Jan Hatzius' Hypothetical Q&A With Ben Bernanke
Goldman's Jan Hatzius, who whether he likes it or not, is probably the biggest variable as to whether there will be a QE3 or not, as every other Wall Street "strategist" immediately parrots what Hatzius says will happen (in no small part due to Hatzius' close relationship with NY Fed's Bill Dudley) has just released a hypothetical Q&A session in which he provides what potential answers to questions during Bernanke's first ever scheduled press conference on April 26 of this year might look like. In order to keep the dodecatuple reverse psychology mystery to a maximum, Hatzius also provides what Goldman's answers would look like pari passu with those of the Fed (which is not all than ironic: after all the Fed gets its teleprompted lines straight from the corner offices at 200 West). So for all forensic linguist/economist/psychologists who are hoping to get an extra ounce of informational clarity on the future of monetization post June 30, here it is. Good luck.
From Goldman Sachs
Questions for Chairman Bernanke
- Today’s focus article proposes some questions that reporters might ask Fed Chairman Bernanke at the press conference now scheduled for April 26, along with answers that we think Bernanke might give and ones that we would give ourselves if we had the opportunity to comment.
- We expect the chairman to indicate that QE2—or in his parlance, large-scale asset purchases—will end on schedule in June without “tapering” of the kind that occurred at the end of the first round of Treasury and agency MBS purchases in 2009-2010. However, we do not expect him to indicate a move toward rate hikes or asset sales anytime soon.
- The recent data have increased the downside risk to our 3½% (annualized) estimate for Q1 GDP growth. However, other indicators including monthly surveys of business activity, industrial production, and jobless claims still point to a healthy pace of expansion. We expect the GDP-relevant data that have yet to be released before the advance GDP report due on April 28 to look stronger and are making no changes to our forecast for now.
- The charts on the right illustrate why. The top chart contrasts the recent weakness in core capital goods orders with the strength in the Philly Fed’s measure of capital spending expectations; our interpretation is that the durable goods data probably understate the capital spending outlook. The bottom chart shows that both industrial production and the ISM manufacturing index still point to healthy expansion in the manufacturing sector.
The Federal Reserve announced on Thursday that Chairman Bernanke will hold press conferences to explain the Federal Reserve’s summary of economic projections four times each year, starting just after the April 26-27 FOMC meeting. Details are not yet available, but it seems likely that the format will be similar to the press conferences given by European Central Bank President Trichet after each policy meeting, with an introductory statement and a question-and-answer session with selected journalists.
Below we list some questions that journalists might want to ask the chairman at the press conference, answers that Bernanke might give, and answers that we would give ourselves if we had the opportunity to comment.
Q: Why did you decide to start holding press conferences?
Bernanke: Academic research has shown that central bank press conferences can be helpful in communicating central bank decisions. For example, Ehrmann and Fratzscher (2009) find that ECB press conferences have on average had larger effects on financial asset prices than the corresponding policy decisions, but smaller effects on volatility. Thus, we view the move to press conferences as another step on the road to clearer communication.
GS: We agree that this is the primary motivation. In addition, the press conferences will provide the chairman with an opportunity to interpret the FOMC’s decision and forecasts straight away, increasing his ability to shape the message for the committee as a whole. Presumably the committee will have to sign off on the prepared statement, but much of the information content may come in the Q&A session. At the margin, the press conferences may also increase the hurdle against dissents by voting FOMC members, at least with respect to “initial” dissents. A member who already dissented at the prior meeting would presumably not see a high hurdle to repeating that dissent, but the fact that the chairman may need to answer questions about an “initial” dissent at the press conference following the meeting might make such a move a little more awkward and thus less likely.
Q: Let’s move on to the monetary policy outlook. Will QE2 end in June?
Bernanke: Based on the information available at this time, the risk of deflation has gone from small to negligible, and most indicators of economic activity point to a sustainable recovery. In such an environment, we believe that a further easing of monetary policy via additional large-scale would not be appropriate.
GS: Our own view is that the risk of deflation has certainly fallen but that the term “negligible” is too strong. If the economy were to slow anew to a below-trend growth pace, deflation concerns could resurface. But that’s neither here nor there with respect to the committee’s decision whether to end QE2, which seems to have been taken.
Q: Many people believe that nominal interest rates should be approximately equal to nominal GDP growth. Right now, nominal GDP growth is 4.2% year-on-year but the funds rate is 0.14%. Does this large gap indicate an inappropriately loose monetary policy?
