Loose monetary policy

[rodra333]

I have read on schweser that a loose monetary policy, will result in a small reduction in real interest and a large increase in inflation expectation which will raise interest rates and reduce bond prices.

My question, I have always think that a loose monetary policy will lower interest rates.

I completely agree with what I read on schweser. To have a solid concept on it my question is that the FED actions to either loose or tight monetary policy affect nominal or real interest rates?

Thanks in advance.

[GothamSenator]

My understanding is that monetary policy typically impacts the short end of the yield curve while fiscal policy impacts the long end. This makes sense as central banks historically controlled the (we won’t expand on current unconventional methods) controls short term rates and governmental fiscal policies impact longer term growth expectations which in turn impact the long end of the curve. Best policy and curve discussion I found out there is quoted below. Here’s the link: http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/9992884

@null_nuller

i have a very simple way I use to re-create the 4 yield curve shapes in a 10 seconds anytime I want. I have used it dozens of times in meetings - with bond traders (who should know better), economists, fund managers - works a treat every time. if you take just 5 minutes to do this exercise a dozen times I guarantee you will remember it forever and be able to re-create it in literally 10 seconds anywhere you want - guaranteed to impress. Just think: “FINS”. FINS stands for Flat, Inverted, Normal, Steep. 1. draw a big plus sign (I mean BIG - take half the page or half the white board) - like the 4 FINS on a wheel or the fins on a propellor - or the 4 FINS on a BMW logo (which is actually a propellor because BMW first started making prop engines for planes in the war). This gives you the 4 quadrants of your matrix 2. in the 4 quadrants - starting from top left going clockwise - write the letters F I N S. (ie “F” in the top left, “I” in the top right, “N” in the bottom right, “S” in the bottom left) This whole thing is a giant wheel that goes clockwise around the economic cycles, so always think clockwise - always starting top left corner. (if you have an audience don’t actually write F-I-N-S - skip to step 3) 3. in the 4 quadrants - starting from top left going clockwise - draw the 4 curves - F-I-N-S - ie: Flat, Inverted, Normal, Steep. That puts your 4 yield curves in the 4 quadrants. 4. Now you have to specify Fiscal/Monetary and Loose/Tight. “F” comes before “M” in the alphabet, so write “Fiscal” on top of the page (above the Flat & Inverted curves, above the vertical Fin). Then write “Monetary” on the left side (left of the Steep & Flat curves, left of the horizontal Fin) 5. Now for the Loose/Tight bit. “L” comes before “T” in the alphabet, so just below Fiscal, write Loose and tight starting left to right - so write “Loose” above the Flat curve, and write “Tight” above the Ïnverted curve. 6. For Loose/tight on the Monetary side - always remember you are going clockwise around this circle, so you write Loose and Tight on the 2 curves on the left side as you as you go clockwise around them - ie “Loose” to the left of the Steep curve, and “Tight” to the left of the Flat curve as you move up around to 12 o’clock. That’s it - you now have the 4 quadrants (4 fins of the propellor), the 4 yield curves, and the correct labels for Fiscal & Monetary, Loose & TIght for both fiscal & monetary. This literally takes 2 seconds per step - after you’ve practiced a dozen times you will do it in 10 seconds flat - on any whiteboard, any meeting, anywhere. eg in the Boston practice exam q.38 in PM section) You can then go around the clock and write in at exactly what month/quarter each cycle turned in your country. You can get cute by making each yield curve into an arrow (always pointing left to right). So the shape of the yield curve is a predictor of economic growth in the future. It is also a predictor of stock markets because both yield curve and stock markets are leading indicators of economic growth. (Tip - in meetings don’t actually draw the arrow on each yield curve - just imagine it’s there - so you sound wise when using the curve as a pointer to future ec growth trends & stock market trends) Eg in the US, the curve flipped to Inverse in June 06 (30y Treasuries fell below the FF rate of 5.25), meaning the arrow was pointing down to the right (down into the future), so from mid 06 to late 07 the economy was booming, but the curve was pointing to negative ec growth (recession) in the future beyond the current phase. The contraction then started at 3 o’clock - on cue. Then in Dec 07 the US curved fllipped to Normal (FF at 4.25 dropped below 30y treas) - pointing to slow/moderate growth in the future (while the ec headed into recession - the yield curve looks beyond that) Then in early 09 the curved headed into Steep territory (eg now 30y treasuries have jumped form under 3% in Dec 08 to 4.5% now, while the FF is still 0%). So now with a Steep yield curve - the arrow is pointing to rapid ec growth ahead. - produced by super low rates at the short end (super loose monetary policy), and reflected by rising yields at the long end (super loose fiscal policy) The cycle doesn’t move around the clock at a constant speed - sometimes it moves quickly around to the next quadrant, other times it stays there for years becore moving to the next. btw - my FINS matrix looks slightly different from the matrix on p. 69 vol 3 of cfa text - they have the relationships correct but they put them in a different order - their’s doesn’t move around clockwise around a clock - mine does. OK so how does this all work - if you want to check the logic. There are 2 ends of the yield curve: the short and the long. The short end primarily reflects monetary policy, and the long primarily reflects fiscal (and the longer term impacts of monetary polciy. - If monetary policy is loose (cash rates low), the short end is low - If monetary policy is tight (cash rates high), the short end is high. - if Fiscal policy is loose (govt deficits, low tax receipts, high welfare), the long end is high with inflationary expecations in the future - if FIscal policy is tight (govt surpluses, high tax receipts, low welfare), the long end is low (low inflation) - Contraction starts at around 3 o’clock - Expansion starts at around 9 o’clock - you can also go around the clock and highlight when bond markets are expected to rise or fall and when stock markets are expected to rise and fall. For bond markets - this is easy - just the movement of the long end. Bond markets rise when the long end is falling. THey get killed when the long end rises. Use the cycle to shift duration along the curve on the basis of how the cycle is changing around the clock For stock markets - the yield curve and stock markets are both leading indicators of the real economy, so the direction of the arrow on the yield curve is a good pointer to stock market direction in the future. It’s a blunt (non-exact) instrument of course, but it’s a good guide to the big picture trends. You can check these out on your FINS matrix in your country to make sure. That’s it - you can re-create the matrix in 10 seconds flat - and you can use it to assess fiscal & monetary policy, predict the direction of the economy, predict the big picture direction of bond and stock markets, and point to when the curve changed in your country and why. spend 5 minutes learning it now and you will remember it forever. Just practice drawing 4 boxes with F-I-N-S in the boxes then put the M,F,L,T labels in the right places. You can scribble it anywhere for practice in a few spare seconds. Hope it comes up on the exam like it did on the Boston exam… cheers…

