“Monetary Buffers Depleted” Boston Fed: Concerns Over Next Recession Mount

In a recession, the Fed typically slashes interest rates 5 PP. No such buffer exists. A Fed study looks at the impact.

One of the reason the Fed seems desperate to hike rates is they want ammunition to cut rates when the recession hits. Typically, the Fed cuts rates by 5 percentage points, but when the next recession hits, no such buffer will exist.

A Boston Fed simulation shows the central bank’s inability to cut rates by the usual amount would disproportionately hit certain states.

“Monetary buffers have been depleted,” said Eric Rosengren, president of the Federal Reserve Bank of Boston, which sponsored the conference this weekend where the research was released. A decline in rates over the past decade means the Fed’s recent experience of running out of room to cut them after lowering them to zero will not be “a one-time event,” he said.

Mr. Rosengren and his co-authors, Boston Fed economists Joe Peek and Geoffrey Tootell, ran an experiment that shows how a recession might affect states assuming a traditional monetary-policy response, in which the Fed could cut its short-term benchmark rate by 5 percentage points.

Then they looked at two other alternatives. In both scenarios, monetary policy couldn’t fully respond because the Fed had raised rates to only 2% before the hypothetical downturn. But in the last scenario, regulatory, state and local, and federal fiscal buffers were also depleted because they weren’t built up before the recession.

Per Capita Income Growth in Recession

Some Unpleasant Stabilization Arithmetic

Message from the Simulations

  • Not only are states differentially affected by recessions, they are also differentially affected by the extent to which policy buffers are insufficient to provide adequate countercyclical policy responses
  • Differences can be quite large
  • Still, effects are understated because they ignore feedback effects on UR from weak policy response

The study cited "concerns about rising federal debt, limited state and local fiscal policy buffers, and any weakening of bank capital regulations."

States heavily dependent on agriculture fared better in the study. The West Coast, Illinois, and Pennsylvania suffered the most.

Mike "Mish" Shedlock

Comments
No. 1-7
RonJ
RonJ

"The study cited "concerns about rising federal debt, limited state and local fiscal policy buffers, and any weakening of bank capital regulations."

Greenspan took banking standards to ZERO. Nobody needed to be a genius to figure out what would happen next- massive banking crimes. Crimes for which no banker has been prosecuted.

LawrenceBird
LawrenceBird

Uncritical acceptance of the 500 bp? Completely ignores the bias of the 1970s-1990 period. Correct question to ask is by what % did their actions cut the effective target rate. In recessions prior to 2000, they cut by roughly 50% (through the time the recession was over). In 2001 they cut 75% and in the last, 100%. Of course, they did not always target the funds rate, though example from 1957 was from 3.5% to 1.25% (and 0.6 after recession was over).

killben
killben

“Monetary buffers have been depleted,” said Eric Rosengren

That will not stop the Fed. QE, NIRP, BUE (Buy-Up-Everything) is their in their tool kit. Also they can always claim but for them the house would have been burnt down. Again a game of power grab!

When are we, the citizens, going to learn to pin the blame where it lies, instead of allowing the Fed to preen about as if the world would have come to an end without them. I for one would love to see what really happens (instead of getting the Fed's version) if we tie the hands of these manipulators. I bet the world will be a better place!

OMG, it made my blood boil to see the photo shoot of the 3 musketeers who are crowing as if they saved the world instead of having destroyed it over the last decade.

killben
killben

“Monetary buffers have been depleted,” said Eric Rosengren

That will not stop the Fed. QE, NIRP, BUE (Buy-Up-Everything) is their in their tool kit. Also they can always claim but for them the house would have been burnt down. Again a game of power grab!

When are we, the citizens, going to learn to pin the blame where it lies, instead of allowing the Fed to preen about as if the world would have come to an end without them. I for one would love to see what really happens (instead of getting the Fed's version) if we tie the hands of these manipulators. I bet the world will be a better place!

Oh my, I need to mention that the photo shoot of the 3 musketeers did make my blood boil.

Mike Deadmonton
Mike Deadmonton

Try negative rates - that should get money flowing into commodities at least.