And I have to teach Monetary Policy, this semester…

Two observations from the blog of (the liberal, the shameless, the Clintonite…and stuff) Paul Krugman:

Treasury rates have plunged close to zero, even though Fed funds is still 2.25%. Since open-market operations take place in Treasuries, I take this to mean that the Fed may not actually be able to reduce short-term rates much from current levels — which means, in turn, that conventional monetary policy has been taken off the table.

fed rates pic

… right now Treasury interest rates are much, much lower than the Fed funds rate — around half a percent on both 1-month and 3-month bills. Weirdness like negative rates on repos aside (I’m still trying to wrap my mind around that one), basically the Fed can only drive Treasury rates down by about another half-point — which would still seem to leave Fed funds well above 1%.

How is it possible for the Fed funds rate to be higher than the Treasury rates? Well, one interpretation is that banks don’t trust each other — not even for overnight loans. Fed fund loans, after all, are unsecured.

In other words, the Fed funds rate may be more like LIBOR than the Treasury rate — and it may be being held up by a premium similar to the TED spread.

Am I being really stupid here? Or is it possible that the fear factor will soon make it impossible for the Fed even to achieve its target on the interest rate it supposedly controls?

I have been moaning about this for a while, now (in meat-space). Last semester’s Macro was a hoot – all manner of interesting things were going on. The semester before that was fun, because I was telling students all about how bad things would get.

This semester? It’s like teaching physics after a black hole shows up in the Kuiper belt and the laws of physics have just plain stopped working.

Between the Fed coming up with new and wonderful ways to give money away, and the traditional policy actions just not doing anything, what is there to teach? That there’s a difference between giving money to commercial banks while the waste-laying bad paper is mostly in investment banks? That Monetary Policy goes off the table when all official rates are pushing negative (because who really cares about the exchange of near-zero-return instruments for other near-zero-return instruments. Or even cash?)?

I think I might just shelve those chapters entirely, and teach the Austrian school this semester. Makes as much sense as anything else and a few Austrians in the Fed over the last couple of years or more certainly would have done wonders.


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