The ZIRP walk

Today’s news from the Fed is that they will continue their zero interest rate policy (ZIRP) until the unemployment rate falls to 6.5%. To be precise, the Federal Open Market Committee (FOMC) announced that they believe the current 0 – 0.25% range for the federal funds rate “will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

This replaces the Fed’s statement from six weeks ago, which was that they expected to continue the ZIRP “for a considerable time after the economic recovery strengthens” and said they thought the ZIRP would continue at least through mid-2015.

I think the new policy is better, first of all because it’s specific. Of course they’re going to raise rates when the economy’s better, but how do they define better? They just told us — 6.5% unemployment (it’s now 7.7%).

The new statement also is better because it’s a fairly clear policy rule, tied to an actual, observable number, as opposed to a prediction about when the ZIRP medicine will no longer be needed. Including a date like mid-2015 is problematic partly because predictions have a way of being wrong, but also because they have a way of creating bubbles. “Through mid-2015” was widely reported not as a prediction but as a fixed commitment by the Fed, which it wasn’t. If enough people in the financial community believe the Fed will keep rates low through mid-2015, there could be a problem. Because if they know that short-term interest rates will be low for the next three years, then they may be more likely to borrow massively in the short-term money market and invest it in longer-term risky assets while rolling over their short-term debts for the next three years. (Some people say we’re already in a stock-market bubble right now, thanks to today’s low interest rates.) Granted, “borrowing short and lending long” is what banks do, but usually it’s without the certainty of near-zero interest rates for the next three years.

So I like the new policy, but one could ask if it’s too loose. ZIRP was implemented in December 2008 when the economy was in free fall and unemployment was rapidly rising, continued through our worst sustained period of high unemployment since the Great Depression, and is still in effect today, when unemployment is still very high but no higher than during much of the early 1980s and some of the early 1990s:

FRED Graph

The Fed did not cut the fed funds rate to zero in either of those episodes, and some doubt that it makes sense now either:

FRED Graph

But inflation was still a big concern in the early 1990s and the big concern in the early 1980s, whereas it isn’t now. Inflation has been under the Fed’s 2% target for the past three years:

FRED Graph

Another big difference is the cause of the slump. Both of the earlier ones were largely caused by the Fed itself, raising interest rates to counter inflationary pressures and establish its credibility as an inflation fighter, whereas the current slump was preceded by almost two decades of low inflation. This slump is the result of a severe financial crisis, and economies tend to recover much more slowly after financial crises. 6.5% was the unemployment rate shortly before the ZIRP began, so it seems like a reasonable target for when the ZIRP should end.

Tags: , , , ,

3 Responses to “The ZIRP walk”

  1. Ron Throop Says:

    Hi fellow blogger.
    Great job.
    Still, I need to rant. For although I am not learned in subjects about the economy, I do live in one. And the layman needs to rearrange the gray matters of money.
    All of this breakdown of decision-making of Federal Reserve bankers with fine suits and excellent jobs hurts my brain. I for one see job opportunities often at our local level. They’re just jobs that nobody wants. Burger King dollar store type employment. Nothing at all like the Depression when there was no work, no money circulating. When shoe leather was a decent dinner for some, but a horrible loss to feet. This rate our government uses seems bogus. I was once employed, however now I choose to be unemployed. There are other ways to rate an economy, and Target’s good health might not be all that necessary. It seems like the Good Ole Boys are just saying what rate they need to see achieved so people keep buying their useless widgets. Keep shopping. To keep shopping one needs to keep working.
    Of course the market is experiencing a bubble. Our family lives frugally compared to many of our neighbors yet would have made enough with our one income to put both kids through college in a different era. We can’t now. Not without significant debt. In fact, we’re buying groceries tonight on credit. To say there is no inflation is like telling my Great Grandfather Henry, a part time engineer in Syracuse, who did put two kids through college, built a modern house, owned two cars, and had a camp (all paid for without loans), that 2013 will be the spitting image of 1932 if we don’t control our Federal interest rates. “No,” he would say. “You’re all just a bunch of credit whores.”
    Here’s the logic, Aristotlian: We the people are in debt. We the People are American. Therefore America is debt.
    With or without the money gods, some balance will show its ugly side soon enough. Won’t corrections come in spite of the noble signatures of bankers?
    Just some mind rant on a blue day. Peace bro.

  2. Larry Says:

    You can’t compare today’s unempolyment rate to that of the 1980’s as the methodology used by the BLS has changed. That is why the target of 6.5% is so problematic. The main reason the unempolyment rate has been dropping is because of people (who in the past would have been considered “unemployed”) dropping out of the labor force, not because people are finding jobs. You can see the BLS’s own data here I guess whenever The Fed decides to raise rates they will quietly ask the BLS to “refine” their methodology such that unemployment comes out at exactly 6.5%

    • Ranjit Says:


      I had a post on the unemployment numbers just a few days earlier:

      It addressed that very issue, and for once I’m basically in agreement with you. It would be better if the Fed’s unemployment target was one of the more inclusive ones (like U-4 or U-5 which include “discouraged workers”).

      That said, I don’t think there’s anything to support the conspiracy theory that says all of the refinements to the survey are designed to make the numbers look better. The basic definition of unemployed (jobless and actively looking for a job) has not changed since I first encountered it as a student in the ’80s. The various tweakings of the survey that the BLS does are fairly technical and not done under political orders. The BLS is well insulated from political pressure.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: