Inflation no obstacle to more Fed easing
Another reason the Federal Reserve may have additional room for monetary easing: Inflation expectations fell sharply in May, according to the latest Thomson Reuters/University of Michigan survey of consumer sentiment. Inflation expectations five years out dropped to 2.7 percent in May, the lowest since January. Fed officials often say expectations are a key leading indicator of actual price increases.
Daniel Silver, economist at JP Morgan:
This level of longer-term inflation expectations is towards the bottom of the range that has been reported in recent years – 2.7% has been hit on several occasions (most recently between October 2011 and January 2012) and 2.6% was only reached back in December 2008 and March 2009, early on in the crisis period. Most other inflation measures that the Fed watches (including core PCE inflation and the 5yr-5yr breakeven inflation rate) have signaled that inflation expectations are still anchored and underlying inflation pressure is modest.
The downshift comes in the wake of inflation figures for April that also pointed to a tame price environment. This is why Eric Green at TD Securities argues “U.S. inflation favors the doves.”:
In many ways the release today is emblematic of what we expect to see on the inflation front over the next six months. That is, steady disinflation on headline prices (driven by roll over and seasonal effects from energy prices) and stable core prices. Headline inflation will fall through core next month as energy prices alone virtually ensure a gain of no more than 0.1%, probably less. As headline inflation drifts to 2.0% y/y next month (from 2.3% y/y April) and 1.8% y/y by August, the inflation metric will work in favor of the more dovish contingent on the FOMC.
Still, deflation fears, a key underpinning of the Fed’s second round of quantitative easing, are not likely to make a comback, says Green:
That does not mean we are in a period of disinflation akin to the pre-QE2 period. Inflation will not be the cause célèbre of more accommodation, it will merely be removed as a potential obstacle among those favoring stronger growth, and truth be told, higher inflation.
In QE3 waltz, Fed again steps toward easing
On again, off again. That’s been the story with prospects for another round of monetary stimulus from the Federal Reserve. Expectations for a third installment of quantitative easing, the much-debated QE3, had ebbed with improving economic data in the first quarter – but are now flowing anew.
Following a weak employment report for last month, the latest hint that more bond buys could be in the offing came from minutes of the central bank’s April meeting, which saw the Fed leave rates near zero and repeat that it would likely hold them there until at least late 2014. Policymakers appeared to be taking an increasingly dim view of economic prospects given an array of looming threats to growth, even if none are particularly new.
According to the minutes:
Participants identified several downside risks to the projected pace of economic expansion, including the fiscal and financial strains in the euro area and the possibility of an abrupt fiscal consolidation in the United States.
To Millan Mulraine at TD Securities, the more negative tone suggested a modestly greater inclination to lean in the direction of easing. In particular, Mulraine singles out this sentence in the minutes:
Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough.
Writes Mulraine:
Last week, the Brits reached the same conclusion I did a year ago: that we’ve reached the point of diminishing returns with QE. The pain from QE-motivated inflation is as damaging as the benefit from stocks rising (wealth effect?)
Hence: There should not be a QE3.
What happens when Operation Twist ends in June 2012? Will Ben launch QE3 during this year’s Jackson Hole conference? I sincerely hope not.
In this country, the central bank (The Federal Reserve) has a dual mandate (since 1978):
full employment
stable prices (read as low inflation)
That’s a short list. Conspicuously absent from that list is a mandate to:
-encourage speculation,
-drive the stock market higher,
-punish investors reliant upon income or that are otherwise unwilling to place a large portion of their life savings in the Vegas-like machine that is the US stock market,
- foment international unrest from a drop in value of the US dollar.
It is true that QE1 played a very significant role in stopping an economic collapse in 2009, and that it spurred another sugar-rush unsustainable stock market rally (is that what prosperity is?). But there was no free lunch. QE1 managed to reverse the deflationary forces taking hold of the economy, but it also significantly debased the value of the US dollar. This in turn meant the most significant export of the United States became inflation.
QE2 took over where QE1 left off:
-another risk-on unsustainable purely speculative stock market rally,
-high quality bonds lost value again (penalizing those that were defensive and conservative),
-interest rates rose on consumer loans and mortgages,
-food and fuel inflation spiked in the US and globally. In no small part, QE2 helped induce the “Arab Spring”.
