The Fed is driving up (and tomorrow probably will drive up) short rates
while the Treasury is driving down long rates. However, as Ellen notes,
there are real limits to this. The banks profited mightily from high long
rates and low short rates in the early nineties (allowing them to escape
the fate of most Savings & Loans). Similarly, they lose when this spread is
shrinking, since they borrow short (taking deposits) and lending long.
Mainstream money/banking/finance says that there normally should be a
maturity premium, so that long rates should always be a fixed number of
percentage points above the geometric average of current and expected short
rates (if we're talking about bonds that are don't differ in terms of risk,
liquidity, and tax treatment, only differing in terms of years to
maturity). That means that the long rate can only fall relative to the
current short rate if expected short-term rates are falling. That is, the
long rate can fall relative to the federal funds rate only if people expect
the Fed to loosen up in the future (increasing the supply of funds) or the
demand for funds to fall (perhaps due to a recession). Alternatively, the
fall in long rates could be seen as temporary.
If it's the latter (which seems likely), then the fall in the long rate
also won't have any big effect on borrowing for business fixed investment,
reinforcing Michael's point. (I'm thinking that a lot of the new debt that
a business investor would take on would have variable rates, so that a
temporary dip in the long rate wouldn't have a big effect.)
Alternatively, monetary policy (tomorrow's hike) and fiscal policy (buying
back long-term government debt) are working at cross-purposes. That would
help explain why Greenspan isn't succeeding at slowing the US economy.
does this make sense?
Tom Dickens wrote:
> > >I don't know Jim, what do you think? Was it the purchase of long-term
> > >bonds that failed to put downward pressure on their yields, the sale of
> > >short-term bonds that failed to put upward pressure on their yields, or
> > >both?
I have forgotten what I knew about "Operation Twist," and can't find the
Modigliani & Sutch article I have on it (and its alleged failure).
Ellen Frank wrote:
> > I've never understood the reasoning behind operation twist.
> > Although a drop in long-rates would make it cheaper to
> > borrow and stimulate real spending, a rise in short rates,
> > it seems, would make lenders less willing lend long and finance
> > real investment. The reasoning behind operation twist seems
> > to presume that the long and short markets are unconnected.
> > Am I misunderstanding this?
Michael P. wrote:
>As I recall the explanation, long-term capital investment depends upon
>long-term rates, while short-term consumption is affected by short-term
>rates. In fact, of course, investment is pretty insensitive to interest
>rates.
Jim Devine [EMAIL PROTECTED] & http://liberalarts.lmu.edu/~jdevine
