Wednesday, April 11, 2018

The Distributed Lag Effect of Monetary Flows { M*Vt }

Nobel Laureate Dr. Milton Friedman, published in the “Journal of Political Economy”, Vol. 69, No. 5 (Oct., 1961), pp. 447-466 “The Lag in Effect of Monetary Policy” where he pontificated that:

"… monetary actions affect economic conditions only after a lag that is both long and variable."

Walter Isaacson pointed out in his biography of Leonardo Da Vinci, “history’s most creative genius”, who maybe said it best: “Before you make a general rule of this case, test it two or three times and observe whether the tests produce the same effects”

Thereby economists and acolytes took the archetypal “Hook Line & Sinker”, viz., “Nobody Can Teach Anybody Anything” W.R. Wees

http://www.dumbassgifts.com/images/thm-L_fw_hookLineAndSinker.gif




Syncing money flows, volume X’s velocity, with gDp was for me like the artisan, Dr. Ernest G. Schwiebert Jr, who was Director of the Theodore Gordon Flyfishers and his attempts to:Match the hatch”.

American Yale Professor Irving Fisher's transaction's concept of money velocity, or the "equation of exchange", is an algebraic way of stating a truism; that the product of the unit prices, and quantities of goods and services exchanged P*T, is equal, for the same time period, to the product of the volume, and transactions velocity of money.

Thus mechanically: M*Vt is synonymous with aggregate monetary purchasing power, AD, and is = P*T (where N-gDp is ≈, a subset).

In Professor Irving Fisher’s – 1920 2nd edition: “The Purchasing Power of Money” asDigitized for FRASER”:

https://fraser.stlouisfed.org/scribd/?title_id=3610&filepath=/files/docs/meltzer/fispur20.pdf

Neither superfluous financial transactions (no “tax needed”) nor John Maynard Keynes’ “animal spirits” are random:

“If the principles here advocated are correct, the purchasing power of money — or its reciprocal, the level of prices — depends exclusively on five definite factors:

(1)the volume of money in circulation;
(2) its velocity of circulation;
(3) the volume of bank deposits subject to check;
(4) its velocity; and
(5) the volume of trade.


“Each of these five magnitudes is extremely definite, and their relation to the purchasing power of money is definitely expressed by an “equation of exchange.”

“In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”


Taking Irving Fisher’s *KATALLACTIC* approach (the science of exchanges), viz., as George Garvy spells out in his: “DEPOSIT VELOCITY AND ITS SIGNIFICANCE” published in Nov. 1959 (as: “Digitized for FRASER”):

https://fraser.stlouisfed.org/files/docs/meltzer/gardep1959.pdf

George Garvy: “Ideally, only balances subject to check or, even better, balances shown on checkbook stubs of depositors should be used to compute velocity rates.”

This is analogous to Dr. Richard G. Anderson’s, Ph.D. Economics, Massachusetts Institute of Technology (the world’s leading guru on bank reserves) explanative: “legal reserves are driven by payments”, payments being “total checkable deposits”.

Documentary proof of this demarcation is given within the G.6 release, Debit and Demand Deposit Turnover, discontinued in Sept. 1996 (discontinued for spurious reasons: “The usefulness of the FR 2573 data in understanding the behavior of the monetary aggregates has diminished in recent years as the distinction between transaction accounts and savings accounts has become increasingly blurred. Further, the emphasis on monetary aggregates as policy targets has decreased.”). Ed Fry was its manager. William G. Bretz (of Juncture Recognition), told Fry he had an error in his statistics. That’s the value of a “knowledge worker”, and not an “arm chair” economist.

This explanation disabused the significance of bank debits (money actually exchanging counterparties):

“Changes in business activity are closely linked with changes in the volume of money payments made by check, of which bank debits provide the best available single indicator. The debit figures cover payments for the purchase of goods in the various channels of production & distribution, for wages ^ salaries, for dividends ^ interest; but they also include payments for property ^ other financial transactions that do not necessarily arise for current production & distribution [which e.g., reflect both new & existing residential & commercial real-estate sales/purchases]. They include, in addition, man duplications arising from a series of payments of identical goods at different stages of production & consumption. Only I a very broad way therefore, do these data reflect changes in general business conditions by showing, among other things changes in the attitude of the public toward holding or spending money.”

Of course, this is just the "unified thread" of algebra, estranged from "general field theory" of macro-economic modeling, where the chorus is: "All analysis is a model" - Ken Arrow.

The NBFIs, non-banks, are the DFI’s customers. Thus all demand drafts originating from the NBFIs clear thru the payment’s system (unified theory). Bank reserves are driven by payments (bank debits). Legal reserves are based on transaction type deposit classifications 30 days prior. 95 percent of all demand drafts clear thru demand deposits (see G.6 release).

Banking and Monetary Statistics, 1914-1941, Part I | FRASER | St. Louis Fed

[section 5]

Of course, money flows registered a (-) negative RoC during the S&L crisis; “the failure of 1,043 out of the 3,234 savings and loan associations in the United States from 1986 to 1995”, during the July 1990-Mar 1991 recession.

Monetary Flows (MVt)

But we knew this already:

In 1931 a commission was established on Member Bank Reserve Requirements. The commission completed their recommendations after a 7 year inquiry on Feb. 5, 1938. The study was entitled "Member Bank Reserve Requirements -- Analysis of Committee Proposal" It's 2nd proposal: "Requirements against debits to deposits"

http://bit.ly/1A9bYH1

After a 45 year hiatus, this research paper was "declassified" on March 23, 1983. By the time this paper was "declassified", Nobel Laureate Dr. Milton Friedman had declared RRs to be a "tax" [sic].




See: “New Measures Used to Gauge Money supply”, WSJ 6/28/83

You don't have to be a NASA rocket scientist (like Dr. William A. Barnett, of: “Divisia Monetary Aggregates”). What he does is laborious. Changes in “divisia” are automatically captured, real-time, in RRs. “Instead of totaling all types of money and treating them equally, the Divisia numbers assign different weights to assets according to the extent they serve as spending, rather than savings, vehicles.”

“The ‘debit-weighted’ money figures developed by the Fed’s Dr. Paul Spindt, support Prof. Barnett’s conclusion. They assign different weights to various categories of money according to how often they turn over, or are spent.”

See Dr. William Barnett:

“The fact that simple sum monetary aggregation is unsatisfactory has long been recognized, and there has been a steady stream of attempts at weakening the implied perfect substitutability assumption by constructing weighted average monetary aggregates.”




http://www2.ku.edu/%7Ekuwpaper/2013Papers/201312.pdf




Note #1: “a KATALLACTIC approach—as distinguished from a national income and product approach—places as much emphasis on production and finance as it does on income and final demand. Every agreement to exchange comes to the economist's attention, rather than simply the net of those agreements aimed at final demand. This is important because if one does not consider the intermediate stages of production and financing, it becomes more difficult to isolate the possible sources and paths of disturbance in the exchange nexus. In this connection, the highly distilled, final demand focus of national income and product accounting in particular—while valid—provides only a narrow view into the overall market process.”




