Monday 22 July 2019

Why tapering may take longer than expected

James Saft

LIKE corded telephones, it is looking like our grandchildren will someday need to have the concept of rate hikes explained to them.

Seriously, someone needs to put a Federal Reserve statement with an interest rate hike into a time capsule so future civilisations can know that once upon a time, monetary policy could become something known as 'tighter'.

And as for the taper, which only recently we were expecting, that too may take quite a while.

In fact, now that we have what passes for a budget deal in Washington, we, and the Fed, can get on with the important business of counting the four top reasons not to taper.


1. There was never economic justification.

There probably wasn't sufficient justification to tighten conditions back in August, before this mess transpired. Inflation was too low and job growth and labour force participation too anaemic. Tightening now would require some new, positive reason, or an overriding commitment to risk management and bubble prevention.

2. There is no new, positive reason – quite the reverse.

The government shutdown did real damage to the economy, both directly and, more importantly, indirectly. Consumer confidence suffered, which is reflected in the buzz coming out of the retail sector.

A study carried out by Macroeconomic Advisors attempted to put the cost of three years of crisis-driven budget negotiations and fiscal policy and came up with a sobering conclusion: it has shaved about one percentage point off of output a year. Borrowing costs are higher than they otherwise would be, and discretionary spending lower.

3. You think this is over? This isn't over.

Despite what anyone may say, we are going to be going down the budget impasse road yet again sometime soon. That not only increases the risk of default, it raises and extends the pause in consumption and investment the budget morass has already caused. All of this makes it possible that Fitch Ratings, which put the US on ratings watch for a possible downgrade of its AAA-rating, will actually pull the trigger.

4. Even the hawks don't like chicken any more.

When arch-hawk Richard Fisher of the Dallas Fed comes out saying the taper has "all been swamped by fiscal shenan- igans", you know we are on hold for some time. True, Esther George of the Kansas City Fed came out again in favour of tapering, but wider support in the near term should be hard to find.


None of this makes a taper in December entirely impossible. There is a press conference then, and now that we have the government collecting data once again, it is possible we'll see some figures that could be used in justification.

But that data is more likely to reflect deteriorating conditions, as the impact of the budget mess makes itself felt.

To be sure, there would be a certain poetry in Ben Bernanke beginning the taper, and he has December and January meetings at which this could be done.

In the absence of really strong data, however, the temptation has to be to wait at least until March, which has a press conference and will be Janet Yellen's first bite at the apple.

Tapering is supposed to be as much about communication as action, so there could be a justification in allowing the person who will bear the load to do the explaining.

Of course, by March we will have more opportunities to shoot ourselves in the foot by defaulting, or by otherwise creating pointless uncertainty over our ability to govern ourselves.

You could, of course, construct a good argument that the Fed should be tapering anyway. That it is not its job to insure the US economy against malpractice by its duly elected representatives. And that, moreover, the longer we continue with QE, the more the negative side-effects pile up. Specifically, QE fosters poor allocation of capital and the formation of bubbles, and does it while disproportionately benefiting the wealthy and financial intermediaries.

Those are reasonable arguments, and just might be true, but they are unlikely to prevail.

More likely, the economy will continue to struggle, Washington will continue to throw sand in the wheels and the Fed will do what the Fed does, which is to support asset prices and financial markets.

A return to "normal" may take a very, very long time. (Reuters)

Irish Independent

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