I do not share the view that the Fed is above politics.? The Fed was created by politicians.? They appoint/approve many of its governors.? They set the rules for what the Fed is authorized to do, whether the Fed follows that or not.? The politicians can change the rules if they want.
Beyond that, there is the formal and informal lobbying from businessmen, bankers, and speculators, who might implicitly argue for preservation of purchasing power, or stimulation of the economy.
There is also the interaction of the Fed with the Department of the Treasury.?? So, from all of this, I view the Fed as an implicitly political institution, which is why my analyses of the Fed stem largely from the economics of the situation, but do not end there.? I engage in “game theory” analyses of prospective Fed actions, asking myself how different scenarios would be received politically.? The Fed lives to protect itself.
So, when I read articles that suggest an apolitical Fed, I come to two possible conclusions:
- The truth is being stretched, and what you hear serves a political goal, or,
- The Fed governor speaking does not care about reappointment.
Politics abhors idealists, outside of semi-revolutionary moments.? Being the art of the possible, politics favors compromisers.? As I see it here, the Fed is under a lot of political pressure to stimulate the economy, and not under a lot of pressure to restrain inflation.? Should it surprise us if the Fed continues to loosen, perhaps aggressively?
It’s actually in the best interests of the Fed govs, and the chairman, to promote the illusion of independence and apoliticality, so I disagree with your second possible conclusion, and since it’s in their best interests to lie about their nature, I would reinforce your first possible conclusion as the only possible one. Several Fed chairman have admitted as much, in off the cuff remarks.
The problems with most Fed analysis falls into one of two camps: (1) what should the Fed do or what would I do if I were the Fed instead of the proper what is the Fed going to do, and (2) blaming the Fed for our own mistakes in trading.
(1) What we think the Fed should do is unimportant. They are what they are, and if we want to “game” them we should understand them.
(2) It’s a sign of mental dysfunction to blame exogenous events for our outcomes. The proper focus is what can we do about the situations we’re in. Unfortunately, most of the Fed analysis on the financial/investing/trading web is of the “Fed in a box/over a barrel/in a corner/across the tracks” variety, or the “market manipulation” variety, and there is very little talk of how individual traders could or should capitalize on the situation.
Why complain about the Fed? It is what it is, and it’s doing what it was designed to do from the very start, almost a century ago. Why not write about how to capitalize on them? This would certainly do more to teach investors …
I absolutely agree that the discussion/debate about “what the Fed should do” or what “would I do if I controlled the Fed” is both silly and a waste of time. The productive/actionable question is what will the Fed do. I think the writing is on the wall regarding that question, and Bernanke’s recent comments only reinforce that.
I continue to hold a substantial position in commodities, hard assets, and gold mining stocks in light of what the Fed is likely to do.
My goal here is to understand what the Fed will do, not what the Fed should do. Though I don’t think the Fed should exist, I’ve made money off of its existence.
I simply think that some other analysts who think of the Fed in purely economic terms miss a large aspect of what makes it tick.
I have written about how to make money off the Fed at present as well. TIPS, foreign bonds, and bonds that benefit from curve widening are the place to be.
David, you disagree with the Fed a lot more than I do. So when I try to figure out what they will do, I think about what I would do and adjust that somewhat in the direction of Fed futures expectations. So their actual decisions don’t give me any implicit evidence that they are politically influenced (except in the meaning of ‘political’ that literary theorists use where it is received truth that all actions are political and more so, the more people are involved). I gather that you believe different Fed choices than those made would often be substantially better by some criteria, and thus you seem to infer that the choices they do make are probably politically influenced. Shrug. By my lights the Fed are more trustworthy and do less of a hack job than the top levels of all three branches of the U.S. govt. (admittedly, a low bar).
I think I am being misunderstood here. I try to avoid what I call “Amateur Fed Governor” syndrome. What I would do if I were a Fed Governor is very different from what I am predicting the Fed will do. I try to not let my views of what a central bank should do affect my forecasts.
What I am disagreeing with are public statements of some other interpreters of the Fed, and Fed Governors themselves. Many people play for the self-interest of their positions, and Fed Governors always project confidence, even when they are worried inside.
My point here is that I have to look at the economic and political influences on the Fed, the way that they make decisions as a group (different under Bernanke than Greenspan), what flaws might exist in their decisionmaking processes, what time horizon they are managing for, etc., in order to come out with a good forecast. Add into that analyzing how the markets are reacting to them, and one can get a fairly full picture of what is going on.
Still, you have to filter out what Fed Governors say, and watch what they do. You also have to filter out the crowd that is talking their books. At least then one has a fighting chance of a decent analysis.
That’s essentially what I understood from the article. I know you are a stat guy, so let me say what I meant a different way using logistic regression as an analogy. Compared with Model1 where some explanatory variable – call it “political pleasing factor X1” – plays an explanatory role, it’s possible that there is another Model2 that gives a better statistical fit than Model1, but doesn’t involve X1, and can’t be improved by including X1. I’m not claiming that I can model the Fed better tha you, but I’m saying that I have a Model3 that makes okay predictions using the unobservable (to you) explanatory variable Me3 (what I would do) and can’t be improved by reference to X1′ (my personal understanding of the relevant politics). I understood you (still) to be saying that your X1 would help improve the accuracy of a model involving DavidMerkerl1 (what David would do as Fed governor). Now, I think, you want to stress that your *best* model involves your X1 but *doesn’t* involve DavidMerkel1 at all. Are we on the same page here?
Ouch. You’re making me think, and that hurts. Yes, my best model would involve X1, but not DavidMerkel1. My view of what the Fed should do is irrelevant, because I think longer term than the Fed, which is under political pressure, and usually reacts to short term complaints, regardless of the lags with which monetary policy works. Political pressure overwhelms academic models of monetary policy.
And yes, my mental constructs can be, and often are dead wrong. I’ve had a relatively good call on Fed policy for the past nine years, but not a perfect one. And, it will eventually fail; it always does.