In the transactions velocity of circulation: “Money is spent and re-spent.” Whereas with income velocity, inflation analysis is delimited to wages and salaries spent. To the Keynesians, aggregate monetary demand, AD, is N-gDp, the demand for services (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end, (“raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp”), etc.

Thus what Milton Friedman had printed on his car license plate: [ M * Vi =P * Q ]was dead wrong for two important reasons.

See the Federal Reserve Bank of New York: “The Money Supply”

To wit: “Thus, in July 1993, when the economy had been growing for more than two years, Fed Chairman Alan Greenspan remarked in Congressional testimony that "The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place."

In a 2006 speech about the historic use of monetary aggregates in setting Federal Reserve policy, Chairman Bernanke pointed out that, "in practice, the difficulty has been that, in the United States, deregulation, financial innovation, & other factors have led to recurrent instability in the relationships between various monetary aggregates & other nominal variables".

The Money Supply - FEDERAL RESERVE BANK of NEW YORK

Money should be defined exclusively in terms of its means-of-payment attributes. The present array of interest-bearing checking accounts has confused the distinction between means-of-payment accounts, and saving-investment accounts, and created a dilemma as to what portion, if any, of these interest-bearing accounts should be considered as savings. This dilemma is resolved when the transactions velocity of demand deposits is taken into account; i.e., deposit classifications are analyzed in terms of monetary flows. Obviously, no money supply figure standing alone is adequate as a "guide post" to monetary policy.

Scientific evidence "is proof, which serves to either support or counter a scientific theory or hypothesis. Such evidence is expected to be empirical evidence and in accordance with scientific method" - Wikipedia

Scientific method is "a method or procedure…consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses" - Wikipedia

The scientific evidence for the last 100 years is irrefutable. I.e., the trajectory in the roc (proxy for inflation indices), for M*Vt (the scientific method), projected a top in the inflation indices in January (signal to sell commodities and buy bonds). Every year, the seasonal factor's map, or scientific proof, is demonstrated by the product of money flows.

The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves.

The FOMC's monetary policy objectives should be formulated in terms of desired RoC's in monetary flows, volume X’s velocity, relative to roc's in real-gDp - Y. Roc's in N-gDp, P*Y, can serve as a proxy figure for roc's in all transactions P*T. RoC's in E-gDp have to be used, of course, as a policy standard.

Lest we are to believe the pundits (those responsible for our condition):

"I know of no model that shows a transmission from bank reserves to inflation" - DONALD KOHN - former Vice Chairman of the Board of Governors of the Federal Reserve System

"Reserves don't even factor into my model, that's not what causes inflation and not how the Fed stimulates the economy. It's a side effect." - LAURENCE MEYER - a Federal Reserve System governor from June 1996 to January 2002

Friday, March 16, 2018

Surrogates

(1) Income velocity is a contrived figure (viz., make believe)
(2) The distributed lag effects for monetary flows have been mathematical constants for over 100 years
(3) Keynes' "Liquidity Preference Curve" (demand for money), is a False Doctrine

Professor Irving Fisher's transaction's concept of money velocity, or the "equation of exchange", is an algebraic way of stating a truism; that the product of the unit prices, and quantities of goods and services exchanged P*T, is equal, for the same time period, to the product of the volume, and transactions velocity of money M*Vt.

The "transactions" velocity (a statistical stepchild), is the rate of speed at which money is being spent, i.e., real money balances actually exchanging hands. E.g., a dollar bill which turns over 5 times can do the same "work" as one five dollar bill that turns over only once. It is self-evident from the equation that an increase in the volume, and/or velocity of money, will cause a rise in unit prices, if the volume of transactions increases less, and vice versa. Of course, this is just the "unified thread" of algebra, estranged from "general field theory" of macro-economic modeling, where the chorus is: "All analysis is a model" - Ken Arrow.

In contradistinction, the mainstream Keynesian-economic metric variant, income velocity - Vi, a contrived figure, is calculated: by dividing N-gDp for a given period by the average volume of the money stock (M1, M2, & MZM), for the same period (viz., make believe). A decline in the income velocity of money (like during the Great-Recession), is supposed to suggest that the Fed initiate an expansive, or less contractive, monetary policy.

This signal could be right - by sheer accident. I.e., the historical trend of Vt vs. Vi, at various intervals, moved in absolutely divergent paths - giving the income velocity economists false signposts:

See: Sept. 30 1979, correspondence between R. Alton Gilbert (Ph.D., Senior V.P., FRB-STL), and Leland J. Pritchard, then Professor Emeritus, KU (Ph.D., "Chicago School", Economics, 1933, MS Statistics, Syracuse).

Remember that in 1978 all economist's forecasts for inflation were drastically wrong. To put that into perspective (Business Week): there were 27 price forecasts by individuals & 9 by econometric models for the year 1978. The lowest (Gary Schilling, White Weld), the highest, (Freund, NY, Stock Exch) & (Sprinkel, Harris Trust & Sav.).

The range CPI, 4.9 - 6.5 percent. For the Econometric models, low (Wharton, U. of Penn) 5.7%; high, 6.6% U. of Ga.).

For 1978 inflation based upon the CPI figure was 9.018%. Roc's in M*Vt projected 9.0%
The importance of Vt in formulating - or appraising monetary policy, derives from the obvious fact that it is not the volume of money which determines prices & inflation rates, but rather the volume of monetary flows, M*Vt, relative to the volume of goods & services offered in exchange. And the importance of Vt is demonstrated by the historical fact that it has fluctuated 2.5 times as widely as the primary money stock over a corresponding 50 year period.

Leland J. Pritchard (Ph.D., "Chicago school", Economics, and Milton Friedman's classmate in 1933) - writing for Dr. Christopher Thomas' IMTRAC:

"N-gDp is the demand for services (human) & final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning, with raw material prices & processing costs at all stages of production, & continues through to the end…

….To ignore the aggregate effect of money flows on prices is to ignore the inflation process. To dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once), is to ignore the fact that Vt is a function of three factors:

(1) the number of transactions;
(2) the prices of goods and services;
(3) the volume of M.

…Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money), created by the Reserve & the commercial banks, plus the expenditure rate (velocity) of these funds. Also, e.g., overlooked is the effect of the expenditure of the savings of the non-bank public on prices (dis-savings). M*Vt's outcome encompasses the total effect of all these monetary flows."

Prior to Sept. 1996, the BOG reported the numeric values for the variables indispensable for solving Fisher's truistic concept money velocity on its G.6 release: "Debit and Demand Deposit Turnover" (back then, it was the BOG's longest running statistical time series).

The significance of bank debits in the G.6's prologue was described as: "Changes in business activity are closely linked with changes in the volume of money payments made by check, of which bank debits provide the best available single indicator."

This aforementioned data was untimely, and un-necessarily, non-conforming: "based upon statistical aggregates where data cannot be compiled accurately or in a manner which conforms to rigid theoretical concepts, in which the entire approach tends to be ex posit and static". 

Despite its delimited character, it provided accurate economic projections.

