The Fed Gives Itself A Triple Mandate

by: Scott Sumner

Every once and a while you need to stop and take stock of just how insane current monetary policy really is:

The tepid demand dampened inflation pressures last month. A price index for consumer spending edged up 0.1 percent, slowing from a 0.4 percent increase in June. Over the past 12 months, prices rose 1.4 percent compared with 1.3 percent in June.

It was the biggest increase since February.

Excluding food and energy, the price index for consumer spending nudged up 0.1 percent after advancing 0.2 percent in June. Core prices were up 1.2 percent from a year ago, rising by the same margin for a fourth consecutive month.

Both inflation measures continue to trend below the Fed's 2 percent target. That, combined with the lacklustre consumer spending, would argue against the U.S. central bank trimming the $85 billion in bond purchases it is making each month to keep interest rates low.

Yes, so it would seem. Indeed they should sharply boost the pace of QE. But they will probably taper anyway. Now I suppose you could argue that the Fed doesn't have a single mandate, they are supposed to also focus on employment, so while easier money is needed to hit the inflation target, the employment target requires . . . umm, easier money?

Reuters continues:

Many economists, however, believe the Fed will make an announcement on the tapering at its September 17-18 policy meeting, starting off with a small cut to the bond-buying program, known as quantitative easing.

"This does nothing to alter our view of tapering. Fear of unquantifiable financial risks within a QE regime that offers diminishing returns is driving the policy agenda, not strong growth and inflation," said Eric Green, global head for rates, foreign exchange and commodity research at TD Securities in New York.

Yes, I forget about the third (and top secret) mandate that Congress gave the Fed; "unquantifiable financial risks." Here's a general observation. When big cumbersome institutions are given the mandate to target "unquantifiable" anything, don't hold your breath for good outcomes. This is really absurd on so many levels. The asset markets are much more stable when you have steady NGDP growth, than when you have wild swings in NGDP. Anyone recall asset prices in 2008-09? The asset markets are suggesting that tapering will create instability in emerging markets, and to a lesser extent, the U.S. stock market.

Ben Bernanke is a student of history, and knows full well that this reasoning is EXACTLY WHAT THE FED DID WRONG in the 1930s. And I mean exactly. You could find dozens of similar articles in the NYT from the 1930s. I hope he's quietly pushing back against this view from within the Fed.

P.S. The current frontrunner for the job of Fed chair is the most famous proponent of focusing Fed policy on reducing unquantifiable financial risks.

P.P.S. The ECB raised rates in 2011. How did that reduce "unquantifiable financial risks?" How about the Fed's tight money policy of 1937?

P.P.P.S. Right now I want all readers to cross their fingers. That's it. That's the Fed's secret plan to bring inflation up to their 2% target.

P.P.P.P.S. Marcus Nunes has a good post on the declining inflation rate in America.

P.P.P.P.P.S. Here's Ryan Avent:

There are limits to what reporting can uncover about a decision that is the president's to make. Mr Obama may in fact be enthralled by Mr Summers' private monetary views. For all I know the president is a die-hard Scott Sumner fan and Mr Summers has whispered to him that market monetarism is now his macroeconomic lodestar. But there are few signs that anything like that is going on.

Here are some signs that that is not going on:

1. I favor strict rules, Summers favors discretion.

2. I believe monetary policy is highly effective at the zero bound, Summers believes it's ineffective.

3. I oppose fiscal stimulus, Summers is in favor.

4. I believe the Fed should ignore asset "bubbles," Summer disagrees.

5. I believe wage flexibility is stabilizing, Summers thinks it's destabilizing.