Posts Tagged: interest rate

The Quandary of Monetary Tightening

25 August 2014 - 5:28 am

Interesting piece in the World Economics Association’s  Real World Economic Review on some of the difficulties the Fed faces when it begins tightening monetary policy.   They point out the policy contradiction that paying interest on excess reserves is an injection of liquidity as they are trying to tighten.

Money quote:

…the payment of higher interest rates on excess reserves promises to be very expensive. It is also expansionary, which runs counter to the purpose of raising interest rates.  The expense is very clear. Given banks hold $2.6 trillion in total reserves, every one hundred basis point increase in interest rates costs the Federal Reserve $26 billion. If the Fed’s policy interest rate returns to 3 percent, that would cost $78 billion. That is an effective tax cut for banks because the Fed would pay banks interest, which would reduce the profits it pays to the Treasury. The banks, which were so responsible for the financial crisis, would therefore emerge winners yet again. Taxpayers, who bailed out the banks, would once again bear the cost.

 Paying interest to banks would also run counter to macroeconomic policy purpose since it would be pumping liquidity into the banks when policy is explicitly trying to deactivate liquidity.  That smacks of policy contradiction.

Eurozone banks are set to take advantage of a new flood of central bank liquidity in a bid to boost lending to the region’s credit-starved businesses.

Faced with a stagnating economy eurozone banks are expected to borrow about €250bn in cheap four-year money from the European Central Bank in September and December, according to projections by Morgan Stanley, under the ECB’s ‘targeted long-term financing operations’. Periphery banks are expected to account for the heaviest borrowing.

“There’s huge interest in the TLTRO funds,” said Huw van Steenis, banks analyst at Morgan Stanley. “We forecast that the peripheral banks will take almost all of their loan allocation as it would lower their cost of funding significantly and, hopefully, be passed on to the real economy in the form of lower interest rates.”

Mario Draghi, the ECB president, recently said that lending could eventually rise to as much as €850bn inclusive of TLTRO monies available periodically after the opening loan splurge this year. >> Read More


Acceding to pressure to cut interest rates to spur growth, Korea’s central bank slashed its benchmark interest rate by 25 basis points to 2.25 per cent on Thursday.

The cut marks the first move in rates in 15 months. It’s also the first significant decision under Lee Ju-Yeo, a 35-year veteran of the bank who became governor in April.

The move comes less than a month after Choi Kyung-hwan was confirmed as finance minister, promising an economic revival and possibly putting pressure on the central bank to cut rates.

Recent data has also suggested the Korean economy is faltering, while inflation been moderating. In light of this, HSBC economist Ronald Man said on Monday that “space for a policy rate cut is certainly there.”

The new rate isn’t a record low. The BoK pushed rates to 2 per cent in 2009 after the global financial crisis.

The won danced around after the release, then fell 0.15 per cent to 1,07.90 per dollar.


The IMF has warned that the pound is overvalued by 5pc-10p, in an update of its wide-ranging annual assessment of Britain’s economy.

After depreciating by 23pc between 2007 and 2009, the real exchange rate has gradually appreciated, and this trend accelerated from the middle of 2013, the fund said, as it praised the Bank of England for keeping interest rates low and welcomed signs that Britain’s surprisingly strong economic recovery is broadening.

A high pound could affect the rebalancing of the economy, according to the staff report. A strong currency depresses domestic demand and encourages spending on imports.

“Further demand rebalancing is needed: net trade has made only a modest contribution to the recovery, and the real exchange rate is moderately overvalued,” the report said on Monday.

>> Read More


The Reserve Bank of New Zealand was the first central bank in a developed economy to lift interest rates this year. It’s not finished.

As was widely expected, the central bank raised interest rates for a fourth time this year, pushing its key rate up a quarter of a percentage point to 3.5 per cent.

While raising rates, Graeme Wheeler, the bank’s governor, warned that the New Zealand dollar was overvalued.

With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall.

Mr Wheeler said the economy appeared to be adjusting to the tightening monetary policy and that it was “prudent” the country’s central bank asses activity before lifting rates further towards a “more-neutral level”.

