The Fed held its last meeting of the year yesterday and announced two important changes in policy. First, as was widely expected the FOMC decided to transition Operation Twist—the bank’s maturity extension program—into QE4. So now instead of printing $40 billion per month to buy mortgage backed securities and selling $45 billion in short-term Treasuries to buy long-term treasuries the Fed will just print $85 billion per month and buy $45 billion worth of treasuries and $40 billion worth of mortgage backed securities. What is the point? The Wall Street Journal editorial page had the same question. To wit:
“That’s the contradiction at the heart of the Fed’s latest foray into ‘unconventional policy,’ which is a euphemism for finding new ways to print money: The economy needs more monetary stimulus because it is still too weak despite four years of previous historic amounts of monetary stimulus.”
It gets even more frightening when you hear Chairman Bernanke’s response to a question about the asset purchases in the post-meeting press conference.
“The asset purchases [money printing] are a less well understood tool. We have, we will be learning over time about how efficacious they are, about what costs they may carry with them in terms of unintended consequences that they might create.”
Just to summarize, the Fed has thrown the kitchen-sink of monetary stimulus at the economy yet growth remains weak. But instead of recognizing the failure of these radical measures, the Fed has decided to double down on a strategy that it doesn’t understand, and of which it has no idea as to the effectiveness or costliness. If you feel like a lab rat, you aren’t alone.
The second policy change that the Fed made yesterday was to its communications strategy. Instead of setting a calendar date to inform the public how long it will hold interest rates at zero, the Fed decided to use unemployment and inflation thresholds.
Bernanke & Co., said they will keep rates at zero so long as unemployment is above 6.5% and inflation projections for one to two years ahead are no higher than 2.5%. Yup, the Fed is again setting policy based on the unemployment rate (hope you liked the inflationary 1970s) even though the Fed and every economist, save maybe Paul Krugman, acknowledge that monetary policy has no impact on long-run unemployment. As for the inflation threshold, yes, you did read that right, the Fed is actually setting policy based on its own inflation forecast. So much for humility.
What is most ironic about the Fed’s decision to shift to inflation and unemployment thresholds is that it may have unintentionally tightened policy. In its post-meeting statement, Bernanke & Co., said that the new thresholds for unemployment and inflation are consistent with the calendar based guidance of raising the Fed funds rate no sooner than mid-2015. Why are they consistent? Because the Fed’s statistical models forecast it. Don’t forget Bernanke and his allies are academics at heart. Elegant statistical models are most often given undue weight with this crowd. But while Mr. Bernanke may have faith in the Fed’s models, the market knows better. Only twelve months ago, the Fed was forecasting a year-end 2012 unemployment rate of 8.5% to 8.7%. Today the unemployment rate is about 7.7%. In hoops they call that an air-ball. If the current downtrend in unemployment continues through 2013, the unemployment rate will be at 6.9% next December and poised to drop below the Fed’s threshold a full-year ahead of schedule.
The Fed’s actions yesterday were just more misguided monetary activism that is likely to harm America’s long-run economic prospects. Oh well, at least we know the monetary and fiscal authorities are working out of the same Keynesian playbook.
Jeremy Jones, CFA
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