With part two of today's Fed-a-palooza due out shortly in the form of the May 1 FOMC meeting minutes, here is an informative recap of the current roster of assorted birds at the FOMC via Bank of America. Of course, since every decision always begins and ends with Ben, and soon his replacement Janet, all of below is largely meaningless.
Hawks, doves, owls and seagulls
Speeches by FOMC participants often get a fair bit of attention, and that has been particularly true of late. The markets are very sensitive to any hint that the Fed might scale back QE3 soon. Unfortunately, given the diversity of views on the FOMC, it is not always easy to separate the signal from the noise when Fed officials speak. The best advice is to listen to the voters (Table 1), especially the core members: Chairman Ben Bernanke, Vice Chair Janet Yellen and New York Fed President Bill Dudley (and vice chair of the FOMC).
While FOMC participants are typically split along a hawk/dove spectrum, in the current group there are several Fed officials with more nuanced views. For example, there are some arguably hawkish (or formerly hawkish) participants who nonetheless favor additional accommodation. Conversely, there are those who are typically thought of as doves yet who advocate scaling back QE more quickly. These conflicting cross-currents only add to the market’s confusion.
To understand most Fed officials’ policy preferences, it helps to step back and consider their philosophical bases — which for many goes back to their training in economics. Specifically, many of the divisions on the FOMC reflect differences between “freshwater” and “saltwater” schools of thought in economics — so named for the location of the US graduate schools (inland versus the coasts) where each has been most prevalent. In brief, freshwater economists emphasize market efficiency, rational expectations and policy ineffectiveness, while saltwater economists see market failures, multiple equilibria and a role for countercyclical
Some key differences between these two schools of thought as they relate to monetary policy are listed below:
- Monetarists versus New Keynesians: The basic modeling framework for freshwater economists is often monetarist, where the key responsibility of a central bank is long-run price stability. Saltwater economists use a New Keynesian framework that suggests policy can help stabilize markets.
- Inflation vs. unemployment: Freshwater economists see inflation as having a clear priority in the Fed’s dual mandate, and are skeptical that unemployment (or slack more generally) has much to do with inflation. Saltwater economists see reducing unemployment as its own objective in the short-run. Both sides agree that a central bank should credibly commit to a long-run nominal anchor, like an inflation target.
- Structural vs. cyclical labor market factors: Freshwater economists tend to see a significant portion of current unemployment as structural; equivalently, they see underlying equilibrium unemployment rate as relatively high right now — and not amenable to monetary policy stimulus. Saltwater economists believe that the labor market suffers mostly from cyclically weak labor demand. Some have suggested that policy needs to be very easy to prevent persistent cyclical unemployment from becoming structural. They forecast the NAIRU (the unemployment rate consistent with steady inflation) to be relatively low (perhaps 5%); saltwater types think it is higher.
- Transmission mechanisms. Monetarist channels of greater liquidity and credit creation are key for freshwater views; these are seen as currently ineffective in promoting growth but a risk for higher inflation. The New Keynesian view associated with a saltwater approach emphasizes low interest rates stimulating demand and higher asset values allowing for balance sheet repair and creating a wealth effect.
- Inflation expectation risks: Freshwater adherents see inflation as determined by the pace of money printing and policy credibility; they worry that large central bank balance sheets risk rising inflation expectations. Saltwater economists counter that persistent low inflation and large output gaps risk inflation expectations deteriorating below long-run inflation targets.
- Costs vs. benefits of QE: Freshwater economists are skeptical of any benefits from QE for real activity, and worry about the potential costs in terms of inflation and financial instability. Saltwater economists see unconventional policy as simply an extension of easing when at the zero lower bound; the way it should work is similar to “normal times.” Both sides are uncertain of the efficacy of continued QE, but saltwater economists tend to be more optimistic of its effectiveness.
From theory to practice
Freshwater programs are associated with universities such as Chicago, Minnesota and Rochester. Saltwater views are more common at institutions such as MIT, Princeton and Yale on the East Coast, and Berkeley on the West. A similar pattern is found at the regional Federal Reserve Banks: those on the coasts tend to have saltwater orientations, while those inland skew more toward freshwater views. But in both cases, there are interesting exceptions that we discuss below.
