Tuesday, December 16, 2008

Two common misconceptions on two central banks

Today's Fed decision was supposed to be irrelevant. At least that's what most of the analysts, journalists and bloggers were saying. I don't know if it's just me, but I still managed to pull out a few interesting observations:
  • To me, the 0-0.25% target range officiates what we already knew: Quantitative easing, not the Fed funds rate, is the Fed's policy tool.
  • Moreover, the Fed has committed to keep rates low for some time, which is consistent with Bernanke's work on Japan (sorry, can't find the paper)- as long as the commitment is credible, of course.
  • Kudos to Rebecca Wilder for the excellent discount rate/TAF analysis. If I hadn't read her post prior to the Fed statement, I would have probably ignored the 75bp discount rate cut.
  • BTW, the Fed is now paying 0.25% on reserves- it'd interesting to see where reserve balances would be headed in the near future.
  • Nouriel Roubini's stag-deflation scenario is in the works.
  • The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.
  • The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.
  • With the money multiplier plunging, the inflationary effects of all this are small for now, but I still worry about the future.
If you are still unconvinced, please take a look at David Merkel's redacted FOMC statement.

Switching gears, the discussion on the relationship between growth and policy rate cuts in Turkey seems to be forgetting the basic constraint of the Turkish economy.

We are dealing with an economy that has an external financing gap and a liquidity constraints in the banking sector, both of which could lead to a slowdown of the traditional monetary transmission mechanism. Therefore, rate cuts are not likely to have the desired effect on growth, at least not by the desired amount.

Changing the direction of the arrows, the CBT has been using the growing output gap in arguing that currency depreciation will not have strong inflationary effects. However, disruptions to capital inflows and liquidity could easily magnify the second-round inflationary effects from a weaker lira.

1 comment:

Rebecca Wilder said...

Hi Emre,

"currency depreciation will not have strong inflationary effects"

Turkey's still worried about inflation? Interesting.

Thanks for the plug - I added you to my blogroll a while ago.

Best, Rebecca