(My writing in italics)
The Chairman of the Federal Reserve Benjamin Bernanke was on 60 minutes, again. This time to defend more than explain the Fed’s policy of quantitative easing to the rest of the country, most of which has a lot of time on its hands, thanks to the level of unemployment, to digest the econ talk.
The Fed’s rhetoric has not changed since the days of the federal funds rate beginning to drop from the “neutral” rate of 5.25 per cent in 2007 to zero and beyond: that the Fed (“we”) has analyzed it comprehensively and that the country must take his word for it. We know the result. We are living it. In the Fed Chairman’s own words, “the unemployment rate is not going down.”
Scarily enough, in a public relations disaster for the Fed’s communications shop, CBS shows Bernanke at Ohio State University waiting for the students there to figure out the remedy to his problems, a slap in the face for the 200 or so PhDs at the Fed from the very best economics programs in the country. God help the country and the economists at the Fed if the nation’s central bank has to yield to the next generation for unemployment to return to healthier levels, similar to Bush 43’s Iraq war rhetoric of generational sacrifice.
To recap, I have copied below some snippets of the interview that was broadcast on CBS’ 60 minutes on Sunday, December 06, 2010 and put down my comments right below his answers to questions from Mr. Pelley of CBS.
Pelley: How great a danger is that now?
Bernanke: I would say, at this point, because the Fed is acting, I would say the risk is pretty low. But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern.
The issue is not whether the Fed should have or should not have acted or that it ought to continue acting. Quantitative easing is necessary. It is, however, how it is acting: the structure of intervention. Pumping money and expecting domestic investment to rise through the transmission channels of the broken system has not thus far worked because the inertia of past habits and failures is continuing. He cannot expect to continue to do the same thing and expect a different result. So, the sub-text is “let Washington implement the new toothless financial regulatory reforms that are safeguarding the status quo, and then hopefully the transmission mechanism will work. Until then let us ward off deflation with more money.”
Critics of Bernanke’s Federal Reserve have the opposite worry: they say the $600 billion and holding down interest rates could overheat the recovering economy, causing prices to rise out of control.
Pelley: Some people think the $600 billion is a terrible idea.
Bernanke: Well, I know some people think that but what they are doing is they’re looking at some of the risks and uncertainties with doing this policy action but what I think they’re not doing is looking at the risk of not acting.
The trouble with Bernanke is that he firmly believes that the Fed made a mistake in the early 1930s by contracting money supply. And, therefore, the antidote according to him is to keep expanding it (then FDR had expanded it through his Treasury after the fact). The reality is that it does not matter. What matters, whether the central bank acts or the Treasury acts, how it acts. Both the Federal Reserve Act and the Congress/Executive can be more interventionist than simply throwing money at the problem.
Pelley: Many people believe that could be highly inflationary. That it’s a dangerous thing to try.
Bernanke: Well, this fear of inflation, I think is way overstated. We’ve looked at it very, very carefully. We’ve analyzed it every which way. One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowing interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re gonna do.
The Fed Chairman, an expert and a scholar on monetary policy does not know what he is talking about. The Fed expands money supply by buying outstanding Treasury securities with newly printed cash. When it contracts money supply it sells the Treasury securities on its balance sheet and burns the cash it gets back. This is the standard procedure. The Fed Chairman’s explanation or non-explanation is only valid if the Fed is selling the mortgage backed securities on its balance sheets (which are good substitutes for Treasury securities) and using the cash that is coming back to it to buy Treasury securities instead. In other words, the Fed is swapping mortgage backed securities on its portfolio with Treasury securities. Only then can the Fed buy Treasuries without printing new money. It is best if the Fed says so on its public web site, by giving a breakdown of exactly how the $600 billion is being recirculated.
Still, this transaction has real implications: the glut of mortgage backed securities due to the Fed’s sales of them should raise mortgage rates. The artificial demand for Treasuries should lower the rates on the them. Given that typically mortgage backed securities are indexed to the long term Treasury notes, the Fed may be betting that mortgage rates will not rise because the long rates will fall through Treasury purchases. The net effect is zero. Besides, the interest the United States government will have to pay on its long debt will be lowered. This reasoning per se is acceptable, but the housing market recovering or not further collapsing greatly depends on job creation through higher domestic investment. To this outcome, the Fed has no answer, but to ask the country to sit and wait until that happens.
In the question immediately preceding this, Bernanke is concerned with deflation. Knowledge of basic economics is sufficient to discern that unless the stock of base money in the economy actually rises, the risk of deflation cannot be lowered. But the Fed Chairman is saying that the Fed is not actually raising the stock of base money supply. It is simply recirculating it. Therefore, he is expecting to pull the magic trick of not causing deflation through psychological manipulation: “we are easing money supply psychologically to avert deflation but not really increasing the stock of money to avert inflation.” Because when the Fed says (not does) that it is easing money supply it is expecting that the expectation of inflation will thwart deflation.
The reality once again confounds the delusions of the economics of rational expectations when the world is on edge, because the net effect could be downward sloping for growth, not demand. Bernanke’s words out of the ivory tower government-paid economics faculty offices on Constitution Avenue render the Fed’s actions non-credible. If the Fed means to increase money supply it must do so credibly and act as permitted by the law that governs the institution (The Federal Reserve Act) to intervene structurally in the economy to raise domestic investment, meaning the Fed must make industrial policy. The Fed has the tools to do so and it must, therefore, do it. Not doing so was the mistake the Fed had made during the Great Depression, waiting for FDR to come along with fiscal policy and later the war which had ultimately and principally extricated the country from the depression. Is Bernanke waiting for Obamanomics à la FDR?
Pelley: Is keeping inflation in check less of a priority for the Federal Reserve now?
Bernanke: No, absolutely not. What we’re trying to do is achieve a balance. We’ve been very, very clear that we will not allow inflation to rise above two percent or less.
Pelley: Can you act quickly enough to prevent inflation from getting out of control?
Bernanke: We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.
Pelley: You have what degree of confidence in your ability to control this?
Bernanke: One hundred percent.
Pelley: Do you anticipate a scenario in which you would commit to more than $600 billion?
Bernanke: Oh, it’s certainly possible. And again, it depends on the efficacy of the program. It depends on inflation. And finally it depends on how the economy looks.”
If the Fed keeps up with zero interest rates, and if it perhaps even decides to credibly raise money supply by printing fresh money, the financial markets will continue to like to borrow cheaply in the United States to invest elsewhere and in U.S stocks for the short term only to raise stock prices in Wall Street without raising domestic investment that is needed to create jobs on Main street. Japan’s experience is all too well known. So, Bernanke cannot credibly follow through on the 15 minutes he needs to raise interest rates when they really need to be raised out of fear that growth could suffer. At high levels of unemployment it will then be not inflation that he needs to worry about but stagflation, causing a complete drain of credibility of monetary policy that was earned by Paul Volcker.
The Fed has not analyzed the issue well enough. It must drop its veneer of independence and begin to act independently to be truly credible.