Fed releases Q3 financial accounts

Today the Fed posted the third quarter Financial Accounts, which includes flow of funds, balance sheet, & integrated macroeconomic account data.

They highlight the following developments in the third quarter:

• Household net worth increased by $3.8 trillion due to increasing stock & home prices and a high saving rate.
• Household debt grew at a 5.6% annualized rate, driven by mortgage debt increases and more subdued growth in nonmortgage consumer credit.
• Nonfinancial business debt contracted at a 0.9% annualized rate after two quarters of rapid growth, reflecting a decline in outstanding nonmortgage depository loans (loans from banks, credit unions, and S&Ls).

Furman & Summers reconsider fiscal policy; Galbraith responds

Jason Furman and Larry Summers recently wrote a paper noting the downward trend in interest rates and arguing for expanded fiscal policy.

"This paper argues that while the future is unknowable and the precise reasons for the decline in real interest rates are not entirely clear, declining real rates reflect structural changes in the economy that require changes in thinking about fiscal policy and macroeconomic policy more generally that are as profound as those that occurred in the wake of the inflation of the 1970s."

They identify three implications for fiscal policy that follow from low interest rates

1. Fiscal policy must play a crucial role in stabilization policy in  a world where monetary policy can counteract financial instability but otherwise is largely "pushing on a string" when it comes to accelerating economic growth.
2. In a world of unused capacity and very low interest rates and costs of capital, concerns about crowding out of desirable private investment have less force. Debt-to-GDP ratios are a misleading metric of fiscal sustainability that don't reflect how the present value of GDP has risen and debt service costs have fallen as interest rates have fallen.
3. Borrowing to finance appropriate categories of expenditure pays for itself.

Jamie Galbraith agrees with the conclusion but calls the underlying economics a mess.

"Their effect, and one may reasonably surmise their purpose, is to make the argument without appearing to question the longstanding "mainstream" theory of interest rates. That [loanable funds] theory, which has been the source of deficit- and debt-hysteria for several centuries, in turn underpins the newly-proposed FS debt-service-to-GDP ratio criterion for fiscal policy. It will be nothing but a source of trouble, unless disposed of...

"[To explain the decrease in rates] Their theory therefore requires one of two things, perhaps in combination: a vast offsetting, autonomous increase in the supply of savings (global or national), and/or a reduction in the private demand for savings, in the form of privately-issued debt ... There are two problems with the argument. The first is that there is no long-term trend in US private savings, nor in the import of savings from overseas - which would show up as an increasing US current account deficit relative to GDP - nor in the ratio of private debt to GDP... 

"The second problem is more theoretical. One way to put it, is to say that "loanable funds" is a theory of the sport market ... the question of maturities is secondary ... so the loanable funds theory has no explanation for the difference between short and long-term interest rates - for the yield curve. But this is precisely what FS are trying to explain...

"FS therefore arrive at a correct conclusion - interest rates will remain low indefinitely - by a route that requires them to argue that the world has changed in some fundamental, relevant ("structural") way, for which no evidence exists."

Rajan and Romanchuk

In How Much Debt is Too Much, Raghuram Rajan writes that

"The new conventional wisdom in these unconventional times is that advanced-economy governments can take advantage of today's ultra-low interest rates to borrow and spend without limit in order to support the economy. But the fact is that there is always a limit, and it may come into view sooner than many realize."

Brian Romanchuk responds, pointing out that Rajan Accuses MMT of Making Errors Made By Mainstream.

"As quite often happens when mainstream commentators critique MMT, no attempt was made to cite or quote MMT sources. In this case, that would have been useful -- since he accuses MMTers of making basic analytical errors. Unfortunately for his case, those errors are actually made by mainstream economists, and MMTers take the other side of debates."

That's debatable: Stop worrying about national deficits

Bloomberg hosted a debate on the national debt asking whether we should stop worrying about national deficits. Stephanie Kelton and Jamie Galbraith argued for the motion, facing off against Otmar Issing and Todd Buchholz arguing against.

Learn to stop worrying and love debt

Paul Krugman explains why "to act responsibly, we must stop worrying and learn to love debt."

"it’s a completely safe prediction that once Joe Biden is sworn in, we will once again hear lots of righteous Republican ranting about the evils of borrowing. What’s less clear is whether we’ll see a repeat of what happened during the Obama years, when many centrists — and much of the news media — both took obvious fiscal phonies seriously and joined in the chorus of fearmongering. 

"Let’s hope not. For the fact is that we’ve learned a lot about the economics of government debt over the past few years — enough so that Olivier Blanchard, the eminent former chief economist of the International Monetary Fund, is talking about a “shift in fiscal paradigm.” And the new paradigm suggests both that public debt isn’t a major problem and that government borrowing for the right purposes is actually the responsible thing to do.

"Why are economists thinking differently about debt? Part of the answer is that we’ve discovered some things about how the world works; the rest of the answer is that the world has changed."

Creditors owed $200 trillion

S&P expects global debt to hit $200 trillion, or 265% of global output, by the end of 2020. They don't see too much cause for concern since interest rates remain low and there is optimism about vaccine distribution.

The report is a reminder of the question: who do we owe?

Global imbalances in risk-free debt

Copy / Paste from John Authers' newsletter. Chart 3 comparing risk-free debt issuance by the US and the rest of the world is especially interesting.

In the years leading up to the 2008 crisis, one phrase recurred again and again as a source of concern: global imbalances. It was shorthand for the way the U.S. was borrowing huge sums of money, particularly from Japan and China, which needed somewhere to stash the cash they had made from highly successful exports. One of the most popular explanations for the global crisis at the time was that a “savings glut” had kept U.S. interest rates unnecessarily low and allowed credit to balloon.

Such worries appear to have come to an end. The U.S. problem is no longer an unhealthy addiction to credit from the central banks of Asia; rather, post-Covid, its problem is now an addiction to credit from its own central bank. As shown by this chart from Bloomberg Opinion colleague Jim Bianco, the Fed’s holdings of Treasury bonds now exceed those of foreign official accounts (central banks and governments) combined:

While the total amount of foreign lending to the U.S. remains higher than before the crisis, it reached a peak early in the last decade and is now declining, largely thanks to a drop in official holdings. As this chart from London’s CrossBorder Capital shows, the interest of the foreign private sector in Treasury bonds remains far higher than it was a decade ago:

But if we have seen an end to an imbalance in demand for U.S. Treasuries, deemed the world’s most unimpeachable “risk-free” asset, there is now a massive imbalance in the global supply of such safe investments. In the decade before the crisis, issuance outside the U.S. exceeded the supply from America. In the decade since, there has been far less choice, largely owing to a cratering in sales by Japan and Germany. Peripheral European debt, or debt issued by U.S. mortgage agencies, no longer seems so “risk-free.” In the last year, there has been far more issuance of risk-free assets in the U.S.:

The implication is that as other countries resume selling such debt, the flows that have been supporting the U.S. this year will diminish. In other words, this should be dollar-bearish. The general decline of risk-aversion has already seen the U.S. currency drop sharply from its March highs. The conventional wisdom is for dollar weakness to continue (which would make life easier for many people around the world):

Why China's economy (probably) won't double by 2035

Michael Pettis explains why Xi's aim to double China's economy is a fantasy unless Beijing boosts consumption by raising the household share of income from 50 to 70 percent -- a move that local governments and elites have resisted. 

