The Federal Reserve will hold its short-term interest rate target at 0% to 0.25% until 2012, according to a new research paper by economist Glenn Rudebusch.
That’s a much longer delay than Wall Street now anticipates. Estimates there for when the Federal Reserve will start to raise rates range from late this year to the first half of 2011.
It’s worth taking this new report seriously. Rudebusch is associate director of research at the San Francisco Fed so his paper, while by no means an official statement of Fed policy, is an indication of what some inside the Fed are thinking about interest rates. And in this case “some” most likely includes Janet Yellen, president of the San Francisco Fed and President Barack Obama’s nominee for the No. 2 slot to Chairman Ben Bernanke at the Federal Reserve.
What does the paper argue?
That the factor with the closest statistical relationship to core consumer price inflation isn’t short-term interest rates but the natural rate of unemployment. The relationship between short-term interest rates and inflation or asset bubbles is, Rudebusch writes, “quite erratic and poorly understood.” Japan has had very low interest rates for 15 years without producing either inflation or a financial bubble.
If the Federal Reserve had used unemployment to guide policy, Rudebusch writes, the central bank would have lowered the federal funds rate in 2009 by another 5%. That, of course, was an impossibility with short-term rates already at 0%.
But that does mean that looking at the current and projected rate of unemployment the Federal Reserve should keep interest rates near 0% until late 2012. “In practice, this suggests little need to raise the funds rate target above its zero lower bound anytime soon.”
This report isn’t Federal Reserve policy and there’s certainly no guarantee that this view, even if it is shared by Yellen, will carry the day. But I think it does suggest that if you were considering a bet on whether the Fed will raise rates sooner than Wall Street now expects or later than the consensus projects, that the best bet would be later rather than sooner.
“If the American People ever allow the banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers occupied.” Thomas Jefferson — 1815
Time has proven Jefferson to be correct time after time. Is it not time now to END THE FED?
With interest rates at 1% and 0-.25% respectively, euro and US dollar will be carry trade currencies e.g. for Aussie dollar where interest rate is 4.75% and going up. Canadian dollar is also stronger. The strength of the Aussie dollar is also impacted by the Chinese growth outlook (because the Australian economy is dependent on raw material exports to China) and the global liquidity story.
Currently there is a tug-of-war between the euro and the US dollar. Assuming a stronger US dollar hurts the US economy by decreasing exports and a weaker euro helps the EU economies by increasing their exports, this should help improve the EU fiscal situation and help stabilize the euro.
The Fed has compounded the banking crisis with the 0% rate. Banks have become dependent on the cheap funds and they need several more years of the no-risk spread to make money and slowly get the bad loans off the books. Fed won’t raise rates until it knows the banks will be ok. Banks are lending like the 0 rate will be around forever. A rise in rates and their 3-5 year loans could be underwater, in which case they will start hemorrhaging again. Say goodbye to a strong dollar, on the bright side, everyone else is in the same shape.
Christopher:
Thanks for clarifying you meant Gueithner. I hope you heard of his sound bite recently saying “I never has a real job. After finishing graduate school (he went to Dartmouth for undergraduate, then John Hopkins), I went to work for World Bank, etc.” This is not anyone making up, but his own words which I heard playing on media. (I bet if you search YouTube, you may find it.) He worked in NY Fed, not Wall Street. BTW, this is by far the best in economic mind in this administration. At least he is not an idealog.
The rest are Larry “the professor who falls sleep many times during presidential meetings” Summer, Christina “the professor and cheer leader” Rumor, Ben “the professor whose own house went under water” Bernanke, Peter “the kid who’ll say anything his boss wants” Orszag. Let’s not even mention the labor secretary is a known business buster! (Her first words when she became the labor secretary was “businesses, these is a new sharif in town!”. You know how much she hates businesses.) This is the current economic team running this country’s economy right now! To be fair, Ben was a leftover from previous administration, but he was re-nominated by the current one. Yes, they did add Paul Vulgar, but only as an accessory! (This is well documented by financial media. They only reluctantly took some Vulgar rules, when the whole world was about to collapse! Even that, these is no guarantee Vulgar rules will survive.)
I’d trade ALL them with just ONE Jack Welch or even ONE Larry Kudlow. I guarantee the economy will turn around.
Ed
“I always find it interesting how two different economists can look at the same numbers and draw different conclusions.”
The confounding thing to me is that often both are right.
Actually, I find that happeneing here every day. ;-]
Cassandra,
Quite true. I always find it interesting how two different economists can look at the same numbers and draw different conclusions. Add a third economist and you can even get a third conclusion! 😉
Yet, the alleged science of economics supposes it can predict the overall outcomes of literally trillions of economic exchanges, when they can’t even agree on how to interpret the data amongst their own kind? Maybe Bernanke should go the Nancy Reagan route and hire a good astrologist…
xy,
I was thinking of Geithner and company, but I guess I’m off the mark there.
