09-08-2016, 11:44 PM
I'm only half way through this thread so far, but it's dense and worth reading carefully, so I wanted to respond to this before I forgot in the course of reading the rest of the thread.
That is one way by which the Fed controls interest rates, yes. The other way, which is the more normal way when natural interests rates are not so low, is by controlling the discount rate at which banks can borrow against reserves.
Granted, the two mechanisms are not independent, so they ultimately control the same thing, namely money supply. So basically both of you are right.
I think the term "quantitative easing" mostly refers to the direct purchase of bonds in large quantities - the Fed owns a large fraction of all U.S. government bonds - in place of using the discount window or similar measures more directly related to the interest rate.
One interesting issue here is why the discount rate has been so unsuccessful in increasing the money supply. It's not just low interest rates, as consumer debt - credit card - interest rates has remained high rather than dropping with the discount rate. There's no sign that the risk premium has increased in lock step with the decrease in discount rates, so that doesn't seem to be the explanation.
I believe the explanation is the tightening of capital requirements in the wake of the financial crisis. With the tight capital requirements, banks are limited in how much they lend out by capital, rather than by deposits. Since deposits are not in demand, interest rates on deposits drop with the discount rate, but since capital is the limiting factor, loan interest rates can remain high. This means that low discount rates are prevented from flowing through to consumption the way they normally would via lower consumer credit interest rates.
This is a good example of where regulations - in this case capital requirements - have an unintended effect, in this case a contractionary effect on the economy.
(05-24-2016, 09:18 AM)Mikebert Wrote:(05-24-2016, 12:14 AM)Kinser79 Wrote:Interest rate policy is performed using open market operations. If the Fed wants to keep interest rates low they buy government debt. They buy it with dollars they create. Monetary easing adds money to the economy. When the Fed hikes rates they sell government bonds for dollars, removing those dollars from the economy.(05-23-2016, 06:27 PM)Mikebert Wrote:I would argue that interest rate policy is indirect money printing. Lowering the interest rate usually signals to borrowers it is time to borrow and that for spenders it is time to spend.(05-21-2016, 12:19 AM)Kinser79 Wrote: The Fed only has two leavers it can work economically, the interest rates and money printing. The interest rate is already at its minimum. That leaves money printing.Interest rate policy IS money printing.
That is one way by which the Fed controls interest rates, yes. The other way, which is the more normal way when natural interests rates are not so low, is by controlling the discount rate at which banks can borrow against reserves.
Granted, the two mechanisms are not independent, so they ultimately control the same thing, namely money supply. So basically both of you are right.
(05-24-2016, 09:18 AM)Mikebert Wrote: Normally the bond being uses are short term government securities. One could do open market operations with other kinds of bonds. When they do that they call it quantitative easing. During 1942-1951 the Fed performed open market operations with both short term and long term debt maintaining interest rate pegs on both.
I think the term "quantitative easing" mostly refers to the direct purchase of bonds in large quantities - the Fed owns a large fraction of all U.S. government bonds - in place of using the discount window or similar measures more directly related to the interest rate.
One interesting issue here is why the discount rate has been so unsuccessful in increasing the money supply. It's not just low interest rates, as consumer debt - credit card - interest rates has remained high rather than dropping with the discount rate. There's no sign that the risk premium has increased in lock step with the decrease in discount rates, so that doesn't seem to be the explanation.
I believe the explanation is the tightening of capital requirements in the wake of the financial crisis. With the tight capital requirements, banks are limited in how much they lend out by capital, rather than by deposits. Since deposits are not in demand, interest rates on deposits drop with the discount rate, but since capital is the limiting factor, loan interest rates can remain high. This means that low discount rates are prevented from flowing through to consumption the way they normally would via lower consumer credit interest rates.
This is a good example of where regulations - in this case capital requirements - have an unintended effect, in this case a contractionary effect on the economy.