Monetary policy: Low rates forever

Posted: November 26, 2013 in economy
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JAMES HAMILTON looks at some interesting new research (which derives an easy way to calculate implied forward interest rates) and finds that markets expect interest rate increases to come very gradually indeed—when, that is, the Fed finally begins raising rates. Right now, the first increase in overnight rates looks likely to occur in early 2015. Markets don’t expect rates to top the 2% mark until 2 years later, and by the end of 2018—almost a full decade after the end of the recession—the overnight rate will still be shy of 3.5%. The anticipated path of tightening is interesting, he points out, in how it contrasts with the experience of the recent past:

Once the Fed got tightening in previous episodes it didn’t mess around. In choking off the last recovery, for instance, the Fed raised rates by 18 basis points per month. If rate increases go as expected in future, by contrast, the Fed will be hiking at just 6 basis points per month. Interestingly, Mr Hamilton notes, markets did a decent job anticipating the faster pace of rate increases during previous tightening cycles.The chart of past rate rises is an interesting one. We see five tightening cycles. Recession falls quickly on the heels of three of them. One is tempted to conclude that about 60% of the time (it’s a small sample I know), the Fed overdoes it when tightening policy.And so considering the evidence, we …

via Economic Crisis


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