Written by Aaron Hartfield
This essay summarizes the findings presented in a Chicago Fed Letter titled “The Interplay Between Financial Conditions and Monetary Policy Shocks.” [1] Do not be scared when you download the PDF. It is 51 pages, but the actual content is only 15, with other pages being graphs, references, etc. Before the findings of the Letter are presented, let’s have an introduction to some of the important topics.
What exactly is the Fed funds rate? The Federal Reserve (Fed) requires banks to have enough cash to cover possible withdrawals – a reserve requirement. Banks that hold cash above the reserve requirement can loan money to banks that do not meet the requirement. The length of the loan is overnight; the interest rate is the Fed funds rate. Not surprisingly, this rate affects the interest rates that banks charge customers and yields on bonds. Adjusting the Fed funds rate is one of the monetary policy tools of the Fed.
In theory and practice the monetary policy conducted by the Fed works to counter the effects of financial conditions. When financial conditions are easy, the Fed tightens monetary conditions and visa-versa. The authors of the Letter determine monetary conditions by looking at the Fed funds rate and financial conditions by looking at a few different measures, with the main measure being the excess bond premium.
What is the excess bond premium (EBP)? It is a measure of corporate bond spreads not attributable to expected default risk, first introduced in a 2012 paper by Gilchrist and Zakrajšek.[2] Corporate bond spreads are the difference in the yields between investment grade corporate bonds and similar duration Treasury securities. Gilchrist and Zakrajšek split corporate bond spreads into 2 components – default risk and EBP. They argue that the EBP is predictive of future output.
The green line (or the lowest line) in the chart below is the corporate bond spread.
How does the EBP predict future output? Corporations sell bonds to fund investments. The yield on corporate bonds can be thought of as the interest that the corporation must pay on its loans, similar to the interest rate that an individual pays on a car loan or home mortgage. Since the default risk of investment grade bonds should be relatively constant through time, an increase in corporate bond yields can be attributed to an increase in the EBP. The EBP can be viewed as an indicator of investor sentiment or risk appetite in the corporate bond market.
A decrease in investor sentiment leads to an increase in the EBP, resulting in higher interest payments for corporations and tighter financial conditions. (Look at the graph of the corporate bond spread again. Notice how the spread increased significantly during the Great Recession in 2008 and 2009, indicating tight financial conditions.) Tighter financial conditions result in corporations investing less, decreasing future output. When this happens, the Fed looks to counter by loosening monetary conditions. Let’s look at how this works in theory.
Investor sentiment in the corporate bond market decreases, resulting in an increased EBP and tighter financial conditions. The Fed notices the tighter financial conditions and decreases the Fed funds rate. This leads to a decrease in interest rates on bank loans. Individuals take out loans for cars and homes and small businesses take out loans for investment. Aggregate demand increases, which leads to an increase in investor sentiment in the corporate bond market, lowering the EBP and loosening financial conditions.
Aggregate demand is also stimulated through the exchange rate. When the Fed lowers the Fed funds rate, bond yields fall. This decreases demand from foreign investors in dollar denominated bonds. Since demand for dollars has decreased, the exchange rate falls. U.S. exports are cheaper and imports are more expensive, resulting in an increase in aggregate demand.
This is the paradigm that the Fed uses when making monetary policy decisions. The Chicago Fed Letter examines the effectiveness of monetary policy and covers 3 topics. 1) Comparing the effects of monetary shocks versus financial shocks. 2) How successful is monetary policy? 3) What happens when there is no monetary policy response to financial shocks? A monetary shock is a movement in the Fed funds rate and a financial shock is a movement in the excess bond premium.
The findings for the first topic are what economists have claimed for a while – the effects of monetary shocks take longer to work through the economy and are variable; the effects of financial shocks peak quickly and die out fast. To reach this conclusion the authors measure effects on gross domestic product (GDP) and business fixed investment (BFI). They find that financial shocks have a larger effect on BFI than monetary shocks, with monetary shocks having a larger effect on GDP. They determine the size of the effect by measuring how far the measure (BFI or GDP) is from trend. Both easy financial and monetary conditions have positives effects on GDP and BFI.
The second topic is attempting to determine how effective the Fed is at countering financial conditions. The authors find that the effects from financial shocks are 50% larger and last 2 years longer with no monetary policy. In other words, monetary policy dampens the effects of a financial shock. Of course, some people may be skeptical toward this finding, as the authors have a vested interest in people believing that monetary policy is effective; however, most economists believe that the authors’ findings are true. The debate is usually about how much the Fed should do to counter financial shocks and if countering financial shocks actually causes more economic volatility in the long run.
The third topic of the paper is looking at current monetary conditions. The Fed’s current target for the Fed funds rate is 0.25-0.5%, with the recent effective Fed funds rate being around 0.41%. At this level, known as the zero-lower bound (ZLB), the Fed will have little room to counter the effects of an increase in the EBP (no monetary policy). The Letter explores how the model reacts to the ZLB.
The graph below displays the effective Fed funds rate over the last 20 years and demonstrates what economists mean when they talk about the ZLB.
The model reaction to the ZLB was measured retroactively. The authors took historical data and when monetary policy reacted to a financial shock, they inserted into the model a counter monetary policy, essentially negating any effect from monetary policy. Using different measures of financial conditions, the finding was “in all but one of these cases, we find that the ZLB contributes to generate instability in the response to the financial shocks.”
This Letter, especially the third topic, may be viewed as the Chicago Fed telling the other members of the Fed that it is time to increase the Fed funds rate. Indeed, if the EBP begins to dramatically increase, the Fed will not be able to counter by lowering the Fed funds rate. And because the effects of monetary policy are not felt immediately (the first topic), an increase in the Fed funds rate at the December meeting will not slow the recovering economy anytime soon.