Since demand deposit, DD, turnover was discontinued (via a theoretical and empirical misunderstanding), in Sept. 1996 (when Ed Fry in D.C., was its manager), RRs, required reserves, have to be drawn upon as a surrogate metric, for all money transactions. And don't be logically trapped - by final-product arguments, which assume that the commercial banks, CB's, the volume of financial transactions aren't random, no, historically, speculation's informative and correlated.

Accordingly, Dr. Richard G Anderson, former V.P., Economic Research, FRB-STL remarked on Thursday, 11/16/2006: "This is an interesting idea. Since no one in the Fed tracks reserves"…"Today, with bank reserves largely driven by bank payments (debits or withdrawals), your views on bank debits and legal reserves sound right!"

Per the last publication of the G.6 release, 93% of all demand drafts, bank debits, cleared thru demand deposit classifications (525 demand drafts/mo for Vt, as compared to 7.648/qtr for Vi on 10/1/1996), and 7% thru OCDs, NOW and ATS accounts. The Fed calculated the G.6 figures by dividing the aggregate volume of debits of these banks against their demand deposit accounts.

Yet the 12/23/14 M2-Vi figure printed @ 1.538 x/qtr? - non sequitur! In other words, with this disparity, it is wanton apocrypha to presuppose, with if half of Americans are living paycheck-to-paycheck, that there is, e.g., no minimum monthly number of current bills, and undisposed income? - naught!

So our "means-of-payment" money is designated by transaction based accounts. Whence, "money" is the measure of liquidity, hence, bank debits - the "yardstick" by which the liquidity of all other assets is measured.

See: "New Measures Used to Gauge Money supply" - WSJ 6/28/83 "The experimental measures are designed to resolve some of the confusion by isolating money intended for spending, the money held as savings. The distinction is important because only money that is spent-so-called "true money" - influences prices and inflation."

Our means-of-payment money is extricable linked to legal or RRs. But the politics are wrong (the ABA erroneously considers RRs to be a tax - not a multiplier, contrary to fractional reserve banking). Member CB reserve maintenance, or policy compliance, is based upon transaction type deposit accounts 30 days prior.

Inexorably, and contrary to the provisions of the ABA's "Financial Services Regulatory Relief Act of 2006", the only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves - as Keynes' "liquidity preference curve, demand for money, is palpably a false doctrine. It is an incontrovertible fact, the money supply, and commercial bank credit, can never be managed by any attempt to control the cost of credit, i.e., thru pegging the policy interest rate on governments; or thru "spreads", "floors", "ceilings", "corridors", "brackets", etc.

The BOG cannot adjust its policy rate (or even fine-tune it through a series of modified pegs), so as to counteract the distributed lag effect of money flows (which can be inherently sudden, sharp, and incessantly temporal). Thus the Fed's always "behind the curve".

On October 15, 2014 the U.S. Treasury market had one of its largest swings in yields in a quarter century, larger than on September 15, 2008, when Lehman Brothers filed for bankruptcy - that's no happenstance. Rates-of-change in money flows (all transactions), or the proxy for real-output (which is based on the distributed lag effect of money flows), has fallen by 1/2 since July 2014. The roc in the proxy for inflation has fallen by 2/3 since January 2013 (i.e., QE's a misnomer).

We should have learned the falsity of this assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. - Fed. Res. Accord of Mar. 1951 was all about. The effect of tying open market policy to a FFR, was to supply additional, excessive, and costless legal reserves to the banking system when loan demand increases.

The sine qua non of monetary management is total current control by a central monetary authority over the volume of legal reserves held by all money creating institutions, and over the reserve ratios applicable to their deposits.

Prima facie evidence that the Reserve banks and the commercial banks have created credit, as with all bank credit creation, is an expansion in the money stock. Prima facie evidence that the money stock, transaction based accounts, has expanded, is given by the roc in legal, RRs - the definitive adjusted monetary base.

But we already knew this: After 7 years of compilation, see article: "Member Bank Reserve Requirements -- Analysis of Committee Proposal"; published -- Feb, 5, 1938.

"In 1931 this committee recommended a radical change in the method of computing reserve requirements, the most important features of which were…"

# (2) "Requirements against debits to deposits"
# (5)"the committee proposed that reserve requirements be based upon the turnover of deposits"

This research paper was DECLASSIFIED after a 45 year hiatus on March 23, 1983. See:  

http://bit.ly/M0JB7X

Roc's in RRs may understate money turnover, Vt, for infrequently, up to 2-3 months, but forward-looking RR extrapolations are still unparalleled. And contrary to all statistical analyses, and econometric modeling, roc's in money flows can't be examined in retrospect - regression analysis, et. al. See: "Lies, damned lies, and statistics - a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments" - Wikipedia

The "unified theory" is: (1) that the non-banks are the customers of the commercial banks. Thus (2) all demand drafts originating from the NBs clear thru the CBs. (3) Bank reserves are driven by payments (bank debits). And (4) legal reserves are based on transaction type deposit classifications 30 days prior.

See: bit.ly/yUdRIZ

Quantitative Easing and Money Growth:
Potential for Higher Inflation?
Daniel L. Thornton (senior economist and V.P., FRB-STL)

"the close relationship between the growth rates of required reserves and total checkable deposits reflects the fact that reserves requirements apply only to checkable deposits"

I.e., RRs = the base for the expansion of new money and credit.

Contrary to monetary theory, and Nobel Laureate Milton Friedman, the distributed lag effects for money flows, have been observable, mathematical constants, for the last 100 years.
M*Vt = P*T; where roc's in RRs = roc's in N-gDp; a proxy for all transactions in the "equation of exchange". I.e., N-gDp is determined by the volume of goods & services coming on the market relative to the actual, transactions, flow of money. Roc's in R-gDp serves as a close proxy to roc's in total physical transactions T, that finance both goods and services. Then roc's in P, represents the price level, or various roc's in a group of prices and indices.

The distributed lag effects for both bank debits and M*Vt are not "long and variable".
The roc in M*Vt (the proxy for real-output) = 10 month delta (courtesy of Montreal, Quebec, Bank Credit Analyst's, "debit/loan ratio".

The roc in M*Vt (the proxy for inflation) = 24 month delta (courtesy of "The Optimum Quantity of Money" - Dr. Milton Friedman.

Note1: their lengths are identical (as the weighted arithmetic average of reserve ratios and reservable liabilities remains constant).
Note2: the roc's were originally derived from the G.6 release. RRs are substituted for bank debits as the proxy for M*Vt, since the G.6's discontinuance.

Manmohan Singh, Peter Stella papers on this are disingenuous. See: "Central Bank Reserve Creation in the Era of Negative Money Multipliers" S& S say that from 1981 to 2006 total credit market assets increase by 744%, while inter-bank demand deposits, IBDDs, owned by the member banks, held at their District Reserve banks, fell by $6.5 billion.

