Tag Archives: quantitative easing

(Revised 1) Rising Interest Rates and Stock Market

The S&P 500 set an all time record as of yesterday, Janurary 14th, reaching a high of 1848.38 barely beating the previous high by .02 from Dec 31st. (http://online.wsj.com/news/articles/SB10001424052702304419104579322302381985992?mod=WSJ_Markets_LEFTTopStories&mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702304419104579322302381985992.html%3Fmod%3DWSJ_Markets_LEFTTopStories) Both other key performance indicators, the Dow Jones Industrial Average and the Nasdaq Composite Index were also on the up and up. The market has finally rebounded to pre-recession levels, and the S&P grew almost 30% in 2013 alone. Of the biggest winners in the market were the tech companies, including Apple.

Although the stock market is in such great shape, some still worry that an artificial bubble has been created from the Feds quantitative easing strategy. The Fed has announced that they plan plan on backing off the quantitative easing strategy and allowing interest rates to rise. With the Fed ending its quantitative easing strategy will the stock markets artificial bubble come to an end?

A little background on the Feds strategy and how it effects the stock market. After the great recession of 2009 the government looked for ways to stimulate the economy. The Fed came out with the strategy of quantitative reasoning, where they would buy up bonds and keep the interest rates artificially low, targeting about 1 point above the federal funds rate. With low interest rates and more money circulating, consumers were able to spend more, hence stimulating the economy. The stock market grows in two ways from the low interest rates. With interest rates rising, it is speculated that people may avoid making bigger purchases which could end the “artificial” bubble the FED has created.

The first reason the stock market grows with low interest rate, is it is viewed as more favorable than federal bonds. As stocks are more favorable than bonds, the demand grows and the prices continue to increase. The other reason stock prices soar is because of market speculation. When analysts see low interest rates they speculate that the consumers will spend more on big ticket items, and take out loans to finance these purchases. This means that the predictions from the analysts will be more favorable, which in turn will boost the stock market.

An article from CNN Money on the rising rates (http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2013/05/24/will-rising-interest-rates-hurt-the-stock-market) argues that the rising interest rates will not have a negative effect on the market. A study conducted by JP Morgan showed that over the past 50 years 10-yr treasury bonds actually have a positive correlation with the S&P 500. They speculated the reason to be the FED works to relieve the economy in hard times by lowering interest rates. Although raising interest rates mean less big purchase spending, it also signals that the economy has recovered. Analyst see this as a good sign and the market continues to grow. Although the interest rates are at an all time low, as the rise it is unlikely that we have any major market meltdown.

In my personal opinion, I believe that the Analysts will way both the quantitive easing and the stronger economy when betting on the market. I believe that they will be a little more hesitant as interest rates will begin to rise, however I think they will bet bigger on the rebounded economy. I wouldn’t be surprised if long term the market continues to grow, but at a slower rate than we have witnessed in recent months.

European Central Bank: Further Easing Needed

The European Central Bank announced that it will open to further easing in order to stimulate the economy. Euro weakens after central bank officials discussed possibility of asset purchases. At the same time, the rest of the world, for example the U.S. and China, are winding down their growth rate. According to Wall Street Journal, President Mario Draghi‘s revelation that the central bank had discussed negative interest rates and large-scale bond purchases — if needed to keep persistently low inflation from undermining growth — caught financial markets by surprise.

[Mr. Draghi said officials had discussed asset purchases, known as quantitative easing, as well as setting a negative rate on bank deposits parked at the ECB—moves that could help bolster the economic recovery and push up prices. The annual inflation rate in the euro zone is just 0.5%, far below the bank’s target of just under 2%.]

At the beginning of this semester, we learnt that the negative interest rates will encourage people to spend more which leads to an increase in aggregate demand; however, this may discourage you from saving your money – the more you save the more you would lose. Theoretically, people have less incentive to save and therefore banks have no reserves for lending loans.

A negative interest rate (though it is currently zero) would also force financial institutions to pay to park their excess funds at the ECB, leading them to lend more to the private sectors. However, in my opinion, quantitative easing is more complicated in the euro zone than in the U.S., where the Federal Reserve has deployed the policy and continues to do so. This is because on the one hand, like states in the US, countries in Eurozone have no exchange-rate tool, no separate monetary policies; however, on the other hand, unlike US states, labor is less mobile across countries and wages are less flexible due to social policies, and there is no mechanism for fiscal transfers among countries. The U.S. borrows more from the capital markets and therefore could filter quickly to its economy.

