As with many other overwrought business media storylines of late, the whining and moaning post-Fed decision has been amusing to follow. Of course, the much anticipated Federal Reserve meeting concluded this week and the Bernanke-led Fed threw the markets and the media for a loop by announcing that pulling back on its long-standing bond buying program would have to wait for another day. Almost immediately Fed watchers of all stripes, especially those convinced that the program is the root of all economic evil worldwide, condemned the decision. Going into the meeting, consensus among market watchers and economists coalesced around the notion that the Fed would cut approximately $10 billion of purchases out of the $85 billion currently purchased monthly. Now that the Fed had backtracked, Bernanke and the Fed all of a sudden faced a crisis of Fed “credibility.” We’ve seen plenty of questions wondering whether the Fed can be trusted anymore or whether markets are due for disruption because the Fed had deviated from consensus. While equity and bond markets rallied, let’s keep in mind that 10-year yields have moved approximately 15 basis points (i.e. not very far) since the announcement. Similarly, US equity markets are actually up less than a percent since the decision. The US dollar index moved down by approximately 1%. Markets seem rather unmoved by the decision, perhaps reflecting the fact that any tapering at this stage, if implemented, was rather insignificant to begin with. Surely, Treasuries have moved higher by approximately 100 bps in recent months, supposedly in anticipation of the Fed announcement. We’d argue that the move was more technical in nature, the result of an absurdly overbought and oversubscribed market due for an outward stampede of some sort, but we’ll leave that for another day to debate.
Forgetting the market moves for a second, let’s return to the notion of Fed “credibility” in broader terms. The Bernanke Fed has certainly worked hard in recent years to increase transparency and communication with the broader public in terms of the future path of conventional and unconventional interest rate policy. Goodness knows we get bombarded with speech after speech from the Fed governors, each of which is parsed and reparsed. Now, we have the pleasure of watching the Fed chairman face the media directly for questioning after a Fed meeting conclusion instead of having to rely solely on a cryptic one page Federal Reserve statement. In many respects, whiny market participants asked for this type of transparency over time. Now that it’s been provided, market watchers are quick to bludgeon the Fed with its own instrument when things don’t go entirely to (their) plan. Yes, “credibility” or keeping one’s word in an admirable quality when it comes to personal relationships and business-dealings. But these are policy makers, and sometimes conditions on the ground change over the course of months, weeks, or even days and hours. Their obligation presumably at any point is to adhere as close as possible to legal mandates and long-term economic goals, not to satisfy the market’s notion of credibility or consistency of message.
What are their legal mandates, by the way? This has been lost in a lot of the discussion over the decision and the debate over the merits of unconventional monetary policy. By statute, the Federal Reserve is held to a dual mandate of working towards “full employment” and price stability. As of this moment, it’s fair to say that neither obligation is close to being satisfied. It’s obvious with an official unemployment rate at 7.3% percent and an employment to population ratio at or near the lowest levels in a generation that we are far from reaching any sort of economic notion of full employment. Meanwhile, even with globs and globs of so-called monetary stimulus, year over year core inflation in this country is dangerously close to stall speed. As of the last reading in July, year over year core inflation was a measly 1.2%, not far at all above lows reached during the height of the crisis. This has actually fallen steadily over the past year and a half. The Fed prefers to see a level closer to 2%. Price stability goes both ways. To any central banker, the prospect of entrenched deflation causes much more heartburn than price spikes. As Volcker proved, inflation can be nipped in the bud reasonably quickly, though some short term to intermediate term pain is usually involved. Deflation once it takes hold is a rot that is incredibly difficult to extract. Just ask Japan after a 20 year spell of stagnation. Or, go back much further and look at the situation faced by global leaders during the years of the Great Depression.
Bernanke and his colleagues were obviously feeling sanguine about broader economic dynamics when they began floating tapering trial balloons a few months ago. Something has now intervened, and it appears to be continued evidence that the US economy is having a hard time achieving escape velocity. Economic growth is steady but unspectacular as we’ve pointed out of late. It’s not enough, though, to enter the realm of “sustainable” as demonstrated by the sensitivity of metrics such as home mortgage applications to the back up in long-term rates in recent months. Perhaps they opened themselves to slings and arrows by holding the line. No matter. It’s much better under the current economic (and political) circumstances to err on the side of caution.
If there’s been any error in judgment by Bernanke over time, it may be the move towards copious communication with markets. While it sounds great in theory, economic policy is a highly complex endeavor not necessarily compatible with sound bites and press conferences and 30 minute speeches. The current economic environment is especially difficult to navigate. It seems over the long-run this type of communication output might invite more trouble than it’s worth. The entire credibility debate probably wouldn’t exist in any form if we were still guided solely by Delphic official Fed press statement releases. Nonetheless, we can’t find any fault with Bernanke’s supposed change of course. As economic time marches on, we’d much rather Ben Bernanke gravitate towards what’s best for the economy at large during a time of stubborn economic growth than worry about satisfying some notion of credibility with media and the markets. If the global economy double-dips into an entrenched deflationary cycle, Bernanke will have much bigger problems to worry about. We can’t help but think back to the wonderful quote often attributed to economist John Maynard Keynes: “When the facts change, I change my mind. What do you do, sir?”
