FRBNY's Bill Dudley: "I Conclude That Further Action Is Likely To Be Warranted"

Tyler Durden's picture

Former Goldman chief economist and current FRBNY and PPT President Bill Dudley has guaranteed QE2: "I conclude that further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long." Dudley's remarks demonstrate the wide opinion rift at the Fed, where those who don't feel like crucifying the dollar (Kocherlakota, Hoenig, Plosser) are directly faced with such middle class monsters as Dudley and the Doves (which does have a rockband like quality to it). Nobody should have any doubt as to which side will ultimately win this argument...

Below are prepared remarks by Bill Dudley to be delivered today.

Remarks at the at the Society of American Business Editors and Writers Fall Conference, City University of New York, Graduate School of Journalism, New York City.

The deep recession that ended in June 2009 has been followed by a very tepid recovery. Economic activity has grown—but only slowly from levels far below the productive capacity of the economy. With demand growth barely keeping pace with firms’ ability to increase productivity, job creation has been too weak to significantly reduce unemployment, which stands today at 9.6 percent. And, as is typical in such circumstances of considerable slack, the rate of inflation has declined.

Viewed through the lens of the Federal Reserve’s dual mandate—the pursuit of the highest level of employment consistent with price stability, the current situation is wholly unsatisfactory. Given the outlook that the upturn appears likely to strengthen only gradually, it will likely be several years before employment and inflation return to levels consistent with the Federal Reserve’s dual mandate.

Today, I will discuss why the recovery has been disappointing and highlight some of the issues facing the Federal Reserve and monetary policy, echoing some of the themes laid out by Chairman Bernanke in his Jackson Hole speech in late August. As always, what I am going to say reflects my own views and does not necessarily reflect the views of the Federal Open Market Committee and the Federal Reserve System.

In recent quarters the pace of growth has been disappointing even relative to our modest expectations at the start of the year. After rising at about a 3.25 percent annual rate during the second half of 2009, there has been a progressive slowing—to a 2.75 percent annual rate during the first half of the year and, very likely, to an even slower rate in the third quarter.

The factors responsible for the failure of the recovery to pick up speed include: (1) the gradual petering out of the contribution from the swing in inventories from rapid liquidation during the first half of 2009 to a modest increase in the second quarter of 2010; 2) the sluggish recovery in consumer spending; and 3) the continued weakness in housing. Normally, at this stage of recovery, the handoff from growth led by inventory accumulation to growth led by private final demand would have been more fully accomplished. This handoff has been delayed because households have been paying down their debts—a process known as deleveraging. In addition, many businesses have been reluctant to hire. This has limited income growth.  Slow income growth, and along with caution in the face of economic uncertainty, has also restrained spending.

Although so-called “soft-patches” are quite common during the early stages of an economic expansion, this soft patch is a bit different. First, it looks like it will last somewhat longer because the deleveraging process is not yet complete. Second, the current weakness is somewhat more concerning because it is occurring at a time that the central bank has already cut interest rates to near zero.

In fact, this failure of the recovery to “catch fire” has occurred despite aggressive monetary and fiscal policy steps to stimulate the economy. On the monetary policy side, short-term interest rates have been nearly zero for a year and a half; the Fed purchased $1.7 trillion of long-term assets, and the proceeds from maturing securities are being reinvested to keep the balance sheet from shrinking unduly. On the fiscal side, a series of measures has provided support to a broad range of activities.

The sluggish nature of the recovery in the face of very substantial stimulus reflects the dynamics at work during the expansion that preceded it. Beginning around 2003, underwriting standards for residential mortgages were significantly relaxed, leading to a sharp rise in household borrowing and in home prices. The two trends were inextricably linked. The rise in home prices helped to support additional demand for credit as households used the collateral represented by their homes to borrow large sums of money via home equity lines of credit and second mortgages. Chart 1 illustrates how the growing proportion of nonprime first mortgage loans helped fuel the sharp rise in home prices.

As home prices rose and the stock market performed strongly, household net worth rose sharply. Households responded by borrowing more and saving less. After all, why save when the rise in home prices was adding to your wealth and the housing equity created by the rise in home prices could be easily tapped for funds as needed? The use of home equity as a source for funds to support consumption is evident in the fact that the homeowners’ equity as a share of home values was essentially flat over this period (Chart 2). This indicates that homeowners were borrowing against their accumulated gains. The surge in home prices pushed up the ratio of household net worth to disposable income to nearly 640 percent and the personal saving fell below 2 percent (Chart 3).

The surge in home prices was fueled by products and practices in the financial sector that led to a rapid and unsustainable buildup of leverage and an underpricing of risk during this period. These dynamics in turn provided the fuel that caused house prices and consumer spending to rise much faster than income. As shown in Chart 4, the share of GDP accounted for by consumption and residential investment climbed to a peak of 76 percent in 2005 from 71 percent in the mid-1990s.

