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Christopher Mahoney
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I spent eight years at Bank of America in New York (1978-86) covering Wall Street, then moved to Moody's Investors Service where I worked for 22 years, covering banks, sovereigns and corporates. I chaired the Credit Policy Committee for four years. I retired in 2007 as vice chairman. PLEASE... More
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  • The Fed's Policy Statements Are Increasingly Orwellian 0 comments
    Jul 11, 2012 8:42 PM

    Below is my reaction to the release today of the minutes for last month's FOMC meeting. Once again, they have an Orwellian (or Japanese) tone:

    Consistent with its statutory mandate, the Committee seeks to foster maximum employment...The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.

    First, Fed tradition requires the FOMC to bow to Mecca and intone that it "seeks to foster maximum employment", in the same way that the city of Sverdlosk committed to meeting the goals of the 10th Party Congress, and the Archdioscese of Cincinatti seeks to promote greater holiness in the tri-county region. The words are cant, devoid of any practical meaning. A layman, uninitiated in the Fed's secret rites, might imagine that a mandate to foster maximum employment would mean that the Fed would be obligated to target maximum employment, but he would be wrong.

    Permit me to translate Fedspeak into English: "The Committee is in favor of maximum employment, thinks it's an absolutely wonderful idea, and will keep doing the kind of things that it's been doing which, it is hoped, will over an indefinite time horizon, increase employment". The mandate is not to achieve full employment, but to bow humbly in its general direction.

    Then, for the rest of the meeting, the FOMC engaged in a lot of hocus pocus about the yield curve, the low interest rate policy, swapping short paper for long paper, and worrying about whether low interests rates are hurting banks. Not once does anyone say "Gentlemen, we've been missing our employment mandate for almost four years; let's talk about targeting our mandate". That would produce an "awkward silence ensued" comment.

    I do not mean to imply that Chairman Bernanke is not a good economist, or that he is unfamiliar with criticism such as mine. It's not an intellectual failing; it's a political one. When he was a Princeton professor, and even when he was a Fed governor, he was free to say similar things. But now that he is the pope, he has a different job: maintaining the Fed's "institutional credibility". This is analogous to Chief Justice Roberts' job: to protect the institution and its authority.

    Not only would targeting full employment require FOMC consensus, which isn't there, but it would also require broad support from the economics profession and the relevant Congressional committees, such as the Monetary Policy subcommittee chaired by Ron Paul. So whatever Ben believes in the privacy of his own den, when he's at work his job is to promote broad consensus both within and outside the Fed.

    In 1933, there was near-unanimous consensus that the US needed to slash government spending in order to maintain the gold standard and the "credibility" of the United States. During his campaign, FDR said as much. But once he entered the Oval Office and saw the devastation being caused by deflation, he took the advice of some prairie college radicals and freed the dollar from gold, causing a sustained inflation (price-level targeting, as we call it today). He had so much power and authority at that moment, and things were so bad, that he could get away with something that would have gotten anyone else impeached.

    The times today are not yet analogous, and Bernanke doesn't have quite the authority that FDR had in 1933. But the issue remains the same: what are you targeting and how do you plan to get there?

    The crucial distinction between manipulating inputs (interest rates, QE) and targeting outcomes is that the amount of input is not under discussion. When FDR decided to raise the price of gold, he had no idea what he was doing. Each morning he would arbitrarily set a new, higher price until he achieved his goal, which was higher commodity prices. He was targeting outcomes, not inputs. His more orthodox advisers were appalled.

    The same policy should be pursued today. Since the Fed has conceded that the risk of inflation is very low, then it has no excuse not to target full employment. Better still, it should say so very loudly. The FOMC should announce that the Fed will engage in asset purchases until employment is restored to its 2007 level. Period. That is similar to what Bernanke repeatedly told the BoJ to do ten years ago.

    But Ben will have to decide whether he is prepared to risk not only his own credibility, but that of the Fed itself. The Fed's statutory independence is a creature of the government's will. Given how many monetary nutcases there are now on the right, and given that the GOP might get full control of the government, he may decide that the Fed's independence is more important than full employment. I could certainly understand that calculus.

    I don't mean to be cynical, but I would not be surprised if the GOP were to change its monetary tune were it to get control of the government in November (as happened to Nixon). I have been informed that, in his heart of hearts, Romney gets monetary policy. I certainly hope so.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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