Should Everybody Have An Account At The Central Bank?

This will be my last posting before Christmas, and depending on what I get up to, possibly the last of 2023. This article is somewhat of a placeholder for my manuscript chapter. It is a group of related topics that I think belongs in there, but not ones that I spent much time looking at. I will revisit this text when I put the manuscript together.

Happy Holidays (and probably) Happy New Year!

In this article, I will breezily run through a few topics that are related to the idea of “everybody getting accounts at the central bank.” Many (but not all) of these proposals are being put forward as a means to fixing the problems with the private banking system that were exposed during recent financial crises, and/or proposals to del with the somewhat backward retail banking infrastructure of the United States of America (and perhaps a few other countries).

Should Central Banks Lend Unsecured To The Private Sector?

This article continues my sequence of articles on central banks as banks, which is projected to be a chapter in my banking manuscript. This article is relatively lightweight, but I wanted to break this issue out of another planned article.

What assets central banks should have on their balance sheet is controversial for some people, but for the post-World War II to 2008 Financial Crisis period, developed countries without currency pegs just held government bonds without raising questions from the bulk of economists. The Financial Crisis forced central banks to buy private sector assets, which re-opened this debate. This article looks at one type of private sector assets to be held — uncollateralised loans to the private sector.

Using Fed Projections To Infer The Term Premium?

I was passed along the article “Views from the Floor — Tighter and Tighter” by the Man Institute published last month. It discusses using the FOMC long-term projections to infer the term premium in the 10-year Treasury yield.

The methodology is straightforward (I have a busy week, so I have not gathered the data to replicate it myself). They describe it as follows:

A better approach is to incorporate the FOMC’s projections of the Fed Funds Rate into the expected path of short rates. This will make term premia estimates more consistent with sub-2% growth. Figure 1 shows that model applied, with an expectation that the short rate matches the Fed Funds Rate over the next year, then it linearly converges to the long-run projection over the next three years, and then remains constant.

The Central Bank And Government Finance

This article continues the sequence of articles on central banks as banks. This article was as brief as possible since it overlapped my book Understanding Government Finance (available for sale cheaply at online bookstores, and I emphasise that it would be an amazing Christmas present for friends and/or enemies (depending on what you think of my writing)). I might need to expand upon the less obvious points herein if this text does get into my book manuscript.

Central banking largely evolved the way it did due to the exigencies of wartime finance. The central government needs control over its financial operations in wartime, and any attempts to interfere by the private sector would be viewed as akin to sabotage. For a free-floating sovereign (and currency pegs are typically broken during major wars), the system guarantees that the financial flows will continue to flow.

Central Bank Balance Sheets

This article continues my series of articles on central banks as banks.

Central bank balance sheets (in the modern era, at least) are relatively simple. There is a split between banks with a currency peg and those without. After that, the key point to keep in mind that the minimum size of the central bank balance sheet is not under the control of the central bank — other actors create a minimal demand for their liabilities. The only freedom of action for central bankers is growing beyond the minimum, which they did not do before the days of Quantitative Easing (QE). The article finishes off with a discussion of consolidation.

This text overlaps material found in my book Understanding Government Finance.

Central Bank Banking Basics

This article continues the plan outlined in the previous article “Central Banks as Banks.” As I described therein, this is projected to become a chapter within my banking primer. I am not going to describe private banking — as that is the job of other chapters — but I will cover the issues of inter-bank transactions. This article is about fundamentals that we normally do not think about.

As the name suggests, central banks are at the centre of the banking system. The objective of a well-run banking system is that you do not have to worry about how it works. So long as everything under the hood is operating, you do not need to enquire how the money gets from one account to another. By not worrying about those details, we tend to only focus on the flashy bits of central banking (e.g., trying to hit an inflation target) instead of the banking system regulation part.

Central Banks As Banks

My plan is to write a draft what should become a chapter for my banking book. The inflation manuscript is in good shape (but way behind schedule), but there’s nothing I can publish from it (other than reposting the edited version of articles posted earlier). This article is somewhat lightweight — it might turn into the introductory section, which I normally just keep as a summary of the chapter contents. The advantage of putting this summary out is that it sort-of explains why I might cover some digressions in the first articles.

Central banks, as the name suggests, are in fact banks. This rather straightforward perspective was lost in the decades after World War II, when central bankers bought into mainstream thinking and they thought of themselves as “benevolent central planners.” Instead of worrying about mundane distractions like credit risks within the system, the researchers were running around pretending they were 1960s control systems engineers optimally determining the trade off between growth and inflation. Of course, this neglect of banking led to the rather awkward Financial Crisis in 2008, where central bankers suddenly had to get a handle on banking risks once again. Since then, central bankers have been quite vigilant about banking risks — at least the ones that are similar to the last crisis.

