Fairytales from the Federal Reserve: 15 Reasons Fed Policies Belong in Fantasyland
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Don’t ever think for a minute that the central bankers know what they’re doing. They don’t. And that’s my own view, but I’ve heard that recently from a couple central bankers. I recently had spent some time with one member of the FOMC, the Federal Open Market Committee, and another member of the Monetary Policy Committee of the Bank of England, which is the equivalent of their FOMC, both policymakers, both central bankers.
And they said the same thing, “We don’t know what we’re doing. This is a massive experiment. We’ve never done this before. We try something. If it works, maybe we do a little more; if it doesn’t work, we pull it away, and we’ll try something else.” And the evidence of this – again, I’ve heard this firsthand, and it’s my view – but the evidence for this is that their have been 15 separate fed policies in the last 5 years.
If you think about it, they started with forward guidance, which was, “We will keep rates low for an extended period of time.” And then they said, “Oh, extended means all the way to 2013.” And then they said, “All the way to 2014.” And they were kind of getting around to, “All the way to 2015,” and they said, “Wait a second. The dates don’t work. Let’s use some numeric concepts.”
So, they started nominal GDP targeting where they said, “We have this threshold of 2.5 percent inflation, but not based on actual inflation, but based on projected inflation, as projected by the Fed, which means it could be whatever they want it, and then 6.5 percent unemployment, but when we got down to 6.5, they said, “Oh, just kidding. We’re not gonna apply that.”
They had currency wars. They had Operation Twist, QE1, QE2, QE3 − except QE3 came in two flavors, $45 billion a month and $85 billion a month, except now, they’re tapering, but the taper isn’t even the first taper because at the end of QE1, that was 100 percent taper, and at the end of QE2, that was 100 percent taper, so we have two data points to say tapering doesn’t work. It fails, and I expect this will fail as well.
My point is, if you add all this up, all the forward guidance, all the dates, all the targets, the currency wars, operation twist, all the flavors of QE, 15 separate fed policies in 5 years, that tells you, you don’t know what you’re doing. You’re making it up as you go along. So people should have no confidence in the Fed. That’s for starters.
Now, beyond that, if you look at Fed models and look at what Fed monetary economists actually do, they use equilibrium models, or they’re called dynamic stochastic equilibrium models. There’s only one problem with equilibrium models: They bear no relationship to reality.
The world is not an equilibrium system. The world is a complex system, or at least the capital markets are complex systems. So you can’t apply an equilibrium model to a complex system. They behave completely differently.
So it’s as if I said, “I’m holding a pen in my hand. I’m gonna release it, and I want you to give me a forecast as to what’s gonna happen to the pen.” You’ll think about it and say, “Well, that pen’s gonna hit the floor.”
And I let go, and sure enough, it hits the floor. Well, how do you know that? Well, you have a model. You know the pen has weight. You understand gravity. We’re on the planet earth, etc. Everything about your model, which is the correct one, says the pen’s gonna hit the floor. Well, the Fed has a model that says the pen’s gonna float to the ceiling. If you have the wrong model, you’re gonna get the wrong result every time.
So, first of all, we have observation of 15 fed policies in 5 years. You’re totally making it up. Secondly, I have firsthand discussions with central bankers, who admit to me privately – they won’t say this publicly – that they are making it up. And, finally, I understand the models, and I understand how the world works, and the models bear no relationship to the reality.
So, for all these reasons, people should have no confidence in what the Fed is doing. They should have a lot more confidence in their own instinct, in their own intuition, and what they’re hearing from independent advisors.
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