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05-06-12, 13:20
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http://www.davidmcelroy.org/?p=3031
www.straitstimes.com (http://www.straitstimes.com) Published on Jun 5, 2012
The Straits Times
EYE ON GLOBAL ECONOMY
Fed can still save the day
In the absence of real fiscal options, all eyes are on the US Federal Reserve to give the economy a boost. Fed chairman Ben
Bernanke might want to consider his old idea of a 'helicopter drop'.
By Andy Mukherjee
LAST Friday's shockingly awful jobs report for America is bound to put pressure on United States Federal
Reserve chairman Ben Bernanke to do more to keep the economy from stalling.
The US economy added 69,000 jobs last month. Consensus expectations were for employment growth of
150,000. The jobless rate inched up to 8.2 per cent, from 8.1 per cent in April.
The world's biggest economy is hitting a squishy patch just as the euro zone is threatening to disintegrate,
Britain is in recession and the economies of China and India are cooling dangerously fast.
Fiscal policymakers in the US are powerless to act. If anything, lawmakers in Washington will drag the
economy through another round of crippling uncertainty at the end of this year, repeating their pathetic
performance from July 2011 when they were negotiating an increase in the government's debt ceiling.
While the limit was eventually relaxed, the political theatre surrounding the deal played a role in stripping the
US of its triple-A credit rating.
This year, the Democrats and the Republicans aren't even going to begin sparring with each other before the
presidential election is over. And if the politicians fail to agree on a deal early next year, Bush-era tax breaks
will expire even as automatic spending cuts worth US$1.2 trillion (S$1.5 trillion) kick in and payroll levies rise.
Overall, stimulus worth 5 per cent of gross domestic product may be lost.
It's being called a 'fiscal cliff', and while the economy may avoid falling into an abyss, it will turn out to be a
close call.
With no hopes from fiscal policy, all eyes are on the Fed. Additional monetary stimulus in the US is now
widely expected. But what more can Mr Bernanke do?
Quantitative easing, through which the Fed buys government bonds and pays for them with newly minted
money, may lift sagging stock markets a bit, but it won't do much for the economy.
An expansion of Operation Twist, in which the Fed sells short-term government securities and uses the
proceeds to buy longer-dated Treasury bonds, may be even less effective.
Think about it. The goal of both quantitative easing and Operation Twist has been to push down privatesector
borrowing costs by helping lower the yield on long-term sovereign bonds. But 10-year US Treasury
yields are already below 1.5 per cent.
The 'safe haven' appeal of US government securities has pushed their prices so high - and their yields so low
- that it's doubtful if any further gains will accrue from a Fed intervention.
So what would work?
If the Fed buys mortgage securities instead of risk-free Treasury bonds, it could help a little bit more. But then
again, not too much more. Mortgage costs are not the reason why the US housing recovery is still muted. It's
the plight of the 'underwater' homeowners - those who owe the bank more than their houses are worth - that
is coming in the way of a more meaningful revival.
This debt overhang is not for Mr Bernanke to clear. He can only urge the Congress to take action, something
he has already done.
What may help the most right now is a 'helicopter drop' of money of the type that Mr Bernanke had
recommended to the Bank of Japan in 2003.
A helicopter drop is essentially a temporary tax cut or spending boost that is paid for by a permanent
increase in the central bank's stock of money.
It isn't that Mr Bernanke will actually have to rent a helicopter to go and rain cash on people.
He can simply make a commitment to print US$1 trillion and lend it to banks, provided the banks lend this
money to the federal government for infrastructure projects. Special bonds issued by the government to
borrow the sum from banks will be accepted by the Fed as collateral.
This is fiscal policy by stealth. It makes perfect sense for the government to take advantage of low, long-term
borrowing costs to modernise the country's infrastructure. Mr Bernanke should take his own advice from 10
years ago and help pay for it.
Finally, the Fed can influence people's expectations of future interest rates. But here, the US central bank is
walking on eggshells.
By telling the markets that subdued economic conditions are 'likely to warrant exceptionally low levels for the
federal funds rate at least through late 2014', the Fed is giving an impression that it knows today what it is
likely to do tomorrow. Does it really?
The market understands 'exceptionally low' rates to mean no change from their current level of between zero
and a quarter per cent. Anyone who's buying a Singapore apartment or any such highly leveraged asset is
doing so on the assumption that the Fed will keep its word.
