Fed Harmony Hides the Dangers of Groupthink

by perrysrest

Traders and investors trying to parse the statements coming from the world’s most important central bank are at a loss: Will an interest-rate increase come in September? And will there be one, two or no hikes this year?

Instead of clarity about the economic outlook, the Federal Reserve is delivering Kodak moments, highly staged events that seek to communicate control but which really suggest that form has replaced substance. If the Fed’s objective last week was to put its September meeting back into play as the potential venue for a rate increase, it can claim a partial success.

Prices in the futures market show traders now see about a 34 percent chance of a hike on Sept. 21, up from 22 percent two weeks ago. But you still have to go out to December before the likelihood rises above 50 percent.

There’s a very good reason for that market skepticism. Raising rates at a time when inflation is dormant and miles away from the central bank’s 2 percent target seems somewhat perverse.

The Jackson Hole Symposium (and let us note in passing what a great word symposium is, adding gravitas to what would otherwise be a mere conference) was an opportunity, as the event title said, to consider “Designing Resilient Monetary Policy Frameworks for the Future.” Instead, Fischer’s comment suggests it’s business as usual at the Federal Open Market Committee, with no room at present for such innovations as changing the inflation goal or targeting nominal gross domestic product.

Fiscal expansion

That’s a shame. There’s a consensus that monetary policy is becoming impotent, and that governments need to step in with fiscal stimulus. But until central banks admit that their firepower is waning, politicians can continue to evade responsibility. “You can’t expect us to do the whole job,” Christopher Sims, a Nobel Prize-winning economist from Princeton University, said last week. “Fiscal expansion can replace ineffective monetary policy at the zero lower bound. So long as the legislature has no clue of its role in these problems, nothing is going to get done. Of course, convincing them that they have a role and there is something they should be doing, especially in the U.S., may be a major task.”

Finance — particularly in an era of fractional reserve banking — is essentially a confidence trick. Depositors have to be confident their money will be there when they try to withdraw it. Businesses have to be confident that the economy is on a sound footing otherwise they won’t invest and hire. Central bankers aren’t just economists and policy makers; they’re also salespeople, selling a story.

Post from Bloomberg