We need monetary stimulus. The Fed will raise rates. Here’s how to do both.

I’m assuming the Fed will raise rates tomorrow, probably by a quarter point.  No point even arguing that issue any further; the “zero rate bound” is gone (and in truth has been gone for about a year.)

And yet market forecasts suggest the Fed will continue to undershoot their 2% inflation target, so monetary stimulus is needed. Here’s how they can do both (and don’t worry, nothing NeoFisherian here.)

The Fed should include the following in its statement:

“Further increases in the fed funds target will be entirely data driven. There is no predetermined schedule for the next increase.  Our models suggest that the tightening labor market should cause inflation to rise, but we also recognize that there is uncertainty associated with these predictions.  Thus further increases in the fed funds target will not occur unless and until there is concrete evidence in the data that inflation is clearly on track to approach 2% in a reasonable period. That data might include some combination of higher core inflation, higher TIPS spreads, higher hourly wage gains, and other (non employment) indicators.  Also note that 2% inflation is not a ceiling, the target is symmetrical.”

I believe the market would regard that communication as expansionary, and that it would help the Fed to achieve its 2% goal more quickly.  Ironically, while the resulting path of interest rates might be lower at first, it could actually be higher in the out years.



74 Responses to “We need monetary stimulus. The Fed will raise rates. Here’s how to do both.”

  1. Gravatar of Benoit Essiambre Benoit Essiambre
    15. December 2015 at 16:02

    Why is this not Neo Fisherian? Haven’t some of them relied on expectations to explain their scheme and wouldn’t this set expectations in a Neo Fisherian way? It could be interpreted as the fed picking the Neo-Fisherian equilibrium out of the multiple equilibra.

    This might be giving the NFs too much credit though.

  2. Gravatar of Richard A. Richard A.
    15. December 2015 at 16:11

    Their action (in raising rates) will be louder than their words.

  3. Gravatar of Britonomist Britonomist
    15. December 2015 at 16:14

    Markets are up today, and I was worried stocks would massively overreact negatively to a rate rise. Either (a) markets have some information indicating no rate rise after-all, (b) the rate rise was priced in so long ago that stocks have hit their bottom and bargain hunters are coming in, (c) something else happened incidentally which was very positive for stocks (but what?) or (d) a rate rise is actually bullish (neo-fisherism vindicated?).

  4. Gravatar of Christian List Christian List
    15. December 2015 at 16:19

    So why a raise in the first place?

    I also don’t get why stock markets went up on Tuesday. We’ll see.

  5. Gravatar of E. Harding E. Harding
    15. December 2015 at 16:34

    How about raising rates while doing QE4? That was my first thought.

  6. Gravatar of Benjamin Cole Benjamin Cole
    15. December 2015 at 16:56

    Good idea.

    Of course today the Fed also has IOER as a tool, and their balance sheet. Even the mysterious reverse repo program ($300 billion program, btw).

    Going to a 1.5% to 2.5% IT band might help too, even though on paper it is the same target.

  7. Gravatar of ssumner ssumner
    15. December 2015 at 16:58

    Benoit, Because the NeoFisherians think the act of raising rates is expansionary.

    At least I think they do, otherwise I’m not sure the point of their analysis.

    Richard, Not if they use my words.

    Britonomist and Christian, Stocks move around every day. Today was nothing unusual, no need to connect it to Fed policy. The increase was not large.

    E. Harding, No chance of that, what would be the point?

  8. Gravatar of Britonomist Britonomist
    15. December 2015 at 17:10

    I was looking at FTSE which was a 2.45% increase which is unusually large, normally it tracks American indexes in lieu of any significant UK news so I just assumed American stocks were similarly bullish. Additionally some news stories seem to want to link the stock rise to rate rises (as well as stabilizing oil prices).

  9. Gravatar of Philo Philo
    15. December 2015 at 17:41

    While raising the Fed Funds target they could eliminate (positive) interest on reserves. That would be expansionary. But they won’t do it, and *no one will even ask them why they don’t*.

