Is A Shift In Fed Policy Coming?

Econophile's picture

From The Daily Capitalist

The Wall Street Journal is running a piece tonight (Monday) on a possible shift in Fed policy (Fed Mulls Symbolic Shift) which I don't believe they would run unless they have some insider tipping them off. The article is authored by Jon Hilsenrath who has been writing about deflation and the efficacy of Keynesian stimulus. As I pointed out, he is a good reporter, but his articles mirror the conventional wisdom which, unfortunately, has been mostly wrong.

However I will assume Mr. Hilsenrath has pretty good connections as a Journal reporter so I will take his piece seriously. Here is the gist of the article:

Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.


The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed's forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.

The article notes the disagreements among the Fed presidents about inflation, deflation, and the direction of the economy. The inflation hawks, chief among them being Thomas Hoenig of the Kansas City Fed, would probably like to increase the Fed Funds rate soon. Charles Plosser (Philadelphia), James Bullard (St. Louis), and my favorite, Richard Fisher (Dallas) have been favorable to quantitative easing by allowing the Fed to continue to buy toxic debt ("quantitative easing"). None of these Fed presidents seem to understand the causes of deflation or inflation as being something that they create through money supply manipulations.

But James Bullard has come up with another twist.

Dr. Bullard released a paper last week about the dangers of deflation ("Seven Faces of 'The Peril'"). I should tell you that he rose from the research department to president of the St. Louis Fed, which makes him a bit of a policy wonk.

Dr. Bullard says we can stop deflation by buying U.S. Treasurys (this form of "quantitative easing" is also called "monetizing debt"). He says ZIRP (zero interest rate policy) encourages deflation and violates the Taylor Rule (the Fed must keep short-term interest rates at a fixed bandwidth above or below "equilibrium" which is some theoretical balance between the rate of interest and inflation expectations). He says ZIRP loses its effectiveness, creates expectations of lower prices, and increases the likelihood of deflation.

Bullard's solution is to monetize federal debt, but to only do it  'just right':

The experience in the U.K. seems to suggest that appropriately state contingent purchases of Treasury securities are a good tool to use when infl?ation and infl?ation expectations are ?too low.? Not that one would want to overdo it, mind you, as such measures should only be undertaken in an effort to move infl?ation closer to target. One very important consideration is the extent to which such purchases are seen by the private sector to be temporary or permanent. We can double the monetary base one day, and return to the previous level the next day, and we should not expect such movements to have important implications for the price level in the economy. Base money can be removed from the banking system as easily as it can be added, so private sector expectations may remain unmoved by even large additions of base money to the banking system. In the Japanese quantitative easing program, beginning in 2001, the BOJ was unable to gain credibility for the idea that they were prepared to leave the balance sheet expansion in place until policy objectives were met. And in the end, the BOJ in fact did withdraw the program without having successfully pushed infl?ation and infl?ation expectations higher, validating the private sector expectation. The U.S. and the U.K. have enjoyed more success, perhaps because private sector actors are more enamored with the idea that the FOMC and the U.K.?s Monetary Policy Committee will do ?whatever it takes? to avoid particularly unpleasant outcomes for the economy.

Let me translate this for you:

  1. He and other Fed presidents are worried about a Japan-style deflation where they had declining prices and asset values and almost zero growth for "a decade" (actually almost 20 years at 0.6% average GDP).
  2. Nothing they (the Fed) have done so far works. Chairman Bernanke and others assumed that all they had to do was ZIRP and inflation would appear, the economy would rebound, and things would be just fine. It hasn't worked.
  3. Chairman Bernanke has no clue why deflation is occurring and neither do the other Fed presidents. He still assumes, through some neo-Classical, Monetarist econometric formula, they can manipulate the economy to their will. If they could do this they would already have done so.
  4. Japan, Bullard says, did everything wrong: ZIRP didn't work and fiscal stimulus left them with huge national debt. He is absolutely right about this. However he believes they went into deflation because (i) no one expected inflation to occur because of ZIRP and that (ii) they didn't try hard enough with quantitative easing.
  5. He believes, with absolutely no evidence, that quantitative easing helped in the UK and in the U.S. in that it prevented inflation expectations from being "too low."
  6. Monetizing federal debt, he says, will convince us that the Fed 'really means it this time' and that we can expect inflation for sure.

Bullard released this paper for a reason and that is to frame the debate about what they are all really concerned about: a sinking economy that will keep unemployment high. Continued high unemployment is not politically acceptable to Congress and the Administration, and the Fed will face tremendous pressure in the next several months as negative data continues to come in.

