35 Trillion Reasons III
Part III - The Fed's Influence
In a speech entitled, "Deflation: Making Sure 'It' Doesn't Happen Here", delivered on November 21, 2002, Federal Reserve Governor Ben Bernanke explained to the world exactly how far beyond conventional levels the policy response could go.
Governor Bernanke explained that the Fed would not be "out of ammunition" just because the Federal Funds rate fell to 0% because the Fed could create money and buy bonds of longer maturity in order to drive down yields at the long end of the yield curve as well.
Moreover, he said, "In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities.
A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices."
He made similar remarks in Japan in May 2003 in a speech entitled, "Some Thoughts on Monetary Policy in Japan". He said, "My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own.
Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt-so that the tax cut is in effect financed by money creation."
These speeches attracted tremendous attention and for some time financial markets believed the Fed intended to implement the "unorthodox" or "unconventional" monetary policy options Governor Bernanke had outlined.
In the end, the Fed did not resort to unorthodox measures. The Fed did not create money to finance a broad-based tax cut in the United States. The Bank of Japan did, however.
Three large tax cuts took the US budget from a surplus of $127 billion in 2001 to a deficit of $413 billion in 2004. In the 15 months ended March 2004, the BOJ created ¥35 trillion which the MOF used to buy $320 billion, an amount large enough to fund 77% of the US budget deficit in the fiscal year ending September 30, 2004.
It is not certain how much of the $320 billion the MOF did invest into US Treasury bonds, but judging by their past behavior it is fair to assume that it was the vast majority of that amount. Was the BOJ/MOF conducting Governor Bernanke's Unorthodox Monetary Policy on behalf of the Fed?
There is no question that the BOJ created money on a very large scale as the Fed would have been required to do under Bernanke's scheme.
Nor can there be any question that the money created was used to buy an increasing supply of US Treasury bonds being issued to finance the kind of broad-based tax cuts Governor Bernanke had discussed.
Moreover, was it merely a coincidence that the really large scale BOJ/MOF intervention began during May 2003, while Governor Bernanke was visiting Japan?
Was the BOJ simply serving as a branch of the Fed, as The Federal Reserve Bank of Tokyo, if you will? In Part IV we will examine the results of these events and the possibility of an alternative explanation.
In a speech entitled, "Deflation: Making Sure 'It' Doesn't Happen Here", delivered on November 21, 2002, Federal Reserve Governor Ben Bernanke explained to the world exactly how far beyond conventional levels the policy response could go.
Governor Bernanke explained that the Fed would not be "out of ammunition" just because the Federal Funds rate fell to 0% because the Fed could create money and buy bonds of longer maturity in order to drive down yields at the long end of the yield curve as well.
Moreover, he said, "In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities.
A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices."
He made similar remarks in Japan in May 2003 in a speech entitled, "Some Thoughts on Monetary Policy in Japan". He said, "My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own.
Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt-so that the tax cut is in effect financed by money creation."
These speeches attracted tremendous attention and for some time financial markets believed the Fed intended to implement the "unorthodox" or "unconventional" monetary policy options Governor Bernanke had outlined.
In the end, the Fed did not resort to unorthodox measures. The Fed did not create money to finance a broad-based tax cut in the United States. The Bank of Japan did, however.
Three large tax cuts took the US budget from a surplus of $127 billion in 2001 to a deficit of $413 billion in 2004. In the 15 months ended March 2004, the BOJ created ¥35 trillion which the MOF used to buy $320 billion, an amount large enough to fund 77% of the US budget deficit in the fiscal year ending September 30, 2004.
It is not certain how much of the $320 billion the MOF did invest into US Treasury bonds, but judging by their past behavior it is fair to assume that it was the vast majority of that amount. Was the BOJ/MOF conducting Governor Bernanke's Unorthodox Monetary Policy on behalf of the Fed?
There is no question that the BOJ created money on a very large scale as the Fed would have been required to do under Bernanke's scheme.
Nor can there be any question that the money created was used to buy an increasing supply of US Treasury bonds being issued to finance the kind of broad-based tax cuts Governor Bernanke had discussed.
Moreover, was it merely a coincidence that the really large scale BOJ/MOF intervention began during May 2003, while Governor Bernanke was visiting Japan?
Was the BOJ simply serving as a branch of the Fed, as The Federal Reserve Bank of Tokyo, if you will? In Part IV we will examine the results of these events and the possibility of an alternative explanation.
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