By
Tim Duy
:
A current acute awareness of forecast bias leaves me almost
hesitant to comment on Friday's
speech by Federal Reserve Chairman Ben Bernanke
.
What is forecast bias? Here I am thinking of the bias of Fed
watchers struggling to interpret every bit of data and every
comment from policymakers in the context of their own views of the
economy. One version of such bias is thinking the Federal Reserve
will do what you think they should do. Because you view the economy
as weak, you assume the Fed will do so as well, and react
appropriately. Such a bias, of course, will lead to an erroneous
interpretation of the data and Fedspeak as it relates to monetary
policy.
I fear falling into a variation of this bias. For months, the
flow of data and the Federal Reserve's own forecasts indicate the
Fed will continue to fall short of both its employment and price
stability mandates. This has been confirmed by numerous Fed
speakers including Bernanke himself. Indeed, Bernanke has often
stated disappointment with the pace of the recovery and, in
particular, the costs of high levels of long-term unemployment. He
has also said that nontraditional policy tools continue to be
effective, indicating that the Fed could do more to boost the
recovery.
Yet such action has been fairly limited. I tend to see the
extension of Operation Twist as simply maintaining the status quo,
not additional easing. Expectations for another round of
quantitative easing have been disappointed for the last three
meetings. The bar to additional action has simply been higher than
many believed.
So now I ask myself if monetary inaction during 2012 leads me to
place a "no action" bias in my own analysis. Am I picking out what
I want to hear, and ignoring what I don't?
Now, in all honesty, I haven't had a strong conviction on the
last two meetings. They seemed like relatively close calls. On
average, though, the Fed has moved gradually toward another round
of quantitative easing, with seemingly only Bernanke holding back
policymakers.
Has Bernanke finally flipped sides, reverting to the Bernanke
that we thought we knew back when he was writing about Japan? That
is the question we ask as we take apart his Jackson Hole speech.
And what biases are we bringing to the table when we do that
analysis?
My first take on the speech was that Bernanke largely rehashed
what I think was general knowledge, although with a somewhat dovish
spin that would indicate a higher probability of quantitative
easing at the next meeting than I had previously believed. No
obvious signs, but certainly on the margin pointing to additional
easing. And whenever I worry about my bias, I seek confirmation
from the bond markets. Right now, yields are down 4 to 5 bp, which
is what I think would be the expected market reaction from a
slightly more dovish Bernanke. So far so good.
Bernanke's speech is largely backward looking. He examines the
effects of nontraditional tools, both balance sheet tools and
communication strategies, and concludes that both have been
effective in easing financial conditions and boosting economic
activity and employment. This result should really come as no
surprise; Bernanke had previously expressed confidence that
nontraditional tools had positive policy impacts. And he is not
going to reverse course now and say that policy has been a
failure.
More important is his subsequent cost/benefit analysis. For
months, we have been able to surmise that Bernanke believed the
costs of additional action outweighed the benefits. If this wasn't
the case, he would have eased already. Is Bernanke's analysis
shifting?
Bernanke lists four potential costs: Impaired functioning of
securities market, heightened inflation expectations, risks to
financial stability from encouraging excessive leverage, and
potential losses to the Fed's balances sheets. He quickly dismisses
every concern, leading one to conclude that another round of QE is
a no-brainer as the benefits obviously exceed the costs. He
concludes the section with:
In sum, both the benefits and costs of nontraditional monetary
policies are uncertain; in all likelihood, they will also vary
over time, depending on factors such as the state of the economy
and financial markets and the extent of prior Federal Reserve
asset purchases. Moreover, nontraditional policies have potential
costs that may be less relevant for traditional policies. For
these reasons, the hurdle for using nontraditional policies
should be higher than for traditional policies. At the same time,
the costs of nontraditional policies, when considered carefully,
appear manageable, implying that we should not rule out the
further use of such policies if economic conditions warrant.
Now I hesitate - is this really a no-brainer? Do "economic
conditions warrant" additional action? And notice that the
cost/benefit analysis varies over time. While the benefits clearly
outweighed the costs during the height of the crisis, is that still
true today?
Bernanke then assesses the current economy. He is clearly not
happy with the current state of affairs:
Notwithstanding these positive signs, the economic situation
is obviously far from satisfactory.
Specifically, he identifies persistent high rates of
unemployment, and dismisses a structural explanation. Thus, with
the problem being cyclical, we have a clear role for monetary
policy. This seems to "warrant" additional action. But what is the
explanation for persistent high unemployment rates?