"Every country that followed the high-savings, investment-led growth model that China adopted in the early 1990s -- such as Japan in the 1970s and 1980s, or Brazil in the decade before -- has gone through three distinct stages. The first stage, characterized by heavy investment in badly-needed infrastructure, delivered many years of rapid but unbalanced growth. In that stage, debt grew in line with the economy because when debt mostly funds productive investment, gross domestic product grows faster than debt. 

"In the second stage, as each country sought to rebalance demand away from investment, typically with little success, growth remained fairly high, although now driven increasingly by non-productive investment. When this happens, total debt in the economy must grow faster than GDP. So the debt burden rose. 

"Finally in the third stage, the country either reached its debt capacity limits or a worried government took steps to prevent debt from rising further. Either way, the economy was forced finally to rebalance away from investment and towards consumption amid far slower, sometimes even negative, growth. 

"China today is clearly in the second stage."

Should we worry about the debt?

Jason Furman makes the case for why now is not the time to worry about public debt (similar to his presentation from last month). The points aren't necessarily novel, but he is making a strong push for incorporating a bit of empiricism in the way academic economists think about the debt. In short, he says be wary of economists speaking of crowd out and intergenerational fairness when evidence points to the effects of public spending operating in the opposite direction today. 

Household debt back on the rise after second quarter dip

New household debt and credit data release from the New York Fed. Mortgages are by far the biggest debt category with over $10 trillion outstanding, followed by college, cars, and cards, at $1.6 trillion, $1.4 trillion, and $800 billion.

"According to the latest Quarterly Report on Household Debt and Credit, total household debt increased by $87 billion (0.6 percent) in the third quarter of 2020, more than offsetting the decline seen in the previous quarter. The data likely reflect improvements in economic activity and the labor market, as well as the positive impacts of relief measures provided through CARES Act provisions or offered voluntarily by lenders. Mortgage originations, including refinances, continued on their upward trend as homeowners continue to take advantage of the low interest rate environment."

Why were interest rates ever positive?

We've been trained to believe that negative interest rates are weird. In On Negative Rates, J.W. Mason explains why positive interest rates for government bonds might be the stranger phenomenon. He makes the case for why we shouldn't think about finance as time travel, at least when thinking about interest rates for government bonds. A couple notes from the post..

One reason we expect bonds to have positive yields is the economic models we're taught:

"In a world with with a fixed or exogenous money stock, or where regulations and monetary policy create the simulacrum of one, there is a cost to the bank of holding government debt, namely the income from whatever other asset it might have held instead. Many people still have this kind of mental model in thinking about government debt. (It’s implicit in any analysis of interest rates in terms of saving.)"

But that model is not applicable to the modern economy:

"... in a world of endogenous credit money, holding more government debt doesn’t reduce a bank’s ability to acquire other assets. Banks’ ability to expand their balance sheets isn’t unlimited, but what limits it is concerns about risk or liquidity, or regulatory constraints. All of these may be relaxed by government debt holdings, so holding more government bonds may increase the amount of other assets banks can hold, not reduce it. In this case the opportunity cost would be negative."

So why haven't interest rates been negative before?

• During the gold standard era, gold, not government debt, was the top of the money hierarchy
• Central banks' use of interest rates for demand control have ensured a positive yield on public as well as private debt
• Safety, liquidity, and regulatory benefits of government debt holdings weren't as large before the 2008 financial crisis.

Corporate default severity rises

Congressional and Federal Reserve actions have minimized default frequency so far during the covid crisis, but the severity of losses conditional on default has risen.

In Bond Defaults Deliver 99% Losses in New Era of U.S. Bankruptcies, Bloomberg's Jeremy Hill and Max Reyes write that

"Bankruptcy filings are surging due to the economic fallout of Covid-19, and many lenders are coming to the realization that their claims are almost worthless. Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies -- if that.

"While few could have foreseen the pandemic's toll on the economy, the depth of investors' pain from corporate distress was all too predictable. Desperate to generate higher returns during a decade of rock-bottom interest rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earnings projections. Corporations, for their part, took full advantage and gorged on astronomical amounts of debt that many now cannot repay or refinance."

Debt issued by retailers like Men's Wearhouse, J.C. Penney, and Neiman Marcus is trading for pennies or fractions of pennies on the dollar. The chart below shows that expectations of recoveries from bond defaults are at record lows. Credit default swaps pay 100 cents on the dollar minus the auction value of the cheapest-to-deliver security.

Loan investors also expect low recoveries -- 40 to 45 cents on the dollar compared to historical averages of 30 to 35 cents. This is happening because of a similar trend towards loans with fewer safeguards, aka covenant-lite loans.

Fewer corporate defaults than expected

In Corporate Defaults Slow, Lifting Debt Market, WSJ's Sam Goldfarb reports that "At the end of September, the trailing 12-month default rate for U.S. corporate issuers of speculative-grade bonds and loans was 8.5% ... below the 11.2% rate that Moody's had forecast in early April and a decline from the previous month's rate of 8.7%."

Congress and the Fed have minimized defaults so far by sending cash to households and making it easier for businesses to borrow.  More than $360 billion of speculative-grade bonds have been issued since the start of 2020, surpassing all previous full-year totals.

But leverage ratios are elevated- "the average high-yield bond issuer now has debt equal to 6.1 times its earnings before interest, taxes, depreciation and amortization, or Ebitda, the highest level on record." So it seems likely that either the peak of defaults has been delayed by more leveraging, or the decline in default rates won't happen as quickly as it has in previous recessions.

Lagarde: Let's discuss permanent EU debt

On Monday Politico's Paola Tamma reported that ECB President Christine Lagarde discussed the possibility of making EU debt permanent, signaling a reversal of her previous stance that the coronavirus borrowing is "a one-off response to exceptional circumstances."

Speaking of the €750 billion debt-fueled response to the coronavirus crisis, which the European Commission is going to borrow on financial markets and disburse as grants and loans to EU countries, Lagarde said "this stimulus tool responds to an exceptional situation. We should discuss the possibility of it remaining in the European toolbox, so that it can be mobilized again in equivalent circumstances."

Intellectual groundwork for a debt bubble

In The debt bubble legacy of economists Modigliani and Miller, FT's Robin Wigglesworth explains how Franco Modigliani and Merton Miller's academic work led to a four-decade decrease in corporate creditworthiness.

