The Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
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 decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
Big trouble from little Cyprus – FT.com
I always enjoy Martin Wolf’s objectivity:
Many insist that any tax on deposits is theft. This is nonsense. Banks are not vaults. They are thinly capitalised asset managers that make a promise – to return depositors’ money on demand and at par – that cannot always be kept without the assistance of a solvent state. Anybody who lends to banks has to understand that. It is inconceivable that banking – a risk-taking financial business – can operate without exposure to loss of at least some classes of lenders. Otherwise, bank debt is government debt. No private business can be allowed to gamble with taxpayers’ money in this way. That is evident.
Read more at Big trouble from little Cyprus – FT.com.
Fed NGDP targeting would greatly increase global financial stability | Market Monetarist
Lars Christensen describes how NGDP targeting would help the global economy withstand shocks like another eurozone crisis:
Lets look at two different hypothetical US monetary policy settings. First what we could call an ‘adaptive’ monetary policy rule and second on a strict NGDP targeting rule.
‘Adaptive’ monetary policy – a recipe for disaster
By an adaptive monetary policy I mean a policy where the central bank will allow ‘outside’ factors to determine or at least greatly influence US monetary conditions and hence the Fed would not offset shocks to money velocity…..
In that sense under an ‘adaptive’ monetary policy the Fed is effective[ly] allowing external financial shocks to become a tightening of US monetary conditions. The consequence every time that this is happening is not only a negative shock to US economic activity, but also increased financial distress – as in 2008 and 2011.
NGDP targeting greatly increases global financial stability
If the Fed on the other hand pursues a strict NGDP level targeting regime the story is very different.
Lets again take the case of an European sovereign default. The shock again – initially – makes investors run for safe assets. That is causing the US dollar to strengthen, which is pushing down US money velocity (money demand is increasing relative to the money supply). However, as the Fed is operating a strict NGDP targeting regime it would ‘automatically’ offset the decrease in velocity by increasing the money base (and indirectly the money supply) to keep NGDP expectations ‘on track’. Under a futures based NGDP targeting regime this would be completely automatic and ‘market determined’.
Hence, a financial shock from an euro zone sovereign default would leave no major impact on US NGDP and therefore likely not on US prices and real economic activity…..
Read more at Fed NGDP targeting would greatly increase global financial stability | The Market Monetarist.
Cyprus: Deposit insurance and moral hazard
The outcry over Cyprus levy on depositors in defaulting banks raises the question: Why were depositors not more wary of where they deposited their funds? Not all banks are created equal. The reason is deposit insurance for deposits under €100,000 implied that the government would stand behind its banks and rescue depositors should the banks ever default. The problem is that no one considered the possibility that all the banks would suffer losses sufficient that the government would be forced to default on both its explicit and implied obligations.
Some time ago I wrote about the moral hazard of deposit insurance:
Deposit Insurance: When too much of a good idea becomes a bad idea
Deposit insurance was introduced in the 1930s and saved the US banking system from extinction. Administered by the FDIC, and funded by a levy on all banking institutions, deposit insurance, however, encourages moral hazard. Depositors need not concern themselves with the solvency of the bank where they deposit their funds so long as deposits are FDIC insured. High-risk institutions are able to compete for deposits on an equal footing with well-run, low-risk competitors. This inevitably leads to higher failure rates, as in the Savings & Loan crisis of the 1980s.
The FDIC does a good job of policing deposit-takers, but no regulator can substitute for market forces. Deposit insurance is critical during times of crisis, but should be scaled back when the crisis has passed. Either limit insured deposits to say $20,000 or only insure deposits to say 90% of value, where the depositor takes the first loss of 10%. That should be sufficient to keep depositors mindful as to where they bank. And restore the competitive advantage to well-run institutions.
Requiring depositors to take the first loss of 10 percent should be standard practice for deposit insurance. The same should hold true for bank creditors. But we need to distinguish between insolvency — where liabilities exceed assets — and a liquidity event where the central bank is only called on to provide temporary respite. If the bank is rescued from insolvency by the regulator, bond holders should be required to take an equivalent haircut — painful yet not life-threatening. No one is entitled to a free ride. And bank shareholders, if a there is a bail-out, should lose everything — similar to the Swedish approach in the 1990s.
