The fed has purchased treasury bills, notes and bonds in exchange for cash which has flowed into excess reserves and an expanded loan base. Presumably slowing down the rate of purchase would be consistent with a small increase in the Fed funds rate. Public statements by the Fed have suggested that they feel that even after the first rate increase, monetary conditions will remain extraordinarily lax.
Volker has been dubious about paying interest on excess reserves. According the Alan Blinder the Fed does this so as not to decimate the money market fund industry. That’s the cost. And they feel the benefit of not paying 0.25% on excess reserves would be pretty modest. Cite: After the Music Stopped, p. 246. Alan Blinder: “I can be definitive on [these 2 explanations] because I have argued for this policy [lowering rates on excess reserves] over and over with FOMC members, unsuccessfully so far.”
I do not know what the policy on excess reserves will be moving forwards. I do not know what if anything the Fed will do to address the zero lower bound problem.
Now you have. I’ll quote from the quote boxes I provided.
I quote Krugman again: “Pre-Great Moderation, recessions were preceded by tightening policy, presumably to control inflation…”
Wiki said: " Each period of high unemployment was caused by the Federal Reserve, as it substantially increased interest rates to reduce high inflation…" You appear to disagree with the claims in Wikipedia.
I think the underlying process is captured in this quote from the article: " Under the leadership of Fed Chairman Paul Volcker, the central bank instituted a policy of tight money that brought an impressive, although costly, victory over inflation. Faced in 1982 with a debilitating recession, Chairman Volcker then reversed course and engineered a rapid and sustained economic recovery." The cost of crushing inflation was the 1980-1982 double dip recession.
I don’t see the contradiction. Most Post WWII recessions were caused by Fed tightening. Not all. In particular not the last 2 ones. But there have been 10-11 recessions since WWII, depending upon how you count them.
To be clear, I’m not claiming that recessions are inevitable if you wish to lower inflation. I’m saying that the Fed’s attempts to lower inflation have often resulted in recession.
And, if you’ll look at this chart, you’ll see that 7 of the 9 recession in the past 50 years were immediately preceded by rising interest rates. (The exceptions were 1990 and 2001.) Every recovery (9 out of 9) began with falling interest rates.
Tim Duy answers the OP and wins the thread. Tim Duy is an economist at the University of Oregon and a leading Fed Watcher. He originally thought the Fed was going to raise rates in June, then in September. His personal preferences have been for going slower. But he has a pretty good sense of the Fed. He now thinks the market fluctuations have taken a September rate increase off the table. But why were they chomping at the bit earlier? [INDENT]The Right And Wrong Arguments For September
This September meeting is the gift that keeps on giving. Right now it is giving by the shear quantity of truly bad commentary arguing for a rate hike next month.
Let’s back up a few weeks. Prior to the recent market rout, September looked like a pretty good bet. And the basic story that justified that view still holds. It isn’t complicated. Just a straight forward Phillips curve story. The economy continues to improve, dragging the labor market along for the ride. Any questions about the meaning of a weak first quarter GDP report were wiped away by the second quarter. Neither is by itself meaningful; the average of 2.5 percent growth for the first half is just about the same as 2014 as a whole. As the labor market approaches full employment, policymakers expect that wage growth will accelerate and they must raise interest rates to prevent those wage gains from translating into above-target inflation. They feel they need to raise rates sooner than later to be ahead of the curve.
That story is not without holes, of course. The lack of widespread faster wage growth or inflationary pressures as the unemployment rate approached the Fed’s estimate of full employment should be a red flag. Moreover, measures of labor underutilization remain elevated. Marked-based inflation expectations were low and falling, the dollar was rising, and commodities were tanking. And it seems that the risks of premature exit from ZIRP still outweigh the risk of holding on just a little too long. The Fed staff highlighted this risk in the July FOMC meeting. From the minutes: …
[/INDENT] There’s more: The Right And Wrong Arguments For September - Tim Duy's Fed Watch
For the quarter the Gross domestic purchases price index was a low 1.5%. Which is odd since 5.9-3.7=2.2: that calculation is usually closer. I must be messing something up.
Thanks for the link. I especially liked the graph showing inflation expectations going down. If I can boil down what he’s saying, it’s that a lot of people in what he calls the “commentariat” are make bad or nonsensical arguments for raising rates.
He doesn’t make it clear whether he’s personally in favor of raising rates, but if rates go up he thinks it will be because:
Which is sad. Real wage growth is a good thing, for the vast majority of people. Even if rising wages translate into inflation - and I think that’s necessarily a given - it would be worth it: rising income inequality comes mostly from the failure of wages to keep up with profits.
