In a comment on this post, the DeLong who is still attached to his hinges left me with quite a reading list.
Prior to 1984, there was a clear correlation between reserves, loans, and M2. After then, while loans and M2 continued to go along in a pretty close lockstep, reserves simply have flopped around all over the place.
Rosser cites Seth Carpenter and Selva Demilrap, who write
For better or worse, most economists think of M2 as the measure of money. M2 is defined as the sum of currency, checking deposits, savings deposits, retail money market mutual funds, and small time deposits. Since 1992, the only deposits on depository institutions’ balance sheets that had reserve requirements have been transaction deposits, which are essentially checking deposits. As noted above, the majority of M2 is not reservable and money market mutual funds are not liabilities of depository institutions. Nevertheless, it is the link between money and reserves that drives the theoretical money multiplier relationship. As a result, the standard multiplier cannot be an important part of the transmission mechanism because reserves are not linked to most of M2.
After reading these and other papers on his list, Mr. DeLong writes,
All this leaves me befuddled as to what the FRB and the econ profession are using as a model of the money machine.
I think that the popular saying among monetary economists these days is that attention has shifted from the Fed’s liabilities to the Fed’s assets. The old story was that the Fed’s liabilities were currency and bank reserves, and the banks lent out a predictable multiple of their reserves. The new story is that banks hold a ton of excess reserves. Also, if you include retail money market mutual funds in M2 (when did that happen? I’m so out of it, I thought that M2 was still, you know M2), then Carpenter and Demilrap are right that the money multiplier was never so reliable, anyway.
Anyway, back to the Fed’s assets. When the Fed buys long-term Treasuries, this takes them out of the hands of private investors, who then have to find something else to buy. They bid up the prices of other bonds and drive down interest rates, or so the theory goes.
My own view is that in an enormous world capital market, the Fed is not driving long-term interest rates. I am willing to be wrong. But my null hypothesis is that the Fed is always in an asset substitutability trap. Financial markets work to create substitutability. As a result, you have Goodhart’s Law: if the Fed can control the supply of an asset class (or definition of money), then that asset class will not have much effect on the economy; if an asset class correlates strongly with economic activity, the Fed will not be able to control it.
Another way to put this is that monetary and financial arrangements are endogenous with respect to Fed procedures. The financial markets will evolve ways to insulate the economy from what the Fed does.
Under QE, the Fed bought 30 Year US Treasuries, EDV, and Zeroes, ZROZ, taking them out of the hands of private investors who looked for something else to buy, and thwarting the bond short sellers, bidding up the prices of other bonds, and driving down the Interest Rate on the US Ten Year Note, $TNX, causing the Flattner ETF, FLAT, to rise in value, and the Steepner ETF, STPP, to fall in value.
This ETF, that is STPP, rose in value, as the 10 30 US Sovereign Debt Yield Curve, $TNX:$TYX, steepened beginning in May 2013, running through September 1, 2013, as bond vigilantes gained control of the Interest Rate on the US Ten Year Note, $TNX; but then from early September to October 4, 2013, the Steepner ETF, STPP, declined in value, as the Interest Rate on the US Ten Year Note, $TNX, fell to its October 4. 2013, rate of 2.65%.
Yes, up until May 14, 2013, investors bought other bonds; but then they sold Junk Bond, JNK, and Ultra Junk Bonds, UJB, Mortgage Backed Bonds, MBB, International Treasury Bonds, BWX, and International Corporate Bonds, PICB. On July 14, 2013, investors reversed course once again and have been long the others, as is seen in combined ongoing credit Yahoo Finance Chart, which reinvigorated World Stocks, VT, Emerging Market Stocks, EEM, Global Industrial Producers FXR, Asia Excluding Japan, EPP, Nation Investment EFA, Small Cap Nation Investment, IFSM, Eurozone Stocks, EZU, and the Nikkei, NKY, as is seen in combined ongoing equity Yahoo Finance Chart. The Nikkei has been falling lately on the rise of the Japanese Yen, FXY, which hurts export companies.
The world as of October 4, 2013, stands at Peak Prosperity, Peak Democratic Nation Sovereignty, and Peak Seigniorage, that is at Peak Moneyness, as is seen in the chart of World Stocks, VT, relative to Aggregate Credit, AGG, that is VT:AGG.
