We’re All Free Riders Now

Melvyn Krauss wrote an interesting piece in the Weekend WSJ on "QE Could Spur Reform in the Eurozone." Its worth a read.

The article points out the "skepticism" of QE "centered on the free-rider problem - that the more heavy lifting ECB does, the less European politicians will do to promote stuctural reforms." Krauss makes an argument that Fed detractors and "QE_Birthers" here at home should consider: Deflation and harsh economic conditions have not pressured periphery governments into reform, as many have advocated here in the US.

The example does not hold much beyond the surface as most recognize the European situation is flawed at its core arrangement and the debt and interest rate differentials are more realistic than the pre-crisis fantasy that all the Euro parts are equal. In the US the narrative remains stuck in evaluating the Fed in terms of the stock market and dollar exchange rate fluctuations. This is a pedestrian view of Quantitative Monetary Policy.

The question Fed members will be addressing this week is "What are the consequences of lifting the floor on the funding rate of the post crisis financial system." In the old days the system wholesale funded itself (much off balance sheet) with non-securitized non-collateralized transactions linked to the lie called LIBOR. Not anymore. The system funds itself through securities funded with the collateral of other securities. The Fed has created a massive bank asset called excess reserves. Structurally, banks do not, will not, need not ever bid for deposits through the rate channel. In fact, as JPM indicated last week, they don't even want the deposits the Fed has hoisted upon them. (A brief chat with Matt Boesler last week, @boes_  , made my day when he concluded "Everything you've been saying is happening in a widespread and profound way." Thanks Matt ! ) So the question of raising the Overnight Funding Rate Range" is more complex than under a rates regime.

What benefit (against what cost) can be isolated by lifting the transaction expense (Floor) of the system plumbing? That a large dislocation between us and Europe will grow larger is only part of the puzzle. The flow will increase the difficulty of lifting the floor rate. An under appreciated reason for attempting the lift is the expansion is now of normal duration and creating the ability to cut (later) is essential. Parsing the statement is a convenient diversion from the critical truth that we have no experience with non-zirp QE regimes sufficiently supporting their economic systems. NONE. The Fed finds itself on a precipice contemplating a leap of faith : "We need to find out if we can do this"

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