The model seems presumptuous that government can set the interest rate and fund the government at that rate. Why would we believe this?
Consider the extreme case of the funds rate being set to zero. When the US government auctions hundreds of billions of bills, the market is going to bid a non-zero interest rate. The alternative is the central bank prints money to buy the government debt offering and this money printing makes bonds less desirable.
I think it is an interesting test of monetary policy to have Treasury issuing debt at the short end all while the central bank claims the power to set the overnight funding rate. Maybe the market will accept the fairy tale on interest rates. Will asset prices / inflation confirm this story or press higher?
Frankly, I think the politicians and government paid economists believe in the free lunch and this idea of funding government with short term debt / loans is proof. Rather than reduce the debt burden by cutting spending, we have financial engineering. Even if it works in the short term, eventually the market is going to be stuffed to the gills with bills and demand a much higher interest rate to buy more of them.
The government can always set the nominal rate, by just offering to freely buy and sell debt at that rate. However, it cannot control inflation and thereby the real rate of interest that it pays on the debt.
John, the TGA is funded with a trillion dollars. Is Bessent at cross purposes after Warsh indicated a rate increase? I suspect Scott is betting, along with his purchases, passive bond fund bids will amplify a rate decline. Of course there are also sellers. My guess, 30y rates, 15y duration, reach market equilibrium at 5%. Especially with 30y TIPS at 3.05% real yield. As on old bond trader who gets his information from markets in terms of real world expectations, I fail to see how your well reasoned models would be implemented by gov officials. IMHO, I think a 2% inflation target is unrealistic, given the budget deficit, 40t debt and the war. The bond markets, in terms of SDF, are skeptical of Bessent's long-term bond buyback program to lower long rates.
Coherent and the Fed is an oxymoron. Forget the model. Liquidate the entire portfolio. Abolish legal tender laws. Substitute privately-provided deposit insurance instead of federally-insured deposits. Each bank can decide the limits or to not offer deposit insurance at all. Allow depositors to decide for themselves. Now we need no Fed. No FDIC. No bailouts. And stop pretending that the Fed or any institution of so-called experts will ever know what the "right" interest rate. Nor the myth that bank regulators can price risk better than markets. And that anyone who has the right to vote has also earned the obligation deposit wisely. The people who have the right to choose who governs all of us should also have the obligation to govern themselves. BTW. I am capable of writing better but then I will be confused with AI. So I take my draft. Convert my writing to be clumsier. And then, voila, Pangram now thinks I wrote the final version when, in fact I also wrote the first draft. I am teaching myself to make more grammatical mistakes. The more polished I write the more I am confused as being AI. Or maybe it is AI being confused with me?
You’re forgetting why central banks were invented. If we adopt your structure there will be a bank run, the gov will be blamed and the Fed will be created again.
The Fed was invented in the USA not to bail-out depositors but to bail out the banks and the bankers. It has been extended to bail-out depositors. All of them. And then even that got extended.
The FDIC should lower deposit insurance back to 100,000. Banks don't lend deposits. All bank-held savings are unused and unspent. Just like the FDIC's drop in unlimited transaction's deposit insurance in Dec. 2012 (which caused the taper tantrum et. al.), lowering rates would increase the supply of loanable funds but not the supply of money. It would not decrease the size of the payment's system. It would raise the real rate of interest while lowering long-term rates.
Link the late: Dr. Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series:
“Monetary Policy: Why Money Matters and Interest Rates Don’t”
Thornton: “the interest rate is the price of credit, not the price of money”
“Today “monetary policy” should be more aptly named “interest rate policy” because policymakers pay virtually no attention to money.”
The current central bank model is clearly broken. On the other hand, the DEFI industry is scaling up and serving the market and customers where banks cannot.
Of course the problem with DEFI is when the firm promising above market returns on deposits liquidates and leaves depositors empty. Then that becomes a political problem and government will respond with more regulations.
So there needs to be deposit insurance. Question is how to provide it and who pays.
I do not believe in subsidized insurance schemes and we should have more than enough evidence that it also becomes a political problem to insure deposits above the stated limit. Your comment incentivizes rent-seeking behavior and a rent-seeking society. Privatizing profits. Socializing losses. Within the context of a captured political system.
Insurance can be a private market good and persons gladly purchase insurance of their free will (life insurance being the perfect example of this). If one is inclined to purchase life insurance, it reasons one will be inclined to purchase deposit insurance. Or, as will likely happen, the financial institution will purchase such insurance and offer it to clients.
