Federal Reserve

Boom and Bust Madness: An Empirical Look at the Fed’s Dollar Binge

by Matthew Melchiorre on December 28, 2011

in Economy, Features

Given the Fed’s continued actions to keep interest rates low and its reported plans to keep them that way beyond 2014, now seems a good time to revisit the deleterious effects that monetary expansion has on the economy.

The data makes all too apparent the relevance of the Austrian Business Cycle in explaining the results of years of easy money.

Loose central bank policy fuels artificial credit expansion—economists like Bernanke would say this is the point of his policies, but he ignores the problems that cheap money creates. Fed-induced cheap credit fuels an artificial boom—that is to say, consumers and producers have access to liquidity that they otherwise wouldn’t had the central bank not intervened. However, artificially low interest rates distort both consumption and investment from their efficient market allocation.

As interest rates plummet, firms shift production from present to future as long-term investment becomes less expensive to finance. But consumers haven’t changed their consumption-saving patterns—meaning that they still consume and save at the same levels as before the Fed altered interest rates. Consumers still prefer to consume today while firms plan as if they instead demand to consume tomorrow. Monetary expansion effectively decouples investment from consumer time preferences of consumption. And the interest rate thereby ceases to serve its equilibrating function between the two.

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Peter Diamond’s Nomination to Fed Benefits from Double Standard

by Hans Bader on April 16, 2011

in Bailout Watch, Economy, Legal, Politics as Usual, Zeitgeist

Liberal economist Peter Diamond is likely to be confirmed to a powerful position, despite issues far more severe than those that blocked the confirmations of highly-respected conservatives. It smacks of a big double standard.

Diamond was nominated to one of the most powerful positions in the land — the Federal Reserve’s Board of Governors, which sets monetary policy. (The Fed is now printing hundreds of billions of dollars to buy up government debt and inflate the money supply, in a controversial policy known as “quantitative easing” or QE2, which some economists have predicted will lead to substantial inflation.)

By law, the Board is supposed to be balanced regionally, but it isn’t: its members come almost entirely from the East and West Coast. So does Diamond, a professor at the Massachusetts Institute of Technology (MIT). He has lived in Massachusetts since 1960.

The Obama administration nominated Diamond for a seat on the Board representing a district in the Midwest, claiming he is from Chicago because he has lectured at Northwestern University. But as economist Mark Calabria notes, Diamond is really from Massachusetts, which already has a representative on the Fed (Fed Board member Dan Tarullo). That violates Section 10-1 of the Federal Reserve Act, which says a new Fed member may not come from a district that already has a representative. If Diamond is confirmed, every single member of the Fed’s Board will come from a coastal state, and none from America’s heartland.

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Taxpayers Absorb Berkshire’s Dumped Bank of America Shares

by Kathryn Ciano on February 15, 2011 · 1 comment

in Economy

Late yesterday afternoon Warren Buffett’s trading conglomerate Berkshire Hathaway dissolved all of its Bank of America shares. Berkshire’s pull-out accounted for 5 million shares — not an enormous amount, but a 100 percent dump nonetheless sends a strong signal to the market.

Berkshire is up $4B this quarter over last — their formula is working. Along with Bank of America, Berkshire dumped shares in Comcast, Nike, Lowe’s, and a few other holdings.

I wrote:

In an interview released last week, the Financial Crisis Inquiry Commission quoted Buffett as criticizing Bank of America for paying a “crazy price” to acquire Merril Lynch in the midst of a financial crisis.

Until an audit subjects the Federal Reserve to transparent decisionmaking, private investments point a clearer path to what paths the public expects will be profitable in the years to come. The Fed may shift interest, but Berkshire Hathaway deals in real dollars.

Cross your fingers for Chevy’s Volt, kids, because BofA is one national investment looking dismal this week.


This is just one more way taxpayers will bear the burden of keeping banks afloat. When Congress first approved TARP last year, Treasury was slated to buy mortgage-backed securities from the banks.

