US Interest Rates
Just more than three years ago, Janet Yellen gave the Michel Camdessus lecture at the IMF, titled Monetary Policy and Financial Stability. The thrust of the speech was that “monetary policy faces significant limitations as a tool to promote financial stability”. As Yellen summarised the point then:
So what he’s saying is, the Fed will raise rates at some point and it won’t be a very long time from now. But he’s not saying it’s going to be in a week or a month or a couple of months. Right. OK.
In the absence of concrete policy plans from the incoming Republican administration, and a sense of how those might play with the respective caucuses (caucusi?) in the House and Senate, the easy assumption is the Federal government will spend more on bridges and roads and/or cut taxes. But history suggests Trump can act in unpredictable ways.
We don’t really understand how changes in the level of short-term interest rates affect things we actually care about, such as growth and employment. There are too many moving parts and leaps of logic required, many of which are based on bogus assumptions about how the world works. So it’s always nice to find new research into a small piece of the monetary transmission mechanism that’s grounded in facts. Researchers at TransUnion, the credit reporting company, looked at which American consumers would be exposed to an increase in the Federal Reserve’s policy rate corridor and the dollar magnitude of the impact of different tightening paths. We recently had a chance to discuss their findings with Nidhi Verma, who led the project.
The Fed sure seems to be getting comfortable with the idea of acting as a centralised counterparty for collateral transactions. It’s unclear whether the market’s quite as enamored with the idea. This year’s Jackson Hole conference was on monetary policy implementation, which often serves as a shorthand for the following questions: how should the Fed control interest rates, and how big of a role should it play in financial markets? While the topic seems arcane, it’s important to understand how thoroughly the Fed has changed its approach to controlling interest rates (and through that, its relationship with markets). The topic isn’t just for technocrats — the debate now is over whether that change should be a permanent one.
Janet Yellen opened the festivities at this year’s Jackson Hole economic symposium by musing on what central bankers had learned since the crisis and how they can deal with future recessions in a world where interest rates are far lower than in the past. Unsurprisingly, bond-buying and “forward guidance” featured prominently in Yellen’s narrative of successful new tools. (On the other hand, scholars have estimated the combined impact of these measures was an unemployment rate a mere 0.13 percentage points below where it would have been using purely conventional instruments.)
Central bankers in Europe have been thinking a lot about The Death of Banks lately. Not so much in the US. There’s good reason for that, of course. Europe has been bleeding out banks with negative rates, so policy makers there have become painfully aware of the banks’ role implementing monetary policy. The US Federal Reserve, on the other hand, has been keeping banks alive with a steady drip of interest on excess reserves, or IOER, to control rates in a financial system awash with liquidity. The Fed’s releasing a policy statement today (we understand if you forgot about that in the heli-frenzy before the BoJ on Friday). Of course, keeping banks on life support with IOER doesn’t help net interest margins. NIM is a key measure of bank profitability. It’s also closely tied to the US yield curve — which is unfortunate for banks, because that sucker has been positively steamrolled lately by the combination of low yields abroad, low inflation expectations and rising US policy rates.
This is a guest post from Richard Koo, chief economist of the Nomura Research Institute and, amongst many other things, author of “The Holy Grail of Macroeconomics, Lessons from Japan’s Great Recession”, which lays out his balance sheet recession thesis in detail. The post is an updated extract from his most recent note for Nomura and reproduced here, with his permission, for your arguing pleasure… The US, the UK, Japan, and Europe all implemented quantitative easing (QE) policies, but the understanding of how those policies work apparently differs greatly from country to country, leading to very different outcomes. With the US economy doing better than the rest, there has been some debate in Europe as to why that is the case.
Even people who don’t normally find money markets interesting (we’ve heard such baffling types exist) might pause to consider a number like this: $160 trillion. That’s the notional outstanding value of US dollar financial products currently indexed to the London Interbank Offering Rate, or Libor — you remember, that rate survey that was awkwardly riggable.
Raghuram Rajan, the luddite at the RBI (for now at least) has been banging on a particular drum for a while. He told the world — at an IMF conference in Delhi earlier this year — that a system of rules governing the effects of monetary policy (or behaviour, if you will) would be nice. It would be based primarily on spillovers and ranked according to a Green, Orange, Red system familiar to anyone who has ever had a work-review of anything, ever. Green equals good, for those who have understandably repressed previous encounters with this type of system. In a subsequent paper Rajan put more meat on the bones of his idea and now here it is in handy table form laying out those suggested rules for the monetary game, courtesy of Prachi Mishra, also of the RBI and Rajan’s occasional co-author:
A quick reminder that we’ll be hosting a special edition of Macro Live today at 1:50pm to cover the release of the FOMC statement and subsequent presser. Back in December 2015, Federal Reserve policymakers expected they would raise the policy interest rate band to 1.25-1.5 per cent by the end of 2016, implying a cumulative increase in short-term rates of 1 percentage point, or four separate decisions to raise rates by 25 basis points. At the time, the prices of overnight index swaps implied an 11 per cent chance this would happen, according to Bloomberg’s WIRP function.
The newly expanded crew of FT Alphaville’s team in New York will be hosting a special edition of Macro Live this afternoon starting at 1:50pm EST (6:50pm London time). You’ll find us at the usual place. Matt Klein and I will be joined by Alex Scaggs, a recent addition to the Alphaville team, to cover the release of the FOMC statement and the Summary of Economic Projections, after which we’ll follow the presser at 2:30pm.
From the New York Times, November 13, 1979 (please note emphasised text): PARIS – Central banks of the major Western industrial powers have privately agreed on a two-stage plan for controlling the explosive growth of the so-called Eurocurrency markets that they now believe is fuelling world inflation, according to a senior central bank governor closely involved in the discussions. The governors of the central banks are reviewing the new Eurocurrency control scheme at their regular secret monthly meeting at the Bank for International Settlements in Basel. However, they are unlikely to unveil it formally before the end of the year, according to the source.
The first question is whether there was a lovely new, but secret, currency accord agreed at the G20 in Shanghai in February. The answer is: Probably not.