Tuesday , March 26 2019
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A very subtle distinction

Summary:
It will be easier to understand this post if you first read the previous post.  The Fed delivered two monetary shocks today.  The first occurred at 2:15pm, and caused yields on 2 and 5 -year bonds to increase.  The second occurred about 30 minutes later, and caused yields on 2 and 5-year bonds to fall back, and end the day slightly lower.  And yet both shocks seemed “contractionary” in some sense.  Obviously there are some very subtle distinctions here, which require an understanding of Keynesian and Fisherian monetary shocks. More specifically, the first shock was Keynesian contractionary and the second was Fisherian contractionary At 2:15 the Fed raised its target rate as expected, and also indicated that another two rate increases are likely next year.  This announcement

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It will be easier to understand this post if you first read the previous post.  The Fed delivered two monetary shocks today.  The first occurred at 2:15pm, and caused yields on 2 and 5 -year bonds to increase.  The second occurred about 30 minutes later, and caused yields on 2 and 5-year bonds to fall back, and end the day slightly lower.  And yet both shocks seemed “contractionary” in some sense.  Obviously there are some very subtle distinctions here, which require an understanding of Keynesian and Fisherian monetary shocks. More specifically, the first shock was Keynesian contractionary and the second was Fisherian contractionary

At 2:15 the Fed raised its target rate as expected, and also indicated that another two rate increases are likely next year.  This announcement was a bit more contractionary than expected, especially the path of rates going forward.  As a result, 2 and 5-year yields rose, while 10-year yields fell on worries that the action would slow the economy, eventually leading to lower rates.

Later, the markets became increasingly worried that the Fed was not sufficiently “data dependent”, that it would plunge ahead with “quantitative tightening” and that the Fed stance on rates (IOR) would be too contractionary.  Watching the press conference, I had the feeling that Powell might have wanted to be a bit stronger in emphasizing that no more rate increases are a clear possibility, but felt hemmed in by his colleagues at the Fed.  But perhaps I was reading into it more than was there.  In any case, Powell said “data dependent”, but didn’t really sell the markets that he was sincere, or as sincere as the market would wish.  This monetary shock probably reduced NGDP growth expectations, and drove 2 and 5 year yields lower.

Do you see how utterly inadequate it is to talk about monetary policy in terms of interest rates?  Even the “sophisticated’ new Keynesian view that it’s the future path of rates that matters is nowhere near adequate.  The 2 and 5-year yields can go up with tightening, or they can go down with tightening.  Today they did a bit of both, within one hour.

If you insist on using Keynesian language, you might say the 2:15 action tightened primarily by raising expected future rates relative to the natural rate, by raising the expected path of the policy rate.  In contrast, the press conference impacted the gap by depressing the natural interest rate by depressing NGDP growth expectations.

PS.  The discussion on CNBC involved lots of people dancing around the “circularity problem”, i.e. the Fed looking at markets while the markets look at the Fed.

PPS. I laughed when a CNBC person suggested Trump might use the Fed as a “scapegoat”.  Hello, who appointed all the top Fed officials?  Has scapegoating the Fed ever worked for any President, even when they weren’t his appointees?

Update:  I forgot to mention Powell’s most interesting comment.  He says the Fed reappraisal of policy techniques planned for this summer in Chicago will look at the zero bound problem in monetary policy.  I view that as really good news.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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