“Last Hurrah” for Central Bankers
We’ve all seen zombie movies where the good guys shoot the zombies but the zombies just keep coming because… they’re zombies!
Market observers can’t be blamed for feeling the same way about former Fed Chair Ben Bernanke.
Bernanke was Fed chair from 2006–2014 before handing over the gavel to Janet Yellen. After his term, Bernanke did not return to academia (he had been a professor at Princeton) but became affiliated with the center-left Brookings Institution in Washington, D.C.
Bernanke is proof that Washington has a strange pull on people. They come from all over, but most of them never leave. It gets more like Imperial Rome every day.
But just when we thought that Bernanke might be buried in the D.C. swamp, never to be heard from again… like a zombie, he’s baaack!
Bernanke gave a high-profile address to the American Economic Association at a meeting in San Diego on Jan. 4. In his address, Bernanke said the Fed has plenty of tools to fight a new recession.
He included quantitative easing (QE), negative interest rates and forward guidance among the tools in the toolkit. He estimates that combined, they’re equal to three percentage points of additional rate cuts. But that’s nonsense.
Here’s the actual record…
That QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in U.S. history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we’re lucky) or crash (if we’re not).
Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as “negative” interest. That hurts growth and pushes the Fed even further away from its inflation target.
What about “forward guidance?”
Forward guidance lacks credibility because the Fed’s forecast record is abysmal. I’ve counted at least 13 times when the Fed flip-flopped on policy because they couldn’t get the forecast right.
So every single one of Bernanke’s claims is dubious. There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.
And the record is clear: The Fed needs interest rates to be between 4% and 5% to fight recession. That’s how much “dry powder” the Fed needs going into a recession.
In September 2007, the fed funds rate was at 4.75%, toward the high end of the range. That gave the Fed plenty of room to cut, which it certainly did. Between 2008 and 2015, rates were essentially at zero.
The current fed funds target rate is between 1.50% and 1.75%. I’m not forecasting a recession this year, but if we do have one, the Fed doesn’t have anywhere near the room to cut as it did to fight the Great Recession.
I’m not the only one to make that point. Here’s what former Treasury Secretary Larry Summers said:
[Bernanke] argued that monetary policy will be able to do it the next time. I think that’s pretty unlikely given that in recessions we usually cut interest rates by five percentage points and interest rates today are below 2%… I just don’t believe QE and that stuff is worth anything like another three percentage points.
Summers goes on to call Bernanke‘s speech “a kind of last hurrah for the central bankers.”
He’s right. But if monetary policy isn’t the answer, what does Summers think the answer is?
Fiscal policy. The government is going to have to spend money directly into the economy instead of relying upon some trickle-down “wealth effect” to stimulate the economy.
Here’s what Summers said:
“We’re going to have to rely on putting money in people’s pockets, on direct government spending.”
Remember the term “helicopter money”? Milton Friedman coined the term 50 years ago when he made the analogy of dropping money from a helicopter to illustrate the effects of aggressive fiscal policy.
That’s essentially what Summers is advocating. It might sound a lot like the idea behind Modern Monetary Theory, or MMT, but it’s not necessarily the same thing. MMT takes helicopter money to a whole new level, and Summers has actually been highly critical of MMT.
But the idea of direct government spending to stimulate the economy is the same, and it’s gaining traction in official circles.
There’s good reason to believe it’s coming to a theater near you. And maybe sooner than you think.
for The Daily Reckoning