Brad Setser: Can the Fed Control Long-Term Interest Rates?
Brad Setser notes Greenspan hinting: perhaps not:
RGE - Did Greenspan suggest that the Fed no longer completely controls US monetary policy?: One of the most intriguing passages in the magisterial Ip/Hilsenrath account of the origins of easy credit in Tuesday's soon-to-be Murdoch Journal comes when Ip and Hilsenrath quote Alan Greenspan discussing how long-term rates stayed far lower than the Fed expected once the Fed started to raise short-term rates:
Looking back, he [Alan Greenspan] says today: "We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed." Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas.
That seems -- at least to me -- to be a rather remarkable admission. After all, the Fed controls at least short-term US interest rates, the expected path of short-term rates should have an impact on long-term rates and the housing market is rather interest rate sensitive. We are only now -- after the most recent Treasury survey and the subsequent revisions to the BEA's data on official purchases of Treasuries and Agency bonds getting a real sense of just how big a role foreign central banks played in that "anticipated surge in capital" from abroad....
Ip and Hilsenrath frame the debate over foreign inflows in terms of Bernanke's global savings glut. But Bernanke's formulation sets aside what to me is a key question -- did the savings glut emerge because the rest of the world just wanted to save more (or invest less), or is it a reflection of the policies adopted by other governments?
Brad DeLong raises a similar point. He argues that Ip and Hilsenrath downplay the magnitude of official inflows and that they ignored that the world's spare savings stem as much from a shortage of investment as a surge in savings. I agree with DeLong's first point, but fully with his second point. The "investment death" argument worked better in 2004 than in 2005 or in 2006. That is when China's current account surplus started to really surge, as savings grew even faster than investment. And that is also when the surge in oil and commodity prices led to a surge in government savings in the oil exporters, as commodity revenue grew far faster than domestic spending and investment. The increase in Chinese, Indian and oil savings seems more relevant than ongoing weak investment in southeast Asia (Thailand and Malaysia most notably). I consequently do believe that there was something of a savings glut. But I also think that savings glut stemmed in large part from government policy choices -- not a surge in private savings....
The role government policy played in increasing Chinese savings isn't quite as obvious, but there is, at least in my view, a tight link. I have long found Martin Wolf's argument that China's government had to take a series of policy steps -- restricting bank lending, running a relatively restrictive fiscal policy, allowing the SOEs to hold on to their rising profits rather than pay dividends -- that pushed up China's savings rate if it wanted to avoid a burst of inflation that would undo the RMB's nominal depreciation to be rather persuasive. In this interpretation, the recent surge in China's savings rate stems directly from its exchange rate policy....
This of course doesn't mean that the Fed is powerless. It still exercises a lot more control over US monetary conditions than say China's central bank. But if China's central bank is buying lots of long-term bonds, it also implies that the Fed may have to push short-term rates up by more than it otherwise would in order to slow interest-rate and credit sensitive parts of the economy.
