Randomly Noted

It is in the interest of  the U.S. Federal Reserve to downplay its decision to reinvest the proceeds of agency and mortgage-backed debt back into Treasury securities. In reality, it’s not a monumental move.

But it shows again that the currently constituted U.S. central bank  would rather be doing than watching as the economy continues to struggle.

No doubt the lessons of the Great Depression – an academic specialty of Fed Chairman Ben Bernanke – and Japan’s deflationary decade loom large for the central bankers as the U.S. economy’s growth becomes less perceptible and inflation declines to potentially unhealthily small numbers.

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There’s no reason yet for the Federal Reserve to accelerate unconventional measures to spur U.S. economic growth.

Indeed, to soon adopt what The Wall Street Journal today called a “modest but symbolically important change” in its quantitative easing might be counter-productive in that it spooks the market into thinking The Fed has lost all confidence in the recovery.

The correlated fear to that is to enlarge in investors’ minds the possibility of deflation.

And the maneuver itself, using money from maturing Fed-owned mortgage-backed securities to buy new securities, probably U.S. Treasurys, has no guarantee of making any measurable difference in the minimalist recovery under way.

Indeed, if the Fed winds up ‘pushing on a string’ with any sort of near-term additional quantitative easing measures, meaning they just won’t work because credit liquidity is not the problem, it could damage the Fed’s credibility.

The Journal’s Jon Hilsenrath reported today  that Fed policymakers are considering the move, not that it has already been adopted. A debate about what if anything to do likely will be continued at the Fed’s regularly scheduled monetary policy meeting later this month.

It’s also a bad idea to ease further when there’s still some debate about how strong the economy is right now. Though he has political reasons to want a rosy view, Treasury Secretary Timothy Geithner today laid out the pluses of the recovery that can’t fully be dismissed.

“Business investment and consumption – the two keys to private demand – are gettings tronger, better than last year and better than last quarter,” Geithner wrote in an op-ed piece in today’s New York Times. 

A more subtle argument also urges against further imminent action by the Fed. Call it fix-it fatigue. We’ve now lived through a couple of years of extraordinary actions by the government and central bank to end a credit crisis and cushion the impact of severe recession.

The great middle would agree that it was necessary, did some real good and kept things from being much worse. On the fiscal side, perhaps it even winds up costing the taxpayers a lot less than originally feared.

Still, that same middle group hasn’t given up on capitalism and realizes that too many short-cuts to avoid any economic downturn might well have helped get us into this mess.

That view argues that minimalist growth is all you can expect in the slow, painful process of deleveraging needed to clear the overextended decks for healthier, more sustainable economic growth.

In short, things need to be worse than they are for the Fed to decide it has to try anew to make things better.

Keeping the public’s long-term expectations about inflation in check is typically the ballast of monetary policymaking.

It speaks of the trust people are willing to place in a central bank to keep inflation from getting out of hand and ruining their savings. It gives a central bank freedom to maneuver.

Yet there are times when the very expectation of low inflation puts the U.S. at risk for the opposite and more perilous outcome – Japanese-style deflation when near-zero interest rates held ad infinitum do nothing to cure the economy’s ills or keep prices from dangerous declines.

James Bullard, the president of the Federal Reserve Bank of St. Louis and a voting meber of the Federal Reserve’s rate-setting Open Market Committee, thinks that if we are not at that point, we are conceivably a negative shock or two away.

“The U.S. is closer to a Japanese-style outcome today than at any time in recent history,” Bullard wrote in an economic paper that finds fault with the Fed’s current policy of promising to maintain near-zero rates for an “extended period” to nurse along the nascent economic recovery.

What we might need right now, Bullard implies, is an old-fashioned dose of higher inflation expectations. And the Fed can spur what in other times might be considered an irresponsible goal by buying Treasury securities, at least raising fears of monetizing the federal debt.

A few words about Bullard. Back in December, we called him a breath of fresh air for his public talk about monetary policy in a substantive and straightforward manner. Those are qualities seen too rarely among central bankers, whose thoughts and actions are now especially crucial.

