Russ Roberts

George Selgin on Monetary Policy and the Great Recession

EconTalk Episode with George Selgin
Hosted by Russ Roberts
A Better Strategy for Feeding ... Does Bernanke deserve the Bage...

Did Ben Bernanke and the Fed save the U.S. economy from disaster in 2008 or did the Fed make things worse? Why did the Fed reward banks that kept reserves rather than releasing funds into the economy? George Selgin of the Cato Institute tries to answer these questions and more in this conversation with EconTalk host Russ Roberts. Selgin argues that the Fed made critical mistakes both before and after the collapse of Lehman Brothers by lending to insolvent banks as well as by paying interest on reserves held at the Fed by member banks.

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Podcast Episode Highlights
0:33Intro. [Recording date: November 23, 2015.] Russ: Now, this conversation is going to draw on a lengthy blog post you made at Alt-M, the blog, that discusses monetary policy during and after the Great Recession. And you start by talking about the tradeoff between preventing a financial meltdown at any particular time, and the challenge of moral hazard. What is that tradeoff? Guest: Well, very simply, it's a choice between allowing firms to fail--particularly, backing firms, not just banking firms--and taking the risk that their failure will cause problems for other firms, and perhaps lead to subsequent failures. As a [?] to allow us rescuing[?] them in order to contain the failure. So, if you rescue them, you avoid the immediate problem of triggering further failures. But you also create a moral hazard that consists of the expectation on the part of other firms that they will be rescued, should they get in trouble. And so this is the difficult choice that Central Bankers face. Russ: Yeah. The metaphor I like is preventing forest fires. You try to put out every fire immediately, so you never have a fire. Eventually enough stuff accumulates--underbrush and twigs and dead trees--that there's going to be a fire that comes along that you can't put out without a huge amount of damage. And that's really the history to some extent of the modern era of Yellowstone National Park and other areas. So we rescued banks from disaster, which, at the time, seems like that's a good thing: We avoid the costs. But that encourages banks to be reckless; that in turn creates the conditions for a meltdown that's particularly unpleasant. My argument, which I think we both agree on this, is that that's part at least of what happened in 2008. Previous rescues led to this expectation of rescue. And now that we've rescued again, with such zeal, we're risking a future crisis. Which, of course, we're going to be right on. So we can't lose this battle. Just as long as we live long enough. Guest: No, and [?] money predicting a financial crisis would come eventually. Russ: It sounds prescient. We have to be careful: it is a little bit-- Guest: Well, some people predict one every year and then make a great deal about it when it finally comes about. I'm not involved in that racket. I'm merely predicting that there will be another one some day. Russ: Yeah. I guess the question--I guess the claim that our view would have to imply is that it's going to get worse and worse each time. Each time there's one, it should be less and less pleasant and more and more costly to put out. Guest: Absolutely. Once--the real change, the real sea change I think came with the rescue of Continental Illinois. And that really is what launched 'Too Big to Fail.' That doctrine had been there implicitly, I suppose, before that. But that particular intervention made it a clear reality and as far as large financial firms were concerned, from that point onward they were playing a different game--a game in which at least some part of their risk-taking was perceived by them to be subsidized as it were by the Federal Reserve. And this was, of course, a new kind of moral hazard. There have been moral hazards in the system as a result of deposit insurance. And we saw how that could get pretty serious in the 1980s with the S&L Crisis (Savings and Loan Crisis). But now the extent of implicit insurance had been broadened tremendously by the doctrine of Too Big to Fail, and that's what we've been dealing with ever since. Every rescue of a big firm only serves to reinforce the expectation of future rescues. Russ: And Continental Illinois was 1984, so we are talking about a 25-, approximately a quarter-of-a-century-, 24-year chance for it to fully come home to roost. I want to point out that in my essay on the Crisis and others that people have written, they don't just point with hindsight, which is of course a lot easier to tell an ex-post narrative, and inherently that is what it is to some extent--you have to be honest about it. But at the same time, there were people in real time who were waving around the concerns that these rescues in 1984--Mexico in the mid-1990s and other firms, Long Term Capital Management (LTCM)--that these were going to lead to problems. People were, I think, aware of the real effects. Guest: Absolutely. Many good economists and some people in the business world as well saw what was coming. And the irony of this is there is something of a self-fulfilling notion of the nature of Too Big to Fail. When the smaller firms, relative to what's happened since, got in trouble, it turns out that in many cases like Continental Illinois--it was by no means at the time but it would be small compared to some of the rescues since--the studies afterward cast tremendous doubt on the claim that the failures of those smaller Too-Big-to-Fail firms really did or would have had such severe systematic consequences as those who defended the bailouts at the time predicted. In fact, it's pretty clear to everyone now that if Continental Illinois had been allowed to fail, we would have gotten over it. And only a relatively small number of not-very-important other financial firms would have been adversely affected. But, of course, as a result of that bailout, the expectation of such bailouts has increased. And the consequences that bigger and bigger firms end up being bailed out. Of course, at some point, you get to firms that really are too big to fail. Russ: Yeah. Well, that's the self-fulfilling part. Guest: But the reason you find yourself in that situation is that you treated others as Too Big to Fail when they really weren't. Russ: Yeah. I think the point to emphasize is that they become "Too Big to Fail" because they have these creditors who allegedly, if the firm fails, then the creditors are going to fail, and there will be this cascading domino effect. And there's an inherent subjectivity about this that makes it hard to assess it empirically. Obviously it's challenging to know how important one failure might be. It's very challenging to know how hard it might be to unravel a firm in the state of bankruptcy--what the consequences of that would be. But I think the economics of it is very straightforward. Which is: Lenders, because they have limited upside and can be wiped out on the downside, tend to be cautious. When they become uncautious, there are only really two possibilities. One is they are foolish--which is always possible. But the second is, rationally or perhaps subconsciously, that their downside has been protected by a government insurance plan. And I think the question is: How big is that effect? You can argue about it.
9:08Russ: Let's move on back to the Fed for a minute, and the 2008 Crisis. I want to talk about an economist we've mentioned before. His name is Walter Bagehot. And he's confusing to talk about because his name is B-a-g-e-h-o-t. And I mentioned on the program before, when I was in graduate school I thought his name was pronounced 'BAG-ah-ho'. And I had no idea who was this Badget-guy people were talking about. But, it's Walter, right--did I get his first name right? Guest: Yes, it is Walter. Russ: So, that was easy. But Walter Bagehot, in a book called Lombard Street, laid out a set of principles for central bankers that most economists would say are the right principles. What is Bagehot's set of principles--rules for how a Central Banker should deal with a financial crisis such as the one we were in, in 2008? Guest: Well, of course, Bagehot couldn't have anticipated the particular crisis we've had now, we had recently. But his principles are very general ones that many economists think are as applicable now as when he set them out. Russ: Which is roughly when? When was he writing? Guest: 1873 or just before. He was responding to the 1866 Crisis that England had faced, and was presumably developing Lombard Street, working on it, in the years following that crisis. But it came out in 1873. The basic doctrine or dictum--it's since been called--as he came up with: faced with a crisis, the Bank of England--he was specifically referring to the Bank of England--should lend freely, at high rates, on good banking collateral. And there were various reasons for this. The high rates were partly intended to deal with an aspect of financial crises at that time which is not necessarily important today, and that's what Bagehot called an 'external drain.' An external drain is when the country as a whole was losing gold or suffering an adverse balance of payments with the rest of the world. High interest rates were partly intended to combat that adverse drain, that external drain of specie by attracting capital from abroad that would offset the tendency for this drain to keep going. The high rates, however, also had the role of discouraging banks from borrowing from the Central Bank just to take advantage of the subsidy and to relent. The idea was that the Central Bank should be providing liquidity to illiquid but solvent firms, but shouldn't be just providing cheap credit for them to use to arbitrage lending with. Russ: So, let's just segue--why don't you explain, because the key distinction there is illiquid but solvent. Guest: That's right. Russ: Banks can be insolvent--in which case they are probably going to be illiquid. Well, no, not necessarily; I guess they could be insolvent but liquid; you quickly found out just how insolvent they are. But, in general, it's easy to get those confused. I may have just made it worse. But tell the listeners and explain what a solvent bank that is illiquid means. Guest: A solvent bank is a bank where the value of its assets is at least equal to the value of its liabilities. Now, this is not a very hard-and-fast notion. There is a lot of wiggle room depending on how the assets are valued. Generally and traditionally in banking, the value of the assets would not be valued on what we now call 'marked to market'--that is, you wouldn't always adjust for their current value. You would look at their realized value at maturity: What are they likely to be worth when they mature? And that allows bankers to not have to panic just because their assets fall in value in the middle of a crisis. In any event, though, the idea is that the assets should provide sufficient revenue and should be paid off as they mature, to an extent that would allow the bank to cover all of its liabilities. Now, liquidity is different. Liquidity has to do with the ability of the bank to service its liabilities in the short run. That means being able to come up with the cash to meet current withdrawals, to pay currently promised interest to liability holders. A bank could find itself illiquid in the sense that it's got good assets, but they are good in the long run. They are going to yield enough revenue in the long run; or, if they are loans, they are going to be paid back in the long run and the bank is going to do well, as far as that concerned, but might still be short of cash for meeting immediate obligations--to other banks and to customers. And so that's a case of illiquidity--where the bank has got good assets but it's not realizing enough of them for the current cash needs that it faces. Russ: So, the jargon here is the bank [Central Bank--Econlib Ed.] should be the "Lender of Last Resort" to keep banks from dealing with their challenge of liquidity that is inevitable from time to time; but they should not be lending to everybody. They should be lending to firms that are solvent as best as the bank can tell. And for listeners: Mild spoiler alert coming! In the movie, It's a Wonderful Life, and we've talked about this scene before, when George Bailey cancels his honeymoon to use his honeymoon money to bail out Bailey Savings and Loan, what he's doing is using his own personal cash to keep the bank--the bank is solvent, as he explains to the people who wants their money. Because it's a run. He says, 'Oh, but your money is tied up in so-and-so's house.' Because he can't claim it quickly. He's going to be getting payments, the mortgage payments, because so-and-so is employed and eventually the money will be available. But if everybody wants their money at once, you can't get it. And George uses his own personal funds to stem that run. Guest: That's right. And a run is an extreme example of a situation that confronts and can confront a bank with extreme liquidity needs. It needs a lot of cash all at once. It may have perfectly good loans and other assets but unless it can accommodate or meet these needs for liquidity, it's only going to find that the panic gets worse, and it can be bankrupted as a result of panicking customers' not getting their money. Usually the rule is if a panic doesn't pay--if it runs out of cash on the spot--that's it: it's failed. That's the definition of failure, regardless of its long-term prospects. So, in a situation where there's a run, you have to have access to liquidity. Now, it's important to recognize, though, on the other hand, that if a bank really isn't solvent--that is, if it's made some bad decisions and is holding a lot of bad assets--it's not in anyone's interest to keep it going. It's not in anyone's interest because, first of all, you can't keep it going forever because it's ultimately going to fail. So, all you can do is delay that failure. Second point, is that it's wasting resources. That is, it's an inefficient firm. So we want it out of the system. You want to weed it out. And if you keep it alive it's [?] going to compound its losses. There's a good chance it will. Because a bank, once it becomes insolvent, lacks the incentives to manage money as well, because once people are off the hook, once the capital has been exhausted, well, the temptation is to use any money to shoot the moon. Say[?] that we can make some hail-Mary investments here and manage somehow to save the bank, but if not, we can't be any worse off than before because we've already been wiped out. So, it's very dangerous to put money into an insolvent institution, apart from the fact that there's no real need for it, because assuming there are plenty of other solvent banks around, what you want to do is keep them from being knocked over from the falling dominoes of the insolvent institutions. You don't need to keep the insolvent ones themselves alive, on artificial support. Russ: And the other issue was referenced by a very nice paper by George Akerlof and Paul Romer, called "Looting," which is about how an insolvent firm that has access to capital is going to essentially overpay its officers. There's a terrible incentive problem then, for the officers. And they detail some of the ways that people have exploited that in the past. It's very a depressing article. Guest: Indeed. That's all part of the perverse incentives that kick in, as soon as a firm no longer has skin in the game, so to speak. That is, as soon as the capital has been wiped out--which is the definition of insolvency, the assets are worth less than the liabilities--then any additional funding supplied to that institution leads to all kinds of, or can lead to all kind of misconduct. So, ideally you want to shut down an insolvent institution right away. The last thing you want to do is to give it more scarce resources to play with.
19:58Russ: So, let's turn to the 2008 crisis and do some grading of the participants. Most, I would say, economists point to the failure to bail out Lehman Brothers as the turning point of the Crisis. I don't agree with that, and I don't think you do either. I point to the bailout of Bear Stearns' creditors. Basically the Fed took $30 billion dollars worth of assets onto its books, off the books of Bear Stearns, so that J.P. Morgan could buy Bear Stearns over one weekend of alleged crisis. Guest: That's correct. Russ: And in your article you quote Ben Bernanke. In his new book The Courage to Act, Bernanke writes the following:
Some would say in hindsight that the moral hazard created by rescuing Bear reduced the urgency of firms like Lehman to raise capital or find buyers.... But in hindsight, I remain comfortable with our intervention.... Our intervention with Bear gave the financial system and the economy a nearly six-month respite, at a relatively modest cost .