The charts published with this Substack article, and the earlier Substack article and essay, are artifacts of your assumed functions for the integrand in the so-called "Lucas Phillips Curve" you propose. A literature search failed to find any Phillips Curve of that kind associated with Lucas's published works. Furthermore, it is doubtful that the model you advance would find support in the empirical data should you ever choose to attempt to verify the model and its assumptions through a rigorous econometric analysis of current or past time series data. The charts look convincing, but the underlying model is not.
Interesting argument. It makes me wonder whether the deeper issue is actually the fiscal constraint rather than the maturity structure of government debt.
If persistent deficits are left unchanged, shortening the maturity structure may alter the monetary transmission mechanism, but it doesn’t remove the underlying fiscal pressure.
Wouldn’t the more fundamental question be whether fiscal institutions can be designed so that monetary policy does not have to compensate for an independently unconstrained fiscal policy?
Donald Trump wants to cut interest rates now as well. He also said he’d get Gov spending under control. He failed the second point, so I’m skeptical of the first, regardless of your proposed mechanism to enable it.
It's funny how when a republican administration wants to do something completely wild and outside the consensus of mainstream economics like lower interest rates to reduce inflation, you're open to it despite no empirical evidence, but if there's a left wing idea that's even slightly up for debate (e.g. raising taxes on the wealth) your attitude is "no! never!". You are so hypocritical.
I don't quite get why issuing short-termed debt reduces output, and hence, ultimately, helps to estabilise inflation. Thanks in advance if you can comment on this
IDK - the neo-Fisherian argument rolled out post-Pandemic was that high short-term rates, particularly benefiting those in the 50th wealth percentile and higher was underpinning spending, via a wealth effect channel. Thus, a symetrical view of the world might expect that lowering rates would cause lower spending and slow the economy, which in a traditional sense is counterintuitive, but maybe things are different these days.
Frequent salivary progesterone monitoring provides a dynamic curve of luteal phase adequacy without requiring daily venipuncture. The clinical challenge is controlling for salivary flow rate and oral microbiome enzymatic breakdown during rapid assay processing.
I understand the theory point, but doesn’t this need to be more properly calibrated to the actual US economy to make more accurate predictions? Or is this approximately calibrated?
The correct response to stagflation is the 1966 Interest Rate Adjustment Act. “while the aggregate of time and demand deposits continued to increase after July, the proportion of time to demand deposits diminished. Whereas time deposits were 105 percent of demand deposits in July, by the end of the year, the proportion had fallen to 98 percent. These were all desirable developments.” - as banks don't lend deposits.
It is with the April through October period that we are most concerned. During this period the Federal Reserve forced an actual reduction in member bank legal reserves, down about $1 billion from a level of approximately $24 billion.
The Reserve authorities allowed bank credit to expand during 1966 by $19.7 billion, or at an annual rate of approximately 6 per cent. This compares to an annually compounded rate of increase of approximately 7 per cent in the preceding ten years, and a rate of about 5 percent for the entire period since World War II.
M1 peaked @137.2 on 1/1/1966 and didn’t exceed that # until 9/1/1967. Deposit rates of banks decreased from a high range of 5 1/2 to a low range of 4 % (albeit not enough). A .75% interest rate differential was given to the nonbanks.
And during this period, the unemployment rate was unchanged, and the inflation rates fell (3.5 to 2.3) and real interest rates rose (1.5 to 3) for saver-holders.
Makes sense when you consider the forward pricing formula. Inventory costs are higher over time with higher risk free rates resulting in the need for higher prices.
So the risk is of course that the risk premium shots up. This could be because of bad reasons (the market participants don’t believe your correct model) and good reasons (e.g., increased roll-over risk). Then there is the question of whether Treasurys of different maturities are sufficiently close substitutes, especially with large volume changes: I think it’s plausible that different investors demand different Treasury maturities and for different reasons.
If you think from a simple fiscal theory intuition, you might just think: this is another step of avoiding a hard and sustainable fiscal plan. This could be a signal of lower future primary surpluses and thereby raise the price level. Then we are talking about independence again.
Can the Fed control the price of oil? Can inflation be reduced to less than 3% given the amount of social spending baked into the Federal budget? What is current view on the money supply regarding inflation? How can productivity be increased when all government spending equals almost 50% of GDP?
The model seems presumptuous that government can set the interest rate and fund the government at that rate. Why would we believe this?
Consider the extreme case of the funds rate being set to zero. When the US government auctions hundreds of billions of bills, the market is going to bid a non-zero interest rate. The alternative is the central bank prints money to buy the government debt offering and this money printing makes bonds less desirable.
