Bernanke's First Step Is Admitting There's a Problem

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In response to questioning by Congress, Federal Reserve Chairman Ben Bernanke quickly referenced the successes of monetary policy under his direction, particularly the stock market's meteoric rise (as if that is the only measure of economic efficacy) and the 2.5 million jobs created since mid-2010 (not really a surprise that he [cherry]picked that starting point, it would be far less impressive if his look-back window began around the same time as all the unconventional policies). He was asked on a few occasions to go beyond the perceived positives of monetary policy, and to probe into any downside. Economists are very fond of speaking about trade-offs, and even for monetary policy these kinds of things exist, so it makes sense to inquire about what might have been lost in the quest for so modest a recovery.

Trade-offs are simple concepts - you give up something to get something. We know exactly what Chairman Bernanke thinks the U.S. economy got out of his monetary stance, he is not shy about repeating it. That the economic record is far short of initial estimates is never really spoken of, though. It was only a year ago that Federal Reserve Vice Chair Janet Yellen spilled the monetary secret estimate, that QE 2.0 by itself was believed to be able to create 3 million jobs in 2012 alone. So we know the Fed quantified the upside estimates.

Beyond just the obvious disappointment relative to those overly rosy math-based guesses, the assumed 2.5 million jobs (how many have been statistical adjustments?) that were created since the job market bottomed in 2010, have also disappointed. Real disposable income is actually lower than in 2008, for various reasons, but mostly because what jobs have come back pay less or are only part-time. So, what, specifically, did we give up to get all this economic beneficence?

When pinned down on the subject of the hardships caused by ZIRP, Bernanke often resorts to platitudes about trade-offs rather than giving anything specific. While he shares the pain of fixed income investors and pensioners, he is at least explicitly accepting the notion that you have to give up something to get something.

In this case, savers have to give up returns and income in order for the banking system to function "normally". Bernanke implies that the latter more than makes up for the former without, curiously, ever giving any specifics about the former. Perhaps we can dismiss this as a remnant of counterfactuals since we will never really know what was lost. We cannot have accountability, however, or even make an informed decision on a trade-off without even the smallest of analysis of the downside leg, the cost. Given the Fed's propensity to model and estimate every economic factor, I have no doubt that the Fed has quantified it all on some level at some point.

Someone, somewhere needs to ask the Chairman exactly what that estimate of ZIRP's cost is. It would be especially useful if that estimate coincided in time with Yellen's pronouncement on the upside of expected employment. It would be hard for Bernanke to claim the Fed has done zero analysis in this area because the economists at the Federal Reserve quantify literally everything they possibly can (badly, but it is done).

When the FOMC decided to implement ZIRP in late 2008, they did so because their models calculated the trade-offs as positive. Recently, as the Fed's models badly underestimated economic "headwinds" (a term from 2011 that I have little doubt we will be hearing again in the coming months), convincing the FOMC to keep ZIRP until 2014 (and likely longer), they did so because their models quantified the expected impacts of doing so. Those impacts take the form of an explicit tradeoff, and I would hope, at the very least, the models' recommendations were implemented because they had quantified both the up and the down. To not do so would be beyond negligent, entering the realm of pure experimentation (which, if that was the case, we have a right to know as well).

We already know they have badly overstated the upside. Challenging the downside to the acknowledged trade-off is the only way to finally begin an accounting or cost/benefit of all this unconventional monetary policy.

I have no doubt that if pressed here, Chairman Bernanke or any of his ideological followers will counter with more platitudes on the importance of credit, and how vital it is to have a functioning banking system. But at least if he were to explicitly and specifically acknowledge that to have this functioning banking system (which is functioning so well that it is in a constant state of crisis) costs the real economy direct activity that can be quantified, we can take the first step in getting the Fed onto that road toward accountability.

Essentially, the issue here is why the banks receive priority over real economy actors. Why does the Fed feel it has to throw its fiat largesse toward the banking system, including dollar swaps with foreign lenders (still $107 billion at last check)? Its policies favor a convoluted, indirect schematic of monetary flow to the real economy, not exactly the most efficient way to conduct monetary affairs. Current monetary policy through ZIRP seeks to take money from savers to create net income for banks, hoping that they then use that "earned" equity to expand their capacity to create credit, then issue that new credit to individuals and businesses. Or, at the very least, expand credit to the public sector to fund indirect transfer payments in the form of rising fiscal government deficits.

