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Below, please find highlights from a weekly perspective of the national economy written by
JPMorgan Chase Senior Economist, James Glassman.
Markets and the Economy
February 15, 2010
Market participants are still wondering why the Fed is talking about the fire exits in the
theater before the main feature begins. Is this just the perfunctory warning, a fire drill,
or the real thing?
If macroeconomic policy were coordinated, logic would argue for the following sequence
of “exit” actions:
o First, allow fiscal stimulus to unwind as scheduled in the coming year. The Fed would
need to stay on the sidelines until the economic impact of that, which includes the
hike in marginal tax rates in 2011, is understood. If the Fed exited prematurely,
Congress probably would with justification extend some of the features of the 2009
stimulus initiative (ARRA 2009).
o Second, when the time is right, the Fed begins to sell off the $1,725 billion of
Treasuries, agency debt, and MBS it purchased earlier to cushion the economy when
financial leverage evaporated. This would quell the widely-held but mistaken belief
that the Fed’s reserve expansion is a potential inflation threat. Assertions that the
housing industry is too fragile to weather Fed asset sales but strong enough to
handle a hike in policy rates don’t compute.
o Lastly, normalize policy rates when labor markets get a pulse and inflation stops
falling and edges back toward the 1.5-2.0% goal. These conditions will take a couple
more years to be realized.
This logical sequence implies that there will be no rush for the Federal Reserve to
normalize monetary policy.
So, why is the Federal Reserve spending so much time discussing exit strategies,
detailing a sequence that could as easily be reversed, and focusing so much attention to
controlling the level of excess reserves that surely it understands is not an inflation
threat … when everyone knows that it will take some time for the economy to exit from
the Great Recession?
Is the Fed smarting from the convoluted assertion that its low rates in the mid-2000s
contributed to the housing bubble? No. Ben Bernanke answered that criticism in a
thoughtful and passionate speech at the American Economic Association this winter.
Continued on Page 2
2. The “exit” conversation almost certainly is aimed at a large community that has become
fixated on the $1 trillion of excess reserves and fears that politics will prevent the Fed
from removing this dangerous “inflationary threat”. Rather than explain why, with the
banking system deleveraging, the high level of reserves that were created to pay for the
Credit-Easing policy are not inflationary and were not created with an eye on expanding
the money supply—that is, does not conform to the money expansion model taught in
Money & Banking textbooks—Ben Bernanke apparently believes that it would be more
productive to assure those who worry about this matter that the way out is routine and
mechanical and that he has given an exit strategy considerable thought, if one is
needed.
Monetary policy adjustments aside, the Fed is winding down its liquidity facilities—they
are little used any more—and soon will return the discount rate eventually back to the
normal 100 basis points margin over the target federal funds rate. These actions are
purely technical, although they could cause a temporary stir in the financial markets.
One more aside, while Mr. Hoenig’s dissent at the last FOMC policy meeting is still on the
minds of some … Mr. Hoenig’s reasoning for dissenting from he FOMC decision to
continue to say that economic conditions justify low rates for an extended period is
unconvincing and his ongoing dissents this year likely will be ignored.
Mr. Blanchard’s call for central banks to aim for 4% inflation instead of the common 2%
goal today got some attention last week. The thought has a certain academic appeal but
will be dismissed by the central banking community. He is the Chief Economist at the
International Monetary Fund.
To see the full report, please go to:
https://www.chase.com/ccp/index.jsp?pg_name=ccpmapp/commercial/resource_center/pa
ge/economic_outlook_national
Copyright 2010 JPMorgan Chase & Co. All rights reserved.
Additional information available upon request.
