Data- Federal Reserve Policy Keynesian vs Q theory of Money vs Marxist Theory of Money Spring 2016

Traditional Federal Reserve Policy before the 2008 Financial Market Meltdown: target short-run interest rates Prime rate- Benchmark rate for bank loans to consumers & businesses Federal Funds Target rate for what banks charge each other for overnight Loans of reserves at the Fed

What has happened since late 2007 through 2010 to short term rates? Traditional Federal Reserve Policy before the 2008 Financial Market Meltdown: target short-run interest rates Prime rate- Benchmark rate for bank loans to consumers & businesses Federal Funds Target rate for what banks charge each other for overnight Loans of reserves at the Fed What theory of money is behind the actions shown above in blue & green? Who initiates the policy? Who carries It out? How is the policy carried out? How is the policy supposed to feed into & impact the real economy? Compare the intended effects of the policy of raising rates (2005-2006) on macro diagrams (Plevel, y) with What has happened since late 2007 through 2010 to short term rates?

Black line inflation rate- % change in consumer prices from year ago Negative means deflation; Financial Crisis followed by Deflation caused the Great Depression

What is the danger of inflation rates (black) that turn negative (deflation)? What would happen to people’s spending if they thought prices would fall in the future? What would happen to people’s ability to pay off debts if wages fell? What would happen to companies’ ability to pay off debts if prices of the goods they sold fell? What would happen to the banking system if everyone defaults on debts? The answer to these questions is precisely what happened 1929-33. With the fed funds rate at zero, unemployment rate soaring, and consumer prices falling, what money policy did Ben Bernanke talk the FOMC into implementing in January 2009?

Federal funds rate- blue, right scale Security Holdings of the Federal Reserve- red, left scale Q: When the Fed took short term interest rates to zero (blue 1/4%) end of 2008, did it run out of ammo to influence interest rates? What did it do? Why?

Fed funds rate (red) right scale Securities held by the Fed (black) left scale Fed steps in and buys massive quantities of bonds in 3 phases QE1, QE2, QE3; With short-term r at 0-1/4% tries to lower long-term interest rates via bond market

Abnormal Times: “Quantitative Easing” Fed buys massive Quantities of Bonds When short-term interest rates hit zero (fed funds rate= 0 to .25%, prime rate = 3 ¼ %), can the Fed lower short-term rates any further? How can the Fed influence long-term interest rates like mortgage rates and interest rates on corporate bonds? Turnover in the long-term Treasury bond market is $500 billion per day; turnover in the Agency Mortgage-Backed Securities market is $300 billion per day. To influence prices of long-term bonds (and inversely, long-term interest rates) on such a large market, what size do open market operations have to be? Answer: Massive (compared to tiny interventions to influence the low turnover overnight federal funds market)

QE 3 QE 2 QE 1 begins Jan 2009 Show the intended effects from a Keynesian perspective on a bond market diagram and a Keynesian diagram of the real economy. How many bonds did the Fed acquire during QE1? QE 2? QE3? Show the intended impact of bond buying on a diagram of the bond market, explain how the P of bonds will affect long-term interest rates, and show the intended effects on the real economy with causal chains and a Keynesian macroeconomic diagram.

Explain each of the actors from the Q theory of Money perspective behind MV=Py By how much did the money supply grow from fall 2008, when the Fed began massive injections of Reserves into the banking system? What would the Quantity Theory of Money predict would happen to Inflation rates? Show with Q equation and Aggregate Demand & Supply diagram of real economy (Say’s Law).

In order to hold down interest rates, the New York fed has had to ___ securities. What happens to bank reserves when the NY Fed does massive open market operations? What will happen to the amount of checkable deposits in the banking system, if banks lend to the max? From a Quantity Theory of Money perspective what will be the aftermath of such a policy on the real economy? Show the effect of an injection of $600 billion in Reserves via open market purchases of securities on the balance sheet of the Fed and the Banking System taken as a whole. Assume 1/10 reserve requirement, banks lend to the max, (no hoarding by banks), firms, households & firms borrow to the max (no hoarding by households, firms), everyone redeposits in the commercial banking system (no hoarding of currency by households, firms). From the balance sheet, how much will the money supply grow by if all assumptions hold? Show the effect on the real economy using the quantity equation (MV=Py) and a Say’s Law diagram of the real economy with Plevel on vertical axis and real GDP (y) on horizontal axis.

