The Fed needs to stop trying to reduce interest rates

Here are two possible messages from the upcoming September Fed meeting:

1.  We are coming out of this meeting with all guns blazing.  We will cut the interest rate on reserves–to below zero if necessary, and do so much QE that we expect NGDP growth to accelerate sharply.  Indeed we expect to have to raise the fed funds target at some time during the next 18 months to prevent NGDP growth from exceeding 7%.

2.  We are growing increasingly glum about the prospects for the economy.  As a result we feel confident that we can hold interest rates near zero for at least another 3 years, and probably much longer.

Which does the Fed see as the more expansionary option?

Over the past few years I’ve been surprised at how hard it is for central banks to move away from interest rates as the lever of monetary policy.  It’s not impossible, just this morning the Swiss National Bank used the exchange rate as a policy tool.  But consider the plight of the Fed.  First they cut rates to zero.  When short term rates can’t be cut any more, they start QE.  But they insist the purpose of QE is not to increase the money supply, but rather to lower long term rates–even though low long term rates are a sign that monetary stimulus has failed.  When QE2 doesn’t seem enough, they move on to promises to hold short rates near zero for an extended period of time.  The Fed seems extraordinarily reluctant to use policy tools that actually would be effective—particularly an explicit nominal target, level targeting.  And then they wonder why their “extraordinarily accommodative monetary policies” never seem to be enough.

Low interest rates didn’t work for the Fed in the 1930s, and they haven’t worked for Japan since 1994.  Why would anyone expect a different result in America today?


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63 Responses to “The Fed needs to stop trying to reduce interest rates”

  1. Gravatar of marcus nunes marcus nunes
    6. September 2011 at 14:41

    “Blame it on Woodford”! and his NK Synthesis. The NK “bible” Interest & Prices!

  2. Gravatar of marcus nunes marcus nunes
    6. September 2011 at 15:01

    From J Hilsenrath at the WSJ:
    At their meeting on Sept. 20 and 21, the central bank’s policy makers will consider next possible steps to help the economy, which could include rejiggering the Fed’s portfolio of bonds; pushing down a 0.25% interest rate it pays banks; restarting a bond-buying program, known as quantitative easing; or doing nothing at all.
    http://blogs.wsj.com/economics/2011/09/06/fed-spectrum-where-fomc-members-stand-on-stimulus/?mod=WSJBlog
    As if “doing nothing” has the usual meaning!

  3. Gravatar of Benjamin Cole Benjamin Cole
    6. September 2011 at 15:08

    You know, if we had an economic boom, that might mean prices begin to go up, and we can’t have that.

    Better to go the Japan route, and first avoid any chance of inflation altogether, and then review your policy options.

    You know, like trying to score a touchdown, while avoiding use of the pass or the run. You hope to score on a punt return, or an intercepted pass. Or the other team will perform an unforced touchback.

  4. Gravatar of James in london James in london
    6. September 2011 at 15:10

    Welcome back. Come on, get off the fence. You said “QE2 doesn’t seem enough”. Make a testable prediction, is it or isn’t it?

  5. Gravatar of flow5 flow5
    6. September 2011 at 16:02

    It’s the bond market’s job to determine the level of interest rates. Even a temporary pegging of a series of federal funds rates over time, forces the fed to abdicate its power to regulate properly the money supply.

    There is only one interest rate that the Fed can directly control; the discount rate charged to bank borrowers. The effect of Fed operations on all other interest rates is indirect, varies widely over time, and in magnitude.

  6. Gravatar of johnleemk johnleemk
    6. September 2011 at 16:26

    “Indeed we expect to have to raise the fed funds target at some time during the next 18 months to prevent NGDP growth from exceeding 7%.”

    I can think of at least one influential economist who is so keen on this, he completely forgot about the part preceding the interest rate hike.

    I think a major issue with quasi-monetarism is that people intuitively understand that as a general rule, you can’t print your way to prosperity. Obama would be laughed off the teleprompter if he spoke out in favour of monetary easing because of this. To frame the issue correctly, we need to explain that you can’t print your way to prosperity, but you certainly can underprint your way to bankruptcy. The Fed has failed the American economy by failing to adjust its policy to accommodate the expectations about income which underlie people’s contractual obligations. By undershooting, the Fed is unjustly intervening in the economy — and not to boost but rather to stifle economic growth.

    This is the only way I can think of for us to sell this policy, but unfortunately, it’s hard to think of any politician who would touch this with a 10-foot pole. Obama, being the politician who has the most to lose from poor monetary policy, needs to make this argument — but he’s too much of a chicken and getting too much bad advice to do it.

  7. Gravatar of Full Employment Hawk Full Employment Hawk
    6. September 2011 at 16:35

    The yield on 10 year tips is now -0.12%. In other words, financial investors are paying the federal government 12 basis points in real terms to let them lend their money to it. And the Republicans are claiming the U.S. government is broke!

