Wednesday, July 31, 2019

How do I know the natural rate is falling?

My previous two posts claimed that the Fed would be right to cut rates, because the natural rate is falling rapidly. Keeping rates steady would eventually cause the nominal rate to be too far above the natural rate, making monetary policy too tight. However, the natural rate isn't observable; so how can we infer what stance the Federal Reserve should take. Well, just as we learned in 08, we can look at market forecasts as a way to determine tightness. 

The TIPS spreads show weak inflation going forward, despite rapidly falling interest rates in the fed funds futures markets. This indicated that monetary policy was too tight.

Short term interest rates are too high. 10 year Treasury bonds were priced a by the market at 2%. A T-Bond shouldn't be 2.4%. The yield curve told us monetary policy was too tight.

https://www.newyorkfed.org/research/policy/rstar

The Fed has ways of estimated r-star when comparing it to market rates at growth, these tools told us that policy was too tight.

Low Productivity, Sluggish Immigration Policy and Trade Wars slows down global growth which puts downward pressure on the natural rate. This told us that monetary policy was too tight.

I almost ordered 10 dollar a slice Pizza while vising Universal in Florida and didn't because I'm not stupid and I didn't have the disposable cash. Money is too tight.

F.Y.I. The Fed should have slashed rates more than a quarter, but I expected a quarter and I expect one more slash. That's my prediction.

Modifying My Last Post on the Rate Cut

Slight Repost

The nominal rate is the rate set by the Fed and is used to influence economic outcomes. The natural rate is set by classic supply and demand forces in the market. Currently, the natural rate is falling rapidly; this means that if the Fed were to keep rate steady, or worse, raise rates, then monetary policy would be highly contractionary, it would be too tight. You cut rates, not to expand, but to avoid tightening. Think of it as the Fed really just keeping their rate the same. If you're thinking that interest rates are indicative of the stance of monetary policy this makes sense, but they're not. The cut is not expansionary, but to keep monetary policy steady. This is a great policy change from the fed and shows they're looking at market forecasts which could have made the recession less bad.

Short Version: Monetary policy would be too tight since the nominal rate, the rate set by the fed, would be way higher than the real rate, the one set by supply and demand forces in the market. This indicates super tight money, which we don't want. The nominal rate is set to influence the real rate to produce desirable outcomes.
We also know that low productivity, lower immigration and a trade war puts downward pressure on rates

Markets Expect and Want a Rate Cut


Cutting rates keeps monetary policy STEADY it's neither contractionary or expansionary right now. Interest rates are not a good indicator of the stance of monetary policy. A rate cut doesn't always need to happen in a recession and a hike doesn't always need to happen in an expansion

Sunday, July 28, 2019

Explaining The Possible Rate Cut

Powell is shaping up to be one of my favourite Fed Chairmen and if he continues to use market forecasts as a way to determine a stance on monetary policy he will certainly become my favourite one. Recent controversies surrounding the possible rate cut make it clear that people still aren't aware that interest rates aren't a good indicator of the stance on monetary policy, due to confounding variables such as the Fisher Effect and IOER. 

The nominal rate is the rate set by the Fed and is used to influence economic outcomes. The natural rate is set by classic supply and demand forces in the market. Currently, the natural rate is falling rapidly; this means that if the Fed were to keep rate steady, or worse, raise rates, then monetary policy would be highly contractionary, it would be too tight. You cut rates, not to expand, but to avoid tightening. Think of it as the Fed really just keeping their rate the same. If you're thinking that interest rates are indicative of the stance of monetary policy this makes sense, but they're not. The cut is not expansionary, but to keep monetary policy steady. This is a great policy change from the fed and shows they're looking at market forecasts which could have made the recession less bad.

Short Version: Monetary policy would be too tight since the nominal rate, the rate set by the fed, would be way higher than the real rate, the one set by supply and demand forces in the market. This indicates super tight money, which we don't want. The nominal rate is set to influence the real rate to produce desirable outcomes.