FOMC Hangover

June 21, 2012

Press coverage of yesterday’s FOMC event agrees basically with my initial impression that less action was delivered than seemed warranted by the use of more dovish rhetoric.  Different explanations have been postulated to explain this disconnection.

  • Officials suspect policy stimulus has reached a point of diminishing net bang for the buck.  They suspect that more forceful actions like a third round of quantitative easing will lift U.S. growth less in the future than when used in the past, and they fear significant unwanted collateral damage.
  • Policymakers are divided on the need for further stimulus.  Europe’s crisis could resolve or get worse, so it’s best to wait and see how it resolves.  Similarly, U.S. fiscal policy prospects remain quite uncertain.  Moreover, the U.S. economy is still expanding.
  • Fed officials are intimidated by the rhetoric of Republican critics, who doubt monetary policy stimulus can improve unemployment but are convinced it will create much greater inflation.  Against a threat of actions compromising Fed independence, central bank authorities only want to act when it’s clear to them that a recession will happen if they do not act aggressively.
  • Trust that rhetoric is a cheap and equally effective substitute for action.  What counts is psychology.  Give markets the bone of Operation Twist, backed by the promise that willingness and ability exist to take stronger steps if and when needed.  One conclusion of this kind of thinking is that the central bank must give markets a gesture if that is what investors assume they will get.  Otherwise market fears become self-prophetic.

The above excuses are poor ones even if grounded in some truth

  • All evidence from America’s recent experience, Japan’s lengthier experience, and the Great Depression suggests that deflation is a greater danger than inflation.  America’s bout with systemically high inflation in the late 1970s was fanned by real GDP growth averaging 3.8% per annum over the twenty years from end-1959 to end-1979.  By comparison, GDP has risen 1.7% per annum since the end of 1999.  Wages are stagnant, and commodity prices are settling back.  Global growth is struggling, too.
  • A wait-and-see game plan is a recipe to action that is perennially delivered too late.  Monetary policy impacts only after long and variable lags.  If policymakers procrastinate until weak evidence is overwhelmingly clear-cut, it will not be possible to restore acceptable growth without enduring an extended period when activity does not meet minimal standards.
  • The Republicans have an effective message.  It is communicated without caveats, self-doubt or room for compromise.  The threat of modifications in the central bank charter is real.  So is the promise to replace Chairman Bernanke, which is the rawest form of interference with a central bank’s independence.  The Republican message is also self-serving.  Weak growth in GDP and employment have correlated with a period of rapid absolute and relative growth in the income and wealth of the richest people.  It is not in the Republicans’ best interest for overall growth to pick up during President Obama’s last months in office or afterward for that matter, and there is no way such will happen if they secure control all the branches of government.
  • For years after Japan’s own financial crisis started in the early 1990s, officials took the view that image is reality.  So rhetoric was very positively slanted, both in describing current conditions and projecting the near- and longer-term outlook.  Unfortunately, the strategy failed miserably. 

Today’s FOMC hangover has been reinforced by disappointing U.S. economic data. 

  1. New jobless insurance  claims averaged 386.25K over the past four weeks, up from 370K in the four prior weeks and a weekly pace of 360K over the eight weeks to March 24.
  2. The preliminary U.S. manufacturers purchasing managers index of 52.9 in June constitutes an 11-month low and is 3.1 points less than April’s reading.  This suggests second-quarter GDP growth might be even worse than the first quarter’s 1.9% pace.  Inflation components of the survey had sub-50 readings for the first time since 2009.  Export demand was very weak, and the rise of jobs slowed more.
  3. The Philly Fed manufacturing index plunged 10.8 points on month to negative 16.6 in June and was 29.1 points lower than in March.
  4. The FHFA home price index increased only half as much in April as in the previous month.
  5. Existing home sales of 4.55 million in May were 1.5% lower than in April.
  6. European and Chinese flash PMI data released today were also sobering.

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

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