The Fed should stop treating all currencies equally
Federal Reserve Update
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The author is an FT special columnist
Every day at 12:45 pm, the Fed will do things that seem a little strange but have a completely rational purpose.
It took a portion of the $5.2 trillion in Treasury bonds it held on its balance sheet, transferred ownership of some of them to money market funds and commercial banks, and then loaned it to itself with the same amount of cash. The next day, the Fed reversed the transaction: it repurchased U.S. Treasuries. But this time the Fed lost a little money. It buys high and then sells low. deliberately.
Banks and money market funds are involved because they have a lot of cash and they have no better ideas on how to deal with it. The Fed offers them this meager profit as an interest rate; the so-called reverse repo transaction sets the bottom line for interest rates in the money market.
Again: everything is completely rational. But in the past year, the daily transaction volume of reverse repurchase has increased from zero to 900 billion US dollars. This is a lot of extra cash. In theory, this should give lenders the confidence to lower their interest rates and make loans more attractive.
This is how central bankers prefer to do their job-buy and sell a set of assets, drag a key interest rate to the right place, set expectations and hope that all other interest rates will be consistent and follow up. For certain types of debt, especially mortgages and corporate bonds, this is happening now. But for all interest rates, it does not work as well as it used to. The reason is not clear. This may not be the Fed’s fault. But this is the Fed’s problem.
Policymakers often quote paragraphs on monetary policy in the Federal Reserve Act: The Federal Reserve’s mission is to provide full employment and stabilize prices. But this is actually only the second half of the task.This paragraph first explains how the Fed should achieve these goals: Banks “should maintain long-term growth in the total amount of money and credit commensurate with the long-term potential of economic growth production.”
The clause is a mouthful, and policymakers tend to treat it as an outdated law, as if Congress has given instructions on when to graze sheep on public grasslands. But it is also a “should”, a legal way of saying that the Fed must do so. This clause instructs the Federal Reserve to ensure that different kinds of new dollars are produced at a steady rate so that they can be put into production. This is not accidental. This is what the Fed does.
The Fed does not make all the dollars in the economy. Anyone who issues a new loan will earn new dollars. When you borrow money—to buy a house or a car—the lender creates brand new dollars and then gives them to you. In return, you promise to repay it in full with interest. The more loans, the more dollars. When the borrower repays the loan, the dollar decreases.
Macroeconomists used to spend a lot of time thinking about totals—the way to add up all the dollars. When someone takes a loan, these new dollars will appear in the form of cash, bank deposits or money market deposits. The monetary aggregate is just a way to calculate some or all of these dollars. The total amount of credit is the opposite: a way of calculating some loans.
But the total amount is difficult to calculate, because every day some geniuses come up with a new loan method. Therefore, in the 1980s and 1990s, the central banking community abandoned aggregates. The Fed does not target the total supply of dollars because you can’t target what you can’t see. On the contrary, like most central banks, it relies on a single interest rate and a huge assumption: if it can move one interest rate up or down, then all other interest rates will follow.
Policymakers refer to this assumption as transmission. But for various dollars, the transmission effect is not the same. Mortgage and corporate bond interest rates still fluctuate cyclically around the Fed’s path. But during the pandemic, car loan interest rates began to diverge.The interest rate on the credit card balance has been Since 2011, it has risen steadily. The growth rate of bank loans used by small businesses is different from the growth rate of corporate bonds of large companies.
When the Fed buys U.S. Treasury bonds, it creates only one type of dollar: reserves, a type of deposit that commercial banks can hold. But, for example, the way in which reserves behave is completely different from the dollars created by commercial banks for credit card balances. Or car loans.
The Federal Reserve and most other central banks are considering all these types of dollars. But they feel uncomfortable about managing them. They will not allocate credit, they will say-it is up to the market. But the Fed is already allocating credit, whether it wants to or not. It has launched so many reserve dollars in the world that banks don’t know what to do with them. Does this increase production capacity as directed by the Federal Reserve’s mandate? At the same time, interest rates on credit card balances continued to climb. Short-term dollar liquidity is cheaper for banks, but more expensive for humans.
When the Fed meets, like this week, we should certainly ask them questions about the throttle: Will they relax? But the crankshaft on that engine must be connected to something. It must generate productive new dollars in every part of the real economy. It’s time to consider all these different kinds of dollars.Transmission between crank and wheel Yes Monetary Policy. It’s in the mission.