With recent Obama appointments to the Fed, it is more firmly under monetary dove thought control. [In the Fed policy tradeoff between inflation and unemployment, the monetary doves are more willing to pay the price of higher inflation in order to achieve lower unemployment than are the monetary hawks.] This includes, of course, the dove-in-chief Bernanke who is one of many the bad appointments of the failed W. years. W. first appointed him as a member of the Federal Reserve Board in 2002 and as Chairman in 2006.
He was reappointed as Chairman of the Federal Reserve Board by Obama in 2009 to start his second four year term in 2010. He was confirmed by the Senate in a 70-30 vote, the smallest confirmation margin for any Fed Chairman due to his controversial role in the financial crisis and subsequent bailouts. It is interesting to note that while at the Fed in 2004 Bernanke gave a speech entitled The Great Moderation in which he mentions that he believed that improved monetary policy should contribute to reduced economic volatility in the future.
Bernanke and his dovish allies on the Fed believe that the Fed needs to do whatever it takes to reduce unemployment from its present level, even though most of the economy’s current sluggishness follows from structural and other factors such as deleveraging by individuals and Democratic Party anti-business policies and uncertainties which cannot be offset by easier money in today’s ultra low interest rate environment. (See blog of June 18, 2010 entitled “Some of President Obama’s Ways and Means” and subtitled “Promotion of Drags on the Economy” which contains a partial review of the anti-business strategy of the Obamans.)
Moreover, the doves’ feeling of urgency with regards to monetary policy seems unjustified. Unlike during the Great Depression of the 1930’s, we do not see press coverage of people starving in the streets or otherwise suffering from a deficiency of food or shelter since the pain of unemployment is mitigated by working spouses, our social safety net features, and the assistance of relatives.
If the Fed’s Quantitative Easing Phase II (QE2) happens, and it now seems almost certain to happen, it most likely will have very little positive impact on the economy as interest rates are already so low and bank liquidity so great that further easing of monetary policy can have no further positive effect on business activity. Of the Fed voting members, Kansas City Fed President Hoenig has been the leading champion of the “QE2 won’t work” viewpoint, but he does not have the votes to stop Bernanke’s pursuit of QE2.
Bernanke is a very intelligent person so he must surely know that QE2 is almost certain to have little direct effect on the economy. Yet he is making many statements in the closing weeks of the election cycle that QE2 will work and the Fed will institute it given the current high rates of unemployment and low rates of inflation. It all makes one wonder if there is not some political component in the timing of his “jawboning” on this subject so often and strongly as the election approaches. The fact that the official Fed QE2 decision will not be made until after the election does not depoliticize it since he has telegraphed that it is a near certainty that the Fed will embark on QE2 shortly after the election.
The recent rise in the stock market since the Fed began to trumpet its willingness to undertake QE2 is probably not related to optimism on the economy as much as it is related to the desperation that investors feel seeing close to a zero return from secure savings alternatives and hearing the promise from the Fed of more of the same low rate environment for the foreseeable future. Moreover, the stock market may have gotten a positive boost from the predicted the strong showing of the Republicans in the mid-term elections and the resulting hope that the Republicans can counter the economic negatives of Obama policies after the next presidential election if not sooner. If QE2 is implemented, the outcome will almost surely be that the additional monetary easing will have no further positive effect on the economy. If no positive economic impact can be discerned, then the Democrats may lead a cry for more stimulus money and other props for the economy that will further run up the federal deficit and federal debt burden without removing any of the current obstacles to economic growth….
Additional massive open market purchases of debt securities by the Fed in pursuing QE2 are likely to make things worse for the economy down the road. The dollar will continue to be devalued in foreign exchange markets due to both the extremely low rate of interest that holders of dollars can obtain and the view that the massive Fed run of the printing press is going to lead to an excess supply of dollars on world markets and future U.S. inflation. This inflation will come about in part from the availability of ultra-cheap short-term and long-term credit within the United States and the increase in the cost of imports to the United States due to dollar depreciation. We import much more than we export and the dollar costs of those imports including large amounts of oil will rise, especially if China allows a significant rise in the value of its currency relative to the dollar.
Devaluation of the dollar may have unfortunate repercussions as foreign governments may find themselves under pressure to fight appreciation of their currencies relative to the dollar or otherwise protect their domestic industries. Massive increases in assets on the Fed balance sheet from QE2 on top of those already incurred are also likely to make it impossible for the dovish Fed to unwind its monetary ease as much as necessary when future inflation jumps above Fed target ranges. If inflation takes off, it might well lead Obama to install wage and price controls with all the misallocation of resources and inefficiencies that would follow and we would be pushing further down the road towards a centrally controlled economy, a prospect which would no doubt be pleasing to Obama….
(written on October 15, 2010)