The boom, of course, was unsustainable. The progressive easing of underwriting standards that was needed to support housing demand could only persist as long as housing prices were rising rapidly. But for home prices to rise rapidly, underwriting standards had to be progressively relaxed in order to generate more buyers. When home prices began to slip beginning in 2006, the dynamic swung into reverse. The collateral values supporting borrowing and spending began to fall.

As banks’ and other financial intermediaries’ credit losses began to mount, credit availability became impaired and this exacerbated the downward pressure on home prices and on borrowing and spending. Not only did households that had overextended themselves have to cut back; others also retrenched because they were also affected by declines in wealth and heightened uncertainty about the economic outlook and their job prospects.

It is not surprising that the workout from the excesses of this type of boom would take a long time. Just as it took several years for the boom to begin and run its course, so it would take years, not months, for households and financial intermediaries to adjust their balance sheets and behavior to the new environment. Households had to raise their saving rates in order to rebuild their balance sheets. Financial intermediaries had to replenish their capital to replace losses via loan charge-offs and other credit impairments. Both adjustments would need to occur before the economy could grow rapidly.

With this in mind, the key questions are: 1) Where are we in the adjustment process, and 2) what, if anything, can monetary policy do to facilitate a smoother adjustment and more rapid progress toward our dual mandate objectives?

In terms of the adjustment process, starting on the household side, most signs point to significant progress. For example, the revisions to the national income and product accounts announced in July revealed substantial upward revisions to the personal saving rate (Chart 5). The current saving rate is broadly consistent with the historical relationship between personal saving and the household net worth-to-income ratio. Of course, part of this story depends on the stabilization of household net worth, which had earlier fallen sharply due to declines in both home and equity prices. Although household net worth dropped significantly again in the second quarter according to the Flow of Funds accounts, the subsequent rise in the U.S. equity market is likely to have reversed that decline. Meanwhile, housing price declines have moderated substantially, helped, in part, by the fact that the low level of mortgage rates combined with the sharp drop in house prices has resulted in a substantial improvement in affordability (Chart 6).

Households have retrenched in terms of their borrowing and this has helped push down the household debt-to-income ratio sharply from its peak in 2007. Another factor behind the fall in the debt-to-income ratio has been credit losses and debt forgiveness. Since 2007, charge-offs have reduced household debt outstanding by over $880 billion.

Some argue that the decline in the household debt-to-income ratio must go much further before the deleveraging process can be complete. After all, the household debt-to-income ratio is still far above the level reached as late as 2002, before the surge in household borrowing began. Some even argue that household debt-to-income ratios must fall back to the level of the 1980s. I think that this is an overly pessimistic view for a simple reason—both household debt and household financial assets have been rising faster than income growth on a secular basis since the 1950s. Focusing just on debt misses what is happening on the other side of the balance sheet (Chart 7). One reason why both household assets and debt have been rising faster than income is due to greater financial intermediation. For instance, tax incentives encourage people to fund their 401(K) pension plans rather than pay down mortgage debt as they get older.

The notion that the household adjustment process is well advanced is also supported by other data, as well. For example, the share of after-tax income devoted to servicing debts, as well as paying property taxes and homeowners insurance or rent, has declined sharply over the past two years and is now back to levels that prevailed in the late 1990s (Chart 8). In addition to the declining stock of debt, households have been able to refinance outstanding debt at lower interest rates.

Moreover, mortgage delinquency rates, even in the most serious category, have started to fall, and data that tracks changes in the proportion of borrowers who are delinquent and then become current versus becoming even more delinquent is encouraging (Charts 9 and 10). Finally, the less serious delinquencies for credit card, auto and student loans have been trending lower, though not the more serious delinquencies (Chart 11). Of course, these recent improvements have come in the context of the stabilization in unemployment and house prices. To ensure that the more favorable trends in household balance sheets continue, the economic environment needs to become more supportive.

We should recognize that there is still considerable uncertainty about the level of the saving rate and configuration of household balance sheets that will prevail in the coming years. It is possible that households now perceive the world to be a riskier place than they did before and will want to have more “rainy day” funds. More saving may also be needed to meet higher downpayment requirements for home purchases. Thus, while we may be far along in the adjustment process, it is difficult to judge just how much further we have to go.

Turning now to the issue of credit availability, there is no question that credit conditions are still tight. There are a number of impediments: 1) Financial institutions—many of which still face balance sheet problems of their own—have tightened underwriting standards and, 2) a decline in property prices has cut collateral values and made the refinancing of many residential and commercial mortgages difficult.

On the banking side, there is considerable differentiation across the industry in terms of health. The largest banks in the United States are generally in much improved health following the Supervisory Capital Assessment Process (SCAP) in 2008, which led to substantial additional equity raising. For smaller banks, the situation is more mixed. According to the FDIC, as of June 30, 2010, 829 of the nation’s 7,830 commercial banks and savings institutions remain on the FDIC’s problem institution list.

