In “The Biggest Myth About the Fed,” David Beckworth, an assistant professor of economics at Western Kentucky University, suggests that the pessimists are wrong to be concerned about what Mr. Bernanke and Co. are up to.
There many myths about Fed policy over the past few years, but the biggest one has to be that the Fed has been monetizing the national debt. This simply is not true, but it does not stop some folks from making this claim. For example, at last week’s Cato Monetary Conference we find former Fed officials pounding the Fed-is-monetizing-the-debt drums:
Mr Warsh and Mr Poole (who was filling in for Allan Meltzer) made a sharp distinction between the “legitimate” efforts to fight the crisis and the subsequent easing actions that were, allegedly, unjustified by the economic fundamentals. According to them, the interventions of 2007-2009 were required to ensure that “the markets could clear”, as Mr Warsh put it, while the second round of easing was done to satisfy “political masters” by monetising the debt. In fact, Mr Warsh said that the Fed was being actively unhelpful by “crowding in” Congress’s supposedly poor policy choices.
My first response is how can they can say this with historically-low U.S. Treasury yields and muted inflation expectations? Surely, if the Fed were truly monetizing the debt we would be seeing a 1970s-repeat in the bond market, but we are not. And this is happening, in part, because the Fed is not that big of a Treasury purchaser.
Consider the figure below. It shows the Fed’s stock of Treasuries by remaining maturity compared to the total stock of marketable Treasuries as of the end of October, 2012. Though the Fed’s share of Treasuries increases by remaining maturity, at most it hits 32% of the total for 10-30 years category.
That means that after many months of Operation Twist, roughly 68% of long-term Treasuries are still held outside the Fed. Overall, the Fed holds about 15% of marketable Treasuries as seen in the “All Years” category. It is hard to square these numbers with the allegations that the Fed is monetizing the debt.
Leaving aside the questions of whether:
- the Fed’s share of the Treasury market will remain as low as it is now if other investors start heading for the hills;
- the central bank’s current intentions with respect to their securities holdings will remain the same if the economic, financial, political, or social landscape changes for the worse; or,
- we can really know for sure that the debt has been monetized until after the fact;
By this sort of logic:
- Mid-2005 was the right time to be optimistic on housing
- January-2007 was the right time to be optimistic on the banking sector
- The spring of 2007 was the right time to be optimistic on credit markets
- The fall of 2007 was the right time to be optimistic on global equity markets
- Mid-2008 was the right time to be optimistic on commodities
- This past September was the right time to be optimistic on technology stocks