The Fed’s QE3 Lives On

And so does my hat!

Much has already been written about the economic implications of today’s pedal to the metal decision by the Fed: The Fed’s open market committee will continue to pump money into the economy, contrary to expectations that an improving economy would lead the Fed to slow the pace of its bond purchases.  Leaving the economics to others, I offer just a few quick thoughts on the political implications of today’s surprising (for many) decision.

First, I was struck (though hardly surprised) by Chairman Ben Bernanke’s response to a reporter’s question about the potential impact on the Fed of the political contest over Bernanke’s successor.

CHAIRMAN BERNANKE: “I think the Federal Reserve has strong institutional credibility, and it is a strong institution, highly competent institution, and it’s independent, it’s nonpartisan, and I am not particularly concerned about the political environment for the Federal Reserve. I think the Fed will be—continue to be an important institution in the United States and that it will maintain its independence going forward.”

Bernanke often emphasizes the Fed’s non-partisanship, as he should given the widely held norm of central bank independence. But yesterday’s news drives home a different way of thinking about the impact of political context of the Fed’s decision-making.  Far from its claims of immunity to politics, the Fed is acutely aware that partisan congressional politics shapes the Fed’s conduct of monetary policy.  That was precisely Bernanke’s point in detailing one of the reasons why the Fed would put off tapering its asset purchases:  “If these actions [threats to shutdown the government and to default on the nation’s debt] led the economy to slow, then we would have to take that into account,” Mr Bernanke said.  The Fed yesterday opted to duck out of the partisan winds and let them pass over while the Fed takes stock of events on Capitol Hill.

Second, the Fed’s decision to keep QE3 in place potentially grants more leeway to Bernanke’s successor  (presumably Janet Yellen). This assumes that the Fed will continue to hold off trimming its bond purchases until after the Senate confirms Bernanke’s successor.  The sooner the Fed begins its exit, the less the discretion of the incoming chair.  Hard to know of course whether the Fed intentionally held off in anticipation of the change in leadership or whether this is just an unintended consequence of keeping the Fed’s punch bowl filled to the rim.   Either way, the timing of the taper will no doubt take center stage when the Senate Banking panel begins confirmation hearings for Bernanke’s successor.

Finally, I am reminded today of something Bernanke said at his September 2012 press conference when the Fed formally launched a third round of quantitative easing.  Bernanke noted that the consensus on the committee was so broad that “even as personnel changes going forward, this will be seen as the appropriate approach and we will have created a reserve of credibility we can use in subsequent episodes.”   The difficulty the Fed has had in communicating its policy intentions since last spring complicates the Fed’s ability to build a “reserve of credibility.”  And as hard as the Fed seems to be trying to get monetary policy right, partisan politics in Washington (particularly within the House GOP conference) continues to confound the Fed’s progress.  The Fed will likely continue to face both of these challenges—communications and fiscal headwinds—for some time.  Hope I don’t lose the hat in the wind.

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