Ben’s secret “weapons” revealed

Talking about Ben’s speech at Jackson Hole I drew your attention to the lack of details regarding the policy tools left at his disposal to further help the US economy. As expected those tools were somewhat detailed in the minutes for the FOMC meeting of August 9th.

Here is the paragraph looking at those instruments:

” Participants discussed the range of policy tools available to promote a stronger economic recovery should the Committee judge that providing additional monetary accommodation was warranted. Reinforcing the Committee’s forward guidance about the likely path of monetary policy was seen as a possible way to reduce interest rates and provide greater support to the economic expansion; a few participants emphasized that guidance focusing solely on the state of the economy would be preferable to guidance that named specific spans of time or calendar dates. Some participants noted that additional asset purchases could be used to provide more accommodation by lowering longer-term interest rates. Others suggested that increasing the average maturity of the System’s portfolio—perhaps by selling securities with relatively short remaining maturities and purchasing securities with relatively long remaining maturities—could have a similar effect on longer-term interest rates. Such an approach would not boost the size of the Federal Reserve’s balance sheet and the quantity of reserve balances. A few participants noted that a reduction in the interest rate paid on excess reserve balances could also be helpful in easing financial conditions. ”

But those views were not shared by all participants. Some thought :

“In contrast, some participants judged that none of the tools available to the Committee would likely do much to promote a faster economic recovery, either because the headwinds that the economy faced would unwind only gradually and that process could not be accelerated with monetary policy or because recent events had significantly lowered the path of potential output. Consequently, these participants thought that providing additional stimulus at this time would risk boosting inflation without providing a significant gain in output or employment.”

However, they all agreed that the topic is very important and decided:

“Participants noted that devoting additional time to discussion of the possible costs and benefits of various potential tools would be useful, and they agreed that the September meeting should be extended to two days in order to provide more time.”

This last paragraph is what worries me. It shows clear determination from Ben & Co. to use any means possible to introduce further stimulus in the economy. It is either they believe that QE2 has worked or that it was not enough. But the thought that this is the wrong policy tool for the current situation does not occur to them.

While all this discussion about further stimulus pleases the markets it worries me as it is proof that the FED has only one solution and will use it over and over again hoping that it will work. It shows lack creativity and assertiveness from the FED. Ignoring the real problem, fiscal deficit and ailing banking sector, the FED is just buying time. But lowering the long term interrest rate through its program of buying securities in an economy faced with prospect of higher taxes and still losses on the books f banks (i.e. costs that need to be covered) will not induce investement.

The Fed and fiscal authorities in US (and not only) are facing a big problem: the capital is pushed through current incentives to move to the wrong sector. Currently capital is attracted to government securities, commodities speculation and cash.

Solving the fiscal problem and creating stability will push capital at least from government securities and cash to other sectors immediately. The commodity bubble will be running out of steam as other assets will start showing returns to investors.

In today’s environment the combination of uncertainty and wrong incentives has scared capital away from investments.  To get it back into investment policy makers need to come up with credible fiscal and monetary policies for the long run. Not just to please the spoiled markets.


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