Written by Henrik R Clausen
This is commentary on an article in The Economist, online edition, Clearing the Air. It is not radically different than other articles concerning the Federal Reserve, monetary policy and speculations about what will happen next. It deserves some analysis, for otherwise this reporting is more confusing than helpful. And while this concerns the US Federal Reserve, the situation regarding the European Central Bank (ECB) is quite similar.
A LITTLE while ago Ben Bernanke, the Federal Reserve chairman, called the economic outlook "unusually uncertain".
This might be because Bernanke and the Federal Reserve Board do not know how to differentiate a helthy economy from a suffering one. Further, expressing 'uncertainty' is helpful, for then you have hedged your statement and cannot be blamed (severely) if you turn out to be wrong.
The Fed has lately been a source of a lot of that uncertainty. Its officials maintained an upbeat outlook for the economy as the news in recent months went from bad to worse, then on August 10 they seemed to abruptly embrace the opposite view by announcing new steps to stimulate the economy. Matters have not been helped by the public airing of divergent views from officials.
At least divergent views provide the public with a variety of official, qualified statements to choose from. If the Fed officials provide us with a buffet of diverse and contradictory statements, chances are that at least one of them will be reasonably right.
Mr Bernanke cleared up a lot of the confusion with a long speech to the Kansas City Fed's annual symposium in Jackson Hole, Wyoming today.
Great. So he eventually found out where we are headed, and spelled that out clearly.
In a nutshell, Mr Bernanke said the economy has, indeed, underperformed, but it will get better.
Everyone should like him for that statement. Thanks a bunch!
And if it doesn't,
Oh, crap... Didn't he just tell us that things will get better? Clearly, without hesitating or hedging? Then, it is more rational to have one person present dissenting views than spreading the task to several.
the Fed will do more unconventional things.
'Unconventional' in this context usually means "Moneyprinting dressed up in clever ways". But that wording has an unpleasent ring to it - it is much less alarming to take pride in the creativity in solving the problems than it would be to be accurate about the actual means to be employed.
The same morning Mr Bernanke spoke, the Commerce Department was reporting that the economy grew at a miserable 1.6% annual rate in the second quarter, down from its initial estimate of 2.4%. The betting is that the current quarter won't be much better.
'Underperform', indeed. Wonder if this is the expected result from the stimulus policy of Bernanke and the Obama administration? Worth also noting the term 'betting'. Bernanke does not seem to actually know where we are headed.
Mr Bernanke admits this is unexpected and disappointing,
Well, it shouldn't be, really. It is the unexpected result of what they promised would restore the economy, but which independent analysts doubted, more or less vocally. The vocal doubters were right, Obama and Bernanke were wrong. Not that it would cause any of them to resign, of course.
but it's not a double dip.
'Double dip' seems to be the bogeyman of these days. The Fed has employed massive 'Unconventional means' to prevent the Double Dip (contraction, growth, then again a contraction of GDP) to happen. He does seem somewhat concerned that his trillion-dollar quantitative easing does not deliver the promised result.
The economy will "continue to expand in the second half of this year, albeit at a relatively modest pace [and] the preconditions for a pickup in growth in 2011 appear to remain in place."
As measured by GDP. Job count in the private sector tell a different story. But as it is easier to manipulate GDP through monetary policy, which is the responsibility of the Fed, it is natural that he focuses on this, rather than unemployment and other facts closer to the lives of ordinary citizens.
Though puzzled that consumption has been so weak,
Wonder if he imagines he can control the spending habits of the public? At least he admits incompetence again, though it didn't make him submit a resignation this time. Perhaps next time he is caught by surprise by the developments?
Mr Bernanke notes several developments that bode well for a pickup: the household saving rate was recently revised up to 6% from 4%,
Compared to double-digit saving rates in other countries, not least the Far East, this is a ridiculous savings rate in the first place. But the increase is a good sign, savings are important.
suggesting households have made brisk progress in deleveraging, setting the stage for more robust consumption
Ehm..? Consumption, not saving, is supposed to be good for the economy? This seemingly counter-intutive idea does have a rational explanation, however: GDP, which is the most common measure for the health of the economy, is easier to manipulate through monetary policy and inducing optimism into the public. The savings rate, which is more important for long-term economical health, is glossed over by a chairman obviously looking for a quick fix and fast approval.