  10. Gravatar of Christian List Christian List
    15. December 2015 at 19:03

    The German DAX rose about 3,1% for no apparent reason on Tuesday. Maybe it’s just a temporary correction, the DAX lost way more during the last days. Plus a lot of noise and volatility because of the outstanding FED decision. There’s also a witching hour at Friday.

  11. Gravatar of Don Don
    15. December 2015 at 19:15

    NGDPLT to the rescue! And stop interest on excess reserves.

  12. Gravatar of rtd rtd
    15. December 2015 at 19:41

    So, we assume the Committee’s credibility begins…….. now! solely because of a new statement? Why should we believe the addendum? I’m thinking the statement would cause a massive amount of market confusion – why release such a statement not supporting your current move? Why would markets believe the Committee will become data dependent……. now!?

  13. Gravatar of HL HL
    16. December 2015 at 01:02

    Interesting news from Korea….


  14. Gravatar of Anonymous Commentor Anonymous Commentor
    16. December 2015 at 05:00


    It’s not a matter of earning credibility now–but of safeguarding it, even as they take a step that unto itself isn’t necessarily (at least ostensibly) consistent with a symmetric inflation target and an appropriate assessment of the asymmetric risks that arise at the ZLB. Markets already believe, I would argue, that the Fed does take these risks into consideration and will temper the path of rate hikes in accordance with the actual development of data–Yellen and Rosengren, for instance, have effectively argued that there’s a higher bar for subsequent rate hikes, whereas the first is, a la Lockhart, based on “faith” that inflation will move back to 2 over the arbitrarily-defined “medium term.”

    What Prof Sumner’s proposed language–which I very much endorse–does is articulate the reaction function markets already believe the Fed follows (which explains why the yield curve has been flattening and fed funds futures suggest expectations of a much shallower rate path).

    It would be an excellent first step, and far superior to explicitly committing to “gradual,” but generating the same effective impact.

  15. Gravatar of Max Max
    16. December 2015 at 05:03

    If you think that the Fed was never really stymied by the zero bound, then there’s no harm in setting the “zero bound” a *little* higher, which would boost financial sector profits.

  16. Gravatar of bill bill
    16. December 2015 at 05:46

    I like that language a lot. I will hope for that.

    Question: what means will the Fed use to get the Fed Funds Rate to rise at this time? What method exists in this situation other than increasing IOR?

    Here’s another expansionary rate rise idea. Raise 5 bps instead of 25 bps. I’d love to see the Fed slap that together with the proposed language.

  17. Gravatar of Robert Simmons Robert Simmons
    16. December 2015 at 05:54

    How about also cutting IOER at the same time? Preferably to zero, but maybe in half if they feel compelled to keep it positive?

  18. Gravatar of Anonymous Commentor Anonymous Commentor
    16. December 2015 at 06:03


    It’s a combination of IOR and their new ON RRP facility: various counterparties, including GRE’s and MMMF’s whose ability to trade in the FFR market made IOR a permeable floor, lend cash to the Fed overnight and borrow a Treasury security, which the Fed then buys back at a higher price. The implied rate of interest is intended to set a floor for money market rates to the IOR ceiling, though the Fed has suggested that the risks to the facility (e.g., that counterparties will flock to this facility to exacerbate liquidity runs) merit only a temporary usage.

    That’s why the Fed couldn’t simultaneously slash IOER to 0: it wouldn’t have any effect, and money market rate would simply gravitate to the ON RRP rate.

  19. Gravatar of Saturos Saturos
    16. December 2015 at 06:08

    Or they could print just the last sentence of that statement, that would be enough.

  20. Gravatar of o. nate o. nate
    16. December 2015 at 07:49

    It sounds like Scott and Larry Summers are on the same page. Here’s the concluding paragraph of his blog post yesterday:

    “Reasonable people can come to different judgements on all of this. I think on balance it was a mistake to lock in a December rate increase though the argument is closer than it was in September. But that decision has been made. I hope the Fed will not now invest its credibility in signaling further increases until and unless there is much clearer evidence of accelerating inflation. I hope it will also emphasize the two sided character of the 2 percent inflation target to mitigate the risk that markets will think the US has an inflation ceiling rather than target. Finally, I hope the Fed will signal its awareness of instability and risk of growing problems in emerging markets.”
    – See more at: http://larrysummers.com/2015/12/15/what-should-the-fed-do-and-have-done/#sthash.9XXh9gda.dpuf

  21. Gravatar of Brian Donohue Brian Donohue
    16. December 2015 at 08:39

    Meanwhile, Barrons reports:

    “But after four years of fiscal policy austerity, Congress is about to step its foot on the fiscal policy accelerator.”

