Bernanke needs to abandon taper talk

Pete Souza, official White House photographer

Article Highlights

  • Since Bernanke's musing about the possibility of “tapering” Fed bond purchases, interest rates have risen sharply.

    Tweet This

  • The tricky part of Bernanke’s messaging problem remains the stock market.

    Tweet This

  • The best Bernanke can do is admit to the slowing economy and return to the original QE 3 messaging plan

    Tweet This

Fed Chairman Bernanke faces a tricky messaging problem for his July 17 Humphrey-Hawkins swan song before the Congress. Since his musing about the possibility of “tapering” Fed bond purchases while responding to pointed questions from JEC Chairman Kevin Brady, interest rates have risen sharply, by over a full percentage point (more in “real,” or inflation-adjusted terms) while the economy has slowed and inflation measures have dropped further to below a 1% pace by some measures.

Fed forecasts of stronger second-half growth have been undercut by weaker data that has driven the latest (second quarter) growth forecasts from about the 2.5% pace that prompted the taper musing to 1.0% or below during the two-month interval between Bernanke’s testimonies to Congress. Notwithstanding the Fed’s oddly persistent optimism, driven in part by a housing recovery that has been jeopardized by the sharp interest rate increases driven by taper talk, the US economy has slipped toward stall speed. Little wonder, with a persistent European recession, slower Chinese growth, and persistent US fiscal drag worth about two percentage points of GDP more than offsetting the boost from housing.

The tricky part of Bernanke’s messaging problem remains the stock market, which has kept rising as investors have shrugged off the taper-driven jump in interest rates by assuming, encouraged by rosey Fed forecasts, that higher growth and better profits will trump any drag on stocks and the economy from higher market and real interest rates. If Bernanke sticks to the higher-growth-taper theme, FOMC hawks will pounce, insisting on tapering QE sooner or even higher fed-controlled interest rates. The further rise in interest rates will jeopardize the housing recovery and and higher stock prices. If, alternatively, he expresses doubts about the Fed’s rosy outlook, rates will come back down and stocks will rise further against a backdrop of deteriorating profits that eventually will puncture the stock market rally. All very awkward with unemployment still stuck at 7.6%, growth close to zero, and inflation still falling.

There are no good alternatives facing Bernanke for now. The best he can do is admit to the slowing economy and return to the original QE 3 messaging plan: monetary policy will remain highly accommodative until unemployment comes down to 6.5% or below and/or inflation gets above 2.5%, something, he can point out, that is highly unlikely given a slowing global economy and the attendant, persistent drop in US and global inflation… no “ifs,” “ands,” or “buts.”

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

John H.
Makin
  • John H. Makin is a resident scholar at the American Enterprise Institute (AEI) where he studies the US economy, monetary policy, financial markets, corporate taxation and banking. He also studies and writes frequently about Japanese, Chinese and European economic issues.

    Makin has served as a consultant to the US Treasury Department, the Congressional Budget Office, and the International Monetary Fund. He spent twenty years on Wall Street as the chief economist, and later as a principal of Caxton Associates a trading and investment firm. Earlier, Makin taught economics at various universities including the University of Virginia. He has also been a scholar at the Bank of Japan, the Federal Reserve Bank of San Francisco, the Federal Bank of Chicago, and the National Bureau of Economic Research. A prolific writer, Makin is the author of numerous books and articles on financial, monetary, and fiscal policy. Makin also writes AEI's monthly Economic Outlook which pairs insightful research with current economic topics.

    Makin received his doctorate and master’s degree in economics from University of Chicago, and bachelor’s degree in economics from Trinity College.


    Follow John Makin on Twitter.

  • Phone: 202-862-5828
    Email: jmakin@aei.org
  • Assistant Info

    Name: Brittany Pineros
    Phone: 202-862-5926
    Email: brittany.pineros@aei.org

What's new on AEI

image Recovering from tax time blues
image 10 welfare reform lessons
image Let HHS nominee Sylvia Burwell explain Obamacare lie
image Why bold ideas backfire in politics
AEI on Facebook
Events Calendar
  • 14
    MON
  • 15
    TUE
  • 16
    WED
  • 17
    THU
  • 18
    FRI
Wednesday, April 16, 2014 | 10:00 a.m. – 11:00 a.m.
Calling treason by its name: A conversation with Liam Fox

Join us at AEI as the Right Honorable Liam Fox sits down with Marc Thiessen to discuss and debate whether America’s intelligence agencies have infringed on the personal privacy of US citizens.

Event Registration is Closed
Thursday, April 17, 2014 | 4:00 p.m. – 5:00 p.m.
The curmudgeon's guide to getting ahead

How can young people succeed in workplaces dominated by curmudgeons who are judging their every move? At this AEI book event, bestselling author and social scientist Charles Murray will offer indispensable advice for navigating the workplace, getting ahead, and living a fulfilling life.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.