From China / Market Implications from Unconventional Monetary Policies…

The Shanghai Development Research Foundation (SDRF) recently hosted a superb dialog on issues stretching from China, the international monetary system, re-thinking the nature of money, among others.  I had the pleasure of presenting on “Market Implications from Unconventional Monetary Policies.”

My remarks centered on:

The need to assess the normalization of monetary policies through the lens of major macro shifts over the last 10 years.

Specifically, three “never befores” need to be resolved.  For instance, “never before” has there been such 1) large scale intervention by central banks and governments; 2) growth in the financial regulatory apparatus and labyrinth of rules governing markets; and 3) distortions across a wide range of financial markets.

Here, CFS monetary and financial data illustrate why goods price inflation has remained subdued and – in contrast – asset price inflation has not.

Evaluation of long-term stock and bond market valuations reveal market distortions.

Speculative positioning has been actively influenced by the patterns of rise and restraint in balance sheet operations in recent years.

Going forward, officials would benefit by seeking balance among these three “never before” forces.

For slides accompanying the presentation:

On a parenthetical note, I left China excited with advances in mobile pay.  It will redefine the nature of money.

Testimony on Monetary Policy

Mickey D. Levy (Chief Economist of Berenberg Capital Markets for the Americas and Asia) testified before the House Financial Services Committee on monetary policy.

He focused on how non-monetary factors including a growing web of government taxes, regulations and mandated expenses were harming the economy.

His line of thinking is of special note as these themes have been revealed over the years by CFS Divisia monetary aggregates and components.

His Testimony Resetting Monetary Policy is available online –

Congress can help the Fed…

President-elect Donald Trump noted that “we have a very false economy,” due to the Fed “keeping the rates down.”  He is right.

Yet, the question remains how to exit from this policy while avoiding catastrophe in the bond market and building a safer monetary policy framework for the future.

The Fed needs to integrate state and bank money into the policy discourse, including its own reports to Congress and the public.

Here, Congress can help.

For full remarks:

Coats on “What is wrong with our monetary policy?”

Former Chief of the SDR Division at the IMF Warren Coats unpacks a statement by Senator Jeff Merkley that

“The Fed should be using its economic expertise to highlight the long-term devastating impacts of failing to provide the opportunity for the skills needed for the economy of the future.” [1]

Warren’s paper examines monetary management in the United States – since the Nixon shock of closing the gold window and launching wage and price controls – to research the statement above. He finds:

  • No tradeoff exists between employment and inflation in the long run.
  • Radical innovations in New Zealand sparked rules that ultimately fell short of expectations.
  • NGDP targeting ignores the benefits of stable money.
  • The return to a hard anchor for monetary policy – such as the SDR – is attractive.

Although CFS is not promoting the idea of a newfound use for the SDR, monetary policy is in need of a rethink. Warren’s ideas are thoughtful and informative.

To view the full paper:

As always, CFS welcomes opinion.

[1] Ylan Q. Mui, The Washington Post Aug. 27, 2016

Financial Markets are More Forward-looking Than We Thought: Fed Funds Futures Prices Ahead of FOMC Decisions

Much of the literature related to Federal Open Market Committee (FOMC) decisions focuses on their post-announcement effects. There is ample evidence that asset prices and volatilities only respond to ‘surprises’ – that is, when the actual target decision differs from the market’s expectation (e.g. Bomfim 2003, Bernanke and Kuttner 2005, Gürkaynak et al. 2005), mirroring the findings of a substantial body of work considering the effects of macroeconomic announcements (e.g. Ederington and Lee 1993, Jones et al. 1998).

In addition, there is an equally large literature that investigates whether FOMC target rate decisions are predictable via macroeconomic announcements, Fed funds futures, or the yield curve (e.g. Lange et al. 2003 Hamilton 2008) or a combination of these, and literature on anticipation of Federal Reserve actions (e.g. Lucca and Moench 2015). Within this literature, there is some evidence that anticipatory effects develop gradually and that Fed funds futures may not fully capture the effects of FOMC decisions on this market.

For the most part, both sets of literature focus on the days immediately surrounding an FOMC decision. There is good reason for this, as is evident when considering extreme examples: first, the instant before the decision reflects all available information, hence providing the most accurate pre-announcement expectation; and second, the instant immediately after the decision is the point of fullest response, before the reaction begins to dissipate or is marred by reactions to other information. Such instant before versus instant after comparisons are the motivation behind much of the event study literature.