(if only employment and incomes can pick up).
Here's another catch. Employment usually doesn't catch up when GDP goes up, making the recovery 'jobless', and thus immaterial to a lot of people. But the strong focus on GDP as the real indicator of economical progress is understandable. When it goes up, suitable publicity can improve consumer confidence and give the impression that the crisis truly is over and done with.
Second, financial markets are loosening up, especially since European policy makers got their sovereign debt crisis under control.
This is good. Let's hope for the US to also get their crisis under control. Doesn't seem to be on the radar just yet, however.
Given this constructive view, what to make of the Fed's decision on August 10 to reinvest the proceeds of maturing mortgage backed securities in its portfolio into Treasury bonds?
This is getting interesting. Just why would the Fed engage in open money-printing, contrary to the wish of the market to let the bonds mature and money supply shrink?
The Fed had previously bought over $1 trillion of MBS as part of its original programme of quantitative easing to bring down long-term interest rates.
OK, the Fed is effectively into the market of providing mortgages. Interesting. Since the Fed, by definition, has an infinite amount of money at its disposal, it would be interesting to know just why it chooses to sink a full trillion dollars into the mortgage market.
The goal of the policy, in part, was to encourage banks and other investors to buy something else more risky, such as corporate loans, thereby boosting investment.
It's interesting to follow the intentions here. The real goal of the Fed being in the mortgage market isn't to be in the mortage market. It is to push others out, that they may increase business investing. This is getting complicated. A short while ago the Fed intended to stimulate consumption. Now it wants to stimulate investment - where in a crisis-struck economy one would expect that investments be let to rest for a while, awaiting new and more profitable opportunities. Not so when the Fed is bent on directing the market and manipulate just how much investing is being done.
There's a risk to this manipulation, however. Driving down interest rates manipulates the calculus of the entrepeneurs, duping them into investing in projects that they would otherwise not engage in (that's the whole point of stimulating investment), which in turn will very likely increase bankruptcies as well. But that's a problem for the future, not for now. The immediate concern is to force GDP up, that the recession can be declared over for real.
But as the economic outlook worsened,
Now, is this the expected or the unexpected result of previous policies? Both options look bad.
mortgage rates plunged, spurring millions of homeowners to pay off their loans and take out lower-rate mortgages.
Common sense of common people, actually. Thinking of the future, protecting the personal economy, avoiding excess risk. Well done, citizens. That rates plummeted can hardly be considered unexpected, that was the original intention of the Fed. Only that actual people would take practical advantage of this was not expected.
Left alone, this rapid pace of repayments would have led the Fed's portfolio to contract by some $400 billion by the end of 2011, representing an unplanned but serious tightening of monetary policy.
Yes. And the Fed would be the last to sit back and let the market react freely to what it does.
Note "by the end of 2011". This is quite a forward-looking calculation, where we are not given the actual figures, rather a forecast based on them. The Fed desires a precedent for be able to do this in the foreseeable future, based on more modest figures we're not being told today.
By reinvesting those proceeds into an equivalent amount of Treasury debt, the Fed neither increases or decreases its level of monetary stimulus.
But it does turn the supposedly 'temporary' money-printing of purchasing mortgage bonds into a more permanent one of buying Treasury debt. Nice bait'n'switch, Mr. Bernanke.
One might wonder here: Who pays? Certainly the Fed doesn't, for it has no solid assets to back 400 billion dollars, not to mention those that already exist. While there is a national gold reserve at Fort Knox, it is not these gold reserves that provides the value of the dollar.
What ultimately provides the value of the dollar is the products one can purchase for dollars. Expanding the money supply with a trillion does not alter this supply of products directly. Instead, the value of existing dollars is diluted to accommodate the newly created money pool, completely in line with Keynesian thinking. That this might be a cause for dissatisfaction among current holders of dollar-denominated assets is a problem the Fed routinely ignores. The Chinese do not.
Having explained the past, Mr Bernanke then turned to the future: under what conditions would the Fed do even more? First, if today's low inflation seems about to turn to deflation.