Will the Fed raise the Fed funds rate at the December meeting? At this point, they probably should, as most of the market is expecting an increase. (The probability for a December rate increase is at about 90%.) If the Fed decides to not raise rates, it is likely that there will be volatility in the market. And if that volatility leads to an increase in the EBP, the Fed will not be able to use the Fed funds rate to counter the effects.
[1] Bassetto, Marco, Luca Benzoni, and Trevor Serrao. 2016. “The Interplay Between Financial Conditions and Monetary Policy Shocks.” Federal Reserve Bank of Chicago October WP 2016-11.
[2] Gilchrist, Simon, and Egon Zakrajšek. 2012. “Credit Spreads and Business Cycle Fluctuations.” American Economic Review 102 (4): 1692-1720.
In this article titled, “Financial and Monetary Conditions in the Economy,” author Aaron Hartfield described and summarized a Chicago Fed Letter entitled, “The Interplay Between Financial Conditions and Monetary Policy Shocks.” Aaron Hartfield describes three main topics in this article; comparing monetary shocks to financial shocks, the effectiveness of the monetary policy, and what may happen if there is no financial policy. In regards to the first of the main topics discussed, monetary shocks are more complex and take longer to work than financial shocks. As many others have stated in their comments, this article was difficult at first to understand, but after a thorough re-read my knowledge on this article became clearer. This article is stating that investors are not as confident, or willing to invest in the economy. For example corporations are investing less, financial conditions becoming less flexible, a decrease in bank interest rates on loans, as well as a decrease in the Federal funding.
Understanding economics in real time is a difficult task, but Aaron Hartfield makes it substantially easier in understanding how critical increasing the Federal Funds Rate is to the success of the U.S. market system. Hartfield goes into depth in explaining how the Federal funds rate acts like a catalyst in determining the output and stability of such a market. The federal funds rate is the interest rate placed upon the loan that enables banks to be within the Federal Reserve requirement, a requirement that determines if a bank holds enough cash for withdrawals. This rate also effects the interest rate placed on loans given out to the bank’s customers. The importance of the federal funds rate is better understood when seeing its importance in guiding monetary policy. Monetary policy allows the Federal government to handle financial conditions, either by tightening or loosening control. However, in conjunction with the excess bond premium, a method of determining financial conditions, is where monetary policy is instructive. The excess bond premium (EBP) Hartfield explains as measure of corporate bond spreads, as corporations sell bonds to fund investments at an interest (known as the corporate bond yield), the EBP will determine the likeliness of the risk appetite or want to invest in such bonds. So, a decrease in EBP will decrease corporate bond yields, meaning an increase in investments. Now, pairing the EBP to the Federal funds rate is where one can begin to see the domino effect one has over the other. Hartfield points to the 2008-2009 financial crisis, where there is a spike in corporate bond spreads due to an increase in EBP as investors likeliness to invest decreases, causing tighter financial conditions that calls in the Fed to play in. To loosen such conditions, the Fed will decrease the federal funds rate which will decrease the interest rate placed on banks loans, leading to more people taking out loans and the EBP would successfully decrease and corporations will once again continue to invest as risk appetite increases. The success of the Fed and monetary policy as described by Hartfield using the 2008-2009 model is clear, which heightens the issue that considering that the Federal funds rate has been at at the zero lower bound (.41%) stagnantly, that domino effect that was just described where monetary policy pulled through will not have any effect if such an economic crisis in the market occurred again. Hartfield final note is that the Fed must increase the brackets of where the federal fund rate should lie if it wishes to avoid a market failure where corporations will cease to invest, which will have the final effect on the populace as they will be unable to procure necessary loans.
In the article titled ” Financial and Monetary conditions in the Economy” the author Aaron Hartfield summarized a Chicago letter entitled ” The Interplay between financial conditions and Monetary Policy shocks”. In this article Aaron Hartfield describes three main things in this article. The articles main topics are comparing monetary shocks to financial shocks, the effectiveness of the monetary policy and what might happen if there is no financial policy. Monetary shocks take longer than financial shocks. Throughout the article he mentions that investors are not confident and not willing to invest. This article is kind of difficult to understand but makes since if you get it.
The Bassetto, Benzoni, and Serrao article was definitely a dense and difficult read for a student who has very little background in economics. Even after multiple read-throughs, I understand very little of the statistics. Hartfield’s summary of the article helps to bring the topics to light with his convincing argument. He defines many of the terms and more clearly explains the chain reaction of what would happen were the Federal Reserve to respond to investor sentiment and consequent output one way or the other. The Fed could decrease the Fed funds rate to encourage demand, thus loosening financial conditions. Alternatively, as Hartfield argues in favor for, the Fed could raise the Fed funds rate to tighten financial conditions as the market is expected to increase, requiring more stability. Were the Fed funds rate to not be increased, the market would become volatile and increase the excess bonds premium (EBP; corporate bond spread, a predictor of future output). A zero-lower bound (ZLB) gives little room to counter an increased EBP, generating instability and costing the economy output. Monetary policy and financial conditions influence one another. Recent recessions are due to financial shocks, which peak quicker than monetary shocks do.
Fed funds rate is the interest at which a bank lends money at the federal reserve to another bank overnight, primarily they only lend to creditworthy institutions. This is where it all begins. it directly affects the monetary and financial conditions of the economy. It is added to the loans that the bank lends out and it follows through that avenue of business. EBP is the excess bond premium- the measure of corporate bond spreads which are the difference in yields between the corporate bonds and the treasury securities. EBP increases as the yield on the corporate bond increase thus the EBP can predict future output. in tighter conditions in the economy corporations invest less which decreases the EBP. This letter is showing a comparison of the fluctuation in the market as the EBP increases and decreases through time. It is saying that as the EBP rises the fed will not have the ability to counter with a fed fund rate decrease and it will prove to show risks in the market entirely not only affecting output. So the fed fund rate directly starts the cycle.