If inflation determined interest rates, you’d expect interest rates and inflation to be closely correlated. On the other hand, if the Fed determined interest rates, you’d expect the federal funds rate and interest rates to be closely related.
If you look at this chart, you’ll see three lines. The red line is inflation. The blue line is the federal funds rate, and the green line is the interest rate on three month Treasuries. What you’ll see is that there is a relationship between both the federal funds rate and inflation - because the Fed normally raises rates in response to inflation, or the fear of inflation. But the relationship between interest rates and the federal funds rate is much closer. With few exceptions - mainly when the Fed suddenly raises the FFR, interest rates and FFR match perfectly.
Inflation, on the other hand, diverges from the other two - sometimes substantially. During parts of the 80s, for example, the difference was 5% or more. Inflation has occasionally been higher than interest rates - most recently over the past six years or so, during the early 2000’s, for a short time in the 1950’s, and during part of the 1970’s.
In the this chart, the inflation rate is matched against Aaa corporate bond yields. Corporate bonds are usually higher than inflation, but not always, and the difference varies significantly.
For example, in 1932, there was a 15% point difference. Bonds were paying 5%, but inflation was -10%. In 1986, bonds were paying 9%, but inflation was less than 2%. On the other hand, bonds don’t always outpace inflation. In 1947, for example, bonds were paying 2.6%, while inflation was running at 14.4%. In 1980, bonds were paying about 12%, while inflation was running at about 13.5%. More recently, bonds have generally outpaced inflation, running at about +9% in the early 80s to about 1.5% in 2012. At any rate, the relationship between corporate bonds and inflation is poor, at best.
Now, I’m not saying that the Fed controls all interest rates. Corporate bonds, for example, might go up or down in value, depending on - for example - what the stock market is doing.
But I don’t think interest rates represent any kind of “floor” for interest rates. There are a number of examples when interest rates - depending on the vehicle - have been lower than inflation.
Maybe because enough rich people will benefit most from it, instead of hurt by it.
So many people that have been living with stagnant wages, losing against inflation wages, no wages, are so far in debt, that an interest rate increase would be a huge windfall to those holding the debt.
It would slaughter a whole bunch of middle and lower class.
So all their property of value could be repossessed and then rented out or resold.
The dream of the top wealth holders is for everything to be rented. Not owned. They own it, you rent it.
I think the tricky part is raising the interest rates at the right speed to crush everyone into being nothing but renters without having them turn on the system in mass. More things are being converted to rentals, leases, streaming, on demand, etc… Becoming the norm. Just have to get the rest.
Then everyone runs a tab at the company store, for everything, forever.
I think you’re fundamentally right. What interest rates are about is taking money from people who are mostly less well-off (relatively poorer) and transferring it to people who are mostly better off. That’s especially true of what I’ll call the ownership class - people whose income comes mostly not from work, but from interest, dividends and profits.
What if the right-wing side of the Fed is signaling that they seek to crunch the economy next year and ensure a GOP Presidential win? If recent economic change is a predictor, and the Fed can hurt the economy at will, then the Fed can force the incumbent party out at will. Scary!
Yes. And Congress can take away the Fed’s independence, something they guard tightly. I’m not saying something like that can’t happen. I’m saying the Fed very much doesn’t want something like that to happen. Expect no interest rate changes in Sep-Oct 2016 barring financial panic. Expect them not to comment on that.
Frankly, methinks shifting to a 3-4% inflation target as I and Kevin Drum advocate is a heavy lift. The weird thing is that the core PCE deflator, the Fed’s favorite measure of inflation, is at 1.2% Jul 2014-Jul 2015. That’s pretty low. Federal Reserve Vice Chairman Stanley Fischer says that, “…there is “good reason” to think sluggish U.S. inflation will firm and move back toward the U.S. central bank’s 2% annual target.” Well I suppose that’s correct in a literal sense. But the Fed seems to be treating 2% as the cap, creating long term risks of Japanese-style deflation. Not good.
So Dr. Fischer, if core PCE inflation stays under 2% in, say, 2017 I would hope that mean that the Fed’s policy was too tight. Right? Right? The bond market is pegging 10 year inflation at 1.5%, which seems to me that they don’t think the Fed will hit its inflation target.
No disrespect towards the preeminent Stanley Fischer intended. Like many college students of economics, I was brought up on Dornbusch and Fischer’s Macroeconomics. The man is a giant.
I agree with the many who think 2% is much too low of an inflation ceiling in today’s conditions.
