Tuesday, April 28, 2009

Going Negative Can Be Good...

According to a staff report from the Federal Reserve. From the Financial Times we learn the following:
The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve's last policy meeting.

The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation.

A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent.

Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150bn (€885bn, £788bn) increase policymakers authorized at the last meeting, which included $300bn of Treasury purchases.

[...]

Still, many Fed officials expect they may well keep rates near zero for another 18 months to two years and some might see value in making this more explicit...

Wow--expanding its money creation beyond the additional $1.15 trillion and keeping interest rates at zero another 18 months. Now that is some real anti-deflationary firepower. It also makes it incredibly challenging for the Federal Reserve to reverse itself once the recovery takes holds, more so than I previously imagined. As The Economist noted in a recent article, a "messier, more political future awaits" the Federal Reserve once this crisis is over.

2 comments:

  1. David,
    Dont take this the wrong way... but are there any economists out there who think this plan is insane? What do we think is going to happen to the money supply if and when the banks lever back up? I understand the argument against deflation. But do we break the dam upstream of the house to put out the housefire?
    I readily admit I dont have a solution other than a very painful liquidation of debt, but how likely is it that our currency is completely wiped out? I really dont fancy adding an S.S. wing to the military to battle the likely civil unrest in that scenario....

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  2. As you might have noticed from this post and this earlier one, I too am becoming more concerned about reversing the Fed's monetary expansion. I have yet to throw my lot in with the "hyperinflation is on its way" camp, but between the demanding task the Fed has ahead of it and the looming problems in our effectively insolvent banking system there is plenty to worry about going forward. To answer your question, there are folks who think this approach is insane. See Henry Blodget for example.

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