Monday, March 30, 2015

The US Fed: Divided, Confused, or Just Crafty?

The workings of the US Federal Reserve have reached a point of drama that is somewhat over the top. The supposedly largest free market capitalist nation in the world has been reduced to waiting to see what wording will appear in the latest Fed pronouncement to decide how its capital will be deployed. Meanwhile, the Fed itself presents a picture to the public that makes it appear to be divided or confused. Is this really the case? Let's take a look at.

First let's look at just a couple of recent news articles quoting Fed officials that illustrate what we mean by appearing to be divided or confused.

St. Louis Fed President (Jim Bullard) Calls for Rate Hikes Soon

"Jim Bullard, president of the FederalReserve Bank of St. Louis, continued his push for the Fed to raise short-term interest rates in a speech Thursday in Germany.
The Fed rate has been near zero for six years, and Bullard said, “A risk of remaining at the zero lower bound too long is that a significant asset market bubble will develop.”
"The Federal Reserve expects both labor markets and inflation to improve, but those projections are so uncertain that the U.S. central bank should err on the side of looser, not tighter, policy, a top Fed official said on Thursday.
"In this paper, we demonstrate that the zero lower bound on nominal interest rates implies that the central bank should adopt a looser policy when there is uncertainty," Chicago Fed President Charles Evans said in a draft of a paper for a Brookings Institution conference on Thursday and Friday. "In the current context this result implies that a delayed liftoff is optimal." Evans is one of just two Fed officials who believe the bank should delay any increase in rates until 2016."
My added comments:
We could easily find many more such conflicting quotes that make it appear that the Fed is deeply divided or even confused. For example, we have Chairwoman Yellen constantly saying the Fed is likely to raise rates sometime this year unless they don't. Since this basically says nothing, why say it at all? But let's ask ourselves a question. Do we really think that Fed officials are unaware that these conflicting statements impact the public and leave the impression the Fed is divided or confused? Of course not. No Fed official gives a public quote unless it has a purpose. In reality, when the Fed actually votes they are quite united for the most part with only one dissenting vote now and then. The current Fed Board is very dovish regardless of what quotes come out from time to time. One thing we can be sure of is that they are going to stay accomodative for a long time. They have said so.
A more plausible explanation is that the Fed wants to keep the markets from "front running" them. When the Fed adopted its new policy of being more transparent and providing "guidance" to try and help keep markets more stable, they knew that market participants would start to make capital investment decisions based on knowing for sure what the Fed was going to do. So, I suspect that all these conflicting statements are just an effort to roll back on the "guidance" and keep markets guessing. It's a way to say you are being transparent and providing guidance without really doing that. Of course, as we have seen, the markets are also a lot more volatile now with Fed officials constantly issuing conflicting public statements. So it may be that the FED is getting what it really wants (market uncertainty so long as it stays in a reasonable range). Perhaps they are more crafty than it appears on the surface.

Added note: Meanwhile, in a new article, Jim Rickards lists what he says are six flaws in the Fed's economic model.

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