Fwd: Re: clarifying FOMC

[Basil Moore <bmoore@xxxxxxxxxxxxxxxxx>]

I am forwarding a comment by John O'Donnell with his permission.

Comments anyone??



> Date: Wed, 06 Dec 2000 19:25:26 -0800
> From: "John O'Donnell" <jackodonnell@xxxxxxxx>
> Organization: @Home Network
> X-Mailer: Mozilla 4.72 [en]C-AtHome0402  (Win98; I)
> X-Accept-Language: en
> To: Basil Moore <bmoore@xxxxxxxxxxxxxxxxx>
> Subject: Re: clarifying FOMC
>
> I've attached a page from the St. Louis Fed that shows the
> significantly larger amount of adjusted reserves over the
> required reserves. The truth of this is that borrowed
> reserves are a convenience over locating available excess
> reserves not a marginal supply that sets the ff rate. The ff
> rate is adjusted by the fed through buying or selling
> government securities [or the equivalent measure of
> adjusting its holdings of repos] as needed to increase or
> decrease the money supply. [i.e. -- reserves or "high
> powered" money]
>
> The ff rate as a monetary target is an intermediate measure
> that indicates how much to increase or decrease the quantity
> of reserves and is adjusted up or down to either reflect a
> target inflation rate or is used in some misguided attempt
> to influence economic activity. When it targets the value of
> money [i.e. == an inflation rate] it always succeeds; when
> it targets economic activity it sometimes succeeds and other
> times just exacerbates the problems by increasing the
> uncertainty in the future value of money.
>
> Also note the inevitable consequence these activities have
> on meaningful interest rates. [i.e. -- those between the
> public and banks, not simply among banks] Increase the
> uncertainty in the future value of money and the meaningful
> rates increase; decrease that uncertainty and the meaningful
> rates come down, often to less than the rate between banks.
> Think about it. The effective cost of reserves could be
> increased or decreased by changing reserve or capital
> requirements without changing the ff rate at all. This is
> true even to the point of setting the ff rate much higher or
> much lower than the meaningful rates.
>
> NOTE: This did not go to the list. Feel free to forward it
> if that was your intent.
>
> Basil Moore wrote:
> >
> > John
> > My explanation would be that BR, though quantitatively small, represents
> > the MARGINAL supply price of reserves to the banking system, and so affect
> > the ff's rate, which in turn through arbitage operations governs
> > other  market rates
> > Basil
> >
> > At 12:56 AM 12/6/00 -0800, you wrote:
> > >Basil Moore wrote:
> > >
> > > > John
> > > > It seems obvious to most economists that the government can expand
> the money
> > > > supply exogenously by simply printing currency and injecting it
> into the
> > > > economy..
> > > >
> > > > But I believe I can show you that this view is false. It fails to
> follow
> > > > all the steps in the process.
> > > >
> > > > Suppose the government buys goods and pays for them with newly-created
> > > > money.
> > > >
> > > > This money will be deposited in the banking system, and the banks
> will find
> > > > that their total reserves have increased. The argument usually ends
> here.
> > > >
> > > > But this additional money will reduce the banks' need for borrowed
> reserves
> > > > (BR), since their NBR's have risen by the amount that the government
> > > > increased the supply of base money.
> > >
> > >An interesting speculation. Unfortunately the facts belie
> > >the assumptions. Check the TOTAL of borrowed reserves
> > >compared to the CHANGE in total reserves over any period.
> > >Since 1919 the total borrowed reserves have rarely exceeded
> > >a billion dollars while just the monthly change in reserves
> > >since 1950 has AVERAGED over $1 billion with some rather
> > >significant deviations from that average such as the
> > >peculiar disturbance in total reserves for Y2K.
> > >
> > >[SEE -- http://www.stls.frb.org/fred/data/reserves/borrow
> > >and http://www.stls.frb.org/fred/data/reserves/adjressl ]
> > >
> > > > If the CB is targeting the interest rate, it must immediately sell
> > > > securities on the open market, so as to reestablish the original
> targeted
> > > > level of BR's. This represents the level of "reserve restraint"
> consistent
> > > > with the CB's ff 's target rate.
> > >
> > >Who said anything about targeting borrowed reserves? The
> > >fact is that banks avoid the discount window for reasons
> > >other than the cost of funds. [Principally to avoid the
> > >regulations the FED imposes on frequent and/or consistent
> > >visitors.]
> > >
> > > > The Fed is continuously adding and withdrawing funds from the system to
