Like Bernanke, I don’t believe that the flow of Fed purchases has been an important factor holding bond rates down, and hence don’t believe that they will jump when the purchases end.
I don’t think I ever wrote this view up, but I was of the same opinion nonetheless. It no longer seems this is true. We’ve had a significant run-up in rates from mere talk about slowing down Fed purchases.
So which other views about the current macroeconomy will we need to revise? That’s what I’ve been thinking about for most of today. The major possibilities are not comforting. I can’t be talked into them by a day or two of market data, but we do need to look more seriously at:
1. The low rates really have been an artifact of Fed policy, at least to a much higher degree than many of us had thought.
2. Emerging markets tanked on the Fed communication, and so we have indeed been exporting bubbles through a “reach for yield” mechanism.
Yikes, and those are not mutually exclusive. I still don’t see either of these as theoretically strong, for reasons outlined by Krugman and for further reasons outlined by me here, but of course theory has its limits. In my post from two weeks ago I will raise my p = 0.05 to p = 0.15, at least.
One also might try to argue #3, namely:
3. Interest rates still haven’t moved “a lot.” Obviously there is no fact of the matter as to what is “a lot,” but I admit to being surprised and Krugman also now seems to have different views, so I don’t think we can throw out the new data as irrelevant.
All of this remains in great flux.