John C. Williams (FRB-SF) is a non-voting member of the FOMC this year. In a speech today, he said that it is “too early” for the Fed to start moving toward tightening monetary policy. He is concerned that “ongoing fiscal contraction” is slowing the economy, and that inflation may remain below the Fed’s target. He stressed that the Fed’s decision to phase out QE will depend on the new incoming economic data. He repeated the party line that “reducing or even ending our [bond] purchases does not mean the Fed will be tightening monetary policy.” He also noted that regardless of what the Fed decides to do about QE, a “large majority” of FOMC “participants don’t expect the first increase in the federal funds rate to occur until 2015 or later.”

Williams had an interesting insight into the recent decline in inflation: “This partly reflects temporary factors, such as a decline in Medicare reimbursement prices forced by sequestration.”

Fed Governor Jeremy Stein took office on May 30, 2012. So he is relatively new to the Fed. He made his mark this year on February 7 with a speech titled, “Overheating in Credit Markets: Origins, Measurement, and Policy Responses.” In it, he examined various excesses in the credit markets resulting from the Fed’s ultra-easy monetary policy. He warned that the Fed needs to monitor such “episodes of credit market overheating that pose a potential threat to financial stability.”

Stein followed up this speech with two other speeches, on “Regulating Large Financial Institutions” (April 17) and “Liquidity Regulation and Central Banking” (April 19). Today, he was the latest talking Fed head to talk about the FOMC’s latest meeting in a speech titled, "Comments on Monetary Policy.”

A few Fed watchers have speculated that the FOMC’s decision to “deputize” Fed Chairman Ben Bernanke to announce that QE would most likely be phased out by mid-2014 might have been aimed at taking the air out of some of the credit bubbles identified by Stein back in February. Remarkably, he didn’t even hint at this possibility in his latest comments!

Instead, he concluded, “We have attempted in recent weeks to provide more clarity about the nature of our policy reaction function, but I view the fundamentals of our underlying policy stance as broadly unchanged.” Instead of taking credit for convincing his colleagues to take some of the air out of credit bubbles, he said that the recent jump in bond yields was an overreaction to the FOMC latest communications! He added:

I don't in any way mean to say that the large market movements that we have seen in the past couple of weeks are inconsequential or can be dismissed as mere noise. To the contrary, they potentially have much to teach us about the dynamics of financial markets and how these dynamics are influenced by changes in our communications strategy.

In other words, Stein enthusiastically joined the FOMC’s damage-control brigade. He suggested that QE most likely would be tapered at the September meeting, even in the event of an unfavorable data release. If that bad news is confirmed by more bad news in October and December, then “this would suggest that the 7 percent unemployment goal is likely to be further away, and the remainder of the program would be extended accordingly.” Is that clear?

Bill Dudley (FRB-NY) is a voting member of the FOMC. In his prepared remarks at today’s “Regional Press Briefing” in NYC, he gave his spin on last week’s FOMC decisions. He also gave his spin on last Wednesday’s press conference held by Fed Chairman Ben Bernanke, who that day had given his spin on those decisions. Is your head spinning? In case you didn’t hear or understand what the chairman said, Dudley offered a succinct summary:

At its meeting last week, the FOMC decided to continue its accommodative policy stance. It reaffirmed its expectation that the current low range for the federal funds rate target will be appropriate at least as long as the unemployment rate remains above 6.5 percent, so long as inflation and inflation expectations remain well-behaved. It is important to remember that these conditions are thresholds, not triggers. The FOMC also maintained its purchases of $40 billion per month in agency MBS and $45 billion per month in Treasury securities, with a stated goal of promoting a substantial improvement in the labor market outlook in a context of price stability.

In its statement, the FOMC said that it may vary the pace of purchases as economic conditions evolve. As Chairman Bernanke stated in his press conference following the FOMC meeting, if the economic data over the next year turn out to be broadly consistent with the outlooks that the FOMC sees as most likely, which are roughly similar to the outlook I have already laid out, the FOMC anticipates that it would be appropriate to begin to moderate the pace of purchases later this year. Under such a scenario, subsequent reductions might occur in measured steps through the first half of next year, and an end to purchases around mid-2014. Under this scenario, at the time that asset purchases came to an end, the unemployment rate likely would be near 7 percent and the economy’s momentum strengthening, supporting further robust job gains in the future.

Dudley had four more pointers for Fed watchers who weren’t listening to what was said last week:

Here, a few points deserve emphasis. First, the FOMC’s policy depends on the progress we make towards our objectives. This means that the policy—including the pace of asset purchases—depends on the outlook rather than the calendar. The scenario I outlined above is only that—one possible outcome. Economic circumstances could diverge significantly from the FOMC’s expectations. If labor market conditions and the economy’s growth momentum were to be less favorable than in the FOMC’s outlook—and this is what has happened in recent years—I would expect that the asset purchases would continue at a higher pace for longer.