But overall, the situation is one in which credit availability is slowly improving. According to the Federal Reserve’s Senior Loan Officers Survey, the percentage of banks reporting that they were tightening credit standards across a wide range of lending categories peaked in late 2008. The most recent data indicate that virtually no banks are tightening standards, and a number of banks have begun to relax credit terms (Chart 12).

In addition to households, the small-business sector is another area that has seen a contraction in credit. Focus groups and surveys conducted by the Federal Reserve System suggest this contraction is the result of three distinct factors—a decline in demand for credit, a tightening of lending standards, and a weakening of credit quality due to lower collateral values and cash flows.1 Which is the most important is difficult to discern.

However, surveys of small-business owners indicate that much of the weakness in lending to this sector reflects lack of demand. The National Federation of Independent Business (NFIB) Small Business Optimism Index, for instance, asks respondents to indicate their single most important problem from a standard list. For some time now, the response “poor sales” has been the most frequently cited problem. In contrast, relatively few respondents cite “financial and interest rates” as the most important problem (Chart 13). A caveat to this is that credit constraints could be inhibiting the formation of new small businesses—something that surveys of existing firms would not capture.

Although credit availability has begun to improve, the decline in collateral values remains a significant impediment. For example, housing prices have declined so far that nearly one quarter of homes are now worth less than the value of the mortgages that finance them. Lacking sufficient collateral value, such homeowners cannot take advantage of the fact that conforming mortgage rates are at their lowest level in history and refinance their mortgages. Overall, the desire to rebuild wealth through savings and the limits on credit availability to households has acted to restrain consumer spending, keeping the recovery tepid.

To some degree, this adjustment is unavoidable, as the economy had reached unsustainable levels of consumption and housing demand. However, the fact that many of these adjustments are inevitable does not rule out a role for monetary policy to support economic activity. Very low interest rates can help smooth the adjustment process by supporting asset valuations, including making housing more affordable and by allowing some borrowers to reduce debt interest payments.

Beyond this direct role in smoothing the deleveraging process—to the extent that monetary policy can “cut off the tail” of the distribution of potential adverse economic outcomes, making a truly disastrous outcome less likely—it can help encourage those households and businesses with money to spend to do so.

Today’s low and falling rate of inflation—at a time when interest rates are near zero—is a problem that is slowing the adjustment process. Currently, by most measures, inflation is below the level that members of the Federal Open Market Committee (FOMC) view as consistent with price stability. Although the Federal Reserve has no formal numerical inflation target, it is noteworthy that the long-run inflation forecasts of the FOMC members cluster around 1.75 percent to 2 percent for the personal consumption expenditures (PCE) deflator. This compares with a 1.5 percent year-over-year rate for the PCE deflator and 1.4 percent rate for the core PCE deflator, which excludes food and energy prices.

Low and falling inflation is a problem for several reasons. First, low and declining inflation makes it harder to accomplish needed balance sheet adjustments. That is because, all other things being equal, lower inflation means slower nominal income growth. Slower nominal income growth, in turn, means that less of the needed adjustment in household debt-to-income ratios will come from rising incomes. This puts more of the adjustment burden on paying down debt.

Second, and even more importantly, low and falling inflation can cause inflation expectations to decline. This is important because inflation expectations are an important factor that influences actual future inflation. Moreover, when inflation expectations decline, the expected real cost of credit increases—a subject I will return to in a moment.

So what could the Federal Reserve do? As I see it, there are two potentially complementary avenues. First, we could take steps to make our current highly accommodative stance of monetary policy more effective in stimulating economic activity by providing additional guidance about what we are trying to achieve today and in the future. Second, we could find ways to increase the amount of stimulus we currently provide via our balance sheet.

Turning to the first issue, clear communication about objectives and intent is an important element of effective monetary policy. For example, communicating clearly our intention to return inflation to more normal levels can help keep inflation expectations well anchored around levels consistent with our inflation goals. As the central bank, we and we alone can control inflation—if not precisely in the short run, then over the medium term. By clarifying our intentions, we can reduce the risk of further disinflation—or even an outright debt-deflation spiral that would make it still more difficult to accomplish the necessary balance-sheet adjustments.

Clear communication on the part of a central bank is important at all times, but it is even more critical when the federal funds rate is at or near its effective lower bound. In this environment, a decline in inflation expectations that drives up the real interest rate and thereby increases the real cost of credit cannot be offset by simply lowering the federal funds rate. Thus, in a very direct sense, a fall in inflation expectations when the target interest rate is at the zero bound represents a de facto tightening of monetary policy and of financial conditions. Such a tightening would clearly be highly undesirable at a moment when unemployment is too high, inflation is too low and the economy has only moderate forward momentum.

In this situation, the FOMC must be clear and resolute in its commitment to its price stability objective. This is why the most recent FOMC statement clearly stated that underlying inflation was running somewhat below levels consistent with the dual mandate.

