25 Dec 2012

Clarification on Fed Monetizing Deficit in 2013

Economics, Federal Reserve 18 Comments

I realized something wasn’t adding up with the numbers, and went and double-checked the JP Morgan report that led me (in this video) to say that the Fed may monetize the entire federal budget deficit in 2013.

Well, that’s a misleading way to describe it (which is why I’m posting this clarification). What the JP Morgan report (and Zero Hedge blogger) are saying is that in its latest announcement, the Fed pledges to continue buying $40 billion of agency-issued mortgage-backed securities per month, but will also start buying on net $45 billion of Treasuries. (Before, with “Operation Twist,” the Fed was buying $45 billion of long-term Treasuries but was simultaneously selling off the same amount in short-term Treasuries. Now it’s going to engage in net purchases.)

So what the JP Morgan report was saying, is that $85 billion per month x 12 months = $1.02 trillion for the year in the growth of the Fed’s balance sheet, and that’s just about what the federal budget deficit is projected to be. Hence, in their words, “QE will offset almost all of next year’s government deficit.”

But the problem with saying it this way, is that the word “offset” makes you think it’s a euphemism for “monetize” when it’s arguably not. For example, suppose the Fed planned on buying $1 trillion of real estate in Hong Kong. Would we still say “QE will offset almost all of next year’s government deficit”?

Now it’s true, the MBS that the Fed is buying, is ultimately backed by the US taxpayer through Fannie Mae et al. So in a sense, those MBS are federal government obligations, just like Treasuries.

Yet in another sense, they’re not “just like Treasuries.” If the borrowers faithfully make their mortgage payments, then the US taxpayer doesn’t kick in a dime. Another problem is that even if you count MBS as equivalent to Treasuries, then “next year’s government deficit” would have to include not just the net increase in Treasuries held by the public (and Fed), but you’d also have to include the net increase in outstanding agency-issued MBS.

So, unless someone corrects me yet again in the comments here, I’m going to stop saying the Fed plans on monetizing the entire deficit next year, since I don’t think that’s really accurate.

18 Responses to “Clarification on Fed Monetizing Deficit in 2013”

  1. Keshav Srinivasan says:

    Bob, have you seen this post by Krugman?


    • Bob Murphy says:

      Not yet, I have to read Krugman on my iPhone so I don’t use up all of the freebie passes on my computer for the NYT.

      • Enopoletus Harding says:

        I don’t think access to NYT articles/blog posts is blocked after you use up the freebie passes- I just remove the extra stuff the NYT website puts at the end of the needed url (the ?gwh=yadayada…).

    • Tel says:

      KRUGMAN: Second, the idea is conceptually wrong. Asset prices should be determined mainly by the stocks of assets, not the changes in these stocks over short periods. If bond investors lose confidence in federal debt, there’s a huge outstanding stock of that debt for them to try to sell, driving rates up, no matter how much of the new issue the Fed might be buying.

      So let’s suppose we are talking real estate prices, and you have a street full of typical residential houses. For argument’s sake, suppose people move house on average of once every 20 years. Then in any given year we would expect 5% of the houses in that street to come onto the market and change hands right? Thus 95% of the houses are not on the market, but Krugman thinks that these houses not available to be bought and sold are controlling the price of real estate in that street? Naaa, I don’t think so.

      The implication of Krugman’s theory would be that it is impossible for real estate prices in any area to suddenly fall, because all that stock of non-trading real estate guarantees price stability. There’s massive amounts of empirical evidence showing that prices can fall suddenly, even when only 5% or 10% of the houses change hands. It just takes a burst of sellers who (for whatever reason, mortgage stress or employment issues) are under high pressure to sell, and a shortage of interested buyers. That’s it, price crashes.

    • Tel says:

      FEDERAL RESERVE: To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will purchase longer-term Treasury securities after its program to extend the average maturity of its holdings of Treasury securities is completed at the end of the year, initially at a pace of $45 billion per month. Asset purchases like these support the recovery by maintaining downward pressure on longer-term interest rates, such as mortgage rates, and by making broader financial conditions more favorable for household and business spending and investment. 