Second, even if this scenario were to occur and the pace of purchases were reduced, it would still be the case that as long as the FOMC continues its asset purchases it is adding monetary policy accommodation, not tightening monetary policy. As the FOMC adds to its stock of securities, this should continue to put downward pressure on longer-term interest rates, making monetary policy more accommodative.

Third, the Federal Reserve is likely to keep most of these assets on its balance sheet for a long time. As Chairman Bernanke noted in his press conference last week, a strong majority of FOMC participants no longer favor selling agency MBS securities during the monetary policy normalization process. This implies a bigger balance sheet for longer, which provides additional accommodation today and continuing support for mortgage markets going forward.

Fourth, even under this scenario, a rise in short-term rates is very likely to be a long way off. Not only will it likely take considerable time to reach the FOMC’s 6.5 percent unemployment rate threshold, but also the FOMC could wait considerably longer before raising short-term rates. The fact that inflation is coming in well below the FOMC’s 2 percent objective is relevant here. Most FOMC participants currently do not expect short-term rates to begin to rise until 2015.

Fed watchers, who concluded last week that the Fed will be increasing the federal funds rate sooner rather than later, weren’t listening to what was said, according to Dudley:

Some commentators have interpreted the recent shift in the market-implied path of short-term interest rates as indicating that market participants now expect the first increases in the federal funds rate target to come much earlier than previously thought. Setting aside whether this is the correct interpretation of recent price moves, let me emphasize that such an expectation would be quite out of sync with both FOMC statements and the expectations of most FOMC participants.

In a speech today, Governor Jerome H. Powell suggested he prefers forward guidance about interest rates over QE:

By stating an intention to hold rates low and linking that intention to the path of the economy, forward guidance affects the path of longer-term rates and allows the market to make adjustments to these rates as economic conditions evolve.

Regarding QE, he was a bit less sure of its effectiveness:

By purchasing and holding large amounts of Treasury securities and MBS, we put additional downward pressure on term premiums and so on long-term rates. Asset purchases are an innovative, unconventional policy. Their likely benefits may be accompanied by costs and risks, the nature and size of which remain uncertain.

He believes that QE1 worked very well to end the financial crisis. He also believes that QE2 averted deflation. What about subsequent asset-purchasing programs? He thinks they have been effective, on balance, though “the evidence across channels is mixed.” His biggest concern about QE is that it may cause asset bubbles and financial instability:

With inflation in check, the most important potential risk, in my view, is that of financial instability. One concern is that our policies might drive excessive risk-taking or create bubbles in financial assets or housing. A related worry is that the eventual process of reducing purchases and normalizing the balance sheet may itself be destabilizing or disruptive to the economy.

Powell briefly mentioned that both equity and home valuations seem fairly valued. However, he shares the concerns of Fed Governor Jeremy Stein about excesses in the credit markets, which have been somewhat reduced by the rise in interest rates since mid-May.

Powell remains concerned about the unemployment problem and stressed that too many people who would like full-time jobs are working part time. He also noted that the number of people who have been unemployed for six months or more remains very high at 4.4 million, or 37% of the unemployed.

Nevertheless, Powell agrees with the FOMC consensus view that the headline unemployment rate should fall to 7% by mid-2014, which “would constitute a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced the current program of asset purchases.” However, he said that he wants to “emphasize the importance of data over date.” In other words, the outlook for QE will depend on the course of the economy.

Jeffrey Lacker (FRB-NY) is a non-voting member of the FOMC this year. Last September, he dissented from the FOMC’s decision to implement QE3. Today, in an interview with Bloomberg Television, he said he is "fine with us tapering it off right now." He explained, “This asset-purchase tapering is just slowing the rate at which we’re increasing the balance sheet. We’re not anywhere near decreasing the balance sheet yet.”

Lacker said Fed Chairman Ben Bernanke “did an excellent job” in his press conference last week, but he admitted that Fed communications have had a “rocky period over the last couple of months.” He added, “Markets got a little bit ahead of us in terms of what they were expecting. They’ve gotten into better alignment now with the committee’s expectations.”

Apparently, the members of the FOMC all have Bloomberg terminals in their offices and are very sensitive to the sensitivity of the financial markets to everything they have to say about monetary policy. Have the members and the markets developed an unhealthy co-dependency relationship?

