Tim Duy on how Fed policy keeps rates low

Garrett pointed me to a very good Tim Duy post on Fed policy:

The Federal Reserve has set reasonably clear expectations that rates will remain low for a long time.  That path, however, seems to be a consequence of doing too little now to ensure a stronger recovery.  In other words, the Fed seems to be taking a lower-rate future as a given rather than as a result of insufficient policy.  Instead of acting to ensure a stronger forecast, they seem more interesting in acting to lock-in the lower path of activity.  And that in turn will tend to lock in a low level of long-term rates. This, I think, is the best explanation for the inability of markets to sustain higher rates.  It is simply reasonable to expect that the conditions which justify higher long rates will be met with tighter policy sufficient to contain growth to something closer to the current path of output than to current estimates of potential output.

This is actually pretty close to Milton Friedman’s 1998 claim that rates in Japan were low because money had been tight.  Or Nick Rowe’s upward sloping IS curve. Duy doesn’t use the term “tight money”, but the phrase “doing too little now to ensure a stronger recovery” implies money is tighter than Duy and I might consider optimal, and that easier money would eventually lead to higher rates.  If you put aside my idiosyncratic definition of “easy” and “tight” money (I use NGDP growth, not interest rates and money growth as policy indicators), my views are actually similar close to those of a mainstream macroeconomist like Tim Duy.  The substance of what we are saying on monetary policy and interest rates (and also monetary offset) is very close, once you get beyond framing effects.

Have our views always been close on these issues?  I’m not sure.



30 Responses to “Tim Duy on how Fed policy keeps rates low”

  1. Gravatar of Nick Nick
    31. May 2014 at 07:53

    I’ve been reading this blog and Fed Watch for a bit. You two do sometimes come to the same conclusion using what seems to me to be very different languages. However, as the taper has played out you two are more and more in sync, even in tone. Perhaps the consistent forecast revisions paired with assurances that the path of the taper is ‘data dependent’ has made professor Duy cranky. I don’t think he cares nearly as much about IOR as you do, though … Which brings me to that interesting Cochrane paper you recently linked to.
    It seems to me a murky consensus is forming … The balance sheet works, we needn’t fear ‘0’, and we know how to keep the price level ‘in control’. Of course many are still on the outside screaming bloody murder. But on the inside regardless of which flavor of macro one previously preferred, the fundamental disagreement is about why we are so happy to keep it ‘in control’ at the current path of growth?
    Did anyone else see CNBCs interview with Paul McCulley on ‘the new neutral’ as a beaming Bill Gross looked on?

  2. Gravatar of Morgan Warstler Morgan Warstler
    31. May 2014 at 08:30

    I think the new normal reflects that everyone looks around and senses that real growth we do have going on doesn’t need Labor or Capital.

    Look at what sectors actually create real growth:


    Other than mining, its basically the tech space, the one that represents the future, valuations are growing at or above QE. Capital can’t find return, so its being plowed into newcos.

    But what does that mean in practice? What do we see happening around us?w

    It’s 10K companies getting $25K. Maybe 1/4 of those getting on to $150K, and maybe another $1M for 500 that get a shot at getting traction.

    Then 100 get a chance to get to profits, and find scale. Along the way they have been hiring the guys who did the 10K companies. Many of these get acquired.

    Say 3 go kaboom, and those companies decimate entire verticals and sectors of the atomic economy.


    Uber crushing Taxis.

    Airbnb crushing hotels

    I’m about to crush Govt. 🙂

    Our shared reality is one where the only way to get a sector to have growth, is either ENERGY (which runs data centers) or adding technology to it, which reduces the need for LABOR AND CAPITAL in that sector.

    This isn’t doom and gloom, but it seems like MM – Scott – you ought to delve into this – the secular stagnation, but seen from this idea:


    And I don’t think that was true with railroads and planes and toilets and tanks, and ships, and roads,etc.


    Just for fun, for a Econlog post (since they wont let me comment there) I’d really love to have you narrate this hypothetical for me.

    In 20 years:

    a) 50% of the avg humans wake time is spent online is in a VR rig.
    b) 50% is spent using a mobile device – outside in the world
    c) 50% of workers work from home – they have no office
    d) 80% of college students are in MOOC / BR – from home
    e) 50% of government buildings have been closed. Budgets are balanced.
    f) the public sector has shrunk from 22M to 7M, past pensions paid, far fewer new employees who paid much more – higher skilled.
    g) only 20% own their own car
    h) 20% of meals are Soylent

    Now here’s the challenge, I really can’t wrap my head around this, if we stipulate that the above is a fact:

    Where does the capital go?

