NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

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livesoft
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NYTimes: Fed will use new tools to try to change interest rates

Post by livesoft » Sat Sep 12, 2015 5:08 pm

Binyamin Appelbaum of the NYTimes reports on the new ways that the Fed will try to implement any of its expected rate hikes. I found the article well-researched, very interesting, and with some unexpected information. I hope you all will enjoy it, too. Basically, it ain't your father's Fed anymore and new things may break.

http://www.nytimes.com/2015/09/13/busin ... rates.html

Last year, there was an interesting 12 minutes that is talked about in this report. Beware!

[edit to fix misspelling of Mr Appelbaum's name]
Last edited by livesoft on Sat Sep 12, 2015 6:45 pm, edited 1 time in total.
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by stlutz » Sat Sep 12, 2015 5:34 pm

Thanks for the link, livesoft. Very interesting!

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by BigJohn » Sat Sep 12, 2015 5:40 pm

Wow, I knew the Fed had pumped a lot of money into the system but did not understand how this has impacted their historical tool set. I was thinking that this interest rate increase would be easy and predictable but maybe not. Thanks for the link.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by nisiprius » Sat Sep 12, 2015 5:43 pm

Thanks, livesoft.
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by kenner » Sat Sep 12, 2015 5:54 pm

Livesoft, thank you for the link. It will take some time to fully analyse this excellent article, but first impression is: not sure the world economy, with only the US, Britain and maybe a few other countries performing well and with China in disarray, will benefit from higher interest rates, even if they are theoretically limited to the US. Deflation, not inflation, may be the greater risk. Deflation is much, much more difficult to solve.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Tanelorn » Sat Sep 12, 2015 5:56 pm

Thanks. May you live in interesting times!

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Busting Myths » Sat Sep 12, 2015 6:10 pm

livesoft wrote:Binyamin Applebaum of the NYTimes reports on the new ways that the Fed will try to implement any of its expected rate hikes. I found the article well-researched, very interesting, and with some unexpected information. I hope you all will enjoy it, too. Basically, it ain't your father's Fed anymore and new things may break.

http://www.nytimes.com/2015/09/13/busin ... rates.html

Last year, there was an interesting 12 minutes that is talked about in this report. Beware!
Would someone care to explain what new ways the Fed will try to implement these rate hikes?

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 6:10 pm

A team led by Simon Potter, a former academic who now heads the Fed’s market desk in New York, has been testing and fine-tuning the details by moving billions of dollars around the financial system.
What a fun job!

The core of the planned, unorthodox approach:
The Fed lacks the legal authority to pay these lenders a minimum interest rate on deposits, as it does to the banks. But two years ago, Lorie Logan, one of Mr. Potter’s top aides, suggested the Fed could achieve the same goal by borrowing from these companies at a minimum interest rate.
But the unorthodox approach will be de-emphasized:
When liftoff arrives, however, the Fed plans to place this machinery inside the familiar language of the old system. It is likely to announce that it is raising the federal funds rate, the interest rate that banks pay to borrow reserves, from its current range of 0 to 0.25 percent to a new range of 0.25 to 0.5 percent. The Fed does not plan to emphasize that this rate is now a stage prop or that the real work of raising rates will be done outside the limelight by its new tools.
Interesting stuff!

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 6:15 pm

Busting Myths wrote: Would someone care to explain what new ways the Fed will try to implement these rate hikes?
The core is summarized in the second quote in my previous reply. The essence is that they will borrow money from unregulated lenders at a rate that will discourage them from lending to others at very low rates.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by in_reality » Sat Sep 12, 2015 6:20 pm

Busting Myths wrote: Would someone care to explain what new ways the Fed will try to implement these rate hikes?
The Fed will pay so that people don't lend.
Say the Fed wanted to raise short-term interest rates to 1 percent, meaning that it did not want banks to lend at lower rates. Because the glut of reserves is so great, the Fed could not easily raise rates by reducing the availability of money. Instead, the Fed plans to pre-empt the market, paying banks 1 percent interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates. “Why would you lend to anyone else when you can lend to the Fed?” Kevin Logan, chief United States economist at HSBC, asked rhetorically.
Question: Where is the Fed getting this money to pay people not to lend?

