The Federal Reserve Controls Short Term Interest Rates, Expected Future Interest Rates, Term Premium, and Liquidity Premium. QED the Yield Curve is a Policy Choice.
I think it's important to acknowledge that firms make their investment, long-term planning, and hiring decisions based on both current credit conditions and expected future credit conditions. If monetary policymakers were communicating that interest rates would go up and policy would contract in the near future, businesses would plan accordingly and not invest/hire as much. NGDP growth would therefore decrease.
This is part of the reason that countries like Japan, Germany, and (to a lesser, but still extremely important) extent the US have struggled to get high nominal growth rates and escape the Zero Lower Bound. Monetary policymakers and institutions communicate that they will tighten rates as soon as possible to end the "extraordinary" stimulus measures, so firms restrict investment. Think about the 2013 "taper tantrum" in the US—despite weak nominal growth and low employment levels, the Federal Reserve was communicating that they would like to end QE in preparation for raising interest rates. Firms expected that policy would contract in the near future and so pulled back on investment and hiring.
This is why temporary monetary stimulus will never have the nominal growth effects that long term stimulus will.
I think a really critical part of fixed income modeling is understanding the Federal Reserve's reaction function and, on a kind of second-order and beyond level of thinking, understanding how their reaction function may change in the presence of new information.
Anyone who could predict the shift to FAIT and understand the Fed's reaction function under FAIT is going to have a better understanding of the fixed income universe.
What are the most likely causes of a CB capitulation on longterm rates?
Public concern about inflation, actual accelerating inflation, political intervention at the CB; are those correct? Are ther others?
This is virtually identical to MMT on monetary operations.
Can you elaborate a bit more on the relationship between nominal GDP and long term interest rate 'policy'?
Sure!
I think it's important to acknowledge that firms make their investment, long-term planning, and hiring decisions based on both current credit conditions and expected future credit conditions. If monetary policymakers were communicating that interest rates would go up and policy would contract in the near future, businesses would plan accordingly and not invest/hire as much. NGDP growth would therefore decrease.
This is part of the reason that countries like Japan, Germany, and (to a lesser, but still extremely important) extent the US have struggled to get high nominal growth rates and escape the Zero Lower Bound. Monetary policymakers and institutions communicate that they will tighten rates as soon as possible to end the "extraordinary" stimulus measures, so firms restrict investment. Think about the 2013 "taper tantrum" in the US—despite weak nominal growth and low employment levels, the Federal Reserve was communicating that they would like to end QE in preparation for raising interest rates. Firms expected that policy would contract in the near future and so pulled back on investment and hiring.
This is why temporary monetary stimulus will never have the nominal growth effects that long term stimulus will.
Also, a lot of corporate loans for large firms have long maturities! That's a direct way for long term interest rate policy to affect growth.
Great article and great answer. Thanks!
Awesome. Is there anything else to mention regarding fixed income?
I think a really critical part of fixed income modeling is understanding the Federal Reserve's reaction function and, on a kind of second-order and beyond level of thinking, understanding how their reaction function may change in the presence of new information.
Anyone who could predict the shift to FAIT and understand the Fed's reaction function under FAIT is going to have a better understanding of the fixed income universe.