TIME Regulation

The Fed Is Staying the Course, and That’s Great

Janet Yellen, chair of the U.S. Federal Reserve, listens to a question during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington on Sept. 17, 2014.
Janet Yellen, chair of the U.S. Federal Reserve, listens to a question during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington on Sept. 17, 2014. Bloomberg/Getty Images

Why boring monetary policy is good

The Federal Reserve’s monthly statement Wednesday was typically dull. Basically, the Fed is staying the course, because the economy is continuing a path of gradual improvement.

The Fed continued its “taper,” reducing the monetary stimulus it’s pumping into the economy by $10 billion for the 10th consecutive month, while announcing that this stimulus—known as “QE3”—should end on schedule next month. The Fed also continued to signal it won’t raise interest rates above zero “for a considerable time,” despite speculation it might soften that language. Fed Chair Janet Yellen then devoted most of her news conference to a mind-numbing discussion of procedural arcana involving “policy normalization principles” and “overnight RRP facilities.”

This is not exciting stuff. But boring monetary policy is an excellent thing to have, especially just six years after a spectacular financial crisis. At the time, the Fed took all kinds of unprecedented actions to save an economy that was contracting at an 8% annual rate and shedding 800,000 jobs a month. Some critics thought those actions would fail to prevent a depression. Others thought they would lead to hyperinflation, a devastating run on the dollar, or a double-dip recession. Instead, we’ve had 54 straight months of job growth. The jobless rate is down from 10% to just over 6% percent. The stock market is booming. Last year, the U.S. had its largest one-year drop in child poverty since 1966, and this year is looking even better. Two of the Fed’s inflation hawks actually dissented from the latest statement, arguing it “does not reflect the considerable economic progress that has been made.”

In other words, things are OK.

Things are not great; as Yellen pointed out, many American families are still dealing with aftershocks of the crisis, including tight credit, lingering debt, depressed wages and a shortage of jobs. Incomes for the non-rich have grown modestly since 2010 and not at all since before the crisis, although tax cuts for the middle class and the poor, tax increases for the rich, and expanded government benefits for the vulnerable have helped offset those trends. It’s true that our recovery from the Great Recession has been slower than previous recoveries from ordinary recessions. But it has been much stronger than previous recoveries in nations that endured major financial crises—and much stronger than Europe’s current recovery. The euro zone’s output has not yet reached pre-crisis levels; it’s still struggling with 12% unemployment and a risk of deflation.

We’re doing a lot better than that. We had more effective bank bailouts, more generous fiscal stimulus—until Republicans took over the House after the 2010 midterms and began demanding austerity—and much more accommodative monetary policy. It’s all worked remarkably well. We’ve faced some headwinds—the contagion from the near-collapse of Greece in 2010, the turmoil after we nearly defaulted on our debt in 2011—but the economy has continued its path of slow but steady growth. That’s why Yellen was able to discuss those mind-numbing “policy normalization principles,” the guidelines the Fed will follow as it starts raising rates and reining in its bloated balance sheet in 2015. We’re approaching normal. And the Fed’s forecast for the next few years also looks pretty decent.

It doesn’t look fantastic. But in 2008, the U.S. suffered a horrific financial shock, with a loss of household wealth five times worse than the shock that preceded the Depression. We’re still dealing with the aftershocks. Many Americans still don’t feel like the economy is working for them, an understandable reaction to persistent long-term unemployment, stagnant wages, and continuing foreclosures.

But as dull as it sounds, it’s working better every year. The lesson of our current plight is not that the system doesn’t work. It’s that financial crises really suck.

MONEY The Economy

Think the Fed Should Raise Rates Quickly? Ask Sweden How That Worked Out

Raising interest rates brought the Swedish economy toward deflation Ewa Ahlin—Corbis

Some investors are impatient for the Fed to raise interest rates. They may want to be a little more patient after hearing what happened to Sweden.

If you’re a saver, or if bonds make up a sizable portion of your portfolio, chances are you’re not the biggest fan of the Federal Reserve these days.

