Reasons why Fed will not ease in September
The economy is struggling, but not actually contracting.
Housing prices, which had been the economy’s albatross, may have turned higher and inventory is clearing, if you ignore hidden bank inventory.
Previous aggressive monetary policy has not produced very much other than lofty asset prices, and has skewed markets.
The best arguments that the hawks seem to have is that there are large costs to be gained (potentially uncontrollable high inflation risks) to future action and benefits.
They cannot win the argument on current inflation and growth, as it is too low.
Hawks are unlikely to win on asset prices that aren’t affecting consumer inflation, and that many investors don’t see as ‘bubbly’.
They cannot argue that fiscal policy should do more when the balance of power in the Executive and Legislative branches is up in the air.
The potentially winning argument the hawks have is that it is not worth the risk to add more money.
Dr. William White at the Dallas Federal Reserve recently posted a paper entitled “Ultra easy monetary policy and the law of unintended consequences”, which specifically argues that the long-term costs outweigh the short-term benefits of “Ultra easy monetary policy”.
Reasons why Fed will ease in September
At the Jackson Hole meeting, Bernanke knew that he needed to address Dr. White’s paper, as that hawks relied on the paper’s argument.
Bernanke included in his speech a section entitled “Making Policy with Nontraditional Tools: A Cost-Benefit Framework”, where he described the potential costs and argued that the costs are manageable and said:
“The costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant”.
Having dismissed that argument, Bernanke presented the doves’ arguments, which is in essence, that growth is too low and the Fed must do something, especially with inflation not yet a threat.
In particular, Bernanke emphasized without improved growth unemployment will remain unacceptably high.
He concluded with “the Fed will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability”.
None of this means that the Fed will ease.
The rally in risk assets Thursday and Friday, despite poor US Jobs data, indicates markets believe that they will ease.
The easing will probably come through one or a combination of the following ways, all intended to make credit more easily available.
- Large scale asset purchases (LSAP, aka buying Treasuries)
- Lowering Interest On Excess Reserves (IOER) that banks hold.
- Making the ‘extended low rates’ promise a long term rule.