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Mar 29, 2023Liked by Marcus Nunes

The analysis is well done, persuasive and clear. But the policy prescription at the very end assumes skilled expertise by an omniscient FOMC staff in manipulating undefined Fed tools. It also assumes the staff's willingness to ignore their precious Phillips Curve models (which never predict anything).

The Fed controls the quantity of bank reserves and currency, not what banks and the public do with them. The Fed cannot regulate the stock or flow of specific Ms (which depend on choices of households, firms, and banks), and they cannot predict velocity (ditto).

If given a mandate to somehow make sure "NGDP growth rises at a 4%-5% click" the Fed would put the IOR rate much higher than that to raise unemployment, curb bank lending, shrink investor wealth, and thwart private borrowing. That can indeed create recessions, but the Fed always eases like crazy in recessions, so the result is more instability, not stability.

Countries with sustained low inflation like Switzerland or Japan never have high interest rates, while countries with high inflation always do. But the Fed is Wicksellian not Fisherian. Whatever target you give them, they'll try to hit it hard with their beloved sledgehammer - the fed funds rate.

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Alan, I agree ! The funny thing about the "policy prescription" is:

1. It was widely discussed during the Dec 82 FOMC (In 1994, Governor Lindsey mentions the need to keep NGDP growth stable)

2. It was again discussed in the AG Fed in one of the 92 Meetings

3. For long periods of time, the Fed managed to keep NGDP growth stable (even if after the GR the Level and growth rate was lower

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re: "The Fed controls the quantity of bank reserves "

That's wrong. By mid-1995 (a deliberate and misguided policy change by Alan Greenspan in order to jump start the economy after the July 1990 –Mar 1991 recession), legal, fractional, reserves (not prudential), 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), & reversion back to lagged reserve requirements on July 30, 1998, combined to remove reserve, & reserve ratio, restrictions.

This was the direct cause of the GFC, the boom in real-estate.

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re: "The Fed cannot regulate the stock or flow of specific Ms"

That's wrong. as Friedman pontificated: From Carol A. Ledenham’s Hoover Institution archives:

“I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.

Under monetarism, the monetary authorities use two tools to control the money supply — legal reserves and reserve ratios. If these tools are to be effective, all legal reserves of all money creating institutions have to be in a form which the monetary authorities can quickly ascertain and absolutely control.

The only type of bank asset that fulfills this requirement is interbank demand deposits in the District Reserve banks owned by the member banks (like the ECB).

Similarly, the monetary authorities have to have complete discretion over changes in reserve ratios. This is essential since under fractional reserve banking (the essence of commercial banking) these ratios determine the minimum volume of legal reserves a bank must hold against a specific volume and type of deposit liability.

Policy should limit all reserves to balances in the Federal Reserve banks (IBDDs), & have UNIFORM reserve ratios, for ALL deposits, in ALL banks, irrespective of size.

As I said in response to Powell removing legal reserves: “The FED will obviously, sometime in the future, lose control of the money stock.” May 8, 2020. 10:38 AMLink

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re: "and they cannot predict velocity"

That's wrong. William Bretz of Juncture Recognition repeatedly notified Ed Fry of errors in the debit series.

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The U.S. was already headed into negative R-gDp growth in the 1st qtr. of 2020. Monetary policy had already hit historical levels by early 2021. Nothing's changed in > 100 years.

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