The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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November 24, 2009

Interest rates at center stage

In case you were just yesterday wondering if interest rates could get any lower, the answer was "yes":

"The Treasury sold $44 billion of two-year notes at a yield of 0.802 percent, the lowest on record, as demand for the safety of U.S. government securities surges going into year-end."

"Demand for safety" is not the most bullish sounding phrase, and it is not intended to be. It does, in fact, reflect an important but oft-neglected interest rate fundamental: Adjusting for inflation and risk, interest rates are low when times are tough. A bit more precisely, the levels of real interest rates are tied to the growth rate of the economy. When growth is slow, rates are low.

The intuition behind this point really is pretty simple. When the economy is struggling along—when consumer spending is muted and businesses' taste for acquiring investment goods is restrained—the demand for loans sags. All else equal, interest rates fall. In the current environment, of course, that "all else equal" bit is tricky, but the latest from the Federal Reserve's Senior Loan Officer Opinion Survey is informative:

"In the October survey, domestic banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households. However, the net percentages of banks that tightened standards and terms for most loan categories continued to decline from the peaks reached late last year."

Demand also appears to be quite weak:

"Demand for most major categories of loans at domestic banks reportedly continued to weaken, on balance, over the past three months."

This economic fundamental is, in my opinion, a good way to make sense of the FOMC's most recent statement:

"The Committee… continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Not everyone is buying my story, of course, and there is a growing global chorus of folk who see a policy mistake at hand:

"Germany's new finance minister has echoed Chinese warnings about the growing threat of fresh global asset price bubbles, fuelled by low US interest rates and a weak dollar.

"Wolfgang Schäuble's comments highlight official concern in Europe that the risk of further financial market turbulence has been exacerbated by the exceptional steps taken by central banks and governments to combat the crisis.

"Last weekend, Liu Mingkang, China's banking regulator, criticised the US Federal Reserve for fuelling the 'dollar carry-trade', in which investors borrow dollars at ultra-low interest rates and invest in higher-yielding assets abroad."

The fact that there is a lot of available liquidity is undeniable—the quantity of bank reserves remain on the rise:


But the quantity of bank lending is decidedly not on the rise:


There are policy options at the central bank's disposal, including raising short-term interest rates, which in current circumstances implies raising the interest paid on bank reserves. That approach would solve the problem of… what? Banks taking excess reserves and converting them into loans? That process provides the channel through which monetary policy works, and it hardly seems to be the problem. In raising interest rates paid on reserves the Fed, in my view, would risk a further slowdown in loan credit expansion and a further weakening of the economy. I suppose this slowdown would ultimately manifest itself in further downward pressure on yields across the financial asset landscape, but is this really what people want to do at this point in time?

If you ask me, it's time to get "real," pun intended—that is to ask questions about the fundamental sources of persistent low inflation and risk-adjusted interest rates (a phrase for which you may as well substitute U.S. Treasury yields). To be sure, the causes behind low Treasury rates are complex, and no responsible monetary policymaker would avoid examining the role of central bank rate decisions. But the road is going to eventually wind around to the point where we are confronted with the very basic issue that remains unresolved: Why is the global demand for real physical investment apparently out of line with patterns of global saving?

By David Altig, senior vice president and research director at the Atlanta Fed

November 24, 2009 in Federal Reserve and Monetary Policy , Interest Rates , Monetary Policy , Saving, Capital, and Investment | Permalink


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Can you say what you mean? (when you work as a public servant)

Bankers make more money investing in totally risk free, highly liquid earning assets, mis-named excess reserves @.25% rather than zero percent t-bills. Not too complex.

Banks are unencumbered in their lending operations(except the venerated, & capricious, 10% bank capital ratios).

Again, whether it's dis-intermedition (contraction or outflow of funds), from the non-banks, or financial intermediaries (e.g., hedge funds, investment banks, finance companies, insurance companies, mortgage companies, pension funds, etc.),

c. 80% of the lending market,

or IMPOUNDING savings within the commercial banking system, both are contractionary (the source of savings deposits within the monetary system is other bank deposits, directly or indirectly via currency, or the bank's undivided profits accounts).

Lower the remuneration rate on excess reserves. Then get the member banks out of the savings business. I.e., money flowing “to” the intermediaries never leaves the monetary system as anyone who has applied double-entry bookkeeping on a national scale should know. And why should the member banks pay for something they already own (interest). The member banks would be smaller, and more profitable, if they did not (1966 proved that, Dr. Alton Gilbert wasn't an expert: "Requiem for Regulation Q: What It Did and Why It Passed Away").

Monetary savings are LOST TO INVESTMENT (bottled up), within the banking and monetary system. I.e., savings held within the monetary system have a transactions velocity of zero, and are a leakage in the Keynesian national income concept of savings.