The view from the trading floor

Anyone who has been near the Treasury desk on a trading floor on the day of an FOMC decision knows the typical pattern surrounding such announcements. The minutes leading up to the announcement give meaning to the phrase “the calm before the storm”. And as soon as the statement is made, a frenzy of activity ensues – reflecting both the surprise reaction of some market participants and the position adjustment of those for whom the “future path of policy” (Gürkaynak et al. 2005) has suddenly been revealed.

Having been on a trading floor in 2004 when the Fed began a steady programme of tightening following a protracted period of being on hold at historically low levels, I know anecdotally that traders generally don’t wait until 2:14pm to adjust their positions in anticipation of a 2:15pm announcement. They ‘set up’ much farther in advance, both to handle any last-minute orders that customers might have and to be ready to respond to trade requests in the aftermath of an announcement.

It is for this reason that I and my co-authors, Dick van Dijk and Michel van der Wel, decided to investigate the extent to which financial market participants set up for Federal Reserve decisions (van Dijk et al. 2016). Our focus on anticipatory effects blends the future path of policy idea of Gürkaynak et al. (2005) with the foresight model specified in Leeper et al. (2013).

To consider this possibility of early anticipatory set-up, we design a comprehensive regression framework that enables us to investigate how the Fed funds futures market is shaped by scheduled FOMC announcements, as well as Federal Reserve communications in the form of speeches and testimony of members of the Board of Governors of the Federal Reserve System, and how those effects interact with announcements of macroeconomic variables during the six months preceding a scheduled target rate decision.

Quantifying the respective contributions of macroeconomic announcements and Federal Reserve officials’ communications to the evolution of daily changes in Fed funds futures prices is the main focus of our study.

We find that the anticipation (or ‘set-up’) occurs over a much longer horizon than previously thought. Furthermore, these effects decline as the FOMC meeting nears: earlier FOMC decisions and surprises in macroeconomic announcements affect Fed funds futures prices more strongly than more recent ones; and Fed funds futures volatility tends to be lower in the days leading up to an FOMC meeting than in the weeks or months preceding it. We argue therefore, that in order to identify fully how information shapes financial market expectations, it is necessary to look much farther back in time.

In contrast to the conventional wisdom that financial markets are reactionary and instantaneous, our work suggests a more methodical approach to digesting central bank communications and macroeconomic announcements, one that considers not only the latest news but how that in turn shapes the path of future policy decisions. In short, financial markets are more forward-looking than we had thought.

One of the challenges in quantifying how the financial markets are affected by Federal Reserve communications over longer periods of time is that other news, such as the release of major economic indicators, also plays a role. By looking at both items together, we find that macroeconomic indicators and central bank officials’ congressional testimony are of comparable importance.

We document that macroeconomic releases have stronger effects on days when Federal Reserve officials are silent (for example, during the ‘blackout period’ – that is, the 7-10 days preceding an FOMC announcement). In contrast, we find that congressional testimony is more important when it coincides with days when important macroeconomic information is released.

Our finding of large anticipatory set-up emphasizes the importance of clarity in central bank communications. The potential importance of these communications has been recognized by the Federal Reserve itself, through a series of decisions since 1994 designed to increase transparency.

An implication of our results, showing that Fed funds futures volatility declines as the FOMC announcement draws near, is that the Fed’s policy rate intentions have been well-understood by the financial markets.

In the paper, we also demonstrate that failure to look back far enough results in inferences that attribute much less significance to both Fed communications and macro announcements in shaping Fed funds futures prices, suggesting that previous studies’ effects may have been understated.


Bernanke, BS, and KN Kuttner (2005), “What Explains the Stock Market’s Reaction to Federal Reserve policy?”, Journal of Finance 60(3): 1221-57.

Bomfim, AN (2003), “Pre-announcement Effects, News Effects, and Volatility: Monetary Policy and the Stock Market”, Journal of Banking and Finance 27(1): 133-51.

van Dijk, D, RL Lumsdaine, and M van der Wel (2016), “Market Set-up in Advance of Federal Reserve Policy Rate Decisions”, Economic Journal 126 (May): 618-53; earlier version of available as National Bureau of Economic Research (NBER) Working Paper No. 19814.

