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67 posts on "Monetary Policy"

April 15, 2015

Please Read This before Betting against Government Bond Betas



Mounting evidence says that “low-risk” investing delivers superior returns, comparable to strategies based on value, size, and momentum. Such tactics include the “risk parity” (RP) asset allocation approach, which received considerable attention during the 2013 taper tantrum when many RP funds reportedly deleveraged. This strategy requires long or overweight positions in low-risk asset classes, such as government bonds, and offsetting short or underweight positions in risky asset classes, including shares. The low-risk umbrella also covers “betting against beta” (BAB) within, rather than across, asset classes. For example, investing in shorter- as opposed to longer-duration bonds beats the bond market, or owning low-beta at the expense of high-beta shares outpaces the S&P 500. Whether RP or BAB, what matters is return per unit of risk, the bang for the buck. Put more formally, RP and BAB profitability rests on an inverse relation between Sharpe ratios (SRs) and beta, the covariance of asset returns with the market portfolio. Such findings contradict the intuition that higher returns compensate for risk. Instead, investors profit handsomely by levering up relatively safe assets and shorting comparatively risky securities. However, as my New York Fed staff report argues, alternative reasoning and samples, as well as the types and number of “risks,” raise questions about not only BAB with government bonds (BABgov) but perhaps also RP. The investment implications are obvious, but the arguments and underlying data patterns also hint at key policy issues.

Continue reading "Please Read This before Betting against Government Bond Betas" »

Posted by Blog Author at 7:00 AM in Financial Markets, Monetary Policy | Permalink | Comments (0)

April 08, 2015

The FR 2420 Data Collection: A New Base for the Fed Funds Rate



On April 1, 2014, the Federal Reserve began collecting transaction-level data on federal funds, Eurodollars, and certificates of deposits from a large set of domestic banks and agencies of foreign banks operating in the United States. Previously, the Fed had only received fed funds and Eurodollar data from major brokers, and not directly from the banks borrowing in these markets. These new data, collected on form FR 2420, have helped the Fed better understand activity in the fed funds and Eurodollar markets. In this post, we focus on the new data on fed funds, in light of the Federal Reserve Bank of New York’s Trading Desk announcement that it plans to use these data to calculate and publish the fed funds effective rate. We plan to publish other posts on the fed funds and Eurodollar markets over the next several months.

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Posted by Blog Author at 4:30 PM in Financial Markets, Monetary Policy | Permalink | Comments (0)

April 01, 2015

Central Bank Solvency and Inflation



The monetary base in the United States, defined as currency plus bank reserves, grew from about $800 billion in 2008 to $2 trillion in 2012, and to roughly $4 trillion at the end of 2014 (see chart below). Some commentators have viewed this increase in the monetary base as a sure harbinger of inflation. For example, one economist wrote that this “unprecedented expansion of the money supply could make the '70s look benign.” These predictions of inflation rest on the monetarist argument that nominal income is proportional to the money supply. The fact that the money supply has expanded rapidly while real income has grown very modestly means that sooner or later prices will have to catch up. Most academic economists (from Cochrane to Krugman and Mankiw) disagree. The monetarist argument arguably applies only to non-interest-bearing central bank liabilities, but since October 2008 a large fraction of the monetary base has consisted of reserves that pay interest (the so-called IOER, or interest on excess reserves) and one linchpin of the Fed’s “policy normalization principles” consists precisely in raising the IOER along with the federal funds rate. Since reserves pay close to market interest rates, they are close substitutes for other short-term assets such as Treasury bills from a bank’s perspective. As long as the central bank can affect the return on these short-term assets by adjusting the IOER, controlling inflation with a large balance sheet seems no different than it was before the Great Recession.

Continue reading "Central Bank Solvency and Inflation" »

Posted by Blog Author at 8:38 AM in Fiscal Policy, Macroecon, Monetary Policy | Permalink | Comments (1)

March 25, 2015

Choosing the Right Policy in Real Time (Why That’s Not Easy)

Marco Del Negro, Raiden Hasegawa, and Frank Schorfheide

LSE_2015_combining-forecasting-models-iStock_000016830894_450

Second in a two-part series

As an economist, you make policy recommendations at any point in time that depend on what model of the economy you have in mind and on your assessment of the state of the economy. One can see these points play out in the current discussion about the timing of interest rate liftoff and the speed of the subsequent renormalization. If you think nominal rigidities are not all that important, you are likely to conclude that accommodative policies won’t do much for growth but will generate inflation. Similarly, if you are convinced that the economy is already firing on all cylinders, you may see little need for prolonged accommodation. The problem is, you are not quite sure about the state of the economy or what the right model is. If you are a Bayesian, you may want to try to put probabilities on different models/states of the world and take it from there. The first post in this series, “Combining Models for Forecasting and Policy Analysis,” introduced a procedure called dynamic pools that shows how to do just that. In this post, we apply that procedure to a policy exercise. We can’t publicly discuss current policies, so we will instead apply our method to consider alternative monetary policies at the onset of the Great Recession.

