Policy tools that could lower interest rates further

Even though the overnight interest rate has been stuck near zero for 20 months, are there options available to the Federal Reserve or the U.S. Treasury to bring longer-term yields down further? I have been looking into this question with Cynthia Wu, an extremely talented UCSD graduate student. We present our findings in a new research paper, some of whose results I summarize here.

Our starting point was a framework developed by Vayanos and Vila (2009), who interpret the term structure of interest rates as arising from the behavior of risk-averse arbitrageurs. This model is one way to capture formally the portfolio balance channel that Fed Chairman Bernanke indicated is central to the Fed’s understanding of how nonstandard monetary operations might affect the economy. Vayanos and Vila’s framework has previously been applied to our question by Greenwood and Vayanos (2010) and Doh (2010). One of our contributions is to develop specific measures of how the available supplies of Treasury securities of different maturities might be expected to influence the pricing of level, slope, and curvature risk of the term structure. Although I began as a skeptic of the claim that bond supplies would make much difference, we found pretty strong evidence that historically they have. For example, we found that over the 1990-2007 period, we could predict the excess return from holding a 2-year bond over a 1-year bond with an R2 of 71% on the basis of the level, slope, and curvature of the yield curve along with our 3 Treasury supply factors.

One of the challenges plaguing this kind of research is the problem of endogeneity. There may be a correlation between bond supplies and interest rates, but is that because bond supplies affect interest rates, or because the Treasury or the Fed are responding to interest rates in deciding which maturities of Treasury securities to sell or buy? Our solution to this problem is to pose the empirical question in terms of a conditional forecast. Suppose you already knew today’s level, slope, and curvature of the term structure of interest rates, and in addition to those values, I tell you today’s 3 Treasury supply factors. How would the latter cause you to change your forecast of next month’s interest rate for any given maturity? Our finding is that the Treasury factors make a statistically significant contribution across the yield curve.

We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates.

Predicted change in next months yields (quoted in annual percentage points) as a function of weeks to maturity in response to Fed converting all its short-term holdings into longest available maturities, average values over 1990-2007. Source Hamilton and Wu (2010).

We then extended the framework to the case when, as at present, short-term interest rates are as low as they could go. Even though short term interest rates have been near zero since the end of 2008, longer term yields have continued to vary from week to week, as shown in the solid lines in the graph below. Our interpretation is that these fluctuations in longer-term yields come from investors’ beliefs that short-term interest rates are not going to be stuck at zero forever. We suppose that investors attach a probability to escaping from the zero lower bound at various future dates, and that, when we do, short-term rates and the rest of the yield curve will revert to a dynamic behavior similar to that exhibited prior to 2007.

Actual (solid) and predicted (dashed) behavior of selected interest rates, weekly from March 7, 2009 to August 10, 2010. Rates shown (in order from top to bottom) are the 30 year, 5 year, 1 year, and 3 month.

We were then able to describe interest rate dynamics since the beginning of 2009 in terms of the historically estimated parameters along with three new coefficients, which correspond to the average short-term interest rate as long as we’re stuck at the zero lower bound, the average new short-term interest rate once we escape from the zero lower bound, and a fixed probability of escaping in any given week. The red dashed lines in the figure above represent the predicted values from this model. This simple framework seems to do a pretty reasonable job of explaining interest rate movements over the past couple of years.

Moreover, the framework gives us the information we need to assess the effects of nonstandard open market operations under a zero-lower-bound regime. The figure below shows how our model implies that the forecasting relation described above would be different under the zero lower bound. The experiment here is the same as before– the Fed sells off all its short-term Treasury holdings and buys an equivalent amount of long-term debt. However, under the zero lower bound, the effect on short-term interest rates all but disappears as a consequence of investors’ beliefs that near-zero short-term interest rates are likely to persist for some time. Quantitative easing– buying the longer-term securities with newly created interest-bearing reserves– would have the same effect in our framework.

Predicted change in next months yields (quoted in annual percentage points) as a function of weeks to maturity in response to Fed converting all its short-term holdings into longest available maturities. Solid line: predicted response over 1990-2007. Dashed line: predicted response in 2009-2010. Source Hamilton and Wu (2010).

