The following is an excellent excerpt from the book “AFTER THE MUSIC STOPPED: The Financial Crisis, The Response, and The Work Ahead” by Alan S. Blinder from Part V “Looking Ahead” in Chapter 14 “No Exit? Getting the Fed Back to Normal” on page 383 and I quote: “The Fractious Fed – Then Greece struck again in the April-July 2011 period. Under pressure from bad budget news (Greece would fail to meet its deficit-reduction targets) and a sagging Greek economy (which made budget targets much harder to meet), interest rates on Greek sovereign debt spiked anew—from about 12.7 percent on 10-year bonds at the beginning of April to about 17-8 percent by the middle of June. By mid-August Greek rates were higher yet.
As if in step, the U.S. economy foundered again. GDP grew by a paltry 1.3 percent annual rate over the first three quarters of 2011. The economy was no longer earning gentlemen’s Cs; it was getting Fs again. These adverse developments strengthened the hands of the FOMC doves—led by Vice Chair Janet Yellen, the New York Fed’s Bill Dudley, Boston’s Eric Rosengren, and Chicago’s Charles Evans. You might have thought such a weak economy would silence the hawks, too. But it didn’t.
Instead, a trio of Reserve Bank Presidents—Richard Fisher of Dallas, Narayana Kocherlakota of Minneapolis, and Charles Plosser of Philadelphia—dissented loudly in August when the FOMC decided to replace its “extended period” language by the aforementioned pledge to hold the federal funds rate unchanged “at least through mid-2013.” Their dissents raised eyebrows because three no votes at a single meeting is virtually unheard of on the consensus-bound FOMC. The dissenters had a point: Economic conditions should trump the calendar. But casting a dissenting vote against wording—as opposed to against a policy action—is quite unusual.
The FOMC’s reentry was not over. With the economy sputtering, the doves ascendant, and the hawkish trio still dissenting, the Fed announced in September 2011 that it would embark on what the media termed “Operation Twist.” The objective of Twist was the same as that of QE2: to reduce long-term interest rates, this time by buying longer-dated bonds (as QE2 did) while selling shorter-dated bonds (which QE2 did not).
Operation Twist could be seen as a kind of compromise. On the one hand, unlike QE1 and QE2, it did not expand the Fed’s balance sheet—which was the main bugaboo of inflation hawks both inside and outside the Fed. Largely for this reason, Twist was a weaker stimulus than QE2. On the other hand, it presumably constituted stronger medicine than doing nothing. If Operation Twist succeeded in nudging down longer-term Treasury rates, it would probably nudge down longer-term private borrowing rates as well. The Fed hawks, however, were in no mood to compromise. Messrs. Fisher, Kocherlakota, and Plosser dissented against starting Operation Twist in September. The normally collegial FOMC was getting testy.
Things got worse at the next meeting. Oddly enough, the FOMC’s three voting hawks did not repeat their dissents against Operation Twist in November. To further cloud the picture, the Chicago Fed’s Evans, who had been arguing for stronger expansionary medicine for months, dissented on the dovish side instead. Chairman Bernanke now faced an almost unprecendented spectacle: He was getting dissents from both sides.
While the Federal Reserve’s equivalent of a civil war was going on, what was happening to expected inflation—the presumed fear of the hawks? Figure 14.7 told the tale earlier in this chapter. As measured by the difference between the nominal and real interest rates on 10-year Treasuries, the expected inflation rate was 2.3 percent at the close of 2010, rose to as high as 2.6 percent, and then fell to as low as 1.8 percent during 2011, and closed the year at 2 percent. The hawks may have been harboring inflation feats, but the financial markets weren’t.
Is Unconventional Monetary Policy the New Normal? – The Fed ran out of conventional monetary policy ammunition on December 16, 2008, the day it reduced the federal funds rate to approximately zero. From that point on, it had two basic choices. It could fold its tent, leaving the economic recovery to the fiscal authorities and the economy’s natural recuperative powers. But Bernanke was not about to let that happen. Years earlier he had promised that Federal Reserve passivity would never again cause a depression. Alternatively, the FOMC could resort to a variety of second- and third-best unconventional monetary policies, such as quantitative easing and verbal commitments. Which, of course, is exactly what they did—and are still doing. Exit is nowhere in sight.