Stacey Adamick
Like many of the of the other commenters, I too had to read through Aaron Hartfield’s essay a couple of times to get a good grasp on the topic of monetary shock and financial shock and the roles that they play in the economy. A brief summary is that monetary shock refers to the policies made by the Fed when adjusting the Fed fund rate, which is a reverse policy that requires banks to have som much money on hand to cover possible withdrawals, bigger banks are also able to loan money to smaller banks to help meet their quota of Fed fund rate. Monetary shock has a direct influence over GDP and is also much more complicated and long lasting than financial shock. Financial shock is looking at the excess bond premium or EBP for short, the way that financial shock is measured in the Chicago Fed Letter is with business fixed investment (BFI) which is the steady factor contributing to EBP, which is a good indicator of the investor sentiment or the willingness to invest in the market. When EBP goes up conditions get tighter and interest rates go up, which lead to less and fewer investments, which are when the Fed steps in with monetary policy to counterbalance the drooping economy. Now, the Chicago Fed Letter is looking at the effects that monetary policy has on financial policy by “comparing the effects of monetary shocks versus financial shocks. 2) How successful is monetary is policy? 3) What happens when there is no monetary policy response to financial shocks?”.
Aaron Hartfield does a thorough job of explaining each topic covering financial and monetary shocks, and monetary and financial policies. First, explaining monetary shocks: a movement in the Fed funds rate, he explains that economists that the effects of monetary shocks take longer to work through the economy and can be variable. Versus financial shocks that peak quickly and die fast. Second, he explains the effectiveness of the Fed countering financial conditions, finding that financial shocks are 50% larger and last 2 years longer with no monetary policy. Lastly, Hartfield explains the current monetary conditions and targets for the Fed funds rate. Hartfield helped me understand this article a little more like my fellow classmates said, and how increasing the Federal Funds Rate is better for our market in order to flourish. For example, if corporations invest less, it will eventually show a decrease in the Federal Funds rate leaving our market unsuccessful as well. Hartfield did a good job at relating real life examples in order to understand the system and how funds work.
Alicia Lim
Hartfield summarizes the findings illustrated in Chicago Fed Letter, “The Interplay Between Financial Conditions and Monetary Policy Shocks” in his essay “Financial and Monetary Conditions in the Economy”. He defines what exactly the Fed Funds Rate is and highlights the three main points of the letter: comparing the effects of monetary shocks versus financial shocks, how successful monetary policy is, and what happens when there is no monetary policy response to financial shocks. Basically the Fed Funds rate describes the interest rate of a loan from one bank to another in order to keep up with their reserve requirement for possible withdrawals. Financial shocks are typically the quicker of the two to peak and therefore dies out faster. Financial shocks also have a greater effect on BFI while monetary shocks have a greater effect on GDP. The main debate regarding monetary policy and financial shocks is the question of just how much the Fed should interfere to counter the financial shocks and how detrimental that might be to the economy in the long run.
This article is titles “Financial and Monetary Conditions in the Economy” by Aaron Hartfield. This essay is about the findings presented in a Chicago Fed Letter titled “The Interplay Between Financial Conditions and Monetary Policy Shocks”. Federal Reserve requires banks to have enough cash to cover possible withdrawals. It holds cash to loan money to banks that do not meet the requirements. Practicing the monetary policy conducted by the Fed works to counter the effects of financial conditions. The author of the letter determines monetary conditions by looking at the Fed fund rated and financial conditions by looking at a few different measures. It shows the findings of the first topic, which states that the economists have claimed an effect of monetary shocks which will quickly die out. The second topic determines how effective the Fed is at countering financial conditions. And the third topic is looking at the current monetary conditions.
At first I had a little trouble reading this article since I was not familiar with some of the vocabulary, but as I kept reading and and with the help of the writer, I really started to understand more about the article therefore I was more focus and engaged. Aaron Hartfield is being very detailed and expressive; he is describing each unfamiliar term as he introduces it. I am quite familiar with the excess bond premium, but I like how Mr. Hartfield talked about it, he mentioned that corporation sell bonds to fund investments in order to predict future outcome. Also, he mentions that EBP is a risk appetite in the corporate bond market. The area where I was more impressed was when he stated the zero-lower bound(ZLB). Mr. Hartfield stated that ZLB is a level where the Fed will have a small room to counter the effects of an increase in the EBP (no monetary policy).
After reading the essay, “Financial and Monetary Conditions in the Economy”, I feel educated on a topic I originally knew little about. As I skimmed through the PDF before I read the essay I was quite lost and had to google a couple of terms such as the Baseline Model, because the explanation in the excerpt was rather confusing. When I moved on to the essay summarizing what I had just read, I was pleasantly surprised by Aaron Hartfield’s ability to simplify all of the terms. What really stood out to me in this essay is the concept of cause and effect in our economy, and how everything seems to almost connect with one another. Simply putting it in the very beginning he explains how banks must have a certain amount of money put to the side in order to cover withdrawals and if they don’t have the money then they get the money from banks that do. Then he goes on to explain how this effects the interest rates that customers must pay. If I am understanding correctly, regarding the financial and monetary conditions is a cause and effect system that essentially effects everyone involved in the economy.
In this article titled “Financial and Monetary Conditions in the Economy”, author Aaron Hartfield summarizes the economies to a more reader friendly topics and easier understanding in the Chicago Letter, “The Interplay Between Financial Conditions and Monetary Policy Shocks”. It was difficult at first but after taking away the main points it become easier to conceptualize. He starts off with his three main topics of comparing monetary shocks to financial shocks, the effectiveness of the monetary policy, and what might happen if there is no financial policy at all. This article highlighted the fact that monetary shocks are what the policies the FED makes when they adjust the FED fund rate. The financial shock focuses on looking at the EBP which is measured with a business fixed investment that contributes to the EBP and the willingness to invest in the market. Hartfield helped me to understand this article and how if increasing the Federal Funds Rate would be better for our market to succeed. He did an amazing job relating these topics to real life examples along with graphs to explain and understand the system overall.