The good news is that euro zone has a low inflation rate. The long-term interest rates therefore remain quite fixed which provides a relatively stable environment for households and business to spend and invest. However, if the interest rates are too low, countries may face some risks, for example, Japan has struggled with deflation for two decades. In order to control the risk, both ECB and Fed aim to keep inflation rate at around 2%.

 

 

 

Can QE* Be an Effective Long Term Policy? Yes, and Here’s How (Part 2)

The research conducted by Joshua K. Hausman (University of Michigan) and Johannes F. Wieland (University of California, San Diego) examines the success Abenomics has had in boosting Japanese GDP and gives insight into how such unconventional monetary policy can sustain amplified GDP growth in the long term.

Named after Japanese Prime Minister Shinzo Abe, ‘Abenomics’ is the name used to refer to Japan’s current three-pronged economic stimulus policy, which consists of a combination of monetary policy expansion, fiscal stimulus, and structural reform. It is the only real and current example of long-term unconventional monetary policy, and is thus viewed by economists as an important test of the policy’s validity.

So far, Abenomics has stood up to the challenge. The Japanese stock market has risen, the exchange rate has depreciated, and Japan’s GDP has jumped by up to 1.7%. Hausman and Weiland claim that one percent of this GDP growth has been directly caused by the monetary policy shift. Furthermore, Abenomics’ effect on the Japanese money supply has been much more effective than that of previous QE policies. The below graphic from the Economist article provides a nice summary of the effects of Abenomics:

unconventional MP_2

Hausman and Weiland attribute the superior effectiveness of Abenomics to the change in inflation expectations it has caused. Japan has set a new 2 percent inflation target and because Abenomics was announced to the public as a permanent change in policy rather than a temporary measure to boost GDP, inflation expectations increased for both the short and long terms. Both short and long-term borrowing appeared cheaper as a result. This, in turn, caused borrowing to increase across the board, stimulating increased consumer spending.

One should not go all-in on Abenomics quite yet, though. Both the article and research paper emphasize that Abenomics is still in its initial stages and has yet to prove itself as an effective catalyst for long term growth. When discussing the long-run outlook of Abenomics, Haussman and Weiland assert:

The research shows that the Bank of Japan is achieving its intermediate objective of higher expected inflation, but that the inflation target itself ‘remains imperfectly credible,’ with long-run inflation expectations below 1.5 percent.  Thus the modest estimates of Abenomics’ effects reflect in part that the Bank of Japan has not yet fully convinced the public that inflation will be two percent.

If the Bank of Japan could somehow more strongly convince the public of a future two percent inflation rate (perhaps through a public announcement reinforcing its intention to pursue the policies of Abenomics), the effects could be substantial. Hausman and Weiland estimate that “the output effects of Abenomics could as much double if inflation expectations rose to the 2 percent level.

In summary, based on the results presented by Gabriel Chodorow-Reich about the positive effects of QE on financial stability, and Hausman and Weiland’s estimates of past and future Japanese output growth as a result of Abenomics, I am convinced that unconventional monetary policy can be used effectively in the long term. If the Fed can convince the public that inflation will be steady at two percent and interest rates will remain low, whilst continuing to purchase assets and pursuing fiscal stimulus, it can achieve both strong economic growth and increased financial stability.

Can QE* Be an Effective Long Term Policy? Yes, and Here’s How (Part 1)

The Fed’s decision to implement quantitative easing and other unconventional monetary policy in December 2008 sparked a blaze of heated discussion amongst economists that has been burning to this day. The questions of if and how these new measures affect economic growth have become the focus of countless blog posts and editorials, and have become an integral part of many university Econ courses. The beginning of QE tapering in December 2013 added even more fuel to the fire, but it also gave many traditional economists a sense of relief. It finally looked like there was an end in sight to these unfamiliar and controversial policies. To the dismay of these traditionalists, however, recent research by the Brookings Institution (paper #1 and paper #2) suggests that there are significant benefits of pursuing unconventional monetary policy in the long term. A recent Economist article, “Staying Unconventional,” emphasizes some of the most important results of this research and raises a provocative question: Can QE, or some alternate form of it, be an effective long term policy?

