“In other words, a determined Fed will be believed by the markets. Lack of credibility is only a problem when institutions are not in fact reliable.”
We are suffering, as a civilisation, from falling institutional credibility from increasingly unreliable institutions. A mixture of spreading bureaucratic and university dysfunction due to various levels of inadequate feedback. The shift from when meritocratic bureaucracy delivers mostly fairly good government (early in a Chinese dynasty) to when bureaucratic pathologies become an increasing problem (late in a Chinese dynasty).
Antony de Jasay’s concern for negative institutional evolution is increasingly more on point than Hayekian evolutionary optimism. (Fortunately, I live in Australia, where such problems are much less acute.) If central banks are getting better, then their feedback mechanisms must be relatively good.
Atlanta's gDpnow's latest estimate: 3.0 percent -- September 17, 2024. You might think that the FED shouldn't cut their policy rates. However, it looks like N-gDp has fallen as an offset.
I first noticed your blog when Tyler Cowen linked to it on Feb 25, 2009, and it was a great joy and relief to finally find a source of information that takes AD and AS seriously.
P.S. I still disagree with the criticism of IOR, which I consider misfocused. The root cause was the mistaken target of the Fed funds rate, while switching to the floor system was just an implementation detail. For any given Fed funds rate target, the floor system is slightly more expansionary through the credit channel.
On the other hand, one could argue that, in addition to a federal funds rate that was too high, Bernanke also made a smaller mistake - he overestimated the magnitude of the stimulus provided by switching to the floor system.
Scott, I believe your comment understates the Fed's commitment to maintaining the federal funds rate target. A prolonged period where the fed funds rate was significantly below the target was never a realistic scenario. Without IOR, the Fed would have employed some other means of balance sheet expansion. Here is an excerpt from 2008 August meeting (Bill Dudley):
"Obviously, further expansion of our TAF or TSLF auctions or single-tranche repo operations would be at our discretion and, thus, does not pose a meaningful problem in terms of reserve management. We wouldn’t expand these programs if we didn’t have the ability to conduct offsetting reserve draining operations. However, what would we do if faced with a huge rise in PCF or PDCF borrowing? An inability to drain the reserves added by such lending would cause the federal funds rate to collapse below the target.
Fortunately, we have a number of alternatives that would enable us to offset very large demands for PCF or PDCF borrowing. First, we could sell our remaining unencumbered Treasury holdings or use them to engage in reverse repo operations with the primary dealer community. This could be augmented by the $35 billion of on-the-run Treasury securities currently set aside for securities lending. Together, these two sources could be used to drain more than $200 billion of reserves. Second, we have made arrangements with the Treasury so that, if the need arises, the Treasury would issue special Treasury bills into the market on our behalf and take the proceeds and deposit them at the Federal Reserve. Putting the proceeds of such T-bill sales on the Fed’s balance sheet would drain reserves from the banking system. The potential scope here is large. The housing legislation raised the debt limit substantially. There is now about $1.2 trillion of headroom under the debt limit compared with only about $400 billion previously. Third, we continue to press for legislation that would accelerate the timing of the Federal Reserve’s authority to pay interest on reserves. Being able to pay interest on reserves would put a floor under the federal funds rate. In this case, an inability to drain additional reserves from the banking system would not result in the federal funds rate collapsing toward zero. Finally, we continue to explore the legal and operational feasibility of expanding our balance sheet in other ways. For example, could we engage in reverse repurchase transactions using the collateral obtained from our single-tranche repo and from our TSLF operations?"
You seem to be assuming that the fed funds rate is a sufficient statistic for the stance of monetary policy. I don't agree. Two wildly different monetary policies can have the same nominal fed funds rate.
I'll do a post that addresses this issue in more detail.
To simplify, let's assume that for any given federal funds rate, there are only two possible equilibria: contractionary and expansionary. First, I don't see anything in the September 2008 FOMC statement that supports the expansionary equilibrium. Second, the existence of these two equilibria does not depend on the presence or absence of IOR. For example, a 1% IOR had opposite impacts in November 2008 and May 2022. Third, in practice, achieving the expansionary equilibrium at any given federal funds rate target is operationally easier with IOR.
Wow! From the beginning you were off on the useless quest for how to “characterize” Fed policy, when the question should be which policy instrument(s) should it move to achieve what target.
Premise 2 and 3 OTOH are spot on. TIPS was already signaling that the Fed should be trying to increase inflation. Reducing the EFFR to zero was the least it could have done.
Bernanke’s call for fiscal expansion was counterproductive in that it let the Fed off the hook for managing aggregate demand so as to achieve it’s inflation target.
I want to quickly comment after a quick reading of your informative and entertaining post that Cochrane is applying Lucas/Sargent arguments to the impact of debt on general price levels.
His investigations are compelling.
I also want to say that you are preserving the Monetarist tradition in your views.
I will will reread your post for further silly comments
If Cochrane thinks the debt level affects the price level except thought its possible but not necessary effect on Fed policy, he's barking up the wrong tree.
Now and increase in the deficit COULD have differential sectoral effects that require changes in relative prices to accommodate, changes that can only be achieved with a temporary increase in inflation above the target. Therefore in THAT sense fiscal policy could influence inflation.
“In other words, a determined Fed will be believed by the markets. Lack of credibility is only a problem when institutions are not in fact reliable.”