  8. Gravatar of Full Employment Hawk Full Employment Hawk
    6. September 2011 at 16:40

    “To frame the issue correctly, we need to explain that you can’t print your way to prosperity, but you certainly can underprint your way to bankruptcy.”

    1. Inflation is caused by too much money chasing too few goods.

    2. Recessions are caused by too little money chasing too many goods.

    3. Depressions are caused by too little money chasing too few goods.

    Conclusion: If the economy is going into a recession print more money. And if the economy is mired in a depression print more money. But DO NOT print more money than is needed to support the growth in potential output if the economy is at potential output.

  9. Gravatar of Scott Sumner Scott Sumner
    6. September 2011 at 17:17

    Marcus, Thanks for the link. Hilsenrath’s usually been pretty accurate. Bernanke seems to have the votes, but will he be bold enough? None of those potential moves are bold enough.

    Ben, Yes, it’s pretty feeble.

    James, I don’t do forecasts, I infer market forecasts. The markets have thought money was too tight since mid-2008, and thus I’ve thought the same.

    My testable prediction is that if NGDP growth speeds up, so will RGDP growth. And reducing maximum UI benefits to 26 weeks will also reduce unemployment.

    flow5, In your comment change “money supply” to “NGDP.”

    johnleemk, I think I know who you are talking about.

    FEH, Yes, the real danger is the Japan scenario, not bankruptcy. The S&P downgrade was silly.

  10. Gravatar of TGGP TGGP
    6. September 2011 at 18:05

    Karl Smith approves of the Fed’s stupid messaging. Because he thinks the audience is too stupid to understand a more effective declared target.

  11. Gravatar of GregorS GregorS
    6. September 2011 at 19:09

    I was wondering if there is a formal model reference for thinking about targeting an instrument that is also affected by the ultimate outcome variable in the context of interest rate targeting. Does anyone know of useful background on how to think through what that means for the policymaker/econometric decomposition?

  12. Gravatar of JimP JimP
    6. September 2011 at 19:48

    Its operation twist.

    http://www.washingtonpost.com/business/economy/fed-considers-buying-more-long-term-treasury-bonds-to-lower-mortgage-rates/2011/09/06/gIQAWHox7J_story.html?hpid=z1

  13. Gravatar of William J McKibbin William J McKibbin
    6. September 2011 at 20:29

    The Federal Reserve is actually quite complacent these days, probably because they are enjoying near zero inflation rates — let’s fact it, the Fed cares most about holding inflation at near zero rates, with growth and employment as distant second and third priorities…

  14. Gravatar of James in london James in london
    6. September 2011 at 21:53

    There is little difference between a forecast and a testable proposition. But at least you made one.

  15. Gravatar of James in london James in london
    6. September 2011 at 22:02

    Sad to see you are still pursuing nationalistic posturing over the S&P downgrade. Objectively, the US was recently, and still is, just a few votes away from a default. Numerous Republicans havre argued it isn’t such a bad idea. Come 2012 these politicians could be even more powerful. There is a significant enough risk to easily justify the downgrade.

    What is truly sad is that so few here or anywhere have protested the barely concealed sacking of the head of S&P and his replacement with an experienced Citi bankster.

  16. Gravatar of Lorenzo from Oz Lorenzo from Oz
    6. September 2011 at 22:10

    Just to bring a view from a different place, RBA Governor Stevens’ most recent speech.

    Our latest GDP results. Meanwhile, unemployment is at 5%, employment grew 1.7% over the year, job vacancies by 8%.

    China is keeping demand for our commodities up (best terms-of-trade ever), China and India are continuing to keep global goods and services inflation down via increasing aggregate supply. And it is a great time to be an Oz buyer of US books :)

    But our inflation rate is 3.6%! Clearly, a disaster! Our CPI inflation is over two-thirds of our unemployment rate, a central bank is only really achieving when the unemployment rate 18 times your inflation rate.

  17. Gravatar of Doug Doug
    7. September 2011 at 03:06

    Excellent comment from johnleemk, regarding the Fed underprinting.

    Most of the money “creation” in our economy is done via commercial bank lending, so most of the “printing” of money is done via private, market-based actors. In normal times, the Fed affects the rate of money creation by controlling short-term interest rates.

    But these are not normal times, the commercial bank industry is broken and has not expanded lending, or printed money, since October 2008. So if we are to have any money growth at all, the Fed has to do it. And we do need at least a small amount of money growth to accommodate economic growth, as money is what we all use to buy and sell goods and services.

    The Fed is not accustomed to printing money directly, and it feels unusually vulnerable to criticism if it is seen as directly printing money, instead of delegating this role to the private sector. Therefore, the Fed wants to engage in acts that it thinks will goose private sector lending — by reducing long-term interest rates.

