Opinion

Felix Salmon

Fed funds datapoint of the day

By Felix Salmon
May 27, 2009

The Taylor Rule ran smack into the zero bound back in October — and kept on falling. Now, according to the Fed’s Glenn Rudebusch, “in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year”:

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Rudebusch says that when a central bank can’t loosen monetary policy by implementing negative nominal interest rates, then that only serves to lengthen the amount of time that it is forced to keep interest rates at zero:

According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive.

But what about all that quantitative easing? Doesn’t that have the same effect as lower nominal interest rates? Not really: it “has likely only partially offset the funds rate shortfall”, says Rudebusch, and in any case the Fed’s balance sheet is going to have to shrink as the crisis abates — which will serve to act as an effective rise in interest rates. And which will only force the Fed funds rate to stay at zero for that much longer. Maybe it’s time for Bernanke to just set rates at zero and head to the beach for the summer — monetary policy seems to be pretty clear for the foreseeable future.

Comments
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If Simon Johnson ever needed any more proof of his idea of the “intellectual capture” of government and the FED by Wall Street , this is it.

Estimating a model on data from any period before 2007 is simply wrong. It is a sign of total intellectual bankruptcy that the FED can produce such and argument that blatantly ignores the fact that we are in a different world.

Even more sinister: This amazingly flawed analysis was first presented by Goldman Sachs ( surprisingly endorsed by Krugman on his blog ) and now presented by the FED.

Its “findings” can be used to justify anything Wall Street wants: QE, long periods of zero rates , anything that perpetuates the mis-allocation of capital that the original sin of the Greenspan Put institutionalised.

Posted by Fred Engels | Report as abusive
 

Let me recommend the following:

“It’s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. The main difficulty—both technological and political—lies in imposing such a tax on currency. In the 1930s, Yale economist Irving Fisher proposed such a system, in which currency had to be periodically “stamped,” for a fee, to retain its status as legal tender.[1] The stamp fee could be calibrated to generate any negative nominal interest rate the central bank desired.

While the technology available for implementing such a system is more sophisticated today than in Fisher’s time, enforcement still seems a mammoth problem. It would require physical modifications to currency and some means of tracking the length of time each piece spends in circulation.”

See the following:

Irving Fisher (1933), Stamp Scrip (New York: Adelphi). Fisher credits the stamp money idea to the German–Argentine economist and businessman Silvio Gesell.

Here’s what Buiter says:

“2) Tax currency and ‘stamp’ it to show it is ‘current on interest due’. This is Silvio Gesell’s proposal, supported by Irving Fisher and re-introduced into the policy debate by Marvin Goodfriend and by myself and Nikolaos Panigirtzoglou.[2] When the interest rate on currency is positive, the currency must be marked (by stamping or clipping coupons) to make sure the (anonymous) bearer does not present it repeatedly for the payment of interest. When the interest rate is negative, the (anonymous) bearer must (a) be induced to come forward to receive his negative interest (i.e. pay interest to the central bank) and (b) must be able to demonstrate that the negative interest has been received. To ensure (b), the currency must again be stamped or marked (electronically tagged). To get the bearer to come forward to pay the negative interest we can either rely on honesty and a sense of patriotic duty, or we can impose sanctions for non-compliance. I am afraid penalties for non-compliance (fines, a day in the stocks) would be required to make negative interest on currency work. This would require random checks etc. It would be administratively costly and unpleasantly intrusive. This may well endear the notion to our governments. ”

I like it. And from Brendan Brown on the economistsforum on FT:

“The relevant government would announce that existing banknotes were to be converted into new notes at a fixed date, say three years from now, at a discount (for example 100 old dollar banknotes would be converted into 90 new).

In the interim, 1:1 conversion of banknotes into deposits would be suspended. Instead, a crawling peg would be established. At the start, the exchange rate between deposits and banknotes would be virtually 1:1. At the end it would be 0.9 banknotes/deposit.

As the discount grew, retailers would quote different prices for cash or cheque/card settlement. And as to the note switch-over costs, the “experiment” of Europe’s economic and monetary union demonstrates the feasibility.

The looming conversion would provide an essential degree of freedom for monetary policy. In terms of our illustrative arithmetic, the risk-free interest rate could fall to a negative 3.33 per cent a year without triggering cash withdrawals from the banking system.

Is the exercise worth it?”

I say, emphatically, yes. Let’s give this idea a try.

 

“[H]as likely only partially offset the funds rate shortfall” makes it sound like the problem with quantitative easing is that there just hasn’t been enough of it.

Posted by Alexis Nicasio | Report as abusive
 

It will be an interesting summer, housing is showing signs of recovery, but labor is deep in the red. Bernanke should really just leave rates at zero and head to the beach.

- L. Berstein
ludwigreport.com

 

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