Step #4 In My Dispute With Beckworth: The Market (Apparently) Lowered Forecast of Future Fed Funds After Critical 2008 Meetings
I have a running response to David Beckworth’s defense of Sen. Ted Cruz’s remarks concerning the causes of the 2008 financial crisis. (Here are links to #1, #2, and #3.) This, #4, is my final argument, though I may do follow-ups based on reactions from David and/or his fans in the comments.
In earlier steps I pushed back on Beckworth’s argument that because the spread between long and short Treasury yields increased during 2008, that this meant the market was expecting a future rate hike.
However, Beckworth had an independent empirical argument in defense of Cruz. Specifically, Beckworth posted a chart that seemed to say that expert forecasts of the 3-month T-bill yield rose as 2008 progressed. Now, I am not sure that the chart means what Beckworth says it means. But, I think that it’s a moot point, because rather than look at expert forecasters (a term that would make Scott Sumner choke on his beverage), we can look directly at what “the market” thought, by using prices on futures contracts.
Furthermore, since we’re talking about Fed policy, we can look directly at the federal funds rate.
In response to my request for reader help, DMS gave us the market’s implied forecast of the fed funds rate for November 30, 2008. I was waiting until I had time to independently verify his calculations, but I am swamped and I thought it more important for me to make this post while people still vaguely remembered I had been arguing with Beckworth. So, by all means, please investigate and make sure you agree with how DMS translated the actual price of the futures contracts into implied fed funds rates.
In any event, here is the information I can compile from DMS’s report:
The Implied Market Forecast of What the Fed Funds Rate Would Be on November 30, 2008, as of Various Dates
6/24 – 2.465%
6/25 – Fed makes policy announcement.
6/26 – 2.34%
8/4 – 2.16%
8/5 – Fed makes policy announcement.
8/6 – 2.12%
9/15 – 1.78%
9/16 – Fed makes policy announcement.
9/17 – 1.65%
So assuming DMS correctly calculated the implied market forecasts of what the fed funds rate would be on November 30, 2008, it seems that the two summer Fed announcements, as well as the critical Lehman announcement, were all associated with a drop in what the market thought the policy rate would be, for a fixed future date.
At this point, I think Beckworth should (if he has time to process this) give one of three types of responses:
(A) Point out that there is something wrong with the above numbers.
(B) Agree that Cruz’s version of history is utterly baseless, and that it was not so much any particular policy pronouncement that made people think the Fed was tightening, but just a general shift in expectations over 2008 that we can’t really attribute to anything specific.
(C) Agree that Free Advice has been the single best source of monetary analysis for years and apologize profusely for calling for monetary inflation.
I am not hoping for (C), but (B) would be nice.
I only apologize for not calling for more monetary inflation. I agree the Money Illusion has been the best source of monetary analysis for years.
The numbers are probably right, but Cruz’s version of history is hardly baseless when you look at TIPS and NGDP.
It’s a slam-dunk.
I hope Dr. Beckworth will be a sport and weigh in. In the meantime my two fiat cents is this: If you look at the spread between the Fed funds rate predicted by the futures market and the effective Fed funds rate at the time of contract, that spread was saying the market went from expecting a significant reduction in the Fed funds rate in early 2008 to expecting a modest increase starting in mid 2008. Dr. Murphy’s point that FOMC announcements did not move expectations seems to hold though.