Now, there's some ellipses in there. You don't quote that literally word for word--well, it's word for word but you've left out some things. But if that is an accurate representation of what Bernanke wrote, it's extraordinary. I'm astounded by it. Why don't you [?] so why don't you comment on it. Guest: Well, I don't think the ellipses leave out anything that would alter the meaning that's conveyed by that quote. I'm pretty careful about not playing that-- Russ: I understand. But it has to be mentioned. I have to just make it clear. Guest: Well, as I put it in the article, I think what he ignores is that this respite drew us [?] really a period in which firms, other very large firms--and there were other investment banks that were substantially larger than Bear--thought they were off the hook and behaved accordingly. And indeed it's during this time that these bad incentives we were just talking about are starting to kick in, particularly at Lehman Brothers, with very, very adverse consequences. Because were it not for the Bear bailout, Lehman would have had an incentive to essentially prepare for bankruptcy. Which is what a firm that is probably insolvent or is looking at a situation that is likely to render it insolvent normally would do. When it has no prospect of getting a bailout, it's going to start planning for the worst. It's going to retrench. It's certainly not going to make bigger gambles, and it's not going to have any more money to play with for that purpose. So, again, this was something that was anticipated by many people at the time. I mention Michael Lewis's comments shortly after the Bear crisis--I quote him in my piece where he says the fact that Lehman is still alive and is still a going concern is because of this bailout. And he predicts that some pretty bad stuff is in store. Presumably he anticipated, as many people did, that the Fed would be driven to eventually bail Lehman out. Of course, what it did instead was to let Lehman fail. I'm reminded--I actually think that letting Lehman fail in itself might have been a good thing. But in the context it was quite harmful because it was contrary to all of the expectations at the time. What I mean is it was harmful in the sense that it was a shock to the system. Russ: It was an unexpected shock. Guest: Yeah, an unexpected shock. Russ: It's what you mean by shock--essentially it was an unexpected turn of events. Guest: Completely unexpected. And it suddenly generated a tremendous amount of uncertainty about exactly what the Fed's policy was. After Bear, people thought, 'Okay, it's too big to fail.' Now, that's a very bad thing for them to think and it resulted in a great deal of misconduct in the system--as if there hadn't already been plenty of that. But then the failure that the Fed allowed Lehman, caused even more disruption. There's another subtle aspect of this, Russ, that I think other writers haven't picked up on much. In principle, and this gets back to Bagehot, the Fed might have tried to insist that it was only bailing Bear out because Bear had sufficient collateral to justify a bailout on Bagehotian lines. This is essentially what Bernanke claims, and he also claims that in contrast, the Lehman did not have the collateral required to justify Fed support to it. So, what Bernanke has tried to argue is that rescuing Bear and helping with that merger and then letting Lehman fail, that was consistent with following Bagehot's rules. That's what he argues much of the time, though not consistently. Russ: Well, his book is called The Courage to Act; your blog post is called "The Courage to Refuse." I would call it, based on that summary, 'The Courage to Fantasize.' And I say that because, the at-the-time accounts, that weekend, when Bear was about to go down, I don't think anybody sat around and said, 'Well, you know, I think, I'm looking at the balance sheet.' There was panic. And so again, to cut Bernanke some slack and to be honest about the ease with which we can criticize, with hindsight--we have to be honest about that--at the time, it was terrifying. They were very afraid. There was a huge amount of pressure for them to bail out Bear, not necessarily for good reasons but for self-interested reasons of other bankers. Those were of course the people they were tending to hear from at the time. And so they made that decision. Now, their ex-post justification that, 'Oh, well Bear had good assets, Bagehot would approve'--now, we'll get to that in a second, because I have a quote from you that we'll look at.
26:52Russ: But I just want to add one thing to your assessment of the 6-month respite, which was, as you point out, that Lehman, instead of getting its house in order, making a last-ditch attempt to make its assets more attractive, actually went in the other direction. Which is that they borrowed money that they were pretty aware they were unlikely to be able to repay, and to get capital they were able to compensate the owners. Guest: Right. Unless they were very lucky. Russ: Right. Unless they were lucky. It's never black and white. Guest: A hail Mary pass. Russ: It's not like they planned to fail; we have to be clear about what's actually going on here. But it's not just that the Fed emboldened Lehman. It's that the Fed emboldened the people who lent to them. Guest: Absolutely. Yes. Russ: So, for me, the thing I point out. Guest: It's the creditors who matter. Russ: Yeah. Guest: The creditors matter. Russ: So what I point out is the big crisis that everyone points to as the signature disaster in the aftermath of Lehman's failure was that a number of money market firms were going to break the buck--they would be unable to pay back, to withhold principle for their investors. And--I always get confused whether it's Reserve Primary or Primary Reserve [Primary Fund--Econlib Ed.]--but it's one of the oldest, if not the oldest-- Guest: Primary Reserve, yeah. Russ: Primary Reserve was at risk of going bankrupt. And then, of course, that was terrifying; and this was the justification then for the subsequent bailouts where people said, 'Well, obviously Lehman was a mistake. We shouldn't have done that; we're not going to make that mistake again. We've got to make sure we bail all these other people out because if money market funds start to go under, then who knows? We could end up with--we are going to be eating cat food on the streets out of cans. And have holes in our clothes.' That was the image. Guest: Well, yeah. Russ: Not literally. Guest: I [?]have a lot about that, too, Russ. Maybe we can get to it. Russ: But my point--I'll get to my point, and then you can add some. I'd love to hear it. But what the heck was a money market fund doing lending money to a firm whose balance sheet we know was not so healthy? We knew they'd--everyone knew--that Lehman's assets were a lot like Bear's. Bear's were not very attractive, despite what Bernanke claims now--and we'll talk about that in a minute. But the fact that they could borrow money from them, they could take investment from a money market firm, was, like--it just shows you how bad the moral hazard problem was. Guest: Absolutely. Lehman had leapt to the head of the class, as I put it, in the Too Big to Fail class. It was--the bailout of Bear was the first of an investment bank. There were other bigger investment banks, including Lehman. As far as creditors were concerned, Lehman was now a very safe bet, under the circumstances. And it is, as you suggested--it's what the creditors are doing that's crucial. You don't care, as a creditor, what terrible things are going to end up-- Russ: Or who pays you back. Guest: That's right. As long as you think you are going to get paid back-- Russ: As long as the check's good. Guest: It doesn't have to be out of the assets of the firm you are putting money in. It can be out of a bailout. And that's just--those dollars are just as good, they smell the same and all that. So, what we saw happening after Bear is money rushing to Lehman, which of course wasn't happening because Lehman's was suddenly perceived to be a better-run firm than it actually was. Or a firm with fewer troubles, market-backed securities than was the case. It was simply that the perception of its standing among potentially Too-Big-to-Fail firms had shifted in its favor.
30:56Russ: So, let's turn to the assets at Bear that the Fed took on its balance sheet. It did this through this thing it created called Maiden Lane. Guest: That's right. Maiden Lane won in this case. Russ: Well, this says--it's interesting. The article you quote is from Bloomberg in 2010. And I don't know about Maiden Lane I. But this is Maiden Lane II and III. I'm trying for a different issue now, which is: A lot of people argue that the Fed--everything turned out fine because the Fed didn't lose any money. And my argument, and I think yours, is that's a total red herring. Explain why, and then we'll move on to this particular example. Guest: Well, these assets that the Fed held, it took a [?] tremendous at a time when their value was falling. And in fact, while the Fed was holding these securities, mostly mortgage-backed securities, their value continued to fall. At one point it had very substantial losses on the portfolio of these securities. Now, it's true that eventually those securities went back up in value. But they did so mainly as a result of the Fed's concerted efforts to pump up the value of those securities by continuing to buy them and by otherwise keeping interest rates artificially low. So, of course if you are a Central Bank you can do some funny things to affect value of securities in your portfolio because you are a big player. But I don't think any reasonable--and any private market participants not being able to anticipate the Fed's game plan, would have touched these securities with a 10-foot pole. And in fact, that's exactly why the Fed had to purchase them in the case of Bear's, because they were considered toxic. And the real question here is not ultimately what happened to the value of the securities. If we are going back to Bagehot and his advice, which Bernanke repeatedly claims to follow, though he occasionally says something inconsistent with that, but he repeatedly claims that he's following Bagehot--there's no way that these assets could be regarded as the sort of assets that would be normally used and accepted as collateral for bank lending. They simply wouldn't. Even the Federal Reserve's own Discount Window, even at the Discount Window, these assets would not have been accepted. And the Fed is the lender of last resort, which means supposedly the collateral that it accepts, at its discount window, consists of a broader set of securities than other bankers would be prepared to accept. Russ: So, I'll defend Ben for a minute here. In 2010, according to the Bloomberg article that you cite in your post, Maiden Lane II, the assets that they--I think they paid $34.8 billion and then they were now, at that point, 2010, down to $15.3 billion. So, they were worth 44% of what they were worth originally. The face value of Maiden Lane III's assets were $56 billion, in [?]; then they were actually worth on the market $22 billion--39 cents on the dollar. So, in theory, the Fed had lost, oh, something on the order of over $50 billion dollars. Even--I don't know if that's a big number any more. I have to hesitate. The way I said it when I first said it was like, 'Oh, wow.' Maybe it's not a big number. Seems like a big number to me. But they lost $50 billion. Now, you're suggesting--that was 2010. Eventually the value of these assets bounced back. Because as the Fed continued to buy them, their market value--it became clear, people were willing to pay more for these because they thought there was a chance the Fed would re-purchase them. So, that's one argument. But I think Bernanke would give two arguments. Here's--I'm going to play Bernanke: 'Okay, they plummeted. And you are going to tell me they were toxic. You are going to tell me I wasn't like Bagehot. But isn't it true that there was essentially a run on the housing market? That housing prices fell temporarily due to animal spirits, a bursting bubble that was going to bounce back? So when these assets were on the books of others, other investment banks, it's true they don't look very healthy. But they would bounce back eventually because this is just a temporary liquidity issue, effectively. Because the true value is going to be much higher. And the fact that we didn't lose any money on them tells you that they did eventually bounce back. And they weren't risky.' Guest: Well, it's not a convincing argument. Because the problems in the housing market weren't just due to fire-sale losses. It wasn't that the value of these things was collapsing because people were panicking. They were collapsing because housing prices fell. And when housing prices fall--which, they weren't falling because of a run or people suddenly running away from houses or whatever it is would make house prices start to fall, but they were falling and default rates were rising substantially, and it was this change in the perceived riskiness of the assets due to the incidence of defaults that was the proximate cause of the collapse in value of those mortgage-backed securities. Not liquidity. And moreover, because of the complicated nature of the securities, no one, including the Fed, really knew, after they started to lose value rapidly, really knew where they would settle down. They just didn't know. Russ: So here's the puzzle. Guest: They just took a gamble. Russ: Fair enough. And you could argue the gamble paid off. I would argue that they just pushed the gamble down the road. We're still in the middle of it. It's too early to tell. But again, that would be my view; and it's kind of easy to say that.
37:41Russ: But here's the puzzle. The Fed has, I think $4 trillion dollars worth of assets. Correct? On their books? Guest: Still more than that. More than that. Russ: More than $1 trillion, more than $2 trillion, more than $3 trillion--$4 trillion. Enormous increase. And presumably a huge chunk of that is mortgage-backed securities. They are a piece of paper that promises the holder the cash flow from a set of mortgages that were thought to be very safe at the time--because they were supposedly diverse. But in fact--we, I thought--they were not so safe. Now, are you suggesting that those assets, that $4 trillion--I assume that's $4 trillion, I don't know, I think that's face value--that's not market value. Guest: That's right. Russ: Are we suggesting-- Guest: That doesn't mark to market. Russ: Right. Strangely enough. But if they did, do you think they'd be worth anything close to $4 trillion? In other words, and we went back to 2008, when so many homes were under water--that is, when so many people owed more on their houses than their houses were worth on the market--have things turned around so much that the expected return to those assets is going to be positive? Guest: I'm not sure. Russ: I'm not either. Guest: I'm not sure. And I think that the problem is that the elephant in the room is interest rates, of course. And that's the elephant not just for the mortgage-backed securities but even for the long-term Treasury Securities that now make up a substantial part of the Fed's balance sheet. The values of all of these securities depends crucially on what interest rates are. And therefore, what you think their proper valuation is depends crucially on what you think interest rates are going to do--whether you think they are ever going to go back up again. And this is part of the great uncertainty that attaches with any long-term assets. There is a lot of interest-rate risk in this. Why, generally speaking, these are not the sort of things that are considered good banking collateral. You know, Russ, getting back to this question of good collateral--we can easily think of all kinds of assets that might or might not gain value that could conceivably be accepted as collateral for a bank loan. And yet no one would consider them good banking collateral. Supposed, just in normal times, somebody offered to secure a loan with stocks. Right? Russ: Yep. Guest: Risky stocks. Russ: It's an oxymoron. I mean, that's a redundancy. Stocks are risky. Guest: It could go up. It could go down. Russ: Right. Guest: You could imagine the Central Bank accepting stocks, if the law allowed it. And ending up smelling like roses because the stocks go up in value. And yet, who would say this is consistent with following Bagehot's dictum? It simply isn't. And I think that we're not that--we're closer to stocks than we are to conventional good collateral, when we are talking about many of these securities we've been talking about. It's as simple as that. Russ: Well, I think if you press Bernanke, and maybe we'll try to get him on EconTalk--I have mixed feelings about it--in general I don't think it's so interesting to have guests on who have a personal axe to grind, who are unlikely to concede, 'Oh, yeah, I guess you are right, I did make a mistake.' So, it tends to be more like a press conference and less like a conversation. So, I tend to avoid that. But this may be an exception. But, I'm willing to give Bernanke bad marks on his Bagehotocity. The question would be: Do we give--And I'm also willing to give him bad marks on the tradeoff between taking risks now versus risk in the future. And I guess we'll see how that one turns out--if my grades are accurate or not.
42:00Russ: Let's turn to a different question, which is: Putting these issues to the side, many economists salute and champion and applaud Bernanke's actions as necessary to keep the economy from going south. What is your judgment on that? In other words, he claims: 'I acted like Bagehot. I saved the economy. I had the courage to act.' I would argue he didn't act like Bagehot. We can debate that; he can maybe defend himself. But either way, I think he sowed the seeds for future problems. But then the question is: Did he at least do well in helping the economy recover from the Recession of 2008? And where do you stand on that? Guest: No, I don't think he did. And, I don't want to come across as a Bernanke-basher, even on this issue of moral hazard. I hasten to say in my article, and I mean it, that the problem with the kinds of bailouts we saw, it's not a Bernanke problem. It's a problem that we would face with any human central banker. It's hard to imagine someone who would not have acted to rescue Bear, for example, under those circumstances. Not because it was--it's not because it was the right thing to do, but it takes a tremendous amount, speaking of courage, it takes a tremendous amount of courage to say, 'No, let's the chips fall because it's the right thing to do, and yes, there's risk, but we've got to draw a line.' And so, I don't fault him so much. I fault the system in that I do believe we need rules that would essentially prevent such emergency lending. I don't think that without rules we can reasonably expect Central Bankers to use discretion the right way to avoid moral hazard. But, there is more to what Bernanke's role was, in the recovery that I think he deserves to be faulted for. And particularly, in paying interest on reserves was a ludicrous policy implemented. At the time that it was implemented, October 2008. Basically, what the economy needed--and by then it was perfectly clear, I think, to anyone who stands back from the obsessive focus on targeting [?] to have been dominant at the Fed and the popular thing in monetary economics. But let's get away from theories and look at what was happening. Lending was collapsing. Spending was collapsing. You can see it very visibly. Now, a not-very-fancy view of what Central Banks should do, of what their key responsibility is--and I subscribe to this non-fancy view; I don't like fancy theories very much--is that their job is to see to it the amount of liquid funds in the economy is sufficient to keep spending going. To keep spending from collapsing. If spending is collapsing, well, that means that people are not--are anxious to accumulate liquid funds that aren't really there for everybody to accumulate. So, all right. What happens in October 2008 is that Bernanke is concerned not with preventing a collapse in spending, but in keeping the interest rate as its designated target. Which is then 2%. And had--I think at some point they finally let it go to 1-and-a-half percent. But they were anxious, by hook or by crook, to keep it from falling as much as they could do. And then they finally latched on to this interest on reserves. The whole point of it was to make sure that interest rates would not--they could control interest rates. And also to make sure that they could bail out Lehman's, and extend their balance sheet without any lending being stimulated by the banking system. So, here you have a concerted effort to see to it that the Fed can expand its balance sheet like mad, putting money into troubled firms. But it's not going to be lent. And that's the point. Because it goes into the reserve market. Interest rates will tend to fall. So we got, by hook or by crook, to keep the banks from lending the extra liquidity that the Fed's created. In other words, the Fed chose, to see to it, through interest on reserves, that the demand for reserves would go up, at least as much as the supply; and created, as it were, a liquidity trap where none would have been created. And by this means sought to it that the collapse in spending that occurred, in 2008, would not be followed by restoration of spending soon afterwards. This was a complete macroeconomic disaster. All premised on the assumption that control of the Federal Funds rate is the important thing, no matter what's happening to total spending--which was, in my opinion, a madness. A kind of macroeconomic madness.
