There’s no such thing as base money anymore

Tim Duy has a great review of why platinum coin seigniorage was a bridge too far for Treasury and the Fed. I think he’s pretty much spot on.

However, with Greg Ip (whose objection Duy cites), I’d take issue with the following:

Ultimately, I don’t believe deficit spending should be directly monetized as I believe that Paul Krugman is correct — at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes.

Note that there are two distinct claims here, both of which are questionable. Consistent with the “Great Moderation” trend, the so-called “natural rate” of interest may be negative for the indefinite future, unless we do something to alter the underlying causes of that condition. We may be at the zero bound, perhaps with interludes of positiveness during “booms”, for a long time to come.

But maybe not. Maybe we’ll see the light and enact a basic income scheme or negative income tax brackets. Maybe we’ll restore the dark, and engineer new ways of providing fraudulently loose credit. Either sort of change could bring “full employment” interest rates back above zero. Let’s suppose that will happen someday.

What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive).

If Ip and I are right, Paul Krugman is wrong to say

It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end.

Printing money will always be exactly as inflationary as issuing short-term debt, because short-term government debt and reserves at the Fed will always be near-perfect substitutes. In the relevant sense, we will always be at the zero lower bound. Yes, there will remain an opportunity cost to holding literally printed money — bank notes, platinum coins, whatever — but holders of currency have the right to convert into Fed reserves at will (albeit with the unnecessary intermediation of the quasiprivate banking system), and will only bear that cost when the transactional convenience of dirty paper offsets it. In this brave new world, there is no Fed-created “hot potato”, no commodity the quantity of which is determined by the Fed that private holders seek to shed in order to escape an opportunity cost. It is incoherent to speak, as the market monetarists often do, of “demand for base money” as distinct from “demand for short-term government debt”. What used to be “monetary policy” is necessarily a joint venture of the central bank and the treasury. Both agencies, now and for the indefinite future, emit interchangeable obligations that are in every relevant sense money. [1]

I’ve no grand ideological point to make here. But I think a lot of debate and commentary on monetary issues hasn’t caught up with the fact that we have permanently entered a brave new world in which there is no opportunity cost to holding money rather than safe short-term debt, whether we are at the zero bound or not.

[1] Yes, there are small frictions associated with converting T-bills to reserves or cash for use as a medium of exchange. I think they are too small to matter. But suppose I’m wrong. Then nonusability as means of payment would mean a greater opportunity cost for T-bill holders than for reserve holders. That is, printing money outright would be less inflationary than issuing short-term debt! And for now, when Fed reserves pay higher interest rates than short-term Treasury bills, people concerned about inflation should doubly prefer “money printing” to short-term debt issuance! Quantiative easing is currently disinflationary in terms of any mechanical effect via the velocity of near-money, when the Fed purchases short-term debt (although it may be inflationary via some expectations channel, because of the intent that’s communicated). The mechanical effect of QE is less clear when the Fed purchases longer maturity debt, it would depend on how market participants trade-off the yield premium and interest rate risk, as well as on what long-term debt clienteles — pension funds etc. — choose to substitute for the scarcer assets. But it is not at all obvious that “printing money” to purchase even long maturity assets is inflationary when the Fed pays a competitive interest rate on reserves.

Thanks to Kid Dynamite for helping me think through some of these issues in correspondence (though he doesn’t necessarily agree with me on any of it!)


48 Responses to “There’s no such thing as base money anymore”

  1. vbounded writes:

    Maybe we’ll see the light and enact a basic income scheme or negative income tax brackets. Maybe we’ll restore the dark, and engineer new ways of providing fraudulently loose credit. Either sort of change could bring “full employment” interest rates back above zero. Let’s suppose that will happen someday.


    There is fraudulently loose credit in a number of countries. Right now. If you compare the demographics, I think you’ll see some differences between them and the US.

    Incentives matter. Arguments do not.

