	Generational Dynamics
	Forecasting America's Destiny ... and the World's

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Generational Dynamics Web Log for 17-Sep-04
Federal Reserve congratulates itself on jawboning policy

Web Log - September, 2004

Federal Reserve congratulates itself on jawboning policy

Fed says it propelled the economy upward merely by promising to keep interest rates low. The claims are based on a study led by Fed Governor Ben Bernanke. The study found that merely by making statements that interest rates would be kept low for a "considerable period," the Fed changed public expectations so much that the values of stocks increased from 2003 to 2004. The conclusion is that the Fed can continue to use verbal statements to affect the economy positively.

I cannot say how strongly I disagree with this conclusion. It presumes that stock prices are based totally on emotions, and not on fundamentals.

Maybe that does work once, for a few months, but could Bernanke and the others possibly believe this strategy could ever work again? The only reason it worked this time is because it's never been used before. If it's ever tried again, people will remember, and won't be fooled a second time.

Which brings me to the Generational Dynamics point. Yes, this strategy might work again -- after 60 or 70 years when the last generation of people who remember the recent events all disappear (retire or die). That, after all, is what the generational paradigm is all about.

What really bothers me about all this is that Fed governors actually seem to believe this stuff.

I listen to high-priced analysts on TV all the time, and for them there's never any bad news. When stocks go up it's good news because stocks are going up; when stocks go down, it's good news because prices are low and people can buy more stocks cheaply. If these analysts were more balanced in their appraisals I might find them more credible, but when it's good news all the time, my conclusion is that they're in a serious state of denial.

Bernanke's report leads me to conclude that the Fed governors are in denial too, if they really believe that they can continue to get away with using a jawboning policy.

As we've previously said, the fundamentals are clear that we're in a period of long-term deflation, and can expect prices to fall by 30% in the next few years. Jawboning might postpone (and indeed has postponed) that result, but the fundamentals will win out sooner or later. In fact, it will probably be sooner, since the Fed has indicated that it will continue increasing interest rates, with the next increase evidently planned for September 21.

Meanwhile, if you're interested in this kind of stuff, then read the Fed's full report (Click here for PDF.)

The problem it addresses is the following: The Fed reduced short-term interest rates to near-zero in 2001, and cannot lower them to below zero, and so the Fed has effectively lost its most valuable tool for stimulating the economy.

The report considers three "non-standard" tools that the Fed could use, once the short-term interest rate string has run out:

The jawboning policy that we've been discussing.

A policy called "quantitative easing," where the Fed in fact does let short term interest rates fall below zero for short periods of time to extend use of this tool

A policy of lowering long-term interest rates by repurchasing long-term 10-year bonds, in order to keep 10-year interest rates low. (This is contrasted to the standard policy of lowering short-term interest rates.)

The report discusses examples of each of these policies at length, in both America and Japan, and concludes that the first of them is very successful. (17-Sep-04) Permanent Link
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Generational Dynamics Web Log for 17-Sep-04 Federal Reserve congratulates itself on jawboning policy

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Generational Dynamics Web Log for 17-Sep-04
Federal Reserve congratulates itself on jawboning policy