47:43Russ: But that claim you are making--that's a--I assume that's a deduction that you are making based on their behavior. That's not their stated argument. Guest: Oh yes it is. That's the funny thing. If you go in and look carefully at the rationalizations given for interest on reserves, you'll see that is exactly their express purpose to make sure that all the extra liquidity that the Fed is providing, to make sure that all the Quantitative Easing [QE] it is undertaking, does not bleed out in to the economy through the corresponding increase in bank lending. It was their express purpose--I can provide you quotes-- Russ: I'd have to see that. That is bizarre. I don't get it. Guest: To make sure that the money, the [?], and specifically that it wouldn't find its way into the interbank market, the Federal Funds Market, because that would cause the Fed to lose control of the target Federal Funds rate. Of course, it did ultimately lose control of it, as it was bound to, because the rate, the natural rate, as you might call it, was collapsing. Now here's what's tragic about this. I mean, it's tragic in many ways, but the thing is, right, the thing about this, you are worried about the Federal Funds rate falling. Right? And falling specifically falling to zero. But, spending is collapsing. If spending is collapsing, rates are going to fall, too, right? Fisher effect, deflation. But there is a level effect here as well. Basically if there is less spending going on, what it means is there is less demand for everything, including funds--including credit. So, if they had acted to revive credit--that is, if they had not worried about maintaining or trying to maintain, by hook or by crook, the Federal Funds Rate at an artificially high level, they would have let the banks lend, and make use of the extra Federal Reserve dollars out there to lend more. That would have boosted spending again, NGDP (Nominal Gross Domestic Product) if you like-- Russ: Nominal GDP (Gross Domestic Product). Guest: Nominal GDP. And that would have, eventually, caused interest rates to come back up. Instead, they--by trying to keep interest rates artificially high, they all but guaranteed that they would fall and stay low. It's a great example of looking only at one aspect of the problem and losing track of the--I can assure you I can come up with all kinds of quotes by the authorities. And incidentally, if they had a better way to justify paying banks to hold reserves at the time that they decided to institute this policy, I would like to know what it was. Because I haven't heard it. Russ: Yeah. So, I challenge you to write a post on that, by the way, assembling some of those quotes. In the meanwhile, we can link to it. Of course people can look for themselves.
51:08Russ: But I guess the--being a less careful reader and consumer of this literature than you are, you know, my, if you ask me, why did they start paying interest on reserves? I have a public theory and a private theory. The public theory--the one that I would have said they used to justify it, was: They wanted control over monetary policy. I didn't think--I wouldn't have gone as far as you seem to be going, which is to say, they not only wanted control over it; they wanted so much control that they didn't want the money to get into the system. Because if you make that claim, you have to argue that they don't really think monetary policy has anything to do with the real economy. It's just--that's just such a bizarre claim. Guest: They think, yes, you are right. They think monetary policy is about interest rates; it's not about flows, it's not about quantities. It's about where the rates are. I know that sounds crazy. Russ: It does sound crazy. And we [?]. Guest: It is crazy. But this is the influence of some contemporary monetary theories. I'm going to mention Woodford by name because frankly I think he's the Doctor Strangelove in this story. But there are many who subscribe to this view. And they felt that interest rates should stay at 2%. If they could have, they would have let that Federal Funds--they would have tried to hold it there forever. The target became meaningless at some point because no activity was happening at 2%. But the reality is, it's really true, Russ, and this is why the United States, whether or not Bernanke did something wrong, I've got to tell you: They wanted to make sure that all the funds--you see up to Lehman, they were sterilizing all their emergency lending. Russ: Explain. Explain what that is. Guest: It's very important. They had--they started out with about, oh, 800, oh goodness, $800 billion dollars of Treasury Securities on the books of the Fed. Right? Standard; that's what they used to buy when they weren't buying all this, before they started buying oodles of this other stuff. So, as they started to acquire their assets through emergency lending, whether it was through direct lending or through the term auction facility or what have you-- Russ: The so-called Quantitative Easing (QE). This is a different form of-- Guest: No, it wasn't Quantitative Easing yet. It wasn't Quantitative Easing yet, because up to Lehman's they were sterilizing all this lending by selling Treasuries as they acquired other assets. Russ: Okay. Guest: So that the total amount of assets on their books, the total size of their balance sheet didn't change. And now, the same philosophy that was behind the sterilization, which also was accompanied by other measures--essentially there was a program having the Treasury park money at the Fed--it was all so they couldn't, wouldn't have the total amount of Federal Reserve dollars sloshing around in the economy increase. Because that would undermine monetary policy. This is what's happening until Lehman's. So, it's important to have this as a background when we ask about interest on reserves. Because what it's pointing to is the fact that the Federal Reserve was very determined that their emergency lending activities would not affect the total supply of Federal Funds in the economy. Which was a goal predicated on the assumption that maintaining control of the Federal Funds rate was the most important thing about monetary policy. Okay. Russ: Hang on. I've got to interrupt. This makes no sense. Now, I'm not going to say that proves your point. I just want to see if you can try to answer this objection: whether you will say, 'Yeah, that's crazy,' too. And I want to remind listeners that in the early days of EconTalk I had the privilege of interviewing Milton Friedman and I asked him this question; you can go back and listen to it. I said to him: 'Your work is all about quantities--the quantity of money, its impact on the economy. Why do central bankers talk about interest rates?' And he essentially said, 'Well, it makes them feel more powerful, that they're doing that. What they're really doing is they are printing money, or pulling it in.' Guest: That's right. Russ: And all of this interest rate stuff is a red herring; and it's a mistake. So, putting that as a background: How can you possibly argue, if you are a Central Banker today, that the Federal Funds rate is the key thing? What the Federal Funds rate is, is the rate at which banks charge each other to move assets around on the Fed's balance sheet. Is that correct? Do I have that correct? Am I missing something? Guest: Essentially. It's the rate they charge for lending so-called 'Federal Funds,' which is bank reserves, to each other overnight. Russ: Correct. You're telling me they actually think that level, that rate, is the key to good health for the economy? Guest: That's right-- Russ: That's bizarro. Footnote: I understand the-- Guest: Monetary policy is about regulating the Federal Funds rate. And other interest rates with it. Russ: But it can't be, because the whole idea of doing that is it has to be that by changing the rate at which banks lend to each other, it would eventually affect what they do out in the real economy. If you actually are arguing that they try to control that rate and also at the same time not let it get out into the economy, what could they possibly be thinking? And I don't think they are stupid people. They must have some story to tell. Guest: No, I know Russ. It's kind of hard to explain. But I can say this: In modern monetary economics, it's not cool to talk about money and it's not cool to talk about quantities. And so--behind this is this idea that if you have a fixed interest rate in the Federal Funds Market, that's equivalent to letting the money supply be demand-determined, because if the demand for Federal Funds increases, that creates an upward shift in the demand for Reserves, which is automatically accommodated by keeping the rate the same. The problem is that the demand for money does not map nicely onto any given interest rate target. There is such a thing as a natural rate of interest that can fluctuate. And so, everything depends on whether you are pegging the interest rate on Federal Funds at the right level or not. And this is where, when--Wicksell was great. Woodford is a kind of bastardized version of Wicksell that forgets about the underlying quantities. See, Wicksell is very much a quantity theorist, but he had this interest rate dimension that made his version of the quantity theory very rich. In any event, without going into too much detail, what was happening during 2007 and 2008 was that the demand for liquidity was going up; the natural interest rate was going down; the Fed was pegging an interest rate that became higher than the natural rate, thinking that it was doing the right thing, that it was accommodating all the necessary money demand, and not noticing that spending and lending were collapsing. It was obsessed with 2%, or whatever its target was. And in order to maintain 2%, it made sure all of its emergency lending was sterilized, as long as it could. Now, when Lehman's happened, and then AIG (American International Group), they literally lacked enough Treasuries-- Russ: They literally what? Guest: Lacked enough Treasury securities in their portfolios to continue sterilizing. They couldn't do it. They physically couldn't do it. They were adding trillions of dollars to their assets, to their non-Treasury assets, and they didn't have trillions of dollars of Treasuries to sell. That's when Quantitative Easing began. Quantitative Easing was their fancy name--or actually they preferred calling it in the large scale asset purchases--but in any event, this was basically the name for letting the Fed's balance sheet grow. We would, in the old days, call it monetary expansion--Federal Reserve monetary expansion. They took to Quantitative Easing because they had no choice. It wasn't something they talked about: 'We've got a theory; this is a great thing to do.' They couldn't sterilize any more because they didn't have enough Treasuries. But there are various reasons why they keep a certain number of Treasuries having to do with income and all of that. And so--and they didn't want to let it fall much below, I think it was about $300 billion, was what they tried to keep on hand. And then they started acquiring some longer-term Treasuries and built that up. But that was also part of Quantitative Easing. In any event, they couldn't sterilize. When they couldn't sterilize, they said, 'How are we going to keep the Federal Funds rate at 2% if we can't sterilize? Now we're expanding the balance sheet. There's more liquidity out there. There's more Federal Funds out there. Supply is growing. That's going to lower the equilibrium Federal Funds rate. What do we do? Ah! We'll pay interest on reserves!' If we pay interest on reserves, first of all we've established a kind of a floor, a different floor for the Federal Funds rate. But the real goal was to see to it that the new Federal Reserve dollars being created would not be lent. Would be held onto. And they speak this way--I will get you those quotes together. A future blog I'm planning is on interest on reserves. But the idea was to have an alternative means by which to make sure that these extra dollars would not translate into any corresponding amount of lending and spending. Even though the economy is desperately in need of more lending and spending.
1:01:58Russ: It's the strangest--you know, I want to believe in George because I'm a conspiracist of sorts on this. Guest: I know. Russ: And my worst--by the way, it's worse than that, because I really am worried. My real fear is that their real motive was to get the toxic assets off the banks' books because that was good for the banks. I have an even creepier theory-- Guest: That was their motive. That's right. Russ: It's creepier than stupidity-- Guest: That's their motive for buying the assets. But it's not their motive their motive for paying interest on reserves. Russ: Oh, that's nice, too, because that helps them rebuild their balance sheets. So that's like, it gets them through the Crisis for a while. That's the creepiest interpretation of this. It's not stupidity. It's corruption. Implicit corruption. It's not literal. But-- Guest: Remember, banks really need to have reserves. They don't need to be paid to hold them. You don't need to pay them to hold them. If you don't pay them, they are going to lend them. Russ: It's hard to argue with that. Guest: That was exactly what the Fed was worried about. They were worried that the banks were going to lend the extra reserves that the Fed could no longer avoid creating as a result of the massive acquisitions it was engaging in. And they were determined. Mind you--putting conspiracy theories aside--they thought that this was important because they felt this was what they needed to do to maintain control of what they perceived to be monetary policy: which was control of interest rates. Russ: Yeah; I said 'conspiracist'; I really meant that the incentives were there to get them to do things that don't look so attractive. I don't get to quote Joseph Stiglitz very often. So, he calls it 'cognitive capture,' which I really like. So, I'm arguing, in my somewhat depressing, sinister view of the world in this area, that the Fed was cognitively captured by the fact that there are listening all day to other bankers and the investment bank folks, who are on their Board; and their natural incentive is to listen to their worries rather than thinking about the bigger picture. But this confirms all my worst--creepiest stories, George. I'm a little bit worried about it. We're going to have to-- Guest: I'm worried about it, too, because I don't like saying things that make it sound like I'm crazy. But I can tell you the quotes--there were abundant quotes backing me up on this. By the way: I need to talk about market monetarists. Can we? Russ: Sure, go ahead. Guest: Because one of the things--there's this line out there: I am sort of a market monetarist fellow traveler in the sense that, as you can tell from my remarks, I think ultimately monetary policy is about keeping a stable flow of spending in the economy. And to me that is the essence of monetary policy. If your spending is collapsing, you've got a monetary system out of whack, whether it's gold or central bank, I don't care. Stable spending is what a properly organized monetary system should be able to maintain. Okay. However, it doesn't follow from that, and from the fact that spending in fact collapsed, that one has to be a believer in Quantitative Easing. In this case, I'm not. I disagree with market monetarists who say Quantitative Easing was a good thing. Why? Because under the circumstances the Fed was engaged in Quantitative Easing but at the same time it made sure that this easing would not increase total spending. It took steps, including interest on reserves--especially interest on reserves--that were calculated to make sure that Quantitative Easing in this case, in this situation would not have the effect of reviving demand. Well, if it's not going to do that, I'm against it. Because what it did do is give us a Fed 4 times as big as before. It created tremendous problems, exit problems that we have yet to see the end of--we're just getting into that new act. And there are all kinds of political economy reasons to not want to see a $4.5 trillion dollar Fed created. There was no point in it. I've made the following analogy. Suppose that you have a car that keeps sputtering out. Right? And some of your friends say, 'Well, it's running out of gas. It's got an empty tank. We've need to pour more gas in there.' Well, they'd be absolutely right, except what if there's a leak in the tank and the gas you pour in is pouring right out onto the asphalt? Then, wouldn't you have a reason to argue against putting more gas into the tank till you've dealt with this other problem? It doesn't mean you don't understand internal combustion engines and how they work. It means that you know that there's a leak. And so I'm not against QE because I disagree with the belief that such easing under normal circumstances can serve to revive demand when it's been flagging. I'm against Easing this time because it's accompanied by other policies that are calculated to make sure the Easing has bad effects but none of the good consequences that we really want from it. And that we can ease till kingdom come without doing the economy any good and putting ourselves in the process into a very dangerous situation.

COMMENTS (56 to date)
DMS writes:

A very rich and complicated topic - you could easily do a half-dozen related spin-off episodes. Still, I think there is an opportunity for some immediate clarification as follows.

Explanations of Fed Governor motivations that rely on stupidity, myopia, venality, conspiracy and so forth offer very little illumination. Instead, if we simply assume reasonable people doing their reasonable best with their reasonable "consensus" worldview, it all flows naturally. Unfortunately, that doesn't mean beneficially.

The Fed saw the world financial system in meltdown, and with a bias for action, chose to "do something". The Fed has many tools for fine-grained monetary management, but for large-scale intervention the Fed really has a single weapon, which is open-market asset purchases with created money. By the way, textbook monetary theory makes it seem like open-market operations are symmetrical when buying or selling, but that is false - it is far easier to flood the market than drain it. Remember that as the Fed talks about changing its direction in the future.

So the Fed simply wanted to increase market liquidity, particularly in housing, and more subtly to move risk out of the banking system. They could not magically make risk just go away, so that risk had to go somewhere, and the Fed's actions served to move a lot of banking risk and stress onto the Fed's own balance sheet, essentially hidden from view. Here's how:

The whole QE project with Interest on Reserves (IOR) is simply a giant security swap. It is as if the Fed issues a new note, call it an "IOR-Note", which allows the holder to earn 25 bps (for now) and to redeem the note at will. These are essentially the terms of banks' reserve deposits at the Fed, but thinking of it as an issued note makes the swap notion clearer. So the Fed takes this "note" and swaps it for equivalent assets at the banks, specifically mortgage bonds and longer-term treasuries. This is Selgin's sterilization, that is, the prevention of new money actually flowing into the economic system.

So what is achieved? Well, for one thing banking liquidity improves dramatically -banks are able to immediately redeem an "IOR-Note" at par versus accepting market prices for a mortgage bond in a less liquid marketplace. Arguably the banks' risk-adjusted returns get a boost. But more importantly, the two main risks in commercial lending, that is of asset quality (repayment) and temporal mis-match (borrowing short and lending long) are now being assumed by the Fed. The Fed provides a floor on asset quality, particularly in the mortgage market, by buying everything it can get its hands on, and does so with very short-term (i.e. immediately redeemable) funding through these "IOR-Notes". The Fed is now acting as a major commercial bank in the real economy, borrowing short and lending long, on an immense scale.

So the Fed has engaged in a massive risk-transfer program, moving essential private sector banking risks into the public sector. This is thoroughly rational from a public choice standpoint. The challenge of course is that taxpayers have now assumed what should be market-based banking risks, and arguably worse, the whole system faces tremendous distortions with unclear and unpredictable effects.

Greg G writes:

I don't believe the Fed's decision to pay interest on reserves is nearly as mysterious or irrational as it was portrayed in this podcast.

The Fed used a number of unprecedented new methods of increasing the money supply in response to the collapse of credit creation in the shadow banking system. They realized that this expansion of the money supply may one day need to be reversed in the face of future inflationary pressures. They were concerned that the existing methods of reducing the money supply might be inadequate to the task when that future day comes - especially in light of the unprecedented nature of the Fed's recent expansionary policies.

Right or wrong, they believe that, for this tool (paying interest on reserves) to be effective when it is needed, it will need to be already in place and in practice. The current rate of a quarter of a percent is as low as it could be if you want to pay a positive rate and move in quarter point increments. Very few credit worthy borrowers are being turned away because banks would prefer to earn a quarter of a percent.

It will be interesting to see if an increase in the Fed Funds rate also means an increase in the rate being paid on reserves. Fed Funds have been trading at around 12bp.

jw writes:

Epic podcast!!!

I'm not sure how to refer to this podcast in the future: the "Selgin for Fed Chair" episode or the "Russ Has an Epiphany" episode.

As this was taped, I am sure that you already have the proof that Bernanke did indeed specifically state that he wanted to avoid the reserves getting into the economy, so he "paid interest on reserves held by the banks" (BTW, this can also be stated as the banks getting trillions in infinite term, non-collateral, non-callable, negative interest rate loans - sign me up for my mortgage, car loans, and personal loans at -0.25%!!!) And yes, this is exactly the opposite of Bagehot.

This allowed Bernanke the fig leaf (although a transparent one to anyone who believes that money has a time value) to testify before Congress that he wasn't "printing" money. Of course he did! It is just all sitting in a big pile in banks, waiting for the day that the music stops, when it will avalanche into the economy.

Remember, QE isn't over when they stop increasing assets or raise rates to a normal 4%-ish (let alone maybe 0.25% this week or sometime next year). It is over when the LSAP's and twists and QE's are unwound and the Fed balance sheet is back to a real $1T. Maybe my grandchildren will live to see it without a massive inflationary "reset", but I doubt it.

QE is not a rational monetary policy. The theory violates common sense and it failed miserably in Japan. It exists for two reasons:

1. The US (or Japan or Europe) can no longer afford a market rate on interest on their debts. Our $18T deficit would be $500B a year higher if we paid an average of 4% interest on it. Meanwhile, generations of savers get zero return on their life savings.

2. The Fed governors know where their bread is buttered. Yes Russ, it is blatantly corrupt with a few years of lag. By charter, they exist as an instrument of the banks, not of the government. The banks have been served well by QE and the recently retired Bernanke is having lush dinners with ten of his closest friends every few weeks - all bankers and hedge funds - who pay him $250K APIECE for a two hour joint dinner (on top of his multiple million dollar a year consulting deals).

I only hope that Fed Chairman Selgin can resist the temptation...

jw writes:

DMS and Greg G,

You are both reinforcing Selgin's point. Via the Fed, the banks expertly privatized profit and socialized risk, creating not only enormous moral hazard, but a huge pool of delayed risk. It has to go somewhere, whether decades of lost opportunity for our children (see Japan) or an inflationary reset.

As evidenced by the enormous increase in debt since the crisis, they have learned nothing. Per Jim Grant: "We have replaced the gold standard with the (centrally planned) PhD standard". I have zero confidence in their ability or their motives.

The piper will be paid (and his name is Von Mises...)

George Selgin writes:

Greg G: "Right or wrong, they believe that, for this tool (paying interest on reserves) to be effective when it is needed, it will need to be already in place and in practice."

