Stanley Fischer’s Well-Timed Fed Exit
Fed vice-chair Stanley Fischer’s surprise announcement of early retirement triggers the obvious question as to whether this could be the fore-runner to a serious market and economic deterioration ahead. Monetary bureaucrats, even if signally bad at counter-cyclical fine tuning, sometimes have a reputation for intuition about how to time their own career moves ahead of crisis. In this case, such suspicion may be wide of the mark given the personal circumstances. Even so, the exit of a Fed Vice-Chair, who in many respects has been the pioneer and the dean of the prevailing doctrine in the global central bankers club, is pause for thought.
The Early Years
When Professor Fischer published his famous paper “On Activist Monetary Policy with Rational Expectations” (NBER working paper no. 341, April 1979), the fiat money world was well into the third stage of disorder following the collapse of the international gold standard in 1914. But things were at a temporary resting point where the skies seemed to be getting clearer. After the violent terminal storms of the gold exchange standard (early 20s to early 30s), and then of the Bretton Woods System, it seemed to many that the “monetarist revolutionaries” had found a better practical monetary navigation route. The Bundesbank, the Federal Reserve, the Swiss National Bank, and even the Bank of Japan were pursuing an ersatz gold rule of low percentage increases in the monetary base or a related aggregate.
Fischer vs. the Monetarists
Despite the optimism at large, Fischer issued a challenge. The monetarist rules (x per cent growth of the chosen monetary aggregate) were doomed to fail when the underlying demand for money and monetary base in particular was so unstable.
Fischer rejected the new popular view (in the late 1970s) of the fashionable “classical economists” (for example Robert Barro) who argued that under market rationality monetary policy was powerless to influence the real economy. All the various trade-offs hypothesized by the Keynesian economists of the previous decade and pursued in part had been based on a view that central bankers could take the public by surprise (who would not realize what they were “up to” until later on). But once the public knew all Keynesian manipulations could not be effective.
In contrast, Fischer purported to demonstrate that if wages were rigid (most likely due to the existence of long-term contracts), then even given rational expectations, monetary policy could stimulate the real economy.
And so Professor Fischer, on the basis of his pioneering neo-Keynesian creed, preached that, yes, central bankers could and should pursue activist contra-cyclical strategies, especially when shocks were large and obvious. But yes, he also recognized that fine-tuning had its dangers and could morph into a long-run rising inflation rate, and so he recommended that policy be bound by the setting of a low inflation target. These ideas were in turn taken up and worked on by leading disciples (students) of Stanley Fischer, including Ben Bernanke and Mario Draghi.
The Birth of the 2% Inflation Standard
And so the fourth stage of fiat money disorder was born — what we may describe as the “global 2% inflation standard”. The prior monetarist experiments faded away in the decade following publication of Fischer’s paper (Paul Volcker abandoned monetarism by 1982, and the Bundesbank was the last hold-out in the year before the launch of the euro). At a stretch we could call this fourth stage the “Fischerian age of monetary policy”. Even though its author is now retiring, the outlook is for this stage to move eventually into a much more vicious sub-stage in which inflation rises far above the levels which the central bankers are purporting to target and the forces of rationality greeted by the classical revivalists have been completely trumped by powerful irrational forces which typify asset price inflation..
And all of this does not depend on who exactly President Trump decides to nominate in Fischer’s and Yellen’s place in coming months, even though there are reasons to speculate that the choice is likely to be pro-3% growth with the near-term target of avoiding defeat in next year’s mid-term elections. The bigger issue is that the so-called 2% inflation target belongs to a collection of fables under the title of the Emperor’s New Clothes. In today’s monetary environment where monetary base has been totally dislocated from the pivot of the monetary system (e.g., there's no stable demand, distinctive qualities of base money are virtually eradicated, and both supply and demand are boated by QE) there is no basis – other than expectation inertia – to view prices of goods and services as anchored.
At the best of times no one knew the precise relationship between monetary aggregates and prices — and indeed under the gold standard or monetarism no one pretended to have the price path under control; at best money was under control and that should foster some long-run tendency for prices to return to the mean, but there was no assurance of this. Strikingly the “Fischerians” have lost all sight of the natural rhythm of prices as responding to fluctuations in the pace of globalization, productivity growth, and of course the business cycle.