Most Fed presidents fear unemployment more than they do deflation. I believe they will keep ZIRP for the foreseeable future and that they will also engage in more "quantitative easing."

Monetizing debt has been a taboo among central bankers because it is a one-way ticket to high inflation. But, Dr. Bullard thinks that is what the Fed should do. That is why I believe we are eventually headed for stagflation.

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Akrunner907's picture

just push up the money supply of each country to allow them to buy each others debt in pro-rata proportions; once the debt is all purchased by the countries declare a debt foregiveness program of righting off debt over five years and push the rates to zero, then you can eliminate each others' debt by reducing currency circulation of each country.  No innocents are injured in the process.

BDF_NYC's picture

All this policy BS is useless hot-air eminating from moronic imbeciles.  The only things that matter are unemployment and the follow on effects of increasing foreclosures and increasing debt defaults by consumers (not to mention cratering retail sales and escalating small business failures).  Take your eye off the ball, and you lose.  Next.

Bartanist's picture

IMO too many assumptions are considered immutable instead of variable.

- just because the base interest rate is low does not mean that the public has low interest rates or that they have access to money. If there is no access to the money by those who need to spend it then they cannot consume or create jobs. Sure the banks get the money, but that does not help the economy, only the banks.

- it seems to me that there is no steady state in a Ponzi-type system. A Ponzi system is parabolic. Sure, a formula defnes a parabola, but the solution to normalize the parabola is not linear.

- The ideal "steady state" is only based on one set of assumption created years ago when the US had value businesses and the vast majority was not in non-value adding activities such as banking and government. It makes sense to me that the type of economy makes a HUGE difference in what adding money to is does. In a healthy economy only enough money is needed for the exchange of value and for the exchange of the increase in value (first derivative... Again not solvable with a linear equation). Money in excess just dilutes value... or cannot find a place unless it is FORCED into the system, such as what is happening with the bank forced increase in commodities and stocks. When commodity prices are increased artifically what it really means is that people can purchas less "value" with their fixed amount of money ... THE PEOPLE WHO NEED TO SPEND ARE NOT GETTING THE MONEY.

- That being able to handle the carrying cost of debt is the same as being able to pay off debt... or that there is no need to pay off debt EVER and that can create a stable economy.

johnnynaps's picture

The problem here is 99% of the population BELIEVED that inflation was under control the last 10 years because LYING Fed members and politicians told us it was! Think about it......everything from housing (which ironically doesn't count on these reports)to banker/CEO bonuses to Right Guard to stock prices to accrual of debt to gasoline went through the roof from 2001 to 2008. Now, the lie is up. Yet no one reflects back as to how skewed these reports were or could have been (my guess is everyones' xanax prescription has joggled their common sense and long-term memory)!

What makes this deflationary environment even more scary is the constant lies out of Washington. Of course, with corporations/banksters hoarding cash and paying off Washington lobbyists faster and faster......hyperinflation will soon be the culprit. ANd, the gap between rich and poor will grow even greater. 

Then, 78 million Baby boomers will become even less productive......drawing on 401k's and eventually leaving this life and us with an even larger supply of real estate.......and.....back to deflation! No Way Out of the vicious cycle we have built over the boom/bust years. Correct prices will be seen when we get a grasp on our National debt, GOVERNMENT, demographics and common sense. My guess.......never.


Buck Johnson's picture

I agree with you Econophile.  They are doing the exact things that they told Japan not to do (and japan didn't listen and we won't either).  They told Japan to get that debt off the books and discharge it because it was pulling down their economy, they didn't do it.  And look at the US, we are doing the exact same thing.  We are keeping this debt (both private and public) on the books in order to help out a group of banksters from losing their company and/or bank, and also to protect the govt. officials who allowed this mess to happen.  There isn't enough money that can be made to pay off all this debt and NEAR future debt without printing money which is hot money.  So they are trying to walk the tight rope of stagnation on one side and inflation/hyperinflation on the other.  Hopeing that they don't go to far on one side or the other.

I wiki'd Stagflation and the 3 and 4 paragraphs pretty much says everything, and that is WE ARE GOING INTO STAGFLATION.  Those two paragraphs point out different things that needs to be done by the govt. and fed in order to cause it, and we have done so in spades.

Dr. Acula's picture

"Chairman Bernanke has no clue why deflation is occurring "

But deflation is not occuring. At least, according to Austrian economists and according to John Williams

While some prices have decreased, other prices - for things like gold and food - have increased. 

Econophile's picture

I don't use the Mises site's AMS chart. Don't think it's quite right. See: Pollaro uses TMS1 which is what Frank Shostak and others think is more accurate. Again prices aren't the key, a decline in money supply is deflation.

