The Fed Shrugs

Since talk of the taper started, interest rates have been gradually rising. When Bernanke talked about the possibility of tapering QE in mid 2014 so long as growth and unemployment remain on track, rates leapt to their highest level since 2011:


A simple supply-demand analysis of Treasuries says that if the Fed buys less, ceteris paribus the price will fall and rates will rise. The Fed is implying it will buy less, and lo and behold markets are selling off on expectations that future demand will be lower. The analysis of those who say that quantitative easing is raising interest rates seems increasingly dubious to me.

The alternative analysis is that rates are rising on sentiment that the economy is improving. I wouldn’t rule that out, but the trouble is that the economy is still deeply depressed. GDP is still far below its pre-crisis trend. Broad monetary aggregates are still massively deflated. Lots and lots of working-age people who were working before 2008 still haven’t returned to the labour force:


So while equities have returned to their pre-crisis heights — unsurprisingly, after all the financial sector is the Fed’s monetary transmission mechanism — the real economy, broadly speaking, hasn’t.

So it’s surprising to me that there is any talk of tapering. Headline unemployment is still 7.5%, and core inflation is just 1%, 1% below the Federal Reserve’s self-imposed target. Bernanke referred to disinflationary and deflationary forces in the economy as “transitory”, but any such diagnosis would seem to be the height of naïveté. The deflation of the shadow money supply and broad monetary aggregates is an ongoing structural transformation in the post-shadow-banking-bubble world. There is nothing “transitory” about it. If inflation was 3% or 4% and unemployment was below 6%, then talk of a taper would be expectable. Right now it just makes it seem like the Fed doesn’t have a clear framework. If QE3 was supposed to target unemployment, why is the Fed considering tapering when unemployment is still so high? Yes, the Fed’s internal DSGE models are saying that unemployment will continue to fall. Of course they do — these models have assumptions of clearing labour markets built into them! But right now inflation is below-mandate and unemployment is above mandate. Assuming away current conditions with the term “transitory” is basically saying that when the storm is long past the ocean is flat again.

Of course, at the zero-bound I think the Fed’s transmission mechanisms are relatively powerless in terms of any ability to stimulate employment or growth. It has taken the horse to water, but the horse hasn’t drunk. What the Fed can control with balance sheet monetary policy is interest rates on assets it buys. By shrugging, the Fed is signalling for a rise in government borrowing costs. That may be extremely premature.

13 thoughts on “The Fed Shrugs

  1. Pingback: The Fed Shrugs | Fifth Estate

  2. @ Aziz “If QE3 was supposed to target unemployment, why is the Fed considering tapering when unemployment is still so high?”

    Managing expectations and taking the froth out of the markets. Nothing more. There will be no “Tapering” until the housing stock (And the Subprime Toxic Securities) has been passed onto international investors, as opposed to US Investors AKA Fed, Hedgies and REIT.

    Think of them as JP Morgan bailing out the market, only to sell to others in an orderly fashion.

    • I would have to agree, as the prevailing empire always figures out a way to screw-over everybody else.

      The Fed could care less about employment [as if they can do anything about it, in any case].

      It’s a confidence game where the professional class will do just about anything for the crumbs the elite throw their way.

      • I don’t think it’s a matter of “care”; their mandate says they have to try and fight unemployment, and Bernanke specifically stated one of the aims of QE3 was reducing unemployment , and that QE3 would be continued so long as unemployment was elevated and inflation was below the Fed’s target of 2%. Clearly, the Fed’s models say that inflation will rise to 2%, and unemployment will fall below 6% in the next year, but Bernanke should know damn well about the dangers of believing too strongly in the outputs of equilibrating models…

        • “…their mandate says they have to…”

          As you and others keep reminding us, the Fed can do WHATEVER IT WANTS.

          It was never about reducing unemployment, never, though that sounds good to the masses. Makes it sound all apple-pieish.

          Mandates are tossed out the window when Bernanke’s masters want them to be.

