Has Macro Policy Been Different since 2008?

3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Was macro policy different after 2008? I interpret that to be the question: “Did macro policy follow the same rule after 2008 that people had presumed before 2008 it would follow in a true tail event?” To answer that question requires determining just what policy rule people back before 2008 thought that the U.S. government was following. Let me propose four candidates for our (implicit) pre-2008 macroeconomic policy rule:

  1. Limit fiscal policy to automatic stabilizers, and follow a Taylor rule with John Taylor’s coefficients (Taylor).
  2. Follow Milton Friedman’s advice and target velocity-adjusted money: if nominal GDP is below trend, print more money and buy bonds; if that does not restore nominal GDP to either the trend level or the trend growth rate (depending on whether your favorite flavor has or does not have base-drift sprinkles), repeat (Friedman).
  3. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound credibly promise to be irresponsible in the future in order to raise inflation expectations by enough to push the real interest rate down to its negative Wicksellian neutral rate value, and so restore real macroeconomic balance (Krugman).
  4. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound resort to expansionary fiscal policy and do as much of it as needed, at least as long as interest rates on long-term government debt remain low (Blinder).

Were there any other live candidates for “the policy rule” back before 2008?

No. There Is Not One Chance in Seven the 2018Q4 Fed Funds Rate Will Be 4.75% or Higher

WTF?! A 15% chance that the Fed Funds Rate will be 4.75% or higher in 27 months? Only a 15% chance that the Fed Funds rate will be effectively zero in 27 months?

Janet Yellen: Figure 1:

Yellen figure1 20160826 png 735×610 pixels

I confess I do not understand how such a graph could be estimated and drawn.

Business cycle asymmetry is a thing. It is an important thing.

The note under the graph says:

Confidence interval equals the median of the end-of-year funds rate paths projected by individual FOMC members (interpolated quarterly), plus or minus the average root mean square prediction error for 0 to 9 quarters ahead made by private and government forecasters over the past 20 years, subject to an effective lower bound of 12.5 basis points.

Eyeballing, I get a 9-quarter-ahead standard error of the forecast of a symmetric 2.2%-points. Look at the data over the past 20 years:

Effective Federal Funds Rate FRED St Louis Fed

There are no episodes in which private and government forecasters underestimated the 9-quarter-ahead funds rate by 2.2%-points. Even in March 2004 observers were expecting more than 2%-points of tightening over the next 9 quarters. By contrast, there have been two episodes in which private and government forecasters’ 9-quarter-ahead funds rate forecasts were more than 4%-points high:

Effective Federal Funds Rate FRED St Louis Fed

If the Federal Reserve is truly failing to take account of business cycle asymmetry here–taking some of the risk that the economy will greatly weaken rapidly and using it to raise its estimated probability of a sudden upside breakout on inflation–then I will be flummoxed. But if that is not what they are doing, why draw this graph?

Indeed, if we look back over the past 40 years, we see only two episodes of an unanticipated tightening of more than 2.2%-points: the late 1970s Volcker disinflation itself, and Greenspan’s late 1980s tightening overshoot. I see no way of ascribing any probability greater than 1 in 20 to a late-2018 fed funds rate of 4.75% or more.

Macroeconomic Policy Reform: A Tentative Agenda

It was 24 years ago this week that Larry Summers and I warned that if we were to push the target inflation rate much below roughly 5%/year, then, in the immortal words of Dr Suess’s the Fish in the Pot:

“Do I like this? Oh, no, I do not. This is not a good game”, said our fish as he lit. “No, I do not like it, not one little bit!”

As I see it, if we want good macroeconomic business-cycle stabilization policy over the next generation, we need to do one or more of four things. I think the more of them we do, the better. And I want Summers and Bernanke to chair a commission this fall and winter to establish the order in which we should attempt to do these four things, and to start building the political and technocratic coalition to get them accomplished:

  1. Raise the inflation target when the economy has any chance of hitting the zero lower bound on short-term safe nominal interest rates–either by nominal GDP or price-level catchup targeting, or by raising the inflation target to 4%/year or so. The way to sell this is to say that the Fed has a dual mandate, that dual mandate requires tradeoffs, and that those tradeoffs are best accomplished via targeting recovery too and growth along a 6%/year nominal GDP growth path.