The BOG's reserve figure fell by 61% from 1/1/1994-1/1/2001. The FRB-STL's figure remained unchanged during the same period - all because the CBs ceased to be reserve "e-bound" c. 1995. S & S neglect to point out legal, fractional, reserves ceased to be binding because:

(1) increasing levels of vault cash/larger ATM networks (c. 1959 the CB's liquidity reserves began to count),
(2) retail deposit sweep programs (beginning c. 1994),
(3) fewer applicable deposit classifications (including the yearly expansion of "low-reserve tranche" and "exemption amounts" c. 1982),
(4) lower reserve ratios (c. 1980, between Dec. 1990 & Apr. 1992 the BOG reduced reserve requirements by 1/3),
(5) and, reserve simplification procedures, have combined, to remove most reserve, and reserve ratio, restrictions.
(6) CU, MSB, and S&L correspondent balances are larger than passthru accounts require for clearing payments.

Prior to c. 1995, an individual bank could theoretically create deposits up to an amount approximately equal to its excess reserve position - unused lending & investment capacity. But by mid-1995, legal, fractional, reserves ceased to be "binding" - making the system's expansion coefficient less predictable.

Note1: the BOG's figure differs from the STL FRB's figure. STL's RAM takes other factors into consideration (but there are some huge errors, e.g., Paul Volcker's version of monetarism or its "cover-up", during reconstruction).

See: http://research.stlouisfed.org/aggreg/newbase.html

Note2: The BOG apparently forgot (oops), to re-index RRs after "Reserve Simplification" was implemented.

The roc's were originally derived from the G.6 release. RRs are currently substituted for bank debits as the proxy for money flows since the G.6 release was discontinued.

The abysmal significance of this discovery (July 1979, then after the G.6 discontinuance is that all boom/busts since the Great-Depression are the Fed's fault, and that Bankrupt U Bernanke caused the Great-Recession, solely by himself (all other factors were immaterial):

As soon as Bernanke was appointed to the Chairman of the Federal Reserve, he initiated, his first "contractionary" money policy for 29 contiguous months (coinciding both with the peak in the Case-Shiller's National Housing Index in the 2nd qtr. of 2006 @ 189.93), or at first, sufficient to wring inflation out of the economy, but persisting until the economy plunged into a depression.
Note: A "contractionary" money policy is defined as one where the roc in monetary flows, our means-of-payment money times its transactions rate of turnover, is less than 2% above the roc in the real output of goods & services. For this entire 2 year period roc's in M*Vt were NEGATIVE - less than zero!

Money market & bank liquidity continued to evaporate despite the FOMC's 7 reductions in the target FFR - which began on 9/18/07. I.e., despite Bear Sterns two hedge funds that collapsed on July 16, 2007, & immediately thereafter filed for bankruptcy protection on July 31, 2007, the FED maintained its "tight" money policy, or credit easing (mix of assets), not quantitative easing (injecting new money & reserves).

The FOMC's "tight" money policy was due to flawed Keynesian dogma - using interest rate manipulation, as a monetary transmission mechanism, rather than by using open market operations of the buying type with non-bank counterparties (pre-1961 operating procedures), to expand legal reserves & the money stock.

Note: BOG's Chairman William McChesney Martin Jr., abandoned the FOMC's net free, or net borrowed, reserve targeting approach in favor of the Federal Funds "bracket racket", or using interest rates as the Fed's transmission mechanism, beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation).

On January 10, 2008 Federal Reserve Chairman Ben Bernanke pontificated: "The Federal Reserve is not forecasting a recession". Bernanke subsequently initiated the economy's coup de grâce during July 2008 (his second ultra-contractionary money policy). I.e., in December 2007, the projection in the rate-of-change in monetary flows forecast a -160 percent decline in aggregate monetary purchasing power during the 4th qtr of 2008. Note: the third contractionary policy was the introduction of the payment of interest on excess reserve balances.

I.e., Bernanke failed to initiate an "easy" money policy until Lehman Brothers later filed for bankruptcy protection (& it was one the Federal Reserve Bank of New York's primary dealers in the Treasury Market), on September 15, 2008. The next day AIG's stock dropped 60%.

Note aside: the 2 roc in M*Vt (which the FED can control - i.e., the roc in N-gDp), peaked in the 2nd qtr of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr of 2007 (or by 33%). N-gDp fell to 6% in the 3rd qtr of 2008 (another 25%). N-gDp then plummeted to a -2% in the 2nd qtr of 2009 (another - 133%).

By withdrawing liquidity from the financial markets, risk aversion was amplified, haircuts were increased, additional and/or a higher quality of collateral was required, liquidity mis-matches were multiplied, funding sources dried up, long-term illiquid assets went on fire-sale, deposit runs developed, withdrawal restrictions were imposed, forced liquidations lowered asset values, counterparties' credit default risks were magnified-- all of which contributed a general crisis of confidence & frozen financial markets (regulatory malfeasance or circumvention were subordinate factors). I.e., safe-assets were turned into impaired ones.

The naysayers "threw in the towel":

(1) In the Federal Register: "The usefulness of the FR 2573 data in understanding the behavior of the monetary aggregate has diminished in recent years as the distinction between transaction accounts and savings accounts has become increasingly blurred."
(2) And from "The Money Supply" (FRB-NY) "Chairman Greenspan added, "The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy".

Money should be defined exclusively in terms of its means-of-payment attributes. The present array of interest-bearing checking accounts has confused the distinction between means-of-payment accounts, and saving-investment accounts, and created a dilemma as to what portion, if any, of these interest-bearing accounts should be considered as savings. This dilemma is resolved when the transactions velocity of demand deposits is taken into account; i.e., deposit classifications are analyzed in terms of monetary flows. Obviously, no money supply figure standing alone is adequate as a "guide post" to monetary policy.

Scientific evidence "is proof, which serves to either support or counter a scientific theory or hypothesis. Such evidence is expected to be empirical evidence and in accordance with scientific method" - Wikipedia

Scientific method is "a method or procedure…consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses" - Wikipedia

The scientific evidence for the last 100 years is irrefutable. I.e., the trajectory in the roc (proxy for inflation indices), for M*Vt (the scientific method), projected a bottom in the inflation indices in December (signal to buy commodity ETF's and sell bonds), and an upswing beginning in Feb. 2015. Every year, the seasonal factor's map, or scientific proof, is demonstrated by the product of money flows.

The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves.

The FOMC's monetary policy objectives should be formulated in terms of desired roc's in monetary flows M*Vt relative to roc's in real-gDp - Y. Roc's in N-gDp, P*Y, can serve as a proxy figure for roc's in all transactions P*T. Roc's in real-gDp have to be used, of course, as a policy standard

Lest we are to believe the pundits (those responsible for our condition):

"I know of no model that shows a transmission from bank reserves to inflation" - DONALD KOHN - former Vice Chairman of the Board of Governors of the Federal Reserve System

"Reserves don't even factor into my model, that's not what causes inflation and not how the Fed stimulates the economy. It's a side effect." - LAURENCE MEYER - a Federal Reserve System governor from June 1996 to January 2002

Manna From Heaven


To begin with, the monetary base [sic] has never been a “base” (money multiplier), for the expansion of new money and credit. Flawed as the AMBLR figure is (Adjusted Member Bank Legal Reserves), it was superior to the Domestic Adjusted Monetary Base (DAMB) figure, which is generally cited. The DAMB figure included AMBLR (interbank demand deposits held at one of the 12 District Reserve banks, owned by the member banks, as well as “applied” vault cash, traditionally ->”prudential” or a part of a bank’s liquidity reserve balances before 1959), plus the volume of currency held by the private-sector’s non-bank public (Nobel Laureate Dr. Milton Friedman’s misnomer: “high powered money”).

Any expansion or contraction of DAMB is neither proof that the Market Group’s “trading desk” intends to follow an expansive, nor a contractive monetary policy (adding or draining interbank demand deposits, IBDDs).. Furthermore any expansion of the non-bank public’s holdings of currency, the “cash-drain” factor, merely changes the composition (but not the total volume) of the money stock. There is a shift out of demand deposits, NOW or ATS accounts, into currency. But this shifting does reduce member bank legal reserves by an equal, or approximately equal, amount.

In other words, we have a “managed” currency system, not a “fiat” one. In a fiat system the volume of currency issued is dictated by the deficit-financing requirements of the issuing government (like the Civil War Greenback). Whereas in a managed-currency system (ours), the volume of currency in circulation is impersonally determined by the public, and the amount which meets the needs of trade.

The basic process by which currency is put into and taken out of circulation is through the banking system. The volume of currency held by the public needs no formal or specific regulation since it is impossible for the public to acquire more of a given type of currency (or even less given current operating policies), without giving up other types of currency, or else bank deposits. In other words, under our managed system it is impossible for the public to add to the total money supply consequent to increasing its holdings of currency.

An expansion of the public’s holdings of currency will cause a multiple contraction of bank credit and “total checkable deposits” (relative to the increase in currency outflows from the banks) ceteris paribus. To avoid such a contraction the desk typically offsets currency withdrawals with open market operations of the buying type (e.g., purchases of government securities for the portfolios of the Reserve Banks, an increase in the Central Bank’s System Open Market Account, SOMA). The reverse is true if there is a return flow of currency to the banks. Since the trend of the non-bank public’s holdings of currency is up (ever since 1930), return flows are purely seasonal & cannot therefore provide a permanent basis for bank credit and money expansion.

And all currency gets into circulation, directly or indirectly, through the liquidation of time deposits, by the cashing of demand deposits. There is one exception in demand deposit creation; those historical instances when the U.S. Treasury borrowed from the Federal Reserve Banks (its prior, and given s
equestration,
too-long since abandoned “overdraft privilege”). However, it cannot be said (as of time-savings deposits), that increases in the public’s holdings of currency reflect prior commercial bank credit creation. It is more appropriate to say that expansions of currency are accompanied by concurrent expansions of Reserve Bank Credit (Manna from Heaven).

Although the DIDMCA of March 1980 made all depository institutions maintain uniform reserve requirements (but placed no restrictions on non-bank, MSB, CU, & S&L, correspondent clearing balances, or “pass thru” accounts), thereby expanding the “source base” from 65% of the member commercial banks to 100% of the money creating depository institutions; Paul Volcker’s unconventional reserves-based-operating-procedure” was not unsuccessful. It was untried; because the BOG attempted to target merely non-borrowed reserves, when at times, 10% of all required reserves were borrowed. I.e., $1b of legal reserves in 1980 (borrowed or otherwise), supported $16b of M1, ergo the M1 money multiplier was 16:1 (not as the FED erroneously reported: 2.5-2.6 in 1980).


I say Chairman Volcker “attempted” because legal reserves grew at a 17% annual rate-of-change, from April 1980, until the end of that year (contrary to Dr. Richard G. Anderson’s a posteriorir maligned required reserves’ reconstruction, viz., rewriting history). This, accompanied by the “time bomb” (the widespread introduction of ATS, NOW & MMDA bank accounts), presaged a 19.1% surge in N-gNp (American-owned, as opposed to a country’s geographic boundary), in the 1st qtr. 1981 (a twentieth century high “blowout”). 

Dissenting was Lawrence K. Roos, past President, FRB-STL and former part time member of the FOMC as cited in the WSJ’s “Notable and Quotable” column 4/10/86: “I do not believe that the control of money growth ever became the primary priority of the Fed. I think that there was always and still is a preoccupation with stabilization of interest rates”. The Fed's monetary transmission mechanism is non sequitur, it presumes that a “liquidity preference” curve exists which represents the supply of money. In this system, interest is the cost which must be paid, if lenders are to forgo the advantages of liquidity. All of this has little or nothing to do with the real world - a world in which interest is paid on checking accounts (the elimination of Reg. Q ceilings for commercial bankers, and the complete deregulation, “suppression” [sic] of interest rates).
Contrariwise, this so-called “experimental operating procedure” (monetarism), was never “abandoned”, it was never tried. Monetarism involves more than watching the aggregates, it involves properly controlling them. Monetarism is not identical to smoothing percolating reserve position pressures (see factors affecting reserve balances, H.4.1 release), or what Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), stated objective in his 3rd edition of “Open Market Operations” published in 1974: of “gauging the general availability of non-borrowed (interbank) reserves in the commercial banking system (which predates Paul Volcker’s rhetorical and “experimental” [sic] couched approach in Oct 1979.

One dollar of borrowed reserves provides the same legal-economic base for the expansion of the money supply as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days was immaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks. That's before the “discount” rate (perversely below the FFR during Volcker’s inflation) was made a “penalty” rate (perversely during Bernanke’s deflation), in January 2003 (see: Walter Bagehot in his book Lombard Street: "lend freely and at a penalty rate). And the Federal funds "bracket racket" was simply widened, not eliminated. Contrary to “Naked Capitalism’s” Yves Smith, monetarism has never been tried:


On October 6, 1979 Paul Volcker, Chairman, Board of Governors of the Federal Reserve System promised that the Fed was going to mend its ways. Hereafter the Fed would deemphasize the control of the federal funds rate and concentrate on holding the monetary aggregates in check. We were advised to “watch the money supply”. For approximately the first four months following this pronouncement the money supply increased at an annualized rate of 20 percent...up from the 8 percent increase in the prior five months...obviously there had been no significant change in monetary policy. 

And Paul Volcker’s version of monetarism (along with credit controls: the Emergency Credit Controls program of March 14, 1980), was limited to Feb, Mar, & Apr of 1980. With the intro of the DIDMCA, total legal reserves increased at a 17% annual rate of change, & M1 exploded at a 20% annual rate (until 1980 year-end).

Between 1942 and September 2008, member commercial banks operated with no excess legal reserves of consequence.


However, legal reserves were only “binding” between c. 1942 until 1995. By mid-1995 (a deliberate and misguided policy change by Alan Greenspan), legal (fractional) reserves ceased to be binding – as increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994), fewer applicable deposit classifications (including allocating "low-reserve tranche" & "reservable liabilities exemption amounts" c. 1982) & lower reserve ratios (requirements dropping by 40 percent c. 1990-91), & reserve simplification procedures (c. 2012), combined to remove reserve, & reserve ratio, restrictions (i.e., Chairman Alan Greenspan spuriously reduced legal reserve requirements by 40 percent to speciously / artificially counteract the July 1990-Mar 1991 recession precipitating the real-estate boom, the precursor of the GFC).  

