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The Fed is reactive. The Fed doesn't set interest rates, the market does. I believe this is one of the biggest misconceptions about our central bank. Yes, the F

The Fed is reactive. The Fed doesn't set interest rates, the market does. I believe this is one of the biggest misconceptions about our central bank. Yes, the Fed plays an obvious role, more to do with printing money for whatever the issue-of-the-day is, but the market is far more powerful than the Fed when it comes to interest rates. If the Fed raised rates 500bps tomorrow, over time, interest rates would still settle back at 0%, and all the Fed would've done is created complete dysfunction. Central banks are reactive.

dragonwriter 5y ago
> The Fed doesn't set interest rates, the market does. The Fed sets interest rate targets, and the intervenes, maasively if necessary, in the market to acheive them. > If the Fed raised rates 500bps tomorrow, over time, interest rates would still settle back at 0% The only reason rates are near zero is that the Fed has set its rate target near zero and intervened massively in the market to attain that target. If the Fed raised its rate target and kept it higher, rates would rise and stay higher. When the Fed target, was higher (most of the Fed’s history), interest rates remained higher. The Fed doesn't set its targets based on what it thinks the market would do without intervention, but based on what it thinks needs to happen to achieve its balance of employment and price stability objectives. > Central banks are reactive. You bracket your post, beginning and end with it, but you don't seem to understand that all it means is that Central Bank action goals respond to observed conditions. You act as if it means the Central Bank is impotent to affect conditions, and in particular interest rates, which is clearly false.
- chii 5y ago
  > [Feds] intervenes, maasively if necessary The Feds have some scope to nudge the interest rate, but they cannot massively change it against the market. The persistent low rates of the past 2 decades are mostly market driven, because there's been a lack of growth. The feds try to nudge lower the rates past the "natural" rate (a rate as if they weren't there), but the trend of the rates being down isn't determined by the Feds.
  - whimsicalism 5y ago
    Seems surprising to me that you can look at financial history and conclude in any way that the Fed is somehow impotent.
    - chii 5y ago
      this video gives an opinion that i believe to be true: https://www.youtube.com/watch?v=92MA6CxhBXA https://www.youtube.com/watch?v=92MA6CxhBXA The feds have the ability to influence rates a bit, but not set them directly as they wish.
      - whimsicalism 5y ago
        I guess I disagree with this guy's characterization - unless the point he is making is that the Fed has to operate within the constraints of what makes sense given the market or otherwise the market fails. This blog post summarizes my opinion https://www.themoneyillusion.com/monetary-policy-and-interest-rates/ https://www.themoneyillusion.com/monetary-policy-and-interes...
        chii 5y ago
        > Fed has to operate within the constraints of what makes sense that's an implicit assumption all rational economists would have. It's like saying the US could just be holding the entire world hostage by threatening to nuke the entire world. The blogpost you linked is basically confirming that the feds don't have unlimited room for controlling interest rates. they can merely nudge it a bit here and there, and hope for the best. I like the analogy of the bus driver through the Alps.
- ItsMonkk 5y ago
  But they can only set the Fed Funds Rate at a rate that is lower than the 30y Treasury rate. Any higher and we get a yield curve inversion and a recession[0]. And as the GP says, the destabilizing effect of that recession only pushes rates down until we reach 0%. So as the 30YT falls, the Fed can do nothing but allow it to fall further. [0]: https://fred.stlouisfed.org/graph/?g=ENDs https://fred.stlouisfed.org/graph/?g=ENDs
  - dragonwriter 5y ago
    > But they can only set the Fed Funds Rate at a rate that is lower than the 30y Treasury rate. Wrong. They can set the Fed fund rate target anywhere they want. The same interventions that move the rate the target addresses toward the target also normally move other rates, including various Treasury rates, in the same direction, which is why Fed action on the Ged funds target is usually discussed as action on interest rates, not just the single rate the target nominally applies to. > Any higher and we get a yield curve inversion and a recession[0]. Yield curve inversions (in any of the Treasury rates, not just the 30-year) are typically viewed as potential recession signals because they reflect an abnormal decoupling of usually-linked behavior representing broad insecurity with the investment opportunities in private markets. They are not viewed as causing recessions, and thus the 30 year Treasury rate is not a constraint on Fed funds targets.
    - AnimalMuppet 5y ago
      They can set the Fed fund rate anywhere they want... if they are willing to accept the consequences of doing so. Anywhere they set the Fed fund rate, there will be consequences, of one kind or another. The Fed is trying for the lest-bad set of consequences, and therefore their possible policy is severely constrained.
      - whimsicalism 5y ago
        Does the Fed have the ability to set interest rates at whatever it wants them to be? Yes, end of story. Should the Fed set interest rates arbitrarily? No, but that was not what was being discussed.
lottin 5y ago
It's not so much that central banks are reactive as that central banks can't set interest rates and the inflation rate simultaneously. In other words, central banks can set nominal interest rates, but real rates (i.e. nominal rates adjusted for inflation) are ultimately set by the market.
- imtringued 5y ago
  This is just an indirect form of the impossible trinity. https://en.wikipedia.org/wiki/Impossible_trinity https://en.wikipedia.org/wiki/Impossible_trinity Targeting low inflation is price stability and assuming every single central bank targets the same inflation target then you implicitly target a specific exchange rate (with some fluctuations). If you set the interest rate arbitrarily people flee the currency and break the implicit peg which can manifest itself as inflation.
whimsicalism 5y ago
The Fed has effectively complete control over nominal rates, your mental model for the economy is incorrect. I am unsure why you think that 0% is the natural rate for rates (I'm assuming you mean real as the alternative misunderstanding is even worse). People prefer to have money now rather than money later.
- imtringued 5y ago
  He just means that raising interest rates will lead to less debt growth and therefore decrease inflation which then lowers the natural interest rates downwards where it will then get stuck at 0% because negative interest rates can't be implemented on cash. According to the Friedman Rule 0% interest is an ideal interest rate assuming no inflation or deflation. However, what ideal really means in practice and whether we can actually have no inflation is still unknown.