There are a range of options we could pursue if we judged it worthwhile to go even further in communicating our objectives and intent. We could be even more explicit with regard to the inflation rate that the Committee views as compatible with price stability, for instance, by stating an explicit inflation objective as is common practice in other advanced economies. This could help anchor inflation expectations at the desired rate. It would also clarify the extent to which the current level of inflation falls short of that rate.

If we were to go down this path, it would be important to note that any provision of more information on our inflation objective would not be a signal that the inflation element of the dual mandate had become more important than the full employment objective. Instead, it would principally reflect the fact that inflation being “too low” (just like inflation being “too high”) is an impediment to achieving the full employment objective of the dual mandate.

If we judged it desirable, we could go still further and provide more guidance on how monetary policy would react to deviations from any stated inflation objective. One possibility would be to keep track of inflation shortfalls when the federal funds rate is constrained by the zero bound, as is the case today. For example, if inflation in 2011 were a 0.5 percentage point below the Fed’s inflation objective, the Fed might aim to offset this miss by an additional 0.5 percentage point rise in the price level in future years.

In the current environment, such an approach would have some advantages as well as some disadvantages. When there is a large amount of slack in the economy, the Federal Reserve might not easily be able to hit an inflation objective soon. But, the central bank could plausibly promise to make up the difference later on. Indeed, the further the Fed fell behind its inflation objective in the near term, the more inflation would need to increase in order to push the actual path of prices up to the path consistent with price stability over the long run. To the extent this policy was more credible, it might do a better job keeping inflation expectations from falling. This might make monetary policy more stimulative and, thus, might help the FOMC achieve its objectives more quickly.

However, such an approach would only work well if people understood how it would operate and formed their expectations of future inflation accordingly. And there could also be significant costs. For example, if people mistakenly concluded that the Fed was tinkering with its long-run inflation objective, this could lead to greater uncertainty about future inflation. This might lead to higher risk premia and higher nominal interest rates that would undermine the effectiveness of such a policy to stimulate the economy.

In addition to communication strategies, the Federal Reserve has a second set of tools, namely the ability to expand its balance sheet to stimulate activity and move inflation toward desired levels—either by purchasing medium and long-term Treasuries or agency mortgage-backed securities. Such purchases of long-duration assets pull down the level of long-term interest rates by removing duration from private-sector hands, who respond by purchasing other long-dated assets.

Two interesting questions pertain to balance sheet expansion: (1) How much would the Fed have to purchase to have a given impact on the level of long-term interest rates and economic activity, and, (2) what constraints exist in terms of limits to balance- sheet expansion, and what are the costs involved that could impede efforts to meet the dual mandate now or in the future? The questions demand serious consideration prior to any decision to expand the balance sheet further.

With respect to the first question, some simple calculations based on recent experience suggest that $500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point. But this estimate is sensitive to how long market participants expected the Fed to hold on to these assets.

More broadly, the clearer and more credible the framework governing purchases, the greater the likelihood that market participants would act in a manner that helped the Fed achieve its objectives. In particular, the more confident market participants are in the Fed’s ability to exit when the time is right, the more effective its purchases will be in stimulating the economy.

Suppose the Fed was indeed successful in reducing long-term interest rates further—what then? Some claim that lower rates would have no effect on economic activity—that the Fed would be “pushing on a string.” This is too dark a view. Although the responsiveness of demand to reductions in interest rates is probably lower in a world in which balance sheet constraints are important, the responsiveness is not zero. I believe that it remains significant.

Even in today’s challenging circumstances, lower long-term rates would support the economy through a number of channels. Lower long-term rates would support the value of assets, including houses and equities and household net worth. Lower long-term rates would make housing more affordable and support consumption by enabling households to refinance their mortgages at lower rates. This would increase the amount of income left over for other spending. Of course, this channel can be made more powerful to the extent that further progress can be made in efficient mortgage debt restructurings that allow households with negative equity in their homes to take advantage of the drop in mortgage rates. In addition, lower long-term rates would reduce the cost of capital for businesses, thereby fostering higher levels of capital spending for any given economic outlook.

In considering the limits to balance sheet expansion, there are two constraints—one major and one more minor. The first constraint is the risk that the balance sheet expansion might cause inflation expectations to become unanchored, leading to higher risk premia. This risk is presumably greater in a period in which budget deficits are high, as they are today.

If exit concerns were to rise as purchases increased, then a rise in inflation risk premia would offset at least some of the expected fall in interest rates. In contrast, the more credible the ultimate exit strategy, the less likely it is that inflation risk premia would go up and the more effective purchases would be in lowering long-term rates. Also, the more credible the ultimate exit plan, the more confident investors would be about the Fed’s willingness to do what is needed to accomplish its objectives. This is important because it would help stabilize longer-run inflation expectations at levels consistent with the dual mandate.

