As Komal Sri-Kumar points out in this harsh (but fair) discussion of the Fed, (as Tim Iacono notes [11]) the central bank’s abysmal track record on forecasting economic growth and how they have a fantastic track record for “taking the punch bowl away” far too slowly should worry all. "The Fed has been wrong every time on its growth forecast and overly optimistic," Sri-Kumar rants, adding that "the Fed is wrong in terms of its benevolence to the markets." The current environment reminds him of early 2008 noting there are "lots of characteristics which are similar and it worries me a lot." Simply out, "they’ve had five years of quantitative easing, big bond purchases, quintupling of the Fed balance sheet. And we don’t have sustainable economic growth," but the great medication is not working, and "the remedy is that you have to take the shock."
Transcript with Bloomberg's Tom Keene:
Q: What was the key moment within the Janet Yellen news conference on Wednesday?
A: I think the key moment was at 2:47 pm. She essentially said the punchbowl is there and she’s simply not going to take it away. I don’t think they’re going to raise interest rates at the end of 2015 either because the Fed has been wrong every time on its growth forecast and overly optimistic. And as growth disappoints in the second half of the year, I think the rate increases are going to be postponed.
Q: Here is a quote from you after the FOMC meeting: ‘Why are we allowing supposedly ‘emergency measures’ introduced in 2008 to go into their seventh year? What will the Fed do when there is a true shock – increase bond purchases to 100 gazillion, to 250 gazillion?’ This was a substantial takeaway on what the Fed has gotten wrong. What’s the remedy right now?
A: The remedy is that you have to take the shock. You have to stop quantitative easing. You have to have a symbolic increase in interest rates. The Federal funds rate has to go up 1/4 or 1/2 a percent. It will cause a shock to the market. It will bring down equities. It will cause bond yields to rise. Take that medicine now or be prepared to take a much stronger medicine later on when the illness gets worse.
Q: Given the fact that we have unemployment at 6.3 percent, that’s good. We have inflation moving up in terms of the CPI, close to 2.1 percent, that’s good. Why is Yellen still keeping the punchbowl here?
A: She’s keeping the punchbowl because she’s worried about the long-term unemployed. She realizes that the 6.3 percent unemployment rate is largely because of the falling participation rate. She knows there is a lot of pain. And that’s where I think the change comes. That’s where I think the Fed is wrong in terms of its benevolence to the markets.
Q: Is this a bull market you can believe in? Or is it a house of cards developed by not just Chair Yellen but BOE Governor Mark Carney and the other central banks?
A: That’s a great question. I would say this reminds me so much of the first half of 2008. Oil prices were very high and growth prospects were said to be doing very well and everybody was feeling very complacent about the overall in May and June. The ECB raised interest rates in July of 2008 thinking inflation was the major risk. We have lots of characteristics which are similar and it worries me a lot.
Q: You have been persistent in a call for subdued global economic growth combined with a little inflation. What do the optimists get wrong?
A: The optimists expect that the monetary growth, the quantitative easing, will produce economic growth at a rapid pace. Sometimes when you take a medication and it hasn’t worked for five years, you better change your medication. But that’s essentially the error with the optimists. They’ve had five years of quantitative easing, big bond purchases, quintupling of the Fed balance sheet. And we don’t have sustainable economic growth. Why not say you need a different medication? We started out with a zero interest rate in 2008 and we have evidence again and again from Robert Mandel, Milton Friedman, that monetary policy is ineffective at very low interest rate levels. The other problem is unemployment is becoming structural. That means long-term unemployment cannot be changed via monetary policy.
Q: What kind of short-term fixes are on the table?
A: I don’t think there are any short-term fixes. Especially after five years of not having done much. I’ll go one step further beyond fiscal policy. If you’re saying just spend more money and that will create jobs, we tried doing it in 2009 and 2010. It’s just not going to happen.