The above data on Money (black-left scale) and Inflation rates (grey-right scale) fit perfectly the forecasts Of the Quantity Theory of Money. True or False, and Why?

M1 Index 222 Price Level Index 109.8 The M1 money supply has more than doubled (up 120 %) since 2009; the price index for consumer goods less volatile Food and Energy has risen 10 % over the same period. This fits the Quantity Theory of Money forecast of the effects of Quantitative Easing. True or False, Why?

What happened to withdrawals of currency from the banks since the crisis in fall 2008? What did these withdrawals do to the amount of money banks could create? Which assumption Of the Maximum Money Multiplier is violated?

What was the pre-crisis relation between currency in the hands of the public (red) and the total money Base (blue= currency in hands of public + bank reserves); how did that relation change with the Injection of reserves with the financial crisis fall 2008 & QE1 beginning Jan 2009?

Before the financial crisis hit, did banks hold reserves in excess of those required by the Fed? What happened to excess reserves in the fall of 2008 after Lehman Brothers failed? What assumption of the Maximum Money Multiplier is violated by the behavior of banks? What are banks doing with reserves Injected by Fed through Quantitative Easing?

Checkable Deposits at Banks Reserves Checkable Deposits at Banks Approximately $60 billion in Total Reserves (blue= vault cash + electronic reserves at the Fed) used to support $600 billion in checkable deposits; Sept 2008, the world changed; Are banks lending to the max? are companies, firms borrowing to max?

Checkable Deposits at Banks Reserves Checkable Deposits at Banks Approximately $60 b. Bank Reserves When the Fed buys securities, checkable deposits rise in bond dealers’ accounts. What is happening at the Banks to allow checkable deposits to be less than total bank reserves? Hint: How do banks & bank customers engage in the destruction of deposit money?

Reserves of banks; Checkable deposits at banks red Are banks lending to the max allowed by the 1/10 Reserve Requirement?

From a Marxist theory of money perspective, what naturally happens during a slump to the amount of business loans outstanding? What pressures will this have on the amount of checkable deposits at Banks?

When corporate executives feel comfortable about profitability conditions & banks are comfortable About getting paid back, what will happen to the volume of commercial and industrial loans (red)? What happens to the amount of checkable deposits when these loans are expanded? What happens in a bust to corporate borrowing/bank lending? What happens to checkable deposits? This graph supports a Marxist view that money supply is endogenous & depends on profit conditions. T,F,Why?

Corporate profits after tax (black thin line) Business Loans at Commercial Banks (blue line) In an early expansion, profits rise before business loans take off, but in a late expansion as profits begin to fall, companies still borrow and banks continue to lend until the recession hits. Business loans appear endogenous to phases of the business cycle. T or F and why?

Investment real Profits From a Marxist perspective profits drive investment and the real economy and the money supply or velocity Will adjust. T or F, and Why? Show with causal chains, the Quantity Equation, and an Aggregate demand and supply diagram.

Business borrowing at Commercial banks (green, left) tends to lag behind hiring (E, blue, right) in an Expansion.

The behavior of the Velocity of Money M1(checkable deposits +currency) tends to fit the Quantity Theory of Money better than the Marxist Theory of Money. True or False, and Why? Note: During this expansion the non-bank public seems to be hoarding money much longer & more strongly than in past expansions

http://on.wsj.com/1MUnq1R Falling Corporate Profits Blur U.S. Growth Outlook GDP revs up as inventories proved less of a drag, but headwinds loom Nov 24, 2015 Profits at U.S. companies during the third quarter posted their largest annual decline since the recession, underscoring the competitive pressure from a strong dollar and weak global demand that could limit businesses’ ability to support stronger economic growth in the coming months.

http://on.wsj.com/21q3cEK

With Profits and Investment weaker, the economy should grow more slowly on its Own possibly allowing a weaker but longer business cycle expansion, both from a tendency of the rate Of profit to fall theory and the profit squeeze theory. True or False, and Why? Considering the profits and investment scenario, the Fed’s rate increase in December 2015 Is unlikely to be followed by another rate increase any time soon. True or False, and Why?