Ep. 6 - The Financial System ft. Yeva Nersisyan

Funny Money is a show about the economy; how it works, and how it can work better. 

In this episode, Ka and Andrés are joined by Prof. Yeva Nersisyan to discuss Modern Monetary Theory and the financial system including banking, financial regulation, financial crises like the 2008 Global Financial Crisis and Silicon Valley Bank, Quantitative Easing, Yield Curve Control, & more! 

Yeva Nersisyan, Ph.D. is an Associate Professor of economics at Franklin and Marshall College and a Research Scholar at the Levy Economics Institute of Bard College. She is a macroeconomist working in the Modern Money Theory and Post Keynesian and Institutionalist traditions. Prof. Nersisyan has published more than 25 journal articles, book chapters and policy notes and briefs on the topics of Modern Money Theory, monetary theory and policy, fiscal policy, the Green New Deal, banking, and financial instability.

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Transcript

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Hey, welcome to Funny Money. This is a podcast about the economy, how it works and how it can work better. Please follow and subscribe to us everywhere and give us a review on Apple Podcasts and on Spotify. And please send our lovely producer Mike Apple pie. He works tirelessly. He's getting hungry. Today we have a very special guest. It's Yeva Nersisyan She's an associate professor of economics at Franklin and Marshall College. She's a research scholar at the Levy Economics Institute at Bard College. She's a macro economist, unsurprisingly, and she's working in modern money theory. And she also focuses on post Keynesian and institutional traditions. Professor Nersisyan has published more than 25 journal articles, book chapters and policy notes and briefs on the topics of Modern Monetary Theory, Monetary theory and policy, fiscal policy, the Green New Deal and banking. She also focuses on financial instability. We'll get into some of that today. Currently, she's co-editing the Elgar Companion to Modern Money Theory with Randall Wray, who you may know from this podcast or his other work. Her work has appeared in publications such as The Guardian and The Hill as well. Professor Nersisyan and thank you so much for coming on. Funny Money. Thanks for having me on. All right, so let's get started. On this podcast, we talk a lot about money, but the monetary system or a monetary economy is not necessarily the same as a financial system. So what are the differences between the two and what is the financial system? Yeah, that's you know, that seems like an easy question to answer, but it can become kind of tricky and difficult because of how people think of and define money. So we can think of money as just an abstract unit of account. So the dollar. I always ask the question of my students, Have you ever seen a dollar? And they will say yes. And they're thinking of dollar bills of particular financial instrument or a monetary instrument. But in reality, the dollar is an abstract unit of account. I'm in Europe right now, and that unit of account here is the Euro. And there are many different financial instruments which are denominated in the dollar. So it could be bonds and stocks and bank accounts checking accounts, savings accounts and so on. And so that's the universe of financial instruments. And then we take a part of that and we call them monetary instruments. So the ones that are more liquid, the things that we use to make payments. So when people think of the monetary system, they're really thinking of the payment system. So the central bank and the banks together that make sure that if I go to the grocery store and I buy something, or if I go to Starbucks and buy a cup of coffee, then the payment is made to Starbucks or the grocery store. Right. And that goes through the banks, maybe a credit card company if you're using it. And at the end of the day, the central bank. So that's the monetary system. And then the financial system is broader than that. And it includes a whole host of financial institutions. So it's not just the central banks and the banks, but it's also non-bank financial institutions. So think of the stock market or investment banks like Lehman Brothers that no longer exist, right. Or Merrill Lynch that is now combined with Bank of America, which is a more traditional commercial bank, or at least used to be. You have things like mutual funds through which we invest our 401Ks so we're tied to that as well. And then there's a whole different kinds of mutual funds. There is the money market funds and so on. So the financial system is much broader than that. Right? And it includes a whole host of institutions and instruments that we use as stores of value in particular ways to reduce risk and so on and so forth. Yeah, that makes a lot of sense. I mean, it seems like when people think of the financial system, they think about the stock exchange, you know, the buying and exchanging of stocks. Wall Street How has this part of the economy that seems to have a lot of influence, how has that shaped the kind of economic system we have? Yeah, So finance is very important today, right, in the US economy in terms of how many people work there, what percentage of the profits go to the financial sector and so on and so forth. I mean, personally I see a lot of my students go into finance, not necessarily a big fan of that, but at the end of the day, they have very high tuition costs and they're trying to recuperate that money. So it's understandable. But finance wasn't always such a big part of the US economy, so such a big part of the lives of American people. So let's say before we had 401Ks or before we had things like money market mutual funds and so on, that wasn't really part of people's lives. And it's like 401Ks didn't always exist, right? So they started in the 1970s, for example, the stock market. I mean, Americans generally have been a lot more invested in the stock market, I would say, than, say, people in Europe. We love our stock market. Yes, we do. We do. But we've obviously become more