This Is What the End of the Line Looks Like

This is what the end of the line looks like; we're staring at the floor.

The Federal Reserve announced Tuesday afternoon that it was "establishing a target range for the federal funds rate of 0 to 1/4 percent." This is a bit like a fish issuing a press release that it will hereafter be swimming in water.

The target rate for Fed funds is lowered anew to just above zero, but the effective Fed funds (which is based on actual banking transactions) is already there, and has been for some time. Nonetheless, Bernanke and the boys are right to announce the new lower range for the target Fed funds, which works out to as much as a 75-basis-point cut from yesterday's target rate. Just don't hold your breath for an encore performance when the next FOMC meeting commences on January 28-29.

As is now crystal clear, the economy is weak and getting weaker and a similar sucking sound is abundantly clear in prices, as we noted earlier today. To a man with a hammer, the world looks like a nail. For the Fed, a general decline in prices and slumping economic conditions cry out for monetary stimulus. Today, the central bank was still able to satisfy. But from here on out it's time for plan B.

The new world order of unconventional monetary policy easing begins now. Yes, the Fed has been practicing the dark art of quantitative easing for some time. One example: using various levers to lower long-term rates, which is usually the province of market forces. On the surface, there appears to be some traction on this front. The 10-year Treasury yield, for instance, is quickly plunging toward the 2% mark. Just two months ago it was 4%. Of course, it's not clear if the fall in the 10-year is due primarily to Fed efforts or just the general fear of deflation and recession or a little of both. There are many questions in the new world order and few concrete answers.

Along those lines, it's generally unclear just how effective quantitative easing will be, in part because its track record is sketchy and the medicine has been rarely applied. The great deflation of Japan offers the most recent experiment in nontraditional monetary policy of magnitude. Alas, the jury's still out on whether it was a success, failure or something in between. Looking for clues about how to proceed from Japanese deflation is a bit like looking for consensus on the Internet: lots of information wrapped in a hurricane of debate.

Consider a 2006 essay by the San Francisco Fed:

"While there is little evidence that quantitative easing [in Japan] stimulated overall lending activity, there does appear to be some evidence that quantitative easing disproportionately supported the weakest Japanese banks." But there's no free lunch because "in strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform."

"Some of these alternative policy tools are relatively unfamiliar," Russell Jones, global head of fixed-income research at RBC Capital Markets, told Reuters last month. "They may raise practical problems of implementation and calibration of their likely economic effects."

That doesn't mean we shouldn't embrace innovation at this juncture, but we shouldn't expect miracles either. The good news is that quantitative easing comes in many flavors, and so there's more than one way to skin this monetary cat. Imagination may count for much in these times. If something doesn't seem to work here, one can try an alternative effort over there. Good thing, too, since the marginal risk of experimenting at this point is virtually nil relative to the risks of letting economic weakness and deflationary tendencies build.

But it's hard to overemphasize the fact that we're now in a gray area of monetary policy, a type of never-never land that has little precedent in the modern era, at least in the U.S. Graham Turner of GFC Economics is correct when he warns that it's best to keep an open mind about the possible outcomes from here on out. In an October essay in FT's economists' forum he wrote, "There is no guarantee that such a radical monetary policy will succeed. Central banks may have left it too late. Cutting the Fed funds target to 0% is necessary, but is unlikely to suffice. Driving the 30-year Treasury yield down to Japanese style levels, of 1% or so, may not be enough either."

The key problem is that much of the current woes seem to have unfolded / accelerated in the wake of Lehman Brothers' collapse in September. Rarely, if ever, has such a large economy deteriorated so quickly and with such force and depth. That's made the challenge immensely more difficult. It was, after all, only a few months ago that oil was climbing to absurdly high records and inflation was still considered a real and present danger. But now we have the opposite threat. Six months sometimes makes all the difference in the world, even in the dismal science.

The world has changed — radically, and it may change radically yet again. Exactly what does or doesn't suffice for monetary policy in the weeks and months ahead remains an open debate. No doubt there'll be definitive answers after all this is over. The playbook for monetary policy may be rewritten as a result. But for the immediate future, it's anyone's guess what happens (or should happen) next. No doubt we'll hear lots of policy recommendations from far and near. Making sense of it all, if at all, may be the toughest challenge.

Comments

[Lin:]

Re

We're finished , stick a fork in it , we're done ! We have not had a viable economy for ions ! Greenspan artificially inflated the housing boom , past the dot.com crash . This was also a fed created boom , as the US had no real economy . We're talking total collapse here . The Fed's actions today merely confirm their utter desperation . The B Madolf debaucle is simply the iceing on the US cake . Foreign invstors were already freaked out re their losses in the US housing /derivatives scam . The money will fly out of the US now . Who will pay for our growing debts ?

2008 Dec 17 12:21 AM

[Tony O:]

Who will pay for our growing debt? WE WILL! We have the printing presses and while the FED has them all warmed up to get out us out of this mess that free money (virtually free as in very low interest rates) created , why not just print up a few extra Trillion and sneak it in there?

hmm?

