Friday, January 25, 2008

The Bernanke Rule - A Reality-Based Modified Taylor Approach

We are witnessing an historical evolution in US financial and monetary policy in the form of "The Bernanke Rule" which is a stock-market market-based modification of the Taylor Rule for setting Monetary Policy. The Taylor Rule was developed as an attempt to create a systematic approach to the correct setting of Monetary policy, in order to attempt to remove more arbitrary components and so ensure better transparency and convergence between market expectations and actual future policy moves.

The Taylor rule, proposed by (who's buried in Grant's tomb??!?) Stanford economist Dr. John B. Taylor stipulates how much the central bank should change the nominal interest rate in response to divergences of actual GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation, nicely summarized by Wikipedia.

The Bernanke Rule, by contrast, stipulates how much the Central Bank should change the nominal interest in response to nominal divergences of the stock market indices from levels that cause those that own lots of stocks - whether leveraged or unleveraged - to hoot, howl, cry-foul, (and this is most important distinction) irrespective of what these changes in interest rates will do to the actual rates of inflation, inflationary expectations, in comparison to any reasonable target rates of inflation.

It's a good thing all that work of Dr Bernanke towards his BSc., MA, PhD in economics and all that professorial research didn't go to waste!!!! The Chart below highlights the impact upon monetary policy of changes in Stock Market Prices as implied by the Bernanke Rule:

7 comments:

Anonymous said...

GET TO DA CHOPPA

RJH Adams said...

Excellent!

Woland said...

Your recent posts are in a runaway bull market. Keep it up!

Macro Man said...

Cassie, you don't need me to tell you how amusing that is. Nice one.

"Cassandra" said...

aw shucks, you guys are nice, but, really, I did the easy bit. The actual credit (no pun intended) and really funny bit was done by the genius' with egg-on-their-face. They've got to be as feeling as f*cked and "gotcha'd" as a Bloomberg subscriber who's terminal contract has just been stealthily "auto-renewed" for another two years.

Now about that $75bn notional European equity position that gave traders everywhere, a bad case of "the runs"...

Macro Trading Ideas said...

Great, it's really funny but sadly also true, and if I think about it and about possible consequences..no comment!
Socgen number one house in derivatives..and we've seen what happened, Helicopter Ben most important man in the world of finance (Institutional Investor Journal), any analogy in the future??
About Socgen story I see a lot of black holes.. 50bn in "arbitrage" position, long futures versus what?
So a 31years-old guy alone kept a so impressive position (this accepted and known), at least 5 billion in manteinance margin, and what about entire prop desk??

"Cassandra" said...

I will have a longer post on the SocGen rogue tomorrow or next day, suffice to say, IF you're Derviatives House of the Year, then you should have a reasonable guess-timate of what market impact $50 to $75 billion i notional position would have upon BOTH markets and implied volatilities SO....why not take the huge team of traders around the globe and get 'm to lift every offer of ST gamma EVERYWHERE? They could have made back at least half their losses including transaction costs, spreads etc. Puzzling, no?