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That’s a fair -er- misunderstanding. You get that sense from the financial media.
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Well sure…I’m a network engineer, not an economist. I participate in threads like this as a sanity check to determine how clueless my baseline perceptions are or aren’t.
Am I saying that? No…I basically read it in various economic publications, as you noted. So, my opinion has been informed by those readings, which seem to indicate that as things currently stand the Fed would be unable to use that particular tool if there were a recession. I understand that there are others, but that seems to be the one used heavily in the past. Are you saying that the Fed doesn’t need that in a theoretical future recession? Can you explain that For Dummies?
However, external shocks can also set them off. Currently the stock market is going through a large adjustment due to a perceived slow down in China’s economy coupled with issues in the EU and falling oil prices. From what I’ve read, the US economy is still strong at this point, despite the dip in stock value, but that additional shocks could set up a recession. Not true?
I think the Fed is quite concerned with their lack of flexibility should another downturn present itself. Their most potent tool is not in their arsenal. This is probably the primary reason why they seek to raise interest rates, even as inflation concerns are tempered.
It is quite an exaggeration to suggest that a 25-basis-point increase would cause a recession or even have much of an impact on economic growth. If that were the case, the Fed would never change interest rates.
The Fed was notoriously reactionary until the Volcker years, who himself was acting overtly as a reaction to hyperinflation. The pre-emptive changes in interest rates are a nascent phenomenon, and I’ve never seen the suggestion that the Fed has caused any recession. Things that have caused recessions are the tech bubble bursting, the housing/financial crash, the various energy crises of the 70s and 80s, and fiscal overreach. Nowhere has an interest rate change by the Fed been credited with causing a recession. Worsening an already-existing recession, sure. You are drastically inflating the consequence of a modest change to the fed funds rate.
Don’t bring up foolish analogisms. This thread was about the Fed raising rates (i.e. the fed funds rate) and you bring up your car loan as some refutation to the reality that the fed funds rate has been nearly zero for a historically long time.
It’s your stupid analogy in your own thread. Dig yourself out of it and leave my economic understanding to stand by its merit.
I agree, though opinions may differ on tools not attempted.
Disagree. It’s not that type of tool. Cutting rates stimulates the economy. Raising rates deflates the economy, cutting some combination of output and prices. Past experiences with raising rates prematurely have not been pretty. You don’t let air out of your tires so that you can inflate them later. You don’t overfill your tires so that you can deflate them later. You try to keep your tires at the correct pressure, or at least a certain range.
They like to stay subtle about this. I can return to this later. The classic example would be October 1979 though.
Breaking News
Tim Duy, the go-to Fed guy: Dudley Puts The Kibosh On September Whew. Duy: “Bottom Line: The Fed has long argued that the timing of the first rate hike does not matter. I had thought so as well, but that is clearly no longer the case. A rate hike during a period of substantial financial market turmoil would matter a great deal. It looks like the Fed’s plans to raise rate will once again be overtaken by events.”
Inflation is not a floor for interest rates. If you look at the period from 2002 to 2005, inflation was higher than interest rates for 3 month Treasury bills. The same thing has been true since the end of 2007, until now, with the exception of most of 2009, when inflation was negative, and a short time at the beginning of the year, when inflation briefly went negative again.
The floor for interest rates is whatever the Fed says it is.
The connection between inflation and interest rates is that the Fed generally raises rates when it sees inflation. It’s not that inflation itself causes interest rates to go up.
The inflation of the 70’s corresponded with the oil crises of the same decade. The US allowed itself to become dependent on foreign oil, and when oil imports plunged and prices spiked, we got simultaneous unemployment and inflation. Without enough oil, the economy couldn’t run at full capacity, and the higher prices of the oil we did get caused increases in the prices of almost everything.
I don’t think there’s a fixed natural rate. But I do think that failing to take advantage of human resources that are currently un- or under-employed is pissing away an opportunity. They could be doing work that desperately needs to be done, and that would represent a real investment in the future.
