The Aleph Blog » Blog Archive » An Alternative To Federal Reserve Forward Guidance

An Alternative To Federal Reserve Forward Guidance

I hesitate to write this piece, because I think doing this would be a bad thing.  Then again, I don’t believe that most of the jawboning done by the Fed is useful.

So let the Fed put its money where its mouth is, and, hey, improve its asset-liability match in the process.  After all, over the last five years, the Fed discovered that they have an asset side of their balance sheet.  They decide that they can try to twist the Treasury curve, lowering long rates, and stimulate the housing market via QE.

But aside from monetizing debt, which often leads to serious inflation, QE has not shown much potency to do anything good.  Thus the Fed thinks that enhanced guidance will be the tool to use to breathe life into this over-leveraged economy.  A possible example: “We promise not to raise the Fed funds rate until 2017.”

Deeds, not words, I say.  I challenge the Fed to do the following: Offer multiple tenors (maturities) of Fed funds.  At present, Fed Funds is an overnight rate.  Offer 1, 3 and 6-month Fed funds.  Offer 1, 2, 3, 5, and 10-year Fed funds.  Give the banks the ability to lock in funds for lending or investing for longer amounts of time.  Create the Fed funds yield curve.

Rather than merely promise that Fed funds will remain low for so many years, offer banks a way to have a guarantee of low Fed funds rates for that time period.  That would be powerful.  Whether it would be powerful for good is another matter.  Personally, I doubt it would be good, and I think the same of enhanced guidance.

In doing this, the Fed might realize that they have a liability side of the balance sheet, and one that does not have a zero duration.  If they have long term assets, why not long term liabilities?

Sigh.  In the old days it was easy.  The Fed did not have an over-leveraged economy, and so they invested in short-dated Treasuries, and adjusted Fed funds as their major policy lever.  Open market operations took care of the rest.

Introducing long term liabilities to the Fed means that policy accommodation can no longer be removed instantly.  The longer dated Fed funds would only shift as it matures.  It would give strength to monetary policy in the short run, but weaken it in the long run.  But hey, we are a short-run society, so why should we care?  Bleed our grandchildren dry, and have the great-grandchildren ready to be bled for our good.

Eventually we have to question why we are pursuing policies that harm the long-run in order to goose the short-run. Once we start doing that, we might be on the road to maturity, even if it means we get a severe recession, or even a depression.  The “greatest generation” was the greatest because of character formed out of depression and war.  Sad that they sucked the blood of their grandchildren via Social Security and Medicare.  We live with the results of their short-term thinking.






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4 Responses to An Alternative To Federal Reserve Forward Guidance

  1. taw says:

    David – I almost always agree with your viewpoints. But I view the social security/medicare issue as one exacerbated much more by the baby boomer generation rather than the ‘greatest generation’. Our parents fought WWII to save the world for us; I think they’ve earned their benefits. The riches enjoyed by baby boomers have largely been spent rather than saved and invested for our old age. And we’re still at it -witness the transfers from young to the 55-65 age group in Obamacare pricing.

    • I can go for that. I would only encourage you to look at the generational accounting estimates on returns off of entitlement cohorts by birth decade. It consistently goes down with time. The later baby boomers (like me) are basically breakeven. Those born before me win; those born after me lose.

      I also agree with you on Obamacare pricing; the health actuaries I talked with in 2009 have been proven right.

  2. adequateryan says:

    I don’t know if I have the operational understanding to fully grasp an answer to these questions, but here goes anyways…

    You are questioning Fed jawboning and guidance, but isn’t setting the Fed Funds rate just jawboning? There isn’t necessarily a transaction involved in the process. The Fed states what the rate is and the market moves there. They could theoretically buy/sell enough securities to force the rate wherever they want, but it’s far more likely that people will get out of the way and not compete against the Fed’s unlimited balance sheet.

    Also, seeing as there is very little difference between T-bills and the Fed Funds rate, would it be fair to say there would also probably be very little difference between a full Fed Funds yield curve and the treasury curve? If so, why not just make the treasury curve the Fed Funds curve and pin the entire curve to whatever rate they want?

    I’m making the assumption this is within the Fed’s ability at least in the short term. If the Fed said tomorrow that the 30 year was going to yield 1%, I think the market would move there without question and the Fed probably wouldn’t have to buy or sell anything in the process. Just jawboning and guidance.

    • Response to Fed policy has weakened over the last 30 years, as we have more talk relative to action. There was more punch when the market was not perfectly sure of what the Fed decided to do. Guidance is overrated, because the Fed does not always follow through on what they say.

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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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