Re: the Fed: comment from weblog

"William F Hummel" <wfhummel@xxxxxxxxxxx> wrote in message
news:nkhge1ll48il4tdbohambjf2dndfdb9cdc@xxxxxxxxxx
> On Wed, 27 Jul 2005 20:47:08 -0400, "Dan in Philly" <djr8@xxxxxxx>
> wrote:
>
>>"William F Hummel" wrote in message ...
>>
>>> The fact is the Fed long ago
>>> gave up targeting the money supply because it bore no particular
>>> relation to its primary targets -- inflation rate and unemployment.
>>> It now targets the overnight lending rate, and leaves both the money
>>> supply and banking system reserves as residuals.
>>
>>Which makes sense now that interest rates and inflation rates don't
>>fluctuate dramatically. But I remember the late 70s, early 80s when Volker
>>was trying to kill inflation. Then the emphasis was on the money supply,
>>since no one knew what interest rates were 'appropriate'.
>
> If you recall, in those years the Friedman monetary policy
> prescription of controlling money supply growth was riding high.
> However I don't think Volcker ever had a quantity target for the money
> supply growth rate, although he may have tried to make it seem so as
> political cover for his real objective -- which was to break the back
> of the inflationary spiral. To succeed, he had to raise the Fed funds
> rate to historic highs and keep it high until the economy tanked and
> unemployment soared. In that respect, he succeeded although the cost
> was pretty severe.

There are a few of us who believe that the inflation
could have been stopped with much less colateral
damage through the use of fiscal policy, i.e. tax
hikes, or through a combination of tax increases
and interest rate increases. What Volcker did was
to sacrifice the middle class (and that included most
of all the small farmers and small business owners),
on the alter of the rich. Sombody pocketed all that
interest and it sure as hell wasn't the people that
lost thier jobs or were put out of business due
to the sever cost of credit.

>>
>>>>>Loanable funds are created by the banking system, not by the Fed.
>>
>>>>When the Fed buys bonds from banks, it gives them money that was not
>>>>saved by any saver. The banks can lend that money because it is a part
>>>>of their excess reserves.
>>
>>> This assumes that the Fed initiates a sequence involving its
>>> injecting reserves, which are then loaned by banks. The sequence is
>>> backwards. In truth, the Fed buys bonds from banks (or security
>>> dealers) to satisfy the demand for reserves that banks as a whole need
>>> to back their net lending. The reserves themselves are not loanable
>>> by definition. They are what the banks must hold to back their
>>> lending.
>>
>>I don't see why it's important as to how it's initiated. For example:
>>suppose we start in equilibrium (nominal gdp growing at say 5%, loans
>>growing at 5%, reserves growing at 5%, etc). Now consider two scenarios:
>>
>>1. Hummel's example.
>>There's a sudden increase in demand for loans. Banks lend the money, then
>>need more reserves as required. If the Fed accomodates, then we have more
>>reserves and more loans; if the Fed refuses to accomodate, then the banks
>>will have to reduce their loans back to normal.
>
> The Fed must accommodate or lose control of the Fed funds rate. It is
> important to keep the Fed funds rate stable around the announced
> target rate because all bank lending rates, short and long term, are
> marked up from the Fed funds rate. A volatile Fed funds rate will
> result in higher and more volatile interest rates on bank loans. That
> makes it very difficult for firms to commit to investment plans, with
> a resulting drag on the economy.
>
> If the Fed adopted an arbitrary growth rate target for reserves and
> ignored the Fed funds rate, banks would quickly find they had either
> too much or too little reserves for their needs. Under those
> conditions the Fed funds rate would drop to near-zero or would soar,
> depending on the relative abundance of reserves.
>>
>>2. Textbook case.
>>The Fed increases reserves more than usual. The banks want to lend more, so
>>they drop interest rates to lend the funds.
>
> The textbook case is more or less equivalent to the Friedman plan,
> which has since been pretty well assigned to the scrap heap.

Has Friedman scrapped it, or just the bankers?

>>
>>In either case, an expansion happens if and only if the Fed increases
>>reserves.
>
> Expansion will happen automatically as long as banks have adequate
> capital. Reserves simply follow deposits created by bank lending.
>>
>>As far as maintaining the capital requirement, I don't see a problem (in
>>either scenario). If banks are lending more - either due to increased demand
>>for funds or due to increased supply of funds - they should be able to
>>maintain their profit margin, thus raising total profits accordingly and
>>making it easy to increase capital accordingly.
>
> The capital requirement is designed to prevent banks from expanding
> their balance sheets to the point of becoming insolvent and wards of
> the state. Most banks maintain sufficient capital adequacy to permit
> them to make sizable loans on short notice. Capital growth through
> retained earnings or sale of bank shares comes incrementally and too
> slowly to meet that objective.

So how does "capital growth" happen if not through "retained
earnings or sale of bank shares".

--
"I know no safe depository of the ultimate powers
of society but the people themselves; and
if we think them not enlightened enough to
exercise their control with a wholesome
discretion, the remedy is not to take it from
them, but to inform their discretion by
education." - Thomas Jefferson
http://GreaterVoice.org



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