Liberalism’s prosperity has been a terrific moral hazard based prosperity, as investors came to trust in the US Fed’s policies of easing, which started when it took in Distressed Investments such as those traded by the Fidelity Mutual Fund FAGIX, with the start of QE1, driving up risk assets such as Small Cap Value Stocks, RZV, Biotechnology, IBB, Resorts and Casinos, BJK, IPOS, FPX, Media, PBS, Pharmaceuticals, PJP, Emerging Market Leaders, PIE, Aerospace, PPA, Spin Offs, CSD, Leveraged Buyouts, PSP, and Solar Energy Stocks, TAN, as is seen in combined ongoing Yahoo Finance Chart.
Fiat money died Friday September 20, 2013, with World Stocks, VT, Major World Currencies, DBV, and Emerging Market Currencies, CEW, trading lower, as Jesus Christ is operating in dispensation, as presented by the Apostle Paul in Ephesians 1:10, that is in administrative oversight of all things economic and political, and has pivoted the world out of liberalism and into authoritarianism, and as such the stock market has turned from bull to bear; those ETF sectors which rallied over the last year and countries which rallied from late June 2013 to late September, 2013, seen in this Finviz Screener, will be trading lower from the Tuesday October 1, 2013 rally, on competitive currency devaluation and on the exhaustion of the world central banks’ monetary authority as investors come to greater realization that the US Fed’s monetary policies have crossed the Rubicon of sound monetary policy, and have made “money good” investments bad.
Friday, September 20, 2013, was liberalism’s day of investment instability that marked an inflection point that pivoted the world from the paradigm of liberalism into the paradigm of authoritarianism, and from a moral hazard based prosperity into a debt servitude based austerity. With the financial markets turning from risk-on to risk-off, as indicated by the Market Off ETN, OFF, trading higher, and the stock market turne from bull to bear.
Please consider Corollary #8 from the Dispensation Economics Manifest. The No Taper Rally of September 18, 2013, in World Stocks, Major World Currencies, DBV, and Emerging Market Currencies, was Liberalism’s peak event, which terminated the Creature Jekyll Island and birthed the Beast Regime of Revelation 13:1-4. and which pivoted the world from a policy of investment choice … consisting of credit schemes, such as, free trade agreements, financial deregulation, leveraged buyouts, nation investment, currency carry trade investing, securitization of debt, dollarization, financialization of stocks and ETFs, such as corporate bonds which convert into stocks, all of which created capital for corporations to operate and revenue for governments to operate … to a policy of diktat … consisting of debt servitude schemes, such as, regional framework agreements, bank deposits bailins, new taxes, privatizations, capital controls, austerity measures, and statist vitalizations where banks and other corporations are given charter to operate as public private partnerships for regional economic security, regional stability and regional sustainability.
September 20, 2013, was a pivotal day in global economic history from which there is now no return, despite what liquidity measures any central banker, whether it be Mario Draghi, or Ben Benanke, might propose.
The exhaustion of the US Fed’s monetary policies of easing, as the provision of QEternity marked the crossing of the Rubicon of sound monetary policy, and destabilized global economics pivoting the world from liberalism’s banker regime of democratic nation states into authoritarianism’s beast regime of regional governance and totalitarian collectivism.
Liberalism was the era of investment choice based upon credit and carry trade investing. Authoritarianism is the era of diktat based upon debt servitude.
The Yahoo Finance chart of the EUR/JPY, and the Google Finance Chart of the EUR/JPY, and the Forex Trading chart of the EUR/JPY, and FXStreet chart of the EUR/JPY, show a close at 132.45 on October 3, 2013; from which a trade lower, will soon propel Eurozone Stocks, EZU, and European Financials, EUFN, as well as World Stocks, VT, lower, as The Great Bear Market of all time commenced Friday, September 20, 2013, and envigorated Thursday, October 3, 2013.
On Friday, October 4, 2013, currency traders took the Japanese Yen, FXY, slightly lower to a new weekly rally high, at 100.30, its dark filled candlestick suggests that the rally in the Yen, is at its zenith. And the Euro, FXE, even more slightly lower, to a new weekly rally high of 134.12, forcing the EUR/JPY, to lower to close the week lower at 132.04, yet Eurozone Stocks, EZU, rose to close near their all time high.