The government ultimately deemed it impossible to assess securities’ values. Instead Treasury used TARP to inject free cash flow into banks by purchasing convertible bank shares — effectively bank stock options.

As banks’ losses mount and real estate prices continue to drop the banks have been unable to push these deadweight securities from their balance sheets. Banks have accepted government cash but have not been able to match that influx with equity.

Banks that do not react to investors’ cues do not adequately protect themselves from further government ownership. Last spring the three big American banks converted government-owned stock from preferred to common. Ostensibly this move protected public resources (tax dollars gov’t used to snatch up bank shares in the first place) by paying less per share but continued to “bail out” the banks stuck absorbing our securities failure.

Government holding isn’t about ownership; it’s about control. When government dollars go to preferred stock, banks monitor what Big G owns and how many dollars are going to and from this significant stockholder. When Big G pulls out of preferred and keeps instead to common, the banks are less attentive to exactly how much the gov’t owns.

The more government hands get involved, all of its influence falls victim to mission creep. When gov’t dollars go to common stock instead of preferred, it’s not like the gov’t pulled out some of its cash to match the lower equity it was purchasing. Instead, the same number of G dollars are still flowing to the banks, but holding many more shares.

The Federal Reserve was invented to counterbalance market shifts and dips. That’s the only enterprise big enough to control for inflation.

When taxpayers have to absorb yet another private investor’s signal that BofA is flailing, that’s not inflation, that’s government failure.

Michigan May Fire Salvo Against Regressive Debit Card Price Controls

by John Berlau on February 14, 2011 · 2 comments

in Bailout Watch, Deregulate to Stimulate, Economy, Property Rights

In the battle against Obamacare, the shots heard ’round the world were resolutions against the law by state legislatures. These resolutions led to court cases that have been victorious in two instances, and a new majority in the U.S. House Representatives that voted to repeal the law.

Now, the state of Michigan is poised to pass the first resolution against another command-and-control scheme, and there is bipartisan support for such a resolution. The target is the Durbin Amendment to the Dodd-Frank financial overhaul that Congress passed last year.

That measure sets price controls for the interchange fees that retailers pay issuing banks and credit unions to process debit card transactions. The Federal Reserve’s proposed rule implementing the provision explicitly sets prices at well below cost, excluding items such as fixed costs of infrastructure.

The Michigan resolution, which passed the state house  on Friday and is scheduled to be voted on in the Senate on Tuesday, lists many of the same concerns CEI has highlighted about costs being shifted to consumers, credit unions and community banks so that fat cat retail chains can get a “free lunch” on what they pay to proces debit cards.

It says in part: “Small issuers rely on debit interchange fees to provide free checking services to their customers and to cover costs associated with fraud prevention and data security. If these costs were not fully recoverable, small issuers would be unable to offer debit services to their customers, and the result could be decreased consumer choice and higher fees.”

In the House, the measure was approved by 36 Republicans and 12 Democrats. Given all that Michigan has gone through in the Great Recession, a statement from the legislature that part of a federal law is economically destructive should carry a powerful weight across the nation.

Interchange Price Controls: Gift to Big Merchants, Lump of Coal for Consumers and Community Financial Institutions

by John Berlau on December 15, 2010 · 3 comments

in Deregulate to Stimulate, Economy, Property Rights, Regulation, Tech & Telecom

On Thursday, the Federal Reserve — at the direction of Congress in the Durbin Amendment to the Dodd-Frank financial “reform” bill — will give a giant gift to some of the nation’s biggest retailers. This present is in the form of of direct and indirect price controls on the interchange fees they pay to financial institutions to process debit cards payments

Yet unless Congress acts to delay or repeal the Durbin Amendment, consumers, community banks, and credit unions will be getting a large lump of coal in their stockings by next December as the expenses of running an efficient payment card system are shifted almost entirely onto their shoulders. Consumers have already seen the costs of this rule through the loss of free checking as a result of banks’ anticipation of an estimated 60 to 80 percent loss of revenue from merchant fees. Moreover, the price controls and other provisions of the Durbin Amendment will like reduce investment and innovation to counter emerging hacking and security threats to the payment system.