...First, although the housing sector has shown signs of
improvement, housing activity remains at low levels and is
contributing much less to the recovery than would normally be
expected at this stage of the cycle.
Second, fiscal policy, at both the federal and state and local
levels, has become an important headwind for the pace of economic
growth... It is critical that fiscal policymakers put in place a
credible plan that sets the federal budget on a sustainable
trajectory in the medium and longer runs. However, policymakers
should take care to avoid a sharp near-term fiscal contraction
that could endanger the recovery.
Third, stresses in credit and financial markets continue to
restrain the economy. Earlier in the recovery, limited credit
availability was an important factor holding back growth, and
tight borrowing conditions for some potential home buyers and
small businesses remain a problem today. More recently, however,
a major source of financial strains has been uncertainty about
developments in Europe...
Now I am concerned again, as Bernanke appears to be saying that
the factors currently restraining the economy cannot be addressed
by monetary policy. So what are the benefits to additional
nontraditional tools in the current environment? Is he kicking the
can back to Congress? Indeed, he later says:
In addition, in the present context, nontraditional policies
share the limitations of monetary policy more generally: Monetary
policy cannot achieve by itself what a broader and more balanced
set of economic policies might achieve; in particular, it cannot
neutralize the fiscal and financial risks that the country faces.
It certainly cannot fine-tune economic outcomes.
This does not sound like he believes additional monetary policy
would be particularly effective in the "present context." But he
follows with this:
As we assess the benefits and costs of alternative policy
approaches, though, we must not lose sight of the daunting
economic challenges that confront our nation. The stagnation of
the labor market in particular is a grave concern not only
because of the enormous suffering and waste of human talent it
entails, but also because persistently high levels of
unemployment will wreak structural damage on our economy that
could last for many years.
So now I am thinking he has focused his comments almost
exclusively on the employment portion of the mandate, not the price
stability part (which they aren't hitting anyway, but that is a
different story). This alone should scream additional easing. But
is Bernanke really hinting at a bias toward additional easing, or
is he simply trying to convince everyone that he really cares about
unemployment, even though he has not acted more aggressively to
date? He cares, but just can't do much about it? Or is that just my
internal bias speaking, the bias from months of the Fed seeming to
say one thing while doing another?
Attempting to take my own bias into account, my takeaways
are:
-
Bernanke gives a very clear defense of nontraditional
monetary tools to date. The benefits have clearly outweighed
the costs. His rapid dismissal of the potential costs leads one
to believe that he is more inclined than not to additional
action. This is critical; he is the key to moving the middle
ground to additional easing.
-
That said, the analysis is clearly backward looking. Do
current conditions imply the same cost/benefit analysis, which
Bernanke clearly states varies over time?
-
Bernanke expresses considerable concern about high levels of
unemployment. But he also seems to say that the factors
preventing more rapid labor market improvement are beyond the
scope of monetary policy. This sounds like Bernanke is not
confident that more monetary policy will be effective.
Taken together, Bernanke is attempting to be a man for all
seasons, giving a spirited defense of the past that clears the way
for additional action, while explaining why such action might not
be effective or taken in the future. Felix Salmon sums it up
with:
The overall tone here, then, is defensive: Bernanke's on the
back foot, trying to justify past and future actions against
critics on all sides. And when an institution is in a defensive
crouch, it's not going to do anything bold. The Fed was bold in
2008-9, at the height of the financial crisis; those days are
over now. And so, whether we like it or not, any real boost for
the economy going forwards is
not
going to come from the Fed, and is going to end up having to come
from Congress instead. I'm not holding my breath.
Yes, if Bernanke is leaving it up to Congress, we have some
troubling days ahead.
Bottom Line:
On net, Bernanke's speech leads me to believe the odds of
additional easing at the next FOMC meeting are somewhat higher (and
above 50%) than I had previously believed. His defense of
nontraditional action to date and focus on unemployment point in
that direction. This is the bandwagon the financial press will jump
on. Still, the backward looking nature of the speech and the
obvious concern that the Fed has limited ability to offset the
factors currently holding back more rapid improvement in labor
markets, however, leave me wary that Bernanke remains hesitant to
take additional action at this juncture. This suggests to me that
additional easing is not a no-brainer, but perhaps that is just my
internal bias talking.
See also
Why Mattel's Dividend Is Worth A Look
on seekingalpha.com