  2. Give the Federal Reserve the tools that it needs in order to properly manage aggregate demand. That means such things as:

    • Deciding by itself how it is going to use its seigniorage revenue, rather than returning its profits to the Treasury as a matter of course. (Yes, this is helicopter money.)
    • Funding mechanisms to support what ought to be state-level automatic stabilizers in a downturn–states should not be cutting construction and education and public safety spending when the economy as a whole is in recession, and thus when there is plenty of slack in the labor market.
    • More aggressive use of regulatory asset-quality and reserve-requirement tools as countercyclical policy instruments.
  3. Act to substantially reduce the risk premium on safe highly-collateralizable assets, both to repair a significant microeconomic financial market failure and to raise the medium-run equilibrium short-term safe real interest rate–the r*–in order to provide the central bank with more sea room on the lee shore it finds itself on. This requires operating both on the side of boosting market risk tolerance and expanding the supply of safe assets. This means moving beyond “government debt and deficits are always bad!” to “under certain conditions, the national debt of those sovereigns with exorbitant privilege that create safe assets when they issue debt can be a global blessing.”

  4. Reintegrate macroeconomic policy. Return forecasting from three separate exercises–the White House’s Troika (CEA-Treasury-OMB), Congress’s OMB, and the Federal Reserve–back to the Quadriad (Federal Reserve-CEA-Treasury-OMB) or on to a Pentiad (Federal Reserve-CEA-Treasury-OMB-CBO), with the principals to whom it reports being not just the President and the FOMC, but also the Majority and Minority Leaders of the Senate and the Speaker and Minority Leader of the House.

The argument against (4) is, of course, that the Fed needs to be insulated from the broader policy-political world because (a) the Fed can do the job by itself, and (b) having its elbow joggled by the policy-political world would only bolix things up. Well, the past decade has proven to us that (a) the Fed cannot do the job by itself, and (b) Fed “independence” does not keep the policy-political world from bolixing things up. The moment the Republican Party decided in January 2009 to go all-in in root-and-branch opposition to Obama, it necessarily also decided to go all-in in root-and-branch to policies pursued by Obama–which meant root-and-branch opposition to the Federal Reserve as well.

And certainly if we are not going to do (2), we definitely need to do (4).

Some very recent background reading:

Larry Summers: A Thought Provoking Essay from Fed President Williams:

John Williams has written the most thoughtful piece on monetary policy that has come out of the Fed in a long time…. He stresses the desirability of raising r* by pursuing structural policies to raise growth and affirms the importance of fiscal policy. I yield to no one in my enthusiasm for improved education and educational opportunity, but I do not think it is plausible that it will change the neutral rate appreciably in the next decade given that the vast majority of the 2030 labor force will be unaffected.

If Williams is overenthusiastic on education, he is under enthusiastic on fiscal stimulus.  He fails to emphasize the supply side benefits of infrastructure investment that likely enable debt financed infrastructure investments to pay for themselves as suggested by DeLong and Summers and the IMF.  Nor does he note at current interest rates an increase in pay as you go social security could provide households with higher safe returns than private investments…. Nor does Williams address the possibility of tax measures such as incremental investment credits or expansions in the EITC financed by tax increases on those with a high propensity to save.  The case for fiscal policy changes in the current low r* environment seems to me overwhelming….

Williams’s comments on monetary policy have generated more interest…. If the Fed believed that a 2 percent inflation target was appropriate at the beginning of 2012 when it believed the neutral real rate was above 2 percent, I cannot see any argument for not adjusting the target or altering the framework when the neutral real rate is very plausibly close to zero.  The benefits of a higher target have increased and so far as I can see nothing has happened to change the cost of a higher target. I am disappointed therefore that Williams is so tentative in his recommendations on monetary policy…. Moreover even accepting the current framework, I find the current policy framework hard to comprehend.  If as it asserts, the Fed is serious about the 2 percent inflation target being symmetric there is an anomaly in its forecasts….

