Apr 08/15 – A big mistake in the making

2015-04-08 9am EDT  |  #bonds #Fed #Kocherlakota #Yellen

Yesterday Minneapolis Fed President Narayana Kocherlakota gave a speech in Bismark, North Dakota. Most of you have probably never been to Bismark, and you most likely want to keep it that way. But having grown up in the Canadian province that borders North Dakota, I can claim the dubious distinction of having visited Bismark on more than one occasion. Kocherlakota’s speech did not warrant the big media outlets sending their business reporters to North Dakota, and all of the local reporters were busy reporting on the unusual band of heavy snowfall that passed through town and dumped another 14 inches of snow Monday night (although this doesn’t seem like that big of a news story for North Dakota to me). So unfortunately there were no reporters at the event. Most of the newspapers are using stock photos of Kocherlakota to accompany their story, but I have enlisted my prairie contacts to obtain an exclusive picture of the Fed President giving his speech yesterday…

We all knew that Minneapolis Fed President Narayana Kocherlakota was a dove. But most of us probably didn’t realize the full extent of his leanings. Or at least I didn’t. Yesterday’s speech lays out in clear black and white his radically dovish beliefs.

(Reuters) – Minneapolis Fed President Narayana Kocherlakota on Tuesday laid out a case for waiting until the second half of 2016 to start raising interest rates, and to then raise them gradually to just 2 percent by the end of 2017.

It was the first time the dovish policymaker detailed his preferred path for “late and slow” rate hikes. His remarks afterwards to reporters suggest he is increasingly worried that market expectations for nearer-term rate rises, fueled by comments from many of Kocherlakota’s Fed colleagues, could knock the wind out of the economic recovery.

“That conversation (about raising rates) in and of itself is a tightening of policy,” Kocherlakota said. “I do worry about the ongoing conversation about tightening monetary policy being a drag on economic performance both in terms of growth and in terms of employment outcomes.”

Not only does Kocherlakota not want rates being raised for another year and half, but he wants us to stop talking about the possibility of raising rates because he is worried that the simple act of discussing that policy is tightening monetary conditions.

The crux of his argument boils down to his belief the labour market is still far from recovered. He sees no inflation on the horizon and thinks that the Fed has an obligation to continue to help foster full employment. His conclusion sums up his thinking:

From 2006 to 2009, we saw a marked deterioration in labor market performance. As recently as a year ago, it seemed like this loss of human resources might prove to be permanent. But the rapid growth in employment that we saw in 2014 shattered this hypothesis. The lesson of 2014 is clear: We can do better. The FOMC is charged with promoting maximum employment. In the wake of 2014, I see no reason why the Committee should not aim to facilitate continued improvement in labor market conditions. Indeed, I see no reason why we should not aim for the kind of strong labor market conditions that prevailed at the end of 2006.

But we will only get there if we make the right choices. The FOMC can only achieve its congressionally mandated price and employment goals by being extraordinarily patient in reducing the level of monetary accommodation. Under my current outlook, I continue to believe that it would be a mistake to raise the target range for the fed funds rate in 2015.

Even the title of the speech – “We Can Do Better” betrays his unbelievable easy monetary policy beliefs.

Kocherlakota is under the illusion that the Federal Reserve can actually create economic growth. He believes that the Fed is responsible for ensuring full employment. I disagree completely. The Fed can only influence economic behaviour. Kocherlakota’s belief about the Central Bank’s ability to create economic growth is what got us into this mess in the first place. Instead of focusing on keeping an even playing field with a stable monetary policy, the Fed has fostered a series of bubbles in attempt to maximize economic growth.

The only reason I remotely agree with Kocherlakota is the fact that we are so mired in debt, the only way out of this mess will be to inflate it away. So I actually agree with him that we might as well go full hog and get the reset over with. But the key difference is that he believes the Fed can be the architect of prosperity. I believe just the opposite. The Federal Reserve should be like a referee. A good ref is almost invisible. He makes the right calls and ensures the game is fair. But the ref does not determine the outcome.

I am drifting off track. The key point I want to stress is that Kocherlakota’s speech shows how any idea that the Fed will somehow get ahead of the curve is a complete pipe dream. I know that Kocherlakota is not currently a voting member of the Federal Reserve, but don’t think that this sort of thinking is not also whirling around Janet’s head. In her heart of hearts, she believes the same things as Kocherlakota.

I have said it many too many times, but at the risk of being redundant, I will repeat it here again – we will look back at this time when we were worried about not being able to create inflation and laugh at our naivety. When we have the likes of Kocherlakota giving speeches about how even though rates have been at zero for seven years and the unemployment rate has gone from 10% to 5.60%, we should still wait for another year or two before raising rates from zero, you know there is a big mistake in the making.