Federal Reserve | timiacono.com - Part 55

The Federal Reserve Has a Plan

After much debate following last week’s market swoon that was induced, to some degree at least, by the central bank’s dim outlook for the U.S. economy, a new plan has emerged.

From the Lee Judge archive at the Kansas City Star.

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Inflation, Unemployment, and Fed Chairmen

Here’s an interesting way to look at the performance of Federal Reserve Chairmen over the last 60 years via this item in the current issue of Time Magazine, a publication that frequently produces some compelling graphics about the U.S. economy.

On the inflation metric, this is not really fair since its calculation has changed so dramatically over the decades, stripping out the prices of things that were going up and making both Greenspan and Bernanke appear to have done better jobs than they’ve done.

We can only dream of having another Fed Chairman like William McChesney Martin…

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Did Bernanke Do That on Purpose?

Yesterday’s Fed policy statement was a curious one. What could have motivated it?

The choice of words to describe the health of the U.S. economy in the form of “significant downside risks to the economic outlook” is clearly what has sent financial markets reeling in the last 20 hours or so and the curious thing about it is that it is so out of character for the central bank.

They are normally an optimistic lot and, after making clear with QE2 last year that one of their policy goals was higher stock prices, why on earth would they choose this point in time to suddenly express the gravest of concerns for the economy?

It’s not likely that they casually added the words “significant downside risks” to the statement and they must have known what kind of impact they would have.

A look back at the policy statements in mid-2008 – about nine months into the recession that had yet to be declared and leading up to the worst financial market turmoil since the Great Depression – they expressed very little concern about how things were going.

In the Fed policy statement from August 5th, 2008, we got these comforting words:

Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.

It wasn’t until the day after the Lehman bankruptcy that downside risks were clearly characterized as “significant”, as seen from the September 16th, 2008 statement.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee.

What should one make of this seeming contradiction between then and now?

Well, the Republican’s letter to the Fed Chairman was probably a factor. To what extent, we’ll never know, but, if I were the Chairman of an independent central bank and I got that kind of letter, I’d certainly want to respond in some way.

Maybe, the Fed Chief figured he’d show them a thing or two about who wields the bigger bully pulpit and, if that was the case, then he has certainly succeeded, so far.

Another possibility is that Bernanke figured another massive bond buying program – in the form of a $1+ trillion QE3 program – would ultimately be needed and, given all the political posturing about how unpopular (and unsuccessful) QE2 was, he’d need some pretty big cover to pull that off and a tanking stock market would go a long way in filling that bill.

My guess is that it was a combination of the two.

Mr. Market to Mr. Bernanke: “Me No Likey”

Well, it looks as though the stock market isn’t too impressed with Operation Twist so far. I’ve not yet scanned the other news, but, based on the sell-off beginning at around 2:30 PM EST and then accelerating into the close of trading, it’s a pretty safe bet that markets were expecting something more from the Fed. After seeing the least volatility in months over the last week or so, stocks are suddenly volatile again as we move further into the two most dangerous months of the year with the Fed now sitting on their hands.

Look for more big swings after today’s 284 point plunge for the Dow (down 323 points from the intraday high just before the Fed policy statement was released). And it was going so good there for stocks last week when everyone thought that the Fed had their back.

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