This option is economically backward - why is this indirect method preferable to a more direct "stimulation". Asset income, especially interest income in this case, would be a direct "bailout" of savers, transferring money directly to the very people the Fed purports to help - the very people that have actually acted responsibly. Not to mention that this would also give rise to a more correct, market-determined price of risk, taking steam out of the artificial "stimulation" paths conventional policy prefers (another trade-off).

The primary weakness of this recovery has been household income (even the primary drivers of the income "recovery" since 2008 have been lower tax and mortgage payments, not exactly the basis for a resounding rebound). Interest income, which is not a trivial amount, especially at the all-important margins - it was 9% of GDP in 2007 and 13% in 1990 - would be a direct contribution to household income, and would certainly provide some boost to sustainable activity.

I think everyone understands that credit is vital to businesses, but they also intuitively understand that customers are probably more vital (and the largest problem for businesses of all sizes since 2008). I don't think Chairman Bernanke can claim that interest income is trivial and therefore not really a consideration, both in an empirical sense (the numbers don't bear that out, especially at the margins) or, perhaps more importantly, in the perceptions of the voting public. If he does, then why is such a trivial amount to savers so important to banks? It cannot be the money multiplier effect since bank net income (the pivot in this trade-off) plays no role in that presumed multiplier - ZIRP is a technique of expanding bank balance sheet capacity. It is the method of circulation that is at issue here, and the Fed and its global central bank cousins are placing all their chips on circulating money indirectly through credit creation. If that is a superior option, then they should be able to demonstrate it.

My point here in this line of thinking is essentially the Fed's bank-first approach just may be a net cost to the economy. Not only is it a "tax" on savers in favor of bank net income, there are indirect costs such as commodity prices and the devalued dollar (in the grand scheme of things, these indirect costs are likely even larger than the direct cost to savers, but since they are indirect there is more gray area where the Fed could claim other factors are involved - like those evil speculators we hear so much about when they stop speculating in only stocks). Since there has been little measurable benefit to monetary policy to date, it is not a hard intuitive leap for impartial observers to make that there is a reasonable chance monetary policy has been, and will continue to be, a net economic negative. To get what little growth we have experienced we, in my estimation, had to give up more growth that might have come from consistent asset income to savers, not to mention avoiding the massive drag of food and energy prices. How much more confidence for sustainable growth would there be without the constant financial volatility that so much central bank intervention in the name of saving the banking system necessarily creates?

There is a mathematical model somewhere at the Fed that has calculated and estimated these trade-offs. Even if these models under-estimated just how much of a cost monetary policy has been (and they most certainly have and will, just as they over-estimate the positive impacts of accommodation), it almost doesn't matter. Just an admission and initial quantification that there is a cost would be a tremendous start in the right direction. Shifting the debate to that realm would reframe the discussion in more correct terms. Once they admit, beyond specious inanities, there is a direct price for free money, the entire discussion changes, an important advancement since so many people actually believe in the free monetary lunch. At least then the door is open to more realistic estimates, and the debate shifts from "if" monetary expansion costs the economy to "how much".

This line of questioning really gets down to who the Federal Reserve works for. If the Fed exists as a tool for assisting the real economy, then it should voluntarily and summarily discard any policies or directives that are a net negative, a common sense proposition that cuts through the intentional fog or veil of modern economic philosophy and orthodoxy. Getting the Fed to admit that "stimulative" monetary policy and all these academic monetary experiments are not neutral propositions, that there are definable and direct associated costs with them, is a good first step toward turning the tide in favor of policies that value true production over endless money, debt and the overgrown financial economy. Public pressure is the political key to this conversion.

It all has to start with a fair accounting of the monetary trade-off, which itself starts with a relatively simple question: How much has ZIRP cost the real economy so that the Fed can pursue this bank-first approach? We should demand Chairman Bernanke answer that question directly and specifically, since we directly bear the costs of that policy. Since he has already acknowledged that there is a trade-off, the burden of proof is on the Fed to at least try to show that monetary policy has been a net positive, or to at least show why if it has not been to this point, that it will be at some point (and all the caveats that would require to make even slightly plausible). There is more to accountability than just auditing the Fed, especially since we still, after years and trillions of "stimulation", struggle without a sustainable and stable recovery.

The Fed was given all kinds of leeway and reserved doubts to act in the wake of the Panic of 2008, but it has been more than four years since the first obvious appearance of danger and we are still awaiting an economic path to long-term prosperity. Chairman Bernanke did admit that monetary policy is not the answer to the real economy problems. Relatedly, the Fed has also become comfortable lately with blaming the fiscal side of the economy, but, before exploring that target-rich environment, it is overdue to see whether or not monetary policy is the impediment.

 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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