Launching QE3 might provide yet another sugar-rush stock market rally (though probably smaller). But whatever the perceived gain might be, it would be counter-balanced by the detrimental effects of heightened food and fuel inflation, and higher interest rates courtesy of foreign buyers of US Treasury bonds balking at our printing press efforts. Surely the point of diminishing returns was reached with QE2.
Conventional monetary policy tools seem to have worked in rectifying previous recessions. A case could potentially be made to launch QE3 if it were obvious we were in a classic business cycle recession and that one more dose of monetary steroids might cure the ailment (not merely mask the symptoms). But it is clear we were not (2007-2009) and are not now in a business cycle recession. Rather, we have been and are in a much more challenging type of recession: a balance sheet recession. The best that can be hoped from monetary policy tools in a balance sheet recession is they act as an expensive snooze button. The systemic economic issues don’t go away. They merely wait to be addressed. But the cost of the most recent monetary policy tools (QE1 & QE2) are such that they’ve added to the systemic problem by increasing our public debt. It turns out you can’t solve a debt problem with more debt.
Let’s briefly look at what joint myopic monetary and fiscal policy intrusion has delivered over the past 12 years:
A recession in year 2000. 18 years of overspending and irresponsible myopic fiscal policy was beginning to take a toll. Arguably, we should have taken our medicine then. But no. Monetary and fiscal steroids were the prescription. The S&P500 lost 47% as demand collapsed. The Fed dropped short term rates to 1% in response. The US Congress & White House gave us unfunded tax cuts for a decade and introduced a massive new unfunded healthcare liability (medicare part D). The result was predictable: an artificial bubble in risk and leveraged assets (the stock market, the housing market). A colossal mis-allocation of resources and waste of several years. The problem was made larger and delayed for someone else to deal with (kick the can).
A recession recurred in 2008-2009 when the eventual housing and stock market bubble burst. The S&P500 lost 57%. This time it took 0% interest rates, QE1, QE2, $ Trillions in US bailouts and Keynesian fiscal policy stimulus (spending beyond our means), and a stream of sovereign bailouts in Europe that remains unresolved. The snooze button again.
Another US recession will likely begin in mid 2012 (June?). Early 2012 sees the S&P500 all the way back up to where it was 12 – 13 years ago. Worse, there is a very good chance stock markets will fall through the March 2009 lows. Why shouldn’t they ? Are the economic prospects that much better than they were 4 years ago?
There should not be a QE3 or any other monetary policy intrusion. Our three decade debt binge needs to be worked off. This position necessarily means the US and most world economies will head into the worst recession since the 1930s. But more monetary policy tricks will only add to the problem.
The last time we saw a balance sheet recession was the 1930s. We know what came next: WWII. Let us try to avoid the same mistakes. Ben, avoiding WWIII may not be part of the Fed’s mandate. But it should be.
Jobs or inflation — Is the Fed distracted?
The Federal Reserve doesn’t get much love from Washington these days but it did receive a rare bit of political backing on Wednesday as Democrats defended its role in promoting full employment as well as stable prices.
The U.S. central bank has been the target of criticism from members of both political parties as a result of bank bailouts and hands-off rule-enforcement that let predatory and unsound lending practices go unchecked, among other shortfalls.
But discussing legislation narrowing the Fed’s mandate to a single-minded focus on price stability, Democrats questioned the need to drop the full employment side of the dual mandate.
“Is it a problem?” asked Minnesotan Keith Ellison. “To the degree that we have problems with monetary policy, is the dual mandate the cause?”
Ellison said that far from distracting the Fed, the lofty 8.1 percent unemployment rate should get greater attention. “This is a national disgrace,” he said.
Ron Paul, a presidential candidate who chairs a subcommittee on domestic monetary policy, held a hearing to discuss several pieces of legislation changing the Fed’s mandate. Two of these would limit the Fed’s focus to price stability.
With partisan divisions and other priorities, Congress is unlikely to make any changes to the Fed’s mandate this year. But the effort could gain momentum if Republicans control both houses of Congress after November.
The Feds don’t control credit unions, that’s why I moved my money. That and the fact that they actually pay you interest on your savings!
Put your rate hike where your mouth is
Jonathan Spicer and Van Tsui contributed to this post.