        • “…their mandate says they have to try and fight unemployment, and Bernanke specifically stated one of the aims of QE3 was reducing unemployment,…”

          John, do you believe that the Fed is going to come out and say that their mandate is to funnel as much wealth as is possible into the banking community’s pockets?

          Let’s say the the American Medical Association also had a printing press and could pump as much money into the health care system as is possible. How would that work out?

          Let”s say the American Bar Association also had a printing press and could pump as much money as was possible to encourage and pay for all things legal. How would that work out?

          Well, we have a private consortium of bankers who HAVE a printing press. How has that worked out over the past 100 years?

  3. To tie the Feb QE to Employment: More QE, more employable robotic workers employment.

    More QE from the Fed, the corporations have more free money to develop more advanced robotic workers to replace the whining, obese, lazy, and high maintenance health -insurance expensive human workers.

  4. “We Want Fairness. There Is No Fairness If You Don’t Let Us Cheat” from Zero Hedge.

    “To find what is perhaps the best analogy of the mentality behind today’s global capital markets and the perhaps the entire US economy as well, one has to travel to Zhongxiang in Hubei province, where a university entrance exam for 800 students did not go quite as expected. Telegraph reports: “When students at the No. 3 high school in Zhongxiang arrived to sit their exams earlier this month, they were dismayed to find they would be supervised not by their own teachers, but by 54 external invigilators randomly drafted in from different schools across the county. The invigilators wasted no time in using metal detectors to relieve students of their mobile phones and secret transmitters, some of them designed to look like pencil erasers.

    In short: everyone was hoping to continue a historical tradition and simply cheat, but the proctors finally and shockingly pulled the plug. End result: hundreds of test takers who had no idea what to do when the system is not rigged. And summarizing best not only what happened in China, but what is going on in the market now that Bernanke has warned he may pull the liquidity Koolaid shortcut to wealth effects and riches: “Outside, an angry mob of more than 2,000 people had gathered to vent its rage, smashing cars and chanting: “We want fairness. There is no fairness if you do not let us cheat.” […]

    We can only hope the crowd of furious E-trade babies, all margined out, that has been used to cheating in the market courtesy of the Fed, swarms the Marriner Eccles building demanding that the cheating continue or else.”

  5. Since the BIS has warned about QE, Australian Bonds have been slaughtered and the dash to cash has begun.

    Since Governments are tapped out, where will the money come from? Structural reforms are a political minefield. Deflation is a serious possibility.

    In fairness to the Fed, they said a while ago, that they can only help settle the stomach, they can’t cure cancer. The Government has to find partisan compromise and reform the economy. Like all Governments in a Democracy, gridlock leads to Fascism.

  6. Latest Fed policy announcements “Clarification”

    The drug junkie cries out in pain and threatens, and the girl friend/boy friend & family members panic and give them more what they want.
    The Fed is a joke. They could have explained more clearly last week. They are clearly losing control.

    “the amount of money that banks have on deposit at the Federal Reserve. In four years or so this amount has ballooned from about $70 billion to over $2 trillion. The problem for the Fed and politicians is that this is the money that was supposed to find its way into consumers and businesses hands to spend, and fuel the recovery”

    My Take: Politicians and the Fed have obviously never worked in Banks, especially at the ground floor where lending decisions are made.
    If the numbers don’t stack up, and there is no collateral, you can’t lend. Maybe if the Banks were in a Communist country, but in the USA, last time I checked, Banks were privately owned, and Directors/Management are accountable to stock holders. Your pay packet relies on the company making money!!!! So they invest where they make return. Which they have and have repaired their balance sheets (Thanks Ben for buying the LEMON) And these companies still exist (Removing the toxic mortgages from their balance sheet) and their inept Management is still employed, ready to make the same mistakes.
    The sooner Government and the Fed get out of the markets, and allow stupid Managers of PRIVATE companies to fail, the sooner this economy will move forward with renewed VIGOUR!

  7. Not only is the Fed a joke, but every other group that latches on to their apron strings.

    It’s going to be a VERY interesting summer [or winter, as the case may be]!

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