For Chairman Bernanke - When did Monetary Policy Become the Laboratory of Academic Theorists?
First, as I read the FOMC statement, it was painfully obvious that the impact of the Michael Woodford piece found willing adherents in the bowels of the Board of Governors of the Federal Reserve. The FED’s language: “IF THE OUTLOOK FOR THE LABOR MARKET DOES NOT IMPROVE SUBSTANTIALLY, the committee will continue its purchases of agency mortgage-backed securities …” Further, in a direct BOW to Woodford: “The committee expects that a HIGHLY ACCOMMODATIVE STANCE OF MONETARY POLICY WILL REMAIN APPROPRIATE FOR A CONSIDERABLE TIME AFTER THE ECONOMIC RECOVERY STRENGTHENS.”
This is the phrase that Chicago Fed President Charles Evans must have written because it is a tribute to his concept of targeting a 7/3 growth story: 7% unemployment rate and 3% inflation. It is very similar to the Professor Woodford argument that the FED OUGHT to target NOMINAL GDP. The desire to basically keep accommodation in place regardless of the underlying growth for a considerable time is the FED communicating that it will err on the side of inflation, no surprise and it certainly means that the GOLD market has well understood the theoretical basis of the Bernanke FED far better than all the economists OCCUPYING WALL STREET. The markets are TOTALLY CONFUSED for all it has to guide it is the THEORETICAL BIASES OF A SOCIAL SCIENCE AMASS WITH ASSUMPTIONS. We are back to the old joke, “LET’S ASSUME WE HAVE A CAN OPENER.”
***CNBC’s STEVE LIESMAN asked Bernanke a very pertinent question: “Does this mean that tolerance of inflation has grown, if not what is the point?” Chairman Bernanke answered: “The goal isn’t to intentionally raise inflation. We still believe that inflation will be close to our target.”
The Chairman’s answer reflects that Bernanke returns to his view that “OUTPUT GAPS” matter. The FED can flood the market with liquidity because with unemployment so high there is no pressure on prices, nor will there be. This of course has been the FED‘s mantra and is the basis for moving to the theoretical principal of open-ended ASSET BUYING or targeting NGDP by any other name.
The problem with all this theory is that it undermines the TRANSMISSION MECHANISM of the interest markets. It is one thing when the FED acts to either stimulate the economy or slow the economy by raising or lowering the FED FUNDS RATE, but when the FED runs a massive program of LARGE SCALE ASSET PURCHASES (LSAP) it is telling the market where to set rates.
The death of the BOND VIGILANTE and thus the purveyors of the TRANSMISSION MECHANISM, means that the FED has moved the U.S. economy to an entire new arena. In a HAT TIP to an avid reader of the blog and long time friend KM, the question arises from an intro comparative economic text: It seems that the U.S. financial markets have transitioned from being a market driven force to that of being a COMMAND ECONOMY. Prices for U.S. debt is now priced from the top down rather than bottom up. The market forces no longer establish what the value of U.S. debt.
This is a very dangerous time as we are now dependent on the theoreticians to establish prices. How comfortable are the international markets going to be in realizing that their vaults are full of assets based on the theoretical value set by FED MODELS. The last 10 years have certainly revealed how badly flawed the FED‘s policy has been.
***The Federal Reserve screwed Mario Draghi today with its Woodford-enhanced policy. The U.S. DOLLAR fell as markets assessed that the FED would create growth at any cost. A declining DOLLAR is not what will aid the DEBT stressed European countries. The ECB‘s recent maneuvers by Draghi, “whatever it takes,” cannot overcome the theoretical nature of FED policy. The EURO does not need to rally as that will do nothing to alleviate the 25% unemployment rate in Spain or the high unemployment throughout the rest of the peripheral nations. To confirm the problems of dueling CENTRAL BANKS, the GOLD/EUR cross mad all time highs afte the FOMC statement was released. Bernanke also painted himself and his predecessor into a corner by admitting that monetary policy’s because impact is on ASSET PRICES.
If monetary policy is principally about affecting asset prices then Greenspan’s missives about not being to identify asset bubbles turns the central bank into a serial bubble blower by default. Mr. Bill White has always maintained that the best role for a central bank is to “lean against the wind,” or act in an anti-cyclical manner. In admitting that the greatest impact of money policy the Bernanke points his finger at Greenspan as being its bagman, he left rates far too low for far too long.
***The BOND markets are most certainly broken as a TRANSMISSION MECHANISM but it will be important to monitor the U.S. YIELD CURVE to see if there is any movement out of U.S. debt that could put pressure on the FED‘s approach to fulfilling its dual mandate.
Also, the question arises: Now that the ECB and the FED have both entered upon new stimulus programs, WILL THE JAPANESE ALLOW THEMSELVES TO BE THE SUCKER IN THE GAME AND MAINTAIN ITS OVERVALUED YEN? Let’s keep our eyes on the GOLD/YEN CROSS AND THE NIKKEI FOR POSSIBLE MOVES ON THE YEN BY THE BOJ and Ministry of Finance (MOF). But of course this is only theoretical. As usual the markets will test this theories and we will react accordingly, for unlike the FED, Markets Can Remain Irrational Far Longer Then You and I Can Remain Solvent (John Maynard Keynes).
***Now let me pose a THEORETICAL QUESTION: If the Fed Chairman presents the looming “Fiscal Cliff” as a severe problem and the failure of Congress to deal with the issue forces the FOMC to embark upon a round of open-ended, hasn’t the FED in fact encroached upon the realm of FISCAL POLICY? (Of course, just theoretically.)