May 22, 2013

Part I: Bernanke Testimony before the Joint Economic Congressional Committee

Chairman Bernanke didn’t say anything startling or out of character, but world financial markets swayed to and fro depending on then nuances of the language of his answers and whether such implied reductions in monthly asset purchases happening sooner and by larger increments or the converse.  If it seemed that the Chairman was talking from both sides of his mouth, that was the result in part because of the prosecutorial and partisan nature of the questions posed.  The thinking of Bernanke’s inquisitors was locked into the old framework in which the size and duration of quantitative easing was determined up front, when in fact the new framework doesn’t answer “when” or “how much” questions directly.  The answer depends on future data trends, how the data are interpreted, and what reported statistics suggest about future trends.  This approach is hardly revolutionary.  It’s how economists to some extent always use empirical evidence to inform policy recommendations. 

Bernanke has not hidden his predisposition regarding the risks versus the benefits of an ultra-accommodative monetary policy that utilizes both exceptionally low overnight interest rates and quantitative easing.  He acknowledges both but has thus far been very persuaded that the dangers of moving to a neutral policy stance prematurely outweigh the risks of keeping the present stance until its is safe beyond a reasonable doubt to start cutting back.  At all points, moreover, the direction of future policy changes is to be two-sided, depending on what the data say.  In this context, it is mistaken as some analysts have been saying to assume that QE cannot begin winding down so long as the jobless rate exceeds 6.5%.  That quantitative guidepost on another regarding inflation are constraints on the timing of a rise in the federal funds target, not on asset buying behavior.  So the pace of $85 billion per month of QE could start to wind down as soon as next quarter, but I suspect this won’t be done before September and quite plausibly later.  U.S. data have lately been too mixed in my opinion to produce an earlier decision to act.

My major takeaway from the testimony, however, does not involve the substance of the banter but rather what the hearings say about credentialing and the perils of deciding questions upon which the welfare of millions of people hinge.  Monetary policymaking requires great familiarity with economic concepts, financial market mechanisms, and the collection, peculiarities, and proper use of empirical evidence.  As a Ph.D. economist from MIT, a renown expert on the Great Depression, a Princeton professor, a former Federal Reserve Governor, and someone who taught himself calculus at a young age out of a textbook, Bernanke has all the credentials one would hope to find in a Fed Chairman.  An while one can debate how much credit ought to go to Fed policy, it is a fact that despite a more severe financial market shock than felt in the late 1920s and early 1930s, the United States experienced a much less severe economic downturn this time around and also fared better than economies managed with less bold monetary policies.  Now compare all this to Bernanke’s inquisitors, some like JEC Chairman Brady with no formal education beyond an undergraduate degree and job experience as a politician only.  It takes grand chutzpah for congress to lecture the Fed about the risks and rewards of this monetary policy or that, and it’s scary to see U.S. policymaking in the hands of such amateurs.  Wouldn’t it make sense that to run for congress, one must prove an ample proficiency in economics by passing at test?  In almost every field, credentialing counts.  Why leave the selection of public officials to a beauty contest, easily corrupted by money?

Part II: FOMC Minutes

Minutes of the April 30 – May 1 meeting showed a wide range of views but an overarching disposition toward caution regarding the exit from future quantitative easing.  With added bolding, the critical paragraph reads

Participants also touched on the conditions under which it might be appropriate to change the pace of asset purchases. Most observed that the outlook for the labor market had shown progress since the program was started in September, but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate. A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting and mentioned that the Committee had several other tools it could potentially use to do so. Most participants emphasized that it was important for the Committee to be prepared to adjust the pace of its purchases up or down as needed to align the degree of policy accommodation with changes in the outlook for the labor market and inflation as well as the extent of progress toward the Committee’s economic objectives. Regarding the composition of purchases, one participant expressed the view that, in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities.

To underscore that future policy changes would be driven by an evolving data-driven consensus, FOMC members agreed to include in its statement released May 1 wording to such effect and an indication that the size of QE could rise or fall: “the Committee was 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.”  The minutes lack a smoking gun on either unemployment or inflation to suggest a sense of urgency to scale back quantitative easing soon.

On the labor market, some doubts were expressed that labor market slack has diminished as much as the decline in the unemployment implies.   “Several participants cautioned that the drop in the unemployment rate in the latest month was also accompanied by another reduction in the labor force participation rate; the decline in labor force participation over recent quarters could indicate that the reduction in overall labor market slack had been substantially smaller than suggested by the change in the unemployment rate over that period.”

Regarding inflation, some anxiety was expressed over the implications of the current sub-target trend. “A number of participants expressed concern that inflation was below the Committee’s target and stressed that future price developments bore careful watching. Most of the recent reports from business contacts revealed little upward pressure on prices or wages. A couple of participants expressed the view that an additional monetary policy response might be warranted should inflation fall further. It was also pointed out that, even absent further disinflation, continued low inflation might pose a threat to the economic recovery by, for example, raising debt burdens.”

Investors got a big dose of Fed-speak today.  Bear in mind that the minutes are highly sanitized versions of the discussions that actually occurred.  By and large, market participants heard what they wanted and disregarded the rest.  In reaction, commodity prices are lower.  The 10-year Treasury yield moved marginally above 2.0%, 40 basis points than at the start of May.  Dollar/yen has risen to a strong 103 handle, while the euro at $1.2842 tells little about where that relationship wants to go.  U.S. share prices, which rose solidly in the first minutes of Bernanke’s morning testimony, are now down 0.5% on the S&P 500.

I believe that Fed officials genuinely believe odds are good that enough evidence will emerge to cut back the size of monthly asset purchases sometime in the second half of this year, or they otherwise would not be offering that possibility merely to mollify critics.  But they are guarding against locking themselves into a first move, if the outlook doesn’t fall into place for taking such action.  Policy change when it comes is going to proceed in fits and starts.  It’s ironic that rising sovereign debt yields are currently associated with expectations both that the Fed will begin snugging its stance later this year and that the Bank of Japan is not going to relent from an aggressively stimulative policy until the inflation goal is met, which may take many more years.

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



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