That a space heater may come in handy in mid-winter is no reason to try it out in the middle of a heat wave!

A.J. writes:

Interesting point about the hazard of pumping more money into insolvent because they develop a "hail mary" strategy is exactly what we're doing with insolvent city governments who are able to hide this reality with cash-accounting and tax-exempt 30 year bonds used to finance yet another strip mall or big-box retailer despite countless examples of those failing before the maturation of debt.

Michael Byrnes writes:

This was an excellent (albeit frightening) episode. (And I hope there will be future opportunities to have George Selgin on as a guest.)

Thinking back to the Gary Taubes episodes, I am sort of wondering if the Fed funds rate is sort of the "cholesterol level" of monetary policy, in that there is some relationship between cholesterol levels and cardiovascular disease, yet pharmacologic manipulation of cholesterol levels is not the be all and end all of cardiovascular disease (ie, it's just a marker - and a not very straightforward one at that, not the problem itself). The Fed funds rate is (in part) an effect of monetary policy, not the effect of monetary policy. Really tragic how confused our supposed leading experts are.

George said a lot of interesting things - here is one of them: the profitability of the assets on the Fed's balance sheet is partly a function of future interest rates. Makes sense. But... could this be part of the reason we have a Fed that wants to keep a lid on spending? (Not just the assets held by the Fed, but those held by the rest of the banking system as well)). Or should I be wearing a tinfoil hat for even asking this question?

Gary Anderson writes:

Saving the banks is always more important to the Fed than saving the economy. The Fed has a real dual mandate, to sell treasury bonds and save banks. The derivatives markets is a good place to sell bonds for collateral, but it hurts the economy. Saving banks hurts the economy too.

emerich writes:

Yes, an excellent podcast and Selgin clarifies a number of points, such as the self-defeating nature of paying interest on reserves. It might be time to have Scott Sumner back as a follow-on. With the Fed hiking rates, there's tremendous confusion everywhere about what hiking means for the economy and monetary policy. As Selgin notes, even at the Fed they forgot that in itself the Fed Funds rate tells you nothing. What matters is what the money supply is doing, or as Scott would prefer it, what NGDP is doing. If the Wicksellian rate right now is 0 or even negative, which it almost certainly was for a while in late 2008 and all of 2009 (and beyond?), then even a 25bp FF rate is contractionary.

Greg G writes:

The explanations offered in this discussion for paying interest on reserves were limited to corruption and stupidity. The Fed does realize that paying interest on reserves is contractionary. They do realize that this runs counter to their goal of currently having a more expansionary overall policy.

They believe that the contractionary effects of paying an extremely low rate on reserves are slight and easily outweighed by the massive money creation they have been able to achieve with other tools.

They believe there will be a significant future value to having this program already in place when a more contractionary policy is desired.

They also believe the policy serves a present goal of putting a floor under the rate that Fed Funds are traded at, which has consistently been well below the target of 25bp. Fed Funds have been trading at about half of that. Offering interest on reserve reduces the supply of money that banks are willing to loan into the Fed Funds market and therefore increases the rate that Fed Funds actually trade at. Yes, I know this is also slightly contractionary but they think the trade offs are worth it. They think having better control of rates is important.

When discussing the motives for Fed policy it is also necessary to remember that these decisions are the product of a committee of people with varying views. Some are more worried about inflation. Some are more worried about deflation. In such a situation, it will be easy to come up with the conflicting quotes about the reasons for policy.

I don't know what the best monetary policy is and I am not advocating for a particular policy here. I am advocating for a more charitable interpretation of other people's motives.

The discussion at the end on market monetarism came across as odd: Selgin basically says "I'm very sympathetic to market monetarism, but I disagree on the effectiveness of QE in the context of the Fed paying interest on reserves (IOR)." This is a fine point, but it also sounded exactly like something that Scott Sumner could say. He would focus more on expectations, but still he has been a critic of IOR and of how QE is not the right measure.

George Selgin writes:

"The explanations offered in this discussion for paying interest on reserves were limited to corruption and stupidity. The Fed does realize that paying interest on reserves is contractionary."

Greg, if I gave you this impression I did so quite unintentionally. (I am quite sure in any event that I never referred to "corruption" as an explanation.) It has been my position that the Fed deliberately sought to prevent its asset purchases from contributing to an increase in bank lending or the broader money stock. (This was also the reason for its having sterilized its emergency lending prior to the AIG bailout, when it reached the limit of its ability to counter lending with Treasury sales.) Bernanke claims as much in his memoirs. What was "stupid" was not the Fed's understanding of the (contractionary) consequences of IOR, but the fact that it did understand those consequences, but believed that circumstances warranted the step nonetheless.

Greg G writes:

George Selgin,

Thanks for the clarification. It was Russ, not you, who referred to corruption. You favored the stupidity interpretation as quite vividly expressed in the space heater metaphor in your reply to my first comment.

At the time of the AIG bailout, and before, inflation concerns were much more of a factor than they are today. It is only with hindsight that we know those fears were unfounded at the time. And the inflation alarms have always been rung the loudest by the Austrians. Back then we were in even more uncharted territory. Today we have had years of experience with these policies.

I don't know how you would quantify a reasonable estimate of how many good bank loans are deterred by the possibility of earning 25 bp annually instead. My intuition is that very few good loans go unfunded for this reason. Do you have some method of estimating the effect?

Whether or not the future benefits of having the tool in place are outweighed by the contractionary effect of having it in place depends entirely on the size of these effects. Reasonable people can disagree about the size of the effects.

Robert Bienenfeld writes:

Um, great topic, I think. How about another podcast to unpack and explain this last one? I had the feeling I was listening to something really important, but it was pretty esoteric. A little help?

jw writes:


I am sure that Greg is referring to the comments, not the podcast. In any case, I still maintain that the Fed, when acting as a central planning entity, suffers from the same Hayekian knowledge problem that governments do. They could not and have not been able to fathom the unintended consequences of unleashing their QE pile of money.

It is no accident that big banks had their most profitable years in history since QE (Cantillon still rules). Now that they have a pile of cash (and income from the Fed) to pass any "stress" tests, it allows them to take on MORE risk with other parts of their bank (they have to make their bonuses somehow), especially knowing that they will be bailed out if they fail.

Not only do the banks have $3T in Fed cash, when they figure out that any agreement with the Fed not to lend the money is toothless (what is the Fed going to do, take it back?), then that 0.25% will look pretty low compared to even a few percent on the $50T of credit that it could bring at a 6% fractional reserve rate. Think of the fees and bonuses!

Sure, total US consumer credit (auto, student and credit card = $3.5T), mortgages ($13T), corporate ($8T) and even government ($18T) are dwarfed by this theoretically available credit. Maybe they can finance future losses in the $1Q derivatives market, who knows? (Sorry, I forgot, the theory says that there cannot be any losses in the derivative markets, so don't worry...)

What could go wrong?

Almost every economist nowadays admits that price controls cannot and do not work. Yet our esteemed Fed believes that controlling interest rates WILL work. Isn't interest merely the price of money?

Yep, trust your net worth and your children's future to those omniscient and altruistic Fed governors, they only have your best interests in mind when they decide to openly manipulate the markets.

Greg G writes:


>---" I still maintain that the Fed, when acting as a central planning entity, suffers from the same Hayekian knowledge problem that governments do. They could not and have not been able to fathom the unintended consequences of unleashing their QE pile of money."

Well, it's impossible to argue with the last sentence because unintended consequences are, everywhere and always...unintended.

As for the knowledge problem, it certainly exists and applies to the Fed as well as government. That doesn't settle the debate. Deciding that government should do nothing is still a policy decision.

Hayek was not an anarchist. He thought government should do some things despite the fact that the knowledge problem was always there. The knowledge problem also makes it hard to know exactly which are the times government shouldn't do anything.

George Selgin writes:

"At the time of the AIG bailout, and before, inflation concerns were much more of a factor than they are today. It is only with hindsight that we know those fears were unfounded at the time. And the inflation alarms have always been rung the loudest by the Austrians."

All quite correct, Greg. As you probably know, I have long taken the view, also shared by Market Monetarists, that it is stability of spending, rather than of either the price level or the inflation rate, that matters. By October 2008, when IOR was introduced, the fact that spending was collapsing was already evident (as I mention in my Alt-M post on sterilization). Those, including many Austrians, who anticipated high inflation, and who argued for tightening to head it off, were mistaken on both counts. But you will not find any indication that I was among them. This doesn't mean that one cannot understand the Fed's actions. Nor does it really warrant calling them "stupid" (a term I employed only in the context of clarifying my position). If I believed that "smart" people could easily manage a central bank in such a way as to avoid serious errors, I would not be a determined opponent of discretionary central banking. In any event the Fed's actions during the summer and fall of 2008, as well as afterwards, were mistaken, and tragically so.

Greg G writes:

George Selgin,

Again, thanks for participating in the discussion. I am a big fan of EconTalk and all the more so when the guests are involved in the discussion. I appreciate you clarifying your views because I probably am not as familiar with them as most commenters.

>--"By October 2008, when IOR was introduced, the fact that spending was collapsing was already evident..."

Yes that is certainly true, but many feared the possibility of a prolonged stagflation like we saw in the 70's. In the stagflation scenario, today I think the Fed would want to come down more in favor of inflation fighting than they did in the 70's. So I still maintain that it was not nearly as obvious then as it is now that they didn't need to worry about inflation at the time.

It is not obvious to me why the absence of central banking wouldn't make it harder, rather than easier, to keep spending stable. I would love to hear another podcast on that topic.

Michael Byrnes writes:

Greg G., I believe that George Selgin has already done an Econtalk on Free Banking - check the archives.

In the immediate aftermath of Lehman's failure, the Fed declined to cut the Fed funds rate, citing equal risks of inflation and recession. So your comment ("it was not nearly as obvious then as it is now that they didn't need to worry about inflation") is sort of trivially true. Had it been obvious to them that there was no inflation risk they would have acted differently.

That said, it should have been obvious to them. The central bank focus on stabilizing inflation (rather than on stabilizing spending) was a huge mistake, right along with their focus on the Fed funds rate.

Kevin Erdmann writes:

This is so interesting, and yet frustrating, for me to hear. I loved George's blogpost, and I think it brought to light some great new information. But, I think you guys are joining the Fed in the greatest error that encompasses this whole issue. The Fed was instituting extremely tight policy all the way back at least to 2007. George's post is a great window into that error. I'm surprised that George is complaining about the Maiden Lane assets. Isn't the fact that liquidity was the difference between them being toxic or valuable a very strong clue that a lack of liquidity was the problem? And, I'm surprised to hear George complain that the value of these assets is pumped up by low interest rates when he has just done such a great job of (1) showing how outrageously tight the Fed was, even to the end of 2008, and (2) explaining how interest rates are a terrible way to explain monetary policy.

I think you both are making a terrible mistake, but it is an understandable mistake. You are convinced that there was a housing bubble, and the home prices had to collapse. The cause of this whole mess is that there developed a consensus in this country for unstable monetary policy, and you both are still making that error. Looking at the Fed's positions even as late as the end of 2008, how could we have had any outcome here except for a collapse?

Here is a Fred graph, which shows the coincidental collapse of mortgage growth, housing starts, home prices, and mortgage delinquencies. All of these things started to collapse in 2006 and 2007 (along with NGDP growth) for the same reason - disastrously tight monetary policy - which George's post documents.

I am in the early stages of writing a book on the topic, and the first domino that my research pushes over is that the housing bubble was overwhelmingly a supply issue, not a demand issue. At some point in the future, Russ, when the book is published, I hope that you can find a place for me to be a guest and make the case. Once I understood the central position of supply (not demand) on the housing issue, I realized that it was the bust that was the problem. Look at that graph in my link. Those sharp trend breaks go back to 2006, yet in late 2008, with mortgage levels actually declining, and house prices down by 15 to 25% around the country and their regional presidents telling the FOMC that banks were turning away good clients for lack of liquidity, the Fed was still trying to prevent credit from getting into the system.

I know it sounds unlikely. But, George's input here is so much more powerful if you imagine that the collapse didn't need to happen. I hope you can keep an open mind about this long enough for me to come on your show and make the case, Russ. ;-)

jw writes:

Comments on above:

- I think that we have to divide the debate into two distinct timeframes: QE1 to address the crisis and QE2/3/4/LSAP/Twist afterwards. There is a lot more justification for QE1 and one can see how the political pressure to "do something" can outweigh the more prudent economic alternatives. However, if you think that Bagehot had ANY kind of a point, then even QE1 was the wrong thing to do. Of course the bankers (and their political allies) would have screamed if they had to provide collateral and pay significant interest on the provided liquidity, however, this does not justify "it's hard to know what to do so let's give them trillions in free money (and an extra trillion in TARP)". Alternative strategies existed.

