I remained under the radar for the past two weeks. Summer finally got the best of me, perhaps just as well, as I did not have the opportunity to backtrack from my last assessment of Fed policy:
All in all, this is pretty weak medicine given the condition of the patient. I would have preferred to see an open-ended commitment to asset purchases - buying up anything not nailed to the floor at a rate of $10 or $15 billion a week until achieving the dual mandate is in clear sight. But policymakers, on average tend to think they have relatively weak ammunition to stimulate growth. Their tools are more effective against deflation. And until the former turns into the latter, expect the Fed to do little more than modifications of the basic zero interest rate / hold balance sheet constant policy combination.
As was widely noted, Federal Reserve Chairman Ben Bernanke emphasized the Fed’s “wait-and-see” position, offering only an extended September meeting to consider the available options. Nothing specific to hang our hats on, no clear guidance as to the next move – suggesting the next "move" is likely to be more of the same, especially if financial markets stabilize and growth lifts off the first and second quarter floors. I believe we need to see even weaker growth, coupled with a steeper drop in long-term inflation expectations to prompt additional action.
The failure of Bernanke to push for more aggressive action is even more puzzling in the wake of this speech. According to the Fed chair, the situation is becoming urgent:
Our economy is suffering today from an extraordinarily high level of long-term unemployment, with nearly half of the unemployed having been out of work for more than six months. Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment.
I suppose I should be happy that someone in Washington considers unemployment to be a crisis, both near and long term. That said, Bernanke follows up with this:
Notwithstanding this observation, which adds urgency to the need to achieve a cyclical recovery in employment, most of the economic policies that support robust economic growth in the long run are outside the province of the central bank. We have heard a great deal lately about federal fiscal policy in the United States, so I will close with some thoughts on that topic, focusing on the role of fiscal policy in promoting stability and growth.
So he passes the ball to fiscal policy. With good reason, to be sure. Congress and the Administration are failing miserably at macroeconomic policy. The debt debate was an unnecessary, destabilizing, pointless disaster. Does this mean the Fed should be let off the hook? Consider that question in the context of Bernanke’s speech on February 3 of this year:
Although large-scale purchases of longer-term securities are a different monetary policy tool than the more familiar approach of targeting the federal funds rate, the two types of policies affect the economy in similar ways…By easing conditions in credit and financial markets, these actions encourage spending by households and businesses through essentially the same channels as conventional monetary policy, thereby supporting the economic recovery.
A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions. For example, since August, when we announced our policy of reinvesting maturing securities and signaled we were considering more purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels…Interestingly, these developments are also remarkably similar to those that occurred during the earlier episode of policy easing, notably in the months following our March 2009 announcement of a significant expansion in securities purchases. The fact that financial markets responded in very similar ways to each of these policy actions lends credence to the view that these actions had the expected effects on markets and are thereby providing significant support to job creation and the economy.
Funny that additional quantitative easing yielded “significant support to job creation” in February, when Bernanke wanted to justify QE2, yet now “most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.” Sometimes I think the only person who doesn’t read Bernanke’s past speeches is Bernanke himself. In any event, it seems the key difference between then and now, from the perspective of the Federal Reserve, is that the recent burst of inflation spooked them badly, raising in their minds the possibility of any central banker’s worse fear, an inflation spiral.
The bottom line: We are playing a data game as we approach the next FOMC meeting – lacking a more extensive collapse of growth forecasts and or inflation expectations, the Fed looks likely to stay the course.