Tuesday, June 12, 2012

Effect of Further Fed Easing "limited by a fundamental economic equilibrium condition."

The Fed in what is called “Operation Twist” could try to further lower long term interest rates relative to the negligible rate on treasury bills by buying long term bonds. This might reduce further the spread in interest rates (that is, flatten the interest yield curve), but this effect is limited by a fundamental economic equilibrium condition. Long term interest rates tend to be an average of current and expected short term rates since more investors would shift into short term rates when long term rates are below this average; conversely, investors shift into long term rates when these are above the average of current and expected future short term rates.
Read it at The Becker-Posner Blog
Is Further Quantitative Easing by the Fed Warranted?
By Gary Becker

At least one Nobel laureate understands the reasoning behind current low yields on Treasuries. Edward Harrison has often made this point and though it’s been mentioned several times before here, it bears repeating.

(Note: I don’t interpret this use of “equilibrium” to mean some defined level at which interest rates become stable or clear other markets. I believe the term, in this sense, merely implies the normal give and take of market prices around fluctuating expectations that never resolves itself at any stable level. Also, this “equilibrium condition” only holds for sovereign currency issuers (eg. US, UK, China, Japan) and not sovereign currency users (eg. Europe).)

Related posts:
Permanent Zero: Record Low Treasury Yields and Banking Instability
Treasury Yields Low for Good Reason

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