    Unfortunately, the Fed has become confused about how to goose private sector lending, and perhaps it doesn’t really understand how broken the commercial banking sector is. The Fed used to goose private sector lending by reducing short-term interest rates, but the actual mechanism of this act was to increase the spread between short-term and long-term interest rates. Banks make money by borrowing short and lending long, so by increasing the spread between short and long, you encourage banks to lend more.

    As the Fed labors to decrease long-term rates, it actually hurts the commercial banking sector, by decreasing the spread between short and long, and decreasing bank profits.

    So, the Fed is confused. It doesn’t want to take over the role of the private sector, but it doesn’t know how to fix the private sector either. The economy still isn’t quite bad enough to overcome the natural conservatism of central bankers, who will continue to look for small (but ineffective) steps so it looks like they are doing something, without feeling like they are doing too much.

  18. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 03:49

    Now you are finally starting to get it…

    “Indeed we expect to have to raise the fed funds target at some time during the next 18 months to prevent NGDP growth from exceeding 7%.”

    But this isn’t near enough.

    What the fiscal side needs to hear is this:

    “In fact we expect to drive NGDP to 4% and keep it there, from this moment on we will be NGDP level at 4%. KNOW THIS: whenever NGDP goes over 4%, we are going to be raising rates, so we never get in this mess again. This mess was caused by easy money, and with a level target, we will NEVER have to worry about Walll Street doing this shit to us again.

    “What this means is that NEVER again will there be a chance of deflation, and since there is no such chance… WE ENCOURAGE the government to REORGANIZE and become more productive without concern for lost or lower paying public sector jobs.”

    There are explicit reasons for conservatives to support NGDP targeting, the Fed needs to explicitly state those.

    This isn’t really about what the unemployed get, this is about what the Tea Party gets.

  19. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 03:57

    johnleemk,

    “The Fed has failed the American economy by failing to adjust its policy to accommodate the expectations about income which underlie people’s contractual obligations.”

    This won’t fly. People want to see liquidations.

    The focus needs to be on the protection targeting NGDP gives us against the ARGUMENT of deflationary or slow growth effects.

    Democrats LOVE to say that now is not the time to be laying off public employees, now is not the time to be ending minimum wages, etc.

    The whole point of NGDP is that now is the time to do the deflationary things because they get us productivity gains, and they will be offset with printing.

  20. Gravatar of Scott Sumner Scott Sumner
    7. September 2011 at 04:42

    TGGP, But Smith doesn’t tell us whether he thinks low fed funds rates are easy money or tight money. He assumes the reader is smart enough to know that. But I’m not smart enough, and I doubt the average Joe is smarter at monetary economics than I am. So if I don’t understand what that sort of communication means, why would the average person?

    Gregor, There must be such models, but I don’t know of any.

    JimP. Operation twist would be a really bad idea. It wouldn’t work, and it would prevent better options from being adopted.

    William, Bernanke doesn’t seem like a happy man to me.

    James. There have been countless fights over the debt ceiling during my lifetime–it’s all sound and fury signifying nothing.

    Lorenzo, I wish we had Australia’s “problems.” I suppose the inflation hawks that comment here think that 3.6% inflation is a disaster, not offset by 5% unemployment.

    Doug, The Fed doesn’t even need to do easy money–just stop doing tight money.

    Morgan, I fear your love affair with the Tea Party will somehow end badly.

  21. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 05:00

    Scott,

    The Tea Party = The vest majority of 30% wealthiest in every town in America.

    They aren’t going away. Not until Obama has been rescinded.

    But once “everybody knows” Obama was a mistake and the Dems all kick themselves and say, “we have to just elect Clinton Conservatives”

    I’ll expect another mea culpa from you.

  22. Gravatar of MTD MTD
    7. September 2011 at 06:16

    Scott – Great post, welcome home. A related issue is that the Fed told the public both QE1 and QE2 were and effort to boost the economy via ‘lower interest rates’. When long rates rose with equity prices after QE1 & QE2 set sail, it opened up the Fed to criticism that it failed because rates rose instead of fell. The Fed then tried to do a 180 and argue that higher rates were a sign of optimism (which they were) yet that’s not how the Fed pitched the program to begin with. Larry Meyer came on CNBC to argue the counterfactual: rates were lower than they otherwise would have been. Um, no. If the Fed had been as boneheaded as the ECB, long rates would be even lower as the temporary growth pickup occasioned by the QEs would not have been forthcoming. The US has averaged 4.1% NGDP versus the eurozone’s 2.9% average NGDP since late ’09. Worse and worser. Perhaps the toxic political backdrop and discord on the FOMC has convinced Bernanke that the best he can deliver now is a
    sterilized Twist, which will work to keep long rateslow only if it fails to lift NGDP. This isn’t progress.

  23. Gravatar of Lee Kelly Lee Kelly
    7. September 2011 at 06:16

    Right. We need to get people to realise that interest rates are not low because of the Fed’s attempts at expansionary monetary policy, but rather interest rates are low despite them.

