Just Smile, and Pretend You're Absolutely and Unshakably Optimistic

The setting was surely an uncomfortable one. After all, the mild recession had ended more than a year and a half before. The work of the policymaking committee should have been done and over with, the heavy burden of stimulus being replaced by the warm, soothing afterglow of roaring recovery. If the one had become the other, the conversation would’ve been more and more about inflation, the signal of confirmation in a job well done.

What was on each and every official’s mind during those two days was instead deflation, its devastating and opposite monetary twin. Keynes was right about that, at least. Both monetary phenomena were forms of pure evil. But if you have to choose, inflation was obviously the lesser.

It was June 24 and 25 in the year 2003. The dot-com recession of 2001 hadn’t been all that much, subsumed in the minds of most Americans by the events of September 11. In fact, many if not most equated that economic contraction with the attacks even though in truth it had begun six months before them.

But what perplexed Alan Greenspan’s Fed in the early summer of 2003 was only recovery, meaning the lack of it. The Presidential campaign of 2004 would feature the term “jobless recovery” as an obvious and obviously related epithet since there was truth behind it. Something wasn’t right in the economy, and it was the Fed’s job, because the Fed had given itself the job, to figure out why it was turning out this way.

Well, not really. They never did do anything like that. Interest rate targeting had meant a complete shift in how monetary policy worked from the ground up. Central bankers were no longer bankers toiling down in the trenches with the financial system. They were now detached overlords, supposedly, supervising everything from way above.

Targeting only the federal funds rate, the issues of “how” and “why” were secondary to “what.” And in June 2003, “what” was simply the jobless recovery; and after 18 months it began to take on worrying proportions.

So, the discussion centered around what the Federal Reserve would do about it. And what they were contemplating seemed beyond incongruent. Today it sounds perfectly quaint, but in the runup to 2008 the discussions of 2003 were the preview. Greenspan had proposed the FOMC vote to bring the fed funds target down to a shockingly low 1%.

The slow-moving stock market crash of the dot-coms, the lack of economic recovery, a combination which many worried would prove devastating. Policymakers did fear stocks on the downside, if only because they no longer understood their place in the monetary hierarchy (shares don’t have one). They no longer understood the monetary hierarchy.

With those factors acting together, though, Greenspan argued for the forceful response of ultra-low 1% rates. The FOMC and its Chairman reasoned they simply couldn’t afford to take any chances.

In the modern framework, what matters, what counts as “stimulus” isn’t the quantity of money printed. It is instead the quantity of rate cuts; how many times a Fed Chairman gets to go on TV and tell the American public he just helped them out.

What does he do, exactly, to help Americans out? Most people couldn’t tell you. Something about lower rates being good because everyone says lower rates are good. And those same people might be surprised that’s just how policymakers want it. Under expectations policy, which is what every central bank uses, the signal not the substance is what counts.

Again, that’s just what troubled the “maestro” in June 2003. The Fed had shifted gears (late) as the dot-com recession approached, moving out of tightening (for an inflationary breakout that never showed up) and into easing at the very start of 2001. The fed funds rate began its descent from a level of 6.5%.

By June 2001, Greenspan had engineered five rate cuts of 50 bps each. By November, there were several more (including two that were “only” 25 bps). When the dot-com recession concluded the fed funds target had been brought all the way down to just 2%.

Many were astonished already by how aggressive and powerful the response had been. Interest rate targeting was still relatively new, the Fed transitioning sometime during the eighties and it had only really been tested the one time during the 1990-91 recession (with similarly questionable results quickly forgotten in the internet and computer revolution of the rest of the nineties).

But the dot-com recession had the dot-com bust along with it, the menace of stock market deflation and 1929 still lingering in Greenspan’s stained and preoccupied imagination.

A huge amount of “stimulus” and yet by June 2003 very little recovery and very few jobs created. There were only two possibilities at that point – the deflationary pressures were so big, so huge that the Fed might have to push the envelope even further; or, monetary policy was all a parlor trick, a whole lot of hand waving and furious motion that in the end really didn’t amount to all that much which was actually, functionally relevant to the economy.

