Because I Said So
Economic data continues to bind our hands. It continues to be good enough that QE2 seems unnecessary (unless, of course, Congress starts being fiscally tight), and yet bad enough that calling this a “recovery” (as NBER has done) seems inappropriate given the usual meaning of the word.
The main data surprise today was from Consumer Confidence, which was much weaker than expected at 48.5. Remember, though, that Consumer Confidence isn’t like the purchasing manager surveys: 50 is not some sort of dividing line. As the chart below shows, Consumer Confidence remains at levels that are lower than at the depths of the worst recessions of the last thirty years.
Hard to be hopeful if the future seems so hopeless!
Consumer confidence is only “recovering” because it was as low as the mid-20s early last year. A significant portion of this lack of confidence derives from the sense that jobs remain very hard to get, as the “Jobs Hard To Get” index remains up at levels not seen since the early 1990s recession.
The folks who are actually lining up for jobs don't see the improving employment picture!
There can be no question that the economy is currently very weak. Some economists believe this is a situation that is in the process of resolving itself as we speak, and the future of course is open to debate. But there isn’t much room for debate about the current situation.
Now, Fed policy is however supposed to be directed at the future. Since it isn’t clear whether Congress will extend the Bush tax rates or not – currently it seems unlikely that this will happen before December, if at all – the Fed needs to begin preparing the ground for whatever their next steps are going to be. They are prudently working to get the system in place to eventually reverse QE, although that isn’t likely to be necessary for a couple of years at least; more-urgently, they are trying to decide what form QE2 will take.
I am on record as saying that purchasing bonds as part of QE2 doesn’t make a lot of sense unless the Fed also eliminates the payment of Interest On Excess Reserves (IOER), but much more discussion seems to surround the question of how big to make the QE2 program if it becomes necessary. An article in the Wall Street Journal yesterday presented St. Louis Fed President Bullard’s argument for incrementalism: making a series of smaller purchases of bonds in an open-ended fashion, perhaps tied to a Taylor-type rule that would guide investors and help them understand that the FOMC doesn’t intend to stop until a certain level of inflation is achieved: “The shock and awe approach is rarely the optimal way to conduct monetary policy…I really do not think it is the right way to go except in really exceptional circumstances.”
President Bullard is apparently not aware of Robert Lucas’ “Policy Ineffectiveness Proposition,” which basically says that if monetary policy is anticipated, then it can have no effect. According to that model, the only thing which works is a significant change which surprises investors (that is, shock and awe).
Since the beginning of the Greenspan era, the Fed has instead tilted increasingly towards glasnost, believing that fully telegraphing their moves as much as possible is the best thing for the economy. Moreover, both Greenspan and Bernanke have acted as if they are afraid to surprise the markets because of the tendency of surprises to cause blowups and unanticipated consequences.
The reason that surprises cause blowups is that they happen so infrequently. A hedge fund that doesn’t need to worry about something odd coming from the Fed without ample warning may be tempted to lever a “carry trade” far more than would be prudent if randomness was part of the landscape. That is, the Fed’s openness causes excess leverage. This is so obvious, and the evidence so unambiguous, that it continues to amaze me that the Federal Reserve seems not to believe it. I started writing about this in the ‘90s (and it is a major topic in my book, Maestro, My Ass!, which is available cheaply to readers of this column here).
I think the Fed should make one final announcement. They should announce that they are no longer going to make announcements, that Fed speeches will be subject to a one week “quiet period” on either side of the meetings during which the economy may not be discussed (the way it used to be), that there will no longer be releases of Fed minutes, etcetera. Since the Fed began its openness campaign, there has been much concern at the Fed itself – as far back as the early ‘90s – that its “message” was not being properly understood by the media and the markets (after all, why be “open” if no one understands what you are saying?). The solution they instituted was more-frequent communications, much like doting parents believe that explaining their actions in more detail to a four-year old will produce better behavior. The four-year old doesn’t need to be informed. The four-year old needs to be instructed, and doesn’t need to understand the reasoning of the parents. The right answer is, sometimes, “Because I said so.”
Now, I don’t have a lot of confidence in this Fed to be a good parent, but that’s just the point. I shouldn’t have enough evidence that they are rotten forecasters who always are misdiagnosing the problem so that I can lose confidence. If their actions were shrouded in mystery, I would never know whether their easing actions were because they thought growth was weak or because inflation is too low or because they know about some bank that is teetering or for some other reason that is beyond my ken. I would have to cut them a wide berth and work into my forecasts the “known unknown” of the Fed. This would be better for everyone.
I don’t have a lot of hope that the Fed will evolve back into the mystery-shrouded institution that it once was. About the closest we can come is when some Fed speakers make a habit of crazy talk. Tomorrow, Minneapolis Fed President Kocherlakota, one of the main sources of crazy talk these days, will be speaking in London around 10:15ET, so be alert. Plosser speaks around 12:30, and Rosengren around 1:15ET. With no other data due out we probably do need to be on the lookout for tape bombs. I suppose, when you think about it, there is one group that is clearly a winner from an open Fed: brokers!