While Resorts and Casinos, BJK, International Telecom, IST, IPOs, FPX, Small Cap Energy, PSCE, and Energy Production, XOP, traded to a new rally high, monetization of debt, has finally turned money good investments bad. Investments in Risk Assets, such as Small Cap Value Socks, RZV, has ended, as confirmed the Market Off ETN, OFF, and Volatility, XVZ, trading higher this month of October 2013. The interventionist policies of the world central banks no longer provide investment stimulus in Global Industrial Producers, FXR, as leaders such LPL, IP, WHR, MHK, PHG, ERIC, VPRT, ABB, ENR, ITW, ROK, MMM, FLS, SNA, LECO, SI, GM, GE, and BA, are trading lower. Jesus Christ acting in the Economy of God, Ephesians, 1:10, has ended the Fed; He did what Ron Paul could not do.
Yes, the Fed be dead. Charles Hugh-Smith of OfTwoMinds blog, writes in Zero Hedge, The Fed Bubble Era Is Over This is seen in the Too Big To Fail Banks, RWW, trading lower from their rally highs. And Asset Managers such as BlackRock, BLK, and Eaton Vance, EV, that coined liberalism’s wealth, are trading lower as well. Now under authoritarianism, the policies of nannycrats and technocrats, working in schemes of regional integration, will underwrite economic activity.
Debt deflation, specifically competitive currency devaluation, has commenced, terminating Nation Investment, EFA, and Small Cap Nation Investment, IFSM, and Emerging Market Investment, EEM, and liberalism’s fiat wealth, VT.
The modern money system is broken and bust; the age of speculative leveraged investment, is done, over, and finished. Liberalism’s democratic fiat money and banking system is being replaced by Authoritarianism’s diktat money and regional governance and totalitarian collectivism system.
Financial Apocalypse could commence immediately on either on a US Default, or a surge of stock market short selling caused by a rise in the Interest Rate on the US Ten Year Note, $TNX, or currency traders selling any number of currencies such as the Japanese Yen, FXY, the Euro, FXE, the Canadian Dollar, FXC, the British Pound Sterling, FXB, the Swedish Krona, FXS, the Swiss Franc, FXF, the Brazilian Real, BZF, the Australian Dollar, FXA, the Indian Rupe, ICN, or Emerging Market currencies, CEW, which would cause the US Dollar, $USD, UUP, to rise for a period of time from its greatly sold off price of 80.25.
The tie between the various types of money and the monetary base comes from redeemability.
Who says that M2 is the best measure of the quantity of money?
MZM is better and the Divisia measures better yet.
Since the development of sweep accounts, the reserve requirements have been meaningless. Banks can sweep funds out of transactions accounts into something that has no reserve requirement. They just keep whatever amount of reserves they think is appropriate.
There is a theory of reserve demand, and it doesn’t suggest a constant reserve ratio.
But that doesn’t mean that changes in the quantity of base money are no longer positively related to more inclusive measures of money.
Helpful comments. It’s odd that there is so much inertia in the textbook story of money creation.
“Another way to put this is that monetary and financial arrangements are endogenous with respect to Fed procedures. The financial markets will evolve ways to insulate the economy from what the Fed does.
the Fed can control the supply of an asset class (or definition of money), then that asset class will not have much effect on the economy; if an asset class correlates strongly with economic activity, the Fed will not be able to control it.”
It just depends on how relevant the asset class controled by the fed is IMO. It doesn’t matter how much base the fed creates because most of the economy doesn’t use it. Of course there is a demand for currency but it is only a small proportion of overall money supply. The fed can create as much base as it likes and the banks will just park it in reserve accounts. In order for the fed to have an effect on the economy it needs to affect assets which are relevant.
If the fed directly affected the broader money supply the endogenous and exogenous aspects of financial markets will be more connected . This can be done by allowing people to directly transact in base or crediting deposit accounts of people at commercial banks when conducting policy.
As much as I regard MF as the prior century’s greatest economist, it’s time to shift from the quantity of money to MV. V used to be stable. Now it isn’t. We have to incorporate its ebbs and flows into policy. Thus, NGDP. If nothing else, it calms the other stuff down, because it buffers the exogenous changes that so often sank our ships. See 1937, 1998, etc.