    Low interest rates have more to do with low demand for credit than any increase in the money supply. And the low demand for credit is a symptom of an excess demand for money. Expansionary monetary policy can satiate the demand for money, increase the demand for credit and, all else equal, increase interest rates.

  24. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 06:58

    Over at Fred Wilson’s blog, we see what the hawks at the Fed really think:

    http://www.avc.com/a_vc/2011/09/what-is-going-on.html#disqus_thread

    Fred is an Obama supporter.

    He’s an Obama supporter that WANTS Obama to throw public employees and entitlements under the bus.

    There is only one path out, Obama has to give the conservative members of the Fed and his Wall Street supporters what they really want.

    Unsticking wages is job #1.

    Note the link Fred points to:

    http://blog.tomevslin.com/2011/09/americas-industrial-revival.html

    “The government is running out of money for pursuing an “industrial” policy.”

    GO READ IT.

    Look, you hippies HAVE to get over it, in real terms the unemployed and the public employees are worth less money than what they have been promised.

    Just keep repeating Mundell’s mantra for Europe, “Pensions at no more than 50% of last salary.”

    That’s how a REAL macroeconomist speaks.

  25. Gravatar of o. nate o. nate
    7. September 2011 at 07:00

    I don’t understand the mechanism that will lead from your proposals for cutting interest rates on reserves and another round of QE to the end goal of NGDP growth. Could you give a hint of the scale of QE that would accomplish your NGDP goals, and what the mediating mechanism would be? I don’t see how more QE can do much with interest rates already at near-zero levels. I also don’t understand how by pronouncing an intention to target NGDP growth that the Fed can actually produce NGDP growth. Apologies if you’ve already covered this in previous posts.

  26. Gravatar of johnleemk johnleemk
    7. September 2011 at 07:37

    o. nate, if you print more money, it will either show up in higher inflation or output. If the Fed promises to print more money until it hits its NGDP target, that target will be attained. It’s only a question of how much NGDP growth will comprise inflation (N) versus real output (GDP).

    How much QE3 will the Fed need to do? Who knows. It’s the commitment to ease and following through on that commitment to ease at all times until the target is attained that matters. Not the precise amount of easing at a discrete given point in time.

    We could of course get into the exact mechanics of how QE3/lowering the interest on reserves would constitute “printing money” — but it seems clear to me that anyone who is worried about QE3 leading to inflation believes QE3 does essentially “print money”, and there aren’t many folks out there, MMTers aside, who would argue otherwise.

    The zero-interest rate trap is just wrong. Printing money reduces real interest rates and spurs the velocity of money. You don’t ease by cutting nominal rates. You cut real (and in more normal circumstances, nominal as well) rates by easing. If holding money gets so expensive because you know it will lose real purchasing power sitting idle, you’re going to find something tangible to put it in.

  27. Gravatar of Scott N Scott N
    7. September 2011 at 08:05

    Charles Evans (Chicago Fed President) said:

    “One way to provide more accommodation would be to make a simple conditional statement of policy accommodation relative to our dual mandate responsibilities. The goal would be to enhance economic growth and employment while maintaining disciplined inflation performance. This conditionality could be conveyed by stating that we would hold the federal funds rate at extraordinarily low levels until the unemployment rate falls substantially, say from its current level of 9.1% to 7.5% or even 7%, as long as medium-term inflation stayed below 3%.

    With regard to the inflation marker, we have already experienced unduly low inflation of 1%; so against an objective of 2 percent, 3 percent inflation would be an equivalent policy loss to what we have already experienced. On the unemployment marker, a decline to 7.5% would be quite helpful. However, weighed against an overly conservative estimate for the natural rate of unemployment of 6%, it still represents a substantial policy loss—indeed, one that is higher than the policy loss from high inflation of 3%.

    Accordingly, these triggers remain quite conservatively tilted in favor of disciplined inflation performance over enhanced growth and employment, and it would not be unreasonable to consider an even lower unemployment threshold that would be enough progress to justify the start of policy tightening.

    There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.10 Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating—they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today.

    The trigger policy I noted above and level-targeting policies may result in inflation running at rates that would make us uncomfortable during normal times. But we should not be afraid of such temporarily higher inflation results today. As I noted earlier, Ken Rogoff (1985) has written that in normal times, we may want conservative central bankers as institutional offsets to what would otherwise be inflationary biases in the monetary policy process. But these are not usual times—we are in the aftermath of a financial crisis with stubborn debt overhangs that are weighing on activity. And as Rogoff himself wrote in a recent piece in the Financial Times, higher inflation could aid the deleveraging process.11 To quote him: ‘Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.’”
    http://www.chicagofed.org/webpages/publications/speeches/2011/09_07_dual_mandate.cfm

    I am encouraged by Evan’s remarks. It looks like he will be pushing for the FOMC in September to modify its statement to promise to hold interest rates low until unemployment reaches some target. That is a good first step, but I doubt it will do much in the long term.

