What factor is
responsible for the recovery that Fed policy has, by most accounts,
stimulated in financial (housing and labor also?) markets over the
last four and a half years? Is it the directing of a fire hose of
cheap money - directly (via LSAP, OMO) and indirectly (burying
yields) - toward riskier assets? Or is it a well-tailored
"communication" policy - via FOMC statements, Ben Bernanke's press
conferences, and Fed governor speeches - that leverages Fed
credibility as lender of last resort to continue the virtuous cycle
of positive market and economic sentiment?
The first suggestion will be familiar: Four and a half years on
from the onset of QE1, it's a widely-held assumption (rightly or
wrongly) that Fed policy is effectively pumping money into stocks.
If anything, recognition of the Fed's communication policy as a
discrete and "unconventional" tool (the second idea) is meager and,
where acknowledged, usually treated as an effect (e.g. Fed prints
money. Stocks go up. Quarterly 401(k) statements are green.
Perceived wealth effect engenders optimism/stimulates spending.)
rather than a cause.
This may seem like an academic distinction - doesn't one just stem
from the other? - but I think not.
When the Fed begins to tighten by reducing asset purchases and/or
raising rates, the causal roles of the multi-pronged Fed policy -
what worked, and how well - will be revealed
ex post facto.
Remember, these are vast and uncharted policy waters the Fed is
treading. Calm may rule while policy accommodation is fully
unwound, but what if the superficial placidity right now belies a
rogue wave of adverse consequences? Fed pessimists have long
suggested big problems are baked into that policy-unwind cake.
Others say it's all about how deftly the Fed plays the hand of exit
cards it has dealt itself.
What if the Fed can identify the cards it's holding, but doesn't
understand how to best play the hand(s) that result? Any
misconception by the Fed regarding 1) the efficacy of Fed policy
even 2) financial markets' perception of Fed policy initiatives
could build a lot of negative momentum into that rogue wave.
Before I mix in any more metaphors, recall the ideas in the first
paragraph: How much of the bid under asset prices is a result of
hard, quantitative easing (including the LSAP iterations and other
facilities of the past four and a half years)? And how much results
from the soft, "tail-wagging-the-dog" structure of market optimism
that is reiterated, reinforced, and refined with every communiquÃ©
from the Fed?
My impression, in brief, is that these factors of Fed policy are
very easy to identify. After all, the Fed has described and
demonstrated them in detail, over and over again. Determining how
effective they are, relative to one another and to an absolute
degree, is very difficult -- to the Fed, and to observers
(politicians, economists, market participants). According to
is working, but what that is and how quickly or slowly it can be
taken away remains largely unknown.
I plan to write some upcoming posts going over this question in
more detail. For now, I'd like to throw the original question out
Which factor is
responsible (of the above, or another you may have in mind) for the
recovery that loose Fed policy has stimulated in markets? Why so?
Will this factor pose problems for the Fed as it attempts a smooth
exit, or not?
I welcome your thoughts in the comments section below.
This article by Andrew Kassen was originally published on