FOMC Message Carries More Bark than Bite

June 20, 2012

The Fed did less than hoped.  Operation Twist was extended for 6 months beyond the original 9 months.  This is the strategy of lengthening the maturity of its balance sheet in a sterilized way that doesn’t actually increase the asset total.  The idea is to reduce long-term interest rates.  Ten-year Treasury yields are in fact 27 basis points lower than at the end of 3Q11, consistent with the intermediate objective, but growth in jobs and GDP haven’t done well these last three quarters.  Employment rose 2.1% annualized between end-3Q11 and end-1Q12 but by just a third of that pace over the first two months of this year’s second quarter.  GDP climbed at a 2.4% annualized pace over the last two calendar quarters but likely will do worse in the second quarter of 2012.   The FOMC’s statement downgrades assessments of employment growth, unemployment, and consumer spending.  Inflation in coming months is seen tracking lower than imagined before.  Bernanke in Q & A spoke of potential drags from the European crisis and approaching U.S. fiscal cliff.  He said housing still isn’t providing a typical recovery boost and observed tighter credit for mortgage finance. 

The Fed had other options.  Bernanke said they will be used if needed but didn’t spell out how much more evidence of worsening trends is sought to trigger a more forceful counter-response.  An element of bluffing is possible, and certainly it is reasonable for some investors to draw that conclusion even if it overstates the element of policy intimidation.  Since monetary policy impacts with a long and variable lag, one can infer that more stimulus becomes overwhelmingly necessary, it will arrive too late. 

The Fed’s forecasts signal mounting worry.  Projected GDP growth in 2012 was cut by 0.5 percentage points in spite of a substantial decline in oil prices.  Growth next year was sliced relative to forecasts made in April by 0.3-0.5 percentage points.  Unemployment in 2014 was bumped up 0.3 percentage points to a range of 7.0 – 7.7%.  That roughly 1.75 percentage points above the long-term trend.  The two new Board Governors since the prior meeting appear to think the most appropriate timing of an initial policy firming is in 2015, lifting the total number of FOMC members to six with that view, just one less than the total preferring a timing of 2014.  By comparison, just six members think a tightening should occur no later than end-2013.

Criticism of the Fed for not providing more support centers around a perceived inconsistency between voiced alarm and forthcoming action.  A core principal of central bank independence is a belief that officials will do what they believe is best for the economy. Fed credibility is hurt if it appears that officials would like to pursue one course but for whatever reason do something else.  Central bank transparency in turn suffers if the central bank talks one view but pursues a different path, and investors conclude that they are being played by monetary officials, who are vocalizing a message in which they really do not believe but in fact predisposed to following a different course from belief that markets wouldn’t handle the truth well.

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



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