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 6:26 pm

in_reality wrote: Question: Where is the Fed getting this money to pay people not to lend?
The part of the article you quoted actually is the less unorthodox part, but your question is at least partially answered in the subsequent paragraph:
This is not a cheap trick. Since the crisis, the Fed has paid banks a token annual rate of 0.25 percent on reserves. Last year alone, that cost $6.7 billion that the Fed would have otherwise handed over to the Treasury. Paying 1 percent interest would cost four times as much. The Fed has sent roughly $500 billion to the Treasury since 2008. As the Fed raises rates, some projections show that it may not transfer a single dollar in some years. Instead, the Fed will pay banks tens of billions of dollars not to use the trillions it paid them previously.
In other words, the Fed earns lots of interest on the Treasuries it owns, and can use that to pay more interest to the banks instead of turning it over to the Treasury.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by saltycaper » Sat Sep 12, 2015 6:28 pm

Assuming this is true, and the Fed is successful in using its new tactics . . .
“If you’re into the internal plumbing, I suspect there will be times when that looks messy because this is new,” Mr. Faust said. “But central banks can raise interest rates, and they will. And as long as that happens, from the standpoint of the broader economy, everything is fine and the rest will be forgotten or become a footnote of history.”
. . . then the most interesting part of this chapter of monetary policy, as far as outcomes are concerned, may be something that's not so new:
The rise of an interconnected global financial system has weakened the Fed’s influence over interest rates. When the Fed last raised short-term rates, beginning in 2004, officials were surprised that long-term rates failed to rise because foreign money was pouring into the housing market and other domestic investments. This time, there are plenty of warnings that the weaknesses of other developed economies could once again make it harder for the Fed to raise domestic interest rates.
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by in_reality » Sat Sep 12, 2015 6:34 pm

Kevin M wrote:
This is not a cheap trick. Since the crisis, the Fed has paid banks a token annual rate of 0.25 percent on reserves. Last year alone, that cost $6.7 billion that the Fed would have otherwise handed over to the Treasury. Paying 1 percent interest would cost four times as much. The Fed has sent roughly $500 billion to the Treasury since 2008. As the Fed raises rates, some projections show that it may not transfer a single dollar in some years. Instead, the Fed will pay banks tens of billions of dollars not to use the trillions it paid them previously.
In other words, the Fed earns lots of interest on the Treasuries it owns, and can use that to pay more interest to the banks instead of turning it over to the Treasury.

Kevin
OK maybe I see. If their earnings were insufficient to pay the banks, would they "buy" more Treasuries (they don't really pay anything for them right) to increase their earnings so they could pay the banks not to lend?

If in some years they might not transfer a single dollar to the Treasury, that tells me that there might also be some years in which they don't have enough or would they they switch to a different plan? Or aren't they saying? Or don't they know?

Just trying to figure out if it has a potential to be a liability.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 6:42 pm

in_reality wrote:If their earnings were insufficient to pay the banks, would they "buy" more Treasuries (they don't really pay anything for them right) to increase their earnings so they could pay the banks not to lend?
Not my area of expertise, but I assume they could sell some of their huge inventory of Treasuries to raise more cash if necessary. Also, they can just not roll over Treasuries as they mature (which I think they already may be doing), so there also is cash flow from maturing Treasuries.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by SimpleGift » Sat Sep 12, 2015 6:53 pm

All I can add is that, with the immense complexity of the global financial system these days, I'm thankful that these very smart and knowledgeable folks are hard at work every day trying to provide stability and balance to the U.S. economy.

Without their efforts in response to the 2008-09 credit crisis especially, our financial futures might well be looking very different today. Because of their work, we sleep better at night with our broadly-diversified stock and bond portfolios!
  • Meeting of the Fed Open Market Committee, Eccles Building, Washington, D.C.
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    Source: Wikipedia
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Cordially, Todd

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by livesoft » Sat Sep 12, 2015 6:55 pm

I really liked the part where in the confusion of that 12 minutes, some firms bought and sold Treasury instruments to themselves apparently without realizing it.