"So How Did You Lose Money Buying Risk-Free Bonds?"

The title of this article is deliberately silly, but there are times where I just need to be deliberately silly. I am not going to discuss why people (like myself, sigh) decided to not cut their bond allocations to zero ahead of the recent Bond Catastrophe, but rather how to judge or even calculate returns based on the most common bond market data — constant maturity yield series.

(This article is a bit rushed, since I yet again have family visiting from out of town…)

Employment-Population Ratio Revisited

I have been writing some manuscript comments about labour market capacity constraints and inflation, which I hinted at in my previous article. One tangent that came up that will not fit the manuscript is the behaviour of the employment-to-population ratio. Although the argument that the “labour market overheating is a major component of sustainable domestic inflation” is quite plausible, the problem is defining “overheating.” If we want to tell stories about the back history, we can pick and choose data as we wish. But it we want to make quantitative forecasts — which is what you need for a falsifiable theory of inflation — you need some variables to feed into your model.

No, QE Is Not Costless

I ran across a couple lame attempts at blaming the U.S. Treasury for not extending the duration of issuance during the pandemic low in yields. This is entirely typical for market commentary — going after fiscal policymakers and ignoring the major culprit, which is the central bank. To the extent that the United States has put itself into an awkward macro stabilisation situation with respect to interest rate expenditures, it is the result of the brain trust at the Federal Reserve.

Inflation Theories

I have been editing sections of my manuscript, and nothing out of that writing output is publishable here (since it is just a rehash of an earlier article). However, I am adding a new section on inflation theories that I will need to think about. This article summarises what I think I will cover.

My manuscript is somewhat unusual in that I am mainly discussing the “known properties” of inflation, without offering a theory of inflation. The more usual situation is that people have extremely strong views on what explains inflation (and more often than not, these views contradict “known properties” of inflation). I decided to not cover inflation theories on the basis that it somewhat difficult to get good introductory information due to the huge mass of disinformation. By avoiding theory, the manuscript statements are relatively safe to make, and so my manuscript itself hopefully stays out of the “disinformation” category.

"Paying For Two Wars"

Comments by Treasury Secretary Yellen and President Biden about “paying for two wars” has attracted some chatter. For example, Adam Tooze just wrote an article on it.

As Tooze notes, saying that America is paying for two wars is a particularly bad framing for support for Ukraine and Israel. A good portion of United States aid is shipping “obsolete” weaponry (admittedly not as obsolete as Russian 1950s era equipment that is showing up on the front line), the offloading of which saves the United States the expenditures associated with decommissioning it. The United States is not going to have combat personnel on the ground under most plausible scenarios, and so the usual disruptive effects of a war are not present for the United States.

Slopes And Recession Probabilities

Menzie Chinn just published a short note “Inversions, Bear Steepening Dis-Inversions, and Recessions.” He was responding to an article that argued that a bull steepening is a good sign for the economy, as it indicates less need for the Fed to cut in response to a recession. Chinn updated some recession probability indicators based on the yield curve.

Comments On Logan Speech

Lorie Logan of the Dallas Fed gave a recent speech in which the term premium figured. Although I think Logan’s remarks are fairly innocuous, I saw some chatter that extended to a “oh no, fiscal!” story.

At Least It's Not As Bad As 1994

The current Treasury bear market has been impressive, and unfortunately for the bond bulls, there is no valuation reason for it to stop. For example, the 5-year Treasury is still trading well below the overnight rate. If we look back to the 1994 bond bear market, the 5-year traded about 250 basis points above cash — versus about 100 basis points below now.

Posting Hiatus

I have been busy with some consulting work, and will be travelling next week. Although I will be able to do some book editing, not sure if I can get any articles posted for one to two weeks.

Since I should knuckle down and get the inflation book out of the way, my posting should be cut back for some time. However, Larry Summers might say something stupid enough to provoke some comments.

The "Economists Monkeying With The CPI" Debate

Note: This is an unedited draft section of my inflation primer manuscript. It is is a chapter about misunderstandings/myths about the CPI. This section aims at claims that economists have fooled around with the methodology to lower the reported inflation numbers. I think one subsection was already published as a draft, but I will leave it in there. At present, I only some overview sections to write, as well as the need to take the axe to a couple sections that ended up overlapping.

A popular belief in hard money internet commentary is that economists are conspiring to lower reported inflation. The advantage of this is to mislead voters and to reduce cost-of-living adjustments paid by the government. Admittedly, there are cases in emerging markets where there is widespread skepticism about government inflation statistics, and the government inflation numbers do not appear to align with market data. As such, I label this as a “misunderstanding,” as I accept that CPI numbers probably have been fudged somewhere. However, the usual case in developed countries is that statistical agencies are transparent about their methodologies, and the complaints are bad faith misinterpretations of the methodologies.

