For The First Time Since The Great Financial Crash, Taylor Rule Implies A Federal Funds Rate Higher Than Actual

Tyler Durden's picture

Following yesterday's release of advance Q1 GDP and deflator data,for the first time since the full unwind of the Great Financial Crisis in late 2008, early 2009, the Taylor rule is not only positive (it hit 0.1% in Q4 2010, in line with the federal fund's rate) but has now jumped substantially above the prevailing interest rate, hitting +0.4% in Q1 2011. Needless to say this will not remove any of the latent animosity between John Taylor, whose rule, or at least a special case thereof, is used by the Chairman in determining monetary policy, and the Chairman: as the possibility of a hike is negligible for at least one more year, with a far greater possibility for another QE episode, we expect to see this number continue to diverge substantially from the Taylor implied number for a long time, which in turn will mean that the Fed will be forced to scramble, just as it did in the 05-07 period to catch up with runaway inflation. Only this time it will have $3 trillion in asset to unwind as well. We hope Volcker will not mind being thawed from carbonite a second time when runaway inflation surges in about a year or so, and Volcker's expertise is needed more than ever.

Stone McCarthy has more:

For the second consecutive quarter, the original-specification, quarterly version of the Taylor rule, based on real GDP figures and the GDP price deflator, produced a positive result.

The previous day, the BEA released its advance estimate for real GDP figures in Q1 2011. Based on those numbers, the Taylor rule prediction for the federal funds rate target in Q1 2011 is +0.4%. In the previous quarter of Q4 2010, the Taylor rule prediction was +0.1%.

We still believe it will be some time before the federal funds rate target is lifted by the Federal Reserve but at least it is moving in the right direction.

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Josh Randall's picture

It's pronounced "Tyler" rule - the "a" is silent

Alex Kintner's picture

Well, that's the way they pronounce it in Sydney anyway.


mynhair's picture

O/T, but is this pig Market open?

Silver Bug's picture

By the time they "start to scramble" it will be far too late. They will keep the rate artificially low, the bond vigilantes are basically negligible right now in the U.S. As they fear going up against an opponent with unlimited funds. But there will be a day, and indeed it is already happening that Countries are becoming the new Bond Vigilantes. This I don't even think the FED can handle.

QE to Infinity is assured. Even if they don't call it QE3. Rest assured. Which means Gold and Silver only have one way to go. And I think we know which way that is.

Missiondweller's picture

But does Volcker still have any credibility after being used as a prop by the Obama administration to pump its economic program?

carbonmutant's picture

Volcker has squandered his credibility for one last moment of fame...

X. Kurt OSis's picture

There are many different kinds of Taylor rules.  You just have to find the one that suits your purpose.

Tense INDIAN's picture

nothing new added today ...just a recap of yesterdays charts :'

LawsofPhysics's picture

The Fed missed the opportunity to raise rates a long time ago.  Combined with the government's inability to address fraud, gold, silver, and all commodities will go to the moon.

Dr. No's picture

Hopefully this small finding will remind people of the FEDs mission statement: To backstop the biggest banks.  Any other activities in which the FED engages either support the mission statement or as a courtesy to parties of the big banks. I agree in order to get a monopoly on money supply, the FED had to promise to give a good ole' college try to maintain price stability and employment in order to keep public acceptance.  It has been fun to bash The Bernak since he seems to be violating the price stability and employment, but those are not the metrics he is measured by.  He is measured by the wealth of the big banks.  The big banks need ZIRP, so they get it.  Although the Taylor rule would imply higher rate is good for the money, Bernak is maintining ZIRP so therefore I conclude the big banks still need ZIRP.

pgeorgan's picture

What gives? I read this morning in the Gartman Letter that Taylor Rule is implying Fed Funds rate of negative 4.0%....

TooBearish's picture

Yeah I saw that too - funny how same inputs yield totally conflicting conclusions....

Tyler Durden's picture

On one hand you have Stone McCarthy. On the other you have Dennis Gartman.

pgeorgan's picture

So where is Gartman getting his numbers from?

