Summary

This brief explains the work of Senior Macroceonomic Policy Specialist, Marc Labonte, and colleagues, published primarily through the Congressional Research Service (‘CRS’). I do not know Mr. Labonte personally, nor have I corresponded with him, however, his work is often illuminating, perceptive, and educational. He is also an author of books, and some of his papers have been published through Harvard and Yale Universities.

This brief note explains how the papers and briefs have motivated insights, connections, and further research in global finance, the Federal Reserve (the 'Fed'), and macroeconomic policy. The papers have provided illuminating insights into the Fed 'repo' market and other tools used by the Fed to manage US monetary policy.

Introduction

I first became aware of Mr Labonte's publications around February 2020, when I was researching the great financial crash (GFC) of 2008, though I had been reading his earlier papers before that date, on the CRS web.

It was the paper 'CRS Report RL30354: Monetary Policy and the Federal Reserve: Current Policy and Conditions. Updated February 6, 2020 [1], that first lit a spark. I discovered it had been issued as a rolling update, approximately every three months, the most recent publications listed on CRS [2], and all of them back to 2001 listed on a site not affiliated with CRS [3].

I also discovered later that the February 06 version was the last one produced, an interesting fact we will come back to, without making too much of it. The back page acknowledged “This report was originally authored by Gail E. Makinen, formerly of the Congressional Research Service”. I cannot find precisely which version was her last, it could have been an earlier update.

Turning to the paper, this will not be a blow-by-blow analysis, I would heartily recommend reading it, however, a small amount of narrative is necessary to arrive at certain points highly relevant to where we are today.

Insights from the paper

The paper begins with a one-page summary, and notes the Fed’s price stability mandate, and the Fed’s longer run goal of maintaining controls to permit no more than 2% inflation. It then describes the Fed’s main operations, its "exclusive ability to alter the money supply and credit conditions more broadly", and how it conducts monetary policy by "setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis”.

From 2007, the Fed reduced the federal funds target rate from 5.25% down to between 0% to 0.25%, known as the zero lower bound. As Mr Labonte notes “by historical standards, rates were kept unusually low for an unusually long time to mitigate the effects of the 2007-2009 financial crisis and its aftermath”.

Beginning in December 2015, the Fed raised the rate nine times by 0.25% each time, and then, considering economic uncertainty, began reducing the rate again in a series of steps from July 2019.

The Fed’s independence from Congress is noted, and some concerns raised with that autonomy, quoting President Joe Biden, and members of Congress.

It is the next subject that starts to get interesting: quantitative easing (QE), that is, the practise of providing “additional stimulus through unsterilized purchases of Treasury and mortgage-backed securities (MBS)”. ‘Sterilized’ is when there is an offsetting purchase or sale of Treasury securities, a practice that is considered to have small or temporary effects at most. Unsterilized is not covered, and therefore adds to the Fed’s balance sheet.

Mr Labonte notes that the Fed undertook three rounds of QE between 2009 and 2014, “at which point the Fed’s balance sheet was $4.5 trillion—five times its pre-crisis size”, and then maintained the balance sheet at that level until 2017 when it began to reduce it. That is a significant, unprecedented change.

The next point is illuminating (my emphasis): “The Fed has raised interest rates in the presence of a large balance sheet through the use of two new tools - by paying banks interest on reserves held at the Fed, and by engaging in reverse repurchase agreements (reverse repos) through a new overnight facility. In January 2019, the Fed announced that it would continue using these tools to set interest rates permanently … In response to turmoil in the repo market in September 2019, the Fed began intervening in the repo market and began expanding its balance sheet again in October 2019”.

This was a significant change to operating procedure: the Fed was established by Congress, and President Woodrow Wilson signed the Federal Reserve Act into law on December 23, 1913. One hundred and ten years, and these tools have never been used before.

What follows in the paper is a relatively complete dive into the nuts and bolts. Risks are discussed, including reputational risk to the Fed, the need for transparency, a high-level explanation of Repos and Reverse Repos, and the methods used by banks and other financial institutions to access the Fed's discount window, to assist them in managing their own liquidity [4].

