Monetary Policy:

Contemporary Issues

ECO 473 - Dr. Dennis FosterW.A. Franke College of Business

Monetary Policy: Contemporary Issues

I Heading into crisisII The failuresIII Fed inaction & actionIV What has the Fed

accomplished?V The problem with policyVI The Austrians & rethinking

policyVII Outlook for the economy

What does the Fed Want?

• Policy? Stimulate spending by reducing interest rates.

• Why? They are Keynesians.

• Effect? Creates housing boom.

• A healthy & strong economy with low unemployment and low inflation.

I.

Head

ing

in

to c

risi

s

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• $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.

Th

e f

ailu

res

• 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 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

Did the Fed see this coming?

III. F

ed

inact

ion &

act

ion

Did the Fed see this coming?

• Cut interest rates.• Lend to everyone.• Quantitative Easing.

What did the Fed do?II

I. F

ed

inact

ion &

act

ion

Federal Funds rate of interest, 2004 to 2015

IV.

What

has

the F

ed

acc

om

plis

hed

?

Fed Lending Programs: 2008-2010

See Appendix B for details

30 year mortgage rate, 2004 to 2015

Housing Revisited

Median home prices, 1999 to 2015

Housing Revisited

190,000

Home sales, 1999 to 2015

Housing Revisited

The Fed charts new territory.

MonetaryBase

$4 tr.

$2.6 tr.

ExcessReserves

$2.5 tr.

Fed-held USTreasuries

$1.7 tr.Fed-held

MBS

V.

Th

e p

roble

m w

ith

polic

y

+649%

+178%

+44%

The Quantitative Easing Programs

A Tale of Four Recoveries +25 Q

+33%

+24%

+18%

+14%

What is the exit strategy?

• The FED will have two choices:• Continue policy hyperinflation• Halt policy recession

• Or . . . Wage/Price controls?

What has the Fed done?

• Has it maintained the value of the dollar?

• Has it stabilized the economy?• Has it reduced moral hazard?• Has it lessened distributional

problems?• Is the risk of inflation gone?

Rethinking Policy:The Austrian School of Thought

• Recessions are the solution,not the problem!

• Keynesian policy - interest to spending.• Leads to misallocation of resources.• Leads to an unsustainable boom.• Leads to eventual conflict (C vs. I).

• What should we do? Wait!!VI.

Th

e A

ust

rian

s &

reth

inki

ng

polic

y

2008 1981

1920

2015 Nov. 5%

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 ratioOr, 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!!

GDP (2015) = $23.5 tr. vs. $16.4 tr.

1990 - 2015 net gain = $59 tr.

3.8%

What if … ?

• Let bad firms/banks go bankrupt.– We don’t lose real resources!!!!!

• Abolish Fannie & Freddie.

• End the Fed.

• End the government monopoly on money.

What is the Outlook?• Interest rates will stay low.

Yellen hints at increases.Banks awash in cashEconomic performance is weak.

• Inflation is still a looming danger.Where will all the money go?Can the Fed stop rising inflationary expectations?

• Worst case scenario?Economy surges, banks lending, and dramatic inflation.Recession within 3 years???

• Best case scenario?Economy is sluggish, Ur stagnant, and and banks hold massive XS reserves.Another year (or 2?) on the knife edge.

VII.

Ou

tlook

for

the e

con

om

y

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

ECO 481:Public Choice Theory

Dr. Dennis FosterFCB #208

The W.A. Franke College of BusinessNorthern Arizona University

Spring 2016

W h y G o v e r n m e n t F a i l s

Monetary Policy:

Contemporary Issues

ECO 473 - Dr. Dennis FosterW.A. Franke College of Business

Appendix A: Stock prices collapse ofIndyMac, WaMu, Lehman Bros.

Term Auction Credit

Appendix B: Fed Lending Programs

Primary Dealer Credit

Appendix B: Fed Lending Programs

Commercial Paper MMMF

Appendix B: Fed Lending Programs

Asset-backed Securities

Appendix B: Fed Lending Programs

Monetary Policy:

Contemporary Issues

ECO 473 - Dr. Dennis FosterW.A. Franke College of Business