Finally there is this:  Everything we know about business cycle history suggests an overwhelming likelihood that there will be downturns in the industrial world sometime in the next several years. Nowhere is there room to cut rates by anything like the normal 400 basis points in response to potential recession.  This is the primary monetary and indeed macroeconomic policy challenge of our generation. I hope it will be very much in focus at Jackson Hole.

Greg Ip: The Case for Raising the Fed’s Inflation Target:

Six years ago, Olivier Blanchard, then chief economist at theInternational Monetary Fund, floated the idea that central banks should target 4% inflation instead of 2%. I remember giving a colleague countless reasons why he was wrong. It was I who was wrong….

Last week John Williams, president of the Federal Reserve Bank of San Francisco, made the case for a higher inflation target in a bank newsletter. The subject will almost certainly be in the air when Fed officials and their foreign counterparts meet next week at the annual Jackson Hole symposium…. The historical case for low inflation rested on the assumption that high inflation created damaging distortions and more frequent recessions. Low inflation or deflation was a trivial risk because central banks could easily drive inflation higher by promising to print more money. But in 2008, central banks around the world cut interest rates to nearly zero and printed copious amounts of money, and only lackluster growth followed….

Here are my original objections and how they have changed.

  1. Central banks have invested their credibility in a 2% target. If they raise it, the public will assume they’ll raise it again, and expectations will rapidly become unanchored…. If anything, central banks are too credible: Investors seem to believe 2% is a ceiling, not a midpoint.

  2. As inflation rises, individual prices become more volatile, which makes the economy less efficient and more prone to booms and busts. This is still true, but against that we can see the harm from not being able to lower real (inflation-adjusted) rates further is much larger than anticipated. Meanwhile, the microeconomic harm of higher inflation is elusive….

  3. Since inflation is below 2% now and there are no new tools to get it higher, it will undermine central banks’ credibility to raise the target. Japan’s success in getting inflation back above zero, albeit not to 2%, suggests adopting a higher inflation target can bring a shift in expectations, and actions, that help make it happen.

  4. A higher inflation target makes real interest rates more negative, which would spur reach-for-yield and other speculative excesses. This is true but the alternative may be worse….

  5. What happened in 2008 was unique. Why change the target for something that happens maybe twice per century? Interest rates have been near zero now for more than seven years, and there is every reason to think similar episodes are going to happen again…. Williams sees ample evidence that deep-seated structural forces have dragged down the real natural interest rate—which keeps the economy at full employment without stoking inflation—from around 2.5% before the recession to 1% now. It may be lower….

John Williams: Monetary Policy in a Low R-Star World:

The inflation wars of the 1970s and 1980s led to a broad consensus on two fronts among academics and policymakers….

[Larry Summers and I warned]:

First, central banks are responsible and accountable for price stability… often acknowledged through… formal adoption of… inflation targeting…. Second, monetary policy should play the lead role in stabilizing inflation and employment, while fiscal policy plays a supporting role through… automatic stabilizers…. Fiscal policy should focus primarily on longer-run goals such as economic efficiency and equity….

In the post-financial crisis world, however, new realities pose significant challenges…. A variety of economic factors have pushed natural interest rates very low and they appear poised to stay that way…. Interest rates are going to stay lower than we’ve come to expect in the past…. Juxtaposed with pre-recession normal short-term interest rates of, say, 4 to 4½%, it may be jarring to see the underlying r-star guiding us towards a new normal of 3 to 3½%—or even lower…. Conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go…. In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher…. If the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price and economic stability.