"Their initial findings [that whether companies funded themselves with debt or equity was irrelevant] only held in a world without "frictions" -- such as taxes, imperfect information and inefficient markets. But a later revisitation that incorporated the tax-deductibility enjoyed by interest payments showed that the value of an indebted company is actually higher than that of an unleveraged one. It eventually helped lay the intellectual groundwork for a dramatic erosion of corporate creditworthiness."

By focusing on efficiency in a theoretical economy rather than resilience in a real one, Modigliani and Miller (as well as later economists who argued that debt could ensure corporate discipline and therefore increase economic dynamism) laid the intellectual groundwork for companies to leverage up and increase returns to shareholders at greater risk to the economy as a whole.

It's reflected in corporate credit ratings. In 1980, Standard & Poor's gave 65 companies (6 percent) a AAA rating, with the majority of companies in the A range. Today five companies out of 5,000 have a AAA rating, and only 14 percent are in the A range. 

US fixed income market statistics

Last week SIFMA released its Research Quarterly: Fixed Income - Issuance and Trading, which provides data on US fixed income markets.

The statistics (split by issuance and outstanding) cover US Treasuries, mortgage-backed securities, corporate bonds, municipal bonds, agency-backed securities, asset-backed securities, money markets, repurchase agreements and the secured overnight financing rate.

A couple charts from the report are below. US fixed income markets comprise 40% ($42 trillion) of the $106 trillion of fixed income securities outstanding globally, and US Treasuries make up 31% of US fixed income issuance but 63% of trading. Total third quarter issuance of $3.2 trillion is up 37.5% from a year earlier, and year-to-date issuance is up over 10%.

Bank earnings: traders do well with high volatility, retail bankers struggle with low rates

The big US banks reported earnings this week. The performance of JPMorgan, Citigroup, Goldman Sachs, Bank of America, Wells Fargo, and Morgan Stanley was driven mostly by whether they focus on trading or retail clients.

Banks with a trading focus - Morgan Stanley and Goldman Sachs - did well as clients bought and sold stocks in response to the pandemic and companies went public or raised fresh capital.

Banks with a retail focus - Citigroup and Bank of America - struggled due to historically low interest rates and low consumer spending.

Links to Reuters summaries:

• JPMorgan executives offer slightly brighter view on pandemic recession
• $19.4 billion in credit loss provisions so far this year -- 4x higher than last year. Added $611 million to loan loss reserves in Q3. CEO Dimon said "There's so much uncertainty. If better outcomes happen, we are over-reserved by $10 billion. If the double-dip happens, we would be under-reserved by $20 billion.
• "Low interest rates hurt JPMorgan's results in a predictable way", but they are ready to restart buybacks when regulators allow.
• Citigroup profit tumbles on low interest rates, loan demand
• Quarterly profit dropped by a third due to "record low interest rates and a slowdown in loan demand due to the pandemic-induced recession."
• Goldman's trading business returns to former glory during pandemic strength
• "Simply stunning results".. Goldman's "loan portfolio is small and of very high quality compared to those of other large bank holding companies. It has minimal exposure to credit cards and small business, which we see as the biggest COVID-19 risks. But it has upside leverage to more active capital markets."
• $2.8 billion in credit loss provisions so far this year. Added $278 million to loan loss reserves in Q3.
• Bank of America profit falls on pandemic woes
• Wells Fargo profit falls as pandemic hits growth
• Morgan Stanley profit crushes estimates on trading strength

IMF makes the case for public investment in uncertain times

The IMF published a Fiscal Monitor chapter today on "Fiscal Policies to Address the COVID-19 Pandemic". FT's Chris Giles reports that the fund has formalized its reversal on austerity.

"Most advanced economies that can borrow freely will not need to plan for austerity to restore the health of their public finances after the coronavirus pandemic, the IMF has said in a reversal of its advice a decade ago."

Global public debt is likely to hit a record high of 100 percent of GDP in 2020. But government borrowing costs are expected to stay below the economic growth rate, enabling cheap borrowing to offset the weak growth and low tax revenues that the IMF predicts will result from the coronavirus pandemic.

Vitor Gaspar, IMF's Director of Fiscal Affairs, writes

"The overall size and speed of fiscal action [in response to COVID-19] was unprecedented at about $12 trillion globally, contributing to extending critical lifelines to households and firms.

"More than six months into the pandemic, the Fiscal Monitor emphasizes the importance of not pulling the plug of fiscal support too soon, in spite of the high levels of debt prevailing worldwide...

...

"The Fiscal Monitor makes the case for public investment. The relevant macroeconomic context includes very low interest rates, high precautionary savings, weak private investment, and a gradual erosion of the public capital stock over time. But the novel argument in the Fiscal Monitor relates to uncertainty. Investment multipliers are particularly high when macroeconomic uncertainty is elevated--and uncertainty in the current World Economic Outlook is "unusually large." Under such conditions, public investment acts as a catalyst for private investment to take off."

G20 to extend debt freeze for poorest nations, still wrangling over next steps

Reuters reports that the G20 economies are "poised to extend a multi-billion-dollar debt freeze for the world's poorest countries to help them weather the coronavirus crisis, and may adopt a common approach to dealing with longer-term debt restructurings." They are expected to finalize wording today, after "intense" discussions.

"China, Turkey and India had balked at language that would lock them into future debt writeoffs.

"Beijing, the largest new creditor for emerging market economies, objected to adoption of a common framework for dealing with debt concerns beyond the G20 debt moratorium ... "The fight is far from over," the source added."

... 

"The absence of private creditors also remains a problem, as does the failure of China to fully participate with all its state-owned institutions."

To repeat the summary from The Guardian,

"Debt relief is no longer simply a question of getting a bunch of rich western governments to agree to a deal: it now requires the involvement of private sector creditors, such as BlackRock, and Beijing."

Saving gluts and low interest rates

The US is nearly nine months into a pandemic that has resulted in 215,000 deaths and 11 million fewer Americans employed (159 million in February vs. 148 million in September). There is no clear end in sight. At the same time, stock markets, bond markets, and house prices are at or near record highs. What is going on?

Two recent papers by Atif Mian, Ludwig Straub, and Amir Sufi might have part of the answer: The Saving Glut of the Rich and Indebted Demand. Basically, some people have a lot of money, and what better thing to buy than a $1.8 million average-price home in Miami Beach or more stocks. The papers are interesting because they link wealth distribution, low interest rates, and future economic growth.

Since the 1980s, debt levels have increased and interest rates have decreased. Mian, Straub, and Sufi explain this by showing that the bottom 90% of the income distribution has taken on more and more debt while the top 10% - and especially the top 1% - has taken on more and more claims on that debt. This matters because the top 1% saves more than half its income, while the bottom four quintiles save between 1% and 17%. As a result, higher inequality tends to lead to lower demand for goods and services in the economy, which results in lower prospective returns on investment, lower interest rates, and lower growth.