If the economy was a car, then we should be thinking of fixing it, when we have the opportunity, instead of driving it slowly.
My own opinion is that when the media says stocks went down (or up) on a particular day because of XYZ, they’re mostly making it up. Sometimes they’ll say stocks went up because of X, only to say at a later on that stocks went down, for the same reason.
As far as interest rates go, there are at least two reasons some traders might fear rising rates: one is that they fear some people who had been buying stocks would instead start buying bonds. (Less demand for stocks means prices fall.). Another is that raising interest rates could cause a downturn in the economy, which would be bad for the stock market, because companies sell fewer products in a recession.
A third possibility is that the investment class has different incentives than the rest of the country. For most people, rising salaries and wages are good things - because most people work for a living. But for owners, salaries cut into profits. If you’re an owner, you want to pay as little as possible, while charging as much as possible. Some unemployment is a good thing for owners, because it keeps wages down.
LinusK, I think you over-fixate on Fed-set interest rates, rather than the interest rates set by the market.
Of course expectation of inflation causes interest rates to go up; think of supply and demand. People are happy to borrow when they’ll need to pay back less than they borrowed! Investors, OTOH, will buy gold rather than lending to get back less than they lend.
I didn’t mean to indicate catastrophe: I was making a qualitativie point, not a quantitative one. I wasn’t clear. I hope the switch to the tire filing analogy helped.
Still, those are only analogies which don’t prove anything. My underlying model involves potential gdp (which rises with the workforce, machinery and technology) and actual GDP. If potential GDP is a lot higher than actual GDP, that implies unused capacity, for example unemployment. If actual GDP is above potential GDP, that implies lots of overtime hours… and accelerating inflation.
The economy is a lot stronger now than it was 3 years ago. But this chart suggests to me (doesn’t prove) that there’s some excess capacity, at least over the medium term. It show the declines in the labor force participation rate since the beginning of the Great Recession. (Yes, it’s only a 1st step in a legitimate analysis: that series has some pronounced secular trends operating on it as well).
At any rate, with my simple model, lowering the speed by which you close the gap between potential and actual GDP only weakens the economy: the best policy is to close that gap as soon as practical. Moving forwards, if you want to increase the effectiveness of monetary policy (and personally I do) you need to make lower real interest rates possible, even if nominal rates can’t go much below zero.
Recall also the expectations effect: raising rates now introduces anticipation of future rate increases, which leads to higher long term rates. The effect of the first 25 basis point increase should be higher than the second increase.
Krugman, 2009: What seems clear is that the nature of monetary policy leading up to recessions has changed dramatically. Pre-Great Moderation, recessions were preceded by tightening policy, presumably to control inflation; the combination of policy tightening and a high underlying inflation rate meant high rates going in, giving lots of room for policy loosening. Increasingly, however, recessions have been the result of bursting bubbles, with monetary policy getting looser even before the recession begins. http://krugman.blogs.nytimes.com/2009/05/29/changing-recessions/comment-page-2/?_r=0
Wikipedia: A brief recession occurred in 1980. Several key industries including housing, steel manufacturing and automobiles experienced a downturn from which they did not recover through the end of the next recession. Many of the economic sectors that supplied these basic industries were also hard-hit.[13] Each period of high unemployment was caused by the Federal Reserve, as it substantially increased interest rates to reduce high inflation; each time, once inflation fell and interest rates were lowered, unemployment slowly fell.[14]
Bill McBride of Calculated Risk: Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation.
Read more at Calculated Risk: Predicting the Next Recession
I agree though that the 2000 and 2007 recessions didn’t follow Fed tightening. Also, the Fed successfully threaded the needle during the mid-1990s: they tightened enough to curb incipient inflation but didn’t go so far as to tip the economy into recession.
It’s unclear whether widespread knowledge that the Fed has caused recessions to nip inflation in the bud is politically sustainable. And it’s not like the Fed necessarily wants recession: presumably they would be willing to slow down an overheating economy gradually. It’s just that errors can happen. To quote one European central banker, “We are not inflation nutters.”
