Kamis, 15 Juni 2017

The Treasury Portfolio

Charlie Plosser makes the case that the Federal Reserve should hold only Treasuries in its asset portfolio, at Hoover's "Defining Ideas"

Background: The Fed is essentially a giant money-market fund. Its liabilities are cash and bank reserves. Its assets are .. well, they used to be entirely short term Treasury securities, but now include mortgage-backed securities. In the crisis, the Fed bought a lot of other securities. Other central banks buy stocks, and it's pretty clear if there were a recession tomorrow, after interest rates hit zero the next day, the Fed would go on a buying binge. The Fed is a government agency, but it is "independent," enjoying a lot of freedom to do what it wants no matter what Congress or the Administration want it to do.

Plosser's proposal,
 1.        The Federal Reserve should be required to maintain a Treasuries-only policy as it pertains to the conduct of monetary policy. 
2.         The Federal Reserve should be prohibited from purchasing non-Treasury securities, private sector securities or lending against private collateral except through traditional discount window operations with depository institutions. 
3.         Emergency lending under Section 13(3) of the FRA should be eliminated and replaced with a new Fed-Treasury accord...

The Fed may buy other securities, but basically has to swap them back to the Treasury or sell them within 60 days. If the government is going to subsidize credit to various industries, voters, and constituencies, then the politically accountable Treasury should do it, not the independent Federal Reserve. Charlie allows here that the Fed may be able to move faster in a crisis.

Why only Treasuries? Why should the Fed not always have greater power to guide the economy more forcefully by buying whatever assets it thinks need propping up? Because,

 ...in a democracy, independence must come with limitations on the central bank’s authorities and discretionary powers. Otherwise, central bankers can use their powers to venture into policy realms unrelated to monetary policy, especially fiscal policy, which more appropriately rests with elected officials. ...Engaging in such actions also undermines the central bank’s legitimacy and the case for independence
A central bank that hands out money to voters, or denies such money when it wants to prick bubbles, cannot stay independent for long. That central bank then becomes a piggy bank for legislators and presidents.
More troubling was the lending under Section 13(3) of the Federal Reserve Act (FRA), which included support of the creditors of Bear Stearns and AIG. The Fed also funded other lending programs designed to support the purchase of commercial paper and other types of asset-backed securities.... Regardless of the rationale, the Fed sold Treasury securities from its portfolio and used the proceeds to purchase risky private sector securities. These actions amounted to debt-financed fiscal policy but without the explicit authorization of Congress. Given the distributional effects of such interventions, it is not surprising they proved controversial.
...The discretion to engage in credit allocation represents an open invitation to politicians and interest groups to pressure the central bank to use its authority to manage its assets to further some other agenda. Maybe the Fed should invest in green energy companies, in domestic manufacturers who pledge not to ship jobs overseas, or infrastructure bonds issued by state or municipal authorities. This may seem far-fetched, but Congress asked the Fed to invest in the automobile companies in 2008. After all, it had already supported Bear Stearns and AIG, and weren’t the big four auto companies as important to the economy and employment as these financial firms? Fortunately, the Fed said no, but the discretionary authority to engage in credit allocation could prove to be a threat to Fed independence. 
My first reaction, a few years ago when I started talking to Charlie about these things was, this is a tempest in a tea pot. The Fed and Treasury have one consolidated budget constraint. If the Fed loses money, it comes out of the Treasury eventually. This is like arguing whether you should pay restaurant bills from the cash in your left pocket or the cash in your right pocket.

Both Charlie and quite a few conversations inside the beltway convince me this is wrong. The average legislator does not see things this way at all, the Fed balance sheet really does look like a piggy bank.

Charlie cuts the gordian knot cleverly, I think. The Fed does move faster in a crisis. But buying securities is not the same as holding securities.

Actually, I would think the Fed would want such a deal. Right now, as I understand the legalities, the Fed is not allowed to swap securities with the Treasury. This is one of the brilliant legal constraints our ancestors put in against inflationary finance. They didn't want the Treasury to force the Fed to buy securities at inflated prices. But for the Fed, the ability to buy what it wants but not have to hold the risks, or political fallout, forever should be very attractive.

If there is a contrary view, I think it must be that there really is nothing left to monetary policy. Now that reserves pay interest, all Charlie's Fed will do is to act as a giant Treasuries only money market fund, to undo the curiosity that the Treasury itself cannot figure out how to issue true floating-rate debt directly, and to figure out what rate to offer.

Take the view then, that the Fed's central role is to interfere with -- sorry, to "supervise," "regulate" and "stabilize" -- financial markets, perhaps in crises only, or perhaps because you view markets as inherently unstable and behavioral and the Fed somehow able to offer super-rational financial dirigisme. If the independent Fed is going to be running "macro prudential" policy and scrutinizing banks credit policies, telling banks who to lend to, then it might as well interfere directly in the same markets, and even start buying and selling stocks to offset "herd" mentality in markets or whatever. Charlie doesn't talk about it, but the Fed's regulatory arm is already allocating credit.

This is, I think, where we are and are heading. But I think Charlie's point applies. This Fed as Great Financial Director cannot, in a democracy, stay as independent as has evolved for a Fed whose power is limited to old-fashioned monetary policy implemented by buying Treasury securities and managing a vanishing stock of money. And while it's fun for economists to write papers about just how rational we are and if someone put one of us in charge we could spot those bubbles and herds, I think we all agree politicians, handed another set of excuses to start handing out credit here and there, are not going to do a great job of it.

The tension remains. If the Fed is going to be deeply involved in directing the financial system, either it must be powerful, but then subject to the usual sort of political accountability as Treasury, and therefore subject to all the political craziness of the rest of government financial and credit allocation policy, or it must be severely limited in what financial levers it can push with great independence.