Economist's View: Fed Watch: Changing the Mix, Not Level, of Accommodation: Brad DeLong says that I confuse him, but nicely places the blame on Federal Reserve Chairman Ben Bernanke. And, truth be told, I have to admit to some confusion, as it it difficult to see how we arrived at this whole tapering debate in the first place. The data simply doesn't lead you to it. So how did the Fed get here?
It is difficult to say the path of activity has meaningfully accelerated…. And the improvement in the job market in recent months is really less than meets the eye…. To be sure… the unemployment rate is also on a steady downward march…. But at 7.6 percent still too high, as too are measures of underemployment. Moreover, one would think that the recent path of inflation would in and of itself end any discussion of tapering….
It looks as though we started the tapering discussion solely on the expectation that the data would soon improve as the impact of fiscal contraction waned. Yet that seems very premature…. So, again I ask why are we having this discussion? The plot thickens further as Bernanke has altered the nature of the discussion…. From the Reuters transcript of Bernanke's House testimony:
You talked about the weakness of the economy, I think that's evidence that we need to provide continued accommodation even if we begin to change over time the mix of tools that we use in providing that accommodation.
Bernanke is talking as if the goal is to change the mix of monetary policy but not the level of accommodation, essentially trading some reduced accommodation from ending asset purchases for additional accommodation by extending the forward guidance on interest rates. But why? If the level of accommodation is the same, does the mix matter?… I can see two reasons. One is that somehow asset purchases have a more negative distortionary impact. Another is that there exists an internal bias in the FOMC against expanding the balance sheet…. Some FOMC participants are not comfortable with asset purchases because the fear financial instability. And maybe they should, but at first blush I am hard pressed to say why shifting the accommodation to interest rates doesn't simply trigger another instability elsewhere…. Give the hawks a bone by giving a time line to ending asset purchases but take it away by waffling on the Evans rule to push back the timing of the first rate hike…. As is often said, talk is cheap. Actions speak louder than words…. If Bernanke had a plan to change the mix of accommodation without changing the level, that plan failed…. Even if higher rates don't undermine housing purchases, they will reduced refinancing activity….
Trying to reconcile the tapering talk with the data is not easy. I think that's why many analysts missed the direction the Fed was heading. It was somewhat incomprehensible based on the Fed's previous guidance.