE AMOUNT OF LIQUIDITY THAT IT PROVIDES THE FINANCIAL MARKETS The allocation of liquidity among households and firms, in turn, is determined by financial markets.

Beyond the liquidity crises of individual firms, an interesting question is whether the aggregate amount of liquidity in the economy was appropriate before and during the crisis: Was there a liquidity crisis in the “large” as well as the “small”?

The recently updated Monetary Service Indexes (MSI) published by the Federal Reserve Bank of St. Louis provide some evidence.2 These indexes build on the idea that monetary assets (including checkable deposits, saving deposits, small-denomination time deposits, and money market mutual funds [MMMF]) furnish “monetary services” that households and firms use to buy and sell goods and services. Some assets are immediately media of exchange (e.g., currency), while others are not (e.g., saving deposits and small denomination time deposits).

The MSI are chained-weighted index numbers (similar to those used to measure gross domestic product) that combine observed market data on financial asset quantities and own rates of return in order to measure these flows of monetary services. The own rates of return received by households and firms on their monetary assets, compared with broader market rates of return, provide measures of the opportunity cost of the monetary services furnished by each asset.

Economic and statistical theory provides specific mathematical functions with which to calculate the MSI as described in Anderson and Jones (2011). The chart shows five MSI. (These MSI differ with respect to the number of included assets.3 The data are log levels, each normalized to 1.0 in August 2001.) MSI-M1 contains only currency and checkable deposits, and MSI-M2M includes the assets in MSI-M1 plus savings deposits and retail MMMF; both leveled out in 2004 as the FOMC tightened its policy stance and later increased sharply during the autumn of 2008.

MSI-MZM includes the assets in MSI-M2M plus institution-type MMMF; it accelerated beginning mid-2007. MSI-M2 includes the assets in MSI-M2M plus small denomination time deposits, and MSI-ALL includes all the assets of MSI-M2 plus institution-type MMMF.

These broader series grew more steadily both before and during the crisis. Although the evidence is mixed, the MSI overall suggest that monetary policy was accommodative before the financial crisis when judged in terms of liquidity. —Richard G. Anderson and Barry Jones

================

This is of course a COVER UP. Bernanke drained legal reserves for 29 months prior to the collapse of the financial system.

The Federal Reserve doesn’t gauge the volume and timing of its open market operations in terms of the amount and desired rate of increase of member commercial bank's COSTLESS legal reserves, but rather in terms of the levels of the federal funds rates (the interest rates banks charge other banks on excess balances with the Federal Reserve).

Monetarism entails controlling money flows (MVt) using binding legal reserves.

The FED always covers up their errors. Their propaganda is comprehensive:

"These broader series grew more steadily both before and during the crisis. Although the evidence is mixed, the MSI overall suggest that monetary policy was accommodative before the financial crisis when judged in terms of liquidity. —Richard G. Anderson and Barry Jones"

This is of course a lie. Nominal gDp collapsed because by definition - money flows collapsed. The Monetary Service Indexes (MSI) obviously do not represent either "money" nor "money flows".

[flow5]

Yahoo says: "Stocks Buoyed by Solid Corporate Earnings" Dow up 188.08.

It's similar to what the great market technician Joeseph Granville advocates. Headlines don't drive markets. But he just watches the tape.

www.edwardothorp.com/sitebuildercontent/sitebuilderfiles/JEGranvilleProphetOfProfitsPart1.pdf

[dothedd]

F5...

Thank you for your expert research on the subject. I have a special interest dating back to 2005 when I first became aware that the Federal Reserve is a very powerful [WORLD] entity.

Carry on.

dothedd

[flow5]

These "QE programs" (& talk of new ones), distract attention away from the FED's primary objective. And as long as the money stock*velocity is expanding at 2-3 percentage points above real-output (maybe slightly higher right now), then nominal gDp should grow. The FED's job is to ensure steady growth in commercial bank credit using its open market power. Otherwise, it is up to Congress to modify & initiate legislation favorable to business growth. Congress is responsible for our underemployment & unemployment problems. The FED's mandate is unachievable under its own roof.

[flow5]

WASHINGTON (AP) -- The No. 2 official on the Federal Reserve says U.S. economic growth will end "noticeably stronger" in the second half of this year, but she says the central bank still needs to keep its policy options open to provide more support to the economy if necessary.