Today’s FT reported on an interview with Richard Fisher (FRB-Dallas), who is a non-voting member of the FOMC this year. He said that the Fed had anticipated a significant market reaction to last week’s announcement that it was likely to phase out QE by mid-2014 if the unemployment rate continued to fall toward 7.0% by then and inflation remained subdued. Fisher, a former hedge fund manager, warned traders not to test the Fed’s resolve:

I don’t think anyone can break the Fed….But I do believe that big money does organise itself somewhat like feral hogs. If they detect a weakness or a bad scent, they’ll go after it.

He acknowledged that the Fed is monitoring market movements. However, he suggested that the Fed has become concerned about bubbles that have developed in a number of financial markets, mentioning EMs, REITs, and junk bonds specifically. He said, “I wasn’t alone in drawing attention to these factors” at the last meeting.

Mixing metaphors, he tempered his hawkishness with a dovish comment: “I don’t want to go from Wild Turkey to ‘cold turkey’ overnight.”

Bill Dudley (FRB-NY) is a voting member of the FOMC, and flies with the committee’s doves, who believe that monetary policy can and must be used to lower the unemployment rate as long as inflation remains low. In a speech delivered yesterday and posted today, he added a third mandate, namely financial stability:

Financial stability is a necessary prerequisite for an effective monetary policy. There is a critical chain of linkages from monetary policy to banking and onwards to the real economy. Financial stability is a necessary condition for those linkages to operate effectively. Thus, it is a necessary condition for monetary policy to be able to achieve its economic objectives.

He stressed that “the central bank has a major role to play in ensuring financial stability and should evaluate the stance of monetary policy in light of problems in the financial system that may impair the monetary policy transmission mechanism.” More specifically, he said that the central banks must do what it can to avert asset bubbles:

The central bank needs to be willing to respond to limit financial market bubbles from developing in the first place. This includes not just paying attention to asset price bubbles, but also to related excesses in leverage and in short-term funding markets. As I noted in a speech a few years ago, this is difficult to do in practice. After all, bubbles are difficult to identify in real time and the central bank’s policy toolkit to deal with bubbles may be limited. However, this difficulty cannot be an excuse for inaction. Using the bully pulpit, implementing macroprudential measures, or adjusting monetary policy can generate superior results compared to inaction.

As a by-the-way, Dudley admitted that QE may not be as effective as he once thought:

At the zero bound, the central bank is not powerless, and may turn to other monetary policy tools such as forward guidance and large scale asset purchases. But these tools may not be as effective as lowering the short-term rate instrument. In particular, the central bank may not be willing to use these nonconventional tools to the full extent necessary to provide the same degree of stimulus as it would provide if it could set interest rates at negative levels. That might be because of uncertainty about how nonconventional tools will work or because of the potential costs associated with the use of such tools in terms of market functioning and the risks of future financial instability.

Narayana Kocherlakota (FRB-Minn) serves as an alternate voting member of the FOMC. He voted for the course of action outlined in the last FOMC statement dated June 19. However, like a juror having some second thoughts, he posted a note clarifying his position today. He seems to be nitpicking, but that’s what happens when members of the FOMC are allowed to speak freely. Free speech is allowed in our country, but too much of it from the Federal Open Mouth Committee tends to confuse the markets rather than to provide the clarity that Fed officials claim they are striving to achieve with their more transparent communication policy.

In fact, Kocherlakota's main complaint is that the FOMC’s latest “communications do leave the public with large amounts of residual uncertainty about the Committee’s likely course of policy choices when the recovery is more advanced. The Committee could better achieve its policy goals if it were to reduce this uncertainty through communicating more information about its likely reactions to additional economic eventualities.”

Needless to say, he has some specific suggestions. In particular, he would keep the federal funds rate near zero until the unemployment falls not only to 6.5% (as the FOMC decided at the end of last year) but also until it falls below 5.5%. He concludes:

There is a difference between FOMC communications, including recent ones, and the policy strategy described above: The latter provides more detail about the likely reaction of monetary policy to key economic eventualities. In my view, the Committee could better achieve its goals by augmenting its communications to provide the missing clarity. For example, the Committee has not described how it will set its fed funds rate target when the unemployment rate has fallen below 6.5 percent but remains above 5.5 percent—a period of time that I currently expect to last about two years. In contrast, the policy strategy that I described above says specifically that the FOMC will keep the fed funds rate extraordinarily low over that time frame (as long as the inflation conditions are satisfied). This additional clarity about future policy actions will tend to push downward on a variety of market interest rates and provide needed current stimulus to the economy.

Is that clear?

The PBOC engineered a liquidity crisis over the past couple of weeks to warn financial institutions, especially those in the so-called banking system, to rein in their speculative activities. Today, the Chinese central bank backed off and eased credit conditions, saying that it will guide interbank interest rates to reasonable levels.

