tag:blogger.com,1999:blog-2499715909956774229.post508732354151776800..comments2024-03-22T22:37:02.639-07:00Comments on Stephen Williamson: New Monetarist Economics: FOMC Minutes, June 22-23Stephen Williamsonhttp://www.blogger.com/profile/01434465858419028592noreply@blogger.comBlogger12125tag:blogger.com,1999:blog-2499715909956774229.post-44727864509676170182010-07-29T19:38:49.700-07:002010-07-29T19:38:49.700-07:00Yes, that looks pretty funny now, doesn't it? ...Yes, that looks pretty funny now, doesn't it? At the time Chari seemed convinced that the people at the Board were trying to put one over on us.Stephen Williamsonhttps://www.blogger.com/profile/01434465858419028592noreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-28214050121334440822010-07-29T14:09:49.094-07:002010-07-29T14:09:49.094-07:00Thanks for the link to Chari's testimony. Thou...Thanks for the link to Chari's testimony. Though it was primarily concerned with the state of modern macro theory, I think it would have been interesting for him to also examine some of the less technical policy/data analysis that some of its practitioners issued in the wake of the collapse of Lehman. For example, I wonder if he would have told the committee that he still stands by this analysis:<br /><br /> http://www.minneapolisfed.org/research/WP/WP666.pdfPhil Rothmanhttp://personal.ecu.edu/rothmanp/rothman.htmnoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-66344000952906612852010-07-27T23:07:35.928-07:002010-07-27T23:07:35.928-07:00Ok, late to this one, but let's start here:
&...Ok, late to this one, but let's start here:<br /><br />"Under the current circumstances, if the private sector can arbitrage across maturities, a swap of reserves for long Treasuries (or short Treasuries for long Treasuries) should not matter. Moving long rates down would have to depend on some inability to arbitrage, and I'm not sure that there is any evidence that such a friction exists."<br /><br />Allright, my ABD is in finance, and I've spent a lot of time on arbitrage (and "arbitrage", where there's really some risk, and/or an initial your-own-capital requirement, and/or something else that doesn't fit the classical definition of arbitrage).<br /><br />Now what arbitrage, or "arbitrage", are you thinking of?<br /><br />POSSIBILITY 1– Something like this:<br /><br />The Fed tries to buy down 10 year treasury rates (say currently at 3%), by purchasing lots of 10 year treasuries. So their rate (yield) then starts to drop. So, some people start saying, hey, it's not a good deal anymore, so I'll "arbitrage" by selling 10 year treasuries, and instead engaging in a plan to buy 3-month treasuries for the next 40 three month periods. <br /><br />Here's the problem: It's not really an arbitrage because 40 three-month treasuries in a row is not exactly equivalent to one ten-year treasury. With the ten-year treasury you're guaranteed an interest rate for ten full years, not just three months. If you switch to 40 three-month treasuries you take a risk of ending up with less interest after ten years than you would have gotten with the ten-year treasury. If there's risk, then it's not an arbitrage, and people won't necessarily do it unlimitedly as long as it exists. <br /><br />If the Fed starts to push down the ten-year rate with its buying, then yes, some people will engage in the above "arbitrage", but others will say it's not worth the risk. Even if the rate on ten-year treasuries drops a half point to 2.5%, it's still worth it to me to have that ten-year lock – which no other investment, combination of investments, synthetic plan, nothing else, can provide exactly, with the U.S. Government guarantee of payment.<br /><br />Thus, if the Fed wants to push the ten-year treasury rate down to 2.5% then all it has to do is buy out every investor whose reservation rate is over 2.5%. The remaining investors (and there will be some, who care enough about getting the ten year lock and know that they can't get it exactly with any substitute) will hold at an equilibrium rate of 2.5%.<br /><br />POSSIBILITY 2 – People "arbitrage" by selling U.S. ten-year bonds and buying the ten-year bonds of large foreign governments. Again, not an arbitrage, the risks of the bonds are not exactly equivalent. But in any case, this would just slow a drop in the ten-year rate, as the Fed would be pushing down the rate in a larger market, the global one for "risk-free" ten-year fixed bonds. The Fed could still push down the rate substantially, it's just that they would have to do it for the larger global market, so it would take more buying.<br /><br />So, I don't see it as a matter of frictions. It looks to me like there just aren't any real arbitrages, just "arbitrages". Thus, the Fed can buy down long term rates with enough buying.Richard H. Serlinhttps://www.blogger.com/profile/09824966626830758801noreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-5302069330968925672010-07-20T18:44:03.348-07:002010-07-20T18:44:03.348-07:00Robin Greenwood of the Harvard Business School has...Robin Greenwood of the Harvard Business School has been pursuing, in what I think is a thoughtful way, the idea that relative quantities of long and short bonds matter (as do wealth flows to different agents). Here's a link to one of his papers:<br />www.people.hbs.edu/rgreenwood/papers/bondpressure.pdfAngelonoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-43488575431602941122010-07-20T08:31:42.651-07:002010-07-20T08:31:42.651-07:00The value in the Fed swapping short for long matur...The value in the Fed swapping short for long maturity Treasuries is that private sector borrowing rates are typically keyed off longer-term Treasury rates and so flattening the term structure would encourage corporates/consumers to borrow and invest/consume.