The Fed ' s Shifting Goalposts

When I publishedFloored!last October, I thought I ’d said all I could say concerning the adverse consequences of the Fed’s then decade-old decision to adopt a “floor”-type operating system. In the new arrangement, the Fed pays interest on bank reserves, and uses changes in the rate it pays, instead of adjustments to the available quantity o f bank reserves, to regulate other interest rates. Among other things, I explain in my book, as I’ve also done to some extent here atAlt-M, thatdecision contributed to the U.S. economy ’s deep downturn in late 2008, thatit undermined banks ’ incentives to monitor each other’s safety, and thatit has made it more tempting for politicians to treat the Fed as a giant piggy-bank to drawn upon for theirpet trillion-dollar projects.But it turns out I overlooked a serious shortcoming of the Fed ’s floor system. Not that I’m kicking myself: I could hardly be blamed for overlooking a problem that wasn’t at all evident in the fall of 2018. But the problem has since become all-too obvious. I refer to the new operating system’s inability to get interest rates to go where it wants them t o.Interest-Rate Control under the Fed ’s Pre-Crisis System…To see what I mean, let ’s first consider how successful the Fed’s pre-crisis “corridor”-style operating system was at keeping interest rates on target. Then as now, the Fed’s official rate targets were targets for the “federal funds rate,” which is the rate at which ban...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs