Just Say No to Zombie Banks!

The market seems to have stabilized for awhile as Ben Bernanke has been giving speeches and making appearances every where he can.  For those of you  that really want to take on empirical studies in Economics (econometrics and all), this is a part of a strategy he outlined in  Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment.  (Bernanke and Reinhardt 2001).  It’s 113 pages long so be prepared to spend some time with it like I did last year.  However, my guess is you can read the front parts and the back parts and skip the methodology and findings and be just as happy.  It is basically the Chairman’s take on the Japanese Lost Decade and monetary policy at the time.  It talks about quantitative easing which is the new approach that even the Bank of England is using now.  That is when the Central Bank uses its balance sheet to buy and sale various financial assets to try to unclog lending channels. Since this is the first time the acting Chairman of the Federal Reserve Bank has ever appeared on any major news channel to have a fire side chat as in last night’s appearance on Sixty Minutes, I thought I’d point you to the motive behind the method.  It’s outlined in that academic paper.  Bernanke and Reinhard argue that Federal Open Market Committee (FOMC) announcements of policy and other announcements by the Fed shape market expectations and results. (Yes, I know El Presidente told us we shouldn’t care about the DJ but the FED chair still does because he knows IT MATTERS.)

Has the Federal Reserve’s policymaking body, the Federal Open Market Committee, historically exerted any influence on investors’ expectations about the future course of policy? Although members of the FOMC communicate to the public through a variety of channels, including speeches and Congressional testimonies, official communications from the Committee as an official body (ex cathedra, one might say) are confined principally to the statements that the FOMC releases with its policy decisions.

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The FOMC has moved significantly in the direction of greater transparency over the past decade. Before 1994, no policy statements or description of the target for the federal funds rate were released after FOMC meetings. Instead, except when changes in the federal funds rate coincided with changes in the discount rate (which were announced by a press release of the Federal Reserve Board), the Committee only signaled its policy decisions to the financial markets indirectly through the Desk’s open market operations, typically on the day following the policy decision. In February 1994, the FOMC began
to release statements to note changes in its target for the federal funds rate but continued to remain silent following meetings with no policy changes. Since May 1999, however, the Committee has released a statement after every policy meeting.

The FOMC statements have evolved considerably. In their most recent form, they provide a brief description of the current state of the economy and, in some cases, some hints about the near-term outlook for policy. They also contain a formulaic description of the so-called “balance of risks” with respect to the outlook for output growth and inflation. A consecutive reading of the statements reveals continual tinkering by the Committee to improve its communications. For example, the balance-of-risks portion of the statement replaced an earlier formulation, the so-called “policy tilt”, which characterized the likely future direction of the federal funds rate. Much like the “tilt”statement, the balance of risks statement hints about the likely evolution of policy, but it does so more indirectly by focusing on the Committee’s assessment of the potential risks to its dual objectives rather than on the policy rate. The relative weights of “forward looking”and “backward-looking” characterizations of the data and of policy have also changed over time, with the Committee taking a relatively more forward-looking stance in 2003 and 2004.

Of course, investors read the statements carefully to try to divine the Committee’s views on the economy and its policy inclinations. Investors’ careful attention to the statements is prima facie evidence that what the Committee says, as well as what it does,matters for asset pricing.

I’ve highlighted that last paragraph because it is extremely important in explaining both the Chairman’s sudden interest in TV appearances and the market’s relief rally recently.  Bernanke has been out there saying that the Fed will not let major banks fail, he dislikes then entire AIG thing and wants to ensure it never happens again,  he’s been asking the senate committees he visits for more regulation, and he’s repeatedly said that the FED expects the recession to experience the trough later this year.  We’ve not seen any meaningful discussion about the type of recovery to expect (L shaped or otherwise).  We have however, seen more upbeat statements geared to appease the markets and their role in asset pricing.

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