Will the funds rate have time to get back to “normal” (wherever that is) before the next recession?

August 24th, 2016 at 1:20 pm

I’ve got  a piece up at WaPo riffing off of this new paper by Fed economist David Reifschneider (DR). I wanted to add an interesting figure here that I couldn’t jam in the WaPo post.

Some of the data in the figure comes from DR’s table 1 showing the number of basis points (hundredths of a percent, so 100 bps is one percentage point) that the Fed has reduced the main tool it controls–the Federal funds rate–over a number of recessions. The black dot shows where the funds rate was when they began their lowering campaign, the arrows show how much they lowered, and the green box shows where they stopped (this excellent graphic was custom made for me by Ben Spielberg; see data note below). For example, to apply countercyclical monetary policy in the case of the Great Recession–the last bar in the figure–the Fed took the rate down from about 500 bps to zero.

Source: Reifschneider, Federal Reserve

Source: Reifschneider, Federal Reserve

The last dot shows where the rate is today–close to zero (~40 bps)–which is where it should be IMHO as we’re not yet at full employment and there’s no worrisome signs of overheating; inflation remains quiescent such that the Fed keeps missing their 2% inflation target on the downside.

DR’s simulations assume that last dot climbs in time to give the Fed some height to drop from when the next downturn hits (importantly, he stresses that the neutral funds rate is very likely lower than it used to be), but, as I argue in the piece, with some evidence from market expectations of the funds rate, I’m skeptical.

Data note for graph: The maximum and minimum federal funds rates before 1990 were almost all calculated using the methodology described in Reifschneider’s footnote 1, table 1. They are the maximum and minimum effective federal funds rates in any given month spanning from 6 months before the recession began to 6 months after the recession ended, with only one exception: the end period extends to only the official end of the 1980 recession in July of 1980, and not 6 months afterwards, because rates began rising afterwards and including those months would have made the drop appear larger than it actually was. During the three most recent recessions, the time periods used to determine the maximum and minimum effective federal funds rates were June 1990 to December 1992 (DR’s ftnt has January 2002 for the latter date for this period but we assume that’s a typo), December 2000 to January 2002, and August 2007 to December 2008. The methodology for the post-1980 recessions is slightly different than that Reifschneider used, as he uses “intended” fund rates beginning in 1990, which differ slightly from effective rates, but they tell the same story.

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13 comments in reply to "Will the funds rate have time to get back to “normal” (wherever that is) before the next recession?"

  1. John Smith says:

    You didn’t link to the washington post article correctly, both links go to the paper!

  2. Smith says:

    This thinking is somewhat backwards in that interest rates won’t matter anyway in a recession from weak demand, and they can’t matter in a recession with low inflation already. There will be no high interest rate holding back investment. There will be no high interest rate that was raise to counter inflation. You can have economic malaise that others call mythical sec stag to describe a stagnant economy that mimics feudal society only with much higher standard of living. The peasants (the 99% with stagnant or declining wages) work for the 1%, with little productivity improvement, capital investment, or impetus for invention. Just endless rounds of downsizing, mergers creating economies of scale and less jobs, globalization, importing workers who depress wages due to country of origin standards, or because they don’t have full labor rights or any labor rights (all employer sponsored based immigrants).
    When and if that recession hits and there is no available monetary response, then perhaps a fight will ensue between Republicans and Democrats over fiscal measures (tax cuts vs. deficit spending). May the best party win. Either way large deficits will lead to recovery pumping money and spending into the economy, either a weak recovery that fosters greater inequality, or stronger recovery that funds needed government programs. Either way the life goes on.

  3. John San Vant says:

    We are at full employment. Getting rid of the yry composite shows a projected 3.1% rate of wage growth in 2016. That is a noticeable acceleration from 2015 and will grow stronger in the future.

    What your talking about is max employment and no, we are not there yet. But the Fed pretty much by not raising rates, has created a situation where overheating looks likely by 2019-20. They let the China fake out earlier in the year effect them.

  4. Tom_in_MN says:

    That top rate starting point is about at the 10 year Treasury rate, which is less than 200 bps now, so that’s the best starting point one could hope for. I though this


    Was good on this point. I don’t think things will get better until the inflation target is raised, at least there is an increasing number of influential people talking about it. This also ties in with your full employment emphasis, which the above article claims the FED is ignoring, which is certainly how things have worked out.

  5. Blissex says:

    Does the FOMC worry about the impact of changing interest rates (nominal or real) on bond prices, especially those use for collateralized trading, and through that to balance sheets?

