Next Week's FOMC: A Third Bowl Of Peanuts
Last week, Chairman Bernanke spoke at the annual Jackson Hole monetary conference, where he laid the groundwork for additional QE, which is good news. However, he did not even mention the idea of a higher inflation target, or an NGDP target. Rather than defend the Fed against the patent failure of its policies, he chose instead to defend it against the counterfactual claim that QE is inflationary.
Thus, Bernanke’s Fed continues its policy of periodically tapping its toe on the accelerator, rather than targeting a desired speed and opening the throttle until it is achieved. Not only that, but by playing around with QE without a target, he is discrediting QE because "it hasn’t worked”. That is analogous to giving a starving patient a bowl of peanuts and then concluding that the peanuts didn’t help because the patient is still starving.
Let’s take a look at the current economic telemetry and see what kind of a job the Fed is doing.
In terms of its 2% inflation target, the CPI has fallen 25% below target and remains at a suboptimal 1.5%.
In terms of its “maximum employment” mandate, the Fed continues to be creative in its excuses for four years of nonfeasance. Civilian unemployment at 8.2% is now 50% above the Fed’s informal target of 5.5%. Bernanke is full of reasons why this is the best that he can do. At Jackson Hole he said that, when interest rates are at the zero bound, we must tolerate higher levels of unemployment than normally. This argument was demolished ten years ago by an economist with the same name as the current Fed chairman. Then, Bernanke argued that monetary policy remained fully effective below the zero bound; now he says it doesn’t. The old Ben was right, and the new Ben is disingenuous.
Currently the Fed tolerates having 24 million people out of work or underemployed because there are “unquantifiable downside risks” to aggressive monetary expansion. The US economy is growing at an anemic 4% nominal rate, versus 6-7% before the recession, an output gap of 2.5%. With federal debt growing by 9% while NGDP grows at 4%, we have a fiscal trajectory that is modeled on Japan's.
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With regard to the Fed’s policy stance, its balance sheet has gone sideways for over a year; there has been no expansion since last spring, despite high unemployment and weak nominal growth. I can think of no reason why the Fed should not have been growing its balance sheet at some pace over this period, even 10% p.a., in order to increase employment. This is disgraceful, and it has been unfair to the incumbent president, who should be able to expect that the Fed will fulfill its legislated mandates. (I wonder if Obama is even aware of how badly he has been screwed by the hawks on the FOMC.) Obama’s policy mix been bad for growth, but not half as bad as Bernanke’s. They've made a great team.
What will the FOMC do next week? I expect the Fed to announce a third round of QE without any kind of employment or growth target. The first QE (post-Lehman) was $1 trillion. The second QE, in the first half of 2011, was $700 billion. I would imagine that this round, QE 3, will be in the neighborhood of $500 billion, enough to palliate but not to cure.
The failure to announce any targets undercuts the potential growth benefits of the exercise. Instead of announcing that it will feed the starving patient until he recovers, the Fed is handing him another bowl of peanuts, and pledging “close monitoring” of the his vital signs going forward. “In the event that the patient continues to starve, there are further steps we can take, including additional peanuts.”