I never really had a problem with paying .25% on excess reserves, mainly because I think one consequence is helpful to consumers: if the Fed paid nothing on excess reserves, banks would have no reason to seek out deposits, which would lead to higher fees on deposit accounts. Paying .25% on excess reserves is relatively inexpensive: $2.5 trillion * .0025 = $6.25 billion. But if you double that, you’re talking $12.5 billion, and reverse repos add more on top of it. And that’s just to push up interest rates by a couple of tenths of a percentage point. Anyway, the point is the Fed is paying a lot of money (which would otherwise be going to the Treasury) to move the needle just a tiny bit.
I think the Fed’s trying to avoid shrinking its balance sheet, because that would mean moving $2.5 trillion - a huge amount of money - out of the economy altogether. While I don’t know what they think the result of that would be, I think it would be a train wreck.
As I’ve argued before, the Fed’s huge expansion of base money (along with Treasury deficits) are what propelled the US recovery in the first place. Taking all that money out of the economy would likely lead to another recession.
The Fed should be moving in the opposite direction: buying more Treasuries, and leaving the interest rate on excess reserves alone.
I entirely agree with Larry Summers, except that I’d argue that the Fed should tolerate more that 2% inflation, so long as it leads to full employment and higher real wages (and therefore a smaller income gap between the rich and the poor.)
Liberals talk about raising the minimum wage, but the best way to raise wages is through market forces: force employers to compete for workers, which results in higher wages and better benefits without any of the unintended consequences of minimum wage laws.
Inflation has been positive over the last six years.
It’s not zero. It’s not less than zero. It’s low, or muted, or anchored, but we are not living in a period “without inflation”. Nor were they living with no inflation in the New Deal, even with double-digit unemployment. Inflation went up at the same time spending went up. Which leads me directly to my next point: The argument here is that more spending “does not cause inflation”. This is not new. Similar arguments have been offered before. This is from a previous thread.
The problem is that these sorts of arguments have been offered before.
To quote my previous post one last time:
On double-checking, I see that that post was written three months ago today.
One year percentage changes in prices and 10 year bond rates are here. 10 year bond rates don’t give a very good picture of Fed policy, apparently. http://wm40.inbox.com/thumbs/8c_130b32_7cd2e9_oP.png.thumb
You can see inflation during the economic recovery and deflation following Fed tightening.
Wikipedia plots changes in income followed by various countries dropping the gold standard:
I sort of do. Accelerating inflation can get unemployment way down, but it’s only a temporary fix. Then you are stuck with the old unemployment rates and higher inflation. So price stability is reasonable mandate. If the Fed can credibly target nominal GDP levels (that is GDP without adjusting for prices) it can both permit decent growth and long run price stabilization, thereby addressing both targets.
There are 2 issues here. One is whether the Fed is following the proper framework. Another is whether they are properly following their stated framework. Lots of analysts seem to accept a long run inflation rate target of 2%. But even if you accept that, raising rates this month would be a mistake, IMHO.
As for the framework, the existing one risks extended downturns and lost decades like Japan and oh, the US. It should be fixed but the Fed doesn’t seem to be able to do that. Maybe I was wrong when I supported Yellen over Larry Summers. I would accept a number of different approaches, though my biases make me more sympathetic to some than others. What I don’t like is the current FOMC’s apparent passivity to evident economic challenges.
You’re right of course: I should have said low inflation, rather than “without inflation”.
Sorry, I’m on my iPad, so no quotes within quotes. But to respond to your comments: I agree that whenever supply can’t keep up with demand, you will see inflation. One very good example, I think, is the 1970’s. There were several sudden constrictions of the supply of oil. Oil was then, even more so than now, a critical resource. It was so critical, that the U.S. economy could not function at full capacity without it. The result was both unemployment and inflation.
Moreover, there can be a lag between new demand, and the ability to respond to it. You can see it, for example, if some new consumer product becomes wildly popular: if a supplier anticipated selling a million gizmos, but consumers want to buy 5 million, the price of the gizmo might rise signicantly while the manufacturer gears up to produce more of them.