Another general comment, which may be related to the fact that inflation is too low, is that present-day unemployment in countries like U.S. and Japan is already rather low, given the low inflation rates. To ask for higher employment may be to ask for higher demand than exists, i.e. to expand the “consumerism” decried by many of the same liberals who are asking for higher employment.
Some in the thread assert that high interest rates tend to transfer funds from the poor to the rich. Ralph takes an almost contrary view, asserting that low interest rates adversely affect retirees. Both positions ignore the difference between short-term and long-term interest rates. Those investing in short-term bonds will get better rates as their investments “roll over.” Those investing in dividend stocks have gotten higher capital gains as yields fall (or vice versa).
These St. Louis Fed graphs don’t show me what you write. Perhaps you missed a step in preparing a permanent URL for the graphs you created.
In any event, Fed policy tends to determine short-term interest rates, while inflation expectation tends to determine long-term rates. Exceptions from the 1930’s tell us little about today: economists of all stripes concede that major mistakes were made in the 1930’s.
I’m happy for you to show me or tell me where I made a mistake, or if you want, you could link to your own analysis. That inflation expectations tend to determine long-term rates is a statement, but you haven’t provided evidence or argument in to support it. (I know one of the arguments: that lenders won’t lend if real rates are below zero. I think the argument is false: lenders are price-takers, not price-makers. Or to put it differently - since the interest rate market is a market - borrowers and the Fed have more market power than lenders do. Lenders are people with money. They want the best rate they can get. But if the best rate they can get is below whatever they expect inflation to be in the future, they’ll still take it, because the option to not lend is even worse than the option to lend at negative real rates. Not lending simply means they lose even more money (in real terms) than if they lend at negative real rates.
I disagree that current unemployment in the US is too low. We’ve had lower unemployment in the past, without inflation. Japan currently has lower unemployment and low inflation. As far as consumerism is concerned, I’m less worried about that than rising inequality and stagnant wages. And, of course, we have any number of investment opportunities that are currently going unmet. The usual argument is that we can’t “afford” to make real investments (in transportation and transportation infrastructure, for example, or education). I would argue as long as we have millions of unemployed, we can afford it. The true measure of what we can afford is the number of people who aren’t working, not federal budget numbers. Employing those people would have both short-term and long-term positive effects on the economy. The best way to ‘save’ for the future is by paying for real investment. The government - meaning the Fed and the Treasury - can create more money at virtually zero cost. They’ve been doing it for years, with successful results, and they should continue doing it, until we have either real full employment, or actual inflation. For my part, I’d quickly accept 5-6% inflation, if it meant less unemployment, more real investment, higher wages, and a narrowing of the wealth gap - not that I actually think 5-6% inflation is actually necessary to accomplish those things. But if it was necessary, that would be fine with me.
I claim: the US would benefit from a higher core inflation target.
Prediction: If higher inflation is to occur, it will happen by accident or at least what appears to be an accident. Then the debate will be whether to lower inflation and by how much. The Fed fears, probably correctly, that the swamps will freak if the Fed says they want higher inflation. So that won’t happen. This is unfortunate.
Also and separately:
Effectively, higher inflation taxes savings. There are distributional issues here. Let’s say we’re back to normal times and a bond pays 3% over the inflation rate. The upper income tax on the last dollar is, say, 40%. (None of this applies to those saving money in an IRA. Also taxes on dividends and stock appreciation are lower than taxes on interest payments.) Compare:
Nominal rates of 1.5% inflation + 3% = 4.5% rates or 2.7% after tax.
vs.
3.5% inflation + 3% = 6.5% rates or 3.9% after tax.
In the first case the bond pays our affluent investor 1.2% after tax. In the higher inflation case they earn 0.4% after tax. Big difference.
Things are more complicated, since you have to consider the effects on savings rates (if any) on all of this, which might affect real returns: there are “General equilibrium” issues. But to a first and reasonable approximation, those whose income derives from investments rather than wages with high marginal tax rates have an interest in lower inflation. They also share a very real interest in avoiding financial crisis and faster GDP growth. For the CEO, growing economies are more fun than shrinking ones, though some of them apparently have pretty sensitive egos that need to be stroked. Weird, I know. Anyway, I think a higher inflation rate would be a net positive for pretty much everyone though for the affluent or richer it’s not a slam dunk.
The Fed expanded its balance sheet three times. Most dramatically in 2008, when it went from $.9 trillion to $2.2 trillion. Then again in 2010-11, when it went from $2.3 to $2.8. Then finally between 2012 to 2014, when it went from $2.8 to $4.5. Since 2014 it’s fallen, but not significantly. I don’t know that stopping purchases or even reducing the Fed’s balance sheet a little will do anything, as far as interest rates. Recent history certainly suggests not.