This week, for the second time ever, the U.S. Federal Reserve published policymakers’ forecasts for when the central bank should start raising rates. The chart suggested a split Fed, with three policymakers expecting a rate rise this year, three next year, seven in 2014 and four in 2015. That’s useful information, as far as it goes.
But as much as the Fed has embraced transparency in recent years, it stopped short of saying which policymaker backs a rate hike in which year – a key bit of data for grasping where the voters on Fed Chairman Ben Bernanke’s policy-setting committee stand, and how their positions shift over time.
Below is the bar graph that the Fed published Wednesday, with Reuters’ best estimates of who fell where. We stand ready be convinced otherwise by readers offering evidence or insight that supports a different view. Send us an email, gives us a call, write a comment or shout us out on Twitter.
You can find more information about the policy leanings of each top Fed official in our handy interactive hawks-doves chart.
Bernanke: U.S. is not Japan, and I have not changed my mind
Of all the questions Federal Reserve Chairman Ben Bernanke was asked during his press conference on Wednesday, one appeared to pique his interest in particular: Was he being less aggressive as central bank chairman than the advice he dished out to Japan as an academic in the 1990s would prescribe?
It was the second half of the question asked by Binyamin Applebaum and yet the chairman was eager to get right to it: “Let me tackle that second part first,” he began.
Applebaum may have been channeling the Nobel-winning economist Paul Krugman, a Princeton colleague of Bernanke’s and critic of Fed policy, who recently argued the Fed chief was being inconsistent and overly cautious.
Bernanke argued that the Fed has done a lot already to support growth and bring down unemployment. Actively aiming for higher inflation with additional use of unconventional tools would risk the central bank’s long-term credibility. Here is his answer in full:
So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.
I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation – that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer – are not exhausted. There are still other things that the central bank can do to create additional accommodation.
Now, looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy.
So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And, clearly, when you’re in deflation, and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.
Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal. The policy is extraordinarily accommodative. We – and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction – a slightly increased pace of reduction in the unemployment rate?
The view of the committee is that that would be very reckless. We have – we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.
Listen to FOMC, ignore the dots
Federal Reserve Chairman Ben Bernanke was asked about the discrepancy between individual rate forecasts of policymakers, many of whom — represented as dots on a chart — see rates rising in the next couple of years, and the Federal Open Market Committee’s statement that it sees rates staying low until late 2014. Bernanke’s answer was clear: the FOMC is king.
The individual projections are inputs to the committee decision, so the committee decision is the critical element in that respect. The committee was quite comfortable with the consensus that we have reported today.
Resolving Shirakawa’s conundrum
The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:
It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.
Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:
At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.
Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.
Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:
Roubini takes on the ECB
It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.
Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting — to the clear discomfort of some policymakers in the room — that measures to weaken the currency could provide a badly-needed boost to exports:
I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.
But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.
So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?
Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.
ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:
We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.
So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.
Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.
Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden:
Monetary policy as a skimpy spare tire
Central bankers have said repeatedly since the start of the global financial crisis that monetary policy can only do so much to heal a broken economy. Agustín Carstens, president of Mexico’s central bank, chose an interesting analogy at an IMF event this weekend to describe the adjustment needed in countries with very high debt levels:
In relatively modern cars the spare tire is (pretty small). Basically that spare tire should be enough to take you to the next gas station. But if you want to drive your car (a very long distance) it’s likely you will never get there.
So today I think what central banks have done is that the tire was gone, they used the spare tire, the spare tire is this big, and you can go just a few miles to the next gas station and you repair the car. So, if they (the fiscal authorities) don’t do that then they will be left on the road.
Somebody call AAA.
Five reasons why the Fed would prefer to avoid QE3
The Fed appears to have moved away from the notion of additional bond purchases in recent weeks, for a mix of tactical and practical reasons including:
1. Policymakers worry about venturing any further into uncharted territory.
2. Growth isn’t weak enough to make a clear case for additional monetary easing.
3. Many officials think QE is better at thwarting deflation than boosting employment.
4. Cutting rates before a presidential election is probably not ideal timing.
5. Bernanke would like to save the Fed’s remaining ammunition for a truly rainy day.
And yet 11 of 15 primary dealers polled by Reuters following a disappointing March payrolls report still believe the central bank will ultimately embark on another bond-buying stimulus plan. Given the Fed’s rather high bar for further asset purchases, that must mean these banks expect the economic backdrop to get materially worse from here.
