Subject: Term premia
From: Jude Wanniski 8:31 pm 3/31/2005
Well..... I'll grant you the term premia can cover lots of kinks in the yield curve, but you still have not found a place to put the inflation premium. You have yet to mention it, either in the Dayton speech, or in your e-mail. On the other hand, I had staff complain that the Phillips Curve runs through your speech, as if there really is a tradeoff between inflation and unemployment. I said you really had no choice, because Congress demands that you fight unemployment and inflation at the same time, when you only have the ability to deal with one or the other. Greenspan thinks the Phillips Curve is baloney, and of course as I said Milton Friedman ridiculed it in his Bloomberg interview March 9 (there is no transcript, but you can listen to it on a Bloomberg terminal if you are interested). Your job would be much easier at the Fed if the Congress would have passed legislation that has been kicking around for more than 15 years to free the Fed from having to be concerned at all with unemployment. Of course, I don't know if you really are a Phillips Curver deep down in your heart, or upstairs in your head.
It's late.... Enough for tonight. Jude
At 02:20 PM 3/31/2005, you wrote:
Thanks for the kind words.
Regarding the term structure, don't forget that the yield curve includes term premia, which include all kinds of effects --- e.g., behavior of foreign central banks, general preferences for duration, differences in risk and liquidity, hedging demands etc. Changes in term premiums are no doubt important and help explain part of the conundrum. As a logical matter, however, there is no reason even with fixed term premiums that the yield curve couldn't invert (e.g., if policy is tighter now than neutral)
or that long rates couldn't fall while short rates rise (near-term tightening is anticipated, but investors are more pessimistic about the long term or expect lower inflation in the long term.)
From: Jude Wanniski <email@example.com
To: Ben.Bernanke@* * * * *.gov
Subject: Dayton Speech 03/31/2005 02:13 PM
What a great tutorial on the nuts and bolts of the Fed!!! The assistant you credit for helping you with it should get a pat on the back... It is the best I've ever seen and I plan to use it as a lesson in my Supply Side University (at some point). The current semester is on fiscal policy.
Since you are such an important guy, we are planning a client letter for tomorrow, "Ben Bernanke's Yield Curve," or something like that. Paul Hoffmeister read the speech as soon as it was posted. (He checks every day.)
Our first take is that your yield curve is too mathematical, insufficiently behavioral. That's generally our criticism of all "neo-classical" academic economics. That is, if the yield curve can be sliced into short-term investments and rolled over and over until we get 10- or 30-years out, how does a yield curve invert? And why would the yield on the long-bond fall while the ff rate rises, your conundrum? And of course there are those treadmill effects, the kind Henry Wallich discussed way back when. You should spend more time thinking of why gold never backwardizes.
You'll of course get a copy hot off the presses.