Randomly Noted

Reading the minutes of the rate-setting Federal Open Market Committee’s meeting of Aug. 10, one is struck by the two uses of the word “anticipated.”

In both cases, the minutes, released today, talk of anticipations by Federal Reserve policymakers that were not being met. Both those thwarted anticipations are on the downside for the recovery and the resumption of more usual economic conditions in the U.S.

Example one: “members generally judged that the economic outlook had softened somewhat more than they had anticipated, particularly for the near term, and saw increased downside risks to the outlook for both growth and inflation.”

Example two, which follows shortly afterwards. “Members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.”

The dual mandate is to maximize employment andto keep inflation under control. Ususally that means keeping inflation from rising. Now, the tougher concern is that the inflation rate is too low.

Federal Reserve Chairman Ben Bernanke made a much-anticipated speech this morning and didn’t break the news the world wanted to know: what would trigger a significant new round of quantitative easing measures by the U.S. central bank.

“At this juncture, the Committee has not agreed on specific criteria or triggers for further action…” Bernanke said. The committee is the rate-setting Federal Open Market Committee.

In general, at a very sensitive point in the economic life of the nation and world, Bernanke chose his words carefully, seeming to understand the weight they carry. His complex sentences at times were reminiscent of his predecessor, Alan Greenspan.

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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.

If I were one of the state legislators shuffling out of the venue in Charleston, S.C., after having been addressed today by South Carolina native and current Federal Reserve Chairman Ben Bernanke, I would feel pretty low.

In addition to having essentially been given the long slog view of the national economic recovery (“But we have a considerable way to go to achieve a full recovery in our economy, and many Americans are still grappling with unemployment, foreclosure and lost savings”) Bernanke  told the folks running states and cities they have some intractable long-term problems.

And Bernanke wasn’t much for providing helpful answers.

Take the ticking time bomb of pension and health benefits promised state and local employees. Many feel they compare too well to what’s offered in the private sector. And because of the squeeze of the recession on government tax receipts, some states have been neglecting their contributions, simply making the future hole bigger.

One solution is for the political leadership to say sorry, we simply can’t afford these pension costs and slowly over time adjust the costs downwards.

Not so fast, said Bernanke. “This daunting problem has no easy solution,” he said in remarks prepared for delivery today to the annual meeting of the Southern Legislative Conference of the Council of State Governments. “Proposals that include modifications of benefits schedules must take into account that accrued pension benefits of state and local workers in many jurisdictions are accorded strong legal protection, including, in some states, constitutional protection.”

If the states can’t change what’s already agreed to, they better get moving on adjusting down the retirement costs of future employees, which presumably they have to power to do.

Just about every state can’t use long-term bonds to cover deficits in operating budgets. That’s a good thing given human and political nature. Absent that, we’d have 50 mini (or perhaps on a percentage basis, not so mini) versions of the gaping federal government deficit.

Bernanke applauds that restraint but laments the resulting state spending cutbacks in weak economic times, “when services are most needed.”

Freed from such restraints, the growing budget gaps from Washington to Athens to Madrid to London tell you something’s got to give. Over time, political leaders have to find ways to spend less and lower taxpayer expectations of government’s role.

Bernanke mentions beefing up state rainy day funds when things are flush to supplement revenues during downturns. The central bankers admits this “may not be politically popular.”

Separately, Bernanke notes the municipal bond markets has remained “reasonably receptive this year to most borrowers ….”

I hope they have something fun planned for this evening in Charleston. Those legislators will have had more than enough daunting news for one day.

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.

We are as close as you can probably get in an economy as large and as sophisticated as the U.S. economy to being becalmed, basically stuck in neutral.

That’s the impression one gets from the very first paragraph of the summary of the “Beige Book,” the compilation of economic activity across the various districts of the Federal Reserve.

The latest Beige Book was released by the Fed today and is based on information collected on or before July 19. Taken together, it’s a picture of an economy not declining, but growing at a level that’s probably not all that discernible from unchanged.

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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.

Ben Bernanke is now positioned to outshine his long-serving predecessor among those making the greatest impact as leaders of the U.S. Federal Reserve.

It’s not just that the 18-year reign of Alan Greenspan, the once universally admired Maestro, is now perceived as severely tarnished from the vantage point of our post-2008 woes.

Greenspan, who once could do no wrong with the denizens of Capitol Hill and the inhabitants of bank trading rooms, now stands accused of being so allergic to economic downturn as to prime the system for asset price bubbles.

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In a just-published potpourri of options said to be under review by the Federal Reserve if it decides its long-standing and remarkable policy of zero short-term interest rates isn’t enough to spur a recalcitrant U.S. economy, one idea jumps out as a particularly bad one.

The notion in question, as published in a Washington Post article today by Neil Irwin, is that the U.S. central bank could publicly commit to an even longer period of keeping short-term interest rates at the emergency level of zero to 0.25%.

To paraphrase the view of the lone and chronic dissenter on the rate-setting Federal Open Market Committee, Federal Reserve Bank of Kansas City President  Thomas Hoenig, and a lyric from Bruce Springsteen, it’s already been one long emergency.

Hoenig wants the Fed to raise short rates to the still-quite-easy 1% and then pause and gauge the impact. That certainly reasonable step, of course, is not going to happen.

Irwin reports in the Washington Post that under consideration is the extension of the current blanket commitment to exceptionally low rates for an “extended period,” perhaps “adding specifics about which economic conditions would lead them to raise rates.” Irwin adds that some policymakers would be sure to object to this because of the limits it places on future Fed policy flexibility.

One would hope there are some objections. As it already stands, few expect the Fed to raise rates at all until at least the middle of 2011. That’s about a year away.  Assuming that scenario, short rates will have stood at zero for more than a couple of years.

Time for the caveat: it’s good that the Fed, along with the rest of humanity, has noticed an apparent deceleration in the growth path of the U.S. economy from slow growth to marginal growth.

Marginal growth is not good. It won’t allow for any significant decrease in unemployment, which in turn won’t let growth climb much from marginal. Given this reality, the Fed should think about what else it could do.

But while the Fed should think about what it might do in a weakening economy scenario, the Fed should hold its fire. The central bank has essentially done what it can. To do more might simply be pushing on a string, loading liquidity into an economic scenario where it has no growth-acceleration power. That would simply make the Fed look weak and demoralize the rest of us.

The economy is in the process of a major deleveraging. It’s slow and painful and necessary and it will restrain growth for some time. But there are no short cuts. To try to take short cuts at this point will invite greater pain later on.