Scott Sumner  

Powell's Senate testimony

PRINT
The Highs and Low of Today's W... Risk of Death for Border Patro...

Jerome Powell recently testified in front of Congress. This caught my attention:

So the Fed's balance sheet is about $4.5 trillion now, and we know that it will be much smaller than that when it reaches its new -- its new sort of equilibrium size. It will be larger, however, than it was before the crisis.

And we've also said that it will consist primarily -- mostly of Treasury securities, at that time, and it will be no larger then it needs to be for us to conduct monetary policy. We will be shrinking the balance sheet by allowing securities, as they mature, to roll off passively. And that should -- that process should take three or four years before we -- before we reach our new sort of stable level of the balance sheet.

And the factors that will determine that will be, really, in the end, the public's demand for our liabilities, particularly cash and reserves. Those will be principal factors that will -- that will decide what the final size of the balance sheet will be.

We don't actually know what that demand will be, but, my own thinking, it moves us to a balance sheet of in the range of, as I mentioned, $2.5 trillion to $3 trillion. I don't -- again, there's no certainty in that.


There is a sense in which the size of the balance sheet can be viewed as demand determined, especially if the Fed is targeting inflation at 2%. But that's only true if the Fed doesn't pay interest on reserves. Without interest on reserves (IOR), the Fed's balance sheet would be about 7% of GDP, slightly above the demand for currency. But with IOR, the balance sheet can be whatever the Fed wants it to be. The figures cited by Powell ($2.5 to $3.0 trillion) are more than 10% of GDP and imply the Fed will continue paying IOR, which is no surprise. But that means it will be the Fed, not the public's demand for cash and reserves, that will determine the size of its balance sheet, .

KENNEDY: What did the community banks do wrong to contribute to the meltdown in 2008? POWELL: Fair to say that the community banks did not contribute to the meltdown in 2008.
Is this true? I was under the impression that smaller banks made lots of bad loans during the mid-2000s. Didn't most of the bank failures (during 2008-13) occur among smaller banks?

Overall I was struck by the fact that there were relatively few questions on monetary policy, and even those were often on somewhat tangential issues. Nothing on negative IOR, a different inflation target, Bernanke's recent level targeting proposal, NGDP targeting, etc. Most questions involved financial regulation. Powell handled the monetary questions skillfully, which is a good sign. But he was never really pressed on a difficult point.

PS. Timothy Taylor recently made this comment:

One of the ongoing puzzles of the US economy in recent decades is why inflation has stayed so low. Even outgoing Fed Chair Janet Yellen has highlighted this puzzle. The "Amazon effect" may be part of the answer: basically, the Amazon effect is that a higher level of competitive pressure from the rising level of on-line retail sales is holding back price increases that might otherwise have occurred.
There are cases where increases in aggregate supply can hold down inflation--for any given increase in NGDP. Indeed this occurred during the late 1990s. However this is not the cause of low inflation today, as productivity growth is also quite slow. Rather the low inflation is caused by low NGDP growth. Of course even if inflation were being held down by rapid growth in productivity, the Fed should offset that with monetary stimulus if they want to hit their inflation target. (Or better yet, just target NGDP and allow the low inflation.) But again, that's not why inflation is currently running at low levels---it's excessively tight money that is causing the low inflation.

HT: John McDonnell


Comments and Sharing


CATEGORIES: Macroeconomics , Money




COMMENTS (7 to date)
Devan writes:
Is this true? I was under the impression that smaller banks made lots of bad loans during the mid-2000s. Didn't most of the bank failures (during 2008-13) occur among smaller banks?

Maybe Kennedy and Powell are referring to different kinds of community banks. Credit unions were pretty resilient.

Ken writes:

It’s too bad that Mr. Powell was not questioned about IOR.

I read an article by George Selgin a few months ago that made the case that the IOR rate is greater than the market rate and therefore illegal. As I recall, Selgin considered the Fed Funds rate to be the appropriate rate for IOR.

So it would have been interesting to hear what Mr Powell considers to be the appropriate market metric to determine IOR.

Michael Byrnes writes:
There are cases where increases in aggregate supply can hold down inflation--for any given increase in NGDP. Indeed this occurred during the late 1990s. However this is not the cause of low inflation today, as productivity growth is also quite slow. Rather the low inflation is caused by low NGDP growth. Of course even if inflation were being held down by rapid growth in productivity, the Fed should offset that with monetary stimulus if they want to hit their inflation target. (Or better yet, just target NGDP and allow the low inflation.) But again, that's not why inflation is currently running at low levels---it's excessively tight money that is causing the low inflation.

Great paragraph. The idea that improvements in aggregate supply can somehow be damaging to the economy as a whole just seems absurd on its face, yet it also seems to be becoming the conventional wisdom.

Scott Sumner writes:

Thanks Devan, That makes sense.

Ken, I agree.

Michael, In fairness, I'm not sure the claim is that the supply side improvements hurt the economy overall, just that they prevent the Fed from hitting its 2% inflation target. But even that is wrong.

Michael Byrnes writes:
Michael, In fairness, I'm not sure the claim is that the supply side improvements hurt the economy overall, just that they prevent the Fed from hitting its 2% inflation target. But even that is wrong.

I agree that I went a little overboard. But that kind of thinking does seem to come up, for example a few years ago when people regularly worried that a good month for jobs would cause the Fed to tighten, so a weaker jobs report might be better for the economy.

Philo writes:

Fed activity/inactivity causes both (the rate of) inflation and (the rate of) NGDP growth.The latter two are correlative effects of the first. So you should not say that NGDP growth causes inflation.

Mike writes:
Is this true? I was under the impression that smaller banks made lots of bad loans during the mid-2000s. Didn't most of the bank failures (during 2008-13) occur among smaller banks?

Yes, this is a fair statement. The small banks did, indeed, make a lot of "bad" loans during the period but they were enabled to make them over and over again by the money-center banks being ready/willing/able to purchase and securitize them.

The majority of failures (in terms of number of institutions) did happen on the smaller side but that is as much a function of asset composition and secondary effects of the Recession. Small banks generally have significantly higher concentrations of real estate loans in their portfolios than do larger banks so they are much more sensitive to declines in RE values wiping out their capital.

Comments for this entry have been closed
Return to top