Fed’s Bullard: The End of Monetary Policy

The chief of the Federal Reserve Bank of St. Louis thinks monetary policy as we know it is dead. Gone. Kaput. No longer alive, after the Fed recently targeted an effective federal funds rate of zero to 0.25 percent in its most recent policy statement on Dec. 16. “The fact is, monetary policy defined as movements in short-term nominal interest rates is coming to an end, at least for now,” St. Louis Fed president James Bullard wrote in a recent bimonthly review published by the bank. “It’s a funeral for a friend.” Strong words, but perhaps also stark message for financial market participants over what Fed policy will look to do over the months ahead. Bullard acknowledged the Japanese experience, where nominal interest rates fell to zero and the country felt the strong crack of crushing deflation that led to a so-called “lost decade” — and argued that quantitative measures are likely needed to fight what he suggested is a risk of long-term inflation. (Fed-speak uses esoteric terms like “quantitative easing,” but it’s simpler than it sounds: quantitative refers to the money supply, while easing refers to increasing — so quantitative easing is flooding the market with money, in the hopes that some of it gets lent out.) Bulllard argues that more attention will need to be paid to controlling inflation going forward, as a result of recent Fed policy of increasing the money supply; but he also argues that deflation is just as credible a threat for financial markets — particularly for mortgage markets. “Deflation, should it occur in the United States, might be particularly challenging because some of our current core problems are in housing markets, where contracts are written in nominal terms,” he wrote. “An unexpected deflation would make those contracts more expensive for borrowers.” The rise of fiscal policy As the influence of monetary policy wanes — something that every mortgage market participant should be cognizant of, relative to monetary policy’s historic effect upon mortgage rates — Bullard suggests that fiscal policy is rising to renewed prominence after years of being shunned by most major economists. (For those unfamiliar with the difference, monetary policy refers to the management of the nation’s money supply; fiscal policy refers to the management of spending, usually via taxes.) “To the extent there are stabilization goals—goals requiring time-critical policy interventions—the usual idea is that certain types of tax cuts might be beneficial,but that otherwise the effort is best left to monetary policy,” Bullard suggests. “Not least in this thinking is that the Fed can act relatively quickly, while the political process tends to be much slower and more cumbersome.” Of course, as Bullard notes, 2008 proved that notion at least somewhat wrong, with Congress passing sweeping stimulus and intervention policies not once, but twice during the year. Fannie Mae (FNM) and Freddie Mac (FRE) were taken over by the government; tax rebates were pushed through to consumers; and that’s not to mention the $700 billion blank check given to the U.S. Treasury via the TARP legislation. And you can expect much more of that in 2009, if reports of the stimulus package being considered by Obama and his advisors are correct. “While the Fed will continue to be innovative in providing liquidity to markets through existing facilities and possibly some new programs, an important part of the response to ongoing financial market turmoil will come from fiscal policy intervention,” Bullard wrote. “This runs counter to much of the thinking in macroeconomic policy circles over the past two decades.” Which, in many ways, seems oddly appropos. After all, what we’re seeing in the nation’s primary and secondary mortgage markets runs counter to much of the traditional thinking that has existed in mortgage banking for the past few decades, too. That a need to re-examine our assumptions about mortgage banking is coinciding with a need to re-examine our assumptions about the financial markets should suggest just how far-reaching a crisis that began with subprime mortgage really has become. Read the full paper. Write to Paul Jackson at [email protected]. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.