At a macro level, if if you poured enough money into the economy quickly enough, you’d see inflation while producers, generally, geared up to meet the new demand, even if the economy was not functioning at full capacity initially.
I hope that addresses your comments. If not, let me know.
I’ve argued before, and continue to believe that, recessions are the result of excessive reliance on commercial banks to supply the economy with money. The Fed should not be raising interest rates to head off non-existent inflation. They should instead focus on providing a supply of money that’s sufficient for the US economy to grow at full capacity.
You keep saying this, but at what point does “providing a supply of money” equal simply firing up the printing presses? Yes, we are the most powerful economy in the world and can cheat a little on our debts by shuffling accounting entries between the Treasury and the Fed, but at the bottom of it all, we are simply printing money when the Fed “enacts quantitative easing” or “buys T-bonds”. No, we are not doing so like Zimbabwe or post WWI Germany, but your proposal is to continue down that road. I don’t believe it is sound economic policy.
As far as interest rates being “normal,” I agree with some other posters. Interest rates which encourage savings (say 3 to 7 percent) have been expected throughout history. Although I am a conservative, I can appreciate it if a new day has arrived where there shouldn’t be such an expectation. Although I think the burden should be on your side to show why there should be no premium for lending money or putting it in a passbook savings account.
I think you mentioned upthread that you believe that the Fed could not lower interest rates if it wanted to because of the vast amount of money buyback it would have to do. That means it has no tools to correct the economy (other than increase in money supply and when that is found out, hyperinflation). That road doesn’t end well.
Interest rates need to be eventually “normal.” IANA economist, so maybe it doesn’t need to be this year, but it needs to be some time.
Why is it not sound economic policy? Incidentally, lots of countries have loose monetary and fiscal policy from time to time. The big wrinkle is that small economies tend to have bigger foreign trade shares, so if they adjust their exchange rate it gives a bigger kick to their economy. Good or bad. Exchanges rates will adjust to monetary policy as higher interest rates makes the currency stronger (and exports less competitive) and lower interest rates make the currency weaker (and can sometimes encourage an export boom).
A normal interest rate is the one which is consistent with full employment and stable inflation. It varies with time, both cyclically and with demographics and technology.
I’ll accept that burden of proof though. The Fed says it has a target of 2% core inflation. Core inflation is 1.2 - 1.4% and falling. Ergo, interest rates are too high. (But we can’t cut nominal rates below zero, so we are stuck.) The time to raise rates is later.
I concede that if you have a soft 2% inflation cap, “later” could turn out to be next December or March. Now I happen to think that rate is dangerously low - it risks deflation if the US experiences an ordinary negative shock. But that’s a separate argument.
They are normal now. (See above.) But I’d put your point in another way. I agree that some year soon the fed funds rate will top 3%. Or more. And it should (provided the economy recovers - i.e. the Fed doesn’t jump the gun). But that’s a forecast, not a statement about reality. The long-run natural rate of interest might have dropped due to worse investment opportunities. (Though I seriously doubt whether it is below 2%, assuming long run inflation of 2%.)
Fed officials like to speak of well anchored inflationary expectations. Over at the Philadelphia Federal Reserve, a twice a year survey is conducted of professional economic forecasters. Since the early 1990s they have asked about long run inflation expectations. To be specific, they have asked about the average headline inflation rate predicted over the next 10 years.
From then on, expectations of inflation over 10 years fluctuated around 2.5% until the Great Recession. I figured that the forecasters anticipated something like 2% core inflation, plus an allowance for higher oil prices over the long run. Here’s what happened after 2007:
Those are not anchored inflationary expectations. Those are lowered inflationary expectations. I’m guessing that the professionals are still leaving room for higher oil prices, but now think that 2.0% core inflation is a soft cap, as opposed to a hard target. (Also the CPI tends to give higher figures than the PCI.)
