Fed policy statements compared-June and July

Fed policy statements compared

Big surprise comes in small revision package

The chart below is the most important new piece of information we had on the economy in quite a long time. Released today ahead of the FOMC meeting or as it was in progress. It shows that the economy was relatively stronger in 2012 than we thought and that the deceleration in the 2013 is much more severe than what we thought. As such it would be surprising if the Fed did not become more concerned about its projecting that the job market is going to do better since over the last 24 months private sector job growth has averaged 196,000 persons per month. When the economy was going 3% that made sense, now that the economy’s year-over-year growth rate is under 1.5% it would be prudent to question if such job market growth can continue. Yet, the Fed did not go there today. In fact, it seems to have gone in the opposite direction.

 

Economists are being raked over coals frequently for their microscopic parsing of the changes the Federal Reserve statements. However, when the Fed makes the kind of very small changes from statement to statement you’d be foolish to not realize that the Fed is trying to communicate something to us. In the second paragraph the Fed makes what appears to be an extraordinarily small change in language which seems to have a relatively large effect on what the paragraph means.

 The Fed used to say that it anticipates inflation will grow ‘at or below its 2% objective’. However the Fed has been under pressure from James Bullard who dissented last meeting but did not dissent at this meeting. He had urged the Fed to not ignore the inflation undershoot and risk from it. So interestingly, this month the Fed changed the language, it now reads as follows: The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

I have to say I find this change disturbing. The Fed seems to have changed its forecast or assessment of the economy for the sake of creating language that removes Bullard’s dissent. The Fed language now says that it realizes that inflation persistently below 2% could pose an economic risk, acknowledging the criticism that Bullard launched at the last meeting, but sets it aside by saying that it expects inflation will move back towards its objective over the medium-term. That does take-care Bullard’s criticism and also the concerns and I had registered in line with Bullard’s criticism at the last meeting. However, it’s completely different from saying that it expects inflation to remain at or below 2%, also over the medium-term…which is what the passage used to say. Which is it? Does the Fed really believe inflation will stay below 2% or go back up to 2%?

I believe this is the first time in a long time that we’ve caught the Fed red-handed, with hand in the cookie jar. The Fed has just changed some language and it’s totally changed the way it claims that it sees the evolution of inflation. This plays into our worst fears: that the FOMC policy statement is a statement intended to justify whatever policy the Fed wants to implement rather than laying out a true roadmap that it intends to follow and to be governed by. That in fact was essentially the gist of the Bullard criticism last meeting.

In the fifth paragraph the Fed makes the following change in language which is an extremely small tweak with another big impact: “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens”.

The highlighted yellow language replaces the word “expects”. Why would I make a big deal out of that? Of course it is a big deal! It’s a big deal because the Fed made the change. Look at how little of this statement was altered! Why would they make THAT change? Clearly the Fed thinks it is significant to say that it ‘reaffirmed its view’ rather than to say that it ‘expects’. The Fed apparently now has a view that does not reflect its expectation! And, oh, does that make MY head hurt. I really don’t want to haul out my dictionary or find someone with a PhD in English to carefully ‘Splain’ to me like Ricky might to Lucy what this means. It seems clear that the Fed has had another FOMC mud-wrestling match that has resulted in the English language being taken to the mat. And now it appears that there is more dissent within the Fed about keeping this highly accommodative stance of policy for considerable time after the asset purchase program ends. Why else would they change the language?

Does this mean that forward guidance is being attacked from within? What else could it mean? Isn’t this view the whole notion behind the extended accommodative forward guidance the Fed has?

Put on your thinking cap! Something is afoot at the Fed. Policy is hanging by the thinnest threads of hair splitting verbiage. And you thought that you needed to know ‘math’ to be an economist! A PhD in English might help- or not. It makes me wonder if Plosser, George, Fisher and Lacker are drawing support from other members of the committee. Also I wonder if Bernanke is losing influence now that he is being made a lame duck by Obama. This, of course is not evidence of Yellen gaining since this is a shift away from her desired policy. I wonder if Yellen is being handcuffed by the fact that she is under the microscope as a potential Bernanke successor?  The Fed, and its balance of power, appears to be in play.

Minutes from June 19 2003 Meetings

Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.