According to an article in Bloomberg, this statement was published on the PBOC’s website today, but dated June 17. Furthermore, Bloomberg reported:

Today’s PBOC statement adds to a commentary yesterday by the state-run Xinhua News Agency that said China isn’t suffering from a cash shortage and that money isn’t showing up in the right places. Banks, stock markets and small businesses are in need of funds, while investment in wealth-management products and shadow banking show money supply is plentiful, Xinhua said.

The central bank suggested in a separate statement yesterday that it wouldn’t rule out the idea of loosening credit. The nation should “appropriately fine-tune” its policies, according to a statement that summarized the monetary policy committee’s second-quarter meeting in Beijing. It was the first time since September that the panel, led by Governor Zhou Xiaochuan, has used the “fine-tune” phrase.

Adam LeBor's new book, Tower of Basel: The Shadowy History of the Secret Bank That Runs the World, is about the central bank of the central banks. The BIS was created by the governors of the Bank of England and the Reichsbank in 1930 to handle reparation payments imposed on Germany after World War I. Protected under an international treaty, it is legally beyond the reach of any government or jurisdiction. Swiss authorities have no jurisdiction over the bank or its high cylindrical tower in Basel.

LeBor finds lots of reasons to attack the role of the BIS in the past and in the present. These include its cooperation with the Nazis and its role in promoting the euro. He makes a good case, but overstates it. The BIS isn’t a secret financial power covertly running global finance. It’s more like a clubhouse for central bank members only.

Like its members, it has a staff of macroeconomists who write lots of working papers and publish quarterly and annual reports. They aren’t shy about criticizing the policies of their members. See, for example, our June 25 post: BIS Tells Central Banks to Ease Off.

Jaime Caruana, the General Manager of the BIS, gave a speech today on the occasion of the Bank’s Annual General Meeting. It is titled, “Making the most of borrowed time.” In short, he said that central banks have done all that they can do and it is time for them to ease off of easing:

Central banks have borrowed the time that the private and public sectors need for adjustment, but they cannot substitute for it. Moreover, such borrowing has costs. As the stimulus is sustained, it magnifies the challenges of normalising monetary policy; it increases financial stability risks; and it worsens the misallocation of capital.

Finally, prolonging the period of very low interest rates further exposes open economies to spillovers that are now widely recognised. The challenges are particularly severe for the emerging market economies and smaller advanced economies where credit and property prices have been rapidly growing. The risks from such a domestic credit boom at a late stage of the economic cycle are hard enough to manage. Strong capital inflows exacerbate such risks and challenges for market participants and authorities; and they expose economies to large sudden reversals if markets expect an exit from unconventional policies, as volatility during the past few weeks seems to indicate.

In short, the balance of costs and benefits entailed by continued monetary easing has been deteriorating. Borrowed time should be used to restore the foundations of solid long-term growth. This includes ending the dependence on debt; improving economic flexibility to strengthen productivity growth; completing regulatory reform; and recognising the limits of what central banks can and should do.

In essence, he said that monetary policy has enabled even more leveraging of private-sector balance sheets and the continuation of reckless fiscal policies. He said, “Ultra-low interest rates encourage the build-up of even more debt. In fact, despite some household deleveraging in some countries, total debt, private and public, has generally increased as a share of GDP since 2007.”

He sided with the austerians who claim that mounting government debts are depressing rather than stimulating economic growth:

Low rates have allowed the public sector to postpone consolidation at the risk of a further deterioration in sovereign credit quality and damage to longer-term growth. There is plenty of evidence that as public debt surpasses about 80% of GDP, it becomes a drag on growth--because it raises debt servicing costs (and uncertainty about the future tax burden); it increases sovereign risk premia; and it reduces the room available for countercyclical policy.

Caruana’s speech provided a good overview of the main themes of the BIS Annual Report.

James Bullard (FRB-SL) serves as a voting member of the FOMC this year. He was one of the two dissenters at the latest meeting of the FOMC on June 18-19. According to the FOMC statement released on June 19, he “believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.” Today, in a news release, he scathingly criticizes the decisions taken at the latest meeting:

In his view, the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings. Inflation in the U.S. has surprised on the downside during 2013. Measured as the percent change from one year earlier, the personal consumption expenditures (PCE) headline inflation rate is running below 1 percent, and the PCE core inflation rate is close to 1 percent. President Bullard believes that to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.

He then questions the committee’s judgment in explicitly specifying the Fed’s exit strategy from QE:

President Bullard also felt that the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed. The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store. President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.

He strongly objects to “the Committee’s decision to authorize the Chairman to make an announcement of an approximate timeline for reducing” QE. In his opinion: “Policy actions should be undertaken to meet policy objectives, not calendar objectives.”

He didn’t resign in protest, but rather “he does feel that the Committee can conduct an appropriate and effective monetary policy going forward, and he looks forward to working with his colleagues to achieve this outcome.”