Aaron Hartfield wrote “Financial and Monetary Conditions in the Economy” to address an article titled “The Interplay Between Financial Conditions and Monetary Policy Shocks” presented in a Chicago fed letter. Aaron Hartfield summarized the three main themes in the Chicago Fed Letter which were as follows; the excess bond premium, how effective the Fed is at countering financial conditions, and looking at monetary conditions now. Hartfield goes on to explain the excess bond premium as a measure of corporate bond spreads not attributed to expected default risk. The Fed uses an increase in the Excess bond premium to dictate whether to tighten or loosen the monetary policy and end the financial condition. Hartfield indicates that monetary policy dampens the effects of a financial shock, which without intervention tend to be fifty percent larger and last two years longer. The Fed monitors the financial situation with the recent Fed fund rate being around point forty-one percent. This rate being near the zero-lower bound and leaves the Fed little room to counter an increase in the Effect Bond Premium. Hartfield ends with the fed needs to increase the Fed Fund Rate before the market becomes volatile.
Most economists who expect the Federal Reserve to hold off from raising interest rates point to more restrictive financial conditions in the wake of August’s market turmoil as a key reason to refrain from liftoff. “The recent volatility in financial markets introduces a new wrinkle into the Fed’s calculus,” wrote Neil Dutta, head of U.S. economics at Renaissance Macro Research, for example. The Fed does not want to send a firecracker into fragile capital markets nor do they want to give the impression that they are captive to markets either. But what do economists mean when they talk about financial conditions, and how do these variables affect the real economy? A plethora of financial conditions indexes have been developed by regional Federal Reserve banks and Wall Street’s biggest financial institutions. While the composition of each index differs, most take into account these criteria: the strength of the U.S. dollar, the level of bond yields, credit spreads, and stock prices.
II find it very interesting how the whole lay out of the paper was put into three main topics. 1) Comparing the effects of monetary shocks versus financial shocks. 2) How successful is monetary policy? 3) What happens when there is no monetary policy response to financial shocks?
Starting with the first one, it is very interesting to know that monetary shocks takes longer than financial shocks to be seeing over time. It is a way to see how financial shock can be seen very rapidly but it will be gone faster as well. Overtime, monetary shocks take more time to impact on the economy. On regard of the the effect that monetary shocks does to financial shock hesitates me and intrigues me more as to how that is about. Financial shock last 2 years longer as well as 50% better with no monetary help. For the last topic I do believe that I need more understanding to make a decision. The article is hard to follow without questions being answered.
Hartfield first explains the Fed funds rate: The rate of interest charged by banks that hold cash above the reserve requirement to banks that need funds. The Fed controls that rate and it largely determines the rates individual banks charge their customers and the banks yields on bonds. The Fed can use this power to manipulate the economy.
He then explains excess bond premium (EBP). It is the difference in yields from corporate bonds (sort of like interest that individuals pay on their loans) and Treasury securities. The Fed uses EBP in making decisions whether to raise or lower the Fed funds rate.
The Chicago Fed Letter takes a 3 part look at monetary policy. Firstly, it finds that the effects of monetary shocks (change in the Fed Funds rate) take longer to effect the economy than financial shocks (EBP). Secondly, it finds that financial shocks cause more volatility in the economy and last longer without monetary policy adjustment. And, thirdly, and most talked about, is the current monetary policies. The Chicago Fed Letter tells other Feds that they need to increase the Fed Fund rates because if they don’t they won’t have any room to counter the effects of the EBP. Hartfield says that the Fed will most likely raise Fed funds rate at the December meeting.
From what I understand, when the EBP increases there is an increase in aggregate demand because U.S. exports are cheap but imports are expensive. This therefore de-values the American dollar. Hartfield then answers three questions regarding the Chicago Fed Letter about monetary policy. The first response dealt with the differences between a financial and monetary shock. Hartfield made it very clear that monetary shock took a long time to take effect in the economy while the financial shock was quick. In the second response, he clarified that, per trustworthy research, monetary policy does not help in times of crises. In fact, it is better when there is no monetary policy. This is somewhat concluded in Hartfield’s third response. The Fed should increase the Fed funds rate to fix the problem they are facing. This will be the quickest way and will ensure there is stability in the market. In the end, however, I still don’t quite comprehend how this all affects the average citizen of the U.S. With the given information, I can reason how it effects the country but not a student or everyday worker. As of now I am if the Fed funds rate is not fixed, there will be instability in the market. This instability is a problem for the consumer (U.S. citizens) because prices may increase and our value of money could decrease. Both are bad for the everyday worker. Especially since they need to support their family.
At first sight the essay ” The Interplay of Financial Conditions and Monetary Polich Shocks” is quite overwhelming. Especially for someone who has never dealt with economics. However Aaron Hartfield’s summary was so amazing, I was able to understand everything after reading it. The author hits three main points in his work.
The first point he defines federal reserve.A federal reserve requires that a bank have enough cash to fulfill the withdrawals of the day. The federal reserve is based on many factors, but the excess bond premium hold the most influence. The excess bond premium is actually a measure of corporate bond spreads.
The second point deals with how effective the federal reserve has been. From the graph by Board of Governors of Federal Reserve, one can see that in the earlier years it did work. However in present day it seems to barely or not be working anymore.
The last point is talking about current monetary conditions.
Hartfield’s article about monetary and financial shock was very informative. touching on the comparison between financial and monetary shock, E.B.P., investor confidence, fed effectiveness and more gives a very interesting read. I learned that as EBP increases, accordingly so will corporate bonds. I was able to take away from the graph of Federal Reserve effectiveness that in the past, the fed has been effective, alternatively not in most recent years.