connected to it, partly because our pensions are invested. Right. So I remember Jon Stewart when he used to do The Daily Show, he had this episode where he was showing how, you know, pundits were talking about the stock market all the time. So he showed like a clip of Obama giving a speech and then like he had this the Dow Jones ticker on his forehead or something like that. Right. So that's kind of appropriate. Right. And it's partly because we are all shareholders. We're all you know, we all think that we are really invested in the stock market because a lot of us are because of the pensions. Right. But it wasn't always that way. Right. So think of the 1950s and 1960s. Yes. People used the banks to get a mortgage to buy a home, but and they had a checking account in the bank. But that was basically the extent of people's relationship to finance. Right. So people did not rely on debt so much to finance their their spending. And today they do a lot more of that. So when we talk about the stock market, we're talking about one way that the capital is used to put real productive resources to use. Right. I think about these companies like maybe they have angel investors, maybe it's someone starting a business from the ground up. They have this IPO, this initial public offering. You have the publicly raised capital for companies, but then also you have banks who make a lot of decisions about how new capital enters the economy and how money flows. Can you walk us through how banks work, how banks shape economic life in this way? Yeah, I think here we have to make a distinction between, say, a commercial bank and an investment bank, right? I mean, that distinction doesn't exist anymore. Very much in the real world since we repealed the Glass-Steagall Act, which actually separated banks into investment banks and commercial banks. So commercial banks is where you would go for your checking account, right? Maybe get a mortgage, maybe get a credit card and something, stuff like that. And then investment banks did not really deal with households. They would be dealing with companies. So if a company wants to do an IPO, initial public offering, they would go through an investment bank and that's how they would try to raise the investment bank would basically help them issue bonds to borrow money, issue stocks. Right. And stuff like that. And as I said today, that distinction is less clear. So one institution can combine both of those functions, but the functions are still different, right? So on the one hand, we have commercial banking, so that's again the checking account and so on. And it's also where smaller businesses would go to get loans, because a small business does not really have access to the stock market. They don't have access to other kinds of financial markets where they were bigger. Corporations can raise funds so they would have to go through the commercial bank route. So in that sense, you could say commercial banks are directing resources by, say, supporting or lending to small businesses or not lending to small businesses. Right. But even large corporations to some extent rely on commercial banks for their short term borrowing needs. So before the company has produced whatever they're producing and sold it and raised revenue, they need access to finance, right? So they need access to a way to finance their wage bill, to pay their workers, to pay their suppliers and so on. Right. And that's where commercial banking comes in. So the commercial banks would be there to lend short term to the company so the company could borrow, pay their workers, get the production going, produce stuff, sell it, get the revenue and then repay the loan. So what I just described is what economists would call a monetary circuit, right? So production starts with a loan from a bank and the bank runs the loans and the workers get paid and the suppliers get paid. So the production process gets going. And then at the end, when the revenue is raised and the loan is paid, that circuit is closed. It doesn't have to be closed every time. But that would be an example of, say, a monetary circuit. So that kind of takes us back to that initial question. What is the financial system? Well, the financial system is there to finance spending to help us finance spending through borrowing and hopefully finance productive kinds of spending Right? I think something I encounter and I think MMTers encounter a lot is a lot of people assuming that banks are loaning out other people's deposits and that the dollars that are at the bank, that are invested by the bank come from depositors. MMTers obviously see this differently. Can you break down how that common trope is just not accurate? Yeah, it's not just people who are not economists, who feel this way or think this way, right. Even somebody like Paul Krugman seems to be under the impression that banks are lending people's savings. Right. So it comes from something that MMTers encounter when it comes to government finance, where we generalize our own personal experience. Right. So we say, well, if I want to say start a business right, then I have to save some money. And then this saving is going to then help me finance my business, right? If I want to start a small business, I have to have some of my savings. So they then think that at the level of the economy as well, it's people's savings that are flowing through the financial system to the firms, right? Every economics textbook, even a money and banking textbook will have some kind of a diagram where it's showing how money goes from the savers to the banks or the financial system in general, and then from the financial system it's then flowing to, say, others who are trying to borrow right from savers to borrowers. Well, once you understand what money is, which is an IOU, right. It's a promise to pay that can be issued on demand or it can be issued when the issuer wants to issue it. Then you understand that that cannot be true. Right? So what are we doing when we're getting a loan from a bank? We are not borrowing, say, government money necessarily. We are borrowing bank money or we're actually