Tuesday, June 14, 2011

Bernanke finally gets it that the Fed controls the yield curve?

Edward Harrison of Credit Writedowns:

This time the Fed will target price instead of quantity.

MMT economists were saying from the beginning that this is what the Fed would have done to control the yield curve. Now Bernanke seem to have figured out that he should be targeting price (yield) instead of quantity (announcing the total projected buy).

Harrison sums up what is likely to happen very well including this important quote of Bernanke:

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities. There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt(say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

There's much more in Harrison's summary, including a quote from Scott Fullwiler. However, I disagree with Ed about the outcome, which he thinks will result malinvestment. (Ed is an Austrian economist.)


Matt Franko said...


Current 2-year treasury yield: 0.4%, 3-year treasury yield: 0.7%

that is already pretty low...if they do a QE3 that targets rates they may have to go way farther out the curve.

But before that lets see what happens when the Fed actually ends the QE2 and exits the marketplace... my hunch is that yields will go back to where they were back before the start of QE2 ie LOWER on their own... as the economic data in many ways has turned down since before QE2, and the Feds massive scale-down buying has assisted the speculative sell off in the bonds.

I think all of this is empirical evidence that Monetary Policy is impotent. maybe it works in a closed economy.... Resp,

Mike Norman said...

Bernanke said this NINE YEARS AGO, yet he did not do it. What makes Harrison and Gross (who would pay attention to Gross, anyway?) think he's had such a change of heart? There is no way he will do it because the political fallout will be unbelievable. The cries of "printing money" will be huge!

Tom Hickey said...

Mike, there is already a huge outcry over at ZH about the Fed's have to buy up all the bonds to control the yield curve this way, potentially swelling the Fed balance sheet to unimaginable proportions and sparking hyperinflation through a dollar collapse.

On the other hand, Ed quotes Scott saying that all the Fed has to do is announce its target rate and the market will fall in line, just as it does with the FFR, without the need to purchase bonds. The market knows that the Fed stands ready to purchase any quantity and as the means to do so, so it just falls it line with the targeted rate.

Mike Norman said...


Good point by Scott.