Saturday, September 08, 2007

Monetary Policy Targets

Pondering my last post, I got to thinking: Why stop with LIBOR? Why not target commercial paper yields? Or even maturing junk bond yields? In practice, there are a couple of reasons I wouldn’t suggest such things. First, I don’t trust the rating agencies enough to make them partners in monetary policy. (The definition of what is being targeted would have to be standardized on the basis of ratings, which means that any upgrade or downgrade would change the de facto target.) Second, market-specific problems could distort the economic meaning of the policy. (The latter is already an issue, though, because problems specific to the banking system can distort the economic impact of a federal funds rate target.) But I still think that, in theory, targeting risky interest rates is a good idea.

Here’s my argument: The Fed sets its policy based on an economic forecast, which contains some implicit or explicit assumption about the price of risk. If the price of risk changes, there ought to be some automatic mechanism for altering policy so as to offset the change in the forecast. Targeting risky interest rates would be such a mechanism. (This is essentially the argument I made last month about why a cut in September would make sense.) In fact, the Fed already does this to some extent by targeting the federal funds rate: if the price of risk rises, so does the spread of the funds rate over the risk-free T-bill rate, and the Fed acts to push down the risk-free rate so as to keep the funds rate constant.

But if automatic policy adjustment is a good idea, why stop with risky interest rates? Why not, instead of targeting a single interest rate or reserve aggregate, target some linear (or nonlinear) combination of economic and financial data. (I’ve always thought, for example, that while targeting a single monetary aggregate makes little sense, the aggregates do contain information about how Fed policy is affecting the economy. I’d like to see them be part of such a composite target.) Seems to me that, with today’s technology, it is quite feasible to put monetary policy on autopilot between meetings instead of fixing some particular interest rate (which is kind of like just a primitive version of autopilot). And the formula could be announced and followed by the markets, as any competent quant could program her spreadsheet to mimic the Fed’s spreadsheet. And the decision at a meeting would be, not whether to change an interest rate target, but whether to adjust the autopilot parameters. OK, I’m dreaming, but…

Labels: , , , ,

18 Comments:

Anonymous William Polley said...

Second, market-specific problems could distort the economic meaning of the policy. (The latter is already an issue, though, because problems specific to the banking system can distort the economic impact of a federal funds rate target.)

There you go bringing up the "zero interest rate floor" again from the last post. This is not much of an "issue" at the time horizons for the effectiveness of monetary policy. We had a few days where a few trades were conducted at low prices because a constraint wasn't binding. It was, in fact, proof that the liquidity injection was sufficient to get through the few days of greatest strain on the system. This is a bad thing?

If the price of risk changes, there ought to be some automatic mechanism for altering policy so as to offset the change in the forecast. Targeting risky interest rates would be such a mechanism.

But the Lucas Critique applies here. If you base monetary policy on the price of risk, you will alter the behavior of market participants with regard to risk. That's a big concern.

Why not, instead of targeting a single interest rate or reserve aggregate, target some linear (or nonlinear) combination of economic and financial data.

Because you cannot consistently control too many things at once. The simple, canonical example is that you can't fix the inflation rate and the exchange rate simultaneously without capital controls. Likewise, you can't fix the T-bill rate (or the spread) and keep control over reserves. The markets are interconnected, and when you tug on one string, you unleash forces in places you hadn't expected. Tug on multiple strings and some cancel out while others unravel.

I suppose if an omniscient, benevolent social planner knew how all the threads were interconnected, then an internally consistent spreadsheet could be constructed.

Yeah, I think that meets the definition of dreaming.

Sun Sep 09, 02:41:00 AM EDT  
Blogger Karl Smith said...

I was checking out the time path of the 3M t-bill and the funds target.

It looks to me like the t-bill leads the funds target downward into recessions and though it is harder to tell it seems to lead the target upwards during inflationary periods.

Doesn' this mean targeting the t-bill will make credit markets less responsive to changes in the economy, since expectations of future policy could not be priced into the t-bill.

