The FOMC decided
not only keeping the policy rate low until 2014, but also has changed its way
of doing monetary policy trying to act via expectations, reducing uncertainty
and creating a more translucent relationship with the market. As I’ve pointed
out in the last post (here),
today the FOMC released forecasts for real GDP growth, inflation and
unemployment. It’s also the first time the monetary authority commits itself
with an explicit inflation target.
These are tough
times and require bold actions (see here
my post about it). This may be one. Inasmuch as the entity discloses these
forecasts, it is trying to anchor expectations about recovery and price
dynamics, providing short-run estimates and long-run references.
Anchored expectations
is important regardless what kind of environment you are dealing with. The US
households are amid a deleverage process, lacking aggregate demand and stuck
within a liquidity trap. If expectations are out of control, it would be one more
(big) problem to handle and since a few options are available.
The zero-low
bound of nominal interest rate is binding, so monetary attempts cannot be the
conventional ones; however the toolkit is getting scarce. Fiscal policy has its
own issues. First of all, there’s a lag between the conception and
implementation. Second, the debt level amid a not-very-favorable political
process makes a stimulus plan hard to be implemented.
Therefore, the
initiative of the Federal Reserve in communicating with the market in a way
that would induce a convergence of expectations may be in the right direction.
I’m only not sure if it will do much effect. Publicizing the 2% target it’s
just ratifying something that people already expect. On the other hand, what can indeed be
interesting are the estimates regarding short-run economic growth and
unemployment, since these are drivers for several economic decisions.
The question on the Federal Reserve actions is do they know what they're doing? Or what they've done to the economy? If we analyze their actions based on the movement of the federal funds rate (see http://research.stlouisfed.org/fred2/series/FEDFUNDS), it is clear that when the FOMC raises the rates, recessions occur. Raising the federal funds rates drains reserves from the banking system, which restricts the credit and money channel as transmission mechanisms.
ReplyDeleteThus, central banks, including the Fed, ought to reexamine in light of the crash the misapplication of formal and informal inflation targeting policies that restricted growth; there is a trade off between inflation and unemployment. The more central banks fight inflation, the higher is the unemployment.
The Fed response to the Great Recession was to increase bank reserves in the fourth quarter of 2008 from approximately $50 billions to $1.6 trillions. Clearly, they had to be aware that they had choked of growth by not allowing enough money in circulation.
Putting money in the banking system, however, does not solve the crisis, particularly if the banking system fails to open the credit channel (providing credit to borrowers), so that the money channel can become active.
The irony is that most politicians, the public, and even many economists, do not understand that credit is the engine of economic growth and they argue for less credit and less government; in essence, for shrinking the money in circulation.