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.

The World’s Opinion Page

Help support Project Syndicate’s mission

subscribe now

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.”

http://prosyn.org/DjkKa6n;
  1. Television sets showing a news report on Xi Jinping's speech Anthony Wallace/Getty Images

    Empowering China’s New Miracle Workers

    China’s success in the next five years will depend largely on how well the government manages the tensions underlying its complex agenda. In particular, China’s leaders will need to balance a muscular Communist Party, setting standards and protecting the public interest, with an empowered market, driving the economy into the future.

  2. United States Supreme Court Hisham Ibrahim/Getty Images

    The Sovereignty that Really Matters

    The preference of some countries to isolate themselves within their borders is anachronistic and self-defeating, but it would be a serious mistake for others, fearing contagion, to respond by imposing strict isolation. Even in states that have succumbed to reductionist discourses, much of the population has not.

  3.  The price of Euro and US dollars Daniel Leal Olivas/Getty Images

    Resurrecting Creditor Adjustment

    When the Bretton Woods Agreement was hashed out in 1944, it was agreed that countries with current-account deficits should be able to limit temporarily purchases of goods from countries running surpluses. In the ensuing 73 years, the so-called "scarce-currency clause" has been largely forgotten; but it may be time to bring it back.

  4. Leaders of the Russian Revolution in Red Square Keystone France/Getty Images

    Trump’s Republican Collaborators

    Republican leaders have a choice: they can either continue to collaborate with President Donald Trump, thereby courting disaster, or they can renounce him, finally putting their country’s democracy ahead of loyalty to their party tribe. They are hardly the first politicians to face such a decision.

  5. Angela Merkel, Theresa May and Emmanuel Macron John Thys/Getty Images

    How Money Could Unblock the Brexit Talks

    With talks on the UK's withdrawal from the EU stalled, negotiators should shift to the temporary “transition” Prime Minister Theresa May officially requested last month. Above all, the negotiators should focus immediately on the British budget contributions that will be required to make an orderly transition possible.

  6. Ksenia Sobchak Mladlen Antonov/Getty Images

    Is Vladimir Putin Losing His Grip?

    In recent decades, as President Vladimir Putin has entrenched his authority, Russia has seemed to be moving backward socially and economically. But while the Kremlin knows that it must reverse this trajectory, genuine reform would be incompatible with the kleptocratic character of Putin’s regime.

  7. Right-wing parties hold conference Thomas Lohnes/Getty Images

    Rage Against the Elites

    • With the advantage of hindsight, four recent books bring to bear diverse perspectives on the West’s current populist moment. 
    • Taken together, they help us to understand what that moment is and how it arrived, while reminding us that history is contingent, not inevitable


    Global Bookmark

    Distinguished thinkers review the world’s most important new books on politics, economics, and international affairs.

  8. Treasury Secretary Steven Mnuchin Bill Clark/Getty Images

    Don’t Bank on Bankruptcy for Banks

    As a part of their efforts to roll back the 2010 Dodd-Frank Act, congressional Republicans have approved a measure that would have courts, rather than regulators, oversee megabank bankruptcies. It is now up to the Trump administration to decide if it wants to set the stage for a repeat of the Lehman Brothers collapse in 2008.