    By anchoring expectations to low inflation and ever falling interest rates, that have been embedded in bond prices, the FOMC may have created a big Minsky moment, and now have the tiger by the tail.

  6. Smith says:

    Sad news today reported on the Times website, Yellen pronounces economy strong enough for interest rates to rise, though the article speculates not until after the election.
    The labor force is missing a million workers who left in the past four years. That’s excluding the another million from retiring boomer demographics. Wages have gone nowhere though aided by one time drop in oil prices. The world economy is in worse shape. Business investment is weak except for mergers that create economies of scale, less jobs, less competition, less money available for R&D and improved productivity.
    The article closes by citing the need to increase productivity with education and investment. Except currently there is a glut of college graduates who take away jobs from those with less education. There are a ton of low wage low skill jobs however, for which depression level unemployment levels and exploited immigrants keep wages low. The 1% who profit from a weaker economy, giving up some sales to retain dominance over pliant labor market, and 20% share of national income, laugh all the way to the Fed Bank

    • Smith says:

      ok, asuuming the Times correctly reported what Yellen said, it just gets crazier.
      Here’s the quote and reporting:
      “Finally, and most ambitiously, as a society we should explore ways to raise productivity growth,” she said. Among the possibilities, she mentioned investment in education and infrastructure and reductions in regulation.
      My previous comment already mentioned the American workforce is already over educated for available job openings. Investment in infrastructure is needed to forestall decline in productivity from decaying roads and transportation networks. But it’s not a recipe for improved productivity. Better productivity results from incremental change in factories and offices when a growing economy and higher wages mean sustained incentive to produce more efficiently. Higher wages push productivity, not higher productivity allows higher wages.

      The remark on regulation is laughable, one hopes this isn’t an accurate portrayal of her thinking. It would be effective to streamline and automate compliance with regulations, but that’s not what the reporting implies.

      One more comment, investment in education doesn’t mean more money thrown at a problem, NY, NJ, and Mass spend $20,000 per student per year for public schools. College tuition is very inflated and misdirected to overhead expenses and million dollar salaries for fund raising.

      • Smith says:

        Left out obvious need for increased productivity, increased funding of R&D by government, and not with corporate partnerships that makes science proprietary.

  7. Fritz III says:

    What’s interesting about this graph is the the fourth, fifth and sixth arrows collectively span a period of time which, for boomers and gen-Xers, represents a significant amount of their adult lifetimes and personal experience with what “normal” interest rates are. It colors their fears of inflation, and drives their desire to raise rates sooner rather than later in response.

    • Jared Bernstein says:


    • Smith says:

      Not to spoil the fun for anyone, but a relatively tiny number of people pay any attention to moves by the Fed, the inflation rate, and interest rates. Things like inflation and unemployment really have to get very seriously out of whack for Americans to punish politicians for economic conditions at the polls. Even when voters seek redress for high unemployment or inflation, it’s based on buying into a short term narrative that is successfully sold by the winning party, not previous experience.

      My main point is fear of high inflation from middle age adult or childhood memories, even if they exist, are mostly irrelevant. The battle over interest rates and basis points is an insiders game fought between bankers, lobbyists, and politicians. Democrats are corrupt because they could win this game with public pressure by saying if the Fed raises rates, your credit card payments go up, your car payments go up, the value of your house declines, bankers profits increase (not that they aren’t too high already).
      Some research contradicts expectations based on historical record:
      However this research may not apply to present conditions.

      In the public sphere, debate over inflation is led by the current effectiveness of rhetoric and dominant message in the media, not memory, which itself is subject to manipulation. Privately, actual decision makers and influencers readily concede they are unable to predict or control inflation without resorting to the bludgeon of higher unemployment. There is no mention of the true source of inflation, higher prices, and the measures available to combat that actual cause. Exceptions due to extremely egregious cases exist, hence the Epi-pen.

      Meanwhile, actual inflation is .8% albeit due to oil price drops, nominal wages are stagnant, and workforce participation historically low, excluding demographic effects, masking recession level unemployment. These conditions plus a weak global economy, all argue forcefully against any inflation threat or rate rise. What possible explanation can then exist for the serious consideration by a center left led central bank for such contraindicated policy? It’s possibly a huge error, like ignoring the housing bubble was, though this violates the doctrine of Fed infallibility. This does not excuse the political class from insisting on more sensible alternatives, but there is no opposition to bankers. “They frankly they own the place.” (Sen Durbin) Only when a political party or class sees the dominance of the 1% as a threat to their election or incumbency, will the Phillips Curve and NAIRU be consigned to the dustbin of history.

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