Posts Tagged ‘ZIRP’

The ZIRP walk

12 December 2012

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. (more…)

Advertisements