This unleashed unrecognized inflation, money illusion (not factored into the CPI), the real-estate bubble and the dot.com boom. This growth was largely a velocity phenomenon driven by financial re-engineering, innovation, and new money substitutes (accelerating Vt – something the FOMC doesn’t discuss).

Subsequent to this period (in conjunction with the Emergency Economic Stabilization Act of 2008), Regulation D was amended, & the Board gave the District Reserve Banks the authority to pay the member banks quarterly interest on their (1) required and (2) excess reserves. As a result of the FOMC’s initiatives, QE programs, unused excess reserves expanded dramatically (absent credit worthy borrowers and a paucity of existing safe-assets, e.g., new Treasury short-term T-bill issuance, viz., Treasury-Federal Reserve corroboration). 


This new policy instrument (remunerating IBDDs), was contractionary (reminiscent of Reg. Q ceilings between the DFIs and the NBFIs), & induces dis-intermediation within the non-banks (where the non-banks shrink in size, and savings are idled, & the commercial banking system’s size remains unaffected, and new money is used as a monetary offset to an errant policy induced deceleration in AD).

In our Federal Reserve System, 92 percent of “MO” (domestic adjusted monetary base) was represented by the currency component prior to Oct. 6, 2008. There is no “expansion coefficient” assigned to the currency component. And the currency component of MO is so prominent, and the proportion of legal reserves so negligible (and declining); that to measure the rate-of-change in currency held by the non-bank public, to the rate-of-change in M1 (where 54% was currency), is, yes, to measure currency vs. currency (cum hoc ergo propter hoc); in probability theory and statistics, not a cause and effect relationship.

William Barnett (a former NASA “rocket scientist), is right, the Fed should establish a "Bureau of Financial Statistics". The data the Fed collects and compiles is unusable

Complicating the measurement of the monetary base is the fluctuation in the percentage of foreign currency circulation, to domestic currency circulation. The FED’s research staff estimates that foreigners hold one half to two thirds of all U.S. currency (this spread can result in a wide margin of error). Inflows and outflows of foreign-held U.S. currency (e.g., seldom are untaxed
earnings ever
repatriated) are attributed to political, and price, instability (as well as to seasonal flows), and all are immeasurable in the short run. I.e., the domestic monetary source base equals the monetary source base minus the estimated amount of foreign-held U.S. currency.

The “shipments proxy” estimate of foreign-held U.S. currency uses data on the receipts and shipments of currency, by denomination, at the Federal Reserve’s 37 cash offices nationwide (note: > 80 percent of foreign-held U.S. currency are $100.00 bills). Because of its influence on the DAMB, quarterly estimates of foreign-held U.S. currency are reported in the Feds “Flow of Funds Accounts of the United States” & in the BEAs estimates of the net international investment position of the United States.

The volatility of the (1) K-ratio, the public’s desired ratio of currency to transactions deposits (or currency-deposit-ratio), and the volatility in (2) the ratio of foreign-held, to domestic U.S. currency, both influence the trend rate for the cash drain factor (the movement of the domestic currency component of the DAMB). And the evidence points to sizable (& unpredictable), shifts in the money multiplier (MULT – St. Louis), for the constantly changing shifts in the composition of the “M’s”.

The Federal Reserve Bank of Chicago uses legal reserves (“t”-accounts), exclusively, to explain the creation of new money and credit in the booklet “Modern Money Mechanics”. The booklet is a workbook on bank reserves and deposit expansion (changes in a bank’s deposits-loans resulting from open market operations). The stated purpose of the booklet is to “describe the basic process of money creation in a "fractional reserve" banking system” - the monetary base plays no role at all in this analysis.

It is therefore both incorrect in theory, and thus inaccurate in practice, to refer the DAMB figure as a monetary base [sic]. The only base for an expansion of total bank credit and the money supply is the volume of legal reserves supplied to the member banks by the Fed, in excess of the volume necessary to (1) offset currency outflows from the banking system & (2) offset fluctuations in the level of member bank’s reserve balances (diverted & detained via the remuneration rate), in the 12 District Reserve Banks. The adjusted member bank legal reserve figure is that base.

The Wrong Criteria


“The exact sciences are characterized by accurate quantitative expression, precise predictions and/or rigorous methods of testing hypotheses involving quantifiable predictions and measurements.”

The money stock (& DFI credit, where: loans + investments = deposits), can never be managed by any attempt to control the cost of credit [or thru a series of temporary stair stepping or cascading pegging of policy rates on “eligible collateral”; or thru "spreads", "floors", "ceilings", "corridors", "brackets", IOeR, etc.].

Using a price mechanism (interest rates as a monetary transmission mechanism), to ration Fed credit is non-sense.Interest is the price of loanable funds / available credit (credit funded by new money and existing: foreign and domestic savings) or the Fed’s bailiwick. The price of depreciating money is the reciprocal of the price level (the free market’s bailiwick). Keynes’ liquidity preference curve (demand for money), is a false doctrine.Reserve targeting worked reasonably well until William McChesney Martin Jr., abandoned the FOMC’s net free, or net borrowed, reserve targeting position approach in favor of the Federal Funds “bracket racket” beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation).

Net changes in Reserve Bank credit (since the 1951 Treasury-Reserve Accord) were previously determined by the policy actions of the Federal Reserve. Note: the Continental Illinois bank bailout provides a spectacular example of this practice. In other words the Fed allowed the commercial bankers to change their own operating procedure, and usurp their power to regulate properly, our money stock. I.e., the FRB-NY’s “trading desk” accommodated all requests at the pegged rate.

That is, additional & costless excess reserves were made available to the banking system whenever the bankers and their customers saw an advantage in expanding loans. As long as it is profitable for borrowers to borrow and commercial banks to lend, money creation is not self-regulatory. This observation would be valid even though the Fed did not use the federal funds device as a guide to open market operations. The Fed has always been motivated by an overwhelming desire to accommodate bankers and their borrowing customers

The effect of tying open market policy to a fed funds bracket was to supply additional, & excessive, legal reserves to the banking system when loan demand increased, and vice versa.
The effect of current open market operations on interest rates (now via the remuneration rate), is indirect, varies widely over time, and in magnitude. . What the net expansion of money will be, as a consequence of a given change in policy rates, nobody knows until long after the fact. The consequence is a delayed, remote, & approximate control over the lending and money-creating capacity of the banking system.

Economists should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. – Fed. Res. Accord of Mar. 1951 was all about.

By using the wrong criteria (interest rates, rather than member bank reserves) in formulating and executing monetary policy, the Federal Reserve accidentally concocts its own output gap. 


The "administered” or actual prices would not be the "asked" prices, were they not “validated” by money flows, i.e., “validated” by the world's Central Banks.

A Flawed Monetary Transmission Mechanism

Summary

•Interest is the price of loan-funds.

•The price of money is the reciprocal of the price-level.

•Keynes' "liquidity preference curve" is a false narrative.

1.Thrust is applying a robust force.

