On February 24th, St. Louis Federal Reserve President James Bullard took the floor and trotted out his version of the Fed's "dog and pony show" for the folks gathered at the Bowling Green, Kentucky Area Chamber of Commerce Coffee Hour. In his presentation, he discussed "Quantitative Easing, Global Inflation and Commodity Standards". It sounds like a real eye opener (?) but I'll persevere and hit the high points from his presentation which is available here.
As we all know, the Federal Open Market Committee (FOMC), of which Mr. Bullard is a member who voted in favour of QE2, announced last November that it was going to purchase Treasury securities totalling about $600 billion over an eight month period ending in Q2 2011 at a pace of approximately $75 billion per month. This is what is known as quantitative easing and has frequently been labelled QE2 since it is the second in what will presumably be a series of not so subtle economic nudges.
QE2 was enacted for the following reason:
"...Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities..."
Basically, the Fed has kept interest rates at near zero levels for an extended period of time in an attempt to prod the economy out of its moribund state and came to the conclusion in November that "free money" simply wasn't working and that it was pretty much out of ammunition. The Fed's "ultra-easy" (Mr. Bullard's words) monetary policy created a disinflationary trend (a decrease in deflation) in 2010 and raised the horrifying spectre of deflation, that fiscal nightmare that creates many sleepless nights for central bankers around the world! Here's how bad disinflation looked until the Fed came to the rescue:
The Fed will have to create money to purchase Treasury securities. The resulting increase in money supply and the increased demand for Treasuries is expected to push their price up and their yields down further out the yield curve than normal. As a result, corporations and individuals want to borrow and spend more, creating demand for labour and demand for goods resulting in lowered unemployment and somewhat raised inflation miraculously fixing all that ails the American economy.
Mr. Bullard also noted that the "Japanese experience with mild deflation and a near-zero nominal interest rate has been poor.". No kidding.
Here's Japan's nominal discount rate for the past 15 years:
Here's Japan's inflation/deflation rate for the past 25 years:
It certainly looks like inflation took right off - except that it didn't for long. In fact, Japan's inflation rate has been negative since February 2009, three short years after the end of quantitative easing. Japan's QE policy was in effect from March 19th, 2001 to March 9th, 2006 during which time the Bank of Japan raised its current account balances nine times and increased its purchases of long Japanese sovereign bonds. This flooded Japan's banks with reserves which kept interest rates at zero. By the Federal Reserve Bank of Cleveland's own admission, the program was, at best, a modest but temporary success. Here's a quote from one of the Cleveland Fed's analyses of the Bank of Japan's QE program:
"The connection between the quantitative easing policy and the macroeconomic recovery remains somewhat more flimsy. Most observers believe that because the quantitative easing policy aided the banking sector, economic activity at least did not deteriorate further. The pace of economic activity did pick up, with contributions from consumer spending and investment, but exports, which benefited from growth among Japan’s trading partners, spurred much of the improvement. Although deflation ended in 2006, along with the quantitative easing policy, it returned after a very short hiatus in 2007, and continued until the recent commodity price boom." (my bold)
Hmmmm. Is non-existent another word for flimsy? It begs the question how things will be different this time out, doesn't it Mr. Bernanke?
Here are a selection of slides from Mr. Bullard's speech where he shows all of us just how brilliant the Fed's QE2 program has been at...
...bumping up inflation:
....pushing up equity prices and making ALL of us richer!:
....and pushing down real interest rates:
My goodness, I'm surprised that the Fed hasn't claimed that QE2 has cured both the common cold and cancer! But, as the saying goes "if you don't toot your own horn, no one else will".
Back to Japan for just one moment. Here's how well their program of quantitative easing worked over the long-term for....
...the Nikkei 225 Index (hint - it's down 30 percent since QE ended):
....and the country's unemployment rate:
Hardly a ringing endorsement for the long-term positive effects of quantitative easing, is it?
In the next part of Mr. Bullard's speech he goes on to discuss global inflation and the United States output gap, the difference between the actual output of a given economy and the output that the same economy can achieve when it is at full capacity. If a country's output gap is positive, it is overworking its capacity and this can lead to inflation as the cost of both labour and production rise in response. In the case of the United States, the output gap is rather large (the economy is struggling to produce at full capacity) which is putting downward pressure on inflation; in contrast, the global output gap is small or even positive which is putting upward pressure on inflation.
He also notes that some critics suggest that the Federal Reserve's policies (i.e. "printing" sky-high piles of money) are encouraging global inflation and that the Fed is concerned only with domestic issues and is not considering the impact of its policies on the rest of the world. He noted that:
"...the Fed is charged with controlling U.S. inflation, but perhaps global inflation will drive U.S. prices higher or cause other problems..."
Mr. Bullard also highlighted the different scenarios for the world's advanced economies which are experiencing modest growth and a deflationary trend (although definitely not the case for the United Kingdom which just reported CPI Inflation of 4.0 percent for the month of January 2011) and for the emerging economies which are experiencing strong growth and high inflation (think China and their 4.9 percent inflation rate for January 2011). He's using these differences to explain why the Fed's policies really aren't impacting the worldwide economy.
In light of mounting commodity prices, one has to wonder if central bank policies of increased money supply aren't creating yet another price bubble in the commodity markets, after all, all of that "money" has to go somewhere. In the case of the United States, the economy is so weak that producers are unable to pass along the additional costs to consumers without threat of further drops in sales. Perhaps low inflation in the United States is a reflection of economic weakness and under-utilized capacity more than it is a reflection of what is going on in the real world.
In closing, Mr. Bullard had the following to say:
"Inflation targeting is another way to force more accountability to the central bank and anchor longer-term expectations. Make the central bank say what it intends to do and hold the central bank accountable for achieving the goal.” (my bold)
Either that, or reform the system so that a handful of people don't control everything that matters!