College Majors That Lead to High Salaries

Notice Economics in the rankings. Read more here.

The Fed's Exit Strategy

This Op-ed by Federal Reserve Chairman Ben Bernanke does an excellent job explaining the Fed's strategy for avoiding the inflation than many fear as we exit recession. I found the discussion on the Fed's relatively new practice of paying interest on deposits rather fascinating.

Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.

Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.

Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.

Considerable international experience suggests that paying interest on reserves effectively manages short-term market rates. For example, the European Central Bank allows banks to place excess reserves in an interest-paying deposit facility. Even as that central bank’s liquidity-operations substantially increased its balance sheet, the overnight interbank rate remained at or above its deposit rate. In addition, the Bank of Japan and the Bank of Canada have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

A Random Walk

Indexing is one of my favorite blogging topics when it comes to investing, so this article about Burton Malkiel caught my eye. Malkiel is a Princeton Economics Professor who literally wrote the book on index investing. Here is a notable blurb from the interview:

We have a lot of information about how index funds have done, as well as the typical actively managed mutual fund. I find that consistently two-thirds of active managers are beaten by the indexes, and those that beat the index in one year are not necessarily the ones who beat it the next year.Over a very, very long period, sure, there are a few people who have outperformed the index. But you can almost count them on one hand. I still believe -- even more strongly than I did in 1973 -- that most investors would be much better off having at least the core of their portfolio in a low-cost index fund.

And on the most frequent criticism of indexing:

There is no question that it is a rap on indexing -- that at the peak of the market in 2000, you had more Internet stocks than you should have had, in retrospect. But active managers had an even a greater proportion than did the index funds.

Similarly, you could say that with an index fund at the end of 2007 and the beginning of 2008, you had too much in financial stocks, absolutely. But that's what killed all the value managers who had done so well for so long.

So you are quite right that, with an index fund, you will be invested in what turns out to be the most overvalued part of the market. But you will also be invested in what turns out to be the most undervalued part of the market.