The financial media are universally predicting that the Federal Reserve will announce next week that it will cut back on buying bonds. This story is typical.
Federal Reserve Chairman Ben S. Bernanke and his colleagues meeting next week are poised to take two steps that appear inconsistent.
They will probably lower their estimates for growth for this year and next for the third consecutive time. Simultaneously, they are forecast to start scaling back the $85 billion in monthly bond purchases they have been relying on to stoke the recovery.
What’s more, annual inflation has been running at least a half percentage point below the Fed’s goal since December. And while the unemployment rate, at 7.3 percent in August, is falling, that’s mainly because some Americans are leaving the labor force.
“As a central bank, you are lowering your growth forecast, inflation is running low, and hiring is slowing and you are going to taper your asset purchases?” said Julia Coronado, chief economist for North America at BNP Paribas in New York and a former member of the Federal Reserve Board’s forecasting staff. “That is a communications challenge.”
What is the nature of this challenge? To demonstrate to the public that the FOMC’s boilerplate press releases every six weeks since December have been accurate statements of Federal Reserve policy. These press releases barely change. They change only enough to prove that they are not exactly the same report.
These reports have been clear: the FOMC will not cut the QE3 policy of buying $45 billion in U.S. Treasury bonds and $40 billion in Fannie/Freddie bonds every month until unemployment falls to 6.5%, or price inflation exceeds 2.5%.
Here is what the FOMC said on July 31.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. . . .
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.
This could not be any clearer, given the limits of FEDspeak. Let me translate. The words “highly accommodative” mean “inflate like there’s no tomorrow.”
Why will it cease QE3? Is the economy booming? No. It is likely the the FOMC will announce lower projections than previously. Is price inflation close to 2.5%? Not the CPI. Is unemployment anywhere near 6.5%? No.
So, if the FOMC announces a reduction in its purchase of bonds, it is saying, loud and clear, “anyone who trusts us is an idiot. We lie.” That is what the phrase “communications challenge” means. Yet the entire financial industry is said by the financial press to believe that the FOMC will in fact announce a policy of reduced bond purchases.
Stocks are up. Bonds are not down. So, the market says: “business as usual. Clear sailing ahead. Buy now.” But the media say: “The FOMC will change. The taper will hit. The FED is lying. No problem.”
So far, it is not the Federal Reserve that has a communications challenge. It is the financial media.
If the FOMC stops inflating, there will be a recession. If it merely slows its rate of bond purchases, the Treasury and Fannie/Freddie will have to find new investors. At what rates? No one says. If it switches from bonds to T-bills, the FedFunds rate will stay at just over zero, where it has been for five years.
Such a change will have no stimulative effect. Why, then, will the FOMC change course? It will have to explain its reversal of policy change, which means re-writing its boilerplate.
The financial media expect such a change. But there is no agreement about what the effects will be on the markets.
If nothing changes, watch what will happen. Within a week, the media will have recovered, and we will hear about tapering in November.