No Change

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was James Bullard, who believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

Minutes from July 31, 2013 Meeting

Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

No Change

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

Why is policy being run by morons and Bozos? Yes bipartisan BOZOS no innocents here

The real policy dilemma

When you follow policy issues and hear someone say were going to talk about the real policy dilemma you probably think in this environment it's going to be something critical about the Federal Reserve chairman selection process. That process has devolved into a name-calling credential-comparing circus largely involving Larry Summers and Janet Yellen. There's very little in the way of substance other than the name-calling that brands Summers is an egotist and Yellen as a policy dove. Could their whole careers really be boiled down to be as simple as that? And while that is something that bothers me it's not my point.

So next, you probably think it's about fiscal policy. Long-term fiscal policy remains a mess current tax collections have stepped up causing the recent budget deficit to shrink more than expected and as a result the President is no longer aiming at any kind of budget reduction. The Republicans are still concerned about the long run budgetary consequences. While I am concerned about fiscal policy and I think the long run is a mess, that's not the issue I'm after either.

I'm after the neglected and not well understood problem of why the economy has not been able to get a real recovery going. And, curiously enough, that's not substantially about either fiscal policy or monetary policy.

What it's about is US-  United States' - competitiveness.

I am more than a little concerned that people including some economists are focused on the energy finds in America and think that this will be the basis for an improvement in our manufacturing sector and in our competitiveness. I'm quite concerned that if we are able to develop this energy-find and that if it does help to lower energy costs, that will simply compensate for the higher costs of doing business we have elsewhere. Then, when our energy largess runs off we will find that we haven't addressed the underlying problem at all. And that's the real problem: why we are not competitive.

Developing domestic energy has contributed to some improvement in the US balance of payments. As the economy has grown we have not sucked in as many oil imports as we would have without the improvement in domestic energy production. But our trade deficits remain large. They are large as a percent GDP. We are still looking at better than 30 years since the US has had any kind of a significant surplus on our current account.

How will we ever get back to surplus or balance?

Looking at a nation's welfare, monetary economists look at the terms of trade. The terms of trade refers to the ratio of export to import prices. That ratio reflects the terms under which trade is conducted. The higher are export prices relative to import prices the more export earnings are able to pay for our imports. On the other hand when import prices rise relative to export prices imports become relatively more expensive and are an added burden on the economy's balance of payments.

But that only looks at the price ratios. And what's interesting is that in order for exports to be competitive prices have to be low compared to global competition. So while we might want export prices high because they represent increased purchasing power from the exports we sell, set export prices too high we might not sell anything.

In a nutshell that describes the allure as well as the peril of a too-strong dollar. Over the last 20 to 30 years, as Asian economies have hyper-developed, they have focused more on using exports as way to stimulate domestic economic growth. They have focused more on the potential to increase export sales, and export sector employment because of increased export sector output than they have on trying to get the most for the exports that they sell. This is somewhat less than profit maximizing behavior but you can see the tremendous growth it has fueled in Asia as country after country has tapped into the domestic demand in the United States and in Western Europe. Instead, of having to balance their own economy with supply and demand they have been able to hook their export stream into one of our able-bodied arms and drained off some of our lifeblood like a donor participating in a blood drive at the Red Cross.

Only have more or less watched this happen and let it go. Republicans have watched it. Democrats have watched it. No one has really been too worried about it. American companies, instead of moving out of the industrial North into the right to work states in the South, or, instead of migrating jobs south of the border to Mexico, have picked up factories lock stock and barrel and located them in Asia where wages are even lower. And because these corporations are powerful I think they've had a substantial effect of keeping American politicians quiet. 

This is been done in a system that has masqueraded under the mislabel of floating exchange rates buttressing free trade.

Exchange rates in fact have been very controlled by the countries in the pursuit export led growth. Asian countries have stockpiled foreign-exchange reserves which is the price they have had to pay-to keep buying excess dollars-in order to keep their currencies from running up as they sold more to the US than they bought from it. And when exchange rates are determined by governments rather than by markets you do not get a free trade result.

We can see that clearly in the United States where current account deficits, raw deficits, or deficits relative to GDP continue to be huge and surpluses are scarcer than hens' teeth. 

This is not a result that emanates from free trade. This is not a result you expect if you have freely fluctuating exchange rates. This is a result you would never expect if you had a gold standard and if the countries that ran persistent current account surpluses were amassing gold reserves that they were taking from you - YOU!. Could you imagine the US allowing China, Korea, Taiwan, and earlier, Japan to have accumulated so much of our gold under a fixed exchange rate system?

