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May 25, 2017 LFPR anyone?
Apr 26, 2017 What's up with the FED?
March 10, 2017 Feb Employment Situation
Oct 10, 2016 Tax Burden
Aug 1, 2016 Here Comes the Debt
June 26, 2016 Moribund US Economy
June 16 2016 Labor Update
Mar 10, 2016 Spring Renewal for Labor Markets?
Feb 21, 2016 GDP Gap
Feb 16, 2016 FED and Monetary Policy
Jan 19, 2016 Employment Gap Age Groups LFPR
Jan 10, 2016 A look at the Employment Situation
Dec 30, 2015 Fed Funds Rate up 25 Basis points...so what?
Dec 15, 2015 Fed Funds on the rise? Has Yellen 'Fell-in'?
Oct 15, 2015 Labor Markets Seven years of misery
Oct 6, 2015 Sept: Horrible Month for Labor
Sept 30, 2015 The FED: Interest Rate Angst
Sept 11, 2015 FED on the Monetary Policy Front
July 31, 2015 Trade and Foreign Exchange Rates
July 20, 2015 Economic Growth?
July 10, 2015 Labor Picture by Age Group
July 2, 2015 Disastrous Month in Labor Rpt
June 19, 2015 Minimum Wage - Income Distribution
Jun 5, 2015 Encouraged Worker Effect
May 8, 2015 Updated Employment Situation for April
May 4, 2015 Languishing Labor Markets
Apr 7, 2015 LFPR Doldrums on the Labor Front
March 8, 2015 Less than Zero Interest Rates - Trade War
2014 Articles
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2011 & 2010 Articles
Dec 23, 2011 Revisionist History Depression
Dec 10, 2011 Depression & Now Part 1
Dec 5, 2011 Lies, Damned Lies, Statistics
Nov 16, 2011 Taxes Part 2
Nov 8, 2011 Taxes Pt 1
Nov 1, 2011 Demographics
Oct 12, 2011 Fed-FOMC
Oct 6, 2011 Fed's Operation Twist
Sep 30, 2011 What Price Bailouts?!
Sep 9, 2011 Trade Deficit - States
Sept 3, 2011 Unemployment Ongoing Challenge
August 22, 2011 Restricting Oil Supply
August 11, 2011 Credit Rating-Taxes
August 8, 2011 QE3? What to do?
Aug 5, 2011 Employment Update
August 1, 2011 Competitive Free Mkt Capitalism
July 26, 2011 Cradle of Democracy
July 16, 2011 Capital Ratios
July 10, 2011 Unemployment Again
July 1, 2011 QE2 Over-Apres Moi, le Deluge
June 11, 2011 Unemployment
June 8, 2011 Net Worth Collapse
May 18 2011 Credit Collapse '08-'10
May 15, 2011 Fed Miracle-Mayhem
May 10, 2011 Unemployment
Mar 30, 2011 Puppet Show
Mar 18, 2011 Locked-in-Effect
Mar 10, 2011 Bummer Days
Feb 12 2011 Inflation by Decontenting
Feb 6 2011 Unemployment
Jan 14 2011 Money Supply
Jan 12 2011 Trade Deficit
Jan 6 2011 Printing Press Myth
Dec 18, 2010 College Pricing
Dec 7 2010 Debt & Deficits
Dec 2, 2010 J-Laffer Curve
Sep 24 2010 Competition
Sept 23 2010 Trade Deficit China
Introduction
About us
Links of Interest
Straw Poll
Definitions & Miscellaneous
 

Economic Newsletter for the New Millennium

October 12, 2011

Editor
Donald R. Byrne, Ph.D.
dbyrne5628@aol.com  

Associate Editor
Edward T. Derbin, MA, MBA
edtitan@aol.com  

Download Current Blog (soon)


Fed Open Market Operations...a trail of tears


OPEN MARKET OPERATIONS HAVE BEEN – AND - WILL CONTINUE TO BE THE FED’S CHIEF TOOL FOR IMPLEMENTING ITS MONETARY POLICY DECISIONS


The occurrence of the Financial Fiasco of Two Thousand and Eight (FFTTE) led to a significant departure for the FED (Federal Reserve System) in carrying out its policy decisions http://byrned.faculty.udmercy.edu/2009%20Volume,%20Issue%201/2009volumeissue1.htm.  They purchased private sector securities, for the most part CDOs (consolidated debt obligations) including MBSs (mortgage backed securities) as part of their share of bailing out the yield and commission-chasing losers, opened wide the nearly closed (at the time of the onset of the FFTTE) Discount Window and resorted to a variety of measures either not used for a number of years or a few that were novel.

