Prior to a recent speech to a small group of individual investors, my host asked them to submit some questions to me in advance. Here are the questions submitted with some brief answers.
Is it possible for the sitting president who is up for reelection to manipulate economic figures in order to create a falsely favorable (to him) improvement, or must he rely on promoting a complementary interpretation with stated numbers for a better public image?
He and his surrogates will put the most favorable spin on the numbers, but I doubt overt manipulation. The Civil Servants who create the numbers are very smart people dedicated to producing the most accurate numbers possible and would make a major stink if someone tried to bias that process. The risks and consequences of doing so would not be worth it.
How does the Fed lower its balance sheet?
The Fed shrinks its balance sheet when it sells assets, allows them to mature without replacing them, has loans repaid.
The total assets on the Fed’s balance sheet grew from roughly $800 billion just prior to the financial crisis to just under $3 trillion. The growth was larger than it might have been because the traumatized banking system held onto the reserves created by the Fed rather than making maximum use of them in making loans and investments which create deposit money. The economy and financial system has adjusted to the Fed’s current balance sheet. It won’t be advisable to shrink it until more vigorous lending by the banking system threatens to be inflationary. At that point the expansion of the “money multiplier” will need to be partially offset by the Fed draining reserves, i.e. shrinking its balance sheet.
How much control does the Fed have on interest rates.
It has pretty close control over the Federal funds rate and other very short-term rates. It’s influence (rather than control) over longer term rates depends on market sentiment, which, in turn, is based on economic conditions. Lately, economic circumstances and the credibility of the Fed have given it pretty much influence over longer term rates. That is the point of Mr. Bernanke promising low rates for an extended period of time. If that is believed, longer term rates stay low, as in a 2 percent rate on a 10 year bond. If growth and/or inflation pick up substantially, that rate will rise (and longer rates will rise more) whether the Fed likes it are not.
Recently, Bernanke made some very dovish comments which seems to favor the current political party . . . is the Fed chief politically inclined.
The Fed chief always wants the best economy possible and sustainable; so one might say that it favors incumbents. But, remember that while Mr. Bernanke was reappointed by the Democratic President, he was originally appointed as a governor and later as Chairman (and to the Council of Economic Advisors in between) by a Republican president. He wants the best legacy possible for himself regardless of which party might share the credit.
What was the most interesting/unusual experience you had as a FOMC/Bank President?
On a recurring basis, the most interesting aspect of the job was the FOMC meetings about every six weeks and the preparations with my economists leading up to those meetings. Budgets, other meetings, personnel issues, operation issues were all less fun. I enjoyed particularly some of the creativity we brought to our annual reports. For example, one year I included a picture of myself visiting three graves: Buddy Holly, Adam Smith, and Sam Houston. There wasn’t room for Evita.
How will the EU troubles, specifically Spain’s, potentially manifest themselves in our economy? What is the best fix? What correlations are there between our own fiscal policy/economic conditions and those of Spain, Greece, and Portugal?
Countries are tied together through both trade (imports and exports) and financial transactions such as bank loans security holdings and the like. As southern Europe drags all Europe into recession, European demand for U.S. exports will decline, thus affecting our exporters. Some U.S. banks may own European sovereign debt, or private debt, and U.S. mutual funds may as well. This train wreck has been so slow moving that I assume that banks and mutual funds and money market funds have lessened their exposure substantially. I don’t expect the direct impacts on us to be substantial. The worrisome thing, however, is the absence of a reasonable way out of the European mess and the jeopardy it puts the Euro in. So far the “remedy” imposed by Germany as a condition to helping financially has been austerity. Austerity measures are shrinking the indebted economies, which hardly helps them with their debt. They need specific measures to curb government borrowing combined with measures to produce economic growth, presumably structural measures like labor market reform, etc. There is no easy way out. Asset sales, or privatization, would generate government revenue without shrinking the economy, but I don’t know what is available to privatize. If they were a family, selling the family jewels would be in order.
Do we ever worry about inflation again?
Yes, but right now, based on recent and current policies, inflation is not a “clear and present danger.”
What will the Fed look for to actually tighten monetary flows/economic policy.
Right now the Fed’s dual mandate is skewed. Inflation is slightly above the official target, but isn’t likely to accelerate soon, while unemployment is far above the implicit target, whatever that is. The Fed will start easing off the accelerator when those to goals are more evenly achieved. Faster GDP growth and faster employment growth will set the stage for an eventual change in policy.
What key indicators have traditionally signaled a healthy, robust economy that is vital and independent of monetary injections or government subsidy?
I would vote for entrepreneurialism, which the government can’t do much to promote except stay out of the way. A related statistic would be rapid productivity growth, or more output per unit of input, or output per hour worked. Rising productivity is what gives us a higher standard of living, but in the very short run it competes with employment growth.
What do you think of Texas A&M’s move to the SEC?
Beats me. I asked the President of A&M by phone the other day (a good man, by the way) and he said it was a long story.