Since I didn’t get in too much trouble making reference to a religious text a few weeks ago, I’ll take an even riskier tack and try to make sense of where we stand with monetary policy following the Federal Reserve’s extended forecast meeting, its policy summary statement, and Chairman Bernanke’s press conference. Discussing monetary policy in the same paragraph as the Bible is appropriate to the extent that central bank watchers tend to pore over the exact wording of Fed announcements with a diligence
that resembles scholars studying ancient scripture. The big difference, of course, is that no one could begin to imagine that monetary policy is the result of divine revelation, no matter how any of us may define it. All-too-human committees and their all-too-human research staffs make policy and in today’s environment do so under economic, financial and political conditions for which there’s little, if any, precedent.
As I noted in my recent post, Feast and Famine’s 7-year Cycle, the Fed seems to accept a prophesy shared by the Bible and economic historians that economies need about seven years to recover from the damage done by a major financial meltdown of the sort the U.S. experienced in 2007 and 2008. Fed pronouncements, including recent ones, should be understood within this context. That premise leads to forecasts of slow overall economic growth, high unemployment and a weak housing market. During that seven-year period, the Fed—rather than the financial markets—will determine interest rates and
spreads while it waits for the financial system to repair itself.
While it is justifying this extraordinary policy, the Fed also has to quiet the objections of those who are arguing for more stimulus—QE3 or stepped-up mortgage purchases—now. And so we learn that the committee expects growth to “pick up gradually” and inflation to be pushing up against the 2% target. Harry Truman’s lament about two-handed economists (“Give me a one-handed economist! All my economists say, “on one hand . . . on the other.”) comes quickly to mind, but I see the Fed’s leadership using those two hands to push back opposition from both sides while we wait out the recovery period.
While we wait, potential problems remain, such as a heightened financial crisis in Europe and our daily trek towards a fiscal cliff from which we could fall. Though it’s appropriate for the Fed to promise more monetary action if things deteriorate, I’m slightly reassured by the Chairman’s press conference statement that there’s “absolutely no chance that the Federal Reserve could, or would, have any ability whatsoever to offset that effect on the economy,” should Congress and the administration fail to deal with the impending fiscal mess. I’m one who thinks that the Fed’s aggressive actions in the fall of 2008 and into 2009 were critical in avoiding a much worse outcome, but I also think it’s time for the central bank to recognize and tell us that there are economic and governance problems that they can’t fix.