Every central banker had really believed lowering the fed funds target from 6.5% to 2% and then 1.25% (November 2002) was powerful accommodation. And that made for a rare moment in FOMC discussions.

Officials wouldn’t talk about it in the first person, however. They would instead direct their doubts toward another much further along in the process. If Greenspan was uncomfortable with the Federal Reserve going as far as 1%, a line which had been set unofficially as one no central bank should cross, the Bank of Japan had already exploded beyond it four years before.

Greenspan’s Japanese counterparts had pushed their rate targets down to the zero lower bound – the place of central banker nightmares. For all the academic talk about how rate cuts help banks and that’s where the stimulus and easing comes from, in reality it’s only what Economists want you to think.

Whether rate cuts help banks doesn’t actually count; so long as you think it helps in some way, any way. Monetary policy is simply trying to influence your behavior, so if you are led to believe that rate cuts help banks and that’s the way they work on the positive side then all the better. If you never find out that’s not how banks truly operate, then your ignorance is policy.

When they get to the zero lower bound, however, what then? How do policymakers then get the public to believe they are helping? A negative interest rate for banks doesn’t make much common sense (and opens up other troubling doors). What’s left is only more creative theater designed with your perceptions in mind.

Without any more rate cuts left, why not then give you the impression that the central bank can still help banks by handing them free money. Not only are rates already zero, meaning, allegedly, free money for what’s already out there, the central bank will “print” some more and just give it out to the banking system.

Thus, even though rates are constrained by the zero lower bound monetary policy is only really constrained by what it can get you to believe.

The Japanese pioneered the approach beginning in March 2001 with what was called quantitative easing. Even the term itself was designed specifically for public perception. Quantitative – a scientifically measured amount, carefully calculated by obviously the smartest people around. Easing – there aren’t rate cuts left but boy that’s just the beginning of what a central bank can do to facilitate, enable, and assist.

It was all bunk. Complete crap.

What’s more, in June of 2003 the Fed’s policymakers knew it. Japan’s unsavory QE results like the Fed’s with pure rate cuts left them with competing interpretations. Seeing things a different way, it really wasn’t too far of a journey to seriously question if QE like rate cuts, the Fed like the Bank of Japan, neither amounted to anything much. All sizzle, no steak. Surprising no one, this option wasn’t taken all that seriously – but it was discussed, albeit briefly.

The preferred interpretation, for obvious reasons, was to put the Bank of Japan’s QE failure down as a result of the Bank of Japan’s botched QE execution. Monetary policy at the zero lower bound might’ve still been effective if Japanese officials hadn’t screwed it up.

How did they screw it up?

“MS. JOHNSON. Relative to the kinds of options that these gentlemen have put on the table today, I think there would be a lot of agreement that there was one thing the Bank of Japan did that was very wrong. Namely, at each step along the way they portrayed the situation as abnormal and an emergency, and they indicated that the actions they were taking made them uncomfortable and that it was their intent to return to more-normal operations absolutely as soon as possible.”

That’s the thing about expectations-based policy; everything has to be portrayed in a certain way otherwise, according to theory, it undermines the credibility of that policy. And credibility is everything; the only thing.

Therefore, what the Bank of Japan should’ve done differently is to say to the Japanese public, hey, this is no big deal, nothing you should really get concerned about. All this huge and strange stuff, just another day at the office. Nothing to see here other than the fact that we are really pumping up enormous accommodation. All good, no bad.

Economists really do see you and me as simpletons. As if it is not human nature to first ask; wait a minute, if Mr. or Mrs. Central Banker feels it necessary to do all these big and powerful things, helpful as they may be, doesn’t that first indicate there has to be something big going wrong? Whether or not a central bank declares it emergency policy doesn’t mean much to the existence of the emergency.

Don’t tell that to policymakers, though. Because what they require is a happy and quite blatantly ill-informed public. The situation becomes downright Potemkin.

