What to Expect from Jackson Hole: “Party On”

In the past, the Fed’s Jackson Hole Symposium produced some new and controversial proposals.  Two years ago, for example, then Chair Bernanke introduced QE3.  And, the financial markets loved it.  So, what can we expect from this Jackson Hole Symposium?

Given the stances that Yellen has taken throughout her short tenure as Chair, it would be very surprising if the Symposium weren’t used by the Fed as a justification of continued zero interest rate policies (ZIRP) and insistence that the Fed’s monetary policy tools aren’t for market stabilization (i.e., “macroprudential” policies are for that).  Let’s look at the evidence.

The BIS

At the end of June, the Bank for International Settlements (BIS), the supposed Central Bank for central bankers,  put out a report saying that the world’s leading central banks should not fall into the trap of raising rates “too slowly and too late… The risk of normalizing [interest rates] too late and too gradually should not be underestimated.”  They said that governments should promote policies that improve the performance of their economies, like removing obstacles and rules regarding hiring and firing in their labor markets (e.g., Southern Europe) like Germany did some 20 years ago, structurally reform their tax codes (e.g., U.S.), strengthen the capital base of their banking system (e.g., Europe), and encourage capital formation.

The Fed’s Answer: “No Way”

A couple of days later, the BIS got their answer from the Fed, as Chairwoman Yellen distanced herself from all of these ideas.  In a somewhat shocking statement, she said that the Fed’s monetary policy tools (short-term rate setting and its balance sheet) were not tools to be used to try to anticipate the risk of future financial instability.  And then she introduced a new term, “macroprudential” policy.  Later, in her semi-annual Humphrey-Hawkins testimony to Congress, she clarified the meaning of this new term: the regulators of the financial system through policies regarding bank capital, rules around derivatives and margin, etc. are responsible for the financial stability of the system.

Macroprudential Policy to Fight Financial Repression

There are two critical issues here: 1) the Fed’s monetary policy of financial repression (ZIRP) is causing financial risk (e.g., investors stretching for yield in the junk bond market which Yellen acknowledged when she told Congress that the junk bond market appeared stretched), and 2) the Fed is still the primary financial institution regulator in the nation and is supposed to be the “lender of last resort,” a function that is aimed at keeping markets and the economy “financially stable.”   So, we would expect that the Fed would use every tool in its toolkit, including monetary policy, to also fulfill its regulatory obligations.

Bubbles and the Regulatory Track Record

Since the Fed wants to rely on its regulatory powers to insure financial stability, let’s look at the regulatory track record on the bubbles issue.  In early 2007, the then head of the Fed, Ben Bernanke, assured the public that the “the problems in the subprime market seem likely to be contained.”  At the time of those remarks, that bubble was already bursting and the primary regulator didn’t see the devastating implications.  Then, as it burst, it took the biggest dose of liquidity (via the Fed’s balance sheet) the world had ever seen to keep the financial system from collapse.

Let’s also recognize that the regulatory process is reactionary.  Every single piece of major financial legislation [most recent: Sarbanes-Oxley and Dodd-Frank] has been the result of some financial disaster, not in anticipation of it.  The regulators simply aren’t capable of stopping financial instability, either because they don’t recognize it, or because they do not yet have the regulatory powers (i.e., legislation to prevent a particular kind of bubble won’t be passed until the bubble bursts).

So, Party-On

My expectation from Jackson Hole is that the Fed will confirm a continuation of ZIRP despite the misallocation of resources or the bubbles it causes.  To justify a continuation of ZIRP, Yellen needs to reiterate her stance on “macroprudential” policy, i.e., it is the function of the regulatory arm of the Fed and other agencies to prevent bubbles.

No one in the financial arena, including myself, actually believes that the Fed won’t provide liquidity and do what it can with its balance sheet in the event of another financial implosion.  I suspect the current Fed stance is there only as a continued justification of current policies, which are being questioned by more and more economists.

So, after Jackson Hole, the party in the financial markets is likely to continue awhile longer.

-Robert Barone, Ph.D.