Now, this is meant to be seriously scary. There is one enemy to be defeated at practically any cost, and that enemy is named 'deflation'. Unfortunately, inflation / deflation are measured through the Consumer Price Index (CPI), which has been extensively retooled over the last decades, in order that it may show lower figures than it would 20 or 30 years ago.
This has the fortunate side effect that it reduces payments on indexed bonds, the cost of indexes expenses such as Social Security and wage demands, while giving the Fed more opportunities to expand the money supply, that the CPI may be prevented from falling. The disadvantage is that the policy gets out of touch with the experience of ordinary citizens, who see rising costs of food, fuel and other costs of living. Shadow Government Statistics provides alternative CPI figures based on the old methods of calculation.
Deflation fears are on the rise, with TIPS bonds forecasting a 10% to 15% probability over the next five years.
The official CPI calculation is taken for fact, of course, and are quoted as a reason for fear. What exactly makes 'deflation' fearsome is not explained, it is assumed that everybody knows.
But Mr Bernanke thinks deflation is pretty unlikely, and in fact doesn't seem to think inflation will go lower than its current, underlying rate of around 1%.
'Underlying'? If there is any 'underlying' cause for inflation, it would be the growth in money supply. Inflation is not caused by itself, it is caused by inflating the money supply.
The second condition, and one more likely to trigger action, is if the economy makes no progress in closing the gaping gap between today's GDP and potential GDP.
Here is another term one is supposed to understand, namely the Potential GDP, for it is a (fictious) parameter that the Federal Reserve is trying to achieve through its policies. Then, if the economy doesn't deliver the growth it 'should', the Fed has a reason to increase the money supply.
As a practical matter, that means growth has to move above 2.5% and unemployment has to drop.
Something firm, that's good. GDP growth is a positive trend, yet falling unemployment would constitute real improvement for real people, a real and lasting improvement.
Mr Bernanke doesn't seem to think that will happen until 2011, which implies a willingness to wait a few more months for evidence on the prospects for that 2011 pickup.
This is how influential the Fed is: The press even speculates what the chairman "seems to think".
That the Fed is not ready to do more quantitative easing yet is arguably disappointing.
As if we didn't have enough money-printing already... But then, The Economist would have a large share of its readers in the financial sector, which by definition (Fractional Reserve Banking) stands first in line to benefit from 'quantitative easing', which makes the disappointment understandable.
It could easily have justified more action a full year ago given what even then was its lacklustre outlook, and the downside risks (which seem to be coming to fruition). That's the path the Bank of England, facing similar circumstances, chose.
Sure, Bank of England chose that course. In context it would be useful to also be told what results that brought about, if the extensive quantitative easing done by BoE had finished off the problems for good.
But that's uncharitable. That Mr Bernanke has not moved as quickly as many of us would have preferred is less important than the fact that his views are still diametrically opposed to the Bank of Japan credo that monetary policy can't and shouldn't be used aggressively in a deleveraging, post-crisis economy.
That is something the BoJ would know about. It used quantitative easing extensively to solve the Japanese financial crisis in the 1990's, which did manage to keep many moribound banks and businesses alive for years, create an amazing national debt, and keep the crisis intact fo a full decade. BoJ seems to have learned a lesson not heeded by BoE, the Fed, or the author of this article.
What would additional action consist of? Mr Bernanke cites four possibilities. One, raising the Fed's inflation objective (now around 2%), he dismissed out of hand: it would "squander" the Fed's "hard won credibility".
The scare quotes seem appropriate. Increasing the inflation target (keep in mind the CPI problems mentioned above) would create more headroom for 'quantitative easing' (money-printing) by the actual tools the Fed has. The inflation target is not a tool in itself.
Another, hardening its commitment to zero rates for a long time, would have marginal benefits
Put another way: That doesn't create all that much more money.
and run up against the market's well known tendency to wrongly assume that such commitments are unconditional.
The Fed, as usual, is set against the free market. Entrepeneurs, bankers etc. prefer a predictable environment for business decisions and will try to lock in to the current state of things. That makes it easier to deterimine the appropriate investments to do in order to run business in a profitable manner. That they have an opponent able and dedicated to manipulating the business environment in unpredictable manners complicates matters, and business decisions, somewhat.