getting the banks agreement to make a payment on our behalf. I think that would be more appropriate to say so. Well, let me put it in terms of, say, borrowing bank money. Right. And maybe I should take a step back and say when we think of money, we think of just one thing, right? The dollar bills, like my students when I say, have you seen a dollar? They're thinking of dollar bills, but there isn't just one money in the economy. There is many different kinds of monies. They just have different levels of acceptability. So we like to think about a hierarchy of money where the government's money sits at the very top. It's the most acceptable. But then there are other institutions that create money, banks being one of them, and banks are right below the government in that hierarchy of money. And why is it that basically anyone can participate in this money issuance or money creation process? Well, that's because money is an IOU, right? It's a promise to pay. So we don't think that we as households issue money, but we do or they do participate in that money creation process. So, for example, I cannot go to Starbucks again, and it sounds like I go to Starbucks a lot. I actually don't. But I couldn't go to Starbucks and say, hey, here is a piece of paper, which is my IOU. Can I have a cup of coffee for it? They will just walk me out of the store if I do that. But I can go to Starbucks and use my credit card and I will walk out of there with a cup of coffee. And what I'm doing there is I'm basically issuing an IOU to my credit card company and giving them my promise to pay at a future date. And then my credit card company, which could be a bank, is making that payment on behalf of me to Starbucks. So I issued an IOU. I didn’t issue directly to Starbucks. I issued it to my bank, and then my bank issued their own IOU and gave it to Starbucks. And so Starbucks will not take my IOUs, but they will take bank IOUs, which we call bank deposits. So that's another issue that people have. They don't necessarily understand that bank deposits are the liabilities of the bank. Right. Because we think, well, when I go and deposit money into a bank, a bank is getting something right. So they think that the bank deposit is like an asset for the bank. But when you deposit money, the bank is getting something right. It could be cash, it could be electronic government money, and that would be on the asset side. But on the liability side, they're issuing you a deposit. Right. They're saying that they now owe you, let's say, $100 because you're deposited$100 there. So the deposit is the bank's IOU. And when we think of money, of course, we think of our checking account, Right. We think of that as money, just like we think of cash as money. Well, if the bank deposit, which we consider money, is an IOU for the bank, then that means the bank can just issue those IOUs. And because those IOUs are considered money, then we can then say the bank can issue money. Okay, So people kind of get hung up on that point that the bank can just create money. Well, the reason why the bank can create money is because what we consider money is the bank's liability is the bank's IOU, which it can create as long as there are takers for it. In this case, if I go to Starbucks, I am actually a taker for that deposit. Or Starbucks is a taker for that deposit, they will take it as payment. Even though they wouldn't take my IOU directly. So the banks basically create their IOUs whenever they're making loans. So when I go to a bank and I guess that was a long answer to your question. When I go to a bank, I don't walk out of there with a suitcase full of money. You can try, I guess, but that's not normal. That's not the usual case. You walk out with a debit card to a checking account, which you can now spend out of, Right. For instance, Or you just, you don't even walk out with anything monetary. If you are borrowing money to get a car, you walk out with a car and now you have a loan and then the car dealership gets that money in the form of bank deposits. So I would also like to say that people call this like creating money out of thin air. It's really not out of thin air. Right. Because there is something that standing behind that bank money creation. And that's my IOU, my promise to pay, my promise to make a payment to my credit card company for that Starbucks coffee that I bought. That money that I will have to pay them at some point in the future. I mean, I think something really interesting about that, too, that MMT has talked about is that in order for banks to be able to do a lot of that, they have to have a charter or a license from the government and a whole bunch of institutional support. Can you tell us a little bit about how it's best to see banks as franchisees or licensed by the public? Sure. So today, of course, one in the United States and many other countries, bank money is protected by guarantees, government guarantees. We saw that very clearly in case of the Silicon Valley Bank. Right. When SVB failed, the government stepped in and said we will protect all of their deposits. Right. And then they sort of extended a blanket deposit guarantee to all bank deposits in a sense. Right. And so we have the FDIC guarantee, which makes bank IOUs like money, right? Because we don't doubt that we can always convert bank IOUs to government IOUs, which sits at the very top of that money pyramid, which makes them a lot more acceptable in some sense right now. Did banks exist before there was FDIC? Before there was. There were government guarantees. And the answer is yes, they did. And they they do what they're doing today. The answer is yes, they did. Right. So the banks can exist without government guarantees and they can issue money. In fact, they issued bank notes before that. So the banks would not trade deposits. They would issue actual paper money. And each bank would issue their own. They wouldn't be equivalent. So money issued by a big New York bank would not be equivalent to money issued by a small bank in Missouri. So there would be a discount if you took your money that was issued by a bank in