A FED Dove Calls for All Inflation, All the Time
Reality Check
Charles Evans is the president of the privately owned Federal Reserve Bank of Chicago. On January 14, he gave a speech in Hong Kong. As with all speeches by Federal Reserve Bank officers, except for Bernanke the Boring, he was careful to say that his views were only his own. "Before I begin, let me say that the views I express here are my own and do not necessarily reflect the views of my colleagues on the Federal Open Market Committee (FOMC) or within the Federal Reserve System." This, of course, is utter poppycock. No outfit in Hong Kong pays good Chinese currency to buy US dollars in order to hire the president of the Federal Reserve Bank of Chicago to fly to Hong Kong and give a speech based solely on his opinions. He was flown there in order to get insight into what a member of the Federal Open Market Committee thinks.
What he thinks is standard Federal Reserve nonsense. But it is always nice to refresh our memories about how such ideas really are nonsense.
TRANSPARENCY, SO CALLED
First, he reaffirmed the myth that the Federal Reserve System has an interest in letting the public know what it is doing and why. He spoke about the new "transparency." Well, if the Federal Reserve had ever wanted transparency, it could have had it at any time over the last century. It has never wanted transparency. It has fought Congress tooth and nail every time Congress has attempted to get a little more transparency. Bernanke refused to appear before Ron Paul's subcommittee on monetary policy. So, what you are about to read is a con job, and anyone who believes it is a blithering idiot.
Recently, the FOMC has made significant changes in its communications by providing economic guidelines for the conduct of future monetary policy. This is part of a larger strategy intended to make monetary policy more transparent and predictable to the public -- which we feel can increase the efficacy of our efforts to achieve our dual mandate goals of price stability and maximum sustainable employment.
Transparency would begin with an outside audit of the Federal Reserve System by the Government Accountability Office. It would be conducted annually, with this attention paid to any foreign legal claims on the gold that is held for the federal government by the Federal Reserve Bank of New York. The FED refuses to allow this. Congress does not require it. Congress does what it is told to do by the real powers, which are not the voters back home.
ACCOMMODATION
He accurately referred to monetary policy as highly accommodative. "In the current setting, such efforts have meant maintaining a highly accommodative monetary policy well after the end of the financial crisis and steep recession." The phrase "highly accommodative" means monetary base inflation on a scale never seen before in Federal Reserve peacetime history. He justified this policy. "We have had to do so because the economic recovery has been quite modest by any standard and because we continue to face numerous near-term obstacles to growth."
This assumes that massive monetary base inflation in some fundamental way restored the economy. It assumes that counterfeit money on a massive scale is necessary in order to create economic prosperity. This idea really is not Keynesian in origin. Keynes was concerned with fiscal policy -- taxes and spending -- and only secondarily with monetary policy. This policy is surely not monetarism in the sense of Chicago School economics. There is no college-level textbook ever written which would indicate that a central bank should double the monetary base in a matter of weeks in order to make an economy more productive.
What he was justifying is an ad hoc policy invented by the FOMC out of desperation at a time in which previous Federal Reserve policy had led to the bankruptcy of Lehman Brothers, which had overextended itself. It was not a general banking crisis. How do we know this? Because the events did not send short-term interest rates into the stratosphere. Always before, a bank liquidity crisis was accompanied by massive increases in short-term interest rates. There was an increase, but nothing indicating a catastrophe.
These guys never tell you what they are doing or why, but they always pretend to. Following Bernanke's lecturing rule, which is to bore listeners to death by telling them what they already know, he began as follows: "Before discussing the U.S. monetary policy situation in more detail, I'd like to mention some longer-run challenges facing the U.S. and many other advanced economies throughout the world, with an eye on their implications for the medium-term economic outlook."
CHALLENGES
What are "challenges"? This is the bureaucrats' favorite code word for "politically unsolvable problems."
These issues revolve around demands on the United States' fiscal resources. At the risk of oversimplifying, I would say that the situation seems to be characterized by three important features. First, the current level of federal government debt to gross domestic product (GDP) in the U.S. is about 70 percent and quite high by our historical standards . Second, we face a critical driver that, if unaddressed, points to higher debt in the future -- this is the need to fund and deliver large benefits to an increasingly aging population. Third, the recent downturn and prolonged period of high unemployment have complicated the formulation of policies aimed at adjusting to a new sustainable fiscal path.