The Durbin Amendment regulates the debit card issuers as public utilities — something they are not, as the amendment itself makes reference to a “the number of payment card networks” — but it sets price controls more severe than even rate regulation for local phone companies and utilities by not even explicitly allowing for profit.

Thus, as argued by a lawsuit challenging the Amendment from Minneapolis’ TCF National Bank, the fee controls likely violate both the Due Process and Takings Clauses of the 5th Amendment because they deprive banks and credit unions that issue cards of their property rights to a return on capital invested. The Supreme Cou,rt in its 1989 case Duquense Light Co v. Barasch, affirmed that  a government-set “rate is too low if it is so unjust as to destroy the value of the property for all the purposes for which it was acquired.”

The Durbin Amendment likely crosses this constitutional line by requiring the Federal Reserve to set interchange fees at a rate “proportional to the cost.” And the measure expressly discourages some costs from being considered by the Fed. Expenses such as paying employees to service the complex payment system and long-term fixed costs in setting up the sophisticated infrastructure may be excluded.

In fact, amazingly, the Merchants Payments Coalition, which represent Wal-Mart, Walgreens (who Sen. Durbin admitted — on the Senate floor — lobbied him for price controls), and some of the nation’s biggest stores, says that the cost for retailers should be “at par” or zero. Even Ebeneezer Scrooge or the Grinch couldn’t come up with a more self-serving call for corporate welfare.

And consumers have already started paying for the merchants’ “free lunch.” At banks of all sizes, free checking accounts are disappearing, particularly for lower-income consumer who don’t have linked accounts or can’t maintain higher minimum balance thresholds.

And given the experience of other countries with interchange price controls, consumers will likely lose even more without reaping any significant savings from retailers. The Government Accountability Office of the U.S. Congress found last year that after Australia enacted fee controls on credit cards, Aussie consumers faced “reduced rewards and raised annual fees,” and that there was no “conclusive evidence” that any of the retailers’ $1.1 billion in savings had been passed on to consumers.

The Durbin Amendment will also hurt community banks and credit unions. Durbin and his supporters make much of the fact that the bill officially exempts financial institutions with less than $10 billion in assets from the price controls. But both the Credit Union National Association and the Independent Community Bankers of America remain in opposition to the bill, recognizing that government controls of the market rates of credit and debit card networks will adversely affect all financial institutions that issue these cards. And smaller financial institutions are not exempt for the the other, indirect price controls in the bill, such as the routing rules that also compromise consumer privacy and data security.

Obviously, the Fed should interpret the mandates as flexibly as it can and not be bound by the vague language of some of the measures. But Congress can’t absolve itself of responsibility for this burdensome and regressive measure. This includes normally conservative Republicans, such as the duo from the state of Georgia, who speak out correctly against price controls in health care but voted for the controls in the Durbin Amendment after lobbying from Atlanta-based Home Depot

It should enact a bipartisan repeal — or at the very least delay — the Durbin Amendment at its first opportunity. It should gift-wrap this legislation by titling the bill, as I have suggested before in The Wall Street Journal, the “Free Checking Restoration Act.”

Photo credit: tidewater eyesores’ flickr photostream.

In Offense of Ben Bernanke, Part III: Bernanke, Blinder, and Underpants Gnomes

by Alex Schibuola on December 14, 2010

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes:

Here’s the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, ‘by lowering short-term interest rates,’ you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that’s mostly Treasury bills). Yes, they print money. [Italics added]

But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities.