Bernanke: That’s not the right way to look at it. Optimal monetary policy rules typically include a role for the level of output and employment relative to potential, not just the growth rate. At present, the level of output is far below potential, which justifies a relatively easy stance of monetary policy in which the funds rate is far below nominal GDP growth.
GS: We agree.
Q: Professor John Taylor argues that his eponymous monetary policy rule currently implies a need for tighter monetary policy. Is he right?
Bernanke: We would take a different view. As I explained in my answer to Sen. Toomey’s question at the semiannual monetary policy testimony to Congress, there are different versions of the Taylor rule and there is no particular reason to choose the one that Taylor picked in 1993, which he now argues shows that Fed policy is too loose. In the past, Taylor himself has suggested that other formulations are possible. Our own work on this issue using models that explain the FOMC’s past behaviour suggests that the funds rate currently “should” be well below zero, at least under our forecasts for inflation and economic activity.
GS: We agree.
Q: Speaking of your inflation forecast, how concerned are you about the recent pickup in inflation?
Bernanke: In recent months, inflation has rebounded from levels that we thought were too low in late 2010. However, most of the rebound has been due to commodity price increases which may not last. With still-ample slack in the labor market and the economy at large, we expect the faster pace of price increases to be temporary.
GS: We agree with this but would add one important point. In our view, the chairman’s decision to avoid the term “core inflation” is unfortunate. It is important to explain to the public that while headline inflation is—of course—a better measure of backward-looking changes in consumer purchasing power, core inflation is a better measure of the underlying trend of inflation and generally a much better predictor of future price trends than headline inflation.
Q: But don’t the recent data also suggest that there is less spare capacity in the economy than you previously thought? After all, one way to estimate the amount of spare capacity is to back it out of an inflation model. And when inflation—especially core inflation—is rising, typically this means that economists have to reduce their output gap estimates.
Bernanke: It’s a little too early to say. Monthly inflation data are noisy and their significance should not be overstated. On a year-on-year basis, underlying inflation remains low. But yes, if inflation were to accelerate, and especially if this feeds into significantly higher long-term inflation expectations—something that has not happened to a meaningful degree yet—we would conclude that there is less spare capacity than we thought. And that could mean that the Federal Reserve would need to tighten policy in a timely manner.
GS: We agree.
Q: The Federal Reserve is currently buying 70% of the net supply of Treasury securities. Once the purchases stop, some influential market participants expect a sharp increase in Treasury yields. Are they right to be worried?
Bernanke: We don’t think so. We believe that the impact of LSAPs works via the stock of securities held by the Federal Reserve, not the flow of purchases. This distinction sounds like a technical detail, but it is actually very important. If it is the flow of purchases that matters for the level of interest rates and asset prices, interest rates will rise as soon as the flow goes from the current $75bn-$80bn per month to zero. But if it is the stock of purchases that matters, rates will only rise once we announce a reduction in our securities holdings.
GS: Again, we agree with this, as explained in more detail in Thursday’s US Daily. However, neither we nor the chairman can be sure that it is the right answer—after all, there are some very astute and successful investors who believe the precise opposite! And in order to be sure, the FOMC will want to leave at least a couple of months after the end of QE2 before it takes the next step toward a tightening of monetary policy. This means that even if the data are strong, it is unlikely that the committee will want to stop the reinvestment of MBS paydowns and/or make a change in the “extended period” language in the FOMC statement until a couple of meetings later.
Q: Does your answer to the last question imply that you have no appetite for “tapering” the end of QE2, i.e. gradually reducing the pace of Treasury purchases as you did with the Treasury and MBS purchases back in 2009 and 2010?
Bernanke: We do not intend to taper the end of the purchases. The reason is that we believe it is the stock rather than the flow that matters, as explained previously. If so, the benefit from tapering in terms of minimizing the risk of market disruptions is negligible.
GS: We agree that the benefit from tapering is likely to be low, although the cost is also very low. Thus, our own view is that a decision to taper could make some sense. But of course it is the Fed’s view that matters.
Q: When are you going to raise rates?
Bernanke: I can’t tell you that!
GS: Our forecast remains that the first hike will occur in early 2013. However, the higher-than-expected inflation numbers in recent months have somewhat increased the risk to this view, and it is certainly very possible that the tightening process will start in 2012. At this point, the evidence against our forecast—in which inflation depends on the level of the output gap and the (anchored) level of inflation expectation—is still not very strong given the noise in the data. But a few more months of higher core CPI and PCE numbers could change our mind, especially if these were accompanied by higher inflation expectations. If so, the risk of earlier hikes would rise.