    His second and third policy options – price level targeting and NGDP targeting – are much more interesting. I doubt the FOMC will adopt those in the next meeting, but if they perform the “twist” and promise low rates as long as unemployment is above 7.5% and those policies fail, then I think the path will by paved for some kind of level targeting … and hopefully they are competent enough to set the right level.

  28. Gravatar of o. nate o. nate
    7. September 2011 at 08:12

    johnleemk,
    Thanks for the thoughtful reply. I guess my objection is that a short-term Treasury bond that pays essentially zero interest is already pretty much indistinguishable from money. It seems that all the Fed can do with QE3 (assuming it follows the pattern of QE1 and QE2) is to give people money in exchange for these Treasury bonds, which were already effectively money anyway. So I still don’t see how this does anything to stimulate the real economy or drive up inflation.

  29. Gravatar of StatsGuy StatsGuy
    7. September 2011 at 08:25

    Lorenzo:

    “a central bank is only really achieving when the unemployment rate 18 times your inflation rate.”

    ROFL!! I laughed myself out of the chair… I’m imaging plosser in wood paneled room, yelling at Bernanke: “You’re a loser, you can’t do any better than running unemployment at 18 times inflation?”

  30. Gravatar of JimP JimP
    7. September 2011 at 08:29

    Here is one Fed board member who is actually worth what we pay him (unlike Ben):

    http://www.chicagofed.org/webpages/publications/speeches/2011/09_07_dual_mandate.cfm

    to quote
    Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

    In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

    The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.

    Today, I would like to explore further the implications of the Fed’s dual mandate framework for monetary policy-making in today’s environment. And don’t worry, the views I am about to express are my own and not necessarily those of my Federal Reserve System colleagues.

  31. Gravatar of JimP JimP
    7. September 2011 at 08:35

    More quotes from the Evans speech

    begin quote
    There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.10 Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating—they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today.

    The trigger policy I noted above and level-targeting policies may result in inflation running at rates that would make us uncomfortable during normal times. But we should not be afraid of such temporarily higher inflation results today. As I noted earlier, Ken Rogoff (1985) has written that in normal times, we may want conservative central bankers as institutional offsets to what would otherwise be inflationary biases in the monetary policy process. But these are not usual times—we are in the aftermath of a financial crisis with stubborn debt overhangs that are weighing on activity. And as Rogoff himself wrote in a recent piece in the Financial Times, higher inflation could aid the deleveraging process.11 To quote him: “Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.”
    end quote

    nota bene bene:

    When he is discussing communications:

    “Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession.”

    Exactly!

    Come on Ben! DO IT.

  32. Gravatar of StatsGuy StatsGuy
    7. September 2011 at 08:41

    @nate

    yes, and no. That’s the “all the fed can do is target the rate” argument. This is DeLong’s argument – that the Fed buying Tbills just changes one zero return instrument for another.

    Theoretically, true, subject to some assumptions. In practice, this misses the fact that the Fed is creating money to buy them. If the Fed holds the short term instruments indefinitely (by indefinitely rolling over purchases), then it has just printed money. Now, if banks are holding all of this on reserve, what has that accomplished?

    Two things – first, drop IoR. Seriously.

    Second, we’re running a large deficit, and that gives the Fed a LOT of ammunition. All the Fed needs to say is “we’re going to monetize the deficit until such time as NGDP hits our target, and we’re starting today with a purchase of XX billion. Watch over the next few days as we keep buying XX billion, if you don’t believe us. Otherwise, get out of our way.”

    Do you seriously think the markets will not react to that by increasing NGDP expectations? The question is how much inflation, and how much real – Plosser thinks NONE of it is real. He’s of course got an agenda, even though he talks about watching out for the poor.

    I disagree with Scott that lowering long term rates has no impact, depending how it’s done. HOWEVER, it’s a one time thing – it immediately increases the value of bond holdings, effectively injecting cash into the system. In a sense, it brings bond returns forward in time. IF long term rates stay low, it moves cash returns from the future to the present. Scott is thinking about new issues, less about the huge debt market currently out there. If you take 3-4 trillion of 20 yr average length and drop returns from 4% to 3%, that’s a several hundred billion giveaway.

    Effectively, this has sustained pension funds (lowering rates) for a long time, but the limit on this is approaching (it’s called zero). Presumably, holders of long bonds will at the margin shift this extra cash… somewhere. So there’s a wealth effect of sorts, and possibly a shift into other asset classes.

    BUT, I agree with scott the impact isn’t as big as saying “we’re going to monetize the deficit until NGDP hit’s a level target of 5% growth, from a 2008 base, and then hold it there”. That statement alone, and 7 days of followup bond buying, would end the AD problem. Period. Then, just maybe, we could focus on the OTHER huge problems we have.