    Just noting for the record that the federal deficit is likely to “bottom out” at about $440 billion before now going up again five years into a recovery. Austerity, yeah.

  22. Gravatar of TravisV TravisV
    16. December 2015 at 10:04

    Bob Murphy: “Did “Tight” Fed Policy Cause the Financial Crisis?”


  23. Gravatar of Gary Anderson Gary Anderson
    16. December 2015 at 10:22

    So, I think economists in this group, Sumner, Erdmann, and Rowe and maybe Cochrane, want to do what was done before with the Fed being up to snuff next time. But I think toxic loans were really toxic. They were established with the lenders knowing they would not be paid back. How could they be paid back? After all, securitization took these loans off the books of the banks and underwriting went away. Banks may be regulated now but they weren’t then. Underwriting was no longer important. That could not be fixed by the Fed doing everything right.

  24. Gravatar of Justin Justin
    16. December 2015 at 11:20

    *”those data”

  25. Gravatar of Mike Rulle Mike Rulle
    16. December 2015 at 11:33

    I could not find the desired “in the data” statement in the release; but it seems their message is similar to your recommendation

  26. Gravatar of o. nate o. nate
    16. December 2015 at 11:34

    Sadly there was no mention of 2% being a symmetrical target, although you could argue it was implied.

  27. Gravatar of Mike Rulle Mike Rulle
    16. December 2015 at 11:38

    Actually, it is the last 3 words of the second to last paragraph “as informed by incoming data”

  28. Gravatar of Mike Rulle Mike Rulle
    16. December 2015 at 11:44

    As I think about it though, your idea is much more aggressive in emphasizing “data”; whereas their statement emphasizes “judgment”. One could say that is a distinction without a difference but I don’t think that is the case.

    (I wonder what Bertrand Russell would think?).

  29. Gravatar of TravisV TravisV
    16. December 2015 at 11:54

    Yellen during the press conference: “We recognize that monetary policy operates with lags.”

    Does Yellen believe that lags are long and variable?

  30. Gravatar of ssumner ssumner
    16. December 2015 at 12:19

    Philo and Robert, If they eliminate IOR then the only way they can raise rates is to remove almost all of the excess reserves at once. That won’t happen. (However, I do prefer they remove the ERs before raising rates.)

    rtd, Believe me, if they did something as radical as I suggested, it would get the market’s attention (alas, they didn’t.)

    Thanks HL, very interesting.

    Bill, They will increase IOR.

    Brian, That’s what happens with a GOP Congress.

    Saturos, That would help a bit, but not nearly as much.

    O. Nate, Sumners and Sumner

    Mike, Unfortunately there is nothing new in this statement, very disappointing. (But not unexpected.)

  31. Gravatar of Britonomist Britonomist
    16. December 2015 at 13:12

    Stocks rallying, *sigh* – really is blindfolded monkeys throwing darts and all that.

  32. Gravatar of ssumner ssumner
    16. December 2015 at 14:00

    Britonomist, The rally was not on the announcement, but rather the press conference—what did she say?

  33. Gravatar of Christian List Christian List
    16. December 2015 at 14:46

    I think Yellen was pretty clear and did a good job. I assume the markets rose because of these statements:

    “The process of normalizing interest rates is likely to proceed gradually, although future policy actions will obviously depend on how the economy evolves relative to our objectives of maximum employment and 2 percent inflation.
    Even after today’s increase, the stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.”


    No more Greenspan mumbling things that are hard to understand.

  34. Gravatar of Christian List Christian List
    16. December 2015 at 14:48

    She als talked about data:

    “The actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

    I think that’s pretty close to what Scott wanted?

