Analysis & Comment

Opinion | Does the U.S. Economy Still Need Booster Shots?

The experts disagree. Some say the protection that has already been provided is enough. Others say a booster is necessary.

Covid-19? Yes. But also monetary policy.

Let me explain the parallel between medical science and economic … well, let’s call it science. The Federal Reserve has been trying to immunize the U.S. economy against the threat of recession by buying long-term bonds, both U.S. Treasuries and mortgage-backed securities, a practice known as quantitative easing. How this helps is a bit complex, as is the precise pathway by which a vaccine generates protective antibodies.

Now, the Fed is debating when to begin tapering its purchases down to zero. That is, when to stop with the booster shots. Watch for headlines about this issue on Sept. 22, when the Federal Open Market Committee meets and the Fed chair, Jerome Powell, holds a post-meeting news conference.

There are three camps with differing views on what it will mean for the economy if the Fed slows down and eventually stops its bond purchases. They are the impulse camp, the flow camp and the stock camp.

If you’re in the impulse camp, you’re worried about the taper. You think that to strengthen economic growth, the Fed needs to accelerate its bond purchases. Keeping the current pace, you think, is just adequate for maintaining the current pace of growth.

If you’re in the flow camp, you’re also worried about the taper, though you’re less aggressive in your approach to bond purchases. You think that to support robust economic growth, the Fed needs to constantly add to its pile of bonds, although not necessarily at the current pace.

If you’re in the stock camp, you’re not worried. You think that what matters is the total amount — or “stock” — of bonds that the Fed already owns. That stock is very large, as this chart shows:

A person in the stock camp reasons that the bonds the Fed owns aren’t available to private investors. So investors compete for the remaining bonds that are still available to them, which pushes down their interest rates, which supports the economy. According to this view, the current stash of bonds will continue to do its good work even if it doesn’t grow.

The former Fed chair Ben Bernanke made a strong case for the stock camp in his presidential address to the American Economic Association in January 2020. Compared with the flow view, he said, “the stock view conforms better to the underlying theory and has better empirical support.” He pointed to several studies showing that interest rates stayed lower after the flow of bond purchases in various programs stopped, which is what the stock view would predict.

Still, Bernanke acknowledged that markets sometimes focus more on the rate of change in bond holdings than on the level of holdings — as in the “taper tantrum” of 2013, when Bernanke, who was then chair of the Fed, caught investors off guard by hinting at a tapering of bond purchases. “Communication around ending or reversing growth in the central bank balance sheet can indeed be delicate,” he told the economists.

The Bank of England is also in the camp that says what matters is the size of the central bank’s portfolio, including expectations of how big it will ultimately get. But Governor Andrew Bailey did say in a speech last year, that “in a case of extreme market dysfunction” investors do suddenly care about flow — the rate at which the central bank is adding to its holdings.

Andrew Norelli, a portfolio manager for J.P. Morgan Asset Management in Columbus, Ohio, wrote a neat description of the three camps in 2017. I caught up with him last week. He said he’s a flow person. But he’s less worried about tapering than some other flow people, he says, because of a Fed policy tool that was introduced in 2014 and became very important to financial markets this year: the overnight reverse repurchase agreement facility. This newsletter is complicated enough already without trying to explain how that tool works, but let’s just say the facility holds more than $1 trillion of reserves that could dribble back onto the market if there’s demand. Says Norelli, “The cushion of the trillion dollars is a good safety net if there is a liquidity shortage.”

Number of the Week

0 to 0.25 percent

The target range for the federal funds rate that the Federal Open Market Committee is likely to confirm at a meeting on Sept. 22. The committee cut the floor of the range to zero on Sunday, March 15, 2020, to fight the pandemic recession.

Quote of the Day

“Happiness is not a goal, it is a byproduct.”

— Eleanor Roosevelt, “You Learn by Living” (1960)

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