I find Hartfield’s monetary and financial shock article very important and easy to understand, I think the information posted here is an opportunity to be able to think critically about all the things that makes the market be volatile and also to know what are the counters the fed have in case of a monetary shock or a financial shock. in base of this article the more remarcable thing or alarming is noticing that the fed funds rate are in 0.41% which as mention by the chicago fed the better move is to raise the fed funds because, otherwise there will be a market volatility and if the EBP raises the fed wont have the resources to lower the rate and that could leave to a tough economy position for the future.
While difficult to read, the article did give me some insight into how the Federal Reserve helps to stabilize economic conditions through manipulating the Fed funds rate. This seems like an effective system, but with some loopholes. If the Fed makes a mistake with how they decide to handle the rate at a specific point, it can cause a great deal of harm. If financial conditions become easy and the Fed wasn’t ahead of the game and prepared to impose restrictions, it will cause the volatility noted in the article. I believe that if the Fed has such a profound power over investment that there should be a system of checks and balances in place. The author speaks to a meeting in December holding weight over the next change in rate and how it is a concern. If the meetings to determine rate adjustments are infrequent, I would suggest increasing frequency to ensure meeting the financial demand on time.
The article and essay were difficult to understand as there were several main sectors of economic principles and indicators mentioned in the article as well as the intricacies of how each of these indexes affect each other. It is obvious that interest rates affect a borrower or investor’s mindset when considering taking out a loan or investing in a corporation’s tender for project funding. It seems that the financial market is so fragile that experts must maintain constant vigilance on the indexes and remain prepared to make adjustments to the Fed Rate when certain economic conditions arise to warrant an adjustment. Of the entire article, the part that worried me most is that the Fed has very little “wiggle room” to make adjustments to the Fed rate. It was stated in the article that the Feds effective funds rate is 0.41%. At this rate called zero-lower bound, the Fed has little room for error in making adjustments to monetary policy. It seems to me that if economic conditions worsen rather quickly due to some potential worldwide crisis, the Fed can make one small adjustment to the rate. If this small adjustment does not work to satisfactorily correct worsening conditions, then there would remain little the government could do to try to soften a long term economic downturn. So, in my uneducated view, it seems the Fed should raise the interest rate by some percentage to build a larger cushion from which to work on future adjustment requirements.
I found the article interesting. While I know I didn’t grasp everything the author was explaining, I did learn some things. First off, I didn’t even know what the Fed was until reading this article. I didn’t even know what Fed stood for. I found it interesting to learn how the Fed worked to lower EBP, which was another term I didn’t know about. I also thought it was interesting that the author states that Fed dampens the effect of financial shock. And, by a large margin if he is correct that without it the effects are 50% larger and last 2 years longer. The author kind of lost me when he started talking about Fed in regards to ZLB. I do not think I am grasping what he is explaining there. Overall though, the article was interesting. I had to read it a couple of times, because there is a lot to it and it was a little overwhelming.
This essay is a summary of a letter written by the Chicago Fed. The main point of the essay, and letter, seem to be about the necessity of increasing the Fed Funds Rate. However, seeing as it is probably written to inform students, or anyone else who knows nothing about the subject, the author had to give a lot of background information before he could make his point.
The background information consists of 4 crucial sub-points which help the reader understand his final point. The first being what the EBP is and why it is worth keeping track of. The second is the differences between Financial and Monetary Shocks. The third is, why the Fed increases and decreases the Fed Funds Rates and what the affects it has on the economy. The fourth sub-point talks about the Zero-Limit bound or ZLB and how it affects the way the Fed can mitigate the effects of a “tight condition”. And finally in the last paragraph he states what seems to be the whole point of this paper. He implies* that this letter was the Chicago’s Fed way of telling the rest of the Fed to increase the Fed Fund Rate.
This is what I personally took from the essay. However, I could of course be completely off base. If that happens to be the case please let me know where I’ve made an error.
*I say “implied”, because he uses the words “may be viewed as”.
The essay, Financial and Monetary Conditions in the Economy written by Aaron Hartfield, is somewhat of a hard read for a novice on the subject. Although, through the authors explanation one can get an idea of how the Federal Reserve can affect the United States economy. However, one should read more articles on the subject to alleviate the possibility of a one-sided view and a better understanding of the subject. One question to ask is, besides the cost of living, what effects do monetary conditions have on those who do not invest in stocks, who do not own property and are in the low-income tax bracket? Also, what can one do; rather than relying on the government, to be shielded from the adverse effects of the market? If we are dependent on the federal government to keep our economy going, then where does this leave us should our government not have the means to turn the economy around? Therefore, educating oneself on economics could change the economy in a small way. Reading the essay is one way to wet ones appetite for knowledge.