The FOMC should be able to assure investors that it has both the means and the will to exit when—but not before—the time is right. That is because the Federal Reserve has the tools to control financial conditions and credit creation even with an expanded balance sheet. Payment of interest on reserves allows us to control short-term rates with even a large amount of excess reserves outstanding. In addition, we can drain excess reserves in several ways. We have developed term deposit accounts and the ability to conduct reverse repurchase operations with a large number of counterparties that would allow us to drain a large volume of reserves. Also, when the time is right, the Fed can always sell assets. Such asset sales would lead to a rise in longer-term rates and this would have a contractionary effect on the demand for credit.

I am very mindful of concerns here and abroad that balance sheet expansion could be interpreted as a policy of monetizing the federal debt. However, I regard this view to be fundamentally mistaken. It misses the point of what would be motivating the Federal Reserve. The FOMC would only engage in large-scale asset purchases in order to push the economy more rapidly toward the dual mandate goals of full employment and price stability. Once these goals were accomplished, there would be no basis for further purchases regardless of the government’s fiscal position because additional purchases would not be consistent with this mandate.

The second constraint is that further balance sheet expansion would increase the Federal Reserve’s interest rate risk by raising the maturity mismatch between its assets and liabilities. Recall that the bulk of the Fed’s liabilities are overnight reserves and the bulk of its assets are longer-term Treasuries, agency and agency MBS securities. The bigger the balance sheet becomes, the more a future rise in interest rates will squeeze the Federal Reserve’s net interest margin.

Some worry that this exposure to higher short-term rates could conceivably affect the Federal Reserve’s monetary policy credibility in the future. Some market participants might worry that the Federal Reserve could become reluctant to raise short-term rates in a timely way because this would constrain the amount of revenue that it would earn and remit to the Treasury. I am confident there is nothing to worry about on this score.

Even if the Federal Reserve was not obliged to act in keeping with its dual mandate—which it is—with its assets skewed toward longer-duration securities, the Federal Reserve would have every incentive to ensure price stability over the long term.

It is true that the larger the size of the balance sheet, the more likely it is that the Fed would ultimately sell assets back into the market, potentially at prices that could result in losses. Although some fear that such losses could compromise the Federal Reserve’s independence, there is no reason why this should be the case, providing we stick closely to our mandate at all times.

To date, the Fed’s actions in responding to the crisis have resulted in abnormally large profits that might reasonably be set against any subsequent losses. But much more importantly, our dual mandate does not state that we should do what is necessary to promote full employment and price stability only at times when we are virtually certain that in doing so we will make a profit. It directs us to promote full employment and price stability at all times. Profits and losses in any given year are much less important than getting the U.S. economy back to the highest level of employment consistent with price stability.

In making our assessments about next steps, we need to be a bit humble about our capacity to forecast how market participants would respond to our actions. We do not control their behavior nor have much historical experience that we can draw on to easily assess how they are likely to behave. Even viewpoints that turned out to be incorrect could persist for a long time and generate adverse consequences. It is not enough for us to be right in theory. We also have to be convincing in practice and in explaining why concerns we think are misplaced are indeed unwarranted.

As Chairman Bernanke indicated at Jackson Hole, the FOMC’s decision with respect to providing additional accommodation will be made by weighing the costs against the benefits. This is a dynamic process, which depends on the evolution of the economic outlook and our own ability to learn how to become more effective in improving the cost/benefit trade-offs.

And, at its last meeting in September, the FOMC said it 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.”

Currently, my assessment is that both the current levels of unemployment and inflation and the timeframe over which they are likely to return to levels consistent with our mandate are unacceptable. In addition, the longer this situation prevails and the U.S. economy is stuck with the current level of slack and disinflationary pressure, the greater the likelihood that a further shock could push us still further from our dual mandate objectives and closer to outright deflation.

We have tools that can provide additional stimulus at costs that do not appear to be prohibitive. Thus, I conclude that further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long.

Thank you for your kind attention. I would be happy to take a few questions.

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tunaman4u2's picture

Dudley really believes he can control the economy & the problem with the economy is deflation\inflation.


Henry Chinaski's picture

People are waking up and the ZH phenomenon is an example of this.  Everyone saw that our wise experts and leaders in central planning, weilding the vast (and expensive) resources of government power and economic genius, were powerless to prevent the crash of 2008.  Now people are witnessing the powerlessness of those same central planners as they are unable to deliver a recovery despite unprecedented intervention.  It is only a matter of time before the central planners are removed from power and hopefully punished.  It's too bad that the associated misery can't be avoided.

All the king's horses and all the king's men couldn't put Humpty together again.



MichaelG's picture

Long, long way to go yet.

communicating clearly our intention to return inflation to more normal levels can help keep inflation expectations well anchored around levels consistent with our inflation goals. As the central bank, we and we alone can control inflation

They think they're gods, don't they?  Like they can just declare: "Fiat inflation".  (And there was inflation.  And Ben saw that it was good.)

And he bangs on unclearly about 'clarity'.  Because 'clarity' is of course one of the important 'tools' that they will only use if absolutely necessary.  Rather than the current method of giant run-on sentences consisting entirely of qualifiers.  Where's the specific unemployment target?  Dual mandate my soon to be getting rapidly thinner ass.