Hence our estimates imply that whereas an asset swap by the Fed could not reduce interest rates in normal times, under the present situation, it would succeed in driving overall interest rates lower. To take an illustration, the Fed’s combined $1.1 trillion in mortgage-backed securities plus $300 B in new longer term Treasury purchases might have succeeded in driving 10-year yields 50 basis points lower than they would have otherwise been.

Although our estimates imply that the Fed could do more than it already has, in many ways the U.S. Treasury is the more natural institution to implement such a policy. According to the theoretical framework that motivated our measures of the Treasury risk factors, the average slope of the yield curve arises from the preference of the U.S. Treasury for doing much of its borrowing with longer term debt. For reasons presumably having to do with management of fiscal risks, the Treasury is willing to pay a premium to arbitrageurs for the ability to lock in a long-term borrowing cost. If the Treasury has good reasons to avoid this kind of interest-rate risk, it is not clear why the Federal Reserve should want to absorb it.

But, according to our estimates, if the Fed wanted to absorb more of this risk, it could reduce the slope of the yield curve further by doing so.

The full paper is available here.

41 thoughts on “Policy tools that could lower interest rates further

  1. Bob_in_MA

    Isn’t it obvious that the increase in household debt to unsupportable levels, and the increase of financial leverage to to unsustainable levels, was at least partly due to ever-decreasing interest rates?
    Is the only way out of this a path that leads to even higher debt-to-GDP ratios? And even greater financial leverage?
    Is there no point where you would say, debt levels are too high and must be allowed to fall?
    Just curious.

  2. mort_fin

    The Fed is exposed to prepay risk thanks to all the mbs they are holding. treasury might be more institutionally amenable to driving down long rates.

  3. don

    My gut feeling is that monetary policy has two avenues:
    1) Hold up (still overvalued) asset prices in a strategy of deny and delay.
    2) Encourage more consumer borrowing and business investment. In the face of excess capacity and overburdened consumers, this is as effective as pushing on a sting.
    I don’t much like either avenue. The main effect of concentrating on monetary options is to take attention away from fiscal policy, where it belongs.

  4. ppcm

    Should my understanding be correct Fed and treasury standing alone, have the ability to influence the long term yield through open markets arbitrage between short term and long term treasury papers only and reach ZLB.Should this demonstration be holding at all levels of interest rates and curves slopes (risk remaining the same,one country one system) would you conclude as well that interest rates swaps and bonds derivatives are superfluous instruments ?
    Banks are holding approximately 30% of the government bonds issues
    Then if derivatives are implicitly deemed not be required through your study, why such a thick permafrost of them in the banks books?(OOCC derivatives reports,BIS statistics)
    PS Arbitrageurs cannot be wrong and still alive for so long unless they are betting the same.

  5. Hondo

    It’s not about interest rates, it’s about wages and salaries income to support a certain level of consumption and debt service.

  6. KevinM

    “are there options available to the Federal Reserve or the U.S. Treasury to bring longer-term yields down further?”

  7. RicardoZ

    Bob_in_MA and don,
    Both of you make an important point.
    When Keynes and Hayek began their grand debate in the 1930s it was driven in large part because the Classical Economists discounted the impact of money on the economy. From the arguments of Keynes has grown an almost pure money interpretation of interest rates (thanks in large part to Milton Friedman.)
    In truth as both of you imply interest rates are time preference a person “charges” for restricting the use of owned assets through loans and such. The pure money interpretation totally loses touch with the reality of interest rates and analysis become academic sudoku with no meaning other than the game. It is a mathematical curiosity but I am not sure it is economics.