  35. Gravatar of TravisV TravisV
    16. December 2015 at 15:06

    Yellen on natural rates (from her speech):


  36. Gravatar of bill bill
    16. December 2015 at 15:48

    Is IOR the one instance where it’s ok to reason from a price change? It’s only being used because supply and demand curves aren’t moving to produce the price, right?

  37. Gravatar of Gary Anderson Gary Anderson
    16. December 2015 at 16:36

    I thought banks borrowed at the short rate and loaned out at the long rate. If the long rate is perpetually low, due to outside demand factors like the use of bonds as collateral, banks won’t make money lending and won’t lend much. If rates are raised at the low end, don’t they have to do something about the long bond to slow demand and let yield rise on that bond?

  38. Gravatar of Frank Taussig Frank Taussig
    16. December 2015 at 17:45

    @Garry A.

    With all due respect, I think you are operating under an antiquated model of banking. At one time bankers had to borrow (from savers) in order to make loans. In the present fiat/fractional reserve system a banker will simply write a loan, and credit the borrowers demand account (checking account). The bankers only worry is clearing settlement at the end of each business day.

    Accounts between banks are settled nightly at the Fed. Banks that do not have enough liquidity to settle all of the payments made by their clients during the day must borrow electronic base money ( fed funds)from other banks. It is in this market ( the market for “fed funds”) that the Fed open market desk operates on a daily basis in order to effect the conditions decided by the FOMC.

    The fed chairperson does not change the rate at which banks “borrow”, she changes the cost at which they get through the clearing/settlement process.


  39. Gravatar of bill bill
    16. December 2015 at 17:52

    banks have done fine in spite of a yield curve that isn’t overly steep because they’ve been able to get larger spreads since 2008 (even before Lehman) than they got prior to 2008. At times, spreads have been hundreds of basis points wider than they were in 2006.

  40. Gravatar of rtd rtd
    16. December 2015 at 18:58

    I’m wondering if we will have dissents at the January meeting? Current committee alternate mebers Cleveland, Boston, St. Louis, and Kansas City are set to be voting members beginning 2016. Based on the dot plots, two non-voting district presidents (I’m assuming these were non-voting presidents as there were no dissents in the policy statement) currently view the “midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar” for 2016 to be 0%-0.25%.

  41. Gravatar of Ray Lopez Ray Lopez
    16. December 2015 at 19:04

    I find it amusing people try and explain random noise short term trader herd effects, such as gold spiking up after Fed rate rise. Fed not credible? Some other reason? It’s just mass hysteria.

    But somebody please explain this from a monetarist viewpoint; to me it seems contractionary:

    To set the new baseline, the Fed said it would pay banks an interest rate of 0.5 percent on unused money, and it would borrow up to $2 trillion from other financial firms at a rate of 0.25 percent.

    If the Fed is borrowing, it is buying money, hence contracting the money supply, yes? And paying 0.5% on unused money means banks are less likely to loan that unused money to customers, yes? Yet the US stock market is up. Proving nobody really believes any of this nonsense makes any difference (money is neutral).

  42. Gravatar of Gary Anderson Gary Anderson
    16. December 2015 at 23:41

    Frank, they still have to borrow at the low rate, LIBOR, and lend at a higher rate to profit. By the way, LIBOR is a floating rate and is always less than the fixed Swaps rate, except for at the beginning of the great recession. Here is the chart: http://www.talkmarkets.com/content/us-markets/scott-sumner-and-friends-want-unbridled-growth-chicago-school-update?post=80548

  43. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    17. December 2015 at 04:14

    @Prof. Sumner, Britonomist, Christian
    Yellen confirmed something I hear a lot in this blog, that the Wicksellian rate is very low.

  44. Gravatar of Ray Lopez Ray Lopez
    17. December 2015 at 05:16

    @Frank Taussig: “At one time bankers had to borrow (from savers) in order to make loans. In the present fiat/fractional reserve system a banker will simply write a loan, and credit the borrowers demand account (checking account). The bankers only worry is clearing settlement at the end of each business day.” – a fallacy; you are confusing short inter-day imbalances with the requirement that bankers must have assets + capital = liability, at the ‘end of the day’. If there are no savers, there cannot be any equity accumulated from borrowing short and lending long, and/or financial intermediation, and the bank cannot stay in business; the Fed will not save them, even and especially if their name is Lehman Brothers.

