Central Bank Screw Ups in 2003

Macro and other Market Musings has an interesting article about warnings given by William White and the research team at the Bank for International Settlements (BIS). When I read an article like this, I always rev up my Universal Economic Calculator. Doing so, I move the cursor back to the time in question, 2003. and sure enough, I see the yield curve bulging up and out, like a balloon held to the ground by low, short term interest rates. The ballooning is the effect of too many stages of production being established as a result of the steepening. It is not until third quarter 2004 that the Fed gets the hint that is should slowly raise short term rates.

Then I go to my Frequently Used Charts, and enlarge the inflation chart, third from the top. And there is is, in mid 2004 the inflation rate is exceeding 3%, above the Fed target. Also when I move the cursos to July 23, 2003, I see rapid changes in the yield curve as it tries to accommodate more term points. The history trace is much wider, showing overlap in the uncertainty bounds between term points. We would see this at points of transition.

So, behold, we discover that the Fed gets information about inflation too late, the Fed rather should simply focus in the yield curve; or change the parameters of their Taylor rule.

This was not the cause of the recession, however, but simply an illustration that central banking is late to the crime scene.