In China, the overnight interbank lending rate soared to a record high of 13.44% today, according to official daily rates set by the National Interbank Funding Center in Shanghai. That was up from 7.66% on Wednesday and less than 4% last month. The PBOC is allowing this liquidity squeeze with the aim of reining in smaller banks. Many have been tapping the interbank market to invest in higher-yielding bonds, or for speculative off-balance-sheet activities. In an article titled “Credit Tightens as Central Bank Takes a Hard Line,” the NYT reported:

The rise in interbank rates began two weeks ago, before China went on a three-day national holiday. Banks typically face higher demand for cash before public holidays, and the initial uptick in rates was not seen as abnormal.

But as the situation worsened, the central bank refrained from injecting new money into the system. Benchmark seven-day repurchase rates, another measure of borrowing costs, briefly soared as high as 25 percent on Thursday, up from 8.5 percent on Wednesday, before closing at 11.2 percent.

According to the article, China’s central bank is increasingly concerned about excesses in the credit system:

A huge shadow banking operation has emerged in China in recent years, with smaller banks and trust companies borrowing from bigger state-run banks and relending that money at high interest rates to private companies and property developers, a practice that fuels speculation.

Some of the country’s smartest macroeconomists predicted today that “the downside risks to the outlook for the economy and the labor market… [have]… diminished since the fall.” So why did the S&P 500 drop 1.4% today? This upbeat economic assessment appeared in today’s FOMC statement. The Fed's relatively sanguine risk assessment is a new development. The previous statement dated May 1 noted: “The Committee continues to see downside risks to the economic outlook.”

The latest statement repeated the FOMC’s previous promise to keep the federal funds rate near zero as long as the unemployment rate remains above 6.5%. Also repeated was the promise to maintain the current pace of QE “until the outlook for the labor market has improved substantially.” Nevertheless, there were some new insights today on the likely course of monetary policy that clearly upset the markets:

(1) NZIRP & the 6.5% unemployment rate threshold. The FOMC’s latest table of the “central tendency” of the members’ economic projections now shows the unemployment rate falling to 6.5%-6.8% next year, down from their March forecast of 6.7%-7.0%. The 2015 jobless rate forecast was lowered from March’s range of 6.0%-6.5% to 5.8%-6.2%. In other words, the 6.5% threshold for this rate is now expected in 2014 rather than 2015. No wonder that bond yields spiked.

In his press conference, however, Chairman Ben Bernanke stressed that the FOMC won’t automatically begin to raise the federal funds rate when the unemployment rate falls to 6.5%. Instead, the committee will commence discussions to do so.

(2) QE & the 7.0% unemployment rate threshold. In his press conference, Bernanke also specified, for the first time, that 7% is the jobless rate threshold that would mark a substantial improvement in the labor market. The Fed will start reducing its bond purchases later this year if this rate continues to fall toward 7% by the middle of next year, as anticipated by most of the members of the FOMC, according to Bernanke.

(Based on an excerpt from YRI Morning Briefing.)

Today’s stock market rally was widely attributed to an article that the WSJ’s Fed watcher posted on Sunday afternoon titled, “Economists Wary as Fed's Next Forecast Looms.” It’s strange that Mr. Bernanke and his colleagues seem to regularly need to clarify what they intend to do through Mr. Hilsenrath. Why not just communicate with the markets directly? The problem is that when Bernanke & Co. do so, they confuse the markets so much that Hilsenrath is often tapped to provide an off-the-record interpretation to clear up the confusion.

Ironically, in his latest article, Hilsenrath reported that in a recent survey of economists, on a scale of 0-100 for communication, the average grade among all the “respondents is a 62, a D-minus at best. Last August, the average grade was a much more respectable 75.”

The basic message conveyed in Hilsenrath’s latest article is that Fed officials, who were relatively optimistic about the economic outlook in their March projections, could signal they might begin pulling back their QE program later this year if they remain optimistic at the meeting that starts tomorrow and ends Wednesday. Let’s review their March outlook:

(1) GDP forecast. In March, the central tendency of their forecast for real GDP was 2.3%-2.8% for this year and 2.9%-3.4% next year.

(2) Unemployment forecast. Their central tendency for the unemployment rate was 7.3%-7.5% this year and 6.7%-7.0% next year. They don’t expect the jobless rate to fall to 6.5% until 2015.

(3) Inflation forecast. The central tendency for the core PCE inflation rate was 1.5%-1.6% this year and 1.7%-2.0% next year.

In the December 12, 2012 FOMC statement, the FOMC declared for the first time that the “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…” No specific promises were made to keep QE going until that target is achieved.

