Sunday, August 14, 2011

Bernanke grabs the steering wheel

Excerpted from the FOMC’s August 9th statement:

The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman (New York); Elizabeth A. Duke (BOG); Charles L. Evans (Chicago); Sarah Bloom Raskin (BOG); Daniel K. Tarullo (BOG); and Janet L. Yellen (BOG).
Voting against the action were: Richard W. Fisher (Dallas), Narayana Kocherlakota (Minneapolis), and Charles I. Plosser (Philadelphia), who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period [without specifying duration].

This is big news. In the Greenspan era, the FOMC voted unanimously for whatever the chairman wanted. In the Bernanke era, the FOMC has had at most two dissenters (Warsh or Hoenig, both now thankfully gone). It was pretty clear that, in order to maintain “institutional credibility”, Bernanke wanted to minimize public dissent. (So as not to give the Ron Pauls of the world any more meat to chew on.)

What this has meant in practice, is that the hawkish minority have had leverage over the expansionary majority, thus interfering with Bernanke’s desire to grow M2 until he saw growth and inflation moving up and unemployment moving down. He wanted the Fed to do what he had wanted the BoJ to do ten years ago: target outcomes, not inputs.

I see last Tuesday as a breakthrough because it signals that Bernanke has given up on consensus-building, and is prepared to move ahead with continued unconventional policies on the basis of a working majority in the committee.

Under QE1, after the Lehman crisis, the Fed was growing M2 at over 10%. After QE1 ended in 2009, M2 growth slowed to an anemic and deflationary 1%. That is why 2010 was such a disappointment: the Fed was prematurely “conservative”.  The Ben launched QE2 (which ended in June) and got M2 growth back up to over 9%.
I can’t imagine that he intends to keep the monetary aggregates stable going forward, especially with the recent market turmoil,  disappointing employment numbers, and fiscal tightening. I expect him to turn the pumps back on this fall.

I would also hope that he would wake up and stop paying interest on free reserves, which seriously impedes the Money x Velocity = Price x Transactions policy mechanism, by depressing Velocity. If he really wants to get things moving, he should charge the banks a fee (negative interest rate) for parking their money at  the Fed.

If he can grow M while stabilizing V, we will get the nominal GDP growth that we need to put people back to work and to stabilize the debt/GDP ratio.

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