THE BERNANKE PUT? DON’T BET ON IT! (II)

Alan Blinder, a professor of economics and public affairs at Princeton University, former vice chairman of the Federal Reserve, is very critical of the Fed’s latest decision. (See also THE BERNANKE PUT? DON’T BET ON IT!)

(…) Meeting on Aug. 9, the Federal Open Market Committee (FOMC) downgraded its near-term assessment of the U.S. economy sharply. Since the Fed’s code of conduct mandates the use of Fedspeak instead of English, let me offer a quick translation: “Yikes! Things have sure deteriorated quickly!”

The Fed expressed its alarm in two ways, both remarkable. The first was Mr. Bernanke’s willingness to push ahead despite a level of discord that is almost unheard of on the consensus-bound FOMC: The motion passed on a far-from-resounding 7-3 vote. Second, his policy innovation stunned veteran Fed watchers (including me): The Committee more or less promised to maintain the current rock-bottom federal funds rate for almost two more years.

In so doing, the Fed violated one of the most revered canons of central banking: Always keep your options open. No one knows what might happen between now and June 2013—not you, not me, and not the FOMC. A booming economy by, say, Christmas 2012 doesn’t look too likely right now, but it could happen. And if it does, the Fed won’t want to keep the federal-funds rate near zero. So why risk the loss of credibility?

The answer is that the FOMC majority was so concerned about the health of our economy that they felt a duty to offer some support to the frail economy and to soothe the nearly panicked financial markets. But they had used up all their good ammunition long ago.

The two-year interest-rate commitment is based on a wing and a prayer. (…) But there are two big problems, both of which Mr. Bernanke knows well. First, the expectations theory has been proven wrong six ways from Sunday. Did someone say “weak reed”? Second, markets were already expecting very low funds rates for the next two years. So the Fed’s announcement, while stunning, didn’t change market beliefs much. (…)

What all this says to me is that the FOMC majority is very worried. So unless the storm clouds lift quickly, there is probably more easing to come. That could mean another round of quantitative easing, such as the Fed buying more Treasury bonds. Or it could mean paying a lower interest rate on excess reserves. Or the brilliant and creative Mr. Bernanke could pull another rabbit out of his oft-used hat. (…)

 

Leave a Reply

Your email address will not be published. Required fields are marked *