Dallas Fed's Fisher Stunner: Admits Worries Fed Has Created Nothing But Bubbles

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The war of words continues, this time with Dallas Fed's Fisher. More quotes from the fourth spoke in the Kocherlakota, Plosser, Hoenig, hawk sanity quadrangle. In his just released speech we read this stunner: "In my darkest moments,
I have begun to wonder if the monetary accommodation we have already
engineered might even be working in the wrong places."
Aside from adding Fisher to the Shirakawa, Hildebrand suicide watch, it is notable that the Fed is finally doubting the actions of the Fed, and realizing it is creating neither employment, nor moderate inflation, but just bubbles, bubbles and more bubbles. And here is why Fisher may soon be looking to resign: "A great many baby boomers
or older cohorts who played by the rules, saved their money and
migrated over time, as prudent investment counselors advise, to short-
to intermediate-dated, fixed-income instruments are earning extremely
low nominal and real returns on their savings. Further reductions in
rates earned on savings will hardly endear the Fed to this portion of
the population
." Hardly indeed. And next time it won't be the Pentagon.

More highlights:

  • Not clear that economic conditions warrant further 'deployment of Fed's arsenal'
  • Further Easing Rrisks Driving Down Returns For Savers
  • Efficacy of further accommodation using non-conventional policies not clear
  • Much debate still at Fed on pros and cons and costs and benefits of further accommodation
  • Economy barely cruising above stall speed
  • Removing tax and regulatory uncertainties would make any further monetary easing unnecessary'

Full Fisher speech before the New York Association for Business Economics

Rangers, Yankees and Federal Open Market Committee: One Game at a Time

Thank you, Steve (Gallagher). I am incredibly
touched that you and the New York Association for Business Economics
are holding this lunchtime rally for the Texas Rangers baseball

I have been asked to
talk about the economy. I realize that many of you are here looking for
clues as to what will emerge from the next meeting of the Federal Open
Market Committee (FOMC). You might get a sense of what shapes one FOMC
participant’s perspectives and inputs this afternoon. But let me say
right up front that as in the American League championship playoffs,
the outcome of the next FOMC is yet to be determined.

Just as bookies in
Vegas adjust their lines for the playoffs, the oddsmakers on the Street
are constantly reassessing their positions regarding monetary policy.
They change with new developments in the economy (the Fed’s Beige Book,
for example, will be released tomorrow); with every public
pronouncement of individual FOMC members; with insights proffered by
the daily wire services and editorials in the Sunday editions of the
nation’s finest newspapers (and good regional ones like your New York Times);
and with the insights of consultants and analysts, some of whom even
claim, spuriously, to have access to the internal deliberations of
Federal Reserve policymakers. But until the committee meets, nothing is

You should bear this
in mind given the recent speculation about the prospect for further
quantitative easing or the shape and nature of forward policy guidance:
No decisions have been made on these fronts and will not be made until
the committee concludes its deliberations at its next meeting on Nov.

Well, there is your
“take home” from lunch! But given that we have some time left, if you
will indulge me, I would like to give you one man’s view on the outlook
for the U.S. economy. I do so with considerable humility being in a
room full of major league economists. And because the professional
economists among you know as well as I do that John Kenneth Galbraith
was not all that far off when he divulged that “economic forecasting
was invented to make astrology look respectable.”

So what do I divine
from contemplating the celestial bodies of the economy? And how might
this shape my approach to monetary policy?

Late last year and in
early 2010, we had a burst of growth led primarily by inventory
adjustment. Real inventory accumulation rose from a minus $162 billion
in the second quarter of 2009 to a plus $69 billion in the second
quarter of 2010, a swing of $231 billion that accounted for
approximately 61 percent of the 3 percent real GDP growth that we saw
over that four-quarter period. With inventories now better aligned with
sales, it is doubtful this variable will provide much economic
propulsion in the coming quarters.