Bottom line is that I agree that I don’t trust any of them to know the right things to do.
Life as an economist would be much simpler if people were rational decision makers.
I’m surprised at the attitudes of some of the people here, who seem to be implying that there are some more competent economists somewhere who could solve the problem. I’ve never seen a reason to believe that there are such. In fact, some of the economists whose writings I like best seem to say that they don’t believe it either.Noone could get a job as a government economist today unless he was willing to play at being a ‘scientist’. (In a very distantly related field, I’ve even been accused of “physics envy” myself.) Yet look at the numbers for the accuracy of the scientific predictions of the ‘greatest’ modern economists. Try http://blog.broker-reviews.us/2005/10/when-exact-science-isnt.html , for example, or read the original article, if you can get it at a reasonable price.Mr. Jubak likes to quote a Nobel-Prize-winning economist – You see, I do have a sense of humor – who told him that one can’t do a scientific analysis of the stock market because data from a period long enough to filter out the noise just doesn’t exist. The same is true of economics in general. If you want to read the works of great economists, try Adam Smith. Or Veblen. Or Thomas Gresham. Or Jane Austen. Or Borges. But none of them could ever get a government job. Or be taken seriously on a Web board. And I doubt that any of them would be stupid enough to say that they could reliably predict prices for the next five years.Just my 2 cents. Corrected for inflation.
I think the inflationistas are finally figuring this out. Buying 10-yr above 4% wouldn’t be such a bad idea. It’s not much of a trade though, as 4 to 3 is only worth about 4.5% capital appreciation.
Good comment davcbr. I’ve mused about pulling a reverse FDR–going onto then immediately back off of a gold standard to devalue–or congress simply printing the necessary amount to cover their desired deficit level. Either would effectively be a partial default, a pre-organized bankruptcy of sorts, and both more effective than the current pushing on a string policy. After years of failing to see the inevitable and highly warned against housing bubble, it’s somewhat satisfying to see the Federal Reserve so powerless.
We’re so set on our current structure that neither of these seems logical, although fessing up to partial default (vs. pretending we don’t while inflating) is likely inevitable if inflation doesn’t kick in at a significant level. At this point I’d almost prefer the government print and spend instead of deficit finance. If only they could control themselves in the future.
yx & Christopher,
I believe we call those “experts” book smart” not real world experienced !
Christopher:
Who did you refer as from “private” sector? I hope you did not talk about Timmy (the tax guy) who recently said himself that he “never had a real job”. Or you were referring a professor or even a dean from a private university as “private” sector? I just try to make sure I did not miss anything.
Don’t get me wrong, Christopher. I really think an administration that is full of academics, public and community organizers are really “experts” in fixing this economy and creating jobs.
I’ve posted about this a couple of times now. There is an equation that is used by the Fed called the Taylor Rule which works employment into a target for the fed funds rate. Since the 80’s it has an almost perfect track record, and as Jim has said, it is now calling for a target of -5 to -6%. Can’t do negative, but they can print money. They will do this until the taget is above 0.
Then the trick is to suck out all the extra money without the house falling down.
yx,
Some of them come from the private sector. What they do is pick out the guys from the places that have made the biggest mistakes (Wall Street), and say we need them because they are “experts”. 🙁
I heard that the current administration is the most Ivy-League “stuffed” administration we ever had! But not even one had experience in private sector. Don’t hold you breath for jobs.
In country where the consumer is so much of the economic spending, it certainly makes more sense to me that high unemployment is much more likely to drive the inflation rate then the interest rate the government gets to control.
pk3hi,
It’s safe to say GDP could be flirting with reduction if they need to keep interest rates at or near 0% for 2 years.
Here’s the scarier part: Do they even have a clue as to what they will need to do with rates beyond 2 years? The answer is obvious: They don’t have a clue. It could get really ugly.
bobisgreen,
I could pull somebody off the street with more of a clue than anyone running the show now.
Ed,
Translation: The people running our monetary policy don’t know what they’re doing.
The scary thing: Of all the brightest and best this current administration can garner, they choose 2nd & 3rd best. Please tell me there are brighter, more creative and more experienced folks ladened with a huge dose of wisdom and common sense that could be pressed into service! I know, they don’t know what they’re doing. Too, it takes good character to admit to the first case and determination to do something about it…what ever “it” is.
Ed,
Let’s hope they stumble into the right moves managing interest rates.
How would this change US GDP projections and when?
>The relationship between short-term interest rates and inflation or asset bubbles is, Rudebusch writes, “quite erratic and poorly understood.”<
Translation: The people running our monetary policy don't know what they're doing.
Having said that, I agree with Rudebusch's conclusion.