Wednesday, July 31, 2019

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

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