Doesn't this imply that targeting

Sun Sep 09, 09:34:00 AM EDT  
Anonymous Anonymous said...

I agree with a September cut.

Sun Sep 09, 09:42:00 AM EDT  
Blogger knzn said...

There you go bringing up the "zero interest rate floor" again from the last post.

That isn't really what I meant. I was more referring to a hypothetical situation where (for example) funds become tight in the banking system but alternative sources of credit are still easy. I don't know if this has happened, but with all the securitization and "non-bank banks" and such, it certainly seems possible.

But the Lucas Critique applies here. If you base monetary policy on the price of risk, you will alter the behavior of market participants with regard to risk. That's a big concern.

I don't see it as a problem. If the goods and labor markets had perfect price adjustment and the Fed could perfectly control some ideal price index, then the incipient deflationary impact from an increase in the price of risk would immediately result in a reduction of the risk-free rate. I want to make the real world more like that perfect one. True, if the Fed targeted the CP rate, CP holders would have less interest rate risk, but they would have the same default risk (except to the extent that the policy, by stabilizing business cycle conditions, makes default less likely -- but that's a good thing).

Because you cannot consistently control too many things at once.

You can control (to some degree) a mathematical function of many things. Your spreadsheet updates the value of the function continuously as the data inputs change, and you add reserves when the value of the function goes above the target and withdraw reserves when the value goes below the target.

That's roughly what the Fed did (in reverse, of course) when it was targeting M1, although the function in that case was just a simple sum of the different sub-aggregates.

Now that I think about it, that's basically what a Taylor rule is, too, except that the Taylor rule goes further by specifying exactly how much to react, and it assumes perfect control over some interest rate (which gets us back to the original problem).


But Karl has a point, I think: By targeting an overnight rate, the Fed is able to outsource term interest rate policy to people who, collectively, have a lot more resources than it does. Which means the Fed doesn't have to be constantly preoccupied with possibly needing to adjust its target, because the market basically does the job between meetings. I'll have to think about that.

Sun Sep 09, 12:35:00 PM EDT  
Anonymous William Polley said...

Karl's point, which you acknowledge, is actually very similar to mine. Specifically, it is also a version of the Lucas Critique. Karl says:

Doesn' this mean targeting the t-bill will make credit markets less responsive to changes in the economy, since expectations of future policy could not be priced into the t-bill.

Yes and no. They couldn't be priced into the T-bill, of course, because that's what you'd be fixing. But expectations related to other asset prices would adjust. And I don't think it would be a simple matter to trace out those effects. This is what I mean by pulling on one thread causing another to unravel. The bottom line is that the actual effect of targeting some arbitrary asset price with monetary policy will lead to changes in expectations and behavior in other markets to which that asset is linked. The result would be extremely hard to predict...much harder than you are acknowledging.

Now this time you say,

You can control (to some degree) a mathematical function of many things.

But that's not how I read your original...

Why not, instead of targeting a single interest rate or reserve aggregate, target some linear (or nonlinear) combination of economic and financial data. (I’ve always thought, for example, that while targeting a single monetary aggregate makes little sense, the aggregates do contain information about how Fed policy is affecting the economy. I’d like to see them be part of such a composite target.)

Which is it? Many variables as arguments into a function that yields a target for a single policy variable (interest rate, aggregate, or whatever), or targeting a multiple things at once? Your original post clearly says the latter. When I balk, you say that you're talking about the former, like a Taylor rule which is clearly something different (and not at all objectionable).

Do you acknowledge that targeting multiple variables would be problematic (c.f. Poole 1970)?

Of course I have no problem with a Taylor rule.

Sun Sep 09, 03:06:00 PM EDT  
Blogger knzn said...