[flow5]

OLD ARTICLE - krugman;

February 13, 2010, 5:38 pm The Case For Higher Inflation
Olivier Blanchard, normally at MIT but currently the chief economist at the IMF, has released an interesting and important paper on how the crisis has changed, or should have changed, how we think about macroeconomic policy. The most surprising conclusion, presumably, is the idea that central banks have been setting their inflation targets too low:

Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.

To be a bit more precise, I’m not that surprised that Olivier should think that; I am, however, somewhat surprised that the IMF is letting him say that under its auspices. In any case, I very much agree.

I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.

Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.

I think this is especially important in the European context. As I’ve been writing in a number of posts, the period 2000-2008 saw a huge divergence in price levels between the capital-inflow nations of the European periphery and the European core. Here are deflators, Almost surely, that divergence now has to be reduced. Yet with a low overall inflation rate for the eurozone, that means large-scale deflation in the overvalued economies if convergence is to happen any time in, say, the next 5-10 years. (Actually, in Eurospeak I think this is cohesion rather than convergence, but never mind).

The task would be a lot easier if the eurozone had 4 percent inflation instead of 2.

So yes, let’s have modestly higher inflation. Alas, Ben Bernanke — at least when speaking publicly — doesn’t agree. And I can only imagine what Trichet would say.

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When banking and investment wizards inadvertently blew up the financial system in 2008, the Federal Reserve Bank of New York required outside expertise on its triage team. And so it hired banking and investment wizards, including some who allegedly helped precipitate the devastating financial explosion, paying out $659.4 million across 103 contracts from 2008 through 2010.

Among the hires were Goldman Sachs, Morgan Stanley, State Street and JPMorgan Chase -- all of which were recipients of the government's TARP, or Troubled Assets Relief Program funds. The 10 largest contracts awarded by the New York Fed represented 74% of the total amount. Eight of the largest contracts were awarded without competitive bidding.

Recipients of the 10 largest contracts were BlackRock (no bid); Morgan Stanley (no bid); Ernst & Young (no bid); Allianz's Pimco (no bid); law firm Davis Polk & Wardell (no bid); Wellington Management (no bid); State Street; JPMorgan (no bid); Goldman Sachs; and Morgan Stanley's EMC (no bid). Much of the contracted work was with American International Group, Bear Stearns, Citigroup and Bank of America; the no-bids were awarded to companies that were familiar with the innards of these troubled institutions. The New York Fed was lending the troubled institutions money and needed help to evaluate the value of the assets that they proffered as collateral.

The history of this cozy arrangement between the regulators and the regulated is outlined in a 266-page, July 2011 audit by the Government Accountability Office that came to light during an Oct. 4 hearing by the House Subcommittee on Domestic Monetary Policy and Technology, which is chaired by Texas Republican Rep. Ron Paul. The story is also contained in a companion 127-page GAO audit, released Oct. 19, attacking the Fed's inadequate safeguards against potential conflicts of interest among board members at its regional banks. Both reports are one-time audits required by the Dodd-Frank Wall Street reform law.

Though the GAO says all 12 Federal Reserve Banks should tighten up their policies regarding potential conflicts of interest, the watchdog uncovered no crimes. The audit spotlighted the fact that some New York Fed directors were consulted by management and staff there about the creation of emergency facilities back in 2008, but that the board members had no direct role in approving any programs.

Even so, those consultations looked bad. For example GE's CEO, Jeff Immelt, a New York Fed director at the time, was asked for advice about assisting the commercial-paper market. At the time, General Electric was one of the country's largest issuers of commercial paper. The GAO identified 18 instances of this sort of thing.

By reading both audits head to footnote, I noticed things that apparently the GAO did not. Goldman Sachs and JPMorgan both got big contracts in 2008, when company officers were New York Fed directors. Without going into individual cases, the GAO makes a blanket statement that no directors had a say on any vendor contracts. Bully for that.

But from the outside looking in, the Fed looks sloppier than expected, no doubt owing to its insulation from oversight. A Dodd-Frank tweak, authorizing even broader GAO audits of the Federal Reserve System, might be the perfect pill.

JIM MCTAGUE
Barron's - D.C. Current

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Shadow Open Market Committee
October 21, 2011

"Recent months have witnessed an upsurge of interest in the idea that, to quote The Economist (2011), “… rather than directing monetary policy to hit inflation targets (as they have done for the past 20 years) central banks should take aim at nominal GDP (or NGDP).” That is, the idea is that central banks should conduct monetary policy so as to keep the growth rate of aggregate nominal spending at a specified numerical value. This value would equal the sum of the central bank’s target inflation rate (say, 1.5% per annum) and the economy’s long-run average rate of output (real GDP) growth (say, 3.0%). The belief of supporters of the suggestion is that successful achievement of this objective would yield the same long-run average inflation rate as would achievement of an inflation target of 1.5%, and also the same long-run growth of output, but would do so with a reduced volatility of output fluctuations..."

