The Dow votes for QE2

It has been said that the conduct of monetary policy can be analogized to piloting a supertanker, due to the substantial lag between actions and outcomes. But, as Scott Sumner argues, this isn’t true. There is, in fact, a real-time feedback loop for monetary policy, which is the price of equities.


DJIA on August 9th: 10, 700
August 10 FOMC statement:
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.


Translation: We are going to sit on our hands until things get worse.


Market reaction: DJIA on August 26th: 9,900 (minus 800 points).


September 21st FOMC statement:
Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract...
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.


Translation: Things have gotten worse, and we are going to do something. (Subtext: The doves are winning.)


Market reaction: DJIA on October 8th: 11,000 (up 1,100 points)


Hmm. FOMC says in August “monitoring”, stocks tank. FOMC says in September “action”. Stocks up.


What is driving bullish sentiment is that the balance of power on the FOMC is gradually shifting toward the doves (or, as Larry Kudlow calls them, the “inflationistas”). Bernanke is slowly but surely pushing the consensus on the FOMC toward QE2 (helped by the recent addition of two doves to the Board).


Now, it’s time for the Fed to put its money where its mouth is; time to start buying things (Treasuries, agencies, gold, Buicks, houses, Frisbees, Slim Jims, bubble gum, whatever).


The BoJ (yes, the BoJ) is now buying ETFs. Never in a million years would I have believed that the BoJ, the bastion of central banking “respectability”, would be buying stocks. How ironic is it that the BoJ can take Bernanke’s advice* while the Fed remains mired in "eat your spinach" hard money dogma.


Here’s the PhD question for all of you armchair Fed governors:
“How much stuff does the Fed have to buy?”


Scott Sumner’s answer: “Whatever it takes to meet its policy objective.”


How much is that? It could be  lot more than you might think. One number that has been tossed out is $7 trillion. Personally, I don’t know and I don’t care. This country and its citizens will go broke unless the Fed is able to meet its formal inflation targets and its informal NGDP targets.


The Chairman told the BoJ in 2003: Don’t target NGDP growth, target NGDP levels. Meaning: When you fail to meet your targets, catch up.


My prediction: Ben will win. The FOMC will start QE2 and the Dow will cross 12,000.


*I would bet dollars to donuts that the BoJ adopted QE because the DPJ told them that the alternative was an “amendment” to the Bank of Japan Law.