From Steven Kelly's Without Warning substack, June 21:
Credit market interventions aren't just for dovish times
The pithy consensus of the Fed’s current strategy is that it’s raising rates “until something breaks.” It’s so ubiquitous that I’m actually not sure where the phrase began this cycle. But even Richmond Fed President Tom Barkin adopted it (sort of) today:
I think the spirit is, you want to get back to where you want to go as fast as you can without breaking anything.
However, this leaves open an important question: What if something breaks while inflation is still well above the Fed’s target? It’s currently running over six percentage points above target. Liquidity is fragile across financial markets in the face of policy tightening — an assessment traders and the Fed agree on. So, imagine something broke in the coming weeks? Commodities markets went even more haywire, exchanges came under pressure, a high profile default led to wariness across the board, or some other type of event.
In many ways this mirrors the zero lower bound problem. When rates are well above zero, financial stresses can be largely managed by a cut to the policy rate — leaving markets to sort it out (and benefitting some free riders). This can also lead to problematic views of the so-called “Fed put.” We often hear that monetary policy is a “blunt tool” in regards to its inflation/labor market tradeoff. But that’s also the case in its financial markets/real economy tradeoff. Preventing something from “breaking” via the policy rate may mean easier monetary policy that is inconsistent with the real economy macro picture. This may, say, goose the housing market or some such other interest-sensitive free-rider.
The idea of hiking until something breaks assumes that “something breaking” will tell the Fed it’s met its goals. But that’s not obviously the case. For instance, an exchange or corner of the credit markets could “break” without impacting inflation six points’ worth. And the Fed may have a strong wish to keep that given market intact and avoid any long-term damage — but also still need to make significant progress on its inflation goals.
Market Intervention Need Not Be Dovish
The Fed should be clear that it instead will use its full suite of tools as necessary to facilitate its restoration of price stability.[The discount window is still at a 0 bps spread to the upper bound of the fed funds rate; reducing this spread to zero was one of the first actions of the Fed in response to the pandemic. It sat at 50 bps pre-pandemic.]....
....MUCH MORE
Here are Steven Kelly's twitter and and academic home:
https://twitter.com/StevenKelly49
https://som.yale.edu/centers/program-on-financial-stability
You are no doubt familiar with the members of the program's advisory board.
