FedPolicy,dovishdoveandStephanieKelton

FOMC has delivered its decision on the policy with a statement along with the press conference of Fed Chief Jerome Powell. But before we move on to our assessment of what we think about the tone of the same we should check how the markets have reacted. US equity markets like Dow Jones, Nasdaq, S&P ended mildly in red, Asian markets like Hang Seng and Nikkei are trading in green, US 10 yields are back to 1.61 levels which have gone till 1.66 prior to the policy. The major change though is seen in the Dollar Index which is trading at 90.5 which is the lowest level seen since end February. The emerging market currencies have strengthened.

In the policy and Powell’s statements the major point which markets were looking out was the comments on the asset purchase program and whether there would be any hint about the taper timelines. During the conference Fed Chief was specifically asked this question to which his answer was that there has to be “substantial progress” on Fed’s objectives before we can think of tapering. Any such measures will also be communicated well in advance. Till that time, we will remain fairly accommodative.

Let’s simplify what Fed said and meant. What are the Fed’s objectives? Stable prices and Maximum employment. How do you define stable prices? Consumer inflation anchored around the 2% level.

What if the inflation shoots up now? Don’t worry those high readings are transient generated by supply bottlenecks and previously low readings (read base effects). What about employment, how do you define high unemployment? The headline unemployment reading can come down because of low LFPR (Labour force participation ratio) i.e. not enough people are looking for jobs as they have dropped off from the labour force having been discouraged by no opportunities hence unemployment rate is not a reliable measure. Firstly, Fed would like all the people who were holding jobs in pre pandemic era to get back into the job market. As per Powell’s statement there are still 6 million people who need to come back. Powell also said that the wrath of pandemic has fallen unequally on the different segments of society and some equitable justice need to emerge on that aspect too. Hence, we can safely conclude that the maximum employment is an amorphous term on which there is little clarity and the Fed would like to keep it that way. That allows it a long rope. Markets are hence justified in interpreting it as dovish dove policy. Readers would do well to remember that the accommodative stance started during 2008 GFC took a good 5 years before the taper tantrum complains were made. Timelines this time round will be stretched too.

Academic texts of economics start from one basic ground rule on which all the further theoretical edifice is built. Too much money chasing too few goods will result in inflation. In case Fed continues to expand the balance sheet and pumps 120 bn USD extra every month into the system it has to reflect in rising prices. In case it is not happening then there is some disconnect somewhere. Maybe the theory itself needs to be revisited. Economics is not a hard science like physics hence seeking a universally acceptable paradigm is a chimera. Stephanie Kelton in her 2019 book The Deficit Myth propounds some new economic theories (read MMT). She says that in a highly globalized and financialized world the inflation might not occur in the country which is increasing its money supply. As the foreign exchange market transfers the capital flows across borders it becomes increasingly difficult to trace the path of money. Money printing in the US can inflate the prices of lumber in India. Other countries then struggle to keep a check on these flows. Readers would remember that we had quoted a 2104 speech by Raghuram Rajan where he canvassed for a globally coordinated monetary policy so as to ensure that others don’t end up paying for someone else’s profligacy.

We would end at this thought for the readers. In case any country can print and be happy, why would they ever stop. During the start of the year when the US yields were running away everyone thought that MMT’s comeuppance has come but for now that looks unlikely.