    Doesn’t it all get transferred to Technologists?

    As capital lines up to try 50K ideas , instead of 10K, and see 10 newcos go parabolic, with Per Employee profit of $1M+, where the top 5% of coders have 60%+ of corporate stock in each entity?

    I feel like we have to just completely forget the idea of income and wages, when we talk about AG.

    Instead it seems like we:

    1. Establish a baseline of acceptable consumption for all who want to work.

    2. Provide that GI.

    3. Liquidate the labor via CYB.

    If unemployment is off the table, GONE POOF!

    What is the CORRECT level of NGDP?!?

    Why would you ever have NGDP higher than RDGP in a world where ALL RDGP comes from: 1) digital deflation 2) population

    You don’t really ever come down from the 30K view of MP, and on the ground to me, it looks like something profound is going on and I can’t visualize if higher NGDP is going make RDGP ‘deflate” faster.

  3. Gravatar of Edward Edward
    31. May 2014 at 09:20

    Off topic but ,
    Will you do a thorough rebuttal of Piketty once you have the time and you read his book. It seems like everywhere I turn on progressive blogs, they are talking about Piketty, and his feud with the Financial Times.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. May 2014 at 09:27

    There is no shortage of debunkings of the economics of Piketty, Edward. Mankiw links to a few;


    My fave is Xavier Sala y Martin’s;


    In Spanish, but Google Translate makes it readable in English.

  5. Gravatar of ssumner ssumner
    31. May 2014 at 10:11

    Nick, Interesting, but I wonder if the consensus you see is really there. Do people actually agree on the effects of QE?

    BTW, I’m not sure IOR is an important issue. I do think it was a mistake, but even without IOR we might have had an almost as severe recession.

    Morgan, I don’t know enough to comment on future worlds; leave that up to Robin Hanson. If that world comes about then NGDP will be the least of our worries.

    Edward, Yes, I’ll do a few posts on Piketty, but I probably won’t get into the data issue, as I don’t have the time. I’m more interested in other aspects of the debate.

    What I can’t figure out is the whole r > g thing. Is there anyone who defends that “model?” If so, what is the defense? It seems absurd on the surface. And yet Piketty clearly has many many supporters. So how do they defend that?

  6. Gravatar of benjamin cole benjamin cole
    31. May 2014 at 10:28

    Scott Sumner (and all): John Cochrane now says a big permanent Fed balance sheet is wonderful. So does Beckworth. How about a Fed balance sheet that grows steadily?
    What if the national debt is steadily reduced but no inflation thanks to IOR?

  7. Gravatar of Kevin Erdmann Kevin Erdmann
    31. May 2014 at 10:36

    Scott, did you know that in late 2008, when IOR was first raised to the target Fed Funds Rate, the effective Fed Funds Rate was running way below target? So, in the midst of the crisis period, for about 6 weeks, IOR was actually 0.5-.075% ABOVE the effective Fed Funds Rate.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    31. May 2014 at 11:21

    Kevin Erdmann,
    Here is the fed funds target rate and the interest on reserves (IOR) rate in late 2008:


    The first two spikes represent the day that Lehman Brothers filed for bankruptcy and the panic in the markets that ensued two days later. Note that the fed funds rate fell below target afterwards as the Fed stopped sterilizing the credit and liquidity programs and allowed reserve balances to rise.

    On October 6th the Fed announced the implementation of interest on reserves. Initially it was set at 0.75 points below the fed funds target rate of 1.5% or at 0.75%. The fed funds rate spiked above target the two following day but by the 9th it was again below target.

    The whole purpose of interest on reserves was to set a floor under short term interest rates, as the Fed had effectively lost control of the fed funds rate. This of course means that the institution of IOR was contractionary in late 2008, precisely at a time when monetary policy needed to be expansionary.

  9. Gravatar of Morgan Warstler Morgan Warstler
    31. May 2014 at 11:57

    “If that world comes about then NGDP will be the least of our worries”

    Jesus dude, I just described the last 20 years repeated. VR is what Mobile is today. Mobile is what Desktops used to be.

    Every guy I know making investments, you know the really smart guys who trust to be placing the capital…. those guys are all investing towards that EXACT future.

    It’s what everyone from Zuckerberg, Larry Page, and Andreessen et al, all the way down to 10K applicants for YS Combinator all wake up and plot to do everyday.

    AND they want to do Bitcoin.

    It’s the vision of the most favored and cherished Sci-Fi books in SV.