In their indebted demand model, Mian, Straub, and Sufi explain how these divergent saving rates result in lower growth and interest rates when inequality increases:

"Empirical evidence suggests that an important channel of accomodative monetary policy operates through an increase in debt accumulation. This channel is also active in our model, boosting demand in the short run. However, this boost reverses as monetary stimulus fades and debt needs to be serviced, beginning to drag on demand. Due to the presence of indebted demand, this drag can cause a persistent shift in natural interest rates after temporary monetary policy interventions. It is for this reason that monetary policy has limited ammunition in the model: successive monetary policy interventions build up debt levels, thereby lowering natural rates. This forces policy rates to keep falling with them to avoid a recession, thus approaching the effective lower bound.

"When savers command sufficient resources in our economy, for instance due to high income inequality and large debt levels, the natural rate in our economy can be persistently below its effective lower bound. At that point, our economy is in a debt-driven liquidity trap, or debt trap, which is a well-defined stable steady state of our economy."

New record lows for Italian and Greek debt

Reuters reports that "Long-dated sovereign bond yields in Italy and Greece touched fresh record lows on Tuesday." Italian 3-year bond yields are -0.14%, and 10-year yields are below 0.66%. German and French 10-year yields are -0.55% and -0.29% -- their lowest levels since March.

The European Central Bank's Pandemic Emergency Purchase Programme, as well as expectations for more ECB stimulus, have bolstered debt markets. Yesterday, ECB Vice President Luis de Guindos said that the eurozone economy is losing momentum and the ECB will react accordingly.

Election implications for bond yields

In Investors Prepare for Higher Treasury Yields as Election Looms, WSJ's Sam Goldfarb writes that yields have risen in response to polls showing a growing lead for Joe Biden and improving chances that Democrats do well in the Congressional races.

"For debt investors, the key isn't necessarily whether Mr. Biden or Mr. Trump wins. It is whether one party or another has unified control of government, making it easier to expand the federal budget deficit through tax cuts or spending programs.

"Bigger deficits can push yields higher for two reasons: first, by increasing the supply of outstanding bonds as the government ramps up borrowing and, second, by potentially boosting economic growth and inflation, which makes bonds less attractive."

The Treasury Department initially funded most of the coronavirus stimulus with short-term Treasury bills with maturities of one year or less. Since August, it has ramped up issuance of longer-term debt, widening the gap between short- and long-term yields. But many factors, including a contested or uncertain election and Federal Reserve actions, could keep interest rates low across the yield curve.

"A sustained move higher in Treasury yields could be difficult to achieve. Not only is the economy suffering due to the pandemic, but its average growth rate outside of recessions has declined in recent decades. At the same time, inflation has remained stuck below the Federal Reserve's 2% annual target. As a result, investors widely expect the central bank to hold short-term interest rates near zero for years and to keep buying Treasurys--both policies that should constrain longer-term yields."

Why the US risks becoming Greece

New Bloomberg Odd Lots episode with economist and debt historian Michael Hudson. He describes how the US might go down the same route as Greece but for different reasons. Here's Joe's summary:

Hudson "makes the case that ballooning private debt burdens over time have the effect of diminishing demand, consumption, and ultimately investment, essentially creating a de facto austerity. Instead of a government being forced into a policy of austerity in order to keep paying bond investors, it's about individuals, households, small businesses, and regional public entities (like, say, the NYC subway) being forced into degradation due to its debt load. In other words, austerity as an emergent phenomenon, as opposed to a discrete policy choice.

"Of course, policy is still important. And a big part of Hudson's work has been the study of debt jubilees or forgiveness, which is an idea that gets batted around from time to time, often in the context of student loans. As he explained, the ancient king Hammurabi engaged in such jubilees, though they weren't universal. They specifically applied only to debts owed to the state after mass crises. So in other words, there's a long history of private sector obligations being taken onto the government's balance sheet in order to wipe the slate clean, and get the economy restarted after a disaster. Another way of saying it is that the best way for the U.S. to avoid become "Greece" is for Washington to spend even more to make whole the private and sub-national entities whose finances have been clobbered by the COVID-19 disaster."

Republicans are about to rediscover fiscal religion

In Republicans are about to rediscover fiscal religion, FT's Ed Luce summarizes how the GOP's fiscal conservatism depends largely on which party is in power. He predicts that if Joe Biden is America's next president, we will soon start hearing much more about America's dangerously growing debt.

"Republican fiscal conservatism is a curious type of passion, which blows hot or cold depending on which party controls the purse strings. The US national debt exploded during the Reagan years because of tax cuts and high defence spending. It went down considerably (as a share of GDP) during the 1990s when Bill Clinton had to deal with a mostly Republican Congress that had rediscovered its fiscal zeal. They quickly lost their ardour when George W Bush came to office, regaining it only under Obama, once more dropping it under Trump and now waking up again to America's impending bankruptcy in the expectation of a Joe Biden victory. In other words, you can set your clock by it. But this clock has nothing to do with the national debt and everything to do with who benefits from the rising debt."

Rana Forohoohar agrees with Ed's prediction and responds

"It irks me to no end that Republicans will try to make fiscal prudence their issue, because they are so much better at cutting taxes than shrinking the budget. But the truth is that we should all be concerned about debt because our creditors are; many of them (most notably China) have been shifting into gold and euro because they believe that unproductive debt will ultimately erode the value of the dollar."

What we owe to ourselves

The SEC's Division of Economic and Risk Analysis published a staff report, U.S. Credit Markets: Interconnectedness and the Effects of the COVID-19 Economic Shock.

The report provides details on the issuers and holders of credit, as well as the intermediaries who facilitate credit transmission. Its goal is to assist policymakers in their efforts to understand and improve market functioning and resilience.

By the end of 2019, aggregate US credit outstanding was $54 trillion. Here's the high-level credit risk map and a couple observations they include with it:

"First, the federal government ($16.6 trillion), households ($10.6 trillion of mortgages and $4.2 trillion of other consumer debt), and corporations ($13.7 trillion in bonds and loans) are the primary issuers of credit...

"Second, the largest ultimate holders of credit are households with about $14 trillion of credit risk exposure ($4.4 trillion directly and $9.2 trillion indirectly through nonbank financial intermediaries, e.g., mutual funds). Another important channel of households' exposure to credit risk is banks that own $13.2 trillion of credit risk... Other major holders of credit in the capital market are foreign buyers who hold more than $10.9 trillion, insurance companies that hold about $5.6 trillion, and pension funds with more than $4.8 trillion...

"Third, nonbank intermediaries ... account for approximately $23 trillion of credit that flows from issuers to holders of credit. Federal agencies and GSEs intermediate $9.4 trillion, MMFs intermediate $3.6 trillion, and RICs [registered investment companies] and REITs another $6.4 trillion."

