Monday, February 22, 2010

Is The Fed Tightening Or Not?

The announcement that the Fed is raising the discount rate from 1/2% to 3/4% triggered a reaction in the financial markets with bond traders apparently expecting further tightening in the form of rising interest rates. Various people ranging from Mark Thoma to Jim Hamilton declaring that this is not a tightening but an adjustment to other changes such as their raising the amount they plan to pay on reserves banks park at the Fed, which is arguably a sort of tightening.

I agree that the discount rate is not a tightening and is not in itself a sign of likely more tightening per se. However, it is a fact that the Fed is in a gradually tightening scenario that it has announced for some time. This involves removing itself from the many special credit facilities that it put into place in the immediate wake of the crisis, several of which shut down as of Feb. 1, including the very crucial swap arrangements with the ECB and some other foreign central banks. Probably the most important one is the gradual unwinding of Fed support for the housing mortgage market through purchasing MBSs, which is supposed to end on (or about) March 25. That looms as a crucial date regarding the still rather weak recovery. It is not clear if Fannie Mae or Freddie Mac or anybody else is going to really step in and support those markets, and if they do not, we shall probably be in for a double dip in this recession.


Myrtle Blackwood said...

Nineteen million vacant housing units with three and a half million homeless people in the US.

What is to be done?

Destroy all those excess homes, of course.

Thorstein Veblen said...

how's that not a tightening? my economics textbook tells me there're three ways to tighten. fed funds rate. discount rate. reserve requirements. (now 4: interest on reserves).

They just tightened two out of the four.

So, why have you got it right, and why have the markets and textbooks got it soo terribly wrong?

The dollar strengthened, afterall.

vimothy said...

The Fed will tighten when it wants to tighten. There is only one way for it to do this, because the Fed only controls one thing: the price of funds.

Anonymous said...

"Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve's lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC). At that meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."