Allow me to vent for a sec before getting all rational again.
I’m fed [sic] up with all of these arguments that the Federal Reverse’s foremost client is the financial markets, and Janet et al better be careful not to upset the bond traders what with all their whacky data-driven macro-management.
OK, vent over (and, really, a pretty wonky and tame vent, I’d say).
This morning’s papers are abuzz with Fed-watchers reporting on a new paper that focuses on the market risks associated with aggressive monetary policy. While targeting weak demand, the analysis argues, the Fed creates market volatility that is inadequately addressed by “forward guidance,” i.e., when the Fed telegraphs its thinking about its future actions.
The “taper tantrum” from the summer of 2013 is exhibit A in this rap. The Fed says the obvious—um…at some point we’re going to start unwinding our historically unprecedentedly high balance sheet—and market’s freak, as Ylan Mui eloquently puts it:
The Fed had been buying $85 billion in long-term bonds each month to stimulate the economy. But several top Fed officials suggested in public remarks that the Fed could soon begin to scale back the purchases – triggering fears that years of easy-money policies were coming to an end.
The bond market freaked, sending the yield on the 10-year Treasury spiking to 3 percent. That rippled into the real economy as mortgage rates shot up, threatening the recovery in the housing market.
Her last point is well taken, and connects the bond market to the real economy showing that this matters more than my initial rant implies. Yet, mortgage rates were also going to go up, and they remain quite low in historical terms (average for 30-yr fixed since 2000: 5.7%; last week’s rate: 4.4%); still, their rise has slowed the housing recovery a bit.
The problem with this argument, however—that Fed macro-management increasingly incurs market volatility—is that it disallows a critically important position of the central bank right now: the idea that they will be data driven. To be so means that Janet and co. are reserving the right to adjust course if need be, based on incoming data. She’s been careful to underscore caution in this regard—they’re not going to lurch with every dip in the data—but neither can they be a slave to market skittishness.
We want a Fed that transparently yet flexibly pursues its dual goals of full employment and price stability (I’d add bank regulation, but that’s a different discussion). The weight right now must, of course, be on full employment, as Chair Yellen has consistently–and recently–emphasized. The recovery has been shaky and inconsistent, and there’s at least a hint, I’d say a not insignificant one, of another head fake in store. If so, the Fed should alter its course, suspend the unwinding or more, once again targeting growth and jobs. It should and will do its best to explain its moves to the markets with as much advance as possible.
But it can’t be hamstrung by a fear that markets will react unfavorably, as they are but one of its clients. And right now, in terms of who’s reaping the benefits of what growth we’ve seen, I’d say they’re the lesser client.
[Endnote: To be fair, the paper itself–link above–is pretty measured in this regard: “…the tradeoffs for monetary policy are more difficult than is sometimes portrayed. The tradeoff is not the contemporaneous one between more versus less policy stimulus today, but is better understood as an intertemporal tradeoff between more stimulus today at the expense of a more challenging and disruptive policy exit in the future.” But my analysis still holds–the interpretation of this concern in the hurly-burly of monetary policy in the real world raising the potential risk of less aggressive targeting of output gaps.]