Under Alan Greenspan, the Federal Reserve adopted a policy of signaling any policy changes well in advance. So Wednesday’s steady-as-she-goes decision by the Fed’s key policy-making committee didn’t surprise anyone.
Nor was Thomas Hoenig’s solo dissent any news; the Kansas City Fed president has been a lonely voice for tighter money for some time now. But with three Fed policy meetings down and five to go until Narayana Kocherlakota gets a vote, the financial media will pay even closer attention to anything he says about the economy.
Kocherlakota, an economics professor who took over as Minneapolis Fed president in October, attends and participates in Fed Open-Market Committee meetings like all the other Fed district bank presidents. But only five of the 12 vote in any given year, and Kocherlakota must wait another nine months to cast his first vote. Nevertheless, monetary policy soothsayers already poke through the entrails of his public speaking and writing, trying to discern some omen of his views.
Such media obsession was evident in analyses of a talk he gave a few weeks ago in Helena, Mont., in which he argued the Fed should move as expeditiously as possible to get rid of more than a trillion dollars in mortgage-backed securities, largely issued by Fannie Mae and Freddie Mac, that the central bank purchased over the past two years.
Some Fed watchers interpreted that as a sign Kocherlakota is an “inflation hawk” who will take over from Hoenig as perennial dissenter in favor of slower growth of the money supply and hence higher interest rates.
I think that may be partially correct. Kocherlakota comes from a group within economics that is wary about the dangers posed by too-rapid money growth and the potential pitfalls of leaving monetary policymakers entirely to their own discretion.
But just as Sigmund Freud supposedly said, “sometimes a cigar is only a cigar,” there are times when skepticism about the Fed holding hundreds of billions of dollars worth of questionable securities over the long term may be only that.
The Fed bought these up for a variety of reasons. First, it is a way of pumping up the money supply to bolster an economy in sharp recession. Second, doing so in this manner rather than by purchasing conventional Treasury bonds aimed the monetary policy hose directly into mortgage markets, keeping rates low and bolstering otherwise declining housing prices that were worsening the balance sheets of millions of households. Furthermore, it delays the day when the true losses still hidden in some of these securities will need to be recognized explicitly.
Kocherlakota argues that this overhanging snow cornice of questionable “assets” on the Fed’s balance sheet will poison public confidence in the Fed’s commitment to low inflation. Slack demand in the economy means all the extra reserves the Fed pumped into the economy have not yet increased the effective money supply. But that could turn into an avalanche of money growth in a hurry.
Or, to use a different metaphor, all of those excessive reserves created by the Fed are like dry fuel piling up on the floor of a forest. The greater the amount of available fuel, the worse any eventual forest fire will be.
Moreover, the questionable value of these securities, in contrast to certainty about the Treasury bonds the Fed usually buys, spawns economic uncertainty of all sorts that is negative for economic growth.
I am biased. I think Hoenig’s stand is correct. The Fed’s policy of keeping interest rates low for a long time as a response to problems caused by keeping rates too low for too long is fraught with danger.
Hoenig’s term as a voting member ends when Kocherlakota’s begins. So they won’t be able to team up.
So I hope the new Minneapolis president really is an “inflation hawk” and that his wariness about inflation will lead him to continue to speak out, even as one of the Fed’s most junior policymakers.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.