    I’m not talking about AI and Hansonian Hocus-Pocus, this is whats coming, by DESIGN.

    I think the capital just all gets given to tech guys, they’ll be the house in Casino, in every bet, they have winning odds. And the less labor they need, the less capital they need.

    I’d be interested in your take on how this would affect Macro.

  10. Gravatar of Nick Nick
    31. May 2014 at 13:35

    Well, I did say it was a murky consensus–perhaps a little bit damaged in the press by a certain prominent liberal economist’s failure to popularize the results of the exciting ‘sequester / QE extension’ natural experiment of 2013. I’ll feel better about it if the ECB at least manages to keep up with expectations on Thursday. However, what Draghi has accomplished with the microphone alone already is a little reminiscent of the ‘whatever it takes’ moment of monetary policy by bluff in 2012.
    But back in the USA I’m not sure disputes about which specific elements of unconventional policy work best are looming large now that we are flirting with the unofficial inflation target again . . .
    Incidentally, I believe both you and Professor Duy shared an early skepticism that the unemployment rate should be a part of the Evans rule.

  11. Gravatar of Edward Edward
    31. May 2014 at 16:02

    “Edward, Yes, I’ll do a few posts on Piketty, but I probably won’t get into the data issue, as I don’t have the time. I’m more interested in other aspects of the debate.

    What I can’t figure out is the whole r > g thing. Is there anyone who defends that “model?” If so, what is the defense? It seems absurd on the surface. And yet Piketty clearly has many many supporters. So how do they defend that?”

    Thats also what I find mysterious as well. The best I can come up with is the inverse size between the rate of return and the size of someone’s assets. (Or income) Its hard for our 55trillion dollar asset based economy to grow as fast as a billionaire who earns five percent on his investment.

    If thats what Piketty means, then big yawn. So what? as capital grows more abundant it will get harder and harder to grow at the same rate. is Piketty afraid the rich will “eat the economy” lol 🙂

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    31. May 2014 at 16:11


    That’s exactly what I was thinking. IOR at the end of 2008 was much worse than one might even think it was.

    I wondered here:

    if a rising Fed Funds Rate at this point could actually be stimulative, if IOR was left at .25%. The reason is that as the quantity of excess reserves increases, the differential between the FFR and IOR should increasingly lead to bank asset expansion. At some level of excess reserves, the stimulative effect of the higher FFR-IOR difference would have to be greater than the deflationary effects of selling treasuries. Wouldn’t it?

  13. Gravatar of dannyb2b dannyb2b
    31. May 2014 at 21:03

    Could it be that the fed doesnt think QE or negative rates cant do much more for the economy? What is the point of creating more excess reserves?

  14. Gravatar of Lorenzo from Oz Lorenzo from Oz
    31. May 2014 at 23:49

    Off topic: Scott, Calomiris & Haber provide further support for your general “small is better” public policy and country size thesis.

  15. Gravatar of W. Peden W. Peden
    1. June 2014 at 02:31


    You may be right, but not for the right reasons. US unemployment isn’t that far off many estimates of the natural rate, and unemployment isn’t that far below the Fed’s implicit target, so a lot of people at the Fed may well believe that extra AD would make little positive difference. On the other hand, this isn’t because they don’t think that OMOs would make a difference, otherwise they could step up QE-infinity a lot and buy up all US federal debt without negative effects.

  16. Gravatar of Willy2 Willy2
    1. June 2014 at 03:49

    Still dreaming that the FED determines & sets interest rates ?

  17. Gravatar of W. Peden W. Peden
    1. June 2014 at 06:19


    (1) ‘FED’ is an acronym that stands for Felix Edmundovich Dzerzhinsky, founder of the Cheka, as his name was used for a Soviet-era camera. Abbreviations are not usually capitalised.

    (2) Your question is inadequate as it stands: short-run or long-run? Nominal or real? Basic monetarist analysis would tell you that the Fed cannot set the equilibrium rate of either the nominal rate or the real rate (fixing the interest rate either side of the natural rate- or range- leads to hyperinflation or hyperdeflation as a disequilibrium) and in the case of real interest rates it has (at best) only brief influence.

  18. Gravatar of W. Peden W. Peden
    1. June 2014 at 06:20

    And insofar as the Fed can influence the long-term nominal rate, it’s the opposite of the way people tend to think i.e. printing money tends to raise the long-term nominal rate, whereas a hard monetary policy lowers the long-term nominal rate.

  19. Gravatar of TravisV TravisV
    1. June 2014 at 07:54

    Lars Christensen is on a roll!