TooBearish's picture

Looks like Fartman's data set hasn't updated from Mid-09

redpill's picture

USD: Paul, I love you.

Volcker:  I know.

*cue carbon freezing sound effect*


Pool Shark's picture


Helps explain his (hopefully) temporary blindness upon being co-opted by the Obama thugs...


Dick Darlington's picture

OT: Tyler, anyone, any color on this chatter?

04-29 12:10: Market talk that of an imminent "PIGS" bank restructuring
Racer's picture

Laws and rules don't apply to bankster leeches only to peasants and slaves

Idiot Savant's picture

We hope Volcker will not mind being thawed from carbonite a second time when runaway inflation surges in about a year or so, and Volcker's expertise is needed more than ever.

@ ZH brain trust -

I continually read that we can't significantly (10% -15%) raise interest rates without choking on our debt. Is this correct? Are we not able to raise rates and monetize our debt payments?

I'd appreciate help in better understanding this issue and possible outcomes. If high rates are plausible in the future, I want to have a plan in place well in advance. Thanks.

Missiondweller's picture

Much higher rates are a given, its just a question of how long the bernanke can keep them down.


If he allowed them to go up housing would be hit with a massive new wave of defaults causing the deflation he fears. In addition, the federal deficits would skyrocket as the nation's debt service goes up.


Funny thing though, the market is like a river that eventually runs around any boulder thrown into its path. He's fighting a losing battle.

Jovil's picture

In the end it is the banksters who will hoard most of our losses due to the fall of the dollar. They are at the top in the Pyramid of Capitalist System.

AnonymousMonetarist's picture

Time for bed son.

But you promised me a story Daddy!

Yes I did…

There once was a country called America.

It was started by a bunch of rich white guys who were upset about their taxes.

Eventually they became the most powerful country in the world when the rest of the powerful countries darn near destroyed themselves.

The rich and powerful Americans saw a lot of opportunity to plunder the planet. They stopped a lot of other countries from developing self-sufficiency through either war or debt. Their wars were fought to make the other peoples free. The debt was created to make the other peoples prosperous.

It was called free market capitalism and democracy and it was good.

But then there was a war that America lost. The war was very expensive and the American people didn’t approve of it.

So rich and powerful Americans had to change the way they used war and debt to plunder.

They started to use debt to make their own people more prosperous and to make wars less messy.

But the wars were very expensive and their prosperous people became more and more indebted to their prosperity.

Prosperity got out of control and the free market crashed.

So the rich and powerful Americans created more debt and launched more wars.

But the free market crashed again.

So the rich and powerful Americans decided that the free market had to be abandoned in order to save it. They created all the debt they could in order to protect their riches and their power. Eventually they couldn’t afford the wars. Eventually they couldn’t afford the debt.

The people became very upset.

And a bunch of rich folks, not just, but mostly, white men (guess that’s progress!), became very very upset about their taxes.


Is that all Daddy?

What happened to America?

Well son, that’s exactly what folks began to ask themselves.

But the real America was less of a place than an ideal and lots of folks in lots of other countries aspired to that same ideal.

So America went global as did their prosperity. And although times in the old country might be hard right now at least we have a chance to pursue the American dream.

Now it’s time to go to sleep son you need to be well rested for your exam tomorrow if you want to join the cadre.

Sweet dreams.

glenlloyd's picture

It makes little difference 'what' the taylor rule(s) say at this point, latent inflation is cumulative, Mises was right, you either stop and face the music (pain) or you just keep going until it all falls apart (more pain).

As is generally known around here TPTB have chosen the latter course.


gkm's picture

People don't seem to understand that Volker really didn't solve anything.  All he did was raise the interest rates to a level known to induce precious metal selling and that took the steam out of the commodities rally.  In order to keep from contracting the overall economy though he printed money to cover the huge interest cost.

It of course was a key point that the debt capacity at the time was fairly different than now.  So could the same "magic" be worked this time around?  Probably not which is why the Fed is really screwed.  They can't let (or raise) rates rise because that would necessitate inflation.  So I suppose Bernanke's hope is that the commodities will implode on their own.  However, that's what happened in 1937.  Best to look at a chart if you aren't familiar with 1937.