2008 Dec 17 01:53 AM

[investor88:]

Next phase of the battle begins after zero interest rates. The world govt lowering rates, printing money vs a sagging economy and deflation. While the giant forces fight, the small investor average Joe may be wise to keep clear. The best of the best traders can still profit some eg buy Citi few weeks ago now up more than 150%, better than any bull run.

2008 Dec 17 02:50 AM

[Steven Hansen:]

the fed's shot across the bow. i do not think the other central banks can stand still and let their currencies appreciate. they will have no choice but to continue to ease also. japan is screwed because there is no more down for them.

we are coming to a place where money will be just handed to you. you will have years to pay it back. you just have to figure out how to pay it back.

2008 Dec 17 03:34 AM

[Asbytec:]

I agree, Hand.

I agree, Lin...

2008 Dec 17 09:04 AM

[Thrift Maven:]

For heaven's sake. Put a cap on credit card interest rates at 6%. The whole nation would get some relief, be able to pay down some debt and begin rebuilding.

GOP policies have destroyed this country. Roosevelt was right. Regulation, regulation, regulation. For the good of the nation. We used to be trusted. Now we aren't. When wil business folk wake up.

2008 Dec 17 10:42 AM

[mc2406:]

If people hadn't been continually defaulting on their credit card debts, the rates wouldn't be exhorbitant.

The only thing "destroying this country" economically is the lack of personal responsibility for one's own debts (live within your means???)that many Americans (and corporations) are exhibiting, and the support that our professional politicians give to it in order to get more votes and perpetuate their jobs.




On Dec 17 10:42 AM g.pincheot wrote:

> For heaven's sake. Put a cap on credit card interest rates at 6%.
> The whole nation would get some relief, be able to pay down some
> debt and begin rebuilding.
>
> GOP policies have destroyed this country. Roosevelt was right. Regulation,
> regulation, regulation. For the good of the nation. We used to be
> trusted. Now we aren't. When wil business folk wake up.

2008 Dec 17 12:55 PM

[Chris B:]

The end of what road? Does anyone remember from Econ 101 the 3 financial levers that the government has to control money supply?

Interest rates (for fine tuning)
Open market activities (for bigger changes)
Changing Reserve Ratios (nuclear option)

Open market activities occur all the time, but have accelerated recently with govt. purchases of its own securities and of other securities, which injects cash into the system. This could continue for quite a while, as long as deflation lasts, leaving the govt. with boatloads of assets it can sell when inflation returns. They could also just hold to maturity if needed.

2008 Dec 17 02:06 PM

[Lucmee:]

to mc2406's comment... Really?!? the credit card company's wouldn't think of raping and pillaging to maximize profit as long as there's no real regulation? Dream on! You can go on grousing about "personal responsibility" all you want... But the reality is that the national daughter is already preggers!.. Let's get ready for the baby. A cap of 6-10% is what's called for in order to let some debt be paid down and for people to start to spend again. But I don't think anyone sees the banks voluntarily lowering rates. The more repugnant option is to make all that credit card interest deductible. The return of deductibility of car loan interest is a viable idea at this point also. The old Nixonian wage and price freezes may be just around the corner too. I predicted 10 months ago that we'd be hearing noises about changing oil pricing to euros around the 1st qtr of '09... Anyone want to bet a beer?


On Dec 17 12:55 PM mc2406 wrote:

> If people hadn't been continually defaulting on their credit card
> debts, the rates wouldn't be exhorbitant.
>
> The only thing "destroying this country" economically is the lack
> of personal responsibility for one's own debts (live within your
> means???)that many Americans (and corporations) are exhibiting, and
> the support that our professional politicians give to it in order
> to get more votes and perpetuate their jobs.
>
>
>
>
> On Dec 17 10:42 AM g.pincheot wrote:

2008 Dec 17 07:02 PM

[mc2406:]

Tax deductions for credit card interest or auto interest are of little value considering most of the credit card abusers don't pay any Federal tax to start with- more likely another "refundable credit" to pay the bills.

I still believe the only long term solution to the current problem is fiscal reponsibility, and to face the music now will be painful, but less so than when the government turns on the printing presses to avoid its own bankrupcy.

On Dec 17 07:02 PM Lucmee wrote:

> to mc2406's comment... Really?!? the credit card company's wouldn't
> think of raping and pillaging to maximize profit as long as there's
> no real regulation? Dream on! You can go on grousing about "personal
> responsibility" all you want... But the reality is that the national
> daughter is already preggers!.. Let's get ready for the baby. A cap
> of 6-10% is what's called for in order to let some debt be paid down
> and for people to start to spend again. But I don't think anyone
> sees the banks voluntarily lowering rates. The more repugnant option
> is to make all that credit card interest deductible. The return of
> deductibility of car loan interest is a viable idea at this point
> also. The old Nixonian wage and price freezes may be just around
> the corner too. I predicted 10 months ago that we'd be hearing noises
> about changing oil pricing to euros around the 1st qtr of '09...
> Anyone want to bet a beer?

2008 Dec 18 10:08 AM