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May 17, 2011


Brad DeLong

You have got it wrong.

You could tell back in 2008 that the market wasn't short of cash--the short-term safe nominal interest rate was very low. You could tell back in 2008 that the market was choking on much too high a supply of risky debt--the prices of risky debt were very low and their interest rates were very high, while the prices of safe debt were very high and the interest rates on safe debt were very low.

What you wanted to do back then was to transform a whole bunch of risky debt into safe debt: that was the way to get financial markets back into balance.

What conventional open-market operations did was to transform a bunch of safe debt into cash--with very little net effect on the economy.

Brad DeLong

Nathan Smith

Wow! Welcome! I think I get it. Cash *is* a good substitute for safe debt. But the Fed buying safe debt just kept the supply of safe debt + cash the same. Thanks.

If you wanted to transform risky debt into safe debt, TARP was just what the doctor ordered, then, right? And it seems to have worked pretty well, particularly since it wasn't even costly in the end, since the banks paid the money back.

TARP seems technocratically smart to me, but I suspect it had a large hidden cost in terms of political risk and as a spur to rent-seeking. Hank Paulsen's ultimatum to Congress was a revolution: before it happened, hardly anyone would have imagined it was even possible. And afterwards it left behind a lot of uncertainty of what the next sudden transformation of policy might be.


It seems to me the glut of risky investments was at least partially caused by the rapid reassessment of instruments from safer to riskier, turning one kind of product into another after it had been produced. Though this might be regarded as the 'fault' of the supply side actors, it certainly wasn't a planned action, and solutions would have to be on the demand side. It was much too late to just supply fewer such instruments.

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