- There is no economic rationale for the remaining QE's.

- CPI inflation has been muted, but asset prices have skyrocketed, from bonds to stocks to real estate (especially near the Cantillon centers - NYC and DC), and art. I agree that classical Austrians never seriously considered IOR (who could blame them?), so their mainstream inflationary predictions may be delayed (or be limited to assets). I maintain that it simply hasn't happened YET.

- An aside, nice old Mrs. Smith down the street who just celebrated her 100th birthday has seen an average of only 3% inflation. That certainly sounds manageable and not far from the Fed's target rate - until you realize that she has seen 2,000% inflation in her lifetime!

- Again, the socialized risk had to go somewhere. It still exists and will be exacerbated by the moral hazard created by the Fed. Our private debt levels are 40% higher than the pre-crisis peak eight years ago and government debt has doubled. We learned nothing.

- With no bullets left, what will the Fed's response be for the next crisis? Cut the 0.25% that they may or may not raise this week? Or just print more money? Printing has always been the easiest solution, it is almost never the right solution.

- Kevin - what were the underlying incentives that created the oversupply of housing?

- Lastly, government cannot create wealth. The Fed cannot create wealth.

Kevin Erdmann writes:

jw, this is one of the many oddities regarding this issue. Just about everyone reacts with incredulity at the idea that high prices might be a sign of undersupply. I would have, too, until I checked the data, and noticed that when viewed carefully, rising rents are at the heart of most of the increase in prices.

George Selgin writes:

">--"By October 2008, when IOR was introduced, the fact that spending was collapsing was already evident..."

Yes that is certainly true, but many feared the possibility of a prolonged stagflation like we saw in the 70's."

Greg, if spending is collapsing, the only thing that could cause inflation would be an adverse supply shock -- I mean a collapse of aggregate supply, not merely the reduction in quantity of output that is the normal accompaniment of a decline in aggregate demand. And it is precisely that case that tighter policy is least warranted, because it only makes things worse. You do not make up for a collapse in AS by shrinking AD enough to keep P from going up! Try it on a paper napkin and you will see what I mean. Perhaps the FOMC ran out of paper napkins.

On the case for letting P respond to AS shifts, see my IEA pamphlet, Less Than Zero.

DMS writes:

I think in summary that many of us, here in these comments and around the blogosphere generally, struggle to understand what the Fed did during the crisis and why, as well as understand what the Fed is doing now and why. And I think George Selgin's interview with Russ leads us there, with a little twist. To recapitulate:

1. There has been a history of bailouts/rescues, from Continental Illinois through LTCM and up to Bear Stearns.

2. The lack of a bailout for Lehman was therefore a shock.

3. In the wake of the Lehman failure, uncertainty levels rose quickly, arguably to the brink of chaos.

4. The Fed felt obliged to act (btw as did the Treasury, Congress, etc.), especially regarding bank solvency and liquidity.

5. The Fed implemented a variety of programs, ultimately settling on Quantitative Easing as its main policy instrument. I would argue this was its only real tool for implementation on the scale desired.

6. But as George Selgin points out, with Interest on Reserves (IOR), there was no effective injection into the monetary system - any money "printing" was offset by the rise in excess reserves at the Fed (or as I choose to describe it, there was a massive note swap of newly-issued "IOR-Notes" for market-held bonds and MBS).

7. From the Fed's dual mandate perspective, it all kinda/sorta worked, in that the banking system seemed to stabilize (at least on the surface) and unemployment declined while inflation stayed low.

8. Moreover, QE has NOT been a loose policy, with inflation just around the corner. I actually take Bernanke's side on this - he didn't print any new net money. It has been an asset swap, without extra money sloshing around the system at all. The TIPS curve shows that the market confirms this assessment. (Asset price increases, to the extent they require explanation, must be from a different source than excess money. My own personal bet would be the continued downward shift in expected future interest rates, i.e. an ongoing lowering of the discount rate, causing asset prices to rise correspondingly). Yes, letting those excess reserves bleed into the system would represent inflation potential, but that would be a new, separate decision by the Fed. It's like saying inflation is just around the corner because the Fed can print money anytime it wants - true, but not particularly relevant.

9. Given #7, that the Fed thinks it has been fulfilling its mandate, and #8, that economic risks from QE are not evident, what incentive is there for change?

10. And here's the twist - there is massive incentive NOT to change QE. As essentially a reconstituted Commercial Bank, to the tune of $4T in assets (or a quarter of the US financial system), the Fed currently sends about $100B to the Treasury each year. Remember, the Fed borrows at 25 bps (IOR) and lends (buys bonds with a coupon) at 325-350 bps - again it is now acting as a $4T Commercial Bank. This $100B annually is effectively extra tax revenue for the US government. To put that in perspective, it is double the amount of taxes collected for all US financial institutions combined, and about one-third the total of all US corporate taxes combined. I ask - where is the political will and initiative to change this?

So notwithstanding all the breathless press treatment over Yellen and the Fed changing policy and "raising rates", I would predict not much change in such a lucrative, and essentially hidden, source of tax revenue. This is the real scandal.

George Selgin writes:

"I'm surprised that George is complaining about the Maiden Lane assets. Isn't the fact that liquidity was the difference between them being toxic or valuable a very strong clue that a lack of liquidity was the problem?"

It seems we confound each other, Kevin. Far from intending to deny that there was a liquidity problem, my complaint was precisely that by sterilizing its Maiden Lane and other pre-Lehman lending, the Fed failed to address, and even compounded, the liquidity problem!

"You are convinced that there was a housing bubble, and the home prices had to collapse. The cause of this whole mess is that there developed a consensus in this country for unstable monetary policy, and you both are still making that error. Looking at the Fed's positions even as late as the end of 2008, how could we have had any outcome here except for a collapse?"

Yes, I'm convinced there was a bubble, and that easy money contributed to it. But that was before 2006, not after. I never claimed that money was loose in 2007. I also reject the notion that the crisis must have been caused either by tight money or by loose money. Both were factors, at different times. The idea that the Fed can only err in one directions has never appealed to me.

Greg G writes:


>---"- An aside, nice old Mrs. Smith down the street who just celebrated her 100th birthday has seen an average of only 3% inflation. That certainly sounds manageable and not far from the Fed's target rate - until you realize that she has seen 2,000% inflation in her lifetime!"

Making it all a lot more manageable for her is the fact that, if she is like most Americans, she has seen an improvement in her standard of living over the last 100 years that was entirely unimaginable when she was born. I'll bet she cares a lot more about that than the nominal value of her currency compared to 100 years ago.

During that 100 years, the time when she likely saw her living standard decline most dramatically was the very time she saw the value of the money she owned increase dramatically. That would be during the Great Depression.

Greg G writes:


I mostly agree with your analysis of why Fed policy had the effects it did in 2008. Economists are remarkably good at explaining why Fed policies from years ago had the effects they had.

It's predicting the future effects of current policies that's the problem.

Prakash writes:

I feel that the entire quality of collateral argument is a bit different in a fiat based economy.

Is the 2nd or 3rd tranche of an MBS a good investment in a fiat economy? Well, the answer is really dependent on what is the future path of income.
Is NGDP going to be 18 trillion or 19 trillion or 20 trillion?
Is average income going to 45000, 45500 or 46000? Is median income going to be 33000, 33500 or 34000?

Answer one of these with an assurance and you can get an idea of the future quality of the asset. Otherwise, you really are left with the situation where the central bank can make any collateral look good or bad (by adjusting the market's estimates of future income)

I'm with Selgin and the market monetarists here. Target the levels of a nominal variable, now and in the future. My personal preference is nominal median income. Most MMs call for NGDP.

Now that we're done with the targets, announce the instruments. Announce the assets that you will be buying or accepting as collateral and in which exact order. Similarly, announce the order of selling. You may go one level meta here and announce the criteria for assets to get into this list in the future, to incentivize financial engineering for good instead of bad.

No special favours after that. No bailouts. Buy and sell as needed to hit the targets.

Kevin Erdmann writes:

Prakash, that's what I find so interesting and frustrating about the whole crisis. A systemic collapse in securities prices, or even a systemic default crisis, are almost by definition events determined by monetary policy. Normally, there would be a strong consensus that if the Fed could salvage the values of those securities, they should. This is a core function of monetary policy. But, because there is such a widespread belief that the housing market circa 2005 was irrational or out of control, that consensus got flipped on its head, and the Fed was expected to watch home prices decline in an unprecedented way, because it was seen as inevitable.

So, all interpretations really have to go back to one's opinion about the housing boom.

Now, I happen to have been working on this topic, and have developed a lot of evidence that I was surprised to find suggests that housing prices circa 2005 were not pushed by excessive lending significantly away from some fundamental value. And, once I came to this conclusion, I realized that what followed wasn't even a sort of random walk into a contraction, but really was engineered by the Fed, as the last mover in the growth of the nominal economy, as Scott Sumner would put it. And, like George, I see some pretty surprising positions by the Fed, going at least back to 2007, where they were not only putting severe dampers on currency growth, but were also undermining credit growth. Home prices started falling sharply in late 2007, when these monetary positions were really starting to turn the screws down.

If the Fed hadn't done this, they would have taken a lot of heat for propping up the housing market, so I think they were following the will of the country. But, if this wasn't necessary - if home prices weren't being inflated by demand-side policies, but were reflecting some severe supply-side problems, then what have we done to ourselves, here?

To me, this is the story of our young century, and it's interesting to me that George is highlighting an important facet of that story. The Fed first pushed short term rates up high enough to invert the yield curve in early 2006. After about 18 months of that, housing starts had collapsed, prices stagnated, and there were some pretty significant signs of distress developing in credit markets, and at that point, the Fed took some pretty strong measures to make sure credit still did not expand. At about that time, home prices really started to collapse in a crazy way.

I think that collapse was due entirely to policy that were coincident with the collapse. If we blame the collapse on policies in 2005 and before, as if it was inevitable, so that supporting mortgage credit markets in 2007 would have been irresponsible, then I think we will take all the wrong lessons from this whole episode, and we already see the ramifications of that with somewhat broad support for interest rate "normalization" when housing construction has been a disaster for a decade and rents are climbing to unprecedented levels around the country because of it.

Maybe George isn't that far away from me here, in terms of his opinion of Fed policy in 2007. But, I think it makes a big difference whether we see those sharp home price declines as inevitable or avoidable.

(Sorry I'm being so verbose, Russ.)

jw writes:


1-4: Many wrongs do not make a right. The previous bailouts increased moral hazard just as predicted (in fact, the term “Greenspan put” was in wide use). The moral hazard and delayed risk created by QE will rear its ugly head someday in the future but, as above, their bullets will be spent. That will be an interesting day.

6. This was Russ’ epiphany. The Fed injected money but specifically NOT to bail out the economy, but only to bail out the banks’ balance sheets (the banks are why the Fed exists, not the general economy). As shown above, the $3T of QE cash in the banks would support tens of trillions in loans at a conservative (for bankers) 6% reserve. The money that the Fed prints gets quickly amplified by fractional reserve lending if it is lent out into the economy.

7. Ah yes, the dual mandate. Congress can make thousands of pages of new regulations, the President can issue Executive Orders all day, they can raise the minimum wage to $15, but they then mandate that the Fed reduce unemployment and wipe their hands. Congress may as well have added a third mandate to keep the tide from coming in. It turns out that it was far easier to “adjust” the birth/death ratio and the discouraged workers numbers than actually create jobs to lower unemployment. Sure, it’s officially 5%, but we are now in a country with no small business creation and the labor force participation is still down 6% (300bp) from the crisis (and many more part timers at that). Not exactly thriving despite the specious headline unemployment number. With all of the QE and “stimulus”, according to the Keynesians, we should have had a boom, but the only Keynesian argument left is “well, it might have been worse”.

9-10: That is certainly part of the scandal. The $8B in risk free income (and therefore bonuses) to the major banks is another. The tens of billions a year in savers’ interest vaporized to keep down the government’s borrowing costs are another. There are plenty of scandals to go around. But as Russ has mentioned in previous podcasts, the rentier class understands this process all too well.


Mrs. Smith’s increase in her standard of living is not due to inflation, but despite it. Mrs. Smith’s great-grandmother saw a tremendous increase in her standard of living from 1815 to 1915 while seeing a cumulative DEflation (source: I do admit that the fluctuations were much greater pre-Fed, but there was no magic, we simply traded higher inflation for lower volatility.


