Monday, July 22, 2013

The Fed’s Four Mandates
The Fed seems to have four mandates now. The official two are to lower the unemployment rate as much as possible, while keeping inflation low but avoiding deflation. The two “shadow” mandates are to boost stock and bond prices, while avoiding asset bubbles:

During the Q&A session following Fed Chairman Ben Bernanke’s prepared congressional testimony on monetary policy last Wednesday, he said, “I think the market is beginning to understand our message, and the volatility has obviously moderated.” Since the June 24 closing low of 1573, the S&P 500 is up 7.6% to yet another record high of 1692. Over this same period, the S&P 400 and S&P 600 are up 9.7% and 10.1%, also to record highs. Friday’s WSJ reported: “Yields on noninvestment-grade corporate debt fell below 6% at Thursday's close for the first time since June 4, hitting 5.89%.... While that is well above the 5% threshold the debt briefly pierced in a frantic early-spring rally, the milestone comes only weeks after yields on so-called junk debt neared 7%."

Apparently, the message is that Bernanke & Co. wants stock prices to rise and bond yields to fall. That seems to be one of the two shadow mandates. This is the one lurking behind the Fed’s official dual mandate, which according to the FOMC statements since December 12 of last year is to lower the unemployment rate to 6.5% and to boost inflation back to 2%.

Of course, another shadow mandate is to maintain financial stability and to avoid asset bubbles. Fed Governor Sarah Bloom Raskin weighed in on this subject in a 7/17 speech titled, “Beyond Capital: The Case for a Harmonized Response to Asset Bubbles.” She stated, “Even within the regulated sector, crafting appropriate financial regulation to address asset bubbles is challenging. In reality, it is hard to know in real time when asset prices have deviated sharply from fundamentals.”

This seems to be the house view at the Fed. In his Q&A last Wednesday, Bernanke said: “We have some tools. The Federal Reserve has recently issued some guidance to banks on leverage lending and other kinds of practices that could contribute to asset bubbles. All that being said, we want to make the financial system as transparent as possible, I don't think we can guarantee that we can prevent any bubble." Currently, the Fed's priority for the two shadow mandates seems to be to boost stock and bond prices rather than to avert asset bubbles.
(Based on an excerpt from YRI Morning Briefing)

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