  8. CoRev

    This is an interesting article: RIEDL: The fatal flaw of Keynesian stimulus
    From here: http://www.washingtontimes.com/news/2010/aug/31/riedl-the-fatal-flaw-of-keynesian-stimulus/
    A quote: “To recap: All government stimulus spending requires first borrowing dollars that would have otherwise been applied elsewhere in the economy. The only exception is money borrowed from “idle savings,” which for reasons described above likely constitute a minuscule portion of the $814 billion stimulus.
    Yet Washington relies on Keynesian economic models that essentially assume that (in a recession) every dollar of government purchases raises GDP dollar-for-dollar – which could be true only if 100 percent of government spending was borrowed from idle savings to create new demand. That is implausible.
    Once it becomes clear that government spending only redistributes existing demand, the case for “stimulus” spending collapses.
    Yes, government spending can recirculate through the economy via the multiplier effect. But the same dollars would have recirculated through the private economy had they not been lent to Washington.
    Yes, in a recession, Washington can spend $814 billion putting idle factories and people to work. But that requires first borrowing $814 billion of spending power out of the private sector, which – by the same logic – will result in idle factories and workers in the locations that financed the stimulus.
    In that sense, government spending is the equivalent of removing water from one end of a swimming pool, dumping it in the other end, and then claiming to have raised the water level.”
    Your comments?

  9. JDH

    ppcm: All of the term-structure models we estimate impose the condition that there are zero arbitrage opportunities for anybody. However, they also all include some compensation for risk-bearing. By changing the available supplies of different securities, the Treasury and Fed can change the net exposure of the private sector to different kinds of risks, and this is the mechanism by which changing the supplies could affect interest rates.

    As for whether the Treasury could drive the spread all the way to zero, in the simplest form of the Vayanos-Vila model that we discuss, in which Treasury debt is the only long-term debt that anybody issues, the answer is yes, by replacing all the outstanding Treasury debt with one-week bills you would drive the risk compensation (which in that framework accounts for the average spread between long and short yields) all the way to zero. However, as we note in the paper, that’s just a stylized special case and is not consistent with the behavior of interest rates that we observe in the data.

    The numerical estimates reported above are simply a summary of what’s in the data rather than the implication of the stylized model. It is true that we are taking a linear summary of what happened in the past in response to small changes and extrapolating it up to $1.4 trillion, or in your question, well beyond. Obviously one needs to be cautious about any such exercise.

    What we conclude from the exercise is, yes, these operations do have the potential to have an effect, but they may have to be pretty big to make much difference.

  10. Robert Hurley

    CoRev – I do not know what world you have lived in but in my company it is the absense of demand that has curbed borrowing. There is money available but why borrow and invest when demand is so low. Talk about fatal flaws in your argument! I guess your ideological bias is the mote in your eye.

  11. JDH

    ppcm: The no-arbitrage condition is what gives our estimated impact curves their smooth shape. It wouldn’t matter how much the Fed or Treasury pushed on any single issue, it couldn’t make a spike in that curve, because arbitrage would force the yield on an n-period bond to be similar to that on an n-1 and n+1 period bond. According to the model, any given change in supplies affects all yields together by the way in which different yields load on the same risk factors.

  12. Bob_in_MA

    Sorry, my comment sounds hysterical.
    To me, and a I think the vast majority of non-economists, the problem seems fairly straightforward: much our growth has been based on private debt levels growing faster than GDP, until we reached a level of debt that was completely unsustainable. Now, debt will need to grow slower than GDP until we reach a sustainable level.
    I don’t see how anyone looking at debt to GDP numbers can come to any other conclusion. And it isn’t just households, non-financial corporate debt is at record highs, non-corporate debt is at record highs, and we won’t even mention financial debt.
    Over the last couple years, household debt has fallen some but would still need to fall a few $Trillion just to get to the ratio it was in 1999, which was already a post-war high. And contrary to a lot of commentary, non-financial corporate debt has RISEN in the last two years.
    Does anyone know a single employed person with anything but an awful credit rating who is having trouble borrowing now?
    What would be helpful is if economists spent some time determining what a sustainable debt target might be, and how we could get there with the least pain.
    The Hindenburg is not going to rise from the ashes…

  13. ppcm

    The no-arbitrage condition is a condition precedent to an homogeneous shape in time and period,of all main curves,if to be realized in real world.