IOR's are not offsetting when the system's expansion coefficient varies widely

On IORs: Banks create new loans-deposits. The bankers are getting paid twice, for new, free, and additional earning assets (regardless of the expansion coefficient). Interest on reserves is a fraud and deceit upon the American people.

Posted by: Spencer Bradley Hall | November 26, 2009 at 07:59 PM

Thanks for doing this blog. I'll try to keep my comments to a technical nature.

On one hand, I agree that there has been some flight to safety in recent weeks, which I think reflects concerns about the economy's dependence on monetary stimulus, and the sustainability of the stimulus.

On the other hand, I also see indications that the recent retreat in Treasury rates is due also to an increase in the scale of monetary stimulus. The federal funds rate has fallen in recent weeks to around 12 bips, after hovering around 20 bips for most of the year.

This decline roughly coincided with the recent redemption of $185 billion from Treasury's supplementary financing account, which boosted the pace of the increase in excess reserves.

Also, for most of this year the Fed had been able to restrain the stimulus effect of its asset purchase programs by reducing borrowing from the Fed - in essence, replacing the large borrowed reserves built up in 2008 with non-borrowed reserves. But there seems to be little borrowed reserves left that the Fed can reduce, and so its asset purchases seem recently to be translated practically 1:1 into additional excess reserves.

Or this could perhaps be a case of steady monetary stimulus having partly delayed, and thus accelerating effects.

In a different time in a different country, a central banker once explained to me how he would know when monetary stimulus had surpassed its usefulness. He said it's like trying to pour coffee while blindfolded: the only way you know the cup is full is when you can feel the coffee spilling across the table. By that he meant when CPI accelerates.

But this is a novel situation, in which the scale of monetary stimulus is very large and yet the deflationary forces from deleveraging are very powerful. So perhaps the coffee is spilling out, but the table is tilted enough that the Fed isn't feeling any where it has its hand.

Posted by: Tom | November 27, 2009 at 01:23 AM

The Fed is in a box. Raising short term rates now would be bad policy. Perhaps being more stringent on the type of collateral that they take would be a step toward signaling to the market that they are ever vigilant, and are not encouraging bubbles.

Saving is up because people are scared (in the US). Bankers have told me they cannot find good credit risks to lend to. Plus, their existing loans are being paid off as quickly as possible. They are forced to buy treasuries to put their money to work.

The propensity to save in Asia is high. There seems to be a cultural bias toward saving versus spending. The Chinese populace has become richer, but they have not spent those riches and are saving them.

It would be interesting to look at the savings rate of the US from the late 1880's to 1920 to see how it compares. Maybe there is a correlation with saving and development?

Secondly, the economic environment is so uncertain. Business is terrified of the coming actions of the Obama administration. Cap and trade, higher taxes, health care regulations and taxes, pro union actions, and more regulation in general are troubling to any business. The costs of all these actions are not easily quantified into any model-so it's hard to make a decision. The result, is no action. Cash piles up.

Posted by: Jeff | November 27, 2009 at 08:58 AM

In regard to the final question, why is the demand to borrow seemingly lower than the supply of capital, I wonder if it is some combination of:

A. Demographic changes - if young people generally borrow and take risks, and older people generally save (lend), perhaps the baby boom retirement is causing too much savings to chase too few risk takers?

B. Business changes - in the past, the hottest areas of the economy (say railroads) required large amounts of capital investment. Increasingly, the hottest areas (the internet/google) use relatively little capital, and are largely self-financing. Perhaps this shift implies that the same amount of savings is now chasing fewer opportunities for capital investment.

C. Changes in retirement expectations - in the early 1900s, I think many people never expected to retire, and consequently never saved. Now, most expect to retire and most save to attempt to fund that retirement. That increases the number of people looking to save/lend.

I wonder if A, B and C are large enough to cause macroeconomic impacts. I think they could amplify each other, in the sense that there are both fewer risk-taking borrowers per retiree/lender, and each risk-taker needs less capital investment than before.

Posted by: Chris | November 30, 2009 at 06:50 PM

I'd like to play devils' advocate with regard to the fear of rampant inflation that is expected.

True, the money supply has expanded enormously in the credit crisis. It is mind boggling to think about. How could it not lead to rampant inflation?

First, the money isn't in the economy. It is on bank balance sheets.
They are reinvesting it in government treasuries. They are not lending it. As a matter of fact, their credit standards are so high they won't lend it. Furthermore, their outstanding loans are being repaid-so this cash is being reinvested in treasuries as well.

Once the Fed sees that money is being lent out-and the velocity of money picks up-they undertake open market operations aggressively to sop up cash. They raise discount rates by a little-and change the collateral that they take to make it tougher for prime brokers to get cash from the Fed.

If they are fast enough, we will have limited inflation in the overall economy.

Posted by: jeff | December 04, 2009 at 01:14 PM

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