There is every reason to believe that expectation inertia will snap at some point in the future. And the root combination of monetary disorder — a Federal budget deficit of 4-5-6% of GDP at a cyclical peak, a Federal Reserve determined to hold down rates and manage the government bond markets, an administration favoring a weak dollar — there are grounds for fearing a lurch of the monetary train towards high inflation, albeit possibly beyond the next business cycle trough. And all of that despite the pride of Stanley Fischer in his resignation letter to President Trump:
During my time on the Board, the economy has continued to strengthen, providing millions of additional jobs for working Americans. Informed by the lessons of the recent financial ciris, we have buildt upon earlier steps to make the financial system stronger and more resilient and better able to provide the credit so vital to the prosperity of our country’s households and businesses.
Power corrupts, and Washington corrupts absolutely. How can anyone pretend to have learnt the lessons and achieved the results until at least one long business cycle under the given monetary regime has been completed? Only then can all the mal-investment be counted and the financial quake or hurricane damage assessed.
Stanley Fischer Is Out at the Fed
Fed Vice Chair and Yellen ally Stanely Fischer announced his unexpected resignation today, citing “personal reasons.” His term as a Fed governor wasn’t to be over until 2020 and his vice chairmanship was to end June of next year.
Fischer was one of the three most important Fed members, the other two being Yellen herself and the New York Fed’s William Dudley. The WSJ reports:
Mr. Fischer came to the Fed in 2014 a luminary in central banking, having taught many leading policy makers during a more-than two decade career as a professor at the Massachusetts Institute of Technology specializing in international economics. His students included European Central Bank President Mario Draghi and former Fed Chairman Ben Bernanke.
Mr. Fischer also ran a central bank—the Bank of Israel—from 2005 to 2013, held a senior post at the International Monetary Fund and served as a Citigroup vice chairman.
In terms of the insider status of these central bankers, Mr. Fischer was “Mr. Establishment.” Well educated in the machinations of how to control an economy from the top, Fischer was an expert bureaucrat. On paper, Fischer was among the most qualified in the world to be tasked with impossible role of making us more prosperous by diktat.
In reality, Fischer, to the extent he had a marked influence on central bankers like Draghi, Bernanke, Yellen, and so many others, was a key player in the boom-and-bust system of modern monetary economics. Under his watch, we had two major and devastating recessions— the cause of which was not Fischer’s failure individually, but the inflationary framework that pervades them all.
Fischer was considered to have leaned “hawkish” by the financial press. In the old days of Paul Volcker, a hawk was one wary of dangers of rising inflation. This was juxtaposed to a dove, who would downplay the dangers of inflation and advise greater monetary expansion. But in the post-crisis era of the so-called “new normal,” where interest rates are to remain absurdly low and inflation must be targeted at 2%, the hawks have long gone extinct. Fischer was no hawk, he was a cheerleader of the quadrupling of the Fed’s balance sheet, an advocate of unprecedented credit creation, and a hater of sound money.
It remains to be seen where Fischer will go next. But his undying advocacy of the use of central banking to tinker with and manage the economy will live on.
- "The Fed Wants to Test Drive Negative Interest Rates" by Joseph Salerno
- "Stanley Fischer's Eureka Moment" by C.Jay Engel
Stanley Fischer on the Balance Sheet: There will be no Tantrum on Wall Street
Regarding the Fed's balance sheet shrinkage narrative, one of the concerns is an unfavorable market response. The bond market (to the extent an actual market even exists) in 2013 panicked when the Fed began to taper it's asset purchases. While many are concerned the markets could panic, Fed Vice Chair Stanley Fischer on Monday denied this as a true concern. After all, they've been talking about this for some time — even in the FOMC minutes — and the bond market has hardly shrugged.
My tentative conclusion from market responses to the limited amount of discussion of the process of reducing the size of our balance sheet that has taken place so far is that we appear less likely to face major market disturbances now than we did in the case of the taper tantrum.
However, he also stated it was something that needed to be monitored closely:
But, of course, as we continue to discuss and eventually implement policies to reduce our balance sheet, we will have to continue to monitor market developments and expectations carefully.
So, does this mean that the Fed actually submits to the will of traders on Wall Street after all? To this, Fischer is quick to save face:
During a question-and-answer session, Fischer dismissed concerns that the Fed was providing too much information and therefore fueling too much trading.
“I don’t think we’re engaged in a game where they are leading by us the nose,” he said.
Of course he has to say that. No one is supposed to admit that the Fed doesn't do things on the mere science of dispassionate monetary policy. They cater to those whom they subsidize: both the Federal Government and Wall Street. And in the end, despite Fischer's dismissal of a market tantrum, can we really expect Wall Street's traders to smile and carry on as if they truly realize the Fed is no longer buying what they want to sell?
