Friday, December 4, 2009

Playing Mind Games with the Fed

. Friday, December 4, 2009

Brad DeLong says that Ben Bernanke is unprofessional, and recants his support for another term for Bernanke as Fed chair. Why? Because Bernanke said this:

At his confirmation hearing for a second term as chairman, Bernanke emphasized that the government has spent less than half of the money in the $787-billion package passed earlier this year and that analysts are still determining its impact. "Only about 30 percent of the funds have been disbursed," Bernanke said. "It's a little bit early to make a strong judgment, a little bit early to decide whether or not to do additional fiscal actions..."

Meanwhile, Kevin Grier notices Philadelphia Fed President Charles Plosser making noises about an exit strategy for the massive government involvement in the financial sector, and a pullback from its loose monetary policy:

Arguing that the U.S. economy has entered sustained recovery and forecasting growth rates of 3% for next year and 2011, Plosser said the Fed must take “appropriate steps to withdraw or restrict the massive amount of liquidity that we have made available to the economy.”

This could include hiking rates from their current level near zero even “before unemployment or other measures of resource slack have diminished to acceptable levels.”

On the one hand, we could take these statements at face value: the Fed is concerned about the 1970s experience with overreach, stagflation, and the effect of massive public debt on the currency and broader economy. These are valid concerns. Of course there are other valid concerns, like 1937, that points to keeping the pursestrings open for a good while longer. There is good reason to have both experiences in mind, and of course it is always difficult for the Fed to thread the needle between overreach and undershooting.

But there are reasons to not take these statements literally. The Bernanke Fed has had its independence challenged and has faced criticism for too-loose policies and the bailouts. Meanwhile, the Congress seems to have no desire to try to pass a second massive stimulus and is facing massive popular pressure to not explode the deficit much more. So Bernanke's statement during his confirmation hearing may be viewed as telling the Congress what they want to hear in order to reassure them that the Fed is not a loose cannon and is going to act responsibly in the coming years. Why? So they will confirm Bernanke and leave the Fed's independence alone. After all, Bernanke doesn't control the fiscal purse anyway... his every incentive is to dish some cheap talk to Congress.

Plosser's statement may be viewed in a similar light: reassure the government that the Fed isn't going to go crazy and thus try to keep Fed policy off of the Capitol floor. As Grier concludes:

If I were a Fed President (YIKES!!), I guess I would make speeches like this one in public, but support leaving easing in place until unemployment and other measures of slack have turned the corner in private.

I'm not saying this is the only way to read the situation -- Bernanke and Plosser may truly be very concerned about the exploding deficits and the demonstrated lack of political will in Congress to cut back when it truly is necessary -- but it's certainly one way.


Playing Mind Games with the Fed




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