EDITOR NOTE: This is a fairly long and, for some readers, a relatively complex analysis of Federal Reserve aims and actions over the last decade. What it ultimately points to is this: the Fed bases its policy on certain measures, certain goals that, over time, are adjusted. Isn’t this a normal part of every process? Not really, because for the Fed, these measures, which are “couched” in the same defining terms such as “employment” and “inflation” are ultimately based on assumptions whose “meanings” have more or less been transformed or discarded. With such shifting definitions guiding Fed policy, how much of its actions are based on variable, flexible, and hence unreliable measures? In other words, how accurate is a system that rests upon a shifting foundation of concepts?
In early October 2015, former Federal Reserve Chairman Ben Bernanke stopped by the op-ed pages of the Wall Street Journal on his way to taking his victory lap. Poised for the first time in too long a time, the Federal Reserve under his immediate successor was about to hike policy rates fulfilling, in central bank terms, an unbelievably long quest to get the US economy to recover from the Great “Recession.”
A quest that in 2015 had already been surprisingly lengthened…by something. Never mind these other “transitory” factors threatening to spoil the fun, Bernanke wrote, rather focus on the hero. Bernanke.
“For the first time in nearly a decade, the Federal Reserve is considering raising its target interest rate, which would end a long period of near-zero rates. Like the cessation of large-scale asset purchases in October 2014, that action will be an important milestone in the unwinding of extraordinary monetary policies, adopted during my tenure as Fed chairman, to help the economy recover from a historic financial crisis.”
That was his opening. The entire piece thereafter was informally dedicated to his critics; not all of them, mind you, a suspiciously shorter list. These mainstream detractors, like the forgettable and forgotten Economics21 (or E21) which was, somehow, once taken very seriously, had all said to Ben that he couldn’t do it; that the Fed couldn’t get the economy to recover without sparking a dollar and inflation crisis.
Seriously, that’s exactly what the group of famous Economists had warned back in November 2010 when the second bout of “extraordinary monetary policies”, QE2, was just then getting started.
“We believe the Federal Reserve's large-scale asset purchase plan (so-called "quantitative easing") should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed's objective of promoting employment.”
For the five years in between, the economy neither recovered nor did the inflationary crisis materialize. The dollar’s crash? No, the currency’s exchange value was screaming in the opposite way. Inflation? Too little, perplexing both central bankers and Economists alike, only partway through an undershoot period which would end up lasting about five years.
By 2015, however, the dollar and inflation safely denouncing the E21 and the Fed’s critics who were like them, the recovery seemed finally “in sight.” How did Ben come to judge this situation? Two words: full employment.
Back to Bernanke:
“With full employment in sight, further economic growth will have to come from the supply side, primarily from increases in productivity.”
In other words, we’ve done our job and now it’s time to turn everything over to the economy (thus, rate hikes). Monetary policy had achieved all its primary objectives; by the sheer will and tremendous courage of central bankers using genius non-standard techniques to remove from the economy’s path the tremendous drag of the tremendous amount of debilitating macro slack the Great “Recession” had introduced into it.
If we had indeed achieved full employment by late 2015 (better late than never, Bernanke implied), that would mean no slack remaining, QE had functioned with far more of a lag than expected but to completion anyway. Strike up the band, get Bernanke’s parade warmed up.
Except, only one small, minor, teensy littlest thing left for the economy to do, mere formality, he said, the final, final bit was confirming the condition of full employment. Notice what even the heavily invested former Chairman had said; “in sight.” As in, not quite yet.
You might forgive the man his over-eagerness because it had been a long decade for him (as well as, you know, everyone else; particularly anyone who just might have been stuck in the slack).
Even as Janet Yellen’s Fed raised the fed funds apparatus (no single target anymore, though no one ever asks why, or even what changed) in December 2015, “transitory” factors would stall the second planned hike until December 2016. Though technically not full ZIRP over the final twelve months, the zero and just-above-zero interest rate policy would end up lasting eight long years.
What had happened? The dollar crash didn’t show up because, relatedly, neither had the inflation. Premature celebration, after all.
In September 2020, we can now turn to Jerome Powell, Bernanke’s successor’s successor, for a partial explanation.
“Maximum employment is not something that can be reduced to a number the way inflation can. It’s a broad range of factors, it really always has been and really a substantial number of factors we indicated we would look at. It’s broader labor conditions, consistent with our committee’s assessment of maximum employment. So that would certainly mean low unemployment, high labor force participation, it would mean wages, it’s a whole range of things.”
