Monetary Policy: Contemporary Issues Monetary Policy: Contemporary Issues ECO Dr. Dennis Foster W.A. Franke College of Business

Monetary Policy: Contemporary Issues

Anatomy of Financial Crisis I. Heading into crisis

What does the Fed Want? Policy? Stimulate spending by reducing interest rates.Policy? Stimulate spending by reducing interest rates. Why? They are Keynesians.Why? They are Keynesians. Effect? Creates housing boom.Effect? Creates housing boom. A healthy & strong economy with low unemployment and low inflation.A healthy & strong economy with low unemployment and low inflation.

Federal Funds rate of interest, 1995 to 2004

30 year mortgage rate, 1995 to 2004

Median home prices, 1999 to 2006

Home sales, 1999 to 2006 Sept. 2005

The Bear Stearns Story $ week high prior to collapse Lost billions in collapsing subprime market; slowly recovering. March Assets/equity = 35 Lots of assets in MBS. Spring Clients pulling out funds. 3/10/08 - Turned down for $2 b. loan Continued loss of confidence in Bear all week. 3/13/08 – Cash  from $10 b. to $2 b. $400 b. Assets II. The failures

Tried to get LOC w/JPM for $25 b. 3/14/08 – Fed lends $13 b. for 3 days. JP Morgan deal - $2 per share! Fed creates Maiden Lane LLC –Fed loans ML $30 b. –JPM “sells” bad assets to ML. 3/24/08 - New stock deal - $10/share. Cost to the Fed? Was Bear TBTF? Yes! –What about Lehman? The Bear Stearns Story

The Three Failures: IndyMac WaMu Lehman IndyMac –Spun off from Countrywide. –Not a “mac” –Overleveraged on “Alt A” loans. WaMu –Shut down 100’s of offices –Sub-prime victim. –Final 10 days lost $17 b. in cash w/d Lehman Brothers –Losses = $7 b. in Q2 & Q3 –Final day: $1 b. in cash $32 b. Assets $300 b. Assets $640 b. Assets

Stock prices collapse

Did the Fed see this coming? III. Fed inaction & action

Did the Fed see this coming? Cut interest rates. Lend to everyone. Quantitative Easing. What did the Fed do? III. Fed inaction & action

Federal Funds rate of interest, 2004 to 2014

Fed Lending Programs:

Term Auction Credit

Primary Dealer Credit

Commercial Paper MMMF

Asset-backed Securities

+644% +162% +44% The Quantitative Easing Programs

The Fed charts new territory. Monetary Base $4 tr. $2.7 tr. XS R $2.5 tr. US T $1.7 tr. MBS IV. What has the Fed accomplished?

30 year mortgage rate, 2004 to 2014 Housing Revisited

Median home prices, 1999 to 2014 Housing Revisited

Home sales, 1999 to 2014 Housing Revisited

What is the exit strategy? The FED will have two choices:The FED will have two choices: Continue policy  hyperinflationContinue policy  hyperinflation Halt policy  recessionHalt policy  recession Or... Wage/Price controls?Or... Wage/Price controls? V. The problem with policy

Are Monetary Policies Effective? “No”... –Investment channel collapses. –People are rational and counteract. –Lag problems. –It introduces systemic distortions. “Yes”... –Various transmission mechanisms. –Policy is unanticipated. –Wage & price rigidity.

The Fed and its Policies Has it maintained the value of the dollar?Has it maintained the value of the dollar? Has it stabilized the economy?Has it stabilized the economy? Is it enhancing moral hazard?Is it enhancing moral hazard? Is it creating distributional problems?Is it creating distributional problems? Is risk of inflation gone?Is risk of inflation gone?

The Unemployment Rate – Dec. ‘ % June ‘ % June ‘ % Oct. ‘ %

A Tale of Four Recoveries +28% +19% +16% +12%

Tracking Prices and Inflation 3 rd Q yr-to-yr +1.8%

Rethinking Policy: The Austrian School of Thought Recessions are the solution, not the problem!Recessions are the solution, not the problem! Keynesian policy -  interest to  spending.Keynesian policy -  interest to  spending. Leads to misallocation of resources.Leads to misallocation of resources. Leads to an unsustainable boom.Leads to an unsustainable boom. Leads to eventual conflict (C vs. I).Leads to eventual conflict (C vs. I). What should we do? Wait!!What should we do? Wait!! VI. The Austrians & rethinking policy

March 5.5%

GDP (2011) = $18.3 tr. vs. $13.3 tr net gain = $34.6 tr.

Rothbard - A Return to Sound Money Get back on the gold standard. Define $ in terms of gold. No more suspensions of payment in gold. Abolish the Federal Reserve. Redeem every $ of M1 in gold… Get government out of money. Bank notes will replace FRN. 100% reserve ratio Or, let banks fail. Abolish FDIC, US Mint.

The Results of Sound Money 1.No bank panics. 2.No convoluted regulation. 3.No inflation. 4.No discretionary monetary policy. 5.No monetizing of federal gov’t. debt. 6.An end to the business cycle!!

Let bad firms/banks go bankrupt.Let bad firms/banks go bankrupt. –We don’t lose real resources!!!!! Abolish Fannie & Freddie.Abolish Fannie & Freddie. End the Fed.End the Fed. End the government monopoly on money.End the government monopoly on money.

What is the Outlook? Interest rates will stay low.Interest rates will stay low. Yellen only hints at increases. Inflation is still a looming danger.Inflation is still a looming danger. Where will all the money go? Unemployment will be erratic.Unemployment will be erratic. May rise if lfpr rises even with growth. Worst case scenario?Worst case scenario? Economy surges, banks  lending, and dramatic inflation. Recession within 3 years??? Best case scenario?Best case scenario? Economy is sluggish, Ur stagnant, and and banks hold massive XS reserves. Another year (or 2?) on the knife edge. VII. Outlook for the economy

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ECO 481: Public Choice Theory Dr. Dennis Foster FCB #208 The W.A. Franke College of Business Northern Arizona University Spring 2016 Why Government Fails

Monetary Policy: Contemporary Issues Monetary Policy: Contemporary Issues ECO Dr. Dennis Foster W.A. Franke College of Business