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If It Ain’t Broke, Don’t Fix It? Federal Reserve Edition…

June 20th, 2013 · 5 Comments
Macroeconomics · Policy

This morning, in order to keep up my monetary policy knowledge, I decided to peruse the statement from the June meeting of the Federal Reserve Board of Governors- you know, the guys who get together and decide what monetary policy is going to look like for the next month or so. (This group has scheduled meetings 8 times a year, plus other meetings as necessary. Also, see here for a review of what the Federal Reserve is.) The document states that the Fed would continue asset purchases (read, increase the money supply via quantitative easing) by buying agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. (For those of you whose macro 101 is a bit rusty, the Fed increases the money supply mainly via open-market operations that involve buying stuff, since money goes from the Fed to the public when it buys stuff.), It also states a target federal finds rate (the rate at which banks borrow from each other in order to meet their reserve requirements and such) of between 0 and 0.25 percent. (Interest rates tend to move in tandem, so this is basically saying that the Fed is continuing expansionary monetary policy in order to keep interest rates low.)

After reading this, I realized that the information given in the statement wasn’t so helpful in isolation, since much of what I really wanted to know was how the Fed was changing its behavior from what it did the last time it met. Luckily, it’s pretty easy to pull up the statement from the April/May report. I started reading it and, after a few seconds, became paranoid that I had mistakenly clicked on the June statement again by mistake, so I decided to do a comparison, courtesy of Microsoft Word’s track changes feature:

Man, writing Fed press releases has got to be one of the easiest jobs ever. I am picturing the conversation roughly as follows:
Bernanke: “Soooooo, what do you want to do this time?”
Rosengren: “Eh, just do what we did last time, I have a hockey game to watch tonight.”
Bernanke: “But that looks like we didn’t even try- any suggestions for updates? Nothing substantial though.”
Random board member: “Well, we could acknowledge that the labor market has continued to improve in a number of places, does that count?”
Bernanke: “Sure, why not…so, who wants to be the dissenter this time? Bueller? Bullard?”
Bullard: “Fine.”
Bernanke: “The usual reason, or are you feeling frisky this month?”
Bullard: “Meh, whatever gets me out of here quicker.”
Bernanke: “Great, now let’s go have a drink. Am I the only one who’s jealous that the SF Fed has a liquor license?”
Random board member: “Nice…hey, Yellen, was that your doing?”
Yellen: *smiles coyly*

I kid, of course, but you have to admit that the similarity in the statements is pretty ridiculous. This feature also likely explains why so much of the commentary regarding the statement relates to what wasn’t said as opposed to what was said. Justin Wolfers’ take, for example:

The most striking thing from today’s Federal Reserve Open Market Committee decision is what wasn’t said: How will the Fed respond if inflation continues to undershoot its 2 percent target?

Just another reminder that, despite all of the inflation warnings on Fox News, the Fed can’t seem to create inflation even when it tries (and yes, inflation can be helpful in some circumstances)…unfortunately, being perceived as not trying very hard doesn’t help the matter.

Update: In case you are curious as to why the market reacted negatively to this seeming non-information, it’s worth noting that Bernanke reminded people in an associated press conference that the $85 billion per month in asset purchases would start winding down (people seem fond of using the word “taper” for this) once the economy is healthy again, which the Fed expects to be later this year. People are funny, since a. the reminder isn’t really new information, and b. the Fed is pretty bad at making predictions, so I’m not sure why the market reacts so much to them, especially considering that the Fed specifically says it will change course if its predictions turn out to be wrong.

Tags: Macroeconomics · Policy

5 responses so far ↓

  • 1 EconoNerd // Jun 20, 2013 at 5:57 pm

    I notice your link to the point about the Fed being bad at making predictions. The blog links through to an EPI piece essentially stating that the Fed and government are bad at making predictions…

    …Isn’t this a little unfair? If I linked to the Chicago Mercantile Exchange’s quote for a Corn contract for say December delivery, what is the chance that the quoted price RIGHT NOW will equal the actual spot price in December?

    As new events and disasters unfold in the world the futures price will change until expiry and convergence. Maybe it’s because futures contracts don’t outright call themselves “predictions?”

  • 2 Jake // Jun 21, 2013 at 2:53 pm

    Seems to me a lot of it has to do with speculation, i.e. guessing what everyone else will do as a result of the news. Considering Wall St.’s great hatred for the FR and fear of inflation, the markets assumed there would be a sell off as a result of the exit strategy being announced. Everyone was just racing to be first out of the gate.

    It will be interesting to see if the slide continues over the next few weeks or if the markets shrug it off.

  • 3 Philip Nolan // Jun 26, 2013 at 6:08 pm

    “the Fed increases the money supply mainly via open-market operations that involve buying stuff, since money goes from the Fed to the public when it buys stuff.”
    Someone correct me if I am wrong (it has happened – once) but I thought that the money supply increases when banks lend out money. M1 is coins and currency in the hands of the public plus checkable deposits. M2 is that plus some other stuff, all of which are still primarily deposits that bank “customers” can call on, sooner or later. The money supply does not include commercial banks’ reserves, does it????

    Open market operations do not increase the money supply/checkable deposits they merely increase the banks’ reserves; which, of course, CAN increase the money supply, but only if banks lend out some of those excess reserves. If the cash stays in the banks’ reserves no new money is created. In order to lend money banks need more than excess reserves, they need to want to lend and they need someone who wants to borrow.

    First, The banks are being told that the Fed wants a little inflation. So why would they be lending out money medium- to long-term, at very low interest rates, if they are told to expect inflation. Inflation will mean higher interest rates and if the banks are stuck with lots of low interest, long term loans their income statements are not going to look very pretty.

    Second, why would anyone want to borrow. The business outlook is still very bleak and the future is uncertain. The President has just said he is going to do everything in his power to raise energy costs, taxes have gone up across the board, Obama, states and localities want to raise the minium wage, costs of the “affordable health care” law (aka “Obamacare”) are increasing health insurance costs for all employers. Why would anyone want to borrow money to expand a business with all the uncertainties facing them? Borrowing $25,000 to buy a new car is fine, but it is not the same as a business borrowing $2,500,000 or $25,000,000.

    Bottomline is – this makes no sense to me.

  • 4 econgirl // Jun 26, 2013 at 8:47 pm

    You are correct in that the money supply does not include cash in bank vaults, so, technically, if a bank were to hoard all of the cash it got from the Fed in open-market operations, there would be no impact on the money supply. This is sort of what happened a few years ago when banks were hesitant to lend, and it dulls the effectiveness of monetary policy.

    The hope is that people and businesses will want to borrow because low interest rates make it less costly to do so- in other words, the low interest rates are an attempt to mitigate the other factors that you mention that make people and businesses not want to invest. As for lending, a positive nominal interest rate is more attractive than a zero interest rate, which is what banks are earning if they don’t lend, regardless of what inflation looks like. That said, this again gets at the problem that the Fed was having before, when it was hitting the zero lower bound for nominal interest rates and couldn’t get banks to hold/lend more cash. Your point about the long-term fixed rate loans, however, is a valid one- inflation expectations are generally built into the long-term interest rates, but there is always risk that the expectations turn out to be incorrect. It’s important to keep in mind that this interest-rate risk is always present, even in a good economy.

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