The Federal Reserve is putting some
of its post-crisis actions under a magnifying glass and not liking everything
it sees.
In a
white paper dissecting the U.S. central bank's
actions to stem the financial crisis in 2008 and 2009, Stephen D. Williamson,
vice president of the St. Louis Fed, finds fault with three key policy tenets.
Specifically, he believes the zero
interest rates in place since 2008 that were designed to spark good inflation
actually have resulted in just the opposite. And he believes the "forward
guidance" the Fed has
used to communicate its intentions has instead been a muddle of broken vows
that has served only to confuse investors. Finally, he asserts that quantitative easing, or the monthly debt purchases that swelled the central
bank's balance sheet past the $4.5 trillion mark, have at best a tenuous link
to actual economic improvements.
Williamson is quick to acknowledge
that then-Chairman Ben Bernanke's
Fed, through liquidity programs like the Term Auction Facility that injected
cash into banks, "helped to assure that the Fed's Great Depression errors
were not repeated."
"There is no work, to my
knowledge, that establishes a link from QE to the ultimate goals of the
Fed—inflation and real economic activity" -Stephen D. Williamson, St.
Louis Fed vice president
But as for spurring inflation,
reducing employment or otherwise generating sustained economic activity, the
results, particularly for QE, are "at best best mixed." In addition
to muted inflation, gross domestic product has yet to eclipse 2.5 percent for any calendar year during
the recovery, while wage gains, and consequently living standards, have been
mired around 2 percent or less.
"There is no work, to my
knowledge, that establishes a link from QE to the ultimate goals of the
Fed—inflation and real economic activity. Indeed, casual evidence suggests that
QE has been ineffective in increasing inflation," Williamson wrote.
"For example, in spite of
massive central bank asset purchases in the U.S., the Fed is currently falling
short of its 2 percent inflation target," he added. "Further,
Switzerland and Japan, which have balance sheets that are much larger than that
of the U.S., relative to GDP, have been experiencing very low inflation or
deflation."
The primary place where QE seems to
have worked is in the stock market, where the S&P 500 has soared by 215 percent since the recession lows in March
2009. Elsewhere, though, deflation fears have permeated and interest rates have
remained low.
Interestingly, one of the biggest
fears Fed critics have espoused about its activities has been that the bloated
balance sheet would drive inflation by releasing that "high-powered"
money into the economy and driving up prices.
However, the inflation rate for the
U.S., and for much of the other developed world where central bank activism is
high, has remain muted, at least by conventional measures.
In Williamson's view, that's a
product of policymakers wed to the Taylor rule, which dictates the level of
interest rates in regard to economic conditions. The thinking essentially is
that low rates beget low inflation, trapping central banks in zero interest
rate policies (or ZIRP).
"With the nominal interest rate
at zero for a long period of time, inflation is low, and the central banker
reasons that maintaining ZIRP will eventually increase the inflation rate. But
this never happens and, as long as the central banker adheres to a sufficiently
aggressive Taylor rule, ZIRP will continue forever, and the central bank will
fall short of its inflation target indefinitely," Williamson said.
"This idea seems to fit nicely with the recent observed behavior of the
world's central banks."
Source: Federal Reserve Bank of St.
Louis
Steven Williamson
The trap then manifests itself in a
failed communication strategy.
In the third stage of QE, the Fed
sought to establish specific targets for when it would raise rates, such as 6.5
percent unemployment rate and a 2.5 percent inflation target. However, as
unemployment fell and inflation lagged, the Fed began moving the goalposts, to
the point where the headline unemployment rate is now 5.3 percent and the
central bank has yet to move on interest rates.
Williamson argues that the Fed is
perhaps overdoing it with transparency, and he uses a simple comparison of
post-Open Market Committee meeting statements: After the Jan. 31, 2007,
(precrisis) meeting, the Fed statement consisted of just 129 words; following
the Jan. 28, 2015, meeting, the statement more than quadrupled, to 529 words.
In that type of environment, the
market becomes glued to certain phrases the Fed uses. In this case, the FOMC
had been including the term "extended period" for how long it would
remain accommodative. However, as the benchmarks fell and the Fed kept ZIRP in
place, the impact of forward guidance became muted.
"'Extended period' is far too
vague to have any meaning for market participants; monetary policy rules should
be specified as contingent plans rather actions to take place at calendar
dates; 'thresholds' are meaningless if nothing happens in response to crossing
a threshold," Williamson wrote. "Thus, the Fed's forward guidance
experiments after the Great Recession would seem to have done more to sow
confusion than to clarify the Fed's policy rule."
Many Wall Street strategists have
issued forecasts expecting the Fed finally to end zero interest rates in
September. However, uncertainty lingers: The CME's FedWatch tool, which
monitors futures contracts, indicates just a 36 percent chance of September
tightening.
http://www.cnbc.com/2015/08/18/st-louis-fed-official-no-evidence-qe-boosted-economy.html
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