Fed Fatigue

The Econ blogosphere has erupted over the apparently heinously inconceivable idea that Larry Summers might be the next Fed chair.

Here's Ezra on the situation:

As far as I can tell, there’s almost no one in the economics blogosphere who wants to see Larry Summers named as Ben Bernanke’s replacement. The bulk of opinion ranges from relative indifference between the two candidates (“as we know there’s no real daylight between Yellen and Summers“) to extremely strong anti-Summers opinions (“Larry Summers will destroy the economy“) — with much of the latter being driven by Summers’s record on financial regulation. Tyler Cowen is almost alone in holding up the pro-Summers end of the argument.

Personally, I'm a Bernanke guy. I think he did an amazing job in the height of the crisis and would love to see him take another term. But I'd be fine with Larry Summers (I'm sure Larry is breathing a sigh of relief now that he knows) as Chair. I'd be fine with Yellen too, though I worry that she thinks the Fed can do more than it actually can (at least such a belief is not likely to be very harmful in the near term at least).

But, all the commotion about who's going to be the next Chair is way overblown. It's just not that important, for two reasons. First, the Fed is not independent of politics and without big political change there is not going to be big monetary policy change. Second, the ability of monetary policy to reliably guide the real economy is much more limited than most people want to believe.

On the Fed and politics, you can start here, or here.

As a quick example, consider the "Volcker disinflation" in the early 1980s. Big Paul took office in 1979 and announced in October that the Fed would focus on monetary aggregates and lower their growth rates. However, the actual policy of lower money growth didn't happen until after the election in 1980, which installed a conservative Republican president and a Republican majority in the Senate. In the year between the announcement and the election, monetary growth was unchanged from the previous two years. In the year after the election, monetary growth was only half as fast.

On the limited power of monetary policy to control the real economy, you can start with Adam Posen's recent review essay. Here's a good bit:

Indeed, central bankers should be far humbler today than they were in recent decades, when some claimed credit for the so-called great moderation, the period of reduced economic volatility that lasted from the late 1980s to the early years of this century. It is now clear that the prosperity and stability much of the world enjoyed during those years were largely the result of good luck.

In my view, Posen, if anything is overstating the power of monetary policy over the real economy.

Consider post 2007 US monetary history. The Fed promptly took the policy rate to zero. We still had big problems. So the Fed started QE. We still had big problems. So the Fed did further rounds. We still had big problems. So the Fed tried forward guidance. We still had big problems. So the Fed tried outcome-based as opposed to calendar-based forward guidance. Guess what? We still have big problems (I know, counterfactuals are a b**ch, but the Fed clearly didn't fix things).

You may say, "but recoveries after financial crises are always slow". But people, that's just another way of saying that Central Banking is not that powerful when it's most needed!

You may say, "but they should have done more and that would have fixed things".

That's borderline epistemic closure. "The right monetary policy can do anything. The economy is not fixed, so the right monetary policy was not employed", is going to be pretty hard to ever disprove.

I think some of the Summers backlash is because Larry understands that the power of monetary policy for the real economy is rather limited.

How to be your own worst enemy

Ben Bernanke is his own worst enemy these days. He keeps insisting that the Fed is not out of ammunition and can do more to strengthen the economy, but to date, has not actually done anything "new" or "more".

Which leads to his ritual excoriation in the blogo/twitter-sphere.

And rightly so.

4 years on, we still have not reached pre-crisis employment levels.  High inflation is not on the immediate horizon, and growth and growth forecasts keep falling. If you can "do more", it's beyond time to walk the walk, not just talk the talk.

Ben Bernanke is an excellent economist and a smart man. So what is going on?

Continue reading below the fold

Is the upcoming election holding the Fed back?

The US economy is going nowhere fast. Growth is low, unemployment is high and inflation (core and headline) are falling below 2%, re-kindling worries about deflation.

But the Fed is sitting pat. Sure they've done a lot in my view. Dropped rates to zero, promised to keep them there a while, pumped trillions of reserves into the system, ran a couple rounds of quantitative easing and don't forget about "operation twist". Nor do I have much confidence that, at this point in the proceedings, monetary policy is capable of a miracle cure for the economy.

But holy spumoli people, don't they have to do something? Sure they do; they're the Fed, dammit!

Bernanke can't keep saying that the Fed is not out of ammo but never fire the gun. The Wolfersons are KILLING him!