Based on my reading of the research papers that the article cites, I am inclined to say yes. It may not be the QE policy currently being rolled back, but I can see an alternate form of such a policy being effective in the long term (hence the * in the title). Not only does unconventional monetary policy not cause riskier financial behavior, but it also provides a substantial boost to economic growth. In this blog post and the next one, my goal is to defend the bolded argument by highlighting some of the key findings of the research papers I mentioned earlier. The remainder of this post will be dedicated to discussing the first claim:

1.    Unconventional Monetary Policy Does NOT Cause Financial Instability

The argument commonly used to refute long-term implementation of QE is that it encourages individuals and financial institutions to pursue riskier investments, thereby reducing financial stability. The prediction is that long periods of low interest rates incentivize investors to ‘reach for yield’ and take on more credit risk, duration risk, or leverage. The research by Gabriel Chodorow-Reich of Harvard University confirms this prediction but emphasizes that the story is not so cut and dry. Although the Fed’s low interest rate policy has caused financial institutions to take on some riskier investments, it has also boosted the value of these institutions’ portfolios, making them less risky and strengthening the stability of the U.S. economy. Most importantly, Chodorow-Reich’s analysis shows that the stabilizing effect of QE has been stronger than the destabilizing effect caused by ‘reaching for yield.’

Chodrow-Reich determined the magnitude of each effect by evaluating the effect of the Fed’s policies on four categories of financial institutions: life insurers, commercial banks, money market funds, and defined benefit pension funds. Together, these institutions manage $24 trillion in assets. The effects are nicely summarized in the graphic provided in the abstract of the paper:

unconventional MP_1

As Chodrow-Reich states, “In the present environment, there does not seem to be a trade-off between expansionary [monetary] policy and the health or stability of the financial institutions studied.”

Yellen Attempts to Control Expectations

Interest rates rose following the March Federal Open Market Committee (FOMC) meeting in which the Fed eliminated the quantitate thresholds for unemployment and inflation from forward guidance. Without these thresholds, financial markets were left in perplexing uncertainty regarding the timing of interest rate hikes. Particularly, markets speculated as to when rates would rise once the Fed completed tapering its asset purchases. Although the FOMC statement provided an extremely vague time period, Yellen seemed to define the time period to be precisely six months in the post-FOMC press conference.

Unfortunately, financial markets misinterpreted Yellen’s words to be more exact than she intended. Prior to the March FOMC meeting, expectations for a first rate hike were in late 2015 or early 2016. According to the Wall Street Journal, “Some investors had taken Ms. Yellen’s remarks at a news conference after that [FOMC] meeting to mean rate increases might come sooner than they expected”. After the March FOMC meeting, yields on the two-year and five-year treasury adjusted to price in a rate hike around mid-2015 (i.e. about 6 months following the projected conclusion of the Fed’s tapering).

fredgraph2yrTreasuries fredgraph5yrtreasuries

As seen above, the two-year treasury yields had their largest single-day move since 2011 and the five-year treasury yields had their largest single-day move since September 2013 and rose the most since June 2013. The two-year and five-year treasury yields rose to reflect changes in expectations about the future.

In a speech on Monday, Yellen attempted to diminish these expectations to stop yields from moving higher. Yellen offered five reasons why she still sees slack in the economy. First, the number of involuntary part-time workers remains elevated. Second, statistics on job turnover is very low. According to the Wall Street Journal, “[Low job turnover] is an indicator that people are reluctant to risk leaving their jobs because they worry that it will be hard to find another”. Third, wage growth since the financial crisis has been low by historical standards. Fourth, a significant portion of the unemployed has been out of work for six months ore more. According to the Wall Street Journal, “The concern is that the long-term unemployed may remain on the sidelines, ultimately dropping out of the workforce”. Fifth, the proportion of working-age adults that hold or are seeking jobs (participation rate) has continued declining since the recession and throughout the recovery. Yellen believes these signs of slack in the economy give the Fed room to keep interest rates low.

Yellen also attempted to reshape the perspective on tapering. According to the Wall Street Journal, “She emphasized that the Fed’s recent decisions to reduce the size of its bond-buying program, meant to keep long-term interest rates low to spur growth, shouldn’t be viewed as a withdrawal of support of the economy. Rather, she said the Fed is adding support at a lower pace”. Although some might view the tapering of asset purchases as a withdrawal of stimulus, Yellen prefers the perspective that it is only a decrease in the rate by which stimulus is growing. Furthermore, monthly asset purchases themselves do not stimulate the economy. Instead, the size and duration of the Fed’s balance sheet (i.e. balance sheet monetary policy), which the Fed will maintain even after it stops expanding, will continue to stimulate the economy. As a result, financial markets should not be concerned that the Fed’s tapering is representative of tightening monetary policy.