I think it is an interesting test of monetary policy to have Treasury issuing debt at the short end all while the central bank claims the power to set the overnight funding rate. Maybe the market will accept the fairy tale on interest rates. Will asset prices / inflation confirm this story or press higher?
Frankly, I think the politicians and government paid economists believe in the free lunch and this idea of funding government with short term debt / loans is proof. Rather than reduce the debt burden by cutting spending, we have financial engineering. Even if it works in the short term, eventually the market is going to be stuffed to the gills with bills and demand a much higher interest rate to buy more of them.
The government can always set the nominal rate, by just offering to freely buy and sell debt at that rate. However, it cannot control inflation and thereby the real rate of interest that it pays on the debt.
John, the TGA is funded with a trillion dollars. Is Bessent at cross purposes after Warsh indicated a rate increase? I suspect Scott is betting, along with his purchases, passive bond fund bids will amplify a rate decline. Of course there are also sellers. My guess, 30y rates, 15y duration, reach market equilibrium at 5%. Especially with 30y TIPS at 3.05% real yield. As on old bond trader who gets his information from markets in terms of real world expectations, I fail to see how your well reasoned models would be implemented by gov officials. IMHO, I think a 2% inflation target is unrealistic, given the budget deficit, 40t debt and the war. The bond markets, in terms of SDF, are skeptical of Bessent's long-term bond buyback program to lower long rates.
It's funny how the prime role of interest rates has switched from fine-tuning tool of the economy to one hundred per cent inflation control knob.
Coherent and the Fed is an oxymoron. Forget the model. Liquidate the entire portfolio. Abolish legal tender laws. Substitute privately-provided deposit insurance instead of federally-insured deposits. Each bank can decide the limits or to not offer deposit insurance at all. Allow depositors to decide for themselves. Now we need no Fed. No FDIC. No bailouts. And stop pretending that the Fed or any institution of so-called experts will ever know what the "right" interest rate. Nor the myth that bank regulators can price risk better than markets. And that anyone who has the right to vote has also earned the obligation deposit wisely. The people who have the right to choose who governs all of us should also have the obligation to govern themselves. BTW. I am capable of writing better but then I will be confused with AI. So I take my draft. Convert my writing to be clumsier. And then, voila, Pangram now thinks I wrote the final version when, in fact I also wrote the first draft. I am teaching myself to make more grammatical mistakes. The more polished I write the more I am confused as being AI. Or maybe it is AI being confused with me?
You’re forgetting why central banks were invented. If we adopt your structure there will be a bank run, the gov will be blamed and the Fed will be created again.
The Fed was invented in the USA not to bail-out depositors but to bail out the banks and the bankers. It has been extended to bail-out depositors. All of them. And then even that got extended.
The FDIC should lower deposit insurance back to 100,000. Banks don't lend deposits. All bank-held savings are unused and unspent. Just like the FDIC's drop in unlimited transaction's deposit insurance in Dec. 2012 (which caused the taper tantrum et. al.), lowering rates would increase the supply of loanable funds but not the supply of money. It would not decrease the size of the payment's system. It would raise the real rate of interest while lowering long-term rates.
Link the late: Dr. Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series:
“Monetary Policy: Why Money Matters and Interest Rates Don’t”
Thornton: “the interest rate is the price of credit, not the price of money”
“Today “monetary policy” should be more aptly named “interest rate policy” because policymakers pay virtually no attention to money.”
The current central bank model is clearly broken. On the other hand, the DEFI industry is scaling up and serving the market and customers where banks cannot.
Of course the problem with DEFI is when the firm promising above market returns on deposits liquidates and leaves depositors empty. Then that becomes a political problem and government will respond with more regulations.
So there needs to be deposit insurance. Question is how to provide it and who pays.
I do not believe in subsidized insurance schemes and we should have more than enough evidence that it also becomes a political problem to insure deposits above the stated limit. Your comment incentivizes rent-seeking behavior and a rent-seeking society. Privatizing profits. Socializing losses. Within the context of a captured political system.
Insurance can be a private market good and persons gladly purchase insurance of their free will (life insurance being the perfect example of this). If one is inclined to purchase life insurance, it reasons one will be inclined to purchase deposit insurance. Or, as will likely happen, the financial institution will purchase such insurance and offer it to clients.
The charts published with this Substack article, and the earlier Substack article and essay, are artifacts of your assumed functions for the integrand in the so-called "Lucas Phillips Curve" you propose. A literature search failed to find any Phillips Curve of that kind associated with Lucas's published works. Furthermore, it is doubtful that the model you advance would find support in the empirical data should you ever choose to attempt to verify the model and its assumptions through a rigorous econometric analysis of current or past time series data. The charts look convincing, but the underlying model is not.