Bipartisan consensus on deficits

In How America Learned To Stop Worrying And Love The Deficit, Zach Carter describes a shift that has happened in American politics and economics in the last few years. He uses a recent CNBC interview with Minneapolis Fed President Neel Kashkari as the main example. A conservative former Goldman Sachs banker, Kashkari has become "an outspoken advocate of aggressive deficit spending." Responding to a question about whether we should just let capitalism sort things out rather than spend money on stimulus, Kashkari replied

"It's an interesting theoretical concept. It's like letting the forest fire just rage. Let it burn and eventually it will burn itself out and meanwhile, all the animals are dead."

Kashkari is not alone in preferring to avoid placing too much emphasis on a theoretically self-correcting market. Carter notes that

"Kashkari is just as conservative on economic policy as he's ever been. But what it means to be a conservative intellectual is changing. When he calls for aggressive federal economic management, Kashkari is not so much giving ground to the left as giving voice to an emerging bipartisan consensus from the respectable, cuff-linked political center. Under this view, people in a democracy may disagree on just how debt and deficits should accrue, but deficits themselves are a normal feature of a functioning polity, not a dire threat to economic health."

For three decades, deficit hawks made a good business in DC issuing warnings about the dangers of government debt. They consistently sounded alarms that high debt levels would force interest rates up to punishing levels, spark inflation, ignite a financial crisis, and constrain government's ability to act. None of that came to pass, and economists who became famous for warning against debt are now urging Congress to spend more.

John Kenneth Galbraith once wrote

"Ideas are inherently conservative. They yield not to the attack of other ideas but ... to the massive onslaught of circumstance with which they cannot contend."

Economists have responded to circumstances over the past few years by updating their views on debt and the things governments can do with deficit spending. Better a few decades late than never. As Carter describes it, all that remains is for Congress to catch up.

The challenge of finding r-star

IMF economist Peter Williams joined Joe and Tracy on the Odd Lots podcast to discuss the neutral rate of interest, R*. This is the theoretical rate of interest where the economy is in balance with full employment and stable prices. The concept has been central to discussions about monetary (and, increasingly, fiscal) policy in recent years, but discovering the level is challenging/impossible, and the premise itself has been called into question.

The neutral rate can't be directly observed, so estimating it relies on a lot of assumptions. But if we accept the premise, there is agreement that the neutral rate has decreased significantly. A recent Fed paper estimated that the neutral rate of interest is around negative 2 percent, which effectively means that monetary policy setting nominal rates above 0 percent would be restrictive. And if the Fed were to follow its traditional recession playbook and cut nominal rates to ~4 percentage points below the neutral rate, it would have to lower the fed funds rate to negative 4 percent.

Discussions about the neutral rate are interesting because they're central to how central bankers try to manage the economy, but also because they're a useful component for understanding the overlap between fiscal and monetary policy. Part of the reason Powell and virtually every Fed official are begging Congress to spend more is because they realize cutting rates below zero is risky, and the consensus is that when the natural rate is negative, government spending is the best way to direct money to the right channels (e.g., households that need money and will spend it) and has the helpful side effect of increasing the natural rate of interest (e.g., public spending creates more consumer demand, which leads to greater prospective returns on investment, which increases business confidence and investment, raising r star).

Williams provides a good summary of the way the IMF and other authorities use this concept, as well as providing a defense of the establishment view. Here's a question from Joe about the ideology embedded within the equations economists use and the resulting implicit bias.

Q: "What do you make of the critique that there is an anti-government spending, anti-labor ideology embedded in this, which then translates into actual policies of raising the interest rate too soon even though we're not at full employment, or raising the interest rate in response to stimulus, to blunt the effects of fiscal policy. Basically, [what do you make of the critique that] what appears to be science and math is really politics?"

A: "I'm a little skeptical that economists have this deep-seated conservative bias and view of the world... A lot of heterodox people think about the classic theories of econ from the 60s and 70s, with perfect markets and everything's in equilibrium all the time... But when you look around at cutting-edge econ in any field ... it doesn't really make those sorts of assumptions anymore ... If there is a deep-seated intellectual bias inside of us, my coauthors and I weren't particularly aware of it."

On the other hand, the workhorse models that are still used by government agencies, central banks, and think tanks still generally come with assumptions -- such as zero unemployment, perfectly competitive markets, perfect foresight, perfect rationality, perfect cooperation, taxes are distortionary and create deadweight loss, public investment is wasteful, transfer programs transfer no benefits, capital markets are perfect -- that result in a pretty strong bias against public programs. Ad hoc additions have been made, but the "familiar refrain of neoclassical economics about tax distortions, crowding out, and regulatory rigidities" remains embedded in most economic models used to evaluate policy.

Political disagreement over municipal loan program

NYT's Alan Rappeport and Jeanna Smialek summarize political disagreements surrounding federal stimulus aid in Clash Over Municipal Loan Program Delays Stimulus Report.

The Municipal Liquidity Facility, operated by the Fed and supported by the Treasury, is an area of significant disagreement. Democrats argue for more federal aid to states and municipalities, Republicans against. So far, only Illinois and the Metropolitan Transportation Authority have used the MLF, borrowing a total of $1.65 billion compared to a Facility size of $500 billion.

"Democrats and some economists have argued that the Fed and Treasury should be more generous, offering lower rates and longer payback terms.

"The Fed, for its part, has pointed out that the mere existence of the program has helped calm the market for municipal debt, so that states and localities have been able to sell bonds at extremely low interest rates.

A more fundamental issue is that state and municipal governments are facing sharp drops in revenues and are legally prohibited from running budget deficits. In addition to pushing for the Fed to offer loans with lower interest rates and longer repayment periods

"Another proposal would grant state and local governments more flexibility so that the money could be used for capital infrastructure projects, not just for certain cash flow purchases."

Treasuries on steroids

Reuters' Kate Duguid and Lawrence White reported that banks are on track for a record year of revenue from trading agency mortgage-backed securities. Since a peak in the risk premium between agency MBS and Treasuries in March 2020, the Fed has bought more than $600 billion of agency MBS, narrowing spreads by 0.50%.

Agency-backed securities are backed by the US government, so they don't face default risk, but pre-payments can keep their price down. Whereas a decrease in yields automatically increases the price of an outstanding Treasury bond, it can induce more mortgage borrowers to refinance loans, which shortens the duration of the agency MBS and reduces the number of installments paid.

"But banks are likely to keep buying. Though they may be overtaken by the Fed this year, commercial banks are still currently the largest holders of agency MBS. Flooded with deposits during the coronavirus crisis, big banks have put that money to work in agency MBS, among other securities, bringing their holdings to $2.3 trillion according to Fed data."

...

"There is just insatiable demand for agency mortgages by all the depository institutions. And deposits are up. Savings rates are up. Everyone is kind of hoarding cash." 

Keep the receipts, but spend

In an interview with the FT's Brendan Greeley, IMF Managing Director Kristalina Georgieva explains that "The fund needs to have a big bazooka" of $1 trillion to support lending to developing countries. The change in economic orthodoxy on this point in the past two years has been significant.

