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September 2020

Overconfident Ben Bernanke

In the following video, Ben Bernanke answers questions from Paul Ryan (R-WI). Paul asked some really sensible questions. Bernanke remains largely too confident. This is generally not a good sign.

Allan Meltzer, a historian specialized in the Federal Reserve system, in the following WSJ piece, shares his historical view on the Fed and inflation outlook. He thinks Bernanke Fed will put us on another “70s show”.

In the 1970s, despite rising inflation, members of the Federal Reserve’s policy committee repeatedly chose to lower interest rates to reduce unemployment. Their Phillips Curve models, which charted an inverse relationship between unemployment and inflation, told them that inflation could wait and be addressed at a more opportune time. They were flummoxed when inflation and unemployment rose together throughout the decade.

In 1979, shortly after becoming Fed chairman, Paul Volcker told a Sunday talk-show audience that reducing inflation was the best way to reduce unemployment. He abandoned the faulty Phillips Curve thinking that unemployment was the enemy of inflation. And he told the Fed’s staff that while he thought highly of their work, he did not find their inflation forecasts useful. Instead of focusing on near-term output and employment, he changed the Fed’s policy to put more emphasis on the longer-term reduction of inflation. That required a persistent policy that President Reagan supported even in the severe 1982 recession.

We know the result: Inflation came down and stayed down. The Volcker disinflation ushered in two decades of low inflation and relatively steady growth, punctuated by a few short, mild recessions. And as Mr. Volcker predicted, the unemployment rate fell after the inflation rate fell. The dollar strengthened.

That was not unprecedented. The Phillips Curve often fails to forecast correctly. Spanish inflation has increased in the last year while the unemployment rate rose above 20%. Britain also has rising inflation and rising unemployment. Brazil lowered inflation and unemployment together. There are many other examples if only the Fed would look at them.

Throughout its modern history, the Fed has made several of the same policy mistakes repeatedly. Two are prominent now. It concentrates on near-term events over which it has little influence, and neglects the longer-term consequences of its operations. And it interprets its dual mandate as requiring it to direct all of its efforts to reducing unemployment when the unemployment rate rises. It does not have a credible long-term plan to reduce both current unemployment and future inflation, so it works on one at a time. This is an inefficient way to achieve a dual mandate. It failed totally during the Great Inflation of the 1970s. I believe it will fail again this time.

Commodity and some materials prices have increased dramatically in the past year. Countries everywhere face higher inflation. Despite the many problems in the euro area, the dollar has depreciated against the euro, a weak currency with many problems, suggesting that holders expect additional dollar weakness. Imports will cost more.

I believe it is foolhardy to expect businesses to absorb all the cost increases by holding prices unchanged. And loan demand has started to pick up, increasing the amount of money in circulation. It is a big mistake to expect that the U.S. will escape the inflation that is now rising throughout the world.

Because the Fed focuses on the near term, it tends to ignore changes in money-supply growth. This, too, is a mistake. Sustained inflation always follows increases in money-supply growth. Sustaining negative real interest rates (i.e., adjusted for inflation), as we have now, will cause this.

The Fed should make three changes. First, it should increase the short-term interest rate it controls to 1%, which would show that it is aware of the inflation risk and will act promptly to counteract it. Current low interest rates are an opportunity for the Fed to start reducing excess reserves.

Fed Boston Summit

First interview with Boston Fed President Eric Rosengren. 

His main message I took away is, “with nominal interest rate fixed (near zero level), disinflation would be monetary tightening. Deflation would be even worse”. This offers enough reason for further monetary easing.

Also, one lesson learned from Japan was that monetary policy under “liquidity trap” should be proactive. The Fed’s monetary easing can’t afford to be nearly as gradual as Japan.

Second interview with John Taylor. According to Taylor Rule, current interest rate should be at .75%. He is not in favor of QE2.

The last interview with Jim Hamilton on how the Fed might affect long term interest rate through bond purchase.

Allan Meltzer: We don’t need more excess reserves!

Allan Meltzer, author of several books on the history of US Federal Reserve, said with over 1 trillion $ excess reserves sitting on bank’s balance sheet, it would be stupid to add another 1 trillion dollars.

More monetary easing won’t be effective, the key is to remove the uncertainties in the economy so businesses can start investing again. Too much cash held by corporations, too little investment.

Inside FOMC

Rick Mishkin talks about the decisions made during the Fed’s recent meeting.