  14. JDH

    CoRev: The essential Keynesian claim is that, at times like the present, there are inefficiently underemployed resources such that, if we could figure out how to get them back to work, the economy/swimming-pool is perfectly capable of producing more water on its own. Moe isn’t producing because Joe isn’t buying his product, and Joe isn’t buying because he’s unemployed. If we could break out of that stalemate, there’d be more water for everybody. The question is how to get there from here.

    It is true that, when the government borrows it is competing for those borrowed funds with somebody, and there is the potential for some spending to be crowded out as a result. That potential is a function of various parameters such as the sensitivity of spending to interest rates, which at the moment is surely quite low. Moreover, to the extent that we can raise incomes by boosting aggregate demand, that may be much more important for reinvigorating investment.

    Where I am skeptical of the traditional Keynesian story is in the transmission mechanism whereby the fiscal stimulus is proposed to have its effect. The traditional account operates through a failure of prices to adjust to changing conditions. I think there are a number of empirical and theoretical difficulties for this account.

  15. JDH

    ppcm: Most interest rates change every day, both in level and in relation to each other, in both the data and in the model.

  16. Jeff

    Jim, can you estimate the effects of a pure debt monetization? Suppose the Fed buys $1 trillion in Treasury debt such that the proportions of each maturity in total federal debt held by the public do not change and no interest is paid on excess reserves. What happens to the yield curve?

  17. JDH

    Jeff: According to our model, when interest rates are at the zero lower bound, the effect of purchasing outstanding long-term debt with newly created money is almost identical to the effect of replacing outstanding long-term debt with newly issued 6-month T-bills.

  18. JDH

    CoRev: Sorry, I meant to be responding to your comment above but I mistakenly attributed your remarks to Cedric. (I’ve relabeled comment correctly above now).

    Cedric must have wondered why I was going on and on in response to his inscrutable one-word comment.

  19. CoRev

    JDH, thanks. R Hurley, my own experience is different. I am familiar with a small company, a friend of mine, that was very successful up till late winter. He was forced to go out of business/bankrupt because he could not get working capital. He could not get the working capital because one of his customer was slow in paying him, and his bills were seriously over due.
    He opened the same business under a new name, got working capital and is now successful, although slimmed down in accordance with economic conditions.
    What’s the difference? The only difference he can claim is his down sized. Had he gotten the credit when it was needed, the down sizing would still have happened. Oh, nearly all of his creditors were left holding the bag.
    What stimulus would have helped his small business? A loan guarantee (just now being considered.) Tax incentives for home owners with cash or good credit to remodel or to make general improvements (not just green energy) centered efforts. The end result would have been one business not going bankrupt with all the extended impacts that has, especially on jobs.
    So, RHurley, in my world the stimulus was misdirected. Not too small, but aimed at incorrect targets. Oh, and lending was too restricted due to poorly structured regulations.

  20. 2slugbaits

    CoRev “…although slimmed down in accordance with economic conditions.”
    So isn’t that what explains the weak recovery? Access to capital and chaotic financial markets may have precipitated the recession, but the current problem is weak aggregate demand and not capital access.
    “…in my world the stimulus was misdirected.” In my world too. Too much emphasis on tax cuts and not enough on direct spending.
    “… lending was too restricted due to poorly structured regulations”. Isn’t this complaint a little hard to square with the Fox News claim that: (a) there wasn’t enough regulation of mortgage securities and the recession is all the fault of those deadbeat low income folks; and (b) there’s too much financial regulation and we need to relax borrowing requirements for responsible Republican types.
    The Riedl op-ed piece is a joke. He gets it wrong right off the bat. It’s simply not true that in the current economic environment government borrowing crowds out private sector borrowing. That claim is perfectly true in normal times, but not when the Fed Funds Rate is stuck at zero and the implied NAIRU interest rate is (according to Goldman Sachs) around -5% to -8%. Currently government spending crowds in private sector borrowing because it creates demand for private sector services. And this is just completely wrongheaded: “But that requires first borrowing $814 billion of spending power out of the private sector, which – by the same logic – will result in idle factories and workers in the locations that financed the stimulus.”

  21. 2slugbaits

    JDH Making your grad student manually review and correct a gazillion debt instruments?!!! I think you win the Kathie Lee Gifford Boss-of-the-Year Award. “More gruel, please.” 😉 But it seems to have paid off. Now someone will have to maintain it.
    Your research suggests that at least in theory the Fed has another policy tool at its discretion; but while the theory has been advanced we still have to worry about the praxis. Given that business sensitivity to the interest rate is about as flat as it could possibly be (CoRev’s anecdotal story notwithstanding), I’m not sure that I’d want to bet the farm on bending the yield curve. Worth a try and given our political gridlock it may be our last best hope, but it still seems like a longshot. And then there’s the problem of getting the Fed to take any risk. They seem to be more concerned with not failing than they are with succeeding.
    “Where I am skeptical of the traditional Keynesian story is in the transmission mechanism whereby the fiscal stimulus is proposed to have its effect. The traditional account operates through a failure of prices to adjust to changing conditions. I think there are a number of empirical and theoretical difficulties for this account.”
    I think there’s a more direct transmission that Keynes himself hinted at. Keynes observed that in the end economic slumps come to an end because capital eventually depreciates to the point where businesses have to reinvest. A well designed fiscal stimulus program operates in the same way by drawing down inventories and consuming capital infrastructure. When government places orders businesses have to run machinery and consume primary and intermediate level goods. These things eventually have to be replaced, so government spending hurries that process along. That’s really what the cash-for-clunkers program was. It was just a consumer’s version of an accelerated depreciation allowance. We sacrificed some wealth (a stock variable) for some GDP growth (a flow variable). The gamble was that the bump in the flow variable would arouse animal spirits and be self-sustaining.

  22. MDueker

    These are very interesting results, especially because I believed that the main stimulative impact of Fed purchases was to give a slight boost to inflation expectations in order to lower the real rate. Do you have plans to add the real yield curve to your analysis?

  23. don

    I second (what I surmise) to be KevinM’s point. I question how much we can gain from further interest rate reductions. Even in regular times, the response of business investment to interest rates is anemic, if not empirically insignificant. Is the goal, then, to prop up housing prices?

  24. Cedric Regula

    Only Ben can’t tell us for sure. His charter is price stability (and employment) not asset stability. And they have been telling us all decade that houses aren’t prices, and have the CPI calculation to prove it.
    Already the 30 year mortgage rate is about the same as a thirty year bond. That 4.5% is a little higher than the 2.5% on the 10 year note. Is that what they think needs fixing? If so, why didn’t QE2 Lite be used to buy more MBS instead of treasuries?
    Ben does make noises once in a while like “the fed has done everything it can.”
    They may even realize just going thru an exercise of laying out the exit strategy may not work to appease the financial world if the Fed balance sheet goes to 3T, 4T, 5T.

  25. CoRev

    2slugs said: “but the current problem is weak aggregate demand and not capital access.” While completely ignoring the part of the anecdote that said the business went bankrupt because it could not get working capital.
    So, I ask you you what part of: “Oh, nearly all of his creditors were left holding the bag.” is not clear to an ORA and economist like you? It clearly cost jobs, he fired several permanent employees and severed relations with all of his crews (temps), his suppliers probably laid off some, and everyone had lost instead of delayed revenue.