Missouri, for instance. Right. And with government guarantees, that disappears. Right now, we don't care if the money is in a small Missouri bank or in a big bank in Bank of America, although we did see that some people did care to some extent, right as money was flowing out of smaller banks and into the bigger banks because of the too big to fail stuff and so on. So because of the FDIC and also because the Fed is there to act as a lender of last resort, which they did again with the Silicon Valley Bank. Right. They said we will lend to the banks and so on and so forth. And they're very, very favorable, conditions. These kinds of things make bank money equivalent between the banks and they also make it equivalent to government IOUs. Right. And this is a good example to see that different banks issued different moneys. Right? They issued their own IOUs, but we don't think of them as such anymore, even though it used to be the case when they were issuing bank notes. Right. And the reason for that is because we have this unified monetary system and the Fed stands behind it. The FDIC stands behind it. And that's why we see it as just one money, right. And so basically, it's like instead of everybody, all these banks issuing their own money, which I believe in, history did happen. That's right. And there were financial crises because of this. Now we kind of create it all under one system protected, regulated by public institutions. That's right. So we are providing them safety nets, right? We're telling the banks that we will provide guarantees to your deposits, and that puts banks in a special position in the financial system. Right. I will basically put my money in a bank without getting any interest on it, because I know it's FDIC protected. Right. While if I were, I wouldn't do it in any other kind of financial institution. Right. I wouldn't give my money to a money market fund or a mutual fund and say, I don't want any returns. Right. Because there is the fear that you will lose your money. So you're taking the risk, but you're also hoping to get some benefit. There is no risk here right. And the government eliminates the risk with the lender of last resort, with the deposit insurance and so on. And because it is the insurer, it then has the right to then regulate the banks and tell them, you can do this, you cannot do that, you cannot take too much risk, and so on and so forth. Obviously, we've deregulated banks a lot. So we're telling them less and less what they can do, what they cannot do. Right. But the commercial banking sector still remains the most regulated part of our financial system. So in some sense, then there are two conclusions that follow from this. First, that the deposit insurance limits do not make sense, right? Because in a crisis, they're not binding, they disappear anyway. And it doesn't make sense. Right? Once you understand money and you understand that the government does not cannot run out of money, that it's not financially constrained. Right. Then you say, well, there is no reason why the deposit insurance should have a limit, right. It shouldn't. You're either guaranteeing them all or you're not guaranteeing your guarantee then is not credible and you're also giving them to lender of last resort advantages so the banks can go to the Fed and borrow from the Fed if they have collateral to pledge. Okay. But that also means that you get to tell them what they can and cannot do. And if you're telling them what they can and cannot do. This brings us back to Jessica's question, right, that they then you're telling them in some sense how to allocate resources, Right? You're putting limits to where they cannot allocate resources, right? You're telling them you cannot lend to certain activities, like I cannot go to a bank, borrow money and buy a stock. Right. Like a commercial bank. And that's something we're saying because banks are not just private institutions. MMTers like to view banks as public private partnerships. Because banks are not just like any other financial institution. They enjoy all this benefits that the other financial institutions don't have. So if you know, given the role that the public has around the banking system, one would imagine that we wouldn't have fraudulent behavior anymore. We wouldn't have major financial crises. And yet on the application formerly known as Twitter, we've been hearing discussions again about the 2008 financial crisis. I believe we have a clip here that we can pull up from the movie The Big Short. Oh, all right. Let's say you have a pool of 50 million in subprime loans. How much money could be out there betting on it in your synthetic CDOs swaps right now tonight? Let’s see, it’s$50 million ...$1 billion dollars. What? If the mortgage bonds that Michael Burry discovered were the match ... How much bigger is the market for insuring mortgage bonds than actual mortgages? It's about 20 times. If the mortgage bonds were the match and the CDOs were the kerosene soaked rags, then the synthetic CDO was the atomic bomb, with the drunk president holding his finger over the button. It was at that moment in that dumb restaurant with that stupid look on his face that Mark Baum realized the whole world economy might collapse. So, you know, that's a very famous and I think great scene to demonstrate, all of this super confusing technical stuff that was going on that crashed the economy. Right. But MMTers were one of the groups that had been drawing attention to the problems in the system before it happened. And in fact, MMT started to get more and more attention after the financial crisis. Can you tell us what MMT offered in terms of a macro analysis that was able to kind of predict these problems and understand why we're vulnerable to them? Yeah, So there are a lot of people who would say it's the banks ability to create money. What we were just talking about that was at the root. That was the root cause of that problem, right? MMT is look at it from a macro perspective. And they said, well, if you look at the sectoral balances, right, and I can go into more detail into it, but basically you divide