In the past I have sold shares to myself on purpose in order to quickly move the shares from one broker to another, but it was all planned.
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Busting Myths » Sat Sep 12, 2015 7:17 pm

in_reality wrote:
Busting Myths wrote: Would someone care to explain what new ways the Fed will try to implement these rate hikes?
The Fed will pay so that people don't lend.
This is not new and how the Federal Reserve has operated for a long time. When they wanted to raise rates they would sell Treasuries in order to remove cash from the money supply. In order to induce banks to give up cash the FOMC would have to provide a better rate of return than the Bank could get lending it out. The lack of cash supply in the market would then reprice costs as borrowers would be willing to pay more interest (higher interest rates) in order to have access to cash. These are called permanent market operations.

The only thing that has really changed is that they will now drain cash from the banking system by borrowing money from sources in addition to selling Treasuries to the traditional primary dealer. Additionally, the Fed will be using the repo market in order to conduct these operations. Repo agreements fall under temporary market operations which the Fed uses to temporarily add/drain reserves in the banking system. It looks like the FED is going this route in order to give themselves room if they have to reverse course.
NYT wrote: One result is a banking system almost comically awash in money. In June 2008, banks had about $10.1 billion in their Fed accounts. The total is now $2.6 trillion...

Bank of America, for example, had $388 million in its Fed account at the end of June 2008. Seven years later, at the end of June 2015, it had $107 billion. The bank could double in size and double again and still have more reserves than it needs...

The Fed would need to sell most of the securities it has accumulated before short-term rates would start to rise. Selling quickly could roil markets; selling slowly could allow the economy to overheat. So the Fed decided to find another way.

Instead of draining all that excess money, the Fed decided to freeze it.
If there is so much excess supply of cash that the Banks are hoarding it on their balance sheet instead of lending it then why would selling quickly roil the markets?
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by nedsaid » Sat Sep 12, 2015 7:37 pm

in_reality wrote:
Busting Myths wrote: Would someone care to explain what new ways the Fed will try to implement these rate hikes?
The Fed will pay so that people don't lend.
Say the Fed wanted to raise short-term interest rates to 1 percent, meaning that it did not want banks to lend at lower rates. Because the glut of reserves is so great, the Fed could not easily raise rates by reducing the availability of money. Instead, the Fed plans to pre-empt the market, paying banks 1 percent interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates. “Why would you lend to anyone else when you can lend to the Fed?” Kevin Logan, chief United States economist at HSBC, asked rhetorically.
Question: Where is the Fed getting this money to pay people not to lend?
Hint: Pull out the greenbacks in your wallet and see what they say. Federal Reserve note. Hmmm. Take the note into a Fed bank and to pay off the liability, they will just give you another greenback. In other words, they just create the money with a snap of the finger right out of thin air.
A fool and his money are good for business.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by in_reality » Sat Sep 12, 2015 8:42 pm

Kevin M wrote:
in_reality wrote:If their earnings were insufficient to pay the banks, would they "buy" more Treasuries (they don't really pay anything for them right) to increase their earnings so they could pay the banks not to lend?
Not my area of expertise, but I assume they could sell some of their huge inventory of Treasuries to raise more cash if necessary. Also, they can just not roll over Treasuries as they mature (which I think they already may be doing), so there also is cash flow from maturing Treasuries.

Kevin
Actually that makes sense.

Their selling would help them reduce their balance sheet which is probably a goal to move towards at some point.

Doing so would push the price of treasuries down and yields up right? Would that bump up rates? If rates are bumped up, would the Fed. need to pay more to encourage people not to lend? Would they then need more income to do that? Or as you say will maturing Treasuries be enough?

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by livesoft » Sat Sep 12, 2015 8:52 pm

That's a remarkable photo of the FOMC that Simplegift posted from Wikipedia. Remarkable in the sense that there are no laptops showing and it appears that only the one cell phone in the foreground is in the room.

I've been to similar government advisory meetings, but almost everyone has a laptop or smartphone sitting next in front of them
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 9:17 pm

Busting Myths wrote: The only thing that has really changed is that they expanded who they will sell Treasuries to in order to drain cash from the system. Instead of the traditionally primary dealers they will lend to more institutions who are willing to park money at the Fed instead of lending it out themselves or keeping in it reserve.
I don't believe this is correct--at least not according to the article. The article says that the Fed will borrow from unregulated financial institutions at a minimal interest rate, not lend to them. But maybe you are using the term "lend" in a different sense?

