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Markets, Not Janet Yellen, Should Set Interest Rates
Submitted by Dr. Richartd Ebeling via EpicTimes.com,
Financial markets in the United States and around the world are all waiting with “bated breath” for when the Federal Reserve modifies its “easy money” policy and starts to raise interest rates. No one, however, asks a simple question: Why is the American central bank in the interest rate setting business?
In May 20th, the minutes were released of the April 2015 meeting of the Open Market Committee (OMC) of the Federal Reserve. The Open Market Committee decides when and by how much America’s central bank should intervene into the financial markets to influence the amount of money and credit in the banking system and, therefore, over time, in the U.S. economy as a whole.
The members, it seems, were still divided as to whether or not the OMC should start nudging interest rates up through monetary policy, or keep them at the low levels they have been at for years, with a majority leaning to not doing so until maybe September.
In its usual ambiguous language, the published summary of the OMC meeting stated that, “Many participants . . . thought it unlikely that the data available in June would provide sufficient confirmation that the conditions for raising the target range for the federal funds rate had been satisfied, although they generally did not rule out this possibility.”
The next day, Friday, May 21st, Federal Reserve Chairwoman, Janet Yellen, spoke before the Greater Providence Chamber of Commerce in Rhode Island and said she, “Thinks it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy.”
But she added that, “The Fed’s objectives of maximum employment and price stability would best be achieved by proceeding cautiously.”
How the Fed Creates Money and Influences Interest Rates
A key Federal Reserve policy instrument or “tool” is, as Yellen stated, the Federal Funds rate. This is the rate of interest that banks charge each other for overnight or short-term borrowing.
Every bank is required under Federal Reserve rules to maintain a certain amount of cash reserves against its outstanding depositor liabilities. On a daily basis, sums of money deposits flow in and money withdrawals flow out of every bank and financial institution. Sometimes banks find that the withdrawals have exceeded deposits into their vaults, and they are threatened with temporarily falling below that required minimum of cash reserves. At other times, the reverse may be the case, and deposits have exceeded withdrawals resulting in “excess reserves,” that is, those above the minimum required.
Banks borrow and lend funds between each other to cover and smooth out these temporary fluctuations in their deposit and withdrawal flows of cash, and a rate of interest emerges on the market reflecting the availability or “tightness” of such excess funds for some banks to lend to others running a bit short, short-term.
The Federal Reserve can influence this Federal Funds interest rate by purchasing or selling U.S. government securities. The Federal Reserve is prohibited by law from directly lending to the U.S. Treasury. The Treasury first borrows money to cover the government’s budget deficit by issuing IOUs – short-term or longer-term securities – to financial institutions or larger private lenders.
The Federal Reserve then goes into what is called the “secondary market” and offers to buy some of those securities being held by financial institutions or individuals, and pays for them by creating new money that then enters the banking system when those who have sold those government securities to the Federal Reserve deposit the check payments into their bank accounts.
The banks receiving those additional deposits of this new money now have larger excess cash balances with which to extend loans (after setting aside a small fraction as a required cash reserve against the depositor’s newly deposited money).
Finding themselves with larger available funds to lend, banks with try to attract interested and willing borrowers by lowering the rates of interest at which they offer to lend, given such things as the potential borrower’s creditworthiness and the type and term of the loan.
This includes the short-term Federal Funds rate at which banks are lending to each other. Money is said to be “easy” when the Federal Funds rates is low or falling, since this means the banking system is awash with cash to facilitate the reserve requirements of those banks briefly short of required reserves.
This process is reversed when (or if) the Federal Reserve sells government securities rather than buying them. The purchasers of those Treasury securities from the Federal Reserve’s portfolio pay for them out of their bank accounts. This “drains” reserves out of the banking system, tending to push up interest rates, as funds for lending purposes (all other things remaining the same) are reduced.
$4 Trillion of New Money, But Low Price Inflation
Since 2009, the Federal Reserve has been adding loanable funds into the banking system is such a large amount (around an extra $4 trillion) over the last five and a half years that the Federal Funds rate, when adjusted for the rate of price inflation has been “negative” virtually the entire time, as have one-year Treasury securities.