To avoid this fate, central banks and governments should critically reassess the efficacy of their current approaches and carefully consider redesigning economic policy strategies to better cope with a low r-star environment…. Greater long-term investments in education, public and private capital, and research and development…. Countercyclical fiscal policy should be our equivalent of a first responder to recessions, working hand-in-hand with monetary policy…. Stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries…. Monetary policy frameworks should be critically reevaluated to identify potential improvements in the context of a low r-star…. A low inflation rate… is not as well-suited for a low r-star era…. The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target…. Second, inflation targeting could be replaced by a flexible price-level or nominal GDP targeting framework….

We’ve come to the point on the path where central banks must share responsibilities. There are limits to what monetary policy can and, indeed, should do. The burden must also fall on fiscal and other policies to do their part to help create conditions conducive to economic stability…

Simon Wren-Lewis: Helicopter Money: Missing the Point:

I am tired of reading discussions of helicopter money (HM) that have the following structure:

  1. HM is like a money financed fiscal stimulus
  2. HM would threaten central bank independence
  3. So HM is a bad idea….

These discussions never seem to ask… why we have independent central banks (ICB) in the first place. And what they never seem to note, even in establishing (1), is that ICBs deny the possibility of a money financed fiscal stimulus (MFFS)…. Creating an ICB means that a MFFS is no longer possible… [because] it could only happen through ICB/government cooperation, which would negate independence…. Proponents of ICBs say… macro stabilisation can be done entirely by using changes in interest rates, so a MFFS is never going to be needed. Then we hit the Zero Lower Bound….

To then say no problem, governments can do a bond financed fiscal expansion is to completely forget why ICBs were favoured in the first place. Politicians are not good at macroeconomic stabilisation…. Demonstrating (1) does not, I repeat not, imply that ICBs do not need to do HM. Implying that it does is a bit like saying governments could set interest rates, so why do we need ICBs. Most macroeconomists would never dream of doing that, so why are they happy to use this argument with HM?

Which brings us to (2)… never… examined with the same rigour as (1)… just mentioning ‘fiscal dominance’ is enough to frighten the horses…. Imagine the set of all governments that would refuse a request from an ICB for recapitalisation during a boom when inflation was rising–governments of central bank nightmares. Now imagine the set of all governments that, in a boom with inflation rising, would happily take away the independence of the central bank to prevent it raising rates. I would suggest the two sets are identical…. HM does not seem to compromise independence at all. So please, no more elaborate demonstrations that HM is equivalent to a MFFS, as if that is an argument against HM…

Paul Krugman: Slow Learners:

Larry Summers has a very nice essay that takes off from a new paper by John Williams at the San Francisco Fed…. Williams is the highest-placed Fed official yet to suggest that maybe the inflation target should be higher. It’s not a new argument… but seeing it come from a senior official is news. Yet as Larry says, the paper is still weak and tentative even on monetary policy, to an extent that’s hard to understand…. Furthermore, there’s basically no break with orthodoxy on fiscal policy, despite the evident importance of the liquidity trap, evidence that multipliers are fairly large, and basically zero real borrowing costs. Yet Williams is at the cutting edge of policy rethinking at the Fed…. Mainstream thinking about macroeconomic policy has changed remarkably little, remarkably slowly.

You might say that it is always thus. But, you know, it isn’t…. Stagflation emerged as an issue in 1974, after the first oil shock, and pretty much ended with the Volcker double-dip recession of 1979-82–a recession whose end implication was that monetary policy continued to work in a fairly Keynesian way. So it was well under a decade of experience; yet it utterly transformed how everyone talked about macroeconomics.

Then came the 2008 crisis…. The sheer persistence both of depressed economies and of low inflation/interest rates should by now have led to a big rethinking. Depression economics redux has now gone on as long as stagflation did. Yet rethinking has been glacial at best. People who warned about the coming inflation in 2009 are warning about the coming inflation in 2016. Orthodox fears of budget deficits still dominate a lot of discourse. And the Fed still clings to an inflation target originally devised in the belief that the kind of thing that has happened to our economy would never happen.