But the central bank's words do not constitute a promise, and the Fed is not duty-bound to keep it.
That's the first level of confusion that the Fed has created, by allowing what is at best an educated guess to
be misconstrued as a commitment.
The second level of confusion is even worse than the first.
In addition to its monetary policy statement, the Fed has started publishing year-end interest-rate forecasts of
the 17 members of the Federal Open Market Committee - both the members who vote on rate decisions and
those who don't.
Looking at the most recent forecasts, it does not at all seem likely that US interest rates in 2014 will be at
their current levels. At least three of these 17 members are forecasting that rates will rise this year; six
anticipate an increase next year. A majority of members - nine to be precise - expect the Fed's policy rate to
be at least 1.5 per cent at the end of 2014.
One suspects that more dovish members, including Mr Bernanke, are in the camp that anticipates rates on
hold through late 2014. But that's really a minority group. Why should the majority's view not be explicitly
disclosed in the monetary policy statement?
The other day, a property broker friend here sent me a text message saying that she had attended a training
programme at a bank where she was told that interest rates will remain low until 2014. 'I hope it's true,' she
wrote.
One worry is that too many people are starting to make too much out of a mere forecast.
Even if the Fed is not deliberately deceiving people by making them rack up long-term liabilities they may not
be able to afford when capital stops being so cheap as it is now, it is certainly not doing enough to stop
investors from making silly decisions.
The Fed's mandate is local. It is not responsible for the financial well-being of homebuyers in Singapore or
elsewhere outside the US. But it is still the world's most important central bank. It issues a currency that
lubricates the gears of commerce. The wealth of savers globally is predominantly held in dollars, whose value
is ultimately backed by the Fed's credibility.
To protect its credibility, the Fed needs to be a little more nuanced in its communication. One way to do that
would be for the Fed to make a conditional commitment on policy interest rates by linking its promise to hold
them at current levels to future unemployment and inflation. That would give the market a clearer sense of
when interest rates will start to rise again.
The Fed can still do a lot to save the day. But Mr Bernanke's approach has to be more creative than it has
been so far.
[email protected]
Copyright © 2011 Singapore Press Holdings. All rights reserved.
Printed from straitstimes.com
http://www.davidmcelroy.org/?p=3031
www.straitstimes.com (http://www.straitstimes.com) Published on Jun 5, 2012
The Straits Times
EYE ON GLOBAL ECONOMY
Fed can still save the day
In the absence of real fiscal options, all eyes are on the US Federal Reserve to give the economy a boost. Fed chairman Ben
Bernanke might want to consider his old idea of a 'helicopter drop'.
By Andy Mukherjee
LAST Friday's shockingly awful jobs report for America is bound to put pressure on United States Federal
Reserve chairman Ben Bernanke to do more to keep the economy from stalling.
The US economy added 69,000 jobs last month. Consensus expectations were for employment growth of
150,000. The jobless rate inched up to 8.2 per cent, from 8.1 per cent in April.
The world's biggest economy is hitting a squishy patch just as the euro zone is threatening to disintegrate,
Britain is in recession and the economies of China and India are cooling dangerously fast.
Fiscal policymakers in the US are powerless to act. If anything, lawmakers in Washington will drag the
economy through another round of crippling uncertainty at the end of this year, repeating their pathetic
performance from July 2011 when they were negotiating an increase in the government's debt ceiling.
While the limit was eventually relaxed, the political theatre surrounding the deal played a role in stripping the
US of its triple-A credit rating.
This year, the Democrats and the Republicans aren't even going to begin sparring with each other before the
presidential election is over. And if the politicians fail to agree on a deal early next year, Bush-era tax breaks
will expire even as automatic spending cuts worth US$1.2 trillion (S$1.5 trillion) kick in and payroll levies rise.
Overall, stimulus worth 5 per cent of gross domestic product may be lost.
It's being called a 'fiscal cliff', and while the economy may avoid falling into an abyss, it will turn out to be a
close call.
With no hopes from fiscal policy, all eyes are on the Fed. Additional monetary stimulus in the US is now
widely expected. But what more can Mr Bernanke do?
Quantitative easing, through which the Fed buys government bonds and pays for them with newly minted
money, may lift sagging stock markets a bit, but it won't do much for the economy.
An expansion of Operation Twist, in which the Fed sells short-term government securities and uses the
proceeds to buy longer-dated Treasury bonds, may be even less effective.
