Critics need clearer heads

I just read an article by Danielle DiMartino Booth (‘The Bernanke Doctrine is played out’ in ‘Bloomberg View’).  I left the following comment on the article:

I have been reading Ms. Booth’s commentary. They almost always provide a new angle to any story. However, I am not sure if I get the angle in this one. It is clear that the Federal Reserve dare not mention asset prices or financial stability as considerations for raising rates.

Two examples: in 1999-2000, when Greenspan embarked upon a tightening mission (175 bp.), he invoked Wicksellian natural rate of interest. That was his belated, indirect and vicarious acknowledgement of the stock market bubble that he had helped spawn with his aggressive rate cuts to the 1997-98 Asian crisis, Russian Default and then the imagined and exaggerated Y2K fears. His favourite measure of inflation – PCE Core Inflation Rate – never breached 2% (y/y) during his tightening phase.

In 2001-08, the Fed might have officially stopped raising interest rates in 2006 but it kept up with its hawkish rhetoric up to 2007 August. That too was a nod to financial stability concerns arising out of the bubble that their monetary policy had created.

Now, again, the Federal Reserve had waited for too long to raise rates. When they did, they did too little over the last two years: 2015 and 2016.

[Geopolitical concerns or capture cannot be ruled out. They might have been worried about the impact on China, had they tightened somewhat more steadily than they had actually done. Or, they were under the spell of China and financial markets for less benign and less intellectual considerations. We will never know. As theoretical possibilities, they cannot be ruled out.]

So, even though standard economic arguments might weaken the case for sustained hiking of interest rates, they are well aware that, in many respects, they had created another asset bubble monster, the world over, again: stocks, real estate, emerging market bonds, high yield bonds, stock buybacks and M&A. There has been a big surge into U.S. domestic equities in the last few months – remarkably since Nov. 2016 reversing the long spell of equity fund withdrawals. That could be a sign of ‘panic buying’. May be, the Federal Reserve is watching all of this and is tightening accordingly – again, too little too late.

But, it dare not say why it is doing so. That is their intellectual blind spot.

So, to ask them to stop tightening because inflation measures are not warranting one, is confounding. Then, why were they being criticised for being too lax and being asleep at the wheel in 2005-07?

The message to them must be to come clean on why they are tightening and admit to the inadequacy of their models that delayed tightening for this long rather than beseeching them not to tighten further. That would only further aggravate the global bubbles in the various markets mentioned above.

Any crash from then on would be more painful, if it is not already going to be so.

In sum, critics should be clear-headed; only then can we offer clear advice to the policymakers.


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