Wednesday, November 20, 2013

Do I detect a change in thinking?

Joshua Wojnilower, 5 December 2012:

In normal times (pre-IOR), the Fed could either control the interest rate or the monetary base, but not both. Typically the Fed elected to target the interest rate, adjusting the monetary base in response to the actions of Treasury and private banks...

Now that the Fed is paying IOR (and IOER), it actually can control both the monetary base and the interest rate separately.

Joshua Wojnilower, 18 November 2013:

A quick comment on the effective Federal funds rate during the period you highlight. Under the "permanent floor" system currently employed by the Fed (explained brilliantly by Scott Fullwiler), the rate of interest on reserves (currently 0.25%) is expected to serve as a lower bound ("floor") for the effective Fed funds rate. This expectation is based on the notion that no firm would sell/loan a reserve at a price below that attainable by simply depositing the reserve at the central bank.

As your chart shows, the effective Federal funds rate has consistently been below the rate of interest on reserves over the period in view.

And a new graph:

Graph #1: Four Discontinued Series (the purple line and three hidden by it) and one current
series (green) showing the "floor" created by interest on reserves at 0.25%,
and the Effective FedFunds Rate, in the Basement since January, 2009


geerussell said...

Betteridge's law strikes again.

Joshua Wojnilower said...

Haha...good catch :-)

In theory the IOR rate would act as a price/interest rate floor and to the best of my knowledge, it has acted as such in the few other countries paying positive IOR rates. That being said, I strongly believe theoretical predictions should be tested against the empirical evidence. In this case, reality has been different from theory, presumably due to regulations that differentiate between types of institutions.

As Keynes said, "When the facts change, I change my mind. What do you do, sir?"