Joseph Mason from Roubini Global Economics has written an interesting analysis of Fed monetary policy, focusing on the Fed Fund rate as the primary tool of economic intervention, in which concludes that the Fed's traditional weapon for moderating the business cycle is becoming increasingly irrelevant, and has reached a point where the traditional central bank arsenal could be considered irrelevant. By analyzing historical data of rate tightening into and during recessions, coupled with loosening interventions, Mason observes that by "reducing rates before recession may both add to the speculative fury that will (eventually) necessitate the (potentially larger) downturn and leaves no room to lower rates in order to address lagging effects like unemployment." If correct, and if the excess reserve phenomenon currently witnessed, which is purely a function of negative implied interest rates per the Taylor rule, is unable to force the economy into a recovery mode, the Fed will be left with absolutely no additional mechanisms to facilitate monetary expansion, resulting in an impotent Federal Reserve, whose only function would then become to fund balance sheet shortfalls at major financial institutions. And if there is a an actual empirical point arguing that the Fed no longer needs to exist, in addition to all the rhetoric we have witnessed over the past year which implicates the Fed as merely a proxy vehicle for banker status quo perpetuation, this could very well be it.
The key problem for the Fed, encapsulated in the Roubini analysis, is as follows:
The ongoing history of US monetary policy has to be one of a continuing search for monetary targets in an ever-changing institutional context for at least temporarily stable relationships between monetary policy and economic growth. Hence, it makes sense to ask “how is it coming along?” Unfortunately, I think the answer is “not well.” While I present here only one dimension of monetary policy, Fed funds rates, the lesson is straightforward: the recent era of managing the Fed funds rate to reduce the depth and duration of business cycles is failing.
The basis of Mason's argument lies in the data contained in the following graph:
Mason's critical summary of the graph's implication:
The graph [above] illustrates both the reason for embarking on the experiment with Fed funds policy, as well as the failure of the policy to date. The graph shows the Fed funds rate with NBER recession dates (monthly) illustrated in gray. Visually, two things are apparent. First, recessions prior to 1990 are pre-dated by rate increases, which can be thought to have precipitated or at least worsened the ensuing recessions. Second, many recessions are followed by further Fed funds rate declines, which can – intentionally or unintentionally – address the lagging effects of recessions (like unemployment), but which risk adding stimulus after the “horse is out of the barn,” so to speak.
It would seem that the arrival of Greenspan to the monetary scene is in many ways equivalent to the K-T boundary applied to Keynesian economics:
Consider the first line of the table lying below the graph, which reports Fed funds movements as the percent change in the rate over the six months preceding each recession date. Prior to the Greenspan era, rates typically rose in those six months by an average of nearly fifteen percent. Moreover, while rates increased just over five percent pre-dating the 1957 recession and just over two percent pre-dating the 1960 and 1969 recessions, they rose almost forty-one percent pre-dating the 1973 recession and almost thirty-four percent pre-dating the 1980 recession.
Yet something changed in monetary policy about 20 years ago, and that something became particularly obvious in the last two recessions - those of 2001 and 2007:
Given the disruptiveness of those latter two recessions, it is not surprising that policymakers perceived policy mistakes, having effectively tightened into both recessions. (Note, however, that the Fed funds rate was not a target in those periods, so the tightening is not a conscious policy decision.) Contrast that tightening with conscious policy movements prior to post-1990 recessions, where the Federal Reserve, unlike previous periods explicitly targeting the Fed funds rate, began reducing rates in the six months prior to recession. In the 1990 recession – the first application of the principle – rates were reduced by almost two percent. But in later applications, the 2001 and 2007 recessions, rates were reduced about fifteen percent before the recession began. Of course, in neither of those cases did the Federal Reserve avert recession, but they avoided tightening into the recession as in previous episodes. While causality is difficult to verify, the 1990 and 2001 recessions both lasted eight months, shorter than the historical average of ten months for recent recessions.
Yet while one can observe the Fed Funds rate heading into a recession with skepticism as to causality, it is the exit policy (or lack thereof) that is most relevant to our current situation. First, what happened in those long-ago, bubble-free pre Greenspan/Bernanke days:
The fourth and fifth lines of the table demonstrate the historical difficulties the Federal Reserve has always had with exit policy. It appears that the most dramatic after-the-fact loosening took place after the 1957 recession, where the Federal Reserve continued expanding until Fed funds rates had declined another forty-six percent on top of the sixty-one percent decline during the recession. In 1969, policy resulted in a follow-on decline of twenty-four percent, on top of the almost thirty-eight percent during the recession. In 2001, explicit policy reduced rates almost another seventeen percent, on top of the roughly sixty-one percent during the recession.
In the past, as today, overshooting was thought to be a problem. Hence, in the six months following the 1957 recession, rates went up almost one hundred eighty six percent from their recession lows. In 1960 and 1969, rates were fairly stable in the six month window, declining slightly beyond their recessionary lows. Following 1973, Fed funds rates six months after the end of the recession were up roughly thirteen percent over their recessionary lows. Following 1980, they rose almost one hundred percent from their recessionary stimulus levels by six months after the recession, only to be slashed a year later by fifty percent and another eight percent in the 1981 recession, in quick step.
How does that compare to the Maestro's actions:
Looking holistically at recent policy, in 1990, the Federal Reserve decreased rates roughly two percent prior to the recession, then another twenty-five percent during the recession, and another almost eight percent after the recession. It wasn’t for another 108 months, until May 2000, that rates again rose above their stimulus lows in the 1990 recession.
Of course, by March 2001, the economy was in recession, again. The Federal Reserve cut rates by over fifteen percent before the 2001 recession, another sixty percent during the recession, and then – like in 1990 – roughly another seventeen percent after the recession. But, like 1990, the Federal Reserve did not raise rates above the stimulative 2001 recessionary lows until December 2004, approximately a year before the real estate bubble burst in California.
By 2007, the economy is in recession yet again. This time, the Federal Reserve cut rates by almost fifteen percent before the 2007 recession, and some ninety-seven percent during the crisis. The problem is that there is no room to reduce rates following the recession, as in all but 1973 and 1980. If you recall, those were not times of widespread economic prosperity.
And here is the crux of the issue: current bliss substituted for future pain, a lesson so well learned by the current administration.
To me, at least, there is a clear lesson in the Fed funds rate experience and application: while you probably don’t want to raise rates into a recession – 1973 saw a six-month pre-recession increase of over forty percent and 1980 almost thirty-four percent – you don’t want to exclusively wait until during and after a recession to reduce rates. Nonetheless, reducing rates before recession may both add to the speculative fury that will (eventually) necessitate the (potentially larger) downturn and leaves no room to lower rates in order to address lagging effects like unemployment. The lesson, therefore, may be that while we have sought front-end loosening to mitigate recent recessions, we have sacrificed back-end loosening that could be an important component of monetary policy.
At the end of the day, we are now in a position where additional loosening is impossible due to being on the ZIRP boundary, which has forced the implementation of Q.E. The latter is the Fed's last and only method remaining to stimulate a monetary recovery in the economy, and despite a surge in the Monetary Base, the net impact to the consumer has been a wash due to a collapse in the velocity of money. Aside from keeping Mortgage Rates manageable, Q.E. has been a failure from a monetary standpoint. Ben has no more bullets, and since the decade-long phenomenon of inflation-exporting to China may be at an end, the Fed is truly between a rock and a hard place, where, as speculated extensively, the only two realistic outcomes are either a deflationary spiral or accelerating (hyper) inflation. Perhaps it is only fitting that Bernanke should be reappointed in order to fully deliver this country to Keynesian grave which his predecessor did such a great job at digging.
the only two realistic outcomes are either a deflationary spiral or accelerating (hyper) inflation.
Personally I see more the hyperinflation scenario. You could see the Dow Jones at 100'000 points in nominal terms, but worthless in real terms. I wish nothing more than that to the idiotic permabulls as CNBCOMACSTAGANDA.
Perhaps it is only fitting that Bernanke should be reappointed in order to fully deliver this country to Keynesian grave which his predecessor did such a great job at digging.
Ya know, you got a point there Tyler.
The USA never learns its lessons until it's a crisis and then we pretend it didn't happen, lie about it, create diversions, blame it on someone or something else, spin it, and move along, whistling past the graveyard. The exposure of that crisis was Bear and Lehman. One year later, the Fed has created an echo bubble and NOTHING has been fixed on a fundamental and structural basis in the banking system and housing market. With banking it is actually worse in my view as we have legitimized fraudulent accounting via the FASB FAS 157 modifications.
There will be a Minsky moment, just a question of when, and it could be a long time as the US will probably outlast all of Europe's collapse first. Japan as well.
We have fucking blown it for the next several generations of Americans (and many other world citizens as well).
I respect your posts DH, I read here alot more than I actually post.
If the future is blown for the next several generations... What would you have us do?
What am I supposed to do, exactly, for myself, my family, and my toddler? What the fuck am I supposed to do? I have nothing. We have a house. My wife got laid off, I've been laid off and found employment in a TBTF call center that feels alot like the pit of hell... I'm living month to month with all savings depleted.
I'm not sure I can take it anymore. I'm damned if I do and damned if I don't. I can make a stand and most likely lose everything, or I can keep my head down and slave the rest of my life. I'm getting real twitchy.
I need a light at the end of the tunnel. I have it alot better than most, and I'm in it up to my ears.
.....Man I don't have anything else to say.... I'm just speechless...
get a federal gov't job.
What would you have us do?
in a nutshell:
gov't, regulators need to tell the truth.
truth is recognition of massive debt problem we have.
the debt must be delevered, defaulted, or discharged for future economic growth.
adding more debt is insane and that is what is happening on the failed attempt to fix housing.
zero interest rate policies cannot continue. they will only cause bubbles like what we have now.
an honest and open plan must be implemented to reduce corp, gov'tal, consumer debt with specific timetables. example, banks must recognize true value of assets via FASB 157 back to mark to market and every nickel of profit must be allocated to capital account to provide funds for delevering. if a structured plan was agreed to (this will never happen by the way, hence why we are fucked), then some regulatory forebearance on capital could be the guiding point (we are doing this anyways right now!) with the provision that it goes away when the delevering plan is accomplished and if banks don't delever, take 'em over by the FDIC, too bad shareholders and bondholders, it used to be called capitalism.
allow me a few moments to respond about your family, but in advance of that, particularly as a family man with wife and child, whatever you do, NEVER give up as your child needs you. by the way, that's what drives me now as my 3 children are 17-24 and I'll definitely be dead before the ultimate shit hits the fan.
That's good advice. My kids are older too, and we see the effect of the demise of the 'American century' all too clearly. But we'll take care of it, even if my grown children have to live in my house for a few years - quite a few years.
J.M. Synge "The Playboy of the Western World: . . .six strong men retching into an open grave."
Crab...your situation sounds a bit tough, no doubt.
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