MacroScope

Fed Chairman Ben Bernanke’s speech to the Economic Club of Minnesota was long on theory and short on details. Still, Bernanke made one thing clear: the central bank is revving up to ease monetary policy further. Most analysts are looking for some sort of effort to push down long-term rates at the September meeting. While Bernanke did not offer any further guidance on method, he did present a very distinctive sense of direction.

A renewed focus on growth ratcheted the Fed chief’s tone up a notch from his remarks at Jackson Hole:

The Federal Reserve will certainly do all that it can to help restore high rates of growth and employment in a context of price stability.

Bernanke also appeared keen to assuage the concerns of more hawkish Fed members.

We see little indication that the higher rate of inflation experienced so far this year has become ingrained in the economy.

Remember that exchange a couple of months ago between Congressman Ron Paul and Federal Reserve Chairman Bernanke over the definition of money? Pressed by the congressman during testimony, Bernanke said gold is not money. Paul retorted: “Why do central banks hold it?”

Bernanke paused and said: ”It’s tradition, long-term tradition.”

One of the interesting things about the episode was how disparately it was perceived among different audiences. To most economists, Bernanke was stating the obvious. Gold is not money. You can’t walk into a coffee shop and pay for your doughnut with a raw piece of bullion. Not without at least eliciting a “let me get my manager” from the cashier. To Ron Paul’s libertarian supporters, however, this was a major ‘gotcha’ moment for the presidential hopeful.

Think three dissents at the consensus-loving Federal Reserve are a lot? Try 435. According to St. Louis Fed President James Bullard, that’s how many dissents have been logged since 1936 by U.S. central bank policymakers unhappy with the decisions of the majority of their colleagues.

Internal disagreement at the Fed is unquestionably high, so much so that Fed Chairman Ben Bernanke on Friday said policymakers would meet for two days in September, not just one, to discuss their options more fully. Three regional Fed presidents — Dallas Fed’s Richard Fisher, Philadelphia Fed’s Charles Plosser, and Minneapolis Fed’s Narayana Kocherlakota — cast their vote against the Fed’s decision earlier this month to freeze short-term interest rates for two years.

“It depends a lot on the personalities involved, it depends a lot on the situation,” Bullard said of why some decisions draw more dissents than others. Bullard, who does not have a vote this year on the Fed’s policy-setting committee, said he also would have dissented, as did Kansas City Fed President Thomas Hoenig, the host of the annual Jackson Hole meeting of central bankers.

In Jackson Hole, where central bankers and leading economists from around the world are gathering for an annual meeting hosted by the Kansas City Fed, the talk is about the economy, what Fed Chairman Ben Bernanke will signal in his highly anticipated speech on Friday and what Warren Buffett’s purchase of a stake in Bank of America might mean for the beleaguered bank.

Here’s a smattering from interviews on the sidelines of the meeting, which begins in earnest with a formal dinner tonight:

– “QE3 is not in the cards, so don’t expect that,” Bank of America economist Mickey Levy told Reuters Insider, referring to the possibility of a third round of bond-buying by the Fed. Instead, the Fed may aim to reduce long-term rates by replacing some of the shorter-term securities in its portfolio with longer-term assets, he said.

By Amer Bisat
All opinions expressed are his own.

In recent weeks, financial markets have behaved as if the global economy is a plane crashing with no parachute in sight.  The price action is not entirely irrational.  Global growth has indeed fallen sharply and suddenly.  At the same time, the ability of policy makers to engage in bold counter-cyclical measures is being severely constrained by budgetary and political realities.

That said, the assumption that economic policy in the developed world is utterly impotent is an exaggeration.  Monetary policy in the U.S. is a good case in point. The Fed’s tool box is far from empty.  Given the persistent economic weakness and the severe headwinds facing the U.S. over the next few years, it is time for the Fed to become (even) more aggressive.

The notion that the Fed “can do nothing” is fast becoming conventional wisdom.  To an extent, it is naïve to completely dismiss the view.  Monetary policy effectiveness and the Fed’s political room-for-maneuver are arguably both at a historic low. For one thing, even though the Fed has already lowered interest rates to zero (and tripled its balance sheet), U.S. growth is frustratingly tepid.  Politically, the attacks on the Fed no longer emanate from the fringe but now represent the view of important segments of the political and academic mainstream.  The pressure, in fact, has contaminated intra-FOMC dynamics with a rarely seen concentration of dissenting voices within the Committee complicating the Fed’s traditionally consensus-based decision making process.