“In economics, robustness is the ability of a financial trading system to remain effective under different markets and different market conditions, or the ability ofan economic model to remain valid under different assumptions, parameters and initial conditions.”
1.A governor, a credit controldevice, restricts a force.

A restrictive monetary policy is when the Federal Reserve slows economic growth by restricting the growth of money and credit (not demarcated by a change in interest rates).

--------------

Given no change in the Fed’s policy rate, it’s monetary transmission mechanism (interest rate manipulation), economic activity should remain unfettered, impervious to any disequilibria, any volatility, as measured by any outsized deviationin CBOE Volatility Index (^VIX).

According to Wikipedia, “VIXrepresents: a colloquially referred to as the fear index or thefear gauge.”

What is the one truistic policy instrument, the one that is responsive, predictable and impactful? May 7th 2018 will become documentary proof. Any equity decline prior to Mondaymight parallel “Black Monday”. The newspeak is now catching up to the prior economic deceleration.

Whereas using a price mechanism (pegging interest rates), to ration Fed credit is non-sense. The effect of current open market operations on interest rates(now via the remuneration rate), is indirect, varies widely over time, and in magnitude.

The Fed has capriciously emasculatedit’s “open market power”, its sovereign right to create new money and credit: at once and ex-nihilo (by remunerating IBDDs). Unlike Treasury issuance, because the belligerent bifurcation [themis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its counter-parties] is largely unpredictable, so too now is the volume and rate of expansion in the money stock on even a quarter-to-quarter basis. FOMC policy has now been undermined by turning excess reserves into bank earning assets (a monetary policy blunder that prevented a V recovery). The BOG has inadvertently thereby eviscerated all semblance of a“money multiplier.

And the money multiplier is predicated on the assumption that the commercial banks will immediately buy some type of earning asset with their “Manna from Heaven”, IBDDs. This they always did between 1942 and Oct. 6, 2008’s enactment.

But by mid-1995 (a deliberate and misguided policy change by Alan Greenspan), legal (fractional) reserves ceased to be binding– as increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994), fewer applicable deposit classifications (including allocating "low-reserve tranche" & "reservable liabilities exemption amounts" c. 1982) & lower reserve ratios (requirements dropping by 40 percent c. 1990-91), & reserve simplification procedures (c. 2012), combined to remove reserve, & reserve ratio, restrictions.

See the pundit Dr. George Selgin: “I myself don't oppose IOR as a means for limiting the implicit reserve requirement tax [sic]. IBDDs, reserves: excess, borrowed, non-borrowed, required, etc. are not a tax, they are “Manna from Heaven”, costless viz., a “helicopter drop”.

Interest on Excess Reserves: The Hobie Cat Effect - Alt-M

Past Chairman Paul Volcker thought the member banks should be paid interest on reserves "based on rounds of equity” - WSJ 1983. No joke.

A brief “run down” will indicate just how costless, indeed how profitable – to the participants, is the creation of new money (not a tax at all). If the Fed puts through buy orders in the open market, the Federal Reserve Banks acquire earning assets by creatingnew inter-bank demand deposits. The U.S. Treasury recaptures about 98% of the net income from these assets (prior to remunerating IBDDs). The commercial banks acquire “free” legal reserves, yet the bankers complained that they didn't earn any interest on their clearing balances at their District Reserve Banks.

On thebasis of these newly acquired free reserves, the commercial banks created a multiple volume of credit & money. And, through this money, they acquired a concomitant volume of additional earnings assets. How much was this multiple expansion of money, credit, & bank earning assets? Thanks to fractional reserve banking (an essential characteristic of commercial banking) for every dollar of legal reserves pumped into the member banks by the Fed, the banking system acquired about 93 (c. 2006), dollars in earningassets through credit creation.

See SA contributor: “Bank Reserves and Loans: The Fed Is Pushing On A String” - Charles Hugh Smith

Bank Reserves And Loans: The Fed Is Pushing On A String

See: “Quantitative Easing and Money Growth: Potential for Higher Inflation” – FRB-STL’s Dr. Daniel L. Thornton, Vice President and Economic Adviser

bit.ly/2viavlS

And there never has been any mention in the FOMC’s deliberations concerning money velocity.

What the net expansion of new money will be, as a consequence of a given change in policy rates, nobody knows until long after the fact. The consequence is a delayed, remote, & quasi-control over the lending and money-creating capacity of the banking system.

Economists should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. – Fed. Res. Accord of Mar. 1951 was all about.

Net changes in Reserve Bank credit (since the 1951 Treasury-Reserve Accord) are predetermined by the policy actions of the Federal Reserve. Note: the Continental Illinois bank bailout provides a spectacular example of William McChesney Martin Jr.’s “bartending”.

Reserve targeting worked well until Chairman Martin abandoned theFOMC’s net free, or net borrowed, reserve targeting position approach in favor of the Federal Funds “bracket racket” (a corridor system) beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation).

Net changes in Reserve Bank credit (since the 1951 Treasury-Reserve Accord) were previously determined by the policy actions of the Federal Reserve. In other words the Fed allowed the commercial bankersto change their own operating procedure, and usurp their power to regulate properly, our money stock. I.e., the FRB-NY’s “trading desk” accommodated all requests at the pegged policy rate.

That is, additional & costless excess reserves were made available to the banking system whenever the bankers and their customerssaw an advantage in expanding loans. As long as it is profitable for borrowers to borrow and commercial banks to lend, money creation is not self-regulatory. This observation would be valid even though the Fed did not use the federal funds device as a guide to open market operations. The Fed has always been motivated by an overwhelming desire to accommodate bankers and their borrowing customers. If private profit institutions are to be allowedthe "sovereign right" to create money, they must be severely regulated in the management of both their assets and their liabilities.

The effect of tying open market policy to a fed funds bracket was to supply additional, & excessive, legal reserves to the banking system when loan demand increased, and vice versa during downswings, e.g., Bernanke’s preliminary response to the onslaught of the GR (credit easing, not quantitative easing). I.e., during upswings, the pressure is on the top side of the Fed’s plug.

Since the member banks had no excess reserves of significance (between 1942 and Oct 6 2008), the banks had to acquire additional reserves to support the expansion of deposits, resulting from their loan expansion. If they used the Fed Funds bracket (which was typical), the rate was bid up & the Fed responded by putting though buy orders, reserves were increased, & soon a multiple volume of money was created on the basis of any given increase in legal reserves. This combined with the rapidly increasing transaction velocity of demand deposits resulted in a further upward pressure on prices. This is the process by which the Fed financed the rampant real-estate speculation that characterized the 70's.

The fed cannot control interest rates during an economic expansion, even in the short end of the market, except temporarily. And by attempting to slow the rise in a policy rate, the fed will pump an excessive volume of legal reserves into the member banks. This will fuel a multiple expansion in the money supply, increase money flows - & generate higher rates of inflation —& higher interest rates, including policy rates.