The St. Lousi Fed chief shows his worth again by publishing this technical paper and then discussing it with reporters. Will wonders never cease! During that call, Bullard referred to his paper as “geeky,” Dow Jones Newswires reported, a charcterization with which this layman would heartily agree.

Still, the issues dealt with are anything but esoteric. Federal Reserve Bank of Kansas City President Thomas Hoenig has been dissenting fromFed decisions because he thinks its time to jettison the “extended period” language and end emergency low interest rates. His view is that with at least some growth the emergency is over and rates too low for too long cause their own imbalances.

Bullard seems to object to the phrase for the opposite reason. The phrase’s existence - and talk that the Fed would consider even adding to the definition of extended if the economy worsens – implies an economy in need of emergency help and therefore incapable of generating higher inflation.

If there is a negative shock, Bullard wrote, “A better policy response…is to expand the quantitative easing program through the purchase of Treasury securities.”

Bullard told journalists this paper didn’t mean he would dissent at the Fed’s next meeting in August if they left the “extended period” language as is. He wants to spur debate.

In that sense, he reminds one of Ben Bernanke when the current Fed chairman was a central bank governor. Then, Bernanke was able to stray from some majority Fed views (inflation targets) and still stay in the mainstream.

Bullard may be pulling off a similar feat.

A quote jumped out at me from last week’s hearing for nominees to the Federal Reserve Board.

“With unemployment still painfully high, job creation must be a high priority of monetary policy.”

So spoke Janet Yellen, who now heads the Federal Reserve Bank of San Francisco and who is the nominee to be vice chairman of the Fed.

The quote, as reported by The Wall Street Journal, at one level seems simply indicative of one part of the Fed’s two-part mission: controlling inflation and setting the monetary background for the highest possible, sustainable employment and economic growth.

But it still was jarring because it implied a direct connection with job creation that can never be achieved by monetary policy, and certainly not by traditional central bank setting of short-term interest rates.

Say what you want about Fed policy, the policy makers certainly have been accommodative in monetary policy. Short-term rates are next to zero, about as stimulative on that front as you can get.

And even with those super low short rates, as Yellen notes, unemployment is painfully high.

There are, unfortunately, good reasons for that. There also are good reasons for the Fed, having exhausted interest rate remedies, to stick to the sidelines a good long while before trying anything more creative.

The U.S. economy is undergoing a massive and necessary de-leveraging that will take a long time to play out. During that time, housing prices will not climb, and consumer spending will be restrained.

Businesses will be reluctant to hire before they see real and sustained growth in demand. There won’t be hiring in anticipation of greater demand.

So there are other things behind the well-described painfully high unemployment rate besides issues that can be fixed by monetary policy.

Sure, emergency low rates will stay in place for a very long time. But that alone won’t be enough the correct the job creation problem. And the Fed shouldn’t do any more than it already has.

It’s the minimalist Federal Reserve.

With a tad of old-fashioned ‘white out,’ the U.S. central bank could have taken its statement issued at the conclusion of its March 16 policy meeting and re-issued it today to mark the end of its latest interest-rate confab.

Even Thomas M. Hoenig, the honorable dissenter on the Federal Open Market Committee, if left to repeat his solitary stand meeting after meeting.

Hoenig, the president of the Federal Reserve Bank of Kansas City, doesn’t want much, just for the Fed to abandon its phrase that near-zero short-term interest rates will be kept in place for an “extended period.”

Hoenig’s understandable view, in my paraphrase:  the economy is recovering, if slowly, so why use language that would seem to lock you into a longish-term commitment to emergency low rates?

Take away that “extended period” language and you would let people know that at some point you will return to merely easy monetary policy.

But the rest of the FOMC voters see no reason to shut off Groundhog Day. After all, they said (again) that “inflation is likely to be subdued for some time.”

The Fed seems to have a pretty good read on the economy. Slightly better today than in mid-March but far from out of the woods. Today, the labor market is said to be “beginning to improve.” In March it was “stabilizing.”

“Housing starts have edged up but remain at a depressed level.” In March, “housing starts have been flat.” 

