Thursday, September 20, 2012

The Importance of Central Bank Credibility

As much as a tend to shy away from posts made by Krugman (he is too political for me), he hits the nail on the head here. Monetary policy works best when the public believes the Fed's credibility and they are committed to maintaining stable inflation. The Fed needs the public to trust them. Given the current state of politics in the Congress, we need monetary policy more than ever. The constant Fed bashing by the Republicans is not helping. There have been a number of examples where Mitt Romney has gone out of his way to bash the Fed. It is one thing to bash the Fed using credible numbers. It is another to bash the Fed with blatant lies. In the secret video that was released, there was a part where Romney discussed recent treasury purchases by the Fed.  Here is what Romney said:
 [A]s soon as the Fed stops buying all the debt that we’re issuing—which they’ve been doing, the Fed’s buying like three-quarters of the debt that America issues. He said, once that’s over, he said we’re going to have a failed Treasury auction, interest rates are going to have to go up. We’re living in this borrowed fantasy world, where the government keeps on borrowing money.
Without question, if the Fed were buying three-quarters of debt that America issues we would be in serious trouble. So good thing they are not. Here is graphing showing the amount of government debt held by the public, the amount of government debt held by the Fed, and the ratio of the two.

As we can see in the red line (ratio of debt held by the Fed to total public debt) the most the Fed has ever held is a little more than 60%. This happen at one point back in the middle of 2011 following the announcement of operation twist (it was entirely expected). When Romney gave his talk, the Fed was only purchasing 20% of the government issued debt. As of today we can see the Fed is currently no longer purchasing government debt. 

Again, the issue here is that there are a number of people who believe Romney when he states, "Fed’s buying like three-quarters of the debt that America issues," it is simply incorrect. He later predicts we would have a failed treasury auction once they stop by debt. Well, we are waiting.