the economy into different sectors and you say, okay, what are they doing? So you have households and firms, you have the government, you have the foreign sector, and each of these sectors, you can take the difference between their income and their spending. And if they're spending more than their income, then they're in a deficit. If they're spending less than their income, then they're in a surplus. So you can look at the sectors and say, are they in a deficit or are they in a surplus? And of course, when it comes to issues of financial instability, MMT understand that it's okay for the government sector to be in a deficit, right? A mainstream economists would look at it and say, well, they're in deficit, and that's a problem. And my peers would say, well, no, it's the private sector, it's two households, and instead it's the firms that we have to look at what are they doing? Are they in a surplus position or are they in a deficit position? Right. And if they were in a deficit position, that means that they are accumulating debt. So if every month I spend $10 more than my income, I have to again finance that debt spending from somewhere. Right. And that means I have to either spend down my savings or I have to borrow. And so if I'm borrowing, that means I'm accumulating debt. So every month I have $10 more in debt than I had the previous month. And that that's cumulative, right. And so if households, and firms are running deficits month after month after month, it means they're accumulating debt. Right. And at some point you're going to be unable to pay back the debt. Right? Because if I'm accumulating the debt, I have to make monthly payments. There is interest on it right. And if interest rates for some reason start going up, like if the Federal Reserve starts raising interest rates like they did leading up to the financial crisis, right then my debt repayments might be growing bigger and bigger and taking up more and more of my income. At some point I'm going to become unable to pay it back, right? Or I'm going to become unable to service my debt. So when looking at the non-government sector or the US private sector, you could see that the US private sector was running deficits. So they were running deficits in the leading up to the Nasdaq boom and bust and then they were again running up deficits leading up to the global financial crisis. And you could see that that was unsustainable. So by looking at a simple line graph an MMTer could say that this cannot go on. I mean, you couldn't tell when exactly that was going to stop, but you knew that it was going to stop and it was going to be disastrous. Right now there were also all these exotic financial instruments, which multiplied the extent of the problem. So you could have a mini financial crisis if you had a problem of people accumulating too much debt and not being able to pay it back. But if you have layers and layers of debt and debt built on top of each other, then one default means that a bunch of people are going to go bankrupt. So what that clip is explaining is that you had the mortgage backed securities, right? So household mortgages were flowing out of household pockets and into these different investors who had bought the mortgage backed securities. But in addition to that, you had financial institutions that had basically sold like insurance. Which meant that if these mortgage backed securities went bust, they would be making payments. The worst part was that you didn't have to own a mortgage backed security to buy insurance on it. So the synthetic thing that they're talking about is that I could go and I could buy insurance on mortgage backed securities going bust. Right. And if they did go bust, I would be paid even though I didn't own the underlying asset. It's kind of like buying insurance on your neighbor's house, Right. If the house is destroyed for some reason, let's say it burns in a fire, then I get paid. Obviously, that creates very perverse incentives. Right. And that also magnifies the problem. Right. So in this case, the insurance companies not just paying my neighbor when their house burns down, it also has to pay me. Right. So that's why the American insurance group, AIG, basically went bankrupt because they had all these payments that they had to make. But you can see how it's magnified and the size of the problem, right, that now they don't have to pay the 50 billion. They have to pay 2 trillion or 50 million A billion. Right. Whatever that was, billions, trillions. We are we're in a different territory now, right? Like$1,000,000,000,000. Seems like a lot of money just ten years ago and now it no longer does. So, yeah, that's basically what they were talking about in that clip. So let's talk about the role of the of a central bank. A lot of people say that the Fed is not the central bank in the United States because it's private, because it has this board that is not, you know, people elected to serve in the government. Can you talk a little bit about what a central bank does and how the Fed is or is not the central bank in the U.S.? Yeah, the Fed is most definitely the central bank in the United States. It was created by Congress to act as a central bank. And what a central bank is, is it's the bankers bank and it's the government's bank. That's what they do. So they lend to banks and they help banks make the payments. So if I'm making a payment to again, buy that Starbucks coffee, my bank has to make a payment to the bank where Starbucks is banking. And so there has to be like a third party through which the payment is going to be made. And that third party is the central bank. Okay. So it's helping banks make payments to other banks and it's also the government's bank. It's helping the government or the Treasury in case of the US, could be minister of finance. In other countries, it's helping the Treasury make payments on behalf of the government. Right. And it's also actually people don't often talk about it. But one of the jobs of the Fed is to make sure that they maintain an orderly market in US treasuries. So they have to make sure that the US government can