2. Monetary Policy: Contemporary Issues Monetary Policy: Contemporary Issues ECO 473 - Dr. Dennis Foster W.A. Franke College of Business

3. Monetary Policy: Contemporary Issues

4. 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. I. Heading into crisis

5. Federal Funds rate of interest, 1995 to 2004

6. 30 year mortgage rate, 1995 to 2004

7. Median home prices, 1999 to 2006

8. Home sales, 1999 to 2006 Sept. 2005

9. The Bear Stearns Story $133.20 - 52 week high prior to collapse. 2007 - Lost billions in collapsing subprime market; slowly recovering. March 2008 - Assets/equity = 35 Lots of assets in MBS. Spring 2008 - 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

10. 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

11. 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 2007-08. –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

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

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

14. Federal Funds rate of interest, 2004 to 2015 IV. What has the Fed accomplished?

15. Fed Lending Programs: 2008-2010 See Appendix B for details

16. 30 year mortgage rate, 2004 to 2015 Housing Revisited

17. Median home prices, 1999 to 2015 Housing Revisited 190,000

18. Home sales, 1999 to 2015 Housing Revisited

19. The Fed charts new territory. Monetary Base $4 tr. $2.6 tr. Excess Reserves $2.5 tr. Fed-held US Treasuries $1.7 tr. Fed-held MBS V. The problem with policy

20. +649% +178% +44% The Quantitative Easing Programs

21. A Tale of Four Recoveries +25 Q +33% +24% +18% +14%

22. 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?

23. What has the Fed done? 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? Has it reduced moral hazard?Has it reduced moral hazard? Has it lessened distributional problems?Has it lessened distributional problems? Is the risk of inflation gone?Is the risk of inflation gone?

24. 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

25. 2008 1981 1920 2015 Nov. 5%

26. 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.

27. 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!!

28. GDP (2015) = $23.5 tr. vs. $16.4 tr. 1990 - 2015 net gain = $59 tr. 3.8% What if … ?

29. 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.

30. What is the Outlook? Interest rates will stay low.Interest rates will stay low. Yellen hints at increases. Banks awash in cash Economic performance is weak. Inflation is still a looming danger.Inflation is still a looming danger. Where will all the money go? Can the Fed stop rising inflationary expectations? 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

31. Get on the mailing list for Spring 2016 – dennis.foster@nau.edu

32. 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

33. Monetary Policy: Contemporary Issues Monetary Policy: Contemporary Issues ECO 473 - Dr. Dennis Foster W.A. Franke College of Business

34. Appendix A: Stock prices collapse of IndyMac, WaMu, Lehman Bros.

35. Term Auction Credit Appendix B: Fed Lending Programs

36. Primary Dealer Credit Appendix B: Fed Lending Programs

37. Commercial Paper MMMF Appendix B: Fed Lending Programs

38. Asset-backed Securities Appendix B: Fed Lending Programs

39. Monetary Policy: Contemporary Issues Monetary Policy: Contemporary Issues ECO 473 - Dr. Dennis Foster W.A. Franke College of Business