Economic Policy
Commentary
December 18, 2004
The last class of Economics 421 was on Thursday, December 9, and the final exam on Monday, December 13. One of the questions of the final exam was this:
It was recently reported in the financial press (WSJ) that the Fed estimates that the equilibrium value of the real federal funds interest rate is 2 % and that expected inflation is 2%. Use this information as a fact to answer the following:
Most students correctly predicted that the Fed would raise the federal funds rate by 25 basis points the next day, (December 14,) and most likely will continue to raise it in following meetings until it reaches its equilibrium level of 4%.
On the next day, the FOMC issued this press release after its meeting:
Release Date: December 14, 2004
For immediate release
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 2-1/4 percent.
The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Output appears to be growing at a moderate pace despite the earlier rise in energy prices, and labor market conditions continue to improve gradually. Inflation and longer-term inflation expectations remain well contained.
The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Thomas M. Hoenig; Donald L. Kohn; Cathy E. Minehan; Mark W. Olson; Sandra Pianalto; and William Poole.
In a related action, the Board of Governors unanimously approved a
25 basis
point
increase in the discount rate to 3-1/4 percent. In taking this action,
the
Board approved the requests submitted by the Boards of Directors of the
Federal
Reserve Banks of Boston, New York,
In addition, the Committee unanimously decided to expedite the release of its minutes. Beginning with this meeting, the minutes of regularly scheduled meetings will be released three weeks after the date of the policy decision. The first set of expedited minutes will be released at 2 p.m. EST on January 4, 2005.
http://www.federalreserve.gov/BoardDocs/Press/monetary/2004/20041214/default.htm
We note that this FOMC announcement is identical, with the exception of a couple of words, to the preceding one of November 10, 2004, hence our commentary on that press release applies also to this one. To avoid unnecessary clutter, we do not repeat it, but I recommend that we read again that commentary—it is at your fingertips. Recall that our November 10 commentary ended with these words:
We shall continue examining this issue at the appropriate point of the course. When the time comes, we shall see how Fed policy can be designed using these concepts. We shall also see some current estimates of the equilibrium real federal funds rate, the equilibrium nominal federal funds rate, and their difference, expected inflation.
So, the Fed conspired in Econ 421’s favor, to provide a good real-world example of theory.
So, we end this academic quarter’s Economic Policy Commentary as we started it on September 21, 2004, with the FOMC’s Press Release of that day.
November 19, 2004
"So far, foreigners are willing to lend the U.S. money to finance the current account imbalances, Mr. Greenspan pointed out. The worry, however, is that at some point foreigners might suddenly lose interest in holding dollar-denominated investments. That could cause foreigners to unload investments in U.S. stocks and bonds, sending their prices plunging and interest rates soaring.
The sliding value of the U.S. dollar has made some
private economists more concerned about this potential risk."
Count me as one who has been concerned for some months
now.
November 18, 2004
November 10, 2004
Release Date: November 10, 2004
For immediate release
|
COMMENTARY For Fed’s November 10 FOMC Press Release. The 1st paragraph announces that the Fed raised its federal funds rate target by 25 basis points to 2%. Given that the Fed sees no inflation (“Inflation and longer-term inflation expectations remain well contained,”) why is the Fed continuing to increase the interest rates? And how high will the federal funds rate have to rise before the Fed stops? The 2nd paragraph gives the reasons why. The stance of monetary policy is still too accommodative, meaning, first, that unless the Fed removes some stimulus, it is too expansionary, i.e., it may cause inflation down the road. Second, even after this rate increase, monetary policy is still too accommodative, suggesting that the Fed will raise again—it doesn’t say when or by how much—the federal funds rate. The 3rd paragraph is
identical to the third paragraph of the preceding press
release—September 21,
2004. The Fed sees equal chance that the economy may be weaker or
stronger than
it is now. More importantly, it says
that it will be raising the interest rate gradually (at a measured
pace,) but
it stands ready to the raise the federal funds rate faster if it needs
to
thwart any unwanted increase in inflation.
To attempt to predict when the Fed will stop raising the federal funds (interest) rate, we need to know how high the federal funds rate must be. It must simply be at that level that makes the (aggregate) demand for goods and services equal to the economy’s potential (aggregate supply.) This level is called the equilibrium federal funds interest rate. Actually there are two such concepts, first, the equilibrium real federal funds rate and, second, the associated equilibrium nominal federal funds rate. These are concepts that the Fed occasionally highlights but mostly alludes to and both depend crucially on one’s estimate of inflation expectations. Of course, the Fed manipulates the observed nominal rate in order to achieve the equilibrium nominal or real rate. We shall continue examining this issue at the appropriate point of the course. When the time comes, we shall see how Fed policy can be designed using these concepts. We shall also see some current estimates of the equilibrium real federal funds rate, the equilibrium nominal federal funds rate, and their difference, expected inflation. |
October 28, 2004
| The article by David Wessel in today's Wall Street Journal, "Wanted: A Pre-Emptive Economic Strategy,"
was distributed in today's class, and related to Question #1 of the 1st
Mid-term Test ((Oct. 21.) That question linked the U.S. budget
deficit with crowding out of Net Exports (deteriorating current account
deficit,) and crowding out of U.S. investment in plant and equipment. The Wall Street Journal's Pre-emptive strategy? "Cut the U.S. budget deficit to raise U.S. Savings, while encouraging Americans to save more." (Emphasis added.) The article contains several gems: from the Blanche DuBois-like "U.S. reliance on the kindness
of " foreigners"-- private sectors, as well as the Central Banks of
China and Japan; or this quote from former U.S. Treasury Secretary and
current Harvard University President Lawrence Summers: "It surely
cannot be prudent for a country to rely on a kind of financial terror."
|
October 11, 2004
|
Today, Oct. 11, the Wall
Street Journal has two important articles on the current state on the
U.S. economy: Second, a page A2 article, entitled "Tepid Job Growth in September Reflects Hesitant Private Sector. The WSJ raises this issue about the Fed: "The jobs data intensified speculation that the U.S.
Federal Reserve may slow the pace of its interest-rate increases.
The central banks raised its target for the federal-funds rate, charged
on overnight loans between banks, to 1.75% from 1% in three steps
since June and is expected to boost it to 2% on Nov.10." Whatever the Fed does is important for our class. |
September
21, 2004
The Federal Reserve's policy-making arm, the FOMC, after its meeting today, September 21, 2004 issued this Press Release:
| Release Date: September 21, 2004
For immediate release The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 1-3/4 percent. The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly. Despite the rise in energy prices, inflation and inflation expectations have eased in recent months. The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability. Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Thomas M. Hoenig; Donald L. Kohn; Cathy E. Minehan; Mark W. Olson; Sandra Pianalto; and William Poole. In a related action, the Board of Governors unanimously approved a 25 basis point increase in the discount rate to 2-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. |
We shall study this release, noting that :
* The 1st paragraph announces changes in policy (if any)
* The 2nd paragraph explains current conditions, and
* The 3rd pragraph gives the outlook in terms of thw twin goalls
of price stability and maximum sustainable economic growth.
So, first, the Fed raised its federal funds rate by 25 basis points to 1,75%, and second, the reason is the the 1.50% was too accommodative. The Fed admits that economic activity moderated earlier this year, "but output growth appears to have regained some traction." Finally, the Fed says that it will be raising the interest rate at a measured pace., but it stands ready to raise the interest rate faster if it needs to thwart any increase in inflation.