The key fact seems to be that “employers remain reluctant to add to payrolls,” in the words of the Fed. That hasn’t changed and will likely only change to the upside very slowly in the months ahead.

That crucial indicator, and its molasses-like improvement, will keep the Fed’s statement writers nearly idle for the next few meetings. Nothing much will need to be changed.

It’s getting hot in here. With less than three weeks before the U.S. Treasury announces whether it is going to name China as a currency manipulator (for keeping a lid on the yuan to help its exporters), the rhetoric is kicking into high gear.
But how much will the U.S. complaints achieve? If we look at history, the answer is…not much. China hates to be told what to do, and it rarely responds favorably to outside pressure.
Indeed, the U.S. rhetoric could end up being counterproductive. It’s also unclear what would be the end result if Treasury in its semi-annual report opts to label China a currency manipulator. That could potentially open a large can of worms; such a designation sets in train a process whereby trade penalties could be the end result.
China has been getting testier in the past few weeks. Its message (which is being given on a daily basis right now) remains the same: The yuan is not undervalued, and calls for change are counterproductive. But the tone is clearly getting crankier.
Indeed, China’s Minister of Commerce Chen Deming recently warned Beijing “won’t turn a blind eye” to attempts to cite the yuan as a reason for imposing trade sanctions, and central bank Governor Zhou Xiaochuan has said “too much noise” coming from U.S. lawmakers regarding the yuan isn’t helpful in economic policy discussions.
China could yet crank up things up a notch by firmly reminding the U.S. (and the rest of the world) of the massive amounts of U.S. Treasurys held in Chinese coffers. It is already warning that yuan gains may not be to the U.S.’ overall benefit.
Some in the U.S. are calling for everyone to calm down. Several currency experts this week urged Congress not to unilaterally punish China with trade sanctions.
Let’s hope saner heads prevail before someone does or says something regrettable. For more, there’s my recent column on the topic on Dow Jones Newswires: =MONEY TALKS: Yuan A Piece Of Me?

It’s time for banks to wean themselves off cheap Fed credit. This is what the Fed is instigating by boosting the discount rate this afternoon. It’s the rate the U.S. Federal Reserve charges banks for emergency loans, and as of tomorrow it will be a quarter percentage point higher. Others can weigh in on the technicalities. Today’s action feels more like a psychological boost than anything especially substantive — monetary policy remains essentially the same, according to a Fed statement. In my broad-brush view, the Fed’s move counts as a milestone in the financial-crisis era. Maybe, just maybe, the fiasco is really and truly ending and we can go back to normal.

What is “normal” in the aftermath of a crisis that killed banks, insurers, life savings and livelihoods? For banks, the new normal is, after today, a bit more self-sufficiency.  ”These changes are intended as a further normalization of the Federal Reserve’s lending facilities,” the Fed said. This action was expected but currencies are moving on the news – the dollar’s up – and this is probably because well-primed investors nonetheless couldn’t quite believe that the monetary mechanisms put in place during the crisis would ever be unwound. Have a look at colleagues’ Luca Di Leo and Jon Hilsenrath’s coverage.

The Wall Street Journal reports that Iceland’s president vetoed a bill to reimburse the U.K. and Netherlands for bailing out depositors of failed Icelandic banks. Apparently, a referendum will nonetheless go forward next month in which the voters will decide whether or not to repay $6 billion plus interest over 15 years. The Journal notes that the obligation comes to $20,000 for each of Iceland’s 300,000 inhabitants.

It’s understandable that Icelanders wouldn’t want to pay two foreign countries for actions they took to reimburse their own citizens’ deposits in Iceland. On the other hand, Icelanders benefited enormously from the economic bubble their banks promoted through irresponsible lending and investment, and when the bubble popped, Icelandic banks couldn’t honor their deposit insurance pledges, to Icelanders or foreign depositors. The likelihood of Iceland defaulting on its debt is raising the prospect of the International Monetary Fund cutting off aid to Iceland’s depressed economy.

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Some policymakers at the U.S. Federal Reserve apparently are worried about a quite unpleasant possibility, a slow-growth economy that still potentially kicks up inflation over the longer term.

