I went to sleep on Tuesday night content that the markets were in good shape – only to wake up to the news that a 2% fall in the S&P was being blamed on Philly Fed President Charles Plosser’s ‘…attack on QE3.’ The financial press left it at that – but Chuck is no fool, and in fact a far brighter scholar than Ben Bernanke, so let me enlighten my blog followers on what he actually said and what he actually meant.
Chuck was my thesis Chairman and he doesn’t take issue with light matters nor does he seek publicity. His comments should be savoured.
His first point is that the US recovery is actually quite mature and by his estimates likely to accelerate. Noting that property markets have adversely affected individual’s wealth, it is not surprising that people are spending less in order to rebuild their portfolios through saving. This is standard New-Classical thinking – negative wealth shocks need to be rebuilt with future saving – and therefore the recovery cannot rely on consumption to spur growth. This is a big shock to the Keynesians, but the logic is compelling.
His next point follows immediately … if the recovery is happening, why QE3 and why risk the Fed’s reputation if, all of a sudden, they need to reverse policy? Stupidly, Bernanke and his supporters have chosen to ‘commit’ the Fed to a calendar policy timetable – that is, the Fed has said that there will be no rate hikes until 2015. Plosser’s simple point is that the unemployment rate could easily fall to, say, 6% in 2013 and this would place huge stress on the Fed to renege on their own timetable. Why not, said Plosser, make Fed policy conditional on economic outcome rather than a calendar date? For example, if unemployment falls to 6% then the Fed will raise rates to 2%….
Plosser deserves a Nobel prize for eloquence and simplicity. But creating a monetary policy rule that relates Fed action to economic outcome naturally takes the fun and bravado away from the extreme Central Bankers that now hold court around the world.
Plosser’s final warning is that policy confusion ultimately leads to market volatility …. here we go again!