StychoKiller's picture

What Alexander Haig said in resigning:  "I decisioned the necessification of the resignatory action/option due to the dangerosity of the trendflowing of foreign policy away from our originatious careful coursing towards consistensivity, purposity, steadfastnitude and, above all, clarity."

The King of gobbleygook is dead, long live the King!


Translation of Fedspeak:  "We got this really nifty new printer, with a very shiny control panel -- and lights!  Lots of blinky lights!"

Zero Debt's picture

I can't resist de-ciphering all of this lovely fed speak!

So many treasures here but I wish to cherry pick some key points...

I am very mindful of concerns here and abroad that balance sheet expansion could be interpreted as a policy of monetizing the federal debt.

I am very mindful of concerns that all money are lent out at interest and that there is not enough money to repay all debts unless credit grows. I am very mindful that there are only two ways to get out of this: defaults or helicopter money. I am very mindful that this will wipe out real savings through monetization. However it is not my problem.

However, I regard this view to be fundamentally mistaken.

However, I am a central planner who will survive in tenure regardless of the outcomes of my actions.

It misses the point of what would be motivating the Federal Reserve.

It misses the point of staying away from discussing malinvestments, reasons why people save and the marginal utility of debt, so let's not go there.

The FOMC would only engage in large-scale asset purchases in order to push the economy more rapidly toward the dual mandate goals of full employment and price stability.

Since the magnitude of debt created is now so huge that any increases in rates would wipe out the ability to ever pay it back and expose the fradulent nature of the system, rates will be set at nominally 0% forever. Large-scale asset purchases will sooner or later be necessary to prevent massive defaults and widespread panic. The exact timing is unknown, but only two metrics will be used: employment and prices. No other metrics will be considered regardless because that would deviate from the theoretical pillars of Keynes that supports this house of cards. The map is the territory.

Once these goals were accomplished, there would be no basis for further purchases regardless of the government’s fiscal position because additional purchases would not be consistent with this mandate.

If everything goes fine, there would not be an issue, but just in case, just to avoid being caught contradicting myself in the future, I pose this hypothetical statement with sufficient vaguness just in case to cast a thin veil of good spin on the dire underlying situation.

Some worry that this exposure to higher short-term rates could conceivably affect the Federal Reserve’s monetary policy credibility in the future.

There's a lot of people (unfortunately well informed ones) out there who can't be blamed for having animal spirits are already seeing all dollar-denominated assets except hard ones losing value and that the USD is screwed. I hope they are wrong, either way, it doesn't really matter because I will survive in tenure and then IBGYBG. But I know why they are talking, because a spike in short term interest rates would hit lots of folks out there hard. So I have to appease them somehow.

Some market participants might worry that the Federal Reserve could become reluctant to raise short-term rates in a timely way because this would constrain the amount of revenue that it would earn and remit to the Treasury. I am confident there is nothing to worry about on this score.

To keep the delusion going, I hereby emphasize that all is not completely broken yet. There are still some things that actually work, so we should pay attention to these local optimums them and not the global volatility in the system itself. As a central planner, when I make a statement to bring confidence in the market, I shall as far as my job role is concerned assume that this will pervert incentives sufficiently to perpetuate the unsustainable mathematics of the system.

It is true that the larger the size of the balance sheet, the more likely it is that the Fed would ultimately sell assets back into the market, potentially at prices that could result in losses.

Ultimately it's going to crash, but I have to get out first.

Although some fear that such losses could compromise the Federal Reserve’s independence, there is no reason why this should be the case, providing we stick closely to our mandate at all times.

As our mandate is limited to increasing prices and worrying about unemployment without being able to influence the latter and without understanding the further, we will most likely have to continue to worry ad infinitum, but at least that keeps us employed.

Bananamerican's picture

"We have tools"


yes we have....

Man, that phrase is right up there with "i see dead people"

StychoKiller's picture

Time for an omelette, my friends -- a nice Golden omelette (with Silvered onions!)

Instant Karma's picture

What good is monetary stimulus when the idiots in the White House and Congress are destroying the economy with business bashing full retard economic policy?

BobWatNorCal's picture

But...there is no need for QEII?
Time Magazine has gone all out to argue that the Obama stimulus was effective and well-run.

StychoKiller's picture

Translation of Fedspeak:  "We're gonna print more currency, because that's all we know how to do, and damn it, it's ALWAYS WORKED BEFORE!"

Ags Nightmare's picture

Someone paid good money to be in front of this speech.

primefool's picture

Yessuh - ah have a question way in the back over here -- da price of leeeen hogs be up 69% over da past 12 months. Sugar, coffee, grains, etcetc are also up almost as much.
D Y'all think printing all dat money has sumpin ta do wid dat? Or d'yall live in an alternate universe?

bingaling's picture

That is a good question ,  do realize that the price of flat screen TV's has gone down 74% so if you buy one everytime you do food shopping you save 5%, what we are hoping to do with the additional stimulus is get those flat screen prices up so the factories which make them stay in business and we can continue to sell those countries, where things are made, crappy financial instruments which in turn keeps the banks; where you keep the little money you have left , in business . I hope that answers your question .

i-dog's picture

+1,000 chuckles. You made my day!

