“Measuring Economic Uncertainty” is a working paper coauthored by three academic economists. They note that:

In recent years, many commentators have made two claims about economic policy uncertainty. First, that it increased after the start of the 2007-2009 recession because of businesses and households uncertainty about future tax, spending, regulatory, health-care and monetary policies. Second, that this increase in policy uncertainty slowed the recovery from the recession by leading businesses and households to postpone investment, hiring and consumption expenditure. We seek to investigate both claims.

They construct a new measure of economic policy uncertainty (EPU) and examine its evolution since 1985. They find evidence of substantial increases in policy uncertainty in the United States and worldwide since 2007, with their EPU index increasing by more than 50%. Here is one of their major conclusions:

Drilling down into our index we find that the post-2008 increases are driven mainly by tax, spending and healthcare policy uncertainty. Perhaps surprisingly we find no evidence of an increase in monetary policy uncertainty after 2008. One interpretation is that since inflation and interest rates have both been low and stable since mid-2008 onwards, monetary policy is not seen by the news media as contributing to economic policy uncertainty.

Jon Hilsenrath said it all today (Sunday) in his WSJ article about the FOMC meeting scheduled for this week:

"Federal Reserve officials are likely to continue their easy-money policies at the central bank's policy meeting on Tuesday and Wednesday, in part because several recent inflation measures have fallen well below the Fed's 2% target."

That’s a relatively new development. Until recently, Fed officials said that their ultra-easy monetary policy was necessary to reduce the unemployment rate to 6.5%. They said that they would pursue this course as long as inflation didn’t rise more than 50bps above their 2% inflation target. Now they seem to be thinking that with inflation heading below rather than above this mark, there’s all the more reason to stay with the easing course.

Over the past few weeks, the members of the "Federal Open Mouth Committee" were mostly chattering about how they might phase out QE if the labor market continued to improve. They did so at the last meeting of the FOMC on March 19-20. Then, on April 5, March payrolls showed a gain of only 88,000. Now the moderation in the latest inflation data only strengthens the hand of the FOMC’s doves.

In his article, Hilsenrath noted that top Fed officials recently have suggested that they are concerned about the recent decline in inflation. They said that if it persists, then they will favor proceeding with the current bond buying program or even increasing it.

The core PCED inflation rate fell in March to 1.1% y/y, the lowest since March 2011 (Fig. 2). I don’t understand why Fed officials are so convinced that lower inflation is a bad thing. They obviously view it as a sign of economic weakness. They also seem to fear that falling inflation will hurt demand for goods and services by eliminating buy-in-advance attitudes.

Are they aware that much of inflation’s recent improvement (IMHO) is attributable to health care costs? That’s right: The PCED medical care inflation rate was down to 1.7% in March, the lowest since April 1998 (Fig. 3). There have been significant drops in inflation rates for drugs and physician fees (Fig. 4). Does the Fed want to see higher inflation rates in the health care industry so that people will rush to buy medical care goods and services before their prices go up?

Rent inflation has rebounded during the current economic recovery, but now shows signs of peaking (Fig. 5). The CPI and PCED data are nearly identical and show that rent of shelter is up 2.2% y/y. It was actually falling during 2010. It accounts for 17% of the core PCED and 42% of the core CPI. Do Fed officials really want still higher rent inflation?

Do they know what they want? It doesn’t matter to the stock bulls. If the members of the FOMC now believe that both the unemployment and inflation components of their dual mandate oblige them to maintain QE and even to increase it, so be it. QE may be losing its effectiveness in boosting the economy and inflation, but that just leaves more liquidity to float stock prices higher (Fig. 6).

(Based on an excerpt from YRI Morning Briefing)

Here is how Fed Vice Chair Janet Yellen described the Fed’s game plan in a panel discussion at a conference hosted by the IMF on April 16:

By lowering private-sector expectations of the future path of short-term rates, this guidance can reduce longer-term interest rates and also raise asset prices, in turn, stimulating aggregate demand. Absent such forward guidance, the public might expect the federal funds rate to follow a path suggested by past FOMC behavior in ‘normal times’--for example, the behavior captured by John Taylor's famous Taylor rule. I am persuaded, however, by the arguments laid out by our panelist Michael Woodford and others suggesting that the policy rate should, under present conditions, be held ‘lower for longer’ than conventional policy rules imply.

She concluded her short remarks by stating that the Fed’s goal is “to promote a return to prudent risk-taking.” She admits that risk-taking can be taken too far, but reassuringly said she isn’t worried: “I don't see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability.” Ms. Yellen’s only concern so far seems to be that fixed-income investors are “reaching for yield.” Gee, I wonder why they might be doing so? She didn’t mention that margin debt recently rose back to its previous record high. Here it all that she did say:

To put it in context, let's remember that the Federal Reserve's policies are intended to promote a return to prudent risk-taking, reflecting a normalization of credit markets that is essential to a healthy economy. Obviously, risk-taking can go too far. Low interest rates may induce investors to take on too much leverage and reach too aggressively for yield. I don't see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability. But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.

Professor Christina Romer (University of California, Berkeley) spoke at the National Bureau of Economic Research's (NBER) Annual Conference on Macroeconomics on April 12, 2013 about the BOJ’s new ultra-easy monetary policy, which was announced on April 4. Her speech was titled, “It Takes a Regime Shift: Recent Developments in Japanese Monetary Policy Through the Lens of the Great Depression.” She is all in:

The regime shift we are seeing in Japan is just the kind of bold action that might actually succeed in changing both inflation and growth expectations a substantial amount. As a result, it may be an effective tool for encouraging robust recovery and an end to deflation.

She claims that FDR’s similarly bold monetary regime shift “managed to turn our ocean liner of an economy on a dime.” She believes that the Fed has been too cautious since early 2010.

IMF Chief Christine Lagarde, the central banker of the central banks, welcomed the huge monetary stimulus plan unveiled by Japan. She said that Japan’s loose monetary policies and “unconventional measures” should boost global growth, and “the reforms just announced by the BOJ are another welcome step in this direction.”

The BOJ has announced its plan to double the monetary base of the country--adding $1.4 trillion--by the end of 2014 in an attempt to end the deflation plaguing the economy. The BOJ will do so mainly by buying more long-term government bonds raising the average remaining maturity of its holdings from about three years to seven years--keeping downward pressure on yields all along the curve.

Notice that no one is asking whether it makes sense to stop deflation. The BOJ’s theory, which is shared by Fed officials, is that a little bit of inflation is a good thing because it might stimulate demand as a result of buy-in-advance attitudes. Maybe so. More likely is that low inflation won’t have that impact, and it will certainly reduce the purchasing power of consumers.