> > > > keep the ff rate at its targeted level, or if you prefer within its
> > > > targeted bands.
> > >
> > >Yes, but that is only because foolish economists believe
> > >that inflation is needed to encourage employment. If they
> > >would recognize the tautological certainty that printing
> > >money does not cause economic production they might learn to
> > >accept the truth that a stable currency is the best monetary
> > >policy choice and start looking elsewhere for the fiscal
> > >policies that can encourage economic growth.
> > >
> > > > In other words, whenever the CB has an interest rate target, it
> must supply
> > > > base money in a completely endogenous fashion, in order to keep
> rates at
> > > > their targeted level.
> > >
> > >Again, yes, but they have no obligation to maintain any
> > >particular fed funds interest rate. Also, note that the only
> > >rate they can target is the inter bank [ff] rate, not the
> > >rates meaningful to economic activity such as mortgage and
> > >prime that affect people other than banks.
> > >
> > > > As a result In such a regime the government cannot create or
> destroy base
> > > > money, because any changes in the base will be immediately offset
> by the CB
> > > > in its interest rate targeting operations.
> > >
> > >Then explain the continuous creation of reserves while
> > >borrowed reserves are kept trivial as noted in the excerpts
> > >from the FED data referenced above.
> > >
> > > > Basil Moore
> > > >
> > > > At 11:58 AM 12/1/00 -0800, you wrote:
> > > > >Basil Moore wrote:
> > > > > >
> > > > > > >
> > > > > > >Barkley
> > > > > >
> > > > > > May I be so rude as to give you a short lecture? Thank you.
> > > > > >
> > > > > > Monetarism is based on the twin notions that
> > > > > > 1) monetary change explains changes in  income and prices, and that
> > > > > > 2) the money supply (MS) is under the exogenous control of the
> monetary
> > > > > > authorities.
> > > > >
> > > > >Perhaps in your world. In mine, monetarism means dQ/dM = o,
> > > > >nothing more nothing less. As a consequence of this, only
> > > > >the value of money [i.e. -- The price of money is the amount
> > > > >of goods and/or services money will buy; it is not the
> > > > >rental or interest rate of money.] is directly affected by
> > > > >the quantity of money.
> > > > >
> > > > >Any effect changes in the quantity of money have on economic
> > > > >activity are solely because of the inherent redistribution
> > > > >of purchasing power that accompanies changes in money supply
> > > > >the outcome of which is not predictable as to its effect on
> > > > >the economy, if any. Further, the money supply, if defined
> > > > >as the commodity issued by the central bank, [Sometimes
> > > > >called "high powered money" or "reserves" or by some other
> > > > >restricted phrase.] is directly under the control of the
> > > > >central bank or, if defined to include commercial bank
> > > > >credit, is indirectly under the control of the central bank
> > > > >and/or another controlling agency such as, in the US, the
> > > > >FDIC.
> > > > >
> > > > > > The PK recognition and proof that the MS moves endogenously in
> > > > > > response to changes in demand for bank credit, and that the
> > > > > > authorities provides reserves endogenously and passively
> > > > > > (accomodate the banking system's demand for reserves),
> > > > > > but at a price (short term interest rate) of their choosing,
> > > > > > puts paid to the second monetarist notion.
> > > > >
> > > > >Proving a falsehood is not proof, it is merely error. The
> > > > >choice of measure the central bank to determine how it
> > > > >adjusts the money supply does not change the reality that it
> > > > >does change the money supply to accomplish its end be that
> > > > >end an interest rate, an arbitrary measure of the supply or
> > > > >the value of money.
> > > > >
> > > > > > Banks are retailers of credit, not portfolio managers, and like
> other
> > > > > > retailers the amount they sell depends primarily on the demand for
> > > > > > their product.
> > > > >
> > > > >A demand that is affected by, among other things, the
> > > > >interest rate charged for that credit which, in turn, is
> > > > >determined by the quantity of money [or reserves] provided
> > > > >by the central bank.
> > > > >
> > > > ><<SNIP>>
>
> --
>                         -- jbod
>
>                 Tax Privilege, Not People
> ___________________________________________________
> Come visit and see a new economic perspective --
>        http://www.geocities.com/CapitolHill/1067
>            Comments/arguments welcome.
> .

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