“Monetarists will soon have to abandon the myth that a managed market for money can coexist with a free market for everything else.”, Daniel Oliver Jr., New York
Yes, the Fed Got Some things Right, but Look Ahead
Monetarists will soon have to abandon the myth that a managed market for money can coexist with a free market for everything else.
Aug. 29, 2014 5:07 p.m. ET
In “A Few Things the Fed Has Done Right” (op-ed, Aug. 22), John Cochrane purports to expose as “fallacy” the charge that quantitative easing will cause inflation. He states that banks should be indifferent to whether they own Treasurys yielding interest or bank reserves deposited at the Fed yielding the same interest because the two are “perfect substitutes at the margin.” He is wrong.
Deposits can be withdrawn on demand. When rates rise, interest payments on deposits must also rise to discourage withdrawals. The interest rate of a Treasury bond, however, is fixed. The coupon payment stays the same for the duration of the bond no matter what happens to rates.
Mr. Cochrane writes: “The interest that the Fed will pay on reserves will come from the interest it receives on its Treasury securities.” The Fed has been acquiring Treasury bonds with maturities of up to 30 years. When rates eventually rise, the Fed’s income on these bonds will stay the same—for decades. But the Fed will have to increase its payments to the banks immediately to restrain the banks from injecting trillions of dollars of excess reserves into the economy. The higher rates go, the greater the losses at the Fed will be.
A determined state can prevent inflation through capital controls of sufficient strength, but then side effects such as poverty begin to manifest. Monetarists will soon have to abandon the myth that a managed market for money can coexist with a free market for everything else.
Daniel Oliver Jr.
Prof. Cochrane repeatedly refers to “market interest” while paradoxically applauding Fed control of interest rates through asset purchases. If unmanipulated by the government, the market rate is, and always will be, one that covers the cost of funds and expected inflation, plus a variable risk premium.
Mr. Cochrane’s claim that nothing would change if the Fed sold its Treasurys to the banks is true only if one assumes that banks would readily buy the paper at par. What is amazingly omitted by Mr. Cochrane is the fact that the Fed creates interest-free government debt by returning its profit to the Treasury. I doubt that a bank holding Treasurys would be so generous.
I suspect that the savers, retirees and pensioners would disagree that “the existence of the Fed’s program has minuscule effects on investors’ options in a crisis.” Those who save or have saved for retirement, are given the choice of equity risk or a systematically decimated nest egg due to years of negative returns on savings. The saver is the loser—the forgotten man—in the Fed’s grand monetary experiment designed to embody the Keynesian paradox of thrift.
Sugar Land, Texas
Mr. Cochrane reports that monetary policy has been neither deflationary nor inflationary. Another way of describing this outcome is to say that recent monetary policy has been ineffective.
The only way that aggregate demand policies (including monetary policy) increase employment is by creating price inflation that temporarily reduces the real wage, which, in turn, increases hiring. This is only a temporary fix for unemployment because money wages eventually will begin to rise to compensate for the rising prices. Nevertheless, an inflationary monetary policy is, at least, effective in the short term. It is ironic that monetary policy has done so little to shape economic events since 2008 that the best that can be said of it is that it had no effect.
Mr. Cochrane also expresses a concern that the Fed may not be able to maintain its balancing act in the future and will tumble the economy into either an inflationary or deflationary period. This outcome would be particularly tragic since the Fed could have easily implemented a do-nothing monetary policy by simply doing nothing.
Does Mr. Cochrane’s statement “reserves that pay interest are not inflationary” mean that so long as banks never lend them out, which is trite, or more significantly that banks won’t lend them out because the Fed will continuously raise the interest rate paid to banks on their reserves to keep them from being lent out in the face of rising demand from the private sector? This path almost guarantees choking off any private sector-led growth recovery, but, yes, it does prevent inflation. What is it exactly that “the Fed has done right”?
David T. Geithman
St. Augustine, Fla.