(Don’t Fear) The Reaper, The Fed Says ‘More Cowbell’
In a famous "Saturday Night Live" skit, Christopher Walken plays a legendary rock music impresario whose advice, his only advice, to a young band is "more cowbell." The actor Will Ferrell furiously pounds away on a cowbell but it’s never enough for Mr. Walken, who ultimately shouts, "I got a fever, and the only prescription is more cowbell!"
Federal Reserve Chairman Ben Bernanke must be a fan of that skit because he is applying the same logic to monetary policy: The economy isn’t growing fast enough, and the only prescription is more money.
That’s the only way to interpret yesterday’s plunge by the Fed’s Open Market Committee into another round of quantitative easing. This refers to the Fed’s purchase of Treasury debt and other assets such as mortgage-backed securities to flood the economy with more money. The Fed’s traditional policy tool of short-term interest rates has been fixed at near-zero for two years, so this is Mr. Bernanke’s version of dropping dollar bills from helicopters.
Do you see anything wrong with this policy response from the Federal Reserve? If this were 2008 or early 2009 and we were in a liquidity crisis, the Fed could be excused for taking extreme measures. But Lehman Brothers’ collapse was over two years ago. And yet, interest rates in the U.S. are near zero percent and the Fed is still pumping liquidity into the economy. U.S. economic policy is broken; it is sheer madness.
Fed Chairman Ben Bernanke admitted as much himself in an unusual Op-Ed in the Washington Post. Dr. Bernanke wrote:
The Federal Reserve’s objectives – its dual mandate, set by Congress – are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.
Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy – especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.
Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.
Every single time the U.S. is met with an economic downturn (is met by the figurative Grim Reaper), the policy response is always the same: monetary easing (more cowbell). And with interest rates as low as they can go, the Fed has turned to printing money and monetizing debt. This excess liquidity is an economic hazard washing up on the shores of South Korea, Brazil and India, causing policy makers there to consider barriers to reduce the floods from the incoming waves of U.S. money. The excess liquidity is pumping up commodity prices, raising the price of gasoline and food for average American citizens and reducing their purchasing power.
And let’s be clear, this money printing does not have direct effects on the real economy. This is not a helicopter drop either. In that case, the money would actually go to consumers instead of the banks who are primary dealers of U.S. government bonds. It is about interest rates and asset prices. Bernanke writes:
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
So, there you have it in black and white. U.S. economic policy is ALL about asset prices as I have been saying for years now. Give Bernanke credit for making this explicit. But, I think this kind of talk is a mistake. The curtain has been pulled from in front of the wizard and the image we are left with is of impotence.
As for the cowbells, more please.
P.S. – Cue the music