sell the Treasuries whenever it's trying to sell Treasury securities, Treasury bonds, in other words. Right. So that's that's what a central bank does. That's what the Fed was created to do. They were created to act as a fiscal agent for the US government. They were created to act as a bankers bank to make sure that when banks have liquidity problems like what was happening after the collapse of the Silicon Valley Bank, that if they're a good bank in a good standing, they just are running short on liquidity, then they can go to the central bank and they can borrow. That's the lender of last resort role of the Fed. So that's what the Fed was created to do, to stabilize the financial system, to prevent financial crises. Basically, it was created after a financial crisis when the banks realized that they did not have as private sector entities, they did not have the ability to act as a lender of last resort. So that's why the Fed was created. And it was also created to act as a fiscal agent for the government. So the Fed is not independent of the government. I mean, the the Reserve Bank's, the regional reserve banks, they are privately owned. So it's kind of like a compromise in because in the US, of course, everything has to have some kind of private, share and it can’t be purely public right? There has to be some private involvement. So I think that's what that's a legacy of like the US kind of free market system in some sense. But it is a central bank. And who makes all the decisions? Is the Federal Reserve Board, right? The Reserve banks don't really make decisions. They're just conducting the decisions that the the board makes. And the board is in Washington. It's a government agency. I think they themselves say that they are independent within the government and not independent of the government, something like that. So just like any other agency, really, they might have a little bit more freedom, but they're free to do what that's really the question. They're not free to say bounce U.S. Treasury checks. They're not free to say put a brake on how much Congress can spend. They can’t do that. They are free to raise interest rates, which is what they're doing right now. But I would imagine politically, even that has a limit, right? If they raised interest rates to, say, 10%, I mean, I would hope that Congress would act. Congress can certainly act and tell them you cannot raise interest rates more than this. Right. Congress has reformed the Fed over the years and it can reform it again. Let's actually talk about the interest rates for a second. The Fed has this dual mandate of price stability and maximum employment. A lot of people would frame these two things as diametrically opposed. Some would say they have a direct causal relationship of the inverse, whereas if you have more people who are unemployed, that means, you know, we're going to see prices stabilize or go down. If too many people have jobs and unemployment rates are super low, inflation or prices become a major concern and they have this one tool to adjust things and keep the economy stable, keep prices stable, and that is adjusting interest rates. James Galbraith calls this like driving a car where the only thing you can do is either put your foot more on the gas or more off of the gas. There are a lot of important other aspects of driving a car, putting your foot on the brake, you know, turning the steering wheel, getting your engine checked, also putting your blinker on all sorts of things. And it sounds like an extreme metaphor, but I think the more you look in, the more you find it's accurate. I want to play quickly this video from Ayanna Pressley questioning Jerome Powell on the floor of Congress. There's an old. Adage, Chairman Powell, if all you have is a hammer, everything looks like a nail. You've recently said that the Fed's tools like interest rates and the balance sheet, are famously blunt and lacked precision. So in that case, do you agree that the Fed needs new tools that are more precise to better fulfill its statutory mandate of price stability and to maximize employment? No, I don't think we're looking for new tools. So my question for you, Professor, is should they be looking for a new tool? I think I know why they're not looking for new tools, because if you start rethinking inflation and how it arises and how we fight it, then there might be very little room left for the Fed there in in that new framework, which is why they're not really looking for new tools. So they should be looking for new tools. I would say we should be looking for new tools. And in some sense, the new tools might be old tools, which we used to use and we don't use anymore. And I would say it's the tools of fiscal policy that are going to be more effective, meaning in interactions with Congress people Powell has basically, admitted that the inflation is not really coming from the demand side necessary, that it's been because of supply chain disruptions, for instance. Right. There was a New York Times headline which says Republicans are blaming COVID stimulus for inflation. The Fed Chair disagrees. Like, okay, so it's not the COVID stimulus. If it's not demand, right, then what is it that the Fed can do? Because in the same breath, he's also saying, well, we have the tools to affect the total level of demand in the economy. Right. And that's actually very questionable. And what I would say to that is if you're looking for tools to affect a level of demand, why are we using this blunt tool interest rates, right, when we have the direct tool of fiscal policy? So government increases spending, total spending goes up, government decreases spending, total spending goes down. I mean, I'm being a little mechanistic about it, right. But basically that's it in a nutshell. You can use taxes for that purpose as well, right? You have to be very purposeful about what kind of taxes you impose and so on. But if the goal is to increase or decrease demand right, then why rely on interest rates when you can do it in a more directed manner with fiscal policy? Right. And one thing that comes to mind is the Fed's tried all