The fed knows the only way to prop the economy is to create another bubble, hence the historical low interest rates. Seems they didn't learn from their mistakes the last time they kept rates low. Anyone who believes they can time it just right and start raising rates to stave off inflation will be in for great surprises. You have to be an idiot to think low rates is going to bring us out of the biggest credit crisis in history. One big joke is all this is.
If everyone is anticipating a pick up in GDP at the end of 2009 and all of 2010 due to all this wonderful stimulus money then they should be raising rates by October-December timeframe. Will they? Nope....
The point is that they don't have to raise rates. The M1 multiplier is just barely above one. So the excess liquidity isn't coursing through the system creating more money. It's stagnant and therefore unlikely to result in inflation for the immediate future. The only danger of inflation is in expectations. If the market believes that liquidity will not be reigned in before the multiplier returns to normal levels, it will expect inflation and will bid up interest rates - just as it did earlier in the year. Therefore, Ben only needs to convince the market that that the excess liquidity will be reduced before banks begin to increase lending. Changes in the money supply do not automatically affect interest rates. It's rare, but other factors can trump conventional logic. An economy with a multiplier of 3 or 4 will need proportionally less money than one with a multiplier of 1 or less. So if liquidity is reduced in advance of increases in the multiplier, the money supply will be reduced while having no affect on rates. The only exception to this principle is when the market begins to anticipate inflationary pressures which have not yet been manifested.
Yes, agreed, they don't have to raise rates now, but at some point the monetary aggregates will start to move as a result of all the measures. Moreover, muted inflation expectations aren't going to persist forever. There's also the question of the Fed's inflation-targeting and inflation-measuring credibility. Given all that, would you care to hazard a guess as to when the hikes start (if they do)? Or are you of the view that they're on hold for the next 2, 5, 10 years?
My timing has always sucked but I'll give it a stab. And if you want to make fun of me later when I'm wrong, I'll just point to this caveat. I don't think the multiplier will pick up until there is an increase in economic activity. The problem is that this could come from many different sources - some quite unexpected. You may have read that China will be spending down their foreign reserves. Depending on how much of that money they spend in the US economy, that single action could have a dramatic affect and sharply accelerate any proposed time table. Another consideration is when the bulk of the Obama stimulus will be spent. Since the lag could be as much as a year, if not more, and since it maybe 2010 before most of it is out the door, you might not see any pressure on the multiplier until late 2010 at the earliest. So to even attempt a prediction, you need to have a handle on current conditions and I seriously doubt if anyone does. Even so, I'll say that the multiplier will gradually increase but that it will be at least 4 months before you see it increase at an increasing rate. Long before that the fed will implement contingency plans to manage the excess liquidity - such as the proposal to pay interest on excess reserves. This will make it more nimble in responding to events as they unfold. They will ignore the initial changes in economic activity as long as they are not striking. I would expect that during the Christmas shopping season - Nov-Dec. So the first actual tightening will probably occur in February. edit - some of this analysis is not entirely consistent. It sounded good as I was typing it, but didn't hold up upon reflection. I'll have to come back to it. But let me know what you like and don't like.
Cool, thx... Your analysis sounds reasonable and provides some worthwhile food for thought. I will get back to you with my views on the matter and we can compare notes. And I would never think of making fun of someone's thoughts on these complicated issues, even if I disagree with them.