To note: A June 2023 paper investigating why banks avail of the discount window noted that “banks holding less reserves tend to borrow more often (and more) from the discount window. Similarly, banks with less liquid and riskier asset portfolios, and less market-pledgeable collateral, are also more likely to borrow from the Fed’s discount window” [5].

A Washington Post explainer on why banks are using it so much is also helpful [6], as is a Bloomberg/Reuters report [7] noting that the Fed is considering easing access to the discount window, to protect banks from runs such as the SVB collapse. This will strengthen their ability to meet withdrawal requests without selling assets that may have lowered in value over time.

The paper continues with various aspects: the economic effects of monetary policy, real and nominal interest rates, monetary versus fiscal policy, and unconventional monetary policy.

On the last point, Mr Labonte writes “To restore liquidity and stability to financial markets, the Fed responded by taking a series of unprecedented actions… The fundamental problem the Fed faced at the zero lower bound was that traditional monetary policy could not provide any further stimulus, yet the severity of the crisis required more stimulus to restore economic normalcy”.

One of the actions was direct assistance to the finance sector in the Fed’s capacity as lender of last resort: “The Fed made discount window loans during the crisis, but it also created a series of emergency facilities that were unlike anything the Fed had done before in its 100-year history”.

Another action undertaken was large scale asset purchases. To note: it didn’t stop there, as reported in the media. In April 2020, the BBC reported “the Fed's four 'radical' moves to save the economy: Making dollars available to foreign countries and financial firms; buying debt from big companies; lending to small businesses directly; and helping local governments" [8].

Thirteen days later, the New York Times reported that the Fed would commence buying $750bn in corporate bonds, starting with "E.T.F.'s that hold investment grade debt, but it will dabble in junk bonds, with direct purchases of corporate debt to follow" [9]. The Fed also announced unlimited access to US dollars for five central banks (ECB, England, Canada, Swiss National and Japan), and capped access to nine more countries.

We may never know the final figure of funds released to ‘save the world’s economies’ since the early days of 2007-2008, but Mr Labonte’s paper set me off on a trail I will write about in the coming months.

His paper raises the issue of the Fed actively engaging in markets it regulates and he notes: “There has been some concern about the potential ramifications of the Fed becoming a dominant participant in this market and expanding its counterparties. For example, will counterparties only be willing to transact with the Fed in a panic, and will the Fed be exposed to counterparty risk with nonbanks that it does not regulate?”

The paper finishes with a discussion on how the Fed plans to manage downsizing the balance sheet, and a review under way of “Monetary Policy Strategy, Tools, and Communications”.

I have returned to this paper several times, - for historical reasons as events have now decidedly moved on with the Fed active in deeper market engagement and a range of services offered, and also for a refreshingly honest view of fundamentals. I have wondered if that honesty was perhaps the reason the Feb 06, 2020 version was the last update produced, but this is idle speculation; as we see below, Mr Labonte continues to write and release high quality papers on a range of financial subjects.

On the one hand, perhaps we should all be grateful to the Fed for saving the world, because, to me, that’s what it appears the Fed has done, acting in consort with other national and reserve banks and institutions. So, ok, I am grateful. And we may never know what it took in terms of liquidity - extraordinary times demand extraordinary actions and all that.

On the other hand, the moral hazard of a range of small to very large organizations, and industry players, being bailed out, paid for by the present and future taxes of citizens, in actualité, socializing debt and bad behavior, doesn’t sit well. The lucky ones just keep getting luckier, an unbelievable bonanza. Debt write-off is a religious experience; the downside is that in some cases, likely very many, risky behaviours are rewarded. Given the global debt, it is not a happy place to try and architect solutions from. Will the Fed continue to save ships from rocks? Who is worthy?

Back in June 2020, in a Time report by Christopher Leonard, entitled 'How Jay Powell’s Coronavirus Response Is Changing the Fed Forever', he quoted Kenneth Rogoff, economics professor at Harvard University, and former chief economist at the International Monetary Fund, saying: “They’re in dangerous territory, and they know it,” Rogoff says. “The biggest risk is that people will grow increasingly angry when they realize the Fed has been picking winners and losers in debt markets, buying the debt of some cities and corporations and not others. Such resentment is already building” [10].