Despite Yellen’s dovish message, treasury yields have not fallen to their pre-FOMC meeting level. I am not surprised by this because treasury yields were quite low before and are now adequately pricing interest rate risk. Although interest rates might not rise in early 2015, I think rates will start rising by late 2015 and this is reflected in the current level of the two-year and five-year treasury yield.

Indonesian Central Bank’s Response to the Fed’s Taper in 2013

When the Fed for the first time announced to begin scaling back its quantitative easing in summer 2013, emerging economies underwent a sudden massive capital outflow, resulting in depreciation of their currencies. The graph below pictures how Indonesian rupiah, one of the five emerging economies’ currencies in 2013 so-called the fragile five, had behaved right after the beginning of tapering off issues until the end of the year.

imagerpand waterIf we use short run international finance diagram, this capital outflow is represented by the shifted-to-the-right NCO curve. People started to get rid of Indonesian assets and went back to the U.S. assets in the hope that interest rate in the U.S. will increase. This situation is described clearly by the data. Indonesian rupiah depreciated significantly against the U.S. started in May 2013.

In the case like this, at least there are two measures that can be adopted to reduce the volatility and to ensure that the currency not to slump down persistently: increasing domestic interest rate and sterilized sales of foreign (U.S.) assets.

First, the central bank might increase interest rate to deter foreign investors from pulling out their money from the country and attracting others to bring their money in. During the year of 2013, the central bank gradually increased its benchmark interest rate five times: on June 13 by 25 bps (basis points) to 6 percent, July 11 by 50 bps to 6.5 percent, August 29 by 50 bps to 7 percent, September 12 by 25 bps to 7.25 percent, and November 12 by 25 bps to 7.5 percent. As can be seen from the graph above, the interest rate tied closely to the exchange rate pattern, the more the currency depreciates the more the central bank will increase its interest rate.

Second, since the initial problem of this volatility is because NCO curve shifted out, then it requires that we bring back the curve in by sterilized sales of U.S. assets and buy domestic bonds.  If it does work, the currency will start to appreciate. It is hard though to find such data in order to verify whether the central bank had done this option. Thus we will just look at the data on the official reserves and look at to the pattern.

image

As can be seen, Indonesian official reserves had been depleting in around May 2013 and hit the lowest point on July 1, 2013 at 92,671.06 million dollars. If we look at the graph deeper, this pattern seems to confirm that around these months, the central bank used the reserves to intervene rupiah in the market for a while and then abandoning this measure and starting to pile up reserves again.

I believe that Indonesian central bank used both interest rate increase and intervention in the market to response to the Fed stimulus reduction last year though the efficacy of this policy is in question since rupiah often regarded as one of the worst performing currencies in the region in 2013. I reach to the conclusion that the central bank had intervened in the market since a high official in the office had also confirmed that they were ready to take that measure in case of needed to smooth the volatility rather than to strengthen the currency.

Fed fails to indicate what labor market signal will be

The Fed announced today that it will continue its tapering program, reducing purchases of long-term Treasury bonds from $35 billion per month to $20 billion per month, and cut back on its mortgage-backed securities purchases by $5 billion as well, to $25 billion. These results came as expected, with the $10 billion monthly decrease continuing each month. The bigger news was the Fed’s announcement on whether it will start to bring rates back up as the targeted 6.5% unemployment rate is due to be met in the upcoming weeks.

On Wednesday, the Wall Street Journal reported that “the Fed dropped the reference to the 6.5% jobless rate, which officials have come to see as too limited an indicator of the labor market’s health.” The proclamation of being “too limited an indicator” tells true, as unemployment rates have sunk in some part due to discouraged workers dropping out of the work force entirely after failing to find employment. However, the Fed offered little insight on what they believed better labor market indicators to be, or when they will determine that the economy has shown enough recovery. The stock market fell after the news, on the idea that rates may be rising sooner than previously expected.

The majority of Fed officials on Wednesday predicted that rates will begin to increase within the year, with 10 of 16 expecting increases to begin in 2015. The real news of the day was the ambiguity that the Fed left in its wake. Will a 6% unemployment rate be enough to spark a rate increase, or is the unemployment rate now discredited by the Fed as a worthy indicator? What should Americans expect moving forward, and when will the recession really end? According to Fed Chairwoman Janet Yellen, a multitude of factors will tell her when the time is right.

