There was an interesting conversation about the FF rate started by Scott Sumner who asked: Do central banks worry more about the bond market or the labor market? It’s a pretty good post that points out the “bloodbath” in the bond market in 1994 when the Fed “normalized” policy after a recession. I understood it to be more of a political question, or perhaps a moral one, that highlights at least one problem with discretionary monetary policy combined with IT and the interest rate peg that seems to perpetually leave someone with more pain than they deserve. And so, who will it be this time?
Upon reading this post, and Bill Woolsey’s response, I grabbed my populist hat and wrote a post that was one of those knee-jerk, cynical, shoot-from-the-hip and ask questions later kind of responses, the kind that my mother would think much less of me for writing, after considering this part only briefly:
My theory of central banker behavior is to minimize the increase in short term interest rates subject to the constraint that neither unemployment or [sic] inflation rise to [sic] high.
So, that is different from being worried that long term interest rates will rise, creating capital losses in bond markets. A series of small increases in short term rates should immediately depress long term bond prices if anticipated.
In the old days, a liquidity crunch would cause a spike in short run interest rates. This would be really bad for money center commercial banks (who borrow “hot” money,) as well as investment banks borrowing short to fund their inventories of securities that they have underwritten and not yet sold.
Central banks have not forgotten. Avoiding spikes in short term rates is their key mission.
Fortunately, I took the time to, as my old boss used to say, cool my jets. Because my very first impression was that after everything that has been done to labor over the last 7 years in the name IT, it honestly would not bother me that much if the pain were more evenly distributed. But that is entirely a side note to the larger problem of needing a very sober look at what the central bank is actually doing as a result of having the wrong framework.
It has an inflation target and an interest rate target (except for the ZLB). One of these targets dumps on labor (and other people as in this Bill Woolsey post about the effect of IT on prices). The other target dumps on bond investors and short-borrowing institutions.
Once we got into the great recession, nobody wanted “more inflation.” So a good deal of the painful IT mistake that resulted in ultra-tight money landed on labor, average Janes (and please, let’s not talk about UI). Now, after several rounds of QE (bubblegum and bailing wire for a framework that falls apart at the ZLB) we are somewhere between the bottom and recovery… And our friends the central bankers want to start raising interest rates now as to minimize the impact to the bond market (bond investors – which I do have a few myself) – a sliver here and a sliver there to let ‘em down easy while rolling the dice on the equities and labor sides of the economy – all while hitting the inflation target is nowhere in sight.
We know how we got into the mess in late 2008 – a horridly inaccurate inflation forecast (a bit oversimplified, but it makes the point). We couldn’t get out of it because of the political problems associated with QE and inflation hysteria. Now, we can’t just let the status quo simmer until the inflation target is within striking distance because that’s “potentially” bad for somebody else.
See where I’m going with this? The entirety of the current monetary regime, IT with an interest rate peg, is untenable and jaw-droppingly ridiculous
ludicrous sadistic. This stuff is logical to the “smart” people? It’s logical to drive the demand side of the economy this way when there are more neutral options like NGDP-LT to consider? Astounding….