Federal Reserve Chairman Ben S. Bernanke is getting ready to move out so he is setting up his legacy. As the New York Times Binyamin Applebaum reported on a speech to the National Economics Club: “Mr. Bernanke, in a speech with valedictory overtones as he prepares to step down, described the Fed’s efforts to revive the economy since 2008 as coherent, consistent and successful. And he emphasized once again that even as the Fed begins to retreat, it would maintain the bulk of the campaign for years to come.”
In his speech, Bernanke gave some forward guidance: ““Crossing one of the thresholds will not automatically give rise to an increase in the federal funds rate target. Instead, it will signal only that it is appropriate for the committee to begin considering whether an increase in the target is warranted.” Applebaum added: “Some Fed officials support a lower threshold, an option that Mr. Bernanke did not address.”
Forbes Editor-in-Chief Steve Forbes recently wrote that “central bankers like Ben Bernanke and his putative successor, Janet Yellen, claim we need more inflation, preferably an annual rate of 2% to 2.5%. That level would cost a family making $40,000 annually an extra $800 to $1,000 a year in higher prices. If you ever run across a central banker or an economist who shares this weird view, ask that person which elected body gave the Fed–or any other central bank–the authority to impose such a tax. In the early part of the last decade the Federal Reserve and the U.S. Treasury Department instituted a weak-dollar policy, which led to the housing bubble, the boom in commodities, the inflation in farmland prices, hothouse growth in the financial sector and a bubble in bonds–and, perhaps, stocks. But just as many doctors in the mid-19th century fiercely resisted Lister’s germ theory by refusing to wash their hands before surgeries, these policymakers remain wedded to their malignant theories.”
Echoing a thesis long made by Lewis E. Lehrman, Forbes wrote: “Money is a measure of value, just as inches and minutes are measures of length and time. Money facilitates transactions – buying and selling – between willing parties. It’s claim on products and services, and its infinitely less cumbersome than barter. Changing the intrinsic value of money no more leads to sustainable growth than would changing the number of minutes in an hour or how many inches constitute a foot.”
Sustaining the value of money is the real purpose of the Federal Reserve – a legacy that is far too often ignored. As Phil Gramm and Thomas R. Saving recently wrote in the Wall Street Journal of the Fed’s recent quantitative easing: “Never in our history has so much money been spent to produce so little good, and the full bill for this failed policy has yet to arrive. No such explosion of debt has ever escaped a day of reckoning and no such monetary surge has ever had a happy ending.”
Speech Notes. Fuller, more complete text to be published in the forthcoming CATO journal.
November 14, 2013
“The Federal Reserve and the Dollar”
By Lewis E. Lehrman
At The Cato Institute
31st Annual Monetary Conference
“Was the Fed a Good Idea?”
Mr. Allison, Dr. Dorn, distinguished guests:
We are gathered in this hall to evaluate the history of the Federal Reserve System. We cannot help but wonder, whither the Fed?; and to consider wherefore its reform? -- even what and how to do it? But first let us remember whence we came one century ago.
As a soldier of France, no one knew better than Professor Jacques Rueff, the famous French central banker, that World War I had brought to an end the preeminence of the classical European states system and its monetary regime, the classical gold standard. World War I had decimated the flower of European youth; it had destroyed the European continent’s industrial primacy. No less ominously, the historic monetary standard of commercial civilization collapsed into the ruins occasioned by the Great War. The international gold standard -- the gyroscope of the Industrial Revolution, the guarantor of more than one-hundred years of price stability, of unprecedented economic growth, the common currency of the world trading system -- all this was brushed aside by the belligerents. Into the breach marched unrestrained central bank credit expansion -- the express government purpose of which was to finance the colossal budget deficits occasioned by war and its aftermath.