Even though the financial system is far from being out of the deep woods, the FED has begun to revert to the operating style that preceded the FFTTE.  Prior to the onset of the FFTTE, the Discount Window or Discount Facility was all but closed, albeit very gradually.  The use of implementing policy changes through altering required reserve ratios has been both simplified and stabilized for a number of years.  In days of yore, as one goes back in time, these were much more important and more frequently used than in recent years leading up to the FFTTE.

Recall the inverse relationship between interest rates and security prices.  The causality runs both ways: when interest rates rise, security prices fall; and when interest rates fall, security prices rise.  The interest rates are the discount rates that determine the discounted present values or market prices of the securities in question.  When the FED wants to drive interest rates down as in the QE 1-3 (http://en.wikipedia.org/wiki/Quantitative_easing), it purchases securities.  These actions increased the demand for the securities and caused the price to rise resulting in the yields or interest rates on them to fall. 

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In the previous issue of this newsletter, we revisited former Fed Chair, Alan Greenspan’s ‘conundrum’ http://econnewsletter.com/93701/index.html

October 6, 2011

“Greenspan’s frustration with what he termed a conundrum, was due to the mistaken belief of the FED that by driving down short term interest rates, the longer term interest rates would also, like Humpty Dumpty, come falling down.  Alas, they did not do so.” 

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June 1, 2005 – Baltimore Sun – Jay Hancock

http://articles.baltimoresun.com/2005-06-01/business/0506010168_1_greenspan-long-term-rates-short-term-rates   

“In February [2005], he called low long-term interest rates (another way of saying high bond prices) a "conundrum" that was hard to explain in the face of the Fed's repeated increases in short-term rates.”


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(1) – Concerns about rising asset values (wealth effect)


(2) – Concerns about inflation (cost push – coming from recartelized oil!)


(3) – The Conundrum – rising Fed Funds (and hence, short term Treasury rates) but long-term rates not following


Alan Greenspan Testimony before Senate Banking Committee

February 16, 2005

http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm  


(1) “Among the factors contributing to the strength of spending and the decline in saving have been developments in housing markets and home finance that have spurred rising household wealth and allowed greater access to that wealth. The rapid rise in home prices over the past several years has provided households with considerable capital gains.”

(2) “Still, although the aggregate effect may be modest, we must recognize that some sectors of the economy and regions of the country have been hit hard by the increase in energy costs, especially over the past year.”

(3) “For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.”

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http://www.econnewsletter.com/82301.html  


Remarks by Chairman Alan Greenspan
Reflections on central banking

At a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming

August 26, 2005

http://www.federalreserve.gov/Boarddocs/Speeches/2005/20050826/default.htm

In Greenspan’s own words, “Our forecasts and hence policy are becoming increasingly driven by asset price changes.  The steep rise in the ratio of household net worth to disposable income in the mid-1990s, after a half-century of stability, is a case in point.  Although the ratio fell with the collapse of equity prices in 2000, it has rebounded noticeably over the past couple of years, reflecting the rise in the prices of equities and houses.”


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While the FED put upward pressure on short term interest rates, long term interest rates did not follow them upward; in fact, they fell a bit.  Long term interest rates, (reflecting the market consensus as to the behavior of future expected short terms interest rates) did not rise.  The yield curve flattened instead of rising in a more or less parallel fashion.








Targeted Fed Funds.jpg


DRIVING UP FED FUNDS RATE (SHORT-TERM INTEREST RATES




Yield Curve June 2004-June 2006.jpg


DRIVING DOWN FED FUNDS RATE (SHORT-TERM INTEREST RATES






Yield Curve June 2006-Oct 2011.jpg


The need for having a portfolio including a significant quantity of long term securities is asymmetrical.  They can always buy them in order to drive security prices up and interest rate down.  But to drive long term interest rate upward, they must have a sufficient quantity of long term securities in their portfolio than can be sold.  That is probably one of the reasons why the FED had announced its intention to purchase long term government securities.  It not only drives such prices upward and interest rates downward, but it gives their portfolio the possibility of enabling the pursuit of restrictive monetary policies should higher inflation rates occur WHEN the economy once again starts to grow at a reasonable rate.

The FED could have relied on the private debt securities it had acquired, but it would have had to sell a good part of them at losses and the performing MBSs are often eliminated by the parties issuing those underlying mortgages, as they sell their homes after a few years and thus extinguish the mortgages that made up the pool that was behind the derivatives.  

This type of ‘locked-in effect’ and the indeterminacy of the true terms to maturities of the  underlying mortgages makes  U.S. Government securities a better medium in which to conduct monetary policy operations.  Should the FED face inflationary pressures in the future, it will have the portfolio needed to put upward pressure on interest rates by putting downward pressure on government securities by selling them.