  26. lilnev

    CoRev: That’s backwards. The government doesn’t borrow first in order to spend. They spend first, creating new money (and adding to aggregate demand), then issue bonds to re-absorb that money. The operation that destroys private spending power is taxation. If the government decided that they wanted to build infrastructure, and they were going to “pay for it” by raising taxes, then it would be very debatable whether the net effect was stimulatory (quite possibly still yes, if the taxes came from “idle savings”, i.e. from those with a low marginal propensity to consume, but by no means automatic).
    For deficit-based stimulus, the question isn’t “where does the money come from?”, it’s “where does the money go to?” And in particular, how much does it circulate before it gets turned back into bonds (if the govt gave Bill Gates a $100M, he would shrug and buy $100M worth of bonds — no stimulus), and how much of it leaks by funding imports.
    “It is true that, when the government borrows it is competing for those borrowed funds with somebody…”
    Deficits create their own demand for bonds. When the govt creates more money by spending than it destroys by taxes, then the rest-of-world has more money. If that money is not needed for transactional purposes (and note that short term rates are essentially zero, i.e. transactable money carries no premium over very-short-term T-bills), then that extra money is going to be saved by someone, and that someone might as well save in the form of interest-bearing bonds rather than non-interest-bearing money. Any one individual can buy stocks or whatever, but now some other individual has a pile of money and the same decision. In aggregate, money in the private+foreign sectors has nowhere to go but bonds.
    “The essential Keynesian claim is that, at times like the present, there are inefficiently underemployed resources such that, if we could figure out how to get them back to work, the economy/swimming-pool is perfectly capable of producing more water on its own.”
    In general, I approach Keynesian theory from the perspective of “desired savings”, and treat that as exogenous. When housing and the stock market collapsed, and lots of people suddenly felt insecure in their income, their desire to save went up. Saving means having income greater than your spending. But everyone’s income comes from someone else’s spending, so if everyone wants to save at the same time, we’re in the paradox of thrift. Govt + households + firms + foreign aggregates have to balance. The foreign sector has been saving dollars, exporting more to us than they import from us, and shows no inclination to change that. Firms have healthy balance sheets, and might be willing to dis-save (borrow to invest in expansion), but only if they foresee robust demand for their products. Not currently the case. That leaves households, the biggest spenders, but also the ones who are now trying to save, and the government. So the choice is between government dis-saving (larger deficits) or forcing enough households into involuntary dis-saving by destroying their income (unemployment) until the savings desire of the rest can be satisfied. I know which I prefer.

  27. don

    Cedric –
    I quite agree (though the Fed’s actions, such as the response to the stock melt-down following the Soc Gen rogue trader scandal, makes me think they keep a close eye on asset prices).
    I wonder what our host thinks? He has spent considerable effort on this exercise, so presumably he has some thoughts on how much help further interest rate reductions might provide (unless the purpose of the exercise is simply to show that we can’t expect much from this approach).

  28. Cedric Regula

    true, they sure are quick to push the money supply button in response to financial shocks, credit freeze ups, etc… I think that was Greenspan’s contribution to the profession.
    That’s my best guess as to why they don’t blow the whole the wad now. Plenty of looming disasters on the horizon that they may need some ammo for.
    yes, so far JDH has restricted his project to “what is” and hasn’t ventured into the realm of what should or shouldn’t be.

  29. JDH

    don et. al.: I think it is helpful to separate one’s policy position (what should the Fed do?) from an objective scientific question (what would be the consequences if the Fed did X?) We set out in the paper to address the second. We did not have at the outset a particular stake in finding one answer or the other, but ended up concluding that, yes, changing the relative supplies a whole lot could change the respective yields a little.

    As for the first question, I’ll try to say more about this on a later occasion.

  30. Cedric Regula

    Almost forgot 911. That was good for a few point whack in Fed Funds. Maybe bin Laden was responsible for the housing bubble? The Fed missed an opportunity to pin the tail on the donkey there! Still, I’ll wager bin Laden is having a good laugh with his buddies over the whole thing.