dragonwriter 5y ago

> The Fed doesn't set interest rates, the market does. The Fed sets interest rate targets, and the intervenes, maasively if necessary, in the market to acheive them. > If the Fed raised rates 500bps tomorrow, over time, interest rates would still settle back at 0% The only reason rates are near zero is that the Fed has set its rate target near zero and intervened massively in the market to attain that target. If the Fed raised its rate target and kept it higher, rates would rise and stay higher. When the Fed target, was higher (most of the Fed’s history), interest rates remained higher. The Fed doesn't set its targets based on what it thinks the market would do without intervention, but based on what it thinks needs to happen to achieve its balance of employment and price stability objectives. > Central banks are reactive. You bracket your post, beginning and end with it, but you don't seem to understand that all it means is that Central Bank action goals respond to observed conditions. You act as if it means the Central Bank is impotent to affect conditions, and in particular interest rates, which is clearly false.

chii 5y ago
> [Feds] intervenes, maasively if necessary The Feds have some scope to nudge the interest rate, but they cannot massively change it against the market. The persistent low rates of the past 2 decades are mostly market driven, because there's been a lack of growth. The feds try to nudge lower the rates past the "natural" rate (a rate as if they weren't there), but the trend of the rates being down isn't determined by the Feds.
- whimsicalism 5y ago
  Seems surprising to me that you can look at financial history and conclude in any way that the Fed is somehow impotent.
  - chii 5y ago
    this video gives an opinion that i believe to be true: https://www.youtube.com/watch?v=92MA6CxhBXA https://www.youtube.com/watch?v=92MA6CxhBXA The feds have the ability to influence rates a bit, but not set them directly as they wish.
    - whimsicalism 5y ago
      I guess I disagree with this guy's characterization - unless the point he is making is that the Fed has to operate within the constraints of what makes sense given the market or otherwise the market fails. This blog post summarizes my opinion https://www.themoneyillusion.com/monetary-policy-and-interest-rates/ https://www.themoneyillusion.com/monetary-policy-and-interes...
      - chii 5y ago
        > Fed has to operate within the constraints of what makes sense that's an implicit assumption all rational economists would have. It's like saying the US could just be holding the entire world hostage by threatening to nuke the entire world. The blogpost you linked is basically confirming that the feds don't have unlimited room for controlling interest rates. they can merely nudge it a bit here and there, and hope for the best. I like the analogy of the bus driver through the Alps.
ItsMonkk 5y ago
But they can only set the Fed Funds Rate at a rate that is lower than the 30y Treasury rate. Any higher and we get a yield curve inversion and a recession[0]. And as the GP says, the destabilizing effect of that recession only pushes rates down until we reach 0%. So as the 30YT falls, the Fed can do nothing but allow it to fall further. [0]: https://fred.stlouisfed.org/graph/?g=ENDs https://fred.stlouisfed.org/graph/?g=ENDs
- dragonwriter 5y ago
  > But they can only set the Fed Funds Rate at a rate that is lower than the 30y Treasury rate. Wrong. They can set the Fed fund rate target anywhere they want. The same interventions that move the rate the target addresses toward the target also normally move other rates, including various Treasury rates, in the same direction, which is why Fed action on the Ged funds target is usually discussed as action on interest rates, not just the single rate the target nominally applies to. > Any higher and we get a yield curve inversion and a recession[0]. Yield curve inversions (in any of the Treasury rates, not just the 30-year) are typically viewed as potential recession signals because they reflect an abnormal decoupling of usually-linked behavior representing broad insecurity with the investment opportunities in private markets. They are not viewed as causing recessions, and thus the 30 year Treasury rate is not a constraint on Fed funds targets.
  - AnimalMuppet 5y ago
    They can set the Fed fund rate anywhere they want... if they are willing to accept the consequences of doing so. Anywhere they set the Fed fund rate, there will be consequences, of one kind or another. The Fed is trying for the lest-bad set of consequences, and therefore their possible policy is severely constrained.
    - whimsicalism 5y ago
      Does the Fed have the ability to set interest rates at whatever it wants them to be? Yes, end of story. Should the Fed set interest rates arbitrarily? No, but that was not what was being discussed.

lottin 5y ago

It's not so much that central banks are reactive as that central banks can't set interest rates and the inflation rate simultaneously. In other words, central banks can set nominal interest rates, but real rates (i.e. nominal rates adjusted for inflation) are ultimately set by the market.

imtringued 5y ago
This is just an indirect form of the impossible trinity. https://en.wikipedia.org/wiki/Impossible_trinity https://en.wikipedia.org/wiki/Impossible_trinity Targeting low inflation is price stability and assuming every single central bank targets the same inflation target then you implicitly target a specific exchange rate (with some fluctuations). If you set the interest rate arbitrarily people flee the currency and break the implicit peg which can manifest itself as inflation.

whimsicalism 5y ago

The Fed has effectively complete control over nominal rates, your mental model for the economy is incorrect. I am unsure why you think that 0% is the natural rate for rates (I'm assuming you mean real as the alternative misunderstanding is even worse). People prefer to have money now rather than money later.

imtringued 5y ago
He just means that raising interest rates will lead to less debt growth and therefore decrease inflation which then lowers the natural interest rates downwards where it will then get stuck at 0% because negative interest rates can't be implemented on cash. According to the Friedman Rule 0% interest is an ideal interest rate assuming no inflation or deflation. However, what ideal really means in practice and whether we can actually have no inflation is still unknown.