Here is my latest piece on the Fed's policies.
Marty
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Project Syndicate Decoding Bernanke
July 2013
By MARTIN FELDSTEIN
CAMBRIDGE Federal Reserve Chairman Ben Bernanke has been struggling to
deliver a clear message about the future of Fed policy ever since his May
22 testimony to the US Congress. Indeed, two months later, financial-market
participants remain confused about what his message means for the direction
of US monetary policy and market interest rates.
Bernankes formal statements about the Feds two unconventional policies
have been clear. First, the Fed is trying to give relatively specific
guidance about the future path of the federal funds rate (the overnight
rate at which commercial banks lend to each other). Second, the Fed is
indicating the conditions that will cause it to start reducing its massive
monthly bond-buying program and eventually bring it to an end. Bernanke has
emphasized that these two policies are on separate tracks and will respond
to different indicators of the economys performance.
The Federal Open Market Committee (FOMC), comprising the Fed governors and
the presidents of the regional Federal Reserve banks, has agreed that the
federal funds rate will remain at its current near-zero level until the
unemployment rate drops to 6.5% and can be expected to remain there or
decline even further. With unemployment now at 7.6% and falling only
slowly, the Fed may not be ready to raise the federal funds rate until
2015.
But there are caveats that make this forward guidance ambiguous and
therefore uninformative. The Fed warns that it might increase the federal
funds rate if the anticipated annual inflation rate rises from its current
level of a bit less than 2% to more than 2.5%. There is no clue, however,
about how that anticipated future inflation rate will be determined. So
the Fed could, in principle, decide to raise the federal funds rate even
before the unemployment rate reaches 6.5%.
Moreover, the Fed recognizes that a substantial part of the decline in the
unemployment rate in the past year reflects the large number of people who
stopped looking for work (and who therefore are no longer counted as
unemployed). So, if the unemployment rate is deemed to have fallen below
6.5% because of continuing declines in labor-force participation, or
because firms increase the relative number of part- time workers (which
would imply no increase in the aggregate number of hours worked), the Fed
may not raise the federal funds rate.
As a result, it is not surprising that the market is confused about the
likely path of the federal funds rate over the next 24 months. And that is
important, because a rise in the federal funds rate will cause other,
somewhat longer interest rates to increase as well.
The bigger policy uncertainty is about the more immediate prospect that the
Fed may soon reduce its purchases of long-term assets so-called
quantitative easing. Bernanke continues to stress that shifts in the pace
of bond buying will depend on how well the economy is doing. But he
startled markets recently by saying that the FOMCs expected path of
stronger growth could lead to a slower pace of buying later this year and
an end to the asset purchases by mid-2014.
Bernanke justified his position by stating that quantitative easing is
intended primarily to increase the near-term momentum of the economy,
suggesting that stronger momentum would justify less asset buying. The
reality, however, is that the economys near-term momentum has actually
been decreasing ever since quantitative easing began and has decreased
more rapidly as the size of the program has grown.
The pace of real GDP growth fell from 2.4% in 2010 to 2% in the next four
quarters, and then to 1.7% in 2012. The first official estimate of GDP
growth in the second quarter of 2013, to be released on July 31, is likely
to be less than 1%, implying that annual GDP growth in the first half of
this year was considerably slower than in 2012.
So what does this imply about the Feds willingness to taper its pace of
asset purchases? Ironically, it might help to rationalize the decision to
begin tapering before the end of the year.
First, the lack of correlation between quantitative easing and GDP growth
suggests that the pace of asset buying could be reduced without slowing the
pace of growth. That is true even though, contrary to the assumption of
Bernanke and some other FOMC members, interest rates will rise as the pace
of purchases declines.
Second, if the extreme weakness in the second quarter is followed by a
return to a sluggish growth rate of around 2% in the third quarter, the Fed
could declare that it is observing the pick-up in growth that it has said
is necessary to justify the beginning of tapering.
The policy of extremely low long-term rates is now doing more harm than
good by driving lenders and investors to take inappropriate risks in order
to achieve higher returns. Bernanke and the FOMC should recognize this and
gradually bring the bond-buying program to an end during the next 12
months. They can take credit for what quantitative easing has achieved
without holding its termination hostage to the economys future
performance.
It is significant that Bernanke will be stepping down at the beginning of
2014. He did a remarkably good job in dealing with dysfunctional financial
markets during the crisis years of 2008 and 2009. When the financial
markets were working again but the economy was still growing much too
slowly, he turned to unconventional monetary policies to reduce long-term
interest rates and accelerate the housing markets recovery. So, although
the economy is now weaker than he or anyone else would like, he may want to
complete his policy legacy by beginning the exit from unconventional
policies before he leaves the Fed.
Martin Feldstein, Professor of Economics at Harvard, was Chairman of
President Ronald Reagan's Council of Economic Advisers and is former
President of the National Bureau for Economic Research.
Copyright: Project Syndicate, 2013
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7/29/2013
Received on Mon Jul 29 2013 - 11:41:28 EDT
