Re: Hummel Inquiry

[wfhummel@xxxxxxxxxxxxxx (William F. Hummel)]

On Sat, 11 Oct 1997 Warren Mosler wrote:

A few final comments on an interesting question.

>William F. Hummel wrote:
>> You make a good point about banks using their excess reserves to
>> buy interest bearing accounts, and thus ending up with the bonds
>> (or equivalent).   However that is not their only option.  The
>> excess reserves could also be used to write new loans, which
>> would of course further increase the credit money supply.
>
>New loans do not change the reserve picture of the banking system
>in that statement period.  in the next statement period required
>reserves increase somewhat due to the new loans.  Only if the Fed
>was prepared to let overnight rates fall to 0 bid until the
>reserve excess was 'used up' would the above policy be left in place.
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Quite true, so the Fed would buy short term paper to soak up the
excess reserves as they developed.  But the increasing activity
in short term paper due to the large volume of pegged bonds
bought by the Fed would eventually force it to sell the bonds.
But who would buy pegged bonds yielding less than demanded by the
public?  Given the option, the banks normally prefer to use any
excess reserves expanding their loans, not their securities
portfolios.  Thus the dilemma that leads me to question how
realistic it is for the Fed to try to peg a seasoned bond issue
over an extended period at a price above what the market is
willing to pay for it.
>
>If the Fed, as market maker, buys bonds, clearly they can not
>simply resell them without giving up the function of market
>maker.  They would only be acting as broker, and would need
>to let the price of the bonds float at market level rather
>to follow this policy.  So when acting as market maker to peg
>a bond, offsetting operating factors is generally done in the
>short term market.  For example, the Bank of Japan regularly
>buys long JGB's and offsets the reserve imbalance by offering
>short term paper for sale.
>short term paper.
------------
In the discussion regarding the Fed as a market maker, it was to
peg the price of a bond issue (or the yield on seasoned bond
issues of a particular maturity).  In that context, the Fed
obviously could not act as a broker.  It would have to act as a
dealer and stand ready to buy or sell at the pegged price or
yield.  It would have to hold an inventory from which it could
deal.  The Fed would also have to deal in short term paper to peg
the overnight rate as it normally does in response to changes in
system reserves.  But that is true whether there is a bond peg or
not.

>The growth in deposits, apart from those associated with the banks
>purchase of securities, is a function of net loan volume.
>There may or may not be any correlation with the structure of rates
>and such loan volume.  Furthermore, there is the additional
>question of the economic significance of the 'size' of any money
>aggregate.
------------
The term "size of the money supply" is vague.  But what is not
vague is the economic significance of too rapid growth of the
money supply, however defined.

William F. Hummel