I’m afraid that’s only partial credit, though. What the Federal Reserve has yet to elaborate on is why this “stimulates” the economy. You should know, Professor Blinder, that investment appears to be interest-rate inelastic. You wrote this in your journal article, “Is There a Core of Macroeconomics That We Should All Believe?”

The claim that QE2 is supposed to “stimulate the economy” bothers me. For those of you who watch the TV show, South Park, it reminds me of the underpants gnomes episode. The gnomes collect underpants and give the following explanation for why:

Underpants Gnomes:

Phase 1: Collect underpants.

Phase 2: ???

Phase 3: Profit!

Bernanke and Blinder:

Phase 1: QE2.

Phase 2: ???

Phase 3: Economic recovery!

I still want a better explanation for Phase 2… from the Fed. They say they want to be clear and explain their thinking, but I have yet to hear an explanation other than that.

If you want a more sane explanation for QE2: one could point out that many of the Fed’s current assets are maturing. This means that cash will be flowing back into the Fed and they want it out. Thus, the Fed is trying to keep its balance sheet steady rather than expand it per se.

I surmise that they intend to raise the opportunity cost of holding Treasuries, thus making private sector debt and equities relatively more enticing to hold. Then banks go back to private lending, commercial paper, corporate bonds, etc., and investment expands. So it looks like the people at the Fed have discovered a free lunch. But as ECON101 teaches us, Professor Blinder, There ain’t no such thing as a free lunch!

In Offense of Ben Bernanke, Part II: The Natural Rate of Unemployment

by Alex Schibuola on December 14, 2010 · 2 comments

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes: “All in all, it looks like the nation and the world need an Economics 101 refresher. So let’s start with the basics.”

All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics.

There are three types of unemployment: (1) frictional, (2) structural, and (3) cyclical. I am frictionally unemployed if I leave my current job and take time off before starting my new one. I am structurally unemployed if I lose my job to globalization or minimum wage increases, etc. I am cyclically unemployed if the economy is in recession.

Keynes referred to cyclical unemployment in proposing his solutions. The Fed might be gravely mistaken to assume that today’s high, persistent unemployment rate is purely cyclical. The Fed can only impact cyclical unemployment, not structural or frictional. The sum of frictional and structural unemployment is the natural rate of unemployment. The Fed cannot alter this.

There are many reasons why structural unemployment rather than cyclical unemployment might be at play:

  1. Exchange rates are more volatile: unpredictable monetary policies and debt crises are the cause. If I am in an industry that relies heavily on exports, I am in danger of unemployment.
  2. Health care reform: the costs have yet to be determined and increase employment costs. Needless to say, employers care about the total costs of hiring employees, not just the money wage/salary they pay workers. This uncertainty overwhelms the tiny tax credits offered in the stimulus package.
  3. The housing market is still sick. If people can’t move easily, labor mobility is constrained. It’s more difficult for me to find work if I can’t move.
  4. Higher, extended unemployment benefits reduce the incentive to be employed, at the margin.
  5. The Dodd-Frank Act also imposes numerous uncertainties on the financial sector. This complicates the process of linking savers with investors. Consequently, investment is curtailed and higher unemployment results.
  6. The uncertainty about the capital gains tax rate didn’t help. Increasing taxes on capital decreases capital accumulation (investment). It does not help it. If productivity-increasing equipment costs me $200,000 and I’m willing to pay $250,000 for it, that’s great! If I have to pay a $60,000 tax on it, that’s bad: The equipment now costs me $260,000 and I was only willing to pay $250,000 before. Now I won’t buy it. I am worse off. The equipment supplier is worse off. The employees of the equipment supplier are worse off because they’ll need fewer workers for production.

If 10 percent is the new natural rate of unemployment, then fiscal policy simply crowds out private investment — private sector spending declines 1 for 1 with increases in government spending in that case. Monetary policy is completely impotent.

