Finance Basic To Advance Level Knowledge

As readers of this blog know, I have an interest in the Fed's operating system . This interest has culminated in a new paper  where I look at the consequences of the Fed moving from a corridor system to a floor system in 2008. In particular, the paper looks at what this change has meant for bank portfolios and, as a result, financial intermediation provided by banks. The paper concludes with some policy recommendations. I would also note that George Selgin has just released a new  book  on this topic. My hope is that these projects will help inform the conversation over what operating system the Fed wants as it continues to normalize monetary policy.  Paper Outline So what does my paper have to say? It starts by laying out the standard arguments for a floor system: The central idea behind this move was to remove the opportunity cost to banks of holding excess reserves by offering the banks a deposit rate at the Fed—the IOER rate—that was equal to or abo...

Andrew Metrick of Yale University interviewed former Fed Chair Janet Yellen today. It was an interesting discussion and one where they talked about, among other things, what changes the Fed could bring about in light of the recently announced strategies, tools, and communication review  to be held in 2019.  Janet Yellen said her idea for reform "has much in common with NGDP targeting". Her response can be seen in the video below: Glad to see her endorse a NGDPLT-like monetary regime. 

Tim Duy reports that r-star, which rose to prominence over the past few years, is experiencing a Caesar-like betrayal at the Fed: The Federal Reserve’s “r-star” has gone full supernova. New York Federal Reserve President John Williams, its key proponent, made clear in a speech late Friday that the neutral interest rate is no longer a guiding star for monetary policy. This means a federal funds rate in the range of what is considered neutral has no special significance as far as policy is concerned...  Williams’s attachment to r-star cannot be overstated. At a professional level, it has been a key element of his research agenda. As recently as May he said that for “the moment, r-star continues to shine brightly, guiding monetary policy, but hold steady, low on the horizon.” The moment quickly passed. Last week, he tossed aside the metric, saying that it has “gotten too much attention in commentary about Fed policy.” A remarkable shift after just two 25-basis-point rate i...

The quote in the title should be the motto for the 2018-2019 FOMC. For the FOMC is set to raise its interest rate target next week and expected to raise it several times more in 2019 despite a flattening treasury yield curve. As seen in the above chart, the outright inversion of the treasury yield typically leads to a recession.  Despite this robust pattern , a growing number of Fed officials have become emboldened in their dismissal of it "since this time is different."  As  Caroline Baum notes,  In April, John Williams acknowledged that an inverted yield curve is “ a powerful signal of recessions, ” based on a significant body of research , including that by staff economists at his former bank.  By September, Williams was already disavowing that signal . “I don’t see the flat yield curve or inverted yield curve as being the deciding factor in terms of where we should go with policy,” Williams said following a speech in Buffalo on Sept. 6.  ...

In an  earlier post and Bridge article , I discussed some ways to use nominal GDP (NGDP) as a cross-check on the FOMC "navigating  by stars" of r*, u*, and y*. The  motivation for these pieces was Fed Chair Jay Powell's concerns about the challenge of using these star variables when they seem increasingly in flux. Here, again, is a key excerpt from his talk : Navigating by the stars can sound straightforward. Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly… the FOMC has been navigating between the shoals of overheating and premature tightening with only a hazy view of what seem to be shifting navigational guides. The Fed chair is implicitly challenging us to find indicators that shed light on the stance of monetary policy without having to know r*, u*, and y*. The metric I suggested in the earlier pieces was the "sticky-forecast" ...

Are the days of the Fed's floor system numbered? Last month I claimed that they could be if President Trump's fiscal policy continues to spawn rapid increases in the issuance of treasury bills. His administration is relying heavily on treasury bills to finance its deficits as seen below: This increased issuance of treasury bills matters because it implies, all else equal, a rise in treasury bill yields. Below is a figure showing the  DTCC overnight treasury-repo rate  relative to the IOER rate. Lately, the treasury-repo rate has been bouncing  above the interest on excess reserves (IOER) rate. This development could be a big deal. If sustained, this rise of overnight interest rates above the IOER rate could spell the end of the Fed's floor system.  To see why, recall that the Fed moved to a floor operating system in late 2008 by paying interest on excess reserves (IOER) at a rate higher than comparable short-term market interest rates. T...

I have a new article over at The Bridge   where I piggyback off of Jay Powell's  recent speech about the challenges of the Fed 'navigating' by the stars of  r*, u*, and y*. His concern is how to use them when they seem to be moving a lot: Navigating by the stars can sound straightforward. Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly… the FOMC has been navigating between the shoals of overheating and premature tightening with only a hazy view of what seem to be shifting navigational guides. Here is a chart I made for the piece that did not make the final cut. It shows the changing range of FOMC estimates for u* and the actual unemployment rate (u). I also added some red-lettered commentary on the chart to highlight the varying levels of FOMC concern about the gap between u and u*: Okay, so what is the FOMC to do with all the...