Let’s face it: inflation is a lagging indicator and Federal Reserve officials look at it that way. So for all the talk that the Fed now faces a higher bar for a third round of quantitative easing, the rise in core consumer prices to 1.8 percent in July is likely to be seen as temporary. As analysts from Commerzbank put it, “the weak economy should help to contain inflationary pressure.”

More worrying for policymakers, particularly the more dovish members of the Federal Open Market Committee, are hints the third quarter may not be showing a lot of the improvements built into official forecasts. A string of reports ranging from consumer sentiment to manufacturing suggest things may have actually taken a turn for the worse in August. From a Goldman Sachs note:

The Philadelphia Fed index unexpectedly fell to -30.7 in August. In the past, this level for the index has only been observed in or immediately prior to recessions (though the index was around -20 in 1995 for a brief period, and the economy did not fall into recession).

“Horrendous”

“Stink”

“Meltdown”

These are just a few of the (printable) words analysts have used to describe the August release of the Philadelphia Fed’s factory activity index.

And well they might — the Philly Fed has proven to be a nightmare indicator for economists. At -30.7 in August, the index came in far below the consensus forecast for a rise to +3.7 from July’s +3.2. Even the lowest forecast was only -10.

That’s probably one of the worst misses the Reuters polling team can recall in recent memory.

Minneapolis Federal Reserve President Narayana Kocherlakota on Friday released the following statement explaining his vote against the U.S. central bank’s decision this week to declare that interest rates will likely remain near zero until mid-2013:

One of my jobs as president of the Federal Reserve Bank of Minneapolis is to serve on the Federal Open Market Committee. At its last meeting on August 9, the Committee took what I viewed as a significant policy step. I dissented from its decision. I believe that transparency is an essential part of effective policy formation, and so I’m offering this brief explanation of my decision. These views are not necessarily those of others on the Federal Open Market Committee, including presidents Richard Fisher and Charles Plosser.

Entering the meeting, the FOMC was following an unprecedentedly accommodative monetary policy. There were three elements to this policy. First, the Federal Reserve owned over $2.5 trillion of long-term government and government-backed securities. The purchase of the final $600 billion of these assets was announced in November 2010 and completed by the end of June 2011. Second, as it had since December 2008, the Committee was maintaining the fed funds rate at between 0 and 25 basis points. Third, as it had since March 2009, the Committee statement included the forward guidance that it anticipated keeping the fed funds rate at this low level for “an extended period.” The “extended period” is generally interpreted as being between three and six months.

Last month the U.S. Federal Reserve published a new communications policy designed to keep the dissonant voices of central bank officials in check and prevent leaks of market-sensitive information. Among the rules, is a blackout period from the Tuesday before any policy-setting meeting to midnight of the Thursday after during which participants must “refrain from expressing their views about macroeconomic developments or monetary policy issues in meetings or conversations with members of the public.”

So it was curious that on Wednesday, just a day after three members of the Fed’s policy-setting committee revolted against Chairman Ben Bernanke’s pledge to keep interest rates low for the next two years,  one of the dissenters  – Minneapolis Fed President Narayana Kocherlakota – suggested to the Wall Street Journal that his revolt may be only temporary.

On this occasion, I dissented from the Committee’s decision. Regardless, I have nothing but the highest regard for the acumen, integrity, and ability of all other FOMC meeting participants.

The Fed this week took the unprecedented step of putting interest rates of virtual permahold for a set period of time — in this case, until the middle of 2013. That’s a long time away, and the promise underscores just how concerned about the central bank is about the U.S. economic outlook. In the short-run, it looked a clever trick, stemming a precipitous slide in global stock markets. (The hint that it might be prepared to take even further action didn’t hurt either). But will the Fed’s doubling-down on its “extended period” pledge work to support a flagging economic recovery when other, stronger unconventional monetary tools have already been deployed to questionable avail?

Many economists think the move is unlikely to have a major impact on growth or the nation’s jobless rate, which has been hovering around 9 percent since the start of the year. A lack of employment prospects, weak consumer demand and a major housing overhang — not high borrowing costs — are the main impediment to economic progress at the moment, they say.  And for that particular ailment, monetary policy has proven an especially blunt tool.

Yet with Washington focused on cutting spending, fiscal policy appears largely off the table. Fed Chairman Ben Bernanke has warned Congress that despite the need for longer-term steps to reduce the U.S. budget deficit, the government should be careful not to cut spending too quickly. Given just how weak U.S. GDP growth has proved this year — economists in a Reuters poll now see 2011 growth at a paltry 1.7 percent — Bernanke may be wishing he had been a little more vocal in urging for a proactive fiscal policy to get the country of the doldrums.