Monday, November 1, 2010

Can We Get Some More Certainty, Please?

 This NY Time article highlights one of the key problems with the way the Fed currently functions (my bold below):
Everyone on Wall Street is waiting on the Fed. Whatever the outcome of Tuesday’s midterm elections, the Federal Reserve is widely expected to take new steps this week to spur the nation’s snail-paced recovery.. The question is how aggressively the Fed will act... Analysts expect the central bank to buy securities on the open market in an effort to the unlock the flow of credit to the economy. Estimates of the size of the program range from $500 billion to $2 trillion...
But while investors have been staking out their positions for weeks the announcement — and the potential ramificationsremain fraught with uncertainty. Given that the Fed’s news is expected to land as Wall Street is digesting Tuesday’s election results, analysts are bracing for a volatile day, particularly if the Fed underwhelms investors.
This shouldn't be.  A modern central bank should have an explicit nominal target to help create certainty.  Yet, here we are in the 21st century guessing what the most influential central bank in the world  plans to do at  its next meeting. In fact, we have been guessing all year as we watched in bewilderment as inflation expectations dropped from  January through September.  "Why wasn't the Fed responding?", we wondered.  Then, suddenly, we learn in late September the Fed had had enough.  Inflation would not be allowed to fall any further and this would happen with a second round of quantitative easing.   Inflation expectations responded accordingly by jumping back up.  I am glad for the change of heart, but enough of this monetary policy roller coaster ride!  And this is not just any monetary policy roller coaster ride, but a Space Mountain monetary policy roller coaster ride where you can't see what is coming next.  There are many issues with a gold standard, but at least one knew what to expect going forward. If we are going to make our fiat monetary system work we need to have the same forward-looking certainty. These past few years such certainty has been  missing.   It is not hard to imagine how much  better our economy would  have been had the Fed adopted an explicit nominal target a few years back.  It is well past time for the Fed to move beyond its wishy-washy, guess-if-you-can policy goals and commit to an explicit nominal target.  

2 comments:

  1. Seems perhaps that the QE didn't come earlier because the administration wanted to appease fiscal conservatives prior to the mid-term elections. The simpletons hate the politically simplistic and short sighted concept of a "devalued" dollar. I like Dr. B's analogy of the Space Mountain ride. Especially if you knew that the ride was taking you towards a brick wall at high velocity but you didn't know where the wall was, only that it's there somewhere.

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  2. The Fed is divided. Plosser, Hoenig, Fisher are all against QE2. So it is unsurprising that no clear message is coming out.

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