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-82026635941107346252010-07-17T17:40:14.565-07:002010-07-17T17:40:14.565-07:00I’m not an academic and not familiar with that app...I’m not an academic and not familiar with that application of MM. My intuition on MM is that a more highly leveraged debt-equity structure requires a higher cost of equity for a reduced equity component, such that the blended total cost of debt and equity capital remains the same, etc.<br /><br />The intuition isn’t as obvious to me for government debt because there is no equity account. I assume it means that different mixes of short and long term debt result in the same overall cost of debt. But the risk profile is much different. Insolvency risk isn’t comparable to the private sector case. The main risk on government debt is interest rate risk. There is no equity account, so realized risk on the cost of debt gets absorbed into future budgets and future debt rather than the realized cost of equity capital in the current period. The Fed and the government are commingled economically, so I don’t see any separate issue for the Fed’s balance sheet in this regard. Its (equity) capital account rolls up economically into the government budget and deficit.<br /><br />One other particular aspect is that term treasuries, because of their liquidity and credit quality, are quite valuable in hedging duration risk of financial institutions and convexity risk on refinancing activity in the mortgage business. So there’s supply value there that may not show up in interest rate arbitrage arguments that don’t consider this benefit directly.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-20806406621182493042010-07-17T14:13:40.565-07:002010-07-17T14:13:40.565-07:00Modigliani-Miller gives us a theorem that tells us...Modigliani-Miller gives us a theorem that tells us under what conditions the financial structure of the firm doesn't matter - and it doesn't matter because the agents holding the firm's debt and equity essentially undo the effects of changes in the firm's debt/equity ratio. All theorems concerning the irrelevance of government policies are essentially of the same character (for example, this one: http://www.jstor.org/pss/1802777). Wallace's "Modigliani-Miller Theorem for Open Market Operations" gives us conditions under which open market operations are irrelevant. This gives us a starting point for thinking about why open market operations matter. Similarly, if someone is telling me that it matters if the Fed swaps short Treasuries for long Treasuries, this must be due to the failure of some MM theorem (the financial of the structure of the Fed matters), and I want to know exactly what the failure is.Stephen Williamsonhttps://www.blogger.com/profile/01434465858419028592noreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-64625335951239070622010-07-16T21:09:49.536-07:002010-07-16T21:09:49.536-07:00“You'll have to explain this one.”
I’m not su...“You'll have to explain this one.”<br /><br />I’m not sure what it means to suggest the private sector undo the effects on term structure or why you would suggest or expect that. The private sector can’t replace the credit and liquidity characteristics of a US treasury. And I’m afraid I don’t understand how MM is applicable in this context.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-74116494400795189432010-07-16T14:17:02.224-07:002010-07-16T14:17:02.224-07:00Yes, he just sent it to me.Yes, he just sent it to me.Stephen Williamsonhttps://www.blogger.com/profile/01434465858419028592noreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-62988735788227681662010-07-16T13:46:46.945-07:002010-07-16T13:46:46.945-07:00This paper by Chris Neely:
http://research.stloui...This paper by Chris Neely:<br /><br />http://research.stlouisfed.org/wp/2010/2010-018.pdf<br /><br />suggests that the Fed's purchases of Treasuries (and other stuff) with long maturity brought down long-term rates. It would be interesting to see your thoughts on this finding.Phil Rothmanhttp://personal.ecu.edu/rothmanp/rothman.htmnoreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-44121674952065180522010-07-16T07:32:18.806-07:002010-07-16T07:32:18.806-07:001. Yes, apparently I wasn't paying much attent...1. Yes, apparently I wasn't paying much attention.<br />2. You'll have to explain this one. If the Fed swaps short maturity Treasuries for long maturity ones, why doesn't the private sector undo any effects this would have on the term structure? Why doesn't Modigliani-Miller work here? <br />3. Sure. The Fed has a monopoly on supplying currency, and thus it profits from issuing currency and buying other assets. My argument didn't involve the Fed making negative profits, just having profits go down. How much profits go down of course depends.Stephen Williamsonhttps://www.blogger.com/profile/01434465858419028592noreply@blogger.comtag:blogger.com,1999:blog-2499715909956774229.post-20695593462408859292010-07-15T19:25:20.153-07:002010-07-15T19:25:20.153-07:00The manager of SOMA is about the first person ment...The manager of SOMA is about the first person mentioned in the minutes of every Fed meeting for the past few decades or so.<br /><br />Reduce the supply of long Treasuries and you'll tend to have an effect on yield. Arbitrage doesn't mean prices don't respond to supply.<br /><br />Zero cost currency is a partial buffer for balance sheet interest rate risk.Anonymousnoreply@blogger.com