Excess reserves currently stand at about $2.5 trillion, which means the Fed would have to sell off that much (while also sucking that much money out of the economy) in order to start forcing interest rates back up. Destroying that much money - I suspect - would do a lot of damage to the economy, long before it started affecting interest rates.
From reading popular articles, I get the impression people think the Fed’s still in a position where it can buy or sell off a few billion in Treasuries to change interest rates. It’s not in that position anymore, and hasn’t been for a long time.
So I’m still unsure about how the Fed’s planning on raising interest rates.
I mean the same thing I always mean: changing the conditions when they pull the trigger on Chekhov’s conditional gun.
90% of the “effort” of monetary policy is done out in the world in the markets, based on the broader public’s expectations of how the central bank will react. The central banks of the world don’t (necessarily) need to buy more bonds, don’t need to create more money. They need to change expectations. They need to make the current money permanent. They need to take their finger away from the trigger. They need to tell the world they won’t yank back on the chain until spending is higher.
More money flowing through the economy would buy up more resources. It would seek out opportunities. It would gobble up those potential opportunities. This would have two effects.
One factor in the interest rate is simply the ability of investors to park their cash elsewhere. No one would lend to the US Government at 2.18% if they thought a similarly safe opportunity existed at 10%. That’s an exaggeration, but it illustrates the point. As more and more enticing offers get dangled in front of investors’ eyes, the US government will have to offer more in order to compete. A second factor in the interest rate is inflation. More spending in the economy won’t just push up real production exclusively. It will also push up prices, and (all else equal) investors will demand a premium if the future money they get paid back with has less purchasing power. All else is never equal in macro, but in this case, any other determinant of broad interest rates is likely to move along with these two effects, or at least not negate them. More spending would push up rates.
Like balancing a tall pole on the hand (the Nick Rowe analogy), the Fed would eventually respond with a higher fed funds rate just to keep things from tipping over. The Fed “controls” the federal funds rate but if they don’t compensate for balancing the pole, then their control will vanish as it crashes to the ground.
Janet Yellen could change the federal funds rate by walking up to a podium and saying into the microphone at a press conference after the FOMC meeting that the committee has decided to change the federal funds rate.
I agree that - at minimum - the Fed should make the new money permanent. (I actually think they should make more of it, and the Treasury should spend it, preferably on infrastructure and other investments that will yield real improvements in the lives of people in the future, while not incidentally reducing unemployment and increasing real wages.)
Yes. When you talk about ‘resources’ are you talking about natural resources? Employment? Something else?
I’m not sure what you mean by this. I understand when somebody puts their cash in a drawer, it’s “parked” - it’s not going anywhere (at least until they take it back out again). But if somebody buys a stock, for example, the money just changes hands. If a corporation sells a bond, it gets money for the bond, but then it spends it. Perhaps to open new branches, or hire more people, or buy new equipment. But it’s not “parked”. It’s changing hands. If you’re talking about a safe opportunity to “park” cash, what opportunity are you talking about?
I’ve argued before that investors are price-takers, not price makers; or more accurately, that the Fed and borrowers have more power in the market than lenders. Lenders must take whatever is the best interest rate, regardless of whether it loses money on an inflation-adjudsted basis. Because the alternative - not loaning - loses even more. (I’ve tried to support the argument using FRED graphs, but apparently that doesn’t work. The charts reset at some point.)
I’ve also argued that more spending - more demand - does not cause inflation, so long as new production is able to keep up with demand. We’ve had long periods of growth without inflation - in the 90’s, 2000’s, and over the last 6 years - without inflation.
Obviously, that can’t continue forever. If or when production can’t keep up with demand, because of full employment, for example, or inadequate supplies of natural resources - oil, for example - the result will be inflation. But as long as there’s room for growth in the economy, additional demand will result in growth, not inflation.
That would be an interesting experiment. I certainly don’t disagree that expectations about what the Fed will do drive many important economic decisions. But if Yellen made an announcement, and then did nothing, I wonder how long before the funds rate returned to normal? So long as banks, collectively, have excess reserves - which should continue for quite a while, unless the Fed starts selling off its portfolio - they’re going to be collective buyers of funds. They will, instead, continue to purchase funds from institutions that are not eligible for IOR. That puts a cap on the funds rate of whatever the IOR is. That means whatever Yellen says, the funds rate won’t go above that rate.