    Further, the Fed does not “create new money at the push of a button” except at the interest rate of the Fed funds rate. The Fed cannot legally create new money ‘out of thin air’. It must accept collateral (commercial paper, bonds, gov’t paper) and this collateral is by definition ‘existing money’ rather than ‘new money’ (it’s existing money despite being fractional reserve created money, if you think it through you’ll see my point). The true ‘new money’ is only the money given for the interest rate that the Fed pays (and BTW the Fed does not ‘set’ this rate, the market does, but let’s not go there).

    Another fallacy that even our host has fallen into is that Fed collateral is 100% safe, because the Fed holds it. This is false. The Fed expanded its base from under $1T before 2007 to $4.5T today; largely by taking on ‘junk paper’ as collateral from underwater banks. This paper is junk and most be unwound at some point, which will require that the Fed write off this paper as worthless. Fed junk paper is *not* the same as a US government bond/note, despite what Sumner may imply. Having this junk paper on the Fed balance sheet is potentially inflationary, but that’s a problem for another day.

  45. Gravatar of collin collin
    17. December 2015 at 05:58

    Frankly, I just glad Yellen simply raised the rate slightly so I can hear the new version of the Fed Failure from Peter Schiff. I am with Krugman that this move was signaled so much that it has become a non-story and in the long run probably not change much.

  46. Gravatar of ssumner ssumner
    17. December 2015 at 07:15

    Christian, No, I wanted her to say no more rate increases until we are clearly on track to hit the 2% target. We are not on track. I’m saying no more rate increases until the data shows we are clearly on target. Right now the Fed could easily raise rates again in March, even if the economy is basically the same as today. That is, if the inflation/wage/TIPS data are all exactly the same, they still might raise rates because their “model” shows them that inflation should soon rise.

    Now I’m not saying you are completely wrong, the markets did increase during her press conference and perhaps the markets inferred she was doing 10% or 20% of what I wanted, in those rather vague statements, but it certainly was nowhere near as forthright as I wanted.

    Bill, Yup, it’s not a market price, it’s a tax/subsidy scheme. It’s also OK to reason from a higher excise tax on gasoline.

    Ray, You said:

    “Yet the US stock market is up.”

    So does Ray think the rate increase was “new information” to the markets? Really?

  47. Gravatar of Ray Lopez Ray Lopez
    17. December 2015 at 09:16

    Maybe ‘new information’ was the trillions the Fed promises to buy from private lenders?

    OT–(but on point for Sumner’s NGDPLT): Brazil has seen inflation surge since the middle of 2014, yet GDP is down dramatically. If Sumner’s ‘money illusion’ and ‘sticky wages’ theory was correct, we’d see a turnaround by now.

  48. Gravatar of Don Geddis Don Geddis
    17. December 2015 at 09:50

    @Ray Lopez: “(commercial paper, bonds, gov’t paper) and this collateral is by definition ‘existing money’

    LOL. If you don’t understand the difference between “collateral” and “money”, it’s no wonder that monetary policy confuses you.

  49. Gravatar of Derivs Derivs
    17. December 2015 at 10:49

    Sticky wages can’t really apply in Brazil since the gov’t basically mandates annual salary changes for pretty much every job you can imagine…

    The country is truly a basket case right now… nothing but a bunch of thieves.

  50. Gravatar of Frank Taussig Frank Taussig
    17. December 2015 at 10:54

    Hi Gary.

    Respectfully, I think you are mixing apples and oranges now. We are talking about the american payment system and the american clearing system and the framework of all of that which is The Federal Reserve System. Libor, as it’s name clearly implies, is a component of an altogether different ecosystem.

    Aside from that, you are still using a model of banking that has not existed for decades. As counter-intuitive as it may be, the idea that a bank must borrow before it can lend is just not true today.

    When a bank writes a loan they are creating money ex-nihilo. They don’t need to borrow it, they make it. Now, obviously they are not empowered to create base money ( vault cash + electronic vault cash i.e. fed funds) but the “money” that we use when we write a check or use a debit card is created by private banks when a loan is granted.