Think about it. The goal of both quantitative easing and Operation Twist has been to push down privatesector
borrowing costs by helping lower the yield on long-term sovereign bonds. But 10-year US Treasury
yields are already below 1.5 per cent.
The 'safe haven' appeal of US government securities has pushed their prices so high - and their yields so low
- that it's doubtful if any further gains will accrue from a Fed intervention.
So what would work?
If the Fed buys mortgage securities instead of risk-free Treasury bonds, it could help a little bit more. But then
again, not too much more. Mortgage costs are not the reason why the US housing recovery is still muted. It's
the plight of the 'underwater' homeowners - those who owe the bank more than their houses are worth - that
is coming in the way of a more meaningful revival.
This debt overhang is not for Mr Bernanke to clear. He can only urge the Congress to take action, something
he has already done.
What may help the most right now is a 'helicopter drop' of money of the type that Mr Bernanke had
recommended to the Bank of Japan in 2003.
A helicopter drop is essentially a temporary tax cut or spending boost that is paid for by a permanent
increase in the central bank's stock of money.
It isn't that Mr Bernanke will actually have to rent a helicopter to go and rain cash on people.
He can simply make a commitment to print US$1 trillion and lend it to banks, provided the banks lend this
money to the federal government for infrastructure projects. Special bonds issued by the government to
borrow the sum from banks will be accepted by the Fed as collateral.
This is fiscal policy by stealth. It makes perfect sense for the government to take advantage of low, long-term
borrowing costs to modernise the country's infrastructure. Mr Bernanke should take his own advice from 10
years ago and help pay for it.
Finally, the Fed can influence people's expectations of future interest rates. But here, the US central bank is
walking on eggshells.
By telling the markets that subdued economic conditions are 'likely to warrant exceptionally low levels for the
federal funds rate at least through late 2014', the Fed is giving an impression that it knows today what it is
likely to do tomorrow. Does it really?
The market understands 'exceptionally low' rates to mean no change from their current level of between zero
and a quarter per cent. Anyone who's buying a Singapore apartment or any such highly leveraged asset is
doing so on the assumption that the Fed will keep its word.
But the central bank's words do not constitute a promise, and the Fed is not duty-bound to keep it.
That's the first level of confusion that the Fed has created, by allowing what is at best an educated guess to
be misconstrued as a commitment.
The second level of confusion is even worse than the first.
In addition to its monetary policy statement, the Fed has started publishing year-end interest-rate forecasts of
the 17 members of the Federal Open Market Committee - both the members who vote on rate decisions and
those who don't.
Looking at the most recent forecasts, it does not at all seem likely that US interest rates in 2014 will be at
their current levels. At least three of these 17 members are forecasting that rates will rise this year; six
anticipate an increase next year. A majority of members - nine to be precise - expect the Fed's policy rate to
be at least 1.5 per cent at the end of 2014.
One suspects that more dovish members, including Mr Bernanke, are in the camp that anticipates rates on
hold through late 2014. But that's really a minority group. Why should the majority's view not be explicitly
disclosed in the monetary policy statement?
The other day, a property broker friend here sent me a text message saying that she had attended a training
programme at a bank where she was told that interest rates will remain low until 2014. 'I hope it's true,' she
wrote.
One worry is that too many people are starting to make too much out of a mere forecast.
Even if the Fed is not deliberately deceiving people by making them rack up long-term liabilities they may not
be able to afford when capital stops being so cheap as it is now, it is certainly not doing enough to stop
investors from making silly decisions.
The Fed's mandate is local. It is not responsible for the financial well-being of homebuyers in Singapore or
elsewhere outside the US. But it is still the world's most important central bank. It issues a currency that
lubricates the gears of commerce. The wealth of savers globally is predominantly held in dollars, whose value
is ultimately backed by the Fed's credibility.
To protect its credibility, the Fed needs to be a little more nuanced in its communication. One way to do that
would be for the Fed to make a conditional commitment on policy interest rates by linking its promise to hold
them at current levels to future unemployment and inflation. That would give the market a clearer sense of
when interest rates will start to rise again.
The Fed can still do a lot to save the day. But Mr Bernanke's approach has to be more creative than it has
been so far.
[email protected]
Copyright © 2011 Singapore Press Holdings. All rights reserved.
Printed from straitstimes.com