That’ll teach me to go on a one week vacation!
Over the past few weeks the Fed has reduced NGDP expectations even further below their already dismal levels. Today’s decision reached a new level of futility. The Fed did correctly diagnose the problem, slowing growth and slowing inflation (i.e. slower growth in NGDP.) But they failed to construct any sort of effective policy response. The FOMC doesn’t seem to understand that it’s not the Fed’s responsibility to forecast slower NGDP growth, it’s the Fed’s responsibility to prevent slower NGDP growth.
Yes, there was the decision to promise low interest rates as far as the eye can see; but ultra-low rates are merely a sign that money has been too tight. The bankrupt Keynesian theory (that central banks must target interest rates) is what got us into this mess. Keynesians had no answer for a scenario where rates hit zero. And now the same bankrupt Keynesian model is preventing us from exiting the low spending morass. Zero rates won’t solve the problem as Bernanke ought to understand from his studies of Japan.
And as for the three hawks, who argued that even doing nothing is much too stimulative in a world of collapsing nominal growth expectations, I hardly know what to say. One would have to go back to the 1930s . . .
Don’t be fooled by the late rally in stocks. The real stock market response to the Fed has occurred over the past few weeks, as NGDP growth expectations have plunged (based on plummeting yields in the T-bond market.) Stocks may benefit slightly from the fact that rates will stay very low for an extended period, but the level of stocks is still far below what one would expect if there was a healthy growth outlook (as in 2007.)
In recent weeks the stock and bond markets have predicted a Federal Reserve policy failure of epic proportions. Let’s hope they are wrong. Unfortunately, when bold action is needed, hope is all the Fed seems willing to offer.
[I’ll do a few more short posts, and catch up on comments tomorrow.]