The Reserve Bank forecasts New Zealand’s economy will expand by 3.7 per cent this year.


IMF head Christine Lagarde has warned that financial markets maybe a little too upbeat given the persistently high levels of unemployment and debt in European economies.

She also warned that continuing low inflation could undermine growth prospects in the region.

But she did say the European economy was recovering and interest rates should stay low until demand picks up.

Last month, the European Central Bank cut its main interest rate to 0.15%.

It also cut its deposit rate – the rate it pays banks to keep money on deposit – to -0.1%, becoming the first major central bank to introduce negative rates. >> Read More


A mismatch between a strengthening US recovery and the record low level of interest rates risks storing up problems for the world’s largest economy, a Federal Reserve policymaker has warned.

James Bullard, the president of the St Louis Fed, said on Thursday that:

The macroeconomic goals of the Committee are close to being met. However, the policy settings of the Committee are far from normal.

While this mismatch is not causing macroeconomic problems today, it takes a long time to normalise policy and the mismatch may cause problems in the years ahead as the economy continues to expand.

Mr Bullard’s intervention comes as a strengthening US jobs market intensifies speculation over when the Fed will lift interest rates for the first time since the financial crisis.

Janet Yellen, the Fed chairwoman, this week signalled in testimony to Congress that interest rates are likely to stay at record low levels as the economy continues to recover.

Mr Bullard, who doesn’t have a vote on interest rates this year, added: >> Read More


One (voting) policymaker has suggested the Federal Reserve will pull the trigger on the first rise in US interest rates since the financial crisis in the early part of 2015.

Richard Fisher, the president of the Dallas Fed and a voting member on the Fed’s top panel, said on Wednesday that the world’s largest economy is recovering more quickly than the central bank had forecast.

Despite a surprise contraction in the first-quarter, the US labour market has continued to improve with the unemployment rate falling to 6.1 per cent in June.

That has intensified speculation among investors over when Fed officials will raise their key overnight borrowing rate. In a speech in Los Angeles, Mr Fisher said:

That early next year, or potentially sooner depending on the pace of economic improvement, the FOMC may well begin to raise interest rates in gradual increments, finally beginning the process of policy normalization.

Mr Fisher also took issue with the argument that a combination of tighter regulation and new capital requirements on banks will be enough to temper the potentially risk-taking by investors that low interest rates encourage. >> Read More



Janet Yellen, the chairwoman of the US Federal Reserve, is delivering her semi-annual testimony to Congress on Tuesday.

Here are some key extracts from the testimony, which will be followed by a Q&A session with members of the Senate Banking Committee:

On the recovery

Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants’ estimates of its longer-run normal level.

On the US jobs market

Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.

On the timing of interest rate increases >> Read More


With EURUSD hardly budging, constantly disappointing economic data (from periphery to the core now), and central bank transmission mechanisms that are entirely clogged and useless for anything but stuffing the pockets of bloated bank balance-sheets with domestic sovereign debt, it is no wonder Germany’s Bundesbank has said ‘enough’. “If we pursued our own monetary policy… it would look different,” explained Bundesbank chief Jens Weidmann. As Reuters reports, Weidmann noted that many savers in Germany were irritated by low interest rates and property prices were overvalued in some big city areas in Germany; implicitly threatening the ECB’s chatter-box that “this phase of low interest rates, this phase of expansive monetary policy, should not last longer than is absolutely necessary.”

As Reuters reports,


The European Central Bank’s interest rates are too low for Germany, Bundesbank chief Jens Weidmann said on Saturday, adding that ECB monetary policy should remain expansive for no longer than absolutely necessary.


Speaking at a Bundesbank open day for the public, Weidmann noted that many savers in Germany were irritated by low interest rates but said these were aimed at supporting investment and consumption.



“It is clear that monetary policy, when seen from a German viewpoint, is too expansive for Germany, too loose,” Weidmann told a crowd at the start of the open day. “If we pursued our own monetary policy, which we don’t, it would look different.”

>> Read More

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