Turning to final
demand, the weak pace of recovery in U.S. export markets and political
and budget realities mean that little near-term growth impetus can be
expected from net exports and government purchases. Only consumption
and nonresidential fixed investment are likely to make positive
contributions to the expansion. In these sectors, there is no reason to
believe that growth will be notably strong, though the latest retail
numbers surprised to the upside despite the warm weather, which
typically retards fall sales. Residential investment, meanwhile, was an
outright drag on growth last quarter, reflecting the hangover from
expiring tax incentives; now, the foreclosure debacle has added a
serious wrinkle to the potential for a clearing of that crucial market.
On net, then, I see only modest third-quarter growth at a level
slightly above 2 percent, with a gradual rate of acceleration to what
would best be described as moderate growth after that.

Contemplating this
scenario, the brow begins to furrow. We are barely cruising above what
we at the Dallas Fed call “stall speed.” Annual real gross domestic
product (GDP) growth below 2 percent has predicated every recession
since 1970. If we continue to barely clear the 2 percent hurdle, the
pace of economic recovery will be insufficient to create the number of
jobs the United States needs to bring down unemployment significantly
in the foreseeable future. If we cannot generate enough new jobs to
sufficiently absorb the labor force over the intermediate future, we
cannot expect to grow the final demand needed to achieve more rapid
economic growth.

In the summation of
the recent FOMC meeting, released after we concluded our deliberations,
it was crisply noted that “employers remain reluctant to add to
payrolls.” At the same time, the committee reported it saw no prospect
on the foreseeable horizon for inflation?the bête noire of all central
bankers?to raise its ugly head; neither was the bête rouge of deflation
highlighted. Instead, in more convoluted syntax, the majority view of
the committee was summarized as follows: “Measures of underlying
inflation are currently at levels somewhat below those the committee
judges most consistent, over the longer run, with its mandate to
promote maximum employment and price stability.” The statement
concluded by saying that the FOMC is “prepared to provide additional
accommodation if needed to support the economic recovery and to return
inflation, over time, to levels consistent with its mandate.”[1]
Chairman (Ben) Bernanke, who I might add is the only person empowered
to speak on behalf of the entire committee, repeated this verbatim in
the penultimate sentence of his speech last Friday in Boston: “In
particular,” he said, “the FOMC is prepared to provide additional
accommodation ifneeded to support the economic recovery and to return inflation over time to levels consistent with our mandate.” And
he concluded by saying: “Of course, in considering possible further
actions, the FOMC will take account of the potential costs and risks of
nonconventional policies, and, as always, the committee’s actions are
contingent on incoming information about the economic outlook and
financial conditions.”[2]
In short, the Chairman said nothing in Boston that hadn't already been
said in the FOMC's most recent pronouncement or in his earlier speech
in Jackson Hole, Wyoming.

Let me give you my two
cents on some of the potential costs and risks that the Chairman has
been referencing in his recent speeches.

I very much share the
concerns of my colleagues who fret that unemployment is not receding
quickly enough. (I spent too much of my childhood with a father who,
bless his soul, often struggled to find work.) Given that we at the Fed
are mandated to maintain price stability and create the monetary
conditions to encourage maximum employment growth?at a time when
inflation is “somewhat below” what the committee as a whole judges
appropriate?I instinctively understand the impulse to put the monetary
pedal to the metal to try to move the needle on employment growth. The
problem is that, presently, the efficacy of further accommodation using
nonconventional policies is not all that clear.

When the Federal
Reserve buys Treasuries to drive down yields, it adds money to the
financial system. In sharp contrast to the depths of the Panic of 2008,
when liquidity had evaporated and we stepped into the breach to revive
it, today there is abundant liquidity in our economy. The excess
reserves of private banks parked at the 12 Federal Reserve Banks exceed
$1 trillion. Nonfinancial corporations have an aggregate liquid-asset
ratio running at a seven-year high; cash flow from current production is
running above total investment expenditure; cash as a percentage of
market cap is extraordinarily high. Credit availability remains a
challenge for small businesses, but only 3 percent of small businesses
surveyed by the National Federation of Independent Business reported
financing as their top business problem in October.[3]
And reports of lagging receivables or the stretching out of payment
terms that were so prominent only one year ago in the corporate supply
chain have become as scarce as hens’ teeth.

