As I write the initial draft of this piece, Fed Chair Ben Bernanke has announced that it intends to "taper" the Fed's policy of "quantitative easing" as the economy improves. So stock markets have just followed with a two percent hit.
It's enough to drive a guy to drink. First, the terminology. Quantitative easing? As students, we learned it as an "expansionary monetary policy" and, as professors, taught it that way to our students because - well, that's what it is, an expansion of money and credit with reduced interest rates.
"Quantitative easing," dubbed "QE3," adds absolutely nothing to clarify jargon that is already confusing enough to laymen.
And now, "taper," as synonymous with "scale back," "ease off," "gradually reduce," well, you get the idea. Okay, "taper" is a descriptive term, but before this is over we will be as tired of "taper" as I am already tired of "tipping point," and "game changer." You'd think that semi-articulate chattering heads could be more original.
Then there is the negative market reaction, appropriately enough dubbed, the "taper tantrum." You'd think Bernanke surprised and double-crossed Wall Street. Anyone with a positive IQ who was paying attention had to know that expansionary monetary policy, er, quantitative easing, had to eventually end, or, excuse me, "taper off," as the economy eventually strengthens.
For those who don't religiously follow this stuff, here's the deal. During recession, an expansionary monetary policy is intended to make money and credit more readily available to producers and consumers. Available credit and low interest rates are intended to encourage business investment and consumer spending, thereby moderating recession and expanding economic activity.
A primary means of executing this policy is the monthly $85 billion in bond purchases by the Fed. This puts money in the hands of the public and increases bank reserves, making money available for lending. Note that while this encourages borrowing and lending, that is, makes it possible, it does not insure that borrowers will borrow or that lenders will lend. It is thus permissive, and indirect.
Many, if not most, economists, myself included, believe that what is needed is an expansionary fiscal policy. But since the Congress has opted out of this approach, macroeconomic policy is all left to Bernanke and the Fed.
Long run economic health would benefit from an economic structure that raises incomes of middle class America. Greater returns to labor would spur economic growth. But don't hold your breath. It's not in the cards with this Congress.
Conventional wisdom credits Bernanke's expansionary monetary policy with the dramatic rise in financial markets since the Great Recession. Actually, there are other reasons, such as increasing corporate profits due to increasing labor productivity, while keeping labor costs low. Gains from increasing labor productivity have accrued not to the middle class, but to a very few at the top of the income scale. But that's another story.
So when Bernanke announces that the expansionary monetary policy will someday "taper off," - no, not today, or tomorrow, but as the economy improves, Wall Street acts like the party is over and goes into a tantrum. Financial markets tank.
But if the tapering accompanies an expanding economy, shouldn't this be a good thing? And couldn't anybody who follows this stuff, like Wall Street fund managers, anticipate this, and not be so shocked?
Probably only if you believe in the "efficient market hypothesis." That concept asserts that asset prices reflect all available information and instantly reflect changes in information. The "information," or reality, of an eventual tighter monetary policy, rising interest rates and falling bond prices, was there all along - but ignored or discounted. Although Big Ben's announcement only confirmed the obvious, it seems to have shocked Wall Street.
The "strong efficient market hypothesis" goes so far as to assert that prices accurately reflect hidden and inside information.
If you think this sounds far-fetched, so do a lot of economists. Critics of the efficient market hypothesis assert that markets are not necessarily the product of cold, calculating, decisions reflecting all information. In reality, market decisions are made by humans governed by emotions, often resulting in a herd mentality and bubbles such as those leading up to the recession of '08. Markets characteristically overshoot and do not necessarily self-correct.
Recognition of the realities of emotional factors in economic decisions has given rise to fields previously relegated to the academic backwater, behavioral economics and behavioral finance. These fields attempt to integrate the insights of psychology with economic theory to explain economic decisions.
With this in mind, it is easier to understand the reaction of supposedly rational, cold, calculating investors to Bernanke's announcement.
The timing and speed of any future tapering is subject to legitimate debate. Some critics opposed Bernanke's policy from the beginning; others think he should already have "tapered," or even ended it. Others fear he will end it too soon, before the economy improves. Some believe he should not have announced its eventual tapering and are shocked, shocked at the reaction of the bond market, the speed at which investors are dumping bonds with the prospect of rising interest rates.
Many of us believe that while Bernanke's expansionary monetary policy is appropriate, it should have been relegated to the role of "supporting actor" to an expansionary fiscal policy. The "sequester," is the opposite of the needed expansionary fiscal policy, acting as a brake on economic expansion.
If Bernanke's expansionary economic policies have not produced full employment, it's because the task is far too big for the Fed to do alone. Not only did he get no help from Congress, it worked against him.