Hawks and doves inside the Fed

FT dissects the Fed:


Janet Yellen, president, San Francisco Federal ReserveVote

Leading dove on the committee. A heavyweight former senior economic adviser in the Clinton White House who recently joined the Group of 30 leading global policymakers. Expects the recovery will “look something like an L with a gradual upward tilt”. Believes the output gap exerts the dominant influence on prices and that “economic slack and downward wage pressure are pushing inflation below rates that are consistent with price stability”

Eric Rosengren, president, Boston Fed No vote

Has a special interest in the problem of banks “too big to fail”. Thinks the recovery is “quite capable of falling short” of market expectations. Like Ms Yellen, is worried about inflation falling too low and fears premature tightening. Says rate policy should be based on the understanding that, “We need the economy to grow rapidly enough that unemployment falls substantially and inflation settles at a rate near 2 per cent”


Donald Kohn, vice-chair, Federal Reserve boardVote

The most influential figure after chairman Ben Bernanke, Mr Kohn is an anchor against pressure from hawks. Defends the dual mandate, and a focus on core inflation and the output gap, saying the Federal Reserve act requires the Fed to consider the “level of output relative to the economy’s potential” alongside the inflation rate. Thinks “the persistence of economic slack” will keep inflation subdued and worries about inflation falling too low

William Dudley, president, New York Fed Vote

Succeeded Tim Geithner as head of the New York Fed, a pivotal position in the system. Sees a recovery “less robust than desired” because of headwinds from the banking sector. Distinguishes sharply between the “how” and “when” of exit strategy, and stresses that the Fed’s preferred option is not to sell its portfolio of assets back into the market. Says, “We face meaningful downside risks to inflation over the next year or two”


Ben Bernanke, chairman, Federal Reserve boardVote

The chairman defines the centre of the committee and fashioned the radical “credit-easing” strategy that is now winding down. Shares the doves’ belief that there is a large output gap that will put considerable downward pressure on inflation but puts more emphasis on inflation expectations as an autonomous factor. Last year edged the Fed away from an exclusive focus on core inflation; is not indifferent to dollar weakness

Daniel Tarullo, governor, Federal Reserve boardVote

An Obama appointment with close ties to the White House, he is an expert on regulation and leads the Fed’s overhaul of financial supervision including bankers’ pay. Has not taken sides in the debate over monetary policy. Says pay should be viewed as a “safety and soundness” issue, and wants to avoid a “formulaic approach” to achieving this. Favours stronger capital and liquidity requirements for banks and more co-ordinated bank supervision

Elizabeth Duke, governor, Federal Reserve boardVote

The former banker has remained relatively quiet in public on monetary policy, though she is an influential voice on the banking sector and credit trends. A few months ago she judged that the “decline in lending is not tremendously large relative to the experience of past business cycle downturns” and that the credit crunch was less intense than that of the 1990-91 recession thanks to massive policy interventions

Charles Evans, president, Chicago FedVote

Has gone further than others in putting a time frame on the first rate rise – “most likely to be towards the end of 2010/11” – though that assessment is not set in stone. Gives weight to the output gap and inflation expectations. Says “resource gaps remain substantial today. That’s a significant mitigating factor against inflation pressures”. Also sees inflation expectations as a “powerful determinant of inflation”, the stability of which cannot be taken for granted

Dennis Lockhart, president, Atlanta FedVote

Centrist leaning recently towards the dovish, with fears about the underlying strength of the recovery. Notes that “both the data and anecdotal descriptions of ground-level reality are quite mixed”, with foreclosures, unemployment, income and bank failures continuing “to disappoint”. Is “particularly concerned about interaction among bank lending, small business employment” and commercial property, with small businesses reliant on credit from troubled banks

Sandra Pianalto, president, Cleveland FedNo vote

A centrist with dovish tendencies, she says: “We have a lot of ground to make up before we even get back to the levels of output seen in 2007”. Sees “considerable slack” and “tangible evidence” that this will help keep inflation subdued. But still sees the inflation outlook as “uncertain”. Why? Inflation concerns relating to the Fed’s swollen balance sheet “must be taken seriously” even if policymakers think these concerns are misplaced

James Bullard, president, St Louis FedNo vote

Centrist leaning towards the hawkish, says uncertainty over inflation is “as high as it has ever been since 1980”. Still sees a lingering deflation risk but, beyond that, an inflation risk. An independent thinker, he shares some positions with doves and some with hawks. Has little time for output-gap analysis – thinks the Fed should start tightening as soon as strong job growth resumes. Favours selling assets rather than raising rates to begin with

Narayana Kocherlakota, president, Minneapolis FedNo vote

Newcomer who took office only last month. No policy views yet expressed


Kevin Warsh, governor, Federal Reserve boardVote

The DC Fed’s ambassador to Wall Street, he puts more weight than others on the upswing in financial markets as a “forward-looking sign of growth and inflation prospects”. Is optimistic about a “positive feedback loop” between market strength and economic activity, but is watching asset prices carefully. Warns against waiting until the economy is back to normal before raising rates and says when the Fed tightens it may have to do so rapidly