Recall that nobody complained about high inflation in the early 1990s. Form an expectation of inflation in the 3.5 - 4.5% range, and monetary policy would have much more potential power, since real rates during recession could be brought to a lower level. Inflationary expectations are headed in the wrong direction.
Yes, yes, you could also attempt a level targeting approach. That would be superior to pretending that our zero lower bound problem was adequately addressed with QE and a lost decade.
I’m not an economist, but as I understand it, interest rates simply can’t be what you call “normal” under present conditions.
Investment money competes with other investment money for interest. If there is a glut of saving, the return on investment decreases.
Over the last twenty years, the proportion of compensation going to capital over labor has increased. Over the last forty years, the proportion of compensation going to low-skilled labor has decreased to a worrying degree. Consumer demand was propped up by credit for a while; that has fallen away. So there is less consumption, more saving (for less interest), and less money going to wages and salaries.
In these circumstances, without inflation, where is a 3% return on investment even going to come from? Who borrows at that rate, and how optimistic are they?
The entire banking system is upside down. Historically, banks have taken deposits from people who had money that they wanted to save for later. These deposits were loaned out to others, to generate income for the banker. The banker payed interest to the depositors, and charged interest to the borrowers.
But consumerism caused the average savings rate in the United States to fall below zero, where people were spending money faster than they were making it. Banks were not getting deposits, so they had to sell bonds to investors to get money to loan out. Credit became an indispensable tool, used by everything from corporations to local governments.
Now, consumers are unwilling to use credit, and are paying down credit balances, instead of spending on unnecessary goods and services. The demand for money is weak, because very few people are actually making money. So much profit is being taken that the ones creating the wealth are not getting properly compensated, and so have nothing to spend.
The Fed wants to raise interest rates because that would mean that things were getting back to normal. Good luck with that!
Actually it was probably part demographics, part mystery. Higher returns can actually discourage saving to some extent: if you are saving for a downpayment on a car or house, a higher interest rate will allow you to reach your goal faster and with less money set aside. That said, you are correct that higher returns also encourage substitution into future consumption and away from present consumption. Which effect is stronger is an empirical issue.
I’m skeptical of this story. ISTM that banks would fund with bonds if it was cheaper for them to do so. And changes in the savings rate would affect the interest rate on long term bonds as well. The mix of bonds and deposits was probably driven by other factors.
If you are interested, I prepared a chart showing the changes in the share of bond financing (or rather non-deposit financing) over commercial banks total liabilities. Unfortunately the series only starts in 1973: I would have liked a longer series. But back then the share was something like 11%, which isn’t nothing. It rose over time, peaked in 2000, peaked again in 2007 (~30%), then fell back. Yeah, the recession of 2001 and 2008 had an effect (~22%).
At every point. They mean the same thing. That’s why I try to impress on people that the Fed has been firing up the printing presses for the past 6+ years, and the effects have been unequivocally positive. I’m not arguing the Fed can print infinity dollars without inflation, but it I am arguing they can print trillions (about $4 trillion so far) with low of inflationion and improved overall economic performance.
It has absolutely nothing to do with cheating. Central banks expanding their balance sheets - firing up the printing presses - is absolutely legal, and commonplace. China, for example, does it regularly. The EU central bank does it much less. But then again their overall unemployment rate is around 10%.
Zimbabwe and Weimar Germany are always brought up in these kinds of threads. But we are not Zimbabwe or Weimar Germany. Nor am I arguing for unlimited Fed purchases. A couple more trillion, is all I ask.
I don’t agree. All interest rates are equally artificial. There is no such thing as a natural interest rate. Interest rates have been high before and they have been low before. The overall pattern is that high interest rates lead to recessions. It’s in our national best interests to reward people for working - as opposed to not working - which adds 0 to GDP. Rewarding people - in other words, paying them to do nothing - is counterproductive. High interest rates are the equivalent of welfare for the rich: it’s paying them to do nothing.
Not quite. The Fed has other ways to raise interest rates without selling off its portfolio. I’m not in favor of raising interest rates, but the other ways - although objectionable - are infinitely better than sucking trillions of dollars out of the economy.
My take is that all information about the tightness of Fed policy is contained in the US treasury yield curve and that during normal times the Fed Funds rate is sufficient. Well that’s not quite right: you also have to form an estimate of expected inflation.
My guess is that the preceding hypothesis is wrong: “All” is a strong word after all. I’d like to see the evidence though; I’d like to locate my ignorance. There may very well be a paper on the topic or several. Also conceptual error. And trivial error: when the New York Fed uses open market operations to target interest rates they have to form daily and weekly joint forecasts of both.
We’ve seen that the market gave a 34% of a September liftoff. Goldman Sachs thinks it will occur in December and will study the press conference carefully for evidence that the date could be postponed until 2016. Bill McBride at Calculated Risk thinks liftoff will occur next week. He thinks this is the key sentence from July’s FOMC meeting:
[INDENT]“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”
Read more at Calculated Risk: FOMC Preview and Review of Projections [/INDENT] We’ve seen improvement in the labor market (though it isn’t roaring and real wages are not spiraling) and Fed Vice Chairman Stanley Fischer thinks inflation will move upwards. That argument was dispatched by Tim Duy upthread, incidentally.
Duy, Summers and McBride think raising rates now would be a mistake. I opine that the Fed is a sensible institution when seen on their own terms. So there will be no liftoff in September: I am even-money confident.
Calculated Risk: [INDENT]Economists at Goldman Sachs, Deutsche Bank, J.P. Morgan, Nomura, and many others see December as more likely than September (some see the Fed waiting until 2016). Economics professor Tim Duy also thinks a September rate hike is unlikely. Duy and Goldman Sachs chief economist Jan Hatzius have probably been as accurate as anyone in forecasting Fed actions - and neither expects a rate hike this week.
Read more at Calculated Risk
As generally expected, the Fed did not raise interest rates last week. Calculated Risk quotes a Fed dove and hawk on the issue. John Williams goes over the case for raising rates and the case for staying put: the two are moving closer together, but the case for staying put has the edge.
James Bullard, who is not a current voting member, notes that we are pretty close to our target of inflation at 2%, as well as the unemployment target. One of my concerns is that the long term relationship between the labor force participation rate and the unemployment rate became unstuck during the Great Recession. So that framework is a little inapt.
Jeffrey Lacker voted for tighter policy. He also dissented in 2012. He was worried about inflation. It declined thereafter, implying that he got it wrong that time. It happens. But as Matt Yglassias pointed out in 2013: [INDENT][INDENT]… being an inflation hawk in general seems to mean never having to say you’re sorry. I saw Charles Plosser from the Philadelphia Fed talk over the weekend, and he (like Lacker) was very troubled about the possible future inflationary consequences of recent Federal Reserve initiatives. But he, too, seemed to have forgotten that he’s been warning about this for a while and it keeps not happening. [/INDENT][/INDENT] I don’t know whether Lacker has rigorously reviewed his poor forecasting record. He might have. I hope so. Among Fed officials Kocherlakota is noteworthy for actually changing his mind when the data conflicted with his earlier perceptions. He has been rotated out, but has advocated that the Fed attempt to hit the 2% core inflation rate target from above, given their extended period of remaining below it.
I say that if you’ve been stuck with a 0.25% fed funds rate for 8+ years, then ergo your inflation target is way too low. Either raise your inflation target by a percentage point (or two! or three!) or adopt another framework such as nominal GDP level targeting. The machinery is broken. It needs to be fixed.
Some stock and bond market participants are sick of waiting and can’t handle the suspense. They need to get a grip: risk management is your job. The Fed’s job isn’t to keep you happy or hold your hand, it’s to pursue a dual mandate of full employment and price stability. The Fed’s concern is the entire economy, not the asset markets.