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by gkaplan » Sat Sep 12, 2015 9:33 pm

livesoft wrote:That's a remarkable photo of the FOMC that Simplegift posted from Wikipedia. Remarkable in the sense that there are no laptops showing and it appears that only the one cell phone in the foreground is in the room....
That's a good thing, right?
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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Busting Myths » Sat Sep 12, 2015 9:38 pm

Kevin M wrote:
Busting Myths wrote: The only thing that has really changed is that they expanded who they will sell Treasuries to in order to drain cash from the system. Instead of the traditionally primary dealers they will lend to more institutions who are willing to park money at the Fed instead of lending it out themselves or keeping in it reserve.
I don't believe this is correct--at least not according to the article. The article says that the Fed will borrow from unregulated financial institutions at a minimal interest rate, not lend to them. But maybe you are using the term "lend" in a different sense?

Kevin
You are correct, Kevin. They will borrow and not lend. I edited my post and thanks for catching it! My point is still the same though.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by FiveSigmas » Sat Sep 12, 2015 10:38 pm

That was one fascinating read. Thanks livesoft.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by Kevin M » Sat Sep 12, 2015 10:43 pm

in_reality wrote: Their selling would help them reduce their balance sheet which is probably a goal to move towards at some point.

Doing so would push the price of treasuries down and yields up right? Would that bump up rates?
Yes, the general approach has been to buy Treasuries to lower rates and sell them to raise rates, as mentioned in the article:
Before the crisis, the Fed controlled the interest rate on those loans by modulating the supply of reserves: It lowered interest rates by buying Treasury securities from banks and crediting their accounts, increasing the supply of reserves; it raised rates by selling Treasuries to banks and debiting their accounts.
A key problem pointed out by the article is that the Fed has such a huge supply of Treasuries that it can't use its standard procedure to raise rates:
The Fed would need to sell most of the securities it has accumulated before short-term rates would start to rise. Selling quickly could roil markets; selling slowly could allow the economy to overheat. So the Fed decided to find another way.
A big problem is all the excess cash held by unregulated financial institutions:
The rest of the financial system is also awash in cash, and lenders — like money market mutual funds — put downward pressure on interest rates as they fight to attract borrowers.
But the Fed can't use the same procedure it uses with regulated banks:
The Fed lacks the legal authority to pay these lenders a minimum interest rate on deposits, as it does to the banks.
And hence the new approach of borrowing from the unregulated lenders to "freeze" the amount of money the unregulated lenders have available to lend to others, hopefully driving rates higher.
in_reality wrote:If rates are bumped up, would the Fed. need to pay more to encourage people not to lend?
Makes sense to me. Lending to the Fed is risk free, so the rate to lend to someone else must be high enough to compensate for risk. As rates increase, the reward for taking the additional risk increases, thus driving up the risk-free rate.
in_reality wrote:Would they then need more income to do that? Or as you say will maturing Treasuries be enough?
Well, they can always sell Treasuries to raise cash, but one of the points of the article is that this is new territory, and markets often don't behave as expected:
The Fed can be precise in its planning, but the market is unpredictable in its reactions.
The 12-minute spree that livesoft mentioned in the OP is used to demonstrate the unpredictability and somtimes unexplainability of markets:
The 12-minute spree was among the largest price movements ever seen in one of the world’s most liquid markets, yet the government report found no clear cause.
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Good article about the mechanics of Fed interest rates

Post by theunknowntech » Sun Sep 13, 2015 8:58 am

[Post merged into here, see below. --admin LadyGeek]

There's a _very_ good article in today's (Sunday 13 September) New York Times about the mechanics of the upcoming Fed interest hike:

http://www.nytimes.com/2015/09/13/busin ... odayspaper

Things have certainly changed.

edit: should be merged with livesoft's pointer to the same article yesterday, which I didn't see because I was looking at the single-page view.

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NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by dbCooperAir » Wed Sep 16, 2015 11:21 am

[Post merged into here, see below. --admin LadyGeek]

I'm not well versed in Fed Policy, ok not at all.

