some excellent questions from john mauldin for yellen/the fed: There were three papers delivered by highly regarded economists at Jackson Hole this summer that suggested that quantitative easing had no significant effect and that forward guidance was the actual effective policy. At about that time, economists from the regional reserve bank at which you were president (San Francisco) also published a paper suggesting the same thing. This past week major Federal Reserve staff economists, as well as other economists, reiterated this view and proposed a different set of policies. This growing discussion begs the following question: Do you agree with these papers and believe the quantitative easing has exceeded its usefulness, especially in its current rather massive form? If not, can you point us to research that supports your view, other than theoretical analysis? The Federal Reserve balance sheet is currently at $4 trillion. At the current pace it is expanding by roughly $1 trillion per year. Is there a theoretical limit in your mind as to the size to which the Feds balance sheet should be allowed to grow? If so, what is that amount? Simply saying that this number would be dependent upon future economic data would imply that you have no true idea of the limit and are making up the rules as you go along. Perhaps we are indeed in unexplored territory for monetary policy and it is appropriate to adjust policies based upon unfolding economic events; but if that is the case, what are the guidelines you would use? Given the time lag required to realize the impact of monetary policy upon the economy, at what point and by what standard might you determine that the balance sheet of the Federal Reserve had reached its limit and that any further stimulus must be the responsibility of the Congress and the executive branch? Is there a discussion within the Federal Reserve that balance-sheet expansion has the potential to produce an asset bubble? There seems to be an emerging consensus that it would be inappropriate for the Federal Reserve to pursue quantitative easing indefinitely at the levels we see today. There must be an endpoint, but the question of course is, when? Last May, Chairman Bernanke suggested that the Fed might begin to taper in the coming months. Market reactions worldwide were decidedly negative, and many members of the FOMC and Board of Governors were at great pains in the following weeks to suggest that tapering would be either very gradual or postponed altogether. Even so, the markets seemed to assume that a small reduction in the amount of quantitative easing would be announced at the September FOMC meeting. There was quite a lot of surprise when there was no tapering at all. The decision not to taper brings up several questions: What data was the Federal Reserve looking at that caused it to back away from even a small reduction in the amount of quantitative easing? Given that the balance sheet of the Federal Reserve is $4 trillion, what was the thought behind not reducing the ongoing increase of the balance sheet by a mere $10 billion a month? All things considered, $10 billion would seem a rather negligible amount. Were you concerned that the economy might not be able to handle even such a small reduction in quantitative easing? Recent papers from Federal Reserve economists and others suggest that QE (i.e., the large-scale purchase of assets) is not as effective as forward guidance and that the FOMC should indicate that interest rates will be held at very accommodative levels as far out as 2017, in contrast to the current guidance that suggests rates will be allowed to rise gradually beginning in late 2014, or more likely in 2015. What do you think of this view? If you agree with this, are you concerned that such a policy shift might encourage a dollar carry trade? By that I mean that banks and other financial institutions might be encouraged to borrow in dollars to invest in all manners of financial engineering projects, especially overseas, given that the cost of borrowing would be so cheap. This is different from traditional banking in that it would not foster lending for productive domestic purposes such as the expansion of plants or the purchase of productivity-enhancing equipment. Given the problems we have seen with carry-trade currencies, especially the Japanese yen, how far out do you think forward guidance should go? Again, viewing the experience of Japan, carry-trade currencies seem to strengthen unduly, apart from natural trade and investment flows. Further, given the extraordinary developments in energy production in the United States and the reduction in the trade deficit, it is quite possible the dollar could strengthen rather dramatically on its own. Do you agree that positioning the dollar as a potential carry-trade currency would strengthen the dollar? Is that a good thing in your view? Given that the strength of the dollar is at least nominally (policy-wise) in the purview of the US Treasury Department, what kind of coordination with the Treasury do you think would be appropriate in extending forward guidance for a very-low-rate regime into 2017? Chairman Bernanke and others have clearly hoped there would be a wealth effect from current monetary policy. By wealth effect I mean that if asset prices rise, people are encouraged to spend money, and the positive effects trickle down to the lower echelons of the economy. There has been a significant amount of research which suggests that the wealth effect is no longer operative in the United States. Do you agree with this? If you do believe in the wealth effect, where is the research, beyond theoretical models, that supports your view? If you do not agree that current monetary policy is in effect a trickle-down monetary policy, then what do you believe is the transfer mechanism from quantitative easing to the general public? Chairman Ben Bernanke has explicitly taken credit for the rise in the stock market from his policies of quantitative easing. Do you think hes right? In pursuing QE, has the Federal Reserve taken upon itself an implicit third mandate, that