Further thoughts on Taylor. This is taken from a paper he wrote about the fed funds mechanism.
The simple model of the supply and demand for Fed balances presented in this paper is
capable of explaining the “open mouth operation” phenomenon that changes in the target federal
funds rate cause changes in the actual federal funds rate with little or no immediate action by the
Trading Desk. However, traditional “open market operations” are the fundamentals that underlie
these announcement or expectations effects. By specifying a reaction function of the Trading
Desk and showing how the demand for Fed balances depends on expectations of future federal
funds rate, the model demonstrates how it is the “threat” of future open market operations that
actually moves the rate. One reason why the deviations of the federal funds rate from the target
rate at the times of target rate changes has diminished may be that traders are placing increased
credibility on the reaction function of the Trading Desk as the FOMC has provided greater
clarity about the target itself.
He says, "However, traditional 'open market operations' are the fundamentals that underlie these announcement or expectations effects." So he's saying that what counts is what the Fed does, not what they warn they might do.
Then he says, "By specifying a reaction function of the Trading Desk and showing how the demand for Fed balances depends on expectations of future federal funds rate, the model demonstrates how it is the “threat” of future open market operations that actually moves the rate."
So which is it? "actual operations which underlie expectations effects" or "'threat' of future open market operations that actually moves the rate"? If it's the latter, then the former, the actual transactions are superfluous. And if it's the former, then the "open mouth", or Fed guidance, is superfluous.
No one puts any credence in what FED says they might do, because by the time they take an action the conditions have substantially changed so they often do something else. It's the material economic conditions which causes the fed funds futures to change, not some jawboning by Fed governors or committee guidance. If ever there was a machine to determine expectations, it is the fed funds futures. They beat guidance 80% of the time. |