    Unless, of course, certain groups don’t want to end the problem just yet…

  33. Gravatar of Benjamin Cole Benjamin Cole
    7. September 2011 at 10:10

    Excellent commentary, and framing of the issues.

  34. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. September 2011 at 11:06

    ‘Unless, of course, certain groups don’t want to end the problem just yet…’

    You mean like Obama’s friends in organized labor? Their recent performance over Labor Day week-end didn’t sound like they’re interested in anything other than more power for themselves.

  35. Gravatar of OhMy OhMy
    7. September 2011 at 11:36

    “We will cut the interest rate on reserves–to below zero if necessary”

    As MMT explained to you, this will make banks less willing to lend, not more. Banks do not lend out reserves, but they do need to convert some of their portfolios to reserves when they create deposits in the process of lending. Negative interest increases the cost of holding these reserves. Also, in aggregate, the negative interest is a tax on banks, draining aggregate demand from the economy, directly. Not very stimulative.

    http://bilbo.economicoutlook.net/blog/?p=4763

  36. Gravatar of W. Peden W. Peden
    7. September 2011 at 12:59

    O. Nate,

    By buying the bonds, it increases the price of ALL assets, because one section of assets (securities) has been reduced in quantity. So suddenly, for instance, companies can raise equity more easily, and borrow more easily in the form of loans & bonds. & other channels. Logically, there are plenty of ways for QE3 to boost demand.

    However, it’s true that the RELATIVELY small difference between short-term bonds and money (which is accentuated by the Fed paying interest on excess reserves) means that only very large and permanent increases in the monetary base are likely to have significant effects on asset prices.

    In the UK, a greater variety of assets were purchased in the US and there was a clear committment to increasing aggregate demand from early 2009 onwards. Despite low interest rates, the UK NGDP shot up and most of our problems right now are supply-side rather than demand-side. This is in spite of a very meagre fiscal stimulus (most of the UK deficit is cyclical or due to the bank recapitalisation) in comparison to the US, suggesting that quasi-monetarism is right and Keynesianism is wrong. Perhaps the UK has a lot to teach everyone else about how to get out of a liquidity trap.

  37. Gravatar of James in london James in london
    7. September 2011 at 13:01

    Most countries, companies, people, on the verge of default offer bland assurances that they’ve been close to default before but come through it. That any fuss is just “sound and fury signifying nothing”.

    However, the deficit is large and growing, larger than ever before in peacetime, the state is far larger, politics is more fraught, serious political leaders are suggesting default as a strategy. Well respected economist bloggers spend large amounts of time pointing out how poor is monetary management. I thought going out of the country for a bit might have enabled you to see the US as others see it.

  38. Gravatar of marcus nunes marcus nunes
    7. September 2011 at 13:04

    If only more FOMC members thought along the lines of Evans…
    “There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.10 Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating—they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today”.
    http://www.chicagofed.org/webpages/publications/speeches/2011/09_07_dual_mandate.cfm

  39. Gravatar of ChacoKevy ChacoKevy
    7. September 2011 at 13:53

    Is it me, or did the econ blogosphere just have a collective “Holy ****” moment from the Evans speech that left everyone stunned? My RSS feeds are slow today while everyone, from what I’m guessing, is figuring out how to react.

  40. Gravatar of W. Peden W. Peden
    7. September 2011 at 14:01

    ChacoKevy,

    The quasi-monetarists are gobsmacked to hear such sensible views. The New Keynesians are sceptically pleased. The Post-Keynesians think it’s like King Canute on coke. And the Austrians, if they were smart enough to invest in gold, should hope that others at the Fed agree.

  41. Gravatar of marcus nunes marcus nunes
    7. September 2011 at 14:11

    Sorry. Hadn´t noticed that Scott N & JmP had linked to the Evans piece. Anyway its much more reasoned than the stuff we´ve been hearing from the 3 “Stooges” (F, K & P) at the Fed!

  42. Gravatar of dwb dwb
    7. September 2011 at 14:16

    It’s too bad the Fed cannot print about $100 Bn-$300 Bn and hand out checks (or cash) directly. screw more QE, put the cash directly in the hands of consumers.