  2. A few months back I laid out a similar view in a blog post, “Interest-On-Reserves Regime” Will Rule Monetary Policy For The Foreseeable Future ( I reference a paper by Marvin Goodfriend, of the Federal Reserve, about Interest on Reserves and Monetary Policy that is a good resource on the topic. It may be a while until the mainstream recognizes how monetary policy has changed.

  3. Ashwin writes:

    I agree with most of it – as I like to say, the liquidity trap is the permanent condition of an economy with interest-bearing money.

    My only disagreement would be: IMO interest on reserves is merely the result of this transformation, not the cause. Liquid markets and repo markets have meant that there hasn’t really been a reason for anyone to hold zero-interest money for a while now. There’s quite a lot of research in emerging markets, esp. Turkey, on how the private sector can monetise government dent just as effectively as the central bank can. More detail in this post .

  4. JKH writes:


    You’re probably right on the floor system assumption.

    But the only reason to expect that excess reserves will be permanent in any material way is if the Fed never leaves the zero bound in any material way – because there’s no good reason to leave reserves in chronic excess otherwise – it would be sloppy management in a system that still offered liquid government securities. And operational exit is easy from QE unless the Fed can’t permanently escape the zero bound. But you seem to believe that as well.

    In any case, short term debt and reserves at the Fed are not perfect substitutes. Short term debt is more liquid. Banks can’t “sell” reserves to non-banks. The market for bills is much broader than the market for bank reserves. And it will probably trade at a lower rate than the floor rate on bank reserves as a result.

    And holders of currency do not have the right to convert to bank reserves. Only banks do. Non-bank holders cannot convert to reserves – another version of the relative illiquidity of the bank reserve market.

    And the disinflationary effect of QE reserve interest compared to Treasury bills has to be considered along the fact that QE also flows to the liability side of banking (because banks are not the original portfolio source of QE bonds) and that bank liabilities often pay less than the treasury bill rate. QE analysts tend to overlook completely the effect of QE on the liability side of banking.

    I certainly agree – “It is incoherent to speak, as the market monetarists often do…”

  5. Max writes:

    “Printing money will always be exactly as inflationary as issuing short-term debt, because short-term government debt and reserves at the Fed will always be near-perfect substitutes.”

    This is true if government bonds have no default risk. But this is precisely why some people object to monetization – they believe government bonds *should* be risky. Because only if government bonds are risky can the central bank stabilize prices regardless of fiscal policy. If bonds and money are equal priority claims on a single entity, then fiscal policy can override monetary policy.

  6. Dan Kervick writes:

    JHK, A bank might not literally be able to “sell” its reserves to non-banks, but it exchanges redeemable claims on those reserves pretty much every time it buys something. And if the seller from whom the first bank buys banks at a different bank, then the sale results in the more-or-less immediate conveyance of some of the first bank’s reserves to the second bank. So I’m not sure I see any meaningful sense in which the reserves are less liquid than short-term debt. There is nothing you can buy with a the short-term bill that you can’t buy by issuing a claim on your reserves, is there?

  7. Lord writes:

    Those are reasons to monetize to me. While not materially different at the zero bound, monetization demonstrates firmer future commitment, allowing us to collectively deleverage and diminish fear of future debt. It is monetization that could insure money and debt are different in the future and that rates won’t have to perpetually fall ever closer to zero even if not in recession. Too much debt will prevent that from occurring.

  8. Fed Up writes:

    “Maybe we’ll restore the dark, and engineer new ways of providing fraudulently loose credit.”

    I believe what you are asking is why and how to get more medium of exchange (MOE) and medium of account into an economy. Right?

  9. Hi Everyone,

    Frances Coppola is also talking about this issue over at her place too.

    Here is a post on a very closely related topic.

    We need to hold a convention or something very much like a convention. :)

  10. JKH writes:


    I suppose it’s an unusual thing to say, with risk of ambiguity, so I get your perspective.