In this here article named, “Financial and Monetary Conditions in the Economy,” Aaron Hartfield delivered a summary and posed questions regarding a Chicago Fed Letter entitled, “The Interplay Between Financial Conditions and Monetary Policy Shocks.” Aaron Hartfield defines several terms. Without understanding these terms, it is impossible to come to terms with what it all means. (Pun intended.) He first defines the Federal Funds Rate as (paraphrased) the interest rate of the loan to which banks lend each other money so that they have enough money to cover withdraws. Being a financially responsible college student, it makes sense that there is such an importance on not over-drafting, but on the contrary, I would never loan my friends money from my “financial cushion” if you will, unless I had some potential benefit, like charging interest. (Maybe that’s why you shouldn’t do business with your friends…) The article also states that “monetary policy conducted by the Fed works to counter the effects of financial conditions.” You could compare this to walking a dog on a leash. Think about it: when you’re on a stroll with your pal and he/she/it has to lunge for a squirrel or some other moving object, you loosen the leash because the strain on your muscles is difficult for you to bear. Similarly, when financial conditions are difficult, the Fed loosens monetary conditions. Reverting back to the pet analogy, when there is excessive slack on the leash, (walking has become easy) you might wrap the leash around your wrist a few times and tighten control. Similarly, as the article states, “when financial conditions are easy, the Fed tightens monetary conditions.” The author then goes on to define the excess bond premium or EBP, defining it as “a measure of corporate bond spreads not attributable to expected default risk.” To understand you have to know that, “Corporate bond spreads are the difference in the yields between investment grade corporate bonds and similar duration Treasury securities.” I could go on to state definitions, but will now move on to the meat of this educational meal so that you will have time to digest the information. The author, Hartfield, makes three main presumptions. First, he states that “the effects of monetary shocks take longer to work through the economy and are variable” and concludes that “Both easy financial and monetary conditions have positives effects on GDP and BFI.” Secondly, he contemplates “how effective the Fed is at countering financial conditions.” He concludes that monetary policy helps cushion the blow of financial shock. You could compare monetary policy to shocks on a bike. Ironically, the bike shocks are actually the object that absorbs the physical shock from landing a jump. (Shocking right?!) Skeptics who don’t believe in this will be hurt by their skepticism in the long ride, since they can’t handle the truth. (puns always intended). The author then talks about “current monetary conditions and how the fed wants its rate around “0.25-0.5%”, but the current level, “.41%” is at the “ZLB” which was found to create instability. If the fed doesn’t raise the federal funds rate, and there’s no countering of the EBP, meaning no monetary policy, then there are no shocks on the bike. No cushion. No protection. The end result is pain. The public will be Fed up when consumer interest rates go out of control, so a rise in the funds rate is the only hope at preventing an epidemic of pain in the joints of American economics. Thank you.
In this article,“Financial and Monetary Conditions in the Economy,” written by Aaron Hartfield describes and summarizes a Chicago Fed Letter entitled, “The Interplay Between Financial Conditions and Monetary Policy Shocks.” I realized how important this economics class is going to be to me and why it is so very important to at least get a taste of what is going on in the economy, and why.
This article summarizes three key points however if you are new to the lingo needs to be read thoroughly so that you can understand its meaning. I personally took notes. It is clarifying for you exactly what the FED fund rate is. This essay also breaks it down into three key findings. First there is a comparison on financial shocks versus financial shocks. Secondly it is discussed How successful or effective is the actual monetary policy and thirdly what would happen if there is no monetary policy to respond to financial shocks? I found most interesting that this is theory and will continue to unfold as more information is gathered. I also found it interesting that this is actual debated among some so I will have to see what a flip side would be when it comes to the FED rate and its play on Monetary Conditions.
Overall I saw a comparison similar to what is going on in the oil and gas market today. I sure love paying the low gas prices right now, and I am not excited one bit to watch them go up. However, the flip side is many many people are losing everything they have because that way of life came to a standstill. Its a ying-yang. So when big businesses are loaning money the mortgage interest rates and car loans are high interest. It may not be exactly the same thing but it is what i thought about. This was a very interesting read and I hope as I discover more in the economics world and a even better understanding will unfold.
Going to financial depth of our federal government has never been something I understood to well. First of all I have always wanted to be involved with stocks and bonds especially through my company because I hear of many people who are in it and benefit from it. Although I get scared cause I don’t keep up with the current economy behind the walls, I don’t know when is the right to move my money or the conditions get tighter and I should contribute less. This article gave me somewhat of a theory on how the Fed looks to loosening monetary conditions. I didn’t even know that monetary shock existed. Economists really do go through these stages and the article explains well on how effective Feds are doing in these financial conditions. This article says that not many investors are not even sure their selves about investing this is just a gamble you must be willing to take.
Financial and Monetary Conditions in the Economy
This essay “Financial and Monetary Conditions in the Economy,” written by Aaron Hartfield, is a summary of the Chicago Fed Letter titled “The Interplay Between Financial Conditions and Monetary Policy Shocks.” He begins by explaining what some of the words used in this letter mean. The Federal Reserve (Fed) for example, is a reserve of money that is mandatory for banks to have to fund potential withdrawals. Customer’s interest rates that the bank charges and the money that investors earn on their bonds, are affected by this rate. The effects of the financial conditions are reversed by the monetary policy regulated by the Fed.
The success of the monetary policy is analyzed by the Chicago Fed Letter and contains three topics. First, distinguishing the consequences of monetary shocks versus financial shocks. Second, how profitable is monetary policy? Third, what will happen if there is not a monetary policy reply to financial shocks?
A change in the Fed funds amount is a monetary shock and the consequences of it functioning through the economy takes longer and are liable to change. A change in the excess bond premium is a financial shock and the consequences of it, climax rapidly and disappears swiftly. How capable is the Fed at opposing financial situations? The results from financial shocks are fifty percent bigger and will continue for two more years without a monetary policy, per the author. Looking at current monetary conditions, the Fed funds rate is around 0.41%. and at this level, they will not have much room to reverse the outcome of an increase in the EBP (no monetary policy).
The Chicago Fed may be perceived as informing members of the Fed that it is time to increase the rate of the Fed funds, in this letter. There may not be stability in the market if the Fed decides not to increase the rates and it will not be able to use the Fed funds rate to reverse the outcome, if that volatility contributes to a raise in the EBP.
