Happy Monday. Looking forward to taking your questions on the Fed and Ben Bernanke's Jackson Hole speech on Friday.
Thanks for joining us, Kevin. Readers are speculating that Ben Bernanke won't be taking any action any time soon. What do you think?
Depends on how one defines "action."
Are you expecting any action? Maybe some additional quantitative easing?
The minutes of the last policy meeting make it fairly clear that unless the economy takes off like a rocket, the Fed will act. Will that be QE3? Maybe not. It could be a more benign move, such as extending the promise to keep rates low.
Bond buying is the most effective weapon the Fed has. The Fed is uncomfortable with it, however, because officials don't have a long history with it. If economic indicators continue their moderate rise, the Fed will resist bond buying for now, I think. If the data over the next few weeks are poor, we could see bond buying in September.
Readers have suggested Bernanke has been timid in his actions. Why do you think that's the case?
The "timid" argument relates entirely to the relatively weak recovery. Those who argue that Bernanke hasn't done enough believe monetarpy policy has the power to crank up the recovery. However, there are at least as many observers who believe that yet looser policy could only make things worse.
What's your opinion? Can the Fed do anything useful at this point in time?
I'm unpersuaded by those who argue the Fed has done too little, just as I am unpersuaded by those who argue the Fed has planted the seeds for the next economic disaster. At this stage, I think the Fed can keep the economy afloat, and perhaps add a bit of momentum. At the same time, borrowing costs already are very low. The economy now needs people, companies and even governments to spend some money.
Do you think the upcoming U.S. election will have any effect on the Fed's decisions?
That's a good question. It comes up a lot. Central banks must maintain the confidence of the public and their political masters. So all things equal, I think the Fed would steer clear of changing policy during an election cycle. Yet all things aren't equal right now because the recovery is slipping. I think that trumps political considerations. I read one commentary this morning that suggested the Fed could choose to go with QE3 next month because the next opportunity would be October -- a month ahead of the vote. That's possible, but I think ultimately if the Fed does QE3 in September it will be becasue Ben Bernanke has decided it's necessary to do so.
You mentioned interest rates earlier. The Fed minutes indicate officials want to keep borrowing costs low, at least to the end of 2014.
That's right. It's a conditional promise: provided inflation doesn't take off, we will keep the benchmark rate near its current level until at least the end of 2014. The Bank of Canda did something similar during the financial crisis. The idea is to inspire some confidence with the guarantee of low, low rates for a long time. Most analysts think the Fed will extend that promise, perhaps to the end of 2015. I expect that will happen at the September policy meeting.
Aside from more quantitative easing, does the Fed have any other tricks up its sleeve?
The conditional commitment and QE3 are the main ones. The Fed was toying with reducing the interest rate on deposits from private banks, but the minutes suggest that idea wasn't widely embraced at the last meeting. The Fed also is looking at lending money to banks on condition the money finds its way to business. The minutes say policy makers intend to give that idea some more thought.
Let's take a few questions from readers.
Broadly, yes, I think Bernanke still does have credibility. You're right: he's been off the mark a lot, but so has most everyone else. I guess that gives him a pass with the majority of observers. Recent polls that I have seen suggest the public's confidence in him is much higher than it was.
I see the U.S. within the next few years enacting a serious deficit-reduction strategy like Canada did in the 1990s. Nothing will happen until after the election. In the lame duck session, Congress and the White House will put off the impact of the "fiscal cliff" for a year. Then 2013 will be dominated by the U.S. coming up with some kind of budget strategy. It won't be pretty, but I think the resolve is there. But there's too much at stake in the election to do anything sooner...
...as for why the U.S. isn't Greece, that comes down to the dollar's role as the world reserve currency and the fact that the U.S. still is among the world's strongest economies. Investors need dollars, and companies still need American consumers. That combination keeps the fiscal disaster at bay.
Some of the recent indicators in Canada suggest that households have decided that now is the time to start repaying their debts. Credit growth is slowing down, as are home sales. If that happens, I think the Bank of Canada would be comfortable that a crisis can be avoided.
The Dodd-Frank Act forbids the Fed from doing a lot of what it did during the crisis, so we wouldn't see an exact replay. But that's not really the point of your question. Depends on the institutions, and depends on the state of the economy. The banking system is stronger, so the Fed and White House might be able to find banks willing to do the bailing out for them. But ultimately, I don't think that much has changed. Too big too fail still is a problem.
I don't know if either party has the courage to demand that much austerity. But you might see a year-long negotiation that ends with less vital agencies facing cuts of that size, and smaller reductions at other departments. Whatever is agreed will be a compromise, so there will be lots of disappointment. But I do think there is a consensus in Washington that something serious must be done. In this town, serious things happen in the year or so that follows a presidential election.
Let's wrap it up with one last question from Jimmy. His comment echoes that of many readers.
I'm sympathetic to Jimmy's point, but society chose "fantasy" when it embraced fiat money. In such a system, you can keep the faith or bet on what you think will hold value if the entire construct collapses. I actually think central banks retain considerable credibility and take their mandates seriously. But that won't count for much if the majority turns against them. But that hasn't happened yet.
Kevin, thanks for taking the time to answer questions today. Is there anything you'd like to add?
Nothing to add. Thanks to those of you who joined and took the time to keep the discussion going.