When I said, "some linear (or nonlinear) combination of economic and financial data," I meant a mathematical function, such as SUM(w[i]x[i]), where the x's are the individual variables you are combining, and the w's are chosen as a set of parameters embodying the current policy. My idea was just that you push reserves when the function goes above its target and pull reserves when the function goes below. (Just as a formal matter, the x's need to be defined such that they tend to fall when you push reserves, so for example, you would choose "yen per dollar" rather than "dollars per yen" and so on.)

One step further is to make the amount of reserves you push/pull a function of the amount by which the objective deviates from its target. (And of course the instrument doesn't need to be reserves; it could be the T-bill yield. I guess Taylor treats the federal funds rate as the instrument, but that's abstracting a bit, since the Fed doesn't really have its hand directly on that instrument. So a Taylor rule in practice involves two levels of instrumentation.)

I have issues with the Taylor rule in particular (which I'll probably discuss in a later post), but what I'm suggesting is essentially a between-meeting operating procedure that would have a form analogous to the Taylor rule.

Sun Sep 09, 03:34:00 PM EDT  
Anonymous William Polley said...

Ok, our misunderstanding was over the word "target". When I see "target" as in "target a single interest rate" or "target some linear (or nonlinear) combination of economic and financial data", I read that as a statement about the desired outcome. As in, the target for the fed funds rate is 5.25%. That's the desired outcome. For an inflation targeting scheme, you might have a target of 2% inflation. Again, the target is a (single) desired outcome. I balked at the idea of having multiple targeted outcomes. You can have multiple inputs, but in general you can't induce the desired change in all the inputs simultaneously. That's how I read your original post. Sorry for the misunderstanding.

So yes, you can control a function of many things. I'm not convinced that it would be desirable to have a lot of things in that function though. As you start to construct the mapping and add variables I fear that it would start to look like a Ptolemaic system of epicycles upon epicycles. The model would be a complicated and in need of frequent revision.

Whereas something like a simple inflation target would be simpler and would be almost as good (and perhaps better) at achieving the goal and with less need for revision.

I don't think we understand the economy well enough to construct a one-to-one mapping of, say, more than three variables to a policy instrument. Do you? And what happens the first time that the model kicks out a result that doesn't square with the "boots on the ground" instinct of the central bankers? The more variables in the model, I think the more likely that scenario becomes.

Mon Sep 10, 12:22:00 AM EDT  
Anonymous Anonymous said...

福~
「朵
語‧,最一件事,就。好,你西.............................................................................................................
..................

Thu Apr 02, 10:33:00 AM EDT  
Anonymous Anonymous said...

酒店喝酒,禮服店,酒店小姐,酒店領檯,便服店,鋼琴酒吧,酒店兼職,酒店兼差,酒店打工,伴唱小姐,暑假打工,酒店上班,酒店兼職,ktv酒店,酒店,酒店公關,酒店兼差,酒店上班,酒店打工,禮服酒店,禮服店,酒店小姐,酒店兼差,暑假打工,酒店經紀,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,台北酒店,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,寒假打工,酒店小姐,禮服店 ,酒店小姐,酒店經紀,酒店兼差,暑假打工,酒店小姐,酒店傳播,酒店經紀人,酒店,酒店,酒店,酒店 ,禮服店 , 酒店小姐,酒店經紀,酒店兼差,暑假打工,招待所,酒店小姐,酒店兼差,寒假打工,酒店上班,暑假打工,酒店公關,酒店兼職,禮服店 , 酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工,酒店,酒店,酒店經紀,酒店領檯 ,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,禮服店 ,酒店小姐 ,酒店經紀 ,酒店兼差,暑假打工, 酒店上班,酒店經紀

Mon Apr 20, 11:13:00 PM EDT  
Blogger Talia.float said...

Bought the Tennis Racquet is important, exercise can reduce the harm, especially for the wrist injury. But the good of Tennis Racket in general in the real prices are more expensive, so a lot of websites now have cheap tennis racquet,tennis racquet discount,cheap tennis racket,discount Tennis Racket .

Tue May 19, 12:09:00 AM EDT  
Blogger how to buy air shoes said...

