Don Kohn says Fed policy has kept rates down 100 basis points

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I received a high-quality note from Marc Chandler, Chief Currency Strategist at Brown Brothers Harriman, which I think worthy of posting.  He makes several points which are game changers regarding fiscal and monetary policy.  They are:

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  1. Don Kohn, an influential Fed official, thinks that the Fed has kept long-term interest rates down in the United States, despite the recent explosion in long-term rates. This has added $1 trillion to GDP in his view.
  2. Kohn also thinks that a zero nominal rate makes fiscal stimulus doubly impactful.  Translation: all of the fiscal stimulus which is in the pipeline will have a meaningful impact in buoying growth in 2009 and 2010.
  3. Sweden and Norway have gone QE.  This means that pretty much every major Western central bank and the Japanese are taking unconventional measures.  The list includes Japan, the U.S., the U.K., Switzerland, and the Eurozone.  I think this argues for global reflation.  Obviously, if we do not see recovery, it will not because monetary policy was restrictive.

I see that commodities are generally trading down today.  However, I see these reflation points as supportive of commodities and particularly gold and silver. Below are Chandler’s comments.

This past Saturday the Fed’s Vice Chairman Donald Kohn spoke on a panel at Princeton University. Kohn is also the most experienced person on the FOMC and he also headed up the working committee to help improve the FOMC communication. What he says is particularly important.

He claimed that the Fed’s purchases of Treasury and GSE securities may have helped hold down long term rates as much as 100 bp and could boost nominal GDP by $1 trillion. Given that the FOMC minutes of the April meeting indicated that the door to increased purchases was open, depending on financial and economic conditions. Because Kohn’s evaluation of the purchases was favorable, this would seem to underscore possibility that the Fed increases the purchases of long-term assets–and this is particularly relevant for Treasuries as the Fed’s purchase program was to expire Aug/Sept while purchases of GSE assets run until the end of the year.

The other note of interest from Kohn involved the multiplier of fiscal stimulus. Kohn suggested that the multiplier impact could be higher with federal funds near zero than in more normal times. Kohn suggested the multiplier could be as a high as 2x rather than 1x assuming that the stimulus is perceived to be temporary.

Lastly note that it is not just the Fed that may have to step up what Kohn called LSAP (large scale asset purchase program). We suspect that by the end of the summer the BOE may request authority to buy more gilts.

In the last 48 hours, officials in Sweden and Norway have opened the door to unconventional measures as well if the economic situation worsens. Norway in particular noted that inflation may undershoot its target and the Norwegian banks need to boost capital. We wonder if Norway would not find itself in a similar position as Switzerland, with too small of a domestic bond market to pursue the king of quantitative easing (buying government bonds) that the US, UK and Japan are engaged in and be forced to buy foreign bonds.

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