Yesterday's Washington Post article suggesting the Fed was moving closer to additional policy action left me somewhat puzzled. It left out a critical piece. What is the threshold for additional action? Particularly any action of significance? Recent Fedspeak suggests the threshold is pretty high - financial crisis high. Otherwise, any action is likely to be more window dressing than anything else.
Neil Irwin at the Post claims:
Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.
Note the rhetorical claim suggesting this article is sourced by "top Fed officials." But the only officials cited are St. Louis Fed President James Bullard and Boston Fed President Eric Rosengren. No one from the Board, interestingly. To be sure, Bullard is an intellectual heavy hitter. But Bullard can be difficult to read. He talks. A lot. But with Bullard, the Post reduces his quotes to pretty pedestrian stuff:
"If the economic situation changes, policy should react," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. "You shouldn't sit on your hands. . . . I think there's plenty more we could do if we had to."
Surprising. I have to imagine that Bullard provided a lot of good quotes. And Irwin doesn't appear to challenge Bullard to explain how much the economic situation needs to change to prompt a policy change. But, luckily,Bullard gave an interview to Reuters at the end of June, and reporter Mark Felsenthal gave us a little more to work with. Yes, this is not new news. Just new for the Post.
For me, the Reuters piece had three main takeaways. First, Bullard and his colleagues underestimated the likelihood of a jobless recovery:
"We just started getting our job growth going three months ago, and then all of sudden we get a kind of a weaker number," said Bullard, who is a voter this year on the Fed's policy-setting panel. Nonfarm payrolls added a disappointing 41,000 private sector jobs in May, denting hopes for a speedy recovery.
Second, and related, the Fed actually believes we are experiencing a typical post-war recession in which output rapidly returns to trend:
Setting aside worries raised by softer economic indicators and Europe, the Fed continues to envision a moderate recovery, Bullard said.
"We would expect ... at some point start to gradually withdraw the accommodation and then things would continue to recover, and then eventually we would get back to normal," he said.
Does the Fed really fail to realize that the only reason the US economy returned to "normal" after the last recession was attributable to a housing bubble that was unsustainable? A topic for another time. Finally, the threshold for meaningful additional action is very, very high:
However, if the economy takes a decisive turn for the worse, the Fed would have to consider further stimulus, probably buying more Treasury securities to ease financial conditions, Bullard said.
"If things got really bad in some dimension and we were back in crisis mode, I think the FOMC wouldn't hesitate to do more if we had to, but I don't really think that that's the situation we're in right now," he said.
Note: "back in crisis mode." Note: "ease financial conditions." Nothing like "to ease the pain of unemployment." Did Bullard say the same thing to Irwin? We don’t know, because Irwin falls back on plain vanilla quotes.
Putting the pieces together, it appears the Fed is beginning to realize that economic activity will not bounce back rapidly, but there is little meaningful they are willing to do unless they are in crisis mode. And that analysis is based largely on interviews with a single Fed official. Other Fed officials appear even less likely to act. From Bloomberg over the weekend:
Two Federal Reserve policy makers differed on the strength of the U.S. consumer in Nikkei newspaper interviews, amid evidence that the recovery in the world’s largest economy is slowing.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said consumer spending is “moderately strong” and along with business investment will help sustain the recovery, the Japanese newspaper quoted him as saying. Richard Fisher, president of the Dallas Fed, cited “cautious” households as a reason for a growth to cool in the second half.
The remarks reflect debate on the durability of the economy after reports last week showed private-sector payrolls rose less than forecast in June, consumer confidence slumped and manufacturing growth slowed. Fed officials last month retained a pledge to keep record-low interest rates for an “extended period” and signaled Europe’s debt crisis may harm growth.
Lacker said he was comfortable with the current level of interest rates, according to Nikkei. Later this year it will be a “legitimate question” whether to drop the ‘extended period’ language and “think about raising rates,” the newspaper reported him as saying.
Fisher said any tightening of monetary policy “depends on the course of the economy,” according to the report. He said on June 4 that while it’s not time for central bankers to tighten policy, they may be “getting closer” as the economy further expands this year.
Goodness, over the weekend, both Richmond Fed President Jeffrey Lacker and Dallas Fed President Richard Fisher were still looking forward to tightening policy. Of course, Fisher, similar to Bullard, likes to talk. Indeed, Fisher looks closer to Kansas City Fed President Thomas Hoenig:
Hoenig, 63, has been the sole policy maker to dissent this year from decisions of the Federal Open Market Committee, objecting four times to its pledge to keep interest rates at a record low for an “extended period.”
He also said the central bank should dispose of assets accumulated while fighting the crisis “as reasonably as we can, as quickly as we can.” While he has proposed raising the target for overnight loans among banks to 1 percent by September, Hoenig said in the interview that the timing “can be debated.”
Fisher indicated there’s little more the Fed can do after cutting interest rates to a record low in December 2008 and pumping more than $1 trillion into the financial system through asset purchases.
“We ought to be very careful about not going too far,” he said. “Interest rates are zero. It’s not the cost of money that’s the issue.”
One can only imagine what kind of crisis would prompt Hoenig for additional action. Something that would rapidly deteriorate to the guns and gold portfolio. Still waiting for someone from the Board to speak. Wait, yes they did. Fed Governor Kevin Warsh gave a rousing speech:
The Federal Reserve should be wary of the short-term allure of further asset purchases, said Fed governor Kevin Warsh on Monday. In a speech in Atlanta, Warsh set a high bar for his support of further asset purchases, saying he would need to be convinced the benefits of the purchases would outweigh the costs of "erosion of market functioning, perceptions of monetizing indebtedness, crowding-out of private buyers, or loss of central bank credibility."
Which gets to the crux of the issue. Realistically, to generate significant impacts at the zero bound, the Fed is going to have to commit to policies that look a lot like debt monetization. We are nowhere near that stage. Indeed, after two decades, the Bank of Japan is not there. Sure, maybe the Fed commits to a long term ZIRP (pretty much there already), buys mortgage backed assets to offset maturing securities, or, as a temporary response to a fresh crisis, expands the balance sheet a bit. But commit to a higher inflation target? Target long bond rates? Those actions likely require sustained, massive purchases of US Treasuries - a bridge too far to cross for policymakers who view central bank credibility as a one sided game. The only real policy error is inflation. Anything else is interesting, but not important.