The likely outlook for the next year or two is for unemployment well above the Fed’s target of around 5.6 percent, inflation at or below the Fed’s 2 percent target, and extremely low nominal interest rates. If that scenario comes true, the Fed will have to stick with unconventional monetary policies (UMPs) for several more years. Even when things return to normal, we are likely to be living in a world of 1 percent to 2 percent inflation, not 4 percent to 5 percent inflation. In that sort of environment, random events are far more likely to push the federal funds rate down to near zero in the future than in the past—calling again for UMPs. Let’s recall briefly what some of those are:
Two classes of UMPs have been discussed extensively in this chapter because the Federal Reserve has deployed them time and again. One is making verbal commitments to keep fed funds rate low for “an extended period,” or “at least through late 2014,” or until certain interim targets for inflation and unemployment are achieved. The other is conducting large-scale purchases of assets, as in QE1, QE2, and Operation Twist. We may see more of both of these UMPs from the Fed in the coming years, as we did in September 2012.
But there are other options, and if the economy falters, we may see those, too. As a rule, central bankers disdain these other options because they are so out of the ordinary. In fact, they don’t much like even making long-run verbal commitments or conducting large-scale asset purchases—the two UMPs the Fed has already employed. But given the way the U.S., European, and Japanese economies look right now, things may remain unconventional for a while longer yet. As discussed earlier, the Fed can:
• Peg one or more bond prices: Instead of purchasing a stated dollar volume of bonds, as in a typical QE program, the Fed can pledge to buy as many bonds as necessary to drive the corresponding interest rates down to prescribed target levels. Example: The Fed could purchase as many 10-year Treasuries as it takes to drive their yield down to 1.5 percent.
• Reduce the interest rate it pays on excess reserves: Instead of inducing banks to hang on to idle reserves by paying them to do so, the Fed could pay banks nothing, or even charge them a modest fee, to encourage bankers to do something more useful with their money. Example: The Fed could charge banks 25 basis points instead of paying banks 25 basis points.
Are We Waiting For Godot? – Godot took his time. Similarly, the Fed may have to wait a long time for its opportunity to exit.
In 2012 the U.S. economy just plodded along. The Fed started a new round of experiments with a different sort of verbal commitment—publishing forecasts of its own behavior—in January. Those forecasts included widely disperse predictions from FOMC members about when the exit from near-zero interest rate pledge to “at least through mid-2015” and surprised markets by making QE3 an open-ended commitment to buy mortgage-backed securities at a rate of $40 billion per month.
As this book went to press, there was not yet much sign that exit is in sight. Indeed, few people even clamor for it any longer. The time for Federal Reserve exit will come one day. But it’s not here yet.”
(YOU CAN SEE WHY THE BIG INVESTMENT BANKS MUST REINSTATE THE GLASS-STEAGALL ACT. THESE SUBJECTS HAVE TO BE TALKED ABOUT IN THE 2016 PRESIDENTIAL ELECTION. I DON’T LOOK FOR MUCH HOPE FROM THE REPUBLICAN CANDIDATES BECAUSE VIRTUALLY ALL OF THEM WANT TO LOWER THE INCOME TAX, ESPECIALLY ON THE WEALTHY, WHICH WOULD BRING IN LESS INCOME. MANY REPUBLICAN CANDIDATES AGAIN WANT TO PROMOTE STEVE FORBES’ FLAT TAX, WHICH WOULD DEFINITELY HELP OUT THE RICH BILLIONAIRES, WHO ARE IN THE STOCK MAREKT. THIS WOULD DEFINITELY HELP BILLIONAIRES BECAUSE THEY CLASSIFY THIS AS “UNEARNED INCOME” AND AT THE SAME TIME PUTS A BURDEN ON ANYONE STILL WORKING YET BECAUSE THEY CONSIDER THAT AS “EARNED INCOME.” IN REALITY, THE RICHEST BILLIONAIRES ARE LIVING OFF THE WORKING CLASS, LIKE A BUNCH OF FREELOADERS LIKE THEY ARE BECAUSE THE REPUBLICANS CONTROL THE U.S. HOUSE OF REPRESENTATIVES AND U.S. SENATE AND CATER TO THE WISHES OF THE KOCH BROTHERS, SHELDON ADELSON AND OTHERS, WHO ARE ALREADY MAKING RECORD PROFITS, WHICH IS REPORTED ON IN THE FORBES MAGAZINE.
LaVern Isely, Progressive, Independent, Overtaxed middle Class Taxpayer and Public Citizen and AARP Members