Outright QE2 opponents are few but vehement.
The day after Yellen spoke to the NABE, Kansas City Fed President
Thomas Hoenig, another current voter, really ripped the idea at the same
forum.
Hoenig, who has dissented all year against the FOMC’s zero interest
rate stance and called for the Fed to start “normalizing” interest
rates, disputed estimates of how much QE2 would lower rates and said
that even if rates are reduced, the economic impact would be small due
to business uncertainty about tax and regulatory policy.
Hoenig said QE2 could lead to resource “misallocation,”
“imbalances” and “volatility.” What’s more, he said it could “unanchor”
inflation expectations, cause a disruptive downward spiral of the dollar
and undermine the Fed’s independence by encouraging perceptions that the
Fed is engaging in fiscal policy.
He scoffed at the notion that the Fed can “fine tune” inflation
expectations upward, which is exactly what the Fed would be trying to
do.
Asked whether he would support a policy that committed the Fed to
getting inflation and inflation expectations up to within the Fed’s
long-term forecast of 1.7% to 2.0%, Hoenig said that neither he nor
anyone else is capable of managing inflation expectations. And he
postulated a disastrous scenario.
“When you put it out there and you say my (inflation) goal is
whatever it is,” say 2%, “… and you put this much out there…here’s
what happens: You put half a trillion in, and inflation expectations
don’t change. Or actual inflation, because of the excess capacity, picks
up a tenth. So you put another half a trillion in, and it ticks up maybe
another tenth…
“What’s happening here?” Hoenig imagined his colleagues asking.
“(Inflation) is only 1%. So you put out another half a trillion.”
“The balance sheet is now $3 1/2 trillion,” Hoenig continued.
“(Inflation) is at 2%, but you’ve been below (2%) so now you want to go
a little bit above. So you leave it there for a while.”
“You don’t want to short circuit anything,” he continued. “(You
should) just pull it back. We don’t pull it back. So you leave it there.
Inflation is at 3%. Now the economy takes off and inflation is 5%, and
you say, “what happened?”
“I wish I could fine tune,” Hoenig went on. “I mean I wish I could
say ‘I want inflation at 2%” and everyone would believe me and that’s
where we’re going to go, and as soon as we get there everything is fine
and we pull the money out, and everyone’s asset values aren’t affected
or upset …. (But) as desperate as I am to see unemployment brought
down … I don’t want to take short-term measures that I think in the
long-run may not solve anything and might actually contribute to (bad
consequences.)”
Hoenig is not alone in his fears. Among next year’s voting
presidents, while Evans seems like a definite vote in favor of Q.E., two
others — Dallas Fed President Richard Fisher and Philadelphia Fed
President Charles Plosser — have argued loudly against more Q.E.,
making many of the same arguments as Hoenig. And they are likely to have
the backing of non-voting Richmond Fed President Jeffrey Lacker,
he indicated again Wednesday night.
Nearly the whole purpose of QE2 would be to increase inflation
expectations and actual inflation, as the FOMC has made clear.
The minutes of the Sept. 21 FOMC meeting disclose that “meeting
participants discussed several possible approaches to providing
additional accommodation but focused primarily on further purchases of
longer-term Treasury securities and on possible steps to affect
inflation expectations ….”
“A number of participants commented on the important role of
inflation expectations for monetary policy: With short-term nominal
interest rates constrained by the zero bound, a decline in short-term
inflation expectations increases short-term real interest rates (that
is, the difference between nominal interest rates and expected
inflation), thereby damping aggregate demand. Conversely, in such
circumstances, an increase in inflation expectations lowers short-term
real interest rates, stimulating the economy ….”
The Sept. 21 minutes, which are obviously dated at this point but
hardly irrelevant, do not give any sense that QE2 was a definite outcome
of the Nov. 2-3 meeting. They reflect the same kind of division that
subsequent comments have revealed.
