Monetary Policy:
Contemporary
Issues
ECO 473 - Dr. Dennis Foster
W.A. Franke College of Business
Monetary Policy: Contemporary Issues
I
II
III
IV
V
VI
VII
Heading into crisis
The failures
Fed inaction & action
What has the Fed accomplished?
The problem with policy
The Austrians & rethinking policy
Outlook for the economy
I. Heading into crisis
Anatomy of Financial Crisis
What does the
Fed Want?
• A healthy & strong economy
with low unemployment and
low inflation.
• Policy? Stimulate spending by
reducing interest rates.
• Why? They are Keynesians.
• Effect? Creates housing boom.
Federal Funds rate of interest, 1995 to 2004
30 year mortgage rate, 1995 to 2004
Median home prices, 1999 to 2006
Home sales, 1999 to 2006
Sept.
2005
The Bear Stearns Story
II. The failures
• $133.20 - 52 week high prior to collapse.
• 2007 - Lost billions in collapsing subprime
market; slowly recovering.
• March 2008 - Assets/equity = 35
 Lots of assets in MBS.
• Spring 2008 - Clients pulling out funds.
• 3/10/08 - Turned down for $2 b. loan
$400 b.
Assets
 Continued loss of confidence in Bear all week.
• 3/13/08 – Cash  from $10 b. to $2 b.
The Bear Stearns Story
• Tried to get LOC w/JPM for $25 b.
• 3/14/08 – Fed lends $13 b. for 3 days.
• JP Morgan deal - $2 per share!
• Fed creates Maiden Lane LLC
– Fed loans ML $30 b.
– JPM “sells” bad assets to ML.
• 3/24/08 - New stock deal - $10/share.
• Cost to the Fed?
• Was Bear TBTF? Yes!
– What about Lehman?
The Three Failures:
IndyMac WaMu Lehman
• IndyMac
$32 b.
Assets
– Spun off from Countrywide.
– Not a “mac”
– Overleveraged on “Alt A” loans.
• WaMu
$300 b.
Assets
$640 b.
Assets
– Shut down 100’s of offices 2007-08.
– Sub-prime victim.
– Final 10 days lost $17 b. in cash w/d
• Lehman Brothers
– Losses = $7 b. in Q2 & Q3
– Final day: $1 b. in cash
Stock prices collapse
III. Fed inaction & action
Did the Fed see this coming?
III. Fed inaction & action
Did the Fed see this coming?
What did the Fed do?
• Cut interest rates.
• Lend to everyone.
• Quantitative Easing.
Federal Funds rate of interest, 2004 to 2014
Fed Lending Programs: 2008-2010
Term Auction Credit
Primary Dealer Credit
Commercial Paper MMMF
Asset-backed Securities
The Quantitative Easing Programs
+644%
+162%
+44%
IV. What has the Fed accomplished?
The Fed charts new territory.
$4 tr.
$2.7 tr.
Monetary
Base
$2.5 tr.
US T
XS R
$1.7 tr.
MBS
Housing Revisited
30 year mortgage rate, 2004 to 2014
Housing Revisited
Median home prices, 1999 to 2014
Housing Revisited
Home sales, 1999 to 2014
V. The problem with policy
What is the exit strategy?
• The FED will have two choices:
• Continue policy  hyperinflation
• Halt policy  recession
• Or . . . Wage/Price controls?
Are Monetary Policies Effective?
• “No” . . .
– Investment channel collapses.
– People are rational and counteract.
– Lag problems.
– It introduces systemic distortions.
• “Yes” . . .
– Various transmission mechanisms.
– Policy is unanticipated.
– Wage & price rigidity.
The Fed and its Policies
• Has it maintained the value of the dollar?
• Has it stabilized the economy?
• Is it enhancing moral hazard?
• Is it creating distributional problems?
• Is risk of inflation gone?
The Unemployment Rate – 1980-2014
Oct. ‘09 - 10.1%
Dec. ‘82 - 10.8%
June ‘92 - 7.8%
June ‘03 - 6.3%
A Tale of Four Recoveries
+19%
+28%
+16%
+12%
Tracking Prices and Inflation
3rd Q
yr-to-yr
+1.8%
VI. The Austrians & rethinking policy
Rethinking Policy:
The Austrian School of Thought
• Recessions are the solution,
not the problem!
• Keynesian policy -  interest to spending.
• Leads to misallocation of resources.
• Leads to an unsustainable boom.
• Leads to eventual conflict (C vs. I).
• What should we do? Wait!!
2008
1981
1920
March 5.5%
GDP (2011) = $18.3 tr. vs. $13.3 tr.
1990 - 2011 net gain = $34.6 tr.
Rothbard - A Return
to Sound Money
Get back on the gold standard.
Define $ in terms of gold.
No more suspensions of payment in gold.
Abolish the Federal Reserve.
Redeem every $ of M1 in gold…
Get government out of money.
Bank notes will replace FRN.
100% reserve ratio
Or, let banks fail.
Abolish FDIC, US Mint.
The Results of Sound Money
1.
2.
3.
4.
5.
No
No
No
No
No
bank panics.
convoluted regulation.
inflation.
discretionary monetary policy.
monetizing of federal gov’t. debt.
6. An end to the business cycle!!
• Let bad firms/banks go bankrupt.
– We don’t lose real resources!!!!!
• Abolish Fannie & Freddie.
• End the Fed.
• End the government monopoly on
money.
VII. Outlook for the economy
What is the Outlook?
• Interest rates will stay low.
Yellen only hints at increases.
• Inflation is still a looming danger.
Where will all the money go?
• Unemployment will be erratic.
May rise if lfpr rises even with growth.
• Best
case
scenario?
Worst
case
scenario?
Economy
sluggish,banks
Ur stagnant,
and
Economyissurges,
lending,
and
hold inflation.
massive XS reserves.
andbanks
dramatic
Another
yearwithin
(or 2?)3 on
the knife edge.
Recession
years???
Get on the mailing list for Fall 2015 – dennis.foster@nau.edu
The W.A. Franke College of Business
Northern Arizona University
Spring 2016
ECO 481:
Public Choice Theory
W h y
G o v e r n m e n t
F a i l s
Dr. Dennis Foster
FCB #208
Monetary Policy:
Contemporary
Issues
ECO 473 - Dr. Dennis Foster
W.A. Franke College of Business