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Nominal gDp targeting per the Shadow Open Market Committee
shadowfed.org/wp-content/uploads/2011/10/McCallum-SOMCOct2011.pdf

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Money-market funds added to recent market stress-Volcker

* Funds need capital requirements, insurance-Volcker

* Gov't should get GSEs out of mortgage market-Volcker

Oct 23 (Reuters) - Former U.S. Federal Reserve Chairman Paul Volcker is advocating for regulatory control over the money-market mutual fund industry and believes the government should stop financing mortgages.

Volcker said in a recent speech that money market funds have exacerbated stress in the financial markets because they pulled back on short-term lending to European banks.

If money-market funds are to continue providing significant funding to regulated banks, they should be subject to capital requirements, deposit insurance protection and stronger oversight of their investments, Volcker said.

"The time has clearly come to harness money market funds in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential," Volcker said in a speech last month that was highlighted by The New York Times on Saturday.

The speech, titled "Three Years Later: Unfinished Business In Financial Reform," also criticized the government's role in the U.S. mortgage market through government-sponsored enterprises Fannie Mae and Freddie Mac.

Today, he noted, the U.S. residential mortgage market is almost entirely dependent on financial support from taxpayers. The federal government placed those entities into conservatorship in 2008 and has funded hundreds of billions of dollars' worth of losses on their mortgage portfolios.

"It is important that planning proceed now on the assumption that Government Sponsored Enterprises will no longer be a part of the structure of the market," Volcker said.

In his interview with the Times, Volcker acknowledged that it will take time to remove government support from the mortgage market, which is still struggling to repair itself, but said policymakers now have "an opportunity to get rid of institutions that shouldn't exist."

Volcker's opinions are highly regarded among some economists and regulators and he was a top adviser to President Barack Obama on financial regulatory reform.

But a measure he championed to restrict banks' ability to bet with their own capital, now known as the Volcker rule, has become a target for financial industry lobbyists seeking to blunt its impact on Wall Street profits.

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Make the Treasury Responsible for 'Unofficial' Debt

The huge debt of Fannie Mae, Freddie Mac, other government-sponsored enterprises and Ginnie Mae fully relies on the credit of the United States. It is in fact government debt, but it is not accounted for as government debt. It is not "considered officially to be part of the total debt of the federal government," the Federal Reserve coyly notes.

Not "considered officially" — but agency debt has proven its ability to generate huge losses for the taxpayers. It is off-balance sheet debt and hidden leverage for the government.

In 1970, Treasury debt held by the public was $290 billion. Agency debt was minor by comparison: it totaled only $44 billion.

But by 2006, at the height of the housing bubble, while Treasury debt was up to $4.9 trillion, agency debt has inflated to $6.5 trillion. Treasury debt had increased 17 times during these years, but agency debt had multiplied 148 times!

In 1970, agency debt represented only 15% of Treasuries. By 2006, this had inflated to 133%. At that point, there was a lot more agency debt than Treasury debt — more government debt off-balance sheet than on it. To move debt off the balance sheet was a practice of many financial actors during the bubble, but the government was a champion at it.

If we add the on and off-balance sheet debt together, we can get a total of "effective government debt" (debt dependent on government credit) held by the public. See the graph, below, that compares this "effective government debt" with Treasuries — an instructive comparison.

Observe that effective government debt held by the public now totals nearly $17 trillion (this is not counting the intra-government debt held by the Social Security and other "trust funds").

The expansion of agency debt not only imposes risk and credit losses on taxpayers. It also increases the interest cost of Treasury's direct financing by creating a huge pool of alternate government-backed securities to compete with Treasury securities, a point Treasury debt expert Frank Cavanaugh was already worrying about in 1996.

Investors substitute agency debt for Treasuries. We can observe a striking example of such substitution in the aggregate balance sheet of the commercial banks.

In 1970, commercial banks owned $63 billion in Treasuries and $14 billion in agency securities. Their Treasury holdings were more than four times their agency holdings. By 2006, at the peak of the bubble, this had flipped in remarkable fashion. All commercial banks owned merely $95 billion in Treasuries, which was dwarfed by their $1.14 trillion in agencies. They then had 12 times the investment in agencies as in Treasuries.