That’s because ever since the financial crisis, the nation’s central bank has kept short-term interest rates at practically zero, meaning your savings accounts and bonds are yielding next to nothing. The Fed has also added trillions of dollars to its balance sheet by buying up longer-term bonds and other assets in an effort to lower long-term interest rates.

Thanks to some positive economic news — like the recent jobs report — lots of people (investors, not workers) think the Fed has done enough to get the economy on its feet and worry inflation could spike if monetary policy stays “loose,” as Dallas Fed President Richard Fisher recently put it.

If you want to know why the argument Fisher and other inflation hawks are pushing hasn’t carried the day, you may want to look to Sweden.

Like most developed nations, Sweden fell into a recession in the global financial crisis. But unlike its counterparts, it rebounded rather quickly. Or at least, that’s how it looked.

As Neil Irwin wrote in the Washington Post back in 2011, “unlike other countries, (Sweden) is bouncing back. Its 5.5 percent growth rate last year trounces the 2.8 percent expansion in the United States and was stronger than any other developed nation in Europe.”

Even though the Swedish economy showed few signs of inflation and still suffered from relatively high unemployment, central bankers in Stockholm worried that low interest rates over time would lead to a real estate bubble. So board members of the Riksbank, Sweden’s central bank, decided to raise interest rates (from 0.25% to eventually 2%) believing that the threat posed by asset bubbles (housing) inflated by easy money outweighed the negative side effects caused by tightening the spigot in a depressed economy.

What happened? Well…

Per Nobel Prize-winning economist Paul Krugman in the New York Times:

“Swedish unemployment stopped falling soon after the rate hikes began. Deflation took a little longer, but it eventually arrived. The rock star of the recovery has turned itself into Japan.”

And deflation is a particularly nasty sort of business. When deflation hits, the real amount of money that you owe increases since the value of that debt is now larger than it was when you incurred it.

It also takes time to wring deflation out of the economy. Indeed, Swedish prices have floated around 0% for a while now, despite the Riksbank’s inflation goal of 2%. Plus, as former Riksbank board member Lars E. O. Svensson notes, “Lower inflation than anticipated in wage negotiations leads to higher real wages than anticipated. This in turns leads to many people without safe jobs losing their jobs and becoming unemployed.” Svensson, it should be noted, opposed the rate hike.

image (8)
Sweden

Moreover, economic growth has stagnated. After growing so strongly in 2010, Sweden’s gross domestic product began expanding more slowly in recent years and contracted in the first quarter of 2014 by 0.1% thanks in large part to falling exports.

As a result, Sweden reversed policy at the end of 2011 and started to pare its interest rate. The central bank recently cut the so-called “repo” rate by half a percentage point to 0.25%, more than analysts estimated. The hope is that out-and-out deflation will be avoided.

So the next time you’re inclined to ask the heavens why rates in America are still so low, remember Sweden and the scourge of deflation. Ask yourself if you want to take the risk that your debts (think mortgage) will become even more onerous.

MONEY The Economy

The Return of the Most Interesting Man on Wall Street

Paul McCulley
I don't always call for stimulus, but when I do it's monetary AND fiscal. Lori Shepler—Reuters

Paul McCulley returns to PIMCO as chief economist. Here's how he explains the mysteries of the Fed and ultra-low interest rates.

Pimco, manager of nearly $2 trillion in assets and home to Bill Gross and his massive $230 billion Pimco Total Return bond fund PIMCO FDS PAC INVT TOTAL RETURN A PTTAX -0.2752% , annouced last week that it has brought back Paul McCulley. McCulley, who made his name at the firm with his sharp commentaries on the Federal Reserve, will be Pimco’s chief economist. For 100 days per year.

The return of McCulley is attracting attention in part because of recent management turmoil at Pimco, which saw former co-CEO Mohamed El-Erian clash with Gross and leave unexpectedly. Reports also mention McCulley’s imaginary Q-and-A with his pet rabbit and recent unusual hair. (He’s since cut it. The photo here is from 2011.)