“MR.KOHN. Another problem in Japan was that the authorities were overly optimistic about the economy. They kept saying things were getting better, but they didn’t. To me that underlines the importance of our public discussion of where we think the economy is going and what our policy intentions are… The other issue is the one that Governor Gramlich raised about how specific we should be. Like him, I’m more disposed to being vague rather than specific; it helps with the flexibility. I’m convinced that numerical forecasts under those circumstances would be fraught with difficulty and problems and would be bound to be wrong.”

To sum up QE and the problem with the zero lower bound: give people as little realistic information as possible. Leave them nothing other than the myths and fables. Don’t say there’s a problem, and don’t be specific about how you think you can solve it. Instead, just put on a smile and be happy, making sure the public sees in every speech and TV appearance that you are absolutely and unshakably optimistic.

QE works because sunshine and rainbows, unicorns frolicking through magical fairy lands. It is all nothing more than a puppet show. And policymakers know it. They are, in fact, counting on it.

So, in June 2003 US authorities decided that what must have gone wrong in Japan’s QE wasn’t the lack of money in it, instead it was the playacting performance of its practitioners. From that, they were comforted by their foreknowledge and therefore if the time ever came, showtime, they would be well-rehearsed and fully prepared for the performance of their lives.

But what if? Some had asked, if we do this and it doesn’t work, then what?

“MR. GUYNN. If we lower nominal rates to near zero and state publicly that we intend to keep them down until the economy recovers, then there’s a nontrivial risk—especially if the economy weakens further—that the public’s expectations for deflation will be heightened. That clearly happened in Japan.”

If you say something works and it turns out that it doesn’t, sure, people are quite naturally going to get the impression that it doesn’t work. The tautology that throws the wrench in the whole thing. Which is why Donald Kohn suggested authorities need to be vague, muddy the definition of success. The public expects monetary policy “works” to mean recovery and legitimate, sustained growth; maybe instead they should just say term premiums or something else, a much lower standard to keep QE plausible.

Still, in the case like Japan where it doesn’t go as planned, it would be hard to get around simple Euclidean logic:

“CHAIRMAN GREENSPAN. There is no credible long-term possibility that a central bank can keep creating money, in many cases high-powered money, and the price level will continue to fall. That just is not credible.”

As Milton Friedman once showed, inflation is always and everywhere a monetary phenomenon. Therefore, if QE = money printing, and, money printing = inflation, then, QE must = inflation. If at the end of the day there is no inflation, and you have to repeat QE’s to achieve at best only a little and always well below your explicit target, then QE =/= money printing. No matter how good the puppet show, no matter how captivating its performances, it is logic and not emotion which illuminates the path toward resolution.

The Europeans are back in the QE business again as of yesterday. Markets are pricing a more than reasonable chance the Federal Reserve will follow by some point next year, if not sooner. Perhaps it isn’t better actors that might separate past Japanese QE from European or American (and current Japan). Maybe it’s the exclusive focus on acting.

In its announcement, the ECB put in all sorts of bells and whistles and all of them designed toward those original criticisms about Japan. Give off the impression this is no big deal, there is no emergency. Cold, calculating measures conducted out of an abundance of caution, an overly sensitive prudent nature. Mario Draghi wants Europeans to be assured there aren’t really any serious problems on his horizon.

But at the same time, give off another impression that this is all very impressive, complicated, and therefore leave the public no other choice but to believe how it must be extremely powerful. This isn’t just your very young and closely-aged father’s QE; it is enough different, new and improved now with better ingredients!

Europe is going to get the most sophisticated and accommodative QE anyone could have ever conceived - even though it doesn’t really need any. Sure.

More than ever, though, Europeans are asking themselves how it could be that after almost four years of it the ECB managed to go just nine months without it. There is more than just QE at issue here, all of monetary policy up to and including the most basic of basic rate cuts. The last round(s) of QE had ended only in December 2018. By September 2019, back at it again?

Greenspan, for once, was exactly right. That just is not credible. From the very beginning, it never was.