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Posted by warren mosler (65.113.90.26) on 11:46:00 11/06/07
> The high points and some comments from Fed Governor Frederic Mishkin today
> at a conference I'm attending.
>
>
> His speech was heavily focused on macroeconomic risk due to financial
> instability that can arise from adverse feedback mechanisms due to
> tightening credit and falling collateral valuations.
> He indicated recent financial "crisis" risk not just in the margins, but
> real and potentially systemic, justifying what he termed, "timely, decisive,
> and flexible" action.
Yes, seems the speech was meant to justify the latest cut.
> Timely meaning before any major correction or instability can take root
> Decisive meaning large enough to restore market efficiency and remove the
> need for further action for this purpose (avoiding financial instability)
> down the road
Yes, that's why the cut 50 sep 18- they reasoned that if the cuts are
for 'market functioning' purposes there's not point in not doing
enough up front to solve the problem.
> Flexible meaning data dependent such that the easing can be taken out
> quickly as needed.
That can be taken two ways.
First, if data shows markets are functioning sufficiently the cuts can
be taken back. This implies there wouldn't have been cuts based on
the macro economy without the 'market functioning' issues.
Second, if inflation continues to show signs of intensifying the cuts
can be taken back, regardless of market functioning, which would have
to be addressed by something other than 'inflate your way out of debt'
interest rate cuts.
> He was insistent that the feds role in promoting financial stability in the
> face of increasingly asymmetric risk (lender/borrower information) falls
> well within the bounds of the feds "dual mandate"
It does, but here's where he seems to move away from mainstream
economic theory, which says that long term growth and employment are
optimized by low and stable inflation. The mainstream is also
emphatic that the cost of reeling in inflation that has gotten too
high is much higher than the cost of keeping it in check early even if
that means a recession. Several Fed members have repeated that to us
over the years, right up to the Sep 18 meeting.
> He noted that the intention of the recent action was to mitigate or "offset"
> macro weakness due to financial instability risk,
(potential weakness)
not valuation risk
> (falling asset prices) and that the "structural revaluation" of market
> segments was not their target.
right.
> In the meantime, he reiterated that the downside risk to growth currently
> appear to be roughly balanced with the inflationary risks and that the fed
> has done enough for now.
Again, as a point of logic, this is a departure from mainstream
thought. There is no 'balance' between inflation risk and near term
downside growth risk. Inflation risks long term growth and
employment, with any near term macro setback far less costly than
'letting the inflation cat out of the bag' and having to reel it in
later.
> When pressed on inflation pressures he kept coming back to the theme that
> despite some inflationary readings, overall inflation expectations are
> anchored. Until inflation expectations become "unanchored" the fed will
> have the flexibility to respond as needed.
Another departure. The mainstream say when expectation elevate it's
too late and the cost of bringing them down is far higher than the
cost of keeping the anchored in the first place.
> He argued that despite rising energy costs, falling dollar (increased
> aggregate non-domestic demand), and the recent fed cuts, "inflation
> expectations remained anchored."
He can argue that, but all know the ways to measure expectations are
severely limited, as well articulated by Chairman Bernanke a few
months ago in a speech devoted entirely to inflation expectations.
Also, TIPS break evens are widening, and, also interesting, the
'straight' TIP floater
indicates a 10 year 'real rate' below the actual 10 year 'break even'
inflation rate. So markets are discounting the Fed keeping the
nominal rate below the rate of inflation for the next 10 years. The
mainstream would label this as highly accomodative at best.
> He also noted that the downside effects on growth due to housing correction
> have, in his view, been nominal and that the spillover effects to the
> broader economy have not exceeded expectations at this point.
>
two paragraphs from the speech, comments in CAPS:
"Decisive action is also important. In circumstances when the risk of
particularly bad economic outcomes is very real, a central bank may
want to buy some insurance and, so to speak, "get ahead of the
curve"--that is, ease policy more than it otherwise would have simply
on the basis of its modal economic outlook."
'BUY INSURANCE' IMPLIES THERE IS A PRICE TO PAY, BY WHICH THEY MEAN INFLATION.
"However, because monetary policy makers can never be certain of
the amount of policy easing that is needed to forestall the adverse
effects of disruptions in financial markets, decisive policy actions
may, from time to time, go too far and thus produce unwelcome
inflationary pressures."
AS ABOVE.
"That's why I said that flexibility is also an important
characteristic of monetary policy during a time of financial turmoil.
If, in their quest to reduce macroeconomic risk, policymakers
overshoot and ease policy too much, they need to be willing to
expeditiously remove at least part of that ease before inflationary
pressures become a threat."
HOW CAN THEY NOT CONCLUDE THAT THE CURRENT INFLATION- FOOD, ENERGY,
AND THE FALLING $ IN GENERAL- IS NOT THE PRICE THEY ARE
PAYING FOR THE CUTS?
"In voting to ease policy, I carefully considered the effect of that
decision on our other objective--price stability. I reasoned that the
anticipated softening of economic growth and perhaps the emergence of
some slack in the labor market might reduce those pressures, and I
judged that a cut of 25 basis points in the target federal funds rate
would not materially alter that modal outlook."
I'M SURE THEY ALL NOW FEEL THE CUTS DID MATERIALLY ALTER THE INFLATION OUTLOOK.
"However, I recognized the risk that, even if readings on core
inflation have improved modestly this year, recent increases in energy
and commodity prices, among other factors, may put renewed upward
pressure on inflation."
WHICH HAS SUBSEQUENTLY HAPPENED, AND APPEARS TO BE ACCELERATING
"Consequently, in considering appropriate future adjustments to
policy, I will monitor inflation developments carefully."
THEY NOW SEE INFLATION IS RIPPING WITH NO SIGN OF LETTING UP. WHILE
NOT NECESSARILY THE FED'S FAULT, IT IS THE HAND THEY HAVE BEEN DEALT.
AND THE ONLY TOOL THEY HAVE TO DEAL WITH INFLATION IS HIGHER REAL
INTEREST RATES.
>
> Unfortunately Q&A was cut short so there was little opportunity to get into
> much more detail but I thought I'd least share what I heard.
The Fed is in a very bad place. They got 'cute' and deviated from
'tried and true' mainstream theory by cutting rates into what they
call a double 'negative supply shock' of food and energy, a falling
$US that's generating rising import and rising export prices, and a
geo political confusion that could cause all this to accelerate.
They have told us repeatedly the textbook reaction to a supply shock
is to 'not let a relative value story turn into an inflation story by
providing too much demand and monetizing the price increases.'
Unless they've abandoned the notion that low inflation is a necessary
condition for optimal long term growth and employment they now have to
come up with other ways to address liquidity issues, and at the same
time restore a sufficiently high 'real rate' of interest to 'lean
against the inflation wind' and 'remove the accomodation' currently
implied in the markets.
If they don't care about inflation they will continue to cut. So far
I've been wrong in conclusing they do care about inflation and that
they do subscribe to the mainstream theory they've been advancing over
the last 25 years.
I suspect the mainstream view of history will show Bernanke's 'pause'
to have been an error, as food and energy were even then showing signs
of moving higher, and the latest cuts a 'rookie blunder' should
inflation continue on its current path. Look for 3.5%+ year over year
cpi Nov 15, and a projected 4% for 07, and deteriorating annecdotal
news in general as margin compression turns into cost induced price
increases, even with modest output gains.
Meanwhile, Saudis and probably Putin as well now setting price, and
it's not impossible they are doing it an attempt to disrupt the west
which means the price could go much higher.
Warren
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