Comments on economics, mystery fiction, drama, and art.

Tuesday, August 20, 2019

Should the Fed be driving interest rates down now? Trump says yes; I say maybe

Trump's appraisal of Jay Powell when he nominated him to be Chair of the Federal Reserve Board of Governors:
"That is why we need strong, sound, and steady [pause] leadership, at the United States Federal Reserve. I have nominated Jay to be our next Federal Chairman. [pause] And so important, because he will provide exactly that type of leadership. He's strong. He's committed. He's smart. And, if he is confirmed by the Senate, Jay will put his considerable talents to work, leading our nation's independent central bank. Jay has learned the respect and admiration of his colleagues for his hard work, expertise, and judgment. Based on his record, I am confident Jay has the wisdom and leadership to guide our economy through any challenges that our great economy may face..."
Trump's appraisal of him now:
"Our Economy is very strong, despite the horrendous lack of vision by Jay Powell and the Fed, but the Democrats are trying to “will” the Economy to be bad for purposes of the 2020 Election. Very Selfish! Our dollar is so strong that it is sadly hurting other parts of the world.* The Fed Rate, over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well. If that happened, our Economy would be even better, and the World Economy would be greatly and quickly enhanced-good for everyone!.."
https://www.bradford-delong.com/…/donald-trump-that-is-why-…
My own take (keeping in mind that monetary policy is not something in which I have any deep expertise) is that Powell has done a better job than I expected, but that we may be at a point at which some cuts in the interest rates that the Fed controls are probably warranted. How can the Fed do this? Well, it would have to buy existing (presumably short-term) bonds--like 30-day US government bills; the interest rate on those is currently about 1.91% (annual basis). Driving the rate on 30-day Treasury bills down to 0.9% would have a spillover on other interest rates, which could be expected to fall as well, probably by less than 100 basis points (1 percentage point). So borrowing becomes cheaper, and, presumably, there would be some increase in purchases typically made on credit.
But the effect depends on the extent to which *other interest rates* fall when the Fed forces the T-Bill rate down. So, for kicks, I looked at the relationship, since 2008, between the 30-month T-Bill rate and the interest rate on 48-month car loans. It look like driving the T-Bill rate down from its current 1.91% to 0.02% would push the car loan rate down from about 4.75% to about 4%, or, on a $30,000 car loan, the monthly payment down from about $690 to about $677--a 2% reduction in the monthly payment. Frankly, that's unlikely to provide a strong incentive for more car purchases. (And similarly for other types of consumer loans.
The point, really, is that even if the Fed cuts interest rate to essentially zero, it's likely to have a fairly small impact on consumer behavior. The Fed should probably cut rates some, but, because it has so little room for maneuver, it won't make much difference in the short run.
(DISCLAIMER: MY ESTIMATE OF THE EFFECT OF A RATE CUT ON CAR SALES MAY WELL BE SERIOUSLY WRONG.)
(Incidentally, a 100-basis point reduction in the interest rate that the Fed actually directly controls--the Federal Funds rate--is currently 0.12% (annual rate)--would mean a Fed Funds rate of -0.88% (per year). The Fed Funds rate, by the way, is "The interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis." So if Bank A wants to borrow $100 million overnight from Bank B, Bank B would actually *PAY BANK A* about $2400 (again, for an overnight loan)--Bank B would be repaid LESS than the $100 million that it lent. Cutting the Fed Funds rate by 100 basis points would make Bakn A a lot more willing to borrow--but what other bank would be willing to lend?)
*I gotta comment on this. A "strong" dollar means it takes more euros or remnibi of pounds or Australian dollars or Canadian dollars of pesos to buy a dollar. So those countries will react by buying less stuff from the US because it has become more expensive. But a "strong" dollar also means that the US can buy more euros (and so on) for a dollar. Wo we will react by buying more of the stuff people in other countries produce. It's arguable, then, that a "strong" dollar actually helps other countries' economies...that they have no particular desire to see the dollar "weaken."

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