Fed Policy
Discussion point: Is it time for the Fed to start contracting its’ balance sheet and otherwise withdrawing the special financing it provided while it was faced with the zero interest rate bound
and preparing to soon raise fed funds.
My fed policy index says the zero bound should no longer apply and that it is time for the fed to start preparing to soon raise fed funds.
This is my version of the Taylor Rule. The biggest difference is that my index gives inflation and unemployment equal weight while the standard Taylor Rule gives inflation double the weight of the various measures of excess capacity.
Of interest is that Bernanke’s prepared statement confirms that the term Fed Funds is going by the boards. They will be managing ST rates by changes in the deposit rates they pay on excess reserves.
This is a technical but still interesting development. It is a consequence of the past 18 months of monetary policy. Banks used to lend eachother ‘excess reserves’ through the Fed Fund market. Now it all clears through the Fed. I am not sure of the implications of this.
To your question, yes it is high time that the Fed begin to withdraw some of the massive monetary stimulus. But I doubt it will happen.
We will get some very small increases in rates by September. Maybe 1/2 percent. But that is still zero as far as I am concerend.
Look at the stock market.When the dollar rises, stocks fall. The reason is that a strong dollar is bad for our economy. Bernanke bet the farm with his QE policy. He is not going to risk the outcome of that if the dollar gets too strong too fast. He will keep rates artificially low in an effort to offset dollar strength.
Over time the Funds target tracked GDP. There has been period where it was above growth and periods where it was below. I think that is a natural balance in market pricing of ST money.
What is a reasonable growth number? Forget Q4 5.7%. That was a fluke. A better number would be a miserable 2%. But that is where I think ST rates should be targeted. Historically low, but zero is a joke.
Hi Spencer,
What’s the rationale behind equating the inflation effect with the output gap effect? An econometric estimation clearly signals for a statistically larger output-gap effect – about twice the size (this is back from Sep 2009, but one can see my regression here).
Rebecca
If you do the regression tht includes the Volcker era you get results that give you the Taylor rule type results where inflation has a heavier weight. In the Volcker rera the economic issue was reducing inflation from double digit levels, so giving inflation a greater weight was the correct economic decision. But now the economic problem is not inflation. Rather it is stagnation and the very real threat of actual deflation, as in Japan. If the threat is deflation and your policy rule gives inflation double the weight of the output gap, then policy is likely to overract to any evidence of inflation or underreact to economic weakness and end up actually creating deflation.
HI Spencer,
Nice explanation. If I remember correctly, though, you lose a lot of goodness of fit if the regression model dates back to the 1980’s. What else was going on then?
Rebecca
“This is my version of the Taylor Rule. The biggest difference is that my index gives inflation and unemployment equal weight while the standard Taylor Rule gives inflation double the weight of the various measures of excess capacity.”
Given the prospects of persistent high unemployment, why not give unemployment even more weight?