Up until this year, or sometime over the last year and a half, that’s just what full employment had been reduced to – a number in just the way inflation had. It had been, in fact, a specific number which had launched those former Chairman’s self-congratulations.
That sound you hear is air rapidly draining from every one of Bernanke’s 2015 parade balloons, each deflating for the use of this single pin. Transitory factors? Nope. Turns out - surprise! - they weren’t transitory at all. The “best and brightest” at the Fed today admit it was all a big mystery. Not a series of temporary small mysteries, but a single big and continuous one.
Instead, as Powell now says, central bankers don’t really know exactly where, or what, full employment is.
Though neither he nor Bernanke would like you to work backwards a step or two from what is an understated, truly remarkable bit of damning contradiction, you’ve probably already done so just in your head on common sense and raw human inquisitiveness. If full employment is a mystery, and recovery is defined by full employment, then QE, ZIRP, and all the rest “extraordinary monetary policies” achieved, what, exactly?
Officially: results undetermined. After now almost twelve years of QE and ZIRP, the latter interrupted in only three of them (one, as noted above, a “stout” 25 bps for an entire year), we can’t say for sure whether there’s macro slack still left in the economy following a long ago, near ancient global monetary panic that had caused an even bigger economic calamity.
From 2015 forward, half a decade more of inflationary talk (not the E21 kind, of course), recovery guarantees, unemployment rate celebration, hawkishness and their like. So much constant monetary “accommodation”, the most powerful and effective the world has ever seen, and the result is…Economists have to rethink full employment.
A dozen years is more than enough to make every judgment necessary with perfect clarity and unflinching certainty. If you have to upend the very notion of full employment, you’re simply trying too hard.
For all that time, the entire focus had been lasered in on the presumed power and effectiveness of these policies. Always only the two options: either QE will be just the right amount given enough time to complete even the biggest jobs, or it will end up being too much, too energetic and therefore will spark inflationary, currency-destroying excesses.
Monetary policy is always treated like Doc Brown’s stolen Libyan plutonium slug, the smallest little bit of a single element that can alone generate the unthinkably enormous 1.21 gigawatts his time machine employs to easily overcome and violate every known standard for universal entropy. You can only handle it with the utmost of care, it’s so potent, both the doc and Marty McFly have to be completely suited up in full radiation gear just to get near enough to drop it safely into their DeLorean’s overly engineered lead-lined construction.
The slightest little jolt in the glass case, and Marty near leaps out of his suit. Its only comparison is a bolt of lightning!
This is not much hyperbole, either. Go back and read all the press accounts; the more contemporaneous the better. “Ultra-accommodative.” “Flood of liquidity.” “Ultra-loose.” On and on.
More and more it is absolutely clear that the Fed’s critics should have instead focused their lamentably squandered opportunity on the opposite case; monetary policy’s a dud. Not all-powerful; utterly powerless. In danger of “too much?” Not a chance, it never even got off the ground enough to achieve “too little.”
Yet, the public imagines Bernanke time and again in front of the cameras wearing his radiation suit, even adding more protective gear to it as time passed, always talking about the Federal Reserve DeLorean’s thankfully lead-lined interior. Monetary plutonium. The stuff of pure atomic currency bombs.
And full employment says it was all a ruse; a carefully orchestrated puppet show featuring a cast made up of the financial media in all the starring roles – most of them still today don’t even know they were in it.
This includes the E21. Providing Bernanke, as well as Yellen and Powell in later years, what every good drama requires – the caricature villain, or foil. Written up as his worthy opponent, some sturdy weak dollar antagonist who in the end is bested by our gallant stimulus protagonist after his hero’s quest in search of the Holy Inflation.
The E21 had thoroughly acted the part, along with so many others, giving the Fed its straw man to cathartically overcome. To provide mainstream monetary policy with a counterargument that had no basis in fact or reality, therefore no matter what happened monetary policy practitioners could point to their dramatic foil and say, see, I told you I was right!
In fact, as the dollar itself traded higher and higher rather than even a little lower, it was given as loose evidence for QE’s success – so long as it was framed in the right way, at the expense of these critic’s last remaining dignity. Transitory inflation and the US economy as the world’s cleanest dirty shirt. Not quite plutonium.
