I’m visualizing Paul Volcker chomping down hard on his cigar and Alan Greenspan smacking a raw serve into the net. Why? Several senior Federal Reserve officials, notably, regional presidents Fisher, Bullard and Plosser of the Dallas, St. Louis and Philadelphia Federal Reserve Banks, respectively, have been publicly criticizing Fed policy. In particular, they have voiced doubts about the efficacy and wisdom of the Fed’s $600 billion quantitative easing program, suggesting it be trimmed materially before its expected conclusion in the middle of the year.
In the past Fed officials hewed to the company line and, apart from an occasional dissenting vote, avoided criticizing announced policy. When they did speak in public, they tended to follow some variation on Greenspan’s oft-quoted rule for Fed-speak, “If I turn out to be particularly clear, you’ve probably misunderstood me.” Monetary policy was to be debated and decided upon behind closed doors, with public statements carefully crafted to reinforce established policy.
The regional Fed presidents’ statements reflect Chairman Bernanke’s new and improved Fed transparency policy and are notable for deviating from past policy and for the gyrations they introduced into the Treasury market. A little information can be a dangerous thing. Following these statements, the Fed Funds futures market began implying an earlier date for the Fed to actually begin raising rates. Did a more transparent Fed help? Is it time for investors to begin planning on tighter monetary policy? I doubt it.
For the Fed to abandon QE2 and begin raising official rates before the end of 2011, policymakers would need to see the whites of inflation’s eyes and that’s just not happening. While surveys and TIPS markets no longer forecast deflation, they’re not at inflationary levels. The employment picture is brightening, but upward wage pressures remain the working person’s dream, and companies, presumably concerned about passing along higher input prices, have backed away from last year’s pace of capital spending. The precursors of inflation just aren’t there.
From a credibility point of view, the Fed must be reluctant to reverse a policy they affirmed—with Fisher and Plosser’s votes—just over two weeks ago. The natural and human-made shocks and tragedies the world has recently endured are more likely to slow the global economy than induce inflation. Despite all the cigar-chomping, the open discussion ends up doing more to confuse markets than to manage their expectations.
So the Fed stays the course, stops buying Treasuries mid-year, begins to sop up liquidity in the fall, and, if all goes well, starts raising rates in early 2012. Most importantly, the subsequent events will provide ample data for the next generation of economists to figure out whether all this was a good idea or not. Monetary policy may, like sausage and legislation, not be watched too closely.