"Traditionally, and particularly within the IMF, economists have argued in favour of the scarcity of austerity -- a conscious decision to cut deficits. First, the argument went, wages and prices would adjust down. Then, without any more looming debt crises, citizens and investors would have more confidence in that country and place their bets, buying things and paying for more buildings and machines to make the economy productive again."

Despite its consistency with classical economic theory, the argument has become viewed as flawed because most people don't think about what government deficits might be in future decades when deciding whether to run out to IKEA and buy a couch. Today, Georgieva agrees that

"the adjustments people have to make during periods of austerity don't fix the problem; they are the problem. Austerity and autocracy offer comparable challenges. In both cases, it's not that people buy less. It's that for reasons outside their control, they can't be productive."

In short, the IMF has shifted from promoting spending cuts to "Spend. Keep the receipts. But spend."

Central banker argues for central bank power

BIS General Manager Agustin Carstens gave a speech yesterday Maintaining sound money amid and after the pandemic.

He first summarizes the challenge of "fighting persistently low inflation and economic stagnation in a low interest rate environment." The second half of Carstens' speech received more attention. He highlights "the significant strengthening of the nexus between fiscal and monetary policy" and asks "How can the spectre of fiscal dominance be kept at bay?"

"Central banks have launched renewed large-scale purchases of government debt as part of their crisis response, motivated by the stabilisation objectives within their mandates... At the same time, there is an ongoing debate about the need for greater coordination of fiscal and monetary policy in an environment of reduced policy space due to persistently low interest rates, with some pundits arguing in favour of overt monetary financing. This raises the general question of how central banks can best contribute to economic growth and stability, in the current situation and in general. Is it by directly financing the government?

"I will argue that the best contribution monetary policy can make is always to maintain sound money, to focus squarely on preserving price and financial stability. Support for the government is justifiable in the pursuit of these goals. Otherwise, the risk arises of real or perceived fiscal dominance undermining central bank credibility as the foundation of sound money... the natural boundaries between fiscal and monetary policy need to be respected."

The speech was generally viewed as being more political than economic -- a defense of monetary authorities who simply don't want to lose power relative to fiscal authorities. Economist J. W. Mason summed up the general response: "it would be an interesting exercise, and shed a lot of light on where orthodox thinking is these days, to work out exactly what are the causal links in the implicit model underlying his speech."

The debate about fiscal-monetary overlap will continue for a while because of that strengthening "nexus". The chart below shows the extent of central bank government bond purchases relative to total increases in public debt across countries.

Fed's Rosengren on low rates and fiscal policy

Boston Fed President Eric Rosengren is an advocate for higher rates, at least in non-pandemic times. In remarks yesterday he argued that

"Abnormally low rates for a long period during times when economic slack is no longer a concern can result in excessive risk-taking, as businesses and firms take on additional debt and accumulate more risky assets in search of better returns - potentially bidding up asset prices to unsustainable levels."

Hard to disagree with that, although a tougher question is whether economic slack was a concern.

On the role of Congress, Rosengren agrees with other Fed officials that fiscal policy is the right tool for the current situation:

"I think it's tragic that it has not been employed already ... when interest rates are quite low, the ability of monetary policy to stimulate the economy, it's not that we have no tools, but the fiscal policy tools are much more effective."

WSJ summary - Fed's Rosengren Says Pre-Pandemic Risk Taking Will Likely Slow Recovery Effort.

Furman on debt sustainability

Jason Furman gave a presentation at Peterson Institute today titled Global Economic Prospects, focusing on COVID-19 and labor markets. He covers the fiscal response and non-response, labor market policy debates, and the future of fiscal policy. Here are the slides on fiscal policy, a nice overview:

Note- the primary balance needed to stabilize the debt (slide 27) is derived from the formula primary balance = (i - g) / (1+g) * prior period debt. I think he's assuming g = 0.

$3.1 trillion deficit

In its Monthly Budget Review for September 2020, CBO reported that the federal government ran a $3.1 trillion deficit for the fiscal year ended September 30. Or as Sri Thiruvadanthai, Research Director at the Jerome Levy Forecasting Center, calls it: "the people's surplus for promoting freedom and defeating Communism." Someone's deficit is always someone else's surplus: federal deficits are supporting household and business balance sheets.

The Treasury Department will publish the official number later this month.

Reinhart: Fight the war, then pay for it

In an FT interview, World Bank Chief Economist Carmen Reinhart urges developing countries to borrow money to fight the economic impact of coronavirus. They can deal with the "unprecedented wave of debt crises and restructurings" once the pandemic has been addressed.

"While the disease is raging, what else are you going to do? ... First you worry about fighting the war, then you figure out how to pay for it."

Reinhart makes the case for debt write-offs and transparency, pointing out that we're in an unprecedented situation and we need clear information to manage it.

• Write-offs: "In terms of the coverage, of which countries will be engulfed, we are at levels not seen even in the 1930s. This is why we are talking about debt write-offs."
• Transparency: "many loan contracts have non-disclosure agreements so they are not known about." As a consequence, when assessing debt sustainability, the private and official sectors are operating on the assumption that debts are lower than they really are.

Issues might be exacerbated as bond redemptions rise in the next couple years.

Lastly, it's notable that Reinhart is making the case for more borrowing. She is best known for her work with Kenneth Rogoff on the effects of financial crises and debt levels. Using research that was later shown to have errors, they promoted austerity policies in 2010 by claiming that rising levels of government debt are associated with lower rates of economic growth.

FOMC minutes - fiscal stimulus, interest rate policy, asset purchases

The Federal Reserve released the minutes of its September 15-16 Federal Open Market Committee meeting today. Three takeaways

1. The Fed expects more fiscal stimulus
• "Fiscal policy measures, along with the support from monetary policy and the Federal Reserve's liquidity and lending facilities, were expected to continue supporting the second-half recovery, although the recovery was forecast to be far from complete by year-end. The staff's forecast assumed the enactment of some additional fiscal policy support this year; without that additional policy action, the pace of the economic recovery would likely be slower."
2. There is a lack of consensus about interest rate policy
• Minneapolis Fed President Neel Kashkari prefers stronger guidance. He wants to keep interest rates low until inflation has moved above 2 percent for some time.
• Dallas Fed President Robert Kaplan is worried about limiting the Committee's flexibility in future years. He doesn't want to commit to keeping the fed funds near zero until employment and inflation criteria are met, and he's concerned about the buildup of financial imbalances.
3. In future meetings the Fed will review and communicate how its asset purchase program is helping to achieve its goals of maximum employment and price stability
• It is currently buying $80 billion of Treasuries and $40 billion of agency mortgage-backed securities per month to decrease market interest rates.

