Friday, December 13, 2013

Is Princeton's Alan Blinder the Greatest Inflationist in America?

The $2.5 trillion in excess reserves at the Federal Reserve is a massive overhang over the money supply and economy. If that money leaves the Fed and enters the economy, it is very likely to cause massive price inflation.

Even Fed officials understand this and are desperately trying to figure out a way to drain those reserves before they hit the economy.

Yet, Alan Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, stands 180 degrees with an opposing perspective on the excess reserves. He wants to trigger an avalanche of these excess reserves into the system.

In an op-ed written for WSJ earlier this week, he said (my bold)
Unless you are part of the tiny portion of humanity that dotes on every utterance of the Federal Open Market Committee, you probably missed an important statement regarding the arcane world of "excess reserves" buried deep in the minutes of its Oct. 29-30 policy meeting. It reads: "[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage."

As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous.[...]

If the Fed turned the IOER negative, banks would hold fewer excess reserves, maybe a lot fewer. They'd find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want.

A second reason for cutting the IOER answers some of the criticisms the Fed has taken for its asset-buying programs called quantitative-easing: Doing so would stimulate the economy without increasing the size of the Fed's balance sheet.
Yikes, the only reason the Fed's balance sheet is a concern is because it has a strong tendency to lead to expansionary money supply. To call for driving excess reserves into the system and hailing this as a reason to cheer because the Fed is no longer adding to its balance sheet, is like cheering that an alcoholic has been stopped from driving drunk by allowing him to take an LSD hit and get behind the steering wheel of a car.

The money supply (M2 NSA) currently stands at $10.9 trillion. Thus, if the $2.5 trillion in excess reserves were driven into the system by a Blinder negative interest rate, the money supply, not counting likely multiplier effects, would increase by 23%! Given that the money supply would likely expand by a multiplier of what comes out of excess returns, an increase in the money supply of 50% to 75% is not out of the question. These are insane rates, only seen in places like Zimbabwe during certain periods of their hyperinflation. And this is what a Princeton professor is calling for!

The man should be teaching at Rapid Results College, where Gideon Gono, the president of Zimbabwe's central bank during the height of its hyper-inflation, received his degree in Accounting, Economics and English Law, by correspondence.

1 comment:

  1. I can't help but wonder if lowering the IOER rate will be one of the next mad scientist experiments to be inflicted upon the public. My thinking is as follows:

    (1) The Fed is worried about the continued growth in the size of its balance sheet and the possibility that excess reserves will suddenly start flooding the market with too much credit.

    (2) However, it is also worried that tapering will cause interest rates to spike and thus exposing the bubbles that have been caused by its ZIRP policy.

    (3) When the plans of an interventionist fails, they tend to focus on the new problems that were caused by their previous intervention by offering a new intervention to counteract the symptoms of the new problem that they just created.

    Therefore, if I take off my libertarian tinfoil hat and replace it with a cone-shaped bureaucratic paper hat, I conclude that the Fed might mix some tapering with a reduction in the IOER rate. Their thinking might be that a reduction in the IOER rate might counter-act the spike in interest rates that would be caused by tapering.

    These types of experiments always seem to miss some important factors and seem to be very dangerous. While I wish that the Fed would stop with all of the monkey business, it seems necessary to second guess their actions if one wishes to minimize the harmful consequences.