A brief follow up to my previous post on inflation, commodities and the Chicago Fed’s research on this link.
The aim of their work was not to model the Fed Fund Rate, but they did build a model to assess this as part of their research. (They needed to confirm whether the non-response of core inflation to commodity prices was because of the Fed Funds Rate being increased in response to higher commodity prices, which would invalidate the lack of link between commodity prices and core inflation. As it turns out, a 10% increase in commodity prices was historically associated with only a minuscule 10 basis point increase in interest rates.)
What’s interest from their analysis is that, ignoring the 0% lower bound below which nominal interest rates cannot fall, the modelled Fed Funds Rate for 2009 was -2.66%. That’s nearly 3% below the actual rate. Which suggests a pretty serious cost to money in real terms, compared to the general views of “easy money”.
The point is that Quantitative Easing was only required because with a liquidity trap and the problem of the zero lower bound, interest rates were no longer a useful tool for monetary policy.
It’s just a pity that the fiscal stimulus was so late, weak and too brief.