is, to support the level of the stock market? Should that be the Feds responsibility? When the Federal Reserve begins to taper, or even suggests it will begin to taper, it appears that the markets will react negatively; yet reactions from Federal Reserve Board of Governors members seem to suggest that the Fed is extraordinarily concerned about a negative market reaction and subsequent negative effects on the economy. UBS strategist Beat Siegenthaler wrote this last week: The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fueling asset price bubbles, which could burst eventually and do major damage. The September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, it now appears that the situation is much more binary. If so, the hurdles for tapering might be substantially higher than originally thought. Do you agree with that assessment, and if not, why? The Bank of England published the following chart in Q3 2011. It tells the story of their expectation that while QE was in operation there would be a massive rise in real asset prices, but that this would dissipate and unwind over time, starting at the point at which the asset purchases were complete. It also suggests that they felt it possible that real asset prices would fall after the withdrawal of quantitative easing. Did the Federal Reserve hold internal discussions (such as those evidently held at the Bank of England) regarding what would happen with the withdrawal of QE? Given the recent market response to the suggestion of tapering, was the possibility of a fall in asset prices accounted for in your decision to pursue quantitative easing? Has the Federal Reserve has, in reality, created a form of monetary trap for itself through its extensive use of quantitative easing? That is, do you see a way in which the Federal Reserve can exit QE without having a negative effect on the stock market, at least initially? And should the Federal Reserve care? The current philosophy of the Federal Reserve seems to be that monetary easing is stimulative of consumer spending and therefore of the economy in general. This improvement is apparently supposed to be transmitted through lower interest rates for housing and for leveraged borrowing that facilitates consumer spending (on autos and other durable goods) as well as lower interest rates for businesses, which hopefully encourage spending on plants and facilities to increase productivity and boost employment. However, lower interest rates also mean that investors and pensioners get less income, so they must reduce their spending. I assume it is not the policy or the suggestion of the Federal Reserve that retired individuals should increase the level of risk they take on in the deployment of their retirement savings; but if the Fed seeks to increase the assets of those who hold equity in the stock market, an unintended consequence may be to penalize savers at the very moment in their lives when they need higher interest rates to be able to maintain their lifestyles. Explain to us the economic rationale behind artificially lowering rates for an extended period of time, which penalizes savers at the expense of equity holders. Do you believe that consumer spending fostered by quantitative easing is greater than the consumer spending lost by decreased returns to savers and investors on their fixed-income investments? Is there any data that suggests this is turning out to be the case? If there is a greater good for the economy at large in pursuing massive QE, can you show us the research that proves it and explain why retirees should be content with your policies? Do you have suggestions for those who have saved all their lives and are now being forced to either reduce their standard of living or dip into their savings? If reserve injections by the Federal Reserve were evenly distributed throughout the economy, then the money multiplier would be higher and more stable. This has not happened, as evidenced by the graph below. Further, the availability of loans to middle-level banks and businesses does not seem to have risen. How has QE helped these banks and firms? The Federal Reserve has a dual mandate to achieve the stability of the purchasing value of money and to foster an environment that affords full employment. If the money multiplier is inordinately low and if it should begin to revert to what was its norm prior to the Great Recession, there would seem to be a serious potential for the return of higher-than-acceptable inflation. As chairperson of the Federal Reserve, which of the two mandates would you consider to be a higher priority in a time of rising inflation? Are you prepared, as Chairman Volcker was in the early 80s, to raise interest rates in order to protect the value of money, in spite of the harm it caused to employment? As a follow-on, I would also like to know what, if anything, you would have done differently from Chairman Volcker. Federal Reserve economic forecasts have proven notoriously inaccurate, historically speaking. Indeed, some have suggested that random models would have produced better results than those upon which the Fed relies. How can we trust your models and your policy projections when the Fed’s forecasts have been so wrong for so many years? Why does the Fed persist, to this day, in the use of models that have been so consistently bad at predicting the future? Will you be basing your monetary policy on projections generated by existing, clearly faulty models, or do you anticipate a change in the construction of your models? Finally, let us turn to the employment mandate. Can you explain to us precisely how monetary policy is supposed to work to improve employment? What is the transfer mechanism from quantitative easing to higher employment? If you were designing a central bank system from scratch, would you include an employment mandate? Where do you think the primary responsibility for establishing an environment for full employment should rest, with the federal government or the Federal Reserve?
Posted on: Sun, 10 Nov 2013 23:42:06 +0000
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