Unconventional Policy, Conventional Fed
Ben Bernanke, rather than ride out his last six months as Federal Reserve chairman in relative peace and contentment, has chosen to initiate a debate on tapering the Fed's asset purchases, sending long-term interest rates soaring.
Why? Economist and blogger Tim Duy says the whole debate seems premature, given the levels of unemployment and inflation. "So how did the Fed get here?" he asks.
Good question. The Fed's forecast for improved second-half growth is just that. We've been waiting for years for stronger growth to emerge in the next quarter, or the next quarter after that.
One possible explanation for the shift is internal Fed politics. Many of the more hawkish Fed presidents have been uncomfortable with quantitative easing from the start. And for good reason. There is little in the way of data on which to evaluate the short-term benefits of QE versus the long-term costs. For them, the priority is preserving the Fed's hard-won credibility on inflation at all costs.
Another possibility is concern that asset purchases can distort the market. While the Fed has been sucking up $45 billion a month of Treasuries, especially those with maturities longer than five years, the Fed's holdings as a share of the total U.S. publicly held debt (15.1 percent) is about the same as it was in 2007 and is lower than in 2003, according to Torsten Slok, Deutsche Bank AG's chief international economist. That said, by the end of 2013, the Fed will own 45 percent of the 30-year bonds and 35 percent to 40 percent of seven- and 10-year notes.
A third reason is Bernanke's sense of responsibility. He was present at the creation of QE. He wants to have a hand in seeing it put to rest.
I suspect the explanation is something simpler. In spite of all the unconventional policies the Fed implemented during and after the financial crisis -- from an array of emergency lending facilities to its zero-till-cancelled funds rate to large-scale purchases of mortgage-backed and Treasury securities -- this Fed is still quite conventional at heart. Policy makers are uncomfortable with a $3.5 trillion balance sheet that's still growing. Yes, they say they have the tools to unwind it, or can hold assets to maturity. But it's still a big unknown. They are anxious to get back to what they know best: the overnight funds rate as a policy instrument.
I can't say I blame them.
(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)