What The FOMC Should Do? Don’t Be Corrupt

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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(Image Courtesy: National Public Radio)

In 2010, I was asked by a senior executive of the Board of Governors of the Federal Reserve System “[not to] tell them what they should do.” I was a mid-level government civil servant, unconstrained and, I thought, protected by the law then but for the ruffling feathers and bureaucratic policies constrained by the law.

The chickens have come home to roost, feathers ruffled and shorn in a fluffy blanket on the floor of the organic free range on Constitution Avenue in Washington, D.C., for the Federal Open Market Committee (FOMC) of 19 members from across the 13 regions of the United States’ Federal Reserve System (FRS) muffled by the economic condition they are facing. It is time to tell them once again what they should do to constrain them to a cage before the slaughter should they not listen.

The central bank of the United States of America has a simple job to do, whatever may be the rosy delusions of Rosengren, President of the Federal Reserve Bank of Boston, as reported in the press, about his desire to continue Operation Twist as if this decade is the roaring Twenties before it could end in a thud as it had once done in October of 1929, instead of a bang as it should.

Financial institutions borrow short, beginning at the mouth of the money river – at the Fed in New York after the prime directive is issued in Washington, and lend long in cascading layers which make up the financial value chain. The profit in banking is in the spread, the difference between the long rate for investment on Main Street and the short rate of borrowing on Wall Street a.k.a monetary transmission mechanism.

Lower long rates could perhaps help lower the borrowing costs of the government (interest paid on outstanding government bonds in the Daily and Monthly Treasury Statements) and help the Fed meet its Congressional mandate on moderate long rates under the misguided and complacent presumption that economic and political risks to the United States of a run on its debt and currency are low for the government to keep borrowing more in ever higher debt ceilings.

How moderate is moderate?

Long rates must rise for the spread to be sufficiently attractive for Wall Street bankers to  lend to businesses to use existing unused capacity and to build new capacity for hiring more workers for the purpose of lowering unemployment sooner than later.

The FOMC’s prime directive should be for the Fed, not the US Treasury, to begin selling, not buying long bonds, to take the cash back to the burn bins beginning April 1, 2013, after the first quarter of 2013, 9 months from now, in accordance with the time tested heuristic of Milton Friedman’s period of monetary transmission.

The FOMC should transparently telegraph its intent of steadily raising the Federal Funds Rate by 25 basis points or 0.25% at every FOMC meeting at the Fed’s next press conference to take the Fed-member overnight inter-bank borrowing cost by end-2014 to 3.5% to maintain stable prices in a growing and recovering economy while highlighting the downside risks to the economy due to continued budget deficits and ever higher national debt.

Doing so will raise the long rate because of the glut of long bonds in the market. Bond investors will ask for a higher yield from the Treasury notwithstanding the government’s freeze of all future borrowing by fixing the budget constraint at the nominal dollar level of the 2012 budget should it materialize (it may not).

What do I know, except that more bonds on the Fed balance sheet means more in Fed income. Fed employees want to make more money for themselves, free to send back to the Treasury whatever is remaining after the institution’s bloated operating expenditures. Lower rate for Wall Street implies promotions and bonuses for Fed economists, no matter where that money goes. Who cares if Americans are unemployed in droves?

The American taxpayer is paying the price for the Fed’s independence by borrowing from China to pay Saudi Arabia.


About Chandrashekar (Chandra) Tamirisa

This entry was posted in Economics, Fiscal Policy, Monetary Policy, Transformations LLC and tagged . Bookmark the permalink.

2 Responses to What The FOMC Should Do? Don’t Be Corrupt

  1. Faisal J. • Chandra, From your magazine, “US economy must be reflated back to the 2 to 5% headline range not by loosely-coupling financial assets from real assets (or more technically lowering the correlation between real economic growth rates and financial asset price growth rates) to prop up consumption by wealth effect as a substitute for higher domestic real investment and growth beyond the medium term but by forcing structural change from now into the long term through a more intrusive monetary policy in accordance with the FRA.”

    Why do we need a negative growth? Why not set r=o and let the fantasy-capitalism die. And everything and anything that can bootstrap itself will stay. And others who are heavily leveraged will know the price of “real” growth. My issue is with contraction and with false-hope through leverage under uncertainty. For true-economic-growth r=o and no outside interference in the market except for security and transparency. What do you think?
    30 minutes ago• Like• Reply privately• Flag as inappropriate

    Chandrashekar Tamirisa • Faisal, the current US growth rate is positive 1.9% in Q1 2012. r is negative because pi is 2 and i is 0.

    To set r = 0, i = pi.

    It is feasible provided raising i, for example, from 0 to 2 keeps pi at 2. It should not slow down the economy and lower pi. Typically, the immediate effect of raising rates is a slowing economy.

    At expected growth rates of 0.6 to 1% at 0% nominal interest rate, raising rate to 2% will slow the economy down into a recession by a probability of at least 50%.

    It depends on how any rate increase is communicated to the markets over the next year or so. I am all for it in US given the rise in energy and food prices but it is a tight rope walk.

    The Fed must focus on inflationary risks while conditioning the investment portfolios of its primary dealers over the next 18 months or so, something Bernanke has not done thus far.

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