Bernanke’s Retirement, the Lottery, and Casper the Friendly Ghost

Young Ben had planned on saving for his retirement. But alas, each time he got close to putting a few bucks into his saving account something came up. One time it was Aunt Barb’s lobotomy – another it was Jason’s need for a new ant farm. But Ben was not afraid and he boldly told everyone that his retirement income was already in the bag. After a few JD’s Ben would loudly explain his plan. Upon his 65^th birthday he would retire and promptly play the Indiana State Lottery and win upwards of $50,000,000. Surely $50 million would be enough to provide for his retirement years.

That sounds pretty silly doesn’t it? But this is almost exactly what Ben Bernanke and the press are saying about monetary policy. Last week a few members of the FOMC were brazen enough to question when the Fed might begin pulling out some of the zillions of dollars of reserves they pumped into the economy the last five years. Has it really been five years Martha? Wasn’t the recession over in 2009?

Anyway, you would have thought that Oliver had asked for more porridge. The markets had heart attacks and TV anchors gazed at all of us with anguished faces. Pull out the money??? We can’t pull out the money with France in a dither and with US unemployment at 8%! Ben agrees and he assures us that he will know exactly when to pull out all that money. And he will do it in a painless and happy way. Hey guys did you hear that Ben pulled out the money and no one even noticed it. Man that Ben is like the best eco-money surgeon.  He can pull trillions of dollars out of the system without anyone even realizing it. He is better than Casper the friendly ghost.

So what is going on here? Why is Ben Bernanke waiting to begin pulling the money plug? The answer is that it is like Jason’s Ant Farm. When faced with a decision to disappoint your child or save money for retirement, many people’s hearts are tugged. Ben looks around and sees a lot of unemployed workers and he realizes that the second he announces a policy to withdraw monetary stimulus, interest rates will rise and jeopardize spending and economic expansion and along with it employment. Surely when you compare that scenario to waiting a while to remove the money, it seems more humane to leave the money in the system.

So why do his colleagues on the FOMC want to start withdrawing stimulus now? Are they hard-hearted fiends and vampires? Perhaps, but I think not.  They want to help unemployed workers too but like waiting until the last minute to win the lottery to support you in old age – these Fed officials believe that it is better for the Fed to start the process now – instead of later. It is probably true that an announcement to reverse the course of policy of the last five years would result in a rational forecast that interest rates will rise. That expectation alone can start interest rates rising immediately. That doesn’t sound good. But keep in mind that short-term interest rates are basically zero right now. EVERYONE knows this is a temporary situation. The only real question is when they will rise and by how much.

Okay – so rates are going to rise back to something more normal. But how much will they rise? Expectations will drive rates up as soon as the announcement is made. But then what?  First, notice that a policy to begin removing money when there is a ton of it out there might not disturb money and credit markets very much. That is, banks are sitting on so much money that they have plenty of it around for quite a while. Markets will not immediately find money scarce. So this excess supply should help to slow and hold down interest rate increases. Second, the economy is not exactly roaring right now. When the economy surges ahead, this often creates soaring demand for credit that can cause large increases in interest rates. Without a rapid increase in US or global demand, we should not expect much pressure for interest rates to rise. Third, much has to do with inflationary expectations. That is, whenever we think inflation is going to rise in the future, these increases are mirrored in interest rates.  The reason for pulling out the money today is to reduce expectations of future inflation.  So a policy to begin gradually removing monetary stimulus ought to begin an orderly increase to normal levels of interest rates – but one that won’t necessarily reduce economic growth and employment gains.

The bigger risk comes from waiting. By waiting the Fed continues its stimulation of the economy and encourages bubbles. These bubbles are already impacting many prices and encouraging increased financial risk taking. These bubbles raise our expectations for inflation and raise the demand for money as a response to the increase risk and uncertainty generated by not knowing when the policies will change.  We increasingly encourage hostility from our trading partners as our surplus money seeks overseas opportunities and reduces the competitiveness of their exports.

Of course the timing problem is exacerbated by the Federal government who seems unable to control future budget deficits. This means credit markets will have to digest $1 trillion or more government bonds each year for the foreseeable future. Normally interest rates would rise as private firms sell bonds that compete with the government for precious private saving. The Fed’s aggressive purchasing of government bonds make it possible for the government to finance its deficits without driving up interest rates. Thus an expansionary monetary policy seems necessary to fund an expansionary fiscal policy. If the government continues on this path it puts upward pressure on interest rates. Clearly a reversal of both fiscal and monetary policies is what we need right now.  

The Fed’s decision to ease up would be very much aided by a prudent fiscal policy. But with or without the proper fiscal change, the Fed does us all a favor by doing the right thing and starting that right now.  Waiting risks another bubble and another explosion.