By Thomas I. Palley

There is much debate over whether the Federal Reserve should tighten or further ease monetary policy. This dichotomous framing overlooks another possibility, which is whether the Fed should change the mix of its stance, tightening in some areas and further easing in others.

In particular, there are strong grounds for the Fed to abandon its support of the Treasury bond market and to gradually raise the federal funds rate (to say 1 per cent), while simultaneously increasing its purchases of mortgage-backed securities. If permissible, the Fed should also purchase state government bonds according to a per- capita formula. Continue reading "The Fed should raise rates and lower them too"

Update: Read Prof Farmer’s response to readers’ comments

By Roger E. A. Farmer

There is a widespread perception that quantitative easing is synonymous with increasing the money supply. But it is more than that. In 2006, the Bank of England began to pay interest on the reserves of commercial banks held at the Bank. QE, in conjunction with the payment of interest on reserves, allows the Bank to influence the short term interest rate and at the same time, to influence the prices of long term assets. This new flexibility is the key to understanding how to prevent inflation without creating another Great Depression. Continue reading "We need more quantitative easing to prevent another Great Depression: Round 2"

It is time to tackle the systemic flaw in housing policy - reliance on leverage – and introduce minimum downpayment regulations for all homebuyers, writes Charles W. Calomiris

Without high leverage the subprime boom and bust could not have happened. Risky no-docs borrowers would have been unwilling to deceive lenders if they had to pledge a large amount of their own savings as a downpayment (deposit). House price declines would not have produced huge loan losses if homeowners had retained a minimum 20 per cent stake in their homes.

During the 1990s and 2000s leverage tolerances on US government-guaranteed mortgages rose steadily and dramatically at FHA, Fannie Mae and Freddie Mac. The average loan-to-value (LTV) ratio of FHA mortgages rose to 96 per cent, and a third of Fannie and Freddie’s purchases leading up to their insolvencies had LTVs of greater than 95 per cent.

Not only are high LTVs destabilising, they undermine the objectives of housing policy. Its central goal is promoting stronger communities by encouraging residents to have a stake in them. But a 97 per cent LTV creates a trivial stake; homeowners become renters in disguise, able to abandon homes at little cost. Continue reading "Time to introduce minimum downpayments for mortgages"

Update: Read Prof Farmer’s response to readers’ comments

By Roger E. A Farmer

I argue in this piece that:

• Quantitative easing should be expanded
• Even if the Bank of England were to buy the entire UK national debt that this policy would not be inflationary
• The global recovery is faltering and an expansionary policy is needed to encourage private investors to create jobs
• Additional quantitative easing could save as much as £38.5bn a year in interest costs to the taxpayer

May 18, 2006 was an important day. It was the day when the Bank of England began to pay interest on reserves. In October 2008 the Fed followed suit. This monumental change in policy gave the Bank an important new tool in its arsenal. It allowed the Bank to influence the economy not just through expansion or contraction of the stock of money, but also through the composition of its balance sheet. Continue reading "We need more quantitative easing to create jobs"

By Richard Robb

What should investors in developed countries worry about — inflation or deflation? Evidence from the past two decades suggests the answer is “neither.” Progress in monetary policy may have rid the world of price instability once and for all; like smallpox, Germany military aggression or the spread of orthodox Marxism, inflation could well turn out to be last century’s problem.

As recently as the 1990s, France, UK and Italy pegged exchange rates. The US and UK targeted money supply in the late 1970s and early 1980s, while the Bundesbank targeted Germany’s money supply right up until monetary union. Continue reading "The next headache: Inflation or deflation?"

These are uncertain times for global economic governance. For over six decades after the second world war the west framed the rules of engagement for the global economy.

In the initial years, the United States was the preeminent power, which oversaw the creation of the Bretton Woods system (International Monetary Fund and World Bank) and the initial rounds of trade liberalization under the newly-born General Agreement on Tariffs and Trade (which became the World Trade Organization at the end of the Uruguay Round in 1993).

As Europe recovered from the ravages of war and Japan launched on its high growth phase, these new leviathans (especially Europe) increasingly asserted themselves and won greater voice and roles in world economic governance. But it was still an essentially western enterprise, with a demilitarized Japan content to go along in return for an American nuclear umbrella.

The Soviet Union and its satellites were not an integral part of this economic system and the developing countries didn’t carry significant economic clout, not even the populous Asian giants of China and India. Continue reading "Uncertain times for global economic governance"

Laurence Kotlikoff, economics professor at Boston University, writes an open letter to Lord Turner, chairman of the UK’s financial regulator, the FSA. Lord Turner examines Prof Kotlikoff’s proposal for a radical reform of the institutional structure for credit extension in a new book, The Future of Finance. This is the second of a  two-part open letter. You can read the first part here.

The essential challenge indeed is that the tranching and maturity transformation functions which banks perform do deliver economic benefit, and that if they are not delivered by banks, customer demand for these functions will seek fulfillment in other forms.

As previously indicated, tranching (some investors taking more risk than others within a fund) is part of limited purpose banking. Indeed, CDOs are, to repeat, effectively mutual funds with this property. The fact that so many CDOs invested in toxic loans is because the loans were fraudulent, not because the loans were risky. We don’t say that stocks are toxic, even though the stock market has fluctuated dramatically since its peak. We say mortgage-backed securities are toxic because borrowers’ incomes were misstated, collateral values were misstated, and credit worthiness was misstated. Furthermore, tranching is just one way for some people to take more risk than others. A simpler way is for more risk-averse people to simply invest in mutual funds that purchase safer asset.  I.e., tranching is not the end all and be all of risk allocation in the economy. Continue reading "Laurence Kotlikoff replies to Lord Turner: Part 2"

Laurence Kotlikoff, economics professor at Boston University, writes an open letter to Lord Turner, chairman of the UK’s financial regulator, the FSA. Lord Turner examines Prof Kotlikoff’s proposal for a radical reform of the institutional structure for credit extension in a new book, The Future of Finance. This a two-part open letter; the second part will be published on the FT’s Economists’ Forum on Tuesday July 20.

Adair Turner’s Misplaced Concerns About Limited Purpose Banking

Dear Adair,

Your chapter in the just released Future of Finance is masterful. But the very strong concerns you express about Limited Purpose Banking are, I believe, misleading, misdirected, and rather surprising since LPB delivers precisely the reforms you advocate.

Let me respond in italics to the specifics of what you wrote (the bold text) and then indicate why LPB does what you say you want. Continue reading "Laurence Kotlikoff replies to Lord Turner: Part 1"