If he's wrong and commodities aren't in a bubble but the USD is in full on crash, then he's probably just a deer in the headlights.

Alex Kintner's picture

Of course, It seems that the full on crash of USD (caused by massive USD printing) is causing a flight into PMs and a subseqent bubble.

davepowers's picture

very interesting developments in the FED's balance sheet the last two weeks.

first, for the latest week (ending April 27) there was essentially no QE 2. The FED acquired only a touch over $10 bn in Treasury paper, itself a low, but almost 9 Bn of that was from MBS rolloff (QE Lite).

But the interesting thing is that in the last two weeks, they've developed a new twist on bank reserves - namely, the reduction of bank reserves by $80 bn and the corresponding increase in the Treasury checking acct at the FED by the same amount. Plus they paid for the prior week's QE ($20 bn for week of April 20th) by adding $20 to the Treasury checking account.

Some have argued that they will replace QE by the FED (Fed buys Treasury paper) by using the $1.5 trillion plus in bank reserves to do the buying. That theory came close to being put into practice over the last two weeks for the last two weeks.

I'm guessing the bank reserve to Treasury checking acct transfers was handled in the same way the bank reserves were built up - by simple data punch entries where a number is subtracted from one column and put in another - just like Bernanke described before Congress last summer.

a side question on legality if that is even relevant to FED operations - when the FED paid for $20 bn in QE 2 during the week of April 20, not by crediting bank reserves but by crediting the Treasury checking acct at the FED, was the FED engaged in direct purchases of Treasury paper and wouldn't that be against the law? Supposedly, they've had to purchase paper from third parties (the PDs) rather than directly from the Treasury to work around this law.


BT310's picture

Thanks for the research.

hedgeless_horseman's picture

was the FED engaged in direct purchases of Treasury paper and wouldn't that be against the law?

Like exceeding the debt ceiling?

Dapper Dan's picture

On Tuesday, Senator Bernie Sanders office released a CRS report titled "Banks Play Shell Game with Taxpayer Dollars" that sheds a bit light on the shady ways the Fed conducts its business.  Sanders "found numerous instances during the financial crisis of 2008 and 2009 when banks took near zero-interest funds from the Federal Reserve and then loaned money back to the federal government on sweetheart terms for the banks."

So, now we have irrefutable proof that the Fed was simply handing out money to the banks. More importantly, the report shows that this was not just a few isolated incidents, but a pattern of abuse that increased as the needs of the banks became more pressing. In other words, giving away money became policy. Is it any wonder why the Fed has fought so ferociously to prevent an audit of its books?

From Sander's report: "The banks pocketed interest on government securities that paid rates up to 12 times greater than the Fed’s rock bottom interest charges, according to a Congressional Research Service analysis conducted for Sanders."

Are you kidding me; 12 times more than what the Fed was getting in return?

That's larceny, my friend. Grand larceny.

From Mike Whitneys post on Counter Punch

Alex Kintner's picture

If only we were a nation of laws, this would all stop. Oh wait, laws are only for the commoners.

From Bernanke's Star Wars screen test.
Bernanke: "Loot, I am your Fodder!"
Director: "Cut... Next."

PulauHantu29's picture

dave, thanks for the insight and analysis. Much appreciated!

DonutBoy's picture

" ...thawed from carbonite"  LOL

if only

The Axe's picture

BLUELIGHT special on cat chow....fat finger melt-up in a no liquidity market      RAH

ivars's picture

See how nicely USA stimulating effects on DJIA pattern follows those of Greek government on Athens index in 2009. The USA seems to be very close to Greece in some financial behaviour aspects. Hence the future may also be the same:

kito's picture

and how is paul volker going to resolve the unresolvable. if we are to assume we are at the end game, what can anyone do? mr. volker will come in and raise interest rates to 18%? bye bye treasury

LoneCapitalist's picture

Can anyone explain why bond fund shares are not dropping? Do you think someone is propping them up to keep the sheep herd from panicking? It seems like ma and pa mainstreet would be getting out of bonds. I think theres some frogs being boiled.

