Bond chief Mohamed El-Erian warns of dire consequences if the Fed continues its present course:
Look for the Fed in the next few weeks to go further in revising down its job, growth and inflation forecasts for 2012. Given the institution’s dual mandate of price stability and maximum employment, this will inevitably raise expectations of additional policy activism.
Having exhausted long ago the effectiveness of traditional monetary policy tools, the Fed has no choice but to consider another mix of unconventional measures – specifically, additional purchases of securities, a lower interest rate on excess reserves, an even more aggressive communication policy, and enhanced access to the discount window.
But, more of the same will not have a durable beneficial impact, especially if other policymakers remain missing in action. Indeed, the advantages of another round of unusual Fed activism are declining while the risk of both collateral damage and unintended consequences is material and growing.
I’ve mentioned it before but this looks like a good time to remind you of it. Here’s an example of the “collateral damage”: the insurance industry is having serious problems due to the Fed’s actions. There are, essentially, two ways of making money in the insurance business. You can make money by investing the premiums you take in, usually in certificates of deposit or bonds, or you make money in the form of commissions. To increase the amount of money made in commissions premiums must rise. There are limits to how far premiums can rise without people dropping coverage, hence collateral damage.
This sounds like a good time to return to our old friends, Alphonse and Gaston:
Mr. El-Erian and Dr. Bernanke want the Congress to move first with fiscal stimulus. Congress wants Dr. Bernanke to move first with monetary stimulus. The obvious alternatives for fiscal stimulus, mostly “tax cuts for the wealthy”, are deeply distasteful to the Congress, particularly to the Democratic leadership who’ve obviously convinced themselves that increasing taxes will be good for the economy or, at least, that’s what they’ve been selling to their constituents.
There won’t be any action from the Congressional side until after November and the posture of the Fed appears to be watchful waiting.
an even more aggressive communication policy
They’re going to talk the economy into shape? Who are they going to hire, Tony Robbins or Oprah?
I wonder how many people will get the A&G reference. My grandfather used it often.
Anyway, see my comment on public finance in Dave’s later post about CALPERS.
Folks. You can run, but you cannot hide. And the only people making out right now are the pols and the big institutions. Large corporate.
And the Average Joe gets screwed.
Let’s break this down a bit:
1) additional purchases of securities
He wants the FOMC to swap the securities in exchange for additional reserves. We’ve pumped up reserves by 2000% already for virtually no stimulative impact, because the capacity of banks to make loans is not dependent on their reserve positions. For one thing reserves aren’t something that gets loaned out to customers anyway, they’re just used to clear payments between banks. For another thing bank already have access to any quantity of reserves they require because the Fed is bound by its charter to provide them.
2) a lower interest rate on excess reserves
I assume he means lowering the support rate paid on excess reserves from the lousy 25 bps (.25%) being paid out now. The problem is the Fed has already lowered the fed funds rate from 5.7% in 2008. I question whether lowering it another ten bps will have any significant impact.
3) an even more aggressive communication policy
Talking up the markets seems more like an act of desperation than an actual policy.
4) enhanced access to the discount window.
This either means lowering the penalty the Fed charges for borrowing from the discount window, or he wants the Fed to allow investment banks to borrow limitless sums. The latter is obviously problematic, while the former is just another method of lowering prices on reserves. But reserves can already be gotten from the interbank market for 25 basis points! How would altering the penalty make it easier for banks to make loans?
What’s really odd here is that El-Erian fails to discuss the one way the Fed really could increase banks ability to make loans, by lowering capital requirements.
Ben
Is that your bottom line position? Lowering bank capital requirements?
I admit it – I don’t get the A&G reference. Maybe I’ll look it up later. Or maybe I’ll decide that this is another mystery best left unsolved.
Here’s an explanation of the reference. I’m a bit of an anachronism. For reasons I’ve tried to explain from time to time ideas that are obscure today but were commonplace to my parents’ generation are part of my normal discourse.
@Drew
I don’t think it’s a good idea, but it would in theory accomplish what monetary policy fetishists want.
We need a Fed study on the bias towards action. I’ve run some numbers, I think its about:
Before Problem: -0.30
After Problem: +1.00
You have lurched uncontrollably onto the underlying point of this post, that the assumption is that there must be some action at the federal level.
To be honest I think that’s true but the actions that would have the biggest bang for the buck would be stopping doing some of the things currently being done at the federal level in favor of doing other things. That’s not an idea that’s unique to me. Paul Samuelson proposed it as a method of engaging in fiscal stimulus without additional spending a half century ago.
But it’s a forlorn hope. The things that are being done are already the things that had the best lobbyists.
“To be honest I think that’s true but the actions that would have the biggest bang for the buck would be stopping doing some of the things currently being done at the federal level in favor of doing other things.”
My one remaining hope is that if we can get beyond a focus on quantities (how much is spent), maybe we can start to concentrate on qualities (how well). It might not happen even then, but it sure won’t the way we look at things now.
Icipick
do yourself a favor. Go investigate Alphonse and gaston. It’s old school humor. But it’s from a classic era. It’s not Three Stooges, it’s subtle.
I’m probably showing my age and biases, but who remembers Moose and Squirrel, Boris Badinov, Fractured Fairy Tales, The Wayback Machine, Sherman and Mr Peabody and so forth?
brilliant.
Drew,
I have all the videos. Classics.
It’s not Three Stooges, it’s subtle.
How much more subtle do you want than a law firm named “Dewey, Cheatum & Howe”?!
And I grew up on Moose & Squirrel, in re-runs of course.
Incidentally, the most scientifically minded show of all time was the original “Scooby Doo, Where Are You?” It’s kind of the anti-“X Files” – the mystery is always something prosaic, turned up after careful examination (ahem) of the facts. It’s always a guy in a rubber mask! Take THAT, “Cosmos”!
Speaking of subtle, some of those old Warner Bros shorts were pretty good too.I remember a few years ago seeing one with Bugs Bunny. I’m sure I had seen it countless times when I was a child. He’s sitting by a pool, eating a carrot and reading a book. As the camera angle moves around, Bugs is saying, “Oh! So THAT’S how they do it!” Eventually the camera reveals the books title: How to Multiply. That kind of thing goes right over your head when you’re five, unless you live on a farm….
Sure, and next we’ll have spontaneous peace in the Middle East.
Sure, and next we’ll have spontaneous peace in the Middle East.
That could happen, if someone conjures up a few mushroom clouds first.