Headlines focused on each of these topics: 

1. Fiscal stimulus
• CNBC: Fed officials worry that lack of help from Congress will threaten recovery
• SeekingAlpha: FOMC assumed more fiscal stimulus this year
2. Interest rate policy
• FT: Fed minutes leave room for manoeuvre on interest rate policy 
3. Asset purchase program
• Bloomberg: Fed to Debate Bond-Buying Program in Possible Step Toward Action

Powell says main risk is spending too little

Fed Chair Jerome Powell gave a speech yesterday at the National Association for Business Economics' Annual Meeting. He provides an assessment of the response to the economic fallout from Covid-19 and discusses the path ahead. The most-discussed part of Powell's speech was his call for more fiscal stimulus. He's made the point several times already, but this time with more urgency.

"The expansion is still far from complete. At this early stage I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods."

Emerging market debt restructuring

Last week the IMF's Managing Director Kristalina Georgieva published a blog post titled Reform of the International Debt Architecture is Urgently Needed. She and her coauthors explain that the increases in debt levels related to the pandemic will hit emerging market economies especially hard. "While many advanced economies still have the capacity to borrow, emerging markets and low-income countries face much tighter limits on their ability to carry additional debt."

"Indeed, about half of low-income countries and several emerging market economies were already in or at high risk of a debt crisis, and the further rise in debt is alarming. Just as they are starting to recover from the pandemic, many of these countries could suffer a second wave of economic distress, triggered by defaults, capital flight, and fiscal austerity. Preventing such a crisis can make the difference between a lost decade and a rapid recovery that puts countries on a sustainable growth trajectory. As IMF research has recently shown, waiting to restructure debt until after a default occurs is associated with larger declines in GDP, investment, private sector credit, and capital inflows than preemptive debt restructurings."

The blog introduces a report, The International Architecture for Resolving Sovereign Debt Involving Private-Sector Creditors. It evaluates the existing debt restructuring framework and proposes reforms such as enhancing collective action clauses to improve coordination among bondholders and increasing transparency around debt amounts, terms, and holders. It ends with a warning about the scale of COVID-related debt:

"Finally, should a COVID-related systemic sovereign debt crisis requiring multiple deep restructurings materialize, the current resolution toolkit may not be adequate to address the crisis effectively and additional instruments may need to be activated at short notice ... These instruments raise significant legal and policy issues, would require careful consideration, and would be expected to be used only as a last resort and on a time-bound basis to address the unique challenges posed by the crisis."

The Financial Times and Guardian summarize why reforms to sovereign debt restructuring matter:

FT: "The magnitude of the economic shock from the Covid-19 pandemic has badly weakened the often already fragile public finances of many poor and emerging countries. While welcome steps have been taken to avoid immediate liquidity crises, the pandemic's drawn-out nature means we are only at the start of the financial problems it will leave behind ... The rationale for all bankruptcy arrangements, after all, is precisely this: it can be in the interest of creditors, too, to restructure payment obligations when changed economic circumstances make these more onerous than expected."

The Guardian: "Georgieva has already made the case for a new debt framework and that is indeed sorely needed. Debt relief is no longer simply a question of getting a bunch of rich western governments to agree to a deal: it now requires the involvement of private sector creditors, such as BlackRock, and Beijing."

Danske says r < g makes public debt nbd

In a research note published September 30, Danske Bank wonders whether the worry about public debt levels after COVID-19 is "much ado about nothing."

Danske explains that central banks have the power to cap borrowing costs, effectively keeping interest rates below growth rates. This strategy, which has the unfortunate name "financial repression", can enable countries to gradually grow (or inflate) their way out of debt. However, Danske also argues that "counting on interest rates to stay low forever can be a dangerous strategy and financial repression is not without costs, especially if it leads to an erosion of central bank independence."

Despite risks, Danske views the interest rate-growth differential as "a key variable that distinguishes sustainable debt levels from unsustainable ones." They cite Olivier Blanchard's work on Public Debt and Low Interest Rates and explain that more economists are beginning to see higher debt levels as less of a worry. A persistently negative interest rate-growth differential makes it possible to roll over debt while decreasing it as a share of GDP. As shown in the chart below, countries like the UK have had much higher debt levels in earlier times and been fine. Adam Tooze summed it up: "If you remember WWII, WWI and the Napoleonic wars, the 2008-COVID fiscal shocks are really not such a big deal."

An interesting historical note:

"The US experience with financial repression in the form of yield curve control (YCC) after the Second World War also provides some cautionary lessons. The Fed adopted YCC in April 1942 to support war financing, agreeing to cap the Treasury bill yield at 0.375% and the long-term government bond yield at 2.5%. From March 1942 to August 1945, the Fed bought USD20bn worth of Treasury securities (10% of total issued). When the war was over and the economy rebounded, inflation did as well. This started a conflict between the Fed, which wanted to raise short-term rates to combat high inflation, and the Treasury, which wanted to maintain low Treasury yields. Eventually, the YCC policy was abandoned in February 1951, but the Fed's experience in the 1940s and 50s illustrates the risks fiscal dominance can have to central bank independence."

Two thoughts on this report: First, something that Danske doesn't mention but might be interesting to think about is the counterfactual: what if the US Treasury had raised taxes in the late 1940s instead of not raising taxes and pressuring the Fed to keep rates low. Taking money out of the economy when it was overheating might have reduced inflation, enabling the Fed to keep rates low for longer. Second, the report begins to call into question the purpose of central bank independence. Central bank independence is viewed as an unquestioned good thing, and mostly for very good reason. But I wonder if it prevents useful discussion about the overlap between fiscal and monetary policy, and to what extent the Federal Reserve should support the Treasury. For example, if we had to choose between an independent central bank and high unemployment (Volcker) or a collaborative central bank and low unemployment (Powell), maybe we shouldn't dismiss the collaborative option too quickly.

(Ratioed) Tweet of the day

BBC tweeted a video in which UK Chancellor Rishi Sunak promises to "protect the public finances, over the medium term getting our borrowing and debt back under control." Sunak says

"We have a sacred responsibility to future generations to leave the public finances strong, and through careful management of our economy this conservative government will always balance the books."

A tough line to take on a day when even the IMF is imploring governments to spend more.

Responses to Sunak's statement include

• Jack Seale: "Balance the books" always, always means taking from the poor and vulnerable, by cutting their benefits and smashing the public services they rely on, and getting away with it thanks to basic lies about how government finances work. About as far from "sacred" as you can get.
• Pavlina Tcherneva: Economic malpractice. Obsessing over accounting ratios that say nothing about the health and wellbeing of the community.
• Simon Wren-Lewis: Sacred?! From fiscal rules that treat government like a household to fiscal rules ordained by God?
• Richard Murphy: Staggering that he has no idea about macroeconomics, the need for deficits during recessions, and the role that they have in creating employment and wellbeing.

Is the IMF Keynesian again?

In its October Fiscal Monitor, the IMF makes the case for more government spending. It explains how increased public investment can boost growth, increase resilience, and provide for the development of a more inclusive economy.

After a decades-long adherence to austerity policies that are widely viewed to have imposed more pain than gain, it might be a sign that the IMF is becoming Keynesian again (Keynes and Harry Dexter White were the intellectual founding fathers of the International Monetary Fund, drafting the blueprints for it in 1944).

