Good job, people. Just to recap what has been my perspective, here is from my September post, The Paradox of No Market Response:
…the good news scenario is if the Fed’s decision doesn’t matter much for the markets. Woe unto you if your economy is so fragile that a quarter point or so in the short rate, mixed in with some cheap talk, were to matter so much.
So if at first prices were to stay steady, following any Fed decision, then equities should jump in price. That is the “no news is good news” theory, so to speak. It’s a better state of the world if it is common knowledge that the Fed’s actions don’t matter so much in a particular setting.
Equity markets did in fact rise across most of the world, after a slight period of no reaction. And I wrote:
If I were at the Fed, I would consider a “dare” quarter point increase just to show the world that zero short rates are not considered necessary for prosperity and stability. Arguably that could lower the risk premium and boost confidence by signaling some private information from the Fed.
Someone at Bloomberg — I can no longer remember who — wrote at the time that this was the worst possible argument they ever had heard in favor of what the Fed was thinking of doing and subsequently did. Was it? Other commentators today have called this a “risk rally,” namely that fear of a prior risk seems to have diminished.
And to recap some broader points:
1. In most periods of crisis, central bankers are too reluctant to use expansionary monetary policy soon enough or strong enough.
2. However true that may be, it doesn’t describe our current situation.
3. Beware of models which rely too heavily on the Phillips curve, and two-factor “inflation rate vs. unemployment” considerations, especially in “long run” situations. I don’t see that any of the commentators working in this tradition had good predictions this time around.
4. The successful “lift off” still probably won’t matter very much, but better a success than not. Don’t think that America’s major economic problems somehow have gone away.
The Fed felt that they simply had to do something or they would risk becoming irrelevant, even if that something was meaningless except as a signal that they were monitoring the situation and knew what was going on. One quarter of one percent? And they still can’t predict the outcome of this dramatic move.
> And they still can’t predict the outcome of this dramatic move.
As you note, it isn’t that dramatic. And it is hardly the Fed’s fault that humanity hasn’t derived robust macroeconomic models that hold under a variety of real world constraints.
+1.
Maybe I’m miunderstanding you second statement. Are you saying the Fed do not have some obligatoin to have viable macro models that give some relevant insight to the impact of their policy decisions on real economic conditions? Or are you saying it’s not the Feds fault people don’t want to behave according the the assumption of the underlying macro models uses by the Fed?
The Fed has certainly written a lot to storify the power of the Fed. As I’ve said, I think this is good in the sense that it instills confidence, but it might be bad too, if it has given the impression of robust macroeconomic models that hold under a variety of real world constraints.
My “model” is this:
– any nation with a currency must manage that currency, the money supply, the interest rate
– a good currency is necessary but not sufficient for a good economy
– a good currency will not change global economic conditions
– in extreme conditions, extreme actions with a national currency may be required, even if they risk imbalances
These add up to power when you really need it, but not so much day to day power, when you can’t take unnecessary risk.
So, false confidence is better than a lack of confidence?
You may have a bright future in economics.
“And it is hardly the Fed’s fault that humanity hasn’t derived robust macroeconomic models that hold under a variety of real world constraints.”
If not them, who? They’ve the resources. The challenge is formulating a workable model of an unpredictable future, which is impossible. Yet they’re still allowed to tinker with the lives of millions of innocents.
Money quote: “Don’t think that America’s major economic problems somehow have gone away.”
What inflation? Housing prices in my market approaching 2006 levels. OTOH, oil and commodity prices crashed. Is the end in sight? Maybe food prices (lower transport costs) will drop, too.
Economists are people who do not understand markets.
I’m not really seeing “America’s major economic problems”, sure there is excess regulation, more distortionary taxation than before, but overall it is still one of the greatest places to do business on earth.
Nope. It’s over. The planet is burning, the country is bankrupt, and there are no jobs anyway.
