Cacophony of the Clueless?
A friend just mailed us a few items that were posted at Zerohedge today as they came over the wire services. As is by now a well-worn tradition, individual FOMC board members (both members of the board of governors as well as district presidents) are delivering speeches and interviews galore in the wake of the most recent rate non-decision.
The Photo credit: Sukree Sukplang
Superficially one gets the impression that they aren’t really trying to “explain” anything to the hoi-polloi, since it all sounds remarkably uncoordinated. Today Bill Dudley (GS emissary at the NY Fed) and Charles Evans (Chicago Fed überdove) piped up, which reads as follows in the above mentioned summary by the wire services:
DUDLEY: HE EXPECTS FED PROBABLY WILL RAISE RATES LATER THIS YEAR
DUDLEY: THAT’S NOT CALENDAR GUIDANCE, THAT’S DATA-DEPENDENT
DUDLEY: FED RATE PATH WILL BE SHAPED PARTLY BY MKT REACTION
*EVANS: BEST APPROACH IS FOR LATER LIFTOFF, GRADUAL TIGHTENING
*EVANS SAYS `EXTRA-PATIENT APPROACH’ TO TIGHTENING IS WARRANTED
*EVANS SAYS `THERE IS NO PROBLEM IN MODERATELY OVERSHOOTING 2%
*EVANS: APPROPRIATE TO RAISE RATES VERY GRADUALLY AFTER LIFTOFF
*EVANS SAYS HE SEES SUBSTANTIAL COSTS TO PREMATURE RATE LIFTOFF
Apart from the bewildering factoid that Mr. Dudley seems to think the phrase “end of the year” has nothing to do with the calendar, the two gentlemen seem to contradict each other. One of them keeps pretending that a rate hike remains “imminent”, while the other is telling us that after abandoning its employment rate guidance, the Fed should ditch its “inflation target” guidance next.
After all, we’re in a never-ending “emergency”. It evidently hasn’t occurred to Mr. Evans just yet that the policies of the organization he’s a member of may be directly responsible for said permanent state of economic emergency.
William Dudley, the emissary of Goldman Sachs at the Fed
Photo credit: Brendan Smialowski / Getty Images
Applied Kremlinology
So what to make of these seeming contradictions? Donning our hat of well-trained Kremlinologists, we will try to explain. First of all, one needs to keep in mind what the Fed’s policies are based on. As we have recently discussed, we agree with Professor Salerno’s analysis that is all rests on a foundation of Fisherian “price stabilization policy” (the disastrous policy that was inter alia responsible for the 1920s boom and the subsequent depression), topped up with a heavy dollop of Keynesianism and a sprinkling of Monetarism. All of this has been well-stirred and modern-day monetary policy is the result.
Various FOMC members have different preferences with respect to the theories contained in this mixture, but the upshot is that it is a given that the Fed will as a rule err on the side of easy money at every opportunity (there is a persistent myth that former chairman Volcker was somehow different, which even laymen can easily dispel by simply studying the money supply growth rates accompanying his reign).
This preference for easy money is largely owed to the nonsense made popular by Keynes (he didn’t invent any of it, but he sure popularized it and gave it a scientific gloss) – such as the fallacious “paradox of thrift” (thoroughly debunked long before Keynes even entered the scene) and the associated erroneous belief that spending and consumption are driving economic growth. Hence, central banks are supposed to manipulate the money supply and interest rates so as to spur “aggregate demand” (in essence these ideas were first formulated by John Law, who implemented them to truly disastrous effect). This is of course the functional equivalent of putting the cart before the horse.
However, the imperatives of Fisherian price stability policy can at times interfere with the urge to keep monetary policy as loose as possible, and the comments by Dudley and Evans have to be seen in this light. Below is a chart of the annual rate of change of CPI:
CPI (not seasonally adjusted) y/y change rate – as of August, it stood slightly below a mere 0.2%, via Saint Louis Federal Reserve Research – click to enlarge.
What both Dudley and Evans are presumably well aware of is that the recent CPI reading near 0.2% y/y is highly likely to soon give way to much higher annualized change rates. The reason for this is the so-called “base effect” – the huge decline in energy prices that took place a year ago is no longer going to influence the data in the final few months of this year.
We suspect that Dudley therefore concludes that it is necessary to prepare the markets for the possibility that the Fed will have to at least implement a token rate hike (whether it likes to or not), as higher CPI readings will rob it of a major excuse for keeping ZIRP going.
Evans by contrast is proposing to construct yet another excuse in line with his well-documented dovish inclinations, by proposing to “temporarily” ditch the price stability target when this happens.
Conclusion
To the extent that the messages are contradictory, they merely reveal the literal impossibility of central planning – neither Dudley nor Evans can possibly know at what level short term interest rates should be set. Ben Bernanke remarked in one of his early blog posts:
“The best strategy for the Fed I can think of is to set rates at a level consistent with the healthy operation of the economy over the medium term, that is, at the (today, low) equilibrium rate. There is absolutely nothing artificial about that! Of course, it’s legitimate to argue about where the equilibrium rate actually is at a given time, a debate that Fed policymakers engage in at their every meeting.”
It is quite funny that it didn’t seem to occur to him that there would be nothing to discuss if the markets were left to set the “equilibrium rate” on their own. The correct interest rate reflecting society-wide time preferences would reveal itself in the markets if central bank intervention didn’t interfere (to be fair, the activities of fractionally reserved private banks can also push gross market rates below their “natural” level without a central bank, but only to a far more limited and hence less harmful extent).
Anyway, there actually isn’t really a contradiction in the statements of the two luminaries, merely a difference in emphasis: Dudley seems to think that based on the dictates of the “price stability” policy, the Fed could soon be forced to hike (so as to avoid “credibility” issues), while Evans appears to be looking for reasons that may allow the Fed to once again postpone acting on said dictates.
All in all, we would take it as a strong hint that ZIRP will soon face fresh complications.
