Hummel Inquiry

[Warren Mosler <mosler@xxxxxxxx>]

William,

Both of your posted questions are attached:

> -----------
> Are you saying the money supply (defined as deposits, not bonds)
> will remain unaffected by the net purchase or sale of bonds due
> to OMOs supporting the overnight rate?

In this case, yes.  However, there is the possibility that
the public could be selling bonds to the Fed, and putting
the $ in a bank, with the bank buying the bonds.  This would
increase the money supply as generally (narrowly) defined.
There may be some economic difference between the case of the public
holding bonds or deposits, if the holding itself effects the
propensity to spend.

  If so, are you implying
> that both the overnight rate and the bond rate can be pegged
> simultaneously at arbitrary points by this method?

Yes.

  If so, can
> this system work for a number of different bond maturities
> simultaneously, in other words could the entire term structure be
> controlled by the Fed by making a market in a range of longer
> term securities while using OMOs to control the overnight rate?

Yes.

> All with caveat that the money supply would remain unaffected?

As above, and also below.
I don't find the term 'money supply' very useful in isolation.
It is often used with the implication that a larger or smaller
'money supply' per se, is some type of 'monetary force.'


> Please elaborate.
>
> William F. Hummel

-----------
Why would the banks wind up holding the bonds?

When individuals sell bonds to the Fed, and add to their
bank deposits, the banking system has a reserve excess.
If the only offset the Fed offered was bonds, the banks
would have to buy them or leave their $ in non-interest
bearing reserve accounts.  If the Fed provided other sources
of interest, such as repos, the banks would end up either
holding the repo collateral (bonds) as short term investments
or the bonds themselves-their choice.


 Or to put it
differently, why would the banks be willing to pay the pegged
price for bonds that the public is eager to sell at that price?

Different liquidity preference.

It seems to me that the Fed itself would have to be the buyer, in
effect making a (one-way) market at the pegged price.  In other
words, as Basil has said, the money supply would rip.  Until the
public had sold to its satisfaction, the overnight rate would be
out of the Fed's control.

No such thing.  The Fed can offer unlimited access to interest
bearing accounts (such as securities) to 'drain' excess reserves.


  The choice then would be which to peg,
the overnight rate or the bond rate.

No.  The Fed has unlimited ability to buy or sell any
Tsy sec. at any price it wishes, and unlimited ability to
add or drain reserves in the overnight market.

Warren

William



--
Warren B. Mosler
Director of Economic Analysis
III Finance

See:

"Soft Currency Economics"
"Full Employment AND Price Stability"
=========================
And related documents:

http://www.warrenmosler.com