And back in October 2019, the International Monetary Fund (IMF) sounded a warning about how interest rates were motivating companies to take on more debt that risked becoming a “$19trn timebomb in the event of another global recession”, noting that “almost 40% of corporate debt in eight leading countries – the US, China, Japan, Germany, Britain, France, Italy, and Spain – would be impossible to service if there was a downturn half as serious as that of a decade ago” [11].

One wonders how a meltdown did not happen, given the subsequent rises in interest and mortgage rates, but yes, we may have dodged a global recession through extreme liquidity injections. Easy access to the Fed’s discount window, and the vast overnight market in repos, reverse repos, and other new services, are most likely the answer. Early days, and high fragility, seem to be relevant notes; the coming months will be critical for the global economy and financial stability. It is a new world now, the river flows as liquidity from the Fed; stability by faucet. Will we ever get trillions in debt down? Is this sustainable?

According to the American Enterprise Institute (AEI), the Federal Reserve System owns $5.3 trillion in US Treasury securities, or about 17% of the $31 trillion of Treasury debt outstanding. The Fed uses about $2.7 trillion of these securities in its reverse repurchase agreement operations, leaving the Fed with about $2.6 trillion of unencumbered US Treasury securities in its portfolio. The AEI suggests that the Fed writing off Treasury securities would not be a good idea [12].

When I review the Feb 2020 paper again, the potential for systemic risk by the Fed, actively engaging in markets it regulates, and counterparty risk - whatever the situation may be - are the points that come back to me. I have since increased deeper research on various aspects, through hundreds of papers and many tens of books, and plan to share insights over the coming months; I have Mr Labonte to thank for planting the seed in early 2020.

Other papers

Inflation in the U.S. Economy: Causes and Policy Options, October 6, 2022

We all think we know what causes inflation, through economic history and research around the times of extreme inflation, but this paper is highly illuminating in its breadth and depth of analysis, and a welcome refresher.

The one-page summary notes “The last time inflation was this high was during the 'Great Inflation' from the mid-1960s to the early 1980s, when a series of supply shocks, changes in inflation expectations, and a failure to sufficiently tighten monetary policy ultimately resulted in double-digit inflation. A number of policy initiatives over that period proved unsuccessful at reducing inflation, including price controls and credit controls. Inflation fell only after a long and deep recession in which the Fed raised interest rates as high as 19%.”

The oil shocks in 1973-1974 and 1979 are discussed, attributing inflation to a cause: “The long-term upward trend in inflation over the entire period is attributed to monetary policy that was persistently too 'easy' (i.e., stimulative) and the unmooring of inflation expectations.”

High inflation was finally tamed when the Fed "sharply tightened monetary policy under new Fed Chair Paul Volcker in the early 1980s", but it triggered a deep recession in the process.

This paper is useful to refresh historic experience with inflation and motivates thought on a range of potential paths for the coming 12 to 24 months, and longer.

The paper was authored by Marc Labonte and Lida R. Weinstock, Analyst, Macroeconomic Policy [14]. There are extensive references, one being a briefing note (two pages) on Volcker-era inflation, and policies, written by the same authors [15].

Foreign Holdings of Federal Debt, Updated June 9, 2023.

The paper is an overview of current status, noting “Federal debt represents the accumulated balance of borrowing by the federal government. The gross debt is composed of debt held by the public and intragovernmental debt held by federal trust funds. To finance the publicly held debt, U.S. Treasury securities are sold to investors”.

“As of December 2022, there was $24.4 trillion of publicly held debt outstanding, up from $16.1 trillion in December 2018, an $8.4 trillion increase (figures are rounded)... Because the total debt has increased faster than the debt held by foreigners has, the share of federal debt held by foreigners has declined in recent years. In December 2022, foreigners held 30% of the publicly held debt. Interest on the debt paid to foreigners in 2022 was $184.4 billion”.

The paper graphs the composition of foreign held debt by country, and asks why foreign investment in U.S. Federal Debt should be an issue of concern? It notes a range of issues, one potentially being “Unsustainable growth in the net foreign debt could lead to foreigners at some point reevaluating and reducing their U.S. asset holdings. If this happened suddenly, it could lead to financial instability and a sharp decline in the dollar’s value”.