More related and unrelated helpful content here => http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91345342

[onlysimon]

i find the concept easy to understand, and I think rote memorisation is not needed.

to inject liquidity, the central bank will buy bonds and use printed money to pay for them. this drives up demand for bonds, therefore prices, and therefore reduces yields.

intervention is usually at the short end.

at the long end the printed money worries investors and a premium is demanded for the reduced real TVM. so prices drop, yields rise.

more interesting is the interation of taxation (fiscal policy) and international effects, capital controls etc - this will be tested. I doubt there will be any pure monetary questions, schweser is feeding you candy bars.

[rodra333]

Thakns everyone! It did help a lot! Totally worth it getting into the FINS example.

[PierreCFA]

@rodra333

I have read on schweser that a loose monetary policy, will result in a small reduction in real interest and a large increase in inflation expectation which will raise interest rates and reduce bond prices.

My question, I have always think that a loose monetary policy will lower interest rates.

I completely agree with what I read on schweser. To have a solid concept on it my question is that the FED actions to either loose or tight monetary policy affect nominal or real interest rates?

Thanks in advance.

I have the same question, but I can’t find the answer in this topic nor the in the repply of GothamSenator. I don’t know if rodra333 he had the answer.

I resume the question of rodra333.

Suppose we are under expansionary monetary policy, the central bank injects money into the economy. The evident consequence is : the expectation of inflation rate increases. Now, If the monetary policy affects only the real short term interest rate, the nominal short term interest rate may increase (because of increase of inflation). If the monetary policy affects the nominal short term interest rate, both real and nominal short term interest rate will decreases.

The question is: loose monetary policy affects only the real interest rate or it affects either nominal and real interest rates?

[curiouscat]

Did you guys figure this out. I feel like this has to do with the fact that in macroeconomic textbooks they are talking about long-term and short-term implications of the monetary and fiscal policies separately (sticky prices in the short-term, and fixed output in the long-term). However the CFA does not make such distinction which creates hell of a confusion for me personally. Persistently loose fiscal and monetary policies shall result in high inflation and high real rates - which what I expect to happen IN US for more than five years now.