Everyone knows it’s coming, but when? Everyone recognizes that at some point it’s essential, but the associated benefits and risks are debatable.
One thing we can be reasonable sure of, as we discussed on Monday, is that central bankers are prone to misjudge the future. Indeed, there’s plenty of that to go around. In any case, it comes with the territory when wielding supernatural decisions over money with the conventional processing power of wetware.
Thus the great conundrum: What to do next? It’s always lurking, of course. The only difference is that the stakes are higher than usual. Not for tomorrow, next week or next month necessarily. But sometime down the line, in the amorphous future, monetary policy decisions will make a big difference, for good or ill. But how? And when? Ah, the debate has only just begun.
“The main concern surrounding exit policies… is not technical, but one of timing: can the timing and pace of the exit be properly judged?” reminds a newly minted essay published by the Bank for International Settlements, a think tank and quasi-regulatory body for central banks the world over.
And thanks to the somewhat experimental nature of the current round of monetary stimulus—i.e., quantitative easing and the like—there’s that much more mystery surrounding what to do and when and what it all means when the inevitable change of plan comes. “The possible long-term collateral damage in terms of market functioning and central bank operational autonomy of balance sheet policies underlines the need to put in place clear exit strategies,” the BIS paper advises.
Of course, the only clarity we have at the moment is largely related to the stated discipline to maintain the status quo for the foreseeable future. Or as the Fed’s FOMC explained earlier this month at its regularly scheduled confab, “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
That may suffice for the moment, but the crowd will demand more details in the weeks and months ahead in terms of how to end, or at least begin winding down this love affair with cheap money and related commitments.
Indeed, the stimulus extends well beyond the Fed’s purview. To cite the other elephant in the room, the U.S. government is on the hook for any number of prop-‘em-up strategies. The Troubled Asset Relief Program, or TARP, for instance, isn’t open ended, even if it appears otherwise. Perhaps Congress should consider letting it die as this year concludes. Treasury Secretary Geithner made comments to that effect yesterday. But President Obama may be leaning in the opposite direction.
TARP, of course, is just the tip of the iceberg. It’s easy to dig a hole. Climbing out of it requires a different skill set. At some point, someone will have to start talking tough, which is a prelude to acting tough. In a perfect world, with perfect foresight, the Fed and Congress would know exactly when and how to start pulling back. In the real world, however, uncertainty abounds. To be sure, the risk of acting prematurely shouldn’t be dismissed. But neither should we overlook the hazards that await if we do nothing for too long. History is full of examples of the fallout from both extremes.
As with most things in life where absolute clarity is missing, some happy medium that hedges the risk is preferred. We might start with a small hike in Fed funds, if only to remind the crowd that the price of money can move in more than one direction. Perhaps it stands as the only hike for months ahead, but every risky journey must begin somewhere.
We can’t see the future clearly and so we have to make compromised decisions. True for investing, true for central banking. That implies that gradual change is the least worst of all decisions unless you know something that eludes everyone else.
There’s a case for arguing against the idea that the central bank should try to overtly pop bubbles. The same logic says we should leave interest rates at virtually zero until a politically satisfying recovery is virtually assured. Perhaps there’s a middle ground. Perhaps some in Washington are actually willing to act on that reasoned assumption.