The Commercial Appeal

Fed’s differing stance confuses markets

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Try as he might, Federal Reserve chairman Ben S. Bernanke can’t seem to get the market to understand the central bank’s plans. The problem might be less his communicat­ion skills than what he’s trying to communicat­e.

Since last week’s Fed meeting, at which Bernanke sought to clarify the central bank’s plans to decelerate the bondbuying program known as quantitati­ve easing, investors have acted as if he signaled a major pullback in stimulus. A simple analysis suggests the market has overreacte­d.

The yield on the 10-year Treasury note, a standard measure of long-term interest rates, stood at about 2.6 percent on Monday, up 0.4 percentage point from where it was before last week’s Fed pronouncem­ents.

It’s worth comparing this with previous market responses to monetary stimulus. Drawing on a dozen careful academic studies of quantitati­ve easing, Goldman Sachs

economist Jan Hatzius has estimated that it takes about $1 trillion in bond purchases to move longterm interest rates by 0.4 percentage point. In other words, the market’s recent reaction is roughly what would have occurred if the Fed had revealed a plan to cut back on quantitati­ve easing by $1 trillion.

The Fed did no such thing. Bernanke said the central bank expects to start tapering its $85 billion a month in bond purchases toward the end of this year, with an eye to ceasing them altogether by the middle of next year — assuming the unemployme­nt rate has fallen to about 7 percent. At most, he moved the tapering schedule forward by three months compared with what the market anticipate­d. That amounts to just $255 billion less quantitati­ve easing.

So what spooked the market? The answer probably lies in the way the Fed has sought to distinguis­h its policy for quantitati­ve easing from its policy for interest rates.

When Bernanke set out the parameters for the former, he tried to emphasize that the latter had not changed. The Fed remained committed to keeping its short-term interest-rate target at or near zero until unemployme­nt falls to 6.5 percent. The intended message: Interest rates will stay low until after the economy has recovered, so please feel confident to spend, invest and hire.

Investors, though, perceived the tapering of quantitati­ve easing as a sign that the Fed would also start raising shortterm interest rates sooner than previously thought. Prices in futures markets currently suggest a high probabilit­y that the target rate will rise to 0.25 percent by May 2014. Before last week, the rate increase wasn’t expected until much later in the year.

The market’s reaction means that the Fed’s extraordin­ary commitment to low interest rates in the future isn’t yielding the desired effect. Either investors don’t understand the Fed’s promise, or they fear that the Fed will renege as soon as the economic outlook improves.

To see why investors aren’t convinced, consider the Fed’s tortured logic. Fed officials are saying that the U.S. economy has two drivers — one in charge of quantitati­ve easing, the other in charge of interest rates. The former is ready to tap on the brake (or, in Bernanke’s preferred language, to ease off the gas), while the latter is on cruise control. By the Fed’s view, we shouldn’t make inferences about one from the behavior of the other.

To complicate things further, Fed officials have set three separate destinatio­ns: a 7 percent unemployme­nt rate, beyond which the central bank will cease new bond purchases; a 6.5 percent unemployme­nt rate, below which it might start raising interest rates; and a longer-term target unemployme­nt rate of 5 percent to 6 percent.

In reality, both drivers are in the same car, facing the same weather conditions and getting their instructio­ns from the same Fed officials. Markets recognize this and have perceived a willingnes­s to slow the car as a lack of commitment to stimulatin­g economic growth. As we’ve learned, investors’ interpreta­tions can have all-too-real consequenc­es.

Central bankers are naturally conservati­ve, so making a commitment to future policy feels somewhat radical. It’s also a strategy that can have a powerful effect if the public is convinced. My advice to Bernanke: Choose a single destinatio­n, turn on the cruise control, and make sure the markets know we have more than enough fuel to get there. Bloomberg View columnist Justin Wolfers is a professor of public policy and economics at the University of Michigan.

 ?? AHN YOUNG-JOON / ASSOCIATED ORESS ?? Currency traders at the Korea Exchange Bank in Seoul work in front of a TV showing Ben Bernanke. Asian stock markets fell Thursday after reports the U. S. Federal Reserve said it could start scaling back its economic stimulus program.
AHN YOUNG-JOON / ASSOCIATED ORESS Currency traders at the Korea Exchange Bank in Seoul work in front of a TV showing Ben Bernanke. Asian stock markets fell Thursday after reports the U. S. Federal Reserve said it could start scaling back its economic stimulus program.

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