    Banks borrow, yes, to get through the clearing process and to meet regulatory capital requirements; not for lending.

    If this subject is very important to you, look into a guy called Perry Mehrling. He is my guru on the day to day mechanics of the banking system. He has written several great books and has a mooc.

  51. Gravatar of o. nate o. nate
    17. December 2015 at 11:54

    Commercial banks in the US fund themselves primarily from deposits. It seems reasonable to consider deposits as a form of short-term borrowing. Even if banks in some sense created those deposits ex nihilo, once created they are liabilities of the bank.

  52. Gravatar of W. Peden W. Peden
    17. December 2015 at 12:28


    Brazil continues to be the country of tomorrow, forever.

  53. Gravatar of Frank Taussig Frank Taussig
    17. December 2015 at 12:53

    Hi O. nate,

    Sentence 1. strongly disagree

    Sentence 2. totally agree with your logic, but do not concede that this is the sine qua non mechanism of contemporary banking.

    Sentence 3. totally agree

    Guys, this is not my personal opinion, I linked to a BOE pdf above. BOE, an august institution if ever there was one.

    Also: read Perry Mehrling, Anne-Marie Meulendyke and Stigum and you will have a crystal clear picture of how the mechanics of the system function.

    I am not talking about monetary policy, I am not at all expert in that. I am here to learn that from Prof. Sumner. I am only claiming knowledge of the mechanical workings of the system in a day to day business sense.

  54. Gravatar of o. nate o. nate
    17. December 2015 at 13:07

    Not sure what you disagree with about Sentence 1, but you can easily look up on FRED about the liabilities of US commercial banks by type. Deposits are by far the largest category.

  55. Gravatar of E. Harding E. Harding
    17. December 2015 at 13:41

    Guys, can anyone explain this?


    The T-Bill rate has soared. The Federal Funds Rate is still where it’s always been.

  56. Gravatar of Frank Taussig Frank Taussig
    17. December 2015 at 13:44

    Hi O. Nate,

    Demand deposits are bank liabilities, this is an accounting identity,
    An undeniable fact.

    I would still disagree, however, because of your implication that banks require some external input (funding) to make loans, they do not.

    Can you imagine at a Giants – Patriots game, if the team management asked the crowd to deposit points with the scoreboard crew so that they would have enough points on hand to score the game? We can’t start the game…..we have not yet received enough points in the point bank.

    Banks require funding, of course, to meet certain regulatory requirements and most importantly to fulfill commitments during the payment process.

    This is why the fed open market desk exerts direct control over the pool of liquidity used for final clearing of the payment system.

    I have recommended some really worthwhile resources above, I hope you check them out

  57. Gravatar of o. nate o. nate
    17. December 2015 at 14:21

    I think there is a misunderstanding about my use of the word “funding”. I don’t mean by this that some external party gave the bank the funds to make a loan. I’m using the word “funding” interchangeably with “liabilities”. I simply mean that when the bank pays interest on those deposits (if it does at all) it is paying something tied to a short-term rate. So in a real sense the bank funds itself at a short-term rate.

  58. Gravatar of James Alexander James Alexander
    17. December 2015 at 14:40

    This might help the confused on today’s ST rate moves.

  59. Gravatar of ssumner ssumner
    17. December 2015 at 16:43

    Thanks James.

  60. Gravatar of Negation of Ideology Negation of Ideology
    17. December 2015 at 17:37


    Off Topic, but it’s been discussed on this blog – what do you think of Finland’s plan to replace its current welfare system to a basic income?


  61. Gravatar of Gary Anderson Gary Anderson
    17. December 2015 at 17:39

    LIBOR is central to interest rate swaps, a 500 trillion dollar market. LIBOR is the most common rate for the low floating side of the swap. Our TBTF banks have massive positions, usually the low interest floating side of the bet, often tied to LIBOR. Look at the chart. That is obvious. Chart don’t lie. Link is at my name. But also, read this from Wikipedia: n an interest rate swap, each counterparty agrees to pay either a fixed or floating rate denominated in a particular currency to the other counterparty. The fixed or floating rate is multiplied by a notional principal amount (say, $1 million) and an accrual factor given by the appropriate day count convention. When both legs are in the same currency, this notional amount is typically not exchanged between counterparties, but is used only for calculating the size of cashflows to be exchanged. When the legs are in different currencies, the respective notional amounts are typically exchanged at the start and the end of the swap, which is called cross currency interest rate swap.