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Posted by Blog Author at 7:00 AM in Macroecon, Monetary Policy | Permalink | Comments (1)

March 23, 2015

Combining Models for Forecasting and Policy Analysis

Marco Del Negro, Raiden Hasegawa, and Frank Schorfheide

First in a two-part series

Model uncertainty is pervasive. Economists, bloggers, policymakers all have different views of how the world works and what economic policies would make it better. These views are, like it or not, models. Some people spell them out in their entirety, equations and all. Others refuse to use the word altogether, possibly out of fear of being falsified. No model is “right,” of course, but some models are worse than others, and we can have an idea of which is which by comparing their predictions with what actually happened. If you are open-minded, you may actually want to combine models in making forecasts or policy analysis. This post discusses one way to do this, based on a recent paper of ours (Del Negro, Hasegawa, and Schorfheide 2014).

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Posted by Blog Author at 7:00 AM in Macroecon, Monetary Policy | Permalink | Comments (1)

March 02, 2015

Euro Area Inflation Expectations–Anchors Away?



Euro-inflation

Euro area inflation expectations have been falling at both short- and long-term horizons, with the latter development suggesting the current low inflation environment is perceived as likely to persist. Because long-term inflation expectations play a key role in the decisions of households and firms, economists have stressed the importance of long-term inflation expectations being anchored at a central bank’s target. In this post, we use survey data on inflation forecasts to document evidence of recent “unanchoring” of euro area long-term inflation expectations, and note the difference in comparison to the 2008-09 period, when current inflation and short-term inflation expectations also declined but long-term inflation expectations remained steady.

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Posted by Blog Author at 7:00 AM in Macroecon, Monetary Policy | Permalink | Comments (0)

December 08, 2014

Global Asset Prices and the Taper Tantrum Revisited



Global asset market developments during the summer of 2013 have been attributed to changes in the outlook for U.S. monetary policy, starting with former Chairman Bernanke’s May 22 comments concerning future curtailing of the Federal Reserve’s asset purchase programs. A previous post found that the signal of a possible change in U.S. monetary policy coincided with an increase in global risk aversion which put downward pressure on global asset prices. This post revisits this episode by measuring the impact of changes in Fed’s expected policy rate path and in the economic outlook on the U.S. dollar and emerging market equity prices. The analysis suggests that changes in the U.S. and foreign outlooks had a meaningful role in explaining global asset price movements during the so-called taper tantrum.

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December 05, 2014

Survey Measures of Expectations for the Policy Rate




Liberty Street Economics Blog Derivatives and Monetary Policy Expectations
Second in a two-part series
Market prices provide timely information on policy expectations. But as we emphasized in our previous post, they can deviate from investors’ expectations of the most likely path because they embed risk premiums and represent probability-weighted averages over different possible paths. In contrast, surveys explicitly ask respondents for their views on the likely path of economic variables. In this post, we highlight two surveys conducted by the Federal Reserve Bank of New York that provide information about expectations that can complement market-based measures.

Continue reading "Survey Measures of Expectations for the Policy Rate" »

Posted by Blog Author at 12:05 PM in Financial Markets, Monetary Policy | Permalink | Comments (0)

Interest Rate Derivatives and Monetary Policy Expectations



First in a two-part series
Market expectations of the path of future policy rates can have important implications for financial markets and the economy. Because interest rate derivatives enable market participants to hedge against or speculate on potential changes in various short-term U.S. interest rates, they are a rich and timely source of information on market expectations. In this post, we describe how information about market expectations can be derived from interest rate futures and forwards, focusing on three main instruments: federal funds futures, overnight index swaps (OIS), and Eurodollar futures. We also discuss how options on interest rate futures can be used to gain insight into the full distribution of rate expectations—information that cannot be gleaned from futures or forwards alone. In a forthcoming companion post, we explore an alternative source of policy rate expectations based on the two surveys conducted by the Trading Desk at the Federal Reserve Bank of New York.

Continue reading "Interest Rate Derivatives and Monetary Policy Expectations" »

Posted by Blog Author at 12:00 PM in Financial Markets, Monetary Policy | Permalink | Comments (2)

November 05, 2014

Forecasting Inflation with Fundamentals . . . It’s Hard!



Controlling inflation is at the core of monetary policymaking, and central bankers would like to have access to reliable inflation forecasts to assess their progress in achieving this goal. Producing accurate inflation forecasts, however, turns out not to be a trivial exercise. This posts reviews the key challenges in inflation forecasting and discusses some recent developments that attempt to deal with these challenges.

Continue reading "Forecasting Inflation with Fundamentals . . . It’s Hard!" »

Posted by Blog Author at 7:00 AM in Macroecon, Monetary Policy | Permalink | Comments (4)
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Liberty Street Economics features insight and analysis from economists working at the intersection of research and Fed policymaking.

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