If the bound can't be easily sidestepped, what options does the Fed have? As we implied at the outset, to be effective, monetary policy must do more than simply give the private sector "change for a twenty." In other words, monetary policy must take actions that expand the sum of zero-interest money and its zero-yielding substitutes, not simply swap one for the other. This can be achieved if the Fed purchases assets that are not perfect substitutes for money. We will consider three possible candidates:In short, the Dallas Fed notes that beyond devaluing the dollar and buying Treasuries (which the Fed is already doing), it can also purchase real goods and services in the economy! We're not there yet, and I suspect that step will not be needed. But we are getting to the point where the markets are heavily discounting a meaningful turn in the economy.
Strategies that target the first two candidates can only succeed if the Fed coordinates its policy actions with those of other actors -- namely, foreign central banks or domestic fiscal policymakers. A strategy targeting the third is something the Fed can do today, unilaterally, within the constraints imposed by the Federal Reserve Act.
- Foreign exchange.
- Real goods and services.
- Other domestic securities, such as longer-term Treasuries.
NEW YORK ( TheStreet.com, RealMoney) --Much has been made of China's successful efforts to stimulate its economy through a massive and mandatory expansion of money and credit. Not only has China exploded its money supply by a whopping 28% (as economist Ed Yardeni has noted in recent days), that money has been put to use in the real economy. That has not been the case here in the U.S., where the money supply is increasing, but the velocity, or turnover of money, is not. M2, the most widely watched measure of the money supply, has grown about 9% year over year, while "money with zero maturity" (MZM) -- what economists call "high-powered money" -- has exploded.
In addition, the monetary base, another money measure, has grown to about $14 trillion. Assets of money market mutual funds total more than $3 trillion. Consumer savings are at a record dollar amount of $787 billion. But the cash sits idle on the sidelines as individuals and corporations squirrel it away for a rainy day that, in truth, has already come and gone. In fact, if they continue to hoard cash, they could very well bring the rain back again, an unwelcome development that is nonetheless a natural response to the economic trauma we all have lived through.
The growth of the money supply, the expansion of the Fed's balance sheet (quantitative easing), the reduction of short-term interest rates to near zero (zero-interest-rate policy), fiscal stimulus and other revival efforts have plugged the hole created by immense capital losses in the financial system, the markets and in residential real estate. But the creation of money has yet to provide the same boost to the economy that it has in the past. While this has not yet resulted in a "liquidity trap" where the Fed "pushes on a string," we are at a point where the efforts will work or they won't. My bet is that they will. However, rather than watching the raw monetary aggregates, we need now to focus on the aforementioned velocity of money. The more rapid the money supply's turnover -- which today is near zero -- the quicker the economy will grow. At least that's what monetary theory tells us. If this does not work as completely as policymakers had hoped, all is not yet lost. The Federal Reserve still has a few tricks up its sleeve that could force money to be spent. In a paper titled "Monetary Policy in a Zero-Interest-Rate Economy," published by the Dallas Fed in 2002-3, the authors argue that policymakers can stimulate the economy even when interest rates are at the so-called zero bound. (That's where they are today.) The Fed can tax bank deposits of both institutions and individuals, causing them to lose money on their savings accounts. This action would force cash into the system and drive funds toward more productive and stimulative efforts.
If that does not work, the Dallas Fed added that the following efforts can be undertaken to revive the economy and restore normalized growth and turn back deflation:
Before we get disappointed that it hasn't fully materialized -- despite more and more signs that are turning positive each day -- remember that the Fed can still do a lot more to ensure that the economy recovers fully from this long national nightmare.
warning about China and Russia being in the midst of a speculative episode in the equity markets. While the 5% drop in Chinese shares wiped out a week's worth of gains, I will admit that Chinese equities have wildly outperformed our own market, as has Russia's key market indices. Both are up mightily in the last month and since the March bottom. However, I maintain that it's safer to play here at home, despite what could be a mini-correction beginning on Wall Street today. I will be spying on China and Russia closely in the days and weeks ahead to make sure I don't miss a trigger that launches an intercontinental ballistic sell signal if these markets suddenly implode.