The causes were widespread. First and foremost were government institutions and policies mis-incentivizing investment in housing. There was widespread fraud in mortgage origination and management. The trigger was more probably the mark to market accounting rule for illiquid securities and the cure was the reinstatement of the mark to model rule (not that mark to market was wrong or that I know the solution to pricing illiquid securities). There was also widespread incompetence. The Fed was a contributor, but not the sole cause.

We take risks. Sometimes we succeed, sometimes we fail. But if there are no consequences to our failures, we cannot learn. We did not learn from the 2008 crisis (in fact, Dodd Frank was the opposite of learning…). When the next crisis hits, and it will, maybe we will learn then.

Greg G writes:


Yes, it's true that 1815-1915 saw a great increase in living standards without inflation. I would be more inclined than you are to attribute that to the Industrial Revolution rather than the absence of inflation. I am more inclined than you are to think that trading higher inflation for lower volatility is worth it. I suspect that Mrs. Smith thinks that one Great Depression was more than enough. Great grandma Smith saw many more depressions than your neighbor Mrs. Smith ever did.

George Selgin identifies with market monetarists and expresses a desire to maintain the stability of spending even if you have to use inflation to do it. I'm not sure how you square your inflation phobia with your desire to see him as Fed chair.

jw writes:

No one's perfect...

rhhardin writes:

I think the reserves interest rate account is a little misguided. The Fed is trying to prevent inflation (and deflation), which apparently it has done, by keeping new funds supplied to recapitalize the banks from winding up in the economy. Unwinding this accomplishment is where the problem will lie, though I suppose they could just raise the reserve requirement, as used to be done in the old days. That would hit other banks, however.

As for thinking the interest rate is what's regulated, that's not quite the right analysis.

Money is not wealth. It looks like it to an individual, but it is not to a country.

Instead, it's a ticket in line to say what the economy does next, presumably something for you.

The Fed regulates the number of tickets outstanding so that the economy neither goes idle nor experiences inflation through too many tickets telling the economy to do more than it can at once.

The way it regulates tickets is by buying them back in exchange for government debt (selling Treasuries) or creating new ones by buying back government debt (buying Treasuries) on the open market.

The interest rate is a way to make minimal interventions in the open market, not a way to control it. It's the opposite of arrogant. It's minimal.

The Fed meets and looks at leading indicators of inflation. If it looks like it's too high, the Fed raises its interest rate target a little, which will cause the Fed to sell government debt until the market response is that interest rate rise. If it looks like it's too low, the Fed lowers its interest rate target a little, which will cause the Fed to buy back government debt with money until the market response is that interest rates fall.

The target tells the open market desk when to buy and when to sell. No quantity is contemplated, just the rate.

That does not make the rate controlling except in the sense that it tells the open market desk how to work until the next Fed meeting, when they look at leading indicators again.

The rate is actually a market output rather than a Fed input, starting with the leading indicators of inflation and ending with the new leading indicators of inflation.

That's all in normal times. Note that the leading indicators of inflation that they use have to be orthogonal to the interest rate, lest they blind themselves by changing the target.

They don't believe that the interest rate is the important thing, just its change and that it be a small change. They don't want it to get to zero, however, or nobody will buy their Treasuries.

In today's times, they're still looking at leading indicators of inflation but in effect changing the reserve requirement instead of open market operations, only making it voluntary by paying interest on reserves.

As for the economy, nothing the Fed could do would have helped. It's bad because of insane regulation and cost of employment, which is a huge wedge between what something is worth to employers and what is is worth to employees.

Bob S writes:

Perry Mehrling of Columbia Barnard College has written "The New Lombard Street" and other papers on shadow banking, including "Bagehot Was A Shadow Banker." He characterizes central banks as having moved from the role of "lender of last resort" to "dealer of last resort." He might make an interesting guest.

Rob Pirnie writes:

GREAT podcast!

What a way to get our minds working just before we sit down to long holiday dinner discussions with family members!

Question...when will George Selgin be back to elaborate on the key question he poses at the 1:06:12 mark...we now have a fed 4 times as big as it was, we are just getting into the tremendous exit problems that we have yet to see the end of and we are just getting into this new act?

We need another podcast to further explore how the "New Act" might play out! I would love to hear George's thoughts.

jw writes:


I admit that I dashed off a quick line just for the fun of it, but now that I have more time to address your points, let’s get started:

- George Selgin advocates paying more than lip service to Bagehot as Ben did. I certainly agree that the Fed should lend freely in a banking crisis, but per Bagehot’s rules. This would also prevent the banks from asking for unnecessary liquidity and prevent them from creating even more money in the system via fractional reserve lending as the lending rates would be even higher than the borrowing rates. Yes, some banks would go under and some bank bondholders would be affected. But the deposits would shift to other solvent banks and life would quickly go on. Risk would actually be reduced by the insolvent banks defaults and moral hazard would be eliminated.

- As the Fed handled the crisis, risk was not reduced (no question, it was reduced locally for the bankers) but redistributed and delayed. It is still out there and growing.

- You mistake unintended consequences and unknowable consequences. For instance, there is currently a groundswell of support on the left for a $15 minimum wage. The intention is to pay people a “living wage”. The vast majority of economists know that this will increase unemployment, especially for the lowest strata, and result in a net harm, but some jurisdictions are already passing these laws. People will suffer due to unintended, but knowable, consequences. Plenty of people saw the drivers and predicted the consequences of the housing bubble (and some profited handsomely), but a lot was due to people not understanding that the road to hell was paved with their (regulatory) intentions.

- The 20th century saw some significant technological progress as well, again despite inflation. One of the best moments listening to this podcast was when the guest pointed out that human productivity was basically flat from 100,000BC to 5,000BC when agriculture was invented, then flat again to around 1800AD, where it has since taken off. Productivity is everything.

- George Selgin wants the Fed to target spending/NGDP. I read the linked articles above and an article or two by him from Cato. I have not seen his opinions on inflation related to spending yet. Currently, the Fed is targeting 2% inflation. This is good for borrowers who pay back in inflated dollars. Why didn’t the Fed target zero percent (a riff on one of George's links above)? Since inflation is the excess money supply, not the money supply, why not zero? Granted, sticking with one mandate is all the Fed can muster, so it should be the right one. Whether inflation or spending, fine tuning a money supply to account for a growing population and other factors that are legitimate is hard enough, let alone making sure that you hit an arbitrary additional inflation target or try and create wealth with it.

- I am paranoid about a LOT more than just inflation. Asset bubbles, 30 year bond bull markets hitting the ZIRP, why anyone in their right minds would invest at a negative interest rate, federal debts doubling every eight years, PhD’s in positions of power (sorry Russ), innumeracy in modeling, the list is almost endless…

Greg G writes:


Market monetarists have been calling for more, not less, inflation than the Fed has been willing to produce since 2008.

A low but steady rate of inflation has several beneficial effects. To the extent that it favors debtors it supports entrepreneurship and encourages spending rather than hoarding. Wages and real estate prices tend to be too sticky in a recession. Some inflation allows them to adjust downward in real terms more quickly to market conditions.

Negative interest rates are no mystery. Think of them as a fee for safely and reliably storing your money. This is not something new. It is something very old. Banking started with people paying goldsmiths to store their gold. They did this because goldsmiths had the best security and it was safer than storing it at home.

Investors have to choose from the options available to them, not the ones they wish were available to them. There is nothing like watching your stocks go down 30% in a panic to make negative half of one percent look pretty good. You can always rent a safe deposit box and fill it with $100 bills. Most people will find this inconvenient and be willing to pay a small fee not to have to do it.

You say that I "mistake unintended consequences and unknowable consequences." I'm not sure why. It was you who introduced both terms into the discussion. I merely agreed that unintended consequences are unintended.

Glenn writes:

Another great podcast Russ.

If the moral hazard started with Continental Illinois, then there would have been a Lehman-like shock had they let Bear Stearns fail. By that point the entire chain of debt was ready to collapse, so people would have been looking for the next Bear Stearns, and Lehman probably would have appeared on that list. The result would have been the same.

I don't fault Bernanke for attempting to prevent a collapse. What the government should have done is not cover the lenders at 100%. Goldman and the rest should have taken some losses - enough so that it hurt and they would remember it, but not so large that it would create a cascade of failures. Obama missed a golden opportunity to reduce or eliminate moral hazard in that famous meeting with the leading banks.

Alessandro writes:

A very insightful talk for me...

But the question that sprang to my mind was, why has the Fed allowed 'Quantitative Easing' to be positioned in the financial and non -financial media as 'pumping liquidity in the system' and 'propping up asset prices', when if George's argument is correct, the Fed has in actual fact been preventing that from happening by paying IOR?

Is it that the media has completely got the point of QE wrong, or was QE part of bigger Fed initiative to prop up consumer and investor confidence by seeming to pump liquidity in the system, but actually sneakliy keeping all those extra funds tied up in Fed reserve accounts. Has the Fed has allowed the media to completely misrepresent the point of QE to achieve its own outcome?

Ross, i think we need a follow up interview soon!

Nick Zbinden writes:

@George Selgin

Thank you for this podcast.

The podcast sadly ended a bit to early. Their are some questions left that I would like to ask.

1. What is the danger of the QE?

The balance sheet is bigger, I get that. But what is the real danger of this.

2. How can we bring back spending without QE?

Until now I was a supporter of QE because this is the only way, I could see, how to bring back spending. What is your plan to revive spending?

George Selgin writes:

Nick, QE in the context of IOR meant that the Fed could expand its balance sheet by trillions without generating any corresponding increase in spending and therefore without facing the immediate consequence of corresponding inflation. The adverse consequences of this are, first, that we now have a Fed that, far from merely supplying reserves necessary for interbank settlement, has effectively nationalized a large share of scarce savings that would normally be intermediated b the private sector. Central banks are not designed to be efficient intermediaries, and they are in fact not efficient intermediaries, so the nationalization is a drag on the economy.

Yet--and this is the other part of the adverse effects--the Fed now finds itself in a situation that makes it very difficult for it tor "normalize" monetary policy by shrinking its balance sheet. Most of the assets it took on in connection with QE are illiquid, so it cannot readily dispose of them even if tightening is called for. Any pronounced recovery of market interest rates and bank lending could therefore pose a risk of inflation that the Fed cannot hope to address through the usual device of open-market asset sales. Instead, the temptation will be for it to address the threat of inflation by further increasing IOR, which means preserving the swollen stock of bank reserves, and correspondingly inefficient use of scarce savings. Indeed, that is just what happened yesterday, when the Fed, in order to combat a supposed risk of above target inflation, doubled the rate of IOR. (The concurrent doubling of the fed funds target, on the other hand, was a mere gesture, as the lower target was already ineffective.)

rhhardin writes:
which means preserving the swollen stock of bank reserves, and correspondingly inefficient use of scarce savings.

Wasn't the inefficient use already made by the private sector?

Those tickets were misspent once and now are in a mattress, forever idle, removed from the money supply.

What's wrong is that the banks are still there and being supplied with free interest. Unless, of course, the interest has to stay in the reserves too.

The scarce savings are elsewhere, in the daily buying and selling. It's not crowded out.

George Selgin writes:

"Wasn't the inefficient use already made by the private sector?"

Despite common beliefs to the contrary, plenty of commercial banks behaved responsibly during the crisis. There were some notorious bad apples, but the main troubles were in free-standing investment banks and specialty mortgage lenders.

Central bankers, in contrast, no nothing about investing wisely. Nor is it their job to do so.

That said, I also favor reigning in too-big-to-fail and other sources of moral hazard, which presently undermine private sector investors' incentive to avoid excessive risk taking. But since the Fed is itself the main source of this moral hazard problem, it should not be rewarded for the mischief it itself is to blame for by being allowed to commandeer a vast chunk of the public's savings.

stuart writes:

Wonderful discussion.

I think you overlooked mentioning one huge implication. If the Fed had done QE in the absence of paying interest on reserves, this would have been a market-based (capitalist) method of stimulating the economy. Government stimulus spending is a socialist action. It is saying (screaming) that the government knows how to spend money better than individuals, the private sector, capitalists.

I understand why George is against QE in this case but I don't understand why he is against it in the case where the Fed continued to pay no interest on reserves. What's the third option besides govt spending and QE that goes into the market?

Another thing. How is the Fed EVER going to stop paying interest on reserves without a huge stimulative affect? ... sell their security holdings at the same time?

I have had conversations with a nationally reknowned economist (among other economists anyway) who argues the stimulus needed to be bigger. Maybe, maybe not. Either way, he disagrees when I suggest that the Fed paying interest on reserves counteracts the stimulative effect of QE by encouraging banks to hold more reserves. Now I can point to something from an expert that agrees with me AND adds details I never even knew. Thanks!

