Wednesday, December 15, 2010

Heads I win, tails you lose

I am a little bit confused about Fed policy evaluation 101. I seem to be flunking that course.

Quantitative Easing II was supposed to lower long term interest rates. That was the stated goal of the policy.

Long term interest rates have been steadily rising (even before the latest borrowing binge announcement).

Yet many people say that the fact that rates are rising MEANS QE II is WORKING!

As my good friend Doug Nelson likes to say, "you have to be a very highly trained economist to come to that conclusion".

Now maybe the Fed is playing the long con and deliberately misinformed the public about the true purpose of their policy. Could you see the Ben Bernank announcing "We want to raise inflation expectations and long term interest rates"?

I think that they actually expected to lower long rates and the episode should be viewed as an example of the idea that the further out in the term structure the Fed aims, the less control they actually have over rates.

I guess there are two kinds of people in this world; those who think the Fed is always wrong and those who think the Fed is always right.


Anonymous said...

perhaps fiscal policy is also affecting the 10-year note yield?

Anonymous said...

Doesn’t the Fisher equation say that i=r+pie^e? If i=almost 0 then the only real power the fed has is to create inflation expectations. If nominal interest rates are rising, then yes the policy is a success. I believe that Ben is truly concerned about deflation. If I remember correctly fishers debt deflation theory would also explain what the fed is doing right now. Right or wrong this is likely why we have QE2. Am I incorrect?

Contemplationist said...

I beg of you. Please, please read your Scott Sumner. Economists need to stop flailing about and read Scott Sumner NOW.