And reflecting this, interest rates on various commercial and other loans have been “dirt cheap,” again, especially when adjusted for price inflation as measured, say, by the Consumer Price Index.
It may be asked, why, if this is the case, price inflation has not been much higher with $4 trillion of extra loanable funds in the banking system? Sure, with that much additional money in the economy prices in general should have been rising much higher than the CPI measured rate of price inflation of far less than two percent a year.
Fearful of the price inflation its own “easy” monetary policy might generate, the Federal Reserve has been paying banks not to lend a sizable portion of that $4 trillion by offering banking institutions a rate of interest slightly above what it could earn by lending to you and me. Thus, nearly $3 trillion of the $4 trillion have sat in the banks as unlent “excess reserves.”
In viewing and treating interest rates as “policy tools” to influence the general levels of employment and prices in the economy, the Federal Reserve prevents interest rates from doing their “job” in a functioning market economy.
Market-Based Interest Rates have Work to Do
In the free market, interest rates perform the same functions as all other prices: to provide information to market participants; to serve as an incentive mechanism for buyers and sellers; and to bring market supply and demand into balance.
Market prices convey information about what goods consumers want and what it would cost for producers to bring those goods to the market. Market prices serve as an incentive for producers to supply more of a good when the price goes up and to supply less when the price goes down; similarly, a lower or higher price in?uences consumers to buy more or less of a good. Finally, the movement of a market price, by stimulating more or less demand and supply, tends to bring the two sides of the market into balance.
Market rates of interest balance the actions and decisions of borrowers (investors) and lenders (savers) just as the prices of shoes, hats, or bananas balance the activities of the suppliers and demanders of those goods. This assures, on the one hand, that resources that are not being used to produce consumer goods are available for future-oriented investment, and, on the other, that investment doesn’t outrun the saved resources available to support it.
Interest rates higher than those that would balance saving with investment stimulate more saving than investors are willing to borrow, and interest rates below that balancing point stimulate more borrowing than savers are willing to supply.
There is one crucial difference, however, between the price of any other good that is pushed below that balancing point and interest rates being set below that point. If the price of hats, for example, is below the balancing point, the result is a shortage; that is, suppliers offer fewer hats than the number consumers are willing to buy at that price. Some consumers, therefore, will have to leave the market disappointed, without a hat in hand.
Central Bank-Caused Imbalances and Distortions
In contrast, in the market for borrowing and lending the Federal Reserve pushes interest rates below the point at which the market would have set them by increasing the supply of money on the loan market. Even though savers are not willing to supply more of their income for investors to borrow, the central bank provides the required funds by creating them out of thin air and making them available to banks for loans to investors. Investment spending now exceeds the amount of savings available to support the projects undertaken.
Investors who borrow the newly created money spend it to hire or purchase more resources, and their extra spending eventually starts putting upward pressure on prices. At the same time, more resources and workers are attracted to these new investment projects and away from other market activities.
The twin result of the Federal Reserve’s increase in the money supply, which pushes interest rates below that market-balancing point, is an emerging price in?ation and an initial investment boom, both of which are unsustainable in the long run. Price in?ation is unsustainable because it inescapably reduces the value of the money in everyone’s pocket, and threatens over time to undermine trust in the monetary system.
The boom is unsustainable because the imbalance between savings and investment will eventually necessitate a market correction when it is discovered that the resources available are not enough to produce all the consumer goods people want to buy, as well as all the investment projects borrowers have begun with the newly created money for which real savings does not exist to complete or fully sustain them.
Federal Reserve Policies Bring About the Boom and the Bust
What is important to understand is that while price inflation carries it own negative effects on the economy by eroding the real value, or buying power, of the money in people’s pockets, the most serious consequences of monetary expansion and interest rate manipulation are those distortions and imbalances brought about in the underlying supply and demand relationships between savings and investment in the economy.
That is why even if price inflation, as measured by such statistical methods as the Consumer Price Index, may seem moderate or even near zero, as in recent circumstances, the most serious effects brought about by Federal Reserve monetary policy are those beneath the surface of the macroeconomic aggregates of total employment, total output, or the “general price level” of goods and services.