I’m not entirely sure why learning has been so slow this time. Part of it, I suspect, is that the anti-Keynesian backlash of the 1970s had a lot of political power, and behind the scenes a lot of money, behind it–which influenced even academics, whether they realized it or not. And these days that same power and money is deployed against any rethinking. Whatever the explanation, however, it’s taking a painfully long time for serious policy discussion to arrive at a point that should have been obvious years ago.

Five Revisions of Its Model That the Fed Should Make or Test

Must-Read: Five Revisions of Its Model That the Fed Should Make or Test: And I do not think that the Fed is handling the process of revising its thinking properly.

I say that the Fed should, right now, be rethinking its estimates of:

  1. the long-run real natural rate of interest,
  2. the natural rate of unemployment,
  3. the slope of the Phillips Curve, and
  4. the gearing between recent past deviations of inflation from its target and expectations of future inflation.

Ryan Avent says that the Fed is rethinking (1) and (2), but also rethinking a (5): its estimate of long-run potential output growth. I don’t think there is evidence to rethink (5). I think that the consilience of a low pressure economy and apparent sluggish potential output growth is just too large for people to be satisfied rejecting it as a mere coincidence. Ryan agrees with me, and asks why the Federal Reserve seems to want to jump to conclusions about (5) rather than testing it. I agree. But I also want to ask: why isn’t the Fed rethinking its views on (3) and (4) as well? There is powerful evidence that they are different from the implicit model Fed policy has been running off of for the past decade as well:

Ryan Avent: Absence of Evidence: The Fed Rethinking One Thing too Many:

OFFICIALS at the Federal Reserve, a few of them anyway, seem to be rethinking their views of the economy in some dramatic ways….

Ben Bernanke suggests… top policy-makers still have confidence in their mental model of the economy; they have just been tweaking a few of the parameters… long-run… GDP growth… unemployment… and their benchmark interest rate…. The latter two [what I call (1) and (2)]—a lower unemployment rate and a lower long-run interest rate—clearly imply that rates will rise more slowly to a lower overall level. The projection of a lower potential growth rate [what I call (5)], however… suggests, for instance, that the American economy is running closer to its “speed limit”… push[ing]… toward a more hawkish stance…. These three revisions are not created equal…. [(1) and (2)] are clearly justified…. [(5)] is different, however. Available evidence is consistent with a world in which long-run potential growth has fallen… but… also… with an economy… growing slowly because of too little demand… in which both strong employment growth and low productivity growth are side effects of the low level of wages.

The only way to resolve the question in a satisfying way is to test it: to push the economy beyond the estimated potential growth rate and see if inflation rises…. Bernanke argues that Fed officials are willing to be a little patient with the economy, to see whether running it a little hot brings more workers into the labour force and encourages productivity-enhancing investments. It certainly seems clear to me that overshooting is the right way for the Fed to err….

But I am less confident than Mr Bernanke in the Fed’s openness to overshooting. It did not exactly intend to run the unemployment rate experiment that demonstrated how run its previous projections had been…. Now, the Fed looks all too willing to revise down its GDP growth projections without ever really testing them…. There is far too little radicalism at the Fed. It risks making permanent a low-growth state of affairs which is largely a consequence of its own excessive caution.

I would say may be rather than is. But one thing we agree on is that it is definitely the Fed’s responsibility to find out. And on its current policy trajectory it will find out only by accident–only if the economy turns out to be stronger than the Fed currently projects.

Datawrapper LsH98 Visualize

The Federal Reserve: I Repeat Myself

Real Gross Domestic Product FRED St Louis Fed

I repeat myself: to begin a tightening cycle and a process of interest-rate increases in December 2016–in fact, to announce in mid 2014 the end of further moves toward monetary expansion and a bias toward tightening as soon as it is not grossly imprudent–requires that one place only an infinitesimal weight on:

  1. Bond market very pessimistic long-run expectations.
  2. The asymmetry in policy responses and thus in risks created by the zero lower bound on short-term safe nominal interest rates.