    The most common interest rate swap involves counterparty A paying a fixed rate (the swap rate) to counterparty B while receiving a floating rate indexed to a reference rate like LIBOR, EURIBOR, or MIBOR. https://en.wikipedia.org/wiki/Interest_rate_swap So, this is a massive part of banking. Massive. And no one even takes it into account when figuring out why the Fed acts as it does.

  62. Gravatar of Gary Anderson Gary Anderson
    17. December 2015 at 17:43

    So, to continue, this massive demand for bonds as collateral for these swaps is causing demand for long bonds never seen before. In fact, the new clearing houses predict a shortage of long bonds. That can only drive yield DOWN.

  63. Gravatar of Ray Lopez Ray Lopez
    17. December 2015 at 20:21

    @Don Geddis – my comment about new money was directed to collateral being used to expand base money by 1/1-x, where x: 0 < x <1. You do know what I'm talking about, don't you? Don't you? LOL.

    "new money" is only interest rates paid on government securities in my book.

    The exception: the Fed gave US currency for junk commercial paper, from 0.7T to 4.5T in 2008 to present. You can argue this is also "new money" since traditionally the Fed does not accept so much commercial paper, instead they traditionally accept only government securities as collateral.

    Sorry if I'm talking over your head.

  64. Gravatar of What I’m Reading: Links for Dec. 17, 2015 | Personal Blog of William Freeland What I’m Reading: Links for Dec. 17, 2015 | Personal Blog of William Freeland
    17. December 2015 at 21:17

    […] https://www.themoneyillusion.com/?p=31368 […]

  65. Gravatar of TravisV TravisV
    17. December 2015 at 23:16

    Great stuff! “Remember When”


  66. Gravatar of James Alexander James Alexander
    18. December 2015 at 01:02

    And the follow up:
    But as one wag on Twitter put it: “will soon be a trillion”. Then what?

  67. Gravatar of Ray Lopez Ray Lopez
    18. December 2015 at 06:38

    @James Alexander- thanks for that link; nice graphic too to show that interbank lending has fallen 90% since 2008, which undercuts any monetarist argument that the Fed has any power. Interest rate manipulation in an attempt to influence the money supply is pushing on a string, even if you accept the monetarists’ assumption of money non-neutrality.

  68. Gravatar of Gary Anderson Gary Anderson
    18. December 2015 at 07:59

    The Fed has a different kind of power, Ray. You are correct, however I wrote this on page 2, about Sumner’s friend Grumpy (Prof Cochrane) and his friend:

    So, we need to look at the ways in which the Fed has set things up to predispose it to keep rates low.

    1. Grumpy’s friend says the Fed can’t afford to pay the treasury interest if rates are significantly raised. That is almost a hostage situation.

    2. The banks have bet on low rates, taking the floating low side of the swaps bet when they issue loans.

    3. The Fed pays interest on the excess reserves in order to restrain lending.

    4. Long bonds are in massive demand as collateral, the new gold, and there are shortages, even with BRICS nations selling into a deep market.

    So, rates are predisposed to stay low barring some unforeseen circumstance.


    The Fed has power, but it is a different kind of power. It is a power to keep long bond rates low (and lending slow), and thus protect the banks who bet on Libor floating rate. Libor may stay low forever if there is no need for interbank lending, by the way.

  69. Gravatar of derivs derivs
    18. December 2015 at 09:19

    Do you realize that saying fix for float, or float for fix, is just a really f’n annoying way of saying long or short. Both sides have a float piece. Either I am long fix-short float, or short fix -long float.

