Tuesday, June 17, 2014

instruments of Fed policy

If the fed raised the reserve requirement (not now; under the sort of circumstances that we persist in calling "normal" more than five years since they were last seen), that should steepen the yield curve as long-term credit becomes scarcer relative to the supply of demand deposits and other short-term highly liquid investment. In periods historically where the yield curve becomes inverted I imagine some benefit might have been derived from somewhat tighter constraints, and where it's steepest perhaps somewhat looser; perhaps it would make sense to change reserve requirements in tandem with a target for the steepness of the yield curve.

The tl;dr version of the previous post is that, in the short term — on the order of an eighth of a year — the FOMC is likely to continue to ask the New York Fed to aim at something that is readily monitored in something like real-time, and it seems like the difference between long-term rates and short-term rates is a better target over that kind of period than short-term rates alone; in particular, if long-term rates go up over the weeks after an FOMC meeting, presumably that means the market has come to believe that inflation and/or returns to sunk capital will be higher than was believed at the last meeting and a somewhat high short-term rate is appropriate.

So I'm now suggesting that the FOMC set a target for the steepness of the yield curve, and, just as it customarily used to change the deposit rate in lockstep with the FOMC federal funds target, the board of governors would then customarily change the required deposit ratio in lockstep with the target for the steepness of the yield curve. There are clearer reasons for deviating from this from time to time than was the case with the deposit rate, and I'm not denying the board of governors the ability to do that, but rather than "leave them unchanged" as the default, I would suggest something slightly procyclical as the default instead.

No comments: