Nouriel Roubini and Ian Bremmer come to us today with a WSJ op-ed all about what the Fed must do to stick the landing, or nail the exit strategy, or however you want to describe the process of undoing easy money.
It looks like a prescription for the Fed’s tricky situation, but the subtext is clear: Bernanke (and by extension us) is screwed.
The Fed does not control fiscal policy. But to avoid a game of chicken wherein loose fiscal policy forces the Fed to monetise deficits to prevent a spike in bond yields, the Fed needs to pre-emptively state it won’t be buying more Treasury bills.
Please. How on earth is the Fed credibly going to make that threat to spend-happy politicians? It can’t.
And then on increasing rates:
As for the exit from monetary easing, the Fed must learn from the fateful mistake it made after the 2001 recession. Then, the central bank cut the federal-funds rate too much and kept it too low for too long. It also moved far too slowly when the normalization occurred—in small increments of 0.25% from summer 2004 until the summer of 2006, when it peaked at 5.25%. Normalization took two full years. It was in that period of slow normalization that the housing, mortgage and credit bubbles spiraled out of control. The lesson learned: When you normalize, move rapidly, or prepare for another dangerous bubble.
Of course, this is easier said than done. From 2002 to 2006, the Fed moved slowly because the recovery appeared anemic and because of significant deflationary pressures. This time around, the recession is more severe—unemployment is at 9.8% and is expected to peak above 10%, and we are experiencing actual deflation. Therefore, the incentive not to exit too soon will be greater and the risk of creating another bubble is greater. Indeed, the sharp increase in the stock market and commodities, and narrowing of credit spreads since March, are partly due to a wall of global liquidity chasing assets and already causing asset inflation.
Again, fine on paper: In realy, it’s not going to happen.
And on solving too-big-to-fail
It won’t be easy to define systemic regulation and too-big-to-fail. There is a significant risk that doing so will provide an implicit guarantee for large and complex financial institutions. There is also a longer-term risk that actions taken by congressional and regulatory agencies will distort global financial markets. Western financial institutions now depend heavily on state financial backing, and several governments have tweaked rules and regulations to support the large financial institutions that are now at least partially taxpayer-owned. Further, governments could increasingly require domestic financial institutions to lend more at home, which will curtail their foreign operations. Creating a system of effective financial regulation—while resisting the impulse to favour domestic institutions—will be a real challenge for most countries, including the U.S.
So basically, there are a lot of things we must do in practice, but in reality, we really have no idea.