I have been asking for quite a while now why any FOMC would choose to place such an infinitesimal weight not on just one but on both of these considerations. I have not gotten an answer from anywhere. I would like one. Very much…

What More Has to Happen Before the Fed Concludes That This Looks Like Yet Another Failed Interest-Rate Liftoff?

Real Gross Domestic Product FRED St Louis Fed

If you had told the Federal Reserve at the start of last December that 2015Q4, 2016Q1, and 2016Q2 were going to come in at 0.9%, 0.8%, and 1.2%, respectively, a rational Fed would not only have not raised interest rates in December, they would have announced that they would not even think of raising interest rates until well into 2017, and they would have started looking for more things they could do that would safely boost demand.

So why is the FOMC now not cutting interest rates back to zero? I mean, what more has to happen before the balance of probabilities says that this is likely to be yet another failed liftoff of interest rates?

Must-Read: Jon Faust: Why Has Transparency Been so Damn Confusing?

Must-Read: I believe that the extremely sharp Jon Faust is completely correct when he says that over the past three years Fed policy has been driven by: (1) as long as employment gains persist, gradually reducing accomodation; and (2) as long as inflation remains below target, pause in the removal of accommodation if it looks as though employment gains might falter. The problem is that there has been an awful lot of information hitting the Fed over the past three years about the economy. For one thing, we have learned that the unemployment rates typically thought of as reflecting full employment now come with prime-age employment-to-population ratios of not 81% or 80% but 78%:

Employment Population Ratio 25 54 years FRED St Louis Fed

And we have learned that financial markets are not looking forward to any maturity of Treasury bonds yielding more than inflation for, well, forever:

30 Year Treasury Constant Maturity Rate FRED St Louis Fed

Both of those pieces of information should have led to a reevaluation of the policy rule. They have not. Both of those pieces of information are not consistent with the economy evolving as the Fed expected it three years ago.

So the great question is: What–if anything–will trigger the Fed’s reevaluation of its policy rule? And what will it change its policy rule to if that reevaluation is triggered? That–rather than people getting distracted by shiny pronouncements from individual FOMC participants–is why transparency has been so damn confusing:

Jon Faust: Why Has Transparency Been so Damn Confusing?: “[Fed] consensus has behaved consistently as if driven by two principles…

…[1] So long as steady job market gains persist, continue a gradual, pre-announced removal of accommodation. [2] So long as inflation remains below target, take a tactical pause if credible evidence arises that the job gains might soon falter…. Over the last three years, we’ve gotten normalization at a preannounced pace as in to the first principle, punctuated only by brief (so far) tactical pauses as under the second…. My story directly contradicts the popular narrative of a skittish, market-obsessed Fed flip-flopping at every opportunity. This is where the well-disguised part comes in….

The 19 policymakers on the FOMC have, since the crisis held widely divergent views…. Under the leadership of the Chair, these views somehow blend in a reasonably coherent compromise policy… fully embraced by no one…. The chosen policy often appears to be an orphan, at best, and can become a whipping boy. But the consensus policy is generally much simpler to understand than those 19 component views…. There is a strong pull toward that ‘skittish, market-obsessed Fed’ narrative…. The FOMC statement and press conference… are the principal places where the communication is unambiguously directed at explaining the consensus…. Communications other than these systematically obscure and confuse much more than they clarify…

Must-Read: Narayana Kocherlakota: Three Antidotes to the Brexit Crisis

Must-Read: Correct, IMHO, from the very sharp Narayana Kocherlakota. Now perhaps his successor Neel Kashkari and the other Reserve Bank presidents not named Charlie Evans might give him some back up?

The one thing I do not like is Narayana’s “Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system.” That sentence seems to me to misread market psychology completely. As I see it–and as the people in markets I talk to say–right now markets are fairly completely spooked by their belief that the Federal Reserve is unconcerned, and takes that lack of concern as a sign of Federal Reserve detachment from reality. Narayana’s following sentences seems to me to be highly likely to be the right take: “I’d say the markets are already pretty spooked” and “By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management”.