  70. Gravatar of o. nate o. nate
    18. December 2015 at 10:26

    Gary, in respect of your item #4, I’ve yet to see any convincing evidence that the need for bonds as derivatives collateral is having a significant effect on bond prices. When you look at the notional numbers for swaps, they look huge, but you need to keep in mind that only a very small fraction of that would need to be collateralized in most cases. There’s a BIS working paper that estimates that under medium volatility conditions, $500 billion of collateral should be enough to cover the needs of the interest rate swap market globally. When you compare that to the US treasury market at $12 trillion, it’s a relatively small piece of the market, and that’s not even counting Europe, Japan and other government issuers. For comparison, China alone has sold on net about $500 billion of Treasuries just since last year.

  71. Gravatar of James Alexander James Alexander
    18. December 2015 at 11:05

    You shot your bolt with me a long, long while ago. Talk. To. The. Hand.

  72. Gravatar of Gary Anderson Gary Anderson
    18. December 2015 at 11:09

    Yeah, so you are a company who has collateralized a bunch of treasury bonds. You have to protect yourself, O Nate, by buying a bunch more of them, in order to protect against raising interest rates and margin calls even though they seem unlikely. Nothing is foolproof, however. Look, it isn’t me who is worried about a shortage of treasury bonds, it is Larry Summers. And Jamie Dimon said the same thing. It isn’t just collateral, although I think that is understated, but it is the need for collateral in the next downturn. The demand for treasuries is immense. http://www.usatoday.com/story/money/2015/04/09/jamie-dimon-letter-treasuries-liquidity/25512091/ Taking away TBTF also has an impact on demand for treasuries.

  73. Gravatar of ssumner ssumner
    18. December 2015 at 12:18

    Negation, The basic ideas has pros and cons. I don’t know enough about that particular plan to comment—but the amounts seem far too large. It would be a massive subsidy to a family of 5 that simply chose not to work. At a minimum, the payments for children should be lower than for adults.

    James, I hope they start selling off those bonds.

  74. Gravatar of flow5 flow5
    19. December 2015 at 10:59

    The Fed targets ultra-short-term interest rates, or the FFR, the interest rate at which DFIs, depository financial institutions (CBs, S&Ls, MSBs, and CUs) lend reserve balances, their IBDDs held at District Reserve Banks, to other DFIs overnight, all on an uncollateralized basis, i.e., their Keynesian monetary transmission mechanism.

    The FRB-NY’s “trading desk” couldn’t move the FFR without a boost from the IOeR rate (there are just too many excess reserve balances, i.e., excess CB liquidity or clearing balances).

    It’s a monetary policy blunder (further reducing NIMs). The yield curve was brutally flattened (as opposed to steepened). It drove up short-term/money market (wholesale non-bank funding in the borrow-short to lend-long savings-investment paradigm), rates by 131 percent.


    While wages/salaries have now “bottomed” along with the “price-level” (which the FOMC considers the unemployment rate key), the FFR stair-step move will invert the policy yield curve, which initially will result in a stoppage in the flow of savings thru the non-banks (i.e., reducing money velocity).

    Increasing the IOeR rate will create ever higher levels of stagflation (business stagnation accompanied by inflation). In the long-run it will create higher real rates of interest rates, lower tax receipts, and higher federal deficits (which already need reduced). I.e., R-gDp will decelerate and inflation will accelerate – giving us an unwanted policy mix.

    The Fed’s 300 Ph.Ds. simply don’t know the differences between money and liquid assets. It is an incontrovertible fact: never are the CBs intermediaries in the savings-investment process. The utilization of bank credit to finance real-investment or gov’t deficits doesn’t constitute a utilization of savings since financing is always accomplished by the creation of new money (loans=deposits).

    So raising the FFR for the CBs has no impact on their lending capacity. The lending capacity of the CBs is not predicated on the level of interest rates (rather credit worthy borrowers). It is a psuedo-economic analysis to compare the CBs “cost of funds” (what they pay depositors), with their loans/investments. The CBs could continue to lend/invest even if the non-bank public ceased to save altogether.

    In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary in order to make the statement correct. This is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, the elimination of Reg Q ceilings, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Financial Services Regulatory Relief Act of 2006, the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.

    I.e., the CBs can force a contraction in the size of the non-banks/shadow banks, & create liquidity problems in the process, by outbidding the non-banks for the public’s savings.

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