  20. Gravatar of TravisV TravisV
    1. June 2014 at 07:56

    Benjamin Cole is on a roll!



  21. Gravatar of Peter K. Peter K.
    1. June 2014 at 08:11

    Off topic, but another prime example about how conservatives and Republican economists are clueless sellouts and Krugman is right.


    50 Shades of Fed
    June 1 at 11:10 am

    STANFORD, Calif. – Several dozen economists and one-third of the regional Federal Reserve Bank presidents gathered in the California sunshine last week, and they spent two days talking about how and why to rein in a central bank that, in many of their eyes, has been acting awfully naughty lately.

    The name of the conference was “Frameworks for Central Banking in the Next Century,” but the word of the week was “rules.” The Fed isn’t following them faithfully enough, speaker after speaker said in an auditorium at Stanford University’s Hoover Institution. In particular, they said, Fed officials need to be following a rule named for the economist who hosted the group, Stanford’s John Taylor, who long ago built a model to suggest how to set short-term interest rates to respond to changing economic conditions.

    A Fed following the Taylor Rule would have raised rates by now, and it would not have exposed the nation to inflation risks by buying so many trillions of dollars of bonds and mortgage-backed securities over the past few years, several of the economists at the podium said. One paper presented at the conference, by University of Houston economist David Papell, found that the economy does better when the Fed sticks close to the Taylor Rule or something like it.
    By straying from that rule, many economists said, the Fed is hurting the economy and courting high inflation. So perhaps it’s time for some discipline. And if the Fed won’t take it on itself, they said, then Congress should shackle it – narrowing the central bank’s mandate to focus solely on keeping prices stable.

    The tension here is that the Great Recession and its aftermath have scrambled a lot of the old monetary policy rulebook. Growth is slow. Interest rates are low, and so is inflation. So the Fed has waged an unconventional campaign to reduce unemployment. It bought massive quantities of bonds in an effort to depress long-term interest rates and stimulate economic activity that would lead to hiring. It has left short-term rates near zero for five years running.
    That’s a lot of improvisation, historically. Fed officials have argued that it’s necessary, because the economy, post-recession, is stuck in something called a Liquidity Trap, where there’s no room left to cut interest rates and inflation isn’t much of a threat.

    The attendees didn’t talk much about unemployment in their presentations. They focused mostly on inflation risks – which, to be fair, many of them have been warning about for years, even as the inflation rate stayed below the Fed’s 2 percent target.

  22. Gravatar of W. Peden W. Peden
    1. June 2014 at 08:39

    Peter K.,

    “but the word of the week was “rules.” The Fed isn’t following them faithfully enough, speaker after speaker said in an auditorium at Stanford University’s Hoover Institution.”

    Correct. The lack of regard for the Fed’s current inflation target is a big problem and more monetary stimulus is needed. An inflation target isn’t the best option, but it’s even worse to have an inflation target and then ignore it.

    … Oh, that’s not what they were talking about? Astonishing.

  23. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. June 2014 at 09:20

    Piketty is increasingly resembling Peyton Manning in the SuperBowl; comes in with the gaudy numbers and hype…then meets his Legion of Broom which proceed to sweep out the cobwebs in his thinking. Say, Debraj Ray;


    ‘Here is what Piketty concludes from this Law, as do several approving reviewers of his book: that because the rate of return on capital is higher than the rate of growth overall, the income of capital owners must come to dominate as a share of overall income. Once again, we are left with a slightly empty feeling, that we are explaining one endogenous variable by other endogenous variables, but I don’t want to flog this moribund horse again. Rather, I want to make two related points: (a) the above assertion is simply not true, or to be more precise, it may well be true but has little or nothing to do with whether or not r > g, and (b) the law itself is a simple consequence of a mild efficiency criterion that has been known for many decades in economics. Indeed, most economists know (a) and (b), or will see these on a little reflection. But our starry-eyed reviewers and genuinely interested readers might benefit from a little more explanation, so here it is.

    ‘The rate of return on capital tracks the level of capital income, and not its growth. If you have a million dollars in wealth, and the rate of return on capital is 5%, then your capital income is $50,000. Level, not growth. On the other hand, g tracks the growth of average income, not its level. For instance, if average income is $100,000 and the growth rate is 3%, then the increase in your income is $3000. Saying that r > g implies that capital income will grow faster than labor income is a bit like comparing apples and oranges.’

    Too bad everyone isn’t reading an actually useful book, as Lorenzo is doing.

