We would be remiss if we did not note that the Federal Reserve announced yesterday that it was going to keep printing money until the unemployment rate -- as incomplete a measure of employment as one might choose, notwithstanding its propaganda value -- falls below 6.5%, unless the inflation rate rises above 2.5%. The big change is that rather than relying on the reading of tea leaves and mood, the Fed has picked a visible metric and will flood the zone until that metric has been achieved, with only the inflation rate as a governor. Naturally, we have a number of observations with questions.
First, we note with interest that the Fed has decided that it will get better results by being explicit rather than, well, not. Heretofore, and certainly under Chairman Greenspan, the view seemed to be that markets would be less prone to discount (that is, immediately reflect) monetary action if they did not know how long it would go on. So, for instance, if markets do not know that temporary stimulus is temporary, they may be more likely to take it for underlying economic health and bid up prices. In effect that meant that it was (in theory) possible to "deceive" markets in to thinking that we were more prosperous than we are, and that made stimulative monetary interventions more effective. Was that old thinking wrong?
Second, one of the lessons we learned during the financial crisis is that monetary authorities ought to be concerned with credit creation, perhaps even more than inflation. Too little and the economy stagnates, too much and you get a debt bubble. One of the reasons we got in to trouble was that the Fed thought that consumer price inflation was a good secondary indicator of credit creation. Sadly, however, consumer prices remained stable even while debt ballooned because of huge reductions in cost (primarily by the shifting of so much manufacturing to China and other low cost countries), and the Fed failed to tighten in time to avert disaster. In reverting to inflation as a proxy for credit creation, are we at risk of repeating the massive folly that preceded the financial crisis?
Third, the effects of this shift in policy are not merely economic, but also political. By turbocharging monetary policy in the absence of a deal on the "fiscal cliff," the Fed is fundamentally indemnifying our political class against the consequences of its own incompetence. Anybody else worried about that moral hazard?
Fourth, we wonder why the Fed did not announce this change in policy before the election. Most likely, to preserve its credibility as above or apart from politics. Fine, protecting the credibility of the institution is part of the any leader's charge. But if the new policy is so beneficial, we should remember that the Fed may have deferred its implementation (and therefore its economic benefits) for political reasons.
Release the hounds.