When Humphrey Met Sadie and What the Fed Wants Us to Know

February 29, 2012

Federal Reserve Chairman Ben Bernanke gave Humphrey Hawkins testimony before the House Financial Services Committee on this Sadie Hawkins Day of 2012.  The dual references to Hawkins, one for the testimony and the other for the day, are a curious happenstance.  The testimony is called Humphrey Hawkins for the two sponsors of the 1977 Full Employment Act that among other things obligates the Fed Chairman to testify twice each year before both the House and Senate on the economy and Fed policy.  Augustus Hawkins was a congressman from California, while Sadie Hawkins is a fictional character from Li’l Abner.

Be that as it may, long before this era of overt Fed transparency, Humphrey Hawkins testimony provided a rare window through which to peer into the thoughts of America’s lords of finance and perhaps glean insights into their plans.  In that era of intentional policy deception, Fed chairmen were famous for revealing as little as possible during long hours of testimony. 

So what did Fed officials want us to learn today?  Fitting for the once-in-four-years occurrence of Sadie Hawkins, they had not one, but two, cracks at sending a message, first via Bernanke’s testimony and then from publication of the Beige Book, a compilation of regional economic trends.  Most of the lessons had been delivered already, but repetition doesn’t hurt to refine and reinforce the message.  Here are ten elements.

  1. Policy continues to be guided by levels more than changes.  The level of unemployment is more important than how fast it’s falling.  Inflation has risen but remains lower than desired and likely to remain so during the policy horizon.
  2. The Fed has quantifiable and publicly revealed targets for employment and inflation against which conditions are measured.
  3. Within this framework, it is not inconsistent to run an ultra-accommodative credit stance while the economy expands and amid diminishing near-term risks of deflation.
  4. The U.S. economy still has loads of slack.  The long-term central tendency of GDP growth is 2.3-2.6%, but output grew 1.6% over the past four quarters and 0.6% per annum during the last five years.
  5. The economy is in its eleventh quarter of recovery, yet the pace of expansion is very uneven across regions and sectors, and it is associated with heavier downside than upside risks.  The Beige Book characterized the expansion as modest in some areas and no more than moderate in the rest.
  6. Unemployment of 8.3% versus a long-run goal of 5-6% remains too high and will fall unacceptably slowly given the growth prognosis.
  7. The core personal consumption price deflator, which is optimal when at 2.0% and likely to remain near that target, rose 1.8% over the last four quarters but at an insufficient 1.4% per annum pace between 4Q08 and 4Q11.
  8. Core inflation tends to accelerate persistently when productive resources are fully employed and demand is rising faster than its long-run tendency.
  9. Neither of the conditions in point number eight are currently being met, and the stretched size of the central bank’s balance sheet only poses an upside risk after excessive bank lending is observed.
  10. Headline inflation may climb in the near term because of commodity price pressures, but the increase is unlikely to be permanent because of the economy’s slack and in the face of well-anchored price expectations.

From these points, I infer the following.  Officials seem comfortable with the status quo.  The current phase of Operation Twist, which is lengthening the average maturity of the Fed’s balance sheet and providing support for the housing sector in particular, will not be completed for four more months.  That’s plenty of time to assess price, housing, and labor market trends.  Considerably more about the future will be known in June than now, and a decision does not need to be made soon on whether to undertake further accommodation after midyear.  The recovery process is not proceeding as rapidly as officials wish but fast enough not to rock the political boat with another policy modification at this point.  Politics in this context does not refer to November’s election or to differences between what the main parties favor.  Rather, it is an acknowledgement that the Fed has plenty of opponents and mustn’t jeopardize any additional goodwill by taking actions that monetary officials aren’t convinced are absolutely necessary.  The spring will be a time of waiting and watching.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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