What Jeremy Stein really meant


I am going to try to make the case that, all else being equal, monetary policy should be less accommodative–by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level–when estimates of risk premiums in the bond market are abnormally low. These risk premiums include the term premium on Treasury securities, as well as the expected returns to investors from bearing the credit risk on, for example, corporate bonds and asset-backed securities. As an illustration, consider the period in the spring of 2013 when the 10-year Treasury yield was in the neighborhood of 1.60 percent and estimates of the term premium were around negative 80 basis points. Applied to this period, my approach would suggest a lesser willingness to use large-scale asset purchases to push yields down even further, as compared with a scenario in which term premiums were not so low.

So that readers don´t have any doubts about Stein´s meaning, my friend and reader Catherine Johnson provides a prize-winning translation:

I believe the Federal Reserve should block full employment any time interest rates on bonds are abnormally low.

I believe the Federal Reserve should keep people out of work any time interest rates on bonds are abnormally low.

I believe the Federal Reserve should slow the economy’s growth any time interest rates on bonds are abnormally low.

I believe that when money is tight, we should make it tighter.

5 thoughts on “What Jeremy Stein really meant

  1. Egads…tighten money when rates are low…and tighten money when inflation is above one percent…and tighten money if any asset market might be heading into a bubble…when is it a good time to tighten money? When does an alcoholic want a drink….

  2. And when “less accommodation” causes term premiums to become even more abnormally low? Tighten more! Vicious circle.

  3. It really does appear that the biggest danger to financial market stability are the guardians of financial market stability. Go figure.

    That said, I do have some sympathy with the regulators of banks. The beasts are so large and so complex that regulators need to be impossibly knowledgeable insiders to do their job effectively and thus the job is, well, impossible. TBTF has created uncontrollable, ungovernable monsters. That said, again, it is not appropriate to use monetary policy as a substitute for financial market regulation, or you end up causing the very thing you are trying to prevent.

  4. “Putting it all together, this reasoning suggests that the credit risk premium–as measured, say, by a forecasting model like that of Greenwood and Hanson–may be an operationally useful measure of financial market vulnerability. When this risk premium is low, there is a greater probability of a subsequent upward spike in credit spreads and the EBP. Moreover, such upward spikes, when they do occur, are associated with significant adverse economic effects. To be clear, we are not necessarily talking about once-in-a-generation financial crises here, with major financial institutions teetering on the brink of failure. Nevertheless, the evidence suggests that even more modest capital market disruptions may have consequences that are large enough to warrant consideration when formulating monetary policy. If so, the indicated directional adjustment would be to be less aggressive in providing monetary accommodation in the face of above-target unemployment, all else being equal, when risk premiums are abnormally low. ”
    Surely this is faulty logic? Doesn’t Stein’s evidence suggest the opposite conclusion: you need to be ultra-careful in ending monetary accomodation in the face of above-target unemployment when risk premiums are abnormally low. Even if, on his evidence, that monetary accomodation is not helping reduce unemployment.

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