Ederington, L, and J Lee (1993), “The Short-run Dynamics of the Price Adjustment to New Information”, Journal of Financial and Quantitative Analysis 30(1): 117-34.

Gürkaynak, RS, BP Sack, and ET Swanson (2005), “Do Actions Speak Louder than Words? The Response of Asset Prices to Monetary Policy Actions and Statements”, International Journal of Central Banking 1 (May): 55-93.

Hamilton, JD (2008), “Assessing Monetary Policy Effects Using Daily Federal Funds Futures Contracts”, Federal Reserve Bank of St. Louis Review 90(4): 377-93.

Jones, CM, O Lamont, and RL Lumsdaine (1998), “Macroeconomic News and Bond Market Volatility”, Journal of Financial Economics 47(3): 315-37.

Lange, J, B Sack, and W Whitesell (2003), “Anticipations of Monetary Policy in Financial Markets”, Journal of Money, Credit, and Banking 35(6): 889=909.

Leeper, EM, TB Walker, and SCS Yang (2013), “Fiscal Foresight and Information Flows”, Econometrica 81(3): 1115-45.

Lucca, DO, and E Moench (2015), “The Pre-FOMC Announcement Drift”, Journal of Finance 70(1): 329-71.


Economic Policy Uncertainty and the Credit Channel…

I am grateful to John Duca at the Federal Reserve Bank of Dallas for highlighting a recent NBER paper that he co-authored with Michael Bordo and Christoffer Koch.

The authors find that “policy uncertainty significantly slows U.S. bank credit growth, consistent with it having an effect on broad loan supply and demand.”

These results corroborate our findings in recent years evaluating the performance of CFS Divisia monetary aggregates.

Bordo, Duca, and Koch also did fine work quantifying the regulatory and reporting burden on banks since Dodd-Frank (see Figure 2 on page 26). In fact, their data stretch back to 1960. For instance, the number of pages per regulatory filing for banks was less than 10 from 1960 into the early 1980s, gradually advancing to roughly 50 prior to the financial crisis. Since the crisis, the pages per filing are near 90 and advancing at a seemingly geometric rate.

The paper is available at

Central bank policy is founded on flawed analysis

Professor Michael Wickens (University of York and Cardiff Business School) publishes a thoughtful letter in the Financial Times “Central bank policy is founded on flawed analysis” –

Professor Wickens illustrates how assumptions underpinning monetary policy actions actually damage financial stability.

Center for Financial Stability members and friends know how our Advances in Monetary and Financial Measurement (AMFM) data developed under the leadership of Professor William A. Barnett illustrate present day challenges to the conduct of monetary management and financial stability.

For instance, Fixing the Fed’s Liquidity Mess – – a Wall Street Journal piece that I wrote with Stephen Dizard highlights the specific challenge to financial stability from illiquid markets.  We offer three solutions.


U.S. Secular Stagnation?

Johns Hopkins Professor Steve Hanke (CFS, Special Counselor) penned a thoughtful piece on “secular stagnation.”

Steve also meaningfully employs CFS Divisia monetary aggregates to examine future U.S. economic growth prospects.

The full article – U.S. Secular Stagnation? – is available at

WSJ features CFS monetary analysis and data…

This morning’s Wall Street Journal features CFS views and data in “Shadow-Credit Rise Is Good Sign” by Michael Casey on page C3.

The article highlights how CFS data on market finance or “shadow banking” can measure the durability of the recovery and help frame the policy debate in a balanced way.

A few highlights include:

“Seven years after the financial crisis, lending in the so-called shadow-banking system finally appears to have bottomed out, a reversal that could presage a long-awaited uptick in U.S. economic growth.”

“Extrapolations from CFS data show that the level of market finance is significantly below where its post-1967 trend would predict. In other words, a great deal of expansion is needed to bring this market back even to a level projected by its prebubble state. Until then, shadow banking will continue to do far less of the heavy lifting in credit creation than it used to.”

For the full article “Shadow-Credit Rise Is Good Sign,” please see page C3 of this morning’s paper or view

State of the International Financial System: House Committee on Financial Services Hearing

The U.S. House Committee on Financial Services announced a full committee hearing titled “The Annual Testimony of the Secretary of the Treasury on the State of the International Financial System.” The hearing is scheduled for March 17, 2015.

It will be informative to see how Secretary Lew assesses backdoor currency wars (see pages 2, 9, and 10 of the New York Society of Security Analysts presentation).