In Offense of Ben Bernanke, Part I: The Fed is Competent?

by Alex Schibuola on December 14, 2010

in Economy

Professor Blinder writes: “To create the fearsome inflation rates envisioned by the more hysterical critics, the Fed would have to be incredibly incompetent, which it is not.”

First off, I’ll admit that critics of Dr. Bernanke may use bad logic. Nevertheless, a good economist will tell you that people are rationally ignorant: The opportunity costs of becoming an expert at everything, such as nuclear physics, foreign policy, and macroeconomic policy are very high. Consequently, people take many mental shortcuts. Politics is no exception.

Politicians fill this void usually by concluding an argument such as, “that so and so is a Nazi.” Translation: “so and so” or “such and such” policy is bad. In econ-speak: the costs exceed the benefits to society. While the applied logic of politicians and pundits may be (probably) wrong, it doesn’t mean that Dr. Bernanke and the Federal Reserve don’t warrant criticism.

Now, truth be said, I believe Dr. Bernanke to be a first-rate academic and a very well-intentioned person. However, I doubt his ability (or anyone’s for that matter) as Federal Reserve chair. After all, they’ve been tasked with a fool’s errand: maintain full employment and a stable price level — and if there’s time, to maintain stable long-term interest rates. Underlying this is the premise that they can find the market-clearing interest rates better than the market itself.

You should give the Fed more credit, Professor Blinder. They failed in the early ’20s, they created and exacerbated the Great Depression, they let inflation get out of hand between the ’50s and ’80s, and there are strong theoretical propositions pinning the stock-market bubble of the 1990s and the housing bubble of the 2000s to the Federal Reserve.

If you were to read former Federal Reserve Governor Frederic Mishkin’s textbook on money and banking, one chapter documents how every decade since its inception, the Fed always found a new way to mess up. The Fed is just not that great.

Professor Blinder writes: “All in all, it looks like the nation and the world need an Economics 101 refresher. So let’s start with the basics.”

Let me conclude Part I by stating: All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics.

See also:
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Quantitative Easing Explained (Video Comedy)

by Lee Doren on November 15, 2010

in Bailout Watch, Economy

Sometimes humor is better at explaining economic concepts than wonkish theory. Below is an interesting video regarding quantitative easing. Although it may place too much blame on companies like Goldman Sachs, it does a pretty good job describing the the corruption and absurdity that takes place with monetary policy in the United States.

While it is argued that the Federal Reserve must be entirely separate from politics in order to utilize independent judgment for its policy, often conflicts of interest appear to play a role nevertheless.

Enjoy and take this video below with a grain of salt.

Ron Paul to Head Federal Reserve Oversight Subcommittee?

by Kathryn Ciano on November 5, 2010

in Bailout Watch, Economy

In a bizarre turn of events following Tuesday’s elections, Rep. Ron Paul, the government’s #1 “end or audit the Fed” guy, will likely be in charge of Federal Reserve oversight:

Paul is the ranking member of the Subcommittee on Domestic Monetary Policy and Technology on the Financial Services, which oversees the Federal Reserve, the U.S. Mint and American involvement with international development groups like the World Bank. Unless someone bumps him, he’s next in line for the subcommittee gavel.

This means that Ron Paul will be in charge of ensuring that monetary policy is transparent. Ron Paul, who blames the Fed for manipulating interest rates in a way that deteriorates the way a healthy market functions, will make sure that the public knows what Fed Chairman Ben Bernanke does all day.

Blogging at the D.C. Examiner, I wrote:

The Federal Reserve has enjoyed casual oversight while Congressman Barney Frank served as chairman of the Monetary Policy subcommittee. That is about to change.

Ron Paul has spent his tenure in politics pushing vehemently for a Federal Reserve audit. Paul has been particularly forceful in asking that the Fed reveal where the government is actually spending TARP funds.

After the Nov. 2 election, Ron Paul made it perfectly clear that he intends to use his oversight power to keep the Fed transparent:

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