Janet Yellen and the other members of the Board of Governors may be waiting for price inflation to rise into the neighborhood of two percent a year (their desired “target” for inflation) before being seriously concerned about the impact of their own easy money policies. But by that time, beneath that macroeconomic surface of statistical aggregates and averages, the savings and investment patterns and the use and allocation of labor and other resources among different sectors and activities in the economy will have been given a “wrong twist.”
As a consequence, Yellen’s monetary and interest rate policies meant to assure full employment and stable prices will have set the stage for another “bust” following another unsustainable “boom.”
In her address in Rhode Island Janet Yellen recalled taking economics classes at Brown University and thinking, “Gee, I didn’t realize how much influence the Federal Reserve has on the health of the economy. If I ever have a chance at public service” working at the Federal Reserve “would be a worthwhile thing to do.”
The only way to bring an end to these cycles of booms and busts is to end Federal Reserve power and authority to manipulate the money supply and interest rates. But that is unlikely to happen any time soon with “activist” policy addicts like Yellen running the central bank who think it is “a worthwhile thing to do.”
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Damn straight.
Yellen is a felon.
Woulda, coulda, shoulda. Failure dies an orphan.
The markets are raising rates.
QE and FOMC chatter are reaching their limits.
That's why Greenspan, Lindsey, Fischer (both of them), Yellen, Bernanke, etc. are filling their pants.
The snake-oil salesmen are speakng sincerely with furrowed brows, however they are meantime getting ready to bolt.
It’s all her money.
That was the bogus deal in 1913.
All you got is a string of electrons that are the credits she lets you have and maybe some inked paper in your pocket or mattress.
She can charge whatever she can get away with for it.
"Markets, Not Janet Yellen, Should Set Interest Rates"
Why not save a step and be completely honest with:
"States, Not International Usurers, Should Issue Debt-Free Money".
If this were the case, interest rates would find their natural levels without the kosher-nostra banksters' criminal influence.
Or remove the compulsion that is required to maintain the monopoly of involuntary demand?
Or no more issuing "General Obligation" bonds?
Maybe issue bonds that are underwritten by collateral that currently exists instead of expecting that it be usurped from the direct taxation of the people?
Interest = demand.
The more people demand money (to borrow), the higher the price (the rate).
At some point, this concept was decoupled and interest no longer meant how "interested" people were in borrowing the money that was available. I suppose when you get to dictate the supply as well...
Almost there.
Voluntary demand determines the purchaser's interest.
Involuntary demand determines the seller's interest.
Freedom from compulsion vs the establishment of compulsion.
If i have the temerity to print fiat in my basement they will send the Festapo (FBI), and/or Secret Prostitute Service over to shut me down.
If I have an Unconstitutional authority, a working knowledge of the Talmud, and a high priced suit, they'd celebrate and protect me.
Liberty is a demand. Tyranny is submission..
Is this article written by Rip Van Winkle?
The FED can't own you without owning interest rates.
Absolutely.
The Fed will never give up the zero bound. This is how the "constituencies" (special interest groups) get paid.
War on Terror? Total fraud probably since day one.
"Nuke the dollar/pay yourself." Rinse/launder...repeat.
No way (more) State pension plans don't start blowing up here in my view.
This ain't Zimbabwe.
Competitive devaluations are always on the table when it comes to the Fed.
They care neither about price stability nor recovery. In fact they hate them both.
That is one HUGE defense budget though...
Just took a horse carriage ride through St. Louis this weekend and we passed one of the seats of power at the St. Louis Federal Reserve.
They were advertising an Inside the Economy Museum, where you they will "immerse you in a one-of-a-kind experience that explains the economy, and your role in it, in a fun and interactive way."
https://www.stlouisfed.org/inside-the-economy-museum/
I should have requested for the horse to leave a present on their doorstep.
what "markets" ? inane.
"Markets, Not Janet Yellen, Should Set Interest Rates"
And Muggers shouldn't take wallets and purses.
Liberty is a demand. Tyranny is submission..
No kidding!
