Submitted by David Stockman via Contra Corner blog,
Opining gravely, medieval theologian Thomas Aquinas asked, “Can several angels be in the same place?”
In only slightly modified terms, the Fed is now pre-occupied with a similarly unanswerable and fanciful question, according to Jon Hilsenrath’s pre-meeting missive on the Fed’s current monetary policy “debate”. Figuratively estimating the number of angels which can dance on the head of a pin, Fed officials and economists suppose they can specify the the appropriate money market rate down to the decimal place for virtually all time to come:
When Federal Reserve officials gather for their policy meeting Tuesday and Wednesday, the most challenging question won’t be where to push interest rates in the next few days, weeks or even months. It will be where rates belong years into the future.
So if you want to know why there are exceedingly dark clouds gathering on the economic horizon just consider some of their answers and the reasoning behind them. Until recently, a majority of our monetary plumbers in the Eccles Building believed that the ideal long-term Federal funds rate was around 4% in a “well balanced” macro economy where inflation is about 2% and unemployment is about “low” around 5.5%.
Of course, every one of these three magic numbers are perfectly arbitrary, academic and silly. Due to the structural failures of the US economy owing to decades of destructive Washington policies, the “unemployment rate” today is not remotely comparable to what was being measured in the 1950s and 1960s when today’s Keynesian theology with respect to the Phillips Curve, Okun’s Law and full-employment policy was being formulated.
Today there are 102 million adults not holding jobs, for example, but only 43 million of these are retired on OASI (social security) and just 11 million are counted as officially unemployed. At the same time, there are upwards of 40 million part-time job holders, which self-evidently represent additional unutilized potential labor hours. So there are upwards of 100 million adults in America who represent a massive but latent labor supply that makes a mockery of the silly “U-3″ unemployment ratio that the Eccles Building theologians insist on counting down to the decimal points.
Stated differently, the BLS recently revealed that the private business sector of the US economy generated 194 billion labor hours in 2013—the exact same number as way back in 1998 and notwithstanding the massive growth of the adult population in the interim. Indeed, as recently as 2000, there were only 75 million adults (16-years and over) not holding jobs. Yet of the 27 million gain since then, only 7 million entered the OASI rolls. This means that during a 14 years period in which there was no growth of aggregate labor hours in the business economy, 20 million more adults ended up in the safety net, in mom and dad’s basement or on the streets.
These realities are not a mystery, and they do reflect a dangerous fiscal and social policy breakdown. But they are also thumping proof that monetary policy has exactly nothing to do with employment conditions and job creation. During the last 15 years, the Fed engaged in massive and nearly continuous Keynesian stimulus maneuvers, expanding it balance sheet 8X from $500 billion to $4.3 trillion. Yet millions of employable adults and billions of available labor hours have been flushed out of the private economy, while measured hours worked have been absolutely frozen.
The excuse that counting decimal points on the head of the U-3 unemployment rate may sound medieval but that Humphrey-Hawkins makes them do it is just palaver. The so-called dual mandate and minimum unemployment target is just a vague statutory aspiration; there is no quantitative target in the law and the current U-3 version of the endless alternative ways to measure the “unemployment rate” did not even exist when the statute was passed in the late 1970s.
Accordingly, when Bernanke previously, and Yellen now, appear before the Congress or press and piously intone about their full employment “mandate” being a license for perpetual money printing they are simply indulging in a self-serving lie.
The same foibles pertain to the 2% inflation target. Its not in the law; and until the last two decades, price stability was thought to mean an average of zero inflation over time. Certainly William McChesney Martin and most of the first generation of modern Fed policy-makers believed that. Even today, Paul Volcker properly asks why is 2% inflation forever so virtuous when it means that the purchasing power of the dollar will be cut in half every 30 years.
And that doesn’t even consider the total manipulation of the BLS inflation measures that happened beginning a decade after Humphrey-Hawkins was enacted. These manipulations include arbitrary hedonic adjustments for “quality”; continuous reweighting of the price basket based on substituting cheaper chicken for more expensive beef; the use of geometric means to eliminate items with extreme increases; and of course, the foolishness of excluding food and energy from the price index used to make Fed policy—-the so-called PCE deflator. Rational policy in a $17 trillion economy caught in vast global cross-currents cannot be made based on trends shorter than one year. So on a running one-year basis there is no distortion due to food and energy price spasms, and these items are the foundation of every household budget.
Thus, the 2% inflation target is just more monetary Thomas Aquinas. And this is especially the case with respect to the lame proposition that the inflation target is being missed from below. As shown in the graph, there has never been a sustained period since the 1990s in which there was a shortfall of inflation from below. The entire notion of inflation targeting, in fact, is just self-serving Keynesian nonsense that provides yet another excuse to keep the printing presses going at full tilt.
What deflation? 16 years of creeping CPI.
But the most egregious of the three magic numbers is the target for Federal funds. The entire discussion as reflected in the Hilsenrath notes is that it is the “control variable” which has no other purpose than to be manipulated by the twelve allegedly wise men and women who comprise the FOMC. Yet that is the heart of the anti-capitalist folly that constitutes current monetary policy.
In fact, the money market rate is the most important single price that exists—its the price of leveraged financial speculation and the carry trades. It needs to be set by honest price discovery in independent markets for genuine private savings and business driven short-term borrowings. Rather than being a pure creature of Fed manipulation—–its determination should never happen within a country mile of the Eccles Building.
Once upon a time the founders of the Fed understood this, and provided that the nation’s new central bank would operate as a “bankers bank”, passively providing liquidity against real bank loans and discounts at a penalty rate above a floating or mobile discount rate set by the market. The virtue of that pre-Keynesian model is that is guaranteed honest two way markets and thereby built-in checks and balances on speculators on Wall Street. And it did not pretend that this mobilized discount rate was a tool to manipulate the entire GDP, the unemployment rate, the CPI, housing starts or consumer spending. Instead, these were to be outcomes on the free market, not orchestrations from Washington.
In short, the pre-Keynesian Fed would not be counting decimal places on the head of the Federal funds rate, nor would it be listening to the likes of William Dudley gumming about immeasurable things like “headwinds” or Larry Summers arriving at a 3% Federal funds target on the preposterous grounds that the world is suffering from a flood of excess “savings”!
This simply illustrative the massive intellectual confusion of the Keynesian model. The world’s central banks have created a tsunami of credit, but there is no balance sheet in the Keynesian model, only quarter-by-quarter flows. So Professor Summers makes the lunatic argument that since the Federal deficits has declined for several quarters, that means there is too much savings.
Mr. Summers, in an email exchange, said a broader set of factors will hold down rates in the years ahead. Around the world, households (especially wealthy ones and older ones), businesses and governments are saving more, piling resources into bonds and driving down interest rates in the process.
“I suspect unless circumstances change fed funds rates may well average less than 3[%] over the next decade,” Mr. Summers said…..
They suggested that once these headwinds recede, rates can go back toward their long-run averages. But more recently, some Fed officials have acknowledged the possibility of a lingering weight on rates.
A 4% fed funds rate would be “much too high in the current economic environment in which headwinds persist, and somewhat too high even when these headwinds fully dissipate,” New York Fed President William Dudley said in a speech last month.
Thomas Aquinas would be proud.