TradingJoe's picture

Jesus! This guy needs a new brain, spine and maybe a one way plane ticket to the frickin' moon! Some of the M's rising is due to Benjie's uncontrolled printing, yet it all goes to Da' Boyz and not where it should, this why it is smokes to believe there is ANY liquidity out there, this why I believe DEFLATION CRASH is more likely to happen BEFORE INFLATION hits! ALL dumbies think there is a lot of money chasing fewer goods(inflation) but it's wrong, there is little money,(the banks aka PD's aka Da' Boyz have it all) chasing lots of goods(deflation), this is why Benjie is printing his heart out can't "save" the banks since no one know the real damage on them books! What a douche!

primefool's picture

Y'All take "further action". We reglar folks will take our own kinda "further acckshun " - y'hear?

Ags Nightmare's picture

That roiters article yesterday left me speechless..and thanks. At the rate the Fed is going, they are going to run out of moral hazard by the end of the year. These guys are nuts.

Cognitive Dissonance's picture

Nobody should have any doubt as to which side will ultimately win this argument...

Any argument is for public consumption only, to help support the illusion that the Fed is uncertain about what it should do. If there were serious internal opposition to this foregone conclusion, it would be The Fed knows precisely what it wants needs to do.

Pump, pump, pump. (Electronically) print, print, print.

And then pump and print some more.

i-dog's picture

They'll keep printing and pumping until they decide the middle class has been sucked "sufficiently" clean ... then the country goes into lockdown.

Upon lockdown, they'll check their master list to see how much mortgage loan, student loan, car loans, credit card loans, trading loans, personal loans, and a variety of instant taxes each middle class slave owes and offer him/her indentured servitude in the military or work camps for a few decades to pay it all off. One bowl of gruel a day will keep y'all working.

Voilà ... full employment ... problem solved.

Dismal Scientist's picture

Candidate for 'Best band name ever'

knukles's picture

I don't know about that.

CNBC today had on "Recovery Testimonials" (Propaganda rocks!) where one of the silicon enhanced dimwit chick-a-dees reads these anonymous (Opppps, kinda like those evil bloggers!  Forget thet for the moment, trust me!.) letters from people telling gut wrenching, tear jerking stories about how fantastically well the economy is doing by their own anecdotal experience.  Almost spiritual in effect.  (Strains of heavenly music, angels singing.)

So if things are being reported as so wonderful, where's the disconnect between the Fed's dismal outlook and the rest of mankind's Hopie Changie experience?

Why do I get the felling I'm living in the land of Smooth Gears?

sarc/not to sure anymore

Cognitive Dissonance's picture

I watched in rapt attention as Amanda "Bleached Blonde" Drury read those inspiring stories on air. I was impressed more with her ability to pronounced the names of various American cities and back water towns than I was with the stories themselves.

Of course, the sole purpose of the "Recovery Testimonials" is to give the indentured servants and slaves hope that there's a light at the end of the tunnel. This is why we always hear stories of slaves that escaped to the big time. It feeds into the false hope so many of us need in order to drag our asses out of our financed bed, into the shower of our financed (and presently underwater) home, then into the financed automobile that takes us to our place of slavery...ops....employment.

Wash, rinse and repeat.

knukles's picture

Indeed, even Josef Goebbels Ativan intake would prove insufficient to combat ever increasing anxiety whilst observing the Power Elite's fragmenting memes. 
Desperation wholesale.  Bluring Illusions and Symbols. 
The Foreshadowing Apparition of Defeat Rising from the Jaws of Victory. 

StychoKiller's picture

Shades of "The Running Man" right there!

wiskeyrunner's picture

Just look at the index futures go, seems everyone but main street knew the numbers in advance. Ever wonder how the banks have 100 plus trading days with out a loss, wonder no more.

bigdumbnugly's picture

except i don't think you needed clairvoyancy to know whatever the case the solution was "print" anyway.

yesterday's lows were an ideal time to pop back in for some more low hangers.

Species8472's picture

"Slower nominal income growth, in turn, means that less of the needed adjustment in household debt-to-income ratios will come from rising incomes. This puts more of the adjustment burden on paying down debt."

And there it is, we will inflate away debts. Screw the savers.

Silverhog's picture

Sears might be a good investment soon, wheelbarrows are going to be in hot demand.

Alfred's picture

Yes and Pitch Forks too!