Paying less interest is the difference between the warm glow of sending your kids to school in new school clothes, and the chilling effect of seeing them off to school in the same clothes they wore last year.
It’s also the difference between the warm glow of having a store full of parents buying back to school clothes, and the chilling effect of a store filled with unsold merchandize.
How does the Fed increase interest rates without selling off the trillions of excess reserves they’ve purchased over the last several years? Do you see them increasing the rate they’re paying on excess reserves?
Wall Street love low interest rates, because it allows for increased speculation. The explosion of derivatives and exotic investments is because of low rates. Goldman Sachs loves it, because the big money investors cannot accept low bond yields, and hence, fire up the derivatives market. The low rates have also directed much capital toward unstable 3rd world countries-like the BRICs-Brazil is now collapsing-ask people who poured money into Brazilian stocks how happy they are now. China also had a huge inflow of capital-now their market is collapsing.
But the main issue is the retired people-who cannot live on the paltry investment returns they get.
But, Wall Street like low rates-so to h*ll with them.
Wasn’t addressed to me, but will try to answer it anyway.
IMO, the underlying problem is reliance on commercial bank credit. Of course there’s always a proximate cause, but it’s a bit like walking a tightrope: if you fall, is it because the wind picked up - or is it because you were on a tightrope?
Maybe if you hadn’t been up there in the first place, the wind wouldn’t have knocked you down.
With sufficient government money (as opposed to commercial bank money) recessions are not inevitable. The Fed is not like regular banks. It can’t go bankrupt, and it can readily expand its balance sheet during times when commercial banks are shrinking theirs. The Fed has about a $4 trillion balance sheet, but there’s no reason why it can’t add an additional one or two trillion. Doing so, IMO, would reduce unemployment, and add stability to the U.S. economy.
Sweden raised rates too soon and pushed the country into deflation. That’s bad. But what’s even worse is if raising rates too soon pushes a country into a deflationary spiral. Those are extremely difficult to get out of (see, for example, Japan). Well, I don’t think they’re that difficult to get out of, but politically in the US, it’s difficult to implement the policies needed to get out of a deflationary spiral.
If the Fed raises rates too early, the potential consequences are extremely bad. If they raise rates a bit too late (and it’s just going to be a bit too late, since the moment they see mild inflation, they’re going to start raising), then big deal. We’ll suffer a bit of mild inflation, which will probably be helpful at this point anyway.
All this is saying is that bubbles in the economy are (possibly) burst a little sooner due to easy monetary policy. The bubbles, of course, are what caused the recession.
Stagflation presented a classic dilemma that was solved by Paul Volcker: when unemployment is high due to a stagnant economy and inflation is high due to supply shock (i.e. oil in the 70s and 80s), monetary policy is in a catch-22. If you keep rates low to stimulate the economy, you are exacerbating inflation tendencies, whereas if you raise rates to stifle inflation, this will likely exacerbate the stagnant economy and increase unemployment. Efforts at accommodating monetary policy had failed as inflation was roiling the market’s ability to make long-term investments. Volcker came in as Fed Chair and took drastic measures to tame inflation. In the short-term, this increased unemployment. However, in the long-term the economy recovered mightily once the burden of high inflation was removed.
The lesson from the Volcker years is that inflation is the variable most easily controlled by the Fed, and must be controlled in a predictable manner to ensure market stability. What the Volcker tenure did not prove is that the Fed causes recession.
The gist of this is that the Fed should have been raising rates in the years leading up to the '91 recession. Apparently underlying inflation was high and the Fed was keeping money too loose. The headline itself is to grab attention: Krugman doesn’t actually argue that the Fed causes recessions.
This contradicts your first cite where Krugman states “increasingly, however, recessions have been the result of bursting bubbles, with monetary policy getting looser even before the recession begins.”
I participate in threads like this as a sanity check to determine how clueless my baseline perceptions are or aren’t.