  43. Gravatar of marcus nunes marcus nunes
    7. September 2011 at 14:36

    According to Williams of the SFF, blame for the dire economic situation goes to:
    1. God (weather and Japanese earthquake)
    2. Oil exporters
    3. US Congress
    4. Europeans
    5. House Market
    6. Leveraged Consumers
    He sees MP as trying (not very successfully) to provide “aid”, never as an important factor behind the “sickness” itself:
    “During the recession, the economy deteriorated sharply and inflation dropped to very low levels. In response, the Fed’s policymaking body—the Federal Open Market Committee, or FOMC—took aggressive monetary action. It lowered the Fed’s benchmark short-term interest rate—known as the federal funds rate—close to zero in December 2008 and has left it there since. In addition, the FOMC carried out two rounds of purchases of Treasury, mortgage-backed, and government-sponsored-agency securities, bringing our holdings of these instruments to $2.65 trillion. These purchases have reduced longer-term interest rates, thereby improving financial conditions more generally and providing a boost to the economy. They also reduced the risk of slipping into sustained deflation.
    Despite these efforts, the recovery slowed to a crawl this year. But what does this mean for monetary policy? After all, monetary policy cannot cure all that ails our economy, which in large measure involves the aftereffects of the mortgage lending boom, the housing crash, and the resulting financial crisis. But, monetary policy can help limit the damage and provide support to other areas of the economy. A medical analogy is useful. Today’s economy is like a patient who has suffered a number of injuries and needs time to heal. For the healing process to succeed, it is essential that the bleeding be stopped, the patient be properly hydrated, blood pressure and temperature properly regulated, and secondary infections avoided and treated. These treatments don’t cure the injuries directly, but they reduce the risk of the patient getting worse and allow the natural healing process to take hold.
    Concluding: “Right now, though, the real threat is an economy that is at risk of stalling and the prospect of many years of very high unemployment, with potentially long-run negative consequences for our economy”.
    So, what are you prepared to do about this “doomsday” forecast?
    http://www.frbsf.org/news/speeches/2011/john-williams-0907.html
    It appears that Evans is lacking support!

  44. Gravatar of johnleemk johnleemk
    7. September 2011 at 15:06

    Morgan,

    Wants cover for what? As Shane points out, the Republicans are undermining any traction he might get for accommodative monetary policy which would reduce government intervention in the economy. The government is artificially deflating, and central planning anti-stimulus GOP men like Perry and Romney support it.

    I think Huntsman is laying the groundwork for 2016 at this point (good luck to him running in the primary against President Perry or Romney though…*shudder*) but I think he is the best serious candidate I’ve seen yet, by far. Good on him for speaking up about the importance of free movement of goods (free trade) as well as people (immigration) tonight.

    Romney would probably quietly backpedal his anti-stimulus comments if he takes office…he doesn’t need to do anything anyway, just appoint someone Republican like Mankiw or Libertarian like Scott to succeed Bernanke. With unimpeachable political and academic credentials, nobody’ll kvetch about “inflationism” when NGDP growth is back on track.

    Perry, however, I would say is probably crazy enough to hold firm on the no-further-stimulus line. He’s smart and savvy, but so is Obama, and look where that got him.

    In Romney and/or Huntsman we must trust…

  45. Gravatar of JimP JimP
    7. September 2011 at 17:20

    http://www.econbrowser.com/archives/2011/09/following_the_s.html

  46. Gravatar of marcus nunes marcus nunes
    7. September 2011 at 17:29

    Cannot do any worse than this:
    http://online.wsj.com/article/SB10001424053111904103404576556943051259236.html?mod=WSJ_hp_LEFTTopStories
    One step getting considerable attention inside and outside the Fed would shift the central bank’s portfolio of government bonds so that it holds more long-term securities and fewer short-term securities.

    …The move—known to some in markets as “Operation Twist” and to some inside the Fed as “maturity extension”—is meant to further push down long-term interest rates and thus encourage economic activity. The program draws its name from a similar 1960s effort by the U.S. Treasury and the Fed, in which they tried to “twist” interest rates so that long-term rates were lower relative to short-term rates.

  47. Gravatar of marcus nunes marcus nunes
    7. September 2011 at 17:34

    JimP
    But they are only able to think in terms of interest rates!!!
    The Fed could decide to do something similar (to the SNB move) at the next FOMC meeting, except with Treasury securities rather than the exchange rate. Concretely, the Fed could commit to buying any Treasury security with a maturity date in or before 2016 at a yield of (say) 25 basis points. The commitment would remain until the securities matured. This would reinforce and extend the existing commitment to keeping short rates low and would be a failsafe version of quantitative easing. It would be different from QE1 and QE2 in pegging a price, not a quantity. This strategy would be very likely to lower rates on other assets that are close substitutes. Fiscal policy would be a better tool(!), but of course that is not in the Fed’s domain. At this point, directly targeting longer-term interest rates is the most promising course for boosting demand available to the Fed (except perhaps for raising the short-run inflation target).

  48. Gravatar of CA CA
    7. September 2011 at 17:50

    Ouch. Romney just said in the debate that he’d fire Bernanke, that Bernanke has inflated the currency too much, and that quantitative easy doesn’t work. How depressing:(

    Now who am I supposed to be rooting for??

  49. Gravatar of Shane Shane
    7. September 2011 at 17:56

    Romney has officially come out against Bernanke, QE 1 & 2, and further monetary stimulus. So it looks like there’s no Republican saviors on the horizon (unless he changes his mind–stranger things have happened!) But one potential positive is that Bernanke cannot but realize now that he sinks or swims with Obama, and thus that his reputation as Fed chairman depends on immediate monetary stimulus.

