51 – George Selgin on Reforming Open Market Operations and Normalizing Fed Policy

Episode Summary

Executive Summary: George Selgin argues that the Fed should normalize policy by shrinking its balance sheet and ending crisis-era interventions, but only alongside a deeper reform: flexible open market operations open to many counterparties and broader collateral. He rejects proposals to expand the Fed into retail banking or maintain a large balance sheet as a “safe asset” supplier, calling these forms of financial repression.

Main Topics: New books and broader monetary history project (Priority: 2/5): Selgin briefly discusses several upcoming books on U.S. money, Fed history, and monetary policy, including a critical history of government intervention in money. Flexible open market operations reform (Priority: 5/5): His main proposal is to replace the primary-dealer-centered system with broader auctions open to more banks and possibly other institutions, using more types of marketable collateral. Why crisis-era liquidity tools were inadequate (Priority: 5/5): He argues the financial crisis exposed the limits of the primary dealer system and the stigma-ridden discount window, leading to ad hoc Fed facilities that were inefficient and arbitrary. Opposition to widening the Fed into retail banking (Priority: 4/5): Selgin rejects ideas that the Fed should offer deposit accounts broadly to households and firms, warning that central banks would crowd out private financial intermediation and innovation. Critique of a large Fed balance sheet and ‘safe assets’ logic (Priority: 5/5): He argues a large balance sheet does not create real liquidity; rather, regulations and administered rates artificially boost demand for reserves and other government liabilities. Balance-sheet normalization and monetary control (Priority: 4/5): Selgin supports shrinking the Fed’s balance sheet, but says it must be done carefully alongside reforms to IOER, reverse repos, term deposits, and the liquidity coverage ratio.

Key Arguments: The Fed’s core job should be supplying the right aggregate liquidity, not separately managing a rigid distinction between routine monetary operations and lender-of-last-resort functions. The primary dealer system is an anachronism; broader counterparties and auction-based access would distribute liquidity more efficiently during normal times and stress episodes. The discount window is stigmatized and moribund, so emergency lending should be replaced by flexible open market operations rather than by more ad hoc facilities. Keeping a large balance sheet does not increase real safe assets; it mainly reflects regulations and administered rates that raise demand for Fed liabilities, which is a form of financial repression. Opening the Fed to retail deposits would crowd out private banks, reduce financial innovation, and amount to central bank nationalization of credit. Shrinking the balance sheet is desirable, but passive runoff alone may be lumpy; active, orderly sales plus other tools are needed to manage the transition. Interest on excess reserves, reverse repos, and the liquidity coverage ratio all prop up demand for reserves and Treasuries, making the system less liquid in a real sense.

Data Points: Fed assets before crisis: just under $900 billion - Used to illustrate the growth of the Fed’s balance sheet since the crisis. Fed assets after expansion: just under $4.5 trillion - Current size of the balance sheet discussed in the normalization debate. Balance-sheet increase: roughly four-fold - Comparison of pre-crisis and post-crisis Fed assets. Interview timing / policy expectations: 2017 - Described as a year likely to feature multiple Fed rate hikes and renewed discussion of balance-sheet reduction. Book release timing: April - Selgin says Money, Free and Unfree will be published in April. Number of books Selgin is working on: 3 - He describes three projects: a collected essays volume, a monetary policy primer, and a short Fed history book.

Pivotal Quotes: "it’s time to move beyond that" — George Selgin: On the outdated split between monetary policy operations and lender-of-last-resort lending. "it’s a lot of crap. It’s financial repression, pretending to be an arrangement that makes markets more liquid" — George Selgin: On arguments that large reserve balances and related regulations make the financial system safer or more liquid. "No emergency lending. No 13-3 lending. Don’t need any of that." — George Selgin: On how a reformed auction-based open market system could replace ad hoc crisis facilities.

Implications: Selgin’s view implies a smaller, more rule-based Fed with broader auction access, less emergency improvisation, and fewer distortions from reserve-heavy regulation. For markets, it favors private intermediation over central-bank expansion.