    The market for excess reserves as an asset to hold is essentially the interbank market, which is quite restricted in scope relative to the economy as a whole. There are fewer players among which to distribute excess reserves as assets than there are in the case of treasury bills. So if a bank is literally trying to move excess reserves off its books, it may have more difficulty in doing so, given the circularity of flows within the banking system, relative to the wider circularity of the bank and non-bank system combined in the case of treasury bills. Reserves can circle back to the bank that’s trying to get rid of them, particularly among the larger US banks with $ 1.5 trillion in excess reserves swishing around the system. It is “awash” in that sort of cash. The system is liquid in reserves, but reserves aren’t liquid in the sense of individual banks not particularly wanting them and wishing they could do something with them. The banking system as a whole can’t do anything with them, but it can certainly move out of treasury bills by selling them to non-banks.

    Excess reserves are pretty much useless, except as earning assets. They’re liquid as the medium of exchange, but not so liquid from a market liquidity aspect – wanting to move them off the balance sheet.

    Also, the pricing of excess reserves as an asset class is set by the Fed. The pricing of bills is market determined. There’s more demand for bills than there is for excess reserves because non-banks can’t access excess reserves. So for the same amount of assets, there’s obviously a greater scope of demand for the asset. In that sense, it’s not that surprising that the yield on bills might be driven below the yield on excess reserves.

    But we could debate this point forever.

  11. JKH – You mention “the only reason to expect that excess reserves will be permanent in any material way is if the Fed never leaves the zero bound in any material way – because there’s no good reason to leave reserves in chronic excess otherwise”

    I’ll defer to your expertise on these matters, but here is my brief understanding…

    The Fed previously controlled the fed funds rate by managing the amount of reserves in the banking system in close proximity to total required reserves. The fed funds rate set the floor for interest rates and the discount window rate set the ceiling. Now, at the ZLB, the Fed need not worry about excess reserves pushing the fed funds rate to zero since it’s already there. The Fed then began paying IOR for several reasons including setting a floor for the fed funds rate.

    Going forward, if the Fed wishes to exit the ZLB it appears they have two primary options:
    1) Sell Treasuries and Agency-MBS to purchase reserves until the excess is removed from the banking system or
    2) Increase the IOR and discount window rates to create a higher corridor for the fed funds rate (while maintaining sizable excess reserves)

    Given the response of asset markets to QE and commentary from Fed officials, the first option poses significant risk of deflation in asset markets spilling over to the real economy. The second option increases direct payments to banks and reduces Fed profits, while allowing the monetary base to decline as assets mature. Therefore I expect the Fed to select option 2.

    In an earlier comment I mentioned a previous post on this thinking. Whether or not I’ve erred in my analysis, insight from others is greatly appreciated.

  12. […] There’s no such thing as base money anymore – interfluidity […]

  13. […] Trap of My Own Making, by Tim Duy: Steve Waldman at interfluidity catches me in a trap of my own making. Waldman focuses on this quote of […]

  14. JKH writes:


    That all looks spectacularly correct to me (IMHO), with a couple of slight adjustments from my perspective:

    “The fed funds rate set the floor for interest rates”

    I’d describe it a little differently – the actual trading rate for fed funds was a real time “instantaneous floor”, because the floor always coincided with the rate, in a manner of speaking. In fact, the target rate was not a floor, because the trading rate could move below target. The Fed reacted to the (target – trading rate) differential and volatility by responding with marginal excess reserve adjustments in the opposing direction. And all of this was super-sensitive because excess reserves were generally held at a tightly binding level relative to system requirements.

    In terms of the two options that you note for exit, I expect they will do both in combination. The excess reserve adjustment will be done at a “measured pace” over time, and in conjunction with gradual fed funds tightening. And therefore, they will have to maintain a floor (or corridor) system at least for some period of time while outsized excess reserves are still outstanding and not yet fully drained away. (They also have the option of issuing term deposits to lock in term structure on excess reserves while in the process of draining them only gradually.)

    They won’t be able to return to pre-2008 type reserve management, even if they want to, until they exit fully from outsized excess reserves.

    But as SRW says and expects, they may well convert permanently to a floor system, regardless of their intended destination for a permanent excess reserve management approach.

    All that said, I’m not sure why they would target permanent chronic excess reserves in any future regime as a characteristic of what would be a normally functioning system at that time. The advantage in moving to SRW’s suggestion is that it allows future flexibility to respond to non-normal conditions with an excess reserve management technique that is more aggressive than what was the case in the pre-2008 regime.