Nnthnt1's picture

Tyler, you have to read Taylor's blog. He reported that his ORIGINAL rule is being abused by Bernanke. Bernanke was very vague about 'which taylor rule' he used @the latest Congress testimony. Taylor responded very clearly that there's only ONE.

riley martini's picture

 The FED won't need more QE all they have to do is extend the maturities on the Bonds that they already hold and purchase more bonds with the interest payment. Sounds crazy so did the first time I wrote about the FED buying treasuries . I meant it as comedy of the absurb but about two weeks after I wrote about it the FED announced QE 1.

AntiMort's picture

I can't help but wonder if things would be different if the Fed would have followed the Taylor method.  It looks to have stabilized between 02-03 at ~3% to where the fed funds rate continued lower to 1%.  In '03 the taylor model began tightening while the fed kept loosening and didn't begin tightening to mid '04.


Is there a chart that goes further back in history?

gwar5's picture

Volcker was sent to God's little waiting room (carbonite...LOL!) by Benzebub pretty much right after he'd been trotted out long enough to establish credibility. 

The moment Volcker was ushered off the stage was the moment we all knew that ZIRP and inflation was going to be game. Volcker was just a distraction to the Bernanke after that.

Richard640's picture

The TBT and I

There is just no way the 30 yr. bond yield will exceed 5% again in our lifetimes...There is just no way that the "virtuous circle" for U.S. dollar denominated paper assets will ever be broken...Japan has a debt that is 200% of GDP-what's the ratio here? Almost 100%?-we have a long way to go--[the Japanese had or have $11 trillion in savings to finance their debt-we depend mostly on foreign sources and printing--but nevermind]...and the streets of Japan don't resemble those of Upper Volta...China and Japan with their huge holdings of U.S. treasuries are a captive audience...there will be neither hyper-inflation nor a deflationary collapse in the U.S....the "New World" idolum embodied in the American culture is still irresistible...The brightest and the best students from China and India aspire to come here and live...

In investing/trading, when one "just can't imagine" something, it's usually time to fade that idea...the drivel I wrote in the above paragraph has become the "dialogue" manufactured by the paper-peddlars [the financial industry]...A high profile trade--like Bill Gross's supposed short treasury position...can be a trap...

I have been watching the TBT for a long time-but never bit-A friend of mine has lost a bundle screwing around with it--In June 2008 the TBT hit $72...guess what? The 30 yr bond yield was 4.8%...The implied volatility has collapsed...September 2011 and Jan12 TBT calls are quite reasonable...but I "just can't see" rates moving up...if they do, I do not envision a slow, steady 2 year rise to 5% or 5.25%...I think some event-and it doesn't have to be spectacular--causes rates to move up quickly...could it be that inflation gets out of control-the $ crashes? I don't mind to spend 10 or 15 grand to get a few yrs option coverage on the TBT for the next 2 years...

Can anyone give me a pep talk? Sing me a lullaby...tell me how rates will spike in the next 6-18 months...I've got scenarios...but they never seem to materialise...

Richard640's picture
$1569.80 was the high in June gold…weird but the more the $ sinks the more the 30 yr bond appreciates

How long can this go on? Who beside the FED would buy bonds in a falling currency?–”we believe in free market capitalism”–[Sir Lawrence Kudlow]----It looks like gold's gonna keep up with silver finally...

flow5's picture

"Volcker's expertise is needed more than ever"

What the hell are you talking about???  Volcker was a complete IDIOT. 

Paul Volcker’s version of monetarism (along with credit controls), was limited to Feb, Mar, & Apr of 1980.  With the intro of the DIDMCA, total legal reserves increased at a 17% annual rate of change, & M1 exploded at a 20% annual rate (until 1980 year’s-end). 

Why did Volcker fail?  This was due to Volcker's operating procedure. Volcker targeted non-borrowed reserves when at times 10 percent of all reserves were borrowed. That's before the discount rate was made a penalty rate. And the fed funds "bracket racket" was simply widened, not eliminated. Monetarism has never been tried.

