This was originally published in Health Affairs.
It has been five years since the epicenter of the global financial crisis that erupted in late 2008 moved from the United States across the Atlantic. Since then, while the U.S. economy has enjoyed recovery with steady growth, the euro area economy has languished, going through a double dip slump and currently at risk of falling back to an unprecedented triple dip recession. The mismanagement of the euro area crisis has converted a relatively small and potentially easily manageable fiscal problem that originated in Greece into a systemic crisis for the euro area as a whole.
The Federal Reserve and many other central banks have achieved remarkable credibility in the two decades preceding the financial crisis of 2007-2008. However, the recent financial crisis and the call for central bankers to focus more on financial stability and especially the tools of macro prudential regulation may pose significant challenges for central banks to preserve their credibility in the future.
The classical theory of inflation attributes sustained price inflation to excessive growth in the quantity of money in circulation. For this reason, the classical theory is sometimes called the “quantity theory of money,” even though it is a theory of inflation, not a theory of money. More specifically, the classical theory of inflation explains how the aggregate price level gets determined through the interaction between money supply and money demand.
These days deflation risk is a concern that many central bankers, pundits, and journalists voice regularly. Concern may be the wrong word; it might be better called an obsession. Central bankers – we are told – must battle deflation risk today at all costs because deflation slows growth, and may cause recessions and financial system collapses. As I will show in this essay, the economic risks associated with disinflation or deflation are being exaggerated by central bankers and others.
How often have we heard the phrase “if the Fed hikes rates too early, the economic recovery will be derailed”? It’s ingrained into the Fed’s mindset and statements like it appear frequently in the media. Yet the history of Fed rate hikes during prior economic expansions suggest that such fears are unwarranted, and the current 5 ½ year old expansion is on sound footing and would fare just fine and even be enhanced if the Fed began hiking rates. Normalizing interest rates should be welcomed, not feared by the Fed.
Quantitative monetary policy at the zero interest bound should be understood as a “bond market carry trade.” Net interest earnings on the front end of the monetary carry trade should be retained—to guard against the central bank having to create reserves (or borrow) to pay interest on reserves or managed liabilities on the back end, and to show that interest expenses are paid for in large part by earnings from the front end. In the United States, the Federal Reserve balance sheet reflects the front end of a carry trade in that by the end of 2014. The Fed has long asserted independent authority to retain net interest income thought necessary as surplus capital against prospective exposures on its balance sheet. The Fed recognizes that the retention of net interest earnings to build up surplus capital incurs no resource cost for the Treasury or taxpayers. Yet, the Fed has chosen not to build up surplus capital against the carry trade exposure and risk on its balance sheet, jeopardizing the operational credibility of monetary policy for price stability.
The appearance of the Bitcoin system, which offers a radically new type of asset that is intended to be used not only as an investment but also as a medium of exchange—and whose operation lies entirely outside the domain of the Federal Reserve—is an extremely interesting recent development in the area of monetary institutions. As matters stand now, the quantitative magnitude of Bitcoin is extremely small in comparison with traditional assets. It must be said, nevertheless, that the development of the system reflects an extremely impressive intellectual achievement.
“In God We Trust” was first emblazoned on U.S. paper currency in 1957, and was steadily introduced to all U.S. paper currency by August of 1966. How has this demonstrative, articulated trust in God underpinned the value of our currency? Trust in God, sadly it seems, has led to an over two-fold increase in the rate of deterioration in the value of our currency. Trust in God alone has not preserved the value of our currency – so in the spirit that we “render unto Caesar that which is Caeser’s” , trust in the Fed is likely more important to underpin the value of a dollar. But can we trust the Fed?
My findings cast doubt on claims that rising inequality is responsible for slowed income growth in America—and they suggest that attempts to reduce income inequality, in the U.S. and elsewhere, may not produce higher living standards among the poor and the middle class.
When most people consider the effects of government policy on economic inequality they think of taxes, welfare programmes, charter schools or student loans. But, as we show in our new study of the history of politics in shaping banking policies around the world, inequality can be affected by the rules of the game under which banks operate. Those rules define, among other things, who gets to be a banker, who gets access to credit and who pays for bank bailouts.
Obama can threaten corporations ad infinitum, but he can only stop inversions by encouraging Congress to reform the code so that U.S. multinationals have the same tax and investment advantages as foreign ones. By inverting, corporations are only acting in their best interests and in the interests of their shareholders, and they should be praised for doing that.
Honorable Members of Congress, you could immediately assist Ukraine and other countries by amending the Natural Gas Act to ensure that the Energy Department approves LNG export applications within a short period of time.
You could also pass legislation allowing LNG to be exported to all World Trade Organization members, irrespective of whether they have free trade agreements with the United States. You could go still further, and cease to require approval for LNG exports.