Eugene Fama Believes The Fed Is Not Responsible For Near Zero Short Term Interest Rates

Update As Of 12/14/2013

Meanwhile, Prof. Eugene Fama gave a second interview to a leading German language newspaper. On 12/7/2013 appeared an interview with him in the Frankfurter Allgemeine Zeitung titled “‘Der Markt ist rational, das glaube ich immer noch’”. In the meantime (12/18/2013), a member of the editorial staff of the FAZ has confirmed to me that there is no English version of it and that the content of the interview is as accurate as reasonably possible.

Again Prof. Fama denied that the extreme low interest rate policies of central banks had anything to do with the recent real estate bubble or financial crisis or sovereign debt crisis. Central banks could not prevent the current low level of interest rates nor do they have any significant influence on it in his words referring to the same research paper of his as before (see below).

Update  As Of 11/12/2013

Meanwhile, I have inquired with the editorial staff of the Neue Zuercher Zeitung and was assured that the wording of the interview with Prof. Fama is as accurate as reasonably possible. An English version of the interview is unfortunately not available.

Thus, I would have to research whether Prof. Fama in the past has voiced any similar notions previously.

Eugene Fama

He won this year’s Nobel Prize in economics. I am not very familiar with Fama’s work or with other interviews or papers with or by him.

Interview With The Neue Zuercher Zeitung

Just read his interview with the leading Swiss newspaper NZZ dated 11/9/2013.

Here is the relevant excerpt from his interview:

“[Question:]Angesichts der Tatsache, dass das Wirtschaftswachstum in den USA zunimmt und sich die Arbeitslosenrate erholt, finden Sie es in Ordnung, dass die Zentralbank an ihrer Nullzinspolitik festhält?

[Answer:] Das Fed ist nicht verantwortlich dafür, dass die kurzfristigen Zinsen fast null sind. Sie hat – wenn überhaupt – im Vergleich mit den Marktkräften lediglich einen geringen Einfluss auf die Entwicklung der Zinsen, wie ich jüngst in einem Aufsatz gezeigt habe.

[Translation: Q: Do you agree that the central bank continues with its zero interest rate policy? A: The Fed is not responsible that the short term interest rates are almost zero. The Fed has, if at all, only limited influence on the development of interest rates compared to market forces as I have demonstrated in a recent paper.]”

Prof. Fama’s answer dropped my jaw a bit as I am a former economist myself.

Counterfactual: What would happen if the Fed decided this week to raise the Federal Funds rate by 2 percentage points effectively immediately. Would Mr. Fama then argue that given the current market forces short term interest rates would stay low for a significant period and not follow?

Fama’s Research Paper In Support Of His Assertion

The full text is available here: http://raps.oxfordjournals.org/content/early/2013/08/02/rapstu.rat007.full.pdf. He specifically referred to this paper in defense of his answer above.

I did not take the time to read the full paper titled “Does the Fed Control Interest Rates?” as it is 20 pages long and filled with lots of dazzling econometric work, which I do not claim to fully understand.

Fama comes to the conclusion e.g. “This suggests that there is lots of variation in open market rates beyond Fed control.” (emphasis added) I grant him that immediately. Of course there is lots of such variation. This triviality has been known for decades if not longer. Actually, this is the usual outcome of any econometric study of real world time series data of economic relevance.

Not enough, he also concludes:

“The estimates of regression (1) in Table 2 show that open market rates have little or no tendency to move toward TF on a day-to-day basis. This is clear evidence that the day-to-day variation in open market rates has little to do with the Fed’s target rate. This result is also consistent with the stronger hypothesis that the Fed has little control of open market rates.” (emphasis added). Here Prof. Fama is stressing another triviality that occurs indeed on a day-to-day basis.

In his paper, Prof. Fama also suggests “Thus, judging the power of the Fed over rates largely depends on determining the extent to which changes in TF are due to active attempts by the Fed to control rates versus passive adjustment to market forces.” (emphasis added). I agree, there probably were periods during which the central bank responded in a more passive way, but that does not mean the Fed has no or only little control over short term interest rates.

He completely misses the point. Government run central banks do not try to control short term interest rates on a day to day basis, but as we have now so painfully learnt they keep short term interest rates ultra low for many months if not years to fuel speculation and profligate, reckless government expenditures and deficits.

Previous, Related Blog Posts

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