Stanley Fischer's Eureka Moment
Fed Vice Chairman Stanley Fischer's February 11th speech at Warwick Economics Summit was built around a story from his youth:
Eureka moments are rare in all fields, not least in economics. One such moment came to me when I was an undergraduate at the London School of Economics in the 1960s. I was talking to a friend who was telling me about econometric models. He explained that it would soon be possible to build a mathematical model that would accurately predict the future course of the economy. It was but a step from there to realize that the problems of policymaking would soon be over. All it would take was a bit of algebra to solve for the policies that would produce the desired values of the target variables.
Unfortunately, he expresses in his conclusion, this Central Planner's Dream is proving more difficult than he once thought:
... the eureka moment I thought I had 50-plus years ago was a chimera. Why is that? First, the economy is very complex, and models that attempt to approximate that complexity can sometimes let us down.
"Sometimes let us down." Call him Stanley "Understatement" Fischer.
The entire lesson of monetary central planning since the gold window was closed in 1971 (and arguably since the founding of the Fed) is that central bank bureaucrats and their various models are a systematic let down writ large.
Fischer wants to take a jab at the rising "rules-based" monetary policy trend that is seeking to threaten the "discretionary policy" nature of the Bernanke-Yellen regime. His point is that models (and therefore rules produced by models) aren't perfectly adaptable to the changing nature of economic conditions. Thus, Fischer defends the alleged need for policymaker discretion.
The problem, of course, is that the "changing economic conditions" are actually simply the various and ever-shifting actions of human agents throughout the economy. And thus not only is the model itself unsuitable for predicting their behavior, but no amount of "discretion" no matter how well educated, can make a beneficial one size fits all decision regarding money supply and interest rates.
The time preferences and supply and demand relationships as communicated through the price system are not up to the discretion of the monetary bureaucrats. And thus, the actions of the Stanley Fischers of the world, rather than supporting "economic man" undermines and frustrates the plans of the individual.
The lesson that Fischer should draw from the failure of econometrics to predict the path of the economy is not that the models need adaption and tinkering. No! What the central planners and their academic lapdogs need to understand is that no amount of modeling and centralized (political) decisionmaking can aid the economy. The economy is merely an analogy for human interaction, it's not a machine to be tinkered.
Fischer finishes with the following:
What Samuelson said was this, "I'd rather have Bob Solow than an econometric model, but I'd rather have Bob Solow with an econometric model than without one." And Samuelson, who was a shameless eclectic, would almost certainly have said essentially the same thing about policy rules.
Better idea: End the Fed and do away with the government economists, econometric models, and policy rules once and for all.
Showdown: Yellen and Trump
On most fronts, the Trump era is off with a bang — both upsetting the status quo, but also offending numerous Austro-libertarian free market principles. Particularly, there is growing tension within the spheres of monetary and regulatory policy. Those who made themselves comfortable in the Obama administration are swiftly being uprooted by a new narrative in the Eccles Building.
Mr. Trump said the U.S. dollar was already “too strong” in part because China holds down its currency, the yuan. “Our companies can’t compete with them now because our currency is too strong. And it’s killing us.”
The yuan is “dropping like a rock,” Mr. Trump said, dismissing recent Chinese actions to support it as done simply “because they don’t want us to get angry.”
On the other side, the story at the Fed is that we are now in a rising interest rate environment. Yellen herself is talking up a "strong dollar" policy via both Fed Funds hikes and also addressing the Fed balance sheet.
In effect, then, Yellen and Co. are jawboning the dollar upward while those on Team Trump are talking it lower. There's a clear collision here, between the Fed and the White House. This brings us to Yellen's congressional testimony Tuesday and Wednesday of this week. Bloomberg lists a few important topics that will likely be discussed at the hearings: balance sheet plans, the Dodd-Frank Act, and even Yellen's future at the Fed. On each of these, the coming clash between the Trump narrative and the Obama-era cohorts is obvious.
Yellen will continue to talk about monetary policy "normalization" (which means policy lunacy, just at a slower rate) and she will defend the Dodd-Frank regulations. Meanwhile, Trump will continue to push for a weaker dollar, Dodd-Frank repeal, and a Trump-friendly Fed board. Yellen's term expires next February — which gives her one year to accomplish her goals, assuming the probability that Trump will seek a replacement for her as Fed Chair.
There's a showdown brewing between the current Fed and the Trump administration. To go to even greater lengths to push the dollar down would be to prolong the capital-draining nature of bubble economics; to reverse policy and address the balance sheet or more aggressively pursue higher interest rates would be to prick the bubble.