Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Yellen’s Footnote 8 Would Put Interest Rates on Autopilot

Interest-Rates / US Interest Rates Sep 19, 2016 - 02:07 PM GMT

By: John_Mauldin

Interest-Rates

Yellen’s Jackson Hole speech was widely reported, so I’ll spare you the summary.

What wasn’t widely reported was her Footnote 8. Yellen cited approving a mathematical formula that could put interest rates on autopilot. The Fed hasn’t yet followed the rule, but its presence in Yellen’s paper suggests its use is on the table.


Footnote 8 lays the groundwork for negative rates

For Yellen to adopt any fixed rule would be a major strategy shift. She has declined to use the so-called “Taylor Rule” favored by some economists, claiming the Fed should be flexible but “data-dependent.”

The rule described in Yellen’s Footnote 8 uses variables like core PCE inflation, the Fed’s inflation target, and the unemployment rate to calculate an optimal Federal Funds rate target. If the Fed had been following the rule during the last recession, they would have dropped rates to -9%.

Yes, you read that right, -9%.

As a point of reference, the ECB right now is at -0.4%. Europe is now experiencing all kinds of bizarre consequences.

Yet, here’s our own Fed chair bringing up a method that would send rates far lower.

To be fair, Yellen didn’t say she endorses this idea or wants to adopt it. She concedes it would have been impossible to drop rates that far in 2008.

So why even bring it up?

A generous interpretation: Yellen wanted to demonstrate that the Fed’s control over interest rates has limits as a tool for stimulating economic growth. And in her speech, she does go on from there to talk about other policy tools.

Still, it was no accident that she mentioned the rule for autopilot rates. This was another in a series of small nods to the idea that negative rates might be appropriate in some situations.

The Fed’s muddled assumptions

The Yellen Fed’s mental status gets clearer every day. They think that their crazed ideas—ZIRP, QE, Operation Twist, and the rest—are what brought the economy back from the brink of collapse. Last December’s one-and-done rate hike was the victory lap. They think everything is fine now and have turned their attention to preparing for the next recession.

But, this thinking is completely wrong. Yes, the economy did recover (slowly), but it did so in spite of the Fed. Not because of anything the Fed did.

The Fed’s base assumption, as I explained in "Six Ways NIRP Is Economically Negative," is that making interest rates go down will stimulate demand for goods and services. That is true on the margin. It is not true always and everywhere.

It’s especially not true for non-bank private businesses and consumers. To them, interest rates are one of many costs… and not necessarily the most important. On the other hand, interest income is very important to this group.

The Fed is banker-driven

Bankers think differently. This matters because bankers have the most influence on Federal Reserve policy. To them, short-term interest rates are a kind of fuel cost. Liquidity is to bankers as crude oil is to refinery owners. You pump it into your refinery, process it, and out comes something your customers will buy.

Banks are lenders, but they are also borrowers. They borrow cash from depositors and bondholders. Then they loan it to borrowers at a marked-up interest rate. Cost of funds is critical to bankers.

It is not critical to most other businesses. The decision to open a new factory doesn’t usually hinge on getting a lower interest rate. It depends on whether or not customers will buy the goods that the new business produces.

But because the Fed is banker-driven, it thinks cost of capital is everything. Therefore, a lower interest rate will stimulate activity. They’re right—up to a point—but that relationship is not linear. It flattens out as you get closer to zero.

Yellen is aware of this. Her point with Footnote 8 was that interest rates aren’t always an effective stimulant. But also, she isn’t the only vote. She has to convince the other governors and regional Fed bank presidents. And they are all influenced to varying degrees by the banking industry, which loves lower rates.

Footnote 8 is a warning

Negative rates are death to commercial banks. A -9% NIRP would kill many banks.

So maybe that footnote was a warning, the Yellen equivalent of a brushback pitch to overly eager bankers. “Look what can happen if we don’t do it my way.”

I don’t think Yellen will take us down to -9% or anywhere close to it. I do think she is prepared to go below zero if she sees no better alternatives according to her personal economic religious beliefs.

I’m also confident that she and her colleagues won’t take rates much higher from here. I think we will see 0% again (and below) before we see +2%.

Sooner or later, a recession is coming. This feeble recovery is already long in the tooth. There is the real chance we will enter at least a mild recession no later than the end of 2017, brought about by a crisis and recession in Europe.

How will the Fed respond when that recession hits?

The Fed is making those plans right now. If you think 2008–2009 was a wild ride, fasten your seatbelt and prepare to take an airbag in the face. The next ride will be wilder.

Subscribe to John Mauldin’s Free Weekly Publication

Each week in Outside the Box, John Mauldin highlights a thoughtful, provocative essay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box. Subscribe now!

John Mauldin Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in