But McCulley is also a man with unusual ideas for a Wall Streeter* (*West Coast Division—Pimco is based in Orange County). Those ideas will certainly be of interest to investors in Earth’s biggest bond fund. But they also point to a different way of thinking about what the ever-mysterious Federal Reserve has been up to.

In his time away from Pimco, McCulley was chair of fellows at a group called the Global Interdependence Center, where he co-wrote a pair of unorthodox papers on the future direction of both the Fed’s interest-rate setting (monetary policy, in the jargon) and government spending (fiscal policy.)

Here’s the conventional wisdom on what the Fed has been doing: By holding interest rates very low, by buying up massive amounts of bonds in operations called “quantitative easing,” and by communicating that it is really, really, super serious about keeping rates low until inflation runs at at least 2% and unemployment falls under 6.5%, it is sending a message to the markets. This will encourage people to buy stocks, to borrow, to invest in businesses, and to spend.

McCulley’s argument (at least in early 2013 when he wrote the most recent paper) is that this is only half the game. When the private sector is still trying to climb out of a debt hole and the Fed has already cut rates near zero, the economy needs the public sector to pick up some slack. “Fiscal ‘irresponsibility’ (running large deficits despite large deficits as far as the eye can see) may in fact be far more important at the zero bound than monetary irresponsibility,” McCulley and coauthor Zoltan Pozsar write. In their language, “irresponsibility,” or unorthodoxy, is a good thing under the circumstances.

They say what the Fed has really been doing (or maybe should have been doing—it’s not clear) with its extraordinary actions is to send a message to Congress and the White House: “Please, go spend some money! Even if it triggers some inflation and blows up the deficit, we won’t get in your way.” In fact, McCulley and Pozsar write, the central bank should have gone further, making clear it would essentially fund deficits by keeping up QE.

If that was ever the message, it was not received. In fact, the deficit has been falling, and recent battles between Congressional Republicans and the President over the debt ceiling have put an end to any talk of fiscal stimulus.

In Europe, the other big engine of the global economy, policymakers are if anything even more austerity minded.

So instead of worrying that the Fed has gone too far with QE and is about to ignite inflation, a McCulley-ish view of the world has central banks basically pushing on a string. If you believe that, you’d think the Fed’s going to be keeping rates low for some time to come. And you’d probably be inclined to ignore the constant refrain that Treasury bonds, with their super low yields, are a bubble just waiting to burst.

Beyond the stock and bond markets, you’d expect sluggish growth ahead. Unemployment has dipped to 6.3%. But some worry that too much of this is due to fewer people looking for jobs.

Pimco’s latest market outlook has been for a “new neutral”—that is, a world where growth and inflation never really take off in a big way, but then neither do interest rates, and investors can expect modest returns. Sounds like they’ve been keeping tabs on McCulley’s writing and thinking. Does that mean the funds will stay bullish on bonds for a while? Maaaaybe. What a firm like Pimco says in public is one thing. They make their money by timing the turns from the status quo to the next big move. They probably won’t tell you about it first. (Pimco has had a mixed—at best—record of getting interest rate and inflation moves right in recent years.)

Pimco has told its investors that a lot of the “new neutral” story is built into today’s high asset prices and low bond yields. So even at face value, this isn’t so much a bullish case as an argument that risks aren’t as high as some people worry they are. In other words, the Pimco view is that we are not yet set up for a repeat of the 2007-2008 “Minsky moment”—a term McCulley coined for the tipping point when complacent investors discover that they took to much risk. (He’s also been credited with the term “shadow banking.” Like I said, interesting guy.)

Beyond what it means for Pimco’s shareholders it should be interesting to see how McCulley, whose new role all but guarantees him a guest seat on CNBC and the ear of every financial reporter, affects public debate about fiscal and monetary policy. Imagine Paul Krugman sitting besides a $2 trillion portfolio.

