Tuesday, December 08, 2009

Bernanke: She lied to us! Terminate her immediately!

Ben Bernanke told us yesterday that inflation "could move lower from here," obviously suggesting that any Fed tightening is a long way off. These comments got the market's attention, particularly after Friday's surprisingly benign jobs number.

However, I think Bernanke is essentially telling us that the Rebel base is on Dantooine. He doesn't really think inflation is likely to fall from here. Consider his actual words: "Inflation is affected by a number of crosscurrents. High rates of resource slack are contributing to a slowing in underlying wage and price trends..." What is he saying? Currently, we have too much excess capacity to produce. Should aggregate demand expand, firms will soak up some of the slack, but its a long way from being inflationary. Its a little Keynesian, but its probably correct given the extreme amount of slack we currently have.

But that line of thinking only holds if Friday's improvement in unemployment is a one-off. And it might be. But what if it isn't? Its fair to say that this number was hardly out of the blue if you consider the previous trend. The Non-Farm Payroll statistic has been steadily improving for several moneths. Additionally, consider all the data we've seen in the last three months or so. Almost universally its been pointing to a muted recovery, but a recovery none-the-less.

The Fed won't be able to justify zero interest rates if unemployment starts falling.

There are already plenty of hawks on the FOMC. So far they haven't actually dissented but I think that merely reflects a willingness to acquiesce for now given how fragile conditions are. Read the recent speeches from hawks like Plosser or Fisher. You'll hear a consistent theme. Yes, I think extreme measures are warranted... for now.

If we see resource utilization (including labor) improving, the hawks will no longer be willing to give in "for now." Because the "now" will be something totally different. I've said it several times. There is plenty of room between zero fed funds and tight money. 0.5% would still be accommodative. 1% would still be accommodative. Hell my Taylor Rule estimate says 2% is right, so even 1.75% would be somewhat accommodative!

Now consider the position in which Bernanke finds himself. We have to remember that the man can hardly just go out there and speak his mind. When he saw the actual jobs number, (whether or not that was before the rest of us) I'm sure he was as surprised as we were. I'm sure it occurred to him that this could be a game changer. But can he come out and say that? Of course not. What if it really is just a one-off and actual job improvement is a long way off? Publicly, Bernanke has to wait until he's much more certain before saying anything too definitive.

So he goes out and tells the world that inflation could fall further, implying that monetary policy will remain as is for an extended period. I just don't buy it. If Non-Farm Payrolls turn positive in the next 2-3 months, we'll get a fed funds hike by June.

13 comments:

Doug said...

Bernanke elsewhere has given us a three-fold test for Fed tightening: resource utilization, inflation trends, and inflation expectations. All three must be headed upwards to justify tightening in a fragile financial environment.

"Only a direct hit will initiate the chain reaction that will destroy the Death Star."

nobody said...

my dollars hope that the FED will hike in september 2010.

It will be very interesting to see bernanke handle the other half of this crisis, hopefully he will avoid the same mistakes of the previous chairman.

In Debt We Trust said...

So, how far along is the USA from becoming Japan? (.5-.6% growth over the past 20 years).

Flow5 said...

The rate-of-change in monetary flows (MVt), our means-of-payment money actually exchanging hands, or the proxy for inflation, crests in March of 2010.

However, inflation, or reflation in this case, (the consequence an excessive flow of money relative to the volume of financial transactions consummated, and the volume of goods and services offered in the market place), remains at excessive levels throughout 2010, i.e., until October.

This gives the FOMC a limited range of opportunity in which to conduct its open market operations (it will be constrained by its past (since Aug08), inflationary policy).

On the other hand, the rate-of-change in money flows, or the proxy for real-growth, remains anemic throughout 2010, indeed, cresting very early in January of 2010.

I.e., for 2010 as a whole, business activity will stagnate, and re-flation (a rebound or recovery in prices subsequent to an economic downswing), will probably exceed any inflation target, or result in an across-the-board increase in most price indices exceeding 3%

I hope the tea leaves are telling the truth.

michaeld said...

I said it before, and I am going to say it again: What we need in this country is vigorous economic growth. If other countries can grow at 10% a year, so can we! It is all a matter of putting in place the right policies and tax incentives.

This is the only way out of this mess that we are in. Strong growth reduces unemployment. This is a prerequisite for homeowners to have a paycheck to pay the mortgage, so that real estate stabilizes and the banking crisis abates.

It will also increase company profits and help the stock market move higher to help people's retirement plans catch up. Why don't we do it? Wish I knew. All the focus has been on irrelevant issues and not on this important one. Hopefully it will be addressed soon.

By the way, with all the volatility in the stock market, it is important to know when to get in and when to get out. Timing signals can help an investor enhance their investment returns.

Consider http://invetrics.com

Its daily DJIA index trading signal is up a respectable 77% for the year (as of December 2, 2009) and it is free of charge for individual investors.

BullandBearWise said...

Can someone explain to me how the Fed can raise rates at all with a over a trillion dollars in non-borrowed reserves? Talk about pushing on a string.

wagner2626 said...

When you took a survey on when they raise rates, I stated that I believed that it would be 50 bps on June 23rd. I stick with that.

I think that lots of the economic stimulus has not yet taken place. According to www.recovery.gov only 30% of the $787bn fiscal stimulus has been spent. While the Fed Balance sheet has ballooned by 1.2trillion, much of that has been absorbed by the excess reserves of nearly 900bn. If banks start to move that money into more productive investments, it could have a dual effect - 1)an obvious stimulative effect on the economy and 2)a potential to increase the velocity of money - to what degree we do not know.

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Matt Johnson said...

try increasing the weight on the output gap for your taylor rule. i think that most central banks have done this over the years - it's welfare enhancing where CBs have credability.

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