Cyprus Deposit Levy: No Panic Yet But Scary Long-Term Consequences – Forbes
Karl Whelan, Professor of Economics at University College, Dublin reminds us:
….the fact that we don’t see lines at ATMs in Spain and Italy doesn’t mean there isn’t a bank run going on. The Northern Rock episode was a complete anomaly. Modern bank runs stem from people pushing buttons to execute electronic withdrawals of large amounts of funds. For example, I was living in Ireland in 2010 when non-residents pulled €186 billion out of Irish banks between the end of July and the end of December. This was over 100% of Irish GDP and yet there wasn’t a single sign of panic among retail depositors.
Read more at Cyprus Deposit Levy: No Panic Yet But Scary Long-Term Consequences – Forbes.
J.P. Morgan, Goldman Get a Dose of Fed's Reserve | WSJ.com
David Reilly reports on the Fed’s latest stress tests:
The passes show how far big U.S. banks have come since the financial crisis. But capital levels seen under the tests, and taking into account the capital-return plans, weren’t especially strong. Tier 1 common ratios for J.P. Morgan and Goldman, for example, were only marginally above the 5% minimum needed.
What’s more, leverage ratios including capital returns are particularly thin: Of the six biggest banks, four had ratios below 5%. While above the test’s 3% minimum, such levels wouldn’t give banks tremendous room to maneuver in a crisis.
The leverage ratios are particularly telling because they don’t allow for risk-weighting of assets. That approach is coming under increased criticism for potentially allowing banks to mask the true level of risk on their books.
Read more at HEARD ON THE STREET: J.P. Morgan, Goldman Get a Dose of Fed's Reserve – WSJ.com.
ZERVOS: 'This Is A Nuclear War On Savings And Wealth' – Business Insider
Joe Weisenthal reports on Jefferies strategist David Zervos’ latest note:
What happened to Cyprus on Friday evening was one of the most significant developments in the Eurozone since the Greek election last summer. To tax the bank deposits of savers sends an ominous message to the entire global investment community. All of us should really take a moment to consider what the governments of Europe have done. To be clear, they initiated a surprise assault on the precautionary savings of their own people. Such a move should send shock waves across the entire population of the developed world.
Read more at ZERVOS: 'This Is A Nuclear War On Savings And Wealth' – Business Insider.
NGDP level targeting – the true Free Market alternative (we try again) | The Market Monetarist
Scott Sumner suggests that NGDP targeting is a far more conservative approach than the current inflation targeting practiced by the Fed and many other central banks:
Most of the blogging Market Monetarists have their roots in a strong free market tradition and nearly all of us would probably describe ourselves as libertarians or classical liberal economists who believe that economic allocation is best left to market forces. Therefore most of us would also tend to agree with general free market positions regarding for example trade restrictions or minimum wages and generally consider government intervention in the economy as harmful.
I think that NGDP targeting is totally consistent with these general free market positions – in fact I believe that NGDP targeting is the monetary policy regime which best ensures well-functioning and undistorted free markets.
And here explains why inflation is not a threat under NGDP targeting:
Inflation will be higher under NGDP targeting. This is obviously wrong. Over the long-run the central bank can choose whatever inflation rate it wants. If the central bank wants 2% inflation as long-term target then it will choose an NGDP growth path, which is compatible which this. If the long-term growth rate of real GDP is 2% then the central bank should target 4% NGDP growth path. This will ensure 2% inflation in the long run.
Read more at NGDP level targeting – the true Free Market alternative (we try again) | The Market Monetarist.
Fed's Fisher: Too-big-to-fail banks are crony capitalists | Reuters
Pedro Nicolaci da Costa reports
The largest U.S. banks are “practitioners of crony capitalism,” need to be broken up to ensure they are no longer considered too big to fail, and continue to threaten financial stability, a top Federal Reserve official said on Saturday……
[Richard Fisher, president of the Dallas Fed] said the existence of banks that are seen as likely to receive government bailouts if they fail gives them an unfair advantage, hurting economic competitiveness.
Read more at Fed's Fisher: Too-big-to-fail banks are crony capitalists | Reuters.
Dousing the flames with gasoline
We are in the fifth year of recovery from the worst collapse of global financial markets in more than 50 years fueled by massive debt expansion, with non-financial debt rising as a percentage of GDP from 50% in the 1980s to almost 100% in 2008.
Household debt subsequently fell to 80% of GDP during the GFC as households diverted income away from consumption to reduce debt. But now we are starting to see worrying signs: consumer debt is again rising as a percentage of disposable income.
Corporate bond yields have fallen to lows last seen in the 1960s.
Interest margins for large banks are falling
(Click on the image to open the Yahoo: Steve Keen interview in