This is a paper that is updated regularly and worth checking in on.

Authored by Marc Labonte, and Ben Leubsdorf, Research Librarian [16].

Two-Pagers

Central Bank Digital Currencies, Updated April 20, 2023.

This brief paper focuses on Federal Reserve and Treasury actions, CBDC design considerations, international initiatives, and issues for Congress to address, including enacting laws. It notes that “In the absence of congressional action, no consensus has yet emerged within the Fed or Administration on whether to adopt a CBDC after years of debate… in the meantime, bills have been introduced to address the potential effects on the dollar and the international financial system of other countries, such as China, developing CBDCs.”

Authored by Marc Labonte and Rebecca M. Nelson, Specialist in International Trade and Finance [17].

Bank Failures and Congressional Oversight, July 21, 2023

This brief paper focuses on efforts for Congressional oversight in light of the failures of three large banks in spring 2023 - Silicon Valley Bank (SVB), Signature, and First Republic: “Some Members (of Congress) have asserted that because supervisory information is confidential, there is insufficient transparency, and that hampers effective oversight.”

It is a work in progress, and so further updates will come available, but it is good to see where the progress is, or not, on ensuring a healthy banking system.

Authored by Marc Labonte [18].

Federal Reserve Launches FedNow, July 24, 2023

This is an illuminating brief paper, on the launch of the FedNow service by the Federal Reserve “which provides interbank clearing and settlement that enables funds to be transferred from the account of a sender to the account of a receiver in near real-time and at any time, any day of the year, to enable instant or real time payments (RTPs). It is available to all banks, who will be required to make those funds available to their customers immediately. The service had been pilot testing since September 2022.”

The paper notes that “FedNow directly competes with private sector settlement services. Several private-sector initiatives are also underway to implement faster payments… Some fear that FedNow will hold back or crowd out private competitors, will be underpriced since the Fed is not a for-profit organization, and could be a duplicative use of resources… From a societal perspective, it is unclear whether it is optimal to have a single provider or multiple providers in the case of a natural monopoly.”

Perhaps the most telling paragraph is this: “FedNow is not a central bank digital currency (CBDC), and no decision has been made on whether to introduce a U.S. CBDC. However, since FedNow enables RTPs, it reduces one of the benefits of introducing a CBDC”.

Visa does not seem to be concerned, according to Lynne Marek writing in BankingDive [19]. Bob Fernandez, writing in the Wall Street Journal, notes a range of comments concerning competition, and the fact that RTP systems have been available in other countries for years, but it appears that the take up has been successful [20].

Authored by Marc Labonte [21].

Summary

This brief note is simply to raise awareness of the research available at the Congressional Research Service, and to note a macroeconomic professional's work I have found to be insightful and valuable to read.

I check in at the CRS on a regular basis, and always search for new papers by Mr Labonte. This has been a richly rewarding activity, the subject matter is handled well. Other authors at the CRS are also worth reading, by searching against subject of interest here [22].

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Part 8: Future humanity

[1]: M. Labonte, ‘Monetary Policy and the Federal Reserve: Current Policy and Conditions,’ Congressional Research Service, 2020:  https://www.everycrsreport.com/files/20200206_RL30354_d2620ae4bc0820cb5e4fbe4987bf64bc6e46e87d.pdf

[2]: CRS, ‘Monetary Policy and the Federal Reserve: Current Policy and Conditions (RL30354)’, Feb 2020:  https://crsreports.congress.gov/product/details?prodcode=RL30354

[3]: everycrsreport.com, ‘Monetary Policy and the Federal Reserve: Current Policy and Conditions,’ everycrsreport.com, 2020. https://www.everycrsreport.com/reports/RL30354.html

[4]: P. Hendry, ‘The Federal Reserve’s Discount Window: What It Is and How It Works,’ Community Banking Connections, 2016. https://www.communitybankingconnections.org/articles/2016/i2/federal-reserve-discount-window