For most FOMC participants, the freshwater/saltwater divide mirrors the hawk/dove categorization — Chart 1 plots a fairly standard spectrum for the current FOMC participants. Thus, for example, the steady hawks have strong freshwater connections. The research records of Philadelphia’s Charles Plosser and Richmond’s Jeffrey Lacker belie the East Coast locations of their Banks. While Dallas’s Richard Fisher and Kansas City’s Esther George are not trained as economists, they hail from solidly freshwater Banks. The backgrounds and affiliations of each FOMC participant are listed in Table 2.
These four members have cast the majority of dissents in recent years (in addition to George’s predecessor at Kansas City, Thomas Hoenig, who also was a serial dissenter). They have been critical of QE since its first round, and have lately called for its early end, arguing the costs exceed the benefits. Of this group, only George is a voter this year, and we expect her to dissent at least until the Fed starts to taper QE3. As Chart 2 shows, a core group of hawks have been a persistent source of dissents during Bernanke’s time as chairman — nearly 60% of FOMC meetings have not been unanimous since he took the helm in 2006.
At the other end is the more dovish majority. This group includes Chairman Ben Bernanke, Vice Chair Janet Yellen, and New York Fed President Bill Dudley, as well as Boston Fed President Eric Rosengren. All are voting members this year. We expect the other Board members who are not trained as economists — Sarah Bloom Raskin, Elizabeth Duke, Jerome Powell and Daniel Tarullo — to vote with the majority, as all have indicated support for the current policy stance within the past few months. And while some in the market have speculated that Governor Jeremy Stein has a hawkish streak after his 7 February speech on “Overheating in Credit Markets,” we note that he characterized his discussion as “an extended hypothetical” and concluded that any potential losses are “confined” and a “relatively limited” source of systemic risk.
Neither fish nor fowl
Other Fed officials do not fit into this hawk/dove categorization quite so neatly. Atlanta’s Dennis Lockhart and Cleveland’s Sandra Pianalto are typically centrists who vote with the majority; lately Lockhart has been generally supportive of the current QE plan, while Pianalto has raised some concerns. Neither is a voting member this year, but Pianalto will be a voter in 2014.
Three Midwestern Fed bank presidents are less hawkish than their counterparts at Dallas or Kansas City, despite their freshwater training: Chicago’s Charles Evans, Minneapolis’s Narayana Kocherlakota, and St. Louis’s James Bullard. Both Evans and Bullard are voters this year, while Kocherlakota votes in 2014.
We consider them the “owls” in our classification, given their tendency to make model-based arguments around policy — and to have taken more dovish policy positions recently. All three have given their support to QE3 purchases, for example, and Evans and Kocherlakota both have enthusiastically promoted the use of economic thresholds for forward guidance.
St. Louis’s James Bullard
Bullard is arguably the most traditionally hawkish of the owls, describing himself as the “north pole of inflation hawks” — despite regularly drawing on New Keynesian models in his research. He also has been the most vocal advocate of making small changes to the purchase pace for QE. In his most recent speech on 21 April, he said that QE “remains the best monetary policy option” in the current situation and recommended continuing at the current pace.
Note that Bullard is regarded as having been early in calling for QE2, although he also has been an opponent of forward guidance — so his track record as a barometer of where the rest of the FOMC may go has been mixed. Bullard has argued for beginning to taper QE3 as the unemployment rate gets close to 7% and growth rises to around 3 ¼%. While he has seen these outcomes as possible by the end of this year, the March projections by the FOMC suggest most of his colleagues don’t expect to hit those criteria until later next year.
Minneapolis’s Narayana Kocherlakota
Kockerlakota has a relatively short history on the FOMC — he became President of the Minneapolis Fed in October 2009 and first voted in 2011 — but it has been
a colorful one. In 2011 he twice joined Fisher and Plosser in hawkish dissents: against introducing a calendar date for forward guidance in August, then against additional accommodation in the form of Operation Twist in September. However, in September 2012, Kocherlakota had a road-to-Damascus conversion. He completely changed his song, and called for the Fed to adopt a “liftoff plan”: keep rates low until the unemployment rate hits 5.5% — provided that inflation was no more than 25 basis points above target. Since then, he has said that more stimulus would be “desirable.”