TIME

Janet Yellen: Cool, Calm, Collected—Yet Again

Janet Yellen Testifies At Senate Banking Committee Nomination Hearing For Fed Chairmanship
Andrew Harrer—Bloomberg/Getty Images

Alan Greenspan would be amused, if not proud of Federal Reserve chair Janet Yellen’s testimony before Congress Wednesday about the state of the economy. The Dow had opened on the frothy side, up 75 points in the opening hour, but by the time Yellen’s words had been digested like the morning’s cronut, the DJIA was flat again.

Greenspan used to flummox the Street and Fed watchers has his own distinct vocabulary that tried to neutralize, if not paralyze, the market when he testified before Congress. Yellen is the complete opposite: She makes a point of being entirely comprehensible and what she said today is that things are pretty darn okay, America. “With the harsh winter behind us, many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter,” she said.

But things are not okay enough to change the current policy of low short-term interest rates, even as the Fed ratchets down its purchases of mortgage debt designed to accommodate growth. Yellen is still concerned about the slowing housing market, which is a drag on near term growth and, in the long-term, the historically low labor participation rate. It is the Fed’s mission to maximize employment while containing inflation. “Looking ahead, I expect that economic activity will expand at a somewhat faster pace this year than it did last year, that the unemployment rate will continue to decline gradually, and that inflation will begin to move up toward 2 percent,” she said.

Housing has been slowed by rising interest rates and lagging household formations, even though rates are still low by historical measures. The lagging number of household formations, Yellen said, stems from the fact that kids coming out of college are weighed down by student debt and end up back with their parents. “As the job market strengthens and economy strengthens, we will see household formations will pick up,” she said in questioning before the Joint Economic Committee, and to the relief of many boomerang parents around the country no doubt.

A number of her questioners cited a deep-seated concern about inflation, which had been fueled by economist Allan H. Meltzer in a Wall Street Journal column this morning warning that higher inflation was unavoidable given the massive amount of liquidity the Fed has injected into the economy. Yellen wasn’t taking the bait. “We have the will, the tools and determination to remove monetary accommodation to avoid inflation,” she said. Yellen noted that she and other Fed staffers remember the inflationary late 1970s all too well—interest rates topped 20%—and weren’t about to repeat history.

One reason Yellen is a bit sanguine about inflation is that economic growth should be putting upward pressure on wages, for instance, which would then chase prices higher. That hasn’t happened, and one reason is that, while the unemployment rate dropped sharply last month, a half a million people dropped out of the labor force. Yellen noted that the reasons behind the drop in the labor participation rate aren’t fully known. It could be that more people are going back to school, boomers are dropping out, or something else.

She’ll look into it. But she again saw economic expansion as the solution to the problem. It generally is. Only in Yellen’s Q&A session with Congress did she give the Street anything to go on. Having signaled she’s sticking to the previously announced policy on interest rates, which favors stocks over bonds, she also remarked that she didn’t see any big issues in asset prices. “There are pockets where we could see misvaluations, in smaller cap stocks. But overall, the broad metrics don’t suggest we are in bubble territory,” she said. In other words, as you were Wall Street. The bulls quickly got back to work, sending the Dow higher before lunch.

TIME

Markets Need Janet Yellen to Kick Them in the Pants

Janet Yellen testifies before the Senate Banking Committee during a hearing on her nomination to become Chair of the Federal Reserve on Nov. 14, 2013 in Washington, D.C.
Kris Tripplaar—SIPA USA

Poor Janet Yellen. She does a good job communicating a complicated (and appropriate) mix of policy decisions at her first FOMC meeting today, including a slightly larger and quicker than expected interest rate hike, as well as a movement away from a set unemployment threshold for keeping rates low and toward a more nuanced view of labor market health. So what happens? She gets hammered by pundits and bankers alike for supposedly ending Bernanke style clarity, adding “mystique” to Fed communications and “shaking up” the US central bank’s mandate of keeping unemployment and inflation low.