Then came the "time bomb", the widespread introduction of ATS, NOW, & MMMF accounts -- which vastly accelerated the transactions velocity of money (all the demand drafts drawn on these accounts cleared thru demand deposits (DDs) – except those drawn on Mutual Savings Banks (MSBs), interbank, and the U.S. government).This propelled nominal gNp to 19.2% in the 1st qtr 1981, the FFR to 22%, & AAA Corporates to 15.49%.

By the first qtr of 1981, the damage had already been done. But Volcker screwed up again (supplied an excess rate of legal reserves to the banking system), in late 1982-83. AAA corporates yields later hit 13.57% May 31st 1984. 


And the TAYLOR RULE.   Keynes's liquidity preference curve is a false doctrine.  The money supply can never be managed by any attempt to control the cost of credit.   His rule is expost. 


Our excessive rates of inflation (especially since 1965), has been due to irresponsibly easy monetary policies. Our monetary mis-management has been the assumption that the money supply can be managed through interest rates

Between 1965 and June of 1989, the operation of the NY Fed’s “trading desk” was dictated by the federal funds “bracket racket”. Even when the level of non-borrowed reserves was used as the operating objective, the federal funds brackets were widened, not eliminated.

Ever since 1989 this monetary policy procedure has been executed by setting a series of creeping, or cascading, interest rate pegs.

This has assured the bankers that no matter what lines of credit they extend, they can always honor them, since the Fed assures the banks access to costless legal reserves, whenever the banks need to cover their expanding loans – deposits.

We should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. – Fed. Res. Accord of Mar. 1951 was all about.

The effect of tying open market policy to a fed Funds rate is to supply additional (and excessive, & costless legal reserves) to the banking system when loan demand increases.

Since the member banks (when reserves were binding), operated without any excess reserves of significance (since 1942), the banks had to acquire additional reserves, to support the expansion of deposits, resulting from their loan expansion.

Apparently, the Fed’s technical staff either never learned, or forgot, how Roosevelt got his “2 percent war”. This was achieved by having the Fed stand ready to buy (or sell) all Treasury obligations at a price which would keep the interest rate on “T” bills below one percent, and long-term bonds around 2 -1/2 percent, and all other obligations in between.

This was achieved through totalitarian means; involving the control of total bank credit and the specific rationing of that credit we had official price stability and “black market” inflation.

The production of houses and automobiles was virtually stopped, and credit rationing severely reduced the demand for all types of goods and services not directly connected to the war effort. This plus controls on prices and wages kept the reported rate of inflation down.

Financing nearly 40% of WWII’s deficits through the creation of new money laid the basis for the chronic inflation this country has experienced since 1945. Interest rates, especially long-term, would have averaged much higher had investors foreseen this inflation. This was reflected in the price indices as soon as price controls were removed.

There were recently 5 interest rates (ceilings tied to the Primary Credit Rate @.50%), that the Fed could directly control in the short-run; the effect of Fed operations on all other interest rates is still INDIRECT, and varies WIDELY over time, and in MAGNITUDE.

It is a long-standing historical fact. The money supply can never be managed by any attempt to control the cost of credit (i.e., thru interest rates pegging governments; or thru "floors", "ceilings", "corridors", "brackets", etc). IORs simply exacerbate this operating problem. 

As long as it is profitable for borrowers to borrow and commercial banks to lend, money creation is not self regulatory.  This observation would be valid even though the Fed did not use interest rates as a guide to open market operations.

With the use of this device the Fed has actually pursued a policy of automatic accommodation.  That is, additional costless reserves, & excess reserves, were made available to the banking system whenever the bankers and their customers saw an advantage in expanding loans. 

The member banks, lacking excess reserves, would just bid up the federal funds rate to the top of the bracket thus triggering open market purchases, free-gratis  bank reserves, more money creation, larger monetary flows (MVt), higher rates of inflation – and higher federal funds rates, more open market purchases, etc.