it could do to try to raise the inflation rate after the global financial crisis, because when they say we can achieve a target, it's not about bringing it down, it's also bringing it up. So if the inflation rate is 0% and the Fed has a target of 2%, then they're not achieving their target. Right. Even in that case. So they kept trying and trying trillions and trillions of dollars of quantitative easing, every kind of facility that they could think of, which they created after the global financial crisis. And they kept undershooting their target. Right. The inflation was below 2% year after year after year. And then we have COVID. And, you know, even if you were to take the argument that it was fiscal policy that inflated the economy, doesn't that itself raise questions, right. Saying that if fiscal policy could inflate the economy in one year and the Fed was trying to do that right, they were trying to inflate the economy for ten years and they couldn't do it then. Doesn't that say that fiscal policy has a bigger role to play for prices than monetary policy does? Right, Whether it's inflating or deflating the economy, because it's kind of the same thing, right? If you can inflate it, then you can probably deflate it, too, with that same tool. And so I would say fiscal policy is where we should be looking at. Right. And that's why there will be very little room for the Fed. Now, we can think of things like credit controls and so on. Right. And that would be appropriate for a credit driven boom like the global financial crisis. Right. So the Fed could come in and say, you cannot do this sub subprime mortgages anymore. Right. For example, because the Fed is also a regulator, they can tell the banks what they can and cannot do. So they could tell them no more subprime mortgages. You have to stop all this securitization nonsense and so on. Right. They could do that as regulators, right, in a credit driven boom. But in this case that's not what we had. Right. We haven't necessarily had that same kind of credit driven boom where credit controls would be useful. Now with the housing market, I think that's one area where you could say interest rates could play a role. But even they're right. It's just such a blunt tool because it's, pricing out new homeowners. While, say, corporations who have cash, financial investors who have cash can just keep buying and buying the homes because interest rates don't affect them. Which then is making your housing situation even worse. So on that note, some have also called for like a green monetary policy. Would it make sense in your eyes to, for example, put credit controls on fossil fuel spending? If we were already investing renewables and things like that? Sure. I think if there is any role for monetary policy or the Fed in trying to help with achieving a more sustainable, greener economy, that would be exactly that. To say no more lending to fossil fuels, they're too risky, and so on and so forth. Right? I wouldn't go very far in putting my faith in central banks. A lot of people do, especially in Europe, because they don't have a European treasury and so on. They put a lot of their faith in the central bank. We have to push the central bank to try to say help with fighting climate change. I would again say that it's the role of fiscal policy. So public investments and so on. That's really what we need. So like a Green New Deal, right? More, much more public investment than we've done in the even in the past year or two where we've appropriated quite a lot of funds for that. But we need a lot more than that and it has to come from Congress. I think the people who want the central to do a lot of the heavy lifting do it because they don't understand MMT, because they think the central bank is not financially constrained. But the Treasury is right. But the central bank is the Treasury's bank. If the Treasury wants to spend, they can do it. So just a moment ago, you mentioned QE this is kind of an approach to economic stimulus where the Fed is making large scale asset purchases. What should we make of QE or quantitative easing as a tool? Well. I mean, it's a lot of it's trillions of dollars of nonsense. I would say quantitative easing and, you know, central banks did trillions and trillions of dollars of it, and they have nothing to show for it. Right. We had an anemic growth. We had a jobless recovery after the Global financial crisis, again, with all the trillions that were being spent. And to compare it to the COVID recovery rate, we spend less than that on fiscal stimulus. And the recovery was much, much faster. But what quantitative easing does basically what it is It's the central bank buying Treasury securities and sometimes other kinds of securities, like after the global financial crisis, it was mortgage backed securities. Now, if you're buying mortgage backed securities because they're trash and nobody wants them and you're trying to bail out financial institutions, then sure, you can do it and you can call it what it is. It's a bailout. Okay. And in some sense, if the goal is to provide financial stability at any cost including like all the moral hazard that you're creating, sure, that's a great policy. But as far as macroeconomics goes, if you're just buying, say, Treasury securities, what does it do? Well, what it does, it just lowers the long term interest rate. Okay. So Treasury securities, what bonds in general, you have an inverse relationship between the price and the interest rate. And why is that? Well, because they're fixed income instruments. Right. So if I buy a bond that's promising to pay me $1,000 a year from now and I pay $900 for it, then I'm getting basically a 10% return. Right. I'm getting the difference between $1,000 and $900. It's $100 and it's 10% of the face value, which is that$1000 that I'm getting back at the end. Okay. Now, if I were to pay more for that same security that's promising to pay me $1,000 a year from now, if I pay$950 for it, then my return is only $50 and it's only 5%. So you can see how higher price means a lower interest rate. Okay, so there is that inverse relationship