  24. Gravatar of ssumner ssumner
    1. June 2014 at 10:18

    Ben, If they have to pay IOR, you haven’t really reduced the size of the national debt. You’ve just exchanged bonds for excess reserves.

    Kevin, Yes, I do recall that.

    Morgan, I don’t see how it matters for monetary policy and NGDP.

    Nick, I agree that the effect of Draghi’s actions are mainly from the expectations channel.

    Edward, I was bothered by something else. He says r > g implies wealth will grow faster than income. But it doesn’t imply that.

    Danny, You asked:

    “Could it be that the fed doesn’t think QE or negative rates cant do much more for the economy?”

    It’s exactly the opposite. They are stopping QE precisely because they think it can do more for the economy. But they don’t think the economy needs “more.”

    Lorenzo, Very interesting.

    Peter, Yes, the GOP economists have been wrong, and Krugman has been better on monetary policy. But the MMs have been even more accurate than Krugman.

  25. Gravatar of Peter K. Peter K.
    1. June 2014 at 12:31

    Patrick Sulliavan –

    Milanovic responds to Debraj Ray.

    “It is indeed a contradiction of capitalism because capitalism is not a system where both the poor and the rich have the same shares of capital and labor income. Indeed if that were the case, inequality would still exist, but r>g would not imply its increase. A poor guy with original capital income of $100 and labor income of $100 would gain next year $5 additional dollars from capital and $3 from labor; the rich guy with $1000 in capital and $1000 in labor with gain additional $50 from capital and $30 from labor. Their overall income ratios will remain unchanged. But the real world is such that the poor guy in our case is faced by a capitalist who has $2000 of capital income and nothing in labor and his income accordingly will grow by $100, thus widening the income gap between the two individuals.

    So, If K/L ratio was the same along the entire income distribution, r>g would not have any special meaning. I grant that to Debraj. But precisely because the K/L ratio in capitalism is most emphatically not equal along income distribution (and we do not have a single historical example where it was), but is rising, we do get increasing income inequality driven by r>g.”

  26. Gravatar of Peter K. Peter K.
    1. June 2014 at 12:32


  27. Gravatar of flow5 flow5
    1. June 2014 at 12:43

    Both QE2 & QE3 both produced negative real-gDp figures (1st qtr of 2011 & 1st qtr of 2014). The payment of interest on excess reserves is responsible. Shifts in savings/investment accounts from the non-banks to the commercial banks exacerbated the trend.

    I.e., the expansion of Reserve bank credit during quantitative easing was inadequate to offset the slow growth in non-bank lending/investing (pre-Great Recession, 82% of the lending market).

    The 24 month rate-of-change in proxy for money flows decelerated sharply after both QE2 & QE3.

    Unless money (& money flows), expand at least at the rate prices are being pushed up, output can’t be sold and thus jobs will be cut (i.e., there is insufficient upward & downward price flexibility within our economy, e.g., “sticky wages” to counteract a contractionary money policy).

    The problem is that the Fed has emasculated its “open market power”. Whereas between 1942 & 2008 the CBs minimized their non-earning assets, now the Fed accommodates the bankers with a remuneration rate that exceeds all money market rates (exceeds all returns in the wholesale funding market on the short-end segment of the yield curve).

    So POMOs between the Reserve and commercial banks only affect excess reserves (are just asset swaps). Before the CBs would buy short-term securities (increasing their liquidity reserves & the money stock). After the introduction of the payment of interest on reserves the CBs now hold higher yielding IBDDs.

    The Fed’s policy rate (credit control device), induces dis-intermediation among just the non-banks. It provides the CBs with the option to outbid the NBs for loan-funds (“specials”). This is exactly the same funding problem that existed with Reg Q ceilings where in 1966 the CBs outbid the NBs for loan-funds).

    Unless CB lending/investing offsets the decline in NB lending/investing aggregate monetary purchasing power will be lost.

  28. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. June 2014 at 17:34

    ‘Milanovic responds to Debraj Ray.’

    Whoever he is, he either didn’t read Ray’s piece very carefully, or he doesn’t understand it.

  29. Gravatar of maynardGkeynes maynardGkeynes
    1. June 2014 at 18:20

    So, is the argument that fear of deflation is holding back consumer spending and business investment?

  30. Gravatar of ssumner ssumner
    2. June 2014 at 07:45

    Peter, In that paragraph the writer seems to confuse levels with growth rates. The income does not grow by $100, IT IS $100. Income only grows if the stock of capital grows and the rate of return stays at 5%, which is an entirely separate issue.

    Maynard, I doubt many people expect deflation.

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