On Sunday, Bob interviewed Alan Blinder, former Vice Chairman of the Board of Governors of the Federal Reserve System and current Gordon S. Rentschler Memorial Professor of Economics and Public Affairs at Princeton University and Co-Director of Princeton's Center for Economic Policy Studies. The following commentary is from my "Retirement Advisor" writing partner, David Korn.
- Bob said nobody asked Ben Bernanke this week whether if there is a QE3 what kind of impact he would hope to get. How would you answer that? Alan said if and when they do QE3 it will most likely be concentrated in mortgage backed securities in order to push mortgage rates down even further.
- What did you think of QE1? Alan says QE1 was a success. It came out in the height of the crises when the MBS market had died. The fed came in as a big time buyer and re-established a market reducing the spread relative to Treasuries. That would be the object again in QE3 but it could not have the success as QE1 because the market is not in a catatonic state
- What about QE2? Alan said the upper limits you could have expected from QE2 was probably a B rating and we got a B- grade. It appeared to have pulled down the medium to long-term maturity yield.
- What do you think of Operation Twist? Alan said it is weaker than QE2 because in Operation Twist it is buying long term maturities and selling short ones. Buying bonds is expansionary, but selling bonds is contractionary. So you are pushing up with one hand that is stronger than the other hand that is pushing down. So it is not as potent as QE2.
- Alan said the big punch from the Fed was when it brought the Fed Funds rate from 5.25% down to essentially zero. That is a lot of interest rate power which you would expect to have major effects on both short term and long term interest rates and it did. QE1 was very beneficial because of the chaos. Once we got into QE2, expectations were lowered as to how much effect it would happen.
- Bob asked Alan about our national debt. Alan said it is worrisome that we have a huge debt. The good news is he thinks Congress will get serious about bringing down the deficit in a bi-partisan way once interest rates start rising. Right now, people including politicians see this low interest rate environment and don’t react. But once the government starts paying 4% for the 10-year bond versus 1.5%, things will move quickly.
- What do you think of the US adopting an austerity program. Alan said he is not in favor of it right now as we are having no problem borrowing money on a global basis. We are getting money for free. In fact, in real terms, we are getting it at negative rates. We could put this money to good use. There are roads that need repairing and other infrastructure issues that money could be well spent on.
- A caller asked if at some point all of this quantitative easing will translate into an inflationary force? Alan said the money supply has not grown all that much, but bank reserves have exploded. Normally, they keep only the legal requirements. But since Lehman brothers they have been accumulating money, $1.7 trillion. At some point, those bank reserves have to get sucked back in. It will be inflationary if the Fed does a bad job. If you put the bank reserves back too quickly it will cause a recession like in the 1930s. Or you could leave it too long and get an inflationary spiral. Alan doesn’t think the Fed will get this 100% right. But he is not worried too much about inflationary consequences and believes that the Fed will get it more or less right.
- Bob asked Alan whether when you are on the Federal Reserve, is it a free and open exchange of ideas or do you basically defer to the chairman. Alan says when he was on board under Greenspan, it was a little more dictatorship like. Ben Bernanke never felt that was the best way to run things and he has changed things considerably from what he has heard and there is much more of a free flow of information being exchanged where objections are raised.
- Could we get an inverted yield curve if Operation Twist is bungled? The yield curve only becomes inverted when monetary policy is tightened and the Fed is pushing up the Fed Funds rate. You can see this in the current situation because even with the way depressed 10-year bond rate at 1.65% against the fed funds which is 0.15%, that is a 150 basis points above the historic slope over the last few decades. To get an inverted yield curve, it is always because the Fed pushed up the short end dramatically and the long end couldn’t keep up pace.
- Given we have been in a slow growth economy for some time, why with zero percent interest rates isn’t the economy showing more life? Alan said when economies go into dumps because of huge debt crises it takes longer to climb out. We are experiencing a deleveraging following a time when consumers had huge debts. Also, the housing market has shown minimal recovery. Past recoveries would suggest we should be in a home building boom by now. But we are not for a variety of reasons, including the overhand of bad mortgages that are still hanging out there. Government spending is actually falling as well.
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