Mark Crankshaw writes:


I am advocating for a more charitable interpretation of other people's motives.

I respect your continued persistence in advocating for more charitable interpretations of other people's motives. There is now a little "GregG" voice in my head whenever I wish to cast aspersions onto the motivations of others especially in the political arena.

However, that said, whenever I am contemplating the actions of large political organizations, my gut instinct remains that the most accurate interpretation is the less-than-charitable interpretation of other people's motivations.


Yep, trust your net worth and your children's future to those omniscient and altruistic Fed governors, they only have your best interests in mind when they decide to openly manipulate the markets.

That's a nice summary of the deep distrust I feel towards political institutions like the Federal Reserve. I simply do not believe that this institutions has my interest (or those like me) at heart. The Federal Reserve masquerades as apolitical, somewhat scientific and only interested in technical economics and intent on serving the general public when, in fact, it is purely political, serving solely political masters and will ruthlessly sacrifice any economic theory and the economic interests of others to that end. That's why it was created by those same political masters in the first place...

While the Federal Reserve may have made numerous technical mistakes, one mistake it will never make is to sacrifice the economic interests of the political class it was designed to serve. When its' policies are complete blunders (the Great Depression, the Great Recession) then it will push the interests of the politically weak and disorganized right under the bus every single time, without fail, and without care. This latest catastrophe is just the most recent example of that abysmal trait...sorry, GregG, I think jw is right on the mark here...

George Selgin writes:

"I don't understand why he is against it in the case where the Fed continued to pay no interest on reserves."

Never said I would have been against it in that case.

jw writes:


Actually, the rational reaction to a negative rate environment is to start piling cash under you mattress (putting aside that if you find yourself in a situation with equity bubbles, bond bubbles and negative rates, you are already in a brand new world). However, using that cash or redepositing it in a bank becomes quite problematic when any deposit over $10K is immediately reported to Homeland Security and your assets may be frozen. If you look around the world, capital and cash controls closely follow negative rate excursions.

If you think that the $10K deposit limit is actually to control the drug trade, here is an interesting factoid: the US has $1.4T of currency in circulation. $1T of that $1.4T is in $100 bills. We print almost as many $100 bills as we do $1 bills (in 2013 and 2014, we actually printed MORE $100 dollar bills than $1 bills). Source:

Now, I haven’t seen a $100 bill in circulation since the advent of gift cards for Christmas (outgoing gifts, not incoming…). And McDonalds will laugh at you if you try and use one in their drive through (retailers are not legally obligated to take them), so where do you think this trillion dollars of cash has gone? The Fed and Treasury openly support the drug trade and worldwide black markets in exchange for over $100B a year of debt obligations (cash) that they know will never be redeemed. Nice deal if you can get it.


Krugman has continually argued for massive additional stimulus spending, so there is a Nobel award winning economist on your friend’s side as well. He and other central planning oriented economists actually believe that they can micro-manage a complex and chaotic economy made up of 330M people and force them to make personally disadvantageous choices so that some theoretically constructed macroeconomic target that they deem a greater good can be optimized.

Never mind that the mere existence of the financial crisis and the failure of the TARP stimulus and the Fed money printing afterwards to “stimulate” a recovery are just a few of many data points that disproves their theories. Of course, they can never admit that their theory failed, so they must claim that their personal sub-branch of the central control theory was not followed exactly in order to maintain any credibility. They strongly disagree with the existence of the Hayekian knowledge problem and Schumpeterian market based creative destruction, I strongly agree with both.

George Selgin,

I also commend you for monitoring and replying to this comments section, it is rare here and unknown in most other forums, thank you. I also agree with your replies above.

To Greg’s earlier point, would you advocate inflation to stimulate spending?

1. Is this based on the theory that consumers will spend mildly inflated dollars to get rid of them before they devalue even more? That is much more of a stick than a carrot… (I agree in a significant or significantly rising or hyperinflationary environment people will react this way – but not at low inflation as we are seeing now and it should not be the intention).

2. I understand that as a large debtor, the US government is fearful of deflation, but if the populace decides that savings is the best path for them at some point in time, so what? Won’t that lead to increased capital for investment and potential wealth creation? (I am obviously not concerned with deflationary spirals, as I see them as much rarer and shorter lived than inflation).

[Comment edited, and revised comment posted, with permission of commenter.--Econlib Ed.]

Alessandro writes:

Interesting article from the Minneapolis Fed, putting some numbers to the amount of excess reserves tied up by paying IOR:

Greg G writes:


Storing large amounts of money under your mattress is not rational. It is very risky. You could, of course, rent that safe deposit box (think of the rental fee as a very small negative interest rate) and fill it with $100 bills.

At present, the main motivator for the government's extreme interest in the flow of funds is the fear of terrorism both real and imagined. This is an effective tool for fighting terrorism and it does come at a real cost to personal liberty. There are difficult trade offs involved which might not be that easy to resolve even if we knew the exact levels of risk and effectiveness, which we don't.

Some extraordinarily large percentage of all U.S. currency is used overseas. The dollar is the most universally accepted medium of exchange in the world right now and has been for a long time.

Low inflation does carry some small effect of people spending now to avoid price increases. One of its main values is protecting against deflation. Deflation is pernicious because it discourages investment. In a deflationary environment investing is risky but simply hoarding cash has a guaranteed positive tax free return.

There is no shortage of capital for investment. At no time in world history has more available liquid capital been chasing fewer good investments than right now.

Greg G writes:


I am surprised and delighted that my work here is having some influence on you.

I don't know anyone who believes that Fed governors (or politicians for that matter) are "omniscient and altruistic." Who is it that you think believes that?

The argument in defense of Fed governors and politicians in a constitutional democracy is simply that their selfish interests tend to be more or less aligned with the interests of the general public because they will be more likely to lose their jobs if they are not.

A Fed Chairman whose policies result in low inflation and full employment is more likely to keep his job than one who gets poor results. Those Fed Chairs and governors whose policies get good results will also find more prestige and lucrative opportunities after their jobs at the Fed are over than ones who get bad results. Those factors, not personal virtue, are what discipline their decisions.

Jimmy Carter appointed Paul Volcker against the advise of many of his political advisors who correctly understood that Volcker's intention to tighten monetary policy would doom Carter's re-election bid. Many people forget that the recession that the Volcker policies triggered caused Reagan's popularity to plummet to a low point that occurred only a little before he reappointed Volcker. Carter, Reagan and Volcker deserve a lot of credit for those choices which I believe were motivated, not by altruism, but by a longer term concern for their own reputations.

George Selgin writes:

JW asks, "To Greg’s earlier point, would you advocate inflation to stimulate spending?"

The question as posed originally by Greg gets things backward. "Inflation" doesn't cause spending; spending (or too much of it) can cause inflation. So no, I don't favor inflation as a means for raising spending, because I do not consider it a means for doing that at all.

Yet that doesn't mean that I am opposed to any and all inflation. Why not? Because, besides being a result of too much spending, inflation can also be a result of an adverse supply or productivity shock--that is, of reduced aggregate supply rather than increased aggregate demand. In this case, the inflation will take place even if spending is stable (though a boost in spending would enhance it).

In short, I favor inflation when it occurs despite stable spending, but do not regard it as a means--desirable or not--for boosting spending.

My views on spending and inflation are developed at some length in my pamphlet Less than Zero, electronic versions of which can be found online.

jw writes:


Everything you said is correct and you still have my vote for Fed chair.

I have printed out “Less than Zero” for further study, but I did read the “Practice” and “Conclusion” sections. My problem remains knowing what the norms are. You also state that labor productivity is harder to manipulate, but you could not have known then how twisted our labor metrics have become since.

The highlight is that you recognize that quantifying the norms would be extremely difficult and that the entire theory needed further study. I salute your lack of hubris (this is one of the reasons that I enjoy Econtalk so much, as Russ displays the same trait).

So let’s get metaphysical. One of the tenets of economics is that human want can never be satisfied. It is impossible to disagree with this. However, is there a point where we achieve a balance of what we are willing to work for to acquire that which we want? After trillions in liquidity have been pumped into the economy and trillions more in direct stimulus and indirect deficit spending stimulus, growth is abysmal. Besides again disproving neo-Keynesian theory, where is the demand? Headline unemployment is low, but that is now almost meaningless as labor participation has fallen off of a cliff.

Have we reached a point where a rational person realizes that they can have a pretty good life by not participating? Robert Rector of Heritage has documented the vast improvement in living conditions of the poor in the US. Base income is no longer a reasonable metric for classifying someone as poor as redistribution has greatly distorted the concept that income is linearly related to living conditions. As I have stated before in another comments section, income inequality is a fraudulent issue as long as income is measured pre-tax and pre-benefits, but we all know that there are political reasons for doing so.

In any case, with the average American poor person having more than enough food, a car, big TV, AC, and more living space than the average European, have EBT cards and ESPN replaced bread and circuses? Of course there are still truly poor people in the US, but as a group they are declining.

As difficult as it is to say this, I hope that the lack of participation and demand is just due to rising minimum wages, exploding regulations, general government mismanagement and the business cycle. Otherwise, if the above is the case, I fear for people’s concept of self worth, but that may be a personal projection bias, I don’t know. Even worse, Hayek could have been right in “The Road to Serfdom”.

Harvey C writes:

“Russ: Correct. You're telling me they actually think that level, that rate, is the key to good health for the economy? Guest: That's right-- Russ: That's bizarro. . . .
Guest: I'm worried about it, too, because I don't like saying things that make it sound like I'm crazy. But I can tell you the quotes--there were abundant quotes backing me up on this.”

Roberts and Selgin’s reluctance to say things which many would characterized as “crazy” is warranted and wise. That doesn’t mean that the rest of us should avoid stating the obvious.

There are two major things to consider about the comments having to do with the motive of the Fed in paying interest on bank deposits. Selgin defends this bizarro explanation by the Fed of its motive by noting that the motive is what Bernanke (a politician) said his motives were. A politician’s stated motives is close to per se proof that some other motive is afoot. Especially if the stated motive is bizarro, then there is little reason to give it any credence. Second, a far simpler and much more compelling argument as to why the Fed decided to pay interest on Fed deposits can be made. It will be considered crazy by those who want to believe the best about the government, but, as Galileo proved, “crazy” theories are not necessarily wrong. People in government have not earned the benefit of the doubt.

Wall Street executives are among the largest, if not the largest, donors to Democrats. The investment banks needed to be bailed out to keep those executives in their positions so as to keep the donations coming. Bailing out the banks to keep the executives in place (and wealthy), however, was not sufficient unless those banks were financially healthy. Having the banks invest their funds in a very shaky economy was not a sure thing. “Investing” their available funds in the Fed and earning a return backed up by the ability to print money would assure that the banks would recover and be in a position to fund future campaigns (and the Clinton Global Initiative, etc.). Once bank reserves were in good enough shape to assure the flow of money back to government officials, the interest rate was lowered.

Of course, there could be other even more credible explanations as to why the Fed engaged in bizarre activities. The burden should be placed on government to prove the most obvious explanations to be the wrong answer.

Robert Swan writes:

Very interesting talk, and the comments have been setting an even higher standard than usual.

Often the more technical subjects leave me a bit behind and I need to pause while I think about what's been said (perhaps I should listen to them at half-speed -- 0.25 Mungers if you like). I didn't have that problem with this talk, but I kept feeling that it was like listening in on an 18th century discussion of the humours -- "have we brought the fever down enough yet, or do we let another pint of blood?"

I often think people who think they control the economy (central bankers, treasurers, etc.) have hold of a leash around an elephant's neck. The elephant will still go just where it chooses, but they can pretend they're in charge. Perhaps monetary policy is an electrified leash, so now it's an angry elephant, still going wherever it will.

jw writes:

[Comment removed. Please consult our comment policies and check your email for explanation.--Econlib Ed.]

Russell writes:

I have thought that Interest On Reserves (IOR) probably helped account for a lack of inflation - if the money does not circulate then it effectively does not exist - so much less inflation pressure. The inflation problem would likely manifest itself if interest rates rose and it becomes attractive to lend it out and make more - a tradeoff between the riskless interest of the US Treasury and riskier gains from others with the US Treasury or Federal Reserve then in the unenviable position of trying to sell securities to pull the excess cash out of the economy if it wanted to avoid inflation.

It would seem that by the administration pursuing a new New Deal agenda that we have the effects of the an economy that would not power out of the recession which necessitated the prolonged ZIRP and QE with all those consequences.

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