The Fed and Chinese risk
Commentary and weekly watch by Doug Noland
This from the Federal Reserve Bank of St Louis president James Bullard on February 21: “Let me just talk a minute about [Fed governor] Jeremy Stein’s speech – governor Stein is a Harvard finance professor – surely one of the leading finance people in the world. And we’re fortunate to have him on the [Federal Reserve] Board of Governors. He came out to a conference in St Louis a couple of weeks ago and gave a speech in which he talked about potential imbalances in financial markets in the US and a little bit around the world. The first point to make would be that – my main take away from the speech – he pushed back some against the ‘Bernanke doctrine’.
“The Bernanke doctrine has been that we’re going to use monetary policy to deal with normal macro-economic concerns, and then we’ll use regulatory policy to try to contain financial excess. And Jeremy Stein’s speech said, in effect, ‘I’m not sure that you’re always going to be able to take care of the financial excess with the regulatory policy.’ And in a key line, he said, ‘Raising interest rates is a way to get into all the corners of the financial markets that you might not be able to see or you might not be able to attack with the regulatory approach.’
“I thought this was interesting and I would certainly listen to him. Everyone should take heed of this. This is an argument that maybe you should think about using interest rates to fight financial excess a little more than we have in the last few years, where we’ve always said we’re going to use regulatory policies in that dimension. I thought it was a very interesting speech, but let me give a little broader context.
“The Fed has been talking about asset bubbles since the ‘irrational exuberance’ speech which was 1996. So it’s nothing new. We had a big bubble in the nineties. A big bubble in the two thousands. Those two bubbles ended very differently. The Fed’s been talking, talking, talking about this. So it’s certainly been a concern. It is a concern today. But it’s like nothing new. This has been going on for 20 years. Frankly, there aren’t good answers because we don’t have great models of financial instability.”
For the second straight month, the release of the most recent (January 29-30) Federal Open Market Committee (FOMC) meeting somewhat rattled the markets. From the New York Times (Binyamin Appelbaum): “There are widening divisions among Federal Reserve officials about the value of its efforts to reduce unemployment, but supporters of those efforts remain firmly in control… An increasingly vocal minority of Fed officials are concerned that buying about $85 billion of Treasury securities and mortgage-backed securities each month is doing more harm than good. They argue the purchases may need to end even before unemployment drops, because the Fed’s efforts are encouraging excessive risk-taking and may be difficult to reverse.”
There is dissention as well as confusion at our central bank. There are (“many”) members that believe open-ended QE was a mistake – and that this policy error should be corrected as soon as possible. Others believe aggressive QE could be continued indefinitely, or at least until unemployment has been reduced to a comfortable level. There is broad disagreement as to impacts, benefits and costs associated with the Fed’s long-term zero rate policy, quantitative easing, the mix of asset purchases, the ongoing balance sheet expansion (and, supposedly, eventual “exit”), pre-committing on the future course of policy and communications more generally. While no one wants to admit as much, it’s all become one big and consequential mess.
Those bullish on US equities can easily ignore this increasingly contentious and complex debate. Understandably, they remain confident that Bernanke and fellow Fed members Yellen, Dudley, Evans, Williams and Co will continue to dictate ultra-easy policy for some years to come. What more do you need to know? And it is not outlandish to surmise that the more the doves’ “inflationist” strategy is called into question, the more insular and intransigent this group becomes.