We are suffering, as a civilisation, from falling institutional credibility from increasingly unreliable institutions. A mixture of spreading bureaucratic and university dysfunction due to various levels of inadequate feedback. The shift from when meritocratic bureaucracy delivers mostly fairly good government (early in a Chinese dynasty) to when bureaucratic pathologies become an increasing problem (late in a Chinese dynasty).
Antony de Jasay’s concern for negative institutional evolution is increasingly more on point than Hayekian evolutionary optimism. (Fortunately, I live in Australia, where such problems are much less acute.) If central banks are getting better, then their feedback mechanisms must be relatively good.
Related thoughts: https://stephenkirchner.substack.com/p/a-short-history-of-the-second-monetarist
Thanks Stephen, that's very generous. It's the second recent time where you've done a post on a similar topic that I've liked more than my own post.
Atlanta's gDpnow's latest estimate: 3.0 percent -- September 17, 2024. You might think that the FED shouldn't cut their policy rates. However, it looks like N-gDp has fallen as an offset.
I first noticed your blog when Tyler Cowen linked to it on Feb 25, 2009, and it was a great joy and relief to finally find a source of information that takes AD and AS seriously.
P.S. I still disagree with the criticism of IOR, which I consider misfocused. The root cause was the mistaken target of the Fed funds rate, while switching to the floor system was just an implementation detail. For any given Fed funds rate target, the floor system is slightly more expansionary through the credit channel.
On the other hand, one could argue that, in addition to a federal funds rate that was too high, Bernanke also made a smaller mistake - he overestimated the magnitude of the stimulus provided by switching to the floor system.
"while switching to the floor system was just an implementation detail."
Without IOR the actual fed funds rate would have fallen far below the target.
Scott, I believe your comment understates the Fed's commitment to maintaining the federal funds rate target. A prolonged period where the fed funds rate was significantly below the target was never a realistic scenario. Without IOR, the Fed would have employed some other means of balance sheet expansion. Here is an excerpt from 2008 August meeting (Bill Dudley):
"Obviously, further expansion of our TAF or TSLF auctions or single-tranche repo operations would be at our discretion and, thus, does not pose a meaningful problem in terms of reserve management. We wouldn’t expand these programs if we didn’t have the ability to conduct offsetting reserve draining operations. However, what would we do if faced with a huge rise in PCF or PDCF borrowing? An inability to drain the reserves added by such lending would cause the federal funds rate to collapse below the target.
Fortunately, we have a number of alternatives that would enable us to offset very large demands for PCF or PDCF borrowing. First, we could sell our remaining unencumbered Treasury holdings or use them to engage in reverse repo operations with the primary dealer community. This could be augmented by the $35 billion of on-the-run Treasury securities currently set aside for securities lending. Together, these two sources could be used to drain more than $200 billion of reserves. Second, we have made arrangements with the Treasury so that, if the need arises, the Treasury would issue special Treasury bills into the market on our behalf and take the proceeds and deposit them at the Federal Reserve. Putting the proceeds of such T-bill sales on the Fed’s balance sheet would drain reserves from the banking system. The potential scope here is large. The housing legislation raised the debt limit substantially. There is now about $1.2 trillion of headroom under the debt limit compared with only about $400 billion previously. Third, we continue to press for legislation that would accelerate the timing of the Federal Reserve’s authority to pay interest on reserves. Being able to pay interest on reserves would put a floor under the federal funds rate. In this case, an inability to drain additional reserves from the banking system would not result in the federal funds rate collapsing toward zero. Finally, we continue to explore the legal and operational feasibility of expanding our balance sheet in other ways. For example, could we engage in reverse repurchase transactions using the collateral obtained from our single-tranche repo and from our TSLF operations?"
You seem to be assuming that the fed funds rate is a sufficient statistic for the stance of monetary policy. I don't agree. Two wildly different monetary policies can have the same nominal fed funds rate.
I'll do a post that addresses this issue in more detail.
To simplify, let's assume that for any given federal funds rate, there are only two possible equilibria: contractionary and expansionary. First, I don't see anything in the September 2008 FOMC statement that supports the expansionary equilibrium. Second, the existence of these two equilibria does not depend on the presence or absence of IOR. For example, a 1% IOR had opposite impacts in November 2008 and May 2022. Third, in practice, achieving the expansionary equilibrium at any given federal funds rate target is operationally easier with IOR.
Post 1
Wow! From the beginning you were off on the useless quest for how to “characterize” Fed policy, when the question should be which policy instrument(s) should it move to achieve what target.
Premise 2 and 3 OTOH are spot on. TIPS was already signaling that the Fed should be trying to increase inflation. Reducing the EFFR to zero was the least it could have done.
Bernanke’s call for fiscal expansion was counterproductive in that it let the Fed off the hook for managing aggregate demand so as to achieve it’s inflation target.
"Come on man, tell us the truth! We're all gonna die, aren't we?";)
That I will be compelled to make
I want to quickly comment after a quick reading of your informative and entertaining post that Cochrane is applying Lucas/Sargent arguments to the impact of debt on general price levels.
His investigations are compelling.
I also want to say that you are preserving the Monetarist tradition in your views.
I will will reread your post for further silly comments
If Cochrane thinks the debt level affects the price level except thought its possible but not necessary effect on Fed policy, he's barking up the wrong tree.
Now and increase in the deficit COULD have differential sectoral effects that require changes in relative prices to accommodate, changes that can only be achieved with a temporary increase in inflation above the target. Therefore in THAT sense fiscal policy could influence inflation.