In our view, Kocherlakota is the owl most likely to change his feathers and become more hawkish again. However, we would not expect that to happen while inflation is running (well) below the Fed’s long-run 2% objective. If the outlook for PCE inflation one- to two-years ahead were running above 2.25% or so, we would then expect him to revert to a hawkish stance. But as of now, that looks rather unlikely for next year, when he is once again a voter.
Chicago’s Charles Evans
Evans has been the most avidly and consistently dovish of the owls, supporting aggressive Fed easing as a voter in 2009 and 2011 — and dissenting twice, in November and December 2011, in favor of additional policy accommodation. In late 2011, Evans developed and refined what would ultimately become the threshold approach to forward guidance that the FOMC as a whole adopted in December 2012. Evans’s advocacy for this approach was cited by Kocherlakota as a strong influence over Kocherlakota’s own thinking.
Evans is a voter again this year. In his most recent public remarks on 20 May, he sounded more optimistic about the outlook for growth and employment, although he said he would like to see at least a few more months of data before thinking about tapering. Evans also repeated his condition of several months of greater than 200,000 in monthly payroll growth as a marker for a “substantial” improvement in the labor market. He observed that the Fed is missing on both its employment and inflation objectives, and said the Fed needed more time to assess the effects of policy. He also noted that it was important that policy makers did not become complacent given the still powerful headwinds facing the economy. On net, we interpret Evans’s remarks as suggesting the earliest he would support tapering would be early fall, and mid-year slowdown would reset the clock.
Whereas the owls are dovish-sounding FOMC participants who have hawkish (freshwater) backgrounds or inclinations, the “seagulls” are saltwater doves who have flown far from shore and are starting to sound more hawkish. While some might put Stein or the latest remarks by Evans in this category, we currently see one main member of this group: San Francisco Fed President John Williams.
San Francisco’s John Williams
Before becoming the president of the San Francisco Fed, Williams worked as a staff economist at the Board of Governors in Washington DC and at the San Francisco Bank. Much of his research has been in a New Keynesian framework. And he has been relatively dovish in his speeches since becoming president in 2011. Lately, however, he has been talking about a possible early end to QE3.
In his most recent speech on 16 May, Williams discussed the progress made since QE3 began, noting that the labor market has “improved considerably” but not yet “substantial improvement” — that will take “further gains.” However, he went on to say that “assuming my economic forecast holds true” and “appreciable improvement” occurs in “various labor market indicators” in “coming months,” then the Fed “could reduce somewhat” the purchase pace “perhaps as early as this summer.” “If all goes as hoped,” the Fed could then conclude QE3 “sometime late this year,” according to Williams.
There are a lot of conditionals in those statements, and they require a lot of things to go right. In effect, Williams has outlined more of a “best case” than a “base case” for tapering and ultimately concluding QE3. He has had a similarly optimistic outlook for the past few months, while acknowledging many of the downside risks that have kept his more dovish colleagues cautious and less willing to advocate for a quick end to QE3. That, in our view, makes his current views less representative of the FOMC majority. Given the markets typically view the San Francisco Fed as particularly dovish, he also may be trying to create a more balanced impression and avoid being labeled an über-dove. Most importantly, however, he is not a voter again until 2015.
Birds of a feather
A number of current FOMC participants do not fit so easily into a simple hawk/dove division. While it is still possible to broadly characterize the 19 Fed officials at the FOMC meetings along such a spectrum (as we have done in Chart 1), that can increase the risk that the views of certain members are misconstrued as giving greater insight into the likely policy choices of the Committee than is warranted. As we noted at the outset, most attention should be given to the core of the Committee: Chairman Bernanke, Vice Chair Yellen and New York Fed President Dudley. In addition, it pays to focus mostly on the FOMC voting members — and the current group skews dovish, in our view. Fade the hawks, but also be cautious about interpreting the owls and seagulls — they sometimes fly far from the majority.