Richard Fisher, president, Dallas FedNo vote

Former über-hawk, moving towards the centre. Thinks the recovery will look like “a check mark” with a slope “that is less than desirable and might possibly be repressed by an occasional pause”. Worries that businesses will be slow to start hiring again. Says “inflation is likely to remain subdued for a time” but fears Fed guidance on rates may be fuelling the dollar carry trade, which could end in a disorderly adjustment in asset markets


Charles Plosser, president, Philadelphia FedNo vote

Thinks “the good news will increasingly outweigh the bad news” on growth and views unemployment as a “lagging indicator”. Sees little near-term risk of inflation but “greater risk of high inflation in the intermediate to long term”. Deeply sceptical about output gaps; says the crisis has hit potential output as well as demand. Troubled by the Fed’s interventions in private credit markets and wants to get back to more rules-based policy

Jeffrey Lacker, president, Richmond FedVote

Prioritises inflation expectations and is sceptical about output-gap analysis – which he says “greatly underestimated inflation” in the 1970s. Fears ongoing Fed asset purchases will push bank reserves beyond desired levels at which point policy will become much more stimulative. Sees inflation as medium-term risk and wants Fed to tighten “when growth becomes strong enough and well enough established” – but admits it is not certain that this will come in 2010

Thomas Hoenig, president, Kansas City FedNo vote

Was first to raise the need for the Fed to tighten in a timely fashion in June, with the words “as the economy begins to recover, even at a modest pace . . . the current level of monetary accommodation will need to be withdrawn”. Concerned about banks “too big to fail”. Worries about excess reserves and appears keen to get away from near-zero rates. Says “moving from zero to one per cent, for example, is not tight policy”

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China must eye for its exit strategy

Qin Xiao, chairman of China’s Merchants Group shares his worries about China:

China must keep its eyes fixed on the exit

China, like much of the world, is breathing a sigh of relief that economic disaster has been averted. Better-than-expected macro-economic data are driving growing optimism. But government officials and businessmen should not delude themselves: going back to pre-crisis ways would be a serious mistake.

From a macro point of view, we still have an unbalanced global economy. The US consumes too much and saves too little. China’s problem is the opposite. Despite years of encouragement from government to spend more, many Chinese consumers continue to be more comfortable saving than spending. As Wen Jiabao, the Chinese premier, said just last month at the World Economic Forum in Dalian, China’s economic recovery “is not yet steady, solid and balanced”.

All of us applaud China’s far-reaching stimulus programme. But many in China cling to the belief that the export-led model that has worked so well for 30 years will remain largely untouched after the crisis. The US consumer, after all, has always come back, most recently after the dotcom bubble burst and the terrorist attacks of September 11 2001. But the longer global imbalances persist, the more painful the reckoning. Both China and the US must do more.

China needs to play its part by increasing domestic consumption. In the long term, I am optimistic about China’s consumption growth. The privatisation of large sections of China’s housing market since the late 1990s has contributed to the development of Chinese consumers. The country’s ongoing urbanisation, which is seeing about 20m people a year move from the countryside, will continue to power consumption. However, I am not satisfied with the current process, and China has an urgent need to speed up reform to establish a credible nationwide social safety net.

While consumer prices are mostly under control, asset price bubbles are growing rapidly because of huge liquidity injections by governments around the world. Globally, there does not seem to be an exit strategy in place to drain this liquidity from the system. Certainly, in China, stock and property bubbles are a concern.

While we have avoided the worst recession since the Great Depression, we are probably heading for another asset bubble and more financial turbulence. What can we do? Compared with pouring money into the economy, draining money from the economy is a much tougher job for central banks. The dilemma is this: if we tighten monetary policy, there is a high possibility of a “second dip” next year; and if we continue the loose policy, another asset bubble might be not far away.

I do not believe a quick, steep bounce driven by fiscal fixed investment is a good thing for China. Nor is a moderate slowdown anything to be afraid of. Monetary policy must not neglect asset-price movements. Therefore, it is urgent that China shifts from a loose monetary policy stance to a neutral one.

I am also worried about the role of governments after the crisis. There are some who say that this is a crisis of the market economy. It is not; nor is it a time to turn our backs on markets. There have been failures of regulation and oversight, particularly in the west. In China we are still developing our regulatory system. It is a time to strengthen oversight, improve governance and push for freer and more efficient markets in China and abroad.

However, there is growing concern, especially in China, that the temporary stimulus programme might evolve into permanent government control of the economy. The Chinese government should continue to loosen its grip. Prices, especially of energy but including water and food, need to be freed further. The currency needs to be liberalised. Privatisation needs to move ahead. China needs freer markets, not more state control.

Finally, protectionism is a worry. Recent actions are small in terms of the value of the goods involved. But even imposing symbolic protectionist measures to keep domestic interests happy is a dangerous strategy. Both the US and China must resist domestic pressures to restrict trade or risk igniting a wider trade war. Protectionism poses real threats to the global economy and we must be sensitive to changes in US trade policy, as US policies will largely define the future of globalisation.

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