Tuesday, June 19, 2012

He said, she said

He said, she saidPalm Beach, FL 6/19/12 (StreetBeat) -- Fed boss Bernanke thinks that accommodative monetary policies, including exceptionally low rates, quantitative easing and forward looking statements about interest rates, have helped the economy to climb out of the abyss.

Earlier this year, on March 26, Fed Chairman Bernanke said the labor market was sub-par, at a time when the non-farm payrolls were averaging an increase of 250k per month. The most recent two month average is +73k.

At the same time he figured that “Continued weakness in aggregate demand is likely a predominant factor” in regards to the increase in long-term unemployment, adding that accommodative monetary policies provide support for aggregate demand. When he said that the monthly change in Retail Sales for the previous two months was +0.8%; the most recent two month average is -0.2%.

Fed vice-chair person Yellen said, “…the fact that longer-term inflation expectations have not risen above 2 percent has also proved extremely valuable, for it has freed the FOMC to take strong actions to support the economic recovery without greatly worrying that higher energy and commodity prices would become ingrained in inflation and inflation expectations, as they did in the 1970s.” The Fed thinks that over the long run the PCE Deflator inflation measure should be at 2.0%, this is their defacto target. This price measure was at 1.8% in April, down from a peak of 2.9% hit last September. The Consumer Price Index for May was recently reported to be +1.7%; down from 2.3% in April. Permission granted, maybe. Permission denied, hardly.

The fed funds hit the zero lower bound at the end of 2008, but Yellen explained recently, “To provide further accommodation, we have employed two unconventional tools to support the recovery—extended forward guidance about the future path of the federal funds rate, and large-scale asset purchases and other balance sheet actions that have greatly increased the size and duration of the Federal Reserve’s portfolio.” And, since you asked, she thinks that “an extended period of highly accommodative policy is necessary to combat the persistent headwinds to recovery”.

And just to be clear, Yellen is ready to take additional policy action, if need be. “…if the Committee judges that the recovery is proceeding at an insufficient pace, we could undertake portfolio actions such as additional asset purchases or a further maturity extension program.”

When he spoke back in March Bernanke argued that the increase in long-term unemployment was the results of “cyclical rather than structural factors”. “If this assessment is correct,” said the Fed boss “then accommodative policies to support the economic recovery will help address this problem as well.” He worried that “if progress in reducing unemployment is too slow, the long term unemployed will see their skills and labor force attachment atrophy further, possibly converting a cyclical problem into a structural one.”

The clock is ticking for Bernanke’s labor market models. The situation has worsened to some degree since he detailed his concerns about unemployment in March. Some measures of aggregate demand, a key factor in Bernanke’s labor market calculation, have fallen in recent months. Inflation can be said to be trending downward and therefore is not an obstacle to additional policy accommodation.

Bernanke and his second in charge think policy accommodation has been useful and would be useful again, if needed.

I think the Fed leadership will decide more is needed now and therefore they will lead the FOMC to some kind of further action this week. Now is the time is to err on the side of excess, will their post meeting statement say in not so many words. They may not be ready to do something grand, in a QE sort of way, but a more modest move could be the call. Maybe the forward guidance is pushed out further than the current “late 2014” to something more distant, such as “forever and a day.” They might decide to “twist again like we did last year” and extend the maturity extension program so that there are no changes in the level of accommodation at a time when US data has softened and Europe is a boil. In any case I think the Fed will accommodate this week and indicate that there’s more where that came from.

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