By Caroline Baum
Sometimes I get the feeling that academics are so focused on using mathematical equations to validate their theories, they forget to give their ideas a reality check.
Take the paper presented Friday at Jackson Hole by economists Arvind Krishnamurthy and Annette Vissing-Jorgensen, professors at Northwestern University and the University of California, Berkeley, respectively. In "The Ins and Outs of LSAPs," or large-scale asset purchases, the two economists argue that "Treasury purchases themselves have had limited beneficial spillovers to private borrowers." In other words, the Treasury was able to borrow at lower interest rates, not the rest of us. That's because there aren't many substitutes that qualify as safe assets.
Taken at face value, this is hard to believe. Every loan, every credit instrument, is priced off a risk-free rate, which is generally a Treasury security of comparable maturity. The changes in the price of various instruments before and after the announcement of LSAPs — the economists use the average yield for the five days preceding the announcement and five days after — can't possibly capture the full effect. Treasury yields adjust instantaneously, often in advance; credit spreads more slowly.
At the same time, the authors found that the purchase of mortgage-backed securities (MBSs) had a bigger impact. Hence, their recommendation that Treasury purchases could be stopped without any untoward effects while the purchases of MBS should be the last part to be discontinued.
That's all well and good, but most economists, including those at the Fed, believe the central bank needs to get out of the credit business — giving preference to housing, for example, over student loans — and get back to a Treasurys-only policy.
According to a few people who attended the session, Fed officials were interested in the authors' MBS findings — and somewhat less impressed with the assessment of their Treasury purchases.
Apparently, Krishnamurthy and Vissing-Jorgensen got some pushback on their conclusion that the "sale or cessation of Treasury bond purchases will have minimal negative effects" on other debt instruments and the economy. And understandably so.
One of the dominant themes of the conference was the spillover of Fed tapering onto the emerging markets, which have seen an exodus of money in recent weeks. The Fed had to let its central bank colleagues know that stabilizing emerging markets wasn't part of the Fed's dual mandate just yet.
I wonder what the authors would say about gyrations in emerging markets debt and equity markets, not to mention the 125 basis point spike in 30-year fixed-rate mortgages since May.
Perhaps they would use the evidence to support their claim that the Fed has been imprecise about its plan to end asset purchases. Instead, they advocate the adoption of a rule to avoid creating confusion in financial markets.
Accusations that the Fed has been unclear about the timing and magnitude of a reduction in asset purchases are misplaced. "The Fed has been perfectly clear about tapering," says Jim Bianco, president of Bianco Research in Chicago. "They have no clue, and we have no clue."
He's right. But in an econometric model, uncertainty about the future can't be captured in an equation.
Caroline Baum is a Bloomberg View columnist.
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