Why the Fed May Have to Hike Far Higher Than Expected | Henry Peabody on the Fed’s Triple Mandate and Uneven Transmission of Monetary Policy
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Got a very important conversation today. We are speaking to Henry Peabody, senior investment strategist at GMO. Henry, welcome to Monetary Matters.
Jack, thanks so much for having me. I'm really looking forward to the conversation.
I know you've been doing a lot of thinking about the Federal Reserve. Of course, they have their two mandates for stable inflation and a stable labor market, but they also have some sort of other mandates. Tell us about how you're thinking about the Fed's third mandate.
Yeah. So we published a paper on this a little while ago, and we certainly acknowledge the two statutory mandates from the Fed, stable prices, full employment. But by virtue of transmission mechanisms, by virtue of the evolution of capital markets, as well as sort of the passage of time since we had that rate shock a handful of years ago, The Fed has a new we think of it as a mandate, though it's not an official one really, the transmission of credit across the economy. The system has become certainly less banked, and I'm breaking new ground when I say that. The evolution of private credit, an
So the real theme is that credit is easy for businesses and tight for consumers and very easy for very high quality borrowers and very tight for lower quality borrowers. And that spread always exists throughout history, of course, but it is particularly acute right now. Why is that the case?
It's particularly acute now for a handful of reasons. One, the extent to which we've had to move rates off the zero bound. Those consumers who are in need of financing on a shorter term basis are certainly more affected by this. Also there's a little bit of external factor here. I mean, you look at inflation, who's most susceptible to that? It's certainly the low end consumer. I saw a great chart the other day, and it showed the cost of a breakfast throughout time, and it was toast, it was eggs, it was bacon, and it was deflated by various cohorts of wages. And the highest echelon of wage earn
So Henry, you're you're making the point that when the Fed raises rates for banks, banks tighten credit, Whereas when the Fed raises rates, non banks, private credit lenders, they do not tighten credit. That's the point you're making.
They haven't thus far. And I think there are anecdotal stories about credit being reigned in more conservative measures being taken, and I think that's all well and good. But the point is, is in a bank system, it's a much more linear relationship. And the delay we're seeing in realizing losses, if indeed they're happening, as well as, I think an important distinction, is the visibility of marks. Those make this even more challenging. In 2008, and I don't mean to conflate this with a systemic issue like we had in 'eight, but just on the surface, you had interest rates rising, concurrent with ho
We don't have what mechanism? What do we have?
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