federal reserve

Lots of Fed news this week

Monday Jan. 25, 2010
Posted 11 a.m. EDT

The Federal Open Market Committee meets this week, with an announcement due Wednesday Jan. 27 at approximately 2:15 p.m. EST. While no rate change is in the cards, the Fed will still be in the news this week for a couple of reasons.

First, of course, is the aforementioned FOMC meeting and any adjustments to the accompanying statement. The focus is always on whether the phrase "for an extended period" will remain, an indication of how long the Fed expects to hold off on raising interest rates. So while I expect that phrase to remain, it's the phrase right before it "exceptionally low levels of the federal funds rate" that is most subject to tweaking. Specifically, I expect the Fed to remove "exceptionally" -- whether at this meeting or an upcoming meeting -- as an admission that even once they begin to raise interest rates, that rates will still be low. After all, when you're starting from near zero, you can raise rates quite a bit and only be in the 1.5 percent or 2 percent neighborhood, both of which still qualify as low. And it will be an extended period of time before the federal funds rate is no longer low.

The other matter putting the Fed in the news this week regards the reconfirmation of Ben Bernanke as Fed Chairman. The vote is shaping up to be tighter than expected but news reports say his confirmation is still expected. I’m not a political handicapper so that's not something I can address. However, let me say a few words about the consequences of a close vote or outright rejection of Bernanke.

I’ll begin by saying that in the next couple years we will need a Fed Chairman -- whether it is Bernanke or not -- that has the backbone to stand up to Congress when it comes time to raise interest rates. It's likely to happen with unemployment at 9 percent or 10 percent and amid widespread foreclosures, so you can expect a lot of ruckus and clever sound bites on the evening news from Congress when it happens. But a good Fed Chairman will do it anyway. I've stated repeatedly in this blog that I'm not sure Bernanke has the fortitude to do that.

But if he were rejected or only narrowly reconfirmed, there are both short- and long-term ramifications. Any appearance that the Federal Reserve is being politicized and losing its independence with regard to the conduct of monetary policy will hit the stock market hard in the short term, and hit both bond yields and inflation expectations hard in the long-term. Considering the tenuous nature of the economy, this is not a favorable scenario regardless of how you feel about the Federal Reserve or Chairman Bernanke.

If Bernanke were rejected here's my suggestion for a replacement -- even if it were only for a couple years: Paul Volcker. That's a guy who isn't afraid to make the tough and unpopular decisions, having raised interest rates dramatically in the early 1980s to squash inflation. Volcker was also the last Fed Chairman not to have his reconfirmation a rubber-stamped formality.

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