Let me stress that, at least from where I sit, that confidence in Federal Reserve economic management is, right now, lacking.

The people I talk to in financial markets tend to say that they believe markets took Stan Fischer on January 5 to be something of a wake-up call with respect to Fed groupthink:

Liesman: When I looked at where the market is priced, the market is priced below where the Fed median forecast is. Quite a bit. Two rate hikes really, if you count them in quarter points. Does that concern you that the market needs to catch up with where the Fed is or is it a matter of you think the Fed needs to recalibrate to where the market is?

Fischer: Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis and our analysis says that the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there’s uncertainty. But we think that they are too low.

For eight straight years now the Federal Reserve has been more optimistic than the markets. And for eight straight years now the markets have been closer to being correct. And yet the Federal Reserve still believes that it “can’t be led by what the market thinks” and has “got to make our own analysis”? Why?

Narayana Kocherlakota: Three Antidotes to the Brexit Crisis: “The Fed should ensure that banks have enough loss-absorbing equity capital…

…not allow them to return equity to shareholders…. The measure should apply to all banks, so markets won’t read it as a signal about individual institutions’ relative strength. Second, there’s a risk that investors’ flight to safe assets could develop into a broader credit freeze. To mitigate this, the Fed should lower its short-term interest-rate target…. Finally, the Fed should consider reviving the Term Auction Facility, which allows banks to borrow funds from the central bank with less of the stigma…. Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system. That said, as an outsider who gets much of his information from Twitter, I’d say the markets are already pretty spooked. By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management. One important lesson of the last financial crisis is that the guarantors of stability must be proactive if they want to be effective. It’s time for the Fed to put that lesson into practice.

Must-Read: John Authers: Yield on 10-Yr U.S. Treasury…

Must-Read: That the Brexit vote would deliver a substantial leftward IS shock to the global economy was not very foreseeable. But that something could deliver such a shock was very foreseeable indeed.

S P 500© FRED St Louis Fed 30 Year Treasury Constant Maturity Rate FRED St Louis Fed 30 Year Treasury Constant Maturity Rate FRED St Louis Fed

Do not be reassured by the recovery of the stock market: P = D/(r-g). That the stock market has not gone up as a result of Brexit indicates that the lower interest rates expected in the long run (r) have been offset by the lower growth rate of profit due to additional expected economic weakness (g).

By now Yellen and Bernanke before her have had three full Reserve Bank president-appointment cycles–2006, 2011, and 2016–to get the non-Governor members of the FOMC on the page. It is no longer credible to claim that technocratic imperatives of ideal monetary policy have to bow to the requirements of maintaining committee consensus to promote banking-sector confidence with the Fed.

If financial markets were going to scream any louder that a régime shift to a less deflationary monetary policy régime is called for, how would they do that?

John Authers : On Twitter:

Must-Read: Jamie Chisholm: Treasury Yields Hit Record Lows

Must-Read: May I please have a theory from the Federal Reserve–I am not asking for much: just a theory–as to why they continue to be confident that their models are a better guide to likely futures than financial markets, and as to why they continue to regard the lower tail of outcomes as something that can be handled if and when it happens rather than something they need to be desperately clawing away from as fast as they can?

Jamie Chisholm: Treasury Yields Hit Record Lows: “The 10-year Treasury yield is down 7 basis points to 1.39 per cent…

…earlier touching 1.377 per cent, its most meagre offering on record. The 30-year Treasury yield also hit an all-time low of 2.14 per cent. Equivalent maturity German Bunds and UK gilts are down 3bp to minus 0.17 per cent and off 4bp to 0.80 per cent, respectively — also flirting with record lows. The Bank of England has already said it is likely to loosen policy further in coming months, and governor Mark Carney on Tuesday said banks could stop building up rainy-day funds in an attempt to support lending. Shares in real estate companies, life insurers and housebuilders are leading declines in London, following the Standard Life news. Miners are under pressure too, as the ‘risk off’ mood batters commodities, with base metals lower and Brent crude down 3.6 per cent to $48.31 a barrel.