The world’s economy continues sluggish in the water. The quantitative easing that had kept it afloat artificially may be deflating. “Long before folks fretted the demise of ‘quantitative easing,’ I fretted its existence,” wrote Ken Fisher in Forbes: “It proved the reverse of its image, an antistimulus, and we’ve done okay not because of it but despite it. With its demise forthcoming, I’m bullish on banks, relative to the market.”
Why? Banking’s core business is simple. Take in short-term deposits, make long-term loans. The spread between short- and long-term interest rates pretty well reflects future gross operating profit margins on new loans (effectively cost versus revenue). The bigger the spread, the more profitable future loans will be, all else being equal.”
TIME’s Rana Foroohar thinks the America economy is is “dangerously schizophrenic.” She has written: “The divide between stocks and the real economy tells us some important things. For starters, the foundations of our recovery are weak. Equities have remained relatively strong because the Federal Reserve is artificially propping them up with $85 billion a month of asset buying. The tactic is understandable--the Fed has kept the money spigots open, risking market bubbles, in part because of "fiscal headwinds"--that is, growth-destroying partisan politics. Ben Bernanke can't make Congress agree to fund the government or raise the debt ceiling, but he figures he can at least shore up stock and home prices.
The problem is that this monetary cycle is breaking down. People simply aren't buying into the sugar high of this kind of policy anymore. For proof, look at how the Fed's decision a couple of weeks ago not to taper off its massive spending spree boosted stocks for only a day. Each new round of quantitative easing does less to goose the market than the round before. "It all shows what a weak and narrow recovery we are in," says economist Peter Atwater.
But as the Federal Reserve moves to new policies, it also moves to new leadership and new ways of explaining its new policies. The Wall Street Journal’s Victoria McGrane wrote: “Federal Reserve governor Jerome Powell ...pushed back against criticism that the central bank’s communication efforts have misfired, contending that market expectations are better aligned with the central bank’s thinking after its September policy meeting.
Market participants and even some Fed officials have criticized the central bank’s messaging in the wake of the meeting. The Fed decided then to continue buying $85 billion of long-term bonds each month, surprising many investors who believed the Fed had signaled it would start paring its purchases at that meeting.
The decision not to cut has helped bring market expectations about Fed policy closer in line with where the central bank wants them, Mr. Powell argued.
Having inflated the stock market, the Fed is now trying to deflate expectations. It’s all rather ghoulish.
Wall Street cheered in September when the Federal Reserve decided to keep Quantitative Easing at its current level. But such cheer is often evanescent.
San Francisco Fed Chief John C. Williams recently gave a speech in San Diego in which he defended quantitative easing. Still, he indicated that its impact on the economy may not be so great: “Estimating the effects of LSAPs [Large Scale Asset Purcheses] on the economy—as opposed to financial markets—is inherently harder to do and subject to greater uncertainty. The effects of lower interest rates take place over the course of many months and even years, and over those longer horizons it’s hard to know how much of the change in economic activity was due to the effects of monetary policy or other factors. In some of my own research with colleagues at the Federal Reserve Board, we used the Board’s large-scale macroeconomic model to try to separate the effects of LSAPs from other factors.5 We estimated that the Fed’s $600 billion QE2 program lowered the unemployment rate by about ¼ percentage point compared with what it would have been without the program.”
The Economist’s Free Exchange columnist has written: “Unconventional monetary policy has been attacked for prompting further financial gaming. With piles of cash to play with, the argument goes, investors have bid up prices of equities, bonds, and commodities. Stocks and shares have certainly been on the up. From a low in 2009—just after QE began—World Bank commodity price indices have increased by over 50%. The FTSE 100, an index of stock prices in Britain, has nearly reached its all-time high.”
But a new paper from the International Monetary Fund suggests that unconventional monetary policies (UMPs) do not encourage speculation. Rather, they dampen it. UMPs reduce "tail risk", or the odds of extreme market outcomes like hyperinflation or a new Depression. That, in turn, tamps down market volatility, and that reduces the incentive to speculate. When America announces that it will purchase more mortgage-backed securities or government bonds, markets quickly price in lower volatility. Risk measures can drop by 10% after the Federal Reserve makes unconventional monetary policy announcements, according to the IMF paper.
