Following the latest FOMC meeting yesterday, the Federal Reserve announced that it will maintain its zero-interest-rate policy until at least 2013. This is the first time the Fed has given the market a timeframe for keeping rates on the floor. Plunging global equity markets apparently panicked a reactionary Ben Bernanke. I guess you can’t blame him. After all of the hard work he put into artificially levitating stock prices with QE2, the market has given up almost all the phony gains in only two months.
But Mr. Bernanke’s latest attempt at monetary stimulus may be worse than QE2. It is certainly the pinnacle of hubris. And yes, I mostly mean Bernanke’s hubris. Three of the FOMC members dissented from the Fed’s decision yesterday. The decision was likely all Bernanke, with some shades of Goldman Sachs alum William Dudley and the always dovish vice chairwoman Janet Yellen.
What is my beef with the Fed’s decision to hold rates at zero for another two years? Only six weeks ago, the Fed believed that waning economic momentum was simply due to transitory factors. The committee was expecting economic growth to accelerate in the second half of this year. At the June meeting, the committee was projecting GDP growth of 2.7% to 2.9% in 2011 and 3.3% to 3.7% in 2012.
Now, only six weeks later, this is what the Fed had to say about the economy:
Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity. Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions. More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
I don’t blame Bernanke and his allies for downgrading their economic outlook. Incoming data has been weak. The Fed would have lost serious credibility if it continued to project a second-half rebound. But if the Fed’s economic projections for a six-month period dead ahead can change so drastically in only a few weeks, what gives Mr. Bernanke the confidence that he can project economic conditions two years into the future? That is exactly what the Fed did yesterday when it committed to hold the federal funds rate at zero until 2013. I am sure Mr. Bernanke is a brilliant economist, but his latest foray into unconventional monetary policy signals that he is far too confident in his own forecasting ability and the forecasting ability of the Fed staff.
The Fed has held interest rates at zero for almost three years and injected trillions of dollars of unneeded liquidity into the financial system. Yet unemployment is still north of 9%, GDP hasn’t passed its prior peak, and the housing market is still in the tank. The economy isn’t suffering from a lack of liquidity or from tight money. Continued efforts to stimulate growth with monetary policy are like treating a cancer patient with oxycodone. The drugs might make the patient feel good, but they don’t cure the underlying illness. And if the patient takes too many pills, he risks serious harm to vital organs.
The Fed’s perpetual easy-money policies distort financial markets, impair the structural integrity of the U.S. economy, and risk serious inflation down the road. The treatment is worse than the disease. It is time to let capitalism work. Mr. Bernanke needs to step back and let markets clear.
Jeremy Jones, CFA
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