Investors will be poring over Federal Reserve Chairman Ben Bernanke's August 31 Jackson Hole speech for days to come. One section in particular deserves attention because it highlights what could be a fatal flaw in how Dr. Bernanke looks at the Fed's ability to shape events. That flaw is hubris.
The Chairman notes in his speech that one
potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed's ability to exit smoothly from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability.
Dr. Bernanke goes on to say that such an "unanchoring" hasn't happened yet,
in part because of the great emphasis the Federal Reserve has placed on developing tools to ensure that we can normalize monetary policy when appropriate, even if our securities holdings remain large. In particular, the FOMC will be able to put upward pressure on short-term interest rates by raising the interest rate it pays banks for reserves they hold at the Fed. Upward pressure on rates can also be achieved by using reserve-draining tools or by selling securities from the Federal Reserve's portfolio, thus reversing the effects achieved by LSAPs [large-scale asset purchases]. The FOMC has spent considerable effort planning and testing our exit strategy and will act decisively to execute it at the appropriate time.
Translation from the Fedspeak: I, Ben Bernanke, am confident that we Fed technocrats have the wisdom, knowledge, insights, and ability to bend the financial markets to our will whenever we want to do so.
That is a chilling notion. Mythology, literature, history, and common sense all show that hubris on such a breathtaking scale does not go unpunished. That is particularly so when mortals shake their fists at the economic gods.
Libraries are full of accounts of past disasters that occurred when any of the usual suspects -- policymakers, bureaucrats, politicians, statists, central planners, hedge-fund managers, corporate executives -- acted on the assumption that they had planned and tested their way to figuring out how market and economic forces work. Time and again, such well-laid plans have been blown to bits by real-world forces that can not be reduced to economic models and quantitative relationships. Those forces include fear, greed, and the one that confounds the technocrats most of all: millions of market participants acting in real time in their own best interests.
This time around, Dr. Bernanke is asking us to trust that he knows best, and that he and his like-minded colleagues will be able to control the monumental forces they have unleashed. Let's hope that he is correct. But even as we do, we should brace for the likelihood that the gods noticed the Chairman's hubris, and are already planning his comeuppance.