Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community....From The Econtrarian:
Warning: If you should choose to read this commentary, I recommend that you have ready a pot of coffee or your chosen type of cognitive stimulant. The commentary is lengthy and geeky.
Am I the only one who wondered how the Federal Reserve arrived at a figure of $85 billion as the amount of longer-maturity securities it planned to purchase per month in its third round of quantitative easing (QE)? Why not double that amount? Why not half that amount? How will the Fed know when it is time to “taper” its securities purchases? How will the Fed know by how much to taper? Inquiring minds want to know.
According to conventional wisdom, the rationale for QE is to bring down bond yields in order to stimulate the aggregate demand for goods and services, which, in turn, will bring down the unemployment rate. Implicit in this rationale for QE is the assumption that there is a negative relationship between the behavior of bond yields and the behavior of aggregate demand. That is, there is an assumption that a decrease in bond yields is associated with an increase in the growth of aggregate demand. Because QE involves the Federal Reserve purchase of longer-maturity securities, also implicit in the rationale for QE is that the behavior of bond yields has a larger negative impact on the behavior of aggregate demand for goods and services than does the behavior of money market yields. Before even getting into the issue of the amount of longer-maturity securities the Fed would need to purchase in the open market in order to reduce the Treasury bond yield or the conventional 30-year fixed mortgage rate by one basis point, let’s first check to see if the conventional-wisdom implicit assumptions behind QE are validated empirically. Namely, let’s check to see if, in fact, the behavior of bond yields has a greater influence on the behavior of aggregate demand than does the behavior of money market rates and that there is, in fact, a negative relationship between the behavior of bond yields and the behavior of aggregate demand.
Chart 1 shows that there is a high positive correlation, 0.89 out of a maximum possible 1.00, between the levels of the Treasury 10-year security yield and the overnight federal funds rate. So, in order to discern whether the behavior of bond yields has a greater effect on the behavior of aggregate demand than does the behavior of money market rates, we need some technique to disentangle the independent effects of the behavior of the interest rate on these two types of securities with different maturities. Fortunately, multivariate regression analysis provides such a technique. It enables us to test for the effect of the level of a bond yield on the behavior of aggregate demand independent of the effect of the level of a money market rate and the effect of a money market rate on the behavior of aggregate demand independent of the effect of the level of the bond yield.
Chart 1
The results of such a regression are presented in the table below. The dependent variable, RDOMPURCHYY, is the year-over-year percent change in real gross domestic purchases. The measure of real gross domestic purchases is the volume of currently-produced goods and services purchased by U.S. residents. This measure makes no distinction as to where the goods and services purchased were produced, domestically or abroad. The two key independent variables, the variables upon which the behavior of changes in real gross domestic purchases depends are FFMOVAV4 (-1), the four-quarter moving average of the level of the federal funds rate, lagged one quarter and T10MOVAV4 (-1), the four-quarter moving average of the level of the Treasury 10-year security yield, lagged one quarter. Because there is a lot of trend, or serial correlation, in the behavior of the year-over-year percent changes in real gross domestic purchases and this trend can distort the “true” value of the effects of the independent variables, the level of the federal funds rate and the Treasury bond yield, a correction for this trend (serial correlation) has been made and is represented by the AR(1) and AR(2) variables....MUCH MORE