So allow me to join Hilsenrath and all the other Fed watchers who are trying to clearly communicate the Fed’s policy position on behalf of the Fed: The federal funds rate will remain near zero until the unemployment rate drops to 6.5%. If the jobless rate continues to head in that direction, the FOMC most likely will vote to scale back the Fed’s bond purchases before the end of the year, but not at the meeting that starts today and ends tomorrow.

(Based on an excerpt from YRI Morning Briefing)

How big is the wealth effect on consumption? That’s the subject of a Boston Fed discussion paper titled, “Wealth Shocks and Macroeconomic Dynamics.” It reviews the extensive existing literature on this topic, and concludes that there are “many unanswered issues and questions.” That’s a bit unsettling since one of the Fed’s justifications for QE is that it should increase asset prices and boost consumer spending. On November 4, 2010, a day after the FOMC voted to implement QE2, Fed Chairman Ben Bernanke wrote an op-ed in The Washington Post. He noted that stock prices had already been rising in anticipation of QE2, and “higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

The paper notes that several policymakers have stated that the wealth effect is significant. There is a strong positive correlation between consumption as a share of disposable personal income and the ratio of aggregate household wealth to disposable personal income. However, econometric estimates suggest that the wealth effect is relatively small. A 2001 Fed study found that consumer spending rises by between 3 and 6 cents for every additional dollar of wealth, with the effect occurring gradually over a period of several years. The Boston paper concludes that there are lots of known unknowns about the wealth effect:

We have identified a need to learn more about the underpinnings of wealth effects and how the effects might differ for different components of household wealth, including on the liabilities side of the balance sheet. On a related topic, more work is needed to understand how aggregate wealth effects may have changed (and still are changing) over time. The research has been limited to some extent by lack of good data sources, and, accordingly, some focus should be placed on ways we can improve existing datasets and create new ones.

The IMF conducts regular official staff missions to member countries “in the context of a request to use IMF resources.” It isn’t at all obvious why that was necessary to do for the US. However, the IMF today posted its “Concluding Statement of the 2013 Article IV Mission to The United States of America.” The IMF’s staff gave US policymakers some free advice on their free-spending fiscal policies and free credit policies. Here is what they had to say about the Fed:

The highly accommodative monetary policy stance has provided important support to the U.S. and global economic recovery, and under staff’s growth projections a continuation of large-scale purchases through at least end-2013 is warranted. However, a long period of exceptionally low interest rates may entail potential unintended consequences for domestic financial stability and has complicated the macro-policy environment in some emerging markets.

While the Fed has a range of tools to help manage the exit from its current highly accommodative policy stance—including adjusting interest on excess reserves and conducting reserve-draining operations with an expanded list of counterparties—unwinding monetary policy accommodation is likely to present challenges. The large volume of excess reserves and the segmented nature of U.S. money markets could affect the pass-through of policy rates to short-term market rates.

At the same time, effective communication on the exit strategy and a careful calibration of its timing will be critical for reducing the risk of abrupt and sustained moves in long-term interest rates and excessive interest rate volatility as the exit nears, which could have adverse global implications, including a reversal of capital flows to emerging markets and higher international financial market volatility.

Thanks for the helpful advice! By the way, the adverse unintended consequences may have started to emerge for emerging economies, as their bond yields have been soaring recently while their stock markets have been plunging.

The Fed’s assets and liabilities are reported on Thursday afternoons around 4:30 p.m. in the H.4.1 release. Reuters reports:

The Fed's balance sheet, which is a broad gauge of its lending to the financial system, stood at $3.367 trillion on June 12, compared to $3.357 trillion on June 5. The Fed's holdings of Treasuries rose to $1.906 trillion as of Wednesday, June 12, from $1.898 trillion the previous week. The Fed's overnight direct loans to credit-worthy banks via its discount window averaged $15 million a day during the week versus $8 million a day the previous week. The Fed's ownership of mortgage bonds guaranteed by Fannie Mae, Freddie Mac and the Government National Mortgage Association (Ginnie Mae) stayed about flat at $1.165 trillion. The Fed's holdings of debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Bank system totaled $70.89 billion, the same as the previous week.

Today’s WSJ includes an article by Jon Hilsenrath titled, “Analysis: Fed Likely to Push Back on Market Expectations of Rate Increase.” It was posted just before the stock market’s close at 3:39 p.m. Hilsenrath is the Journal’s ace Fed watcher. He is often chosen by Fed officials to send off-the-record information to the markets. They are clearly concerned that all their recent discordant chatter on when to taper QE is confusing the financial markets and causing bond yields to soar around the world. Hilsenrath was reassuring:

Federal Reserve officials have been trying to convince investors for weeks not to overreact when the central bank starts pulling back on its $85 billion-per-month bond-buying program. An adjustment in the program won’t mean that it will end all at once, officials say, and even more importantly it won’t mean that the Fed is anywhere near raising short-term interest rates.