Under a fluctuating exchange rate system current account balance is supposed to be restored as a country were running a surplus is supposed to see its currency rise. The country running the deficit is supposed to see its currency fall. This more or less automatic market mechanism has been undercut as export oriented countries have continued to buy the dollars to keep the dollar stronger than it should be so that they can maintain a competitive advantage and continue to pump their export goods into the US market.

Economists have largely been blasé about this effect. Many have argued that were getting real goods and the exporters are getting only pieces of paper. True. But these pieces of paper represent payments that we owe to them while our exports are nowhere close to earning the revenue we need to pay them back. 

No one seems focused on this problem. No one seems to be aware that it even exists. However, I'm very concerned that it is what's at the bottom of the growing inequality in America. And that's a big problem because the President is talking about how he is trying to fashion policy initiatives to solve the problem and one of the things that he wants to do is to draw targets on the back of rich people. Does that even make sense?

I international trade there is a very elegant two-factor model called the Heckscher-Olin model that describes comparative advantage and other conditions tha arise when nations trade.  Trading nations use two inputs, call them labor and capital, to create their output. One of the implications of this theory is that you'll get something called factor price equalization even if only one of the factors of production is mobile. Not both of them, just one of them. 

Factor price equalization is just what it sounds like. It means that the factor prices referring to the return to capital and the return to labor will be equalized between the trading nations under conditions of free trade even if only one of the factors of production is mobile. And we have seen how much capital has been able to flow to Asia – most recently to China – making it quite clear that capital is internationally mobile.

It's not much of a stretch to argue that what has happened is since Nixon opened China and since China has developed and capital has poured in is that the process of factor price equalization has been set in motion. And with wages in China so low is it surprising that wages in the United States have not been rising?  or tha real wages have been eroding? Or that unemployment is high and stubborn? Is it surprising that the return to less skilled labor has been held in check? Is it surprising that more skilled laborers, that entrepreneurs, that people with business talent, have been relatively better paid in a world where the pool of unskilled labor has expanded so sharply and skilled labor is relatively scarce?

I think the President has sunk his teeth into an issue that isn't what it seems.

Blaming rich people a.k.a. successful people for being successful is not really the issue here. I don't mean to protect those whose compensation packages have gone to the moon. But the main point here is that there has been a real wedge driven between skilled and unskilled labor by international trade and it has to do with trade rules that do not conform with the principles of free trade and with an exchange rate system that in no way supports what academic models of free trade really address or suppose. 

And because corporate America has largely learned to benefit under this system and can earn its profits either here or there, it has been effective in keeping both political parties from attacking this model. It hasn't just been the fear of attacking China that has kept politicians at bay it has been corporate America. But this model is destructive and it's doing destructive things to America and no amount of education, or, investment, or jaw boning about the rich taking advantage of the poor, is going to solve the problem. Because the problem is emanating from an economic system that is in place and that continues to pump out the same results year after year.

It's not going to stop because you elect a Democrat President. It's not going to stop because you elect a Republican President. And its not going to stop unless you elect someone who sees the problem and vows to fix it. And right now that person doesn't exist.

The closest we have (had), actually is Mitt Romney who saw trade as a big problem. And although people are fond of making fun of Mr. Romney and have his indecision about whether he's a conservative or moderate his position on this issue seems to be the most enlightened one among any recent political candidate. His unearthing of the 42% figure is one of the most astonishing things in American politics that has ever been uncovered and promptly swept under the rug. 

Romney discovered and made it known that fully 42% of our population that filed income tax returns was paid so poorly that it did not pay any federal income tax. Democrats came to their defense, arguing that the people pay property taxes and sales taxes and FICA and other taxes. But at the end of the day so does everyone else. Republicans backtracked on the issue a little bit because the point seemed somewhat mean-spirited to go after people on some of the welfare programs who clearly were needy.

But both of those reactions miss the point. The point of the 42% figure is the 42% figure! I don't glorify it; I don't disparage it. I simply look at it. What it says to me is that every politician of every color, of any partisanship that has held any office in America recently has been part of an abject failure to the American economy and people. When the economy turns out jobs that are so bad that so many people can't afford to pay federal taxes that's a travesty. It's a failure of everyone who's been in office. It's a failure of the Democrat model. It's a failure the Republican model. It's a failure of our system of democracy.