“Ms. Yellen said her dashboard for monitoring economic progress would include
the share of workers who have been unemployed for six months or more, the share
of adults who are holding or seeking jobs and the portion of workers who hold
part-time jobs but say they would rather have full-time occupations.” – WSJ

So while the news coming out of the meetings leaves more to be desired in terms of understanding the actual state of the economy and strength of the labor market, expectations can be made moving forward. All indicators show that the tapering process will continue as planned, $10 billion less bond purchases happening each month, and depressed rates while inflation sits below its targeted level. While the new measure for the state of the labor market certainly is more indicative of its actual all-around health, the Fed left much doubt for when it will finally be ready for a rate increase.

February Employment Report: Implications for Monetary Policy

During her inaugural public appearance since becoming chairwoman, Janet Yellen confirmed that her intention is to continue the policies of her predecessor Ben Bernanke. As the economy improves, Yellen intends to slowly wind down the large-scale asset purchases – also referred to as quantitative easing (QE). I believe the February employment report provides data to confirm this plan, however, constructing forward guidance will still be a challenge.

The February employment report was released on Friday, March 7th and showed positive signs about the economic recovery. According to the Wall Street Journal, “Nonfarm payrolls grew by a seasonally adjusted 175,000 in February, the Labor Department said Friday, following a two month stretch of weaker growth. The unemployment rate ticked up to 6.7%, in part because more people joined the workforce”. Although the unemployment rate increased, it increased for all the right reasons. In this case, the rise in the unemployment rate reflects a rise in the labor force participation rate – a sign that conditions are improving in the labor market. As sentiment about the labor market improves, people are choosing to return to the labor force and pursue jobs. In addition, the increase 175,000 jobs added beat expectations and was more than the previous month – indicating that adverse weather likely depressed previous employment reports this winter. I speculate that the strong February employment report will encourage the Federal Reserve (Fed) to continue tapering.

I believe the Fed might find this an opportune time to adjust forward guidance, but I am not sure how they will do it. According to the Wall Street Journal, “A more vexing challenge for the Fed will be fine-tuning its official policy statement, which is loaded with assurances of low-interest rates in the future”. With the exception of the February employment report, the unemployment rate has been falling consistently. The Fed has already stated that it intends to keep rates low even after the unemployment rate falls below the 6.5% threshold. As I have mentioned before, the Fed might want to consider nominal gross domestic product (GDP) targeting.

However, I do not expect the Fed to announce nominal GDP targeting because it would be too much of a surprise. The Fed’s dual mandate includes unemployment and inflation, which means these two indicators will remain important (perhaps this can be legally changed one day). According to the Wall Street Journal, “[Janet Yellen] and other top officials have suggested a new statement could emphasize the Fed’s interest in a broad array of indicators, rather than a single unemployment indicator”.  Although I do not know what array of indicators they will choose, I believe this is a good first step. I think it would make sense for Yellen to choose a large selection of indicators that provide a sense of financial stability. Financial stability should be an explicit factor for interest rate decisions. Regardless of what indicators Yellen mentions, I am sure she will state that interest rates will stay low for awhile.

Although the economic recovery has been disappointingly slow, the economic outlook is undeniably improving as confirmed by the February employment report. Reducing asset purchases to $55 billion per month should be a clear decision, however, adjusting forward guidance poses more issues.

Time to start saving again?

As all Economics 411 students should know by now, quantitative easing – or balance sheet monetary policy – won’t come back to haunt us in any scenario until the economy starts to heat back up. In that case, only by the Fed missing the signs of an economic rebound and failing to act would the U.S. economy be at risk of overheating. Professor Kimball defends this aspect of QE in many of his posts, but here is one that describes this scenario in more detail than I will go into on this post. In today’s Fed policy meeting, it became clear that some officials are already talking of dumping off assets accumulated through QE in the near future. Selling off these assets would mark an attempt to start bringing up the Federal Funds Rate and other short-term interest rates. Fed “Hawks” brought up the dangers of inflation as the tapering continues and is expected to end in Q4 of 2014.

Is it too early to talk about a boon, and of increasing rates that for years have been stuck near the zero lower bound? I don’t think so. With a strategy as new as QE, it seems that caution is much better than the alternative. And really, how far is the U.S. economy from finally ending talk of recession? As Fed chairwoman Janet Yellen has said, the jobless rate target will remain at 6.5% for the foreseeable future. But how far off is that? Recent news confirms that a strong recent push has brought America down to just a 6.6% unemployment rate. That’s exactly why planning ahead – even to something so foreign to us as inflation has been for the last few years – is imperative for the Fed, and now.

