One thought has driven the Federal Reserve since early 2008 and that thought has been "Don't err on the downside." The Great Recession began in December 2007.
I have argued that behind Mr. Bernanke's thought through this period has been the conclusion Milton Friedman reached in his studies of the Great Depression. That conclusion was that the Federal Reserve did not do near enough to try and stem the Great Depression as it unfolded. The NBER dates the Great Depression as beginning in August 1929 and ending March 1933.
Therefore, Mr. Bernanke was going to err on the side of too much monetary ease.
I have further argued that once the recovery began, Mr. Bernanke was not going to allow a second recession to occur if he could avoid it. His concern here was the 1937-1938 depression that occurred between May 1937 and June 1938.
To avoid this Mr. Bernanke was going to err on the side of too much monetary ease.
Mr. Bernanke, the student of the Great Depression and beyond, saw to it that the Federal Reserve threw as much "stuff" against the wall as it could to see what would stick.
Mr. Bernanke will leave the Federal Reserve in January 2014 with the residual concern that the Fed must not make the mistake of beginning to "taper" security purchases too soon. The Federal Reserve has already "backed off" two early efforts at quantitative easing and does not want to "back off" of its third effort only to have to come back with Quantitative Easing IV.
This is why, I believe, that the Fed is making such an effort with "forward guidance." Fed officials seem to think that they can convince the market with its policy guidance in the face of the historical evidence that the Federal Reserve is no better than any other collection of human beings in forecasting the future. Larry Summers, former candidate to take over Mr. Bernanke's position at the Fed, seems to think this way as well.
But, the Fed knows that it is at a "crossroads" of history and must at sometime begin to get off the horse of quantitative easing and return to the reality of existing economic conditions. Given the magnitude of the decisions it must make in 2014, it is trying to talk its way through the exercise.
The economic recovery is now in its fifth year… pretty long by historical standards. And, by historical standards the economic recovery has been pretty dismal… and doesn't seem to be getting too much better.
The unemployment rate is improving but mainly because people are leaving the work force. Not good!
The new information on industrial production and capacity utilization seem to show a little more strength in the economy, but we have seen many "green shoots" wilt over the past four years.
Industrial production, year-over-year, increased by 3.2 percent in November and is up an average of 3.3 percent for the fourth quarter so far. This is up from an average increase in the third quarter of 2.5 percent. The year-over-year increase in industrial production for December 2012 was 2.5 percent.
Capacity utilization in U.S. manufacturing was at 79.0 percent in November. For the third quarter of 2013 capacity utilization averaged 78.0 percent. At the end of 2012 this figure was at 77.8 percent.
The commercial banking system seems to still be losing about 200 banks per year and the situation in the commercial real estate market still remains tenuous.
In other words, there is still a great deal of uncertainty about the future course of the economy and this is a continuous worry for the officials of the Federal Reserve.
I believe that the economy will continue to grow in the 2.0 to 2.5 percent range in the near future and that Federal Reserve actions will not be able to change this trajectory very much at all… except on the downside.
And, this is the dilemma that Federal Reserve officials face. The rate of increase of the price deflator for GDP has been stuck at 1.4 percent, year-over-year, for the past two quarters. For the past three years, the year-end rate of increase in this measure of inflation was stuck at 1.8 percent.
For the last three months, the year-over-year rate of increase in the Producer Price Index has been negative!
This weakness in prices along with the continued reduction in the labor force participation rate indicates that there are some real reasons to be concerned that economic growth could remain weak… or get even weaker.
It is my feeling that these factors are weighing heavily on the minds of the members of the Fed's open market committee, as they get ready to meet tomorrow. And, this concern will temper anything that they might do… tomorrow… or in the near future.
The Federal Reserve may decide to begin to "taper" its purchases soon. But, it is my guess that if they do any tapering in the near future it will be very minor… very tentative. Forget about "future guidance." The Fed must begin sometime soon to "taper" and Federal Reserve officials know it. However, the downside risk will be very much on their minds and they will want to see how the markets respond to their change in direction. A small move, they hope, will help to protect them on both sides.