But the evidence and the impact are mixed. The Economist columnist noted: “The emergence of a more speculative environment is bad news for fragile economies. The IMF has already warned that Fed tapering could precipitate another euro-zone crisis. Tapering has already damaged India and other emerging markets, as hot money has fled the country. Commodity prices and emerging-market assets might also be prone to new speculative bubbles or crashes. Investors trying to make sensible choices based on information in market prices have their hands full.
“States and cities across the nation are starting to learn what Wall Street already knows: the days of easy money are coming to an end,” reported the New York Times Mary Williams Walsh. ‘Interest rates have been inching up everywhere, sending America’s vast market for municipal bonds, a crucial sources of financing for roads, bridges, schools and more, into its steepest decline since the dark days of the financial crisis in 2008.”
Markets do not like uncertainty. But gridlock in one area can lead to fluidity in others – as we have learned in the aftermath of the Fed’s September decision to keep the spigots open on quantitative easing. The Wall Street Journal’s Jon Hilsenrath wrote: “Federal Reserve officials created new uncertainty about how much farther they will push their easy-money policies—and new questions about how effective they are at communicating their thinking—with the decision to stand pat on the pace of their bond purchases for now.
The Fed on Wednesday went beyond merely deciding to keep buying the $85 billion a month of mortgage-backed securities and U.S. Treasurys that it had been telegraphing for months it might start winding down. In the news conference after a two-day policy meeting, Fed Chairman Ben Bernanke also seemed to walk away from some of the guidance he had given in June on how the bond-buying program would play out over the next year, making it even less clear when the program will end.
The New York Times’ Nathaniel Popper wrote that “even pushing the next steps out just a few months adds a good dose of uncertainty to the process. Some strategists said that if Mr. Bernanke steps down as Fed chairman at the end of the year, as is widely expected, his successor could have more room to reconsider any slowdown in stimulus.
Moreover, some believe that Mr. Bernanke would be hesitant to make such a big change in policy just a month before leaving the job.
“Frankly, it’s set off an awful lot of questions about what’s going on, who’s in charge and what’s happening,” said Robert F. Baur, the chief global economist at Principal Global Investors. “I’m not sure the market really knows what to think.”
Amity Shlaes wrote in Forbes that “Bernanke has made a career of postponing monetary tightening. Of the likely candidates to succeed him Janet Yellen is a relative inflation dove and Donald Kohn has talked only mildly of the possibility of the Fed tapering or reducing the cash it pours into the economy. Kohn said the Fed might “go with a very gentle first step–complete with caveats about how it could be reversed.” Charles Evans, president at the Chicago Fed, actually said he hoped inflation would quicken.”
There are a few exceptions: Esther George of the Kansas City Fed, Richard Fisher of the Dallas Fed and Charles Plosser in Philadelphia. But many of those who previously opposed inflating or reflating are now lining up with Bernanke. Noted scholar Kenneth Rogoff, who wrote This Time Is Different, a book about the damage debt does to growth, is also pro-inflation. Rogoff argues that central banks need to “convince the public of their tolerance for inflation.”
The uncertainty is magnified by the stand-off on fiscal policy – leading monetary doves to call for more quantitative easing. Reuters reported: “U.S. monetary policy is being kept easier to help offset the harm caused by political fighting in Washington, according to two senior Federal Reserve officials who warned on Thursday of damaging consequences if the nation defaults on its debt.
Atlanta Federal Reserve Bank President Dennis Lockhart said the disquiet resulting from the budget battle "vindicated" the Fed's surprise decision not to scale back its asset purchases at its meeting last month.
The Fed's decision to keeping buying bonds at an $85 billion monthly pace startled markets that had expected the U.S. central bank to begin to wind down its ultra-easy monetary policy, sending stocks and gold prices sharply higher.