Economics Prof's Formula Says Fed Rate Still Too High

[A photograph for media use is available at http://www.clarkson.edu/news/photos/atesoglu2.jpg.]

Newswise — A Clarkson University School of Business professor says that the new benchmark federal funds rate of 4.25% is much too high to get the optimum levels of employment and gross domestic product that the Federal Reserve is looking for.

Economics Professor H. Sonmez Atesoglu (SONE-mez Ah-TESH-a-loo) published a paper this summer in the Journal of Post Keynesian Economics introducing a new monetary policy rule.

"Based on the equation I developed, the cut in interest rates today was too little," says Atesoglu. "They did the right thing, but they didn't do enough."

Currently, the Federal Reserve is believed to set the federal funds rate consistent with a formula known as the "Taylor rule."

Atesoglu's proposed rule is based on 20th-century British economist John Maynard Keynes' neutral interest rate. Using econometrics, a combination of economic theory and statistics, Atesoglu estimated this neutral interest rate as 5.5%. To find the optimal federal funds rate, Atesoglu's equation subtracts this 5.5% from the current yield on ten-year government notes (R) and adds it to the number 4 or F= 4+(R-5.5).

Using his new rule, Atesoglu says that the federal funds rate should now be set at 2.44% (F=4+(3.94-5.5), almost 2 percentage points below the new 4.25% rate.

"My equation always steers the economy toward the optimal level of production -- the level that avoids excessive demand-generated inflation and excessive unemployment," says Atesoglu.

Atesoglu says that the Federal Reserve is not setting the rate any lower because it is worried about inflation.

"They think that if they make the money cheaper, they're going to rekindle inflation," says Atesoglu. "They are taking a preemptive posture by trying to keep it low, because they want a chance to attack it before it really becomes a problem. But their concern is probably because of the sharp increase of the price of oil in recent months and its impact on inflation."

Atesoglu joined the Clarkson University School of Business faculty in 1977. Prior to his appointment, he served as an economist at the International Monetary Fund in Washington, D.C. From 1987-88, he held a Fulbright Senior Professor Research Grant for a year at the Kiel Institute of World Economics in Germany. He holds a Ph.D. in economics from the University of Pittsburgh.

Atesoglu teaches courses in money and banking, and econometrics. His research interests include balance-of-payments and economic growth, defense spending and growth, and money and inflation.

He has published articles in more than 50 scholarly journals, including The Journal of Monetary Economics, The Review of Economics and Statistics, Journal of Money Credit and Banking, Southern Economic Journal, Journal of Macroeconomics, Weltwirtschaftliches Archiv, Kredit und Kapital, Review of International Economics, Applied Economics, Journal of Post Keynesian Economics, Defence and Peace Economics, Strategic Review, and The American Political Science Review.

Clarkson University, located in Potsdam, New York, is a private, nationally ranked university with a reputation for developing innovative leaders in engineering, business, the sciences, health sciences and the humanities. At Clarkson, 3,000 high-ability students excel in an environment where learning is not only positive, friendly and supportive but spans the boundaries of traditional disciplines and knowledge. Faculty members achieve international recognition for their research and scholarship and connect students to their leadership potential in the marketplace through dynamic, real-world problem solving.