Cut rates and front-load inflation?? Why Marr the economy??!! (hint: Weimare)
Interesting argument. It makes me wonder whether the deeper issue is actually the fiscal constraint rather than the maturity structure of government debt.
If persistent deficits are left unchanged, shortening the maturity structure may alter the monetary transmission mechanism, but it doesn’t remove the underlying fiscal pressure.
Wouldn’t the more fundamental question be whether fiscal institutions can be designed so that monetary policy does not have to compensate for an independently unconstrained fiscal policy?
Donald Trump wants to cut interest rates now as well. He also said he’d get Gov spending under control. He failed the second point, so I’m skeptical of the first, regardless of your proposed mechanism to enable it.
It's funny how when a republican administration wants to do something completely wild and outside the consensus of mainstream economics like lower interest rates to reduce inflation, you're open to it despite no empirical evidence, but if there's a left wing idea that's even slightly up for debate (e.g. raising taxes on the wealth) your attitude is "no! never!". You are so hypocritical.
I think it is fairly normal for people to do what their employer demands.
very true
I don't quite get why issuing short-termed debt reduces output, and hence, ultimately, helps to estabilise inflation. Thanks in advance if you can comment on this
IDK - the neo-Fisherian argument rolled out post-Pandemic was that high short-term rates, particularly benefiting those in the 50th wealth percentile and higher was underpinning spending, via a wealth effect channel. Thus, a symetrical view of the world might expect that lowering rates would cause lower spending and slow the economy, which in a traditional sense is counterintuitive, but maybe things are different these days.
Frequent salivary progesterone monitoring provides a dynamic curve of luteal phase adequacy without requiring daily venipuncture. The clinical challenge is controlling for salivary flow rate and oral microbiome enzymatic breakdown during rapid assay processing.
I understand the theory point, but doesn’t this need to be more properly calibrated to the actual US economy to make more accurate predictions? Or is this approximately calibrated?
The 1966 Interest Rate Adjustment Act lowered interest rates. And there was no recession.
The correct response to stagflation is the 1966 Interest Rate Adjustment Act. “while the aggregate of time and demand deposits continued to increase after July, the proportion of time to demand deposits diminished. Whereas time deposits were 105 percent of demand deposits in July, by the end of the year, the proportion had fallen to 98 percent. These were all desirable developments.” - as banks don't lend deposits.
It is with the April through October period that we are most concerned. During this period the Federal Reserve forced an actual reduction in member bank legal reserves, down about $1 billion from a level of approximately $24 billion.
The Reserve authorities allowed bank credit to expand during 1966 by $19.7 billion, or at an annual rate of approximately 6 per cent. This compares to an annually compounded rate of increase of approximately 7 per cent in the preceding ten years, and a rate of about 5 percent for the entire period since World War II.
M1 peaked @137.2 on 1/1/1966 and didn’t exceed that # until 9/1/1967. Deposit rates of banks decreased from a high range of 5 1/2 to a low range of 4 % (albeit not enough). A .75% interest rate differential was given to the nonbanks.
And during this period, the unemployment rate was unchanged, and the inflation rates fell (3.5 to 2.3) and real interest rates rose (1.5 to 3) for saver-holders.
Makes sense when you consider the forward pricing formula. Inventory costs are higher over time with higher risk free rates resulting in the need for higher prices.
Imagine the shock waves in commodity and option markets when they calculate the new long-run carrying costs.
It would be nice if you would address things like this https://www.reuters.com/business/trump-says-if-fed-doesnt-cut-rates-hell-stop-trading-with-some-nations-2026-09-04/ with the same scorn and ridicule you would had someone on the left said something similar.
But that is not what he is paid to do. Why do you expect anything different?
So the risk is of course that the risk premium shots up. This could be because of bad reasons (the market participants don’t believe your correct model) and good reasons (e.g., increased roll-over risk). Then there is the question of whether Treasurys of different maturities are sufficiently close substitutes, especially with large volume changes: I think it’s plausible that different investors demand different Treasury maturities and for different reasons.
If you think from a simple fiscal theory intuition, you might just think: this is another step of avoiding a hard and sustainable fiscal plan. This could be a signal of lower future primary surpluses and thereby raise the price level. Then we are talking about independence again.
Can the Fed control the price of oil? Can inflation be reduced to less than 3% given the amount of social spending baked into the Federal budget? What is current view on the money supply regarding inflation? How can productivity be increased when all government spending equals almost 50% of GDP?