July 21, 2017
House Financial Services – Monetary Policy Subcommittee: Monetary Policy v. Fiscal Policy: Risks to Price Stability and the Economy
Key Topics & Takeaways
- Federal Reserve Funds Rate: Selgin argued the Federal Reserve has not been successful in using the federal funds rate to control inflation, and has been unable to meet its two percent inflation target.
- Shrinking the Balance Sheet: Selgin stated the shrinking the balance sheet is a further “tightening measure” that could cause the Fed to again fail to meet its inflation target. Levy indicated a four or five-year plan to shrink the balance sheet would mean most of the balance sheet can be unwound in a “passive way.”
- Interest Payments on Excess Reserves: Leeper stated he has “yet to hear a persuasive argument” for paying above market rates on excess reserves. Williams asked how the Fed’s policies have affected “main street”, and Selgin said that by making it more attractive for banks to hold reserves rather than make loans, banks have cut back on their short-term lending. Selgin noted that total lending is currently equal to only 80% of the level of deposits, when historically the two figures should be equal.
- Dr. George Selgin, Senior Fellow and Director, Center for Monetary and Financial Alternatives, The Cato Institute
- Dr. Mickey Levy, Chief Economist for Americas and Asia, Berenberg Capital Markets, LLC
- Dr. Jared Bernstein, Senior Fellow, Center on Budget and Policy Priorities
- Dr. Eric M. Leeper, Economics Professor, Indiana University Bloomington
Rep. Andy Barr (R-Ky.), Chairman, House Financial Services Monetary Policy Subcommittee
In his opening statement, Barr described a “breaching of the line” between monetary and fiscal policy at the Federal Reserve but noted that Congress has a long history of forcing the hand of the Federal Reserve to accommodate its spending. Barr said that following the 2008 financial crisis, the Federal Reserve pursued policies that accommodated unsustainable fiscal policies and distorted the allocation of credit. Barr highlighted the history of the Federal Reserve’s effective resistance to political attempts to interfere with monetary policy. Barr also noted that the Federal Reserve recently engaged in several rounds of quantitative easing that dramatically increased the balance sheet, and now pays excessive interest on reserves. Barr argued for a more accountable and disciplined monetary policy that would help get the economy back on track.
Rep. Gwen Moore (D-Wis.), Ranking Member, House Financial Services Monetary Policy Subcommittee
Moore used her opening statement by criticizing Congress for cutting safety net programs., She argued that these policies have harmed economic growth more than the Federal Reserve’s actions. Moore offered Kansas as an example of failed Republican policies, saying the state has experienced stunted economic growth and credit rating downgrades.
Rep. Warren Davidson (R-Ohio)
In his opening statement, Davidson voiced his experience with the consequences of fiscal and monetary policy on small businesses. Davidson said that during the recession, the Federal Reserve took “bold steps” to manage the crisis that only enabled the United States to finance massive debt while distorting asset prices and creating further weakness in the country’s banking system. He stated that monetary policy has accommodated unstable fiscal policy in Congress. Davidson recommended that the Federal Reserve unwind its balance sheet and return to normal monetary policy, and that Congress act swiftly with sound fiscal policy to promote growth.
Dr. Mickey Levy, Chief Economist for Americas and Asia, Berenberg Capital Markets, LLC
In his testimony, Levy argued that monetary and fiscal policies have gone off course and need to be reset. Levy also said that the effects of the government’s current spending programs are harming current economic conditions, and that relying on monetary policy is insufficient to counteract the damage. Levy also emphasized that the temporary reduction in the budget deficit by low interest rates encourages undesirable fiscal maneuvers, and contributes to Congress’s delay in addressing fiscal challenges. He suggested that the Federal Reserve continue normal fiscal policy by raising rates, unwinding their portfolio, and stepping back from policy overreach.
Dr. Eric M. Leeper, Economics Professor, Indiana University Bloomington
In his testimony, Leeper criticized the claim that fiscal and monetary policy are in competition, as monetary policy always has fiscal consequences and the two should be examined together. Leeper highlighted that short term rates have been below 1% for a decade, while bank reserves increased by a factor of 52. Leeper continued that long-term treasury bond yields have been trending down, suggesting no rise in inflation. He pointed out demand for treasuries continues, and there should be a fiscal policy concern when demand slows.