    In summary, a “chronic excess” may be a continuing characteristic that gradually amortizes over the trajectory path for complete exit from QE – but I don’t see it as the desired steady state final destination.

  15. Luis Enrique writes:

    I’ve probably missed this in previous posts I haven’t read, but can you add something to this one that shows us why you expect the move to the floor system to be permanent?

  16. […] 2013 by Mark Thoma Tim Duy: A Trap of My Own Making, by Tim Duy: Steve Waldman at interfluidity catches me in a trap of my own making. Waldman focuses on this quote of […]

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  18. Diego Espinosa writes:

    The implication is that the Fed is just a captive government bank financing some portion of government liabilities at overnight duration. Therefore, we should look at the Fed+Treasury balance sheet as a consolidated entity. The more QE the Fed does, the more it converts consolidated liabilities from long to short duration. Since the government’s asset — future tax revenues — is a long duration zero-coupon one, this sets up duration risk on the consolidated balance sheet.

    Any private bank can also issue s.t. liabilities at will to purchase long duration assets. The only limitation is the amount of capital available to cover losses. So M1 is basically a function of 1) the banking (and shadow bkg) system’s desire to increase duration risk; and 2) the deposit-holder’s view of whether the bank’s capital is sufficient to render the deposit “information insensitive”. In the event deposits become “information sensitive” the depositor withdraws funds in favor of some alternative. At that point, raising the deposit rate only makes matters worse (results in more losses).

    The Fed/Treas. balance sheet is no different. Steep duration losses imply higher future tax liabilities. The government’s “capital” is its ability to raise those tax revenues. If the willingness/ability to do so is questioned, then the government’s “deposit” holders will convert deposits to an alternative: goods, assets, or other currencies. At that point, raising the “deposit” rate only makes matters worse (results in more losses).

    The difference is, when the banking system loses deposits, the currency (gov’t deposit) alternative leads to deflation. When the consolidated gov’t balance sheet looses deposits, the non-currency alternatives lead to inflation.

  19. Andy Harless writes:

    Printing money will always be exactly as inflationary as issuing short-term debt, because short-term government debt and reserves at the Fed will always be near-perfect substitutes

    Depends on what you mean by “printing money.” We’ve grown up using the phrase figuratively, but the people who started doing so never anticipated that electronic bank reserves would some day bear interest. I suggest we should go back to using the phrase literally, in which case your statement is not true: printing money will be inflationary (assuming we exit the ZLB), more so than issuing short-term debt (and arguably issuing short-term debt will be inflationary only because it reduces the demand for printed money).

    Back in the days before IOR, the Fed would from time to time change reserve requirements. And if the Fed were to raise the reserve requirement and offset this change with an increase in reserves, we would probably not say that the Fed had “printed money,” even though it had done so in the “literally figurative” sense of having created reserves. But imposing a reserve requirement is essentially the same as paying IOR and then taxing it away. These days the Fed can use adjustments in the IOR rate to prevent the need to literally print money, just as it could use reserve requirements in the past (and still, if it chooses).

    I submit that what is actually relevant is the literal printing of money. (Note that platinum coinage, assuming it were to remain in circulation after the ZLB exit, would not constitute net printing of money, because it would be offset by reduced printing of Federal Reserve notes — or else, if it remained on deposit at the Fed, it would be essentially nonexistent from the private sector’s point of view) The Fed has promised to print money under certain circumstances, but it can control those circumstances (at a cost). Creating reserves is potentially inflationary inasmuch as it raises the cost of refraining from printing money and thus raises the chance that the Fed will print money, but it does not constitute printing of money. Issuance of interest-bearing debt is potentially inflationary inasmuch as it reduces the demand for printed money (by raising the opportunity cost of holding it), thus reducing the amount of money that has to be printed to create a given amount of inflation.

