A small monetary policy question has been bugging me this morning.
The Fed is buying long term bonds and agency debt, with stated desire to drive down long term Treasury and mortgage-backed security rates.
Why does the Fed not simply say "We are going to peg the 10 year Treasury rate at 1.5%. We buy and sell at that price." If the Fed wants the 10 year rate to be, say, 1.5%, then this seems a lot simpler than setting a quantity ($80 billion a month), and then enduring endless arguments with academics like me whether it's having any effect at all, or commissioning complex staff studies to determine whether the impact is 10 or 15 basis points and how long it lasts.
The answers I can come up with are not pretty. Perhaps the Fed understands that any "segmentation" is smaller than it thinks, and doesn't last that long. So, the required bond purchases would rapidly explode in size. If that's the answer, then the Fed isn't doing it so that it can continue to seem powerful when in fact it really is not.
Perhaps it's political. If the Fed can say "we're buying $80 billion a month. This is helping, but we don't know exactly how much," then it avoids responsibility for what the rate actually is. If it says 1.5%, then every car dealer and mortgage broker in the country wants to know, why not 1.4%? This is even more cleverly Macchiavellian. But such deeply political decisions are a long way from the benevolent independent central bank we write about in papers.
Any ideas anyone?
While we're here, two great quotes from Fed economists (obviously un-named) I've talked to recently.
Me: Aren't you worried about big banks borrowing short and lending long? What happens when, inevitably, interest rates rise?
Economist A: "Don't worry, we'll let them know ahead of time."
This was some time ago. I think last week's announcements that the "stress tests" were (at last) going to include plain - vanilla interest rate risk might count as such warning.
Economist B: "Inflation is just not a concern. The Fed now is balancing growth against financial stability."
A new dual mandate, and a fascinating can of worms. I'd love to see that Phillips curve.