Thanks for the comment.

RockyRacoon's picture

Chairman Bernanke has no clue why deflation is occurring and neither do the other Fed presidents.

Come on.  All these folks understand perfectly what is happening; they simply don't have any way to avoid the outcome.   To attribute inaction in the face of fear to ignorance is not fair.  Sure, Ben and the Governors are "ignorant", but Jeff Harding has all the answers.  None of which he has put forth.

Most Fed presidents fear unemployment more than they do deflation. I believe they will keep ZIRP for the foreseeable future and that they will also engage in more “quantitative easing.”

So, what would Jeff do?   WWJD?

Econophile's picture

Rocky, are you trying to bait me? You've probably read me enough to know that I would (1) do a Volker and raise interest rates, and (2) set up an RTC to wipe out b/k banks and sell off their assets. After that I would get rid of the Fed. Instead of years of stagnation we might just recover. But, really I don't think these guys understand that it is their manipulation of money supply that is the problem. Thanks for the comment.

RockyRacoon's picture

I take it (3) is getting rid of the Fed.  All well and good of you to post the 3 working solutions.  Perhaps I should have rephrased my proposal:  Give us some practical and likely solutions.  You'll have to get more micro- than macro- to produce results.  Sure, if I were god I'd do lots of stuff!  No way any of the 3 things you propose will/can happen in this economic or political atmosphere.  That was my basic point.  Thank you for your response to the comment. 

Here's a proposal:  Use LIFO inventory techniques on the whole shebang.  Remove the last government action from the books.  Then the next...  All the way back to 1913 if necessary -- and then you get your Fed gone.  There will be some juicy stuff that will go before its chronological position, but all the better.  It's a process, not a Divine Decree.

DavidRicardo's picture

They're talking about buying Treasuries because Obama is going to propose a $4.6 trillion superstimulus bill.


The Fed, in turn, is going to purchase $6.5 trillion in various kinds of securities. 


Obama should be calling Congress back into special session and addressing it directly in order to present this "second New Deal."


But it has to happen, because economic activity has fallen off the cliff.

the grateful unemployed's picture

i have a problem with this, if Obama makes a speech in which he says the economy has fallen off a cliff, then he proves that his administration has been lying about the situation. If he says the economy is fine, wink wink wink, and QEII is needed to keep the economic recovery going wink wink wink, everyone with half a brain will see through it. Wall Street will assume the second case is true, and rocket higher, a bit or irrational exuberance never hurt anything. Obama looks like a Wall Street lackey, and main street pummels him. If Wall Street thinks the economy really is in the tank, they will sell the news, and Main Street will panic too. This is a lot like selling the Iraq war, first you have to convince the suckers that the war will be hard, (while the insiders call it Cakewalk I). Obama losing credibility if Wall Street sees through the charade, and puts on some numbers. If the economy really is that bad, then things get much worse, I don't think he can afford to do either one, without falling into the Bush model, and governing with the support of 1/4 the population.

NotApplicable's picture

Don't worry, they'll blame it on the next war, starting in 3.. 2.. 1..

Troy Ounce's picture


But the problem is finding people with more than half a brain

DavidRicardo's picture

Sorry, concerns like this have to be put to one side.  You forgot the one option that's going to be used now: reinvention.


That was then.  This is now.  Now we reinvent ourselves at the child of Lyndon Johnson in order to spend spend spend in order to prevent a catastrophe at the polls. 


Money will be spent on everything, everywhere.  States will be bailed out, if you make under 60K you'll be dropped from the Federal tax rolls, education loans will be forgiven.  The point is that consumers are not spending.  The whole thing is imploding faster than the statistics are telling you.


So spend spend spend.  Just do it.  Worry about the consequences later.  Spend spend spend.


And that's exactly what he's going to do, and the Fed is sending massive signals that they will eat up all the Treasury notes the Treasury can put out there.

equity_momo's picture

Thats just going to end in a bigger flame ball.  I suppose JPM could short even more gold to give the economic miracle some legitamcy but if we are talking super stimulus , i am going all-in physical gold and food because there will be no where else safe.


You have heard the expression "pushing on a string" ?  I think its time Obama and Bernanke folded their 3,6 hand because theyre going to lose , theyre going to lose everything they bet.

tecno242's picture

I would like to add to this that Bullards plan is to monetize federal debt..

while also raising the target rate at the same time.

vote_libertarian_party's picture

It's funny how the question is framed with 'the cash from the mortgages being paid back'. hahahahaha So what do they do with the 80% of those loans that defaulted?

Apostate's picture

Why not just give every citizen access  to the discount window? Might as well just blow it all up at once.