Let me translate this for you. First, Congress cannot possibly balance the budget, and we are going to experience trillion dollar deficits on the on-budget budget for the foreseeable future. Second, the unfunded liabilities on the off -budget budget are so massive that they cannot possibly be paid off, and therefore there is going to be a Great Default. Third, we do not know what in the world we're doing at the FED, but we want to make it look as though we do.
As a result, no matter how our fiscal problems are resolved, the U.S. consumer is no longer in a position to be the engine of world growth. Funding the future requirements of retired workers likely will require increases in personal saving or government taxation at some point in the not-too-distant future.
Again, you need a translation. First, the fiscal problems can only be resolved in one way: default. Second, the days of wine and roses are over for American consumers. Third, there are going to be tax hikes on a massive scale. Get ready for this.
Remember, he was speaking to people in Hong Kong. When he was telling them is this: "Sell your T-bills, because we are going to default. We will leave you holding the digital bag of empty promises."
Furthermore, over the near term, many U.S. households will continue to be challenged by a debt overhang and large losses of wealth that were incurred during the financial crisis."
Challenges, indeed. American households are to take a hit to their net wealth, and the voters are going to be hopping mad. That will not do them any good. Federal Reserve policy and congressional fiscal policy have already combined to run up the debts, and there is not a thing that the average Joe can do about it. He had better get used to it.
He went on: "Together, these factors point to lower rates of personal consumption in the United States." This needs no translation.
SINKING SHIPS
Next, the United States is not alone. Foreign central banks and foreign governments have been just as profligate as the Federal Reserve System in the United States Congress.
Moreover, many advanced economies face their own fiscal imbalances and unfavorable demographics that also will likely weigh on total world consumption.
He then called for new rounds of Keynesian fiscal stupidity and central bank stupidity in the Third World. In other words, the Third World has got to do what the United States and Europe have done, namely, push their national governments to the point where the only way out is a default. Or, to put it differently, misery loves company.
This means that emerging markets, faced with reduced aggregate demand from many of their trading partners, will need to endorse policies that encourage domestic consumption and demand. Making that transition will be challenging.
This man cannot write three paragraphs in a row without talking about challenges. This is because he keeps facing reality, and since there are no politically viable solutions, all he can talk about is challenges.
CONGRESS IS TO BLAME
Then he went on about a lot of Bernanke's favorite themes, namely, the irresponsibility of Congress, and the absolute necessity of Congress to get its house in order fiscally, but not yet. Later. As to how much later, he never says. Neither did Evans.
Another important point I want to emphasize is that timing matters. The United States must consolidate its public sector finances; but it must do so gradually if we are to avoid further economic turmoil or another downturn.
I love the word "consolidate." It reminds me of those late-night TV ads for loan-shark companies that tell consumers that they need to consolidate their loans into one easy monthly payment, by which they mean monthly payments until death. The whole world is in a mess, he says.
And looking beyond the U.S. experience, I see that economic growth is already weak in many advanced economies throughout the world. Indeed, Europe is in a recession. And fiscal policy in several European countries is currently restrictive. Certainly, progress needs to be made on reducing outsized deficits. But too much austerity too soon could be very damaging to near- and medium-term growth. Abrupt moves to increase taxes or lower government spending when the economy is already weak could have an amplifying effect on reducing real growth. Indeed, such fiscal moves could cause longer-lasting damage if they result in lower growth in the physical productive capital stock and even more time out of work for the long-term unemployed, whose job skills would be further eroded.
Translation: Well, this is another fine mess Congress has gotten us into. Congress had better do something about it. But Congress had better not do anything major very soon, because if it does, the whole house of cards is going to collapse, and then the Federal Reserve System will have to inflate even more, because if it does not, it will get blamed. Nobody wants that -- certainly nobody employed by the Federal Reserve System.
OLD DOGS, NEW TRICKS
Then he referred to yet another challenge.
