The Punch Bowl Refilled, or, “You Call That a Double?”

Figured we should give you some place to discuss the biggest non-decision since, well, that Syria thing:

After spending months alerting the public that they could begin to wind down an $85 billion-a-month bond-buying program at their September policy meeting, Federal Reserve officials got cold feet Wednesday and decided to keep the purchases in place.

The reasons: An economy that has failed to live up to the Fed’s expectations for growth and a worry that a jump in long-term interest rates over the past several months could squeeze an already weak recovery.

“What we are going to do is the right thing for the economy,” Fed Chairman Ben Bernanke said at the post-statement press conference. Officials said in their policy statement that they “decided to await more evidence that [economic] progress will be sustained before adjusting the pace of purchases.”

Very few of us (including me) thought this would happen, because the Fed typically doesn’t hint at doing something without following through. That creates confusion in the markets. Towards the beginning of his time in the Fed chairmanship, Bernanke said:

[C]entral bank transparency increases the effectiveness of monetary policy and enhances economic and financial performance in several ways. First, improving the public’s understanding of the central bank’s objectives and policy strategies reduces economic and financial uncertainty and thereby allows businesses and households to make more-informed decisions. Second, if practitioners in financial markets gain a better understanding of how policy is likely to respond to incoming information, asset prices and bond yields will tend to respond to economic data in ways that further the central bank’s policy objectives. … Third, clarity about the central bank’s policy objectives and strategy may help anchor the public’s long-term inflation expectations, which can substantially improve the efficacy of policy and the overall functioning of the economy. Finally, open discussion of the central bank’s analyses and forecasts invites valuable input and feedback from the public.

From that perspective, the last three months have been a disaster. The Fed has been engaging in communication that it calls “forward guidance,” but in May, when a Bernanke press conference suggested a reduction in QE3 was in the offing, interest rates shot up. Justin Wolfers rightly calls this a “failed communication strategy.” Of course, Wolfers says the communication should never have happened. I think Bernanke spoke in May without sufficient commitment from his Federal Open Market Committee.

Add to that today’s press conference performance. In his opening remarks, Bernanke commented on the 7.3% unemployment rate, which he called “well above acceptable levels.” Yet the central projections of the Fed’s governors and presidents was for 2013 unemployment to be 7.2-7.3% back in June. It is now expected to be 7.1%-7.3%. If the guidance on unemployment in May was changed by lower labor force participation, Bernanke gave it only a scant mention. Instead, Bernanke blamed financial markets and fiscal policy:

But in evaluating whether a modest reduction in the pace of asset purchases would be appropriate at this meeting, however, the Committee concluded that the economic data do not yet provide sufficient confirmation of its baseline outlook to warrant such a reduction. Moreover, the Committee has some concern that the rapid tightening of financial conditions in recent months could have the effect of slowing growth, as I noted earlier, a concern that would be exacerbated if conditions tightened further. Finally, the extent of the effects of restrictive fiscal policies remains unclear, and upcoming fiscal debates may involve additional risks to financial markets and to the broader economy.

There’s no other way to put this: The Fed lost its nerve. Rates had risen by dint of Bernanke’s May remarks, and, because jawboning all summer to bring those back down didn’t work, they capitulated.

Markets, of course, rejoiced upon hearing another $85 billion would be in the punch bowl next month. And think about this, as Mike Shedlock observed: We are arguing about whether to put $75 billion or $85 billion in the punch bowl, something like the comedian Larry Miller’s motto “you call that a double?” 

What I call it is a loss of credibility for the Fed. Regardless of your view of the taper, it was clearly an error for Bernanke to turn June’s forward guidance into a head fake.