Let’s all take a deep breath, please. For starters, Bernanke’s “clarity” over the last few years was largely Yellen’s doing, in the sense that she’s the one that came up with the 2 % inflation target rate and pushed for more and better Fed communication. Then, there’s the supposedly “hawkish” rate increase (the median interest rate forecast increased 0.25 % to 1 %) which investors now believe could happen by mid 2015 based on a statement by the chair, during her press conference, that rate hikes could start six months after the end of asset purchases (which may well be done by the end of this year).

Again, let’s all practice mindfulness, and focus on what we know will happen if rates stay low forever. Bubbles will form—and they will pop. The Fed’s $4 trillion money dump has already created what Yellen and other Fed leaders know are price distortions in everything from emerging market equities to commodities to certain real estate markets. Many people, including me, have been saying for some time now that while we might wish that the Fed’s easy money and low-interest rate policy could do more for the economy, it probably can’t.

There are complicated structural reasons why we are in the longest and weakest recovery of the post WW II period. When I interviewed Yellen earlier this year, she made it quite clear that she knew that the Fed’s firepower was running low—although she still believed that clear and thoughtful forward guidance could help calm markets. (Today’s reaction shows that will be a tricky act to pull off.) Still, by proving hawks that had predicted a Yellen-led Fed would remain too dovish for too long wrong, she’s showing a careful regard for the market impact of long-term loose monetary policy. She may be concerned about the “human impact” of unemployment, but she clearly doesn’t want markets to crash, either.

All in all, I’m rather surprised that the markets took the rate hike news as so hawkish and definitive, given that she stressed again and again that the Fed would be watching a broad range of economic indicators to make sure that they were getting the timing of internet rate tightening right. (Which, by the way, is appropriate given that the recent drop in the US unemployment rate is indicative of many things beyond labor market health, like boomers dropping out of the workforce by choice or by force.) She told reporters that even when rate hikes began, there would be a “shallower glide path” than normal, and that we shouldn’t just “look to the dot plot”—meaning the Fed’s own projections—but that markets should know Fed governors would be keeping their fingers to the wind at all times, ready to change direction on policy if needed.

To me, that’s reassuring. It’s interesting that to markets it was worrisome. That shows just how dependent investors have become on Fed news going in one direction only and how removed some asset prices have become from fundamentals. When I close my eyes, breathe deeply and visualize the future, I see…more volatility.

TIME Monetary Policy

Fed Looks to Keep Interest Rates Low For Now

The Federal Reserve said it would keep interest rates low until at least early next year in order to encourage more borrowing and spur economic growth amid persistent unemployment and low inflation plaguing the economy

The Federal Reserve signaled Wednesday that it would look to keep interest rates low until at least early next year, as it abandoned its traditional target of a 6.5 percent unemployment rate as a trigger for higher rates.

Citing persistent unemployment and low inflation, the central bank said that the federal funds rate—the short term interest rates set by the Fed—should remain at a “highly accommodative” lower rate in order to encourage borrowing and spur economic growth. The Fed is currently holding that rate at below 0.25 percent. The Fed also said it is continuing to reduce its monthly long-term bond purchases by another $10 billion to $55 billion, in a widely expected continuation of its so-called “taper,” as it scales back its most aggressive economic stimulus.

Wednesday’s announcement was the first action taken by the Federal Reserve under the leadership of its new chairwoman, Janet Yellen. Markets were down after the news, signaling surprise at the possibility that rates could go up in the spring of 2015, earlier than many expected. The Dow Jones closed down 108 points, or about two-thirds of a percent. The S&P 500 and the Nasdaq saw similar falls. But Yellen left the Fed plenty of wiggle room for when and how to raise rates.

Previously, the Fed had said if unemployment fell below 6.5 percent, it would consider raising interest rates, but Wednesday’s announcement scraps that benchmark. The current unemployment rate is 6.7 percent.

The central bank also adjusted its growth estimate for the U.S. economy in 2014, to between 2.8 percent and 3.0 percent, down from its December prediction of between 2.8 percent and 3.2 percent.

Your browser, Internet Explorer 8 or below, is out of date. It has known security flaws and may not display all features of this and other websites.

Learn how to update your browser