Back to the future with the Fed
The Federal Reserve is at it again. We now know another round of ‘QE’ (quantitative easing) is in the pipeline even though the FOMC and Board of Governors have not met to approve it. Apparently it is a done-deal and the ‘stimulus’ will be parceled out in batches instead of in one giant slug. What is its objective? How is it supposed to work? What are the risks? Sadly, the Fed has told us little about these things and it will suffer for those omissions.
Too-much is not enough? The Fed has done QE before in this cycle and now we are to have more of the same. Banks already have many billions of dollars in excess reserves and the Fed leaves unexplained how more are supposed to stimulate the economy. I guess this is a case of too-much not being enough. Perhaps the real idea is not what is happening on the reserve injection side but what is happening on the ‘other side’ of this transaction that enables reserve injections, the asset purchase side. To inject reserves the Fed must buy (or accumulate) assets. If that is the case we could argue that this action is more like fiscal policy in disguise than like a monetary policy action. Altering the stocks of assets in the economy is playing with fire. Traditionally the main impact of a central bank’s action has been its operations in the reserve market or in the interest rate market. Traditionally, the main concern with asset stocks has been that they be liquid enough to permit reserve injections or drains without disturbing markets. The Fed policy seems to have turned this upside down- a position many homeowners with mortgages can readily appreciate.
Don’t capital flows trump reserves? If the Fed’s idea is that asset purchases can make a difference, then why not just wait? One of the biggest asset purchase programs of all is already in force. Here I refer to the huge US current account gap. Each month billions of dollars of capital flows surge into the US. That capital needs to go somewhere. These are not funds swimming around in some ‘reserve pool’ locked away by banks, earning a return paid by the Fed and held in ‘excess.’ These are real monies being invested in the active economy. If these can’t stimulate the economy how will the Fed’s behind the curtain flows do it when reserves already are being hoarded to such a degree?
Playing a new game or not? The new reserve injections planned for QEII do not really matter. They do not change the game. If the economy (banking system) reverts to normal times the reserves currently in excess are plenty of kindling to start a fire under the economy –in fact one that would be too hot. The real objective of QEII is to play with this fire and to reduced the stocks of certain assets in the economy to gain some policy traction. The Fed’s idea is to convince market participants that the Fed is playing a new game. But, this game is a chameleon. The Fed calls it ‘end deflation now’ but it is more famously known as ‘start real inflation now’ and it spawned another game years ago called ‘whip inflation now’. The Fed uses only one of these names, but it’s the same game-board. QE is such a crude tool the Fed cannot fine-tune it and assure us that game-one won’t morph into game-two. Yet, the Fed wants to convince us that it is being responsible and that its plan will ‘work,’ ignoring this very important complication. Doesn’t that undermine Fed credibility?
Consuming credibility – Credibility is not a consumption good for a central bank; when it becomes so, it is in especially short-supply. I find these Fed actions surrounding plans for QEII inconsistent with the Fed’s promise of conduct; these actions have become a drain on Fed credibility itself. The Fed’s ’mandates,’ to which it very oddly referred in its last public policy statement, are not the issue. The issue is the Fed’s own conduct measured against its promise to us about how it would act. The Fed no longer is transparent. Its policy is opaque. Policy decisions are being spoon-fed to us by journalists instead of after FOMC meetings or in speeches after a decision is made. We are now informed by leaks or ‘scoops’. The Fed’s policy tilt is being announced to us by consulting economists with inside access before the policy has been formally announced to the public! The Fed is losing credibility as it is no longer truthful. It is not being candid about the risks of QEII and instead is overpromising its results; hubris is not an excuse for overpromising (and ‘overpromising’ a nice word for ‘deception’).
Shooting at a target or itself in the foot? In truth the Fed has no inflation target but it is playing fast and loose with the ‘forecasts’ the FOMC generates in calling inflation ‘too low’. These Fed forecasts (actually FOMC expectations which are presented in a range format) are not policy targets, they are forecasts. Even a long-run desired result can’t be the basis for short run policy although some Fed members have argued this in public. This sort of argumentation leads to more confusion about Fed policy and the role of its public ‘forecasts’. Early in his first term, Ben Bernanke and the Fed considered inflation targeting but could not get agreement, as Congress stood in the way. But the Fed spoke of an inflation cap like other central banks have of 2%. So how does 1% become too low? If 2% is/was the top of a desired range then zero is the bottom and 1% is the middle. How is 1% too low and how has 2% become the new minimum? How did it happen? What was the process? The Fed ‘forecasts’ do not help us here. Without targets the Fed cannot articulate its policy with precision. These sorts of changes appear as chaos. Is this another game of bait and switch using benchmarks that do not even have normal policy standing?
Shell Game? I see the Fed as engaged in another shell game of policy options like the one it pursued under Arthur F Burns with the many-money targets. Only the Fed knows why it is doing what it is doing. We no longer have intermediate targets like money supply growth ranges; we do not have inflation targets or ceilings like other central banks. We do have the occasional Fed ‘forecast’. The Fed’s credibility is its only credibility, if you will pardon that redundancy. But it is true. There is no process from which the Fed can draw credibility. That fact has become another big problem. Even if the Fed extracts us from this mess where does it leave us in terms of being able to trust our central bank? I ‘d say back in the 1970s.