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Federal Reserve Policy: “Made in Japan”

Written by Gary North on June 4, 2013

Gary North’s Reality Check

The FED says it will inflate. Its major representatives keep saying this.

To understand the Federal Reserve, we must understand how the Federal Reserve interprets the situation in Japan.

The recently adopted inflationist policy in Japan has not yet worked. Business capital spending is down 5%, year to year. Sales were down almost 6%, year to year. But the rise in the Japanese stock market has been extraordinary. There is hope that this will be confirmed by a rise in business investment. So far, this hope has not been confirmed.


William Dudley, the president of the New York FED, by far the most influential of the 12 privately owned FED regional banks, recently gave a speech to the Japan Society. The speech was important for several things. First, he began with a major admission: Japan’s economy was the main model used by the FOMC as to what had to be avoided.

Today, I will discuss the challenge that we both have been working to solve–how best to conduct monetary policy when short-term interest rates are already pinned close to zero, but the economy is still operating well below its potential. This has required considerable learning. After all, until Japan’s experience began in the 1990s, no major country had actually faced this problem since the Great Depression of the 1930s.As the first nation to experience the zero bound in modern times, Japan was an early pioneer in developing unconventional tools and strategies. Its experiences, both good and bad, along with lessons from other periods such as the Great Depression, have helped to inform the policies adopted by the United States (U.S.) and other nations in recent years. The evolution of policy in Japan, in turn, has been informed, in part, by the experience of the U.S. and other nations.

He then asked a question: “So what have we learned to date? Let me highlight six key points.”

First, and most importantly, managing expectations is critical in the execution of monetary policy at the zero bound. This includes expectations about the central bank’s objectives for inflation and the economy, and expectations about how the central bank will use its tools in the future to achieve these goals.Second, in managing expectations, good communication is essential. Expectations will not be well anchored when communications are muddled or inconsistent, or when a central bank acts in ways that are not consistent with its guidance.

Third, actions speak louder than words alone. Thus, there is an important role for asset purchases that ease financial conditions to support growth and keep inflation expectations well anchored.

Fourth, the policy instruments interact so that policy as a whole exceeds the sum of its parts.

Fifth, at the zero lower bound, risk management becomes extremely important. In particular, because the costs of getting stuck in a liquidity trap with chronic deflation are high, a central bank should put substantial weight on avoiding this outcome.

Sixth, the constraints imposed by the zero bound limit what monetary policy can accomplish by itself. This increases the importance of complementary fiscal, financial, and structural policy actions. Credible fiscal policies, actions to ensure a healthy financial system, and structural reforms that lift the potential for growth are very important.

His first point is the key: “First, and most importantly, managing expectations is critical in the execution of monetary policy at the zero bound.” This means that the FED is trying to manage the entire economy by managing expectations. Whose expectations? He did not say. I assume he meant decision-makers: commercial bankers, portfolio managers, and business owners.

(For the rest of my article, click the link.)

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2 thoughts on “Federal Reserve Policy: “Made in Japan”

  1. FOMC, colloquially known as the "Plunge Protection Team", is what keeps stock market prices artificially high since all the small investors got out — or were sheared — years ago. Whenever there is an irrational upward shove in the Dow just before the closing bell on a bad day, that is the FED buying to keep the market from tanking.

    "Managing expectations": creating the illusion that the economy is healthy and in recovery.

  2. Bob Marshall says:

    How many countries today do not have at least one Central bank today?