Thursday, January 7, 2010

HOT: Hoenig Says Fed Should Eventually Lift Main Rate to 3.5%-4.5%

Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank should move “sooner rather than later” to reduce stimulus, with a goal of eventually boosting the benchmark interest rate to “probably between 3.5 and 4.5 percent,” reports Bloomberg. This would be a whopper of a hike. The current effective Fed Funds rate is 0.12%.

“The process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later,” Hoenig, who votes on monetary policy decisions this year, said today in a speech in Kansas City.

“Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment -- not today, perhaps, but in the medium- and longer-run.”

This is what happens when you confuse interest rate policy (control of interest rates) and monetary policy (control of money supply).

With one month T-bill rates around 0.05% and the effective Fed funds rate at 0.12%, I believe the real rate (the rate that we would be at if the Fed did not manipulate the market) would be closer to the 0.05% range.

If the Fed tries to move rates anywhere close to Hoeing's target, it would shrink the money supply by a huge percentage. Hoeing is not an inflation hawk. He is a "nuke the world" advocate. And he is very near the man who carries the launch code.


  1. If the Fed tries to move rates anywhere close to Hoening's target, it would shrink the money supply by a huge percentage.

    Just to make sure we're looking at this the same way: You're saying that the only way the Fed could get the fed funds rate up to 3.5%, would be for it to start sucking reserves out of the system, which in turn would make M2 crash?

  2. Fellas,

    If the Fed were push to 350 bps on FF they would obviously chase away anyone leaving excess reserves at their local Fed at 25 bps. Guys like me would then go back to FHLB to store our excess cash--where it was deposited before this mess started.

    I think the operator is pushing reserves out, not sucking.

    How would M2 crash, if I park my money elsewhere? Credit would dry up, but then loan demand is slacking anyway at this low rate level. People will desire more (higher) bank account balances.

    Just asking.

  3. Mike,

    That's actually what I think too. That's how I think the inflation genie will get out of the bottle. The CPI report comes out on the 15th, it will show almost 3% yr/yr growth, and people will realize, "Holy cow, we're not stuck in deflation at all!"

    Yields will start rising, esp. long-term yields. Banks will no longer keep their reserves parked at the Fed. M1 and M2 will start growing.

    BTW Wenzel, I wasn't trying to trick you with my above question, I just wanted to make sure I understood your logic for why a fed funds rate hike would imply crashing M2.

  4. if loan demand is slacking at these low interest rates, why would it go up at higher rates?

  5. @Mike in Alaska

    The only way the Fed can push fed funds higher is by removing funds from the system.

    Remember, Hoenig is proposing this to fight inflation, so I doubt he would recommend leaving the rate on excess reserves at 25 bps. He would want that marched up right along with the target funds rate.

    @Bob Murphy

    Yields will start rising, esp. long-term yields.

    Long term yields are already rising! That won't impact the Fed funds rate unless the Fed wants it to.

    Further, if a second dip in the economy occurs, I would expect an even greater demand for cash, which means very short-term rates aren't going much higher.

  6. How can you say the estimated real rate is close or at the t-bill rate whenthe t-bill market is an investment with the US government who is linked to the money printing Fed?
    If we had no Fed, I don't think the t-bill rate would be .05%. Assuming that the government still could run fiscal deficits, the probality of default of US debt would be much greater(b/c we couldn't print) and they would need to pay a much higher rate to attract buyers.) Am i totally wrong on this?

    Also, I don't get how the fact that the MB has risen, but due to excess reserves balances rises, they are not going to M2, right? How can a drawdown of these reserves make M2 fall?

  7. @MattM

    By the very fact that the Fed can print money to pay on T-bills is what makes it a near riskless investment. Thus it measures the rate of return demanded in the market without an additional interest rate factor of risk.

    What Hoenig is proposing by boosting the target rate would require the draining of funds that are in the system, not the excess reserves.