Dr. Jared Bernstein, Senior Fellow, Center on Budget and Policy Priorities
In his testimony, Bernstein stated that to most effectively pursue monetary policy and the interests of the American people, the central bank must keep its distance from the political system. Bernstein said that monetary and fiscal stimulus attack different parts of the problem in weak, demand-constrained economies. He explained monetary stimulus works largely through lowering the cost of borrowing, but those hurt by high unemployment may have too little income to take advantage of low interest rates. Additionally, Bernstein said fiscal stimulus puts money in people’s pockets, who are in turn more likely to take advantage of low borrowing costs, and further indicates to investors to take advantage of these rates. Bernstein concluded that monetary and fiscal policies interact in recession to boost fiscal multipliers, and that the two effectively helped the country recover from the recession.
Dr. George Selgin, Senior Fellow and Director, Center for Monetary and Financial Alternatives, The Cato Institute
In his testimony, Selgin explained that while the Federal Reserve was not supposed to begin paying interest on banks’ reserve balances until 2011, because of the crisis, it began doing so in October 2008. Selgin said that the Federal Reserve set the interest rate above comparable market rates, ignoring a legal stipulation that it was not to exceed the general short-term rate. Selgin said this significantly increased the Federal Reserve’s footprint in the United States credit system. Selgin argued the Federal Reserve’s current policy is “financially repressive” and has contributed to slow productivity growth post-financial crisis, and has prevented the Federal Reserve from meeting their inflation requirement of 2%.
Question & Answer
Federal Reserve Funds Rate
Barr asked about the risks and downsides of replacing conventional open market operations with interest on excess reserves as the primary monetary policy tool for setting the federal funds rate. Selgin replied that the original means before the crisis by which the Fed managed the funds rate was through open market operations, where it would adjust the quantity of reserves available to banks to change the rate at which they would lend. Selgin said under the new system, however, monetary tightening consists of the Fed’s adjustment of these administered interest rates. Selgin stated the Federal Reserve has not been successful in using the federal funds rate to control inflation, and has been unable to meet its two percent inflation target.
Shrinking the Balance Sheet
Rep. Roger Williams (R-Texas) asked how the Federal Reserve should proceed with its intent to wind down the balance sheet. Selgin stated the shrinking the balance sheet is a further “tightening measure” that could cause the Fed to again fail to meet its inflation target. Rep. Tom Emmer (R-Minn.) asked about the Federal Reserve’s five-year plan to shrink the balance sheet. Levy replied a four or five-year plan would mean most of the balance sheet can be unwound in a “passive way,” and commented that the Fed should go back to an all-treasuries portfolio. Rep. French Hill (R-Ark.) asked if there is any reason for the Fed’s balance sheet to be larger than it was before the crisis, and Selgin said it should not be that large.
Interest Payments on Excess Reserves
Rep. Trey Hollingsworth (R-Ind.) asked about interest on excess reserves, and if the witnesses agree with Federal Reserve Chair Janet Yellen’s assertion that the Fed needs to pay interest on excess reserves to control the federal funds rate. Leeper responded he has “yet to hear a persuasive argument” for paying above market rates on excess reserves.
Williams asked how the Fed’s policies have affected “main street”. Selgin said that by making it more worthwhile for banks to hold reserves rather than lending, banks are making fewer short-term loans. Selgin noted that total lending is currently equal to only 80% of the level of deposits, when historically the two figures should be equal.
Hill asked about the non-monetary policy structural impediments of the regulatory system. Levy stated that a “growing web of regulations” has contributed to an under-stimulated economy. Levy said that while the Fed has been successful in lowering the cost of real capital, businesses must also consider the regulatory environment when making decisions. Levy noted that portions of Dodd-Frank, particularly stress testing, has affected banks’ willingness to lend.
Rep. Robert Pittenger (R-N.C.) asked if the Federal Reserve’s policy of favoring some sectors over others in credit markets has held back economic growth. Selgin said that to the extent the Fed is shunting savings into the mortgage market and treasury market, rather than into productive bank lending to businesses and consumers, policies are affecting on economic growth. Selgin stated that the economy has always depended on bank lending as one of the important contributors to growth, and robust policies are necessary. Levy stated monetary policy is incapable of addressing certain pockets of economic underperformance, which need to be addressed with the proper policy tools.
Williams said that many on the committee are concerned about the effect of the national debt on future generations, and asked about the consequences of long-term debt. Levy indicated it is not only deficit spending that increases debt, but specifically what the deficit spending is for. Levy said a shrinking portion is being spent on infrastructure, job training, and other programs that would “add to long-term productive capacity” in the economy. Levy said the current allocation of resources is “borrowing from the future,” and spending policies will reinforce “disappointing” economic growth.
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