Inflation And The Labour Market

I have been seeing comments about how labour market models have been misleading this cycle. The fun thing about this subject is how mainstream economics is supposed to be a rigorous data-driven science, yet mainstream economists are flailing around trying to come up with a relationship between two time series. (Note that this article is re-hashing points I made previously; I am too lazy to check whether I am just re-writing an old article.)

The usual response to critics who state things like I just did is “give me a better model.” The idea is that we need to replace one reductionist model with another reductionist model. The reasoning seems to be that economics is like physics, where a lot of the history of the field is doing exactly that. (Physicists might be getting into “complexity,” which may or may not be a mathematical pseudo-science. In any event, this is not what people have in mind when they compare economics to physics.) If inflation is a complicated process, any reductionist model is going to fail.

Any empirical work on the link between inflation and the labour market is going to run into a snag that is the result of what I argue are relatively non-controversial positions.

1. We assume that there exists a unitary variable that summarises the business cycle — which might not be directly measurable. It might be something like the first principal component of a few underlying variables. The usual measured variable that is supposed to be a proxy of this variable is GDP, but one may note that the NBER looks at a variety of variables to date recessions. The justification for the existence of this variable is that recessions are a somewhat nonsensical concept without the notion of some way of summarising the state of the business cycle which goes up and down. (If one wants to insist that no such unitary variable exists, we end up with business cycle nihilism. This might be the correct stance, but makes it very awkward to discuss macro.)

2. Inflation is a pro-cyclical variable, possibly with a lag. This can be justified by eyeballing inflation/GDP charts. There are any number of theoretical stories justifying why this is the case.

3. Employment growth is pro-cyclical, almost by definition. Rising unemployment is one of the defining characteristics of a recession.

4. (Core/median) inflation and employment growth empirically exhibit “trends” — although monthly data might be noisy, the averages across months tend to be smoother after seasonal adjustment (albeit with step changes during things like recession).

5. As an added bonus, we can note that private sector credit is pro-cyclical. This can be seen by eyeballing charts, and is likely to be a component of any model that takes the Kalecki Profit Equation seriously. (Neoclassical models notably do not.) Bank lending and hence deposits are a component of private credit, and thus the bank deposit component of M1 is going to be pro-cyclical.

You do not need a doctorate in statistics or need to study Real Analysis to know that 1-4 taken together imply that inflation and employment growth are going to be correlated to some possibly unknown “business cycle” variable. It is going to be nearly impossible to detect a causal relationship between the variables unless the relationship is simple and stable over time. Guess what? We cannot find any such relationship.

(The fifth point in the list is aimed at any Monetarists who for some bizarre reason decided to read this article.)

Inflation is complicated, and there is no reason to expect that rents are going to move in the same way as college tuition, used automobiles, or imported jeans. To any extent we can model inflation, we need to decompose the aggregate (which was allegedly proved to be the wrong way to look at inflation, according some neoclassical economists).

The whole “unemployment needs to rise to reduce inflation” was a terrible take since it was a somewhat innumerate understanding of a “stylised fact” about recessions. Recessions tend to be associated with disinflation (rate of inflation dropping). As such, one strategy to control inflation is to throw the economy into recession whenever inflation is “too high.” (I am not saying that is a good strategy, but reading between the lines, that is the neoliberal strategy.) However, the causal implication is one way — a recession is (typically) sufficient for disinflation, but it is not necessary (as seen in the disinflation after the pandemic spike).

Book Progress? Sigh.

I am still plugging away at editing my inflation manuscript (interrupted by the CFL Labour Day Classic). Most of the work is tweaking existing text, and thus not publishable here. However, I added a missing section that should show up within a week or so.

If I were productive, I might be able to finish it off within a month or two. Based on past experience, a publishing date in January is more realistic.

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(c) Brian Romanchuk 2023

Jackson Hole Drive-By Comments

I did a short trip to Lake Placid New York last weekend, and largely missed out on the Jackson Hole central banker discussion. Although some specific speeches have been important for macro debates in the past, I generally view the conference importance as over-rated. Although having an idea what the consensus is discussing is useful, the forward-looking information is limited.

Stop Trying To Make BRICS Happen

BRICS was a brilliant bit of sell side marketing, but it has taken a life of its own. One needs to stop projecting fantasies onto the global financial system, and accept that its form follows function.

The extreme dominance of the share of global GDP after World War II by the United States was a historical accident, and so the relative rise of other economic powers was inevitable. Meanwhile, the eagerness of the United States to use sanctions as a foreign policy tool is going to create incentives to develop mechanisms to do an end run around those sanctions. Nevertheless, the geopolitical system is far more stable than is commonly described. (I will enter a geopolitical tangent later in this article to justify that claim.)