Written by: Jolene Valentine
The Federal Reserve has imposed a series of regulations on Banks in regards of the amount of cash necessary for the institutions to allow withdrawals to their costumers and loans to their homologous. In the form of Fed Funds rates, this entity has established a number that determines the interest rate charged to their costumers and yield bonds. Being the latter the case, the Federal Reserve has utilized this fund rate as a monetary policy to regulate the economy under certain financial conditions. When these are easy or “stable”, the regulations are tighter and vice-versa. If the odds were ever to be against them, interest rates would be lowered to loosen the financial conditions and incentive investment. Financial conditions are determined by a major component called Excess Bond Premium. EBP is a measure of corporate bond premiums and, because it is believed to remain constant, it is used to determine future output. Therefore, when the EBP is high, corporate bond interests are as well. When the levels of the Excess Bond Premium peak, monetary policies (Fed Fund rates) need to be taken into place in order to counter the financial shock (any movement in EBP). This intervention would lower bond interest rates, thus reducing the burden on corporations and promoting investment. However, monetary shocks (any movement in the Fed Funds rate) take time to work their way through the economy. Therefore, it would take some time to notice the effects of the policies in respect of the financial conditions.
Based on what has been previously discussed, the article stresses that current monetary conditions are not opted to counter the effects of an increasing EBP. Conclusively, based on “The Interplay Between Financial Conditions and Monetary Policy Shocks.” article, other measures need to be taken into effect before the levels of Excess Bond Premium reach an all time high, where not even current monetary policies will be able to help us.
In this article titled, “Financial and Monetary Conditions in the Economy,” author Aaron Hartfield summarizes the findings from a Chicago Fed Letter. At first it was very difficult to read so I had to look up a lot of terms like “aggregate demand” and “denominated bonds” to really understand the article. The article focuses on three main points of the monetary system. The first main point talks about the Federal Reserve and how the monetary system compares. The Federal Reserve is a banking system which provides a steady and safe monetary system. The Federal Reserve requires each bank to have enough money to cover all possible withdrawals. The second topic explains how effective the monetary policy is. The Feds found that monetary policy reduces the effects of financial shock which is good. The third and final point discusses what would happen if there is no monetary policy in response to financial shocks. “The Fed will have little room to counter the effects of an increase in the EBP” (Hartfield). In the article Hartfield states that the Chicago Feds argued to other Feds that they need to increase the Fed Funds rate or there will be “volatility in the market” (Hartfield).
-Heather Paterson
This article is a summary of the findings presented in “The Interplay Between Financial Conditions and Monetary Policy Shocks.” It explains how the federal reserve requires banks to have a reserve requirement, which is enough cash on hand to cover what people could take out. If a bank doesn’t have enough cash, other banks can loan them cash to meet the reserve requirement. The fed funds rate influences the rate that banks charge customers and yields on bonds. The excess bond premium (EBP) is a measure of corporate bond spreads not attributable to expected default risk. The article argues that is it predictive of future output by being viewed as an indicator of investor sentiment or risk appetite in the corporate bond market. In theory, this works when the Fed notices tighter financial conditions and in turn lowers the Fed fund rate. This lower rate allows people to take out car loans, home loans, and small business loans at a lower rate. This article confirms that the effects of monetary shocks take longer to work through the economy and are variable while the effects of financial shocks peak quickly and die out fast. At this point, the market is expecting an increase in Fed funds rate. If for some reason the raise is not approved, it is likely the market will become unstable and the Fed will not be able to counter the effects.
In this piece by Aaron Hartfield, he sums up what was shown in “the interplay between financial conditions and monetary policy shocks.” He starts by explaining the Fed funds rate. It is one of the Feds monetary policy tools and consists of the interest rate at which banks loan money to other banks to cover the reserve requirement. He then explains the excess bond premium. It is a measure of corporate bond spreads not attributable to expected default risk. Some argue that it can predict output of the future. It can also indicate the willingness to take risks in the corporate bond market. Hartfield then examines the three topics discussed in the Chicago Fed Letter. The first was comparing the effects of monetary and financial shocks. They have different lengths of time, but both have positive effects on GDP and BPI. The second topic was asking how successful monetary policy is. The answer is that it is effective, in that it reduces effects that come with financial shock. The third topic is what happens when there is no monetary policy response to financial shocks. The answer is that the Fed won’t be able to do anything to help with an increase in EBP.
In this article titled, “Financial and Monetary Conditions in the Economy,” authored by Aaron Hartfield summarizes a Chicago Fed Letter entitled, “The Interplay Between Financial Conditions and Monetary Policy Shocks.” My first thought when reading this essay was “Wow! Mr. Hartfield makes some great points”! The essay has quite a bit of information for someone that has never really been involved with economics, but Hartfield summarizes it so well that it becomes clearer. He discusses three topics that were discussed in the letter. 1) Comparing the effects of monetary shocks versus financial shocks. 2) How successful the monetary policy is. 3) What happens when there is no monetary policy response to economic shocks. He points out that not increasing the Federal Funds Rate directly affects the monetary and financial conditions of the economy. It is added to the loans that the bank lends out and it follows through to that avenue of business. The excess bond premium (EBT) is the measure of corporate bond spreads which are the difference in yields between the corporate bonds and the Treasury securities. The EBP increases as the yield on the corporate bond increase thus according to Hartfield the EBP can predict the future output, But when the economy is tighter corporations invest less which decreases the EBP. So, the conclusion that Mr. Hartfield makes clear is that it is essential to increase the Federal Funds Rate to help our U.S. market system become successful.
Here recently I have become very interested with the economy and how it works, just like I am sure everyone else is. Now Mr. Aaron Hartfield’s article makes things more clear for me; someone that doesn’t know a whole about how the economy fully works. So what I have gathered is that the Federal Reserve requires banks to have enough money for possible withdraws. And if a bank that has more money than needed for reserves that they can loan other banks the money they need. Another thing I have learned is that the excess bond premium (EBP) can help determine future output. When EBP goes up things get tighter and interest rates go up, which means lesser and fewer investments are made. So when this happens the Fed steps in with monetary policy to counter the declining economy. Now Monetary shocks are variable and work slow through the economy, but have a large effect on GDP; where as financial shocks peak fast and die fast but have more of an effect on BFI.