There is no one in American politics today that is committed to fix this problem. The President's idea is to tax the rich. Does it make sense to tax the 58% that already are paying all the taxes to have them funnel more money to the 42% who are paying no taxes? I mean they are wealthier but does this really make sense? When more people show up to the party do you cut the pizza slices in half or do you order more pizza?

The President wants to cut pizza slices in half. I want to grow the size of the pie. 

To do that we have to improve the competitiveness of America. And that is certainly going to step on the toes of some of the people who are currently successful under the way the economy currently is running.

It's quite clear that one of the big problems would be swept aside if countries could be forced not to stop running persistent current account surpluses. When the dollar is the reserve currency and countries target their exports on the US market and target their bilateral exchange rate in order to effect their trade objectives the dollar winds up being higher than it should. The US current account deficit is bigger than it should be.  And it stays there persistently. Capital flows continue coming to the US as foreigners purchase dollar assets in order to peg their currencies low and keep the dollar strong. The advantage is that the dollar has stronger purchasing power than it should. So people with jobs are able to purchase goods from abroad cheaply. But because the dollar is strong there are not as many jobs and there are more people who go looking for them and are unsatisfied.

That's exactly where we are today. Many economists do not see the exchange rate as the root of this evil. But I do. And, there such an elegant logical case to explain and justify it in the realm of conventionally known economic theory.  I just don't see how you can dismiss it except to say that people don't want to deal with it. US corporations don't want to change it. US politicians do not want the confrontation. And, in fact, it is much more lucrative for traditional Democrats and Republicans to point the finger and blame at the other guy for the problem.

International cooperation and reform is always hard to come by. One of the fundamental asymmetries in international trade is that it's always the deficit country that's forced to adjust not the surplus country. And as long as the dollar is the reserve unit other countries will peg against the dollar and the US will not be able to peg against them. So countries that choose a weaker exchange rate will be able to attain it. But that doesn't mean that the resulting US current account deficits won't become threatening or damaging either to the US or to the world economy.

We can see from the last G 20 meeting that there is no taste to handle any of these problems having to do with trade warfare or formulating a better international currency system with any sorts of rules or obligations. 

To the extent that the US is adjusting and containing its deficit, as it is one of the deficit countries, it's because of the high debt that is crimping consumption. US consumers simply can't spend money the way they used to. It's because of the lack of competitiveness has led to a high rate of unemployment. And now with financial institutions somewhat beleaguered, they are lending money much less readily so that debt-fueled spending cannot be sustained by the consumer. The development of a domestic energy resource has allowed relatively more the US energy demands to be met by domestic output. But all of that is essentially a passive a reactive adjustment rather than the kind of proactive pro-growth sustainable adjustment that the US economy needs.

In fact the debt problems in the US and in Western Europe finally are affecting China, causing it to change its export-ed growth model because it can't export the way it used to. China has been forced to develop its own domestic demand which means it's going to have to actually pay its workers which means it will have to undercut its own competitiveness in order to fuel its growth. There may be some limited opportunity for China to try to keep wages low in export industries and raise them elsewhere but that's only a partial solution since China cannot continue to export as it used to. Europe simply can't continue to absorb goods at that pace either. China has some of its own  debt worries to face too, as it tries to achieve a more balanced and sustainable basis for growth.

But it should be clear as I describe this situation, that what has happened is that these pronounced systemic imbalances have caused countries to do things that have stopped what I would regard as the madness of their past policies. 

This is not an enlightened approach to a problem that's been discovered. This is a problem that has been dealt with because of systemic repercussions through an unregulated blow back.

This is exactly what the late economist Herb Stein used to refer to when he used to say don't worry if the situation is unsustainable because, if its unsustainable, it won't be sustained! But of course the repercussions of not dealing with problems that we can see are festering and that can't be sustained is that they will remedy themselves in a way that might be even more painful. And that should be a lesson for our politicians except they are too busy fighting one another and setting the other one up as the straw horse that you should fight against – or vote against.

Within the European Monetary Union Germany has been accused of using the same tactics.... of having essentially a fixed exchange rate system and of running inflation rates that are so low that its competitiveness improved compared to everyone else in the system so that Germany came to dominate the European Monetary Union as its most competitive economy and did so largely by restricting the rise of the compensation to labor. German labor acquiesced to this largely because Germans were willing to forgo improvements in their standards of living in order to get assurances that inflation would be kept under control having developed an extraordinary distaste for hyperinflation during the interwar period.

But whatever the reason or whatever the tactic, allowing countries to pursue export led growth is a bad idea. Allowing countries to accumulate ever larger foreign-exchange reserves so that they can peg their currencies to achieve trade objectives is also a bad idea. And at some point it's an idea that will have to be put to an end.

Because of the last financial crisis and the problems that it's created with world banking system problems and the repercussions for policymakers everyone is distracted looking at the minutia of how to recalibrate international banking laws to make the banking sector say for the economy. In Europe there's a focus on debt and how to reduce debt and how to keep the European Monetary Union together. In the US there is is hand wringing about the policies of the central bank, about fiscal policy, about too big to fail and other aspects of bank regulation, and about class warfare... but mostly it's about Democrat-Republican issues. They keep us so busy we can never look at the real problem. 

The real problem is how can we make America more competitive? The real problem isn't how can we blame the rich and pry more money out of their pocket. The real question isn't, are the people poor because they deserve it? It's hard to argue that 42% of the population deserves it- isn't it? Clearly there something systemic that's wrong and our policymakers are pointing their finger's in the wrong direction.

Will anybody figure it out?

Before it's too late?

Clear communication at the Fed: The impossible dream?

Clear communication at the Fed: The impossible dream?

The Wall Street Journal has a new article on the Fed and how it intends to try to improve its easy money communications policy.

Fat chance.

http://online.wsj.com/article/SB10001424127887323971204578628090326782804.html?mod=WSJ_hpp_LEFTTopStories

Let me try to make this as simple as possible. 

The Fed will never succeed in making its communications clearer or even understandable because its policy is inconsistent and in fact involves basic contradictions. Even if it confronts that, it will not be able to make its policy choice clear..

'Forward guidance' is the first oxymororn in the Fed's arsenal: The Fed has offered us several different kinds of' forward guidance'. It has said that it will keep interest rates low for an extended period of time. It has said it will keep interest rates low essentially at zero until a specific period of time. It then changed that point in the future to which it promised to keep interest rates that low. And, recently it has replaced this policy with something new called 'forward guidance' that offers a profile for the Fed funds rate - a very specific profile. 

Now, here comes the 'Magic'

On one level the Fed calls this 'forward guidance' that is supposed to help us make decisions about the future because it has laid out this futuristic yellow brick road for us to follow.

The contradiction is that even this 'forward guidance' is of a conditional nature and not what it seems. The Fed is not pledging to keep interest rates on this path, it is simply saying that it's the Fed's most likely view but that if the economy turns out to be different than policymakers anticipate POLICY will be different too- but it downplays that potential fork in the road. 

In other words the Fed's 'forward guidance' doesn't seem to be any different than the typical economist forecast which says well on one hand this could happen on on the other hand that could happen. The Fed wants us to focus on 'this' hand and on 'this hand' only.

But beyond that, anyone who has paid any attention to the Fed or to what I've written above, is aware that 'forward guidance' should come with a subscript: the letter "t." This is because the the Fed's 'forward guidance' is only the Fed's 'forward guidance' that exists at a particular period, t.. And as we can see (and have seen, in fact) the Fed already has changed the nature of its forward guidance several times in the past.

So since the Fed's 'forward guidance' that it's offering us now, admittedly is conditional, and since the Fed already has exhibited substantial changes in the way it's characterized its 'forward guidance' in the past, why should we consider 'forward guidance' a tool at all - that is other than a broken tool? And, how can the Fed possibly change its communications to make this oxymoron clearer – that is unless it were to give up on the idea of 'forward guidance' altogether?

When Mario Draghi tried to adopt forward guidance at the European Central Bank a day or so after he expressed his intention to keep interest rates low for an extended period of time using almost exactly the old language that the Fed had used, Jens Weidmann, head of the Bundesbank, said quite specifically that 'forward guidance' would not keep the ECB from raising rates if monetary policy rules and price stability required it.

So what good is it anyway? The ECB exchange cuts right to the quick of it; doesn't it?

There is nobody at the Fed issuing this kind of blunt clarification or countermanding statement to Fed Chairman Bernanke. But it should be quite clear that the Fed is trying to deal from the top of the deck and the bottom of the deck at the same time. And this is why its communication message goes astray.

