No, the Fed Doesn't Have a Plan. Yes, the Fed Really is Monetizing Government Debt
Oh, what a difference a few years make.
After the Crash of '08, the Fed entered a period of "extraordinary" monetary policy marked by large scale purchases of Treasuries and other (worse) securities from commercial banks. This process, termed quantitative easing, began in November 2008 as a supposedly temporary measure to provide liquidity (and thus operational stability) to the banking sector. A Wall Street crisis would become a Main Street crisis otherwise, the story went.
As recently as 2013, Fed officials spoke quite confidently about returning the size of the Fed's balance sheet to "pre-crisis" levels. In other words, the unprecedented expansion of the monetary base — from less than $1 trillion to more than $4 trillion — would be reversed. The Fed had a plan!
Here is St. Louis Fed President James Bullard in 2010:
The (FOMC) has often stated its intention to return the Fed balance sheet to normal, pre-crisis levels over time. Once that occurs, the Treasury will be left with just as much debt held by the public as before the Fed took any of these actions.
Furthermore, Fed officials were adamant that QE did not and would not amount to central bank monetization of government debt. According to Fed economists David Andolfatto and Li Li, the question hinges on what the Fed intends to do with its portfolio over the long term. Provided the swollen balance sheet created by QE returns to pre-crisis levels, the Fed is merely acting according to its dual mandate and stabilizing the economy. Here's the forthright statement from the St. Louis Fed in 2013:
For example, the FOMC has made unusually large acquisitions of longer-term securities, including Treasury debt. But is this debt a permanent acquisition? Or will its stay on the Fed's balance sheet be temporary? Andolfatto and Li address these questions:
- If this accumulated Treasury debt is supposed to be permanent, then it is reasonable to expect that the corresponding supply of new money would also be permanent and would remain in the economy as either cash in circulation or bank reserves, Andolfatto and Li write. As the interest earned on the securities is remitted to the Treasury, the federal government essentially can borrow and spend this new money for free. Thus, under this scenario, money creation becomes a permanent source of financing for government spending.
- On the other hand, if the Fed's recent increase in Treasury debt holdings is only temporary (an unusually large acquisition in response to an unusually large recession), then the public must expect that the monetary base at some point will return to a more normal level, with the Fed selling the securities or letting them mature without replacing them. Under this scenario, the Fed is not monetizing government debt;it is simply managing the supply of the monetary base in accordance with the goals set by its dual mandate. Some means other than money creation will be needed to finance the Treasury debt returned to the public through open market sales.
Many economists, mostly Austrians but also certain fellow travelers, have argued for years (even before QE) that the Fed's willingness to buy Treasury debt represented a kind of blank check for Congress: don't worry about the debt, spend what you need to prevent the natives from getting too restless... Just issue Treasuries to paper over the deficits, and we'll be here (wink wink) to provide a ready backstop market. No need to raise rates.
And Fed critics, again mostly Austrians, have argued since 2008 that "normal" monetary policy would never return, that QE would never be unwound, and that artificially low (or even negative) interest rates were here to stay. In other words, that the Fed and its 300 Ivy League economists don't know what to do other than kick the can down the road another few months while hoping for a miraculous economic recovery.
Fast forward to today, and the recovery hasn't materialized. And Fed officials, current and former, are singing a different tune about ever restoring the balance sheet to pre-2008 levels.
Consider this remarkable admission made recently by former Fed Chair Ben Bernanke:
But that principle (reducing the Fed's balance sheet) is now being second-guessed as well. At the Fed’s exclusive annual conference in Jackson Hole, Wyo., which draws some of the world’s most influential policymakers, several prominent economists argued that the Fed should maintain a large balance sheet indefinitely. The idea has the backing of Bernanke, who recently questioned Yellen’s continuing support for the exit strategy outlined two years ago. "Does this plan make sense? The answer is not clear cut," wrote Bernanke, who is now a distinguished fellow at the Brookings Institution. The Fed's"plan to return to a pre-2008 balance sheet and the associated operating framework needs more thought."
This entire Washington Post article is well worth reading. The nod to Sartre is an attempt at humor, although the Post has been among the Fed's biggest cheerleaders. But the comments section to the article, as usual, tells the real story: even progressive WaPo readers sense that the Fed is clueless, and that there are no brilliant people in Washington working on a "plan" to save us. Extraordinary monetary policy is the new normal, and all those pundits who assumed the Fed knew what it was doing were- and are- wrong.