Monetary Policy

Fed policy is set as it was post 1932, when output began to recover, private credit demand was in the doldrums, deflation pressures started to ease and unemployment remained near record levels. To
supply liquidity to the system, the Fed has roughly 2 Stril. of securities and is keeping short rates
at or near zero. Historical 3 mo. T-bill yield

The Fed defends the policy in view of its dual mandate. Here, unemployment is seen as still too high
while there is deflation risk rather than serious inflation risk. Just like the 1930s.

Today, the Fed extended its ZIRP projection to the latter part of 2014. In also buying longer dated
Treasuries and mortgage backed securities, the Fed is trying to maintain housing affordability at
an attractive level and allow homeowners to refinance at historic low mortgage rates. The program
has been stymied by reluctance of lenders to make mortgage commitments that are not gilt edged,
and by a new real estate loan philosophy which emphasizes collateral value rather cash flow
servicing capability. So, just as the mortgage industry was stupidly aggressive in lending over
2003 - 2007, it is now stupidly tight in lending. The way of course to enhance collateral value
in housing is to loosen overly conservative lending standards and allow rising demand to nudge
house prices up and out of the doldrums. In a similar vein, with unemployment still very high,
borrowers are more conservative as well. The Fed is now anticipating a lengthy period will be
required to move the US out of the realestate morass.

By contrast, the post WW 2 indicators that have governed interest rate policy are about 80%
in favor of raising rates, with only the capacity utilization % running a little shy of the red zone.

ZIRP punishes savers, but is a windfall for those who refinance their mortgages. Unfortunately,
even refinance demand has been weakening in recent years, and in acknowledgement, the Fed
will keep the window around longer in the hope the market will loosen up.