Some new style Puma Speed is in fashion this year. chaussure puma is Puma Shoes in french. Many france like seach “chaussure sport” by the internet when they need buy the Puma shoes or buy the nike max shoes.The information age is really convenient. By the way ,the puma CAT is really good chaussures puma ,don’t forget buy the puma mens shoes and nike air max ltd by the internet when you need them . Do you know Nike Air Shoes is a best Air Shoes .

Spring is coming, and how to choose the polo shirts is the main concern of many people. ralph lauren polo shirts is a classic type and reliable. ed hardy clothing is more in line with the aesthetic ideas of young people, so many young people filled with a variety of ed hardy clothes in their wardrobes. New style ed hardy womens shirt match the new style ed hardy sunglasses , it is a good idea.
Do you think this season is not for ugg boots ? maybe yes .but this season is best time that can buy the cheap ugg boots. Many sellers are selling discounted. Do not miss . Please view my blog and fc2 blog .thank you .

Tue May 19, 06:04:00 AM EDT  
Blogger wow power leveling said...

cheap wow gold buy wow power leveling my wow gold cheapest wow power leveling
replica replica rolex
CHEAP wow power level
BUY power leveling
replica rolex replica
cheap lotro gold
replica rolex
CHEAPEST power leveling
cheap rs gold l

Tue Jun 09, 10:14:00 PM EDT  
Blogger zero said...

翻譯|醫學美容|汽車報廢|童裝批發|家教|室內裝潢|徵信|清境民宿|催情性藥品

Fri Aug 21, 03:52:00 AM EDT  
Blogger Adi said...

Oes Tsetnoc one of the ways in which we can learn seo besides Mengembalikan Jati Diri Bangsa. By participating in the Oes Tsetnoc or Mengembalikan Jati Diri Bangsa we can improve our seo skills. To find more information about Oest Tsetnoc please visit my Oes Tsetnoc pages. And to find more information about Mengembalikan Jati Diri Bangsa please visit my Mengembalikan Jati Diri Bangsa pages. Thank you So much.

Sun Nov 22, 01:24:00 AM EST  
Anonymous Tag Heuer Watches said...

Rolex Watches Rolex Watches
Tag Heuer Watches Tag Heuer Watches
rolex replica rolex replica
replica rolex replica rolex
rolex replica watches rolex replica watches
replica rolex watches replica rolex watches
Tag Heuer Tag Heuer
replica Tag Heuer replica Tag Heuer
Tag Heuer replica Tag Heuer replica
rolex rolex
rolex air king rolex air king
rolex datejust rolex datejust
rolex day date rolex day date
rolex daytona rolex daytona
rolex gmt rolex gmt
rolex submariner rolex submariner
rolex yachtmaster rolex yachtmaster
rolex air king watches rolex air king watches
rolex datejust watches rolex datejust watches
rolex day date watches rolex day date watches
rolex daytona watches rolex daytona watches
rolex gmt watches rolex gmt watches
rolex submariner watches rolex submariner watches
rolex yachtmaster watches rolex yachtmaster watches

Mon Dec 21, 04:36:00 AM EST  
Anonymous Anonymous said...

網頁設計FreeForm徵信,翻譯,外遇電扇電風扇涼風扇,酒瓶雕刻禮贈品禮品贈品

Mon Aug 16, 10:26:00 PM EDT  
Anonymous Anonymous said...

|Alexander McQueen Leather zip pumps
|Alexander McQueen Metallic leather zip flip flops
|Alexander McQueen Nude Skull Zipper Flat
Christian Louboutin Big Lips 120 calf hair pumps
Christian Louboutin Bowed Zebra Suede Peep-Toes

Wed Sep 22, 11:34:00 AM EDT  
Blogger boshi said...

power balance
winter boots
ecco shoes
Bakugan Toys
Movado Bold
Baby Carriers

Mon Jan 24, 04:18:00 AM EST  

Post a Comment

Links to this post:

Create a Link

<< Home