Bernanke Press Conference Leaves Me with an Unsettled Feeling

June 19, 2013

I’m a fan of the Fed Chairman.  Under extraordinarily difficult circumstances, his policy instincts contributed critically to the United States weathering the past decade in better shape than other developed economies, meaning faster growth, lower inflation, lower unemployment, a greater drop from the crest of unemployment, a faster drop in the fiscal deficit-to-GDP ratio, and a current account deficit that’s stabilized at manageable levels rather returning to pre-2009 highs.

I was disappointed with today’s press conference and am not surprised by the adverse reaction of stocks, bonds, and the dollar against most currencies but not the yen.  The questions missed the point in many instances, and Bernanke did not make a credible case to prove his main point, which is that future policy will be entirely dependent on real economic data trends and how the Fed’s expectations about future trends evolves, which hinges critically on how financial markets respond to perceived changes in the Fed’s stance.  If Bernanke had convincingly made that point, Bloomberg would not be leading with the headline at this moment, “Bernanke Says Fed on Course to End Asset Buying in Mid-2014.”  Somewhere in his narrative, Bernanke should have found a way to add that if long-term interest rates remain on their recent trajectory — a rise from 1.62% to 2.35% in just seven weeks (more than 500 basis points is the pace is sustained for a year) — then its current expectations about growth, inflation, and unemployment will be far too optimistic and that of course QE will inevitably be needed well past mid-2014. 

The real question that never got aired at the press conference should have zeroed in on what U.S. growth and unemployment might currently be if Fed policy were back to a neutral setting, that is neither augmenting nor constraining economic growth.  With a 2% inflation target and a 2.4% long-term non-inflationary rate of growth, a neutral policy would exist the federal funds rate lies between 4.0% and 4.5%.  Fed officials would presumably say that in order for policy to be neutral, one would ideally like to see the balance sheet trimmed down.  Whatever, no sense was given about how dependent is the economic expansion on Fed stimulus.  If the recovery is entirely dependent on the Fed (that is, if a neutral policy correlates with a contraction of GDP and rising unemployment), it would become quickly apparent that the economy can’t handle tightening, and that effort would soon be aborted and possibly reversed eventually.

The car accelerator/brake metaphor has a flaw.  If less pressure is applied to the accelerator, the motor vehicle isn’t going to maintain speed unless its traveling downhill, which in the U.S. is not the case because fiscal policy happens to be quite restrictive.  So winding down quantitative easing has the same effect on growth as as raising interest rates.  In both cases, all other things being the same, activity proceeds more slowly than if monetary policy were left as it is.  In fact, winding down quantitative easing impacts market psychology instantly, and a rise in long-term rates results.  This has happened recently in the U.S. and in other economies where tightening is anticipated. 

Bernanke’s response to inflation that has moved lower seemed lame.  A literal interpretation that policy is being driven by deviations of employment and inflation from its mandate, as Bernanke and other Fed officials profess, would suggest no more than a balanced approach to policy risks.  In the Fed’s theory that ties policy to the stock of its asset holdings rather than the rate of change in that stock, it still suggests doing no less than maintain the status quo, which involves $85 billion per month of quantitative support, since that level of support is now equated to steady overnight rates but rising long-term rates.  That’s a state of tighter monetary conditions.  So is having a firmer dollar.

The Chairman did his general credibility a disservice by ducking questions about his personal plans.  Bernanke leads the dovish faction.  If he is replaced by someone who must be confirmed by the Congress, policy will end up tighter than otherwise.  And to equate the Jackson Hole conference to any of the ones sponsored by other Federal Reserve districts is an obvious misrepresentation of the truth as the markets see things.

It seems that in a sense Fed policy has reverted to the good old days, when there were no press conferences, no statements, no timely release of minutes, and not even an acknowledgement at the moment that policy was being changed.  Ultimately, what the Fed does is decided by what happens in the economy, which the private sector sees with help from government officials.  Why go through the charade of all this communication mumbo-jumbo?

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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