      But wait, the Fed seems to believe that their asset purchases do have the effect of pushing interest rates down. Don’t they read Krugman? Don’t they understand how foolish they are?

  2. Jason Quintana says:

    Yeah, I was surprised when I saw the video because this was not exactly right given the Dec. 12 announcement. The $1 trillion per year figure gives them the ability though to make subtle shifts in this direction if they want to. That is, toward purchasing 60%, 80% or even 100% Treasuries. They can come out with a message like “the housing market is recovering so we will stop purchasing MBS, but the general economy still needs stimulus so we are sticking to $85 billion a month” if the prices for Treasury bonds need support.

  3. Dan says:

    So what, they’ll only monetize half the deficit? Whew! For a second there I was worried they were doing something crazy.

    • Bob Murphy says:

      Right but last year it was 77%, so dropping to 50% is an improvement…

      • Dan says:

        That’s messed up. We live in a bizarre world

      • Jonathan M.F. Catalán says:

        77 percent of long-term treasuries, IIRC (right?); how many treasuries with shorter maturity rates did the Fed sell?

  4. guest says:

    Peter Schiff has got you covered:

    Ben Bernanke throws the dollar over the Currency Cliff
    Published on Dec 12, 2012

  5. Tel says:

    So, unless someone corrects me yet again in the comments here, I’m going to stop saying the Fed plans on monetizing the entire deficit next year, since I don’t think that’s really accurate.

    The Federal Reserve don’t borrow the money that they are using to buy these assets (as far as I can understand), they merely create the money. While ever they are creating money and buying debt with that money then logically they must be monetizing debt.

    So in terms of accuracy, we have MBS as one type of debt, and Treasuries as another type of debt and the Fed are intending to monetize a bit of each (or they claim this is their intention, but they may in fact do something else when it suits them). Still monetizing debt, but not all of that debt is coming from the deficit.

    Next question: who else is going to buy those Treasuries? Would you? Anyone?

    Probably some private pension funds will be pushed into buying Treasuries because they have formal obligations, and for lack of other options. Maybe Japan will buy more in the hope of further devaluing their currency.

    What possible real incentive would there be to buy US Treasuries right now?

    • skylien says:

      Isn’t the FED, no matter what they buy, increasing the markets capability of sucking up government debt when they increase their balance sheet?

      If they buy 10 trillion worth of Hong Kong real estate, some of this new money will go into treasuries, that otherwise could not have done that, because it wouldn’t have been there in the first place.

      So, I would argue that the FED still uses the markets trust in US bonds, and especially their trust in the FED to buy them if there really is no other buyer left to keep the government financed… It is just another Central Bank put.

      • Tel says:

        Yes, fair point. Someone selling MBS to the Fed is now left with cash in their hand, so they need to do something with that cash. If you can convince them to buy treasuries with the cash then you have the illusion of a “free” market backing the government.

        The more they play this game, the less the market is focussed on anything real, and everyone just puts their energy into second-guessing government policy.

      • guest says:

        Isn’t the FED, no matter what they buy, increasing the markets capability of sucking up government debt when they increase their balance sheet?

        ROFL! More like “increasing the taxpayers’ capability to be a slush fund for the Fed”.


        • Tel says:

          Is that true though? Suppose the Laffer Curve is real, then in order for government to be able to commit future taxpayers as a government asset, they would need to be sure there was room on the curve to generate more future revenue.

          However, at the same time they are trying to maximize present day revenue. Can’t work both ways can it?

  6. Tel says:

    Isn’t it a small world:

    The interest to me was to find that deficit finance has been in the socialist playbook going well back before Keynes. And it is interesting to see that it was identified as a socialist idea as far back as 1910. I had somehow always assumed that it was an innovation of the depression that had followed the use of deficit financing during World War I. Not so. It is instead the very essence of socialist policy making and goes back to Lloyd George’s Liberal budget of 1909-10. Keynes was himself a Liberal. What Keynes did was provide an economic rationale, as flimsy as it might be, for the policies that were anyways one of the cornerstones of socialist policy. He thus introduced into economic theory one of the essential elements of the left.


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