How Bernanke Has Set the Stage for Volatility

Agenda-Setting Financial Insight.
Dec. 13 2012 2:37 PM

How Bernanke Has Set the Stage for Volatility

158277440
Chairman Ben Bernanke made clear that he is worried about the possible negative economic impact of the so-called fiscal cliff.

Photo by Chip Somodevilla/Getty Images

The difference between “and” and “or” could undo the Federal Reserve. At its meeting Dec. 12 the Federal Open Market Committee replaced its estimated duration for low interest rates with thresholds for the unemployment rate and inflation. If reality makes the two measures diverge, the new approach could prove rocky for markets.

Last time around, the Fed suggested it would keep short-term rates near zero until at least mid-2015. Now, it’s replacing that with the idea that its loose monetary policy probably won’t change while unemployment is above 6.5 percent, inflation a year or two out is forecast to be below 2.5 percent, and long-term inflation expectations are under control. That’s “and” rather than “or.” In theory, that means crossing any one of these thresholds - vague as the last one is - could have the Fed rethinking its policy.

But it’s easy to read this as saying the Fed won’t tighten policy unless all these indicators are the wrong side of the thresholds. That could breed confusion if, say, unemployment continues declining only slowly, as it has for the last two years or so, while inflation quickly gathers steam. Plus as the relevant economic indicators approach the Fed’s thresholds, market responses could be odd. A drop in the unemployment rate that brought it within range of the threshold ought to be good economic news, but investors might fear a withdrawal of easy money by the U.S. central bank and react badly instead.

Then there’s the Fed’s ramping-up of quantitative easing, or bond-buying. Chairman Ben Bernanke made clear that he is worried about the possible negative economic impact of the so-called fiscal cliff, the tax increases and cost cuts that could come on Jan. 1 if Congress can’t agree otherwise. While he knows the Fed alone can’t offset that, it’s also surely a factor in flooding markets with yet more cheap money. If those fiscal shifts do happen, the United States will suddenly need to borrow less. The Congressional Budget Office reckons the deficit would fall to under $400 billion in the year to September 2014. But the Fed would be trying to buy $540 billion of Treasury securities every year.

That conflict between monetary and fiscal policy is another potential source of confusion. Add the new focus on specific economic indicators and Bernanke could easily find he has set the stage for volatility, rather than the Fed’s desired stability, in financial markets.

Read more at Reuters Breakingviews.

Martin Hutchinson covers emerging markets and economic policy, drawing on 25 years of experience as an international merchant banker. He ran derivatives platforms for two European banks, before serving as director of a Spanish venture capital company, advisor to the Korean conglomerate Sunkyong and chairman of a U.S. modular building company

Richard Beales joined Breakingviews.com in 2007 from the Financial Times, where he was the US markets editor and a Lex columnist. Prior to the FT, he spent more than 10 years as an investment banker, based largely in Hong Kong.

TODAY IN SLATE

Politics

Don’t Worry, Obama Isn’t Sending U.S. Troops to Fight ISIS

But the next president might. 

IOS 8 Comes Out Today. Do Not Put It on Your iPhone 4S.

Why Greenland’s “Dark Snow” Should Worry You

How Much Should You Loathe NFL Commissioner Roger Goodell?

Here are the facts.

Three Talented Actresses in Three Terrible New Shows

Science

The Human Need to Find Connections in Everything

It’s the source of creativity and delusions. It can harm us more than it helps us.

Foreigners

More Than Scottish Pride

Scotland’s referendum isn’t about nationalism. It’s about a system that failed, and a new generation looking to take a chance on itself. 

The Ungodly Horror of Having a Bug Crawl Into Your Ear and Scratch Away at Your Eardrum

We Could Fix Climate Change for Free. What Exactly Is Holding Us Back?

  News & Politics
Politics
Sept. 17 2014 5:21 PM Don’t Worry, Obama Isn’t Sending U.S. Troops to Fight ISIS But the next president might. 
  Business
Business Insider
Sept. 17 2014 1:36 PM Nate Silver Versus Princeton Professor: Who Has the Right Models?
  Life
Gentleman Scholar
Sept. 17 2014 5:10 PM Should Men Still Open Doors for Women? Or is it ungentlemanly to do so at all?  
  Double X
The XX Factor
Sept. 17 2014 4:36 PM Is Nonfiction the Patriarch of Literary Genres?
  Slate Plus
Slate Fare
Sept. 17 2014 9:37 AM Is Slate Too Liberal?  A members-only open thread.
  Arts
Brow Beat
Sept. 17 2014 5:56 PM Watch Louis C.K., Dave Chappelle, Bill Hicks, Mitch Hedberg, and More on New YouTube Channel
  Technology
Future Tense
Sept. 17 2014 5:26 PM If Fixing Global Warming Is Free, What’s the Holdup?
  Health & Science
Jurisprudence
Sept. 17 2014 4:49 PM Schooling the Supreme Court on Rap Music Is it art or a true threat of violence?
  Sports
Sports Nut
Sept. 17 2014 3:51 PM NFL Jerk Watch: Roger Goodell How much should you loathe the pro football commissioner?