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Bernanke Considers a Taper

12:00 AM, Jun 8, 2013 • By IRWIN M. STELZER
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Federal Reserve Board chairman Ben Bernanke hints that he might—perhaps, maybe—be thinking about possibly slowing the Fed’s purchases of bonds and mortgages. That leads bondholders to start selling, driving up interest rates, and causing tremors on stock markets. Not only here in the U.S.: the nervousness spread to markets around the world. “Taper” is the term being used to describe a slowing of Fed purchases from the current $85 billion per month level. If a mere hint that the Fed might taper its bond purchases can cause such stepped-up volatility, imagine what an actual taper might do. Or consider the possibility that markets might make the Fed less relevant. Former Fed chairman Alan Greenspan is warning that “when the bond market begins to move, we might not be able to control it,” leaving the Fed’s monetary policy committee an observer rather than a player as bond prices plunge, interest rates soar, and the economy tanks. 

Ben Bernanke.

Ben Bernanke.

Meanwhile, it is increasingly difficult to separate good news from bad. Consider two bits of fashionable analysis. The first says that good news is, well bad. If the recovery accelerates, if job creation picks up and the unemployment rate plummets, the Fed will taper—cut back on the easing that has elevated share prices and kept interest rates low. That will drive mortgage rates even higher than the 4 percent they reached last week, aborting the housing recovery. So sell on any good economic news. “The American markets are getting worried … that economic growth may be about to accelerate,” reports the New York Times.

That’s silly, counter other analysts. Good news is just that, good news. A more rapid recovery will trigger a virtuous cycle. Corporate profits will tick up, businesses will unlock the billions sitting in their vaults and begin investing in factories, computers and other assets, adding to consumer buying power, which in turn encourages more business investment. So take your pick: good economic news is a sell signal if it causes the Fed to tighten, or a buy signal if it means higher levels of profit, investment and consumer spending. Little wonder that the market plunged, before adding 400 points to the Dow in the last day-and-a-half of trading this week.

If you can’t figure that out, take a whirl at deciding how much confidence to place in economic forecasts. Last week the International Monetary Fund, an agency with no shortage of well-regarded economists on its payroll, admitted to “notable failures” in predicting the consequences of the austerity program it insisted be imposed in the hope of putting Greece on the road to economic recovery. Alas. “Market confidence was not restored, the banking system lost 30 percent of its deposits, and the economy encountered a much deeper than expected recession with exceptionally high unemployment.” Lest you consider this the sort of “open confession that is good for the soul,” as an old Scottish proverb has it, think again. The IMF concludes that it “considers the broad thrust of policies under the program to have been appropriate.” So here are talented economists, as well trained as those telling you where the American economy is headed, confessing to creating a new Greek tragedy but, unlike ancient tragedians, doing so inadvertently.

With that warning under your belts, you are in a position to draw your own conclusions from the slew of new data about the state of the American economy. The best place for an overview is the Fed summary of business conditions. “Overall economic activity increased at a modest to moderate pace … except [in] the Dallas District, which reported strong economic growth. The manufacturing sector expanded… [there have been] slight to moderate gains in consumer spending. Tourism showed signs of strength …business services expanded … residential real estate and construction activity increased at a moderate to strong pace … [as did] commercial real estate and construction activity…Bank lending…credit quality and deposits increased.”

That picture of modest improvement in the economy is consistent with the job report released yesterday. The private sector added 178,000 jobs in May, more than most forecasters expected, but with 420,000 workers entering the labor force the unemployment rate rose a bit, to 7.6 percent from 7.5 percent in April. That is considerably above the 6.5 percent that Bernanke says would trigger a taper that would signal the beginning of the end for QE3, as his bond-buying program is known. His disinclination to slow the presses is probably reinforced by three facts.

·     Over 20 million workers are either unemployed, forced to work only part time, or simply too discouraged to look for work—that’s almost 14 percent of the work force.

·     Only 58.6 percent of the working-age population wakes up in the morning to head to work; in 2006 that figure was 63.4 percent. “By this measure, the labor market’s health has barely changed over the past three years,” notes Edward Lazear, a Stanford University professor and former chairman of President George W. Bush’s Council of Economic Advisers.

·     He does not yet know whether spending cuts and higher taxes, aka fiscal tightening, will have dire effects on the jobs market.

Recall that President Obama forecast that spending cuts—the so-called sequester—will eventually result in massive job losses. And congressional Republicans forecast that the tax increases on “the wealthy,” forced through by the President, will abort the still-fragile recovery. Bernanke is faced with some evidence that both the sequester and the tax increases are already slowing the economy, but can’t yet decide whether the full impact of this fiscal tightening has been felt in the economy and in the labor market. Most economists are predicting that the economy will not achieve in the current quarter the 2.4 percent growth recorded in the first quarter. So my guess is that the Fed chairman will keep bond purchases at or very near present levels, at least for a while. But that is not a uniform view: some Fed-watchers are predicting at least a slight reduction in purchases as early as September.

Let me conclude with some news that will produce rolling eyes in some readers, and smiles of optimism in others. The Wall Street Journal reports that academic economists and their students are newly interested in macroeconomic research, and are hunting for answers to several questions, among them “What’s going to happen when the Fed pulls back?” This open confession of the inadequacy of existing forecasting tools might be good for the souls of academic economists. Whether it will produce more reliable guides to the economic consequences of monetary policy is less certain.

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