Paul Meek (FRB-NY assistant V.P. of OMOs and Treasury issues), stated objective in his 3rd edition of “Open Market Operations” published in 1974: of “gauging the general availability of non-borrowed (interbank) reserves in the commercial banking system (which incidentally predates Paul Volcker’s experimental and rhetorically couched approach in Oct 1979).

Meek described how the FRB-NY's "trading desk's" used repurchase agreements (and reverse repurchase agreements), to smooth the level of "non-borrowed" reserves.

But history was re-written (and Dr. Richard Anderson fudged the reconstruction of legal reserves, many times the Fed does not keepthe initial iterations). Paul Volcker told Congress:

"He advised the congressmen to watch the non-borrowed reserves -- "Watch what we do on our own initiative." The Chairman further added --- "Relatively large borrowing (by the banks from the Fed) exertsa lot of restraint" [sic].

Paul Volcker targeted non-borrowed reserves when at times 10 percent of all reserves were borrowed.One dollar of borrowed reserves provided the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days wasimmaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks. That's before the discount rate was made a penalty rate on 1/2003 (a penalty rate is one where the Fed fights inflation - not deflation, which was what the GFC was all about). I.e., Walter Bagehot's dictum should not have applied to the GFC. And the fed funds "bracket racket" was simply widened, not eliminated. Monetarism has never been tried.

See also: Lawrence K. Roos, Past President, Federal Reserve Bank of St. Louis & past member of the FOMC (the policy arm of theFed) as cited in the WSJ April 10, 1986 "...I do not believe that the control of money growth ever became the primary priority of the Fed. I think that there was always & still is, a preoccupation with stabilization of interest rates".

By using the wrongcriteria (interest rates, rather than member bank legal reserves) in formulating and executing monetary policy, the Federal Reserve will invariably continue to be behind any: “supply and demand for money” curve. Why? Because interest is the price of loan-funds (what the free markets dictate), the price of money is thereciprocal of the price level (the Fed’s bailiwick).

See again, George Selgin: The Hobie Cat effect can be illustrated formally using a diagram showing the supply of and demand for bank reserves or federal funds under a floor system. The supply schedule for federal funds is, as usual, a vertical line, the position ofwhich varies with changes in the size of the Fed’s balance sheet. The reserve demand schedule, on the other hand, slopes downward, but only until it reaches the going IOER rate, here initially assumed to be set at 25 basis points. At that point the demandschedule becomes horizontal, because banks would rather accumulate excess reserves that yield the IOER rate than lend reserves overnight for an even lower return.

For the initial stock of reserves R(1), starting at the equilibrium point “a,” a slight reduction in the IOER rate would suffice to get the banking system back onto the sloped part of its reserve demand schedule, at point “b,” where reserves are again scarce at the margin. But once the stock of reserves has increased to R(2), it takes a much more substantial reduction in the IOER rate — perhaps, as the move in the illustration from “c” to “d” suggests, even into negativeterritory — to make reserves scarce at the margin again, and tothereby make switching to a corridor system, by a modest further reduction in the IOER rate, possible without any need for central bank asset sales.

Interest on Excess Reserves: The Hobie Cat Effect - Alt-M

There is "no fool in the shower". Interest isthe price of loan funds. The price of money is the reciprocal of the price level.

Friedman conflated stock with flow. From Carol A. Ledenham’s Hoover Institution archives): Friedman pontificated that: “I would (a) eliminate all restrictions on interest payments on deposits, (b) make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.

Since time depositsoriginate within the banking system, there cannot be an “inflow” of time deposits and the growth of time deposits cannot per seincrease the size of the banking system.

George Selgin (who just testified before Congress) said:

“None of this would matterif the Fed acted as an efficient savings-investment intermediary, as commercial banks are able to do, at least in principle.” And: “This is nonsense, Spencer. It amounts to saying that there is no such things as 'financial intermediation,' for what you claim never happens is precisely what that expression refers to."

Or take Martin Wolf, chief economics commentator at the Financial Times writing in his book: “Charles Goodhart of the London School of Economics, doyen of British analysts of finance, responds to such suggestions as follows:

A problem with proposals ofthis kind is that they run counter to the revealed preferences of savers for financial products that are both liquid and safe, and of borrowers for loans that do not have to be repaid until some known future distant date. It is one of the main functions of financial institutions to intermediate between the desires of savers and borrowers, i.e., to create financial mismatch, to make such a function illegal seems draconian."

Take Daniel Thornton:
Re my comment: “Savings are not a source of "financing" for the commercial bankers”
Dr. Dan Thornton’s response:
Thu 3/9, 2:47 PMYou
See the graph below.
Large Time Deposits, All Commercial Banks

No, savings never equals investment. Take the “Marshmallow Test”: (1) banks create new money (macro-economics), andincongruously (2) banks loan out the savings that are placed with them (micro-economics).

Not only are the Fed's econometric models wrong, but their macroeconomic concepts reflect this. These McCarthyites have learned their catechisms, that there is no difference between money and liquid assets (the Gurley-Shaw thesis).

You will soon see the difference.

The Market Group's 6 Seasonal Inflection Points



There are 6 seasonal, endogenous, economic inflection points each year. These seasonal factors are pre-determined by the FRB-NY’s "trading desk" operations, executing the FOMC's monetary policy directives (in the present case just reserve "smoothing" and “draining” operations, the oscillating inflows and outflows, the making and or receiving of interbank and correspondent bank payments by and large using their “free" excess reserve balances).

Every year, the seasonal factor's map (economic time series’ cyclical trend), or scientific proof, is demonstrated by the product of money flows, our means-of-payment money X’s its transaction’s velocity of circulation (the scientific method).
 
Monetary flows (volume X’s velocity) measures money flow’s impact on production, prices, and the economy (as flows are driven by payments: “bank debits”). It is an economic indicator (not necessarily an equity barometer). Rates-of-change Δ, in M*Vt = RoC’s Δ in AD, aggregate monetary purchasing power. Thus M*Vt serves as a “guide post” for N-gDp trajectories.
 
N-gDp is determined by the volume of goods & services coming on the market relative to the actual, transactions, flow of money. RoC's in R-gDp serves as a close proxy to RoC's in total physical transactions, T, that finance both goods and services. Then RoC's in P, represents the price level, or various RoC's in a group of prices and indices.
 
Monetary flows’ propagation, are a mathematically robust sequence of numbers (sigma Σ), neither neutral nor opaque, which pre-determine macro-economic momentum (the → “arrow of time” or "directionally sensitive time-frequency de-compositions").
 
For short-term money flows, the proxy for real-output, R-gDp, it's the rate of accumulation, a posteriori, that adds incrementally and immediately to its running total.
 
Its economic impact is defined by its rate-of-change, Δ "change in". The RoC, is the pace at which a variable changes, Δ, over that specific lag's established periodicity.
 
And Alfred Marshall's cash-balances approach (viz., a schedule of the amounts of money that will be offered at given levels of "P"), viz., where at times "K" is the reciprocal of Vt, or “K” has the dimension of a “storage period” and "bridges the gaps of transition periods" in Yale Professor Irving Fisher’s model.
 
As Nobel Laureate Dr. Ken Arrow says: “all analysis is a model”.
 
-Michel de Nostredame