Financial markets are moved not by cold, rational analysis, but by greed and fear. Meanwhile, we'll just have to put up with the inevitable taper tantrum. Or, even profit from it, depending on cold, calculating rational analysis - or maybe just plain dumb luck.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
It's enough to drive a guy to drink. First, the terminology. Quantitative easing? As students, we learned it as an "expansionary monetary policy" and, as professors, taught it that way to our students because - well, that's what it is, an expansion of money and credit with reduced interest rates.
"Quantitative easing," dubbed "QE3," adds absolutely nothing to clarify jargon that is already confusing enough to laymen.
And now, "taper," as synonymous with "scale back," "ease off," "gradually reduce," well, you get the idea. Okay, "taper" is a descriptive term, but before this is over we will be as tired of "taper" as I am already tired of "tipping point," and "game changer." You'd think that semi-articulate chattering heads could be more original.
Then there is the negative market reaction, appropriately enough dubbed, the "taper tantrum." You'd think Bernanke surprised and double-crossed Wall Street. Anyone with a positive IQ who was paying attention had to know that expansionary monetary policy, er, quantitative easing, had to eventually end, or, excuse me, "taper off," as the economy eventually strengthens.
For those who don't religiously follow this stuff, here's the deal. During recession, an expansionary monetary policy is intended to make money and credit more readily available to producers and consumers. Available credit and low interest rates are intended to encourage business investment and consumer spending, thereby moderating recession and expanding economic activity.
A primary means of executing this policy is the monthly $85 billion in bond purchases by the Fed. This puts money in the hands of the public and increases bank reserves, making money available for lending. Note that while this encourages borrowing and lending, that is, makes it possible, it does not insure that borrowers will borrow or that lenders will lend. It is thus permissive, and indirect.
Many, if not most, economists, myself included, believe that what is needed is an expansionary fiscal policy. But since the Congress has opted out of this approach, macroeconomic policy is all left to Bernanke and the Fed.
Long run economic health would benefit from an economic structure that raises incomes of middle class America. Greater returns to labor would spur economic growth. But don't hold your breath. It's not in the cards with this Congress.
Conventional wisdom credits Bernanke's expansionary monetary policy with the dramatic rise in financial markets since the Great Recession. Actually, there are other reasons, such as increasing corporate profits due to increasing labor productivity, while keeping labor costs low. Gains from increasing labor productivity have accrued not to the middle class, but to a very few at the top of the income scale. But that's another story.
So when Bernanke announces that the expansionary monetary policy will someday "taper off," - no, not today, or tomorrow, but as the economy improves, Wall Street acts like the party is over and goes into a tantrum. Financial markets tank.
But if the tapering accompanies an expanding economy, shouldn't this be a good thing? And couldn't anybody who follows this stuff, like Wall Street fund managers, anticipate this, and not be so shocked?
Probably only if you believe in the "efficient market hypothesis." That concept asserts that asset prices reflect all available information and instantly reflect changes in information. The "information," or reality, of an eventual tighter monetary policy, rising interest rates and falling bond prices, was there all along - but ignored or discounted. Although Big Ben's announcement only confirmed the obvious, it seems to have shocked Wall Street.
The "strong efficient market hypothesis" goes so far as to assert that prices accurately reflect hidden and inside information.
If you think this sounds far-fetched, so do a lot of economists. Critics of the efficient market hypothesis assert that markets are not necessarily the product of cold, calculating, decisions reflecting all information. In reality, market decisions are made by humans governed by emotions, often resulting in a herd mentality and bubbles such as those leading up to the recession of '08. Markets characteristically overshoot and do not necessarily self-correct.
Recognition of the realities of emotional factors in economic decisions has given rise to fields previously relegated to the academic backwater, behavioral economics and behavioral finance. These fields attempt to integrate the insights of psychology with economic theory to explain economic decisions.
With this in mind, it is easier to understand the reaction of supposedly rational, cold, calculating investors to Bernanke's announcement.
The timing and speed of any future tapering is subject to legitimate debate. Some critics opposed Bernanke's policy from the beginning; others think he should already have "tapered," or even ended it. Others fear he will end it too soon, before the economy improves. Some believe he should not have announced its eventual tapering and are shocked, shocked at the reaction of the bond market, the speed at which investors are dumping bonds with the prospect of rising interest rates.
Many of us believe that while Bernanke's expansionary monetary policy is appropriate, it should have been relegated to the role of "supporting actor" to an expansionary fiscal policy. The "sequester," is the opposite of the needed expansionary fiscal policy, acting as a brake on economic expansion.
If Bernanke's expansionary economic policies have not produced full employment, it's because the task is far too big for the Fed to do alone. Not only did he get no help from Congress, it worked against him.
Financial markets are moved not by cold, rational analysis, but by greed and fear. Meanwhile, we'll just have to put up with the inevitable taper tantrum. Or, even profit from it, depending on cold, calculating rational analysis - or maybe just plain dumb luck.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
