The Federal Reserve’s policy is data-dependent, but the data do not appear to include financial market forecasts and judgments.
That is Brad DeLong, sounding Sumner-esque throughout.
My own view is that the Fed cannot control interest rates, particularly long-term interest rates.
Why couldn’t the Fed simply target a specified level of long bond yields and buy all inventory until that yield is achieved? It would seem that the Fed could at least put a cap on yields.
My theory is that to set such a cap, they would have to buy all of it.
My fantasy is to have a futures market in money. It has to be better than what the banks do in regards to debt and interest rates.
The Fed certainly can’t control interest rates in the long (or even medium) run. They shouldn’t even try, and I think Sumner would agree with that. They can control inflation, however, and thus indirectly control the interest via the Fisher relationship.
I believe the Fed can put a floor on any dollar-denominated asset by simply buying it (up to the point of owning the entire stock of that asset). Yes, the laws don’t always allow that but the Fed seems quite able to ignore laws when it desires.
Yes, that’s of course true. They can always whack moles coming out of one mole-hole. But the moles still want to come out, and they come out the other, unwhacked mole-holes.
Or they can always poke their finger in one place of a rippling waterbed and hold that spot constant, but that just creates a single deformity in the surface, and the rest of the waterbed’s dynamic equilibrium just adjusts around it.
If you try to whack the moles and more holes, or fix more and more points on the waterbed, then that is called economic central planning, and it doesn’t work.
Nevertheless, it might just be the case that credibly keeping One Thing as constant, controlled, and predictable as possible could still provide everyone else in the economic ecosystem with a kind of North Star that they can all look to and which will allow them them to coordinate and solve collective action and other game-theoretic problems more efficiently in an environment of limited information and high levels of uncertainty.
It may not even matter what that One Thing is, which could be arbitrary in principle, but in the real world of human cognitive biases and other structural issues, there are probably targets that do the job – however that goal is articulated – much better than others.
Your North Star effect strikes me as the mechanism by which the Fed exerts most of its control. It is very much psychological, where vast portions of financial markets use it to guide their activities. The mantra “don’t fight the Fed” has been cultivated for useful reasons, even if it might not hold. There is certainly an aspect of game theory where taking a position against a mispriced asset results in insolvency while the market stays irrational. Understanding the Fed’s unlimited bid potential, along with its deep-seated desire to maintain at least the illusion of control, and it’s not hard to understand why otherwise savvy investors might choose not to rock the boat and instead act in accordance with the Fed’s wishes, using the Fed’s activity to generate smaller, safer profits.
It’s also hard to believe that the Fed’s influence is limited to policy and market operations. Surely there are back channels of influence between the Fed and Primary Dealers, as well as via the revolving employment door between Fed, Treasury, and private finance. The Fed has many more favors to offer besides Primary Dealer status, access to Fed Funds, and interest on reserves.
Forgot to mention an important aspect of game theory — investors’ belief that other investors follow the Fed. This ties back to the psychological aspects of influence and implies a tipping point before tilting to a dramatically different equilibrium.
>—“My own view is that the Fed cannot control interest rates, particularly long-term interest rates.”
I am not sure whether or not that is true. I am also not sure whether or not that even counts as a prediction.
It appears that the Fed has controlled interest rates for a while although it is possible to argue that other forces have been more important in keeping rates where they are.
If you want the statement about the Fed not being able to control interest rates to be a meaningful prediction then you need to put some kind of time frame on when you expect to see rates clearly diverge from Fed goals.