A slightly off-center perspective on monetary problems.
Some articles point out one “bright spot” in this dismal day—the Fed succeeded in lowering long term yields. They also raised short term yields, making the yield curve flatter. You might want to get out your money textbook to find out what type of monetary policy causes a flatter yield curve. According the an article by Sharon Kozicki at the Kansas City Fed:
The yield spread reflects the stance of monetary policy. According to this view, a low yield spread reflects relatively tight monetary policy and a high yield spread reflects relatively loose monetary policy.
The yield spread is the long rate minus the short rate. Kozicki says the conventional view is that a lower yield spread means tighter money. Today the Fed made the yield curve flatter. You might think; “They know what they are doing; surely they wouldn’t tighten monetary policy. Sumner must have things backward.”
OK, how would tight money affect the dollar? Here’s the euro/dollar (the fall means the dollar soared after 2:15, or 6:15 London time):
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And here’s the Dow:
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So what do you think, monetary stimulus or monetary tightening? The only thing that’s “twisted” is the Fed’s logic. They are so obsessed with the Keynesian low interest rate approach to stimulus that they’ve completely lost their bearings and ended up tightening monetary policy.
PS. I forgot to mention one other piece of “good news,” the Fed action sharply reduced oil prices. Less inflation “worries.”
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40 Responses to “The Fed “succeeded” in flattening the yield curve”
the 5y5y dropped 25bps(!) intraday.
Very interesting commentary by Scott Sumner.
BTW, if you want to become very nettled, read today’s lead editorial in the (paper version) WSJ. Put it this way, they actually write, “as long as we have fiat money” en route to advocating that the Fed abandon any growth targets to exclusively target only price stability.
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They also likely reduced business investment. Less output gap “worries.” There are two ways to close an output gap.
“Operation Twist” had been in the pipelines for some days since Hilsenrath wrote about it. So it wasn´t even unexpected. Even so it was depressive!. Funny that the 3 Stooges (P, F & K)voted against the measure. Does that mean they wanted a more lose MP!?
The 10 year TIPS spread plunged sharply the minute the statement was released. Even if you’re a New Keynesian, rather than a market monetarist, that’s tight money right there. With the FFR fixed near zero, the Fed lowering inflation expectations (and they hadn’t particularly risen much in anticipation of the announcement) spells lower AD. Sometimes, I feel like the idea of having the Fed make a statement every once in a while that’s heavily prepared is silly. Bernanke should come out and say, “this is our policy” and then if inflation expectations immediately tank and that’s not what he really wanted he can say, “no, no, you’ve got me all wrong. Yay 4% inflation for a while” or something. I find it very difficult to believe that the policy had the intended effect in light of the TIPS spread response, and yet they won’t be able to do anything about it until the next meeting. At Bernanke’s next press conference, someone should ask him, “What are you trying to do? What measurable benchmark can we judge your policies by? And if your target is 3% annual NGDP growth after the biggest NGDP collapse since WWII, what on earth are you thinking?”
Wait, isn’t buying long-term bonds the same kind of QE that you cheered on before? Isn’t it the same thing that the Fed would do initially if they started targeting NGDP?
I’d consider attributing the rise in the dollar to the Fed’s stronger negative language on the outlook of the economy. Today was a risk-off day in the markets.
Now I’m confused, I thought flattening the yield curve was the whole point of unconventional monetary policy, such as how Thoma explains here:
http://moneywatch.bnet.com/economic-news/blog/maximum-utility/what-is-qeii/997/
Now you’re saying that is contractionary?
Scott,
Again, I have you to credit for having considered this interpretation myself. I didn’t have an opinion yet about whether the Fed action today actually had this effect, or whether they had such a small effect that more trouble in Europe overwhelmed it easily. I hadn’t looked at many numbers yet.
At the very least this policy action is woefully insufficient.
Brito,
No, as Scott’s pointed out many times, a successful monetary stimulus operation will raise the yield curve toward the long end, as markets predict recovery and eventual Fed tightening.
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