In case that’s not clear enough, Hilsenrath added:

Since last December the Fed has been promising to keep short-term interest rates near zero until the jobless rate reaches 6.5%, as long as inflation doesn’t take off. Most forecasters don’t see the jobless rate reaching that threshold until mid-2015.

At the same time, however, the Fed is talking about pulling back on its $85 billion-per-month bond-buying program. The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low.

This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.

Recent articles by Hilsenrath are posted in The Fed Center Press Box

The discordant chatter about tapering QE coming from various Fed officials recently caused mortgage rates to jump above 4% for the first time in more than a year. This has had the immediate effect of depressing mortgage refinancing activity, as reported today by the Mortgage Bankers Association:

The Refinance Index increased 5 percent from the previous week. Despite the increase in the refinance index last week, the level is still 11 percent lower than two weeks prior and 36 percent lower than the recent peak at the beginning of May. The seasonally adjusted Purchase Index increased 5 percent from one week earlier. The unadjusted Purchase Index increased 14 percent compared with the previous week and was 6 percent higher than the same week one year ago. ….

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,500 or less) increased to 4.15 percent, the highest rate since March 2012, from 4.07 percent, with points increasing to 0.48 from 0.35 (including the origination fee) for 80 percent loan-to-value ratio (LTV) loans. The effective rate increased from last week.

An article in the July issue of the Chicago Fed Letter by two Fed economists concludes that the monthly employment gains necessary to lower the unemployment rate should be much smaller than widely believed:

According to our analysis, job growth of more than about 80,000 jobs per month would put downward pressure on the unemployment rate, down significantly from 150,000 to 200,000 during the 1980s and 1990s. We expect this trend to fall to around 35,000 jobs per month from 2016 through the remainder of the decade. These estimates rely on several assumptions, notably about future labor force participation and immigration.

The authors rightly note that their estimates are lower than the conventional wisdom that 100,000 to 150,000 jobs per month are needed to lower the unemployment rate.

The Fed has been operating under the so-called Evans Rule since December 12, 2012, when the FOMC statement announced that its ultra-easy monetary policy “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 indicator-based guidance replaced the previous date-based guidance.

Chicago Fed President Charles Evan was the first to suggest these numerical targets in a speech on November 27, 2012:

In the past, I have said we should hold the fed funds rate near zero at least as long as the unemployment rate is above 7 percent and as long as inflation is below 3 percent. I now think the 7 percent threshold is too conservative. Our latest actions put us on a better policy path than we had when I first proposed the 7/3 markers a year ago. At the same time, there still are few signs of substantial inflationary pressures. If we continue to have few concerns about inflation along the path to a stronger recovery there would be no reason to undo the positive effects of these policy actions prematurely just because the unemployment rate hits 6.9 percent—a level that is still notably above the rate we associate with maximum employment.

This logic is supported by a number of macro-model simulations I have seen, which indicate that we can keep the funds rate near zero until the unemployment rate hits at least 6-1/2 percent and still generate only minimal inflation risks. Even a 6 percent threshold doesn’t look threatening in many of these scenarios. But for now, I am ready to say that 6-1/2 percent looks like a better unemployment marker than the 7 percent rate I had called for earlier.

With regard to the inflation safeguard, I have previously discussed how the 3 percent threshold is a symmetric and reasonable treatment of our 2 percent target. This is consistent with the usual fluctuations in inflation and the range of uncertainty over its forecasts. But I am aware that the 3 percent threshold makes many people anxious. The simulations I mentioned earlier suggest that setting a lower inflation safeguard is not likely to impinge too much on the policy stimulus generated by a 6-1/2 percent unemployment rate threshold. Indeed, we’re much more likely to reach the 6-1/2 percent unemployment threshold before inflation begins to approach even a modest number like 2-1/2 percent.

So, given the recent policy actions and analyses I mentioned, I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.

The BOJ’s Policy Board met today and released the minutes of the meeting reiterating the QE policy announced on April 4. Investors were disappointed that the BOJ didn’t implement measures to stop bond yields from rising. Reuters reported:

“Bank of Japan Governor Haruhiko Kuroda said the central bank will consider fresh steps to calm markets if borrowing costs spike again in the future, but the central bank held off on new measures on Tuesday arguing that bond markets had stabilized.”

The WSJ’s Jon Hilsenrath is a prolific writer about the Fed. Either that or his Fed sources keep calling him to get their message out to the financial markets. After posting the article discussed just below at 3:15 p.m. today, he posted an article titled, “Why the Fed Hates the Word ‘Tapering’,” at 6:08 p.m. today. Here is the message that I bet Fed officials asked him to pass on:

Stock and bond market investors and many television commentators regularly use tapering as shorthand for the Fed gradually reducing its monthly bond purchases.

