By Niklas Blanchard
I’m coming to the party late, I know…but I figured I’d comment on the Fed’s inaction yesterday as a result of the FOMC meeting. Here are some quotes:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period
This has, of course, been the Fed’s position since the big crash in late ’08. As I have argued, and have tried to provide reasonable evidence for, low rates for an extended period — contrary to being a sign of accommodative policy — is a sign of monetary failure. Since I’ve been fairly vocal on this point in various venues (especially on Twitter), I won’t belabor the point.
In any case, the “big policy announcement” was that the Fed is going to shift its profits from MBS sales into US Treasuries. Thus, it will freeze its balance sheet at the current levels:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.1 The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature. [emphasis mine]
Fairly basic Keynesian cross analysis will tell you that this is a mostly meaningless gesture, as fluctuations in the monetary base does not have any meaningful effect on the price level while in a “liquidity trap”. Nonetheless, Paul Krugman is tepidly optimistic, noting that this merely changes the focal point of the Fed’s strategy from one of tightening to one of “holding the line”. He calls on us to keep up the pressure:
What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.
Of course, I more pessimistic. The stock market indices are flat on the news, and the 10-yr T-bond has actually steadily fallen to a current 2.79. My favorite, the TIPS spread, is at a current 1.75. That is not only well below trend, it is well below the level in which we could plausibly return to the previous trend level of output (NGDP).
This is a major problem, because it is currently en vogue to talk about “structural unemployment”, as the current length in which some people experience unemployment is reaching the fraying limits. Well, of course unemployment is going to remain high while we grind ourselves down to a new NGDP growth level. That’s going to take a long time to fully work out — if that is indeed what we are facing, and that will also necessitate much more productivity growth (and that means less humans), less investment in capital goods, and less consumption. All of those things hurt the unskilled, which are also disproportionately “the poor”.
It’s worth a look at the wrenching social dynamics which persistent deflation brings:
As long ago as 2001, Japan’s Ministry of Health, Labor and Welfare estimated that 50% of high school graduates and 30% of college graduates quit their jobs within three years of leaving school. The downside is permanently shrunken income and prospects. These trends have led to an ironic moniker for the freeter lifestyle: dame-ren (no good people). The dame-ren get by on odd jobs, low-cost living and drastically diminished expectations.
Even more extreme is hikikomori, or “acute social withdrawal,” a condition in which the young live-at-home person nearly walls himself off from the world by never leaving his room. Though acute social withdrawal in Japan affect both genders, impossibly high expectations for males from middle- and upper-middle-class families has led many sons, typically the eldest, to refuse to leave home. The trigger for this complete withdrawal from social interaction is often one or more traumatic episodes of social or academic failure. That is, the inability to meet standards of conduct and success that can no longer be met in diminished-opportunity Japan.
The unraveling of Japan’s social fabric as a result of eroding economic conditions for young people offers Americans a troubling glimpse of the high costs of long-term economic stagnation.
To end, Scott Sumner posted analysis of his reaction to the Fed meeting four days in advance (August 6th), and gave his expectation for each scenario ranging from “Very Bad” to “Inception”. Guess which end the Fed falls on…
Bad: The Fed does something minor. Perhaps it promises to maintain the monetary base at current levels by purchasing T-bonds as the more unconventional assets are gradually sold off. The Dow falls slightly. (Actually, people are now so discouraged that this might be viewed as good news.)
nearly literally exactly what happened.
Update: I forgot to mention, there was a single person who dissented the Fed’s decision roll over MBS into Treasuries. It is worth it to note that this person doesn’t belong on the FOMC, has no business within 5,000 yards of making monetary policy, and may not even deserve to be in banking/finance at all. Who, you might ask? Well, he was on the list last time: Thomas Hoenig.
Update 2: I just noticed that Kevin Drum did the same thing with Scott Sumner’s post. Clever guy.