  50. Gravatar of W. Peden W. Peden
    7. September 2011 at 17:59

    Shane,

    How anti-stimulus do you think any of the Republicans would be if they were in power? How pro-stimulus would Obama be if he was out of power?

  51. Gravatar of CA CA
    7. September 2011 at 18:15

    Oops, that’s quantitative *easing.

  52. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 18:22

    That’s it, Scott you are going to have to let me help you with your blog layout.

    If we’re going to monetize, let’s get serious.

  53. Gravatar of Morgan Warstler Morgan Warstler
    7. September 2011 at 18:23

    GUYS,

    Ben WANTS the cover. Relax.

  54. Gravatar of ScottN ScottN
    7. September 2011 at 18:35

    These are the options the fed is actually considering. http://www.calculatedriskblog.com/2011/09/wsj-fed-prepares-to-act.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CalculatedRisk+%28Calculated+Risk%29&utm_content=Google+Reader

    The first one is operation twist, the second is to cut interest on excess reserves, and the third is something about using words to communicate policy goals better.

  55. Gravatar of “Twist & Shout” | Historinhas “Twist & Shout” | Historinhas
    7. September 2011 at 18:45

    [...] better to follow Scott Sumner’s suggestion: Over the past few years I’ve been surprised at how hard it is for central banks to move away [...]

  56. Gravatar of Shane Shane
    7. September 2011 at 19:37

    W. Peden,

    Good question. Romney has been unwilling to disavow monetary stimulus. This is no longer the case. Is this a cynical lie? No doubt. But the more important point is that firing Bernanke, rather than tightening, is now the crux of GOP monetary policy. Indeed, Bernanke cannot but realize that he is now an all-too-perfect fall guy for the hard money policies his enemies don’t actually intend to pursue. Maybe he still won’t do anything. But this provides a strong incentive to undercut the hard-money-is-loose-money lies his enemies promote.

  57. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. September 2011 at 22:02

    Statsguy: we aim to please ;)

  58. Gravatar of Morgan Warstler Morgan Warstler
    8. September 2011 at 00:32

    Shane, my god man, give it up.

  59. Gravatar of Jim Glass Jim Glass
    8. September 2011 at 01:44

    “The Fed needs to stop trying to reduce interest rates.”

    Speak louder, to be heard over the increasing reports that Operation Twist II is coming.

    How good an idea is it to move towards inverting the yield curve now, on top of everything else?

    (Does anyone at the Fed remember the term “aggregate demand” from school days?)

  60. Gravatar of Browsing Catharsis – 09.08.11 « Increasing Marginal Utility Browsing Catharsis – 09.08.11 « Increasing Marginal Utility
    8. September 2011 at 04:00

    [...] Sumner against interest rate targeting. [...]

  61. Gravatar of Scott Sumner Scott Sumner
    9. September 2011 at 17:33

    Morgan, Top 30%? Including Cambridge and San Francisco?

    MTD and Lee, I agree.

    o. nate. Current NGDP growth is strongly affected by future expected NGDP growth. No one denies that in the future the Fed can set NGDP wherever they want, as the zero rates won’t last forever. In addition, they can do negative rates on reserves. At this point I doubt QE would do much, unless accompanied by an higher explicit nominal target.

    ScottN and JimP, Thanks, I used that in a newer post.

    OhMy, You said;

    “As MMT explained to you, this will make banks less willing to lend, not more. Banks do not lend out reserves,”

    I’ve never met Mr. MMT, when did he explain these things to me? BTW, the purpose of negative IOR is not to encourage lending, so your point is irrelevant. And banks do sometimes lend out reserves. I could borrow reserves from my local bank tomorrow if I wanted to.

    James, I see that the US is a mess, but default is not the risk–higher taxes or inflation would be the endgame.

    Chacokevy, What have others said?

    Marcus, The Fed reminds me of the fireman who set fires, so they can be a “hero” in putting it out.

    CA, I’m very disappointed in Romney.

  62. Gravatar of Toni Toni
    16. September 2011 at 09:56

    The fed keeps interest rates low because of the conspiracy with the US Gov to understate the real amount of the national debt.
    Int. rates of below 4% tell you that your savings is worthless.
    On the borrowing side If you are going to default at 1% You probably will at 4 to 6%.
    The savings MMF, CD, etc rates are grossly affecting buying power. reducing consumer demand. CD int to MMF int to Cking to retailers was the norm for years with personal savings for consumers. Now the use of this money is no longer viable. For all of you economic book worms your theories do not live in the real world. The fed needs to stop controlling int rates and let the free nmarket determine the value of money. With real savings rate you will see consumers stop sitting hard on assets, and spend monthly, income as they see their savings grow.

  63. Gravatar of ssumner ssumner
    17. September 2011 at 09:46

    Toni, The Fed does let the free market control rates. The Fed controls the monetary base, the market sets rates. The only exception is the discount rate, which is not very important.

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