    What is critical here is that there is a demand for Federal Reserve notes — a product that the Fed is licensed to provide monopolistically and can therefore choose a point on the demand curve so as to set the price where it wishes. The fact that the Fed also competitively supplies the market for interest-bearing assets is of less importance. Of course the Fed’s monopoly also becomes less important when normally interest-bearing assets become close substitutes for the Fed’s monopoly product (i.e., when we are at the ZLB).

  20. […] Mark Thoma, I see that Steve Randy Waldman believes that the distinction between monetary base — the stuff only the central bank can […]

  21. o. nate writes:

    Printing money will always be exactly as inflationary as issuing short-term debt

    Um, no. For one thing, the Fed has an unlimited ability to print money, the Treasury does not have an unlimited ability to issue short-term debt. For another thing, speaking of brave new worlds, we are also in a brave new world in which the Fed is not limited to using newly printed money to buy short-term government debt. So the Fed still retains monetary supremacy, so to speak.

  22. Dan Kervick writes:

    JKH, I might be missing the point, but reserve balances aren’t just assets to hold. They are clearing balances.

    And I don’t understand what the concept of liquidity has to do with “wanting to get rid of” an asset. Liquidity as I understand it isn’t a measure of the desirability of getting rid of an asset. It’s a measure of the ease with which the asset can be exchanged for something else.

    The fact that the banking system as a whole cannot get rid of their reserves other than by buying government debt, but can only circulate them among themselves, doesn’t seem to bear on the liquidity issue. After all, for any kind of money X, the whole “X-zone” can’t get rid of the X, but can only circulate it unless the monetary authority swaps something for some of it.

  23. Eric Titus writes:

    You’ve boggled my mind (in a good way, I think) with the idea that US Dollars and T-Bills are really the same, so I’m going to throw some objections out there.

    First, maybe the velocity of money is higher for “real” dollars? It’s just harder to swap T-Bills around than dollars, and harder for the person who you sell the T-Bills to use them as currency in the next purchase, etc.
    Second, there may be institutional differences. T-bills are seen as a legitimate investment whereas cash is not, so firms may keep lower reserves
    Third, they would only be identical if there was the credible possibility that the government might reduce the money supply some time in the future, in the same way that the gvt can reduce the T-Bill supply by running a surplus.

  24. JW Mason writes:

    I think you are basically right about all of this. The only issue I have is with the footnote, which seems to imply that cash is more generally usable as means of payment than T-bills. I don’t think this is correct. For interbank transactions, T-bills function as means of payment, while settling transactions in cash would be prohibitively costly. In other words, while cash is more liquid than bonds for households, bonds are more liquid than cash for financial institutions. if this were not so, we would never observe negative nominal rates, and we do.

    “t’s just harder to swap T-Bills around than dollars” for you or me. But it is much easier to swap T-bills for a bank.

  25. Matthew writes:

    I’m not quite sure what point you are trying to make. It is still the case that total monetary base must equal currency+reserves. There are institutional reasons that treasury bonds will never be the same as currency–you can’t deposit a treasury bond in a bank account and write checks against it. As for the interest on reserves, I think there is a bit of double speak here. It has always been the case that the ability of the Federal Reserve to affect the total money supply (however you define it) is tied to its ability to control short-term interest rates. If it controls the money supply it also controls the interest rate, and if it controls the interest rate it also controls the money supply.

    So, I don’t see the introduction of interest on reserves as a significant change. It is true that if the Fed sets the interest rate too high we will see greatly diminished effects of base money creation on the aggregate money supply and inflation, because much (though notably not all) of the new base will be mopped up in excess reserves. In the past we avoided this by setting interest on reserves as low as we could, now we are setting it as high as we can without going over–essentially playing “the price is right” with bank reserves.

    And about the liquidity trap. I think Krugman’s point about the substitutability of bonds and money has always been besides the point. The point is that the Fed is unable to compensate for negative shocks by lowering interest rates. That means that the fed doesn’t control the interest rate, so it also doesn’t control the money supply (which is what Krugman really means when he says debt and money become perfect substitutes). But, when the interest rate is strictly positive, the fed controls both (at least, that is the generally accepted assumption), and the problem disappears.