At the end of 2010, the corresponding totals were $299 billion of Treasuries and $1.35 trillion in agencies. This long-term trend is shown in the second graph below.

Make the Treasury Department truly responsible for managing all the government’s debt. Managing only Treasury securities deals with only about half, and sometimes less than half, of the effective government debt.

In contrast, in the 1970s, the Treasury Department was more actively involved with agency debt. That may be one reason agency debt was proportially smaller. In those days, for example, it demanded its approval of every individual debt issuance by the Federal Home Loan Banks, as required by the Government Corporation Control Act of 1945.

This act, which grew out of the sensible worry that government corporations were too free in using the credit of the United States, considered that the Treasury Department should be in control of the government's own credit and its use by agencies.

It defined among its terms "a mixed ownership government corporation," reflecting government ownership of some of the capital of the entity, as one category of government corporation — this category included and still does include the Federal Home Loan Banks. In fact, though not yet in law, this is what Fannie and Freddie are now.

The responsibility of the Treasury Department to control the debt of such corporations is spelled out by the act with notable rigor:

"Before a Government corporation issues obligations and offers obligations to the public, the Secretary of the Treasury shall prescribe –

(1) the form, denomination, maturity, interest rate, and conditions to which the obligations will be subject;

(2) the way and time the obligations are issued; and

(3) the price for which the obligations will be sold."

Quite a thorough requirement.

Since 2008, there is no doubt whatsoever that Fannie and Freddie have been and are mixed ownership government corporations. The bulk of their equity capital is owned by the government, although there are small residual private interests in common and junior preferred stock. They are clearly just the sort of government debt-generating organizations the Government Corporation Control Act is meant to control.

Congress should promptly amend this act to add Fannie Mae and Freddie Mac to its list of mixed-ownership government corporations, thus formally subjecting them to the discipline of the Act.

In addition, Treasury should be responsible for reporting to Congress on the cost to the Treasury created by the use of agency debt.

In this way, we could help control, for the future, the use of the government's credit card by agency debt, the consequent possibility of huge taxpayer losses, and the overleveraging of the housing sector which uncontrolled agency debt aggressively promotes.

Alex J. Pollock is a resident fellow at the American Enterprise Institute. He was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.

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Dow up 1,051.32 since Oct 3 bottom. Rally still intact. Pullback today & could continue into next week. The frbNY "trading desk" isn't required to smooth out its open market operations. This market's volatility (today is a good example), is the FEDs fault & not:

"U.S. stocks slid, halting a three- day rally, amid earnings and economic reports that disappointed investors and uncertainty over how much progress European leaders are making in debt-crisis talks. Treasuries rallied, while oil surged on signs of falling supplies" Bloomberg

None of this news had anything to do with stocks.

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I doubt that the "Reserve Requirements of Depository Institutions: Reserves Simplification and Private Sector Adjustment Factor" will lessen this market volatility. The volatility is a function of seasonal factors, the 2 week reserve computation & 30 day maintenance cycles, the low level of reservable liabilities, and the large number of non-bound banks.

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"Significant changes in the growth rate of money supply, even small ones, impact the financial markets first. Then, they impact changes in the real economy, usually in six to nine months, but in a range of three to 18 months. Usually in about two years in the US, they correlate with changes in the rate of inflation or deflation.

The leads are long and variable, though the more inflation a society has experienced, history shows, the shorter the time lead will be between a change in money supply growth and the subsequent change in inflation."

Milton Friedman

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www.financialsense.com/node/5472

Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable

.... That is, in returning to a normal policy regime and reducing the amount of high-powered money in the system, the Fed will have to shrink its balance sheet. But doing so by selling assets while raising interest rates, which seems to be the latest plan outlined in the most recent FOMC minutes, the Fed will incur capital losses, and this may inhibit its will to begin to return to a more normal policy stance. Indeed, for about two years now we have been tracking weekly the estimated duration of the Federal Reserve’s capital and the amount of flexibility the Fed would have to raise rates before the market value of its assets exceeded the value of its liabilities

Our current calculations indicate that this would happen if the term structure shifted up by about 40 basis points. This is far less than the increase that would be required to return to a normal interest-rate/policy regime. There is nothing new in either Melloan’s concern or the work by Ford and Todd in Forbes that he appears to have relied upon to support his argument.

