WSJ Assignment is to find an article on the Federal Reserve and interest rates from the past 30 days. In NOT MORE THAN 1 page, please write a brief summary of

WSJ Assignment is to find an article on the Federal Reserve and interest rates from the past 30 days. In NOT MORE THAN 1 page, please write a brief summary of the article, how it relates to our discussion about the Fed from class, and your opinion on what’s discussed in the article.

What’s the Right Interest Rate for the Fed Anyway?

Standard models watched by economists at the Federal Reserve and elsewhere suggest that rates should now be lower

The Federal Reserve is likely to start lowering its target range on interest rates sometime in the next several months. Just how much lower rates should go is 
where things get tricky.

Models that the Fed keeps an eye on suggest rates should already be lower than they are now. But the economy might not be running to model, and the sharp drops in Treasury yields and other long-term interest rates since last fall add further complexities.

The Fed’s policy-setting committee on Wednesday left the central bank’s target rate at a range of 5.25% to 5.5%—
the 23-year high it has been set at since last July. But it 
introduced language to its policy statement that indicated a bias toward cutting rates, while also hedging on when the first cut will come: “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

After Fed Chair Jerome Powell in his press conference said that the base case for the Fed’s first rate cut isn’t at its next meeting, in March, investors reset their expectations, with interest-rate futures 
now implying a May start for rate cuts. Still, by the end of the year futures imply the Fed will have cut its target by 1.5 percentage points—with the caveat that some possibility of a recession is still embedded in that forecast. Fed policymakers in December, meanwhile, projected a 0.75 percentage point cut in their rate range this year.

Change in gross domestic product from previous quarter, at an annual rateSource: Commerce Department via St. Louis Fed

So where should rates be? There has been a lot of focus recently on the long-term neutral rate—the just-right level of rates for when inflation is at the Fed’s 2% target, and the economy is growing at just the right pace to keep it there. When thinking about where rates ought to be, economists rely on a variety of models. Many of them are riffs on the Taylor rule, put forth by Stanford’s John Taylor in 1993. The complexity of these Taylor-style models varies, but in essence, they typically look at what inflation is doing versus where the central bank wants it, how fast the economy is growing versus an assumption of how fast it ought to grow without moving inflation off target, and spit out an answer.

The Federal Reserve Bank of Atlanta has set up a 
“Taylor Rule Utility” webpage that provides the outputs from three Taylor-style models, each of which shows that, under reasonable assumptions, the Fed’s target rate ought to have been lower in the fourth quarter, heading lower still this quarter. The Federal Reserve Bank of Cleveland 
does a similar exercise across seven models. Its most recent update, in December, showed that the median “right” level for rates as of the fourth quarter was 5.1%, falling to 4.8% in the current quarter and 3.9% by year-end.

Following Wednesday’s policy decision, Powell noted that the central bank regularly consults Taylor and non-Taylor rules, but, he added, “I don’t think we have been in a place where we have been setting policy by them.”

Uncertainty over whether inflation will keep cooling might not be the only thing staying the Fed’s hand on rate cuts. The Commerce Department reported last week that gross domestic product grew at a 3.3% annual rate in the fourth quarter, so there is some question over how much restraint short-term rates are placing on the economy. Plus long-term rates have fallen a lot lately: The yield on the 10-year Treasury, which briefly hit 5% in October, finished at 3.97% on Wednesday. This has brought interest-rate costs down for some borrowers, such as companies tapping the bond market, making financial conditions easier.

So it makes sense for the Fed to follow along with statistician George Box’s oft-repeated aphorism that “all models are wrong, but some are useful.”

What is useful about the models now isn’t so much that they are prescribing rate cuts, but that they are telling policymakers that it is all right to cut rates even if nothing goes awry with the economy and that they can cut them a bit more deeply than they previously supposed. That may ultimately matter more than whether rate cuts start in March or May.

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