Okay, so nobody but The Bernank knows for sure when the taper will happen. I thought that the Fed would taper ever so slightly in September. My prediction was a decrease by $5-10 billion of Treasury purchases with a continuation of mortgage paper purchases at a steady, or perhaps increased, rate.
I think that the biggest clue that Bernanke gave regarding the taper is contained in this question and answer sequence:
Peter Barnes:
Peter Barnes, Fox Business, sir. You mentioned fiscal issues in the statement today. Are you concerned about a government shutdown? We’re hearing more about that possibility. Did that come up in your discussions at this meeting? Of what do you think will be the impact of a government shutdown on the economy, and what could the Fed’s be — or, would the Fed be prepared to respond to that and help the economy with additional accommodation –for example, additional asset purchases? Thank you.
Ben Bernanke:
Well, a factor that did concern us as in our discussion was some upcoming fiscal policy decisions. I would include both the possibility of a government shutdown but also the debt limit issue. These are obviously, you know, part of a very complicated set of legislative decisions, strategies, battles, et cetera, which I won’t get into.
But it is the case, I think, that a government shutdown and perhaps, even more so, a failure to raise the debt limit could have very serious consequences for the financial markets and for the economy, and the Federal Reserve’s policy is to do whatever we can to keep the economy on course. And so, if these actions led the economy to slow, then we would have to take that into account, surely.
So, this is one of the risks that we are looking at as we think about policy. That being said, you know, again, our ability to offset these shocks is very limited, particularly at that limit shock. And I think it’s extraordinarily important that Congress and the administration work together to find a way to make sure that the government is funded, public services are provided, that the government pays its bills, and that we avoid any kind of event like 2011, which had, at least for a time, a noticeable adverse effect on confidence on the economy.
That question and answer segment was the most important part of the press conference.
Bernanke is a student of the Great Depression, who famously referred to the Milton Friedman helicopter drop of money to prevent another Great Depression. Whether that would work or not is a subject for a different day (spoiler: it hasn’t worked to date).
But here’s the kicker. The Great Depression — and the Great Recession — were likely caused by Federal Reserve manipulation. In the context of the Great Recession, some have suggested that the Federal Reserve’s hawkishness (meaning having a “tight” monetary policy) in early to mid-2008 likely caused a mild or moderate downturn to become the biggest recession since the Depression. If this is true (and I think that it may be), Bernanke does not want to repeat the mistakes of 2008.
Fast-forward to 2013. The economy is getting better, slowly. However, there are two albatrosses circling over D.C. right now: Obamacare and the debt ceiling debate. Both are linked to each other in a way, since they relate to the House Continuing Resolution (CR) which funds the government and needs to be passed to continue to keep the government “open” starting October 1st.
Bernanke made a reference to 2011 and the S&P downgrade of America’s credit. I think that he’s trying to remain non-partisan here, but he has a point. The market was shocked by the S&P downgrade. Shortly thereafter the market was shocked again by Operation Twist, which wasn’t full-blown QE, but a mere shifting of the maturities of the Fed’s bond portfolio by selling short-term Treasuries (increasing supply, decreasing demand) and buying long-dated Treasuries (decreasing supply, increasing demand).
The S&P dropped over 200 points – a massive move — after the debt ceiling debate pushed America to the brink and the S&P downgraded America’s credit.
The market dropped another 100 points (albeit briefly) when the disappointing “Operation Twist” was announced.
Bernanke does not want this to happen again. Therefore, I believe that the Federal Reserve will not taper until there is a longer-term resolution of the debt ceiling debate and, to a lesser extent, Obamacare.
These two conditions are necessary, but not sufficient, for the taper to begin. Bernanke made it pretty clear that he wants employment to be consistently higher than it is today before considering a taper of Quantitative Easing. But I think that it’s safe to say that the Fed won’t taper while major issues like the debt ceiling and Obamacare funding are dominating the headlines, with the risk of a government shutdown.
Unfortunately for the next Federal Reserve chairperson, the after effects of a five year Quantitative Easing program will be a challenge to resolve, to say the least. But Ben Bernanke does not want to be at the head of the Fed causing two recessions — or worse — in less than one decade.
As always, free markets are better markets.