[5]: H. Ennis and B. Klee, ‘The Fed’s Discount Window in ‘Normal’ Times,’ Finance and Economics Discussion Series. Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C., 2021:  https://www.federalreserve.gov/econres/feds/files/2021016pap.pdf

[6]: A. Harris and S. Kennedy, ‘Analysis | What Is the Fed Discount Window and Why Are Banks Using It So Much?,’ Washington Post, Mar. 17, 2023: https://www.washingtonpost.com/business/2023/03/17/what-is-the-fed-discount-window-why-are-banks-using-it-so-much/f7c07198-c4de-11ed-82a7-6a87555c1878_story.html

[7]: Reuters Staff, ‘U.S. Fed considers easing access to discount window to help banks - Bloomberg News,’ Reuters, Mar. 12, 2023: https://www.reuters.com/article/global-banks-svb-discount-idINL4N35K0LE

[8]: BBC, ‘The Fed’s four radical moves to save the economy,’ BBC News, Apr. 28, 2020:  https://www.bbc.com/news/business-52390840

[9]: Dealbook Newsletter, ‘The Fed Is Buying E.T.F.s Today - The New York Times,’ 2020. https://www.nytimes.com/2020/05/12/business/dealbook/fed-bond-etf.html

[10]: C. Leonard, ‘How Jay Powell’s Coronavirus Response Is Changing the Fed | Time,’ Time Magazine, 2020: https://time.com/5851870/federal-reserve-coronavirus/

[11]: IMF, ‘Global Financial Stability Report, October 2019: Lower for Longer,’ IMF, 2019: https://www.imf.org/en/Publications/GFSR/Issues/2019/10/01/global-financial-stability-report-october-2019

[12]: P. H. Kupiec and A. J. Pollock, ‘A Frightening Solution to the Debt Ceiling Crunch,’ American Enterprise Institute - AEI, 2023. https://www.aei.org/op-eds/a-frightening-solution-to-the-debt-ceiling-crunch/

[13]: U.S. Department of the Treasury. Fiscal Service, ‘Federal Debt Held by Federal Reserve Banks,’ FRED, Federal Reserve Bank of St. Louis, 2023: https://fred.stlouisfed.org/series/FDHBFRBN

[14]: M. Labonte and L. R. Weinstock, ‘Inflation in the U.S. Economy: Causes and Policy Options October 6, 2022.’ Congressional Research Service, 2022: https://crsreports.congress.gov/product/pdf/R/R47273/2

[15]: M. Labonte and L. R. Weinstock, ‘Back to the Future? Lessons from the ‘Great Inflation.’’ Congressional Research Service, Jul. 28, 2022: https://crsreports.congress.gov/product/pdf/IF/IF12177

[16]: M. Labonte and B. Leubsdorf, ‘Foreign Holdings of Federal Debt Updated June 9, 2023.’ Congressional Research Service, 2023: https://crsreports.congress.gov/product/pdf/RS/RS22331

[17]: M. Labonte and R. M. Nelson, ‘Central Bank Digital Currencies,’ Congressional Research Service, 2023:  https://crsreports.congress.gov/product/pdf/IF/IF11471

[18]: M. Labonte, ‘Bank Failures and Congressional Oversight.’ Congressional Research Service, Jul. 21, 2023: https://crsreports.congress.gov/product/pdf/IF/IF12454

[19]: L. Marek, ‘Who’s afraid of FedNow? Not Visa,’ Banking Dive, Sep. 02, 2022: https://www.bankingdive.com/news/Visa-CFO-Prabhu-FedNow-real-time-payments-competition-federal-reserve-deutsche/631219/

[20]: B. Fernandez, ‘Pro Take: Fed to Face Competition as It Enters the Instant-Payments Space,’ WSJ, Jul. 02, 2023:  https://www.wsj.com/articles/pro-take-fed-to-face-competition-as-it-enters-the-instant-payments-space-50751467

[21]: M. Labonte, ‘Federal Reserve Launches FedNow.’ Congressional Research Service, Jul. 24, 2023:  https://crsreports.congress.gov/product/pdf/IN/IN12207

[22]: CRS, ‘CRS Reports,’ 2023: https://crsreports.congress.gov/