There may be some academic framework in which 'forward guidance' has some application and in the end can work. I suppose if you and pose the idea that 'forward guidance' exists and has credibility you can move ahead to solve equations based upon its existence. But in the real world the Fed cannot really provide true 'forward guidance'. In the real world 'forward guidance' is necessarily conditional and once 'forward guidance' is conditional it ceases to exist or to be useful or evento be guidance (it might well be misguidance). 

Moreover, once 'forward guidance' has been offered in the past and has changed it undermines the impact and the potential usefulness not to mention the outright lack of veracity in trying to use it EVER again.

Except to this Fed...

I think that the Fed has an intellectual model of 'forward guidance' that is inapplicable to the real world and it doesn't understand that. I think when we recognize the intrinsic pitfalls of the policy of 'forward guidance' outside of an academic framework we begin to understand why the Fed communicates its policy intention so badly.

Problems beyond forward guidance and its flawed yellow brick road

In addition to all that messiness, we have the other wishy-washy aspects of Fed policy that have to do with an unemployment rate threshold that is not a trigger and may not be meaningful whatsoever. And as the Chairman begins to wander off into that weird Wonderland of guidance that once again doesn't exist (telling us what may happen when/if unemployment goes below 6.5%) it's no wonder that people get confused. On one hand the Fed seems so eager to please to provide us with benchmarks but on the other hand it recognizes that it can't provide us with benchmarks unless it's sure that they are going to serve the stated purpose it wants to put them to. At that point the Fed confronts a dilemma.So it has given us meaningless numbers!

Therefore, every time the Fed tries to tell us something that's very specific it winds up having hedge it with caveats and conditional statements that have to be elaborated and clarified at a later date. This is why Fed communication strategy can never be successful. It's just not possible.

This all traces back to Ben Bernanke embracing the dual mandate with a two-pronged objective. Even Yogi Berra knows that when you come to the fork in the road, you should take it. Not Ben. He wants them both.

The Fed has long had this same policy mandate but under Paul Volcker and continuing under Alan Greenspan the Fed had argued that it pursued its goal of maximum sustainable growth best when it achieved price stability.In that it successfully had hammered the two tines of that fork into a single cutting edge. But Bernanke unbundled the strategy to reveal two separate prongs of short run objectives. He brought open conflict back to policy. 

He opened a can of worms, worms that continue to crawl across the table at the FOMC each meeting. These worms are not trained nor controllable and they continue to be the basis for the Federal Reserve trying to give us guidance on policy that simultaneously tugs it in different directions.

To make matters worse the Fed seems to have its own separate judgment or conscience working in the background apart from its stated policy metrics. The Fed seems to be wary of the size of its balance sheet at long last and wants to address that even though its policy metrics do not conform to that desire  

So right now even with the unemployment rate well above the Fed's threshold level of 6.5% (whatever the heck that means) and with inflation under-shooting its long run target (2%) and even decelerating, the Fed Chairman is trying to point everyone to the prospect - in fact, what he deems as the likelihood- of the Fed trimming back on its quantitative easing later in the year.

That seems to be 180 degreees wrong, doesn't it?

To justify this at the last meeting's press conference the Fed Chairman finally told us that the factors that govern quantitative easing are different from those that govern the Fed's ordinary policy, effectively trying to drive a wedge between the fact that the factors governing ordinary policy are calling for the Fed to ease further while the Fed is trying to guide us toward a policy that will see it easing by less using QE. (All this completely ignores the fact that QE was adopted to solve the Zero Bound issue and was viewed at first as an extension of the Fed funds policy. So why QE forces now move it in the opposite direction of the Fed funds rate's governing forces is no small trick)

Only Jim Bullard among FOMC members seems to be bothered by the fact that the Fed's inflation objective is calling for it to do something very different from what it's doing.

As you can see I think the main problem with Fed policy has nothing to do with economics and everything to do it logic. Any logician could look at this and understand the conflicts inherent in what the Fed is trying to do.

The Fed by this time has drunk too much of its own Kool Aide and cannot see how foolish its own policy really has become. 

When I was a youngster I remember learning the meaning of the expression that 'you can't have your cake and eat it too'. I think it's an expression that the Fed needs to confront and come to an understanding about. Because, when it comes to 'forward guidance' the Fed very much wants to have its cake and eat it too. It wants that in many other aspects of policy as well as I hope I have made clear above.  

At least I hope it is clearer than the Fed's communication policy. And I hope it clarifies the problems with the Fed's communications policy.

 

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