Introducing the Fiscal Monitor chapter on Public Investment, the IMF writes

"This chapter argues that governments need to scale up public investment to ensure successful reopening, boost growth, and prepare economies for the future. Low interest rates make borrowing to invest desirable... Increasing public investment by 1 percent of GDP in advanced and emerging economies could create 7 million jobs directly, and more than 20 million jobs indirectly. Investments in healthcare, housing, digitalization, and the environment would lay the foundations for a more resilient and inclusive economy."

In the report, they explain

"With ample underused resources, public investment can also have a more powerful impact than in normal times. Public investment and its crowding-in effects on private investment could mitigate secular stagnation and the savings glut, which predate the onset of COVID-19 ... but have been exacerbated by the crisis, since uncertainty about the course of the pandemic has further dampened private investment and spurred higher levels of precautionary saving. Moreover, the recovery of private sector activity is being constrained by weakened private sector balance sheets, losses in human capital because of unemployment, and skill mismatches as demand shifts from high-contact sectors to those that permit social distancing. Public investment can encourage investment from businesses that might otherwise postpone their hiring and investment plans."

Chris Giles at the Financial Times summarizes the report, writing that

"The IMF has issued a rallying call to rich countries around the world to increase public investment and spark a strong economic recovery from the coronavirus pandemic. Advanced economies should worry less about their public debt, but instead take advantage of historically low borrowing costs to increase spending on infrastructure maintenance immediately."

He added "The report marked a shift away from the IMF's normal concerns about public finances in rich countries."

The IMF's deputy director of fiscal affairs Paolo Mauro explained that the high level of uncertainty in the global economy strengthened the case for increasing public investment. "You get a bigger bang for your buck from public investment because investment by private firms is extremely low." 

Central banks for the public good

Since 2008, central banks have propped up the global financial system with "a remarkable display of technocratic energy and imagination."  To stabilize the economy, the Fed has purchased (or acted as the purchaser of last resort for) trillions of dollars of Treasuries, municipal debt, corporate debt, and commercial paper, and set up swap lines with other central banks.

In A Popular History of the Fed, Anton Jäger and Noam Maggor write that the Fed's actions to avoid financial collapse in the US and safeguard assets abroad have "warmed even some on the left to central bank power" while raising questions of how to make the Fed work for everyone rather than primarily the wealthy.

"The Fed might serve as a capitalist savior today, but it could become a weapon for progressive finance tomorrow ... The quiet consensus is that central bank stabilization remains necessary for the survival of the current economy. In undertaking stabilization, however, central bankers also increase existing inequalities and empower economic elites around the world. Even if today's central banks could be democratized, that "democratization" by itself will be insufficient if their field of action remains constrained, shying away from a more ambitious mandate of redistribution and the reorientation of long-term investment."

The 2008 financial crisis and coronavirus pandemic have shown that the Fed can act as a force for good, but its remit has prevented it from acting fully in the public interest. Benjamin Braun and Quinn Slobodian have recently written proposals for central bank reform. In describing the possibilities and explaining how these proposals have historical precedent, Jäger and Maggor look to the American Populist movement of the late 19th century.

"Since the 1860s, when President Lincoln introduced greenbacks to fund the Civil War, the idea that the American state might use its authority to control the money supply from private banks had already stirred the radical imagination. Populists extended these greenback efforts into the 1880s. One of the most pressing problems of the decade was the scarcity of credit and currency in rural areas, which drove an infernal spiral of deflation and price depression. Loosening and widening the base of currency, Populists claimed, would fuel productive investment, raise the price of agricultural produce, and break the power of established merchants, whose hold on currency often went hand in hand with price gouging.

"The most recurrent Greenbacker response--pushed by businessmen, small farmers, and intellectuals alike--to the problem of deflation was a more elastic money supply and so-called fiat currency, terminating America's attachment to the gold standard."

Respected economists and the New York Times laughed at proposals to take America off the gold standard, but President Wilson's Secretary of State William Jennings Bryan and Democrats and Republicans from rural states maintained that

"American banking ... suffered not from overeager country banks on the periphery ... Rather, the control of credit had been monopolized and needed to be seized from a tight cohort of Northeastern bankers. They therefore pressured Wilson to include local banking provisions and more dispersed credit facilities in the law. They wrote provisions into the bill that lowered gold reserve requirements and made agricultural paper and warehouse receipts eligible for discounting at regional reserve banks. Finally, they successfully bargained for Federal Land Banks, which massively expanded the availability of credit to farmers at low rates." 

Jäger and Maggor give three reasons why the Populist banking proposals offer important perspectives for today:

1. The question of accountability is important, but we should not forget the question of what central banks do. Although Populists cared about popular input and control, "the notion of direct control of this bank could never outweigh plans regarding its capacity for action--first and foremost when it came to egalitarian credit allocation."
2. The debate shifts from stabilization and redistribution to predistribution. Good access to credit enabled American farmers in the 19th century to invest in the equipment they needed, creating a highly productive agricultural sector.
3. We've been here before. Democratizing the Fed and making it work for more Americans "could fulfill deep-seated democratic aspirations, articulated by farmers, workers, and craftsmen in the turmoil of the First Gilded Age."

Record debt levels will slow a recovery

In The U.S. Economy Was Laden With Debt Before Covid. That's Bad News for a Recovery, WSJ's Shane Shifflett reminds us that the U.S. entered the pandemic recession with record levels of debt.

"Why does this matter? Economies carrying a lot of debt generally have weaker recoveries. Businesses and consumers focus on cutting their liabilities during downturns rather than spending cash--and spending is what an economy needs to rebound."

Shifflett reviews debt growth by sector: households and nonprofits, nonfinancial business, state and local government, and federal government.

"Some kinds of debt matter more than others. The most important piece of a recovery is consumer spending, which accounts for nearly 70% of the U.S. economy. High household debt levels tend to lengthen recessions and amplify their severity."

Demographics and productivity weigh on GDP growth

In Demographics and Debt Hang Over Long-Term U.S. Growth, the Wall Street Journal's Greg Ip provides a summary of CBO's Long-Term Budget Outlook released last week. 

Fewer births and lower productivity growth lead the CBO to expect annual economic growth to average 1.6 percent over the next few decades. The role of debt is more uncertain. Ip provides a summary of CBO's approach to modeling it at the end of the article:

"The elephant in the room is the national debt. Conventional economic models like the CBO's say government debt soaks up saving and thus crowds out private investment, and the U.S. is about to have a lot more debt ... The "crowding out" model hasn't fared well in recent years: steep deficits have coincided with ultralow interest rates. This is probably because investment has been persistently weak globally relative to saving."

Claudia Sahm questioned why the WSJ included debt in the title, since Ip writes "Most [of the lower growth forecast] reflects longer-lasting forces, namely demographics and productivity." Sahm notes that CBO "is a fairly conservative shop in its forecasts."