I thought the following article did a decent (dumbed down version for us not well versed) overview of the history and current thinking of Fed's policy.

http://www.nytimes.com/2015/09/13/busin ... .html?_r=0
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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by Oicuryy » Wed Sep 16, 2015 12:44 pm

Here is some more reading for anyone who wants to know more about interest on reserves (IOR) as a tool for influencing the fed funds rate. IOR is a somewhat new and relatively untested tool.

Federal Funds and Interest on Reserves
Corridors and Floors in Monetary Policy
Who’s Lending in the Fed Funds Market?
Who’s Borrowing in the Fed Funds Market?

Ron
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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by theunknowntech » Wed Sep 16, 2015 7:43 pm

It does bear repeating. This should be enough to make you feel as nervous as a cat in a rocking chair factory. Factor THAT into the price of stuff.

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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by nisiprius » Wed Sep 16, 2015 7:53 pm

theunknowntech wrote:It does bear repeating. This should be enough to make you feel as nervous as a cat in a rocking chair factory. Factor THAT into the price of stuff.
Really? I think this must be the most openly telegraphed Fed decision ever.

It's not like the days when Alan Greenspan was saying things like
In recent years, there have been tentative signs that the historical relationship linking the velocity of M2--measured as the ratio of nominal GDP to the money stock-to the cost of holding M2 assets was reasserting itself. However, a persistent residual upward drift in velocity over the past few years and its apparent cessation very recently underscores our ongoing uncertainty about the stability of this relationship. The FOMC will continue to observe the evolution of the monetary and credit aggregates carefully, integrating information about these variables with a wide variety of other information in determining its policy stance.
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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by theunknowntech » Wed Sep 16, 2015 8:15 pm

nisiprius wrote:
theunknowntech wrote:It does bear repeating. This should be enough to make you feel as nervous as a cat in a rocking chair factory. Factor THAT into the price of stuff.
Really? I think this must be the most openly telegraphed Fed decision ever.
People underestimate just what is going on there. Livesoft posted about it a few days ago, I reposted one of the links. It's not like waking up to find your toothbrush on the floor.

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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by Kevin M » Wed Sep 16, 2015 8:37 pm

Duplicate post. There was a post about this a few days ago.

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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by LadyGeek » Wed Sep 16, 2015 9:30 pm

^^^ Make that 2 duplicate posts. I merged theunknowntech's and dbCooperAir's threads into here.
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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by Waba » Thu Sep 17, 2015 12:47 am

theunknowntech wrote: People underestimate just what is going on there. Livesoft posted about it a few days ago, I reposted one of the links. It's not like waking up to find your toothbrush on the floor.
It's like waking up and finding that one of the squigely numbers on the MarketWatch rates tab has changed ever so slightly. Which, in fact, it has done every day of the week so far this year.

Otoh, finding my toothbrush on the floor would be upsetting.

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Re: NY Times, Fed’s Policy Mechanics Retool for a Rise in Interest Rates

Post by theunknowntech » Thu Sep 17, 2015 6:57 am

Waba wrote:
theunknowntech wrote: People underestimate just what is going on there. Livesoft posted about it a few days ago, I reposted one of the links. It's not like waking up to find your toothbrush on the floor.
It's like waking up and finding that one of the squigely numbers on the MarketWatch rates tab has changed ever so slightly. Which, in fact, it has done every day of the week so far this year.

Otoh, finding my toothbrush on the floor would be upsetting.
That should be the point. You should never notice, if they get it right. This reminds me of Louis C.K.'s riff about flying, https://www.youtube.com/watch?v=uEY58fiSK8E You are like a greek god flying thru the sky, and if you don't realize that, then [repurposed:] I don't know what to say to you.

What's going on is a miracle of modern financial engineering. If you never notice it, they should get prizes or something. I don't know how to express it in words.

We have the best people.

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Re: NYTimes: Fed will use new tools to try to change interest rates

Post by dumbmoney » Thu Sep 17, 2015 7:09 pm

in_reality wrote: If in some years they might not transfer a single dollar to the Treasury, that tells me that there might also be some years in which they don't have enough or would they they switch to a different plan? Or aren't they saying? Or don't they know?
If the Fed loses money, they won't resume paying dividends until they have earned back past losses.
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