Of course, all of the long-term challenges we face become easier to meet if we can increase the underlying growth potential of our economies. Many public policy choices are relevant here. In the United States, we can improve our educational system, leading to a more productive work force.
What is that? The educational system, which is 98% government financed, has not done a good job? Could that be possible? Does this mean that the Department of Education has failed? And how, exactly, can "we" improve "our" educational system? Our educational system does not belong to us. It belongs to the educational bureaucrats who are in charge of the system, and who have a working arrangement with the American Federation of Teachers.
In the European periphery, economic liberalization, particularly of labor markets, can produce a more efficient allocation of resources and increased potential. And in all countries, smart regulation, efficient tax codes and support for free international trade can increase productive capacities.
What is that? Europe is still mercantilist? Gee, I thought the euro was going to change all this. I thought open borders would change all this. Yet here we are, facing the same old problems that we have faced for the past 400 years. But, Mr. Evans feels certain that this is going to change, Real Soon Now.
What exactly is an efficient tax code? What country has this? What group of politicians has been careful to keep the nation's tax code efficient? Where is the working model? Sadly, he did not say.
PERMANENT STAGNATION
Things are not getting better.
Let me now turn to monetary policy in the United States. When making their projections in early December, FOMC participants projected real GDP growth in 2013 to be moderately higher than in 2012, but still only modestly above potential. Such growth would likely generate only a small decline in the unemployment rate from its current level of 7.8 percent. Against this backdrop of modest growth and still elevated unemployment, most FOMC participants expected inflation to run a bit under the FOMC's stated goal of 2 percent. And though I can only speak for the Chicago Fed, based on what we have seen so far, it does not appear that the effects of fiscal policy on growth this year will be much different from when we made our forecast in December.
Translation: The American economy remains close to stagnation. Therefore, we can conclude, that everything the Federal Reserve has done over the past five years has merely moved the economy out of recession and to stagnation. Whoopee.
These are not ordinary times.
Ordinarily, the normal monetary policy response to high unemployment and contained inflation would be to reduce short-term nominal interest rates. However, the federal funds rate, which is the short-term rate the FOMC targets, is for all practical purposes already set as low as feasible. Consequently, nontraditional means of providing additional monetary policy accommodation must be used. And we certainly have used them.
Translation: Nothing is working, especially American workers.
MORE OF THE SAME
He reviews what everybody knows, which is Bernanke's standard approach. That is to say, he bores people with the obvious. Mr. Evans is not as good at this as Bernanke is. Bernanke's speeches are chloroform in print.
First, there were our large-scale asset purchase programs with pre-announced purchase amounts. These programs bought predetermined quantities of Treasuries and mortgage-backed securities over a fixed period of time. Their aim was to put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative, thereby stimulating business and household spending.
It has not worked.
Last September, we began a new program of open-ended asset purchases. The important new aspect of this program is that the length of time over which we will buy assets is tied to economic outcomes. In particular, the purchases will continue until there is substantial improvement in labor markets, subject, of course, to a continued environment of price stability.
The FOMC is operating on the same assumption that it has used for the past three years, namely, that this recovery can be made substantial by massive increases in the monetary base. This policy has failed, but that does not mean that the FOMC is not determined to make it work by doing it again. This is your standard definition of a crazy person: he keeps doing the same thing, over and over, on the assumption that if he does it one more time, it will change things.
Another unconventional tool we've used is to provide forward guidance on how long the federal funds rate is expected to remain near zero. Beginning in August 2011, this was in the form of a calendar date. Then, last September, the FOMC added its intent to maintain a highly accommodative stance after the economic recovery strengthens. And just last month, we changed from using a calendar date to indicating that the federal funds rate is anticipated to remain at its current levels at least as long as the unemployment rate remains above 6-½ percent, inflation in the medium term is projected to be no more than 2-½ percent and longer-term inflation expectations remain well anchored. We also noted that when the FOMC does begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and 2 percent inflation.
Translation: We are making this up as we go along.
These policy adjustments have been particularly innovative and require careful explanation. Why should policy remain accommodative even after we have a stronger recovery? The delay is a feature of what modern macroeconomic theory tells us is the optimal policy response to the extraordinary circumstances we have faced over the past four years.
