Comments on: IS THIS WHAT WE HAVE TO LOOK FORWARD TO? http://movietradingcards.com/uncategorized/is-this-what-we-have-to-look-forward-to/ Tue, 05 Apr 2011 12:09:19 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Yakuza http://movietradingcards.com/uncategorized/is-this-what-we-have-to-look-forward-to/comment-page-1/#comment-265 Yakuza Mon, 11 Jan 2010 10:46:21 +0000 http://movietradingcards.com/uncategorized/is-this-what-we-have-to-look-forward-to/#comment-265 Indeed, one could argue (and some policymakers do argue) that the most natural sequencing would be to tighten the fiscal stance and the Fed’s balance sheet policies before raising the funds rate. Large-scale fiscal stimulus and Fed asset purchases were only adopted as emergency measures after the funds rate had hit the zero lower bound. Both policies can be thought of as attempts to get closer to the negative funds rate prescription of Exhibit 1. If and when this prescription changes—i.e. if and when the Taylor rate moves back toward zero the logical first step might be to unwind these fiscal and balance sheet policies before raising the funds rate, especially given the structural imbalance of the federal budget and the markets’ hypersensitivity (misplaced, we believe) about the inflationary implications of a bloated central bank balance sheet. It would be a mistake to take this “sequencing” argument too far. On the fiscal side, it will be difficult politically to actively tighten policy, i.e., raise taxes or cut spending at a time when the unemployment rate is around 10%. On the balance sheet side, only a minority of Fed officials seem to favor outright asset sales. Others worry, in our view correctly, that it may be difficult to calibrate the effects of such sales on financial conditions and would prefer hikes in the funds rate to precede outright asset sales. But a softer version of the sequencing argument may still apply. Even if there is no turn to active restraint via tax hikes, spending cuts, or asset sales, it is highly likely that there will be some passive restraint. Exhibit 2 shows that we expect fiscal policy to turn from stimulus by late 2010 or early 2011. Moreover, the asset purchase program is likely to be completed in the first quarter of 2010, and this might lead to a tightening of financial conditions if the “flow” of purchases matters for either the level of long-term yields or the valuation of other assets. The larger these passive restraints, the further away is the point at which Fed officials will need to turn to federal funds rate hikes to in order to fend off inflationary pressures Indeed, one could argue (and some policymakers do argue) that the most natural sequencing would be to tighten the fiscal stance and the Fed’s balance sheet policies before raising the funds rate. Large-scale fiscal stimulus and Fed asset purchases were only adopted as emergency measures after the funds rate had hit the zero lower bound. Both policies can be thought of as attempts to get closer to the negative funds rate prescription of Exhibit 1. If and when this prescription changes—i.e. if and when the Taylor rate moves back toward zero the logical first step might be to unwind these fiscal and balance sheet policies before raising the funds rate, especially given the structural imbalance of the federal budget and the markets’ hypersensitivity (misplaced, we believe) about the inflationary implications of a bloated central bank balance sheet.

It would be a mistake to take this “sequencing” argument too far. On the fiscal side, it will be difficult politically to actively tighten policy, i.e., raise taxes or cut spending at a time when the unemployment rate is around 10%. On the balance sheet side, only a minority of Fed officials seem to favor outright asset sales. Others worry, in our view correctly, that it may be difficult to calibrate the effects of such sales on financial conditions and would prefer hikes in the funds rate to precede outright asset sales.

But a softer version of the sequencing argument may still apply. Even if there is no turn to active restraint via tax hikes, spending cuts, or asset sales, it is highly likely that there will be some passive restraint. Exhibit 2 shows that we expect fiscal policy to turn from stimulus by late 2010 or early 2011. Moreover, the asset purchase program is likely to be completed in the first quarter of 2010, and this might lead to a tightening of financial conditions if the “flow” of purchases matters for either the level of long-term yields or the valuation of other assets. The larger these passive restraints, the further away is the point at which Fed officials will need to turn to federal funds rate hikes to in order to fend off inflationary pressures

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