Interesting article, with a lot to cover. To start off, the author Aaron Hartfield did a pretty good job of showing the relation of the Fed, and monetary policy and its effectiveness in battling excess bond premiums, and financial shock. It would appear in good times the Fed seeks to raise interest rates and tighten financial conditions, this should allow for banks and other institutions providing loans to make a greater return on their investment. However, when the EBP gets too high companies are less willing to take loans and investment can stagnate. The data no doubt shows that the lowering of the Fed’s interest rates can have an effect on the EBP and encourage companies to take loans and invest more freely. Currently though, the Fed’s interest rates being at (.41%) leaves the Fed in no position to actually effect the EBP being that the interest rate is so close to the zero-lower bound. The other issue here is the effect the change in rates has on the dollar’s exchange rates. It would appear that while the intention to be able to improve market conditions through manipulation of interest rates is appealing, there is a chance that overreacting could lead to a weaker dollar costing consumers more when they buy products from foreign countries. For this reason, I believe it best for the Fed to minimize its influence on the market since recovering from financial shock is often easier and shorter in duration than monetary shock.
In this article titled, “Financial and Monetary Conditions in the Economy”, the author Aaron Hartfield summarizes a Chicago Fed Letter called, “The Interplay Between Financial Conditions and Monetary Policy Shocks.” There are 3 main topics discussed : 1.) Comparing the effects of monetary shocks and financial shocks.. from that, I learned that Federal Funds rate goes hand-in-hand with any movement of monetary/financial shock, the effects of monetary stocks takes longer to work through the economy and are variable and have a larger effect on GDP. Financial shocks happen rapidly and the results of these are seen quickly but end shortly thereafter; finnancial shocks have a larger effect on BFI. 2.) How successful monetary policy is.. in other words without a monetary policy in place financial conditions double and last longer because of no restrictive policies helping investors yield more. 3.) Current monetary conditions.. the Feds shoots for a rate in between .25%-.5% and the Chicago Fed in this letter are proposing to other members that an increased Fed funds rate is necessary since the monetary policy effects aren’t felt much later on and won’t negatively affect the economy in the near future giving them x amount of time to make adjustments when necessary.
Heartfelt gives us valuable information on how the federal reserve works. Before i did not know that the reserve requires banks to have a certain amount of cash to cover possible withdraws and that if bank has enough it can give an over night loan to another bank.
HE then goes on to talk about EBP, he states that Corporate bond spreads are the difference in the yields between investment grade corporate bonds and similar duration Treasury securities. The federal reserve also notices drops in bond market and can decrease federal fund rates and therefore reduces bank loans for individual people like car or house loans. another look is determining how effective the fed is at countering certain financial conditions.
In this article titled “Financial and Monetary Conditions in the Economy” by Aaron Hartfield he does a good job of summarizing and simplifying the many concepts he covers. I did struggle a little with understanding a few terms he used, I had to read it a few times and had to google some terms but after all of that I found a better understanding of the subject and it is very interesting how this part of the economy works. What I took away the most from this article and what I found interesting is that banks can loan each other money but it effects the customers of the banks and what amount the banks charges it customers in interest rates, When Fed raising its interest rates to keep financial conditions tight with this in effect it should help the banks and what ever other company and/or corporation have a better return rate on their investments. I also learned that when EBP goes up it means less investments are made. With the yo-yoing of this particular part of the economy it really is a matter of timing and understanding when to make investments.
In the article, “Financial and Monetary Conditions in the economy” by Aaron Hartfield, he does a good job at summerizing the concepts and points he is trying to convey. But he speaks of it as if we all understand it as well. The main points that he conveyed were the effects of monetary shocks and financial shock, effectiveness of the monetary policy, and what may happen if there is no financial policy. In respect to monetary shocks and financial shocks, monetary shocks take longer to work through the economy; the effects of financial shocks climb faster and burn out even quicker. In regard to how effective the monetary policy is; monetary policy dampens the effects of a financial shock. They have done studies where over the course of two years, a financial shock is 50% lager without a monetary policy. And lastly, what may happen if there is no financial policy is that the Fed fund rate may start increasing beyond there predictions. Which means they won’t be able to handle any kind of wiggle room with an increase in EBP.( excess bond premium ).This is all really well summed up in the article and does no beating around the bush. IT is easy to understand and wrap your mind around.
In this article, “Financial and Monetary Conditions in the Economy” by Aaron Hartfield speaks about three major points that are important in the economy. First point is that economists have found that financial shocks have a greater impact on the BFI( Business Fixed Investment ) than monetary shocks. Monetary shocks has a greater impact on the GDP (Gross Domestic Product ). Additionally, economists determine the effect by measuring how far BFI and GDP is from the trend. Second point is trying to figure out how effective the Fed really is when it tries to counter financial conditions. Authors find that the effect from financial shocks is 50% greater and lasts 2 more years without a monetary policy in place. Monetary policy dampens the effect of the financial shock according to the authors. The third point is looking at current monetary conditions. The Feds goal for the Fed funds rate is 0.25%-0.5%, while the current effective funds rate is 0.41%. At this rate known as Zero Lower Bound (ZLB) the Fed will have little cushion to counter the effects of an increase in EBP ( no monetary policy ).
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Borrowing from central banks is this really good to do? Inflation rises, it seems like when there is a big boom in something the cost rises and then the boom stops. Interest, money, lending etc. has seemed to change severely over time as we can see how times are now. In the article it said “Federal Reserve sought to lower the interest rates, increase the money supply, extended its discount window program to central banks, and bailed out other banks in a desperate effort to flood the economy with the currency that was needed to quickly re-start the economy”. Really makes you think if this is the right way to go about things.