Thursday, August 12, 2010

Counting heads on the FOMC

My apologies for being radio silent for so long. There wasn’t much that grabbed my interest until yesterday’s FOMC meeting, which provides us with some limited visibility into how the Fed is thinking.

The FOMC voted (with one dissent, Hoenig of Kansas City) to replace maturing agency paper with Treasuries. This a compromise between the doves who want more quantitative easing and the hawks who want to start shrinking the Fed’s balance sheet now.

Readers will know that I am a student of then-professor Bernanke and thus a super-dove. Like Bernanke, I believe that the Fed should target nominal GDP growth, which means that the Fed should continue purchasing assets until real growth plus inflation are firmly in positive territory, so that deflation is averted and nominal income does not decline.

Unfortunately, the current makeup of the FOMC (including nonvoting members) is six hawks, five doves (if you count Bernanke) and five centrists. So Bernanke simply does not have the votes to get a compelling majority in favor of additional monetary stimulus.

Although Bernanke is a dove, the role of the chairman is to seek consensus, not close votes that hurt “institutional credibility”. Also, I think he also wants to see if there is a double-dip before taking additional action.

Here is the current line-up of hawks, doves and centrists on the FOMC:

Board of Governors (5, pending confirmation of Obama’s three nominees): One hawk (Warsh); two doves (Bernanke and Tarullo); and two centrists (Kohn and Duke).

Regional Feds (voting and nonvoting): Five hawks (St Louis, Kansas City, Richmond, Philly, Dallas); three doves (Boston, New York and San Fran); and three centrists (Cleveland, Chicago and Atlanta).

However, it is possible that the balance of power will shift leftward (dovish) when and if Obama’s three pending nominees are confirmed.

Kohn (vice chair), a centrist, will be replaced on the board by Yellen (SF) who is a dove, and the two vacancies will be filled by dovish-sounding governors (Raskin and Diamond). Presumably Yellen will be succeeded at the SF Fed by another dove.

So you would then have six hawks, three centrists, and eight doves. If the Bernanke/Yellen/Dudley dovish leadership is persuasive, and if the numbers keep coming in weak, there is a good chance of additional monetary stimulus this fall. Keep your eye on real GDP growth and the core CPI (in other words, on nominal GDP growth).

I might also add that, along with leftist economist Nouriel Roubini, I think that we are unlikely to see full recovery until the supply of credit starts rising. Right now, banks aren’t lending, the asset securitization markets are closed, perhaps for good. The credit aggregates are flat or declining, with the sole exception of federal debt.

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