The purpose of the FED is to EXTINGUISH free markets, because free markets always limit the amount of wealth a small group can amass through crime.
her position is simply ceremonial. all she can do is pretend to have control over the "presses" spinning really fast, and even faster than really fast. that is all
I bet you're right.
If markets set interest rates, for one thing, the markets would implode on any rate increase. A rate increase will make government borrowing more expensive, with 20 trillion in Fed and State debt overhang to serivce, any cost of debt service will implode the federal government and state governments. Cities too!
Simple equation "Interest rate increases = government implosions"
And that's a bad thing?
Well, what the fuck are we waiting for then?
It looks like the Fed. is losing credibility to me... Risk is being re~evaluated.
I agree the Fed. isn't going to raise rates... Mr.Yellen will let the markets do it by controlling supply & liquidity. The Fed. owns a huge portion of the bond market across the curve. (They also have state #51 Japan)
FRB: Recent balance sheet trends - Credit and Liquidity Programs and the Balance Sheet
Whatever you do... Make very sure that you kick people like francis_sawyer off of ZH a dozen times for questioning the monopoly that Greenspan, Bernanke, & Yellen accrue (for the benefit of a mathematically impossible limited population) on setting interest rates & all that implies...
That's why I like ZH so much, its UNDYING determination to publish the TRUTH & being a bastion of FREE SPEECH & all...
So I suppose... ON A LONG ENOUGH TIMELINE... Everyone does the phony Greenspan apology tour (even though it isn't an apology at all)...
Dude -
Let It Go ....
I don't think shes the one neo.
failure is what makes capitalism work
tbtf is fascism writ large
Future of the Federal Reserve should be a topic of the upcoming Conventio by the States. Of course, the same should be true for the future of the Federal government .
As a consequence, Yellen’s monetary and interest rate policies meant to assure full employment and stable prices will have set the stage for another “bust” following another unsustainable “boom.”
What we've been saying here for several years, now, ad nauseum.
for you(r) name(sake)
Tom Waits - Falling Down
https://www.youtube.com/watch?v=ksbaPmRDa60
.
"Falling Down"
I've come 500 miles
Just to see your halo
Come from St. Petersburg
Scarlett and me
When I open my eyes
I was blind as can be
And to give a man luck
He must fall in the sea
And she wants you to steal and get caught
For she loves you for all that you are not
When you're falling down
Falling down
When you're falling down
Falling down, falling down
You forget all the roses
Don't come around on Sunday
She's not gonna choose you
For standing so tall
Go on take a swig of that poison
And like it
And now don't ask for silverware
Don't ask for nothing
Go on and put your ear on the ground
You know you'll be hearing that sound
Falling down
You're falling down falling down
Falling down falling down
Falling down
.......
When you're falling down
Falling down falling down
......
Go on down see that wrecking ball
Come swing in on her now
Everyone knew that hotel was a goner
They broke all the windows
And took all the door knobs
And they hauled it away
In a couple of days
Now someone yelled timber
Take off your hat
We all look smaller
Down here on the ground
When you're falling down
Falling down falling down
Falling down falling down
Falling down
Someone's falling down
Falling down falling down
Falling down falling down
Falling down
Blue Valentine Tom Waits 1978
https://www.youtube.com/watch?v=Q6JTnjCVETw
Newton's 2nd Law, The vector sum of the external forces (F) on an object is equal to the mass (m) of that object multiplied by the acceleration vector (a) of the object, F= ma.
NOT THIS COMING BABY!
perhaps because the american central bank cares less
for "america" than any other central bank cares for its
populace or blow flies?
did i say "respect", that should have been "fears"
perhaps?
i'm all confused in the "care, respect, fear"
pool of human integrity. someone out there can
figure it out for themselves and then it will
all work out, no? i hope so.
Fed should be disqualified from setting monetary policy because it is a major conflict of ionterest when they are the largest holder of assets in the universe. Imagine a few larges hedge fund set monetary ppolic for their own books.
I would rather them set rates by decree, frankly. The worst part about all of this is the insult of the contrivance, and the rube goldberg machine required to execute it.
"Why is the American central bank in the interest rate setting business?"
