A few years ago, Ben Bernanke likened sitting in the big chair at the Federal Reserve to attempting to tune up a car engine while driving said car at 60 miles per hour.
Given that the central bank seems intent on adjusting its $85 billion in monthly bond purchases up or down on a somewhat regular basis beginning sometime later this year, it appears that car tune-up analogy is applicable again and Bloomberg’s Caroline Baum has some thoughts on the subject (the Fed, not the analogy) in this commentary today.
If I understand Bernanke, he is saying that every six weeks policy makers will examine an array of leading, coincident and lagging indicators, most of which are revised and subject to seasonal distortions, to take the economy’s pulse and reassess the forecast. From there, they will determine the appropriate amount of monthly bond purchases.
This idea is as infeasible in theory as it is in practice.
Unlike the physician who uses real-time feedback to adjust the dose of a patient’s medication, central banks operate in a world of long and variable lags. Their predictive models have a poor record. The continuation of QE has always been predicated on an improvement in “the outlook for the labor market,” rather than an improvement in the labor market per se. Call it a better jobs market once removed. The inherent flaws in the theory should be apparent.
As a practical matter, the plan is no more viable.
“The Fed doesn’t have a methodological way of calculating the relationship between asset purchases, interest rates and the economy,” says Jim Glassman, senior U.S. economist at JPMorgan Chase & Co.
He’s right. But you could say the same thing about the Fed’s traditional policy tool, the federal funds rate, and the preference for adjusting it in 25-basis-point steps, according to Neal Soss, chief economist at Credit Suisse Group AG in New York. Both have “the same element of science, judgment, and trial and error,” Soss says.
He’s right, too. But interest rates are a lot more visible.
The conclusion that this will be “an extreme case of micromanagement that is likely to run amok” seems spot on and the Fed may already be regretting what, to some, appeared to be a somewhat hasty decision back in December to launch open-ended QE.