However one may view
the prominence of credit constraints for small businesses, it is
unclear whether broad monetary actions will alleviate them; it might be
more appropriate, perhaps, for the Treasury to undertake a targeted
fiscal initiative to improve credit availability to small businesses.
For mid- and large-size nonfinancial firms, capital is fairly abundant
in America, and it is unclear how much they would benefit from lowering
Treasury interest rates.

The vexing question
is: Why isn’t this liquidity being utilized to hire new workers and
reduce unemployment?
Why is it that, as pointed out in Alan Greenspan’s
op-ed in the Oct. 7 edition of the Financial Times, the share
of liquid cash flow allocated to long-term fixed asset investment has
fallen to its lowest level in the 58 years for which data are
If current dramatically high levels of liquidity and low interest
rates are not being harnessed to add to payrolls or expand capital
expenditures, would driving interest rates further down and adding more
liquidity to the system through Fed purchases of Treasury securities
induce U.S. businesses and consumers to get on with spending it?

The intrepid
theoretical economist would argue in the affirmative, the logic being
that there is a tipping point at which the market becomes convinced
that money held in reserve earning negligible returns is at risk of
being debased through some inflation and, thus, should be spent rather
than hoarded. Hence, the appeal of the Fed’s showing a little leg of
inflationary permissiveness.

There is some valid
theory behind this approach. Yet, my soundings among those who actually
do the work of creating sustainable jobs and making productive capital
investments?private businesses, big and small?indicate that few are
willing to commit to expanding U.S. payrolls or to undertaking
significant commitments to expand capital expenditures in the U.S.
other than in areas that enhance the productivity of the current
workforce. Without exception, all the business leaders I interview cite
nonmonetary issues?fiscal policy and regulatory constraints or, worse,
uncertainty going forward?and better opportunities for earning a return
on investment elsewhere as factors inhibiting their willingness to
commit to expansion in the U.S. As the CEO of one medium-size business
put it to me shortly before the last FOMC, “Part of it is uncertainty:
We just don’t know what the new regulations [sic] like health care are
going to cost and what the new rules will be. Part of it is certainty:
We know that taxes are eventually going to have to increase to get us
out of the fiscal hole Republicans and Democrats alike have dug for us,
and we know that regulatory intervention will be getting more
intense.” Small wonder that most business leaders I survey, including
those at small businesses, remain fixated on driving productivity and
lowering costs, budgeting to “get fewer people to wear more hats.” Tax
and regulatory uncertainty?combined with a now well-inculcated culture
of driving all resources, including labor, to their most productive use
at least cost?does not bode well for a rapid diminution of
unemployment and the concomitant expansion of demand.

So, it is indeed true
that some economic theories would lead one to believe we can shake job
creation from the trees if we were to further expand our balance sheet,
and/or induce greater final demand if people and businesses with money
in their pockets believe the central bank will tolerate inflation
somewhat “above” levels consistent with our mandate. Yet, to paraphrase
the early 20th century progressive Clarence Day?the once-ubiquitous
contributor to my favorite magazine, The New Yorker?“Too many (theorists) begin with a dislike of reality.”[5]
The reality of fiscal and regulatory policy inhibiting the
transmission mechanism of monetary policy is most definitely present
and is vexing to monetary policy makers. It is indisputably a
significant factor holding back the economic recovery.

One of my most
intellectually credentialed and also pragmatic colleagues, the
president of the Minneapolis Fed, Narayana Kocherlakota, has noted that
a deep-seated problem is structural unemployment. He believes that we
do not have a workforce adequate to meet the needs of the
high-value-added businesses that define the U.S. “Firms have jobs but
can’t find appropriate workers,” he says. And he concludes, “It is hard
to see how the Fed can do much to cure this problem.”[6]
I would add that if this were true, then the matching of job skills to
needs is doubly complicated if businesses feel handicapped by the
current tax and regulatory regime or see other countries as better
places to expand in a globalized, cyber-ized economy that encourages
investment to gravitate to optimal locations for enhancing return on

While its sports coverage is second to none, my favorite part of the New York Times
is the obituary section. I read it daily not only because it is
superbly written, but because it offers nuggets of wisdom learned by
others who have gone before us. If you had read the obit of former Fed
Governor Sherman Maisel two weeks ago, you might have noticed a
relevant quote from his repertoire: “In my view, changes in monetary
policy may be desirable, but they should be used only to a limited
degree in attempts to control movements in demand arising from
non-monetary sources
.”[7] There are limits to what monetary policy can accomplish if fiscal policy blocks the road.

