The Federal Reserve made news this past week in two separate events. The first came with the Fed’s policy meeting on Wednesday, when the central bank gave no hint that it would taper or slow its QE bond purchases any time soon. Wall Street believes the Fed will taper in September. My thought is that tapering is likely to come in December, or perhaps not until the new year. (More on that logic in a moment.)
The other big Fed event occurred when President Obama gave a strong defense of his former top economic advisor, Larry Summers. In front of a full caucus of House Democrats, Obama offered a full-throated rebuttal to the attacks of left-wing and feminist groups who have been coalescing around current Fed vice chair Janet Yellen. Obama told the Democrats “not to believe everything you read in the Huffington Post.”
Of course, with Ben Bernanke’s term ending in January, this all about the debate over a successor to the Fed chair. It’s a timely topic. But here’s the problem for Mr. Summers: Even though Obama has yet to make a choice on the matter, the president’s strong defense of Summers reduces the likelihood that Summers will be appointed. Why? Because Summers now looks like Obama’s man, even if the president hasn’t yet said so.
Consider this: If Summers looks like Obama’s guy at the Fed, what does that do to the all-important principle of Federal Reserve independence? Remember Arthur Burns? Dick Nixon’s guy at the Fed way back in the early 1970s? What a catastrophic inflationist period that turned out to be as Burns pumped money into the economy in order to get Nixon reelected. Nobody wants to repeat that. And that’s why Obama basically terminated a Summers nomination when he went to bat for him on the Hill. When it comes to appointing Fed heads, I’ve never seen anything like it.
Now, I’m not weeping about any of this. Janet Yellen and Larry Summers, two very smart people, are nonetheless Keynesian fine-tuners when it comes to monetary policy. And we’ve all had enough fine-tuning from Ben Bernanke. It’s probably not going to follow from a Fed nomination by a Democrat president, but what U.S. monetary policy really requires is a clear set of rules to stop the ad hoc, pillar-to-post nature of Federal Reserve operations.
Maybe Bernanke will turn out to be right. Maybe he’ll go down in history as our economic savior. But in the long run, whether it’s a dollar backed by gold and commodities, or a nominal GDP target, or the John Taylor rule, confidence in the U.S. dollar and economy will be greatly enhanced if monetary policy is guided by a clear set of rules. Neither Yellen nor Summers will provide that.
Turning back to the issue of Fed tapering (or tightening), I think the central bank is going to take its time. Indeed, the economic trends suggest there should be no rush to end quantitative easing. Like many conservatives, I didn’t like QE in the first place. But we’re stuck with it. And the trick now is to get out of it without inflicting more economic damage. My suggestion is simply this: Go slowly.
The Fed policy committee made no mention of tapering in its published directive this week. And the recent economic trends show an extremely weak recovery. Over the past year, real GDP has grown by only 1.4 percent, with inflation at 1.5 percent, according to revised GDP reports. Nominal GDP growing at only 2.9 percent is virtually a post-WWII low. It’s a rate that’s more appropriate for recessions than recoveries.
And the Fed itself slightly downgraded the economy this week. It also noted that inflation is below target and is worried that the recent rise in long-term interest rates has damaged the recovery in housing and auto sales.
Yes, there has been better news on the jobs front. But business capital equipment investing, which is the heart of job creation and growth, remains anemic. The 2013 spending-cut sequester has not produced economic catastrophe, but the economy is facing substantial tax increases on upper-end earners and investors. That’s a big headwind.
So let us hope the second half of 2013 produces better growth than the first half, as many economists predict. But until that evidence comes in, let’s also hope the Fed holds its fire and leaves the tapering idea alone.
Then perhaps Mr. Obama will consider a Fed candidate who understands the importance of policy rules and consistency for a strong King Dollar and a much more confident recovery.
– Larry Kudlow, NRO’s economics editor, is host of CNBC’s The Kudlow Report and author of the daily web log, Kudlow’s Money Politic$.