Plus terrorists are going to kill us all, immigrants are ruining the nation, and we’ve just had 7 years with one more to come of the worst president in history, the US is toast. So many better places to live.
Since I declared myself an optimist I have to think differently about things like “4 .. America’s major economic problems.”
I see trends moving in the right direction, but still in the #2MA sense I see room for improvement. The kids are alright, but we should recommend better paths than low return higher education and a job in a shop.
I think your so-called “worst possible argument” is pretty good, and it explains some of the schizophrenia around the Fed and the two-way feedback system the Fed enjoys with the markets.
So, on one hand, people are worried that the Fed isn’t listening to the markets, but on the other hand, when the Fed acts, markets reason that it’s always possible they’re looking at some inside dope on the economy that hasn’t hit the street yet.
Also, Yellen gets credit for emphasizing that future increases, if any, will be 100% driven by future events.
Also, the markets probably like the Keynesian budget deal; short-term, anyway.
Most of the buzz about the Fed comes from people who are paid to talk, and have to fill CNBC minutes or WSJ column inches with something. If they can sell bonds both ways on the story arc they are good.
None of the buzz is on the interesting question .. what rate the global economy will support 5 or 10 years hence. Even worse they leave an implication that “lift off” implies “normal rates” in the near future.
My guess is that “normal” is pretty low for a decade or so.
If you’re talking about daily investing chatter, yeah, of course, there’s a billion zany theories out there. Always have been.
But I think the business press is getting better at understanding how central banks influence the economy. From what I’ve seen, the quality of serious discussion in places like Barron’s has improved quite a lot over the past several years.
And it’s hard to be too tough on the business press considering that 90%+ of economists are themselves utterly at sea when it comes to monetary policy.
Them, but not just them. The just-so story of the Fed managing the economy has great power. Articles like the recent WSJ piece on “missing inflation” are rare.
But I think that article, and the historic global fall in inflation, is much more the real story than a 0.25% “lift off.”
1) The S&P ETF has now given up post Fed announcement gains (so far) as have major bank (GS, JPM, MS, etc.).
2) It would be instructive if you could comment on the Fed’s greater intervention into the repo program and the scope of it not gaining any traction i.e. the lower bound of the Fed’s target potentially collapsing back to zero anyway.
In the old days banks had little incentive to hold excess reserves. So the funds market was a very thin market and it was easy for the Fed to manipulate the market.
Now, banks have massive reserves that the Fed pays interest on. Consequently it is now harder for the Fed to control fed funds and
requires a more complex set of actions, including those in the repo market.
We are seeing an economic experiment play out in real time.
I think the Fed is going to raise interest rates the way a kangaroo can fly.
All over the world the problem is a lack of demand, not inflation.
The world’s central banks have got to start thinking growth. The Fed should print money until we see Full Tilt Boogie Boom Times In Fat City, then print a lot more and then think about what to do next.
Please, no more sermonettes from little boys in short pants.
“The world’s central banks have got to start thinking growth.”
Why? The constant harping on “growth”, without explaining its necessity, is bizarre, especially when it’s connected to central bank/government policy. A sane person would think that a free market system would grow of its own accord in meeting the demands of consumers by allowing the activities of entrepreneurs. The free market is a normal activity that can only be hampered by interference and central planning. The establishment of fiat interest rates can’t be beneficial to the entire marketplace.
We need an anti-chuck to describe the vase, now that we’ve seen the profile.
Oh, and “fiat interest rates” is looney tunes in a global economy with currency exchange.
If controls on interest rates make sense, why aren’t controls put on the price of eggs, golf greens fees, tickets to rock concerts and condoms?
Tyler wants me to cut down, and I will, but what I’m saying is that interest rates aren’t controlled in that sense. The Fed Funds Rate works in a system of supply and demand for loans in US currency, and in exchange to or from other currencies. I think what’s important is that the global rates shape the exchanges and in turn shape the limited ranges of rates available to the Fed.
I say this because I’m inviting correction, if I’ve got it totally wrong.