Time may indeed heal all wounds, but it sure doesn’t seem to lead to many answers. A dozen years after 2008, the only thing that’s meaningfully grown is the list of unanswered economic and monetary questions. Opening more intellectual holes, the only bit proliferating is confusion. Even the attendance at the puppet show has noticeably dwindled.
In November 2010, at the release of both QE2 and E21 ignominy, the stock market roared! Actually, it began its near 45-degree ascent on the mere hint of QE2; Ben Bernanke winking and nodding to an actual audience of live humans in August 2010 at Jackson Hole, telling their indiscriminating brains about how they should get ready for another round of “money printing” (media’s words, not his; Bernanke was always more careful), immediately turning them into trained, mewling seals salivating in mere anticipation of fish guts.
Even the bond market wasn’t so pessimistic; interest rates rose, as they would for any actual recovery. We want higher rates. Rational people welcome them. The upward direction is the direction of success, the signal of an end to this unrelenting horror flick. At least Back to the Future was a well-done comedy.
In August 2020, by contrast, total dud. This time, after the biggest QE’s ever, the most widespread asset purchases “supporting” so many financial markets, a massive ultra-loose-flood-of-ultra-accommodation, Jay Powell appeared virtually “in” Jackson Hole to lay down the keystone of the guaranteed, 100%, surefire recovery edifice.
Average inflation targeting. Double-thick, the radiation suits with this one.
Yawn. Not even stocks moved (yes, they’ve been on a run since March, but one that ended, for now, mere days after Powell).
From oil to bond yields, there had been some modest interest in especially what led the Federal Reserve into average inflation targeting. This grand strategy review I’ve written almost constantly about since it was released (because it is that important, just not in the way monetary officials have imagined) had been widely anticipated.
Maybe they’d really come up with something this time!
Skepticism, however, had already spoiled much of the anticipation. A whole lot of people, and not just bankers hoarding Treasuries, went back and looked at the old footage; Bernanke hadn’t been as careful as he thought. Sure, radiation suit and plutonium slug, but reflecting from his glass face shield you could actually see the director and the camera. In some of the shots, the boom mike had slipped into frame.
Continuity had never been strictly obeyed from one take to the next; first forward guidance had meant that the Fed would let inflation run hot longer than necessary for recovery. But then, in the very next sequence, it was symmetrical inflation targets which would let inflation run hot longer than necessary for recovery. And now, the latest print, average inflation targeting which will let inflation run hot longer than necessary for recovery.
The highly polished, Hollywood production we thought maybe we were witnessing back in November 2010 was just the lack of high definition; a fuzzier, less clarified film that blurred even the production’s most obvious flaws. In the advance of time and technology, continued low rates plus high dollar, there’s just no hiding them anymore. It is plain obvious monetary policy is a filmed work of fiction; not even a manipulated documentary, either.
This won’t matter to quite a few, perhaps many. Some people really enjoy a crummy picture.
I have no idea if that category includes John Maynard Keynes or not, but Keynes, at least, was astute enough to forewarn of the worst kind of horror movie imaginable. I’ve recounted his review numerous times, so given the general topic and what’s about to come next, here it is again from 1923:
“The Inflation which causes the former means Injustice to individuals and to classes—particularly to rentiers; and is therefore unfavourable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment.”
Disastrous to employment. Absolutely right. And in the more modern, 21st century sense it doesn’t even have to be outright deflation anymore. We’ve seen time and again that a realistic threat is all it takes (a reminder about what happened last September before this March).
Familiar to us, if not always easily recognizable, it’s the very hazard of unsolved, chronic liquidity risks that spikes the dollar, keeps interest rates low (interest rate fallacy), and, as Keynes said, is therefore disastrous to employment by the introduction of what current Economists and central bankers otherwise call, while they do everything humanly possible to avoid recognizing, macro slack.
Bernanke, like his predecessors and successors, claims to be a keen follower of Keynes anyway.
What comes next is the weekly reminder about the labor market; initial jobless claims were 870k last week. That is, still, in the middle of September, 200k more than any of the worst weeks on record before March. And this latest “disastrous to employment” comes to us on top of the macro slack which has already forced the Fed to redefine (undefine, really) their whole conception of full employment.
They’ve got everything covered. Recovery’s in the bag. That’s the story, and it’s one with all the same characters, all the same scenery, and, least surprising of all, the same ending.
Originally posted on Real Clear Markets