“‘We are a lot closer to a normal economy than we’ve been in a long time,’ James Bullard, president of the Federal Reserve Bank of St. Louis, said Wednesday in an interview. He sees the jobless rate hitting 6% by the end of the year, which he said could put pressure on officials to start considering rate increases.” -WSJ

While Mr. Bullard’s forecast of 6% seems to be an answer to our economic prayers, there is still a collective worry about the effects that dropping out altogether from the labor force have had. Some believe that while 6.5% sounds great, it is a long shot from the actual state of the U.S. economy at this point. And it’s only fair to assume we have a way to go, especially before the general population is convinced that the recession has passed. Most estimates have interest rates rising by late 2015 at the earliest, as inflation stands well below anything worrisome. It seems like a problem the U.S. economy won’t need to face for a while, but the inflation “Hawks” are starting to circle at the Fed.

Yellen Breaks the Ice

In her inaugural public appearance since becoming the central bank’s first chairwoman, Janet Yellen confirmed that her intention is to continue the policies of her predecessor (Ben Bernanke). According to the Wall Street Journal, “Her comments left little doubt that her plan – as was Mr. Bernanke’s – is to tiptoe away from those policies only gradually as the economy improves”. I agree that it is time to wind down the Fed’s unconventional monetary policy in which it conducts large-scale asset purchases. First, quantitative easing seems to have served its purpose of lowering long-term interest rates. Second, I still worry that we might face some undesirable consequences from quantitative easing down the road. Now that quantitative easing has fulfilled the intentions of its creators, it should be phased out sooner rather than later in order to reduce whatever unintentional effects might be looming in the future.

Although the continuation of the taper means a reduction in stimulus, financial markets responded well to the plan that Yellen outlined. Furthermore, I think financial markets were extremely pleased that Yellen appeared completely as advertised (meaning she performed as expected and without any surprises). According to the Wall Street Journal, “In two instances, she thanked lawmakers for calling her unexciting”. Yellen’s primary theme during her public appearance was predictability. Every detail of the presentation seemed to be planned perfectly. The financial markets are notably sensitive to everything, which includes what Yellen says and how she says it.

Yellen’s calm demeanor and clear rhetoric is exactly what everyone was hoping for and I think the financial markets were extremely pleased with the lack of surprises. According to the Wall Street Journal, “The markets, having anticipated a steady stance, greeted Ms. Yellen’s comments with approval”. As expected, Yellen will continue with the taper and not change the course of the Fed. Despite the two months of disappointing employment reports, the Fed will taper at the same pace ($10 billion reduction per month). Although financial markets rallied when the Fed surprisingly delayed the beginning of the taper last year, I do not believe the financial markets would handle such a surprise the same way today because tapering has already begun. Unless a significant problem develops in the economy, such a deviation from the plan set out only a month ago would signal a lack of confidence in the recovery. If the Fed was confident enough to announce the taper in December, then a departure from the taper only a month later would likely spook investors. Obviously, a major change for the worse would lead the Fed to dramatically change course. However, that event has not occurred yet and I hope it will never.

Yellen was so eloquent that she even managed to dodge the numerous questions she received regarding financial regulation. Although she did not provide any significant details, she seemed to defend and support the Dodd-Frank legislation. According to the Wall Street Journal, “[Yellen’s] comments suggest she’s likely to continue the Fed’s efforts to implement the 2010 Dodd-Frank financial overhaul in a way that places higher burdens on companies viewed as posing risks to the broader financial system. That could mean more capital and liquidity rules requiring the biggest banks to meet higher standards than smaller firms”. The implementation of Dodd-Frank has been a lengthy process with much scrutiny. On the one hand, some critics claim it is too tough and requires banks to hold too much capital. On the other hand, some critics claim it is too lenient and does not require banks to hold enough capital. In this situation, I am torn because I do not know the right amount of capital for banks to hold.

Currently, the additional amount of capital that banks are required to hold is already noticeable. For example, the return on equity for the largest financial institutions is down considerably. Although I understand that the intentions of Dodd-Frank is to avoid the next financial crisis, forcing banks to hold excess capital likely also restricts them from making loans and engaging in other activities that spur economic growth. I would imagine that Dodd-Frank will be shaped to keep American banks on the same page as European banks, which are subject to Basel III capital requirements. I think that it is in the best interest of the global economy to have similar global financial regulations. Otherwise the financial institutions of some countries will have a competitive advantage, but also be much riskier and be a potential danger to the global financial system. I look forward to how Dodd-Frank and other financial regulations are executed.