  31. Nemesis

    The Fed will print as much digital fiat debt-money and buy as many Treasuries out the yield curve, MBS, commercial paper, credit card debt, auto loans, signature loans for boob jobs, and perhaps even corporate bonds as it takes to keep the banking system afloat and the banks’ balance sheets shored up and earning enough interest and trading income to keep the doors open, lights on, prop desks and dark pools manipulating the markets, hot money flowing in and out of Asia, and the bonuses flowing to the rentier parasites. The heck with private productive enterprise. Who needs it?! It’s all in China-Asia anyway.
    Be prepared for the 5- and 10-year Treasury yields at 0.5% and 1.25-1.5% respectively, and the T-bond yield around 2-2.5%.
    5-year ARM rates will drop to 2.25-2.5% (as in Japan because there will be few takers who are not underwater, walking away, moving back with relatives, squatting in vacant property, or taking up residence in a cardboard box under a bridge).
    The U rate will eventually reach 15-16% and U-6 at 25-30%. Millions of Boomers aged 45-64 will lose their jobs and medical insurance and be forced to buy MEGA-deductible policies or do without and take their chances waiting for Medicare only to become eligible and the system is bankrupt.
    Millions of healthy young people will be taxed to buy medical insurance they don’t need or want (or cannot afford). Small employers will likewise be hit with the additional tax they cannot afford to provide medical insurance to employees, forcing them to slash wages, cut hours, or fire workers to stay in business. And we think the U rate for people aged 16-24 and 45-64 is high and rising now; just wait.
    And all the while the so-called “health care” legislation recently passed will be just a massive labor product, business profit, and wealth transfer from young workers (if they have a job or jobs) and their employers to doctors, insurers, and hospital companies.
    But the Keynesians say we need more gov’t borrowing and spending and higher taxes on “the rich” to “stimulate” the economy. They say we need a New Newer Newest Deal and QE II, III, IV, etc., to get those animal spirits aroused. And if that doesn’t work, well, borrow and spend even more until it REALLY hurts!
    Debates one reads on sites like this and hear on Fixed Noise, CNBS, Blahberg, and MSNBS are reminiscent of Middle Age scholars arguing about how many angels can dance on the head of a pin. Do you e-CON-omists realize how utterly irrelevant you are and how much damage you are doing?
    Why is a sauna like a room full of e-CON-omists?
    What do you get when you combine an e-CON-omist and a roll of toilet paper?

  32. Cedric Regula

    Q:Why is a sauna like a room full of e-CON-omists?
    A: It’s full of fat old men always sweating about something?
    Q:What do you get when you combine an e-CON-omist and a roll of toilet paper?
    A: Lots of crap to wipe up and then hand the mess over to the taxpayer?
    Just kidding. Actually I like economists.

  33. Adam P

    JDH: “The traditional account operates through a failure of prices to adjust to changing conditions. I think there are a number of empirical and theoretical difficulties for this account. ”
    Surely the primary price in question is the interest rate so, right now, you shouldn’t have too many theoretical or empirical difficulties with the tranditional account?
    Or is this an exercise in sticy-price denial?
    (apologies if this has been addressed, I didn’t read through all the comments).

  34. aaron

    I think housing and the stock market collapsed because in part because of the loss in confidence in spending, rather than the collapse caused it.
    People continued spending despite excessive prices under the assumption that they were just experiencing a fluctuation and that their low income growth was also temporary and that the promises of higher incomes in future that they’ve been hearing all their lives would come true. When prices didn’t come back down to reality and incomes did go up for several years, people and banks grew weary of all the spending they were doing.

  35. Nemesis

    Q:Why is a sauna like a room full of e-CON-omists?
    Cedric replied:
    “A: It’s full of fat old men always sweating about something?
    Q:What do you get when you combine an e-CON-omist and a roll of toilet paper?
    A: Lots of crap to wipe up and then hand the mess over to the taxpayer?
    Just kidding. Actually I like economists.”
    LOL!!! I have nothing more or better to add to those responses. 😀

  36. don

    JDH: “The traditional account operates through a failure of prices to adjust to changing conditions. I think there are a number of empirical and theoretical difficulties for this account. ”
    No one can reasonably disagree with this statement. However, we have experienced results that can be explained in no better way (at least that I have seen). It takes more than raising problems with this explanation to refute it – one needs to come up with a superior alternative. That is how the advancement of science works – you go with the best explanation until it is displaced with a better alternative.
    IMHO, Lucas should not have gotten the Nobel prize. Rational expectations was the innovation of Edwin Muth – Lucas just applied it. When I read Lucas’s response to a question “what about involutary unemployment?” (something like “That is a Keynesian paradigm. I’m not obliged to explain someone else’s paradigm), I thought that a new experience would come to deny Lucas the nobel prize. Well, here it is. It just came too late – Lucas got the prize first.

  37. Tom

    Kinda wacky, JDH. What are you thinking, an economy with 2% 30 year rates? 1%? I don’t know where to start. Would rates ever rise again? I hope you understand the concept of duration and sensitivity of debt-instrument prices to interest rate movements.

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