Then There is Bernanke, by Tim Duy: Lots of Fed chatter in the last week.
For openers, some background from
It decided on May 1 to keep buying at an $85 billion monthly pace, and
many economists say mixed economic data warrants keeping up the purchases
But persistent warnings from more hawkish Fed officials had fanned talk
that it might start to wind back soon.
The hawkish Fed officials would be Dallas Federal Reserve President
Richard Fisher, Philadelphia Federal Reserve President
Charles Plosser, and Richmond Federal Reserve President
Jeffrey Lacker. These are often colorful voices, but as a general rule are
not voices that will hold much sway with regards to the pace of easing. What is
much more important is to what extent remaining policymakers are coming along to
the same view. In other words, these three can ruffle their feathers all they
want, but that ruffling should not be interpreted as consensus movement within
For consensus movement, turn more toward New York Federal Reserve President
William Dudley. Great
speech today, but I will narrow my focus with a few points I think are
relevant for US policy. While Dudley is clearly concerned about deflation, this
Similarly, current circumstances in the two countries are different, with
deflationary expectations still in the process of being dislodged in Japan.
The BoJ needs to push up inflation expectations, whereas in the U.S. the
current level of inflation expectations is consistent with the long-term
objective of the Fed.
This speaks to his concerns - or lack thereof - about the current US
inflation numbers. My sense is that he will dismiss those low numbers as long
as expectations stay anchored at 2 percent. Later he says:
Let me give a few examples of how my own thinking may evolve. In
terms of our asset purchase program, I believe we should be prepared to
adjust the total amount of purchases to that needed to deliver a substantial
improvement in the labor market outlook in the context of price stability.
In doing this, we might adjust the pace of purchases up or down as the labor
market and inflation outlook changes in a material way. For me, the base
case forecast is not the sole consideration—how confident we are about that
outcome is also important.
Here he brings inflation back as an issue in determining the pace of
purchases. But then in the next paragraph:
Because the outlook is uncertain, I cannot be sure which way—up or
down—the next change will be. But at some point, I expect to see
sufficient evidence to make me more confident about the prospect for
substantial improvement in the labor market outlook. At that time, in my
view, it will be appropriate to reduce the pace at which we are adding
accommodation through asset purchases. Over the coming months, how well the
economy fights its way through the significant fiscal drag currently in
force will be an important aspect of this judgment.
Which sounds as if inflation is not the primary determinant in the decision
to taper. The labor market is the primary determinant, which might be expected
if he believes that low inflation numbers are not a relevant concern in the
context of stable inflation expectations. In such a context, Dudley wants to
see to what extent the labor market will feel the fiscal drag. In other words,
be cautious about how far the low inflation story will travel in the FOMC.
To be sure, you can point to today's speech by St. Louis Federal Reserve
President James Bullard as a reason that current inflation is relevant. From
"Inflation is pretty low in the U.S.," Bullard told reporters after
delivering a lecture in Frankfurt. "I can't envision a good case to be made
for tapering unless the inflation situation turns around and we are more
confident than we are today that inflation is going to move back toward
target," he said.
But is this the consensus view? Robin Harding of the FT smartly tweets:
Re Bullard comments, low inflation has always been the main driver of QE
for him. Entirely different for Bernanke, Yellen et al.
— Robin Harding (@RobinBHarding)
May 21, 2013
I think Harding is right. With inflation expectations stable, from the
consensus FOMC viewpoint tapering will be much more dependent on the labor
outlook than current inflation.
Other voices include Chicago Federal Reserve President Charles Evans who
raises the prospect of a sharp end to quantitative easing. From
"Another approach, which doesn't get talked about that much, we could
continue to go with $85 billion a month until we decide that absolutely
we've seen enough improvement, and then bring it to a quick conclusion at
that time," Evans told reporters after the speech.
"That would be a program going into the fall, I would think, because you
can't really have that much confidence to bring it to an end" before that,
he said. "I think at the moment the key issue is whether or not it is
extremely likely that this (improvement) is going to be maintained over the
next few months."
That last line is important - I think it means that if the labor market
continues on its current pace through the rest of spring and into the summer
(again, assessing the impact of fiscal contraction), then the tapering will
begin in later summer or early fall.
In contrast, Minneapolis Federal Reserve President Narayana Kocherlakota
argues that policy
is still too restrictive:
The FOMC has responded to this challenge by providing a historically
unprecedented amount of monetary accommodation. But the outlook for prices
and employment is that they will remain too low over the next two to three
years relative to the FOMC’s objectives. Despite its actions, the FOMC has
still not lowered the real interest rate sufficiently in light of the
changes in asset demand and asset supply that I’ve described.
And, at a minimum, he would not favor reducing the pace of stimulus:
...this kind of analysis suggests that, currently, the gains from
tightening related to improving financial stability are both speculative and
slight. In contrast, the losses from tightening—in terms of pushing
employment and prices even further below the Federal Reserve’s goals—are
both tangible and significant. I conclude that financial stability
considerations provide little support for reducing accommodation at this
I don't think he would favor it in three months regardless of the labor data.
So many voices, so many views. Looking through the noise, I think there is
strong interest in tapering QE now that we have a string of job reports pointing
to substantial and sustainable improvement in labor markets, but, given the
fiscal contraction, little willingness to pull the trigger on tapering until we
see another two or three similar reports. On net, I think disinflation concerns
will move to the back-burner as long as inflation expectations are stable.
Still, at the same time, the Fed wants to keep its options open, as they are
very much cognizant that past efforts to pull back on easing have been
premature. Hence the talk that future moves could be up or down, which is
really just plain confusing because why would the Fed even begin tapering if
they thought there was a reasonable chance of having to reverse course the next
month? It is even more confusing given that some officials seem to care about
inflation, but others labor markets. The former says more purchases, arguably the
latter says less. And I am not sure they have a consensus view of what would be
the pace of tapering even if they all could agree on the forecast and relevant
indicators. No wonder communications is a problem. Back to Dudley:
An important challenge for us will be to think carefully about what
combination of actions and communications will best ensure that when we do
eventually judge that it is appropriate to begin normalizing policy, the
initial tightening of financial market conditions is commensurate to what we
desire. There is a risk is that market participants could overreact to any
move in the process of normalization.
It seems that lacking a more clear, consistent framework for the exit from
quantitative easing, the risk of miscommunication is high. Hence, we are all
looking toward tomorrow's speech by Federal Reserve Chairman Ben Bernanke to
provide the clarity that appears very much needed.