Of course, if fiscal
and regulatory authorities are able to dispel the angst that businesses
are reporting and put together a credible plan for deficit reduction
that does not choke off growth, further accommodation might not even be
needed. If job-creating businesses are more certain about future
policy and are satisfactorily incentivized, they are more likely to
take advantage of low interest rates, release the liquidity they are
hoarding and invest it robustly in hiring and training a workforce that
will propel the American economy to new levels of prosperity. This
would render moot the argument for QE2, or a second round of
quantitative easing. The key is to remove or reduce the
tax and regulatory uncertainties that act as an impediment to
businesses as they respond to increases in final demand. I think most
all would consider this to be a far more desirable outcome than being
saddled with a bloated Fed balance sheet.

In my darkest moments,
I have begun to wonder if the monetary accommodation we have already
engineered might even be working in the wrong places.
The Treasury
International Capital, or TIC, data released yesterday morning show
that foreign interest in buying Treasuries remains robust. Yet, far too
many of the large corporations I survey that are committing to fixed
investment report that the most effective way to deploy cheap money
raised in the current bond markets or in the form of loans from banks,
beyond buying in stock or expanding dividends, is to invest it abroad
where taxes are lower and governments are more eager to please. This
would not be of concern if foreign direct investment in the U.S. were
offsetting this impulse. This year, however, net direct investment in
the U.S. has been running at a pace that would exceed minus $200
billion, meaning outflows of foreign direct investment are exceeding
inflows by a healthy margin. We will have to watch the data as they
unfold to see if this is momentary fillip or evidence of a broader
trend. But I wonder: If others cotton to the view that the Fed is eager
to “Open (the) Spigot,” as proclaimed on the front page of the Oct. 6 Wall Street Journal,[8]
might this not add to the uncertainty already created by the fiscal
incontinence of Congress and the regulatory and rulemaking excesses
about which businesses now complain?

In performing a
cost/benefit analysis of a possible QE2, we will need to bear in mind
that one cost already incurred in the process of running an easy-money
policy has been to drive down the returns earned by savers, especially
those who do not have the means or sophistication or the demographic
profile to place their money at risk further out in the yield curve or
who are wary of the inherent risk of stocks. A great many baby boomers
or older cohorts who played by the rules, saved their money and
migrated over time, as prudent investment counselors advise, to short-
to intermediate-dated, fixed-income instruments are earning extremely
low nominal and real returns on their savings. Further reductions in
rates earned on savings will hardly endear the Fed to this portion of
the population
Moreover, driving down bond yields might force
increased pension contributions from corporations and state and local
governments, decreasing the deployment of monies toward job maintenance
in the public sector. Debasing those savings with even a little more
inflation than what is above minimal levels acceptable to the FOMC is
also unlikely to endear the Fed to these citizens
. And if?and here I
especially stress the word “if” because the evidence is thus far only
anecdotal and has yet to be confirmed by longer-term data?if
it were to prove out that the reduction of long-term rates engendered
by Fed policy had been used to unwittingly underwrite investment and
job creation abroad, then the potential political costs relative to the
benefit of further accommodation will have increased

Another issue to be
considered before embarking on a program to purchase additional
long-term assets is whether such programs violate the basic tenets of
the bedrock Bagehot principle, named for the 19th century British
leader who “wrote the playbook” for central banking. Walter Bagehot
advocated that when responding to a financial crisis, a central bank
should lend freely at a penalty rate to anybody and everybody on good
collateral. This was the principle we followed in addressing the Panic
of 2008, and it was the right thing to do. While none of us are
satisfied with the current pace of economic expansion and job creation,
presently it is not clear that conditions warrant further crisis-like
deployment of the Fed’s arsenal. Besides, it would be hard to build a
case that the main recipient of further credit extensions, namely the
U.S. Treasury, and borrowers whose rates are based on historically low
spreads over Treasuries have difficulty accessing the capital markets.

Part of our
cost/benefit analysis should include where the inertia of quantitative
easing might take us. Let’s go back to that eye-popping headline in the
Wall Street Journal: “Central Banks Open Spigot.” The article
led off with a discussion of the Bank of Japan’s announcement of a new
bond-buying program. It prefaced this by noting that this round of the
Bank of Japan’s quantitative easing was done “anticipating that the
U.S. Federal Reserve will resume large-scale purchases of U.S. Treasury
bonds and [in light of] strong domestic political pressure to spur
growth and restrain a rising yen.” Referring to the fact that the BOJ
would be buying real estate investment funds and exchange-traded funds,
in addition to government bonds and corporate IOUs, it then quoted the
governor of the bank, Masaaki Shirakawa?a thoughtful man and,
incidentally, a member of the advisory board of the Dallas Fed’s
Globalization and Monetary Policy Institute?as concluding: “If a
central bank tries to seek greater impact from its monetary policy,
there is no choice but to jump into such a world.” The article went on
to say: “Central bankers elsewhere are strongly indicating that they
are preparing to open credit spigots to reflate their economies at a
time when fiscal policy is stalled or contracting.”

My reaction to reading
that article was that it raises the specter of competitive
quantitative easing. Such a race would be something of a one-off from
competitive devaluation of currencies, a beggar-thy-neighbor phenomenon
that always ends in tears. It implies that central banks should carry
the load for stymied fiscal authorities?or worse, give in to
them?rather than stick within their traditional monetary mandates and
let legislative authorities deal with the fiscal mess they have created.
It infers that lurking out in the future is a slippery slope of
quantitative easing reaching beyond just buying government bonds (and
in our case, mortgage-backed securities). It is one thing to stabilize
the commercial paper market in a systematic way. Going beyond
investment-grade paper, however, opens the door to pressure on a
central bank to back financial instruments benefiting specific economic
sectors. This inevitably leads to irritation or lobbying for similar
treatment from economic sectors not blessed by similar monetary

In his recent book titled Fault Lines,
Raghuram Rajan reminds us that, “More always seems better to the
impatient politician [policymaker]. But any instrument of government
policy has its limitations, and what works in small doses can become a
nightmare when scaled up, especially when scaled up quickly.…
Furthermore, the private sector’s objectives are not the government’s
objectives, and all too often, policies are set without taking this
disparity into account. Serious unintended consequences can result.”[9]

While all of us are
impatient with the unemployment situation, it is worth bearing Rajan’s
wry observations in mind. There is a great deal of legitimate debate
still to take place within the FOMC on the subject of quantitative
easing and the pros and cons and costs and benefits of further monetary
accommodation. Whatever we might do, if anything, must of course be
consistent with long-term price stability. But we also must avoid the
unintended consequence of adding to the nightmare of confusing signals
that job creators are already receiving from other government

So, what will we
likely decide at the next FOMC meeting? As with the American League
championship, you’ll find out when it’s over and only then.

Before concluding, I
want to return to the TIC data I mentioned earlier. Yesterday, I asked a
trader of sovereign debt how he interpreted the recent numbers. His
answer: “We are still the best-looking horse in the glue factory.” It
was a witty reply. But it was disturbing. This is America. Whether we
are Ranger or Yankee fans, Texans or New Yorkers, we have been blessed
to live in the most prosperous nation on earth. We cannot now accept
simply being the “least worst” among major economies. We must be better
than the rest.

This cannot be
accomplished by the FOMC alone. Whatever we do with monetary policy
will be of limited utility, if not counterproductive, unless it is
complemented by sensible fiscal policy that restores confidence and
puts the American people back to work. We are not glue-factory horses.
We are thoroughbreds. It’s time to put us back on track.

Thank you.