    Ok, my point may still be unclear. Here is another way of saying the same thing: private lenders cannot be maximizing profits unless at the prevailing interest rate total money supply equals money demand. Hence, if the fed controls interest rates it controls money supply, and vice versa. The degree of substitutability between any assets, money or otherwise, is entirely irrelevant and always has been.

  26. JKH writes:


    The issue is not reserves – its chronic excess reserves as I attempted to make clear in my comments. Those are two different ideas at their core.

    And the concept of liquidity is more multi-faceted than you suggest. The idea can be deconstructed into concepts of asset liquidity, funding liquidity, and market liquidity – among others. This is a common bank risk management framework for liquidity. What I’m referring to comes closest to the idea of market liquidity.

    The banking system must transact with the central bank to adjust its reserve position. Government debt is not the determining factor.

    The circulation of reserves within a banking system is an enormously important concept for bank liquidity management.

    I appreciate your questions, and I don’t mean to be obfuscating or avoiding, and I don’t claim to know everything, but this is a very complex subject in actual banking. I’m just throwing out an idea in crude form as food for thought in the academic treatment of it. But books can be written on the subject.

  27. jck writes:


    Reserves are the ultimate liquidity, surely “chronic excess reserves” are a lot better than running the system with only required [and minuscule] reserves that have to be supplemented with massive recourse to intraday credit.

    [ see this: ]

  28. Dan Kervick writes:

    JW Mason, I assumed that by “cash” and “dollars” in this context, SRW meant to include reserve balances and was not thinking about physical cash. That is, he was still contrasting the stuff ordinarily classified as part of the monetary base with short-term debt.

  29. JKH writes:


    If there’s a legitimate risk concern with the relative level of intra-day exposure, that should be factored into required reserves, rather than expected excess reserves. But I’m not familiar enough with those kinds of risk studies to opine on whether or not regulators are making a fundamental misjudgment there or not. I rather doubt it though.

  30. Max writes:

    “I suggest we should go back to using the phrase literally, in which case your statement is not true: printing money will be inflationary (assuming we exit the ZLB), more so than issuing short-term debt (and arguably issuing short-term debt will be inflationary only because it reduces the demand for printed money).”

    Since any unwanted currency is exchanged for reserves, the Fed can’t directly control the quantity of currency. It controls currency+reserves.

    The quantity of currency might be a better indicator of inflation than the quantity of reserves. But it’s an indicator, not an instrument of control.

  31. […] Krugman has responded to my argument that the distinction between money and short-term debt has been permanently blurred. As far as I […]

  32. Harald K writes:

    vbounded: “incentives matter, arguments do not”

    Fine, then I will disregard what you write until you pay me.

  33. JKH – Thanks for the reply and clarifications. My thinking, along the same lines of SRW, is that the Fed would maintain excess reserves to permit QE when not at the ZLB going forward. Either way, I agree that such a policy may not be desirable or even beneficial (since it removes interest income from the private sector).

  34. […] Paul Krugman, who claims that the quantity of money does matter when interest rates are positive.  Steve Waldman recently criticized Krugman in this post: If Ip and I are right, Paul Krugman is wrong […]

  35. Anders writes:

    JKH – why your concern with chronic excess reserves?

    Assuming (1) they don’t require capital to be set against them, and (2) they aren’t per se loss-making (which, given IOER, looks likely for the foreseeable future), they don’t seem to do any harm. This suggests to me that the Fed will increase the IOER rate and simply leave the chronic excess reserves in place.

    To your argument that if the excess reserves are systemically helpful, then they should be included within required reserves: I think that’s fine for risks which are anticipated. But since there are likely to be “unknown unknowns”, the possibility for subsequent remorse, if the Fed took pains to clean out these harmless excess reserves only to find a liquidity crunch down the line, seems great.

  36. […] if you have been following this debate, you are a dork. To recap the dorkiness: I suggested that, from now on, the distinction between base money and short-term government debt will cease to […]

  37. […] Wonks Both the Fed and the Treasury “emit interchangeable obligations that are in every relevant sense money” – Steve Waldman […]

  38. Benjamin Cole writes:


    Yes, it is possible we in zero-bounf perm-gloom!