That’s one interpretation of the minutes of the Fed’s most recent rate-setting meeting, held early this month. Those minutes were released today.

Those policymakers worried about inflation might be deemed the ’sullen some,’ since Fed minutes characterize different Fed actors as all, many, most, some or few. In this case the word used was some.

“However, some participants noted that the recent rise in the prices of oil and other commodities, as well as increases in import prices stemming from the decline in the foreign exchange value of the dollar, could boost inflation pressures.”

Of course, there were ’some’ on the other side, counting on significant economic slack among other factors to keep inflation and, very important, expectations about inflation, down.

But the ’sullen some’ thought inflation risks tilted to the upside “over a long horizon,” because the huge government stimulus spending and resultant stratospheric federal budget deficits could unmoor the famously anchored inflation expectations of market participants and the broader citizenry.

The ’sullen some’ added to their dark scenario the possibility that banks might try to cut reserves as the economy recovers by buying securities or lowering credit standards and pumping out loans.

Meanwhile, the spectre of a long-standing too-high jobless rate turning this into a truly long slog rather than a rapid recovery was apparent to all who attended the Federal Open Market Committee meeting.

The weakness in labor market conditions remained an important concern to meeting participants, with unemployment expected to remain elevated for some time, the minutes said.

When it came to their ‘central tendency’ economic forecasts, everyone remained sullen on the jobs outlook. The 2010 unemployment rate is seen at 9.3% to 9.7%. The outlying range prediction was for 10.2%.

“Participants discussed the possibility that this recovery could resemble the past two, which were characterized by a slow pace of hiring for a time even after aggregate demand picked up.” The Fed could have saved some words with the phrase ‘jobless recovery.’

The Congressional moves to hem in the U.S. Federal Reserve attack both the central bank’s regulatory powers as well as the independence of monetary policy.

We, and perhaps the Fed, which is pushing back on all fronts, ought to get our priorities straight. What is it we want the Fed to do and what’s its most important role?

I vote for independent monetary policy above all else. Without a Fed as free as possible from political influence, the global credibility of interest rate decisions is diminished and we can look in the long run to a future of higher inflation and a weaker currency. Yes, we have a weak dollar now, but that doesn’t need to be permanent.

If the Fed has to give up bank regulation, it’s much less of a problem. Bank regulators are a more common breed. Look how many already exist in the U.S. And the Fed’s track record here isn’t great.

So instead of a blanket rejection of every populist-themed attack on the Fed emanating from Capitol Hill, maybe we ought to accept some refashioning of the central bank.

Given the current Congressional thrusts, that means leaning toward the Senate and away from the House of Representatives.

It is in the Senate where the Banking Committee is mulling taking away the Fed’s regulatory authority over big banks. It’s an authority the Obama administration wants to ramp up, giving the Fed power over systemically important financial institutions.

There is an upside to taking regulatory authority away from the Fed related to monetary policy independence. As the Fed’s regulatory role grows, it would be enmeshed in the policies and priorities of whatever political party controlled the White House and/or Congress. There would be consistent second-guessing of regulatory decisions and the central bank would look more like just another government agency.

The Fed’s counter-argument is that without regulation it can’t fight financial crises. Federal Reserve Bank of Chicago President Charles Evans is quoted in The Wall Street Journal saying that without supervision “I don’t think we would know enough” about problems in the financial services industry.

Well, the current crisis shows the Fed and other regulators weren’t as plugged in as they ought to have been, even with regulatory powers. And there is a difference between information and oversight. It could be arranged for the Fed to have access to whatever banking information it needed, which could be shared with others in government.

That implies, as it should, that the Fed’s power to lend to troubled institutions remains intact. Let’s remember the Fed was the nimble agency that helped keep last autumn’s credit crisis from becoming something much worse.

It’s also important that the more direct attacks on Fed monetary independence brewing in the House be stopped. There’s no compelling reason to strip regional Fed presidents of  voting rights when interest rate policy is set, nor to send a Congressional watchdog to audit monetary policy decisions.

If Congress wants more transparency from the Fed, there are much less harmful ways of achieving that.