In June, the chairwoman of the Federal Reserve, Janet Yellen, held a press conference after the two-day meeting of the Federal Open Market Committee (FOMC) meeting. The big announcement was that they left interest rates unchanged. The market yawned, fully expecting this. The talking heads, however, needing to fill air-time, arm chair quarterbacked it like true professional spectators.
“What about this economy makes them think we need to have interest rates at emergency levels?”
“They are really losing credibility: They said earlier they were going to raise rates 4 times and now they say maybe once? What gives?”
“They should raise rates in case things get bad so they can lower them again”
One analyst claimed “She mentioned the British referendum to leave the EU in her press conference. I thought the fed had a dual mandate of full employment and stable prices. So which is it? Is she concerned about Brexit or US jobs? She is sending confusing signals.”
Even some of the people that I expected to be Fed defenders turned on the chairwoman. Steve Liesman of CNBC said that she “capitulated” and “gave in” to the market.
This talk was almost worse than Chicago sports talk radio getting all over Jay Cutler for not looking intense enough on the sideline. So there it is – Janet Yellen is the Jay Cutler of financial markets. And just like Jay… I’m a fan.
Since the Fed defenders seem to be few and far between (although a couple have grudgingly gone to the Fed side after the recent British vote to leave the EU) I feel a need to explain why I think they are doing exactly what the economy needs them to do. It’s easy in this environment to doubt the Fed’s decisions to raise or not raise interest rates. They have experienced this loud level of criticism ever since they began their unorthodox monetary policies in response to the financial crisis.
Popularly known as “quantitative easing” the Fed policy of purchasing debt securities, was loudly admonished by a series of hedge fund managers, economists, and talking heads. This Wall Street Journal Op Ed titled “Open Letter to Ben Bernanke” (Dr. Bernanke being the Fed Chairman at the time, link here) from November 2010 was signed by a who’s who of Wall Street, including Cliff Assness, Richard Bove, Jim Chanos, Niall Ferguson, and Jim Grant who were all worried that the Fed risked causing “currency debasement and inflation”. For the record, I tried to dispel those fears even before that letter came out with this Kraken post back in October 2010 (link here). Im not sayin… just sayin.
Despite all the worries about rampant inflation, 6 years later, inflation has been nowhere to be seen. The quantitative easing policies have mostly been rolled back, and the Fed, while certainly taking an extraordinary amount of time and caution, are now beginning the process of raising rates. One has to remember that economic policy has two distinct but equally important components – monetary policy, set by the Fed, which is essentially setting the price and supply of money, and fiscal policy, set by the spending and tax policies enacted by congress, which directly affects the demand for money. With congress not being able to do much except for almost drive our fiscal bus right off a debt cliff, the monetary policy tools of the Fed are, to steal the title of Mohammad El-Erian’s new book, The Only Game in Town.
So the first thing I hear that get people on TV all riled up is “Why does the Fed think that we need to have interest rates at 0%? Is our economy that bad?” The answer is yes – the economy is still weak. Even though unemployment is less than 5%, there is still a lot of slack in the labor force because many people either gave up looking (and are no longer counted as unemployed), or are working part-time when they would rather be full time. Without congress helping stoke some fires on the fiscal policy side, like authorizing an infrastructure bank to help rebuild the country, the Fed has to error on the side of caution which is to raise rates at an extremely cautious pace.
“They said they were going to raise rates 4 times! Now they say it may only be one… This destroys their credibility.” People need to understand that the Fed releases forecasts of economic activity and then what they feel would be an appropriate number of Fed rate increases based on those forecasts. When the economic activity comes in under their expectations, their response, naturally, has to change. That would be like predicting it’s going to take 15 hours to drive to Florida and, therefore, you plan to get gas 3 times. If you hit a massive detour that adds another 5 hours to your trip, you are not going to stick to your plan to fill up only 3 times… you have to adapt to the circumstances as they arise. Yes, they have habitually been over optimistic in their forecasts for the economy, but that does not make them incompetent or deceitful.
“They should raise rates so that if things get bad, they can lower them again.” This is the stupidest argument I have heard on this topic. How about the Fed just does what it’s doing and not cause any unnecessary stress on the economy so it does not have to turn around and lower rates again? That sort of suggestion to raise rates just in case we need to lower them is irrational policy chasing and that would cause me to question their credibility. Thankfully, the Fed is populated with serious, intelligent people, who know better.
In regards to the analyst who said “Make up your mind. Which is it? Jobs or Brexit?” I would try to explain the effects of globalized markets in as kind of a way as possible. The dual mandate of the Fed is to pursue stable prices and maximum employment. Could it be possible that global financial market stability and price levels may be interconnected in some way? I do believe that because the UK voted leave, there could be jobs that do not get filled due to the resulting financial market uncertainty.
As for Mr. Steve Liesman’s more direct criticism of the Fed, saying that they capitulated to the markets, I can’t see that to be the case. The Fed certainly has to look at market reactions as additional data points and I do think they would try not to upset an already shaky market but even now, I do not think that was the driver. We owe the chairwoman, Janet Yellen, at least the respect to take her at her word. She has said that expectations are for continual gradual improvement in the economy and in labor markets, and that inflation should start to peek above that 2% level sometime soon, but there are real risks out there that could derail that forecast. What is dishonest or misleading about that? After the British voted to leave the EU, she could have shouted out a big “Told ya so!” as markets have again gotten nervous and a rate increase in the face of that could have caused pandemonium. Furthermore, there is still a lot of uncertainty around what all of the economic implications of this vote are. Now the betting experts are putting the odds of another Fed hike at around 10%, because the last job report was weaker, and there is a little more toughness out there.
In closing, I believe that former Fed Chair Ben Bernanke legitimately helped keep our entire way of life from falling off a cliff, and the current Fed Chair, Janet Yellen, is doing a great job navigating monetary policy out of emergency territory. These things take time. As we can see there are still ripples of trouble and nervousness everywhere. The Fed has been a steady hand throughout this recovery and deserves our gratitude; not our backseat driver commentary.
Photo credit: Day Donaldson via flickr.com