The hangup for Fed officials is the word “tapering” suggests a slow, steady and predictable reduction from the current level of $85 billion a month at a succession of Fed meetings, say to $65 billion per month, then to $45 billion and so on. And that’s not necessarily what Fed officials envision.

Because Fed officials are uncertain about the economic outlook and the pros and cons of their own program, they might reduce their bond purchases once and then do nothing for a while. Or they might cut their bond buying once and then later increase it if the economy falters. Or they might indeed reduce their purchases in a series of steps if warranted by economic developments—but they don’t want the markets to think that’s a set plan. It is, as Fed officials like to say, “data dependent.”

That’s why the Fed’s most senior officials avoid the word. Fed Chairman Ben Bernanke never uttered the word “taper” in his March press conference; nor did he use it in more than two hours of congressional testimony last month. Instead, he said then, “in the next few meetings, we could take a step down in our pace of purchases.”

New York Fed president William Dudley also has been avoiding the word. Instead, he’s talked about wanting to “reduce the pace at which we are adding accommodation through asset purchases.”

Nevertheless, analysts can’t stop talking about tapering.

Hilsenrath reports that the word showed up twice in the March FOMC minutes and once in the April minutes by Esther George (FRB-KC), who was the lone dissenter and advocated ending QE.

I hope Hilsenrath does a story on “dialing back.” In his speech on April 16, Bill Dudley (FRB-NY) said:

At some point, I expect that I will see sufficient evidence of improved economic momentum to lead me to favor gradually dialing back the pace of asset purchases.  Of course, any subsequent bad news could lead me to favor dialing them back up again. As Chairman Bernanke said in his press conference following the March FOMC meeting "when we see that the…situation has changed in a meaningful way, then we may well adjust the pace of purchases in order to keep the level of accommodation consistent with the outlook."

Whatever happened to “fine tuning?” I think the concept that policymakers could do that was discredited a long time ago. Let’s see what happens to “tapering” and “dialing back.” Stay tuned.

That's the title of an article posted on the WSJ website today at 3:15 p.m. by ace Fed watcher Jon Hilsenrath. He writes:

Federal Reserve officials are likely to signal at their June policy meeting that they're on track to begin pulling back their $85-billion-a-month bond-buying program later this year, as long as the economy doesn't disappoint.

A good-but-not-great jobs report Friday ensured officials wouldn't want to act right away and would instead want to see more data before taking a delicate step toward winding down the program. But they could point at their next meeting to improvement they're seeing in the economy, a prerequisite to reducing the so-called quantitative-easing program.

The next FOMC meeting is scheduled for June 18-19. Recent articles by Hilsenrath are posted in The Fed Center PressBox

ECB President Mario Draghi held his monthly press conference today to report on the outcome of the day’s meeting of the Governing Council. He dialed down expectations that the ECB will do much more than continue to pledge to do whatever it takes to defend the euro. He first made that promise on July 26, 2012. The ECB subsequently set up an Outright Monetary Transactions (OMT) facility to buy the sovereign debt of troubled euro zone governments.

It’s worked like a charm without any actual purchases by the OMT! Draghi gloated about that at the press conference, noting that the ECB’s do-nothing approach to doing whatever it takes has worked much better than the activist QE policies of the other major central banks:

But, certainly, we have observed an increase in global volatility, coming from major monetary policy decisions or announcements of decisions that may be taken in the coming months. However, I do not think that the ECB has in any way been a source of this; I cannot really find any data to support this.

He proudly added: “OMT has been probably the most successful monetary policy measure undertaken in recent time.” I have to agree. It has been more like a stealth bomber than a bazooka.

Nevertheless, investors were expecting that something would be done to ease the credit crunch facing Small & Medium-Sized Enterprises in the euro zone. Draghi said that various “non-standard measures," including ABSs, have been discussed, but “these measures are all on the shelf.”

(Based on an excerpt from YRI Morning Briefing)

Esther George has been the President of the Kansas City FRB since October 1, 2011. She has been a voting member of the FOMC since the start of the year, and has been the lone dissenter during each of the three meetings of this policy-setting committee so far this year. All three times, the minutes noted that she “was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.”

Today, she released the text of a speech (that she was too sick to deliver) in which she continued to ring the alarm bell about the Fed’s QE policies:

These unconventional actions also bring their own uncertainty about the outlook for the economy and increasingly appear to be viewed by markets and the public as "conventional." As a result, several sectors in the economy are becoming increasingly dependent on near-zero short-term interest rates and quantitative easing policies.

She went on to mention that security margin debt and leveraged loans are at all-time highs.