Ben, Agreed. Look at TIPS over the last month as an indicator of future inflation. With the EU and China devaluing to increase exports, and Japan as well, I dont know how a commitment to raise rates helps, rather than simply saying: we will watch the labor market and the inflation rate. Perhaps we are trying to assist the EU and Japan, so that if they improve, they will buy our goods. Dunno. Competitive devaluations and a strong dollar with weak overall world demand makes one more, rather than less, vulnerable.
Some used to call it “pushing on a string”, something few say these days, whichever side of the political divide they may occupy. Sorry, pushing on a string won’t solve America’s economic problems. And neither will ideas such as deferring to other countries (France!) to determine which drugs can be sold to Americans, the likely result being the shift of operations by pharmaceutical companies to the country with the least amount of regulation, taking good jobs with them. Government (federal, state, and local) investment in infrastructure is at an historic low, as is investment by firms in productive capital. The former is the result of Republican control of the purse strings of government, while the latter is the result of Republican control of the purse strings of business. Is it any wonder that the Republican presidential debates are a competition among the candidates in presenting the most negative view of America, the most negative view of the world. Is it any wonder that the most negative regions of the country have the most apocalyptic view of the world. Is it any wonder that the most economically prosperous regions of the country are the most liberal regions of the country.
Thanks for that brain-dead just so story. So insightful and full of data.
The party out of power always paints a negative picture.
XL pipeline is blocked by Blue staters.
So yeah, its easy to block infrastructure in the name of Green thinking.
Same with California: Democrats and enviros wouldn’t build any new reservoirs for decades. then we have a drought, we get funding, and they still won’t fast track. the greens then can slow or stall all infrastructure.
Oh come on that was fun. The Republicans control the corporations for a change, not vice versa! And they don’t clap for tinkerbell, either.
Serious question, why are they still paying interest on reserves?
That’s part of how they are controlling rates these days. It sets an effective floor under the rate that banks will lend out excess reserves in the Fed Funds market.
“Arguably that could lower the risk premium”
What risk premium? The P/E on the S&P 500 is at historic low levels.
If the expected return on risky assets is “risk free rate” plus “risk premium” what good does it do to shrink the premium if the risk free rate rises by more than the narrowing of the premium.
Sell on rumor, buy on news.
FWIW, I think the Fed’s actions were perfectly wrong-headed, though in this regard they at least have the virtue of being consistent with its other wrong-headed decisions since the beginning of the crisis.
Were the Fed serious about “normalization” it would (1) admit that its policy rate has been meaningless since 2008, since the natural ffr is well below it (making a hike in the policy target quite superfluous); (2) abolish rather than raise the rate of IOER, so as to also make it come closer to conforming to underlying market rates; and (3) quit treating expected increases in “headline” inflation, and oil-price based expected increases especially, as ground for monetary tightening; and (4) take necessary steps so that, when such tightening is really necessary, it can be accomplished by reducing the fed’s balance sheet.
I discuss in some detail the wrongheadedness of the Fed’s recent moves, and how it got into its present jam to begin with, on today’s Cato Daily Podcast
Given the nearly dead nature of the Federal Funds Market, is there any reason at all to raise the rate other than to try to convince people that faster growth is just around the corner? In other words, isn’t Yellen only trying to project confidence, and nothing more?
I guess I’m different. I look at corporate bonds first as I focus on investment. I don’t like what I see. This is political economy for me, and not investment talk.
Now that all asset markets around the world have given up all their post fed gains and more, will you revise your opinion?
The Fed tightened monetary policy and will regret it. Markets have responded in kind. Gold down, oil down, $USD up, stock markets down, interest rates down. This is what happens when the central bank raises real rates in a globally deflationary environment.
The Fed has made an unforced error here and will regret the decision.
Your argument was definitely not the worst I’ve heard for the Fed raising rates. I think that honor goes to the amazing “The Fed should raise rates now so it will be able to cut them later if it needs to”.