All good things must come to an end. And bad things, too, if you believe that the Federal Reserve Board’s bond buying program was a mistake. The minutes of its June 17-18 monetary policy committee meeting, published a few days ago, reveal that these purchases, largely credited with keeping long-term interest rates lower than they would otherwise have been, will come to an end in October. Fans of the protracted period of low interest rates say those rates helped bring the recession to an end by forcing up the prices of assets such as homes and shares, creating a “wealth effect” that encouraged consumers to spend. Better still, the low interest rates made it more attractive (cheaper) for businesses to invest in plant, software, and other assets, creating jobs not only for the workers directly involved, but for the butchers, bakers, and candle-stick makers whom they patronize. So say the Fed fans.
Wrong, say the Fed’s critics. If you could print your way to prosperity there would never by a recession. All the Fed’s $1 trillion bond-buying program has done is to store up future inflation as too much money chases too few goods, while creating “asset bubbles” as investors and savers, faced with zero interest rates on safe investments, hunt for yield by buying riskier assets that at least return something to savers and investors.
We might never find out whether the Fed or its critics have the best of the argument because the change in monetary policy will not happen in a vacuum, so that we can say it caused this, that, or the other thing. As the policy change plays out:
· Iraq is coming unhinged and a new Israeli vs. Hamas war is in the offing in a key oil-producing region;
· Opposition to new trade agreements is slowing world trade;
· A congressional election with all of its implication for fiscal policy is around the corner here in America;
· The Chinese economy is or is not slowing (that nation’s statistics are not famous for their reliability); and
· Participation in the U.S. labor market will or will not increase if wages rise, which they may or may not do, a set of unknowns sowing disagreement among the Fed’s monetary policy gurus.
The point of this list, which the reader can extend at will, is that economists need to qualify what they say by adding, “other things being equal.” Of course, they never are, making it difficult to trace cause and effect in a rapidly changing economic environment. Which is one reason economic forecasting is not even a respectable art, much less science. Financial Times journalist/economist Tim Hanford points out that in 2009 49 economies were in recession and economists had not called a single one of these downturns by April of the previous year.
Which brings us to the Fed, which is basing its decision to end it stimulus in October on its reading of the economic tea leaves, a reading that Fed economists and the policy committee believe signals an accelerated upturn. But, as former Fed governor Larry Lindsey points out, the Fed has been “consistently wrong, and in the same direction.” Its forecast for first-half growth was overly optimistic “by about two full percentage points! ...There is no consideration [in the minutes] of why they were wrong.”
Two important aspects of the failure of Fed economists to get their forecasts right are important as we ponder the wisdom of the decision to end the bond-buying program. The first is the most obvious: the decision is based on forecasts by officials who consistently get it wrong. Second, and more important: as Lindsey notes, they always err in the same direction—their growth forecasts are too high. So we have a policy change based on cheery forecasts by officials who are always wrong, and come in on the high side. Nevertheless, the Fed now says that based on its forecasts of more rapid growth, an improving labor market, an increase in the rate of inflation towards its 2 percent annual target, and financial conditions “supportive of growth in economic activity and employment,” it will end its asset purchases in October, with $1.5 trillion in bonds at that end date.
Many Fed watchers approve this normalization of monetary policy. They feel that whatever benefits these purchases might once have had, printing money to pay for asset purchases no longer has much positive effect, and does create distortions in investment patterns that will sooner or later create a new set of problems for the macroeconomy. This sigh of relief at the termination by the Fed of its purchase program does not depend on the future accuracy of Fed forecasts, but on objections to the program as such, regardless of the economic outlook.
The Fed takes a subtly different view. It says its decision to halt its experiment in monetary stimulus in October will stand “If the economy progresses as [we at the Fed] expect. … Participants [in the policy meeting] generally agreed that if the economy evolved as they anticipated, the program would likely be completed later this year. … The [monetary policy] Committee will closely monitor incoming information.”
This is more than a little disingenuous, since if the economy and other indicators disappoint—fall below Fed forecasts as they always do—the Fed can nevertheless end the bond-buying program based on new forecasts of future growth. That is, after all, what it has just done—we got it wrong, we were overly optimistic, but our new forecast of future developments is as cheery as the old, wrong one, so we will proceed as planned. In favor of the Fed it should be noted that its decision to tighten policy, based on expectations of an improving economy, was taken before the latest generally positive report that 288,000 new jobs had been created in June. So such new data as we have constitutes a bit of balm on the recent wounds and old scars of Fed forecasters.
There is a real question as to the effect of the Fed’s change of direction: is it a meaningful change? Chair Janet Yellen has promised that the end of asset purchases does not mark the end of low short-term interest rates. The minutes declare that even when the labor market and inflation rates meet Fed targets, “economic conditions may, for some time warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” The internal discussion at the Fed now centers not on whether, but how to keep short-term rates low.