A third, lowering the rate the Fed pays on commercial bank reserves at the Fed from its current 0.25%, would have almost no impact on the interest rates that people actually pay.
That's true. If the Fed is determined to run interest rates in the commercial market through the floor, alternative methods will surely be needed.
That leaves buying more bonds.
The classical way to create more money: Swap for debt. This never fails.
Mr Bernanke points out the benefits of more QE are uncertain and the costs are growing, as the public might worry that the Fed will fail to keep all the money it printed to buy those bonds from producing inflation.
A valid concern, indeed.
Such fears are largely unfounded
Unfortunately, this is dismissed as 'fear' without further analysis.
-the Fed has many more tools for tightening monetary policy than for easing it further.
Actually the Fed has exacly the same tools for easing as for tightening. It just happens that these tools, in particular the less obviously money-printing ones , are already maxed out in the direction of 'quantitative easing'. Which, as seen above, has not created much in the way of actual economic growth, not to mention new jobs.
But even unfounded fears can affect reality, for example by boosting long-term rates.
What here is called 'unfounded fears' is actually the sum of real decisions by real people, who individually evaluate the economic environment and make decisions what to do. Locking their mortgages into a fixed, long-term rate is the kind of deleveraging and risk minimization we need - it makes people less vulnerable to - aha - rising interest rates! The author of the article is looking at a warning sign the size of a billboard - yet fails to recognize it for what it is, choosing instead to uncritically propagate the Fed narrative.
Mr Bernanke made it clear that if either of his two conditions are met, these misgivings would not get in the way:
So even if the costs of further 'quantitative easing' is rising, Mr. Bernanke is fully intent to go down that road. Nothing seems able to stop this man, who elaborates:
It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable...Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.
Long-winded, but actually clear enough: The 'risk' of deflation (see CPI debate above) eventually beats each and every concern one might have for the consequences of yet more 'quantitative easing'. This invites to quoting an earlier statement:
But even unfounded fears can affect reality.
As true as it gets. In particular for the Federal Reserve.
Fed officials gathered under a hail of criticism for communicating badly.
While usally not spelled out as clear as this, the criticism is richly deserved. Under the chairmanship of Alan Greenspan, hazy and self-hedging statements became the order of the day. That has not changed under the current chairmanship, it still takes a lot of analysis to figure out what was actually said, which parts of that were clear, which were hedged, and what the implications are.
The accusations are off base.
Perhaps to those accustomed to Fed-speak. To most citizens, Bernanke might as well speak Greek. Still communication is less important than actual policy.
The Fed doesn't have a communications problem, it has a policy problem.
While it is simplistic to dismiss the communication problem, there is no doubt that a real and serious policy problems does indeed exist.
The recovery has stumbled and the central bank isn't sure why.
Ehm, could it be as simple as .. incompetence? That the causes for the crisis are not understood, that that appropriate remedy is not understood, and that the failure of the wrong remedies to work is not understood?
Having long ago used up its conventional monetary ammunition, it's not sure how effective more unconventional ammunition will be.
We need to recall here that 'unconventional' means 'money-printing beyond what is supposed to be sound policy'. The guidelines that are being broken when resorting to 'unconventional' policies are those set in place to ensure that money remains sound. Breaking those is dangerous, and breaking them further, based on the first violations not fixing the problem, seems downright foolhearted.
The 17 members of the Federal Open Market Committee, like the outside world, are divided and unsure about what to do.
Perhaps they should simply not do anything. That is frequently the best choice when uncertain what to do and why.
That their divisions have spilled out into the open dismays many at the Fed, but that ultimately doesn't matter.
Except that it could damage the "hard won credibility" of the Fed.
The Fed is not the Supreme Court. What the chairman wants, the chairman gets.
Swell. But it's good to have on record that the Fed functions like a dictatorship.
When Mr Bernanke has decided that one of his two conditions will be met, there will be more quantitative easing.
Anyone surprised here?
Judging from Friday's speech, he's not there yet.
No, he needs to prepare the ground first. Unless someone protests, loudly, we will get more of the medicine that does not work. Then later further 'surprise' that it still didn't. And since the Fed is basically accountable to noone, this can continue endlessly.
Won't somebody take this man to task for his greatest problem: incompetence?