MarkS's picture

Yes, the rift in the FRB is growing daily.  And, it isn't just the normal hawk - dove rift, it is a discussion on whether the FRB has any bullets left in its gun.  The hawks point out that if $800B of stimulus spending and ~$2T of QE didn't get us to the needed 'exit velocity' then how does more QE alone do it and in what strucutre given the previous failure?  The Doves argument is something along the lines of 'well we have to do something'. (ok, it's obvious what camp I am in)

Now, the fact that BB got two more yes votes and that Yellen as Vice is looking to take BBs job next time around puts her in the positon of being the President's person to pound the table and remind that FRB that besides bank stability and stable prices, the other mandate of the FRB is full employment.  She has already said that the 'full employment' mandate is the key to the other two for the long run so this could get interesting.

Bullards compromise plan of deciding on the size of POMO on a meeting to meeting basis may be overruled as BB gets those 2 extra votes but, the FRB has never had an open disagreement in the media and that is what the Hawks have threatened.  Lets see if BB has the stomach for it.


sweet ebony diamond's picture

You forgot about Nancy's surgeries.

There is still alot more to be done

Someone has to pay for that.

Xedus129's picture

I hear Barney and Dodd are donating the fat to smooth out her wrinkles.  

aheady's picture

That has to be the rankest mental image ever entered into the banks of chaos in my mind.

Mariposa de Oro's picture

Agreed.  Now poking out my mind's eye with a glowing hot steel rod.....

DosZap's picture

Easy,if they send out the 2 Trillion and directly put it in the PEOPLES hands, they will get a huge uptick in sales, and demand for everything.Want spending, send it to da peeps.

But, no, their content to NOT print any FRN's, and just make digital entries on Bank screens and say that's increased DEBT?.

How can that be?.

If you just put #'s on/in a computer, you have not inflated shite.

If it no workee,remove the extra Zero's, and since no PHYSICAL paper was printed how can their be an increase in money supply?

That's like having a $60k credit limit on your M/C,if you do not use it,it just sits.......meaning it really doesn't exist until it's USED.

Someone help me with this logic..................or illogical framing of the issue.

Until the increased debt is IN the system,on the streets,and in circulation, how can they/we say there has been liquidity introduced into the economy?.

If it's sitting in multiple Banks,what the Fed giveth, can be removeth-ed.


Assetman's picture

Dudley is living by the terribly misguided belief that by lowering interest rates, rising equity prices will make the masses richer, and those same masses can go in and either refinance-- or buy that house because afforability is getting better.

Dudley seriously overlooks (a) the fact that retail participation in the equity market is SHRINKING due to immediate funding needs and the lack of trust in the structure of the markets; and (b) many people can't afford to buy a house of refinance because the simply don't have the income or the personal balance sheet to support MORE DEBT.

The reality-- as you point out-- is that QE is not filtering through the economy with any effective force.  Banks are benefitting.  Some refinancers are benefitting.  But it's not moving the needle on employment, and banks are not lending net new money.  Savers, however, are getting screwed.

The most troubling piece of Dudley's speech however, is the expressed need for a credible exit strategy in the event of more balance sheet expansion today.  Folks, they were talking about a credible exit strategy in January this year with the expectation that most of this would be removed in March.  It never really happened-- and the balance sheet now is poised to expand even more.  The Fed has ALREADY LOST CREDIBILITY-- end of story.  QE 2.0 will be no better, and whatever plans that are made to communicate a viable exit strategy will eventually be substitiuted by even more balance sheet expansion.

These folks are not only idiots; but idiots with way too much power and should not be trusted.  The only real hope here is that QE 2.0 is met with a panic run on the U.S. dollar-- a run that the Fed cannot control, unless they totally reverse monetary policy.  Otherwise, they are pushing on a string and doing even more potential damage to the economy long run.

But they aren't really thinking more than 12 months in advance, anyway.

snowball777's picture

We'll push the string HARDER!

No matter how high you jackasses push the S&P, it won't generate demand or new employment, Dud.

Bringin It's picture

One thing to look forward to with the end of the Fed is that there will no longer be the need to crawl around in the pig entrails and tea leaves of Fed speak to try to see what they're going to do to us.

itiswhatitis's picture

"The FOMC would only engage in large-scale asset purchases in order to push the economy more rapidly toward the dual mandate goals of full employment and price stability. Once these goals were accomplished, there would be no basis for further purchases regardless of the government’s fiscal position because additional purchases would not be consistent with this mandate." didn't work the first time so let's keep trying more?  A lot of words here in this speech to say that basically we don't have a clue what to do to help this economy other than  more of the same.  

This is a scary shit . . . my gosh.

Hansel's picture


NOTW777's picture

can his name really be "dudley?"

i think all this "talk" of QE is getting old, losing its impact.

how can they pump up stock markets and at the same time argue we need QE cause things are weak?

Overpowered By Funk's picture

Hey man that's my dog's name.

Thunder Dome's picture

From Jesse's Blog:


"It's like a Greek tragedy, where you know what the outcome is bound to be. We're living in a Greek tragedy." Mary Chesnut, South Carolina diarist, 1864

itiswhatitis's picture

And gold goes higher.....

NOTW777's picture

anyone notice $81 oil