“(S)ome members saw merit in accumulating further information
before reaching a decision about providing additional monetary
stimulus,” they disclose. “In addition, members wanted to consider
further the most effective framework for calibrating and communicating
any additional steps to provide such stimulus. Several members noted
that unless the pace of economic recovery strengthened or underlying
inflation moved back toward a level consistent with the Committee’s
mandate, they would consider it appropriate to take action soon.”
The Sept. 21 discussions culminated in a statement that the FOMC
was “prepared to provide additional accommodation if needed to support
the economic recovery and to return inflation, over time, to levels
consistent with its mandate.”
The way markets have interpreted recent Fed speak. anything short
of QE2 will be a big disappointment to Wall Street. Some even warn that
the Fed needs to announce large, not just incremental, asset purchases.
The rally that has taken the Dow Jones Industrial Average above
11,000 could go kaput, hurting household wealth and confidence, Fed
watchers have warned.
PIMCO senior vice president Tony Crescenzi told the NABE conference
Tuesday the FOMC really has no choice but to approve QE2 Nov. 3
because of market expectations.
But, as Lacker said, “we haven’t held the meeting yet.” FOMC
members will be studying the briefing papers, poring over data and
discussing pros and cons, costs and benefits before making a decision.
And, of course, the FOMC will be revising its quarterly, three-year
forecasts of growth, unemployment and inflation — just as a mid-term
election is taking place that could have an impact on consumer and
business behavior.
Hoenig said he is “concerned that we not be subject to the market’s
demands,” and said, the Fed “shouldn’t follow the markets.” And there
is sympathy on the FOMC for that point of view, but it’s really up
to Bernanke to decide whether or not he wants to alter market
expectations.
Another thing: There are other markets besides equities for the
FOMC to consider. With traders convinced that QE2 is on the way early
next month, the dollar has been plunging. And since oil is priced in
dollars, it is surging — U.S. light sweet crude closed up more than 2%
at just over $83 per barrel Wednesday. It was $64 in May.
Fear of dollar weakness is also reflected in a record high gold
price above $1371 per ounce.
The U.S. Energy Information Administration predicts oil will keep
rising next year as stronger global growth increases energy demand.
Calgary University professor Philip Verleger says it could hit $100 per
barrel if the dollar keeps falling. The higher retail fuel prices that
are sure to follow would hardly be a tonic for the U.S. economy.
Even more damaging, potentially, is the currency/trade war that
could ensue if the Fed and Treasury continue to nudge the dollar lower.
So there are offsetting market considerations for Bernanke and his
colleagues to contemplate in the remaining weeks before they meet.
There is, as Bullard said, a lot of time left; a lot more
data and market developments to weigh, and a lot more Fedspeak to
come, starting with Bernanke’s Boston speech Friday.
Bernanke has a chance to “clear the air,” to either cement
the impression that QE2 of some magnitude will be launched on Nov.
3 or to back away and send a more guarded, conditional and ambiguous
message.
He could, for instance, signal that a decision for QE2 is likely
but could be delayed to see whether or not incoming data validate the
new forecast the FOMC will be putting together at the upcoming meeting.
Or he could suggest that, before taking the monumental and risky
step of wading back into the bond market, the Fed might watch and wait
a while longer and try other measures to boost inflation expectations,
such as various communications tactics.
He could suggest that QE2 will be conditioned on whether or
not core PCE (1.4% for the past five months) rises and/or whether
private payroll gains pick up.
Pending Bernanke’s speech, I can’t help but feel swept along by the
tide of market expectations. But I’m still not totally persuaded.
I’m still not convinced that the FOMC will take the fateful step of
expanding an already bloated balance sheet and risk undermining an
already shaky U.S. currency and set itself up for possible failure when
the U.S. economy is, by officials’ own admission, far from deflation or
a double dip.
There’s no question the tide is riding high in favor of QE2. But is
it really inevitable? Is it really essential?
Let’s see what Bernanke has to say. It may be the most important
speech he’s ever given.
**MNI NEW YORK NEWSROOM 212 669 6430**
[TOPICS: MMUFE$,M$$BR$,MX$$$$]
