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Fixing the “Textbook Lag” with FRED (Part I)

Monetary policy in a world of ample reserves

Your economics textbook may still say the Federal Reserve uses open market operations to influence the federal funds rate. But in today’s economy, the Fed uses different policy tools.

Before September 2008, when reserves were scarce, the Federal Reserve bought and sold relatively small quantities of Treasury securities to adjust the level of bank reserves and influence the federal funds rate (FFR). But we now live in an environment of ample reserves. As such, the Federal Reserve can no longer effectively influence the FFR by making small changes in the supply of those reserves. Instead, the Fed uses its newer tools—paying interest on excess reserves (IOER) and the overnight reverse repurchase agreement (ON RRP) facility—to influence the FFR.

Since December 16, 2008, the FOMC has set a target range for the FFR, rather than a specific single target, and uses the rates on IOER and the ON RRP facility to keep the FFR rate in that target range. This process has ensured that the FFR has remained between the upper limit and the lower limit of the range.

The graph above tracks the actual FFR and the upper and lower limits of the range. Our next FRED Blog post provides more details. Stay tuned…

For more information on this topic, see “A New Frontier: Monetary Policy with Ample Reserves.”

How this graph was created: Search for “federal funds rate target”; select “Federal Funds Target Range – Upper Limit,” “Federal Funds Rate – Lower Limit,” and “Effective Federal Funds Rate (daily)”; and click “Add to Graph.” Adjust the date to show the entire period: December 16, 2008, to the current date. In each case, you can adjust the colors to your liking by using the color palette in the “Edit Graph” panel’s “Format” tab.

Suggested by Scott Wolla.

View on FRED, series used in this post: DFEDTARL, DFEDTARU, DFF

Comovements in monetary policy

Revealing international correlations with FRED

Reporters and Fed watchers in the U.S. usually think about monetary policy in a domestic framework. But because business conditions, including commodity prices, are correlated internationally, central banks tend to move their policy rates up and down together and their inflation and interest rates tend to be correlated. FRED makes it easy to see these international comovements of macro and policy variables.

The first graph shows comovement in inflation rates from 1970 to the present for four economies: the U.S., Japan, the U.K., and the euro area. Inflation rose in the 1970s as central banks failed to combat the effects of commodity price increases on the general price level and inflation expectations became established.

Before the Financial Crisis of 2007-2009, almost all central banks in the developed world implemented monetary policy mainly by buying and selling short-term bonds to influence short-term interest rates or “policy rates.” The second graph shows the comovement in these policy rates from 1970 to the present for the Federal Reserve, the Bank of Japan, and the Bank of England: These central banks first hiked their policy rates in the 1979-1981 period to combat inflation and were then able to reduce those rates in the 1980s after inflation fell.

The second graph also shows that the Federal Reserve, the Bank of England, and the Bank of Japan lowered their short-term interest rates to zero during the Financial Crisis. To maintain price stability and continue to stimulate their economies, they turned to “unconventional” monetary policies that included buying long-term bonds to reduce long-term interest rates.

The value of the assets of central banks is one (albeit imperfect) way of measuring the monetary stimulus of unconventional policy. The third graph shows the assets of four central banks using an index for their values in 2008. The index value, rather than the value in each respective currency, allows a rough but easy comparison of the relative monetary stimulus. Central bank asset holdings have all increased greatly over the past decades. The Federal Reserve and the Bank of England had the first large responses in 2008-2009. The Bank of Japan began to accumulate assets in earnest starting in 2013. And the European Central Bank did likewise starting in 2015.

How these graphs were created: First graph: Search for “consumer price index for all urban consumers,” select the seasonally adjusted monthly version of the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the three series “Consumer Price Index of All Items in Japan,” “Consumer Price Index of All Items in the United Kingdom,” and “Harmonized Index of Consumer Prices: All Items for Euro Area (19 Countries).” For each of these four lines, change the units to “Percent Change from Year Ago.” Lastly, change the start date to 1970-01-01.
Second graph: Search for “effective federal funds rate,” select the appropriate monthly series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the two series “Immediate Rates: Less than 24 hours: Central Bank Rates for Japan” and “Bank of England Policy Rate in the United Kingdom.” Lastly, change the start date to 1970-01-01.
Third graph: Search for “All Federal Reserve Banks: Total Assets,” select the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the three series “Bank of Japan: Total Assets for Japan,” “Total Central Bank Assets for United Kingdom,” and “Central Bank Assets for Euro Area (11-19 Countries).” For each of these four lines, change the units to “Index (Scale value to 100 for chosen date)” and select the date 2008-01-01. Lastly, change the start date to 2004-01-01.

Suggested by Chris Neely.

View on FRED, series used in this post: BOERUKM, CP0000EZ19M086NEST, CPIAUCSL, ECBASSETS, FEDFUNDS, GBRCPIALLMINMEI, IRSTCB01JPM156N, JPNASSETS, JPNCPIALLMINMEI, UKASSETS, WALCL

Oil prices and breakeven inflation rates revisited

In an earlier FRED Blog post, we highlighted the simultaneous decline in the 5-year breakeven inflation rate and the price of oil in 2014. (The 5-year breakeven inflation rates are obtained from 5-year Treasury inflation-indexed constant maturity securities and are thought to represent the market’s expectation of CPI at a 5-year horizon.) At that time, we argued that markets might have believed that the drop in oil prices reflected a slowing in global demand that might result in a persistent decline in consumer prices. In this post, we make a longer comparison—from 2011 to 2019—between the same two series shown in the original graph.

The graph above shows that the correlation between the breakeven inflation rate and oil prices is not limited to the steep decline that occurred in 2014. Indeed, the correlation between the two series over the entire period shown (January 2011 through March 2019) is 0.65. Prior to 2015, the two series appear to occasionally move together. The comovement was particularly obvious when the two series exhibited large changes, rising together in early 2011, falling together in late 2011, etc. From January 2011 to January 2015, the correlation between the series was 0.49. From January 2015 to March 2019, the correlation between the two series became even more apparent, rising to 0.85.

A few academic papers have tried to analyze the cause of the comovement, but the high degree of correlation between the two series remains puzzling. Even if changes in oil prices pass through to consumer prices, one wouldn’t expect such a close correspondence between oil prices today and consumer prices at a 5-year horizon.

How this graph was made: Search for “crude oil prices,” select the series “Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma” with a daily frequency,  and click “Add to Graph.” From the “Edit Graph” panel, select the “Add Line” option: Search for “5-year breakeven inflation,” select the first series shown (“5-Year Breakeven Inflation Rate, Daily, Percent, NSA”), and add the data series. In the “Format” tab, change the y-axis position from left to right for the breakeven inflation rate and set the start date to 2011-01-01.

Suggested by Michael Owyang and Hannah Shell.

View on FRED, series used in this post: DCOILWTICO, T5YIE


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