between the price and the interest rate. And so when interest rates in the economy go up, then the price of existing securities is going to go down. Okay. And that's, again, something we saw with the Silicon Valley Bank when the price when interest rates were going up, the price of their existing securities were going down because it's like the new bonds are paying more. They're paying, let's say, 1100 dollars instead of 1000. And here you are. You're stuck with bonds that are just promising to pay a thousand. Again, I'm simplifying, but that's basically the idea. Okay. So when the Fed comes in and says, we're going to buy a lot of these bonds, then what happens is the price goes up. Right. So instead of them selling for 900. They're now selling for 950. So then the yield or the interest rate goes from 10% to 5%. So that's what QE does, right? It increases the demand for Treasury securities. It increases their price and lowers the interest rate. And so people call it unconventional policy. It's really not unconventional once you understand that, it's still about the interest rate. Right. So generally the Fed controls the short term interest rate, but in this case with QE, it says, okay, we're not only going to control the short term interest rate, but we're also going to directly try to set the longer term interest rate, although we don't set a particular rate, we just say we'll just buy a bunch of securities and we'll just see where the long term rate ends up being. But it's going to be lower than otherwise. Right. Now, why would they want to do it? Well, because interest rates are a blunt tool. It goes back to that. And if all you have is a short term rate, then you really don't have a lot of tools. Right. So if you are trying to say stimulate more investment, you can lower the short term rate all you want. But investment, let's say when corporations issue bonds to borrow money to invest, they really care about the long term rate, right? Because it's that long term rate that determines their own borrowing costs. So the ten year Treasury yield, in particular the ten year interest rate is important because corporate borrowing rates use that as a benchmark. Mortgages are benchmarked to that. So then if the Fed lowers the long term rate, there is just, sorry, if the Fed lowers the short term rate, the long term rate might go down, but not as much as the Fed wants. So at that point, the Fed says, I'm going to try to lower it some more. Right. Maybe just ten basis points more, 20 or 50, whatever. And that's going to do it. That's going to jumpstart the economy. So we lowered the interest rate from the short term rate from, say, 5% to 0%. The long term rate went down. Right. The economy is still not doing well. All we have to do is take it down 50 basis points more, and that's going to solve our problem. Of course it didn't. Right. Which is why we had a jobless recovery. Because QE is just a lot of you know, it doesn't help the real side of the economy. You know, that was going to be our last question about the yield curve, because I feel like so many people just don't know what the heck finance people are talking about. But I think you beautifully explained that there and in the middle of it, I was like, oh my God, she's doing it. That's the yield curve. Yeah, it is the yield curve, right? So the yield curve just shows the interest rate on this end of different maturities. Right. So and when we say interest rates of different maturities, when we say the ten year rate, right, people talk about a ten year rate, sort of an abstract, there is no ten year rate in abstract. The ten year rate is the yield on ten year Treasury bonds. That's what it is. Right? So then when we're talking about a yield curve, we basically are talking about the yields of different maturities. So the three month, five year or the ten year. And then usually it's upward sloping or at least that's the normal state of affairs where the long term rate tends to be higher than the short term rate. And that's your normal yield curve. What the Fed does with monetary policy is they push the yield curve down by, say, lowering the short term interest rate and all other interest rates usually follow. With QE, you're not just pushing it down. Sorry, I'm trying to do it. So you're not just pushing the overall yield curve down by lowering the short term rate and hoping that other rates will follow. You're also trying to flatten it some more by lowering the long end of yield curve, say the ten year rate more directly. You could take the five year, right? It doesn't matter if the Fed starts buying a bunch of five year bonds, then it's the five year rate that they're going to flatten. If the Fed wants to control the whole yield curve, they can, right? They can do it. They can buy a bunch of 30 year Treasury bonds. They can buy a bunch of five year. And so on. That's what they did during World War Two. They didn't announce some number and say, we're going to buy trillions of dollars of Treasury securities. They said, we're going to fix the ten year borrowing rate at, say, 2% or 2.5%, and they just bought whatever quantity was needed to bring that yield down to the 2%, 2.5%. That makes more sense than just announcing quantities and then just seeing where the yield is going to be at the end. Thank you so much for breaking that down. I think it's on a lot of people's minds, especially those who heard about Silicon Valley Bank and didn't understand, you know, the inverse relationship between interest rates and bonds. So thank you for that. I think our viewers are going to want to know where to find your work and your latest projects. Can you tell us where we should go and what we should look for? Sure. A lot of my stuff is published at the Levy Economics Institute, and I've been saying I'm going to be on Twitter at some point, but I guess there is no Twitter anymore. Like I can’t be on Twitter So we'll see. Yeah, but not really on social media, at least not yet. But the Levy Economics Institute is where. You can come on Instagram. You can join us on Instagram. Okay. So that's the that's the new thing. Okay.