Strategic Briefing | 8.12.2011 | Rethinking Fed Policy

The Fed Has Not Done Enough and it Has Not Fired Most of its Ammunition
Uneasy Money | Aug 10
We know that QE2 was intended to prevent inflation expectations from falling to dangerously low, even negative, levels, as they seemed about to do last summer. And in this it was successful. The deceleration in growth was associated with a series of unfortunate one-off events: severe winter weather, a spike in oil prices as a result of the Libyan uprising against Colonel Ghaddafi, and the tsunami and nuclear disaster in Japan. But rather than accommodate these supply shocks by allowing prices to rise as would be natural in the face of a supply shock, pressure built to tighten monetary policy to counter the supply-driven rise in prices, with results that are now becoming all too evident: rapidly falling inflation expectations and real interest rates.

Weak Medicine
Tim Duy’s Fed Watch | Aug 9
The story from the Treasury rally is more of a low growth than a deflation story. In what world would anyone foresee that real 5 year yields would be negative, real 10 year yields would be zero, and the real 30 year yield just 1.06 percent? If this really represents annual potential growth over the long run, the next few decades are going to be no fun at all. Now, I think it is perfectly reasonable to argue that low growth will eventually work its way into substantially lower inflation expectations, and it would be better to get ahead of that curve. The Fed doesn’t see it that way. They will need to see inflation expectation numbers turn more solidly south to bring out another round of QE3. I think that takes some additional weakness on top of what we are currently experiencing.
Epic Fail
The Money Illusion | Aug 9
Over the past few weeks the Fed has reduced NGDP expectations even further below their already dismal levels. Today’s decision reached a new level of futility. The Fed did correctly diagnose the problem, slowing growth and slowing inflation (i.e. slower growth in NGDP.) But they failed to construct any sort of effective policy response. The FOMC doesn’t seem to understand that it’s not the Fed’s responsibility to forecast slower NGDP growth, it’s the Fed’s responsibility to prevent slower NGDP growth.
Yes, there was the decision to promise low interest rates as far as the eye can see; but ultra-low rates are merely a sign that money has been too tight. The bankrupt Keynesian theory (that central banks must target interest rates) is what got us into this mess. Keynesians had no answer for a scenario where rates hit zero. And now the same bankrupt Keynesian model is preventing us from exiting the low spending morass. Zero rates won’t solve the problem as Bernanke ought to understand from his studies of Japan.
And as for the three hawks, who argued that even doing nothing is much too stimulative in a world of collapsing nominal growth expectations, I hardly know what to say. One would have to go back to the 1930s . . .
Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over
Mish’s Global Economic Trend Analysis | Aug 12
Hyperinflationits have now blown it twice. First, they insisted hyperinflation would happen before deflation. They were wrong. Then, during the QE2 inspired equities and commodities ramp, they said the same thing. They were wrong again… In the wake of QE II hyperinflationists again started preaching about hyperinflationary crashes. Once again, and with increasing intensity, we heard things like …
•The US is Zimbabwe
•No food available at any price
•Oil is going to $200, then $400
•Excess reserves will pour into the economy causing massive inflation
•No one will be willing to hold US dollars
•Treasury rates are going to the moon
•The US dollar is going to zero
I could assign names to the above list, but I won’t. Two well-known hyperinflationists confidently predicted hyperinflation would start this year. A third said 2011 or 2012 giving himself extra time to be proven wrong. My position all along was that the US would go in and out of deflation over a period of years, just like Japan… The US is now undeniably back in deflation.
A (two volume) history of the Federal Reserve “goes to waste”
Historinhas | Aug 11

This is from Alan Meltzer, the man who wrote it:

How can the Fed know now that a zero-rate policy will be required two years from now? It can’t. Yes, economic growth has slowed, and forecasts of future growth decline daily. But the United States does not have the kind of problems that printing more money will cure.

Banks currently hold more than $1.6 trillion of idle reserves at the Fed. Banks can use those idle reserves to create enormous amounts of money. Interest rates on federal funds remain near zero. Longer-term interest rates on Treasurys are at record lows. What reason can there be for adding more excess reserves?

The main effect would be a further devaluation of the dollar against competing currencies and gold, followed by a rise in the price of oil and other imports. Inflation is now at the edge of the Fed’s comfort range, which is below 2%. Money growth (M2) reached 10% for the past six months, presaging more inflation ahead.

According to him the problems are mainly “structural”!

Our problems will not be solved by stop-gaps like QE3 or lower labor taxes, but they are not intractable. What we need most is confidence in our future.

So tell us, please, Professor Meltzer, that the monetary policy “mishap” depicted in the following picture has no implications for the present “problems”!