Could it be possible that the Fed does not want to be seen "goosing" the economy in the run-up to the Presidential election?

Might the Fed be guarding its vaunted "independence" by avoiding any actions that could be considered politically motivated?

Will we see QE3 or a higher inflation target on the first Wednesday in November?

I think this has to be a factor in the Fed's decision about the timing of further action. Things may worsen enough for them to feel they have to act no matter what, but I think they may be trying to muddle through with the status quo until after the election.

Tell me why I'm wrong in the comments.

stimulus in a backpack

A friend, who was in a military unit in central Iraq some years ago, sends this photo.

Those are $100s.  Approximately $1 million US.  Actual real American simolions. 

My friend took this pic just before they stuffed this into a backpack, and went to go give it away in a village.  This was supposed to buy loyalty.

I submit that the military enlisted personnel are not well suited to carry out this task.  And that the task itself is asinine, because one-time "payments" like this are no more likely to cause growth, or loyalty, then the idiot Keynesian "stimulus" policies in the US.  Both of these policies are just political payoffs to friends, with no prospect of benefit to the nation, or to the taxpayers who are footing the bill.

Still, it had to be fun to have a thousand large in a backpack, walking on the streets of [city in central Iraq].  They should have invested in brown paper bags, to make the Mafia comparison even more realistic.

I have a question

Is it really true that the Fed is buying upwards of half of all new net Treasury issues? That is to say, are they "funding" over half of the deficit?

I ask rather than assert because the evidence that I've found is not exactly authoritative. You can check my sources here,  here,  and here.

If this is so, how can serious people be saying that we should expand borrowing to finance more stimulus because markets are telling us there is a huge demand for more safe assets like Treasuries?

The last link above claims the Fed's share of new issues is rising and consequently private markets' share is falling.

If that is true, is it accurate to say that the low interest rate on Treasuries reflects high demand and justifies further expansion of debt?

Should the IMF enable Argentina?

Argentina is seeking "technical assistance" from the IMF to help design a new inflation index.

Why?

Well, the past (in more ways than one) and current President have made the inflation numbers a political football, firing statisticians and deliberately underreporting inflation by a large magnitude.

Why?

Well, among other reasons, Argentina had issued a lot of inflation indexed bonds and allowing the real inflation rate to be officially reported would have cost the government a lot of money.

Which is exactly why the IMF should NOT be getting involved here.

Making this into a technical issue of coverage or method and not an issue of systematic fraud and abuse will cover the government's tracks and protect it against potential lawsuits by holders of indexed debt.

The Kirchners have been crapping on the IMF for years. It's hard to imagine that the organization has such low self esteem that they are willing to enable their tormenters just to get their foot back into the door.

"Has the Ben Bernank ever run in an election?"

No but he has a nice beard!

People the first three minutes of this video are pure gold:

How to evaluate the Fed

My friends Larry White, George Selgin and Bill Lastrapes have a new paper claiming the Fed has been a failure. They look mainly at US macroeconomic performance to make this claim.

However, I think any realistic evaluation of the success or failure of the Fed would have to look at reelection rates of incumbent politicians!

what goes around comes around

Alan Blinder is up in arms at the audacity of foreign leaders calling QE2 "currency manipulation". So is President Obama, Paul Krugman, and a host of other luminaries.

Here's Blinder in today's WSJ: "But calling QE2 "currency manipulation" is a grotesque abuse of language".

His (correct) argument is that QE2 is basic everyday expansionary monetary policy just applied to a different portion of the yield curve. Sure it may have the side effect of lowering the dollar, but.....

People, the foreign reaction is a predictable consequence of our insistence in labeling China's fixed exchange rate as "currency manipulation".

A fixed exchange rate is a basic everyday policy regime. Bretton Woods was a system of fixed exchange rates, so the US has had a fixed exchange rate in the not so distant past. The countries of Western Europe continued to struggle to achieve a system of fixed exchange rates post Bretton Woods, culminating in the creation of the Euro which is a system of fixed exchange rates between all the participating countries.

Here's another gem from Blinder: "the US is sovereign nation with a right to its own monetary policy".

And China isn't???

Our administration and elite pundits have been blaming other countries for our problems for a while now, so it's not surprising that many other countries are enjoying their chance to throw it back into our faces.