domingo, 6 de mayo de 2018

domingo, mayo 06, 2018

What the Fed’s Latest Moves Mean for Rates

By Matthew C. Klein

    Richard Clarida Photo: Bloomberg News 


Central bankers are supposed to smooth out the ups and downs of the business cycle. The standard approach is to raise borrowing costs when the economy is running hot and lower them when the economy is weakening. This is challenging enough, but the real difficulty comes from figuring out how to set policy at “neutral.”


With the pending elevation of Richard Clarida to vice chairman of the Federal Reserve Board and John Williams to president of the New York Fed, two of the central bank’s most important jobs will soon be held by men who have spent their careers trying to answer this question. They both agree on the approximate level of the neutral interest rate, but disagree sharply on the explanation, which could produce an intriguing conflict over the future direction of monetary policy.

To determine the neutral rate, Clarida has suggested comparing five- and 10-year bond yields to see five-year borrowing costs five years in the future. This is traders’ best estimate of the cost of money outside of the current business cycle. He says he prefers this approach to “building a macro model” because it is “robust to regime changes…and structural shifts.” His method has implied a neutral interest rate of about 2% since the start of 2012, down from more than 4% before the financial crisis. 
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       John Williams Photo: Rob Kim 


He attributes this decline to the breakdown of the pre-crisis “growth model.” Loose credit standards before 2007 made it easy for people to spend more than they earned, which allowed Americans, southern Europeans, and Brits to temporarily make up for chronic underspending by Chinese, Japanese, and Germans. After borrowers took on more debt than they could ever hope to repay, they were forced either to default or cut spending to cover past obligations. The impulse that had been sustaining the world economy suddenly went into reverse.

For a variety of reasons, the excess savers have been either unwilling or unable to pick up the slack. One result has been a glut of “bountiful” goods and commodities relative to demand. This, in turn, has burdened much of the world with old debts that, in Clarida’s view, would be impossible to service at significantly higher interest rates. The “new neutral” is thus a legacy of the bubble and bust.

The “normal” level of U.S. interest rates could rise by several percentage points if, for example, people in East Asia and Europe saved a bit less and spent a bit more, or if Americans relived the bubble years with a new debt binge. Without such big changes, the neutral level of interest rates, in Clarida’s view, will probably continue to stay well below pre-crisis norms.

By contrast, Williams and fellow Fed economist Thomas Laubach estimate what they call the “natural rate” by determining whether the economy is growing above or below its “potential.” If the economy was too hot, the actual policy rate must have been below its natural level. If the economy was in a slump, monetary policy was too tight. This method, like Clarida’s, implies a natural rate of interest of about 2% since the crisis.

The challenge is determining “potential.” Williams and Laubach define it as the economic growth rate associated with stable inflation. Yet this assumes a relationship that may not exist and produces strange results: Their latest estimates imply the early-1990s recession was twice as painful as the financial crisis and the U.S. economy has been “above potential” since the end of 2011.




According to Williams and Laubach, the catastrophe of 2008 was a sharp decline in productivity, not a financial crisis. They claim they found no “evidence that crises are typically followed by lower-than-normal real interest rates.”

Until recently, these different interpretations didn’t matter: Fed officials wanted to push the economy above its “potential” because they were afraid inflation was too weak. That fear has gone. At the same time, the Fed has finally decided Clarida and Williams were right that the neutral/natural interest rate is much lower now than before the crisis.

U.S. central bankers must determine which of them correctly explained why.

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