Wednesday, October 19, 2011

Oh, My Gosh! We Now Need "Forward Guidance"!

Poor Ben Bernanke. 

To me, the kindest thing that can be said about him is that he is suffering the fate of those who are in charge of large institutions with little or no practical experience in administering any other organization of consequence.  He just does not seem to understand how to lead such an organization and he does not seem to have the capacity to adapt how he does things so as to achieve a better performance. 

Where one can criticize Mr. Bernanke and the Fed, as I have done in the past, for claiming that solvency problems are just liquidity problems, one can also criticize Mr. Bernanke and the Fed for claiming that their problems with the market are ones of the appropriate information flow and not one of credibility.

Now we are presented with the specter of something called “Forward Guidance.”  To quote Mr. Bernanke, “forward guidance and other forms of communication about policy can be valuable even when the zero lower bound is not relevant (short-term rates are not around zero).  I expect to see increasing use of such tools in the future.” (

Mr. Bernanke came into the position of Chairman of the Board of Governors of the Federal Reserve System promising to provide greater openness and transparency to what the Federal Reserve is doing.  He has been consistently more available to the press and others than any previous Fed Chairman.  His latest effort has been to talk directly with the press after four regularly held meetings of the Federal Reserve Open Market Committee to explain what the Fed is doing.  The first such meeting was less than rousing. 

Yet, apparently, Mr. Bernanke is unsatisfied with the results of this accessibility.  Why else would we need to have something dangled in front of us like this so-called “Forward Guidance.”

Roughly, “Forward Guidance” provides banks and financial markets with an explicit idea of what the Federal Reserve is attempting to achieve in the future in much the way that the August 2011 statement that the Fed would keep short-term interest rates low until mid-2013.

And, there are other forms the “Guidance” could take.  For example, Mr. Bernanke has been an advocate of “inflation targeting” something other central banks in the world have adopted.  For example, the Fed, during the regime of Mr. Bernanke, has had an informal target for inflation of 2 percent.  Under the new effort to keep the public better informed, this policy effort, tying interest rate levels to an inflation target, would be made more formal and explicit.

One could also do the same thing with respect to an unemployment goal. 

When this effort of communication does not work, I wonder what Mr. Bernanke will try next.  His increasing attempts to inform the public about how the Fed will operate given the policy parameters it is watching seems to be constantly falling short of what Mr. Bernanke and the Fed have expected.  Hence, the need to try different things.

In my mind, Mr. Bernanke and the Federal Reserve have followed one basic policy since late 2007.  This policy can be described as throwing as much “stuff” as possible against the wall to see how much of the “stuff” can stick to the wall.

The term “stuff” can apply to many things.  An early example of “stuff” was the Term Auction Credit (TAC), which first showed up on the Fed’s balance sheet on December 26, 2007.  During 2008, the Fed became the banker to the world lending to the European Central Bank and the Swiss National Bank, among others, through swap lines of credit.  The Fed’s line item, Other Federal Reserve Assets, which includes these central bank transactions, rose from about $56 billion on December 26, 2007 to $105 billion on August 27, 2008.  Added to this was the Fed’s assumption of assets from the Bear Stearns transaction, which first showed up on July 2, 2008.  Then in the fall of 2008, the door swung wide open. 

Whereas the earlier efforts did not expand Federal Reserve credit appreciably during most of 2008 (this measure rose from about $874 billion on December 26, 2007 to $884 billion on August 27, 2008 as the Fed reduced other categories of assets to expand credit where it seemed to be needed) by December 31, 2008, Federal Reserve credit reached $2.250 trillion!

On October 12, 2011, Federal Reserve credit stands at almost $2.845 trillion!

We have had QE1, and QE2, and now we have “Operation Twist.”  Excess reserves in the commercial banking system have risen from less than $2.0 billion in December 2007 to about $770 billion in December 2008 to over $1.550 trillion in September 2011.

Bank lending remains anemic, at best, and economic growth stays modest. 

What is the Fed’s monetary policy?  The Fed’s monetary policy is to flood the banking system with “cash”.  What else needs to be explained? 

“Operation Twist” and “Forward Guidance” and “QE2” and whatever do not change the general thrust of the Fed’s monetary policy.  The Fed is throwing as much “stuff” against the wall as it possibly can.  And, it will continue to do so for as long as Mr. Bernanke and the Fed feel that it is necessary.

But, Mr. Bernanke does not feel that this is enough.  And, so he tries this and tries that to increase the “openness and transparency” of the Fed to the rest of the world.  I believe that he is concerned about this more to calm his own mind than to calm the mind of the banking system and the financial markets.

The problem is that people are attempting to reduce their debt loads.  The fifty years or so of credit inflation released on American families and businesses by the United States government since the early 1960s has resulted in a situation where these same families and businesses feel that they are burdened by too much debt.  Consequently, they are attempting to reduce their debt loads. (See my post, “The US economy will continue to grow”:

However, de-leveraging takes time.  Unfortunately, given the current circumstances, the only thing that would stop the de-leveraging is a rapid build-up of inflation making debt “economically valuable” again.  In one sense, this is what it looks as if Mr. Bernanke and the Fed are trying to do.

But, with modest economic growth and tepid inflation, families and small- and medium-sized businesses will continue to reduce the amount of debt on their balance sheets.  These people will not come back into the debt market for some time.  This is  consistent with the research published by Reinhart and Rogoff in their book, “This Time is Different.” 

Even if this is true, Mr. Bernanke and the Fed, for the history books, do not want to look as if they did not do everything in their power to combat a second Great Recession…a double dip, if you will.  Consequently, they will stand ready to throw as much “stuff” as they feel they need to against the wall and will continue, in an open and transparent way, to tell the world that they are doing everything within their power to get the economy moving again.  To me, this is a lack of confidence that does not enhance their credibility.

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