    Finally, someone gets it.

    See japan? Since 1992. They did QE from 2001-6, and John Taylor gushed it was a success.

    They stopped, and went back to deflation zero bound perma-gloom.

    So? Maybe in the USA we have to do QE for 10 years, and harder than the japanese. Longer and harder.

    Is our Federal Reserve, an independent agency, up to such an alteration in its institutional culture? You see Richard Fisher running around, in sweat-drenched hysterics about inflation? The Fed is not up to this. It needs to garbage-can its 2.5 percent inflation ceiling, and print money to the moon.

    For 10 years. We are talking trillions in QE. And a major reduction in outstanding federal debt.

    The Fed won’t do it. It will dither, feeble about, whimper.

    Ergo, we get zero-bound perma-gloom

  39. […] So, if you have been following this debate, you are a […]

  40. @SRW “Printing money will always be exactly as inflationary as issuing short-term debt”. Are you saying that (the government?) issuing short-term debt is inflationary? I don’t see that.

  41. […] on this matter, since this is at the core of the recent debate between Steve Randy Waldmann (see here, here, and here) and Paul Krugman (see here and here) on the so-called “permanent floor.”  (It […]

  42. This seems to be equivalent to saying two things:
    • The government will not default.
    • The central bank will implement monetary policy via price (as it should—see essay on how to implement £ monetary policy) rather than via quantity.

    I hope that both are true.

  43. […] are all dorks, albeit of a more articulate variety. I say the most articulate dorks of all are interfluidity‘s […]

  44. Wow, what a debate.

    When the amount of reserves in the system routinely exceeds banks’ settlement needs, which is the present situation, the IOER rate, not the Fed funds rate, is effectively the policy rate. In effect we have introduced (or rather, for those with long memories, returned to) a system where monetary policy is transmitted via tweaks to deposit rates rather than funding rates.

    However, the discussion about “exit” from the floor system is distinctly premature. Whichever means of draining excess reserves were chosen – whether raising IOER or open market operations – the effect would be monetary tightening, which I don’t think many people would regard as the right direction of monetary policy at the moment. For better or worse, a floor system is what we have at the moment and will have for the foreseeable future, so it’s important we understand its effects. That’s why this debate is so important. I like Mike’s idea of a convention, or forum, or something.

    JKH, since the Fed has indicated that it intends at some point to move to a zero reserve requirement, it seems it does not wish to return to a reserve management system. But that’s not inconsistent with a return at some point to transmitting policy via the Fed funds rate rather than the IOER rate. The question that Steve raises is “why would they bother to do that”. I would ask a slightly different question: “will they ever be in a position to drain all those excess reserves without causing massive deflation”. As far as I can see the answer is “no”. But maybe I’m just a pessimist.

  45. jck

    As central banks can do unlimited intraday repos at zero interest, and banks can if necessary borrow securities to use as collateral, there is no liquidity problem with regard to intraday reserve shortfalls. So I don’t personally see any need for a positive minimum reserve requirement. When banks are not required to hold reserves they make greater use of the interbank market and overnight repo. This should make monetary policy transmission via the funds rate more effective. The problem we have at the moment is that banks are awash with reserves, so the funding rate is not effective for monetary policy transmission. Hence all the discussions about negative IOER: if the problem is that reserves are not circulating, you can get them to move by charging banks to hold them. I remain unconvinced that any of this has much effect on banks’ lending activities, although positive IOER should exert downwards pressure on commercial deposit rates and the “hot potato” effect would no doubt encourage them to buy T-bills. But it does affect their profit margins.

  46. […] That prognostication, more recently made by Steve Randy Waldman, has generated an intense online debate about monetary operations, base money, the platinum coin and the so-called “permanent floor.” […]

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  48. […] a running argument with Paul Krugman, Interfluidity’s Steve Waldman recently wrote: Cash and (short-term) government debt will continue to be near-perfect substitutes because, I […]