1. Monetary Policy: Contemporary Issues
ECO Dr. Dennis Foster
W.A. Franke College of Business

2. Monetary Policy: Contemporary Issues
Heading into crisis II
The bank failures
III
Fed inaction & action IV
What has the Fed accomplished? V
The problem with policy VI
The Austrians & rethinking policy

3. What does the Fed Want?
A healthy & strong economy with low unemployment and low inflation.
I. Heading into crisis
Policy? Stimulate spending by reducing interest rates.
Why? They are Keynesians.
Effect? Creates housing boom.

4. Federal Funds rate of interest, 1995 to 2004

5. Median home prices, 1999 to 2006

6. Home sales, 1999 to 2006
Sept. 2005

7. Was Bear TBTF? What about Lehman?
The Bear Stearns Story
$ week high prior to collapse.
Lost billions in subprime market.
March Assets/equity = 35
3/13/08 – Cash  from $10 b. to $2 b.
3/14/08 – Fed lends $13 b. for 3 days.
JP Morgan deal - $2 per share!
Fed creates Maiden Lane LLC
Fed loans ML $30 b.
JPM “sells” bad assets to ML.
II. The bank failures
$400 b.
Assets
$10!!
Was Bear TBTF? What about Lehman?

8. The Three Failures: IndyMac WaMu Lehman
Spun off from Countrywide.
Not a “mac”
Overleveraged on “Alt A” loans.
WaMu
Shut down 100’s of offices
Sub-prime victim.
Final 10 days lost $17 b. in cash w/d
Lehman Brothers
Losses = $7 b. in Q2 & Q3
Final day: $1 b. in cash
$32 b.
Assets
$300 b.
Assets
$640 b.
Assets

9. Did the Fed see this coming?
"At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."
-March 2007
"It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions."
-October 2007
"House prices have risen by nearly 25 percent over the past two years… [T]hese price increases largely reflect strong economic fundamentals."
-October 2005
"We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize…”
-July 2005
"The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."
-June 2008
"The Federal Reserve is not currently forecasting a recession."
-January 2008
III. Fed inaction & action

10. What did the Fed do? Quantitative Easing. Raise the money supply
Buy Treasuries.
Buy MBS.
Boost short term lending.
Raise the money supply
Lower interest rates.
"One myth that’s out there is that what we’re doing is printing money. We’re not printing money."
-December 2010

11. 5.25% 2.41% Federal Funds rate of interest, 2004 to 2019
4/2019
2.41%
IV. What has the Fed accomplished?

12. Housing Revisited
Home sales, 1999 to 2015
March 2019
5.21 mill.

13. Housing Revisited
Median home prices, 1999 to 2015
March 2019
$259,400

14. V. The problem with policy
What has the Fed done?
Has it maintained the value of the dollar?
Has it stabilized the economy?
Has it reduced moral hazard?
Has it lessened distributional problems?
Is the risk of inflation gone?
V. The problem with policy

15. The Case of the Missing Inflation

16. What is the exit strategy?
The FED will have two choices:
Continue policy  hyperinflation
Halt policy  recession
Or Wage/Price controls?

17. VI. The Austrians & rethinking policy
The Austrian School of Thought
Recessions are the solution, not the problem!
Keynesian policy -  interest to spending.
Leads to misallocation of resources.
Leads to an unsustainable boom.
Leads to eventual conflict (C vs. I).
What should we do? Wait!!
VI. The Austrians & rethinking policy

18. A Tale of Four Recoveries

19. What if … ? GDP (2015) = $23.5 tr. vs. $16.4 tr.
3.8%
GDP (2015) = $23.5 tr. vs. $16.4 tr.
net gain = $59 tr.

20. Let bad firms/banks go bankrupt. Abolish Fannie & Freddie.
We don’t lose real resources!!!!!
Abolish Fannie & Freddie.
End the Fed.
End the government monopoly on money.

21. The Trouble With Economic Statistics
Poorly defined … poverty, inequality, price level
Imprecise … discrepancy statistic for trade
Flawed … include G in GDP? GDE better?
Misleading … trade deficits bad? WWII prosperity?
Why? Data used to justify government policies.
Why? Market can’t fix problems; government can.
Who tells us this? Bureaucracy, politicians, elected officials.
“We must carefully distinguish between what we think we know and what we really do and can know.” -O.M.
What is the legitimate role of government?

22. Get on the mailing list for Fall 2019 – dennis.foster@nau.edu

23. ECO 481: Public Choice Theory
The W.A. Franke College of Business Northern Arizona University Spring 2020
ECO 481:
Public Choice Theory
Why Government Fails
Dr. Dennis Foster
FCB #308

24. Monetary Policy: Contemporary Issues
ECO Dr. Dennis Foster
W.A. Franke College of Business