It is called a monopoly. Per Thomas Jefferson, it is Unnecessary and Improper:
http://founders.archives.gov/documents/Jefferson/01-19-02-0051
Audit the Fed...
then hang the bastards...
after a fair, honest and speedy trial of course...
Trial? They don't need no trial.
And we don't need no stinking badges, either.
Hidden in Plain Sight
is the missing word ... SYSTEM
The Federal Reserve System. Designed to run on automatic pilot, systematically transferring money from the pockets of the many into the pockets of a few. A little over a Hundred years ago, on Christmas eve, the traitors of the time in the US CONgress passed the legislation, the complicit President signed the bill and the System has been up and running since.
As long as the System exists, there is no hope of financial reform in the U$A.
Will NEVER happen - the regime leaders MUST control interest rates, money supply and spending to continue buying votes and remain in power.
The central banks control interest rates for the same reason they control the military. There is nobody that can stop them.
Who cares what the Feds interest rates are? Are any of you getting loans at that rate?
So shut up. Who are you kidding?
200 years of fair interest rates have been TAKEN from the system at the pleasure of the Fed and the delight of the government. The system has been hijacked
Quite right. Instead of lowering the interest rates they charge credit card holders, the banks are expanding their "loyalty" programs.
The only way they will ever go up by more than Fairies Part, is after the next Crash and everything is transferred back to the Banks. The question is, how little they can raise them and the Media will still report the recovery is in full swing.
Banks create money from loans, this is a well hidden fact (even economists aren’t taught the truth about money) but the BoE decided to come clean and tell the truth last year.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
Banks have even come up with a way of creating money with no reserves at all, mortgages with fees. The reserve is in the fee and the money they lend you is just created out of nothing by typing it into a keyboard. The bank gives you your mortgage money, plucked from thin air, but they own the asset of the house; all is square. Eventually, you pay off your mortgage and the bank gets its money back plus interest and you get your house. At the end of the transaction the house is yours and the bank has made money from the interest. If you default, they seize the house and get their money back by selling it.
Why do banks fear deflation?
All the assets they hold as security against the magic money they created from thin air lose value. Defaults cannot necessarily covered by seizing the asset.
In the housing boom leading to 2008, massive money creation was taking place and feeding into the economy causing that to boom. In the bust, the sub-prime properties no longer could be sold to replace the banker magic money; wholesale money destruction takes place. Their toxic derivative assets become worthless over night and the money created to buy them is destroyed.
Bankers and Central Bankers are equally incompetent in their money creation.
Bankers rig markets and so they cannot be trusted.
We need to take control of the money supply away from bankers altogether.
Interest rates - keep bankers of all types away from them.
The market does set interest rates.
Bank in the 70s, the bank's Prime Rate was watched keenly ...
On Fridays the banks .... the banks...would either raise or lower their Prime Rates..
The Fed would FOLLOW....
THe Fed back then was only concerned with SHORT TERM liquidity issues.
This FED has self expanded its powers off of the "troubles" of 07 08. THeir mandate has no mention of them promoying inflation or forcing rates to "immoderate" levels.
Question the Federal Reserve!!! Yellen is a stooge with double speak answers. THe Central Bankers all over the world are in collusion and run at the pleasure of a few. THere are no free market rates with this arrangement.
Sorry, you have the rate-setting process backwards. The Fed pushes interest rates (federal funds rate) higher by selling short-term treasury bills. The commercial banks follow by raising their prime rate.
Any number of commentators, including the author of this item, have called for the abolition of the Federal Reserve. But not a one of them has proposed a workable alternative to manage the money supply and keep prices stable. I will ignore such diatribes until one appears that offers possible alternatives.
Incidentally, "new" money is not created by the Fed. It comes into existence when a commercial bank makes a loan and credits the borrower's checking account. The Fed puts a limit on this money creation by establishing required reserves of the commercial banks. These required reserves can take the form of a credit balance on the Fed's books, or in the form of vault cash held by the commercial bank.
If more commercial bank loans are paid off than are newly created, then the money supply shrinks, even though the Fed has taken no action. Passively, the Fed reflects this payoff by switching a percentage of the loan from required reserves to excess reserves in its account with the commercial bank involved.