NotApplicable's picture

But what would become of Visa?

downrodeo's picture

That is one huge point that the average person never stops to consider. We think we're getting a great deal with our 4.75% mortgage rate. Never a thought to how the rates are determined, let alone the relationship between banks and the Fed. If you ever want to see somebody's eyes glaze over, just bring this up the next time you're standing in line at the supermarket.

economicmorphine's picture

I assume its a rhetorical question, but that's exactly what Ben Dover was talking about when he told the story of helicopters dropping cash.

Troy Ounce's picture


From Hilsenrath's article in the WSJ, June 14th:

"Federal Reserve officials are beginning to debate quietly what steps they might take if the recovery surprisingly falters or if the inflation rate falls much more.

Fed officials, who meet next week to survey the state of the economy, believe a durable recovery is on track and their next move—though a ways off—will be to tighten credit, not ease it further. Fed Chairman Ben Bernanke has played down the risk of a double-dip recession* and signaled guarded confidence in the recovery.

Good journalist or a mouth piece?

SheepDog-One's picture

We've fallen so far now we have Mexican bounties on sheriffs heads, the Clown in Chief says nothing, media says nothing, we've got mexican gangbangers pulling down US flags and stomping on them, wiping their ass on them while cops stand by and the moron sheeple do NOTHING! Stand there and watch it like a reality TV show! This country is DESTROYED and all people do is marvel at what Ben and Timmy's next move will be to further destroy you? I dont feel sorry for people at all they deserve to be gangraped along with their wives and kids and thrown in a ditch.

NotApplicable's picture

Voters, is there anything they can't make worse?

bob resurrected's picture

Have you considered moving to Mexico to fight the Mexican gangbangers?

Econolingus's picture

Riiiiight, SnoopDog-One.  And you are exactly doing what about it?

Wyndtunnel's picture

Before or after they starve to death?

mnevins2's picture

SheepDog-One - all that you say is true - until it isn't. At least that is my understanding of history. And the "isn't" sometimes can come somewhat quickly.

SheepDog-One's picture

These LUNATICS are stuck on stupid! They keep insisting the Holy Grail is 'pump money into the economy'? They havent pumped a DIME into 'the economy' it just goes into TBTF bank vaults! The PRODUCTION is gone and I dont care if you print 10 quadrillion dollars it wont make a bit of difference to a REAL economic improvement! How this country has fallen so far into pure stupidity is horrible, but at this point the people of this country DESERVE whats going to happen to them! I dont feel sorry for them at all when theyre dragged from their Lexus and their wife and kids are gangraped and killed!


the grateful unemployed's picture

Bush left office like Sherman heading for the sea. The financial crisis was the smell of burning crops. Then Obama came into office, looked over the landscape, and decided to make "scorched" earth policy. In exchange for being allowed to take the oath in January, Obama had to make certain concessions, one was to accept the financial crisis as it was written by the architects of the Bush retreat. In exchange for this concession the former President agreed to leave office, and to utter no public comment about the new President's policies. (In a perverse way Bush is like Pontius Pilate, making Jesus wash his feet, in order to clear the Pilates own soul) Obama and the Democrats agreed to absolve Bush and his people of all responsibility.

Credit Unions were still writing mortgages at the bottom of the financial crisis, but small business, which relies on national banks, was in trouble well before the crisis, and still is, otherwise the real economy would still be working. Except for the outsourcing of jobs, and the use of mortgage debt as a consumer line of credit, mostly taken up by escalating health care costs, to which no reform was forthcoming.

and yet the economy is working in most ways, except for of course the wholesale destruction of public workers and their unions.

Depending on the kindness of strangers, the Fed takes on way too much toxic MBS, and will be the subject of an equity raid itself. Then we get real change, and that will hurt more than what we have now.

SwapThis's picture

Brother SheepDog....the FED makes a profit from our debt.  They don't care where the money goes, they care where the vig goes.

rapier's picture

If all the Fed gives the monetizing cheerleaders is the promise to replace expiring paper then there are going to be a lot of disappointed fans. Those in the know will know that such is pretty significant and might be a harbinger of expanding the balance sheet again but there comes a time when the market will demand that the Fed show them the money, and give it to them.

Bonesetter Brown's picture

If the Fed wants to create some inflation they should sell some of their Treasuries and Agencies and use the proceeds to buy PIGS debt, holding total size of their balance sheet constant.

Buying more Treasuries at this point will only exacerbate current deflationary trends.

SheepDog-One's picture

Hey I got an idea, lets put some people in there who actually know what the fuck theyre doing and get rid of these madcap Zionist Keynesian lunatics before we're all DEAD! Sound like a good idea to anyone else?

NotApplicable's picture

How is that possible?

Since when do criminals provide efficient goods and services, when it is far more profitable for them to fake it, while skimming off the exce$$.

RockyRacoon's picture

Give us some names and we'll see about that. 

"We need to  make things better." is not a solution.

ModernDayYuppie's picture

Looks like it may be time to try some negative interest rates!

Who was it - Mankiw or Krugman one - who jokingly said we could do it by declaring bills with a serial number ending in "X" no longer legal tender.

snowball777's picture

Like dimwits who have hooked the air hose to the wrong tire, Bernanke and his capos can't figure out why the economy is still deflating.

Perhaps they should look at the squid inserted between the air tank and the fucking balloon, que no?

knukles's picture


The Fed is already monetizing the US's debt.  The balance sheet has exploded....assets (maybe mortgage backeds, primarily, but still GSE paper, and buying one is like buying all) and liabilities (cash).

The whole discussion is moot.  The ECB, Fed, etc, do not wish to admit ppear not to be doing so (for we all know where that ends; Wiemar Republic, Zimbabawe) but the denial is simply more political and economic polemics.

The balance sheet grows, debt is monetized.


Assetman's picture

Polemics... isn't that the truth?

The Fed went waaaaaaay beyond ZIRP the first time around.  To the tune of about $2 trillion.  And... its... beginning... to... appear... that... it... didn't... work.  Where's my inflation, dude?

What I find astoudingly dumb is the Fed's unstoppable efforts to prop up asset values without stopping to consider the consequences of pursuing such a myopic strategy.  Constantly papering an economy that needs to clear its balance sheet is an insane strategy, as sooner or later, the rest of the world will catch on to the Ponzi antics that it is.

Supposes the Fed wants to "move the needle" on inflation.  It appears they will need to do magnitudes more than maintaining current balance sheet levels, given what has already happened and what has failed so far.  They will likely need to monetize trillions $ in Treasury debt.  That's going to be one damn effective way of debasing your currency and losing sovereign credibility.  If you want to seriously risk losing your global reserve currency status, monetize away..

No... I think what we are "hearing" from this internal Fed debate is mostly "cajoling" to keep asset prices propped up for a little bit longer, perhaps to election time.  Sure, they may well do a version of "QE Lite" ,and it may have a temporary effect on keeping asset prices propped up and deflation fears at bay.  But, in the end, keeping the Fed's balance sheet where it is won't have much of an impact on economic momentum, or on long run inflation expectations.

But it is a nice way to artifically support bond, stock and real estate prices, though... since it is what the Fed is doing in practice, anyway.

chubynata's picture

Polititian always choose the easiest way.  I have no doubt that next move (already happening) is to allow the USD to devalue, regaining competitiveness and getting some inflation on the way.   If done orderly it would work since FED could keep rates low enough.  That is a lot more difficult to do when you run Current Account surplases, which was the case of Japan.  My eyes are kept on the Chinese and Europeans as they will be the main loosers in that policy. 

Moonrajah's picture

We know how to do one thing and one thing only - how to dig holes. We have studied the art of digging holes under the best minds of the century and have very detailed theories and models on hole-digging that explain everything and anything that we see in our everyday lives.

The little nasty side-effect of our hole-digging in the last few decades was that the mound of dirt that we have dug out has grown too large and we don't know who, how or when will put it all back. Oh, and the hole is so deep that we are in it way over our head.

So our best assholes (Academics for Safe and Secure HOLE digging) have come up with a brilliant solution to the problem - we will start digging more slowly. Our updated models show that this should solve our current problems.

Escapeclaws's picture

"(i) no one expected inflation to occur because of ZIRP and that (ii) they didn't try hard enough with quantitative easing."

Nice hypothesis. Let's test it now on the American economy to see if it works.

A Man without Qualities's picture

I think the BoE is very happy that the inflation rate is as high as it is, as they know getting out of a deflationary spiral is much harder.  The big difference with the UK is that most mortgage deals have a initial 2 or 3 yr term, after which they switch to a standard variable rate benchmarked to base rates.  This means most borrowers are now paying 3/ 3.5% and some less.  This is why there is not too much moaning about inflation (apart from those stupid enough not to borrow 5 times salary).  

So, if the Fed is going to throw everything at creating inflation, but the govt resets most mortgage deals.  It could get things moving a bit, but I don't it will do much for house prices, as the supply demand imbalance is too great.


Bottom line is, there will be no recovery until people have more disposable income.

chistletoe's picture

Bottom line is, there will be no recovery.