Modern macroeconomic policy does not say anything about the conditions the Federal Reserve faces today. Never in the history of modern macroeconomic policy have we seen any textbook recommend that the central bank inflate the money supply on a scale as massive as the Federal Reserve has inflated the monetary base, in so short a period of time. In other words, we are in completely uncharted waters.
Because short-term rates are constrained by the zero lower bound, modern theory says a central bank should promise that once economic activity recovers, it will for a time hold rates below what they typically would be. This makes up for the period when it was constrained from taking rates negative. In other words, the average path for rates is closer to being right over time.
Translation: We do not trust the free market to adjust interest rates. We know that the free market rate is not the right rate today, but one of these days, Real Soon Now, FOMC policy will do something or other -- I am not saying what -- to make sure that something called "the average path for rates," a phrase which nobody has ever heard before, will be closer to being right, whatever "right" may be. In other words, it clearly is wrong today. But that is how we like it.
Why tie the open-ended asset purchases and the funds rate liftoff to specific economic conditions? Well, doing this clarifies how our policy decisions are conditional on making adequate progress toward our dual mandate goals -- which is measured by economic conditions, not calendar time. Indeed, because we cannot foresee all of the developments affecting the outlook, we simply can't commit firmly to a date when those economic conditions will be achieved.
Translation: We are making this up as we go along.
And, of course, some may still interpret a far-distant date for the policy liftoff as a forecast that economic conditions will remain poor for a long time, rather than an intention to keep rates near zero even after the recovery is firmly entrenched.
This assumes that it is Federal Reserve policy which is keeping the federal funds rate at approximately 0. No matter what Federal Reserve policy is, month-to-month, quarter to quarter, the federal funds rate remains approximately 0. This indicates the Federal Reserve policy has nothing to do with the federal funds rate. It indicates that bankers are still so terrified of the so-called economic recovery that they keep $1.4 trillion of excess reserves at the Fed, and they do not borrow overnight. They have no need for reserves, so there is no demand for reserves. Therefore, the federal funds rate, which is a rate of interest paid on overnight loans to other banks so that they can meet their reserve requirements is no longer necessary. But, Evans, like all the other Federal Reserve officials, pretends that it is Federal Reserve policy which is somehow keeping the federal funds rate at zero. What is keeping the federal funds rate at zero is the terror of commercial bankers.
I also would note that the 2-½ percent inflation threshold is not a restatement of our long-run inflation goal -- that goal is still 2 percent. The slightly higher threshold value simply captures how our symmetric view of that long-run goal allows for inflation at times to run modestly above 2 percent.
Translation: We can continue to expand the monetary base until it is too late to avoid mass inflation.
Given more explicit conditionality, markets can be more confident that we will provide the monetary accommodation necessary to close the large resource gaps that currently exist.
Translation: Monetary inflation yesterday, monetary inflation today, and monetary inflation tomorrow.
TRUST US
Additionally, the public can be more certain that we will not wait too long to tighten if inflation were to become a substantial concern.
The public can be certain that the Federal Reserve will kick the can of implementing its hypothetical exit strategy for as long as it can. Until then, the Federal Reserve will continue to interfere with the free market for interest rates.
More explicit forward guidance provides additional accommodation by reducing longer-term interest rates through a lower expected path for short-term rates. Also, clarifying conditionalities can help households and businesses better plan for the future, and so boost the effectiveness of our current policies by reducing risk premia.
CONCLUSION
Then, having bored the audience to death, in either Chinese or English, he graciously came to a conclusion. What was that conclusion? It was a reaffirmation of the inescapability of challenges.
To conclude, I believe that the U.S. and other advanced economies are facing significant long-term challenges in credibly controlling future debt levels. At the same time, we are also confronting the immediate challenge of not imposing too much austerity on our fragile economies. Clearly our fiscal authorities must find the appropriate balance between meeting these two challenges. As almost everyone agrees, this implies putting in place policies that slowly but surely bring the prospects of future revenues into balance with future spending.
Translation: Sell U.S. Treasury debt while there is still time.