While Melloan’s concerns are valid, his comparison of the Fed to a normal commercial bank, and particularly the argument that the Fed has not printed money to engage in QE1 and QE2 but rather has borrowed money from banks at obscenely low interest rates, is totally wrong.

In the fall of 2008, during the financial crisis, the Fed engaged in a number of special-purpose programs – namely the Term Discount Window Facility, the Term Securities Lending Facility, the Term Auction Facility, the Primary Dealer Credit Facility, and three programs to acquire asset-backed securities, and engaged in reciprocal currency swaps with foreign central banks.

As a result, the Fed’s assets expanded from about $900 billion before the crisis to nearly $2.5 trillion. The corresponding increase in Federal Reserve liabilities was accounted for by a $600 billion increase in bank excess reserves, and the remainder was in the form of reverse repos. In effect, made loans and did so by giving the bank borrower a deposit at the Fed, thereby printing high-powered money.

It is important to recognize that once created, deposits at the Fed can only be significantly reduced by one of six mechanisms: a reduction in private bank borrowings from the Fed, a sale of assets by the Fed, a conversion of deposits at the Fed into currency, a shrinkage in the size of the U.S. banking system, a temporary reverse repo with the private sector by the Fed, or a reduction in outstanding swap lines with foreign central banks. All other private entity transactions do not create or destroy deposits at the Fed, but simply change their ownership.

Perhaps the clearest example of printing money, to illustrate the point, is the reciprocal currency swap program the Fed entered into during the financial crisis with several foreign central banks. The ECB, for example, gave the Fed a euro deposit at the ECB in return for a dollar deposit at the Fed.

Accounting-wise, the ECB’s liabilities went up by the amount of the euro deposit granted to the Fed, while its assets went up by the dollar amount of the deposit it received from the Fed. Similarly, the Fed’s assets went up by the amount of its euro currency holdings at the ECB, and its dollar liabilities went up reflecting the dollar deposit it had granted to the ECB. Both central banks printed money.

The ECB then used its newly acquired dollars to provide dollar loans to European banks. When the ECB made a dollar loan to a foreign bank, the ownership of the dollar deposit at the Fed shifted from the ECB to the borrowing foreign bank. When the loan was paid back, the ownership of the dollar deposit shifted back to the ECB, the swap transaction was reversed and the assets and liabilities of both central banks returned to their pre-swap levels.

The Fed’s emergency lending programs phased out as loan programs shrank and reverse repos were retired. Had the Fed not embarked upon QE1 and subsequently QE2, its balance sheet would have shrunk. But with the start of QE1 and QE2 the rundown in the Fed’s assets due to shrinkage of its lending programs was offset by the simultaneous purchase of agency mortgage-backed securities and purchases of long-term Treasuries. In fact, those purchased exceeded the amount of outstanding emergency loans the Fed had previously granted.

From an accounting perspective, the loan programs shrank, excess reserves were retired, and the Fed simultaneously reprinted money to purchase the MBS and Treasury securities. It did not borrow money from commercial banks. Put another way, the money printed to fund the emergency loan programs, and more, was morphed into MBS and Treasury securities and this is clearly shown in a chart of the Fed’s assets www.cumber.com/content/misc/fed.pdf.

Think about it. Where would the excess reserves come from that banks held with the Federal Reserve, if the Fed hadn’t originally made the emergency loans or subsequently purchased assets? If Mr. Melloan’s analysis were correct, the excess reserves, which are assets to the private banking system, would have had to come from shrinkage of their assets and deposits, thereby turning required reserves into excess reserves, or by keeping their balance sheets the same size and shifting the composition of their assets by reducing loans and securities and increasing their reserves at the Federal Reserve.

Just before the crisis in August 2007, banks held only $45 billion in total reserves, and $40 billion of that was in the form of required reserves. Clearly, shrinkage of deposits could not have funded the huge increase in excess reserves in the banking system that came with the Fed’s emergency lending programs. What about a shift in the composition of bank assets from loans and securities to deposits at the Fed? Data show that while bank loans have declined by about $600 billion, securities holdings have increased by about $600 billion. Therefore, the so-called borrowing from commercial banks could not have come from declines in their securities and loans.

So, George Melloan has totally mischaracterized the source of funding for the Federal Reserve’s QE1 and QE2 asset purchases. The Fed first printed high powered money through its emergency lending programs and as those programs were phased out the Fed again purchased agency mortgage-backed securities and Treasuries from the public by printing money, and the proceeds of those purchases show up as customer deposits in banks, with the offsetting asset being not new loans but excess reserves held at the Fed