3 November 2010 – The Aleph Blog

Redacted Version of the November 2010 FOMC Statement

Posted on 3 November 2010 by David Merkel

September 2010	November 2010	Comments
Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months.	Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow.	No real change.
Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	No change.
Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.	Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.	No change.
Housing starts are at a depressed level.	Housing starts continue to be depressed.	No change.
Bank lending has continued to contract, but at a reduced rate in recent months.		Removes sentence.
The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.	Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.	Deletes one sentence, inserts another.? From the language below, they have lost confidence in ?higher levels of resource utilization? anytime soon.? Attempts to say that inflation expectations are under control, but that deflation is governing the present.
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	They highlight that they have a ?statutory? mandate, and a ?dual? mandate. Aside from that, they comment that unemployment is ?elevated.?
With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.	Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.	Translation: we have no idea why our policy is not working, and we don?t know what to do about it.? Monetary policy works with long and variable lags, so we won?t say that our policy isn?t working.? It?s just slow in taking effect.
	To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities.	New sentence.? Launching the QE II.
	The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.	New sentence.? They will stealth-fund the US Government to the tune of $600 Billion.
	The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.	New and meaningless sentence.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	No change.
The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.		Sentence dropped.
The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.	The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.	Changes from prepared to act, to will act.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.	Adds in Raskin and Yellen.
Voting against the policy was Thomas M. Hoenig, who judged that the economy continues to recover at a moderate pace. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and will lead to future imbalances that undermine stable long-run growth. In addition, given economic and financial conditions, Mr. Hoenig did not believe that continuing to reinvest principal payments from its securities holdings was required to support the Committee?s policy objectives.	Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.	No real change here; if anything, Hoenig is more firm in his opinions.

Comments

The Fed launches the QE II.? As I have commented, elsewhere, but can?t find now, the market was looking for about $1 Trillion in QE, so the long end of the Treasury curve sells off.
They highlight that they have a ?statutory? mandate, and a ?dual? mandate.? They are trying to say that they are required by Congress to do these things, and that it is a tough job.? The flip side is that they admit the Congress has the right to tell them what to do, which Ron Paul may make clear as the Chair of the House?s subcommittee on Monetary Policy.
The question is this: will the mechanisms of credit transmit inflation to goods and services?? So far, it has not.? Lowering the policy rate does little to incent borrowing when enough people and financial institutions are worried about their solvency.
Beyond that, if they succeed, how will it be received on Main Street, especially if price inflation is not accompanied by increases in employment, or is accompanied by higher interest rates or lower stock prices?
Hoenig still dissents; hasn?t gotten bored with it yet.
That said the economy is not that strong.? In my opinion, policy should be tightened, but only because I think quantitative easing actually depresses an economy.? It does the opposite of stimulate; it helps make the banks lazy, and just lend to the government.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
My guess is they have no idea why their policy is not working, and they don?t know what to do about it.? Monetary policy works with long and variable lags, so they won?t say that their policy isn?t working.? It?s just slow in taking effect.

The Fed Loses Twice

Posted on 3 November 20103 November 2010 by David Merkel

The Fed lost twice tonight, in that it will face a more skeptical Congress, and that fiscal policy will be jammed for the next two years, meaning that so-called monetary policy will have to do more of the heavy lifting.

Bad timing for the Fed.? They are powerless, or even negatively powerful (They will achieve the opposite of what they are intending), because they don’t understand how monetary policy really works, particularly during times of crisis.

The Fed is imitating Japan, which has done horribly over the last 20 years.? Can’t they learn from recent data?? Interest rates that are too low cause businessmen to make bad decisions.

My advice to the Fed: raise rates.? You might be surprised to find that higher rates lead to greater employment. Economies don’t work well when there is no place for savers to park funds, or when investors don’t have an alternative to risk assets.? Economic agents don’t react well when crisis measures are used… it makes them sit on their hands all the more.? Nothing good ever comes from punishing the prudent, and rewarding the imprudent.? (And, I really fell sorry for seniors in this environment — their ability to generate income in an environment of QE is reduced.)

If the Fed is trying to create inflation, it will find that the creation of asset inflation in what they buy for QE is easy.? But where it goes after that is anyone’s guess.? Currency markets will reflect the debasement, and prices of things we import will rise, like oil, but until Ben buys the helicopter fuel and sends the imagined virtues of currency debasement to the people directly, rather than stealth-financing the government, the price rises of goods and services will be anemic.

But if goods price inflation comes, it may come more aggressively than expected, and be much harder to control than economists presently think.? We don’t have a good model for monetary policy, yet.? After all, consider the last 100 years.

Fed created to provide an elastic currency, so as to avoid another panic of 1907.
In response to a minor economic crisis ~1920, the Fed adopts a loose monetary policy, leading to a large buildup of debt, and then the Crash and the Great Depression.
By 1941, debt levels return to normal.
Post WWII, high inflation, but short-lived.? The Greatest Generation sucks it up, and accepts the high taxes necessary to pay down the war debts.? Their great error: not paying enough attention to child-rearing.? After all, they created the Baby Boomers, of which I am one.
Post WWII, the Fed is restrained an functions relatively well, until the ’60s when monetary looseness leads to foreign governments/central banks trading US Dollars for gold.
The Phillips curve is discovered, and someone decided to experiment with more inflation in exchange for higher employment.
Add in dissolving the final link the dollar has to gold under Nixon.
Alas, the result is stagflation — higher inflation and higher unemployment.
It takes an unorthodox and painful monetary policy from Volcker in the early ’80s to get ahead of the curve.? All rates rise; the short rates go through the roof; unemployment is higher then than today.? But the recovery is brisk.
Under Greenspan, a policy of letting the markets implicitly dictate monetary policy leads to The Great Moderation.
Looks like genius for a time, but the debt builds up to higher levels than during the Great Depression.

Now we deal with the aftermath.? During the bust there are no good solutions; the best one can do is expedite the compromising of debt, and move toward an equity based economy again.? The process is painful, but there is no free lunch.? If you want robust growth, you must allow recessions to do their work, and force marginal uses of capital out of business.

Instead, we adopt a policy that forces rates lower, favoring borrowers over savers, and leads to greater stagnation.? And all this from QE, a theory that is untested, and has not worked in Japan for two decades.? Letting academic economists, who don’t have a good handle on how monetary really works, run monetary policy is lunacy.? They didn’t get it right in the past.? They are not getting it right now.

More later today when I comment on the FOMC statement.